Tag: Business

Creating Effective Incentive Systems: Ken Iverson on the Principles that Unleash Human Potential

The issue of setting compensation seems to be struggled with in every organization. Most are pretty lazy about it — hiring someone else to take care of it and failing to think through the incentives they’re creating.

Some companies are different. Nucor, a steel company, under the leadership of Ken Iverson is one of them. Iverson details his thoughts in the masterful Plain Talk. (This isn’t the first time we’ve covered Iverson’s wisdom on running a company. His genius was exploiting unrecognized simplicities.)

Ken Iverson

Under Iverson, compensation at Nucor had two components: A small but meaningful base pay and a very simple weekly bonus based on production. Outside of benefits and a little profit sharing, that was it. Simple, straightforward, and powerful. No subjective criteria.

The real beauty of Nucor’s compensation system, in my opinion, is that there is nothing to discuss. Daily output and corresponding bonus earnings are posted, so employees know exactly what their bonus will be before they tear open their pay envelopes. No judgment. No negotiation. No surprises.

There are three beautiful aspects to the design of this program.

The first is that it’s eminently clear what you will be paid for: making more steel. It’s so simple. Your compensation is never at the hands of someone who may or may not like you. You have no reason to say it’s unfair: You signed up for it when you signed on. If you worked at Nucor under Iverson, the first thought you had every morning was how to make more steel.

Secondly, it offers immediate feedback. Human nature, and the nature of many other higher-thinking animals, is such that immediate rewards work better than delayed rewards. B.F. Skinner knew this, but some corporations haven’t figured it out yet. A year-end bonus isn’t nearly as effective as a weekly bonus. A year-end review isn’t nearly as useful as immediate feedback. It’s simple.

And lastly, this program gave Nucor’s employees tremendous skin in the game. Everyone was working towards the same goal. Rowing in the same direction. And that makes a tremendous difference.

Nucor’s great success in harnessing incentives reminds me of Charlie Munger’s discussion on Federal Express:

From all business, my favorite case on incentives is Federal Express. The heart and soul of their system—which creates the integrity of the product—is having all their airplanes come to one place in the middle of the night and shift all the packages from plane to plane. If there are delays, the whole operation can’t deliver a product full of integrity to Federal Express customers.

And it was always screwed up. They could never get it done on time. They tried everything—moral suasion, threats, you name it. And nothing worked.

Finally, somebody got the idea to pay all these people not so much an hour, but so much a shift—and when it’s all done, they can all go home. Well, their problems cleared up overnight.

So getting the incentives right is a very, very important lesson. It was not obvious to Federal Express what the solution was. But maybe now, it will hereafter more often be obvious to you.

Does this mean every company should model their compensation program after a steel company? Hell no. But you want to think about it. It’s easy to come up with a suboptimal incentive system — just look around corporate America. The difference between a suboptimal compensation system and an optimal one is huge.

The principles for an effective compensation system work at all companies. Let’s invert — think about the common reasons that compensation systems likely fail. First, most of them are hard to explain. They are overly complicated and wordy. (At Nucor everyone from the CEO to the newest employee could explain it.) Second, the rewards are small and untimely. Yearly bonuses anyone? Third, the program has to be designed in a way that the people in it (and the people running it) can’t game it. Finally, everyone is subject to the same plan.

Done poorly, compensation systems foster a culture of individualism and gaming. Done properly, however, they unleash the potential of all employees.

Why Micromanaging Kills Corporate Culture

“The more he kept sweating the details,
the less his people took ownership of their work.”

***

The most important part of a company’s culture is trust. People don’t feel trusted when you micromanage and this has disastrous implications.

In It’s Your Ship: Management Techniques from the Best Damn Ship in the Navy, Michael Abrashoff  writes:

The difference between thinking as a top performer and thinking like your boss is the difference between individual contribution and real leadership. Some people never make this jump; they keep doing what made them successful, which in a leadership role usually means micromanaging. My predecessor on Benfold (the ship Abrashoff commanded), for instance, was extremely smart—a nuclear engineer and one of the brightest guys in the Navy. He spent his entire career in engineering, and when he took command of Benfold, he became, in effect, the super chief engineer of the ship. According to those who worked for him, he never learned to delegate. The more he kept sweating the details, the less his people took ownership of their work and the ship.

