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What's Wrong With Silicon Valley's Growth Model

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What’s Wrong with Silicon
Valley’s Growth Model
Tim O’Reilly
Founder and CEO
O’Reilly Media
@timoreilly

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What's Wrong With Silicon Valley's Growth Model

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A talk I gave on the oreilly.com live training platform on January 22, 2020, focusing on the way that many Silicon Valley startups are designed to be financial instruments rather than real companies. They are gaming the financial system, much like the CDOs that fueled the 2009 financial crash. I talk about the rise of profitless IPOs, and contrast that with the huge profits of the last wave of Silicon Valley giants. In many ways, it is an extended meditation on Benjamin Graham's famous statement, "In the short term, the market is a voting machine, but in the long term it is a weighing machine."

A talk I gave on the oreilly.com live training platform on January 22, 2020, focusing on the way that many Silicon Valley startups are designed to be financial instruments rather than real companies. They are gaming the financial system, much like the CDOs that fueled the 2009 financial crash. I talk about the rise of profitless IPOs, and contrast that with the huge profits of the last wave of Silicon Valley giants. In many ways, it is an extended meditation on Benjamin Graham's famous statement, "In the short term, the market is a voting machine, but in the long term it is a weighing machine."

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What's Wrong With Silicon Valley's Growth Model

