August 21, 2012

How to invest like a Venture Capitalist in uncertain technology companies like Facebook and Google


Google keeps developing innovations, from the driver-less car to the Project Glass. If you already have, or are currently planning to invest money in Google, how are you supposed to value these innovations. Google may lease the technology from their driver-less car to automobile manufacturers all over the world, or no-one may want the driver-less car. Will they may make billions from the project - or will they may make zero from the project? Facebook may improve their advertisement algorithms and make billions from advertisement revenues, or their users may leave for another social network. Without any users, Facebook will be worth zero. Some even argue that Facebook is the next big operating system, much like Windows and iOS are today. How are you as an investor supposed to invest in these companies when the future is so uncertain?

We can't learn how to invest in innovative technology companies from traditional investors like Warren Buffett or Peter Lynch. Both of them prefer to avoid technology companies, because technology companies are hard to value when using the tradition value metrics such as the p/e-ratio. The type of investors who often love technology companies are the Venture Capitalists - or VCs. To learn how to invest in uncertain technology companies, we should learn how VCs think when they invest in uncertainty.

One famous VC is Peter Thiel who in 2004 was among the first investors in Facebook. Here are the rules he and other VCs are using when investing in uncertainty:
  • The CEO should not be paid more than $150,000 per year. The rule says that the lower the salary, the better. If the CEO is paid less, the CEO will focus on the growth of the company so the company's shares will be worth more. If the CEO has a too high salary, the CEO will not make the correct decisions when something goes wrong since the CEO will focus on keeping his high salary. Note that most VCs invest in companies when they are small and not yet public companies, so this measure may not always be applicable when searching for larger public companies, such as Google and Facebook. Steve Jobs salary was $1 per year, but he received compensations based on the Apple stock price. Apple is now the largest public company in the world.    
  • Invest in several companies. Peter Thiel believes that you should invest in 7 to 8. Another VC, Fred Wilson, believes that 20 companies is enough. If you buy more companies, you are buying lottery tickets. It is important that the company can increase its value 10 times after your investment. If you invest in Apple with a market value of about $600 billion, and believes that Apple can increase 10 times, then how theoretically possible is it that Apple in the future will be worth $6 trillion?
    You should also invest the same amount in every investment. Don't invest more money in one of the companies because you think it will be worth more compared with the other companies in the portfolio. No-one can make that choice. The only sure thing about investing in uncertain technology companies is that there are no sure things.
    In general, the best investment will be worth as much as the rest of the portfolio combined, the second best investment will be worth as much as the the value of the third to the last company in the portfolio, and so on. The result is that the portfolio as a whole, will only make money if the best investment is worth more than the rest of the fund. In a portfolio of uncertain companies, the following will happen:
    1. The bad companies will go to zero and you will lose your investment
    2. The mediocre companies may make 1 times the investment
    3. The great companies may make 3 to 10 times the investment 

Why you need to invest in several companies. Source: AVC

  • When in doubt - stay out. You may need to wait to get more data about the company. If you don't believe in Facebook today, then wait and see what happens. You will not lose money if you wait, you will only "lose a gain" if the Facebook shares increase. 
  • Make up your own mind and don't follow everyone else. You should invest in companies you like and use.
  • Make a short analysis - 3 to 5 pages is enough.
  • Don't be afraid of investing in a company with an idea that has failed before. Ideas are no longer one-time bets. Apple tried in the 90s to create a small hand-held computer with the name Newton, but it failed. Years later, Apple created another small hand-held computer with the name iPhone. 
  • Professional VCs have no idea if their investments will become the next big thing. The VC Morten Lund invested in the startup Skype because he felt sorry for the founders who didn't have much money at the time. Morten Lund didn't really believe in the underlying business idea. Skype was later sold to eBay for at least $2.6 billion. Most VC-funds never make money. Of the around 1000 VC funds in the US, only about 50 are likely to make money. Many funds make a large gain from a couple of the companies in the fund, but they lose more on the other companies in the fund - so they end up with a loss.
  • Are people dying for a new solution? Find companies that make products in an area where people are dying for a solution to a problem they have. Must Google sell the driver-less car - or will the consumers buy the driver-less car because they really need them? 

Source: Blake Masters, YouTube, Paul Graham, AVC, AVC, The Motley Fool, Venture Capitalists at Work

August 5, 2012

Lessons learned from the times when H&M was a startup


The above videos shows what happened when the retail-clothing company H&M opened a store in Toulouse, France. You may think that this is extreme, but this happens every time H&M opens a new store somewhere in the world. When the first H&M store opened in Japan, people lined up at 6 in the morning, and waited for hours before they could get inside. One may think that H&M is a short-lived fashion trend - but H&M was founded in 1947 by the Swedish founder Erling Persson. Here are some lessons learned from the times when H&M was a small company - not the huge company it is today. You can now find 2300 stores in 43 countries.

