The Internet of Things changes everything.

That’s one of the least hyperbolic statements I can make. Existing businesses will be disrupted and their business models will be changed forever. In fact, IoT and the Lean Hardware movement are already a driving force behind why The Nature of the Firm is no longer a tenable thesis.

Let’s talk about why that’s the case.

Meet The Connected Dishwasher

Put yourself in the shoes of Philips, consumer products manufacturer. Philips makes dishwashers. One day, they’re going to throw a sensor and wifi chip into the newest dishwasher model and call it a “smart” appliance.

We’ll have the thing we never knew we needed: the connected dishwasher. (But trust me, I will buy one.)

It’s not so simple though. Philips can’t put some chips into an appliance and call the project complete. They need to design an app that consumers could conceivably use. Then, they need an API so that Smart Things or some other home automation software can control it.

Philips was a consumer hardware manufacturer. But with the connected dishwasher, is it still?? Or is it a software company? Is it an App and API company? Of course not. Philips will continue to build appliances and outsource that kind of work to someone else.

But there’s more work left. The dishwasher needs to communicate to the power grid if it’s going to be “smart” and cycle at the most opportune times. Does that make Philips a data communication company?

And what happens when the dishwasher needs servicing? Luckily, its sensors can determine when repairs are needed before something breaks. The dishwasher “calls” a service provider and tells them what part it needs. Or better yet, a technician could log in remotely and fix the problem with software. No in-person visit required.

Philips is now solving problems the same way Tesla “repairs” my car! Doesn’t that strike you as a big leap for a consumer appliance company?

Dishwasher-as-a-Service

I say “DaaS” only partly tongue-in-cheek.

Because when Philips walks down this path, it will transform how the company does business. Its existing models aren’t compatible with its business needs. The dishwasher company will become a service company.

Not only that, but Philips isn’t competing against its old peers anymore. The company enters a field where it doesn’t have any core competencies: home automation.

The consumer isn’t buying a dishwasher. In their mind, they’re buying another home smart device, no different from a new Beats Pill in their mind. Besides every other consumer appliance manufacturer, Philips now has to compete with Apple, Bose, and Samsung for the same top of mind and share-of-wallet.

The other dishwasher companies don’t seem like a big threat anymore.

Where Do We Go Now?

History repeats.

Today, we’re in a mobile-focused world. Before that, it was the web. Then PC, and then Mainframe. Right now, people think IoT is geeky. They believe it can change “infrastructure,” whatever infrastructure means to them. But what they don’t realize is that IoT is probably the driving force of the next era of computing. We already have more IoT sensors connected to the internet than people In the next five years, the number of sensors will outnumber people by a factor of 10.

Philips and companies like them will have their business models disrupted. They’ll walk down new paths, completely unprepared for the risks that they’ve introduced.

But that’s where the massive opportunities lay. Startups can fill the gap. Investors can finance them. Someone will profit from the demise of the Old Guard.

The next era is coming, and it will either be the IoT era or an era driven by it.

Keep your eyes peeled for opportunities.

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Photo from: https://pixabay.com/en/network-iot-internet-of-things-782707/

A few years ago I was sitting in a classroom at the London School of Economics debating unemployment with my nobel prize winning professor. The conversation was centered around another LSE nobel prize winner, Ronald Coase, who in 1937 observed in his scholarly paper, The Nature of the Firm, that firms exist in order to reduce transaction costs and take advantage of economies of scale. Barring external forces, firms will tend to grow larger and larger over time. This is the fundamental economic framework powering the world economy since the industrial revolution, driving corporate behaviors such as: corporate structure, the rise of M&A, and 20th century management theory.

A few weeks later, Ronald Coase at 101 years old, would go on a podcast and declare his 80 year old nobel winning thesis obsolete. No longer do you need to scale the size of a firm just to obtain efficiency, with modern technology and today’s demographics, you can capture the same value with much smaller firms. Companies will still grow to be larger over time, however, they won’t grow as large as they have in the past.

