Thursday, January 3, 2013

Balancing The Lean Startup with Conviction

Note: the title of this post was renamed from "Everything You Know About Startups is Wrong". The title was too click-bait and undermined the points made.

Every generation finds its own management style. The "Bell Curve" style of management, popular in the 80's and 90's, is now eating holes in many corporations and is being viewed through a much darker lens (see Vanity Fair's excellent piece Microsoft's Lost Decade). While the management concepts may differ, the way to market the New York Times' bestselling management books is the same: "Everything you know about ____ is wrong" (the title is meant to be tongue in cheek).

For our generation, this shift has certainly been towards the "Lean Startup" mentality. We've learned from Steve Blank that a startup is a fundamentally different creature than a developed business. By using analytics, we're effectively introducing the scientific method into our management decisions. We're keeping costs lower and minds open. All good things.

However, I'd like to suggest that we've gorged ourselves and taken this too far. There's a wonderful little clip on YouTube showcasing Steve Jobs' early days at NeXT. While Jobs reaffirms "all that matters is the ship date", he also highlights something that today has become somewhat villainized: the vision. So says Jobs:

There needs to be somewho who is sort of the keeper and reiterator of the vision, because there's just a ton of work to do. And a lot of times when you have to walk a thousand miles and you take the first step it looks like a long ways. And it really helps if there's someone there saying "Well we're one step closer, the goal definitely exists, it's not just a mirage out there". The vision needs to be reiterated...I do that a lot.

Herein lies a problem with taking The Lean Startup too far: it can sacrifice the vision. There will come a time when your coworkers and employees are tired, burnt out, and unmotivated. And chances are, "let's launch another experiment" isn't going to be a sufficient pep talk. People need to feel that they are part of something larger, and it's this something that can often carry them through the difficult times.

It's important to acknowledge what The Lean Startup is when taken to an extreme: the greedy algorithm of business strategy. This is a wonderful thing! It's extraordinarily well-suited to a wide variety of problems. It's advantageous in markets where feedback is readily available. However, in the world of algorithms we still need divide-and-conquer paradigms, and dynamic programming as well. We similarly need different approaches for combating heavily saturated markets, markets where feedback isn't readily available, and markets where your competitors can significantly outresource you.

The Lean Startup has sparked something of a revolution – and appropriately so. However, it should be treated as a process, not a paradigm. Making decisions based on data is a good thing. Admitting when you're wrong is a good thing. Failing to provide your employees with a clear vision is not. And sometimes we encounter problems where a greedy algorithm just won't cut it.

Wednesday, December 19, 2012

Disrupting Politics Part I - For the People by the People

In 1698, 175 Russian men left their military regiment and fled to the capital. After two years of war, the soldiers were starving and had little to show for their victorious campaigns. Back in Moscow, they found sympathizers among oppressed serfs and traditionalists who were upset by the profound cultural changes being forced upon them by their monarch, Peter the Great. As the discontent grew, their rage turned to rebellion, and they plotted to overthrow their ruler. Not surprisingly, Peter the Great quickly squashed the uprising. What is more disturbing is that over the next nine months, he executed over 1,000 men for their failed allegiances, and brutally tortured some 600 more (branding many with iron). Years later, also in his quest to modernize Russia, nearly 30,000 men died in the building of his namesake city.

Yet for all his personal and political atrocities, Peter the Great is widely held as one of Russia's greatest leaders, a man who indeed shifted Russia from traditionalism and slavery to the scientific method and modernism. History is full of such juxtapositions. Many a man or woman in leadership have ruthlessly violated the rights of their people, yet through the lens history, made substantial advancements for their country and their future countrymen.

What then is the role of leaders? This question was a core debate between Thomas Jefferson and Alexander Hamilton as they, among others, debated America's foundations. Jefferson had a deep faith in the ability of the common to rule, while Hamilton felt that rule should come from the educated: those who had the benefit and knowledge of history to avoid pitfalls of the past. We still face this question today, with the Republican Party largely distrusting of large government, and the Democratic Party largely in favor of it.

