This is Kristen O'Brien, Managing Editor at NFX, and this is the founder list. Audible versions of essays from technology's most important leaders selected by the founder community. This is strategy letter 1, Ben and Jerry's versus Amazon, written by Joel Spalski. Building a company, you've got one very important decision to make because it affects everything else you do.
No matter what else you do, you absolutely must figure out which camp you're in and gear everything you do accordingly, or you're going to have a disaster on your hands. The decision Beller to grow slowly organically and profitably or whether to have a big bang with very fast growth and lots of capital. The organic model is to start small with limited goals and slowly build a business over a long period of time.
I'm gonna call this the Ben and Jerry's model, because Ben and Jerry's fits this model pretty well. The other model popularly called the Pete Big Fast, AKA Land Grab, requires you to raise a lot of capital and work as quickly as possible to get big fast without concern for profitability. I'm gonna because Jeff Bezos, founder of Amazon, has practically become the celebrity spokesmodel for Get Big Fast. Let's look at some of the differences between these models.
The first thing to ask is, are you going into a business that has competition or not? If you don't have any real competition like Amazon, there is a chance that you can succeed at a land grab that is get as many customers as quickly as possible so that later competitors will have a serious barrier to entry. But if you're going into an industry where there is already a well established set of competitors, the land grab idea doesn't make sense.
You need to create your customer base by getting customers to switch over from competitors. In general, venture capitalists aren't too enthusiastic about the idea of going into a market with pesky competitors. Personally, I'm not so scared of established competition, Perhaps because they worked on Microsoft Excel during a period when it almost completely took over Lotus 123, which virtually had the market to themselves.
The number one word processor word displace word perfect, which displaced word star, all of which had been near monopolies at one time or another, and Ben and Jerry's grew to be a fabulous business even though it's not like you couldn't get ice cream before they came along, it's not impossible to displace a competitor if that's what you want to do, I'll talk about how to do that in a future strategy letter. Another question about displacing competitors has to do with network effects and lock in.
A network effect is a situation where the more customers you have, the more customers you will get. It's based on Metcalfe's law. The value of a network is equal to the number of users squared. A good example is eBay. If you wanna sell your old Pete Philippe watch, you're going to get a better price on eBay because there are more buyers there. If you want to buy a Pete Philippe watch, you're going to look on eBay because there are more sellers there.
Another extremely strong network effect is proprietary chat systems like ICQ Morgan Instant Messenger. If you want to chat with people, you have to go where they are and ICQ and AOL have the most people by far. Chances are your friends are using one of those services, not one of the smaller ones like MSN instant messenger.
With all of Microsoft's muscle, money, and marketing skill, They're just not going to be able to break into auctions or instant messaging because the network effects are so strong. Lock in is where there is something about the business that makes people not want to switch. Nobody wants to switch their internet provider even if the service isn't very good because of the hassle of changing your email address and notifying everyone of the new email address.
Pete don't wanna switch word processors if their old files can't be read by the new word processor. Even better than lock in is the sneaky version I call stealth lock in. Services which lock you in without you ever realizing it. For example, all those new services like paymy bills.com which receive your bills for you scan them in and show them to on the Internet. They usually come with 3 months free service.
But when the 3 months are up, if you don't want to continue with the service you have no choice but to contact every single bill provider and ask them to change the billing address back to your house. The sheer chore of doing this is likely to prevent you from switching away from pay my bills.com. Beller just to let them keep sucking and lock in and there are no established competitors, then you better use the Amazon model or somebody else will and you simply won't be able to get a toehold.
Quick case study. In 1998, AOL was spending massively to grow at a rate of a million customers every 5 weeks. AOL has nice features like chat rooms and instant messaging that provides stealth lock in. Once you've found a group of friends you like to chat with, you were simply not going to switch internet providers. That's like trying to get all new friends. In my mind, that's the key reason that AOL can charge around $22 a month when there are plenty of $10 a month Internet providers.
While I was working in Juno, management just failed to understand this point and they missed their best opportunity to overtake AOL during a land rush when everyone was coming online. They didn't spend strong enough on customer acquisition because they didn't want to dilute existing shareholders by raising more capital and they didn't think strategically about chat and I am, so they never developed any software features to provide the kind of stealth lock in that AOL has.
