Episode #13: Addressing criticism of 37signals (Part 1 of 2)

Matt: Welcome to the 37signals Podcast. A lot of podcasts are very lovey-dovey. Everyone's agreeing with each other. We're all happy and holding hands. We decided to go the opposite route: let's talk about people who have problems with 37signals. We'll be discussing some things that we found online, people who have issues with us, think we're wrong or missing the point, and we'll respond.

Matt: Sortfolio is our site for connecting web designers with potential clients, and we decided to use it to find a firm or a designer to redesign Signal vs. Noise, our weblog. And the way we did it was you had to be a paid member of Sortfolio, and then, also, you had to put out a tweet where you mentioned your Sortfolio URL. And a few people didn't like this. It rubbed them the wrong way. For example, here's what Nathan Bowers wrote in a blog post. He said, "One thing that's universally reviled on Twitter is when companies turn your friends into marketing robots. Word of mouth is sacred. When our friends tell us to check something out, we want to know that they're doing it because they love us and not because they're being compensated. What smells wrong about 37signals' approach here is this: while they say it's about finding a great design firm, the subtext screams 'marketing exercise.'"

Here's Jason's response.

Jason: So this guy's biggest issue with us is not so much the concept. It sounds like he's just upset about how we use Twitter, that we're using Twitter to promote the contest by requiring people who want to enter to tweet out with "37signals" in it. I kind of get that. But also, who made the rules up that this is how Twitter has to be used and it must be used this way? This guy says that one thing that's universally reviled on Twitter is... Well, I don't know. A lot of people submitted their things and they weren't put off by it, and other people didn't seem to care either. So the idea that someone made up these rules about how Twitter can be used and how you can promote on Twitter I find to be just kind of a weak argument.

David: And the other thing, too, is he says the subtext screams "marketing exercise." Yeah, it is. Part of it is a marketing exercise. Part of it is getting a new design. Part of it is promoting Sortfolio. There's all these elements to it. It can be more than one thing, and I think that's totally fine. And I also think, if you compared this to other design competitions, they're usually public. If you have architects submitting designs for a public-works project, it'll be public. All the submissions will be public. This is a similar way of doing that, just using Twitter for it.

It can be all these things. But, at the same time, he took offense to it, and a couple of other people did. So, obviously, it is something that some people find, I don't know, offensive, that you blend the lines here.

Jason: Yeah. One other thing I would say, too, is basically kind of what David said about marketing and promotion, that it is. But the other thing that people have to, I think, remember is that by promoting this thing, we're actually promoting hundreds of other designers. The whole point of Sortfolio was to get people to pay attention to Sortfolio so other designers can be found by people who are looking for websites. So promoting Sortfolio is not just in our best interest, but it's in the best interest of everybody who's listed on Sortfolio. And that was kind of the reason why we wanted to get the word out using Twitter and the sort of way we did it was to promote everybody's entries on Sortfolio. So even the people who didn't really qualify for us to pick them were still getting promotion because people were still finding out about Sortfolio.

Matt: If you had it to do over again, is there anything differently you would have done?

Jason: Like I said, I kind of understand why people don't like this. And it wasn't something that we really thought a lot about. We were just like, "Yeah, we'll tweet it out and put our name in it and that sort of thing." So, I don't know. Maybe, but probably not. I think it's totally fair game. But I do think that this idea that it's been decided by somebody that this is how you use Twitter and how promotions must look like, I think, is kind of a ridiculous point. [music]

Matt: All right. Next up is an article called "Enough with the 37signals Babble: Venture Capitalists are Not Evil," which was written by Pascal-Emmanuel Gobry in a magazine called "Business Insider." And let's take it point by point. What he starts with is, well, I'll read it. "Nobody said VC was for everyone. VC is only made for a very specific type of company: companies that have the potential to provide at least a hundred-times return for their investors. For the economics of VC to work, most of the startups they back have to fail, because otherwise they're not taking enough risk. But then again, most businesses fail, VC-funded or not, and that's not argument against entrepreneurship."

Here's David's response.

David: So the first point here is that venture-capital money is not for everybody. Damn straight it's not for everybody. I think the problem is there's this sort of culture of "this is what successful web startups are doing at the moment." When you see a large contingency, especially of Silicon Valley startups, coming out with, oh, announcing series-A funding, announcing series-B funding, it creates this atmosphere that this is what "real" web startups do and that's part of what a real web startup is. And I think that just is bad. When there's all this focus on all these companies taking this VC money, it creates an expectation for new entrepreneurs that this is what they should be doing, too. And I think that is definitely harmful. And it's harmful because the bulk of web startups out there are not capital-intensive businesses. They are not building factories. They are not investing in all sorts of hardware, machinery, or huge, long research-and-development processes that take years to complete, which is typically what you would want to invest VC money into.

