Motley Fool Money - Lessons From Startups

Episode Date: May 12, 2024

“Ideas are cheap; the people are what matter.” Startups face a lot of risk. But research suggests that 65% of startups fail because of one particular problem: people. Ricky Mulvey caught up with Martin Gonzalez, creator of Google’s Effective Founders Project, to discuss what public investors can learn from the people problems that plague startups… and any other organization. They discuss: How to spot strong leaders. The downside of overconfidence. How company culture affects stock returns. Companies discussed: SPOT Host: Ricky Mulvey Guest: Martin Gonzalez Producer: Mary Long Engineer: Dez Jones Learn more about your ad choices. Visit megaphone.fm/adchoices

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A lot of companies are always struggle between winning the short game and winning the long game. And to be clear, you need to win both games to be successful. If you don't win the short game, you won't be around to play the long game. And if you over-optimized for the short game, then you make decisions that aren't good for the long-term. I'm Mary Long, and that's Martin Gonzalez. He's the creator of Google's Effective Founders Project, a lecturer at Stanford, and author of the book, The Bonfire Moment. Martin's built a career on studying startups and their founders. He researches what makes talented people tick, whether they're CEOs or middle managers, and he's got a

whole lot of insight into how culture can build up or tear down any organization. On today's show, Ricky Mulvey talks with Martin about what public investors can learn from a venture capitalist approach, why treating people like volunteers is a recipe for success, and what a computer character can teach us all about arguing well. Martin, some of those listening prefer to take like a venture capital approach to stock investing. These are folks, you know, pretty well where they're essentially going for a slugging percentage versus an on-base percentage. And if you're playing that game, one of the things you write about startups and these smaller companies is that these venture capitalists are really sort of picking the jockey, not the horse. They're looking for leaders,

team, culture, fit, that kind of thing, not necessarily the idea or business they're going for. Can you explain that decision or that bias, if you will? Yeah. It stems from the belief that ideas are cheap and that execution is what matters. And that's where the people, the cultural dynamic, the quality of the people really come into play. There's a really classic study that really spurred me on to a lot of this work I do with startups that surveyed a bunch of of venture capitalists around, you know, think of the last companies in your portfolio that failed and why did they fail? And the study revealed that 65% of startups failed because of people

issues. And it was like by far the most important thing. It wasn't so much the idea or the timing. And that study gets replicated again more recently and you find literally the same. And let me tell you what the stats were in the recent one. It's 55% were because of the team and only 10% because of the business model, 9% because of timing, and somehow these factors of the business model, the timing of the product, these all tend to be more, I guess, more salient factors when we make investment decisions.

It's just not the psychology of the VC. And it's also changed over the last four years since the pandemic. And the thing I can't decide is if culture for a company is an investor's evaluating it. If it becomes more or less important, many of these companies go remote and hybrid and the employees become more, I would say, mercenaries to the business they're working for.

You know, it's a good one. I think what a lot of companies struggled with when they went fully remote was the way you identify with your company, a lot of it has to do with the building you enter, the swag you wear, the colleagues you meet, and that builds your sense of identity. So I agree that it's been quite a challenge. I think the one thing, though, is true.

And the pandemic was accompanied by some kind of economic crisis. And one of the things that we write in our book, which is data I've really thought deeply about, is there's a study that was done by a French economist who looked at, I think, four decades of stock returns and looked at companies that were known to have good culture. So these were companies in the best companies to work for list. And they looked at what the monthly alpha was on each of these kind of periods of time. And they'll separate that between the overall industry and these best companies to work for. The results were pretty nuanced.

And they said that, you know, there is an upside, but the upside is very minor on good years. On good years, it's very subtle that you'll see an upside from good culture. the real upside is seen during these global crisis. So they looked at the dot-com crash, they looked at the global financial crisis. These two periods, they found like an alpha of like 1.5% monthly alpha, which is quite significant.

So I'm quite convinced that these cultures become really important to take you through those tough times. 1.5 per month ends up being quite a bit over a year. Martin, a little earlier you mentioned, the overconfidence of some founders and how that might be an issue. As a part of your writing, you researched Daniel Eck, who's the CEO of Spotify. What did you learn from researching and writing about him? You know, Daniel Eck was such an interesting case study to study. He went through both these journeys of overconfidence and then found somehow a good equilibrium.

you know, when he first started, he tells this story of how he thought that he would just build a really cool product and then all these artists would then throw in their music into Spotify and did not realize that, well, the licensing companies had to come into play. And so what thought, what to him was like a two-month effort became like a two-and-a-half-year effort. and I think he learned a lot about overconfidence and hubris. But I think over time, he builds up this really understated, very humble demeanor that meant he would lean on experts on his team. He would seek feedback. He would be happy to be wrong. And he didn't need to let people know that he was a smartest person in the room.

