Everyone Agrees? Think Again. How Venture Capitalists Decide

Christian Soschner00:08:34

Most companies manage risk the same way and get everyone to agree. What does the data say about that?

Alex Dang00:10:24

VCs would believe that conviction is way more important than consensus. More importantly, if you look at the research, then VCs make decisions differently in different VC firms. Some of them still prefer consensus, especially for smaller VC firms. For some of them give a full right to a single partner to make a call, they discuss debate, and then a single partner is enough to make a decision. And then Ilya's team compared the results of these firms and the ones which would prefer full consensus underperform versus the ones which would prefer lack of a consensus to some extent. So what's happening here? What's going on? Because what's the root cause of such an outcome? The root cause is the following. If you're hunting for an outlier or a company that would perform way better than the other, a startup that will transform the world to some extent, these companies, and at the same time, you do not want to make a bet on the company, on the idea that will be a common sense, that will be everyone will bet on, because then typically the valuation will be too high or it will be just a symbol of a hype. So you're looking for kind of a very strange type of a company. It's an outlier which is not yet recognized as a future winner by the other. So if you think about that, this is the ideal company that the VC would invest in. So, therefore, if you just simply apply these set of conditions and expect that every VC partner in the room would accept this and would agree with you, that's ridiculous. It's almost impossible. So, actually, it's the opposite is true then. If everyone in the room agrees that this is the company to make a bet on, then something might be wrong with the company. Maybe that's not bold enough, maybe that's not risky enough, maybe this is not the company. So, to some extent, consensus would be a good symbol of that of a misfunctioning or not functioning, not decision-making that is not functioning well enough. So it's easier said than done. I mean, it's easier said that consensus is not that important, conviction is more important. You have to start with a few sets of rules in the corporate settings that so that you can implement that principle in your daily life. Say the boss should be the last to speak up. Why? Because people are very smart, they will look at the boss and they will look at the leader and they will trust the leader for a good reason, by the way. And if they will hear that, oh, that's a great idea, they will all start to be in line to agree with that opinion. If you just change the order, then the outcome might be different. We actually observe that with Ilya ourselves in our workshops. Or so you have to actually make juniors speak first or experts speak last because they will give an opinion that may impact everyone else's opinion, or keep it unanimous. And that's actually applied not just to investment practices. This could be applied for recruiting practices, for promotion benefits for HR, finance, any kind of decision making. If you want to make sure that the team would make the right decision or a better decision, then you may want to change the rules or the mechanisms of how the meeting is conducted.

Christian Soschner00:13:54

The Venture Mindset has roots in my hometown, Vienna. Alex shared that for the first time in this conversation. It starts with where he wrote it.

Alex Dang00:14:05

And I have to admit and probably Christian, this will be the first time announced on your in this interview. Some part of that book was written in Vienna where I found an escape, when I found an escape from a busy Silicon Valley life. And then I just could respond to people who were sending me emails, you know what, I'm not in the country, I cannot accept your phone call, and literally spent some time writing a book. That was helpful. So to some extent, Vienna definitely inspired me to write a few chapters and sections of the book.

Christian Soschner00:14:41

That's good to know. Why Vienna? What motivated you?

Alex Dang00:14:46

I love Vienna. Actually Vienna and Austrian economists as well as Austrian concepts are mentioned in the book. Say the game theory is mentioned in the book. You definitely know von Neumann and for the game theory. And I'm a big fan. When I was still at my college times, I was a big fan of Ludwig von Mises. And his very thick book, which my professors back then could not understand. Why would I spend that much of attention to that book, though I started with Hayek but then I realized that Hayek was a kind of a was a continuation of Mises' philosophy of human action. And again, that just highlights the importance of human in this process, the team, the jockey. These are the people who are actually building things. But von Neumann, it's definitely someone who created the whole gave us a nice analogy of a poker to some extent. If you think about poker von Neumann believed that would be the best analogy of life modeling. Why? Because if you think about a chess, this is a very predictable game. It's a very well-planned game. And that's why when you hear the things about strategy, you would normally put a chessboard as a picture, as an illustration of that. If you think about VCs, many people many think would think that they're gamblers. But this gambling is different because that's where you rely purely on a chance. Purely you go to a casino and just hope that you will win something. So it's kind of a two opposite parts. Very predictable nature of things, it's chess, that's kind of a game, and very unpredictable, pure luck gambling. Poker is somewhere in between because you collect information, more cards are open to you, more you can predict what's going to be the future, and that should impact your behavior. And von Neumann like that specific analogy of poker in game theory, and we like it as well, because actually VCs act in a very similar fashion. And we recommend even corporate leaders and decision makers think in the same way. You double down or quit. So you collect information and you double down if you like what you see and you quit if you think that the signal is wrong. That's what poker players do.

