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Everything I need to know about startups, I learned from a crime boss

By Donald DeSantis, Giant Thinkwell Jan. 7, 2012, 6:00am PT The door opened and into the room walked the most dangerous person I ve ever met. He reached towards his belt and slowly pulled out his .45 caliber handgun, raised it and paused to evaluate my expression. No disrespect, but it s been pressing into my hip all day. He placed the gun on the coffee table, relaxed into the leather sofa and let his guard down for the first time in a very long while. This person, let s call him Kobayashi (I m a Usual Suspects fan), is one of the most interesting people I ve ever met. He was a well-educated entrepreneur who ran a profitable business that employed dozens of people. He lived in a swanky downtown Los Angeles penthouse. His kids went to private school. He kept his fridge well stocked with imported beer and wine for guests even though he didn t drink. He was, by all measures, a gentleman. But Kobayashi ran an unusual business. He was in the business of organized crime. He started this venture quite young, expanded his operations, diversified revenue streams, and created very profitable independent business units. I have two lawyers, he once told me. I keep them both because they hate each other. Neither one of them can get out of line because the other one is watching him. That keeps me safe. Kobayashi was brilliant, witty, and dangerous. He was a friend and mentor to me during an interesting period of time in my early 20s. Everything I need to know about startups, I learned from Kobayashi. While I can t get too deep into specifics (would you?), I can share a few the things he taught me.

Dont sell rocks when you can sell mountains


Kobayashi didn t work with small packages. His business transactions involved risk at every stage product acquisition, transport, and distribution. But the marginal risk on each decreased with the size of the transaction. Working in large volume reduced his overall risk and rewarded him with a shrink-wrapped palette of cash rather than a suitcase of cash. As founders and early stage employees, we go to great lengths to mitigate risk. So why do we overlook the total marginal risk? Building a profitable small-market company is difficult and carries a high risk of failure. Building a profitable large-market company is also difficult and carries a high risk of failure. But the marginal risk in building a company decreases as the addressable market increases. While a larger company may require more total work, the relative effort is less. Make no mistake: small-market companies still come with 18 hour days, flaky vendors, upset customers, and exasperated spouses. Thinking small increases our risk. So let s think big. [Notes: Large vs. small is a different debate than bootstrapped vs venture-backed , though the two are often conflated. It s also worth noting that serving a small segment and progressively expanding outwards to serve the larger market is a totally legitimate large-market strategy.]

Cut out the middleman


As Kobayashi s businesses grew, he was in a position to start bypassing middlemen. Instead of dealing with distributors, he went straight to producers. Instead of hiring contractors, he purchased required equipment and moved people onto payroll. Everywhere he saw a third party making money, he figured out a way to

replace that person or bring them in-house. He reduced costs at every step. He constantly encouraged me to do the same. Interesting things happen when we cut out the middleman. In addition to reducing cost, we often end up creating an internal byproduct that can be productized and sold to a completely new customer. (Amazon Web Services is an example of this.) Sometimes the middleman s market is so huge, that a freaking enormous business can be built simply by providing their customers a lower cost and more efficient option. Two-sided marketplace businesses are a textbook example of this type of disruption.

Dont shit where you eat


When someone s doing something for the money, people can sense it, like a desperate lover. It s a turnoff. Derek Sivers, Anything You Want During this period of my life, I was running a couple businesses that overlapped around the edges. One business had loyal and enthusiastic customers. This business was glamorous, but hemorrhaging money. The other business was transactional and lacked any customer loyalty or love. This business was antiglamorous and a bit closer to Kobayashi s world than I care to admit. As time passed, I felt increasing pressure to monetize customers from the first group. I began to overlap these businesses more and more. While they included the same customer segments, there were two completely different products. This pollution of something beautiful with something cheap was my act of shitting in the proverbial kitchen. I watched as revenues increased and looked away from the damage I was causing to the customers I really cared about. Thankfully, Kobayashi pulled me aside and straightened me out. The lesson for us is simple. Don t screw with your users. They are your golden-egg-laying goose. Protect them from rapacious cofounders and investors. Don t spam them. Don t abuse them. Don t be a douchebag.

