|Building success into a high-tech start-up
|John T. Preston
The first of two articles
To succeed, a technology-based entrepreneur needs more than an
innovative product. How one organizes a start-up company often
more important than the product in determining whether the venture
succeeds or fails.
From my experience in helping to create technology
companies, the right attitude, people, and actions make a bigger
contribution than a novel idea to the success of these endeavors.
Never underestimate the role of passion, the importance of management
talent, and the significance of teaming with the right investors.
Second, bringing innovative ideas to market requires a series of
actions, from securing patents to moving a high-quality product
to market quickly.
Consider the contrast in behavior
large companies and small companies, which tend to develop innovative
technologies differently. My friend James Utterback of the Massachusetts
Institute of Technology (MIT) Sloan School of Management spent
years looking at radical innovations that had occurred during the
previous 100 years. He found no case in which the market leader
pioneered a radical innovation. Often, the market leader was the
inventor of the radical innovation but refused to pioneer it, out
of fear that it would cannibalize sales of the company’s existing
Let me cite an example. MIT’s Hoo-min Toong helped
pioneer the personal computer, and in 1980, he was also advising
IBM on designing the architecture for what became the IBM PC AT.
One of Hoo-min’s students, Mitch Kapor, wrote a software program
called VisiPlot/VisiTrend and licensed it to VisiCorp for $2.5 million.
Kapor used the money to write a software program called 1-2-3. Hoomin
knew that 1-2-3 would be important, so he arranged with IBM to fly
Kapor to its PC headquarters in Florida three times to try to convince
the company to take an exclusive license to 1-2-3. Ultimately IBM
refused, saying, “Hardware is a multibillion dollar industry.
The market for PC software is only a $50 million industry. So go
off and become successful, and we will talk to you.” Three
years later, when Kapor had built Lotus Development Corp. to the
point where his stock was worth $250 million, he was no longer interested
in licensing this technology exclusively to IBM for $3.5 million.
IBM missed a fundamental paradigm shift—that the value added
was shifting from hardware to software. The relative value of the
intellectual content in software was going up while hardware was
becoming a commodity product whose prices were dropping rapidly.
IBM did, subsequently, take an exclusive license to 1-2-3 by purchasing
Lotus Development Corp. in 1995 for $3.5 billion, 1,000 times what
it could have paid in 1980. Because of its old way of thinking,
IBM missed an opportunity to take advantage of a radical innovation
that was offered to it.
An earlier example of the shortsightedness
of a Goliath corporation is exemplified by the behavior of the
president of Western Union in the late 1800s. William Orton rejected
to buy Alexander Graham Bell’s telephone patent for $100,000
and described the invention as a “scientific curiosity”
that would never have practical use.
Utterback also identified many
examples of market leaders trying to sabotage radical innovations.
For example, the use of the electric chair for capital punishment
was promoted by Thomas Edison to discredit the safety of alternating
current, an innovation of George Westinghouse, an Edison competitor.
Too many innovators underestimate the need for
excellent management. I would rather have a first-rate management
team with average technology than have a first-rate technology
a second-rate management team because the strong management team
is more likely to succeed. One false impression about entrepreneurship
is that it is an individual behavior. What we have found is that
entrepreneurial behavior succeeds more often when performed by
Edward Roberts of the Sloan School, and chairman of the MIT Entreprenership
Center, has spent much of the past 30 years studying the probability
of success for start-up companies. He found that success increases
dramatically with team size until you get up to four or five entrepreneurs
founding the company. Teams of people with complementary skills
perform better. For example, if a technologist partners with someone
who knows the capital markets and another person who knows how
market technology-based products, the team of three will have a
much higher probability of success than the solitary technologist
trying to start a company on his or her own. Experience shows that
first-rate managers hire a first-rate team but second-rate managers
avoid hiring at their level and hire third-raters.
One of the key determinants of success in start-up
companies is the passionate behavior of the founders. People
lack passion often use the first barrier they encounter as an excuse
for failure. People who have high passion will do whatever it
to overcome those barriers.
What we can achieve in life depends
on a number of things: how hard we work, how smart we work, how
much leverage we have on the work we do, and how much courage
have in pursuing our goals. How hard we work is tied to how passionate
we are. One key difference between American and Japanese or European
companies is that U.S. companies are much more generous in giving
stock options to their employees. When you distribute ownership
to the employees, the employees behave differently. They no longer
behave like employees but like owners. Wide shareholder ownership
is one of the best ways to stimulate passionate behavior.
|Figure 2. On the very
successful Southwest Airlines, which has a high percentage
of employee ownership, the pilot, co-pilot, and flight
attendants cleaned up the cabin because they did not want
to spend money on hiring a cleaning crew.
Southwest Airlines provides an example. A decade ago,
I flew back to Boston on Southwest, which is now among the
more successful airlines. I believe it is no coincidence that
it also has a high percentage of employee ownership. During
a stopover, the pilot, copilot, and flight attendants came
through the cabin to clean up trash and prepare the plane for
the next leg of the trip. I started chatting with one of the
flight attendants about why they did so, because normally a
ground crew comes aboard to clean an airplane (Figure 2). She
explained that they did not want to waste the money to hire
a cleaning crew when they could do it themselves. She went
on to tell me how a friend was retiring after 20 years as a
flight attendant and that her friend’s stock options
in the company were now worth nearly $500,000.