This so often happens in organizations: Micromanagement (or picomanagement, if micro doesn’t quite describe it) kills ownership. And when employees don’t have ownership—skin in the game—everything starts to go to hell. This is one reason government organizations are considered to be dysfunctional — everything is someone else’s responsibility. The incentives are awful.

Consider this anecdote Abrashoff uses to illustrate his point.

A pharmaceutical company I was working with promoted its best salesman to be head of sales. Instead of leading the sales force, he became the super salesman of the company. He had to be in on every deal, large or small. The other salespeople lost interest and stopped feeling as if they were in charge of their own jobs because they knew they couldn’t make a deal without him there to close it. The super salesman would swoop in at the last minute, close the deal, claim all the glory, and the others were left feeling that they were just holding his bat.

This reminds me of something Marshall Goldsmith, author of the impressive What Got You Here Won’t Get You There, once relayed in a conference. He told the story of a typical person in a typical organization presenting an idea to the senior approval body. This person did all this work, it’s their idea, and they know it inside and out. Anyway, they present and the senior management team, keen to exercise their egos, start chiming in with things like “did you think of this …” or “but … ” or “however …”. The project gets better with these comments, after all most people don’t get to that level without being somewhat intelligent. However the commitment of the person who presented the idea goes down dramatically because it’s no longer their idea. They’ve lost some ownership (the degree to which is very dependent on the conversation). The end result is a better idea with less commitment. And you know what? The outcome is worse than if the management team just approved the project. Goldsmith was pointing out the obvious and the world has never looked the same to me since.

Abrashoff aptly concludes:

When people feel they own an organization, they perform with greater care and devotion. They want to do things right the first time, and they don’t have accidents by taking shortcuts for the sake of expedience.

[…]

I am absolutely convinced that with good leadership, freedom does not weaken discipline— it strengthens it. Free people have a powerful incentive not to screw up.

Remember the wisdom of Joseph Trussman. Trust is one of the keys to getting the world to do most of the work for you. Call this an unrecognized simplicity — and one that Ken Iverson exploited to help show why culture eats strategy.

Lessons on Leadership: Michael Abrashoff on Turning the Worst Ship in the Navy into the Best

“Organizations should reward risk-takers, even if they fall short once in a while. Let them know that promotions and glory go to innovators and pioneers, not to stand-patters who fear controversy and avoid trying to improve anything.”

***

Michael Abrashoff was in his mid-thirties when he took command of the USS Benfold, a guided missile destroyer and one of the worst performing ships in the navy. Despite her potency, the “dysfunctional ship had a sullen crew that resented being there and could not wait to get out of the Navy.” By the time he left, less than three years later, Benfold had become the highest-performing ship and retention was amazing.

As he recounts in It’s Your Ship: Management Techniques from the Best Damn Ship in the Navy the opportunity wasn’t without its irony.

Our military has spent a lot of time and money preparing for tomorrow’s battles with antiquated methods. We continue to invest in the latest technologies and systems, but, as we all know, technology is nothing but a facilitator. The people operating the equipment are who give us the fighting edge, and we seem to have lost our way when it comes to helping them grow.

Echoing Confucius who said “Real knowledge is to know the extent of one’s ignorance,” Abrashoff believes the key to leadership is about understanding yourself first and then using that knowledge to shape the organization.

Leaders must free their subordinates to fulfill their talents to the utmost. However, most obstacles that limit people’s potential are set in motion by the leader and are rooted in his or her own fears, ego needs, and unproductive habits. When leaders explore deep within their thoughts and feelings in order to understand themselves, a transformation can take shape.

That understanding shifts the leader’s perspective on all of the interactions in life, and he or she approaches leadership from a completely different place. As a result, the leader’s choices are different from those he or she made when blinded by fear, ego, and habit. More important, others perceive the person as more authentic, which in turn reinforces the new behavior. This can vastly improve how people respond to their leaders and makes their loyalty to the source of gratification more likely: my ship, your company, their peers, the culture that gives their lives meaning and purpose.

To be sure, your organization has a pragmatic goal, and obviously, it isn’t to be a therapeutic shelter. My ship’s job was war; your company’s purpose is profit. But we will achieve neither by ordering people to perform as we wish. Even if doing so produces short-term benefits, the consequences can prove devastating.

Adding to this later and expanding on how so many people lead, he writes:

Leaders must be willing to put the ship’s performance ahead of their egos.

[…]

The command-and-control approach is far from the most efficient way to tap people’s intelligence and skills.

