The Myth of Start Up Costs

Conventional wisdom in the start-up community these days is that it has never been cheaper to start and build a company. It's been written and re-written about, but I'll summarize the logic as:

You used to have to build your product, then write enormous checks to Oracle, Microsoft, IBM, Sun, etc to buy the hardware/software that you needed to run your business. Then, if you got big enough, you had to build a datacenter. Contrast that with today, where you simply need to sign up on AWS, get a subscription to Workday/SFDC, etc...and the costs of starting up have plummeted.

Makes sense. Seems logical. But, it seems to me to be only part of the story.

If now is the cheapest time ever to start a company, how do you explain this:




Certainly, I could quickly speculate that companies are staying private longer than before and hence, need more capital. However, if you look at the data below, I'm not sure that argument holds up:




My belief is that the cost of starting a company is essentially unchanged from 10-20 years ago. If anything, its a bit higher. (Note: obviously this depends on whether you look at year 1 costs or costs until liquidity or somewhere in-between year 1 and liquidity. I'm focusing on the latter two cases).

So, why have the costs of starting a company and running it through the mid-years not changed, given that the costs of year 1 are substantially cheaper?

I think there has been one substantial change to start-up economics, that very few are acknowledging or writing about: early stage companies have started paying salaries/benefits, etc that are on-par with what Fortune 500 companies pay. I see this over and over again...and its in all parts of the country. This is partially driven by a war on talent, but I don't think its that simple. I believe the culture and expectations have changed and salaries/benefits are becoming table stakes, as opposed to a nice-to-have. There was a time when you joined a start-up for equity and/or stock options. While there is still some of that, most are joining for salaries/benefits, along with their interest in the mission of the company. This is a fundamental shift in start-up economics and I think it offsets 'The Myth of Start Up Costs'.

I'll acknowledge that some of my data in this post in anecdotal and I certainly do not have extensive data on private companies. However, I am writing this based on what I've seen with my own eyes. Criticism and disagreement is welcome.


IT and the Oracle (of Omaha)




I started following Warren Buffett in college. I don't recall how or why I got interested, but I did, and promptly started reading everything I could find about him. The highlight of my formal education came when he visited the business school at The University of Florida. Doing what is now commmonplace, he promptly conducted an unscripted 2 hour Q&A on any and all topics related to business. It was fascinating and I became an unabashed 'groupie'.

Since then, I have continued to consume everything I can find on Buffett, including, but not limited to, the following highlights:

-His original partnership letters from the first 20 years of his career
-The Essays of Warren Buffett
-CNBC transcripts from his increasingly frequent appearances
-Annual Letters

I'm certainly no expert, but I've done enough homework to credibly speculate on why, after a career of never investing in information technology (IT), he is now the largest shareholder in IBM.

Did Warren Buffett change, did IT change, or did IBM change? I think the answer lies within that multi-part question.

I'll approach the question in 3 steps: 1) Buffet's investment philosophy, 2) How IT has changed, and 3) My answer to the multi-part question.


Investment Philosophy

If anything has been consistent over the past 80+ years, its Warren Buffett's investment philosophy (Note: I think it astutely captured in Pilgrimage to Warren Buffet's Omaha and Secrets in Plain Sight). For the sake of brevity, I'll simplify to 3 overarching points:

1) Chapters 8 and 20 of the Intelligent Investor. These chapters focus on a margin of safety and using the market to serve you, not instruct you.

2) Buy businesses that you understand and accordingly, you can be certain that the company earnings will be materially higher 5, 10, and 20 years from now.

3) Buy major brands, with an extended track record and reputation. He often cites this as an early lesson he learned in his career, which resulted in his purchase of Coca-Cola. It's also among the reasons why companies like American Express, Wells Fargo, and the Washington Post have been ever present in his portfolio.


How IT has Changed





There was a time when IT was a side project in most companies. This is not as long ago as many people think. In fact, I would say the "IT as a side project" era was 1985-1995. No business leader truly cared about IT and it was an afterthought in all strategic and operational planning. Note: there were very few CIO's in this era.

As the internet evolved and the phrase e-business was coined, IT began to transition into the "IT as a function" era (1996-2008). This was the timeframe in which the CIO role was created (often as an unequal among peers). I dont think CIO's really had a voice in the boardroom until the end of this era.

