The Secret History of Silicon Valley 12: The Rise of “Risk Capital” Part 2

This post is the latest in the “Secret History Series.”  They’ll make much more sense if you watch the video or read some of the earlier posts for context. See the Secret History bibliography for sources and supplemental reading.

This is the second of three posts about the rise of “risk capital” and how it came to be associated with what became Silicon Valley.

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The First Valley IPO’s
Silicon Valley first caught the eyes of east coast investors in the late 1950’s when the valleys first three IPO’s happened: Varian in 1956, Hewlett Packard in 1957, and Ampex in 1958.  These IPOs meant that technology companies didn’t have to get acquired to raise money or get their founders and investors liquid. Interestingly enough, Fred Terman, Dean of Stanford Engineering was tied to all three companies.

Varian made a high power microwave tube called the Klystron, invented by Terman’s students Russell and Sigurd Varian and William Hansen. In 1948 the Varian brothers along with Stanford professors Edward Ginzton and Marvin Chodorow founded Varian Corporation in Palo Alto to produce klystrons for military applications. Fred Terman and David Packard of HP joined Varian’s board.

Terman was also on the board of HP. Terman arranged for a research assistantship to bring his former student, David Packard, back from a job at General Electric in New York to collaborate with William Hewlett, another of Terman’s graduate students. Terman sat on the HP board from 1957-1973.

Ampex made the first tape recorders in the U.S (copied from captured German models,) and Terman was on its board as well. Ampex’s first customer was Bing Crosby who wanted to record his radio programs for rebroadcast (and had exclusive distribution rights.) Ampex business took off when Terman introduced Ampex founder Alex Poniatoff to Joseph and Henry McMicking. The McMicking’s bought 50% of Ampex for $365,000 (some liken this to the first VC investment in the valley.) McMicking and Terman introduced Ampex to the National Security Agency, and Ampex sales boomed when their audio and video recorders became the standard for Electronic Intelligence and telemetry signal collection recorders.

Meanwhile on the West Coast – “The Group”  1950’s
When Ampex was raising its money, in 1952, an employee of Fireman’s Fund in San Francisco, Reid Dennis, managed to put $20,000 in the deal. Five years later Dennis and a small group of angel investors who called themselves “The Group” started investing in new electronics companies being formed in the valley south of San Francisco. These angels who were all working in their day jobs at various financial institutions, would invite startup electronics companies up to San Francisco to pitch their deals and they would invest an average of $75 -$300K per deal.

The Group is worth noting for:

  1. Investing their own private money,
  2. Reid Dennis would found Institutional Venture Partners in 1974
  3. First group specifically investing in the valley’s electronics industry

SBIC Act of 1958
During the cold war the launch of Sputnik-1 by the Soviet Union in 1957 both traumatized and galvanized the United States. Having the first earth satellite launched by a country that been portrayed as a third-world backwater with a bellicose foreign policy shocked the U.S. into believing it was behind the Soviet Union in innovation. In response, one of the many U.S. national initiatives (DARPA, NASA, Space Race, etc.) to spur innovation was a new government agency to fund new companies.  The Small Business Investment Company (SBIC) Act in 1958 guaranteed that for every dollar a bank or financial institution invested in a new company, the U.S. government would invest three (up to $300,000.) So for every dollar that a fund invested, it would have four dollars to invest.

While SBIC’s were set up around the country, companies in Northern California including Bank of America, Firemans Fund and American Express (Reid Dennis of the Group ran theirs), began to set up SBIC funds to tap the emerging microwave and new semiconductor startups setting up shop south of San Francisco. And for the first time, private companies like Continental Capital, Pitch Johnson & Bill Draper and Sutter Hill were formed to take advantage of the government largesse from the SBA. Like all government programs, the SBIC was fond of paperwork, but it began to formalize, professionalize and standardize the way investors evaluated risk.

SBIC’s were worth noting for:

  1. The good news – government money for startups encouraged a “risk capital” culture at large financial institutions.
  2. The better news – government money encouraged private companies to form to invest in new startups
  3. The bad news – the government was more interested in rules, regulations and accounting then startups (because some SBIC’s saw the government funds as a license to steal)
  4. By 1968 over 600 SBIC funds provided 75% of all venture funding in the U.S.
  5. In 1988 after the rise of the limited partnership that number would be 7%.

