Attackers & Defenders

A few years ago I had the pleasure of meeting Steve Case -- the original founder of AOL and current CEO of Revolution. He was considering an investment in our company and I was lucky enough to be able to pitch him our business. In the short time that I spent with him I could tell that we were dealing with an extremely savvy investor. He got right to the key issues surrounding our growth and his questions were extremely challenging and relevant.

I came across an interview that he did recently with Adam Bryant from the New York Times. In talking about different types of businesses, he said this:

...I realized the world of business really separates into these two groups. The attackers are the entrepreneurs who are disrupting the status quo, trying to change the world, take the hill, anything is possible, and have nothing to lose in most cases. They’re driven by passion and the idea and intensity. Large organizations — and it’s true of Fortune 500s and it’s also true of governments and other large organizations — are defenders. These guys aren’t trying to pursue the art of the possible, how to maximize opportunity. They actually are trying to minimize the downside, and hedge risk. They’re trying to de-risk situations. Entrepreneurs can’t even think this way. It’s not even a concept they understand.

For the traditional executives running these large companies, of course they want to grow, of course they want to innovate, of course they’d rather have revenue grow faster than slower, but they mostly don’t want to lose what they’ve got. But entrepreneurs are deathly afraid that they won’t be able to change the world, and that somebody else will. Again, these generalizations are a little unfair, but corporate executives are all too often deathly afraid that the business they inherit will be less valuable when they leave than when they started.

This is so true and exactly why no company will last forever. Even the best eventually flame out. The cycle of disrupt >> succeed >> defend is unavoidable and, frankly, perfectly logical. When companies reach a certain level of success, innovation becomes too risky and the smarter, rational move is to protect your turf.

This is why companies like Apple are so impressive and so rare. They somehow continue to attack and innovate despite their immense success.

5 Reasons You Should Read Blogs Written By VCs (even if you're not a VC or a founder)

The other day I was looking through my blog feed (I use the Reeder iOS app) and it occurred to me that I follow just under a dozen blogs written by venture capitalists. My three favorites are Fred Wilson, Chris Dixon and Bijan Sabet.

I started thinking about why I read so many of these blogs. I'm not a VC, and I don't really want to be. Are they really worth the time?

Here's why I think they are absolutely worth the time. Any why you should read them too.

1. Because of the risk profile of VCs they are always ahead of the game. VCs focus on ideas and technologies that, for the most part, are ahead of their time. They make investments in ideas that are highly risky that haven't yet gone mainstream but eventually will. Whether you're just investing for yourself, thinking about staying ahead in your career or just a curious person, it's important to be aware of what's coming next. In addition, most of them are investing in consumer products. An extra perk is that VC blogs will help you stay aware of consumer software and services that you might want to use yourself.

2. They attract communities of smart, motivated people. Every day I read blogs on sports, career, fitness, healthcare, technology and marketing and it seems that the VC blogs get way, way more comments from readers than the others. In addition, the quality of conversation happening in the comments sections of VC blogs is extremely high. Often when I read a VC blog I'll only scan the post but I'll scroll down and read the most popular comments in detail (there's great stuff in there). The people hanging out on these blogs are people you want to hang out with (at least virtually). In addition, I'm sure there are some out there, but I haven't yet seen a VC blogger that doesn't interact with their readers.

3. They'll make you a better blogger (and thinker). One of the neat things about VC bloggers is that they don't have all the answers -- and they know they don't have all the answers. In their posts, you'll find that they're really just putting out ideas, and thinking out loud (if they had all the answers, their investments wouldn't be so risky). As a result, they'll help you generate some great ideas on things to write about and think about. See an example here.

4. They write about things that you should know about. I remember back in college the career counselors would tell us, "before you go into an interview, make sure you know what's being written about on the front page of the Wall Street Journal." Those days are over. These days, if you're interviewing in tech, you better know what VC bloggers are writing about.

5. They'll give you better context. One of the challenges in working at a startup (or any company, really) is that you don't always get to see the context of leadership. I always try to remind people to keep in mind that everyone has a boss (the exec team reports to the CEO and the CEO reports to the board). CEOs don't make decisions to make your life miserable, they make decisions to help make the company better -- or, more practically, to make their boss (the board) happy. I've found that by reading what's going on in the mind of VCs (who very often hold board seats) I get to see a bit of what a founder or CEO is facing. And that gives me a better understanding of what their context might be when making decisions that impact my team. In any company or any situation, context is crucial.

