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What's Wrong With Silicon Valley's Growth Model

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

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