Tag Archives: Competition

The attractiveness of different investment stages

When I first started investing, I thought that the best investment opportunities were at the seed stage. In other words, I thought that the best opportunities were in being the first investor in companies. My reasoning was that, if you know what you’re doing, this is the stage when there is the greatest return potential.

However, in addition to the greater return potential, seed stage investments also feature the greatest risk, and the greatest competition. If you know what you’re doing, you can minimize the risk. However, you can’t change the competition.

The number of people who can lead a $500K seed round, or contribute $50K towards it, are numerous. And this number will only grow as technology in general, and software in particular, changes the way that things are done in more and more sectors. The result is that seed valuations are often pushed higher than what can be justified by seed companies’ underlying business prospects.

As the round size and the resulting check size increase, in other words in Series A and B rounds, the number of people who are competing for a deal declines. And my intuition suggests that the reward to risk ratio does not decline as much. In other words, series A and B investors occupy a more attractive part of the value chain than seed investors.

I’ve participated in a few later stage rounds, beyond the series B. However, I haven’t done so a sufficient number of times to have a feel for whether later stage rounds are even more attractive than series A and B investments. With time, perhaps I’ll find out.

What’s missing from this reasoning is your personal fit for different stages. For example, earlier stage investment decisions are more qualitative in nature whereas later stage decisions are more quantitative in nature. As a result, even if series A and B investments represent a more attractive part of the value chain, they might not be the right fit for a highly qualitative investor.

Startup: A Silicon Valley Adventure

I recently read the book Startup: A Silicon Valley Adventure by Jerry Kaplan. Jerry was the founder of hand-held pen computing pioneer GO Corporation in 1987, and the book tells the story of the challenges, pains, and joys on the road to building and eventually achieving a modest exit with GO.

It’s a story which highlights the importance of product market fit (it turns out that a hand-held pen computer’s close cousin, a touch-based hand-held or in other words a smartphone, is the right solution), timing (GO was a few years too early), and competition (large markets attract the attention of large tech companies with greater resources than startups, and the startups that succeed achieve distribution before incumbents achieve innovation).

I strongly recommend reading the book, which you can check out here.

The flavor of the day

I was recently speaking with another investor about a potential e-commerce investment they’re looking into. While the investor really liked the startup, they were concerned by the threat that Amazon presents for the company. While Amazon has yet to focus on the company’s geography and vertical, the former is likely to happen within the next year and, given Amazon’s somewhat unexpected aggressive moves in the grocery space, it may also unexpectedly decide to focus on the company’s vertical.

While the threat presented by a large and well-funded competitor with a track record of strong execution is important to recognize, this threat alone isn’t sufficient to justify not investing in a team with a similar track record of strong execution with a singular focus on a large market.

The reason is that there is always a big and well-funded company with strong execution capabilities operating in or adjacent to a startup’s target market. Today, the flavor of the day is Amazon. Everyone is fascinated by the company. The respect is certainly deserved, but the fascination is excessive.

2 years ago, this company was Uber. A few years before that, it was Facebook. Before that, it was Google. And before that, it was Microsoft.

Despite Uber’s presence, competitors like Didi in China and Bitaksi in Turkey are clear market leaders. Despite Facebook’s presence, Snapchat emerged and is now a public company. Despite Google, DropBox is a leading player in the cloud storage space. And despite Microsoft, Google developed into the leading search engine.

While the presence or potential interest of a large company in a startup’s target market is a threat to the startup, it also validates the market.

And what the right startup has is talent and focus that’s very often not available to a large company. The right startup founder is at least as capable and more motivated than the division head leading a large company’s efforts in the startup’s market. And the startup’s singular focus on the market is different than the non-pole position which the market occupies on the large company’s priority list.

Sometimes the large company also has users or customers in its core market who it doesn’t want to risk alienating by aggressively entering a new market.

For all these reasons, know the flavor of the day. But also know that it’s just that.

Defensibility

Entrepreneurs are doers by nature. They have ideas for what customers want, build teams to execute on these ideas, and execute.

Assuming that the entrepreneur has correctly identified a real customer want, this approach will likely produce a business that makes money in the short term. However, this isn’t enough for the business to survive in the long term.

The reason is that, if the customer want is really there, competition will either already be there or it will soon emerge. The bigger the customer want the entrepreneur identified, the greater the competition.