Limited Partnerships
By the end of the 1950’s there was still no clear consensus about how to best organize an investment company for risky ventures. Was it like George Doriot’s ARD venture fund – a publicly traded closed end mutual fund? Was it using government money as a private SBIC firm?  Or was it some other form of organization? Many investors weren’t interested in working for a large company for a salary and bonus, and most hated the paperwork and salary limitations that the SBIC imposed. Was there some other structure?

The limited partnership offered one way to structure an investment company. The fund would have limited life. It would charge its investors annual “management fees” to pay for the firm’s salaries, building, etc. In a typical venture fund, the partners receive a 2% management fee.

But the biggest innovation was the “carried interest” (called the “carry”.) This is where the partners would make their money. They would get a share of the profits of the fund (typically 20%.) For the first time venture investors would have a very strong performance incentive.

Venture Capital In 1958 General William Draper, Rowan Gaither (founder of the RAND corporation) and Fred Anderson (a retired Air Force general) founded Draper, Gaither and Anderson, Silicon Valley’s (and possible the worlds) first limited partnership. The venture firm was funded by Laurance Rockefeller and Lazard Freres, but after some dispute lost to the sands of time, Rockefeller pulled his financing, and the firm was dissolved after the first fund.

The first limited partnership that lasted for a while was formed by Davis and Rock in 1961. Arthur Rock, an investment banker at Hayden Stone in New York (who helped broker the financing of Fairchild) moved out to San Francisco in 1961 and partnered with Tommy Davis. Davis (an ex-WWII OSS agent) then a VP at the Kern Land Company got involved with investing in technology companies through Fred Terman. Davis’s first investment in 1957 was Watkins-Johnson (the maker of microwave Traveling Wave Tubes for electronic intelligence systems) where he sat on its board with Fred Terman. Rock and Davis would raise a $5M fund from east coast institutions and while they invested only $3.4 million of it by the time they dissolved their partnership in 1968 – they returned $90 million to their limited partners – a 54% compound growth rate.

Limited partnerships are worth noting for:

  1. By the 1970’s the limited partnership would become the preferred organizational form for venture investors
  2. The “carried interest” (the “carry”) assured that the venture partners would only make real money if their investments were successful. Aligning their interests with their limited investors and the entrepreneurs they were investing in.
  3. The limited life of each fund; 7-10 years of which 3-5 years would be spent actively investing, focused the firms on investments that could reasonably expect to have “exits” during the life of the fund.
  4. The limited life of each fund allowed venture firms to be flexible. They could change the split of the carry in follow on funds, add partners with carry in subsequent funds, change investing strategy and focus in follow-on funds, etc.

Silicon Innovation Collides with Risk Capital
Lacking a “risk capital” infrastructure in the 1950’s military contracts and traditional bank loans were the only options microwave startups had for capital. The first semiconductor companies couldn’t even get that – Shockley and Fairchild could only be funded through corporate partners. But by the 1960’s the tidal wave of semiconductor startups would find a valley with a growing number of SBIC backed venture firms and limited partnerships.

A wave of silicon innovation was about to meet a pile of risk capital.

More on this in Part XIII of the Secret History of Silicon Valley.

The Secret History of Silicon Valley 11: The Rise of “Risk Capital” Part 1

This post is the latest in the “Secret History Series.”  They’ll make much more sense if you watch the video or read some of the earlier posts for context. See the Secret History bibliography for sources and supplemental reading.

This is the first of two posts about the rise of “risk capital” and how it came to be associated with what became Silicon Valley.
———————–

Building Blocks of Entrepreneurship
By the mid 1950’s the groundwork for a culture and environment of entrepreneurship were taking shape on the east and west coasts of the United States. Stanford and MIT were building on the technology breakthroughs of World War II and graduating a generation of engineers into a consumer and cold war economy that seemed limitless. Communication between scientists, engineers and corporations were relatively open, and ideas flowed freely. There was an emerging culture of cooperation and entrepreneurial spirit.

Slide1

At Stanford, Dean of Engineering Fred Terman wanted companies outside of the university to take Stanford’s prototype microwave tubes and electronic intelligence systems and build production volumes for the military. While existing companies took some of the business, often it was a graduate student or professor who started a new company. The motivation in the mid 1950’s for these new startups was a crisis – we were in the midst of the cold war and the United States military and intelligence agencies were rearming as fast as they could.