And chances are that he wasn't all the time, but there were times where he would be. And he just didn't feel the need to let others know that. So I think for that reason, he's a really good role model for a lot of founders as they kind of navigate the ups and downs of confidence. I think that played out a little bit in the latest earnings call. So Spotify had a significant pop on really good user growth, some revenue growth. And then even in the earnings call, Daniel Leck comes in and says, hey, like, hey, investors, don't expect this forever.

this like essentially inevitably this this canon will will slow down and if you have a brash overconfidence CEO I don't think you would be hearing them say such things you know that reminds me of a really fascinating study by a collaborator of mine amir goldberg from Stanford um so he studies what what he calls performative atypical premium so he looks at these CEOs who come into these revenue calls who come in a very bombastic way or kind of show off some really kind of larger than life personalities. And, you know, a lot of analysts will look at that and think, wow, this is exciting. It's rebellious. And what happens is that increases investor expectations.

And then when he controls for all these other factors, he finds that these performative CEOs actually create a negative earnings surprise at the end of it. And so I think that's a really good lesson in, you know, how investors need to read the behavior of CEOs in these calls. I think in many ways, these, you know, the overconfident CEO is something to really raise a flag. Like you need to to really look at that with a lot of scrutiny and think, okay, well, what are the fundamentals here that are maybe, you know, not true based on what's being said? your book looks at a lot of the traps of young companies. And I think there's one in particular that can affect public companies that we follow, which is the trap of speed. And I know you focus on younger startups in this,

but can you explain a little bit of what the trap of speed is and how we can identify it is investors that like looking for a lot of growth? Yeah. Yeah. And so in the book, we talk about how a lot of companies are always, always struggle between winning the short game and winning the long game. And

you know, to be clear, you need to win both games to be successful. If you don't win the short game, you won't be around to play the long game. And if you over-optimized for the short game, then you make decisions that aren't, you know, good for the long-term. I think the same applies to a lot of investors. I think when you see a lot of, and VCs know this intuitively, like, you can actually

make sure that your quarterly returns look abnormally positive and, you know, and risk longer-term, you know, success. And so that's something I always look out for when I, you know, when I look at companies, like, to what extent are they optimizing for Wall Street? To what extent are they optimizing for shareholder perception? I think that tends to be a very difficult path to go down because there's very little you can do to kind of, you know, cover things up for, for, for, the, you know, in the long term. Some of the research in your book I want to talk about is about how companies go public in the compositions of their teams. This came from the research from the Stanford project on emerging companies. And it breaks down startup types into like autocratic. I know there's a fourth one, but commitment and star. Yeah. And the two that really stand out are the commitment

type startups, which is the, this is a, this rings alarm bells for me, but it's the company saying, We're like a family. We're looking for those strong cultural fits. And then you have star startups, which we're going to look for outstanding people and give them what they need in order to do their job. And what the research found is that the star startups, your talent-based startups, are much less likely to go public than the commitment ones. But if the star startups go public, then the shareholders in those can expect much better

returns. Yeah. What do you think explains that phenomenon? So the study, which is quite a seminal study, and it's surprising to me that it doesn't get more press or it didn't get more press when it first came out. So what it basically says is that star kind of blueprint companies who tend to hire for extremely talented people and give them the freedom to operate, they tend to go for bigger goals. more ambitious, more difficult, impossible goals. And as a result, you know, they bear a lot more risk. And so the risk of them going public is so much higher. But when they do, because you have this powerhouse,

kind of this bedrock of really amazing talent, then they're able to really grow far beyond, you know, their peers that might be more of a commitment-type model. Now, on the other hand, the commitment type model, you optimize for fit. What's interesting about that is the commitment model startups tended to have lower failure rates. A big part of what the study explains in that is, you know, the lower failure rates are a result of people having somewhat more homogeneous ideas and homogeneous commitment that they can go in a single direction pretty, you know, pretty single-mindedly and succeed in that single direction. But the moment they go public or they reach a point of growth where they need to expand into new markets or expand to new business units, that's when the failing of this homogeneity kind of kicks in where they're not then able to break out into whole new product areas, et cetera. The big caveat of that whole thing, which is something we caution a lot of leaders for is when you see a company trying to pivot quite significantly, and this is interesting about pivoting in general,