  1. 1 What’s Wrong with Silicon Valley’s Growth Model Tim O’Reilly Founder and CEO O’Reilly Media @timoreilly
  2. You’ve Probably Seen Headlines Like These
  3. You’ve Probably Seen This Headline Too
  4. What makes the difference? “In the short term, the market is a voting machine. In the long term, it’s a weighing machine.” -Benjamin Graham, The Intelligent Investor (1949)
  5. If you weren’t betting, which of these businesses would you rather own? Uber – Revenue $13B, lost $8.6B WeWork – Revenue $1.8B, lost $1.9 Billion Microsoft – Revenue $130B, profits $41B Apple - Revenue $259B, profits $55B Alphabet (Google) – Revenue $155B, profits $33B Amazon – Revenue $265B, profits $11B
  6. A Share of Stock is a Claim on Company Profits Uber – ??? No profits WeWork – ??? No profits Its price is a bet on what those profits will be. The Price/Earnings Ratio shows how many years of future profits are reflected in the price of a share Microsoft – 31.53 Apple – 26.82 Google – 31.77 Amazon – 82.63 S&P 500 – 23.77 S&P 500 in 1950 – 7.22 S&P 500 in 1929 – 17.17
  7. But what if you’d bought Apple shares at its IPO in 1980, Microsoft in 1986, Amazon in 1997, or Google in 2004? Or even better, Apple in 1997, when a share (split adjusted) cost about 60 cents vs $319 today? That’s where growth comes into play in the price. You’re betting on the future.
  8. How Long Should It Take To Reach Profitability? Apple – $250,000 Microsoft – $1 million Google – $36 million Amazon – $108 million* Uber – $24 billion, and still not even on a path to profitability WeWork - $22.5 billion, and still not even on a path to profitability Total Capital Raised pre-IPO
  9. In 2018, 83% of IPOs were for companies with no profits
  10. Betting might not seem so bad if you can cash out before the business gets weighed… Uber founder Travis Kalanick WeWork founder Adam Neumann $2.7 billion $1 billion
  11. Many of today’s Silicon Valley startups are not really companies. They are financial instruments created and sold by VCs, much as Wall Street bankers created and sold collateralized debt obligations (CDOs) leading up to the 2009 crash.
  12. The goal is an “exit”, not an operating business
  13. How to tell if an entrepreneur or VC is bluffing Me: How’s your company doing? Entrepreneur or VC: “We just raised our D round!”
  14. The Venture Capital equivalent of fake news
  15. The big company equivalent of fake news
  16. This isn’t “investing” – it’s extracting 85% of so-called investment no longer goes towards the creation of new capabilities, jobs, products, or services. It’s just money being traded for money, in the highest-stakes poker game in the world.
  17. “It wasn’t the way Steve Jobs would have done it…. Jobs focused relentlessly on creating irresistible life-changing products, and was confident the money would follow. By contrast, Cook pays close attention to the money and to increasingly sophisticated manipulations of money.” Rana Foroohar, Makers and Takers (2016)
  18. Are We In a Bubble? “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.” John Maynard Keynes, General Theory of Employment, Interest, and Money (1936)
  19. “The lightning-fast path to building massively valuable companies.” Derived from the blitzkrieg or “lightning war” strategy of Nazi general Heinz Guderian Aims to “achieve massive scale at incredible speed” in order to seize the ground before competitors do. “Prioritizes speed over efficiency” Risks “potentially disastrous defeat in order to maximize speed and surprise.”
  20. Go for growth even if you don’t know how you are going to make money “I remember telling my old college friend and Paypal co-founder/CEO Peter Thiel, ‘Peter, if you and I were standing on the roof of our office and throwing stacks of hundred-dollar bills off the edge as fast as our arms could go, we still wouldn’t be losing money as quickly as we are right now.’” 21 Reid Hoffman, co-founder Paypal, LinkedIn
  21. Somehow morphed into a winner-takes-all philosophy “As you all know, first prize is a Cadillac Eldorado. Anyone wanna see second prize? Second prize is a set of steak knives. Third prize is you’re fired. Get the picture?” -Alec Baldwin, in Glengarry Glen Ross, quoted by Reid Hoffman in Blitzscaling 22
  22. This reminded me of the ride sharing market Sunil Paul, the visionary who’d patented the use of GPS for ride hailing back in 2000, launched Sidecar with the peer-to-peer driver model in 2011. Uber and Lyft, which had already been funded by VCs with more traditional models, jumped on the new innovation, and took in massive amounts of capital to “blitzscale” the market. Sidecar went out of business. By coincidence, Sidecar had raised $35 million, about the same amount it took to launch Google. But Uber and Lyft raised billions. Customers didn’t pick the winner, the VCs did
  23. Ride-hailing, a transformative innovation, was stunted by the false incentives of too much capital and the race for a profitless IPO!
  24. “Create more value than you capture.” O’Reilly Media Providing technology learning for almost 40 years – books, events, online Trends pioneered – Commercial Internet, Open Source, ebooks, Web 2.0, Maker movement, big data 500+ employees, 5,000+ enterprise clients, 2.5m platform users globally Offices in US, Canada, UK, Japan, China Profitable, with hundreds of millions of dollars in revenue. Privately held, no venture capital, funded entirely by our customers.
  25. Some other companies that grew this way Github Mailchimp Basecamp Lynda.com Shutterstock Wordpress Atlassian Qualtrics But also, given how little capital they raised… Apple Microsoft Google even Amazon were also primarily funded by their customers
  26. Some companies from the OATV portfolio
  27. Indie.Vc WHAT IS INDIE.VC? Indie.vc is a 12 month program designed to fund and support founders on a path to profitability. We believe deeply that there are hundreds, even thousands, of businesses that could be thriving, at scale, if they focused on revenue growth over raising another round of funding. On average, the companies we've backed have increased revenues over 100% in the first 12 months of the program and around 300% after 24 months post- investment. We aim to be the last investment our founders NEED to take. We call this Permissionless Entrepreneurship.
  28. Built to be operating businesses
  29. Nice Healthcare – in Minneapolis
  30. Not your typical Silicon Valley founders
  31. Technological Revolutions & Financial Capital Published in 2002, Carlota Perez’s book placed the dotcom bust in the context of four previous fifty-year cycles: the industrial revolution, steel and railways, electricity and heavy engineering, and automobiles and mass production. All of these previous technological revolutions were accompanies by financial bubbles.
  32. Financial bubbles are a necessary stage “What is perhaps the crucial role of the financial bubble is to facilitate the unavoidable over- investment in the new infrastructures. The nature of these networks is such that they cannot provide enough service to be profitable unless they reach enough coverage for widespread usage. The bubble provides the necessary asset inflation for investors to expect capital gains, even if there are no profits or dividends yet.” Carlota Perez, Technological Revolutions and Financial Capital
  33. Each cycle was characterized by four distinct periods divided into two parts
  34. What if we are entering the maturity phase? “The practical implication … is that the dominant companies in mobile and the cloud — Apple, Google, Microsoft, and Amazon — may have a long stretch of dominance in front of them.” - Ben Thompson, Stratechery
  35. Financial Capital vs Production Capital “Financial capital represents the criteria and behavior of those agents who possess wealth in the form of money or other paper assets…They will perform those actions that, in their understanding, are most likely to increase that wealth.” By contrast, the term ‘production capital’ embodies the motives and behaviors of those agents who generate new wealth by producing goods or performing services (including transport, trade and other enabling activities)…Their purpose as production capital is to produce in order to be able to produce more. They are essentially builders.” Carlota Perez, Technological Revolutions and Financial Capital (2002)
  36. Favor productive investment, not financial speculation Look for companies with revenues, profits, and positive cash flow Making their money from customers, not from venture capital infusions, stock buybacks, or other gimmicks to juice their financial valuation without improving the economics of their actual business
  37. Tesla: Production capital at work $820 million raised pre-IPO, plus $10.4B in post-IPO debt, $8.7B in post- IPO equity. Profitable ($16B on revenue of $182B) but still raising money.
  38. At OATV, when we invest in things that require a lot of capital, it is production capital Planet: launching and operating hundreds of microsatellites to image the entire surface of the earth every day.
  39. Invest in the new beginnings, not the end The transition to a decarbonized economy Electrification Meat replacement and improved agriculture Demographic inversions Worker augmentation - including accelerated learning Healthcare Mass migrations and how to turn them into a net positive Big unknowns and hard problems
  40. Turn our greatest challenges into opportunity
  41. Q&A