[…]

Show me an organization in which employees take ownership, and I will show you one that beats its competitors.

Highlighting the divisiveness that so many organizations experience, he writes:

In business, as in the Navy, there is a general understanding that “they” don’t want rules to be questioned or challenged. For employees, the “they” is the managers; for managers, the “they” is the executive cadre. I worked hard at convincing my crew that I did want the rules to be questioned and challenged, and that “they” is “us.” One of the ways I demonstrated my commitment was to question and challenge rules to my bosses. In the end, both the bosses and my crew listened.

In a world that is always moving, staying still is near-certain death.

Organizations should reward risk-takers, even if they fall short once in a while. Let them know that promotions and glory go to innovators and pioneers, not to stand-patters who fear controversy and avoid trying to improve anything. To me, that’s the key to keeping an organization young, vital, growing, and successful. Stasis is death to any organization. Evolve or die: It’s the law of life. Rules that made sense when they were written may well be obsolete. Make them extinct, too.

The primary reasons that people leave an organization have nothing to do with money.

However the economy is doing, a challenge for leaders in the twenty-first century is attracting and retaining not just employees, but the best employees— and more important, how to motivate them so that they work with passion, energy, and enthusiasm. But very few people with brains, skills, and initiative appear. The timeless challenge in the real world is to help less-talented people transcend their limitations.

Pondering all this in the context of my post as the new captain of Benfold, I read some exit surveys, interviews conducted by the military to find out why people are leaving. I assumed that low pay would be the first reason, but in fact it was fifth. The top reason was not being treated with respect or dignity; second was being prevented from making an impact on the organization; third, not being listened to; and fourth, not being rewarded with more responsibility.

Thus Abrashoff came to the conclusion that the best thing he could do was see the ship through the eyes of the crew. This makes it much easier to find out what’s wrong and help people empower themselves to fix it. Most systems reward micromanagement which only disempowers subordinates and removes ownership and accountability.

Officers are told to delegate authority and empower subordinates, but in reality they are expected never to utter the words “I don’t know.” So they are on constant alert, riding herd on every detail. In short, the system rewards micromanagement by superiors— at the cost of disempowering those below.

Organizations commanded by a micromanager create a sub-culture of micromanagement. Individual initiative is the exception not the norm and the people who exhibit it get beaten down quickly and either quit or become cynical.

I began with the idea that there is always a better way to do things, and that, contrary to tradition, the crew’s insights might be more profound than even the captain’s. Accordingly, we spent several months analyzing every process on the ship. I asked everyone, “Is there a better way to do what you do?” Time after time, the answer was yes, and many of the answers were revelations to me.

My second assumption was that the secret to lasting change is to implement processes that people will enjoy carrying out. To that end, I focused my leadership efforts on encouraging people not only to find better ways to do their jobs, but also to have fun as they did them. And sometimes— actually, a lot of times— I encouraged them to have fun for fun’s sake.

 

No one is capable of making every decision. While there are as many ways to approach this as there are organizations, most seem to create an ineffective system of rules and policies that attempt to prepare for every possible contingency. Over time, people working in these organizations have no ownership — they simply follow the rules. Great organizations, on the other hand, use principles and allow for exceptions. They train people to think and make judgments on their own.

It’s Your Ship goes on to detail the ideas and techniques that Abrashoff used to win trust, create an environment where people felt accountable, and gain commitment.

Culture Eats Strategy: Nucor’s Ken Iverson on Building a Different Kind of Company

Much can be learned about the world by studying business.

***

The problem with most management, leadership, and business books is that many of them harp on the same self-evident points, overconfident in the usefulness of their prescriptions for would-be imitators. They tend to vastly underestimate the role of circumstance, luck, the nature of completion, and the effects of scale, among other things; falling prey to the many delusions described by Phil Rosenzweig in his incredibly important book, The Halo Effect.

The main problem Rosenzweig describes in the book is that attributes we tend to think cause great performance (culture, leadership, etc.) are often just things that are attributed to companies we already know are high-performing. There’s a Halo around everything they do. (Reminding one of the fundamental attribution error.)

How many current high-fliers would ever be described as having a bad culture, or bad leadership? It would be nonsense to say it. Thus, we run into a recursiveness problem. High performing companies have great culture, and great culture is defined as the attributes that cause high performance.

In other words, when you ask someone if Apple has a great corporate culture, they will tell you it does. (And it’s an extremely successful company, so of course it does.)