Yet one of the most remarkable things about the boom in microwave and silicon startups occurring in the 1950’s and 60’s was that it was done without venture capital. There was none.  Funding for the companies spinning out of Stanford’s engineering department in the 1950’s benefited from the tight integration and web of relationships between Fred Terman, Stanford, the U.S. military and intelligence agencies and defense contractors.

These technology startups had no risk capital – just customers/purchase orders from government/military/intelligence agencies.

This post is about the rise of “risk capital” and how it came to be associated with what became Silicon Valley.

Risk Capital via Family Money   1940’s
During the 1930’s, the heirs to U.S. family fortunes made in the late 19th century – Rockefeller, Whitney, Bessemer –  started to dabble in personal investments in new, risky ventures. Post World War II this generation recognized that:

  1. Technology spin-offs coming out of WWII military research and development could lead to new, profitable companies
  2. Entrepreneurs attempting to commercialize these new technologies could not get funding; (commercial and investment banks didn’t fund new companies, just the expansion of existing firms,) and existing companies would buy up entrepreneurs and their ideas, not fund them
  3. There was no organized company to seek out and evaluate new venture ventures, manage investments in them and nurture their growth.

Several wealthy families in the U.S. set up companies to do just that – find and formalize investments in new and emerging industries.

  • In 1946 Jock Whitney started J.H. Whitney Company by writing a personal check for $5M and hiring Benno Schmidt as the first partner (Schmidt turned Whitney’s description of “private adventure capital” into the term “venture capital”).
Jock Whitney writes himself a check to fund J.H. Whitney Co.

Jock Whitney writes himself a check to fund J.H. Whitney Co.

  • That same year Laurance Rockefeller founded Rockefeller Brothers, Inc., with a check for $1.5 million.  (23 years later they would rename the firm Venrock.)
  • Bessemer Securities, set up to invest the Phipps family fortune (Phipps was Andrew Carnegie’s partner,)

These early family money efforts are worth noting for:

  1. They were “risk capital,” investing where others feared
  2. They invested in a wide variety of new industries – from orange juice to airplanes
  3. They almost exclusively focused on the East Coast
  4. They used family money as the source of their investment funds

East Coast Venture Capital Experiments
In 1946, George Doriot, founded what is considered the first “venture capital firm” – American Research & Development (ARD). A Harvard Business School professor and early evangelist for entrepreneurs and entrepreneurship, Doriot was the Fred Terman of the East Coast. Doroit had the right idea with ARD (funding startups out of MIT and Harvard and raising money from outsiders who weren’t part of a private family) but picked the wrong model for raising capital for his firm. ARD was a publicly traded venture capital firm (raising $3.5 Million in 1946 as a closed-end mutual fund) which meant ARD was regulated by the Securities and Exchange Commission (SEC.) For reasons too numerous to mention here, this turned out to be a very bad idea. (It would be another three decades of experimentation before the majority of venture firms organized as limited partnerships.)

The region around Boston’s Route 128 would boom in the 1950’s-70’s with technology startups, many of them funded by ARD. ARD’s most famous investment was the $70,000 they put into Digital Equipment Corporation (DEC) in 1957 for 77% of the company that was worth hundreds of millions by its 1968 IPO. It wasn’t until the rise of the semiconductor industry and a unique startup culture in Silicon Valley that entrepreneurship became associated with the West Coast.

Georges Doriot the first VC

Georges Doriot the first VC

Doriot and American Research and Development are worth noting for:

  1. Some of the very early VC’s got their venture capital education at Harvard as Doriot’s students (Arthur Rock, Peter Crisp, Charles Waite.)
  2. ARD was almost exclusively focused on the East Coast
  3. ARD proved that institutional investors, not just family money had an appetite for investing into venture capital firms.

Corporate Finance
One of the ironies in Silicon Valley is that the two companies which gave birth to its entire semiconductor industry weren’t funded by venture capital. Since neither of these startups were yet doing any business with the military—and venture capital as we know it today did not exist, they had to look elsewhere for funding. Instead, in 1956/57, Shockley Semiconductor Laboratory and Fairchild Semiconductor were both funded by corporate partners —  Shockley by Beckman Instruments, Fairchild by Fairchild Camera and Instrument.