I highly recommend the three blogs I mentioned above. In addition, Forbes did a pretty good article a while back on the Top 10 Best Venture Capital Blogs. I recommend checking out some of those as well.

My Investment Approach

Lately I've been investing in individual stocks a bit more than usual. I'm pretty picky about the stocks that I buy. I was talking to a friend the other night about how I pick them and thought I'd post my approach here. When buying an individual stock, I only invest in two types of companies:

1. Companies that make products or services that I use and that I love. This includes stocks like Amazon, Tumi and FedEx.
2. Companies that are in the industry that I work in, that I know a lot about and that I believe in. Currently, this would be a company like Athena Health.

The only way to gain an advantage in the stock market is to bet against conventional thinking -- and be right. By investing in companies that I personally know and love or know and understand significantly more than the average investor, I'm at least putting myself in a position to gain an advantage.

Disclaimer: while I would certainly advocate that others use my approach to investing, I of course wouldn't advocate that anyone invest too much of their worth in individual stocks (it's too risky, regardless of your approach). Best to put most of your wealth in less risky, diversified investments with a modest but reliable return.

The Big 4 Internet Companies (Continued)

A year ago this month someone asked me this question: if I had to invest in one of the big four internet companies -- Amazon, Apple, Facebook and Google -- which one would it be? Without hesitating, I chose Amazon. I wrote a post about my reasoning at the time.

One year later, I thought I'd check in to see if I made the right choice. Here's how each of the stocks performed in 2012:

• Facebook - down 17% (since their IPO in March)
• Apple - down 1%
• Google - up 33%
• Amazon - up 47%

So it turns out I made the right call. Too bad I didn't put my money where was my mouth was.

That said, it's not a completely missed opportunity. I definitely think there's still a lot of money to be made on Amazon. I'm probably even more bullish on them now then I was 12 months ago.

Taxes

The two most significant taxes that Americans pay each year are a tax on their income and a tax on their investment. The income tax is a tax on people's labor. Firefighters get paid for fighting fires. Teachers get paid for teaching our kids. And CEOs get paid for driving their company's strategy. Depending on how much they get paid, they pay a portion of that pay to the government. The tax brackets break down like this for a family:

• 10% on taxable income from $0 to $12,400, plus
• 15% on taxable income over $12,400 to $47,350, plus
• 25% on taxable income over $47,350 to $122,300, plus
• 28% on taxable income over $122,300 to $198,050, plus
• 33% on taxable income over $198,050 to $388,350, plus
• 35% on taxable income over $388,350

So a father that is raising his kids and working as a firefighter putting out fires and adding direct value to society through his work making $150,000 is paying 28% of the value of his labor to the government.

The investment tax -- capital gains and dividend taxes -- taxes something different. That taxes a bet.

When someone invests in Facebook and the value of the stock increases, or the company pays out some of their profit in the form of a dividend at the end of the year, the profit that the investor made is taxed. This is passive income -- the investor is just sitting there watching the money come in. He's not necessarily adding incremental value to society on top of his investment (in most cases).

There's nothing wrong with this -- investment is critical to a prosperous economy -- and the investor should make as much as he possibly can on his investments. But because he's adding less direct value to society, if we're going to tax him, we should tax him at a higher rate than we tax direct, value-creating labor. Simple, right? Right.

But we don't do that. Here are the current rates:

• 20% on capital gains
• 15% on dividends

So the investor that makes $150,000 per year in capital gains pays 8% less than the firefighter does for his labor.

And this is why our tax code is backwards. This is why Warren Buffet's assistant pays a lower tax rate than he does. This is why, in 2009, the Americans with the top 400 incomes (who made, on average, $202 million per year) paid a lower tax rate than you did. One quarter of them paid less than 15%, and more than half of them paid less than 20%.

We have to fix this. I'm not going argue what the tax rates should be (at least not today).  But I am arguing that we have to flip the structure so that tax rates on labor are lower than the tax rates on investment. It's just backwards.

In his controversial New York Times article, Buffet suggested the following solution:

I would suggest 30 percent of taxable income between $1 million and $10 million, and 35 percent on amounts above that. A plain and simple rule like that will block the efforts of lobbyists, lawyers and contribution-hungry legislators to keep the ultrarich paying rates well below those incurred by people with income just a tiny fraction of ours. Only a minimum tax on very high incomes will prevent the stated tax rate from being eviscerated by these warriors for the wealthy.

Of course this won't fix the entire fiscal mess and I think we need to go a step further and flip the tax structure so investors pay a higher rate than workers regardless of their income. But Buffet's plan is a step in the right direction of creating a fairer tax code that incentivizes the activity that leads to greater prosperity for the country as a whole.

