A Dozen Things I’ve Learned from Chamath Palihapitiya About Investing and Business

Chamath Palihapitiya is the founder of the venture capital firm Social Capital. Chamath lived in Sri Lanka until he was 6 when his family moved to Canada. He is a graduate of the University of Waterloo, where he achieved First Class Honors in Electrical Engineering. Chamath was an early member of the Facebook senior management team. He was Facebook’s VP of Growth, Mobile & International. Prior to joining Facebook in 2007 Chamath held senior positions at AOL (Vice President and GM of AIM and ICQ), Mayfield Fund (a venture capital firm in Silicon Valley), Winamp and Spinner.com. He is also an owner of the Golden State Warriors. The mission of Social Capital “is to transform society by using technology to solve the world’s hardest problems.” The venture capital firm’s portfolio includes or has included ownership in businesses like Yammer, SecondMarket, Slack, and Box. Chamath has said: “We’re going to build an organization that looks different than a venture firm. That organization is going to be this hybrid, bastard-stepchild of Berkshire Hathaway and Blackstone and Blackrock. We want to have a large permanent capital base and we want to basically take really long discontinuous bets on companies and sectors and trends.” What I find most interesting about Chamath is the originality of his thinking. Writing this post was harder than usual. No draft has ever changed so much between my first draft and my final post. I re-read and re-listened to a number of the interviews and each time I went back to my draft and made what I had previously written simpler.

The Dozen Things said by Chamath that I selected for this post are:

“Most people when they think about growth they think it’s this convoluted thing where you’re trying to generate these extra normal behaviors in people. That’s not what it’s about. What it’s about is a very simple elegant understanding of product value and consumer behavior.” “Winamp [taught me] about core product value. What it means is: create a real connection with someone. I think now we all euphemistically call it the ‘A-ha’ moment with the consumer. But also the power of how these communication networks when they develop create real entrenched usage and scale, and how these things can just dramatically accelerate adoption and engagement.” After all the testing, all the iterating, all of this stuff, you know what the single biggest thing we realized [at Facebook]? Get any individual to seven friends in 10 days. That was it. You want a keystone? That was our keystone. There’s not much more complexity than that.” “It’s not just top-line growth. It’s acquisition, engagement, ongoing product value. It’s understanding the core value and convincing people that may not want to use it.” “What we did at that company was we talked about nothing else. Every Q&A, every all hands nothing was spoken about other than this. Monetization didn’t really come up. Platform came up but again in a secondary or tertiary context. But it was the single sole focus. But because we had defined it in this very elegant way that expressed it as a function of product value it was something that everyone could intrinsically wrap their arms around.” “Knowing true product value allows you to design the experiments necessary so that you can really isolate cause and effect. As an example, at Facebook, one thing we were able to determine early on was a key link between the number of friends you had in a given time and likelihood to churn. Knowing this allowed us to do a lot to get new users to their ‘A-ha’ moment quickly. Obviously, however, this required us to know what the ‘A-ha’ moment was with a fair amount of certainty in the first place.” I stitched this set of quotes together from several sources identified in the Notes below. There are a number of excellent interviews with Chamath on YouTube that I enjoyed watching. I always learn a lot doing the research for these posts but in this case I learned more than usual since he is such an original thinker. In the interviews he repeatedly says that there is no substitute for delivering “core product value” to the customer, which he says is far harder and rarer than most people imagine. He is adamant in his view that metrics measuring factors that do not relate to core product value like the number of invitations sent to friends can be not only distracting but harmful. For Facebook, Chamath says that the keystone was: “get any individual to seven friends in 10 days.” Once that keystone was achieved Facebook customers were receiving enough core product value that they were unlikely to churn and more likely to recommend the service to others because they reached the A-ha moment. If a business does not know what the A-ha moment is for its product in the first place, they are highly unlikely to succeed. Getting distracted by theories about monetization, virality or other factors can be an impediment to creating the scalable connections with customers that create operating leverage. This slide from a presentation by Chamath makes the point about core product value:

“[At Facebook, to generate growth] we actually just looked at a lot of data, we measured a lot of stuff, we tested a lot of stuff, and we tried a lot of stuff. Now that masks over a lot of more nuanced understanding but at an extremely high level that’s really what we did. What’s shocking to me is when I see a lot of products out there it’s unbelievable to me that people are trying to shroud products in this veneer of complexity. … Measure some shit. Try some shit. Test some more shit. Throw the stuff that doesn’t work. It’s not that complicated.” Chamath is saying that a business must measure the right things if the process is going to be useful. What a business measures as a keystone must capture its core product value. For example, measuring daily active users (DAU) is not the right keystone since it doe snot capture core product value. Justin Kan sent a tweet recently that said: “Startups mostly don’t compete against each other, they compete against no one giving a shit.” If a business does not deliver core product value no one will care and notifications or invites will be viewed as spam.

