(2019-02-10) O'Reilly The Fundamental Problem With Silicon Valley's Favorite Growth Strategy

Tim O'Reilly: The fundamental problem with Silicon Valley’s favorite growth strategy. Most monopolies or duopolies develop over time, and have been considered dangerous to competitive markets; now they are sought after from the start and are the holy grail for investors. (Reid Hoffman and Chris Yeh’s new book Blitzscaling.)

Blitzscaling promises to teach techniques that are “the lightning fast path to building massively valuable companies.” Hoffman and Yeh argue that in today’s world, it’s essential to “achieve massive scale at incredible speed” in order to seize the ground before competitors do.

This premise has become doctrine in Silicon Valley. But is it correct? And is it good for society? I have my doubts.

Imagine, for a moment, a world in which Uber and Lyft hadn’t been able to raise billions of dollars in a winner-takes-all race to dominate the online ride-hailing market. How might that market have developed differently?

Would a market that grew more organically—like the web, e-commerce, smartphones, or mobile mapping services—have created more value over the long term?

There are plenty of reasons to believe that blitzscaling makes sense.

early days of Paypal. Back in 2000, the company was growing 5% per day, letting people settle their charges using credit cards while using the service for free. This left the company to absorb, ruinously, the 3% credit card charge on each transaction

Of course, for every company like Paypal that pulled off that feat of hypergrowth without knowing where the money would come from, there is a dotcom graveyard of hundreds or thousands of companies that never figured it out.

A strong case can be made that blitzscaling isn’t really a recipe for success but rather survivorship bias masquerading as a strategy.

However, Hoffman and Yeh do a good job of explaining the conditions in which blitzscaling makes sense: The market has to be really big; there has to be a sustainable competitive advantage (e.g., network effects) from getting bigger faster than the competition; you have to have efficient means to bootstrap distribution; and you have to have high gross margins, so that the business will generate positive cash flow and profits when it does get to scale. (Increasing Returns)

Hoffman and Yeh also make the point that what most often drives the need for blitzscaling is competition

sometimes it isn’t just the threat of competition that drives the need to turbocharge growth: It’s the size and importance of the opportunity, and the need to get big fast enough to effect change. For example, you can make the case that if Uber and Lyft and Airbnb hadn’t blitzscaled, they would have been tied up in bureaucratic red tape.

The strategic use of blitzscaling isn’t limited to startups. It can also apply to large companies, governments, and even nonprofits. For example, we’re facing a blitzscaling opportunity right now at Code for America, the non-profit founded and run by my wife Jennifer Pahlka, and on whose board I serve.

Emulating the tortoise, not the hare, has been our goal. We’ve always preferred opportunities where time is an ally, not an enemy.

So why is blitzscaling relevant to us?

it’s about building enough momentum to break through the stone walls of an old established order.

Too often, those passing new laws have given insufficient thought to their implementation, leaving existing bureaucratic processes in place.

After the passage in 2016 of California Proposition 64, which decriminalized marijuana and added millions to the rolls of those who had criminal records eligible to be expunged, San Francisco District Attorney George Gascon announced a program for automatic expungement

Unfortunately, lacking technology expertise, Gascon’s office set out to do it with manual labor, hiring paralegals

When we demonstrated that we could download the records in bulk and automate the evaluation of rap sheets, working through thousands of records in minutes and automatically generating the paperwork for clearance, they were all in.

many other states are also reducing sentences and pushing for record clearance. While we’ve already got our Clear My Record project well underway in California, other states are turning to legacy vendors working through legacy procurement processes

In short, there are compelling reasons to blitzscale, and the book provides a great deal of wisdom for those facing a strategic inflection point where success depends on moving much faster. But I worry that the book oversells the idea, and that too many entrepreneurs will believe this is the only way to succeed.

To understand why I’m skeptical about blitzscaling, you have to understand a bit about my own entrepreneurial history. I started my company, O’Reilly Media, 40 years ago with a $500 initial investment.

