Accidental Empires, Part 18 -- On the Beach (Chapter 12)

Eighteenth in a series. The true test of a good writer is time. Chapter 12 of Robert X. Cringely's 1991 classic Accidental Empires passes easily. His observations about what makes, or breaks, high-tech start-ups is as relevant today as 22 years ago. Every entrepreneur should use this installment as a manual for what to do (or not).

America’s advantage in the PC business doesn’t come from our education system, from our fluoridated water, or, Lord knows, from our tax structure. And it doesn’t come from some innate ability we have to run big companies with thousands of employees and billions in sales. The main thing America has had going for it is the high-tech start-up, and, of course, our incredible willingness to fail.

One winter back at the College of Wooster, in Wooster, Ohio, I took a bowling course that changed my life. P.E. courses were mandatory, and the only alternative that quarter, as I remember it, was a class in snow shoveling.

A dozen of us met in the bowling alley three times a week for ten weeks. The class was about evenly divided between men and women, and all we had to do was show up and bowl, handing in our score sheets at the end of each session to prove we’d been there. I remember bowling a 74 in that first game, but my scores quickly improved with practice. By the fourth week, I’d stabilized in the 140-150 range and didn’t improve much after that.

Four of us always bowled together: my roommate, two women of mystery (all women were women of mystery to me then), and me. My roommate, Bob Scranton, was a better bowler than I was, and his average settled in the 160-170 range at midterm. But the two women, who started out bowling scores in the 60s, improved steadily over the whole term, adding a few points each week to their averages, peaking in the tenth week at around 140.

When our grades appeared, the other Bob and I got Bs, and the two women of mystery received As.

“Don’t you understand?” one of the women tried to explain. “They grade on improvement, so all we did was make sure that our scores got a little better each week, that’s all.”

I learned an important lesson that day: Success in a large organization, whether it’s a university or IBM, is generally based on appearance, not reality. It’s understanding the system and then working within it that really counts, not bowling scores or body bags.

In the world of high-tech start-ups, there is no system, there are no hard and fast rules, and all that counts is the end product. The high-tech start-up bowling league would allow genetically engineered bowlers, superconducting bowling balls, tactical nuclear weapons -- anything to help your score or hurt the other guy’s. Anything goes, and that’s what makes the start-up so much fun.

No wonder they turned the Stanford University bowling alley into a computer room.

What makes start-ups possible at all is the fact that there are lots of people who like to work in that kind of environment. And Americans seem more willing than other nationalities to accept the high probability of working for a company that fails. Maybe that’s because to American engineers and programmers, the professional risk of being with a start-up is very low. The high demand for computer professionals means that if a start-up fails, its workers can always find other jobs. If they are any good at all, they can get a new job in two weeks. So that’s the personal risk of joining a start-up: two weeks’ pay.

Good thing, too, because most start-ups fail.

But they don’t have to. Time for Bob Cringely’s guide to starting your own high-tech company, getting rich, then getting out.

Conventional wisdom says that nine out of 10 start-ups fail. My friend Joe Adler, who eschews conventional wisdom in favor of statistics, claims that the real numbers are even worse. He says that nineteen start-ups out of twenty fail. And since Joe has done both successful and unsuccessful start-ups and teaches a class about them at the Stanford Graduate School of Business, let’s believe him.

If 19 out of 20 start-ups fail, then it seems to me that the books on how to be successful in Silicon Valley are taking the wrong approach. My guide will let success take care of itself. Instead, I’ll concentrate on the much harder job of how not to fail.

High-tech start-ups fail for only three reasons: stupidity, bad luck, and greed.

Starting a mainframe computer company in 1992 would be stupid. In general, starting a company to do any me-too product, any non-state-of-the-art product, or any product in a declining market would be stupid. My guess is that stupidity claims 25 percent of all start-ups, which would explain five of those 19 failures. Fourteen to go.

