Hacking for Defense at Columbia University

Over the last year we’ve been rolling out the Hacking for X classes in universities across the U.S. – Hacking for Defense, Hacking for Diplomacy, Hacking for Energy, Hacking for Impact (non-profits), etc.

All are designed to allow students to work on some of the toughest problems the country has while connecting them to a parts of the government they aren’t familiar with. When they leave they have contributed to the country through national service and gained a deeper understanding of our country.

Here is the view from Columbia University.

If you can’t see the video click here.

Innovation at Speed – when you have 2 million employees

Success no longer goes to the country that develops a new fighting technology first, but rather to the one that better integrates it and adapts its way of fighting…Our response will be to prioritize speed of delivery, continuous adaptation, and frequent modular upgrades. We must not accept cumbersome approval chains, wasteful applications of resources in uncompetitive space, or overly risk-averse thinking that impedes change.

If you read these quotes, you’d think they were from a CEO who just took over a company facing disruption from agile startups and a changing environment. And you’d be right. Although in this case the CEO is the Secretary of Defense. And his company has 2 million employees.

In January, Secretary of Defense Mattis released the 2018 National Defense Strategy. This document tells our military – the Department of Defense – what kind of adversaries they should plan to face and how they should plan to use our armed forces. The National Defense Strategy is the military’s “here’s what we’re going to do,” to implement the executive branch’s National Security Strategy. The full version of the National Defense Strategy is classified; but the 10-page unclassified summary of this strategic guidance document for the U.S. Defense Department is worth a read.

Since 9/11 the U.S. military focused on defeating non-nation states (ISIS, al-Qaeda, et al.) The new National Defense Strategy states that we need to prepare for competition between major powers, calling out China and Russia explicitly as adversaries, (with China appearing to be the first.) Secretary Mattis said, “Our competitive advantage has eroded in every domain of warfare.”

While the Defense Strategy recognizes the importance of new technologies e.g. autonomous systems and artificial intelligence – the search is no longer for the holy grail of a technology offset strategy. Instead the focus is on global and rapid maneuver capabilities of smaller, dispersed units to “increase agility, speed, and resiliency .. and deployment … in order to stand ready to fight and win the next conflict.” The goal is to make our military more “lethal, agile, and resilient.”

The man with a lot of fingerprints on this document is the Deputy Secretary of Defense Patrick Shanahan. Shanahan came from Boeing, and his views on innovation make interesting reading.

“The DoD must become less averse to risk” is something you’ve rarely heard in the government. Yet, Shanahan said, “Innovation is messy, if the (defense) department is really going to succeed at innovation, we’re going to have to get comfortable with people making mistakes.”

All of this means that significant changes will be needed in the Department of Defense’s culture and policies.  But now the change agents and innovation insurgents who have been fighting to innovate from the bottom up at Office of Naval Research, National Geospatial-Intelligence Agency, Joint Improvised-Threat Defeat Organization, Defense Intelligence Agency, National Security Agency, Defense Innovation Unit Experimental, Intelligence Advanced Research Projects Activity, etc., will have the support all the way to the Secretary of Defense.

The innovation language in this document is pretty mind blowing – particularly the summary on page 10. It’s almost as they’ve been reading the posts Pete Newell and I have written on the Red Queen Problem and the Innovation Pipeline.

This document, combined with the split of Acquisition and Logistics, (the office responsible for buying equipment for the military), from Research and Engineering will enable the DoD to better connect with private industry to get technology integrated into the defense department. The last time the country mobilized private industry at scale was the Cold War.

As you read the excerpts below from the 2018 National Defense Strategy imagine the shockwaves this would send through any large company.  This is a pretty unprecedented document for the military.

on page 3
“…Maintaining the Department’s technological advantage will require changes to industry culture, investment sources, and protection across the National Security Innovation Base. “

on page 4
“Defense objectives include: …Continuously deliver performance with affordability and speed as we change Departmental mindset, culture, and management systems;

on page 5
Foster a competitive mindset. To succeed in the emerging security environment, our Department and Joint Force will have to out-think, out-maneuver, out-partner, and out-innovate revisionist powers, rogue regimes, terrorists, and other threat actors. We will expand the competitive space while … reforming the Department’s business practices for greater performance and affordability

on page 7
Cultivate workforce talent. … Cultivating a lethal, agile force requires more than just new technologies and posture changes; …it depends on the ability of our Department to integrate new capabilities, adapt warfighting approaches, and change business practices to achieve mission success. The creativity and talent of the American warfighter is our greatest enduring strength, and one we do not take for granted.
…A modern, agile, information-advantaged Department requires a motivated, diverse, and highly skilled civilian workforce. We will emphasize new skills and complement our current workforce with information experts, data scientists, computer programmers, and basic science researchers and engineers…The Department will also continue to explore streamlined, non-traditional pathways to bring critical skills into service, expanding access to outside expertise, and devising new public-private partnerships to work with small companies, start-ups, and universities.

on page 10
The current bureaucratic approach, centered on exacting thoroughness and minimizing risk above all else, is proving to be increasingly unresponsive. We must transition to a culture of performance where results and accountability matter.