If it dont make dollars, it dont make sense


A business without a path to profit isn t a business, it s a hobby. Jason Fried, Rework

We can build an awesome product and then give it away for free. We can bolt advertising to it. We can turn it into a lead-gen property. We can even sell some virtual goods. Kobayashi wouldn t. He would have built Birchbox rather than Pinterest and Airbnb rather than TripAdvisor. He would have found product market fit and a viable business model before spending money on development resources. Kobayashi stayed close to the money, close to a transaction. Kobayashi was around for the late 90 s tech bubble. He knew many of the players and saw the writing on the wall long before they did. He talked about the first tech wave as if it was a fad that had simply passed, saying things like when dot-com went out If it don t make dollars, it don t make sense may sound like a gross oversimplification. But Kobayashi outlasted those late 90 s startup founders. And he ll probably outlast most of us.

Closed mouths dont get fed


I ve written before about the importance of networking and moving from wallflower to evangelist. Kobayashi was adamant about the importance of this. Closed mouths don t get fed, he would say. If you want something, you have to either ask for it or walk up and take it. We can t expect good fortune to fall into our lap. It s our responsibility to create the circumstances for it and then capture that good fortune. The meek may inherit the earth, but they ll be getting it from Kobayashi.

Be a badass
There s only one thing that will make them stop hating you. And that s being so good at what you do that they can t ignore you. Orson Scott Card, Ender s Game My friend Chris DeVore makes a comparison I love: pirate ships as organizational models. Pirate ships combine an us against the world mentality with a hunt for treasure. This crucible of chaos and ambition somehow allows unstructured groups of mercenaries to complete complex tasks without killing one another (very often). A pirate ship is a meritocracy where he/she who is most badass, leads. I ve met several badasses over the years, though Kobayashi is the most memorable. Each one of these people had a gravitational pull for talent and resources. The world reorganized itself around them as they passed through it. They were larger than life, energizing everyone in their periphery. The one thing these badasses shared was the source of their power: influence rather than authority. This lesson is the most important and also the most difficult to implement. There s no pill, book, or retreat that will turn us into badasses. But if we want to captain a pirate ship, we must become the most badass version of ourselves. Kobayashi taught that we lead only with the influence we earn. Donald DeSantis is a developer and UX designer at TechStars company Giant Thinkwell. In his free time, he travels to faraway cities and helps make Startup Weekend events successful. You can find him on Twitter at @donalddesantis.

The thin edge of the wedge strategy


Establishing relationships with new users is the hardest part of growing a startup. For consumer products establishing relationships can mean many things: installs, registrations, purchases, or even just getting users to think of your website as a place to go for certain purposes. For B2B products, establishing relationships means getting internal users or testers and eventually contracts and payments. For business development partners for example API/widget partners establishing relationships usually means getting functionality embedded in partners products (e.g. a widget on their website). One common strategy for establishing this initial relationship is what is sometimes known as the thin edge of the wedge strategy (aka the tip of the spear strategy). This strategy is analogous to the bowling pin strategy: both are about attacking a smaller problem first and then expanding out. The difference is that the wedge strategy is about product tactics while the bowling pin strategy is about marketing tactics. Sometimes the wedge can be a simple feature that existing companies overlooked or saw as inconsequential. The ability to share photos on social networks was (strangely) missing from the default iPhone camera app (and sharing was missing from many third-party camera apps like Hipstimatic that have popular features like lo-fi camera filters), so Instagram and Picplz filled the void. Presumably, these startups are going to try to use mobile photo sharing as the wedge into larger products (perhaps full-fledged social networks?). Sometimes the wedge is a single player mode a famous example is early adopters who used Delicious to store browser bookmarks in the cloud and then only later once the user base hit critical mass used its social bookmarking features. Other times the wedge lies on one side of a two-sided market, in which case the wedge strategy could be thought of as a variant of the ladies night strategy. I m told that OpenTable initially used the wedge strategy by providing restaurants with terminals that acted like simple, singleplayer CRM systems. Once they acquired a critical mass of restaurants in key cities (judiciously chosen using the bowling pin strategy), opentable.com had sufficient inventory to become useful as a one-stop shop for consumers. Critics sometimes confuse wedge features with final products. For example, some argue that mobile photo sharing is just a feature, or that game mechanics on geo apps like Foursquare are just faddish toys. Some go so far as to argue that the tech startup world as a whole is going through a phase of just building dinky features and companies. Perhaps some startups have no plan and really are just building features, likely with the hope of flipping themselves to larger companies. Good startups, however, think about the whole wedge from the start. They build an initial user base with simple features and then quickly iterate to create products that are enduringly useful, thereby creating companies that have stand-alone, defensible value.