I have seen this behavior in a number of companies. One way
that Mitch Kapor and Jim Manzi built Lotus was to give their
employees incentives through stock options. Kapor’s administrative
assistant, who was the third employee in Lotus, made $10 million
from her Lotus options. What happens to your behavior when
you have the chance to make $10 million? You no longer care
whether you work 9-to-5. You willingly work as many hours as
it takes to make critical deadlines.
Unfortunately, large companies
cannot passionately motivate employees with stock options because,
for example, General Motors’ employees will not see their
stock go up 100-fold from the day an employee arrives to the day
that employee retires. However, small high-tech companies can see
a 100- or a 1,000-fold increase in the value of their shares between
the time their early employees start and when they retire. One method
of motivating employees in large companies is to share credit for
successes. However, too many managers take the credit for their
subordinates’ successes and pass down the blame for management
errors. These practices are ultimately self-destructive because
they kill passion.
Many entrepreneurs are indifferent about sources of investment. They focus
on how much money they can raise for how many shares, and they do not differentiate
between the quality of the sources of that money. But the quality of investors
and the pace at which money flows into the company are keys to determining
its success. Besides cash, investors can also provide significant leverage
(Figure 3, right).
Let me give an example from a company that wanted to do
business in a certain country. During the discussion about
how to proceed, one board member, a world-recognized figure,
suggested that he call the president of the country to ask
how to proceed. That five-minute phone conversation saved
the company six months of hard work. This kind of leverage
from an investor can prove extremely valuable. I remember
talking with the late Robert Swanson about his success in
founding Genentech. One factor that helped immensely was
the role Mayfield Ventures and Kleiner Perkins, two of his
early lead investors, played in opening doors.
|Figure 3. One factor
that helped immensely in the successful founding of Genentech
was the role that two early lead investors played in opening
key determinant of success for start-up companies is their venture
capitalists and whether they can provide adequate access to more
money downstream. New companies typically need more money than
entrepreneurs think, and they more often fail because they run
out of money than because the technology has problems. Companies
that have investors with “deep
pockets” will succeed more often. For example, Venrock—which
invests the Rockefeller family money—is one of the most
successful venture capital firms, in part because it has incredibly
and has the staying power to help ensure the success of companies
in which it invests.
|Figure 1. Scenario A invests
a small amount of money over a long period in hopes of a positive
return. The more aggressive Scenario B ignores the short-term
savings in favor of long-term gains.
Finally, the timing of
in a start-up is also vital. Figure 1 (above) shows two different
investment scenarios, with the net flow of money as a function
the net flow is negative, you are investing money; when the net
flow is positive, you are making a return on investment. The
shows the strategy of putting a small amount of money into a company
over a long period and hoping it goes positive. That curve has
major problems associated with it. First, management often spends
too much time raising money in small chunks instead of building
the business. Second, it creates a wide window of opportunity for
a competitor following the B curve to aggressively enter and
the market. What surprises me is that most large U.S. companies
tend to behave on the A curve regarding radical innovations.
incremental innovations, however, they adopt the B curve, especially
if the time to breakeven is less than two years. The reason
shareholders judge public companies on a relatively short-term
time horizon, typically 6 to 18 months. If a management team
driven by short-term behavior has a radical innovation that might
take five years to hit the payback point, it will cut any investment
from the optimum B curve down to the A curve. All of the area between
these curves after breakeven is long-term lost opportunity,
because management is being judged in the short term, it will make
more money in the short term using fewer assets.
It is possible
to throw too much money at a new startup, as demonstrated during
the dot-com frenzy. Often, when management has too much money,
it spends too freely and undermines the company’s cost
structure and survival chances. I know one company that, after
public offering, bought helicopters for top management and moved
into a fancy building. This spending increased the company’s
overhead, making it less competitive, and nearly killed it.
the helicopters are gone, the company occupies inexpensive offices,
and it is again highly competitive.
Ask a typical entrepreneur
he or she would do if handed a check for $100 million and told
to use it to start or build a company, and the answers would
include: pay themselves what they are really worth (for the first
time in their career), build a nice office with wood paneling,
travel first-class on business. I refer to this as the Taj Mahal
syndrome. Often, entrepreneurs end up building a fancy tomb
Choosing the right people—managers, workers,
and investors—is one important aspect of building a successful
start-up. But a new company must also take specific steps to
its innovative product to market. How well it carries out these
activities, which I will discuss in the August/September issue
The Industrial Physicist, plays an equally important role the company’s
success or failure.
Carnegie, D. How to Win Friends
and Influence People; Pocket Books (reissued paperback edition):
New York, 1998; 288 pp.
Roberts, E. B. Enterprise in High Technology:
Lessons from MIT and Beyond; Oxford University Press: New York,
1991; 385 pp.
Utterback, J. M. Mastering the Dynamics of Innovation:
How Companies Can Seize Opportunities in the Face of Technological
Change; Harvard Business School Press: Boston, 1994; 253 pp.
L. M.; Auerswald, P. E. Taking Technical Risks: How Innovators,
Managers, and Investors Manage Risk in High-Tech Innovations;
Press, Cambridge, Mass., 2001, 220 pp.
John T. Preston has helped start nearly 100 companies as an entrepreneur, venture
investor, and director of technology development and licensing
at the Massachusetts Institute of Technology in Cambridge. Some
this material was delivered in a talk by John Preston in Tokyo
in 1997, and again by Ken Morse of MIT at the International Congress
on the Information Society, February 5–7, 2003, in Bilbao,