“Most people and most companies can barely get one thing right. We all kid ourselves about doing so many different things but there is a value to focus, which is, it constrains optionality and it forces you to have clarity of thinking. Because otherwise what happens is you have all these outcroppings of people within a company that can have their own anecdotal point of view about any kind of random thing. If they practice that rhetoric enough they sound like they know what they’re talking about. Then what happens is you invariably try a bunch of different things and then you end up nowhere. But if you constrain the problem to say there’s one thing. It forces everyone to be an expert or know that one thing, then speak intelligently and most importantly factually about that one thing.” Anyone who has worked at an actual business knows there are always challenges inside EVERY company. Nothing is ever prefect. Maintaining focus is essential. Clarity of thinking and action is powerful when done right. I have written a blog post on Jim Barksdale who likes to say: “The main thing is to keep the main thing, the main thing.” Every business has a profit engine that lies at its core. And that engine is invariably simple if you strip away everything extraneous. Two former Barksdale colleagues write about this about the main thing principle: “We loved that expression when we first heard it from Jim Barksdale, then the COO of FedEx. That single sentence captures the greatest challenge that executives and managers face today: keeping their people and their organizations centered on what matters most. Every organization needs a Main Thing—a single, powerful expression of what it hopes to accomplish. Without it, it’s not possible to align the four elements that produce organizational efficiency and effectiveness: strategy, people, customers, and processes.”

“Users are only ever in three states — they’ve never heard about it; they’ve tried it; and they use it. What you’re managing is state change. So the framework is, what causes these changes? The answer should be rooted more in preference, choice and psychology than in some quantitative thing.” What I want to hear about is the three most difficult and hard problems that any consumer product has to deal with. How to get people on the front door? How to get them to an ‘A-ha’ moment as quickly as possible? And then how do you deliver core product value as often as possible? After all of that is said and done only then can you propose to me how you are going to get people to get more people. That single decision about not even allowing the conversation to revolve around this last thing in my opinion was the most important thing that we did.” “I hate the term ‘growth hacker’. There are a lot of snake-oil salesmen in this field. Let’s not create some wizard-behind-the-curtains thing about this concept called growth hacking. It existed well before me. It’s called product and marketing.” “Most companies in e-commerce right now are negative-gross-margin businesses. Amazon has such enormous scale, and they’re at about 13 or 14 percent gross margins, but on a huge number. In order to compete with Amazon, these businesses have to sell goods for less than what they cost. These companies are in the delivery businesses (Postmates, DoorDash, Instacart) and in the food business (SpoonRocket, Munchery). Basically, a lot of these new-generation, remote-control-type businesses—where the phone acts like a remote control to replace an offline experience—are generally, to date, highly, highly, highly unprofitable. There’s a lot of what I call “venture philanthropy” to prop these businesses up. Time will tell whether any of those can become a real business. If a shoe costs $20, Nike doesn’t sell it for $14. They sell it for $400. We have to get back to this world of having pretty reasonable discipline on business models and understanding that many of these gross-margin businesses will never, never break even or become profitable.” One of the more interesting things happening today in business is how businesses generate these three phase changes Chamath describes above (they’ve never heard about it; they’ve tried it; they use it). Slack CEO Stewart Butterfield said recently: “I think we can get away with not having a sales team in any kind of traditional way probably forever. This is how we have grown so far, and we’d like to continue this forever, which is — people really like it and so they tell other people about it, and then other people start using it. And that’s by far the best because when someone you trust tells you that this thing is good, then you’re much more likely to be inclined to use it.”

“1) Approach with humility; 2) Have strong opinions but weakly held; 3). Change your mind a lot; and 4) Experiment and iterate.” Encountering high levels of risk, uncertainty and ignorance is inevitable, especially when it comes to anything related to technology. Being humble is a great way to stay within your circle of competence and avoid other dysfunctional heuristics like over-optimism, person with a hammer syndrome and overconfidence. Having strong opinions is important since that tends to mean you have developed strong arguments that support your views. But at the same time those strong views should be weakly held because otherwise you may become a victim of dysfunctional thinking approaches like confirmation bias. The justification for changing your mind a lot has to do with being able to profit from optionality. Nassim Taleb has said: “A rigid business plan gets one locked into a preset invariant policy, like a highway without exits —hence devoid of optionality.” Taleb wrote in his book Antifragile: “The idea present in California, and voiced by Steve Jobs at a famous speech: ‘Stay hungry, stay foolish’ probably meant ‘Be crazy but retain the rationality of choosing the upper bound when you see it.’ Any trial and error can be seen as the expression of an option, so long as one is capable of identifying a favorable result and exploiting it.”