Lesson 1. Learn how to sell
As many other entrepreneurs, such as Ingvar Kamprad who founded IKEA and Warren Buffett, Erling Persson was a busy young man. He sold meat, he sold Christmas magazines and other smaller products such as pens, and he also sold merchandise to his army buddies. Sweden used to have a mandatory military service, and almost everyone were recruited, including future billionaires such as Ingvar Kamprad and Erling Persson.

Lesson 2. Move to a large city
Erling Persson moved in 1938 from the small town Västerås to Stockholm, the capital of Sweden. The reason was that he thought he would have more possibilities in a larger city. This is the opposite to Ingvar Kamprad who founded IKEA from Elmtaryd. Elmtaryd is no city at all - its a ranch hours away from civilization. Erling Persson's father said when his son left for Stockholm: "Go away son, you will soon come back." Nine years later, his father had to sell his store in Västerås and move to Stockholm to help Erling Persson with H&M.

Lesson 3. No fear
Before Erling Persson founded H&M, he imported pens from Germany, and once he had to fly down to Hamburg to discuss an issue with the supplier. This was in 1942 and in the middle of the Second World War. Sweden was a neutral country, so it was business as usual with Germany. During the night, the allied bombers flew in over Hamburg, and Erling Persson had to run down into the basement, where he and the other hotel guests drank whiskey. The next morning, he realized that the building next door had been bombed beyond recognition. In the 1980s, H&M opened the first German store very close to this hotel - hotel Vier Jahreszeiten.

Lesson 4. Find inspiration from another culture
Erling Persson traveled in 1947 on a road-trip through USA. It was during this trip, when he visited the retail chain Lerner (New York & Company today), he found the idea to found H&M. Shoes in the US were 75 percent cheaper compared with shoes in Sweden. Why were they so expensive in Sweden? He also found inspiration from the dutch retail chain C&A. The basic business idea behind H&M was to sell fashion cheaper and faster compared with the competitors.

Lesson 5. Make sure to test the idea before the big launch
The first H&M store opened 1947 in Västerås - not in the larger city Stockholm. Erling Persson picked the smaller city because if the idea failed, his reputation in Stockholm would be damaged. He said:
"No-one will notice if everything goes to h*ll, but if everything goes as planned, we open another store."
The name of the company was now "Hennes" - not Hennes & Mauritz (H&M) as it is today. Erling Persson found inspiration for the design of the logotype from Harrods in London.

Lesson 6. Accept ups and downs, and learn something from it
One year after the first H&M store opened, a fashion designer in Paris designed a new skirt. This skirt was longer compared with the skirts Hennes sold in Västerås. The trend with longer skirts spread to Sweden, so the entire warehouse with skirts Hennes had became outdated. Erling Persson managed to survive this crisis, and the next Hennes store opened in 1949. He learned a couple of important lessons from this crisis:
  • Never grow too fast - 15-20 percent a year is enough - "hastening slowly" is the philosophy. It took H&M 50 years before they decided to open the first store in the US
  • You need to have a financial strength - H&M has to make money before H&M can spend the money
  • Purchase the products several times during the year - not once a year to minimize the risk of being on the wrong side of a fashion trend. "We shall follow the fashion - not create it"
  • Minimize the products in the warehouse - each day a product is unsold, it costs money  

Lesson 7. You don't have to be a public company
H&M is today a public company you may invest in on your own. The decision to go public was based on the theory that the money H&M made on their own was not enough to build a global company. This proved to be an incorrect theory, since H&M could have become a global company with their own money. One other reasons was to minimize the taxes that had to be paid when the owner of the company passed away. In total, you had to pay - at this time in Sweden - about 300 percent in taxes when the owner passed away. The decision to go public is today a decision H&M regrets. Too many people have had too many unqualified opinions about the company, and the founders family have paid too much taxes on the dividends. It is today too late to make the company private again - the valuation is way too high.

Lesson 8. Stick to what you can become the best in the world at
This is similar to the findings from the book Good to Great by Jim Collins. The book says that you should focus on one thing only - the thing you can become the best in the world at - if you want to build a great company. The profits decreased in the 1970s because H&M became too ambitious since they wanted to compete with more expensive and luxurious fashion retail stores. But you can't compete with the more expensive stores in the same way you compete with the cheaper stores. The philosophy today is to stick to the basic idea - and "tune it" a little bit while moving forward.

Lesson 9. Practice is more important than theory
Erling Persson loved a quote by a Norwegian professor:
"If you take all the economists in the world and one after each other lies them at the Equator - then that's a very good idea"
H&M needs economists and academic theories - but everything has to be tested against the reality. It is the reality that decides how H&M should be managed. Computers can't forecast everything, and computers can't replace what H&M believes is the most important knowledge: "the common sense."

