Book Notes: Innovation and Entrepreneurship

As with my other book notes, some passages are direct quotes and others are my own paraphrasing/summaries. Any footnotes or [brackets] are my personal comments.

Innovation & Entrepreneurship (1985), by Peter Drucker

Innovation and Entrepreneurship“The entrepreneur,” said the French economist J. B. Say around 1800, “shifts economic resources out of an area of lower and into an area of higher productivity and greater yield.”

All new small businesses have many factors in common. But to be entrepreneurial, an enterprise has to have special characteristics over and above being new and small. Indeed, entrepreneurs are a minority among new businesses. They create something new, something different; they change or transmute values. An enterprise also does not need to be small and new to be an entrepreneur. Indeed, entrepreneurship is being practiced by large and often old enterprises.

The entrepreneur upsets and disorganizes. As Joseph Schumpeter formulated it, his task is “creative destruction.” They see change as the norm and as healthy. Usually, they do not bring about the change themselves. But—and this defines entrepreneurship—the entrepreneur always searches for change, responds to it, and exploits it as an opportunity.

When shifting resources to a more productive area, there is a risk the entrepreneur may not succeed. But if they are even moderately successful, the returns should be more than adequate to offset whatever risk there might be. One should thus expect entrepreneurship to be considerably less risky than optimization. Indeed, nothing could be as risky as optimizing resources in areas where the proper and profitable course is innovation, that is, where the opportunities for innovation already exist. Theoretically, entrepreneurship should be the least risky rather than the most risky course. [There are “hidden” risks of not being an entrepreneur.]

“Innovation,” then, is an economic or social rather than a technical term. It can be defined the way Say defined it, as changing the yield of resources. Or, as modern economists would tend to do, it can be defined in demand terms rather than in supply terms: changing the value and satisfaction obtained from resources by the consumer. Continue reading “Book Notes: Innovation and Entrepreneurship”

Instacart: analysis of a startup

InstacartInstacart is a seed-stage startup that delivers groceries and other basic items in a very short timeframe. They are the “Amazon.com with a 1 hour delivery.” At the moment their current market is only San Francisco and the Silicon Valley area. Customers can place either a 3-hour order ($3.99) or a 1-hour order ($14.99).  Orders are routed to shoppers who work for Instacart, who then pick up the items at a local store and deliver them within the timeframe.

In October they raised $2.3 million from Canaan Partners and Khosla Ventures. Below is a  a very brief analysis if I were considering a potential investment in Instacart.

Quick analysis

So basically Instacart uses software (algorithms & data analysis on the back-end, with good UI design on the front-end) to connect “deliverers” in need of cash with “buyers” who need quick delivery of basic items.

Opportunity: arbitraging the demand for instant satisfaction and convenience, using software + crowdsourcing. This will be disrupting convenience stores on the low-end, and potentially grocery stores in the future. It is taking advantage of the trends in mobile computing, data analysis, and e-commerce (willingness to trust online vendors).

Potential moatsbrand habit developed through repeated purchases. Learning curve — should remain ahead of competition on the learning curve because of technology (software) advantage. This is a business where it pays to have lots of data on: customer habits, traffic, prices, store traffic, etc. It is a virtuous circle: the learning curve reinforces customer experience, which improves the brand. These advantages are all geographically local, so it will be best to roll out to new cities as quickly as possible once the kinks are worked out.

Management: with only doing minimal due diligence with public information on the founders, I didn’t see any red flags. Apoorva Mehta has worked on the Amazon supply chain, so he has some experience in the business. All founders on the surface seem to be very talented. What am I looking for? Amar Bhide found that the most important traits for the founders of a typical startup are the dichotomies of: (1) seeking uncertainty while being risk averse; and (2) persevering while being adaptable.

What could go wrong: (1) other cities are not as receptive to the concept; (2) Amazon or other grocery company catches on and preempts their growth in new cities.

Investment edge: structural (not very many participants at this early stage) and psychological (grocery delivery has failed many times in the past, sometimes spectacularly — Webvan — investors are turned off by the concept because of these past failures).

Final note

This seems like a company with a good future ahead of it. That usually makes it a good investment, especially at this stage. I’m not sure what the valuation of the company is at the moment. But for a startup at this stage, the precise valuation you invest at isn’t usually as important as how well the company does (within limits, of course — refer to the internet bubble).

Disclosure: I have no ownership in Instacart.

References:

Crunchbase: Instacart
Mobile first, desktop second…
I Trusted a Total Stranger to Buy My Groceries…
Instacart Bags $2.3M To Become Amazon of Groceries
How Instacart Hacked YC

On startup dictatorships

There’s a trade-off that CEOs — particularly startup CEOs — must make, and it’s between two roles that can be both conflicting and complementary.

The first role is that of guiding visionary. They guide overall strategy and ensure that the vision, purpose, and values of the organization are aligned with that strategy and permeate the company. This is also a supportive role, where you support other coworkers and projects and try to take an outsider’s perspective on the dynamics of strategy and internal organization. In this role, you are a team-member on the same level as other senior managers (the C-suite, VPs of Product, Marketing, Talent, etc.).

The second role is that of a dictator. Despite being in a team on essentially the same level of hierarchy, as the CEO/founder you have what I call “ultimate dictatorial authority.” This is especially needed in a young startup — there can be no democracy. Firm decisions need to be made and conflicts need to be resolved.