But when we try to pinpoint which aspects of Apple’s culture make it more successful than its peers, and which would be predictive of success at other companies, we run into a difficult problem.

The Halo Effect tells us that we will find a lot of false positives. The attributes we think are causal of success are the same ones we often deem causal of failure when company performance deteriorates. This is the strategy paradox.

***

Plain Talk, by Ken Iverson, is a memoir of his time running the steel company Nucor. Despite the warning, above this book deserves your attention for a few reasons:

  • Nucor was extremely successful, for a long period, in an industry that provided huge headwinds. There are no magic pills to being successful in steel. It’s generally an awful business.
  • The company did some very unusual things that we see in few other companies, even successful ones.
  • The book was recommended by a very smart friend who runs a very successful business of his own, using similar principles.
  • The author/CEO, Iverson, seems honest about the fact that many of his prescriptions are not new or different. The book is not presented as a panacea.
  • It’s generally good to study outlier success or failure.

A Peculiar Kind of Success

Ken Iverson

Under Iverson, Nucor was an unusual sort of steel company compared to the Carnegie-esque behemoths of the past.

Some of its attributes remind us of companies like Berkshire Hathaway, but Nucor did it very differently. There were few acquisitions. The company was totally focused on steel. Iverson describes some of the peculiarities in the opening of the book (this was written in 1998):

  • Our 7,000 employees are the best paid workers in the industry, yet Nucor has the lowest labor cost per ton of steel produced
  • Nucor is a Fortune 500 company with sales in excess of 3.6 billion, yet we have a total of just 22 people working at our corporate headquarters, and just four layers of management from the CEO to the front-line workers.
  • Nucor operates in a “rust belt” industry that lost one out of two jobs over a 25-year time span, yet Nucor has never laid off an employee or shut down a facility for lack of work, nor have we lost money in any business quarter for more than thirty consecutive years.

That is, of course, a very interesting outcome. Most steel companies were struggling mightily when Nucor came up. Bethlehem Steel almost went bankrupt in the late 70s. (They eventually did.) Foreign competition, rising input costs, rising labor costs, commoditization…steel is about as bad a business as you could invent. Yet in Iverson’s 30+ year reign, Nucor compounded its per-share earnings at a rate of about 17% per annum. There must have been something going on here — he sounds like an outsider.

Let’s focus on a few things that were particularly unusual.

Extreme Decentralization

Nucor believed (and to my knowledge, still believes) strongly in decentralization. The only parallel for 22 people at headquarters in a $4 billion business is probably Berkshire itself. Capital Cities, now part of ABC, might have been another parallel.

In order to achieve that leanness at the top, power must have been pushed down pretty far into the organization. And of course, it was:

Each division operates its one or two plants as an independent enterprise. They procure their own raw materials; craft their own marketing strategies, find their own customers; set their own production quotas; hire, train, and manage their own work force; create and administer their own safety programs…In short, all the important decisions are made right there at the division. And the general manager of the division is accountable for those divisions.

This is scary for most companies. They are not willing to allow local general mangers that kind of control and responsibility. The allure of synergy and the allure of top-down controls are too strong. And once it’s in place, headquarters culture has a way of taking on a life of its own. Take a look at PepsiCo, or General Electric, or any number of corporate beasts in the United States. There is huge, expensive bureaucracy at the top. It is always thus. (Of course, that keeps firms like 3G Capital in business.)

But Iverson was willing to take the tradeoffs:

“We are honest-to-god autonomous,” says Hamilton Lott, general manager of our Vulcraft Division in Florence, South Carolina. “That means we duplicate efforts made in other parts of Nucor. The company might develop the same computer program six times. But, the advantages of local autonomy are so great, we think it’s worth it.”

Any of you who have worked in a modern corporation know how unusual this mentality is. Who would allow the same company to develop the same software six times? Why not increase knowledge sharing and synergies?

Part of the problem is that the tremendous benefits of local autonomy are less immediately tangible than the costs. Berkshire has dealt with this for years. Every time one of Buffett’s subordinates acts up, and it happens pretty darn infrequently by our count, people pipe up and ask why he isn’t imposing more rigid oversight on them. It’s very simple: the long-term benefits of trust-giving have far outweighed the occasional cost of non-compliance.

Call this an “unrecognized simplicity.” Nucor’s corporate overhead expense was so small they didn’t even bother allocating corporate expenses to the divisions. That is rare.