Deliver performance at the speed of relevance. Success no longer goes to the country that develops a new fighting technology first, but rather to the one that better integrates it and adapts its way of fighting…. Current processes are not responsive to need; the Department is over-optimized for exceptional performance at the expense of providing timely decisions, policies, and capabilities to the warfighter. Our response will be to prioritize speed of delivery, continuous adaptation, and frequent modular upgrades. We must not accept cumbersome approval chains, wasteful applications of resources in uncompetitive space, or overly risk-averse thinking that impedes change. Delivering performance means we will shed outdated management practices and structures while integrating insights from business innovation.

Organize for innovation. The Department’s management structure and processes are not written in stone, they are a means to an end–empowering the warfighter with the knowledge, equipment and support systems to fight and win. Department leaders will adapt their organizational structures to best support the Joint Force. If current structures hinder substantial increases in lethality or performance, it is expected that Service Secretaries and Agency heads will consolidate, eliminate, or restructure as needed.

Up to now innovation within the Department of Defense has been the province of a small group of insurgents, each doing heroic efforts. Now innovation at speed has become a nation’s priority.  Culture change is hardest in the middle of a large organization. It will be interesting to see how each agency in the Department of Defense (and its contractors) adopts the strategy or whether the bureaucratic middle kills it/waits it out. Time will tell whether it provides real change, but this is a great start.

Janesville – A Story About the Rest of America

I just read book – Janesville – that reminded me again of life outside the bubble.

Janesville, tells the story of laid-off factory workers of a General Motors factory that’s never going to reopen. It’s a story about a Midwest town and the type of people I knew and worked alongside.

When I got out of the Air Force after Vietnam, I lived in Michigan and I installed process control systems in automobile assembly plants and steel mills across the industrial heart of the Midwest. I got to see the peak of America’s manufacturing prowess in the 1970s, when we actually made things – before we shipped the factories and jobs overseas. I hung out with the guys who worked there, went bowling and shooting with them, complained about the same things, wives, girlfriends, jobs, the union and bosses, and shared their same concerns. Janesville is their story.

On the surface the book is an incredibly well written narrative over the course of five years, from 2008 to 2013, that connects the laid off auto workers, job center retraining, union organizers, community and business leaders, and politicians. Five stars for the reporting.

But what makes the book great is that the story is deeper than just the people it follows. On closer reading it busts the shared delusions about our economic system that requires our faith in order for it to survive.

First, America was built on workers who believed that their hard work would allow their children to have opportunities to do better. The hard truth is that part of the Janesville story is about a generation of blue collar workers who grew up thinking that a factory job wasn’t just an entry into the economy, but instead was a multi-generational entitlement. They believed the posters that said, “Our employees are our greatest asset” and assumed it meant forever – instead of reading the fine print which said, “Until we can reduce our labor costs by moving your jobs overseas.”

To be clear it doesn’t mean they didn’t work hard or that they deserved what happened to them. Far from it. But it does mean, that even as evidence was piling up around them that this couldn’t last, they took for granted that a high-paying factory job was a never ending economic cornucopia. The grim reality is that the 50 years of post WWII factory work in GM and other places was a golden age of blue collar jobs – in the U.S. – it’s gone and not coming back. 

Second, the jobs aren’t coming back because while our economy has continued to grow, in the name of corporate efficiency and profitability we’ve closed the shipyards and factories and moved those jobs overseas. In board rooms across the country we traded jobs for short-term corporate profits – while selling out the very people who believed they had a social contract with their company – and their country. And while we gave those policies polite names like globalization and outsourcing, the consequences have wreaked havoc on towns like Janesville. Oh, and the jobs we moved overseas, or never even attempted to build here, (think iPhones)? They helped build the blue collar working class in China and India.