I think startups in general think, oh, it's always good to pivot quickly and like, you know, fail fast, etc. Well, a lot of the researchers pointing to the fact that pivoting actually could be more damaging. You know, and in this case, when it comes to culture, when a company goes from commitment to star, for instance, because they somehow realize they need to hire differently, you actually have a bigger downside and the bigger risk of failure when they try to switch blueprints. many of the people listening may not be in a in a founder or even a leadership role at their company where they're managing people um through your work through the effective founders project what have you learned about being a good a good teammate at work being a good work partner for the people you see every day yeah one of the things we talk about in the book actually um is dealing with inner circles and how it's

kind of the natural state of play that inner circles get formed in a company. Inner circles are sometimes formed around people with power, so people like your manager, the leader, but it could also be formed around personal power, so people who are outspoken, people who maybe have specific kinds of expertise. And the one thing that we've learned in terms of, you know, how you become a good team member is that great teams are actually teams with a lot of conflict, but the conflict crucially is about ideas and not about personalities. And to the extent that you can, as a team member,

find that way that you can debate and disagree, you actually help the team, you know, make better quality decisions and execute a lot more effectively. I think it's very common for people at lower parts of the organization to defer a little bit to the boss or anchor to what, you know, the expert in the group says and almost discount their own instincts. And I think that discount rate that you apply to your own ideas and instincts oftentimes actually results in a worse off team. So I would say, you know, trust your instincts, put your ideas out there, be more willing to disagree and debate

because I think that just makes the work all the better. What is? It's the type two disagreement. That's right. And this is, and this is, you'll explain it better than me. Yeah, no, this comes from actually one of my favorite characters in computer history. This lab manager, Bob Taylor. Bob Taylor is a manager in Xerox Spark. And for those of your listeners that don't know, Zyrox Spark is probably one of the most prolific places for innovation in the late 70s and early 80s. From there, you get the personal computer that Apple then commercializes.

Adobe comes out of their, Pixar comes out. out of there. All these technologies emerged from this place. And he talks about how his job, his main job as a leader, was to make sure that he graduated Class 1 disagreements to Class 2 disagreements. Class 1 disagreements are straw man arguments. They are, Ricky, if you told me what your point of view is, I will represent it in the weakest way possible and then debate it.

And that's usually an easier way to do it. A class 2 disagreement, on the other hand, is let me represent. present to you, Ricky, back to you, your point of view in the strongest way possible in a way that you feel satisfied. And then let me offer my opposing point of view. And Bob Taylor says that his role is to ensure that every class one disagreement graduates to a class two disagreement. And by the way, it's not always his role to resolve any of these disagreements, but to make sure that they are all class two disagreements. And I think as a team member in your job, like find a way to actually achieve those class two disagreements. Those become really useful. I think if we didn't have class one disagreements, we would not have talk

radio. Fair enough. It would be a problem. So I'm going to let's let's extend it. We've talked about inviting disagreement and being willing to disagree with others' ideas as a team member. Maybe what are one or two traits that, you know, middle managers, people in leadership roles at a company, but, you know, maybe they're not a founder, can take from those highly successful founders that you've studied? So the number one thing that we found in the data, actually, was this idea of treating people like volunteers. I wasn't so, as a researcher, I wasn't so thrilled to see this because I'm like, well, we don't

need another message around, you know, having a compelling vision and rallying people around it, but somehow this emerged to be the most critical predictor of success. And treating people like volunteers isn't about do you have a compelling vision? It's really about do you understand how your vision of the future will actually benefit the people who you're asking help from? Like, can you actually talk about the benefits of following you on the premise of what your followers care about? So for instance, you know, one of the founders that I think has done this well was a founder based in Indonesia. I was then based in Google Singapore. And he called me to the food court of the building,

to kind of chat. And he invited me to a chat mostly to talk about some of his cultural challenges. And at the end, he said, he said, look, Martin, look, you can stay on at Google and be a spectator of all this great innovation. Or you can come join me and be the Laslo Bach of Asia. And Laszobach, for those who don't know, he's basically the guy who builds the people operations team at Google. And so this founder knew what would potentially kind of tug at my own, you know, heartstrings and my motivation. Obviously, I didn't jump ship and, you know, I'm still very much at Google. But, you know, that's what it means to treat people like volunteers, that people have options.

Now, if you're a leader, a manager in your team and you think that the paycheck that your team members receive is a good excuse to treat them poorly or, you know, or treat them disrespectfully, will know that good people have options and that they will, you know, that they can walk away. And if you start with that premise, then I think you'll behave and you'll deal with them very differently. As always, people on the program may have interest in the stocks they talk about. And The Motley Fool may have formal recommendations for or against, so don't buy ourselves stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We'll see you tomorrow.