No start-up I know of ever failed because of good luck, but bad luck takes as many companies as stupidity does -- five out of 20. Bad luck comes in the form of an unexpected recession that dries up funding. It often means the appearance of an unexpected rival, introducing a better product the month before yours is to be announced. And it even means getting loaded on the day your company goes public, driving your new Ferrari into a ditch, and getting killed, scotching the IPO. That’s what happened to the founder of Eagle Computer, an early maker of PC clones.

Tip 1 for would-be entrepreneurs: Avoid stupid and unlucky people. If you are stupid or have bad luck, don’t start a high-tech business.

That leaves us with greed, which I say causes at least half of all high-tech start-up failures. If we could eliminate greed entirely, 10 out of 20 start-ups would succeed -- 10 times the current success rate.

Greed takes many forms but always afflicts company founders.

Say you want to start a company but can’t think of a product to build. Just then a venture capitalist calls, looking for someone working on a spreadsheet program for the Acme X-14 computer, or maybe it’s a graphics board for the X-14 or a floating-point chip. Anyway, the guy wants to invest $2 million, and all you have to do to get the money is tell him that’s what you had in mind to work on all along.

Don’t do it.

After the success of Compaq Computer, every venture capitalist in the world wanted to fund a PC clone company. After the success of Lotus Development, every venture capitalist in the world wanted to fund a PC software company. They threw tons of money at anyone who could claim anything like a track record. Those people took the money and generally failed because they were fulfilling some venture capitalist’s dream, not their own.

We’re talking pure greed here, on the part of both the venture capitalist and the entrepreneur. VCs love to do me-too products and have had a tendency to fund simultaneously twenty-six hard disk companies that all expect to have 8 percent of the market within two years. It doesn’t work that way.

Tip 2 for would-be entrepreneurs: Do a product that you want to do, not one that they want you to do.

Or maybe you already know what your product will be, and one day a venture capitalist drops by, hears your idea, and offers you $2 million on the spot in exchange for a large percentage of the company.

Don’t take it.

Start-up founders generally have only ideas, charisma, and equity to work with. Ideas and charisma are cheap, but equity is expensive. To make a start-up work, the founder has to divvy out parts of the business at just the right rate to keep everyone happy until the product is a success. Give away too much of your company too soon to a venture capitalist, to your co-workers, or even to yourself, and you risk running out of distributable shares before the product is done. And that probably means the product won’t be done. Ever.

Tip 3 for would-be entrepreneurs: Don’t take venture funding too soon.

If you are doing a software product, don’t take venture money until you need it to introduce the product. If you are doing a hardware product, don’t take venture money until you have used up all of your own money, your mother-in-law’s money, and everything you can borrow.

Bootstrap. Rent; don’t buy. Don’t hire people to do things you can contract out because contractors don’t require stock options. Don’t hire marketers too soon because that will only dilute the equity pool available to the technical people who are finishing up the product. You don’t want to alienate those guys.

In fact, you don’t want to alienate anyone. As founder, your job is to keep everyone else happy by giving away your company. Give it away carefully, but give it away, because not doing so guarantees you will be the majority shareholder in a worthless enterprise. Don’t be greedy.

As the founder, the man or woman with the grand plan, your function is to manage the distribution of your own holdings so that you end up with fewer shares but more wealth. The idea is to end up with a thinner slice of a thicker pie. When Bob Metcalfe started 3Com Corp. in June 1979, he owned 100 percent of nothing. When 3Com went public in March 1984, he owned 12 percent of a company with a fair market value of $80 million.

Tip 4 for would-be entrepreneurs: Take me to lunch. I’m a cheap date.

There is an enormous difference between starting a company and running one. Thinking up great ideas, which requires mainly intelligence and knowledge, is much easier than building an organization, which also requires measures of tenacity, discipline, and understanding. Part of the reason that 19 out of 20 high-tech start-ups end in failure must be the difficulty of making this critical transition from a bunch of guys in a rented office to a larger bunch of guys in a rented office with customers to serve. Customers? What are those?

Think of the growth of a company as a military operation, which isn’t such a stretch, given that both enterprises involve strategy, tactics, supply lines, communication, alliances, and manpower.