In the United States, it is easy for us to view the Internet through the lens of the impact it can have on other countries, the recent Arab Spring being a notable example. Yet, it is worth considering what impact the Internet can have on how we rule our own county? Will democracy and modern rule look the same 100 years from now as it does today?

In the following few weeks, I'll be making suggestions as to what this looks like, in hopes to stimulate a broader discussion. My first question is this: what role should we expect elected officials to fill? Is it best to elect officials who we believe to be more knowledgeable that ourselves, and to defer to their judgment on issues that are outside of our understanding? Or is it better for an official to serve as a direct representative of the people?

If the answer is the latter, then the technological implications are broad. In this framework, a representative exists as an "aggregator of wills". Historically, it was impossible to poll the masses to determine their collective will. Yet the Internet changes that. Under the right system, each voice has the ability to "cast their ballot" on issues.

So my first challenge is this: a Senatorial candidate whose platform is to have no agenda, but rather, via online polling (through the likes of Votizen), brings every major issue to the people of his or her state, and votes as the people decide. The role of this individual will be one of an educator: he or she will commit to publishing the facts surrounding an issue, advise what he or she believes the impacts on his or her state will be, and then leave it to the people to decide. Understandably, not every issue can be brought to light: it will be at the discretion of this individual to bring forth what he or she considers to be major issues.

It's important to note that in this post, I am not siding with either Jefferson nor am I siding with Hamilton. I am simply highlighting that we have the opportunity to use technology to "test" a new form of representation. May the outcome determine the victor.

Wednesday, December 12, 2012

Understanding the fall and rise of Facebook's stock

While the rear view mirror always allows for the most confident commentary, I wanted to offer a few thoughts explaining the"whys" behind the price action in Facebook's stock. I worked on Wall Street for nearly a decade before a series of health problems moved me to resignation, so I thought I'd share my observations.

Facebook stock price, from Google Finance

Popular media aside, the extreme volatility in FB hardly reflects true swings in valuation, nor does it likely reflect investors "forcing" Zuckerberg and Company to strengthen their mobile platform. Supply and demand, as per usual, are the main stars. Valuation is but one contributor to supply and demand. (In fact, studies show that the volatility in stocks is in no way warranted by changes in real valuation). The two other keys to this story are risk-reward and an agent-model portfolio investment.

Risk-reward is market parlance for "how much upside can I expect versus the amount of downside." The more uncertainty involved, the greater the return required by the investor. From a large revenue standpoint, Facebook is still an early player. Namely, if they execute things well, they have the possibility of rapidly growing their revenues (they have largely already succeeded in rapidly growing their user base). However, the question was never "is Facebook worth $100 billion?" Rather, the question market participants ask is "what is the upside at $100 billion market capitalization?" This is a subtle but very important difference. Based on current revenues (and thus price multiples), it was hard to justify a 50% increase in valuation, however, a 50% decrease was by no means inconceivable. In essence, the risk reward wasn't there. Initiate decline.

This decline was further exacerbated by the employees coming out of "lock up." For many, this was a first opportunity to move from being "paper rich" to "cash rich." As the supply of stock waned (employees slowed their equity exits) and the demand increased (more favorable risk-reward), prices stabilized.

We can make a strong case that the recent rebound has been due solely to favorable risk-reward (you could double your money simply by returning to the IPO price), and the lack of insider selling. However, this fails to recognize a third, very powerful aspect: the agent-model of portfolio management.

In the agent-model of portfolio management, investors with cash (often large institutions) pay somebody to manage their money (for a fee). They will frequently evaluate the performance of the manager and reallocate funds to or from the manager given their performance.

The evaluation of a portfolio manager is a funny thing. Quite opposite to trading, where gains are overvalued and losses under-attributed, in portfolio management, losses are over-attributed and gains inder-appreciated. As such, there is a string pull towards the status quo. The prudent portfolio manager will want diversified bets similar to their bogey (the metric, explicit or implied, against which they are compared). Their positions should reflect the larger picture in the global economy, all the while shuffling exact investment amounts to reflect their opinions and biases.