Since then I have been thinking deeply about what has broken down Coase’s theory which was the fundamental underpinning of the world economy since the Industrial Revolution. After several years of reflection on this, I have come up with four forces:

• The rise of the freelancer economy

• Millennials’ behaviors and impact

• IoT and lean hardware

• SaaS economics and the democratization of IT

The Rise of the Freelancer Economy

According to a report by Intuit, by 2020 approximately 40 percent of the U.S. workforce will be working as freelancers. Another study predicts 50% by 2025. As more members of the workforce decide to freelance, the number of marketplaces to facilitate them will proliferate. In the past you would hire the reputation of a Brand. Tomorrow freelancers will build a reputation on a marketplace and the marketplaces will build a brand.

This trend will lead to more commodity based and strategic outsourcing. Commodity based outsourcing will consist of outsourcing HR, legal, accounting/finance, manufacturing, and software development. Strategic based outsourcing via the freelancer economy will outsource product development, design, and even management.

Millennials’ Behaviors and Impact

By 2020, Millennials will consist of 20% of the workforce, and by 2025, 75%.  Millennials were born mobile and digital; their behaviors will change the way companies interact with their customers as well as how companies interact with their employees. Everything changes from preferred methods of communications (messaging) to marketing (social media) to commerce (mobile first). Traditional management models start to break down with Millennials managing Millennials and selling to Millennials.

IoT and Lean Hardware

At the same time the Millennials are taking over the workforce, we will have 26 billion IoT sensors in production and connected to the internet by 2020. Cheap sensors and widespread availability lead to more big data driven analysis about everything from the lighting in your office, self-driving cars, the temperature of your home, to how your dishwasher runs. Abundant sensors combined with cheaper and small batch manufacturing will drastically change business models, pushing them to be more service oriented. Robotics and AI will eliminate most unskilled jobs, driving employment to be more skilled and knowledge based.

SaaS Economics and the Democratization of IT

While the move to the cloud has already begun, over the next few years, it will be massive. The economics of SaaS software has shifted the decision making power to the line worker from the management and IT. Since you can swiftly deploy cloud-based software within your organization with a free trial, cheap monthly credit card payment, and no physical installation, employees are now making the purchasing decisions, not the IT department. This is breaking down siloed data, enabling remote/distributed teams, and creating more capital efficient companies.

The Next 10 Years

As we enter the post-Industrial era, the dynamics of the firm and the workforce are going to change radically. As the forces that are breaking down Coase’s model only grow stronger, many companies are remaining stagnant. The success of a company no longer depends on growing larger, but now depends on being the optimal size in order to fend off the disruptive smaller companies. Google figured this out when it broke the company into smaller pieces and formed the parent holding company, Alphabet.

The larger this gap between big and optimal sized companies grows, the less chance there is of survival for companies trying to grow by growing bigger, opening up great opportunities for disruptive startup companies. Even more interesting is that this transformation will happen in the next ten years. How tomorrow works is radically different than it is today.

 No one talks about how important it is for your CTO to learn the business side of things. That needs to change. If you’re a co-founder or senior executive at a startup or growth stage company, you need to be more than just an expert in your area.I know that’s asking a lot. Becoming an expert is a massive task. But it’s not enough. Each senior leader needs to be familiar with engineering, marketing, sales, and accounting if you want to maximize your chance for success.

 This concept has been popularized for non-technical founders for some time, through efforts like Mayor Bloomberg’s Learn to Code and Business Week’s magnum opus What is Code. But I’ll wager if you’re a CEO, you suck at social media. You probably don’t understand it, even though it’s the future of customer engagement. That needs to change. And this change needs to extend beyond giving non-technical founders technical skills. We need to help CTOs get business savvy.

 Image by Flickr user foam 

Perform a Self Assessment

If you had to take over any of your company’s functional roles (marketing, sales, etc.) for a short period, would you be able to lead effectively? If the answer’s yes, great. Proceed. But if not, you’ve identified a major need.