Whether invading countries or markets, the first wave of troops to see battle are the commandos. Woz and Jobs were the commandos of the Apple II. Don Estridge and his twelve disciples were the commandos of the IBM PC. Dan Bricklin and Bob Frankston were the commandos of VisiCalc. Mitch Kapor and Jonathan Sachs were the commandos of Lotus 1-2-3. Commandos parachute behind enemy lines or quietly crawl ashore at night. A start-up’s biggest advantage is speed, and speed is what commandos live for. They work hard, fast, and cheap, though often with a low level of professionalism, which is okay, too, because professionalism is expensive. Their job is to do lots of damage with surprise and teamwork, establishing a beachhead before the enemy is even aware that they exist. Ideally, they do this by building the prototype of a product that is so creative, so exactly correct for its purpose that by its very existence it leads to the destruction of other products. They make creativity a destructive act.

For many products, and even for entire families of products, the commandos are the only forces that are allowed to be creative. Only they get to push the state of the art, providing creative solutions to customer needs. They have contact with potential customers, view the development process as an adventure, and work on the total product. But what they build, while it may look like a product and work like a product, usually isn’t a product because it still has bugs and major failings that are beneath the notice of commando types. Or maybe it works fine but can’t be produced profitably without extensive redesign. Commandos are useless for this type of work. They get bored.

I remember watching a paratrooper being interviewed on television in Panama after the U.S. invasion. “It’s not great,” he said. “We’re still here.”

Sometimes commandos are bored even before the prototype is complete, so it stalls. The choice then is to wait for the commandos to regain interest or to find a new squad of commandos.

When 3Com Corp. was developing the first circuit card that would allow personal computers to communicate over Ethernet computer networks, the lead commando was Ron Crane, a brilliant, if erratic, engineer. The very future of 3Com depended on his finishing the Ethernet card on time, since the company was rapidly going broke and additional venture funding was tied to successful completion of the card. No Ethernet card, no money; no money, no company. In the middle of this high-pressure assignment, Crane just stopped working on the Ethernet card, leaving it unfinished on his workbench, and compulsively turned to finding a way to measure the sound reflectivity of his office ceiling tiles. That’s the way it is sometimes when commandos get bored. Nobody else was prepared to take over Crane’s job, so all his co-workers at 3Com could think to do in this moment of crisis was to wait for the end of his research, hoping that it would go well.

The happy ending here is that Crane eventually established 3Com’s ceiling tile acoustic reflectivity standard, regained his Ethernet bearings, and delivered the breakthrough product, allowing 3Com to achieve its destiny as a $400 million company.

It’s easy to dismiss the commandos. After all, most of business and warfare is conventional. But without commandos, you’d never get on the beach at all.

Grouping offshore as the commandos do their work is the second wave of soldiers, the infantry. These are the people who hit the beach en masse and slog out the early victory, building on the start given them by the commandos. The second-wave troops take the prototype, test it, refine it, make it manufacturable, write the manuals, market it, and ideally produce a profit. Because there are so many more of these soldiers and their duties are so varied, they require an infrastructure of rules and procedures for getting things done -- all the stuff that commandos hate. For just this reason, soldiers of the second wave, while they can work with the first wave, generally don’t trust them, though the commandos don’t even notice this fact, since by this time they are bored and already looking for the door.

The second wave is hardest to manage because they require a structure in which to work. While the commandos make success possible, it’s the infantry that makes success happen. They know their niche and expend the vast amounts of resources it takes to maintain position, or to reposition a product if the commandos made too many mistakes. While the commandos come up with creative ways to hurt the enemy, giving the start-up its purpose and early direction, the infantry actually kill the enemy or drive it away, occupying the battlefield and establishing a successful market presence for the start-up and its product.

What happens then is that the commandos and the infantry head off in the direction of Berlin or Baghdad, advancing into new territories, performing their same jobs again and again, though each time in a slightly different way. But there is still a need for a military presence in the territory they leave behind, which they have liberated. These third-wave troops hate change. They aren’t troops at all but police. They want to fuel growth not by planning more invasions and landing on more beaches but by adding people and building economies and empires of scale. AT&T, IBM, and practically all other big, old, successful industrial companies are examples of third-wave enterprises. They can’t even remember their first- and second-wave founders.