The other under-appreciated value of decentralized control is that great ideas tend to rise from the bottom rather than being dictated by the executives. Iverson claims that many or even most of Nucor’s great innovations came from down in the divisions. The company merely had to be smart enough to harness them.

This has happened elsewhere in Corporate America. Look at McDonald’s. Do you think Ray Kroc invented the Chicken McNugget, the Big Mac, and the Filet ‘o Fish? Do you think he figured out how to keep millions of pounds of potatoes fresh and get them to customers tasting exactly the same every time? No. But franchisees and suppliers did. He just had to be smart enough to help the ideas spread. (Hamburger U, anyone?)

Simple and Precise Strategy

In the book Good Strategy, Bad Strategy by Richard Rumelt (highly recommended, and we’ve written about it before), the author is clear that what makes a good strategy is that it’s clear and that it’s precise, a real call to a specific action:

The kernel of a strategy contains three elements: a diagnosis, a guiding policy, and coherent action. The guiding policy specifies the approach to dealing with the obstacles called out in the diagnosis. It is like a signpost, marking the direction forward but not defining the details of the trip. Coherent actions are feasible coordinated policies, resource commitments, and actions designed to carry out the guiding policy.

This is precisely what Iverson did at Nucor:

We don’t clutter the picture with lofty vision statements, ask employees to pursue vague, intermediate objectives like “excellence,” or burden them with complex business strategies. Our competitive strategy is to build manufacturing facilities economically, and to operate them efficiently. Period.

Simple but not easy.

Was the technology that went into developing and implementing this strategy simple? I’m not an expert in metallurgy, but I doubt it. The modern steel company is quite efficient and quite advanced. Nucor made major strides like the mini-mill and thin-slab casting of flat-rolled steel. Whether that kind of technology would have been given a chance to succeed in a different culture is hard to say.  We can’t re-run history but Nucor’s purposeful drive seems to have fostered the right environment.

 

Remove Unnecessary Hierarchy

Ultimately, it’s hard to build a great, supportive, seamless web of deserved trust if the executives are consistently treated as “above the fray” – subject to a different level of treatment than the rank and file. This is the way it is in most organizations.

The results tend to be predictable. Envy, plus a violation of basic Kantian fairness tendency, will create a lot of hatred. You can’t put the managers and the executives in first class and stick the associates in coach and expect anything but resentment. It’s basic human nature, driven by biology. Nucor was smart enough to avoid this folly:

Our executives get the same group insurance, same holidays, and same vacations as everybody else. They eat lunch in the same cafeterias. They fly economy class on regular commercial flights (although we do allow the use of frequent flyer upgrades). We have no executive suites and no executive cars. At headquarters, our “corporate dining room” is the deli across the street.

Our executives wouldn’t have it any other way. They see our egalitarian culture serving their interests as much as the interests of our employees. For one thing, our mangers don’t have to waste time fretting over their chances to get the fancy corner office or arguing over who gets to use the company plane. We don’t have those perks, and we imagine they would cause a lot more stress than fulfillment. What a bunch of nonsense! Chasing meaningless status symbols and tokens of power…

Nucor had essentially four promotions available: Supervisor, Department Manager, General Manger, and Chairman (Iverson himself). That’s it. I can imagine that over all those years of growth, more than one consultant tried to get Iverson to create a whole lot of bureaucracy, but he wisely resisted. The costs (such as the mathematically unavoidable large spans of control due to fewer managers in the system) were once again greatly outweighed by the benefits. Another unrecognized simplicity.

And when it came time for pay cuts, everyone shared in the pain. What a simple, yet generally unused concept:

Why, then, would workers who had endured deep cuts in pay and who had every reason to fear for their futures reach out to share a laugh with a manager passing through a mill? Simple. No employee was being asked to carry more than his or her part of the burden.

You see, their department heads had taken pay cuts of up to 40 percent, and the general managers and other officers of the company were earning 50-60 percent less than we had made in preceding years. My own pay dropped that year to about $110,000, from about $450,000 the year before. We not only shared the pain, but doled out the lion’s share to the people at the top.

Think about what an inversion that is of most organizations, where the CEO takes a minor cut in pay (or worse, no cut) and hundreds of low-level employees simply lose their jobs. Wouldn’t most places work better with Nucor’s ethos? The fact that they did this in the highly cyclical steel business gives some tailwind to the idea. It wasn’t a story like Google, where constant success has allowed them to pamper employees financially and otherwise. Nucor managed to avoid layoffs and share in the pain in a business that, by necessity, is constantly offering pain to share.