Things happen, and you need to prepare for contingencies. Not only that, how can you screen and hire the right person if you can’t speak the same language?

Non-technical CEO’s should code so they can:

• Understand how the sausage gets made

• Talk to their team with the right vocabulary (i.e. Agile, Scrum, and Kanban)  

If you’re the CTO, don’t you want to be relevant in business meetings? You won’t be as strong in marketing as your CMO, but you can add value and influence decisions.

If you outsource business decisions to your non-technical co-founder, there will be consequences. Best case scenario? You disengage from the business side.

Worst case: your disengagement leaves your CEO to feel lonely and stressed. And then one day, you wake up to a phone call from that person saying, “Hey, we’re out of money.”

Don’t let that happen to you.

Jump into the Business Side

 I love founding teams comprised of engineers because:

• Less technical risk

• Solve their own problems

• Shared background with me

  
  

I’ve been a CTO many times in my career, and I’ve exited multiple companies. But heading back to grab my MBA still made me a better CTO.

I don’t think all developers should get an MBA even though, unlike many of my peers, I think there’s value in one. Instead, I’d suggest creating your self-study MBA.

Design Your Personal MBA

Here are my suggestions for a practical education that will make you a better leader in every functional area.

Accounting

 All techies should read The Essentials of Finance and Accounting for Nonfinancial Managers by Edward Fields (who was my Accounting professor in business school).

It’s not exactly A Song of Ice and Fire, but you shouldn’t want to put this book down. You’ll get familiar with:

• Balance sheets

• Income statements

• Cash flow statements

• Budgets and forecasts

• Annual statements

I know. It’s dry. But the book is so necessary.

If you want to supplement it, take an online accounting and finance crash-course like this one at Udemy.

Marketing

 Al Ries and Jack Trout wrote The 22 Immutable Laws of Marketing. The book was published over two decades ago, but it’s still essential. Learn from real world case-studies.

And remember this lesson: if people don’t read your website or emails, they’ll never buy your stuff.

To improve your copywriting, try the great Gary Halbert’s Boron Letters.

Sales

 Sales makes the world go round. Here are two great books:

• He may have been a little corny, but Zig Ziglar’s Secrets of Closing the Sale is excellent. He knows objection handling better than most.

• Then there’s The Little Red Book of Sales. It’s short, sweet, and to the point. It’s a great reference book.

  
  

And finally, for our non-developer friends who’ve stuck through this:

Engineering

 Read the Bloomberg article What Is Code that I mentioned before. It’s an interactive history lesson that walks through everything developer and even delves a little into philosophy.

At the very least, you should get familiar with HTML & CSS so you don’t need to bother your developers on trivial tasks. Brush up over at Codecademy.

 Take Action

 You’re never going to be an expert in all of these roles. But at a minimum, you need to be conversational.

Have a bias for action and carve some time out for learning. Let me know how it goes.

I recently recommended a friend for a PM job at a hot Silicon Valley startup run by another friend. The startup recently raised a big Series A and was looking to scale. I know the risk of linking up two friends in an employment scenario, however, my friend was more than qualified for this job and my founder friend really needed the position filled.  

While my friend was more than qualified, interviewed well, and the team loved him, etc, the founder decided to pass on my friend. The reason:  another candidate with the same skills and experience came along that they hired. The difference between the hired candidate and my friend? The candidate that was hired had the same PM experience but all at big companies like Facebook, Amazon, and Google. My friend has spend his entire career at startups.

My question is: was this the right move? If you had the choice between nearly two identical candidates and one had all their experience at big successful companies and one had their experience at successful startups, isn’t it safe to choose the candidate that worked at the bigger companies? 

Put yourself in the founder’s shoes. You just raised a big Series A. You are being pressured by your investors to “go big or go home.” You have aspirations to be a big company. This is Silicon Valley, shouldn’t you hire the absolute best talent we can find? Shouldn’t you hire people who worked at Facebook and Amazon since you want your company to be big like them one day? 