I learned this the hard way when doing Startup Weekend and being part of a team where each person’s opinion seemed to have equal weight (despite the high average intelligence and good intentions of the group, it was hard to make decisions in the uncertainty). We eventually figured it out but a lot of time was wasted.

“If you try to submit everything to voting processes when you’re trying to do something new, you end up with bad, lowest common denominator type results,” says Peter Thiel.

Strategy is hard and everyone will not agree on everything. Decisions need to be quick and a choice needs to be made, even if it turns out to be the wrong one. The CEO also has to have an open mind and be willing to embrace dissension and explore contrary views, but that’s the subject of another discussion.

Monarchy vs. Democracy

Peter Thiel again: “A startup is basically structured as a monarchy. . . . Importantly, it isn’t an absolute dictatorship. . . . People vest the top person with all sorts of power and ability, and then blame them if and when things go wrong.”

If all startups were democracies, the distribution of outcomes would be much more flat and normal. Everyone would be mediocre. But they aren’t, and the distribution of startup outcomes follows a power law: a few huge successes and lots of failures.

There are many reasons for the huge success of only a few companies, but a “benevolent” dictator with board oversight is one of them. Oversight is needed because, as in political systems, a malevolent dictator will eventually find their way to the top. Unlike in political systems, customers / employees aren’t as captive and companies with a poorly performing dictator won’t last long in the marketplace.

Being a founder is about responsibility

When you start a company alone, you are 100% responsible for every job it entails. You are a true generalist. This means your job consists of product strategy, customer service, development/engineering, UX design, finance, accounting, janitorial work, hiring, distribution, etc. etc.

As you bring new people into the organization, they slowly start taking responsibility from you, job by job. So you hire an engineer, and now they are responsible for 90% of product development while you take the remaining 10%. The talent base has grown but you never abdicate all responsibility for a job… you will always play at least a small role in everything.

You keep hiring people until most of the job responsibilities rest on other people. When this happens, you still play a role in everything, but it is a role more of vision, guidance and support.

So the office is dirty and nobody’s cleaning it up? Yeah, it’s not your primary concern — but you’re still responsible for it. “That’s not my job” shouldn’t be in your vocabulary whether you have 10 people working for you or 10,000.

DRI

At Apple, they assign DRIs (directly responsible individuals) for projects and tasks that need getting done. This is the go-to person that takes ultimate responsibility for the job. It is important that someone is assigned this role because otherwise responsibility may be too diffused, in which case nothing gets done.

So in my view even though the higher up the chain you are the more your responsibility, there still needs to be a specific DRI assigned for each project or job in the business. A DRI is not used to assign blame, but to assign responsibility for maintenance, improvement, and problem resolution. This could be a manager or just someone on a team that came up with a good idea.

Cross posted at the Atlastory Blog

Entrepreneurial Arbitrage

copy-transform-combine

Arbitrage is “the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices.” Once the arbitrage spread closes, the profit is made and the opportunity no longer exists. According to Austrian Economics, entrepreneurs’ profits “derive from the services he performs in detecting and eliminating arbitrage opportunities, thereby allowing supply and demand for a given good to meet.” By recognizing and acting on opportunities, the entrepreneur moves markets toward equilibrium. So entrepreneurial arbitrage is a low-risk way of exploiting gaps between what the market demands and what it’s being supplied until the spread closes.

There is very little “invention” involved—startups imitate or slightly modify someone else’s idea and only introduce breakthrough products or new business models many years later. This is what Peter Drucker calls creative imitation. The technology and market demand already exist, but the creative entrepreneur understands what the innovation represents better than the original innovators. This also includes packaging current technologies into new business models. Paul Graham calls this an idea that’s “a square in the periodic table”—if it didn’t exist now, it would be created shortly.

Continue reading “Entrepreneurial Arbitrage”

Underestimating the Groupon Model

As widely reported, Groupon filed their first S-1 today in preparation for an IPO. They’re raising $750 million on top of the $160 million they have already raised from angel & venture capital investors so far. The likely valuation range will be $20-25 billion (or possibly more after what happened with the LinkedIn IPO).

The hefty valuation, along with the youth of the company (2.5 years) and the reported operating loss may lead observers and the media to cry “bubble.” While I think that $25 billion is a very rich valuation and wouldn’t pay that amount if it went public today, I think people in general underestimate the potential of Groupon’s business model. In other words, they were probably right to turn down Google’s offer of $6 billion (even if they don’t cash out during the offering).

Before going into Groupon’s business model and competitive advantages, here’s a quick run down of some of their customer statistics from the S-1:

In the above equation, those 5 metrics are multiplied to arrive at Groupon’s net revenue amount (the amount Groupon gets to keep after giving merchants their cut). So in the first quarter they made $270 million before expenses.

First the market, then the moat

Before Groupon and all the other deal sites began, local businesses had many lackluster options for advertising their product. They could send coupons in the mail; pay for ads in a local newspaper; pay for outdoor advertising; or pay for online advertising via Google, local news sites, etc. Most of these options (Google less so) are what Seth Godin calls interruption marketing. They are made to interrupt what you are normally trying to do. And because of that, people usually don’t like them, and they have a very low hit-rate in acquiring customers. Continue reading “Underestimating the Groupon Model”