Notes de l'éditeur

  • You’ve probably seen headlines like these. Uber CEO Dara Khosrowshahi Explains Uber’s epic stock crash this week. WeWork’s value plunged more than 80% to below $5 billion last quarter.
  • You’ve also probably seen this headline, in which Google followed Microsoft, Apple, and Amazon into the Trillion dollar valuation club.
  • What makes the difference? Benjamin Graham, the author of a 1949 book, The Intelligent Investor, wrote: “In the short term, the market is a voting machine. In the long term, it’s a weighing machine.” I actually prefer to call it a “betting machine.” What he meant is that in the short term, investors bet on the future, but the value of those bets gets settled up by time. An intelligent investor doesn’t just bet wildly on momentum or popularity, but by assessing the real prospects for business success. Warren Buffett became one of the world’s richest men by religiously following Graham’s advice.
  • How can you tell the difference between an Uber and an Amazon or Google? Ask yourself: if you weren’t betting but holding for the long term, which of these businesses would you rather own?

    Ten years from their founding, Amazon, Apple, Microsoft, Google were all amazing machines for making money. Uber ten years in, by contrast, had large revenues – $13 billion in 2019 – but it lost $8.6 billion in achieving those revenues. 9 years in, WeWork was doing even worse, with losses of $1.9. billion on revenue of only $1.8 billion. Many other so called “unicorns” – Silicon Valley companies valued at a billion dollars or more – are in similar shape, with more bloodletting to come.

    Despite Uber’s and WeWork’s failure to achieve any signs of building sustainable, self-supporting, profitable businesses, investors continued to pile in. Uber’s last private valuation before its IPO was $72 billion. Its management had massive bonuses tied to it reaching $120B public valuation. It is now hovering at around 60B. Meanwhile, WeWork had been valued by its private investors at $47 billion, but after a failed attempt to IPO at $20 billion, it was recapitalized with a value of only $5 billion. And even that may be high.

    Early investors in Uber still ended up billionaires; investors in WeWork were not so lucky, because, with the exception of founder Adam Neumann, most of them were still holding their shares when the phantom value collapsed.

  • So forgive me for a moment if I do a brief primer on value investing.

    A Share of Stock is a Claim on Company Profits. Its price is a bet on what those profits will be. The Price/Earnings Ratio shows how many years of future profits are reflected in the price of a share.

    As you can see, Uber and WeWork have no profits, hence no P/E ratio. You can’t divide by zero. But even the tech giants are pretty highly valued in today’s frothy market. How certain are you that Microsoft, Apple, and Google will be as profitable for the next 25-30 years? How confident are you about Amazon’s profits over the next 80 years???!!!

    This is partly the reflection of a frothy era. The S&P as a whole (which does include these and other tech giants) is valued at a rich 23.77 times current earnings. In 1950, a more sober time, companies were valued at a much more reasonable 7 years of earnings. In 1929, right before the Great Depression, P/E ratios stood at what was once considered a very frothy 17x earnings.