PMs that only worked at companies such as Facebook and Amazon are super qualified PMs. Huge plus. They also know next to nothing about building a startup. Huge negative. People from larger companies bring the bigger company process, procedure, and culture with them. This leads to premature scaling of your business. The problem is that your startup is not a smaller version of a bigger company. As Steve Blank says, a startup is an experiment looking for a business model, not a smaller version of a larger company. Facebook as over 10,000 employees and billions in profits.  My friend’s company has less than 15 employees and no profits. Hire people comfortable working in that environment, who know how to bring a company from 15 people to 150 people. When your startup has 1000 employees and is super profitable you should start to hire PMs from Facebook. In between, you have to hire people who can not only do the job, but also help you grow the business, shape the culture, and constantly evolve the process. 

I made this mistake several times at my past startups. At one startup we realized that we needed an HR manager. Since we had plans to “go big” we wanted to hire an HR manager who came from a big company. Big mistake. We were a team of 12 but all of a sudden we were doing 360 reviews and had to fill out a form in order to take a day off. At another startup we wanted to enter the “enterprise” space, so we hired some “enterprise” software people from a large enterprise software company and gave them fancy titles. The problem is that people who work as executives at big companies usually don’t roll up their sleeves and build a product. Nor do they know how to scale a company, they know how to keep a big company big, but don’t know how to build a big company. In addition they wanted to fly business class and have personal assistants, things that did not jive with our startup culture.

Avoid premature scaling at your company and hire not only the candidates with the best skill set, but also with experience in working at and building a startup. Later on when you are bigger and more mature should you hire the people with bigger company experience. 

Here in Silicon Valley, it is commonly said that it is “easy” to raise $1m in seed funding and $100m in Series C/D growth funding, but impossible to raise the $5-7m in Series A funding. This has been called the Series A Gap, or the lack of funds for startups looking to break out of angel and seed funding. 

There is no Series A Gap

Over the past year as a VC in Silicon Valley, I’ve worked with Fresco’s portfolio companies and met countless other startups looking for funding. I’ve seen good companies left for dead when trying to raise a Series A and some raise a Series A in just a few weeks. I’ve rolled up my sleeves and worked with the founders on their deck, valuation, strategy, and ultimately their pitch. Along the way in the trenches of Series A fundraising, I've learned something: there is no Series A Gap.

Pitchbook and other sources have confirmed what my gut has been saying for the past year: there has been a modest rise of Series A capital over the past few years, but there is a glut of seed funding in the market today-as much as 4x higher in the past 5 years. So it is comparatively easy to raise a Seed round creating more and more startups looking for the same amount of Series A funding. 

Startups have little problem raising seed funds these days. They string together $500k-$2m from many different people on an open source convertible note, typically $100k at a time. (AKA the “Party Round.”) Then they go out and try to find the right product-market fit and business model. Some make it and go on to raise a Series A pretty quickly. Most do not.

The Rise of the Second Seed Round 

The companies that don’t find the product market fit or develop their business model try for a Series A and fail. Typically they are competing against companies that have already found their business model and are executing against it. Eventually they run out of money. 

If you run out of money during your seed round and you can’t raise a Series A, in the past you had three choices:

1. Fold the business
2. Raise a “down” round
3. Keep struggling along on nights and weekends

Now what founders are doing is going out and getting a second seed round. Typically more money than the first seed and almost always at a much higher valuation. Some people call these rounds “pre-A” and “super seed.” I’ve seen a ton of them, some that should be a down round but have a crazy high valuation. (I've walked away from two of them in the past month alone.) 

For example consider this funding for startup NewCo;

• Angel funding $200k @ $2m cap
• Seed funding $1.3m @ $7m cap
• Seed funding II $2.2m @ $12m cap

NewCo now has 20 or more note holders and an insane valuation. If you have a $12m cap on your convertible note and you raised $2.2m on it, chances are your valuation at the Series A will be near $30m. The problem is that now your revenue and growth trends have to justify that $30m valuation. Unless the business model is really strong and the company is progressing nicely, raising a Series A will be all but impossible. There is no Series A Gap, but rather a glut of seed funding and a self-inflicted wound of raising too many seed rounds with little or no growth to show for it.