Margin Call

Over the holidays I watched the movie Margin Call (for the second time).

The movie is a fictional depiction of an investment bank crumbling during the 2008 financial crisis (it was likely inspired by the real life Bear Stearns or Lehman Brothers). The story revolves around a brilliant, young analyst in the company's risk management group. One night he discovers that the company has over-leveraged itself through an over-investment in synthetic CDOs and MBSs. Throughout the night and into the early morning the analyst's discovery makes its way to the highest levels of the company. The movie is a depiction of how the company handles the crisis.

Margin Call is a phenomenal movie. It's brilliantly acted by some excellent actors (Kevin Spacey, Jeremy Irons, Stanley Tucci, Zachary Quinto, Simon Baker and Demi Moore to name a few). And the suspense around watching management learn what has happened and how they handle it elegantly depicts what were probably real events inside many investment banks at the time. The more senior you were, the less likely you were to understand the financial mechanics behind the crisis.

In what is probably the best scene of the movie, the young analyst (played by Zachary Quinto) is asked to explain what he has discovered to the CEO of the company (played powerfully by Jeremy Irons). Irons' character says to him:

Maybe you could tell me what is going on. And please, speak as you might to a young child. Or a golden retriever. It wasn't brains that brought me here; I assure you that.

That line just about sums up much of the cause of the financial crisis of the late 2000s. The people on the ground were packaging and selling a product that management at our largest and most reputable financial institutions did not -- and could not -- understand.

If you haven't seen it yet, I highly recommend renting Margin Call.

Results From My Super Bowl Commercial Experiment

5 years ago when I started this blog, I had a theory. The theory was that participating in big, broadcast marketing was a bad strategy. And that companies that continued to participate in it would likely see their stock prices fall over time. To test this theory, I selected a group of 6 companies that ran television commercials during that year's Super Bowl and noted their stock prices with the intention of measuring their performance against the S&P 500 index. The 6 companies were Pepsi Co., E-Trade, Anheuser Busch, Coca Cola, Bridgestone and FedEx.

Anheuser Busch was of course acquired by InBev back in 2008 so 5 years later that leaves me with 5 companies to test my theory. Here are the results:

• The S&P 500 outperformed the mean of the Super Bowl stocks by just over 13%.
• The S&P 500 dropped 2.2% during this period and the 5 Super Bowl stocks dropped 15.3%.
• The S&P 500 outperformed 3 of the 5 Super Bowl stocks.
• Only one stock price increased during the period (Coca Cola by 22%)
• E-Trade's stock price ell by 83%.

Given the small sample size, I'm not sure the data is all that conclusive. But it certainly doesn't conflict with my theory. So I'll stand by it for now...

Groupon, Chest Pain And Consumer Behavior

It was unfortunate – but not very surprising – to see the news this week that Groupon laid off a portion of their 10,000 employees. If ever there was a predictable bubble, it was daily deals. But it was fun while it lasted, and you can see why there was so much overinvestment in the space. Groupon’s pitch to merchants was to ask them to take a loss by making a super compelling offer that consumers couldn't resist. The offer would generate tons of new customers that would come back and make profitable purchases for years to come.  On the surface, it seemed pretty compelling.

With the Groupon news in mind, I spent some time this week thinking about the problem of hospital readmission penalties in the healthcare industry.  For those that don’t know, the government is trying to improve accountability and the quality of patient care by imposing financial penalties on hospitals that have high rates of 30 day hospital readmissions.  Depending on the rate of readmission, the government will reduce Medicare payments by as much as 1%.  For an industry with very thin margins, this is a pretty big deal.

One of the major challenges with hospital readmission penalties is that now doctors have to not only care for the patient effectively during the initial encounter, they’re now responsible for changing the patient’s behavior after they leave the hospital.

Here’s an example: imagine an older man that doesn’t take care of himself.  He smokes, eats fatty foods, lives a sedentary lifestyle and hasn’t visited a doctor in years. One day, a pain in his chest becomes so severe that he is forced to check himself into the emergency room.  After spending a couple nights in the hospital getting treatment, he starts to feel better. When he’s finally discharged, the doctor recommends that he stops smoking, follows a cardiac diet, takes a prescribed medication, and visits a cardiologist for a checkup every week for the next 6 weeks.

But this is a person that is not used to doing any of those things. The problem that caused him to appear in the hospital – severe chest pain – is not an immediate problem for him anymore.  He feels fine.  So the hospital is being asked to significantly change the behavior of someone without the initial (and powerful) motivator in place. As a result, he’s very likely not going to follow the doctor’s orders and he’s very likely going to reappear at the emergency room.