Now Juno has around 3,000,000 people paying them an average of 5.50 a month, while AOL has around 21,000,000 people paying them an average of $17 a month. Oops. Beller and Jerry's companies start on somebody's credit card. In their early months and years, they have to use a business model that becomes profitable extremely quickly, which may not be the ultimate business model that they want to achieve.
For example, you may want to become a giant ice cream company with $200,000,000 in annual sales, but for now, you're going to have to settle for opening a little ice cream shot in Vermont. Hope that it's profitable and if it is, reinvest the profits to expand business steadily. The Ben and Jerry's corporate history says they started with a $12,000 investment. Ours digital says that they started with an $11,000 investment. These numbers sound like a typical Mastercard credit limit.
Amazon companies raise money practically as fast as anyone can spend it. There's a reason for this. They are in a terrible rush. If they're in a business with no competitors and network effects, they better get big super fast. Every day matters. There are lots of ways to substitute money for time. Nearly all of them are fun. Here are some ways to substitute money for time.
Use prebuilt furnished executive offices instead of traditional office space, cost about three times as much, time saved, several months to a year depending on market. Pay outrageous salaries or offer programmers BMWs as starting bonuses. Cost about 25% extra for technical staff. Time saved, you can fill openings in 3 weeks instead of the more typical 6 months. Higher consultants instead of employees cost about three times as much. Time saved, you can get consultants up and running right away.
Having trouble getting your consultants to give you the time and attention you need bribe them with cash until they only wanna work with you. Spend cash freely to spot solve problems. If your new star programmer isn't getting a lot of work done because they're busy setting up their new house and relocating, hire a high class relocation service to do it for them. If it's taking forever to get phones installed in your new offices, by a couple of dozen cell phones.
Internet access problems slowing people down, just get 2 redundant providers, provide a concierge available to all employees for picking up dry cleaning, getting reservations, arranging for limos to the airport, etcetera. Beller and Jerry's companies just can't afford to do this, so they have to settle for growing slowly. When you're growing faster than about a 100% per year, it is simply impossible for mentors to transmit corporate values to new hires.
If a programmer is promoted to manager and suddenly has 5 new reports hired just yesterday, it is simply impossible for there to be very much mentoring. Netscape is the most egregious example of this, growing from 5 to about 2000 programmers in 1 year. As a result, their culture was a mishmash of different people with different values about the company, all tugging in different directions. For some companies, this might be okay.
For other companies, the corporate culture is an important part of the horizon Beller of the company. Beller and Jerry's exists because of the values of the founders, who would not accept growing faster than the rate at which that culture can be promulgated. Let's take a hypothetical software example. Suppose you wanna break into the market for word processors.
Now this market seems to be pretty sewn up by Microsoft, but you see a niche for people who, for whatever reason, absolutely cannot have their word processors crashing on them. You are going to make a super robust industrial strength word processor that just won't go down and sell it at a premium to people who simply depend on word processors for their lives. Okay. It's a stretch. I said it was a hypothetical example.
Now your corporate culture probably includes all kinds of techniques for writing highly robust code, unit testing, formal code reviews, coding conventions, large QA departments, and so on. These techniques are not trivial. They must be learned over a period of time. While the new programmer is learning how to write robust code They need to be mentored and coached by someone more experienced.
As soon as you try to grow so fast that mentoring and coaching is impossible, you're simply going to stop transmitting those values. New hires won't know better and will write unreliable code. They won't check the return value from Malek and their code will fail in some bizarre case that they never thought about and nobody will have time to review their code and teach them the right way to do it and your entire competitive advantage over Microsoft word has been squandered.
A company that is growing too fast will simply not notice when it makes a big mistake, especially of the spend too much money kind, Amazon buys Jungly, a comparison shopping service Morgan around $180,000,000 in stock, and then suddenly realizes that comparison shopping services are not very good for their business, so they just shut it down. Having piles and piles of cash makes stupid mistakes easy to cover up. Getting big fast gives the impression, if not the reality, of being successful.
