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Standford CS183—Possibly the best class on start-ups ever is back

Stanford’s CS183 course is back and open to the public.

The first class was taught by Peter Thiel, and the class notes written by Blake Masters were so popular, they’ve become a book, Zero to One, co-written by Thiel and Masters.

The new class is titled CS183b How to Start a Startup and is being taught by Sam Altman, who runs Y-Combinator. The Paul Graham class is a good place to start.

Who and What I Read — Recommended Reading

I’ve started including a recommended reading list with our offer letters to potential hires and thought I’d post it here as well. The list includes blogs and books and is arranged alphabetically by author within each section and will be occasionally updated.

General & Organizational

Ben Horowitz: The Hard Thing About Hard Things
Ray Dalio: Bridgewater Principles
Jason Fried and David Heinemeier Hansson: Remote and Rework
Tim O’Reilly: Work on Stuff that Matters
Steve Jobs: Stanford Commencement Speech
Eric Ries: The Lean Startup
Seth Godin: Tribes and Linchpin
Peter Drucker: Managing Oneself

Entrepreneurship & Venture Capital

Peter Thiel: CS 183 Stanford and What Happened to the Future?
Fred Wilson: A VC
Brad Feld: Feld.com
Paul Graham: Essays
Steve Jurvetson: Flickr stream
Mark Suster: Both Sides of the Table
Seth Godin: sethgodin.typepad.com
Vinod Khosla: Gene Pool Engineering
Ray Kurzweil: Law of Accelerating Returns

Science & Technology

Anything and everything by

  • E.O. Wilson
  • Stewart Brand
  • Kevin Kelly
  • Freeman J. Dyson
  • Richard Feynman
  • R. Buckminster Fuller
  • Vaclav Smil
Energy & Resources

Rusty Braziel: RBN Blog
Robert Rapier: R-Squared
Armory Lovins: Reinventing Fire
Gregor MacDonald: TerraJoule.US

The Nature of the Firm — Why Start a Company?

He who gets commoditized last, wins. —Andy Grove

Background

In 1937, Ronald Coase, an economist, asked the question, why do firms (companies) exist? His answer appears to be a simple observation but one that has completely changed the way I think about markets and companies. This was something Coase made a habit of — simple observations with profound impacts — and which won him a Noble Prize in 1991. He lived an incredibly productive and long life, writing a book on China’s economy at the age of 100.

Why Start a Company?

I’ve started a number of companies but never really asked the question, why? And which companies? I think my answer — and the answer most entrepreneurs would give — is that I saw a problem and wanted to fix it. I believe most entrepreneurs would explain that there was no solution to a particular problem or that they thought they could do it better themselves. (The other reason I’d say is freedom — I wanted to control my time.)

[T]he operation of a market costs something and by forming an organization and allowing some authority (an “entrepreneur”) to direct the resources, certain marketing costs are saved. The entrepreneur has to carry out his function at less cost, taking into account the fact that he may get factors of production at a lower price than the market transactions which he supersedes, because it is always possible to revert to the open market if he fails to do this.

What Coase proposed was that firms were created when the internal transaction costs (decisions orchestrated by the entrepreneur) were less than the external transaction costs (decisions set by a price mechanism in a market) — i.e., “I’ll just do it myself.”

A firm, therefore, consists of the system of relationships which comes into existence when the direction of resources is dependent on an entrepreneur.

This was actually very counter to the traditional theory at the time. Adam Smith had shown that markets were efficient (the invisible hand and all): the market works so that the entity that can best provide a good or service mostly cheaply would do so. Thus it would always be better to contract the best than to hire someone who was suboptimal. So while we hear about the efficiency of markets all the time, what Coase proposed is that there is a real cost to operate and participate in a market and that firms are created to avoid this cost. Markets do have a cost and a value; you can simply look at the market capitalization of the Chicago Mercantile Exchange, one of the largest marketplaces in the world, to see this: it has a market capitalization of $27 billion and nearly $3 billion in revenue. These are market costs.