I can totally see, I mean, if you're building a cure for something or a biotech startup that's going to take five years to reach fruition, and it potentially will yield a billion-dollar drug, all right. Fine, VC money makes sense. For starting yet another web startup that can get off the ground in three to six months by a team of three to five people? It doesn't really seem like it. It doesn't seem like VC money's a good for that.

And I think that that's the main push-back that we have is not that venture capital is bad; it's that venture capital is bad when applied to businesses that do not have excessive capital needs. Because then it creates all these sort of distortions, where the money has to be spent and it'll have to be spent on, well, hiring more people, because that's really the one major expense that web startups have.

And then you get into all these sort of problems where you have a vastly over-staffed startup, because that's what you have to spend your money on, so that's what you will spend your money on. And you get, oftentimes, big, crufty, overbuilt products, instead of just focusing the same idea on a much smaller team that doesn't require millions of venture capital and can get out the door with something simpler, build a real business around it.

Jason: Yeah, I don't have much more to add, except one of the things that I've seen is that companies that have a lot of money upfront tend to hire a lot of delegators. They tend to hire people with a lot of experience, maybe some ex-VP at Yahoo or a place like that, because they have the money to throw at people like that. And so they feel like if they can get these trophy hires, that they're all set. But a lot of these people don't actually do any work, and they haven't done any work for a long time. They've just been really good at managing things. And so I feel like you start building up this sort of senior-VP structure, because you have all the money to hire people like that. And you're probably not going to go out and try and find a really good person who's a lot cheaper because you don't need to worry about that. It tends to put the wrong pressures on the wrong places.

David: I was reading an article about the whole Friendster meltdown. I forget the name of the guy who started it. They did exactly that. They took a bunch of their VC money and they went out and got a bunch of trophy hires, all sort of senior-VP people who've supposedly done all this before to great success. And what they ended up with was a thousand cooks in the kitchen. And that was really what he attributed to a fair amount of their trouble, that these people were pulling in all sorts of different directions because they were being brought in as these high-powered, experienced people, so they had to leave their mark somewhere. They couldn't just get in and be a part of the machinery. They had to come in and justify that expense that was spent to bring them in.

It's not that previous VPs of somewhere is bad. It's that bringing in a bunch of them before you have a real business, before you have a real path, is just a bad idea. You don't have a company culture that's settled yet. You don't have a company path that's really well-established. And when that's not true, everybody will sort of just revert to their default ideas of how things should be run. They won't be coming together around one thing and pulling in the same direction. Or at least that's the fear, and that's the risk of bringing all these people in early.

So, if you are going to do high-powered hires, it should come at a much later point. And I guess that's also part of the VC critique here is that the money is being brought in way, way prematurely, oftentimes being brought in even before there is a product, before there is any establishment of whether this current idea is good enough to sort of gear to leverage. And that's definitely a huge part of the trouble.

Matt: Gobry's next point is that taking VC does not mean playing the Google-acquisition lottery, as we've called it. He says, "A company might take VC simply to expand its operations or finance venture capital. And a company might take VC because they have a good product or technology but don't have the will or the resources to focus on monetization right away." Here's Jason.

Jason: His second point is sort of related to the first point. At least David's answer to the first point sort of covered some of these things. But at the end, he says, "A company might take VC simply to expand its operations or finance venture capital." I'm not sure what that second part really means. I think what David was getting at makes sense. Maybe once you have a success, once you have customers, once you have a track record, once you have a clear path, and then you feel like, for whatever reason, you need more money to do something else, then, OK, maybe it makes sense for some companies. So expanding operations, once you actually have operations, may make sense. But you don't expand operations upfront when you have nothing. You first build operations. You first build a few years. You first build some profits and some customers before you want to do that.

So, his example may make sense, yes, for mature companies, or young companies that have a track record. But upfront, it doesn't make sense to expand something that you don't have yet.

David: The example that I like to use for this is: think of a restaurant chain. So, McDonald's is getting started for the first time. Now, if they took the money upfront, the clock is ticking. They have to put that money to use. Would you go out and start, let's say, 500 McDonald's before you even know what the menu is, before you've even designed your hit burger yet? No, you wouldn't. You would run one franchise until you've really honed how that thing is going to work, how a single store can be profitable, can make a space for itself.

And then, once you have that winning formula, you can say, all right, buying a new store, or opening a new store, costs half a million dollars, and it takes, let's say, two years to win that capital expenditure back. Now, this is the point where we can accelerate. We know that the one store works. So, let's get a bunch of money, and let's just get 500 stores that are all going to run off the same recipe, and they're all going to pay us back in two years. So we need the money upfront, and let's do it like that.