    Of course, P/E Ratio alone is a somewhat simplistic view of how to value a business. You also have to take into account growth rate, cash flow, cash on hand, and the value of assets. And there are even more sophisticated models that do an even better job, like the one New Constructs uses to filter out transitory earnings spikes and build a model of core earnings. (See https://www.newconstructs.com/ and https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3467814) I’m using P/E Ratio here because it is one of the original metrics, is widely reported, and is quite easy to understand.
  • But you might ask – might not profits grow in future? What if you’d bought Apple shares at its IPO in 1980, Microsoft in 1986, Amazon in 1997, or Google in 2004? Or even better, Apple in 1997, when a share (split adjusted) cost about 60 cents vs $319 today? That’s where growth comes into play in the price. You’re betting on the future. The future is unknowable, and sometimes, you can make bold bets that pay off. But it’s important to know what kind of bet it is – wild speculation, or a thoughtful forecast.
  • How long should it take to reach profitability?
    One way you can tell is by looking at how much capital it took for those four giants of an earlier era to reach profitability vs the current crop of unicorns. Apple raised only $250,000 before its IPO, Microsoft 1 million, Google $36 million, and Amazon $108 million. Meanwhile, Uber and WeWork raised tens of billions of dollars and 9 or 10 years in are still showing no path to profitability.

    You might have heard that Amazon lost $2.8 billion before becoming profitable, but Amazon financed most of these losses with borrowing, not stock. Why? Because they could. They had positive cash flow to pay the interest on the loans. They were, in effect, financed by the spread between their customers, who paid them immediately via credit cards, and their suppliers, who gave them 60, 90, or 120 days to pay.

  • According to University of Florida finance professor Jay Ritter, 76% of all IPOs in 2017 were for companies with no profits. By October 2018, the percentage was 83%, exceeding even the 81% seen right before the dotcom bust in 2000.
  • But betting might not seem so bad if you can cash out before the business gets weighed…

    Uber founder Travis Kalanick managed to cash out a fortune approaching $3 billion, and Adam Neumann, founder of WeWork, got away with nearly a billion dollars despite his company’s failure.

    Something is very wrong with this picture.

  • Many of today’s Silicon Valley startups are not really companies. They are financial instruments created and sold by VCs, much as Wall Street bankers created and sold collateralized debt obligations (CDOs) leading up to the 2009 crash. Just as in 2009, someone loses. It may be late stage private investors, acquiring companies, or public market investors. But someone ends up overpaying.
  • The goal for far too many VCs and entrepreneurs today is “an exit”, not an operating business. This is not how Silicon Valley got started. The founders of Fairchild, HP, and Intel, and much later Apple, Microsoft, and Dell used venture financing as the means to an end, and that end was building an enduring company.
  • For me, the “tell” that shows me an entrepreneur or VC isn’t focused on building an actual business is when I ask them how they are doing, and they tell me where they are in their fundraising, rather than where they are with revenues.

    This is part of the dirty secret of current Silicon Valley venture capital. It’s all about the fundraising. Getting other VCs to buy in at a higher price than you invested at. Stepping up the valuation.

    Image: https://en.wikipedia.org/wiki/File:Dan_Smith_live_poker.jpg Wikimedia Commons.
  • Sometimes companies do acquisitions or other announcements as a way of stepping up their valuation. For example, when Uber bought self-driving truck company Otto for a reported $680 million, this was a signal to the market that said something like this: “We may not be profitable on our current trajectory, but just wait till self-driving cars let us get rid of the cost of drivers.” Given what we now know about how far we are from self-driving cars, this investment, plus Uber’s massive investment in self-driving car research, can only be explained as an attempt to manipulate market perception of its future value. I rode in an Otto shortly after the acquisition, and I was astonished at the primitive level of the technology. All the truck could do was stay in one lane on a designated stretch of freeway. And to add insult to injury, it later came out that the amount reported as paid was hugely exaggerated, to underline the importance of the acquisition.

    https://www.vox.com/2016/8/18/12540068/uber-paid-680-million-for-self-driving-truck-company-otto-for-the-tech-not-the-trucks

  • Big companies – and not just Silicon Valley companies – are also working to manipulate perception rather than investing in their actual business. Share buybacks are all the rage. Last quarter, Apple spent $18 billion on share buybacks, up from $17 billion the quarter before. Because buybacks reduce the number of shares outstanding, they increase the earnings per share. And because most public market investors don’t dig deeply enough, this makes the company look more profitable, increasing or at least sustaining the stock price. Share buybacks, incidentally, are one reason that the P/E ratio of the S&P 500 is so high.