Examples/Firm Size (Internal vs. External)

Every day, general contractors pick up day laborers or subcontractors for a day or week of work. They’ve made the decision to use the pricing mechanism of a market to pay for a small unit of labor. Most of us use outside services for our firms — accounting, legal, benefits. We do this because it’s cheaper “to buy than to build” these services in-house —  i.e., the market pricing mechanism is more efficient than we could be.

But let’s look at a bigger business, a vertically integrated commodity producer, like a large farm, for example. Their product’s price is transparently set by the market (corn is listed in the Chicago Mercantile Exchange, for example). The founders of this hypothetical firm made the decision to create a company because they believed that their internal costs would be less than the market’s, that they could produce corn for less than the market price. It doesn’t stop there though — should they buy fertilizer, or should they produce their own? Should they process and package their product or just sell a commodity? Should they own or lease their land? All of these are decisions based on internal vs. external transaction costs. Large firms can gain tremendous advantages — internal information, bargaining costs, the effective protection of their intellectual property and trade secrets; thus, we see the success of large, vertically integrated businesses. Often, the more transactions, the more economies of scale, the lower the coordination costs. Think about Amazon in this context — they own retail because they have the lowest coordination costs due to their size and efficiency.

However, there is a limit to the size of the firm. There is a reason we often describe big firms as slow or bureaucratic.

First, as a firm gets larger, there may be decreasing returns to the entrepreneur function, that is, the costs of organizing additional transactions within the firm may rise.

As a firm scales, overhead costs go up‚ and it becomes harder to orchestrate lots of people and to share information. The better the entrepreneur’s management skills, the better he or she can coordinate an organization, and the more the organization can scale without losing efficiency. But eventually, forces start to work against the firm — orchestration costs rise; smaller, more nimble competitors can deliver similar services less expensively.

Conclusions, Observations, and Questions

If you are going to start a firm, you better believe you can minimize the transaction costs, which for almost everything — from software to manufacturing — are collapsing. And you need to believe that you can not only minimize them initially but also keep them lower over the long haul. Secondly, what gets internalized is again a function of transaction costs. During the life of a company, there is a perpetual debate about “buy vs. build” (a dichotomous analysis that, by the way, could be extended to the question of buying from the market or starting a new company in the first place). Before you make that hire, are you sure it’s cheaper? Does the cost of managing more people outweigh the benefit you could find in the market? We like to measure and judge companies by their number of employees, which is often the wrong metric. Bigger doesn’t always mean better. It often means plodding and inefficient.

Additional Reading

The Theory of the Firm, Ronald Coase, 1937

TECHnacity—The End of an Era

At the beginning of this year, I sold my remaining interest in TECHnacity, a software consulting company I started back in college with two partners.

It was the fall of 1997, and I had spent the summer going city to city, auditing mobile-phone sites for a large big-name hardware company. But after two summers, I knew that I didn’t want to be an engineer for a big company. In fact, I had wanted to work for myself for as long as I could remember, from an oddly young age. At the time of my summer internship, the tech world was a pretty exciting place: the Internet was new, Netscape had gone public a couple years earlier, and as a graduate assistant, I was helping put the first classes on the Internet. I was teaching myself how to program and had started spending time at a start-up where I helped build 3D games that taught kids about science (way ahead of its time).

I pitched my dad on buying us a server, a hulking $3,000 computer, probably less powerful than the phone now in my pocket. (I remember the awkward dinner when I asked my parents for money. I’d later learn that they had to put the purchase on a credit card.) We originally named the company Celestial Systems, which makes me cringe a little in hindsight. But I was so excited to have started a business. I still remember the corporate seal that came in the mail-order new-company kit.

I set up basic hosting and e-mail on our server, and we opened up for business. I spent the holiday break, ultimately to no avail, sending letters to everyone I knew who owned a business, offering hosting, e-mail, and web-design services. Back at school, with no customers, we continued to put classes online for the engineering department. The university needed us, and with graduation approaching, we pitched them on the idea of a consulting contract to continue the job after graduation. They accepted—our first customer. I actually ended up doing my master’s thesis in electrical and computer engineering on distance learning using the Internet.