Engineers in these established companies work on just part of a product, view their work as a job rather than an adventure, and usually have no customer contact. They also have no expectation of getting rich, and for good reason, because as companies grow, and especially after they go public, stock becomes a less effective employee motivator. They get fewer shares at a higher price, with less appreciation potential. Of course, there is also less risk, and to third-wave troops, this safety makes the lower reward worthwhile.

It’s in the transitions between these waves of troops that peril lies for computer start-ups. The company founder and charismatic leader of the invasion is usually a commando, which means that he or she thrills to the idea of parachuting in and slashing throats but can’t imagine running a mature organization that deals with the problems of customers or even with the problems of its own growing base of employees. Mitch Kapor of Lotus Development was an example of a commando/nice guy who didn’t like to fire people or make unpopular decisions, and so eventually tired of being a chief executive, leaving at the height of its success the company he founded.

First-wave types have trouble, too, accepting the drudgery that comes with being the boss of a high-tech start-up. Richard Leeds worked at Advanced Micro Devices and then Microsoft before starting his own small software company near Seattle. One day a programmer came to report that the toilet was plugged in the men’s room. “Tell the office manager,” Leeds said. “It’s her job to handle things like that.”

“I can’t tell her,” said the programmer, shyly. “She’s a woman.”

Richard Leeds, CEO, fixed the toilet.

The best leaders are experienced second-wave types who know enough to gather together a group of commandos and keep them inspired for the short time they are actually needed. Leaders who rise from the second wave must have both charisma and the ability to work with odd people. Don Estridge, who was recruited by Bill Lowe to head the development of the IBM PC, was a good second-wave leader. He could relate effectively to both IBM’s third-wave management and the first-wave engineers who were needed to bring the original PC to market in just a year.

Apple chairman John Sculley is a third-wave leader of a second-wave company, which explains the many problems he has had over the years finding a focus for himself and for Apple. Sculley has been faking it.

When the leader is a third-wave type, the start-up is hardly ever successful, which is part of the reason that the idea of intrapreneurism -- a trendy term for starting new companies inside larger, older companies -- usually doesn’t work. The third-wave managers of the parent company trust only other third-wave managers to run the start-up, but such managers don’t know how to attract or keep commandos, so the enterprise generally has little hope of succeeding. This trend also explains the trouble that old-line computer companies have had entering the personal computer business. These companies can see only the big picture -- the way that PCs fit into their broad product line of large and small computers. They concentrate more on fitting PCs politely into the product line than on kicking ass in the market, which is the way successes are built.

A team from Unisys Corp. dropped by InfoWorld one day to brag about the company’s high-end personal computers. The boxes were priced at around $30,000, not because they cost so much to build but because setting the price any lower might have hurt the bottom end of Unisys’s own line of minicomputers. Six miles away, at Fry’s Electronics, the legendary Silicon Valley retailer that sells a unique combination of computers, junk food, and personal toiletry items, a virtually identical PC costs less than $3,000. Who buys Unisys PCs? Nobody.

Then Bob Kavner came to town, head of AT&T’s computer operation and the guy who invested $300 million of Ma Bell’s money in Sun Microsystems and then led AT&T’s hostile acquisition of NCR -- yet another company that didn’t know its PC from a hole in the ground. Eating a cup of yogurt, Kavner asked why we gave his machines such bad scores in our product reviews. We’d tested the machines alongside competitors’ models and found that the Ma Bell units were poorly designed and badly built. They compared poorly, and we told him so. Kavner was amazed, both by the fact that his products were so bad and to learn that we ran scientific tests; he thought it was just an InfoWorld grudge against AT&T. Here’s a third-wave guy who was concentrating so hard on what was happening inside his own organization that he wasn’t even aware of how that organization fit into the real world or, for that matter, how the real world even worked. No wonder AT&T has done poorly as a personal computer company.

Here’s something that happens to every successful start-up: things go terrifically for months or years, and then suddenly half the founders quit the company. This is pent-up turnover because people have stayed with the company longer than they might have normally.

