“You’re just a rent-a-rapper, your rhymes are minute-maid
I’ll be here when it fade to watch you flip like a renegade”
—Rakim, Follow the Leader
When my partner Marc wrote his post describing our firm, the most controversial component of our investment strategy was our preference for founding CEOs. The conventional wisdom says a startup CEO should make way for a professional CEO once the company has achieved product-market fit. In this post, I describe why we prefer to fund companies whose founder will run the company as its CEO.
At Andreessen Horowitz, our primary goal is to invest in the great technology franchises. As we looked at the history of great technology companies, we discovered that founders ran an overwhelming majority of them for a very long time, including:
(*) While not technically cofounders, Andy Grove and Thomas Watson, Sr. were the driving force behind Intel and IBM, respectively. Andy Grove was Intel’s third employee (after the two cofounders Robert Noyce and Gordon E. Moore). Thomas Watson, Sr. joined as a General Manager of the Computing Tabulating Recording Company, but renamed the company International Business Machines and turned it into the IBM we recognize today.
In addition, founders run today’s most promising new companies such as Zynga (Mark Pincus), Facebook (Mark Zuckerberg), Twitter (Ev Williams), Workday (Dave Duffield and Aneel Bhusri) and Fusion-io (David Flynn).
Two more quick data points before I move on to explain why this happens.
First, the University of Pennsylvania’s Wharton School of Business just published an analysis of recent exits for high technology companies such as BlackBoard, BladeLogic, Concur, Danger, Liveperson, LogMeIn, and Netsuite. Looking across these nearly 50 companies, the study finds that founding CEOs consistently beat the professional CEOs on a broad range of metrics ranging from capital efficiency (amount of funding raised), time to exit, exit valuations, and return on investment.
Second, for folks keeping score at home, this phenomenon appears to extend beyond high-technology companies. Felix Salmon, for instance, points out that Fortune’s editorial staff considered twelve other candidates including Warren Buffett, Carlos Slim, and Martha Stewart before naming Steve Jobs the best CEO of the decade in November 2009. Salmon points out that “not a single one of the 12 [candidates] is a CEO who was hired to run a company by its board of directors.”
There are certainly exceptions to this rule, most notably Google and Cisco (I will address both exceptions later in this post), but the evidence is one-sided and overwhelming.
From a pattern matching perspective, it makes sense that we’d prefer founding CEOs, but as I said in an earlier post, pattern matching is not knowledge. So, why are great technology companies so often run by their founders? And why do professional CEOs sometimes succeed?
The technology business is fundamentally the innovation business. Etymologically, the word technology means “a better way of doing things.” As a result, innovation is the core competency for technology companies. Technology companies are born because they create a better way of doing things. Eventually, someone else will come up with a better way. Therefore, if a technology company ceases to innovate, it will die.
These innovations are product cycles. Professional CEOs are effective at maximizing, but not finding, product cycles. Conversely, founding CEOs are excellent at finding, but not maximizing, product cycles. Our experience shows—and the data supports—that teaching a founding CEO how to maximize the product cycle is easier than teaching the professional CEO how to find the new product cycle.
The reason is that innovation is the most difficult core competency to build in any business. Innovation is almost insane by definition: most people view any truly innovative idea as stupid, because if it was a good idea, somebody would have already done it. So, the innovator is guaranteed to have more natural initial detractors than followers.
Steve Jobs’ return to Apple provides an excellent example. At the time Jobs regained control of Apple, the conventional wisdom said that Apple was getting killed by “PC Economics” and had to separate the operating system from the hardware. Specifically, Apple couldn’t compete with Microsoft unless it became more horizontal and let commodity hardware manufactures compete while Apple focused exclusively on the OS. The professional CEO who preceded Jobs (Gil Amelio) took the conventional wisdom to heart. He set out to create an ecosystem of Mac cloners who would provide the commodity hardware complement to Apple’s famous OS.
When Jobs came in and reversed those decisions, most industry analysts thought Jobs was insane. Jobs not only killed all the commodity hardware and the horizontal strategy; he went radically vertical. In addition to the basic hardware and operating system, he added applications (iLife, iWork) and peripherals (like the iPod). He even added retail stores.