And with campaign donations spread equally, both parties supported this exodus and no one in the government stood in their way – in fact, they encouraged it. The result was that the bulk of those corporate profits have ended up in the pockets of the very affluent. The contrast is pretty bitter in towns like Janesville where income inequality stares you in the face. When towns do recover, the new jobs are most often at a fraction of the salary the closed factories once offered. The level of despair and anger of the workers the companies and politicians and the rest of the country abandoned is high. The Janesville’s across the U.S. really didn’t care about Hacker News, TechCrunch, etc, Hollywood gossip in Variety, or the latest financial moves in the Wall Street Journal. They wanted to hear people talking to them about how to get their lives back. They voted their interests in 2016. 

Third, when those jobs moved in the name of maximizing profits, no one (other than unions) pointed out that all the supporting jobs would disappear as well. Not only the obvious ones like machine tool makers, direct suppliers, etc. but that the supporting service jobs would also disappear in the community. Restaurants, movie theaters, real estate agents, etc.

Fourth, this was the story of just one town and one factory. If we believe any of the predictions of autonomous vehicles and disruption in the trucking business, and machine learning disrupting other industries, Janesville is just the harbinger of much larger economic upheavals to come.

Fifth, and a critical insight that I almost missed, because it was buried in Appendix 2, (and a real surprise to me) was that, “laid-off workers who went back to school were less likely to have a job after they retrained than those who did not go to school.” Wow. Talk about burying the lead. Skill retraining is a core belief of any economic recovery plan. Yet the data the author and her associated researchers gathered shows that it’s not true. People who went through skills retraining were worse off than those who went out on their own.

Sixth, this means that in spite of their well-meaning efforts, both the jobs training people and the local boosters of “Janesville will rise again” were actually doing the laid-off workers a massive disservice. The very things they were advocating were not going to help this generation of laid-off workers. I wonder if they’ve come to grips with that.

Seventh, This raises the question of what kind of skills training, if any, should be given to laid-off workers when the factory shuts down in a one-company town. My conclusion from the narrative that followed the families is that they would have been better served by basic training in the reality of their new economic context, financial management and new life skills. For example, teaching a few days of, “Lessons learned from families in other one-industry cities” and “the mortgage meltdown – how to get out from underneath an underwater mortgage,” and practical job search tips outside their community, along with organized trips to other cities and paid-for car pools for they gypsy workers commuting to far off GM plants. In addition, skills training in resilience, agility, etc. would have provided these workers with an education and relevant tools for surviving in the new economy.

A great book that made me sad, angry and make me think long about the consequences of not having a national industrial policy. And why by using the fig leaf of “maximize shareholder value” corporations and financial institutions have set it by default.

It truly feels like a return to the Gilded Age.

Worth a read.

Innovators podcast @ Stanford

A fun interview at Stanford about some old things and new ones.
7:18: Mentorship is a two-way street
14:03: Failure=experience
17:27: Rules for raising a family if you’re a founder
19:25: Startups are not smaller versions of large companies
22:03: How I-Corps and H4X were born
26:25: Your idea is not a company
31:19: Why the old way of building startups no longer works
32:53: Origin of the Lean Startup
34:24 Why the Lean Startup Changes Everything in the Harvard Business Review
35:28: How innovation happens
Company/Government Innovation
41:37: Innovation is different in companies and gov’t agencies
43:30  Deliverable products and services not activities
46:44: Startups disrupting things by breaking the law
Government Innovation
51:12: Fighting continuous disruption with continuous innovation
52:08: How governments innovate
57:54: Innovation from the battlefield to the boardroom

Why GE’s Jeff Immelt Lost His Job – Disruption and Activist Investors

This article first appeared on the Harvard Business Review blog

Jeff Immelt ran GE for 16 years. He radically transformed the company from a classic conglomerate that did everything to one that focused on its core industrial businesses. He sold off slower-growth, low-tech, and nonindustrial businesses — financial services, media, entertainment, plastics, and appliances. He doubled GE’s investment in R&D.

In his Harvard Business Review article summing up his tenure, Immelt recalls that the two things that influenced him most were Marc Andreessen’s 2011 Wall Street Journal article “Why Software Is Eating the World,” and Eric Ries’s book The Lean Startup.

Andreessen’s article helped accelerate the company’s digital transformation. GE made a $4 billion bet on connecting industrial equipment via the Internet of Things (IoT) and analytical software with a suite of products called the “Predix Cloud”.

In response to reading Eric Ries’s The Lean Startup, GE adopted Lean and built their Fastworks program around it. Beth Comstock, GE vice chair responsible for creating new businesses, embraced the lean process. Over a period of years, every GE senior manager would learn the Lean Startup, and GE would be the showcase for how modern companies use entrepreneurial management to transform culture and drive long-term growth.

Innovation at GE was on a roll.

Then it wasn’t.