Say normal turnover is 10 percent per year, which is low for most high-tech companies. If nobody leaves for the first five years because they would lose their stock options, it shouldn’t be surprising to see a 50 percent departure rate when the company finally goes public or is acquired. For years, those people were dying to leave. And they are naturally replaced with a different kind of worker -- third-wave workers who are attracted to what they view as a stable, successful company.

Reasons other than boredom and pent-up ambition cause early employees to leave successful young companies. As companies get bigger, they become more organized and process driven, which leads to more waste. Great individual contributors -- first-and second-wave types -- are very efficient. They hate waste and are good indicators of its presence. When the best people start to bail out, it’s a sign that there is too much waste.

Companies go through other transformations as they grow. Sales volumes go up, and quality control problems go up too. Fighting software bugs and hardware glitches, getting the product right before it goes out the door, rather than having to fix it afterward sops up more and more money. And as volume grows, so does penetration into the population of unsophisticated users, who require more hand holding than did the more experienced first users of the product. Suddenly what was once an adventure is now just a job.

WordPerfect Corp., the top PC word processing software company, has a building in Orem, Utah, where 600 people sit at computer workstations with the sole purpose of answering technical questions phoned in by customers who are struggling to use the product. Typical WordPerfect customers make two such calls, averaging five minutes each, which means that when the founders of a five-person software start-up dream about selling 100,000 copies of their new application, they are also dreaming about (though usually they don’t know it) spending at least 8.3 man-years on the telephone answering the same questions over and over and over again.

Of course, companies don’t have to grow. Electric Pencil, the first word processing program for the Apple II, was the archetype for all word processing packages that followed, but its developer, a former Hollywood screenwriter, just got tired of all the support hassles and finally shut his company down. In 1978, Electric Pencil had 250,000 users. By 1981, it was forgotten.

Some companies limit their responsibilities by licensing their products to other companies and avoid dealing with end users entirely. Convergent Technologies started this way, building computers that were sold by other companies under other names. Convergent was acting as an original equipment manufacturer, or OEM. For reasons that would have made no sense at all to Miss Vermillion, my seventh-grade English teacher, building products that are sold by others is called “OEMing.”

Microsoft started out OEMing its software, selling its languages and operating systems to hardware companies that would ship the Microsoft code out under a different name -- Zenith DOS, for example -- packed in with the computer.

In the software business, there is a strong trend toward small companies’ handing over their products to be marketed by larger companies. The big motivator here is not just the elimination of support costs but also removing the need to hire salespeople, make marketing plans, and develop relations with distributors. It can be easier and even more profitable to have your astrology program published as Lotus Stargazer than as the Two Guys in a Garage Astrology Program.

Finally, there are software companies that elect to remain small but profitable by literally giving their products away -- every mainframe software salesman’s idea of hell. This PC-peculiar product category is called “shareware.”

Shareware was invented by Andrew Fluegelman and Jim Button. Button had spent 18 years working as an engineer for IBM in Seattle when he bought one of the first IBM PCs to use at home but then couldn’t find a database program to run on it. In 1982, the most popular database program was dBase II, which ran under CP/M, but there were no databases yet for the IBM PC.

Technical types who start software companies are either computer junkies who want to be the next Bill Gates (most are this type) or who need a program that isn’t available so they write it themselves. Jim Button was from the latter group. His simple database program -- PC File -- became a hit with friends and co-workers in the Seattle area.

Friends asked for copies of the program, then those friends made copies for their friends, and soon there were dozens, maybe hundreds, of copies of PC File floating around the Pacific Northwest. This was fine except that these many nameless users sometimes had trouble making the program do what they wanted, so they tended to call Jim Button at home in the evenings with their questions, which came to require a lot of effort.

Button wanted to cut down his product support load, so he came up with the idea to put a simple message on the first screen of the program, telling users that they could get updates and improvements to PC File by sending $10 to Jim Button. Shareware was born.