It occurred to me that this is the fundamental problem with the daily deal industry.  Groupon has the same challenge that hospitals have.  Just like severe chest pain, their deals change behavior. Most of the people that buy half-off skydiving, or cooking classes, or services at the super expensive nail salon, weren’t planning to do those things until they saw the deal sitting in their email inbox.  But because the deals are so compelling (50%+ off) they bought them anyway and, as a result, Groupon was able to flood their merchant clients with lots of new business.

But it’s because the initial deal is so compelling that it becomes nearly impossible for Groupon to reliably deliver on their ultimate promise of bringing their merchants new, loyal and profitable customers.  Just like severe chest pain, the daily deal changes behavior.  It forces people to do something that they wouldn’t normally do.  But without a continuous and powerful motivator in place (like chest pain or 50% off) the doctor can’t get the patient to come in for an electrocardiogram and the nail salon can’t get the customer to come back for a second manicure.

Employment Sectors

Albert Wenger had a good post the other day noting some of the changes in employment in the U.S. over the last couple hundred years.  He uses the chart below to illustrate the massive losses in agriculture and manufacturing jobs. Some might argue that this chart indicates that our economy has weakened as a result of these losses. But Albert also notes that while these sectors have seen massive decreases in employment, overall employment as a percentage of the population has actually increased during this time (from 32% to about 45%).  There is no doubt that this kind of change causes of lots of pain in the short term, but it's also clear that the creation of new companies and entire industries is critical to the long term health of the economy.

User Driven Valuations

I wrote about Facebook's IPO back in May pointing out how unbelievable it was to me that a company that started back in 2003 and really doesn't make anything of substance or have a very compelling revenue model could go public at a $100 billion dollar valuation. I ended the post by saying, "the world has changed".

Well, maybe not. A lot has changed for Facebook since then (see stock price chart above).

Their market cap is now below $40 billion and the consensus seems to be that their stock price is going to continue to fall. That said, their shares are still trading at around 32 times earnings -- so there's still a decent amount of hype around this IPO.

One of the primary reasons for all of the hype is that Facebook is so widely known and widely used. They have hundreds of millions of users; many of them use the product several times a day, every day. And the vast majority of these users know absolutely nothing about investing.  But because they use the product and know the product, they were compelled to buy some shares. As a result, the company was hugely overvalued following its IPO.

Contrast this with Globus Medical, a medical device company that went public on Friday with virtually no hype. It’s unlikely we’ll see this stock nosedive like Facebook. They have a fraction of the customers that Facebook has – they make medical devices used in spinal surgery – so there are far fewer people interested in owning a piece of the company. There’s far less hype.

There have been literally thousands of consumer web services started and funded over the last couple of years. Many of these companies have millions of users and no revenue or compelling revenue model. As a result, I’d expect to see more and more companies go public in the near future with inflated valuations that are propped up by their user base.

The Facebook IPO underscores a good lesson for amateur investors: just because you use a product every day doesn’t mean it should be a part of your portfolio.

SecondMarket & the Tech Bubble

There was a fantastic column the other day on Reuters written by Felix Simon titled, Facebook’s SecondMarket Puppets. The column points out how investors that put their money in Facebook using SecondMarket while Facebook was private have actually lost money since the company went public. This is interesting – and scary – for companies with upcoming IPOs that are allowing their illiquid shares to be traded on a secondary exchange. In theory, the value of SecondMarket was that you could get in on a hot company pre-IPO and make big bucks if/when they went public. But it seems that this isn’t a guarantee. Simon’s key insight is this: 

…it’s increasingly looking as though shares in private tech-companies are a bit like fine art prices: a place for the rich to spend money and feel great about owning something very few other people can have. The minute they become public and democratic, they lose a lot of their cachet.  And a lot of their value.

The level of hype propping up the valuations of some of the hot private and public internet companies is enough to keep me far away from these securities...and SecondMarket.

Mary Meeker's State of the Internet

Nobody is better than Mary Meeker -- now a partner at Kleiner Perkins -- at summarizing the state of the internet. Last week she presented her Internet Trends 2012 presentation at the All Things Digital Conference. This presentation is fantastic, I recommend flipping through it when you get a chance. The most compelling part to me is her summary of how technology has forced almost all industries -- from photography to healthcare -- to reimagine their products and they way the deliver value. That section begins on page 33 and ends on page 84.

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