Facebook occupies a unique role: it is, in my opinion, one of the only credible public companies in the social media space. This isn't to slight Groupon or Zynga: rather, their float and scope as too small to be carry a ton of weight with institutional investors. As such, should social media continue to be a real market, institutional investors will need to own at least a bit of it. But those bits add up. Over trillions of dollars of investment capital, even the smallest fraction of a percentage in allocation can make a difference.

Wednesday, April 21, 2010

De-leveraging the Shadow Banking System

What a difference an SEC accusation can make. The once out-of-reach Lincoln bill was approved by the Agricultural Committee 13-8 today, with marginal bi-partisanship. Lincoln's bill calls for the most sweeping overhaul of the financial system to date: the separation of derivative desks from the broader banking system.

Within modern megabanks, there exist the commercial side of activities (which focus on deposit-taking and lending) as well as the investment banking side of activities. Within the investment banks we typically split into traditional investment banking (debt and equity underwriting, mergers and acquisitions), capital markets and wealth management/advisory services.

In a manner of speaking, the Lincoln bill is a tamed-down version of Glass-Steagal. It focuses on separating portions of the capital markets group from the broader financial institution, rather than the entire investment bank. Derivatives are well-considered to be the instruments that create the difficulties associated with "inter-connectedness" and "systemic importance".

Recent regulatory proposals have focused on a combination of consumer protection measures as well as addressing Too Big to Fail. The proposals surrounding the latter have been as tame as requiring companies to create a disaster plan in the event that they collapse (a "living will") and as stringent as the above-stated Lincoln bill. Somewhere in-between is increased regulation (oversight) and further capital constraints (holding more money to protect against losses).

In effect, the large majority of these proposals serve to shrink the shadow banking system (leverage and loans outside the traditional bank realm). Most conservatively, increased capital requirements divert equity away from other investments and into banks (the impact of this would be small). Alternatively, swap desk spin-offs will require some new capital to be raised by the spun-off institutions. Furthermore, the cost of this capital will be higher (as it does not have a government guarantee, nor a form of funding as cheap as deposits). With the higher cost of capital comes a higher cost for leverage, and in all likelihood, a decrease in available leverage. This may be further exacerbated by declines in bridge financing (temporary financing for business or investment opportunities) and other non-traditional forms of lending.

Although it has become increasingly clear that re-regulation is necessary, there are always unintended consequences. I personally think that a decrease in leverage in the financial system would increase stability in the long run. The short-term impacts may be much more significant if executed improperly. It is no small secret that Bernanke views credit contraction as a major cause of the Great Depression. We will need to plan for our own short-term leverage-adjustment for the sake of increasing stability.

Sunday, April 18, 2010

The Political Backlash Begins

As if on cue, there are numerous reports about politicians honing in on the Goldman case. Bloomberg's story "Goldman Suit Harnessed by Obama Political Aides for Internet Ad Campaign" indicates that Obama's official political arm, Organizing for America has paid for top advertising in Google searches for "Goldman Sachs SEC".

From the Bloomberg story:

The ad link takes browsers to a page on that features a picture of the president and the following quote: “We’ve seen and lived the consequences of what happens when there’s too little accountability on Wall Street and too little protection for Main Street. It is time for real change."

Furthermore, both London and Berlin are following suit. Given the unpopularity of a Greece bailout, Germany has appeared to attempt to stall action until state elections on May 9. Similarly, the UK is facing the prospect of a hung parliament on May 6. London was quick to attack (story here), as was Berlin (story here).

Let me be clear that I think reasonable and appropriate actions should be taken (including the restructuring of current regulations). I just want to highlight the timing and nature of the political responses.

Saturday, April 17, 2010

The SEC Strikes At Goldman While the Iron is Hot

On Friday, the SEC charged Fabrice Tourre and his employer, Goldman Sachs, with fraud. It is common to charge the employer, under the doctrine of respondeat superior ("let the master answer") wherein the employer can be responsible for the actions of its employees. This is sometimes known as "going after the deepest pockets".