The beauty of shareware was that there was no packaging, no printing, no marketing, no sales effort of any kind. The manual was included as a text file on the program disk; if users wanted it printed, they printed it themselves. Shareware was pure thought, just as if Jim Button dropped by the customer’s house to give a demonstration of his programming prowess, only the real Jim Button was home in bed. Rather than go to a store or order by mail, users passed the programs around or got them over the telephone from computer bulletin boards. They tried it, and, if they liked it, maybe they sent Jim Button his $10 (later more). Having got the $10, Button sent on the next improved release of the product, which cost him maybe $2 for the floppy disk, envelope, and postage. He answered any questions from registered users and hoped to have the same customers paying him $10 every six to nine months as each new version of the product was shipped out with a few new features.

Button invented shareware during a time of hostile relations between sellers and users of software. The issue was copy protection. Software vendors didn’t want 10 bootlegged copies of each program to be floating around the country for each legal copy, and so they devised all sorts of technical tricks to make it harder for users to make copies of programs -- tricks that alienated users in the process. Warning labels on the copy-protected diskettes said, generally, “Copy this product and we’ll sue you, we’ll take your youngest child, and end your productive life, dear customer.” But Jim Button actually encouraged users to make copies of PC File for their friends. And if the friends didn’t like the program or didn’t feel that they needed their questions answered, they could easily get away without sending Button his $10.

He started a company he called Buttonware, operating out of his basement on evenings and weekends, funded by those $10 checks. Button drafted his wife and son to help with duplicating and shipping floppy disks while he worked on improving the program.

Button’s fantasy, when he started asking for the $10 fee, was that the money would cover his time and eventually pay for a new computer. It went much further than that. Buttonware grew so fast that the Button family soon had no spare time at all, and Jim Button had to make a decision between giving up the home business or his career writing mainframe software for IBM. The decision came down to a simple economic analysis, made in the summer of 1984. Button looked at his 1984 salary for working at IBM, which was $50,000, and compared it to his earnings from Buttonware in the previous year, which were $490,000. Bye-bye Big Blue.

The price of PC File went to $25 when Andrew Fluegelman suggested they coordinate pricing on this new product category, which they were then calling Freeware. Fluegelman’s product was a data communication program called PC-Talk that allowed PCs to emulate computer terminals and link to mainframes over telephone lines. The former corporate lawyer and editor of the Whole Earth Catalog wrote PC-Talk when he found that the communication program supplied with PC-DOS would not allow him to print from the screen while he was connected to an online information service.

Soon there were hundreds of other shareware programs. Bob Wallace, another Seattle programmer who was one of the first half-dozen Microsoft employees back in the Albuquerque days, wrote PC Write, the first shareware word processing package. Procomm was another communication package, this time coming from a company called Datastrom in Columbia, Missouri. Each of these hobby products eventually turned into full-time businesses with annual sales in the $2 million to $3 million range.

Price points were gradually raised, with each entrepreneur wondering when users would find it too expensive to register. Jim Button saw growth flatten when he reached $89, and Bob Wallace made the same discovery. Each man had to decide, then, whether just to control costs and milk profits from their products or to start marketing them finally. Both made the decision to grow, which meant spending money to create a more professional-looking product, advertising for the first time, and finding outlets other than shareware.

The trend in shareware companies is always the same. In the first few years, they grow to meet their destinies. If the product is good, it eventually fills the shareware channel, reaching all likely customers, at which point the companies look for growth through selling upgrades. But even upgrades eventually fade as users reach the point where their needs are served and adding two more esoteric features is not enough to compel them to pay for a $35 upgrade. At that point, while shareware sales are flat, the product has actually reached only 20 to 30 percent of the total software market, with 70 to 80 percent of potential users never having seen or heard of the program. Then it’s time to try to find new channels of distribution. Jim Button tried retail stores, while Bob Wallace tried direct sales to large corporations, and each was successful. Datastorm made deals with hardware manufacturers to ship copies of Procomm bundled with the modems required for computer data communication.

Or maybe it’s not time to grow. That’s the other choice that many shareware publishers make -- the types who want to stay small, working by themselves, and just make a good living mining some tiny software niche in the vast MS-DOS marketplace. Astrology software, anyone?

Reprinted with permission

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