And for a business to survive in the face of competition, it needs to be defensible. In other words, it needs to have a characteristic, or a combination of characteristics, that stops its customers from moving to the competition.

Defensibility comes in many forms. It could be a very strong brand that has perhaps even given its name to a product category, like Coca Cola. It could be the lowest price provider due to a combination of economies of scale and the leveraging of an intrinsically low cost customer service channel, like Amazon. Or it could be a business with strong network effects that prevents users from having the same experience on an alternative network, like Facebook. Or it could be a combination of these characteristics.

Without a source of defensibility, a business’ initial growth will soon taper off and may even reverse into decline, thereby threatening the company’s survival.

As a result, you need to think about the defensibility of your business before jumping into execution. Your company’s survival, and thereby your return on the years of work that you’re going to put in, depends on it.

Competition in China

I recently sat down with a VC who invests across the US and China. We were talking about the geographic expansion possibilities of a tech company that currently operates successfully in a single geography, Turkey.

I focused on the company’s core value proposition and business model to suggest that there would be greater demand for what the company is doing in China than in the US, and that it would be able to operate with superior unit economics in China. I therefore shared that I was in favor of entering China rather than the US.

My counterpart shared that, while the factors I had pointed out were important, I was overlooking the most important variable that the company needs to consider when deciding which geography to enter. That’s competition, and when it comes to competition, doing business in the US is a walk in the park compared to doing business in China. He therefore recommended that the company expand to the US.

I have yet to do business in China, so, until I experience it for myself, I need to take the investor at his word.

I will, however, be visiting China soon. Although a visit is far from enough to understand the true extent of competition in the country, I look forward to getting my first glimpse.

Getting accepted, formally and informally

There are two ways to get accepted into an institution. Examples of such institutions include companies and schools.

The first is to apply using the institution’s formal application process, and the second is to offer up your candidacy through informal means, by getting directly in touch with people at the institution.

If you take the first approach, you’re competing head-on with thousands of other candidates. It’s hard to differentiate yourself.

The second approach makes you stand out. It shows that you want the position more than the thousands of people who applied through the formal process, and that you’re entrepreneurial in getting what you want.

Desire and entrepreneurship are important predictors of success in the eventual role, so most people respond positively to seeing them in a candidate. If they don’t, you might want to question whether you want to be part of an institution where these qualities aren’t valued.

This doesn’t mean that you don’t need to be qualified for the position. I’m not advocating for cronyism or nepotism. Although these unfortunately also often produce results, these results are hollow as you haven’t earned the position.

But the formal process has so many qualified people that you need to do things to stand out. You need to do the informal.

Getting in on the ground floor

After a new venture begins to take off, many people want to get onboard. Competition to join the venture increases.

However, at the same time, since the risks of the venture have decreased, the potential intrinsic and extrinsic rewards it offers also decline. So you’re faced with an environment that’s simultaneously more competitive and has lower prospective returns.

This is why you want to get in on new ventures on the ground floor. That’s when there’s little competition and it’s easiest to get in. It’s also when there’s the prospect of disproportionately high intrinsic and extrinsic returns.

The challenge, of course, is identifying the right new ventures to get into on the ground floor. Fortunately, you can take multiple swings during the course of your life. And with each swing you learn a bit more about the defining characteristics of the right new ventures. So your probability of getting in on the right one improves with time.

And you only need to hit one home run in your life. You only need to get in on the ground floor of the right venture once. The intrinsic and extrinsic returns of doing so are often enough to keep you feeling happy and successful for a lifetime.

But chances are that once you experience this thrill once, you’ll want to experience it again.

Practicing with the best competition makes perfect

The US men’s basketball team won the 1992 Olympics in Barcelona. I remember watching the games as a kid.

There was a huge difference between the US team and every other team at the Olympics. In fact the US team beat each of its opponents by at least 38 points in the tournament. For those unfamiliar with basketball, most games end with a margin less than 10 points.

While each of the US players was individually talented, together as a team they were much more than the sum of their parts. Their performance during the games was simply the outcome of the underlying practice sessions that they had in the run up to the Olympics. In fact, in the video below Michael Jordan refers to the scrimmages they had during these practice sessions as the best basketball games that he has ever played in. This is because he was competing against the likes of Magic Johnson and Larry Bird.

Practice doesn’t make perfect. Practicing with the best competition does.