What to Do?

Founders are better off trying to raise one larger seed (with a lead!) and using the round to focus like a laser beam on finding the right product market fit while keeping the burn low. If you need a second seed round, try to keep the valuation under control and have very specific metrics as what you want to accomplish in order to position yourself for an A. 

Being an early stage investor, I see a lot of MVPs. I mean a lot. The problem is that most people don’t build real MVPs, but descend into building a prototype, then beta, then an actual product and still call it an MVP. Remember an MVP is your most important Customer Development tool. It is an experiment designed to test your value proposition’s assumptions by measuring a behavior and learning from the results. MVPs should be used for a short while in order to validate your learning and then help you develop the plan for the actual product. After you have built a few MVPs and measured the results, what are the top three signs that you are done with your MVP and can start building your real product?

I remember it like it was yesterday. My co-founder and I just left Yahoo!’s New York City office. It was October 31st, 2002, and we were happy because Yahoo! asked us if we would go exclusive with them on our yet to be released online service. At the time, Yahoo! was one of the largest players online (think Google today) and they were offering to resell our data on their site, potentially a lot of money that could possibly make or break our startup. We were at it for months with no revenue and without a salary and unable to hire some more talent, so this was a much needed shot in the arm. 

When we got outside, I called my mentor and our investor to tell him the good news. He said: “ Cool! What minimums did you negotiate?” Minimums I ask? As quickly as I was excited, I was now deflated. 

The Deceptive Value of an Exclusive Contract

The deal we had shook hands on with Yahoo! had the potential to pay well over $1m in six months. Not bad for a startup with no customers, right? Wrong.

My mentor went on to explain that if Yahoo! were to get an exclusive reselling deal, or even a non-exclusive deal for that matter, they needed an incentive to hold up their end of the bargain. If Yahoo! miscalculated the demand from their users, if their sales force did not engage with us and actively sell our product, or if market conditions rapidly changed, we could make nothing. That would force our startup to close its doors. 

In order to create some incentives for the larger party on the other side of any exclusive or non-exclusive contract, you should structure the deal where at the end of the term there is a minimum payment to be made if a threshold is not met. This way you are protected and the larger party has an incentive to uphold their end of the bargain. If the larger party won’t commit to the minimum, they have little faith that they can actually deliver the value that they are promising and that is a bad sign. Typically you should ask for and get a minimum of about 20% of the initial agreement. 

For example, let’s say that you negotiate a contract with a channel partner in India. They promise you $1m in sales per year and want an exclusive arrangement in India. Ask them to “put their money where their mouth is” and offer to pay a minimum at the end of the term if they don’t sell enough. If you stick to a 20% minimum, at the end of the year if they produced no sales, they still pay you $200k. If they produced $100k of sales, they would pay you $100k (the difference between the actual sales they produced and the $200k minimum.)  If they produced $250k of sales, they pay you nothing as they have reached the minimum. 

If the minimum is not enough to cover your costs or offset the opportunity cost of going exclusive, you should not do the deal. If you are a pre-revenue startup and the larger party wants to go exclusive globally for some time, you should also demand that they make an equity investment as well-to show that they are serious and have some "skin in the game". 

Did Yahoo! Agree to the Minimum?

My partner and I went back to Yahoo! and proposed a non-exclusive arrangement and a minimum. They agreed but took a long time to sign the paperwork and get started. In the interim we went to Monster.com, their competitor (we were talking to Yahoo!’s HotJob unit), and signed a similar deal, with a minimum. Within 6 months, we were earning about $1m in revenue from both parties! So glad that we did not go exclusive. 

Not only is it hard to attract talent to your startup (know any free developers in the Bay Area?), as a founder you also have to set the proper structure. A common saying is that you need a “Hacker, Hustler, and a Hipster” on the founding team. In the earliest days that makes sense, especially when you are MVPing and hustling for your first customers trying to find a product-market fit.