Today, people would let Steve Jobs make such a radical turn at nearly any company because of the outcome he’s achieved at Apple. But remember that when Jobs returned to Apple in 1996, he was doing so as the co-founder and CEO of NeXT computer, a marginal computer workstation company which Apple purchased for less than $500M. Let’s just say he didn’t have the benefit of the doubt. What he did have: the founder’s courage to innovate despite the doubters.
So where did Jobs get this “founders courage” and what is it? In addition to general brilliance, we see three key ingredients to being a great innovator:
1. Comprehensive knowledge
2. Moral authority
3. Total commitment to the long-term
Great founding CEOs tend to have all three and professional CEOs often lack them. Here’s why.
To create the original innovation to start a company, founders must exhaustively understand the technology required, the likely competitors (past, present, and future), and the market in all its variations and segmentations. This knowledge becomes the foundation on top of which a gigantic knowledge pyramid gets built which includes:
Knowledge of every employee who gets hired and why
Knowledge of every product and technology decision that gets made
Knowledge of all customer data and feedback generated from day one
Knowledge of exactly what’s strong and weak about the code base
Knowledge of exactly what’s strong and weak about the organization
This pyramid of knowledge enables new, unique innovative thinking. This knowledge is nearly impossible to replicate. Without it, thoughtful people lack the courage to bet the company on entirely new directions.
In retrospect, it seems totally natural that Larry Ellison transformed Software Development Labs from a consulting business into a software company called Oracle. But would a professional CEO have understood enough about the team, the market and the competition to make such a radical change?
Often, true innovation requires throwing out many of the foundational assumptions of the company. If the company is significant, doing so may be extremely difficult for the professional CEO. The company’s core belief system is often entangled in those assumptions. Since the founding CEO made the assumptions in the first place, it is much easier for her. An excellent example of existing, invalid assumptions paralyzing a whole set of companies recently played out in the music industry.
The music business has been continuously disrupted and revolutionized by the underlying technology since the outset. In fact, it’s still widely referred to as the “record industry,” because the entire business was created by the invention of the vinyl record. For the first few decades of the industry, songs were never longer than 3 minutes due to a technological limitation (the record would skip if the grooves were too thin). The album itself is a construct that originated with the total number of songs one could fit on a 33 1/3 Revolutions Per Minute (RPM) vinyl record. In the 80s, the invention of the CD completely revitalized the industry and led to (literally) record-breaking sales.
Despite this dynamic history, modern record company executives badly missed the most sweeping technical innovation—the Internet. How was that possible? By the time the Internet arrived, all of the original founders of the record companies had been bought out, retired, or died. The new, professional CEOs were unwilling to let go of the most basic assumptions driving the cost structure of their businesses. Specifically, they wouldn’t give up their stranglehold on distribution and the value they placed on owning the recording.
They were proficient at running the current business, but lacked both the courage and the moral authority to jeopardize the old business model by embracing the new technology. The transition would have been far easier if these executives running the companies had invented the old models. The founders of the music industry likely would have ditched old assumptions, because they would have been nuts to do continue believing an assumption that no longer makes sense.
Conversely, Netflix, run by cofounder Reed Hastings, provides an excellent counter-example. Faced with a similar transition (from distribution of the physical recording to electronic distribution of the bits), Netflix let go of its old assumption that customers wanted DVDs mailed to them, invested in innovation and produced a series of brilliant new offerings (streaming video to Xbox 360, Sony Playstation 3, Tivo, Wii, connected DVD players, and a host of devices) that are enabling them to transition smoothly. Hastings wasn’t married to the old distribution model precisely because he invented it.
Founding CEOs naturally take a long view of their companies. The company is their life’s work. Their emotional commitment exceeds their equity stake. Their goal from the start is to build something significant. They instinctively know that big product cycles come from investment and that even the biggest product cycles will eventually fade. Professional CEOs, on the other hand, tend to be driven by relatively shorter-term goals. They are paid in terms of stock options that vest over 4 years and cash bonuses for quarterly and yearly performance.
Investments in innovation do not pay out in the current quarter. Typically, they don’t even pay out in the current year. If you care about your bonus this year, you are directly incented not to make investments in new inventions as you will incur the expense, but reap no profits.