During a brainstorming session in one of the engineering buildings, my partners and I came up with our new name. We were combining words and had paired “technology” with “tenacity,” and thus TECHnacity was born. The idea was the relentless (i.e., tenacious) application of technology. Luckily, we didn’t stop at Biznacity. (Incidentally, this is the same way we named Infinium many years later.)

Our office in Champaign was basically in a metal barn on the south farms. The university had some office space there, surrounded by cows and fields, that housed a couple small companies. I’d drive out there after class and often ended up working through the night. I remember two things from that office—the stars and the smell.

The company grew, and we began building prototypes for start-up companies (it was the late 90s after all). We built an XML switching engine for a company that was briefly public, although we’re still not exactly sure what the switching engine did. We put patented processes online, building a site that custom selected toys and one that optimized media buying. We built basic websites and wrote applications as our skills improved. We’d often pitch a project, win the contract, and find ourselves in the computer-science section of Borders (back in the days of book stores), learning the required technology like SQL or XML. Sometimes we’d even buy the book.

I moved to Chicago, and the company continued to grow. I remember forcing myself to go to networking events at night and to make sales calls (both of which I hated). Often, the events would be at the Union League Club, so I’d have to remember not to wear jeans and would often have to borrow a tie from the club host. We built a bit of a customer base in Chicago, and I ran the business out of our living room, eventually having employees come to my apartment every day for work. We lined the living room with desks, which I can’t imagine my three roommates appreciated, but they were very supportive and never said a word.

The problem with billing time is that it doesn’t scale—the only way to make more money is to hire more people or bill more hours. I was running out of hours in the day, and the technology bubble was bursting. Luckily, we had taken some cash and not just stock in the start-ups we were helping. The cash paid the bills as most of the start-ups went under. That period and those projects were hugely valuable to me not just because I could pay my rent but because I learned what did and, often more important, what didn’t work in technology and as a business.

After five years, we scaled down the business, and I became involved in finance, but we kept the company open. For ten years after scaling down, something would still always come up: a contact we met years ago or a former client would refer us work. Now fifteen years after it all started, I’ll technically exit to one of my long-time partners.

This is how most businesses end: there was no grand exit; it exchanged hands at the value of the checking account. But by all measures, it was a success. We billed millions of dollars in revenues over the company’s lifetime, I paid back my dad for the computer, bought a car in Champaign, bought our first house in Chicago, learned a ton, and added value for a variety of customers across all kinds of industries and applications. I am proud of what we achieved, and though I have repeated this process multiple times now with companies that technically were more “successful” than TECHnacity (in terms of revenue, size, etc.), I will never forget the excitement and pride of taking that very first step, the very big risk of eschewing a secure job with a stable employer and making a go of it on our own. And perhaps I’ve even come full circle: with my involvement in ampCNG (where compressed natural gas is made from the waste of dairy cows), cow manure once again smells like independence and opportunity. Who would have guessed.

Dust and Dignity—Travels with Acumen Fund

A couple of weeks ago, I had the opportunity to spend the week with a group of Acumen Fund partners in Nairobi, Kenya. During the course of the week, we visited many of Acumen’s investments and met with their local team. I’ve been an investor and partner in Acumen Fund for over three years and recently joined their Advisory Council.

We cut through the dust, bouncing along on the copper earth on what Kenya calls a road. We are on our way to an ophthalmological outreach camp in Karatina, a couple hours north of Nairobi. The camp is run by Dr. Kibata, the founder of UHEAL. Dr. Kibata grew up on a small farm and watched his father go blind due to diabetic retinopathy. Diabetes is an enormous problem in parts of East Africa and India and untreated can lead to blindness. Dr. Kibata’s core clinic is located in Nairobi, but he has conducted a handful of outreach camps to reach patients in the rural areas. Today we are visiting one such camp. We pull up and find hundreds of patients waiting outside on plastic chairs to see the doctor. They’ve heard about the camp through word of mouth or radio advertisements and have come from the surrounding villages. Today he’ll see over 200 patients, about 10% of whom will need laser surgery to prevent blindness. The patients work their way through an eye exam (conducted in a dark room with sheets hanging on the windows to block out the sun), blood pressure measurement, and blood testing, and lastly they see the doctor. Dr. Kibata is the only doctor in the region who can perform these surgeries, and there is one functioning laser in the country. He operates on a cross-subsidy model where patients in Nairobi who can afford the surgery help underwrite the costs of the outreach camp in rural areas. With the work today, he’ll just break even. It’s early days, but there is a clear path for enormous impact. And soon, he’ll be able to help even more people as Acumen’s investment will help him purchase a laser and fit it into a van to create a mobile clinic for UHEAL.