    Companies are no longer investing in growing their actual business; they are primarily focused on growing their share price, the currency in which their management is paid.
  • What does it mean to “invest” in Apple? The company had more cash on hand than any company in history when activist investor Carl Icahn took a big stake in 2013 and started pushing Apple to drive up its stock price with share buybacks. By the time he exited in 2015, he’d reaped a gain of $3.7 billion, and Apple had started down the path of manipulating its stock price rather than building its business.
  • Rana Foroohar, Makers and Takers, on Apple stock buybacks: “It wasn’t the way Steve Jobs would have done it…. Jobs focused relentlessly on creating irresistible life-changing products, and was confident the money would follow. By contrast, Cook pays close attention to the money and to increasingly sophisticated manipulations of money.”
  • This leads us to the question of whether we are in a bubble.

    Speculation is healthy. As we’ll discuss shortly, bets on the future are important for progress. But we need to understand when those bets are based on good information or wild collective enthusiasm, and too much capital chasing returns that seem out of reach from more pedestrian businesses.

    John Maynard Keynes, the economist whose theories helped pull the world out of the Great Depression, once wrote: “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.”
  • And that leads me to an article I wrote back in February of last year, ”The fundamental problem with Silicon Valley’s favorite growth strategy.” https://qz.com/1540608/the-problem-with-silicon-valleys-obsession-with-blitzscaling-growth/
  • My good friend. Reid Hoffman, the co-founder of Paypal and LinkedIn, had written a new book, and asked me to write a review of it, even if I disagreed. So I did.

    The term “massively valuable” in the subtitle was part of what set me off. “Massively valuable,” not “massively profitable”, not “massively impactful.” That distinction struck me as central to the rot that has come to Silicon Valley.

    Another thing was the title. The idea that “blitzscaling” was based on the “lightning war” strategy of the Nazis is right up there with Peter Thiel, Alex Karp, and Joe Lonsdale naming their big data analysis company Palantir after Tolkien’s seeing stones that corrupt their users.

    Reid offered up as the key to success in today’s Silicon Valley that entrepreneurs should aim to “achieve massive scale at incredible speed” in order to seize the ground before competitors do, “prioritize[] speed over efficiency,” and risk “potentially disastrous defeat in order to maximize speed and surprise.” Oh, and they should raise as much money as possible from venture capitalists in order to do these things. In short, it was the Uber and WeWork playbook.
  • Reid told the story of his own experiences at Paypal. He wrote: “I remember telling my old college friend and Paypal co-founder/CEO Peter Thiel, ‘Peter, if you and I were standing on the roof of our office and throwing stacks of hundred-dollar bills off the edge as fast as our arms could go, we still wouldn’t be losing money as quickly as we are right now.’”

    This has become the religion of Silicon Valley VCs and entrepreneurs: Go for growth even if you don’t know how you are going to make money.

    It’s a maxim among VCs: “Go big or go home.” There’s little room for the kind of stable businesses that actually make an economy robust. Anything that doesn’t look like a possible rocketship exit is starved of investment.

    There’s no question that there are times you need to do this, but it’s really gotten out of hand.
  • What bothered me the most was that Silicon Valley entrepreneurship, which was originally about disruptive innovation, had become a quest for monopoly. Early in the book, Reid had unironically and approvingly quoted Alec Baldwin’s ruthless sales manager in the movie Glengarry Glen Ross, saying to his team: “As you all know, first prize is a Cadillac Eldorado. Anyone wanna see second prize? Second prize is a set of steak knives. Third prize is you’re fired. Get the picture?”
  • This reminded me of the ride sharing market. Customers didn’t pick the winner, the VCs did. Sunil Paul, the visionary who’d patented the use of GPS for ride hailing back in 2000, launched Sidecar with the peer-to-peer driver model in 2011.

    Uber and Lyft, which had already been funded by VCs with more traditional models, jumped on the new innovation, and took in massive amounts of capital to “blitzscale” the market. Sidecar went out of business.

    By coincidence, Sidecar had raised $35 million, about the same amount it took to launch Google. But Uber and Lyft raised billions.

    Vast floods of cheap capital meant that the ride-hailing market never developed naturally. Ridership was subsidized, drivers turned into a commodity. How might this market have developed if it had grown more organically?