6. “Success begets more success.” I’ve written about the self-reinforcing nature of success many times. Cumulative advantage is everywhere in the world today if you know how and where to look for it. This “success begets success” phenomenon has always existed, but not in terms of the magnitude of its impact. Once the world went digital and was increasingly connected by networks, the impact of cumulative advantage was accelerated. Chamath’s life is particularly interesting in no small part because he was involved in one of the most striking versions of cumulative advantage (Facebook) in business history and is funding many other firms through Social Capital that benefit from the phenomenon. Even the Golden State Warriors benefit from cumulative advantage since the more success the basketball team has the more great players (particularly great team players who want to win) want to play there. Additionally, the more success the team has, the more revenues rise, which enables more success [repeat]. A business can generate benefits from cumulative advantage in just the same way as a basketball team. Jack Dorsey said something recently that made me think he believes he can learn a lot about cumulative advantage from this basketball team: “To clear my head, I wake up super-early. I exercise, and have been fascinated by the Golden State Warriors. And I learn a lot from them and their team dynamic. I think what’s really important to me right now in my own leadership is understanding how to build a great team dynamic instead of just hiring a bunch of individuals and heroes. Like, how do we actually build something—a team, and folks who add to the team? And creating a team like the Warriors; that it’s not entirely dependent on one person, but this bench that they have.”

“How to pick a VC: 1) Must be a good picker. 2). Must create interest from others for follow-on. 3) Can help you grow. 4) Is morally aligned.” “[A founder] can’t afford to be in a situation where in the absence of operational help you could run out of oxygen.” “You want to have a situation where your venture investors have the benefit of the doubt with other investors.” The reputation of certain venture capitalist has significant signaling effects with other venture capitalists and potential employees. When uncertainty and fear is high, humans have a tendency to form herds and follow pack leaders. The right venture capitalist can get a business through a rough patch. If a business has raise money from a motley crew of investors and there are no leaders, if times get tough or uncertain there may be no one leader to step up and inspire confidence among the other investors or potential new investors. A founder is essentially entering into a marriage with the venture capitalist so it is important to choose well. Chamath has said in several settings that if the founder is not morally aligned with his venture capitalist big problems can result.

“The business model of the future is to serve individuals, because individuals are now relatively smarter. That’s not correlated with education, by the way—they are smarter because they have access to tons more information. And so we are all more connected, we are all more engaged, and as a result we are all more cynical. And we all see that the emperor has no clothes. That’s true of banking, that is true of people who run educational institutions, and it’s true of healthcare. So the model of the future is to basically deconstruct all of that and empower the edges. That is the way you build a multi-gajillion-dollar company. Give people individual power.” This “power to the people” investing thesis is powerful. I wrote about this topic in my profile of Rich Barton on this blog. Providing consumers with information that was formerly locked up in proprietary information systems means information asymmetry ends. Consumers no longer need to be at a disadvantage when purchasing goods and services since they no longer have less information than the provider. Quality goes up. Service levels go up. The bar gets set higher. A big enabler of all of this is the mobile phone. Everyone has access to high quality product information all the time and the result is phenomena like show rooming (looking on line at prices from many vendors when you are in a physical store).

“Some companies that we invested in sucked. We were wrong about the market or wrong about the people. But in cases where we were kind of right, then we’ll be really right.” “This is the time when people should be building really big, crazy things.” “It really comes down to a very simple thing, which is, the principle of N of 1 vs. 1 of N.” Venture capital is all about grand slam home runs since the failure rate with startups is high. But it is magnitude and not frequency of success that matters in investing (the Babe Ruth Effect). The failure rate is high enough in the venture business that the math dictates that a very small number of winners will determine whether a particular fund will be financially successful. Venture capitalists are looking for significant optionality (an asymmetric upside) with a downside limited to what they invest (i.e., you can only lose 1X what you invest but the potential upside is many multiples of what you invest).”

“It’s fine to fail. But if you fail because you didn’t have the courage to move to Oakland and instead you burned 30 percent of your cash on Kind bars and exposed brick walls in the office, you’re a fucking moron.” “The company builders are just cheap, they’re just grimy, and just, shitty office space, and they’ve got to keep it under 8 or 9% of their total burn, and they find people who really really believe in the thing they’re making, and they decide to just live in Oakland and pay for Lyft, and it’s still cheaper. They do all kinds of creative things that deserve capital so they can build. So it forces us to ask those questions, ‘How are you really company building?’ And that’s how we get the truth on who’s going to stand the test of time.” “We’re trying to coach our C.E.O.s that the window dressing is both expensive from a cash perspective and tremendously expensive from a culture perspective. It distracts the team from building what they need to build. Don’t waste money on things that get away from your mission, which confuse employees about why they’re actually there. Meaning, the quality of the office and the quality of the food are all part and parcel of a lack of discipline, which speaks to the fact that the mission isn’t compelling enough.” Every penny not spent on achieving the objectives of the business goal is not only wasted but a potentially a contributor to a cash gap that can kill the business. The only unforgivable sin in business is to run out of cash. People who are driven to build a business (missionaries) won’t trade off things like free Kind bars if it increases the risk that they will not achieve their goals. Of course, wasting money is stupid if a founder is more of a mercenary. For example, if a business spends $2,000 on an expensive office chair at seed stage, that chair becomes very expensive indeed if the business eventually has a financial exit at 100X that seed stage valuation.