In June 2017, the board “retired” Jeff Immelt and promoted John Flannery to CEO. Since then Flannery has replaced Immelt’s vice chairs responsible for innovation. Beth Comstock is out. So is John Rice, the head of Global Operations along with CFO Jeffrey Bornstein.

Last week’s Wall Street Journal story on GE opened with, “John Flannery, the leader of General Electric for just 2½ months, has already begun dismantling the legacy of his predecessor…” Flannery has pledged to unload $20 billion of GE businesses in the next two years. “We need to make some major changes with urgency and a depth of purpose. Everything is on the table,” Flannery said on a conference call to discuss quarterly earnings. “Things will not stay the same at GE.”

Instead of lean innovation programs, there is a mandate to cut $2 billion in expenses by the end of next year, lift profits and raise the dividend.

So what happened? Are lean innovation and the Startup Way a failure in large companies?

In fact, what happened is activist investors.

During Jeff Immelt’s tenure GE’s stock-market value fell by about half. Its stock is trading where it was 20 years ago. So far in 2017, GE is the worst performing stock on the Dow Jones Industrial average.

In 2015 Trian Partners, an activist investor, bought $2.5 billion of GE stock – about 1.5% of the company. The firm wrote a white paper, “Transformation Underway… But Nobody Cares” which essentially said that GE stock was undervalued because investors didn’t believe that Immelt and GE management would do the things needed to deliver a higher stock price and dividends.

Trian was pretty clear about what they thought the company should do:

  • Take on $20 billion in debt (returning the cash to shareholders by buying back GE stock).
  • Increase operating margins to 18% (by cutting expenses).
  • Buy back more stock than the $50 billion stock purchase plan GE already had in place.

Immelt believed that doing these three things would optimize the stock price and increase the value of Trian’s investment, but the debt and cuts would endanger GE’s long-term investment in innovation.

And now Immelt is now the ex-CEO, and Trian Partners just a got a seat on the GE board.

Activist Investors
The “corporate raiders” of the 20th century have rebranded themselves as “activist investors” of the 21st. With refrains of “unlock hidden value” and “increase shareholder value,” and powered by over $120 billion in assets, activist investors like Trian look for companies like GE (or Procter and Gamble) that have a share price which is underperforming relative to its peers (or those with large amounts of cash on their balance sheets). They then buy stock in these public companies and attempt to convince management to increase the price of the shares.

One key difference in 21st century activists is that they don’t need to buy much of the company’s stock to gain control. (Trian only owns ~1.5% of the GE and P&G shares.) They do it by influencing the votes of the majority of the shareholders. And in the 21st century, the majority of public company shareholders are institutional investors (banks, insurance companies, pensions, hedge funds, REITs, investment advisors, endowments, and mutual funds), not individuals. (In 2015, the 10 largest shareholders in a typical S&P 500 company held almost half of the company’s stock.)  What gives institutions even more say is that while individual shareholders vote their shares 30% of the time, institutions vote their shares 90%. (In the case of P&G, 40% of its stock was owned by small investors, helping the company fight off a 2017 proxy battle with Trian.)

After the dot.com crash in 2001 and the financial crisis of 2008, traditional investors who previously held their shares for the long-term — public pension funds, institutional investors and money managers — are now more interested in short-term gains. This means that company boards who used to side with management no longer automatically protect them, and as Jeff Immelt discovered, may even side with an activist.

Activist investors have a simple goal: increase the value of their investment. But first they need to get management of a company to change their existing strategy. To do that, they start with an implicit (GE) or explicit (P&G) threat of a proxy fight for a seat on the company board.  Next, they make a public presentation to management — like Trian’s “Transformation Underway… But Nobody Cares” — explaining what actions they think the company should take to increase the price of the stock.  Next, they use the financial press and blogs to spread their message to the institutional investors. If that still doesn’t work, they can start a proxy fight and try to gain control of shareholder votes so they can replace the board — and ultimately the company management.

If their campaign is successful, like Trian’s was at GE, they’ll have a seat on the board and a new CEO and management. They’ll have GE execute a playbook to increase the value of their investment: share repurchase programs, increased dividends, and, to reduce expenses, layoffs, factory closings, spin-offs of profitable parts of the company, sell-offs of the least profitable divisions, and asset stripping. And as Trian’s presentation suggests, they’ll get GE to take on more debt to buy back stock. And often they calculate that selling the sum of parts is greater than keeping the company together as a whole. Or they may even put the entire company up for sale.