Christian Soschner00:17:15

Poker works at the card table. Inside a company, the chips are budgets and careers. How do you play it there?

Alex Dang00:17:23

And I would say that successful corporations should do exactly the same way. When we launched Prime Now, which is the one hour to two hour delivery at Amazon, we start with a very small-sized experiment at in a single zip code in New York City. So that's where Prime Now was first launched to collect information to learn more about the user feedback. And only after the first feedback was positive, then it started to scale to other cities and then to other countries. If you think about any bet of a technology corporation, that would be a typical process. You start small and then you scale fast as you learn on the way. But I don't want to miss one critical point that in case the feedback is not positive, then you should close the business, then you should cut your losses. You cannot just simply keep all of them, all of your ideas alive in a lab. Unfortunately, with Ilya and as a consultant, I had a chance to see so many labs and incubators where you can come and see so many ideas all prosper, that see the leadership, simply forget about their existence. And all of these zombies are still there. You have to cut your losses in order to keep the capital and your resources and your effort and your attention focused on the ones which are potentially unicorns or big ideas, which will become these 10x, 100x bets in your portfolio. That's why we use the analogy of a double down or quit which is a combination of doubling down on winners and quitting and or killing your darlings, even though it's one of the hardest jobs to do so.

Christian Soschner00:19:13

Killing a project is easy on paper. Now, picture that project as a CEO's personal favorite. Who in the room says stop?

Alex Dang00:19:23

It's all about, to some extent, the word failure. If the attitude within a corporation to failure is very negative, then you may never solve this problem. Because people are driven by incentives, and incentives drive behavior. Their decisions will be driven by incentives. And if you may lose your job or will not be promoted just because of a failure of your project, then well, it's really hard to expect that no sugarcoating would be happening because people would be and your leaders will be doing everything in the world to keep the project look alive, even though you'd rather close it. So, to some extent, companies which manage to solve that problem by letting people fail and still keep their jobs as well as to continue to experiment more with other ideas, that's a critical point. Of course, you have to define similar to VCs. There is a founder problem and there is a business idea problem, there are so many different risks. So, in some cases, if you're just a wasteful leader or made too many wrong decisions on the way because you ignored customer need, well, such a leader has to be fired by no means. And such a founder should not be funded. But in general the culture which will stimulate your failures in order to hunt for that outlier, in order to find one, I think that's the culture that you may want to enforce in order to get the success. And again, I can refer to companies which we already mentioned too many times on this in this interview Amazon, Apple, Google, all of them made many bets, and some of them are so proud of these bets that they even created a graveyard or of ideas that we invested in, similar to think of Google, similar to Bessemer Venture Partners, which created the anti-portfolio page on their website. What does that mean? It means that you can find companies that they had a chance to invest in, but never invested in. That's a very tough one to have a look at, but that's part of the journey. They appreciate so similar to me, when I was at Amazon, I had in my office press releases of successful projects as well as failures. And some of these failures, I would not name them all, just you will see why, because some of them were sponsored by senior executives as well as the CEO. So, meaning that it was fine to fail, even if it is inspired and sponsored by the CEO of the company.

Christian Soschner00:22:04

Markets usually swing between euphoria and panic, and most people swing with them. Venture investors wait close to a decade for a single exit. What keeps them from following the crowd?