Any serious innovation requires a heavy investment. Beyond the up-front cash, costs may include lower growth, bad publicity, and internal grumbling as existing features atrophy. Recently, we’ve seen Facebook’s founding CEO Mark Zuckerberg make a series long-term bets. He’s radically revamped critical features such as the feed used by hundreds of millions of people. He’s made bold changes to key policies such as privacy and platform. For years, he’s avoided taking any revenue inconsistent with optimizing the user experience.
By committing to the long-term, he put himself under tremendous pressure in the short-term. The press broadly questioned his business acumen and Facebook’s ability to generate any meaningful revenue. Bottom feeding publications such as Valley Wag even went so far as to call for his resignation. Employees leaked to the press that they thought he should sell the company, and some quit due to temporary declines in page views and user growth. We now know these critics were wrong and Zuckerberg was right, but would a professional CEO have taken these risks and endured such vicious attacks for unseen, long-term benefits?
In theory, any professional CEO can rise to the challenge of being a great long-term CEO, but they have to commit to innovation and adopt the three characteristics above. We’ll now take a look at two professional CEOs who have done just that.
Two spectacular exceptions to the founding CEO rule are John Morgridge at Cisco and Eric Schmidt at Google. Let’s look at how these two overcame the issues illustrated above and massively triumphed.
Eric Schmidt has been a spectacular success at Google. He hasn’t just maximized the original product cycle (which was built around search—although he’s done a brilliant job of accomplishing that feat), but he has also overseen the creation of important new product cycles such as Android and Google Apps. Interestingly, he did so by teaming with the founders and gaining the benefits of their knowledge, moral authority, and long-term vision. This may seem like an obvious strategy, but shared leadership and control are incredibly difficult to achieve. Doing so involves intense communication, deep humility, and some hard compromises. Almost nobody ever pulls it off. And that’s why Eric Schmidt is such an important exception.
John Morgidge is another spectacular counter-example of the non-founding CEO building a tech powerhouse. John took over as the company’s second CEO in 1988, a role he held until he became chairman in 1995. With John as CEO, Cisco grew from $5m to $1b in revenue and from 34 to 2,250 employees. He also took the company public in 1990.
How did he do it? In speaking to many Cisco employees over many years and observing the dynamic, innovative product and M&A strategy that enabled them to defeat fierce competitors such as Wellfleet and Synoptics, I believe John Morgridge may have been the greatest professional CEO in the history of the high tech industry. He worked tirelessly to develop the characteristics outlined above as well or better than any founder. He was smart, knowledgeable, tough, innovative, courageous, and, unlike most professionals, legendarily cheap. He once said that if you can’t see your car from your hotel room, then you are paying too much. As a result of this magical combination of qualities, he achieved complete moral authority. He is proof positive that a professional CEO can build a great technology company. At the same time, he is the ultimate exception.
In the best case, you may find the next John Morgidge. If you do, hire him! Otherwise, here is our general rule of investing. If you hire a professional CEO into a company that has found a large product cycle, the professional will be able to maximize that product cycle, but likely won’t find the next one. If you hire a professional to find the product cycle, get the jelly, because your company will soon be toast.
The simple answer is “no.” Being CEO requires a tremendous amount of skill. The larger the company becomes, the more skill that’s required. Steve Blank does an excellent job of illustrating many of these required skills in his outstanding Scalable Start-up series. We almost never meet a founder who has these skills at the time they found the company.
Therefore, the founder must learn the skills required to run the company on-the-job. Doing so is often a miserable, debilitating experience. I can attest first hand to the frustration and exhaustion associated with being responsible for hundreds of employees while learning how to do the job. I constantly made mistakes a more experienced CEO wouldn’t make. These mistakes can be costly in terms of money and jobs.
So, why would any founder want to learn to be CEO on-the-job? Because doing so is the most sure fire way to build a great company.
How does one know if they have what it takes to be the long-term CEO of the company? In our experience, there are two required characteristics:
1. Leadership as described in my early post Notes on Leadership.
2. Desire—not necessarily the desire to be CEO, but the burning, irrepressible desire to build something great and the willingness to do whatever it takes to get there.
If the founder has these characteristics, then we would encourage them to give it a try. If they fail, we will help them look for the next Eric Schmidt or John Morgridge.