Sometime after you have product-market fit and raise a round of funding, you need to hire outside of the core founding team. A lot of founders struggle with the right roles to hire and what the proper structure should be. Some founders hire too many engineers (typically non-technical founders) and some founders hire too many “business” or “marketing” people (typically technical founders), leading to being lopsided in one area. Founders run the risk of being engineering centric or marketing centric in their product development. In reality they need to be customer centric and embrace the Holy Trinity of Product Development. 

The Holy Trinity of Product Development: Dev Lead, PM, PMM

When it comes to product development, you need three distinct roles. Those roles are what I call the Holy Trinity of Product Development: Developer Lead, Program Manager (PM), and Product Marketing Manager (PMM). These three roles work together to represent the customer and build the business, ensuring that you are not too engineering focused or too marketing focused. The role in the middle of that fine line is the Program Manager.

Program Manager (PM)

The program manager, sometimes called product manager, is the most important role in the trinity. The PM manages the product definition by talking with customers and potential customers. A PM owns the UX and functional specs and is the chief customer advocate. A PM not only owns the product definition, but also its strategy, position in the marketplace, and if it is a new product, its go to market strategy. Internally, the PM has to coordinate the teams to get the product out the door. This means working closely with the PMM and business teams on what makes sense for the business. The PM can’t set pricing (that is the PMM’s job) but surely can influence it. At the same time the PM has to work with the engineering team to get the product built on time and on budget. While a PM is not required to have any technical or coding skills, the more technical a PM is, the better. At Facebook for example, all PMs usually can write a little Javascript code. This allows the PM to talk to the engineering team in their own language. 

What is amazing about the PM is that they have no power or authority over the PMM or dev lead, all they can do is influence the engeneering and marketing teams. It takes a unique skill set to get this done. 

Developer Lead

The dev lead has a difficult role to play insofar as they have to represent the engineering team to the PM and PMM as well as work on all of the “tech stuff.” The tech stuff includes: setting the development architecture, get their DevOps game on by organizing the build (doing things like Continuous Integration and Continuous Deployment), coding, and choosing the right technology for the job (Rails or PhP anyone?)  The dev lead also needs to keep the engineering team together and motivated and make sure that the agile process is, well, agile.

The hardest part of the dev lead’s job is interfacing with the PM and PMM. The nature of startups is that they are resource constrained and always in a rush to get something shipped. That means an insane amount of pressure on the engineering team. It is the dev lead’s responsibility to work with the business (PM and PMM) in order to set realistic deadlines and proper expectations, all while not being the guy complaining about lack of resources. Not always an easy task..

Product Marketing Manager

While the dev lead represents the engineers and the PM represents the customer, the PMM represents the business. While the PMM is responsible for what all non-marketing people think of as marketing (ad campaigns, trade show booths, email blasts, product placement, media placement, etc), they are also responsible for the business model of the product and making sure that the product makes money (or reaches its broader goals if it is a loss leader.) This means setting pricing, and if this is a freemium product, that is far more complex than you can ever imagine. The PMM is ultimately accountable for the product making money.

The Right Balance

Some startups and companies are tempted to combine the PM and PMM role. This is bad! What happens when you combine these roles is that the focus usually becomes either too customer centric or too marketing centric; you need two people and two distinct roles to prevent this from happening. The right structure creates the right environment. The right people in the wrong structure is a waste of talent, they will not be able to use all of their talents, they will spend too much time fighting the incorrect structure. No amount of free massages, free lunches, and unlimited cookies will fix an improper structure. (Actually it is Google, Facebook, Linkedin, etc who have pioneered the Holy Trinity in Silicon Valley. They adapted it from the larger tech companies such as Microsoft in the 1990s.) 

The right people in the right structure/environment is where the magic happens. 

This may sound like a lot of overhead, however, you are probably doing this in some form already. Typically at the early stage, founders take on these roles and hire people to pass them off to. It’s a sign that your startup has matured and left the experimental phase. 

Now go and build awesome products!