By 2008, we entered the "IT as a Line of Business" era. This is when IT became an indispensible function of the business, arguably as critical for competitive advantage as the products, marketing, sales, logistics, etc of each company. While I estimate this era as starting on the heels of the 2008 financial crisis, I would assert that we are still in the early stages of that evolution. (In baseball parlance, we are in the top of the 2nd inning and we may play extra innnings.) My view on this fundamental shift in IT and the role of IT is why I have written so much about Big Data and the impact it will have on every business globally.

Ill admit that my definition of the era's and timeframes are debateable, but I believe they are approximately right, for the purpose of this analysis. In short, my conclusion is that IT has changed from a department/role/function....to an essential. IT is as essential to an organization as electricity in the buildings, clients, quality products, efficient supply chains, business and financial controls, and people/management. Even more, in most cases, IT is an critical enabler of each of those items, which makes it "THE" thing for most companies. This is a stark change in the last 20 years.


Did Warren Buffett change, did IT change, or did IBM change?

If there is one thing we know from history, it's that while Warren Buffet may change/evolve his thinking, his principles of investing do NOT change. Hence, I'm confident we can rule out the first part of the question. If you don't agree with me on this one, you need to read some of the sources I highlighted at the outset. His first partnership letter espouses the same themes you see in the most recent Annual Letter.

IT has changed. The technology has changed, the role of the function has changed, and it's no longer SOME THING a company does; it's often THE THING and the enabler of everything. Coming back to Warren Buffet, he has a history of investing in what I think of as the fabric of the economy. This includes things like railroads (transportation), utilities (electricity), insurance (everyone needs it), credit cards (its money in a different form), etc. Over the past 20 years, IT has become the fabric of the economy. It did not happen over night and it will only become more pronounced (think Big Data). In fact, Buffett alluded to this in one of his recent CNBC interviews, when he said that he bought IBM after he talked to many of his Berkshire Hathaway companies and realized how critical IBM was to their ability to operate.

Lastly, IBM has changed and will continue to do so. However, I don't think this was the fundamental driver of Buffet's investment thesis. It's well documented that IBM has made a huge step forward on financial transparency (think: earnings roadmaps). This certainly appeals to Buffet's desire to be able to predict earnings power over 5, 10, 20 year timeframes. This may explain why he chose to buy IBM over other IT companies.

However, despite all of the possible reasons for his investment, I think it boils down to one key insight: IT has evolved from interesting to essential.

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Please contact me if you want a copy of the original Buffett Partnership Letters.

Matching Needs to Skills

In baseball, the term 'utility player' refers to someone that can play multiple positions on the field, as opposed to just one. They are rarely an All Star at any one position, but the combination of their skills can make them an All Star or at worse, extremely valuable to their team. Here is the best one in baseball today:



In my experience Sales Leaders tend to not be utility players. Instead, they each seem to excel in one area. If that area fills a gap in the organization, it is often a potent and positive combination. If it's an overlapping skill, the impact can be muted.

I would categorize sales leaders into 4 types:

Relationship Guys- Great with clients. Build long term relationships. Ask for favors and receive when needed. Their greatest asset is their rolodex.

Operational Leaders- Drive the hour-by-hour cadence of activity. Instill discipline into the sales process. Live in the numbers and metrics.

Dealmakers- Consultative sellers, with the ability to turn nothing into something. Rarely focused on a specific product or capability, more focused on the overall solution/relationship/deal. Strong strategically and financially.

Coaches/Sales Managers- They make the individual sellers better. They motivate, coach, and cajole as needed. Their 'help' is actually help, as opposed to just inspection (operational leaders do that).

I think most sales leaders are dominant in one of these categories, with a minor in 1 other. It is very rare to find the sales leader that has all of them (if you do, figure out how to keep them).

Organizations need a sales leader that will fill a gap in capability. Is your business issue around operations (ie undisciplined behavior and focus)?...get an operational leader. Is your issue around motivating your individual sellers?...get a Coach/Sales manager...etc. It also depends on the state of the business. Here is one scenario below, showing which type of sales leader you need, based on 2 variables: product complexity and state of the business:




Matching the need in the organization to the skills of a sales leader will often determine success...that starts with understanding which skills you need.