The bowling pin strategy


A huge challenge for user-generated websites is overcoming the chicken-and-egg problem: attracting users and contributors when you are starting with zero content. One way to approach this challenge is to use what Geoffrey Moore calls the bowling pin strategy: find a niche where the chicken-and-egg problem is more easily overcome and then find ways to hop from that niche to other niches and eventually to the broader market. Facebook executed the bowling pin strategy brilliantly by starting at Harvard and then spreading out to other colleges and eventually the general public. If Facebook started out with, say, 1000 users spread randomly across the world, it wouldn t have been very useful to anyone. But having the first 1000 users at Harvard made it extremely useful to Harvard students. Those students in turn had friends at other colleges, allowing Facebook to hop from one school to another.

Yelp also used a bowling pin strategy by focusing first on getting critical mass in one location San Francisco and then expanding out from there. They also focused on activities that (at the time) social networking users favored: dining out, clubbing and shopping. Contrast this to their direct competitors that were started around the same time, were equally well funded, yet have been far less successful. How do you identify a good initial niche? First, it has to be a true community people who have shared interests and frequently interact with one another. They should also have a particularly strong need for your product to be willing to put up with an initial lack of content. Stack Overflow chose programmers as their first niche, presumably because that s a community where the Stack Overflow founders were influential and where the competing websites weren t satisfying demand. Quora chose technology investors and entrepreneurs, presumably also because that s where the founders were influential and well connected. Both of these niches tend to be very active online and are likely to have have many other interests, hence the spillover potential into other niches is high. (Stack Overflow s cooking site is growing nicely many of the initial users are programmers who crossed over). Location based services like Foursquare started out focused primarily on dense cities like New York City where users are more likely to serendipitously bump into friends or use tips to discover new things. Facebook has such massive scale that it is able to roll out its LBS product (Places) to 500M users at once and not bother with a niche strategy. Presumably certain groups are more likely to use Facebook check-ins than others, but with Facebook s scale they can let the users figure this out instead of having to plan it deliberately. That said, history suggests that big companies who rely on this carpet bombing strategy are often upended by focused startups who take over one niche at a time.

Six strategies for overcoming chicken and egg problems


Products with so-called networks effects get more valuable when more people use them. Famous examples are telephones and social networks. Complementary network effects refer to situations where a product gets more valuable as more people use the product s complement(s). Two products are complementary when they are more (or only) useful together for example, a video game and video game console, or an OS and an application for that OS. Microsoft Windows gets more valuable the more apps are made for it, which in turn makes Windows more popular, which in turn leads to more apps, and so on. Microsoft Windows is not more valuable simply because there are more copies of Microsoft Windows in the world, but because there are more complements to Windows in the world. Network effects can be your friend or your enemy depending on whether your product has reached critical mass. Getting to critical mass in complementary network effect markets is sometimes called overcoming the chicken and egg problem. Back in graduate school (2003), my friend Jeff Rhodes and I wrote a paper titled Six Strategies for Overcoming the Chicken and Egg Problem in Complement-Based Network Effects Markets. This is a frequent challenge when launching technology products, yet at least at the time we had seen very few people try to systematically document strategies for overcoming it. Some of our examples are a bit dated now, but if you are interested in this topic you might like the full paper. Here is a high level summary of the 6 strategies we describe with a few updated examples. I d love to hear from any readers who have more strategies and/or example products. 1. Signal long-term commitment to platform success and competitive pricing. When Microsoft launched the original Xbox, they made a big deal of publicly committing to spending $500M promoting the platform, thereby signalling that they were fully committed for the long haul and giving comfort to 3rd party game developers. Another way to give comfort that your platform isn t going away is to open source it this way third parties know that even if the company stops supporting the product, independent developers can continue to do so (e.g. Google Android and Chrome). Open sourcing also gives comfort that the company isn t going to raise prices once they ve reached critical mass.