More on the rise of SBIC’s, Limited Partnerships and the venture capital industry as we know it today in Part XII of the Secret History of Silicon Valley here.

Ardent War Story 6: Listen more, talk less

At Ardent we assembled an amazing group of talented engineers to build personal supercomputers to sell to scientists and engineers. (Context here.)  The company failed.

Getting Out of the Building Wasn’t Entertainment – Discovery and Validation
Now that I was the master of the “facts” about customer needs in these specialized vertical markets, and with my team of vertical marketers, I thought I had achieved absolution and redemption. Opinions had been eliminated as part of marketing’s dialog inside the company; we had achieved “fact nirvana.” But there was one fatal flaw. As I enjoyed my post-graduate vertical marketing education, I had forgotten the real purpose of spending time in the field.

While understanding how customer’s do their work was one key part of Customer Discovery, I neglected the other key component – Customer Validation – to understand whether there were sufficient number of customers who had a problem that needed to be solved – and would pay to solve it. I had needed to ask customers four simple questions.

  1. Did the customers know they had a problem?
  2. If so, did they want to change the way they were doing things to solve that problem?
  3. If so, how much would they pay to solve the problem?
  4. Would they write us a Purchase Order now before our supercomputer was even complete, to be the first to solve their problems?

In hindsight, these questions seem blindingly apparent yet not asking them led to the ultimate demise of Ardent.  I just assumed that since customers were talking to me and spending time with me, it must mean that they agreed with our new company’s vision and would spend piles of money with us. At this point in my career I didn’t understand that the goal of getting outside the building was not only finding markets with potential customers to sell to but also confirming the company’s vision, business model and product/market fit.

I had done a good job of Customer Discovery but failed at Customer Validation.

Ignoring the Red Flags
While I had lots of people willing to talk to me, we never really pushed hard to see if any customers were willing to buy and pay for the product before it shipped.

Early startup customers are visionaries just like the founders selling to them. If your startup’s vision is compelling enough, these early customers want to buy into the dream of what could be, and they want to get in early. They will put up with an unfinished system that barely works to get a competitive advantage outside their company (or sometimes a political one inside their company.)  They will count on your startup to listen to their needs for subsequent releases or follow-on systems that actually deliver on the initial promise.

All industries, markets and segments have these visionary, early adopters. It is one of the wonderful intersections between human nature, capitalism, and startups. Not finding a sufficient set of these early visionaries is the biggest red flag a company can encounter.  Ignoring these warning signs is fatal.

Product/Market Fit
Getting out of the building is not to collect feature lists from prospective customers nor run tons of focus groups (I had passed this test.) Instead it was to validate the product/market fit by discovering if their were enough customers who would buy our product as spec’dThis was where I had failed at Ardent. Once we had found our target customers we spent our meetings describing our new personal supercomputer and what it could do for these researchers instead of listening and truly understanding whether what we were offering was a “nice to have it” or “got to have it.”

If I had had actually been asking “Were we solving a problem these scientists and engineers felt they had?” I would have gotten a half-hearted “maybe.” If I had followed that up with a “If our personal supercomputer delivers as promised, would you write me a check now, before it ships?” I would have seen that no one was falling over themselves to be the first to buy our product. Another clue: lots of people said, “We’d try it if you give it to us.”  That answer is always a dead give-away that you don’t yet have a product compelling enough to build a business.

As often happens in a startup, we confused our own vision and passion with the passion of our potential customers.

I had talked too much and listened too little.

What did the company do when we heard customer input that contradicted our business plan and assumptions?  More in the next post.

Lessons learned:

  • We had “discovered” Ardent’s initial markets and customers
  • We spent too much time selling our vision and not enough time validating whether customers would actually buy
  • A lack of early, eager purchasers is a red-flag – time to revisit your business model

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Ardent War Story 5: The Best Marketers Are Engineers

At Ardent we were building personal supercomputers to sell to scientists and engineers. (Context here.) While the last post was titled “You Know You’re Getting Close to Your Customers When They Offer You a Job“, this post should probably be titled, “You Know You’re Getting Close to Your Customers When You Offer Them a Job.”

I would discover that there was a more effective alternative in building a marketing department than hiring traditional marketers with MBA’s.