There is an upside to an activist investor taking a run at a company. It’s often a cattle prod to a stagnant company, or one ignoring disruption by new startups. GE’s gross margin was 21% last year, compared with 28% at United Technologies and 30% at Siemens. At a minimum, as is happening to GE now, it forces a company to go through a review of its strategy. (At GE the biggest problem in 2017 was major revenue misses in their Power business.) The new GE CEO is focusing on a back-to-basics approach to the business: dramatically reducing expenses, with the visible symbols of getting rid of company planes, company cars, and delaying a fancy new headquarters, etc.

The bad news is once they take control of a company, long-term investment is not the goal of an activist investor. They often kill any long-term strategic initiatives. Often the short-term cuts directly affect employee salaries, jobs, and long-term investment in R&D. The first things to go are R&D centers and innovation initiatives.

So What is a CEO to Do?
A CEO of a public company needs to know what explicit and implicit guidance they are getting from their board and institutional investors.

Large public companies like Amazon, Tesla, Netflix, etc. capture the imagination of investors and can focus on revenue and user growth instead of on the bottom line. Almost 20 years after Amazon was launched, it has massive revenue growth and barely has a meaningful profit. Investors in these companies believe that the company’s investments in user growth will result in long-term profits. (Newly public tech companies are now going public with dual-class stock, which allows the founders to have more voting rights than the general public. This protects them from activist investors and allows them to put long-term interests ahead of quarterly results.)

But GE’s core businesses don’t have the scale of those online businesses. No innovation program, lean or otherwise, would have helped the dismal performance of their Power segment.

Companies and government organizations are discovering that innovation activities without a defined innovation pipeline results in innovation theater.  And an innovation pipeline needs to be driven with speed and urgency and results measured by the impact on the top and bottom line.

In hindsight, GE Fastworks wasn’t the problem at GE, and while the Predix Cloud has had a painful birth, GE’s investment in the industrial Internet of Things (IoT) and lean will pay off in the future. But the impact of future innovations couldn’t compensate for poor execution in its traditional businesses. GE’s board was not happy with their margins, stock price, and how Wall Street viewed the future of the company. The immediate threat of a proxy fight with an activist investor forced a decision on the future direction of the company.

Why Uber is The Revenge of the Founders

A version of this article is in the Harvard Business Review

Uber, Zenefits, Tanium, Lending Club CEOs of companies with billion dollar market caps have been in the news – and not in a good way.  This seems to be occurring more and more.  Why do these founders get to stay around?

Because the balance of power has dramatically shifted from investors to founders.

Here’s why it generates bad CEO behavior.

Unremarked and unheralded, the balance of power between startup CEOs and their investors has radically changed:

  • IPOs/M&A without a profit (or at times revenue) have become the norm
  • The startup process has become demystified – information is everywhere
  • Technology cycles have become a treadmill, and for startups to survive they need to be on a continuous innovation cycle
  • VCs competing for unicorn investments have given founders control of the board

20th Century Tech Liquidity = Initial Public Offering
In the 20th century tech companies and their investors made money through an Initial Public Offering (IPO). To turn your company’s stock into cash, you engaged a top-notch investment bank (Morgan Stanley, Goldman Sachs) and/or their Silicon Valley compatriots (Hambrecht & Quist, Montgomery Securities, Robertson Stephens).

Typically, this caliber of bankers wouldn’t talk to you unless your company had five profitable quarters of increasing revenue. And you had to convince the bankers that you had a credible chance of having four more profitable quarters after your IPO.  None of this was law, and nothing in writing required this; this was just how these firms did business to protect their large institutional customers who would buy the stock.

Twenty-five years ago, to go public you had to sell stuff – not just acquire users or have freemium products. People had to actually pay you for your product. This required a repeatable and scalable sales process, which required a professional sales staff and a product stable enough that customers wouldn’t return it.

Hire a CEO to Go Public
More often than not, a founding CEO lacked the experience to do these things. The very skills that got the company started were now handicaps to its growth. A founder’s lack of credibility/experience in growing and managing a large company hindered a company that wanted to go public. In the 20th century, founding CEOs were most often removed early and replaced by “suits” — experienced executives from large companies parachuted in by the investors after product/market fit to scale sales and take the company public.

The VCs would hire a CEO with a track record who looked and acted like the type of CEO Wall Street bankers expected to see in large companies.

A CEO brought in from a large company came with all the big company accoutrements – org charts, HR departments with formal processes and procedure handbooks, formal waterfall engineering methodology, sales compensation plans, etc. — all great things when you are executing and scaling a known business model. But the CEO’s arrival meant the days of the company as a startup and its culture of rapid innovation were over.