But it's kind of hard to translate that, again, to the web business, because you typically don't have that. You typically don't have that you have to buy land and build restaurants and stuff like that. I can perhaps see it in some things like web hosting or something else like that, where you actually have to buy a ton of hardware, but even that is getting less and less true.

But to the second point he had, which was, "Oh, taking VC is not about acquisition lottery." Of course it is. VCs want their money out in three to five years. How many successful IPOs have we had in the past three to five years off tech businesses? Virtually none. How many VC-powered businesses have turned into big cash, money-making machines over the last three to five years? Virtually none.

If you have to get a return on your investment as a VC today, it seems that the acquisition-lottery way is the way to go. That is what's getting all the press. That's what's getting all the attention. And that's what's making all these VCs frothy, when they see tech companies being picked up by larger players and see, "All right, got you." Here we have a "reliable" exit way, some way to get our money back in the three to five years that these guys usually operate on. And that then becomes the target. And then you have a lot of other...

What we're ranting on, in large extents, is the negative forces this puts on you. So you have the negative forces of the VC giving you a chunk of money, and then you have to spend that money. Well, now you have the negative force of the VC expecting some sort of return pretty early, and the regular avenues of getting that are closed or dim, so the acquisition game comes in. Now, what do you have to do get acquired? The things you have to do to get acquired are not necessarily the same things you would do just to build a sustainable business.

So, it's all of this indirection that just seems [growls] wasteful, distracting, taking away from building a crop of new, wonderful businesses that we could be customers of. That's often what I get annoyed about is that all these people, they could be building wonderful services that I could pay money for and be happier to use, instead of just being yet another brain pickup by Google, where you can have a bunch of wonderful people who can go away in some department deep in the bowels of that company and never be heard from again until they emerge three years later because their golden handcuffs have been taken off, and then they'll try to do it again.

Most acquisitions fail. Most tech startups that get acquired end up doing less interesting stuff, once they get acquired, than they were doing before. Sort of a staleness sets in once the big check has been written, and the key founders are either just tapping on the clock until their golden handcuffs get taken off and they can go out and do it again, or they just get disinterested. That's at least my take from watching a bunch of technology startups being taken out.

One of the original rants we had was everybody are so quick to do to the congratulation game whenever somebody gets acquired: "Oh, that's so wonderful. You got acquired." I mean, it is wonderful that somebody made a lot of money, I guess. But in many ways, it should be offering condolences--offering condolences on the future innovation of that product to the customers who are just going to be sucked into this thing that are now way more likely to go stale, and condolences to the poor acquirer, who will probably not see a return on investment for this pickup.

Because that's how it usually goes. It doesn't pan out. It doesn't pay off. It sounds good. It's a great press release. I'm sure that the VP who's responsible for making the sale probably moves up in the ranks if they pick up a high-profile acquisition but it feels like keeping up with the Joneses game. Google just bought this company, now Yahoo has to make a counter move because Google got this shiny new car and Yahoo needs it too. What about Microsoft, who should they be buying to keep up?

This is where this whole trophy thing comes into it and it just distracts from the main thing we should we focusing about which is building wonderful businesses, wonderful tools that people want to use and preferably want to buy.

Matt: All right we'll keep going on this business insider piece. Next up Pascal-Emmanuel Gobry says, "Failing is OK. I would submit that a founder who starts a company, raises VC, leaves it all out in the field and fails has learned more, is more employable and more likely to succeed than someone who hasn't. They say that someone who starts a venture backed startup and fails ends up with nothing but that's just not true." "They end up with skills, relationships and insights that others don't have. Failure is a great way station on the road to success."

Jason: All right so his third point, is the one that really rubs me the wrong way and really kind of gets me going here. This idea that failing is OK. I mean sure ultimately I guess it is OK but it's not OK for most of the people involved. It's not OK for the people's money you've just lost; it's not OK for the employees who don't have a job anymore; it's not OK for the customers who started to like your product but they couldn't use it anymore because you couldn't stay in business. So it's not really OK. I mean it's OK that you're probably not going to die but it's not OK for many other reasons. The last part of his point he says, "Failure is a great way station on the road to success." That is the biggest crock of shit I've heard in a long time. This idea that failure is sort of this prerequisite for success, that you need to fail a bunch of times before you can succeed, that you must get failure out of the way or that you can get it out of the way and once you've failed a bunch of times you won't fail anymore.

That's just ridiculous, that is not the way it works and if you move up further in his point here he says, "I would submit that a founder that starts a company, raises VC, leaves it all out on the field and fails has learned more, is more employable and more likely to succeed than someone who hasn't." Now I'm not one who generally cites studies because I really don't like a lot of them but I will cite this one because it does support my point of view and not his which is that, there's actually a Harvard business study and this was in "Rework" by the way, this study.