A Postscript on the Post-Iverson Era; Implications for Investors 

In the final analysis, Nucor probably didn’t have any core attributes that were unavailable to its competitors. It simply made better choices and was more fanatical about sticking to them. The resulting success was deserved. This is why culture eats strategy.

But the postscript to the Iverson era has been interesting, at least from the perspective of the passive investor. Nucor was a brilliant investment in Iverson’s time as manager, but if you’d bought the stock in the early 90s when Iverson left the CEO post, your results would have been pretty mediocre since. Can we see why? Let’s deduce a few reasons.

  • Partially, the stock was fairly rich at that time – trading for something like 40x price/earnings. That’s high even for a good industrial company. It’s not so high now. But their fundamental performance has not been nearly as impressive either, in the time since Iverson left, especially in the last five or six years.
  • Partially, the effects of compound interest have served to slow down an increasingly large corporation. Nucor is now a giant in the steel business. They started off as a tadpole. If the company’s net earnings had continued to grow at 17% per annum, they would currently be earning $4 billion a year, versus a little over $120 million in 1993. There’s only so much profit available in steel.
  • Is there a tinge of Halo Effect here, as described at the beginning of the piece? Perhaps. Iverson would be the first to say his prescriptions were not that ground-breaking. I tend to think some of the attributes above did contribute greatly to its unusual success, but more of the success may have been situational and strategy driven than Iverson recognized.
  • Even more important might be to recognize that the steel business always was a fundamentally hard one, and even the best ships might struggle on a stormy enough ocean. Iverson and his team rowed very hard and successfully for many years, and that has continued to this day. Bethlehem Steel went bankrupt in 2001 and Nucor made money that year. U.S. Steel has been bleeding red ink for years and Nucor, although less profitable than it once was, has still made money. But the ocean current is what it is.

So even if Nucor has been better than most of its competitors in the last ten or twenty years, and I suspect it has, an investor would have had to ask him or herself: Do I want to be in the steel business at all? As Buffett used to say, something not worth doing well is often not worth doing at all.

Regardless, the lessons from Plain Talk show that the roads less traveled can be worth exploring. They’re not that complicated. But they work.

Peter Thiel on the End of Hubris and the Lessons from the Internet Bubble of the Late 90s

Madness is rare in individuals—but in groups, parties, nations and ages it is the rule.

The best interview question — what important truth do very few people agree with you on?— is tough to answer. Just think about it for a second.

In his book Zero to One, Peter Thiel argues that it might be easier to start with what everyone seems to agree on and go until you disagree.

If you can identify a delusional popular belief, you can find what lies hidden behind it: the contrarian truth.

Consider the proposition that companies should make money for their shareholders and not lose it. This seems self-evident, but it wasn’t so obvious to many in the late 90s. Remember back then? No loss was too big. (In my interview with Sanjay Bakshi he suggested that to some extent this still exists today.)

Making money? That was old school. In the late 1990s it was all about the new economy. Eyeballs first, profits later.

Conventional beliefs only ever come to appear arbitrary and wrong in retrospect; whenever one collapses, we call the old belief a bubble. But the distortions caused by bubbles don’t disappear when they pop. The internet craze of the ’90s was the biggest bubble since the crash of 1929, and the lessons learned afterward define and distort almost all thinking about technology today. The first step to thinking clearly is to question what we think we know about the past.

Peter Thiel:The first step to thinking clearly is to question what we think we know about the past

There’s really no need to rehash the 1990s in this article. You can google it. Or you can read the summary in chapter two of Zero to One.

Where things get interesting, at least in the thinking context, are the lessons we drew from the late 90s. Thiel says the following were lessons most commonly learned:

The entrepreneurs who stuck with Silicon Valley learned four big lessons from the dot-com crash that still guide business thinking today:

1. Make incremental advances. Grand visions inflated the bubble, so they should not be indulged. Anyone who claims to be able to do something great is suspect, and anyone who wants to change the world should be more humble. Small, incremental steps are the only safe path forward.

2. Stay lean and flexible. All companies must be “lean,” which is code for “unplanned.” You should not know what your business will do; planning is arrogant and inflexible. Instead you should try things out, “iterate,” and treat entrepreneurship as agnostic experimentation.