Alex Dang00:22:18

I would just say that the word patience would be probably the one that you would not expect to hear when VC is discussed, VC industry, venture capital industry discussed, but that's actually a critical part of their success. We even named the chapter that good things take time and we refer to the patience of venture investors. If you think about venture capitalists, they make a very early bet on a small company, and then they often have to wait for six, eight, ten years until the time when they can actually exit the deal, when the company becomes either public, i.e., IPO or they would be acquired by a bigger player. And if you think about that investment, it's so it has all the negative aspects of a bad investment in terms of it's illiquid. You never know what's the actual price or a value of that investment until the very end. You can still be in series B, C, D, and yet do not know whether that would be a successful one or not, whether there will be an exit or not. Some investors in SpaceX, they're still waiting for the company to become public. So you have to be a different kind of an investor, and you have to play long in terms of your trends. And that's where they would refer to a very simple principle that there is typically a very short-term hype. So people would expect more from a technology to happen short term, but they underappreciate the impact of a technology midterm. So short term, we think that everything will be changed in the world, and that's kind of a hype mentality. But at the same time, midterm, we may miss some big industrial shifts, or that the whole sector could be transformed by the newly introduced technology like AI, like internet, like mobile, like semiconductor industry, like automation, robots, you name it all, but still thinking these long-term. That's a critical component of a VC mindset. So for a corporation which is making a bet today, if you your leadership expects to generate the first revenue or even profit next quarter, most likely this you either will be disappointed or it is not innovative enough. It doesn't mean that you should not do that. It's just not that kind of an innovation that would generate you 10x, 100x return internally. If you expect, if you want to build internal unicorns and invest in corporate innovation, extend your timeline to five to seven years. That would be a more realistic timeline for the for the business to become truly big. And if you look back at Amazon's example, AWS was a non-existent business, then many years down the road, that became the growth engine. The same would apply to Amazon advertising business. Again, didn't exist, became a big one. Or marketplace. Initially, it represented 1-2% of the total business. Now marketplace items, i.e., items which are not owned by Amazon itself, but owned by different sellers and merchants on the platform. That's now 50, 60, 70 percent of the business. And the curve took a while to get to that level. So patience. I think that would be the most important word to remind yourself. It doesn't mean that you have to be patient with bad results. Like I said, you may have to quit some businesses on the way. You have so many proxies and metrics and other mechanisms to apply. But longer term, that's the metric that you have to keep an eye on. Long-term impact in the time frame of five to seven years.

Christian Soschner00:26:01

All of this sounds like rules for funds and boardrooms. Alex takes it one step further. He applies them to your own calendar.

Alex Dang00:26:10

I would even elevate the discussion to our everyday decision making. If you are making in your everyday decisions only safe bets, then you may want to dial up the risk level a bit. Just because you may want to dedicate some amount of time on decisions and bets which are riskier in its nature which are some kind of wild bet. You don't have to dedicate all your life or all your career to such bets, but why not to pursue some side gig? Why not to respond to that crazy LinkedIn invitation that you've just received from someone that you do not know? Why not to accept that coffee chat with someone who wanted to get to know you, or why not to proactively reach out to professors that you worked with or talked to 10, 20, 30 years ago? So all of these small things or small bets may could be and should be, I think, included into your portfolio and may actually have a significant payoff as a result of that, not just monetary payoff that I'm referring to, just any kind of payoff in terms of accomplishment or just make your life richer in terms of your experience. But this is the way that not just VCs should think. I think everyone of us could leverage some tools and use some tools from that toolkit. Anyways, I'm a big optimist. I think every single time when I visit entrepreneurs and I see a room of hundreds and thousands of people, I realize that there will be a unicorn founder sitting right there. He or she just needs some support, not just from VCs with their capital, but also to explain the rules of the game and to explain to prevent them from making unnecessary mistakes. As well as when I meet with the corporate leaders, I think that they have so much assets and so many ways to experiment. And they have teams, they have expertise, they have customers, they have a supply chain in place. They just have to start running experiments and learn from VCs where to make bets. And for them, these bets are not that expensive. So I'm very optimistic on that front as well. So you can call me kind of a venture or Silicon Valley optimist, but I think the most transformation technology that we will discuss 10, 20 years down the road with you, Christian, will be not the one that we could name today.

Christian Soschner00:28:35

Alex closed with a bet of his own. The technology that defines the next 20 years has no name yet. The people who catch it will have placed many small bets long before anyone agreed with them. The full conversation runs two hours. It covers Amazon's internal experiments, the 3M and Six Sigma story, what cold emails to investors achieve, and the Austrian School of Economics. Listen to the complete episode and follow the show. What small bet will you place this week?