2. Use backwards and sideways compatibility to benefit from existing complements. Microsoft of course has used backward compatibility very successfully for decades with DOS and then Windows, as have many game console makers. In our paper we argue that the successful early bill pay ( bill presentment ) companies provided backward compatibility by sending snail mail checks to merchants who had yet to sign on to their electronic platform. Virtual machines and Bootcamp gave Apple s hardware some sideways compatibility with Windows. Sun s invention of Java could be seen as an attempt to introduce sideways compatibility between its shrinking server market and its competitors (Windows, Linux) by introducing a new, cross-platform programming layer. 3. Exploit irregular network topologies. In the last 90s, most people assumed that dating websites was a winner take all market and Match.com had won it, until a swath of niche competitors arose (e.g. Jdate) that succeeded because certain groups of people tend to date others from that same group. Real-life networks are often very different from the idealized, uniformly distributed networks pictured in economics textbooks. Facebook exploited the fact that social connections are highly clustered at colleges as a beachhead to challenge much bigger incumbents (Friendster). By finding clusters in the network smaller companies can reach critical mass within those sub-clusters and then expand beyond. 4. Influence the firms that produce vital complements. Sony and Philips, the companies that oversaw the successful launch of the compact disc technology in the early 1980 s, followed the CD launch with the introduction of the digital audiotape (DAT) in 1987. The DAT offered CD sound quality and, in a significant improvement over CD technology, it also offered the ability to record music. Despite these improvements, the DAT never gained significant consumer adoption and ended as an embarrassing failure for Sony and Philips. DAT failed because Sony and Philips failed to reassure record companies who were concerned that the recording capabilities of DAT would lead to widespread piracy. Sony finally reached an anti-piracy agreement with record companies in 1992, but by that time consumer expectations for the DAT platform were dampened sufficiently to doom the platform. On the other hand, when Sony and Philips launched the CD, they succeeded because they did a significantly better job influencing complement producers. Most importantly, they addressed the record companies primary concern by making CDs piracy resistant (or so it seemed at the time). In addition, Philips was able to influence Polygram, a major record label, to release music in the CD format because Philips owned a 50 percent stake in Polygram. Finally, Sony and Philips provided the record companies with access to their manufacturing technology and plant in order to ensure an adequate supply of complementary products. As a result, nearly 650 music titles were available in CD format when the first CD players were released and the CD format went on to become the most popular music format. 5. Provide standalone value for the base product. Philips introduced the videodisc player (VDP) in 1979 as a competitor to the VCR. VDPs had slightly better picture quality than VCRs and had potentially lower hardware and software costs, owing to a simpler manufacturing process. However, the VCR had a 3-4 year head start on the VDP and had already developed an installed base of over one million units. Providing a stand-alone use is the strategy that VCR producers used to achieve a successful launch and avoid fighting the difficult chicken and egg startup problem. Unlike the VDP, the VCR offered the ability to time-shift television programming. In fact, when the VCR was launched this was the only application available because the market for pre-recorded videocassettes had not yet developed. The standalone value for the VCR time-shifting television programming was sufficiently strong to get over a million people to purchase the product in the first 3-4 years after its launch. This installed user base of the VCR as a base product was sufficient to entice entrepreneurs to develop a market for pre-recorded videocassettes as complementary products in the late 1970 s. The complement-based network effect that resulted improved the value of the base product, increased sales velocity for the base and complementary products, and ensured that the VCR would be a common feature in most American homes. A good modern example of this would be del.icio.us, which had stand alone value by storing your bookmarks in the cloud, and also had network effects with its social features. 6. Integrate vertically into critical complements when supply is not certain. To overcome the chicken and egg problem, companies must find a way to ensure an adequate supply, variety, and quality of
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complementary goods. By vertically integrating into the complement product as well as the base product, a company can attempt to ensure an adequate supply of both goods. Nintendo is the leading developer of games for its consoles, and Microsoft and Sony fund many of their most popular games. Vertical integration is risky as witnessed by the Apple computer in the late 80s and early 90s. By remaining tightly integrated, Apple precluded market competition from providing the necessary variety of price-competitive complements and base products. ** Many of the above strategies (especially 3 & 5) apply to regular (non-complementary) network effect products.