Erling Persson - founder of H&M. Source: Näringslivshistoria

Source: Handelsmännen (book only available in Swedish), Wikipedia

August 1, 2012

Lessons learned from the times when IKEA was a startup

"Most things remain undone. Glorious future!"
- Ingvar Kamprad, founder of IKEA

IKEA is a company you both love and hate. You love the low prices and you hate the large stores where you have to spend hours wandering through the labyrinth. You love the flat packages and you hate when a piece of the furniture is missing from the package. Today IKEA has 267 stores in 25 countries. Here are some lessons we can learn from the early days of IKEA when the company was a startup and from the Swedish-born founder Ingvar Kamprad when he was a young entrepreneur.

(Note that the numbers here are in SEK (Swedish Krona) and the currency exchange today is about: 1 USD = 7 SEK)

Lesson 1. Learn how to sell
IKEA (Ingvar Kamprad Elmtaryd Agunnaryd) was not the first startup founded by Ingvar KampradLike many other famous entrepreneurs - like Warren Buffett - Ingvar Kamprad was young (only five years old) when he founded his first startup. He asked his aunt when she visited the Swedish capital Stockholm if she could buy 100 boxes of matches for 0.88 SEK a piece and bring them back to Ingvar Kamprad. He later sold these matches for a profit of 0.01 to 0.05 SEK a piece. Ingvar Kamprad would later sell Christmas cards, fish he had caught himself, berries he had collected himself, and taking care of the animals at the farm. 

Lesson 2. Live as you learn - both home and at work
Ingvar Kamprad owns a Volvo 240 GL from 1993. I'm not sure if he is still driving it since he is a little bit old by now, but he drove the car when he was worth $28 billion. But when he was younger, he used to drive a Porsche. The reason to why he bought the Porsche was that he thought he had lost too much of his youth while building the company. His friends went out drinking beer when he stayed home building IKEA - so he wanted to compensate. He is today famous for visiting the local market when it is about to close down for the day and ask if he can get a discount.
"People say I am cheap, and I don't mind if they do. How the h*ll can I tell people who work for me to travel cheaply when I travel in luxury? It’s a question of good leadership."
During his younger years, Ingvar Kamprad borrowed money from other people for the first and last time. He borrowed 500 SEK to purchase fountain pens from Paris and 90 SEK for unexpected expenses. He later said, with a humoristic tone, how he preferred being accused of murder before being accused of borrowing money.

Volvo 240 GL. Source: Billionaire Cars

Lesson 3. No-one knows if your idea is the next big thing
Ingvar Kamprad, who until 1948 only sold smaller products such as pens, wallets, and watches, founded IKEA to compete with the largest competitors who also sold furniture through the post office. He re-named the products from numbers to real names, such as Rut, so he could remember them. The reason to why IKEA today has physical stores is because Ingvar Kamprad wanted his customers to visit the store to try out the quality of the furniture and compare different price levels.

Lesson 4. Focus on one thing only
This is similar to the findings from the book Good to Great by Jim Collins. The book says that you should focus on one thing only - the thing you can be the best in the world at - if you want to build a great company. IKEA used to be a mail order company that sold pens, watches, Christmas cards, furniture, and many other products. In 1952, Ingvar Kamprad decided that IKEA should focus on only furniture and interior decoration. IKEA re-focused again in the 1960s when they realized the main focus should be to sell furniture through large physical stores - not through mail order as it used to be.

Lesson 5. Lose money and gain money at the same time
IKEA doesn't sell food at their stores to make money. The reason to why you can buy food at a heavy discounted price is that you will probably spend more money on the furniture and buy more products if you are not hungry and want to rush home for dinner. 
    In the beginning, when IKEA wanted to enter a new country, they opened a smaller store in the city-center to feel the market and test the customers. If the smaller store worked as expected, they opened a larger store outside of the city.
Other examples:
  • IKEA sold Christmas trees to customers - and promised to buy back the tree if the customers came back with it after Christmas
  • IKEA gave away one shoe of a pair of wooden shoes - and promised to give back the other shoe if the customers came back

Lesson 6. Live in isolation and work, work, work
IKEA was founded in the southern parts of Sweden in a farm called Elmtaryd. The main office would later move to Älmhult - a very small town. The population of Älmhult is currently 9,000 people.

Where IKEA was founded. Bottom marker is Älmhult, top marker is Älmtaryd (or Elmtaryd) in the Agunnaryd area. Source: Google Maps 

Quotes from early employees:
"The life at Elmtaryd consisted of work, a massive amount of work. We had dinner at 18, the phones closed at 19, and you could not call out or get a call from the outside. Then you continued to work as long as you could because you didn't have anything else to do. The nearest town was miles away, the bus didn't go at this time in the evening, and no-one had a car. On Sundays, we went fishing..."
"We used to start early - sometimes at 06:00. If someone arrived later, we used to say: 'Oh, did you spend time reading the newspaper?'"
"I lived with IKEA day and night, it was my life, and now when I'm old, I have to pay the price - but it was worth it. The most important thing was to have fun."