  • I took away the opposite lesson from the one Reid was preaching.

    Ride-hailing, a transformative innovation, was stunted by the false incentives of too much capital!

    Vast floods of cheap capital meant that the ride-hailing market never developed naturally. Ridership was subsidized, drivers turned into a commodity. How might this market have developed if it had grown more organically?
  • I was particularly sensitive to this topic because I started my own company nearly forty years ago with $500 dollars of used office furniture. We were funded from day one with customer revenue. Today we have hundreds of millions in revenue, and have been profitable for most of those forty years. (We had a few rough patches, such as the dotcom bust of 2001.) We’ve helped tens of millions of developers, and have been a catalyst for many a Silicon Valley company, not only through the information we provide but also through our advocacy of big technology trends. We pioneered the commercial internet by creating the first ad-supported web site in 1993, brought together the developers to tell the story of free and open source software, and helped reignite enthusiasm after the dotcom bust with our storytelling about Web 2.0 and what distinguished the companies that survived from those that had died. That was, incidentally, the story of big data and harnessing collective intelligence.

    One of our mottoes has been to create more value than we capture. And one of our strategies has been to play in markets where time is an ally rather than an enemy, understanding trends and investing for the long term. For example, we started work on ebooks in the late 1980s, and built an ebook platform – which has evolved into the learning platform we’re meeting on today - 7 years before the Kindle was launched.


    Providing learning for almost 40 years – books, events, online
    Trends pioneered – Commercial Internet, Open Source, ebooks, Web 2.0, Maker movement, Big data. Our motto is “create more value than you capture.”
    500+ employees
    5,000+ enterprise clients, 2.5m platform users globally
    Offices in US, Canada, UK, Japan, China
    17 global technology events serving 20k individuals and 1,000 sponsor companies


    I’m going to talk about one of the big trends I see in learning today, with a bit of a focus on the problems we solve in our business.
  • We’re not alone. If you look a bit more deeply, there are many well known companies that also grew without venture capital: Github
    Lynda.com
    Shutterstock
    Wordpress
    Atlassian
    Qualtrics

    But also, given how little capital they raised…

    Apple
    Microsoft
    Google
    even Amazon

    were also primarily funded by their customers
  • In addition to my work with O’Reilly Media, I am a partner at early stage venture firm O’Reilly AlphaTech Ventures. We pioneered institutional seed investing in 2005, but in 2015 we launched a new initiative called indie.vc, focused on finding more “real businesses” like O’Reilly Media, businesses that don’t fit the winner-takes-all model of today’s Silicon Valley VCs, but instead serve real needs, and take less capital because they quickly build revenue and profit.
  • If you look at some of the Indie.vc investments, like Storq, a maternity fashion design company, or Simply Eloped, a wedding planning service, you might think that they are among the many doomed-to-fail VC investments that won’t turn into the necessary rocket ships. But you’d be missing the point. They are designed to be operating businesses. They don’t have to reach hyper-scale to be successful. They are aiming for profits, positive cash flow, and steady, sustainable growth. They are businesses that the founders want to engage in, not exit.
  • These companies are not your typical Silicon Valley for another reason. Many of our investments are not in “the usual suspects.” The founders of Simply Eloped are from Boise Idaho, and Nice Healthcare is based in Minneapolis. And it turns out that ome of these companies are growing fast enough to be the envy of any Silicon Valley VC, but with minimal funding, because they are already profitable.
  • Indie.vc’s search for profit-seeking rather than exit-seeking companies has also led to a far more diverse venture portfolio, with more than half of the companies led by women and 20% by people of color. (This is in stark contrast to traditional venture capital, where 98% of venture dollars go to men.) Many are from outside the Bay Area or other traditional venture hotbeds.The 2019 Indie.vc tour, in which Roberts looks for startups to join the program, hosts stops in Kansas City, Boise, Detroit, Denver, and Salt Lake City, as well as the obligatory San Francisco, Seattle, New York, and Boston.
  • I want to return to the question of bubbles. In 2002, economist Carlota Perez publishing an influential book called Technological Revolutions & Financial Capital. She placed the dotcom bust in the context of four previous fifty-year cycles: the industrial revolution, steel and railways, electricity and heavy engineering, and automobiles and mass production. All of these previous technological revolutions were accompanies by financial bubbles.
  • Bubbles in financial capital build new capacity that would not otherwise receive investment
    When the bubble bursts, that capacity is available for a next stage of productive investment.
    This is how the dotcom bust set the stage for Google, Amazon, the smartphone, and the big data revolution.