Building an Advisory Board
In my travels outside the building I kept my eyes out for articulate and visionary scientists and engineers who had expertise we lacked, and were willing to help in an advisory capacity. I set up an advisory board as a vehicle to get these industry experts engaged with the company and product. Some of these advisors from the academic community would work with our of VP of Engineering and help us solve specific technical problems.

Other advisors provided marketing with industry-specific advice in our initial vertical markets (computational fluid dynamics, computational chemistry, finite element analysis, and petroleum engineering). They gave us input on 1) features our system needed, 2) what applications we needed to have, and 3) how to sell to people just like them. Of course we also hoped that in listening to their advice in how to build the perfect computer for customers just like them, they would actually buy one of the first computers.  Since some of these advisory board members were leaders in their fields, we knew they would tell their peers about our company. Our company’s stock was an inducement, but all of them were in it to help us build a better computer.

Velvet Painting Period - MFLOPS Poster

Velvet Painting Period - MFLOPS Poster

Engineers as Marketers
There was one other reason I was talent-spotting our advisors and potential customers. In most other companies a product-marketing department was responsible for the pricing, positioning and promotion of the product. Yet in our case the product, the machine as delivered from engineering, was a blank, featureless computer with just an operating system and compilers. The hardware held no interest for our target customers until it had become a “whole product,” – that is not until the computer had the complete suite of applications appropriate for a scientist in their specific vertical market – i.e. all the applications to run computational fluid dynamics or finite element analysis.

While I had learned a lot about our target markets in the first few months, I would never know as much as people who had spent their careers in these fields. Since the universe of people who were great marketers who also understood these esoteric applications like finite element analysis could be counted on one hand, (and were all working at Cray, the market leader) my choices were limited. I could either hire smart MBAs who were generalists and try to get them up to speed on these simulation applications, or I could hire some of the most articulate domain experts and teach them how to be marketers.

I chose to hire engineers from within each of our target markets and set up “Steve’s one month MBA course for engineers.”

At the time this was a pretty controversial decision. These hires were definitely not your standard marketing types. We hired a PhD in computational fluid dynamics from Duke who had worked on helicopter design. (Years later he would become a venture capitalist at Sequoia Capital.)

Our head of finite element analysis came from General Motor’s Chevy division, where he headed up one of their analysis groups. (He would go on to be a co-founder of two mechanical engineering software companies.) The rest of the vertical marketing recruits had similar backgrounds (and similar careers.)  (I never could find one from the petroleum industry so I wore that hat along with the VP of Marketing title.)

Few of them had ever seen a data sheet or a price list let alone written one, but they were domain experts, they knew their fields, and they could communicate the benefits of owning a machine like ours to run their applications. They knew which applications were critical for their markets and which were nice-to-have. And they were responsible for helping our 3rd party software group reach the right application providers to port their software to our computer. Since these marketers knew what publications their peers read and what conferences and trade shows they attended, they led our presence at the right shows and conferences.  They knew the technology trendsetters in their fields and got us in front of them. In short order they learned how to transition from being customers on the receiving end of a sales pitch to giving one. To a person they became passionate evangelists and effective marketers.

Technical Marketing
Years later in my career I would realize I had simply reinvented what the early pioneers in Silicon Valley knew and did – hiring engineers who were domain experts who could talk as peers to customers and communicate effectively with their own company’s engineers.  (Back in the 1960’s and 70’s no sane MBA’s would work for a Silicon Valley startup.) While MBA’s have a ton of useful skills, what they don’t have is what most marketing departments lack – customer insight.  I found that having a senior marketer responsible for business strategy surrounded by ex-engineers and domain experts makes one heck of a powerful marketing department.

A quick diagnostic I now use for marketing departments: if you are in a startup selling to a specific set of customers and/or industry and your marketing department doesn’t have any people from that industry, your tenure as a VP of Marketing has passed its half-life.

Lessons learned:

  • Advisory boards with domain experts get you connected quickly to customer needs
  • In specialized markets, hire domain experts, and teach them to be marketers

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Ardent War Story 4: You Know You’re Getting Close to Your Customers When They Offer You a Job

In 1985 Ardent Computer was determined to create a market niche for personal supercomputers. To understand our potential markets, we started by analyzing the marketing literature from Cray Research then crisscrossed the country talking to prospective customers – scientists and researchers in advanced corporate R&D centers and universities – to understand their needs.