In 1993, my company launched GNN, the Global Network Navigator, which was the first advertising-supported site on the World Wide Web

Here, the market was exploding, and unless we could grow as fast or faster than the market, we’d soon be left behind. And we could see that the only way to do that would be to take in massive amounts of capital, with the price of chasing the new opportunity being the loss of control over the company.

Wanting to build a company that I would own and control for the long term, I decided instead to spin out GNN and sell it to AOL

Had we followed Hoffman and Yeh’s advice, we would have taken on a contest we were very unlikely to win, no matter how much money we raised or how fast we moved. And even though we abandoned these two opportunities when the blitzscalers arrived, O’Reilly Media has had enormous financial success, becoming a leader in each of our chosen markets.

There’s another point that Hoffman and Yeh fail to address. It matters what stories we tell ourselves about what success looks like.

Travis Kalanick, the co-founder and CEO of Uber, was the hyper-aggressive entrepreneur who raised money faster, broke the rules more aggressively, and cut the most corners in the race to the top.

Hoffman and Yeh embrace this dark pattern as a call to action. Early in their book, Blake, the cynical sales manager played by Alec Baldwin in the movie Glengarry Glen Ross, appears as an oracle dispensing wise advice.

none of these companies (except arguably Amazon) followed the path that Hoffman and Yeh lay out as a recipe for today’s venture-backed companies. Hypergrowth was the result rather than the cause of these companies’ success.

Ironically, Hoffman and Yeh’s book is full of superb practical advice about innovation, execution, and strategic focus, but it’s wrapped in the flawed promise that start-ups can achieve similar market dominance as these storied companies by force-feeding inefficient growth.

the book’s marketing copy does not promise the secret of building massively profitable or enduring companies, but merely “massively valuable” ones.

Is it a business or a financial instrument?

Because this blitzscaling model requires raising ever more money in pursuit of the hockey stick venture capitalists are looking for, the entrepreneur’s ownership is relentlessly diluted.

Bryce Roberts, my partner at O’Reilly AlphaTech Ventures (OATV), recently wrote about the probability of winning big in business:

This philosophy has turned venture capitalists into movie studios, financing hundreds of companies in pursuit of the mega-hit that will make their fund, and at its worst turns entrepreneurs into the equivalent of Hollywood actors, moving from one disposable movie to another. (2012-09-04-RaoEntrepreneursAreTheNewLabor)

The fact that the Silicon Valley blitzscaling model is not suited for many otherwise promising companies has led a number of venture capitalists, including my partner Bryce Roberts at OATV, to develop an approach for finding, inspiring, and financing cash-flow positive companies.

Indie.vc, a project at OATV, has developed a new kind of venture financing instrument. It’s a convertible loan that is designed to be repaid out of operating cash flow rather than via an exit, but that can convert to equity if the company, having established that there is a traditional venture business opportunity, decides to go that route.

OATV has invested in its share of companies that have gone on to raise massive amounts of capital—Foursquare, Planet, Fastly, Acquia, Signal Sciences, Figma, and Devoted Health for example—but we’ve also funded companies that were geared toward steady growth, profitability, and positive cash flow from operations, like Instructables, SeeClickFix, PeerJ, and OpenSignal.

those companies have responsibilities that go with that scale, and one of those responsibilities is to provide an environment in which other, smaller companies and individuals can thrive. Whether they got there by blitzscaling or other means, many of the internet giants are platforms, something for others to build on top of. Bill Gates put it well in a conversation with Chamath Palihapitiya when Palihapitiya was the head of platform at Facebook: “A platform is when the economic value of everybody that uses it exceeds the value of the company that creates it.”

The problem with the blitzscaling mentality is that a corporate DNA of perpetual, rivalrous, winner-takes-all growth is fundamentally incompatible with the responsibilities of a platform. Too often, once its hyper-growth period slows, the platform begins to compete with its suppliers and its customers.