    As Carlota Perez put it, “What is perhaps the crucial role of the financial bubble is to facilitate the unavoidable over-investment in the new infrastructures. The nature of these networks is such that they cannot provide enough service to be profitable unless they reach enough coverage for widespread usage. The bubble provides the necessary asset inflation for investors to expect capital gains, even if there are no profits or dividends yet.”
  • She looked at these previous revolutions and noted that they had four distinct periods, what she called “irruption” – the introduction of game-changing new technology - followed by a financial bubble. At some point, though, the market consolidates, and we enter what she calls the “golden age” of synergy, with positive externalities, higher employment, and societal benefits. Then, inevitably, the industry matures and stagnates, but by then, fortunately, a new disruptive technology is on its way in.
  • I want to give a shoutout to Ben Thompson and his wonderful Stratechery newsletter on technology, business, and investing. I’d read Carlota’s book many years ago, and it has shaped my thinking for decades, but he brought it back to mind in a recent series of issues of his newsletter. (I highly recommend subscribing.) Ben asked he question: what if we are entering the maturity phase.

    “The practical implication” he wrote “ … is that the dominant companies in mobile and the cloud — Apple, Google, Microsoft, and Amazon — may have a long stretch of dominance in front of them.”

    And the further implication is that the financial bubble, where investors can make money from profitless companies, is coming to an end.

    Subscribe: stratechery.com
  • In her book, Carlota Perez makes a distinction that is very relevant to the discussion we are having today. She talks about the difference between what she calls financial capital and Production capital. She wrote:

    “Financial capital represents the criteria and behavior of those agents who possess wealth in the form of money or other paper assets…They will perform those actions that, in their understanding, are most likely to increase that wealth.”

    By contrast, the term ‘production capital’ embodies the motives and behaviors of those agents who generate new wealth by producing goods or performing services (including transport, trade and other enabling activities)…Their purpose as production capital is to produce in order to be able to produce more. They are essentially builders.”
  • So what do you do in the mature phase? Favor productive investment, not financial speculation

    Warren Buffett has long shown us the value of avoiding financial speculation and instead investing in real cash flow and profits, but if Carlota Perez is right, this strategy is about to come back into favor, big time.

    Look for companies with revenues, profits, and positive cash flow
    Making their money from customers, not from venture capital infusions, stock buybacks, or other gimmicks to juice their financial valuation without improving the economics of their actual business

  • Tesla is a great example of production capital at work. Tesla raised a lot of money pre-IPO, but has raised even more since, even though the company is profitable. Capital is being used to grow the productive capacity of the business, not for financial speculation.

    $820 million raised pre-IPO, plus $10.4B in post-IPO debt, $8.7B in post-IPO equity. Profitable ($16B on revenue of $182B) but still raising money.

    BTW, the fact that Amazon is still investing in growing its business while Apple and even Google are playing games with stock buybacks is a good reason to think that Amazon’s best days are still ahead of it.
  • At OATV, when we invest in things that require a lot of capital, it is production capital

    Planet is a great example of a company deploying production capital. They need lots of it not because they are pursuing blind market share, buying users and growth, but because they are making real stuff. I remember a few years back when a launch vehicle blew up and we lost several million dollars worth of satellites.
  • Many of the consumer driven innovations of the last decade are played out. Keep an eye on long term trends and look for the breakthroughs that represent the next phase of disruptive innovation. Here are some of the areas we’re tracking at O’Reilly.

    The transition to a decarbonized economy
    Electrification
    Meat replacement and improved agriculture
    Demographic inversions
    Worker augmentation - including accelerated learning
    Healthcare
    Mass migrations and how to turn them into a net positive
    Big unknowns and hard problems
  • We need to turn our greatest challenges into opportunities.

    The Green New Deal and the commitment to decarbonization is a great example of what Silicon Valley *should* be focusing on. Climate change is a huge threat – and a huge opportunity. For a tutorial on that opportunity, I can’t do better than point you to a series of articles by my son-in-law, scientist, inventor, and entrepreneur Saul Griffith.

    https://medium.com/otherlab-news/decarbonization-and-gnd-b8ddd569de16
  • Thank you very much.

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