Board Control
For three decades (1978-2008), investors controlled the board. This era was a “buyer’s market” – there were more good companies looking to get funded than there were VCs. Therefore, investors could set the terms. A pre-IPO board usually had two founders, two VCs and one “independent” member. (The role of the independent member was typically to tell the founding CEO that the VCs were hiring a new CEO.)

Replacing the founder when the company needed to scale was almost standard operating procedure. However, there was no way for founders to share this information with other founders (this was life before the Internet, incubators and accelerators). While to VCs this was just a necessary step in the process of taking a company public, time and again first-time founders were shocked, surprised and angry when it happened. If the founder was lucky, he got to stay as chairman or CTO. If he wasn’t, he told stories of how “VCs stole my company.”

To be fair there wasn’t much of an alternative. Most founders were woefully unequipped to run companies that scaled.  It’s hard to imagine, but in the 20th century there were no startup blogs or books on startups to read, and business schools (the only places teaching entrepreneurship) believed the best thing they could teach startups was how to write a business plan. In the 20th century the only way for founders to get trained was to apprentice at another startup. And there they would watch the canonical model in action as an experienced executive replaced the founder.

Technology Cycles Measured in Years
Today, we take for granted new apps and IoT devices appearing seemingly overnight and reaching tens of millions of users – and just as quickly falling out of favor. But in the 20th century, dominated by hardware and software, technology swings inside an existing market happened slowly — taking years, not months. And while new markets were created (i.e. the desktop PC market), they were relatively infrequent.

This meant that disposing of the founder, and the startup culture responsible for the initial innovation, didn’t hurt a company’s short-term or even mid-term prospects.  A company could go public on its initial wave of innovation, then coast on its current technology for years. In this business environment, hiring a new CEO who had experience growing a company around a single technical innovation was a rational decision for venture investors.

However, almost like clockwork, the inevitable next cycle of technology innovation would catch these now-public startups and their boards by surprise. Because the new CEO had built a team capable of and comfortable with executing an existing business model, the company would fail or get acquired. Since the initial venture investors had cashed out by selling their stock over the first few years, they had no long-term interest in this outcome.

Not every startup ended up this way. Bill Hewlett and David Packard got to learn on the job. So did Bob Noyce and Gordon Moore at Intel. But the majority of technology companies that went public circa 1979-2009, with professional VCs as their investors, faced this challenge.

Founders in the Driver’s Seat
So how did we go from VCs discarding founders to founders now running large companies? Seven major changes occurred:

  1. It became OK to go public or get acquired without profit (or even revenue)

In 1995 Netscape changed the rules about going public. A little more than a year old, the company and its 24-year-old founder hired an experienced CEO, but then did something no other tech company had ever done – it went public with no profit. Laugh all you want, but at the time this was unheard of for a tech company. Netscape’s blow-out IPO launched the dot-com boom. Suddenly tech companies were valued on what they might someday deliver. (Today’s version is Tesla – now more valuable than Ford.)

This means that liquidity for today’s investors often doesn’t require the long, patient scaling of a profitable company. While 20th century metrics were revenue and profit, today it’s common for companies to get acquired for their user base. (Facebook’s ~$20 billion acquisition of WhatsApp, a 5-year-old startup that had $10 million in revenue, made no sense until you realized that Facebook was paying to acquire 300 million new users.)

2.     Information is everywhere
In the 20th century learning the best practices of a startup CEO was limited by your coffee bandwidth. That is, you learned best practices from your board and by having coffee with other, more experienced CEOs. Today, every founder can read all there is to know about running a startup online. Incubators and accelerators like Y-Combinator have institutionalized experiential training in best practices (product/market fit, pivots, agile development, etc.); provide experienced and hands-on mentorship; and offer a growing network of founding CEOs. The result is that today’s CEOs have exponentially more information than their predecessors. This is ironically part of the problem. Reading about, hearing about and learning about how to build a successful company is not the same as having done it. As we’ll see, information does not mean experience, maturity or wisdom.

3.     Technology cycles have compressed
The pace of technology change in the second decade of the 21st century is relentless. It’s hard to think of a hardware/software or life science technology that dominates its space for years. That means new companies are at risk of continuous disruption before their investors can cash out.