A week might start with a visit to the MIT Media Lab, the next day at Princeton in the Aerospace Engineering department, then off to General Motors’ advanced research group, across to the computer science department at the University of Illinois, up to Minneapolis to meet with ETA, Control Data and Cray, and across the country to Seattle to speak with Boeing’s advanced propulsion group before returning to to the geophysics department at Stanford.

Simulation applications
After six months, we hypothesized that our most likely customers were scientists and engineers who used one of five applications: computational fluid dynamics, finite element analysis, computational chemistry and seismic data processing and reservoir simulation.

At Boeing we had learned aircraft designers needed to calculate the airflow and turbulence around wings and engines. Instead of building a new wing to test designs, numerical simulation would allow them to use a supercomputer to build a virtual model of a wing on the screen and use an application called computational fluid dynamics to watch the resulting airflow without ever flying a plane. If they didn’t like what they saw (say the wing had more drag than expected), they could change the design and rerun the simulation.

At General Motors we heard from mechanical engineers who needed to calculate the strength, breaking point and failure modes of structures – everything from piston rods to bumpers. Their interest was easy to understand. Before computer simulation, they would test real objects until they physically broke (or get sued when something important broke, blew up, or collapsed.) Now applications called finite element analysis could calculate these stresses and failure modes on a computer screen.

A third simulation market, this one new and just emerging, allowed biologists to examine how drugs would interact by simulating them on a computer.  A precursor to today’s biotech revolution, these computational chemistry applications allowed the active docking sites of potential drugs to be modeled and tested on a computer screen rather than in a test tube.

Finally, we could see that petroleum engineers at oil companies like Chevron and Exxon were using computers in exploration and extraction with seismic data processing and reservoir simulation, applications which were moving oil companies into the supercomputer age.

Traveling around the country had helped me begin to understand how these customers currently did their work, what journals they read, where they got their funding, what other software they ran on their machines, etc. I came back to the company and described the day-in-the-life of each type of customer.

This was one of the happiest times in my life as a marketer. I had known nothing about supercomputers and numerical simulation applications; now there wasn’t a day that went by that I wasn’t learning something new. As I traveled to some of the most arcane trade shows and conferences (AIAA, SPE, MSC, etc.), my hotel room was stacked with the journals and textbooks about each vertical market just to keep up with the people we were meeting. (I was a marketer, not an engineer and most of the fine points were way over my head – and probably not just the fine points. But reading their literature allowed me to discuss the problems and opportunities with customers.)

My Velvet Painting Period

My Velvet Painting Period

You Know You’re Getting Close to Your Customers When They Offer You a Job
I believed that good marketers used their own products. I got facile enough with a few of the applications that I could even run some of them myself. I could build simple finite element models with Patran and set up a run of the Nastran analysis codes.

Later on in the company’s life I went to give a lunch-time seminar to Chevron’s La Habra research center on the use of graphics supercomputers in petroleum applications. I spoke about the state of the art in computational reservoir simulation and what could be accomplished using finite difference and finite element methods on the new class of machines that were coming from companies like ours.  During the question and answer session my heart was in my throat since like any good marketer, my depth of knowledge was no more than one level away from being a complete idiot. At the end of the talk the head of the research facility came up to me and said, “That was a great talk. We’re glad your company hired a real petroleum engineer to come speak to us. We hate when the sales and marketing types come down and try to get us to buy something.”

For one of the few times in my life I was at a loss for words, and I was completely unprepared for what came next.  “Here’s my card, if you ever want to consider a career in Chevron research. We’d be happy to talk to you.”

Marketing was really fun.

Lessons learned:

  • To sell to customers you need to understand them:  how they work, what they do and what problem you will solve for them.
  • You can’t understand customers from inside your building.

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Ardent 3: Supercomputer Porn

As VP of Marketing at our new startup, the CEO literally threw me out of the building and told me not to return until I understood the market and could identify the key applications and customers for Ardent’s new personal supercomputer. (See the previous Ardent posts for context.)

Supercomputers
With the introduction in 1976 of the Cray-1, supercomputers were defined as the fastest vector-processing computer, one in which a single instruction performed operations on an array rather than a single number. Cray’s first customers were the U.S. Nuclear Weapons Laboratories which used supercompurters to run their hydrodynamics codes to simulate what went on in the first microseconds in a nuclear weapon and the National Security Agency (with Cray putting in a special population count hardware instruction) used to facilitate decryption of codes.