In downtown Nairobi, we see a similar business model. David Kuria, the founder of Ecotact, a public sanitation company, shows us his Iko Toilet, a pay-for-use toilet. David, the designer and an architect by training, is addressing the dangerous lack of public sanitation in the slums of Kenya. Like Dr. Kibata, he relies on a cross-subsidy model where the downtown toilets in commercial districts help underwrite the cost of toilets in the slums. Ecotact has 26 toilets in operation with over 4 million uses last year, and customers pay 5 shillings (about 7 cents) per use. We visit a facility in the downtown business district, and business is booming. This unit leases out space to a small refreshment store and a shoeshine operation off the back. It’s a beautiful day, and there is a line for shoes to be shined. The toilet in the slum is less busy, but a steady stream of people flow through. It’s a hard problem—how do you convince someone to pay for something typically viewed as free (going to the bathroom) out of very limited income? David has a unique approach: make sanitation sexy. He’s had Miss Kenya, the vice president, and various other Kenyan celebrities visit his facilities. Still, it’s an uphill battle—the fact that the business even exists shines a light on the government’s inability to provide basic services, and David has to negotiate the land lease with the government each time he opens a new facility.

In Kibera, we meet other aspiring entrepreneurs. There is a youth group that has built a greenhouse on what was previously a trash pile; their tomatoes are just starting to sprout. And they’ve installed a pay-for-use toilet similar to Ecotact’s—success brings competition, after all. The youth group meets in a structure on the edge of a ravine where the railroad to Uganda comes through. Kibera sits on both sides of these tracks. The railroad technically owns 100 meters of land on each side and could reclaim it at anytime. We visit Hot Sun Films, a film school and production company in the middle of Kibera. Through the gate, crammed into a small room, we find iMacs and a group of young directors brimming with excitement. Their latest movie, Together Supreme, is being shown at the Vancouver International Film Festival. We leave as the prayer bells begin to ring, passing a bright red wall painted with Enjoy a Coca-Cola. It seems iMacs and Cokes are universal.

We find out at the airport that our flight to Kitale is a couple hours late, and we eventually leave at 2:30pm on our scheduled 11:30am flight, necessitating several calls to reschedule an entire afternoon of visits. On our way to western Kenya near the border of Uganda, the dual-prop plane sways with the currents as we climb. The landscape changes from dry arid plains to green rolling hills dotted with teepees of drying corn. It’s harvest time, and farmers are busy. As we pull off the airstrip, school kids are waiting in uniform. They come out to watch the one daily flight land. After lunch, we head off to see an agricultural finance organization that makes loans for agricultural assets.

The organization has over 8,000 members, over half of whom are women, and on our visit, we meet a community of borrowers. A small group has formed in order to get access to capital. A handful of members can have a loan out at any given time, and once it is repaid, other members request access. Loans are for a cow, a chicken coop, and the group asks about getting a loan for a milk chiller that they all could use collectively. The committee does the due diligence on each member, who first must be active in the group for a number of months, then raise a down payment, pass a house visit, and finally submit a formal project with detailed plans justifying the loan amount requested. The group is led by a 71-year-old woman as sharp as ever. If she was in charge of due diligence at the banks here, we wouldn’t have had a financial crisis. The group structure inherently creates accountability, and the loans go to assets (livestock and equipment) that pay real yields in the form of eggs and milk.