3. Improve on the competition. Don’t try to create a new market prematurely. The only way to know you have a real business is to start with an already existing customer, so you should build your company by improving on recognizable products already offered by successful competitors.

4. Focus on product, not sales. If your product requires advertising or salespeople to sell it, it’s not good enough: technology is primarily about product development, not distribution. Bubble-era advertising was obviously wasteful, so the only sustainable growth is viral growth.

These lessons, Thiel argues, are now dogma in the startup world. Ignore them at your peril and risk near certain failure. In fact, many private companies I’ve worked with have adopted the same view. Governments too are attempting to replicate these ‘facts’ — they have become conventional wisdom.

And yet … the opposites are probably just as true if not more correct.

1. It is better to risk boldness than triviality.
2. A bad plan is better than no plan.
3. Competitive markets destroy profits.
4. Sales matters just as much as product.

Such is the world of messy social science — hard and fast rules are difficult to come by, and frequently, good ideas lose value as they gain popularity. (This is the “everyone on their tip-toes at a parade” idea.) Just as importantly, what starts as a good hand tends to be overplayed by man-with-a-hammer types.

And so the lessons which have been culled from the tech crash are not necessarily wrong, they are just context-dependent. It is hard to generalize with them.

Peter Thiel Think For Yourself

According to Thiel, we must learn to use our brains as well as our emotions:

We still need new technology, and we may even need some 1999-style hubris and exuberance to get it. To build the next generation of companies, we must abandon the dogmas created after the crash. That doesn’t mean the opposite ideas are automatically true: you can’t escape the madness of crowds by dogmatically rejecting them. Instead ask yourself: how much of what you know about business is shaped by mistaken reactions to past mistakes? The most contrarian thing of all is not to oppose the crowd but to think for yourself.

In a nutshell, when everyone learns the same lessons, applying them to the point of religious devotion, there can be opportunity in the opposite. If everyone is thinking the same thing, no one is really thinking.

As Alfred Sloan, the heroic former CEO of General Motors, once put it:

Alfred Sloan

The Single Best Interview Question You Can Ask

In Peter Thiel’s book, Zero to One: Notes on Startups, or How to Build the Future — more of an exercise in thinking about the questions you must ask to move from zero to one — there is a great section on the single best interview question you can ask someone.

Whenever Peter Thiel interviews someone he likes to ask the following question: “What important truth do very few people agree with you on?

This question sounds easy because it’s straightforward. Actually, it’s very hard to answer. It’s intellectually difficult because the knowledge that everyone is taught in school is by definition agreed upon. And it’s psychologically difficult because anyone trying to answer must say something she knows to be unpopular. Brilliant thinking is rare, but courage is in even shorter supply than genius.

The most common answers, according to Thiel, are “Our educational system is broken and urgently needs to be fixed.” “America is exceptional.” “There is no God.”

These are bad answers.

The first and the second statements might be true, but many people already agree with them. The third statement simply takes one side in a familiar debate. A good answer takes the following form: “Most people believe in x, but the truth is the opposite of x.”

[…]

What does this contrarian question have to do with the future? In the most minimal sense, the future is simply the set of all moments yet to come.

We hope for progress when we think about the future. To Thiel, that progress takes place in two ways.

Horizontal or extensive progress means copying things that work— going from 1 to n. Horizontal progress is easy to imagine because we already know what it looks like. Vertical or intensive progress means doing new things— going from 0 to 1. Vertical progress is harder to imagine because it requires doing something nobody else has ever done. If you take one typewriter and build 100, you have made horizontal progress. If you have a typewriter and build a word processor, you have made vertical progress.

best interview question peter thiel

At the macro level, the single word for horizontal progress is globalization— taking things that work somewhere and making them work everywhere. … The single word for vertical, 0 to 1 progress, is technology. … Because globalization and technology are different modes of progress, it’s possible to have both, either, or neither at the same time.

Peter Thiel
Here is Thiel’s answer to his own question:

My own answer to the contrarian question is that most people think the future of the world will be defined by globalization, but the truth is that technology matters more. Without technological change, if China doubles its energy production over the next two decades, it will also double its air pollution. If every one of India’s hundreds of millions of households were to live the way Americans already do— using only today’s tools— the result would be environmentally catastrophic. Spreading old ways to create wealth around the world will result in devastation, not riches. In a world of scarce resources, globalization without new technology is unsustainable.