At first only the national laboratories and the largest companies could afford to buy supercomputers, (the Cray-1 cost ~$9 million) but over time scientists and researchers were also starting to use them. Companies wanted to run numerical simulations to model things that were too expensive, too dangerous or too time consuming to physically build.  Because of the vagaries of how floating point units in computers were designed, your average IBM mainframe of the day would take forever to run a simulation application. A supercomputer could be a 100x faster.

What Markets?
At Ardent our hypothesis was that if we could build a desktop supercomputer powerful enough to run and display these numerical simulations there were enough customers to make this a big business. My job was to figure out what markets Ardent should target, who were the key customers in these markets and what applications these customers had to have.

The problem was I didn’t have a clue. And while others in our new startup came from companies like Digital Equipment Corporation (DEC) that had sold computers to automate scientific instrumentation and process control, the computers we were building at Ardent were targeted to different customers and markets.

The one thing I did know is that we were probably going to be running some of the same applications as the market leader Cray. I concluded that my first job was to understand what Cray’s markets, customers and applications. When I learned that Cray users would be giving papers at the Society of Petroleum Engineering conference in Denver the next day, I got on a plane to listen and learn.

Follow the Leader
At the conference I attended a bunch of technical sessions, and got lost when the speaker got past, “My name is xxx.”  I could see that quite a few oil companies were buying or thinking of buying their own supercomputer.  As I walked out of the conference hall, I ran into a small booth with salespeople from Cray.  Since their computers were way too large to bring to a trade show, the Cray booth just had literature describing their machines.  I grabbed one of each piece of literature, stuffed into my bag, and wandered through the exhibit hall looking at other hardware and petroleum software companies.

Later I sat down for lunch and began to leaf through the bag of data sheets and brochures I had collected.  Hmm… typical booth stuff…key chains, data sheets, pens… Until I got to the material from Cray.

Intelligence
As I leafed through the Cray sales material, a glossy magazine with the headline Cray Channels jumped out of the pile.  Skimming a few pages, I realized that this particular issue was all about computational fluid dynamics, one of Cray’s key markets.  The articles described the applications these users depended on and featured interviews with their most important customers.

I went back and looked at the cover not quite believing what I was reading was real. Cray Channels was describing my market, applications and customers for me.  Was it possible that my market research was being handed to me by the existing market incumbent?

Cray Channels Magazine Covers

I kept thinking, “could this be possible?  Did Cray ever publish any more of these magazines?”  I looked at the cover of the magazine again and almost fell off my chair. It was Volume 7 issue 2.  These magazines had been published for the last seven years. Could Cray have actually been describing their markets and users for that long?

I ran back to the Cray booth and as casually as I could, asked the salesman about the magazine. He assured me that each one profiled a different market, applications and users. I could order back issues from their publications department.

I don’t remember how quickly I got to a payphone, but I’m pretty sure that every back issue of these magazines were on the way to Sunnyvale by the end of that day.

Supercomputer Porn
When the back issues of Cray Channels arrived at Ardent, I ripped open the package with the Cray return address and eagerly started to flip through them. I was excited about what I was going to learn, yet somehow felt guilty, as if I really shouldn’t be looking at them. The pictures were great but I was reading it for the articles. But I was breathing heavy and it felt like I was looking at supercomputer porn. The magazines got passed around to all the engineers until they were dog-eared and worn.

I spent the next few days building a table with three columns: markets, applications, key customers.  At the same time I had found the Wall Street analyst who followed Cray (now a public company) who kept a list of where every one of Cray’s machines was installed.  I could now cross-correlate the markets by company who used supercomputers.

I started sharing what I had learned about potential target markets with our engineering team and my CEO. We agreed that now we had a roadmap, it was time to hit the road, talk to Cray customers and learn about supercomputer markets and applications in detail.

Lessons learned:

  • If you are in an existing market or trying to resgement an existing market you need to understand the market leader
  • Market leaders tend to educate the market
  • Step one for a startup is know what the market leader knows

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Fun For Hours

Charts like the U.S. Frequency Allocation Chart keep me amused for hours.  Download it here.

Interesting to consider how many billions of dollars of business is done over the electromagnetic spectrum we didn’t know existed 150 years ago.

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