Train Your Brain to Focus


Next time you are sitting in a meeting, take a look around. The odds are high that you will see your colleagues checking screens, texting, and emailing while someone is talking or making a presentation. Many of us are proud of our prowess in multitasking, and wear it like a badge of honor. Multitasking may help us check off more things on our to-do lists. But it also makes us more prone to making mistakes, more likely to miss important information and cues, and less likely to retain information in working memory, which impairs problem solving and creativity. Over the past decade, advances in neuroimaging have been revealing more and more about how the brain works. Studies of adults with attention deficit hyperactivity disorder (ADHD) using the latest neuroimaging and cognitive testing [PDF] are showing us how the brain focuses, what impairs focus and how easily the brain is distracted. This research comes at a time when attention deficits have spread far beyond those with ADHD to the rest of us working in an always-on world. The good news is that the brain can learn to ignore distractions, making you more focused, creative, and productive. Here are three ways you can start to improve your focus. Tame your frenzy. Frenzy is an emotional state, a feeling of being a little (or a lot) out of control. It is often underpinned by anxiety, sadness, anger, and related emotions. Emotions are processed by the amygdala, a small, almondshaped brain structure. It responds powerfully to negative emotions, which are regarded as signals of threat. Functional brain imaging has shown that activation of the amygdala by negative emotions interferes with the brain's ability to solve problems or do other cognitive work. Positive emotions and thoughts do the opposite they improve the brain's executive function, and so help open the door to creative and strategic thinking. What can you do? Try to improve your balance of positive and negative emotions over the course of a day. Barbara Fredrickson, a noted psychology researcher at the University of North Carolina, Chapel Hill, recommends a 3:1 balance of positive and negative emotions, based upon mathematical modeling of ideal team dynamics by her collaborator Marcial Losada, and confirmed by research on individual flourishing and successful marriages. (Calculate your "positivity ratio" at www.positivityratio.com). You can tame negative emotional frenzy by exercising, meditating, and sleeping well. It also helps to notice your negative emotional patterns. Perhaps a coworker often annoys you with some minor habit or quirk, which triggers a downward spiral. Appreciate that such automatic responses may be overdone, take a few breaths, and let go of the irritation.

What can your team do? Start meetings on positive topics and some humor. The positive emotions this generates can improve everyone's brain function, leading to better teamwork and problem solving. Apply the brakes. Your brain continuously scans your internal and external environment, even when you are focused on a particular task. Distractions are always lurking: wayward thoughts, emotions, sounds, or interruptions. Fortunately, the brain is designed to instantly stop a random thought, an unnecessary action, and even an instinctive emotion from derailing you and getting you off track. What can you do? To prevent distractions from hijacking your focus, use the ABC method as your brain's brake pedal. Become Aware of your options: you can stop what you are doing and address the distraction, or you can let it go. Breathe deeply and consider your options. Then Choose thoughtfully: Stop? or Go? What can your team do? Try setting up one-hour distraction-free meetings. Everyone is expected to contribute and offer thoughtful and creative input, and no distractions (like laptops, tablets, cell phones, and other gadgets) are allowed. Shift Sets. While it's great to be focused, sometimes you need to turn your attention to a new problem. Set-shifting refers to shifting all of your focus to a new task, and not leaving any behind on the last one. Sometimes it's helpful to do this in order to give the brain a break and allow it to take on a new task. What can you do? Before you turn your attention to a new task, shift your focus from your mind to your body. Go for a walk, climb stairs, do some deep breathing or stretches. Even if you aren't aware of it, when you are doing this your brain continues working on your past tasks. Sometimes new ideas emerge during such physical breaks. What can your team do? Schedule a five-minute break for every hour of meeting time, and encourage everyone to do something physical rather than run out to check email. By restoring the brain's executive function, such breaks can lead to more and better ideas when you reconvene. Organizing your mind, and your team members' minds, will yield a solid payoff in the year ahead. Adding "high-quality focus" is a great place to start. Try holding a no-multitasking meeting and see what happens when everyone in the room gives their undivided attention. Have you ever tried this in your organization? If not, do you think it would fly?