This guy did some research about in fact about tech startups and he found that, someone who succeeds in a startup and sells it and does something else or decides to do it again, is more likely to succeed than somebody who failed in a startup and in fact, somebody who failed is no more likely to succeed than somebody who never tried in the first place. So not trying at all and failing gives you the same percentage or same potential of success but the better potential for success is someone who has succeeded before.

And that totally makes sense to me is that, when you've succeeded you understand how to make it, you know what works and you know what you can do again to do it better. The idea that failing is going to give you this experience that's going to let you get failure out of the way and succeed next time, I just don't buy it. I think the things that you get used to over time are the things you continue to do and if you keep failing and failing and failing and following the same failed model, I don't understand how eventually somewhere down the road you're going to run into this beautiful success moment.

So I don't buy this entire paragraph, I think his point falls very flat.

David: I also think it's very easy for VC who has the money to invest in let's say 10 or 20 startups and only needs one big success out of that lot to say, "Failure's fine, it's doesn't really matter, we got our one big hit that sold to Google for a billion dollars so our fund is fine." Well it's not fine for the other nine to 19 startups who didn't make it as part of that and part of our argument is that, if you take VC money, I hate this fucking term but "swinging for the fences" come into it. You are more likely, which A, I don't think is true. Well their argument goes; you are more likely to then have a blow-out billion-dollar success but you're also more likely to fail, it that sort of makes sense. The possibility of the blow-out success is there but it'll be more likely that you'll fail. Well that's fucking terrible. First of all I don't think it's true. If a company is destined to be a billion-dollar company, I think it'll get there without the fucking VC money.

And second; I think there's tonnes of great companies who could of been million dollar companies that get killed in the process, in the pursuit of trying to become a billion-dollar product and I think that the VCs are part of that. They are part of killing great million dollar companies because they infuse all this money, they blow up the idea way too early and all of these negative pressures we've been talking about.

And it doesn't really matter to the VCs because if they just get their one success, the fund is fine, but it does matter to the other 19 startups or nine startups or wherever the pool success has to be or the pool failure rate happens to be who gets blown up too early, and who very well might of made it if it wasn't because they were supposedly swinging for the fences, and trying a billion-dollar shot.

Jason: So his last point here in this email is he goes, "Of course you can tick off countless other examples, Google, eBay, Facebook, Twitter, even Apple, etc., etc., etc." and I'm just going to stop there because I don't really care what the rest of this paragraph says, because what he is saying here is, he's lumping in two companies that may or may not be making money with three companies that absolutely are. Google, eBay and Apple, I'm assuming eBay is still making money but Google, eBay and Apple are wildly profitable companies, hugely profitable companies. Facebook and Twitter do not belong in that group. The fact that they're popular does not make them profitable. Now Facebook may be profitable, it looks like it's going that way, fine, but why don't we give them five years of solid profits before we call them anywhere near on the same level as Google and Apple, and Twitter, who knows what is going to happen with Twitter.

So I don't think we should be in such a rush to call out Facebook and Twitter as examples of successes or examples of companies that are anywhere near the same level as Google and Apple.

Matt: Why does the opposite point of view seem to get so much traction if what you guys believe is the correct view?

Jason: Well I think there is obviously the lure of getting hundreds of thousands or millions of dollars in the bank that isn't yours that you can spend, it's very hard to turn that down and I totally get it. I remember when we were just starting out as a web design firm, there was some situations where people wanted to invest in us and it's very, it's flattering to hear some rich guy wants to give you money that you don't really have to worry about. I mean I totally get that. So I think that's why people are so into it. It's hard not to like we've said before, the easiest thing to do in the world is to spend someone else's money, and when there's really no ramifications because if you lose their money you don't owe it to them to pay it back, it's a very tasty treat I think to go for that. So I get that, but I think it's I think a bit of discipline and sort of reality is what's more interesting than just going off and spending someone else's money.

David: I think also everybody wants to be Michael Jordan. We look at fucking Google and eBay, and a handful of vastly, vastly profitable billion-dollar businesses and people think that the road to that goes through the VCs. If they want their shot at being the Google, they have to go that path and that is really appealing. They forget that the odds of that happening are vanishingly small. They forget the fact that they could just aim to be a million dollar business and they'll probably be a lot better off. They'll probably have a lot higher odds of success, but it's just not as sexy. It's really sexy to swing for being a billion-dollar business and I can totally see the appeal of that, but just like we don't encourage schoolchildren everywhere to think they're going to make it into the NBA, we shouldn't be encouraging startups everywhere to think they're going to be the next fucking Google.

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Matt: All right, that'll wrap it up for this edition of the 37signals podcast. If you want to see links that we've discussed in this episode, you can go to www.37signals.com/podcasts, we list all the related links there and that also has previous episodes of the podcast. Thanks for listening.

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