Lesson 7. Accept mistakes and try to learn something from them
Ingvar Kamprad always said:
"Only those who are asleep make no mistakes. There are few people who have made so many fiascos in my life as I have." 
IKEA has failed many times, including:
  • Lost between 30-50 million SEK after a failed investment in a tv-factory with the name Prinsen
  • Lost between 100-125 million SEK after a failed investment in Russia. The reasons were a combination of the Russian mafia and the Russian bureaucracy  
  • Lost 50 million SEK in a failed factory in Romania
  • Opened a small store in the city Konstanz when they should have opened it in Koblenz. The project manager had heard the wrong name

Lesson 8. Use the current trend
Sweden was a neutral country in Europe during the Second World War, so after the war ended, all of the manufacturing industry in the country remained intact. Most industrial buildings in Europe had during the war been bombed beyond recognition. The result was that Sweden became a richer country and 1 million new apartments were built over a period of 20 years. Guess who sold the furniture to these apartments?

Lessons 9. Consultants are not always the best
IKEA hired a consultant in the 1960s to help them improve the company. The consultant arrived and said after the first day that if someone had asked him if IKEA could make money from such a small place as Älmhult (see the map above), the consultant would have said: "No! That will never work." But since IKEA now is making money, the consultant explained how his models are wrong and he will now return home again since he didn't have any knowledge to give back to IKEA.

Lesson 10. The competitors will try everything to stop your disruptive business model
IKEA had a disruptive business model and the traditional sellers of furniture tried everything to stop the new company. The suppliers of furniture to IKEA became scared and didn't want to be connected to IKEA. Some of the remaining suppliers had to send furniture with trucks with a hidden logo and other suppliers changed the design since the traditional sellers of furniture didn't want to sell the same furniture as IKEA. Some suppliers had to ship furniture during the night when no-one could see them. IKEA and Ingvar Kamprad himself were banned from different industry exhibitions and they had to create shadow companies to be able to incognito visit the exhibitions. At one exhibition, Ingvar Kamprad had to ride in the cargo area of a car underneath a carpet to get inside. All of this resulted in:
  • IKEA got more customers because of the way they fought back against the traditional industry. People loves a fighter - especially if they have low prices
  • IKEA had to create their own exhibitions - those exhibitions are now the large stores we see today
  • IKEA had to learn how to design their own furniture
  • Since IKEA couldn't buy from suppliers in Sweden, they had to buy from suppliers with lower prices in Poland

Lesson 11. Don't be afraid of the wild ideas
The decision to buy furniture from suppliers in Poland was a wild idea. Poland was a communist country and a member of the Soviet Union (this was in the middle of the Cold War). Sweden was a neutral country, but each move made by Ingvar Kamprad in Poland was tracked by the Polish security police. In the beginning, the people from IKEA couldn't leave the capital Warszawa because of restrictions, and they had to smuggle spare parts from Sweden to the manufacturing machines in Poland. The sawing machines often broke down due to the bullets stuck in the wood as a result of the fighting during the Second World War. Poland is today among the largest of the suppliers.

Lesson 12. Avoid the stock market
IKEA is not a public company and Ingvar Kamprad has always been scared of modern capitalism. He believes modern capitalism is too short-term and it's too hard to build closely related relations with key suppliers if you think short-term. If you are a public company, the shareholders force you to grow profits and expand despite a recession. The growth of IKEA has been slower compared with if IKEA had been a public company, but IKEA can't grow fast. One employee said: "We can't just ride on the autobahn and find suitable places where we can build IKEA-stores." 50 percent of the resources available will always improve the existing IKEA and 50 percent will always finance the future IKEA. 
    When IKEA opened the first stores in the US, the managers said: "No public company in the US would have ever accepted the slow growth IKEA showed in the beginning. But since IKEA believes in the long-term and patience, we could create a new foundation for survival. But we needed every day of the time we had." The US is now the second largest market with 37 stores - behind Germany with 44 stores.

Lesson 13. Adapt to cultural differences
IKEA experienced a very slow growth in the US. Here are some reasons why:
  • The customers liked the beds, but couldn't figure out the meaning of 160 cm. "What's a cm? And why doesn't IKEA have a king-size-bed?"
  • IKEA needed softer couches. In Europe, you are sitting on the couch - in the US, you are sitting in the couch
  • The turkey-test. It was impossible to sell a table in the US that couldn't fit a large turkey in the middle and glasses on each side of the turkey

Ingvar Kamprad - founder of IKEA. Source: Wikipedia

Source: IKEA (book), Wikipedia, How to start a small business