To stay in business in the 21st century, startups  do four things their 20th century counterparts didn’t:

  • A company is no longer built on a single innovation. It needs to be continuously innovating – and who best to do that? The founders.
  • To continually innovate, companies need to operate at startup speed and cycle time much longer their 20th century counterparts did. This requires retaining a startup culture for years – and who best to do that? The founders.
  • Continuous innovation requires the imagination and courage to challenge the initial hypotheses of your current business model (channel, cost, customers, products, supply chain, etc.) This might mean competing with and if necessary killing your own products. (Think of the relentless cycle of iPod then iPhone innovation.) Professional CEOs who excel at growing existing businesses find this extremely hard.  So who best to do it? The founders.
  • Finally, 20th century startups fired the innovators/founders when they scaled. Today, they need these visionaries to stay with the company to keep up with the innovation cycle. And given that acquisition is a potential for many startups, corporate acquirers often look for startups that can help them continually innovate by creating new products and markets.

4.     Founder-friendly VCs
A 20th century VC was likely to have an MBA or finance background. A few, like John Doerr at Kleiner Perkins and Don Valentine at Sequoia, had operating experience in a large tech company, but none had actually started a company. Out of the dot-com rubble at the turn of the 21st century, new VCs entered the game – this time with startup experience. The watershed moment was in 2009 when the co-founder of Netscape, Marc Andreessen, formed a venture firm and started to invest in founders with the goal of teaching them how to be CEOs for the long term. Andreessen realized that the game had changed. Continuous innovation was here to stay and only founders – not hired execs – could play and win.  Founder-friendly became a competitive advantage for his firm Andreessen Horowitz. In a seller’s market, other VCs adopted this “invest in the founder” strategy.

5.     Unicorns Created A Seller’s Market
Private companies with market capitalization over a billion dollars – called Unicorns – were unheard of in the first decade of the 21st century. Today there are close to 200. VCs with large funds (~>$200M) need investments in Unicorns to make their own business model work.

While the number of traditional VC firms have shrunk since the peak of the dot com bubble, the number of funds chasing deals have grown. Angel and Seed Funds have usurped the role of what used to be Series A investments. And in later stage rounds an explosion of corporate VCs and hedge funds now want in to the next unicorns.

A rough calculation says that a VC firm needs to return four times its fund size to be thought of as a great firm. Therefore, a VC with a $250M fund (5x the size of an average VC fund 40 years ago) would need to return $1 billion. But VCs own only ~15% of a startup when it gets sold/goes public (the numbers vary widely). Just doing the math, $1 billion/15% means that the VC fund needs $6.6 billion of exits to make that 4x return. The cold hard math of “large funds need large exits” is why VCs have been trapped into literally begging to get into unicorn deals.

6.    Founders Take Money Off the Table
In the 20th century the only way the founder made any money (other than their salary) was when the company went public or got sold. The founders along with all the other employees would vest their stock over 4 years (earning 1/48 a month). They had to hang around at least a year to get the first quarter of their stock (this was called the “cliff”).  Today, these are no longer hard and fast rules. Some founders have three-year vesting. Some have no cliff. And some have specific deals about what happens if they’re fired, demoted or the company is sold.

In the last decade, as the time startups have spent staying private has grown longer, secondary markets – where people can buy and sell pre-IPO stock — have emerged. This often is a way for founders and early employees to turn some of their stock into cash before an IPO or sale of company.

One last but very important change that guarantees founders can cash out early is “founder friendly stock.”  This allows founder(s) to sell part of their stock (~10 to 33%) in a future round of financing. This means the company doesn’t get money from new investors, but instead it goes to the founder.  The rationale is that since companies are taking longer to achieve liquidity, giving the founders some returns early makes them more willing to stick around and better able to make bets for the long-term health of the company.

7.   Founders take Control of the Board
With more VCs chasing a small pool of great deals, and all VCs professing to be the founder’s best friend, there’s an arms race to be the friendliest. Almost overnight the position of venture capitalist dictating the terms of the deal has disappeared (at least for “hot” deals).

Traditionally, in exchange for giving the company money, investors would receive preferred stock, and founders and employees owned common stock. Preferred stock had specific provisions that gave investors control over when to sell the company or take it public, hiring and firing the founder etc.  VCs are giving up these rights to get to invest in unicorns.

Founders are taking control of the board by making the common stock the founders own more powerful. Some startups create two classes of common stock with each share of the founders’ class of common stock having 10 – 20 votes. Founders can now outvote the preferred stock holders (the investors). Another method for founder control has the board seats held by the common shareholders (the founders) count 2-5 times more than the investors’ preferred shares. Finally, investors are giving up protective voting control provisions such as when and if to raise more money, the right to invest in subsequent rounds, who to raise it from and how/when to sell the company or take it public. This means liquidity for the investors is now beholden to the whims of the founders. And because they control votes on the board, the founders can’t be removed. This is a remarkable turnabout.

In some cases, 21st century VCs have been relegated to passive investors/board observers.

And this advent of founders’ control of their company’s board is a key reason why many of these large technology companies look like they’re out of control.  They are.