Also on Friday, Democratic Senator Blanche Lincoln unveiled a sweeping derivatives regulatory bill, which in spite of alleged attempts to craft a bipartisan bill, had no Republican lawmaker support for the legislation.

Without opining on the culpability of Mr. Tourre or Goldman (The Baseline Scenario makes strong arguments against the firm here, while Goldman makes strong responses here), I think there are a few bigger picture concepts to take note of.

1. The timing of the accusation largely coincides with the need for votes to pass financial regulation. Of the handful of financial regulatory bills currently circulating, there is very little in the way of bipartisan support. Although I am fully supportive of implementing prudent regulation to promote long-term stability within the financial system, we must take care not to pass reactionary rather than visionary legislation.

2. These allegations are a big win for the Democratic party. It is no secret that Obama's approval ratings have dropped precipitously. It is also no secret that Wall Street bankers seem to rank with pedophiles and traitors as the most-hated segment of society. While the Republicans have been chasing Wall Street donations (see WSJ article here), Mr. Obama is attempting to position himself as a champion of the people against the banks. The Democratic party is incented to push for an overly restrictive bill in order to discourage Republican support. Come mid-term elections, they may poignantly declare "why vote for so and so when they refused to regulate fraudulent companies…do they really have your best interest in mind?". My fear is that the resultant political banter may take away from the larger issue of an appropriate regulatory backdrop.

3. Where will the money come from? Taken to its logical conclusion, there is simply not enough available money in global financial institutions to make investors whole for the losses that they incurred. If litigation were pursued on all levels, we would see clients suing their investors, investors suing investment banks and ratings agencies, ratings agencies and investment banks suing mortgage lending companies, mortgage lending companies suing the appraisers and the individuals that committed representational fraud, etc. By no means am I arguing that legal recourse should be foregone, but in a room where everybody is shooting at each other, the only winner is the funeral home. We have a messy situation on our hands.

Altogether, this is an unfortunate and complicated situation. Its impact has the potential to be much more far-reaching that the single outcome ("deny and settle" seems to be the mainstream PR response.

Saturday, April 10, 2010

China Runs a Trade Deficit?

China reported today that it ran a trade deficit for March, where it imported more than it exported (the last time that this occurred was April 2004). See NYT article here. This is much more complicated that the headline, and does not undermine the piece I wrote previously, Why China Needs the United States. A single month does not change a decade of imbalance, and furthermore, we will see that the underlying causes are not sustainable.

1. Chinese growth has begun to overheat, and appears to be causing Chinese authorities concern. Like numerous countries worldwide, China unleashed large stimulus packages in early 2009 in order to keep their economy growing. Although stimulus packages are often portrayed as "jumpstarting" the economy like a car, "whipping the horse" is probably a more accurate portrayal. When you whip the horse too hard, it can go berserk and run faster than intended. In Beijing, housing prices rose at 8.8% in the month of March and over 60% in the past year! Not only is this fast, it is accelerating.

2. In response to massive demand, residential and commercial construction is occurring at breakneck speeds. In order to achieve this building, China needs to import natural resources, such as oil, iron ore and copper. Record import volumes helped to drive oil up over 5% in March and copper up nearly 9%. Iron ore prices are up some 40% year-to-date.

3. An unwelcome outgrowth of this is large scale speculation. Individuals are purchasing second and third homes in the face of rapidly rising prices (a process that officials are likely to try to discourage). Anecdotal reports suggest that iron ore traders are stockpiling the commodity in anticipation of future demand. As a result, Chinese authorities are trying to limit imports of the raw material.

As we know all too well, rampant asset-driven growth like the housing bubble of 2007 and the crude oil bubble of 2008 is not sustainable. Although China's trade deficit may persist for a few months, it is very unlikely that this will be a long-term shift. Nonetheless, it is coincidentally convenient that this "shift" occurred only weeks before US Treasury Secretary Geithner was originally to decide whether to label China as a "currency manipulator". Sustainable or not, it is all too likely that they will use this data point to defray potential allegations.