Timing The Market

April 2nd 2016

Here at Silverman Ventures, we’re really happy with small failures on a daily basis. Small failures show you’re trying new, innovative things. Looking for breakthroughs. Pushing the limits of your team’s intellectual capability.

There’s immense learning value in little failures. We cherish it. We spend a tremendous amount of effort learning from our little failures. Encouraging and understanding small failure prevents bigger failures from occurring. Like entire companies failing. Those are kinds of BIG failures we don’t like.

Silverman Ventures aren’t a traditional VC – where outsized returns from 10% of the portfolio cover the entire fund several times over. (Some refer to this as the VC power law)

We’re more measured in our approach, aiming for 90% of our portfolio to be alive and profitable within 5 years of founding. It’s the inverse of power law investing.

In order to consistently attract success, one needs to learn to avoid failure. Studying other successes only leads to survivorship bias. (for startup failures, read this amazing compilation by CBInsights)

There’s great story about Abraham Wald, a Columbia university mathematician who founded the field of statistical sequential analysis. During WW2, the air force called in Dr. Wald to help with reducing the number of bombers that were being shot down. They knew how to resolve that – add more armour. The question though was where on the aircraft and how much of the armour to add.

So the Air Force filled a giant warehouse of bombers that returned from actual WW2 sorties, riddled with bullet holes, for a statistical analysis led by Wald. The Air Force commanders wanted to put thicker armour protection where they could clearly see the most damage, where the bullet holes clustered on the aircraft.

Abraham Wald, however, did the complete opposite. He added more armour on the places without any bullet holes. And he was right.

Did that make sense to you?

The planes in the hanger were the ones that survived. The bullet holes in the surviving planes actually revealed the locations that needed the least additional armour. “Look at where the survivors are unharmed”, Wald said, “and that’s where these bombers are most vulnerable; that’s where the planes that didn’t make it back were hit. That’s where we need more armour.”

Prior to starting this fund, we studied failure with religious fervour. What caused companies to fail? Was it poor product market fit? Lack of funding? Lack of a monetisation model? Competition?

All of those factors cause failure. But what was the single, biggest, cause?

According to our research, it’s timing.

Timing accounts for 42% of the difference between success and failure – Bill Gross, IdeaLab [4]

Webvan was a failure in 2000, but AmazonFresh and Redmart are successes in 2016.
Mercata and Mobshop failed in 2001, Groupon in 2016 however….
Kozma crashed and burned in 1999. Netflix in 2016 looks to be a rousing success.

In fact, there are tons of other examples.

Timing is everything.

So how do we know NOW is the right time?
For new startups we’re considering, we always try to fit them into one of 3 categories below:

Category 1: Technology Maturation

Great ideas often happen at similar times. Take the process for smelting aluminium [5]. The Hall–Héroult process was invented, independently and almost simultaneously in 1886 by the American chemist Charles Martin Hall, and by Frenchman Paul Héroult. 2 people, across the Atlantic, identical idea, same time.

Their simultaneous discovery was driven by the sudden availability of large amounts of electricity, a key component of the smelting process, thanks to the invention of the dynamo in 1881. Dynamos allowed cheap and plentiful electricity to become far more widely available by 1885 – thereby enabling this new electricity driven smelting process.

Even today, our advances in machine learning are primarily based on Neural Networks, a concept first proposed in the 1960s, but only viable today thanks to cheap & easily accessible computing power. (thank you AWS!)

So when starting a startup, we ask – has there been a sudden shift in technology that suddenly makes this idea viable?

Category 2: Consumer Taste Maturation

Sometimes, the best ideas are just a little bit too ahead of their time. The market needs to be primed and ready for your entry.

Take e-Commerce for example, Warby Parker wouldn’t have succeeded if consumers weren’t comfortable purchasing online. That taste shift / market education was led by Amazon.com, Zappos and Blue Nile. The online buying market was primed. All new e-commerce entrants after had it much easier. A similar argument could be made for any cloud SaaS startup – salesforce.com had done all the heavy lifting.

It’s almost akin to the second mover advantage. First movers in a market have a dismal 8% chance of success. Later movers however, have as high as a 43% chance of success. It pays to let the market be ready for you. [6]

Category 3: Change in Market Rules

Changes to the law can adversely alter a startup’s growth trajectory (eg. Uber in Indonesia). Occasionally though, it can suddenly make a startup’s vision totally viable.

This was the case for the greatest corporation of its time – the East India Company (EIC).

In the early 1500s, British law created what was then a radical new type of business: a joint stock partnership. For the first time, people could sell shares in their company to raise capital. This gave ambitious companies, such as EIC, the means to procure capital to fund some very expensive (and risky) wages to the East. A new law suddenly made this high-risk-high-return business model viable. With it’s fat coffers, the EIC successfully funded voyage after voyage, holding a monopoly on the supply of cotton textiles and Indian tea in Europe.

Almost every unicorn of the past decade can be fit into the 3 category model above:

Facebook: Consumer Taste Maturation. Friendster & MySpace primed the market for their entry.
Uber: Technology Maturation. Internet & GPS Enabled smartphones in the hands of consumers & drivers made the marketplace work.
Buzzfeed: Consumer Taste Maturation. Increasing shortening attention span of millennials drove this new form of viral news site.
Intel: Technology Maturation. Silicon microprocessors got increasingly reliable whilst decreasing in $/Hz
Alibaba: Change in Market Rules. China’s opening gave rise to a flood of local manufacturers, eager to export their goods.

Shifting grounds often create ripe opportunity for disruption. Be it a Technology Shift, Consumer Taste Shift or Market Rule Shift. Keep your eyes on the horizon, soldier!

References

[1] Leslie Berlin, “Try, Try Again, or Maybe Not,” New York Times, Mar. 21, 2009.
[2] Wikipedia. https://en.wikipedia.org/wiki/Survivorship_bias. Retrieved on Mar 21 2016
[3] http://youarenotsosmart.com/2013/05/23/survivorship-bias/ Retrieved on Mar 21 2016
[4] https://www.ted.com/talks/bill_gross_the_single_biggest_reason_why_startups_succeed/transcript?language=en Retrieved on Mar 21 2016
[5] https://en.wikipedia.org/wiki/Hall–Héroult_process Retrieved on Mar 21 2016
[6]http://www.forbes.com/sites/avaseave/2014/10/14/fast-followers-not-first-movers-are-the-real-winners/#34fcf7f49d7e Retrieved on Mar 22 2016