“Poker is a microcosm of my own life.” Michael Mauboussin likes to point to cigar-chomping gambling legend Puggy Pearson to make point about how there are similarities between playing poker and investing:

“Born dirt poor and with only an eighth-grade education (“that’s about equivalent to a third grade education today,” he quipped), Pearson amassed an impressive record: he won the World Series of Poker in 1973, was once one of the top ten pool players in the world, and managed to take a golf pro for $7,000—on the links. How did he do it? Puggy explained, “Ain’t only three things to gambling: Knowin’ the 60–40 end of a proposition, money management, and knowin’ yourself.” For good measure, he added, “Any donkey knows that.”

Charlie Munger ascribes no small amount of his financial success in investing to the time he has spent playing poker and bridge. Munger has said: “The right way to think is the way Zeckhauser plays bridge. It’s just that simple.” At a fundamental level, investing is just one form of making a bet. It’s essential, however, that the bet be made in a way that is investing (net present value positive) rather than gambling (net present value negative). Investing is inherently a probabilistic exercise and experience with other games of chance can be helpful. The great bridge player and Harvard Professor Richard Zeckhauser points out: “Bridge requires a continual effort to assess probabilities in at best marginally knowable situations, and players need to make hundreds of decisions in a single session, often balancing expected gains and losses. But players must also continually make peace with good decisions that lead to bad outcomes, both one’s own decisions and those of a partner. Just this peacemaking skill is required if one is to invest wisely in an unknowable world.” Buffett also believes that bridge shares many characteristics with investing: “Every hand is different and yet what has happened in the past is meaningful. In investing you must make inferences about every bid or card and cards that are not played. Also, as in bridge, you can benefit from having a great partner and having strong interpersonal skills. Understating probability and statistics is essential in both card playing and investing.”

[What to look for in a founder] “Very high IQ; Strong sense of purpose; Relentless focus on success; Aggressive and competitive; High quality bar bordering on perfectionism; Likes changing and disrupting things; New ideas on how to do things better; High integrity; Surrounds themselves with good people; Cares about building real value (over perception).” “We try to find businesses that are technologically ambiguous, that are difficult, that will require tremendous intellectual horsepower, but can basically solve these huge human needs in ways that advance humanity forward. Those things don’t necessarily take lots of money, but they generally do take lots of time. And they require really mission-driven people.” This is a great list. There is too much there to talk about everything but on the last point, founders who are mercenaries are not as likely to care about building real value. Missionary founders are naturally aligned with the interests of investors and customers. Creating a startup is such a challenging endeavor that having missionary founders significantly increases the probability that the company will prosper because of this alignment. Chamath puts it this way: “What you value is what you achieve.” Core product value must be the goal instead of short-term optimization if you are going to build a sustainable business.

Notes:

Vanity Fair interview: http://www.vanityfair.com/news/2016/03/chamath-palihapitiya-interview-says-start-ups-are-mostly-crap?mbid=social_twitter

Semil Shah Interview of Chamath Palihapitiya: http://blog.semilshah.com/2015/09/17/transcript-chamath-at-strictlyvcs-insider-series/

Chamath Palihapitiya Slide deck: http://www.slideshare.net/growthhackersconference/how-we-put-facebook-on-the-path-to-1-billion-users

Genius transcript of Chamath Palihapitiya: http://genius.com/Chamath-palihapitiya-how-we-put-facebook-on-the-path-to-1-billion-users-annotated

Interview of Chamath: https://www.youtube.com/watch?v=ZlYln36BRpo

TechCrunch Interview: https://www.youtube.com/watch?v=59uTUpO8Dzw

StartupGrind Interview: https://www.youtube.com/watch?v=ncjum-bkW98

Chamath Palihapitiya on Quora: https://www.quora.com/What-are-some-decisions-taken-by-the-Growth-team-at-Facebook-that-helped-Facebook-reach-500-million-users

Wired article: http://www.wired.co.uk/magazine/archive/2014/09/features/growth-hacking

Chamath Palihapitiya Medium post on values: https://medium.com/@chamath/values-1d00431c35f1#.wbltxp3mu

Mauboussin: http://www.jstor.org/stable/10.7312/maub14372