When prospective employees see that you're hiring 30 new people a week, They will feel like they are part of something big and exciting and successful which will IPO. They may not be as impressed by a sleepy little company with 12 employees and a dog, even if the sleepy company is profitable and is building a better long term company. As a rule of thumb, you can make a nice place to work, or you can promise people they'll get rich quick.
But you have to do one of those or you won't be able to hire. Some of your employees will be impressed by a company with a high chance of an IPO that gives out lots of stock options Such people will be willing to put in 3 or 4 years at a company like this, even if they hate every minute of the working days because they see the pot at the end of the rainbow. If you're growing slowly and organically, the pot may be farther off.
In that case, you have no choice but to make a work environment where the journey is the reward. It can't be hectic 80 hour work weeks. The office can't be a big noisy lot jammed full of folding tables and hard wooden chairs. You have to give people decent vacations. People have to be friends with their coworkers, not just coworkers. Sociology and community at work matter. Managers have to be enlightened and get off people's backs. They can't be dilbert asked micro managers.
If you do all this, you'll attract plenty of people who have been fooled too many times by dreams of becoming a millionaire in the next IPO. Now they're just looking for something sustainable. With the Ben and Jerry's model, if you're even reasonably smart, you're going to succeed. It may be a bit of a struggle. There may be good years and bad years, but unless we have another depression you're certainly not going to lose too much money because you didn't put in too much to begin with.
The trouble with the Amazon model is that all anybody thinks about is Amazon. And there's only one Amazon. You have to think of the other 95% of companies which spend an astonishing amount of venture capital and then simply fail because nobody wants to buy their product. At least if you follow the Benigeria's model, you'll know that nobody wants your product long before you spend more than one Mastercard's worth of credit limit on it. The worst thing you can do.
The worst thing you can do is fail to decide whether you're going to be a Benigeria's company or an Amazon company. If you're going into a market with no existing competition, lock in and network effects, you better use the Amazon model, or you're going the way of wordsworth.com. Which started 2 years before Amazon and nobody's ever heard of them. Or even worse, you're going to be a ghost site like MSNBC auctions with virtually no chance of ever overcoming eBay.
If you're going into an established market, getting big fast is a fabulous way of wasting tons of money as did barns and noble.com. Your best hope is to do something sustainable and profitable so that you have years to slowly take over your competition. Still can't decide? There are other things to consider. Think of your personal values. Would you rather have a company like Amazon or a company like Ben and Jerry's?
Read a couple of corporate histories Amazon and Ben and Jerry's for starters, even though they are blatant hedge geographies, and see which one jives more with your set of core values. Actually, an even better model for Ben and Jerry's company is Microsoft, and there are lots of histories in Microsoft. Microsoft was, in a sense, lucky to land the Pete deal but the company was profitable and growing all along, so they could have hung around indefinitely waiting for their big break.
Think of your risk reward profile. Do you want to take a shot at being a billionaire by the time you're 35, even if the chances of doing that make a lottery look like a good deal? Ben and Jerry's companies are not going to do that for you. Probably the worst thing you can do is to decide that you have to be an Amazon company and then act like a Ben and Jerry's company while in denial all the time. Amazon companies absolutely must substitute cash for time whenever they can.
You can think you're smart and frugal by insisting on finding programmers who will work at market James. But you're not so smart because that's going to take you 6 months, not 2 months, and those 4 months might mean you missed the Christmas shopping season. So now it costs you a year and probably made your whole business plan unviable.
You may think that it's smart to have a Mac version of your software as well as a Windows version, But if it takes you twice as long to ship while your programmers Beller a compatibility layer and you only get 15% more customers, well, You're not going to look so smart then, are you? Both models work, and you've gotta pick 1 and stick to it, or you'll find things mysteriously going wrong, and you won't quite know why.
For more audio essays from the people who've built companies like Instacart, Facebook, TrelloHubSpot and Dropbox, visit the founder list at nfx.com Omri subscribe to the nfx podcast at podcast dotnfx.com Omri wherever you get your podcasts. I'm Kristen O'Brien, and this is the founder list.