From there, we head off to visit test plots of hybrid seeds developed and distributed by Western Seed Company. The farmers walk us through various plots, past corn taller than we are, and we’re trailed by kids excited to get their pictures taken. Western Seed makes a variety of seeds that have been selected based on the high elevation and water traits unique to the area. The seeds are more productive, but convincing farmers to change is hard business. Most farmers here farm a half acre to a hectare in total, so over the course of a lifetime, a farmer may make only 40 choices on what to plant, and the resulting harvest determines not only financial success but whether the family will have enough food for the year. Innovation in agriculture inevitably takes a long time because the feedback cycle is often measured in years. We head back to Kitale, passing a flipped truck on the highway—the roads are probably the most dangerous part of the trip. After a fantastic dinner by candlelight (power is out in Kitale), we head back to the Kitale Club, which is a relic from the past. You can imagine some fine British chaps exchanging big-game stories sitting around the fire. You can golf the beautiful 9-hole golf course if you don’t mind the monkeys on the course or the occasional cow wandering through.

The next day, Saleem Esmail, the founder and CEO of Western Seed, leads us on a tour of the Western Seed facility. Saleem is a fifth-generation Kenyan, a Muslim, and from Southeast Asia. He’s an inspiring entrepreneur, and you just want to follow him no matter where it leads. The last couple years, demand has outpaced supply, and Saleem needs to increase productivity. With help from an Acumen investment, he’ll do this by purchasing and cultivating his own land to grow seeds that are then processed at his facility. His alternative to Acumen’s investment is a loan at 16% from a local bank that demands 200% collateral made up of both assets and guarantees from the board. You can see what patient capital really means with Saleem. It takes him on average 3 years to convert a customer from the competitor’s seeds, he has to plan 2-3 years in advance to ensure he has the proper stock ready, the weather is always unpredictable, farmers frequently do not have enough fertilizer, and he has limited access to financing. But Saleem has a plan, and he’s as sharp as any CEO you’ve met. He talks about the need to put cashflow to work (if you can’t, he says, you’re stagnant), about how critical good people are (his team is incredible, and morale is high in the plant), and how they work 24 hours a day in shifts if needed to address a problem. I’m always so impressed by farmers—the job requires them to be incredible business people.

We head back to Nariobi and, over the balance of the week, see variety of companies. There’s d.Light, founded by Sam Goldman and Ned Tozun, that produces solar lanterns to replace kerosene. They’ve sold 350,000 lanterns already throughout Africa, India, and Southeast Asia. Sam’s mission is to eradicate kerosene, which kills well over a million people in the developing world every year, from both fire and indoor pollution. We learn of a fire earlier in the year from a spilled kerosene lamp that killed several girls in Tanzania, and Sam’s motivation for starting the company came years ago when a friend of his was badly burned in a similar fire. In Tanzania, d.Light is getting traction through schools as students receive a $6 lantern to study with at night included in their school fees. The lamp runs on a 3w bulb, and newer versions have the ability to charge your cellphone. Often people have to travel 2 hours to charge their phones on car batteries, so this is a great improvement. Still, the cost is relatively high, and adoption is somewhat slow, but d.Light is making steady progress.

We visit the factories of Insta, a company with a license agreement to make a calorically dense and nutritionally rich nut-paste-based product for distribution through various aid agencies. The product is often prescribed as medicine to get HIV patients’ BMIs high enough to go on antivirals. Insta is the model globally and the leader in the space, but still the work is complicated. Payments are irregular and the reliability of supplies (peanuts, milk) volatile. Acumen recently provided working capital to move forward on a batch of the product. Still, despite the critical importance of the nutritional supplement to those most in need, hard work lies ahead.

We visit Botanical Extracts EPZ Limited (BEEPZ). From a locally grown plant, BEEPZ extracts artemisinin, which is then used in antimalaria medicine. Hailed by Thomas Friedman in the New York Times a number of years ago, the company has had a tough go. Pricing for the drugs has been volatile and extraction efficiency hard to achieve. BEEPZ is running a couple days a week now, producing in limited quantities.

We end the day on a positive note at a housing development built by Jamii Bora, a local microfinance bank with 170,000 members, making it the largest in Kenya. The development is part of a plan to provide housing and community to people currently living in the slums. A group of women greet us as we arrive, and after some singing and dancing (in which we are included), they show us their work. They’ve made literally millions of bricks and roof tiles for homes that will be constructed. We visit the local school, the well, the water-treatment ponds, the clinic, and their homes. The woman are so excited about and proud of the development, and it’s amazing to think how far they’ve come, from the slums we visited earlier in the week to two-bedroom houses with running water. People are moving in that day, and there’s a real sense of community that you can just feel.

I leave each business thinking just how complicated these problems are. They touch on behavioral economics, marketing, finance, public policy, ethics, technology, and education. The problems exist an environment with little physical infrastructure—poor roads constitute 40-50% of the cost to transport goods, and there are frequent power outages. The effects of climate change are being felt so directly that the conversation has shifted from mitigation to adaptation already. I worry about how little institutional and governmental support there is, thinking back to Dr. Kibata’s eye clinic, which, adding confusion to inefficiency, is regulated by the Ministry of Health and competes with organizations selling glasses, who are regulated by the Minister of Culture and Social Services, often with different plans and conflicting incentives. These businesses operate in a country with a life expectancy of 54.5 years. Each of these entrepreneurs is—and I say this intending only the highest praise—unreasonable, slightly crazy, and incredibly inspiring. It’s unreasonable people who create change. Whether it’s the 200 patients that UHEAL saw the day we were there, the 350,000 lanterns d.Light has sold, the 8,000 members of the agricultural finance organization, or the 1200 tons of seed Saleem will produce at Western Seed, each one is producing real, measurable change. While they all might not make it, there’s not one of them I wouldn’t be proud to be invested in.

This is what I love about Acumen—it backs local entrepreneurs to solve the hardest problems for the people most in need. If you can prove the model, the sector follows. There’s now $4 coming into these sectors for every $1 Acumen puts up. You realize that aid has become a business, and while intentions are good, there are vested interests and incumbents often all too concerned with protecting their own positions first and foremost. And in this well-intentioned world filled with white SUVs, Acumen gets dirty. Their people on the ground have a working relationship with each of their investments. These guys don’t presume to know the answers, but they know the process that leads to answers and the systems of accountability that increase the chances of success. The problems are complicated—if they were easy, they would have been solved a couple billion dollars ago—but Acumen is creating measurable, repeatable examples of success founded on the belief that people want dignity, not dependence.

For ways to get involved with Acumen, please visit www.acumenfund.org or join a local community chapter in your area.

If you will be in Chicago on November 13th, Chicago’s Acumen chapter will host Dignity, a photography exhibition and auction, in partnership with the Nuru Project. Full details can be found here—we’d love to have you.

O’Reilly: Stuff That Matters (2009)

Tim O’Reilly on working on Stuff that Matters:

Some of you may end up working at highflying companies. Some of you may succeed, and some of you may fail. I want to remind you that financial success is not the only goal or the only measure of success. It’s easy to get caught up in the heady buzz of making money. You should regard money as fuel for what you really want to do, not as a goal in and of itself. Money is like gas in the car — you need to pay attention or you’ll end up on the side of the road — but a well-lived life is not a tour of gas stations!

Whatever you do, think about what you really value. If you’re an entrepreneur, the time you spend thinking about your values will help you build a better company. If you’re going to work for someone else, the time you spend understanding your values will help you find the right kind of company or institution to work for, and when you find it, to do a better job.

Don’t be afraid to think big. Business author Jim Collins says that great companies have “big hairy audacious goals.” Google’s motto, “access to all the world’s information” is an example of such a goal. I like to think that my own company’s mission, “changing the world by sharing the knowledge of innovators,” is also such a goal.

Don’t be afraid to fail. There’s a wonderful poem by Rainer Maria Rilke that talks about the biblical story of Jacob wrestling with an angel, being defeated, but coming away stronger from the fight. It ends with an exhortation that goes something like this: “What we fight with is so small, and when we win, it makes us small. What we want is to be defeated, decisively, by successively greater things.”

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