The Gift/Curse of Visionary CEOs
Startups run by visionaries break rules, flout the law and upend the status quo (Apple, Uber, AirBnB, Tesla, Theranos, etc.). Doing something that other people consider insanity/impossible requires equal parts narcissism and a messianic view of technological transformation.

Bad CEO behavior and successful startups have always overlapped. Steve Jobs, Larry Ellison, Tom Seibel, etc. all had the gift/curse of a visionary CEO – they could see the future as clearly as others could see the present. Because they saw it with such clarity, the reality of having to depend on other people to build something revolutionary was frustrating. And woe to the employee who got in their way of delivering the future.

Visionary CEOs have always been the face of their company, but today with social media, it happens faster with a much larger audience; boards now must consider what would happen to the valuation of the company without the founder.

With founders now in control of unicorn boards, with money in their pockets and the press heralding them as geniuses transforming the world, founder hubris and bad behavior should be no surprise.  Before social media connected billions of people, bad behavior stayed behind closed doors. In today’s connected social world, instant messages and shared videos have broken down the doors.

The Revenge of the Founders – Founding CEOs Acting Badly
So why do boards of unicorns like Uber, Zenefits, Tanium, Lending Club let their CEOs stay?

Before the rapid rise of Unicorns, when boards were still in control, they “encouraged” the hiring of “adult supervision” of the founders. Three years after Google started they hired Eric Schmidt as CEO. Schmidt had been the CEO of Novell and previously CTO of Sun Microsystems. Four years after Facebook started they hired Sheryl Sandberg as the COO. Sandberg had been the vice president of global online sales and operations. Today unicorn boards have a lot less leverage.

  1. VCs sit on 5 to 10 or more boards. That means most VCs have very little insight into the day-to-day operation of a startup. Bad behavior often goes unnoticed until it does damage.
  2. The traditional checks and balances provided by a startup board have been abrogated in exchange for access to a hot deal.
  3. As VC incentives are aligned to own as much of a successful company as possible, getting into a conflict with a founder who can now prevent VC’s from investing in the next round is not in the VCs interest.
  4. Financial and legal control of startups has given way to polite moral suasion as founders now control unicorns.
  5. As long as the CEO’s behavior affects their employees not their customers or valuation, VCs often turn a blind eye.
  6. Not only is there no financial incentive for the board to control unicorn CEO behavior, often there is a downside in trying to do so

The surprise should not be how many unicorn CEOs act badly, but how many still behave well.

Lesson Learned

  • VC/Founder relationship have radically changed
  • VC “Founder Friendly” strategies have helped create 200+ unicorns
  • Some VC’s are reaping the downside of the unintended consequences of “Founder Friendly”
  • Until the consequences exceed the rewards they will continue to be Founder Friendly

The Red Queen Problem – Innovation in the DoD and Intelligence Community

“…it takes all the running you can do to keep in the same place. ”
The Red Queen Alice in Wonderland

Innovation, disruption, accelerators, have all become urgent buzzwords in the Department of Defense and Intelligence community. They are a reaction to the “red queen problem” but aren’t actually solving the problem. Here’s why.

In the 20th century our nation faced a single adversary – the Soviet Union. During the Cold War the threat from the Soviets was quantifiable and often predictable. We could specify requirements, budget and acquire weapons based on a known foe. We could design warfighting tactics based on knowing the tactics of our opponent. Our defense department and intelligence community owned proprietary advanced tools and technology. We and our contractors had the best technology domain experts. We could design and manufacture the best systems. We used these tools to keep pace with the Soviet threats and eventually used silicon, semiconductors and stealth to create an offset strategy to leapfrog their military.

That approach doesn’t work anymore. In the 21st century you need a scorecard to keep track of the threats: Russia, China, North Korea, Iran, ISIS in Yemen/Libya/Philippines, Taliban, Al-Qaeda, hackers for hire, etc. Some are strategic peers, some are near peers in specific areas, some are threats as non-state disrupters operating with no rules.

In addition to the proliferation of threats, most of the tools and technologies that were uniquely held by the DoD/IC or only within the reach of large nation states are now commercially available (Cyber, GPS, semiconductors, analytics, centrifuges, drones, genetic engineering, agile and lean methodologies, ubiquitous Internet, crypto and smartphones, etc.). In most industries, manufacturing is no longer a core competence of the U.S.

U.S. agencies that historically owned technology superiority and fielded cutting-edge technologies now find that off-the-shelf solutions may be more advanced than the solutions they are working on, or that adversaries can rapidly create asymmetric responses using these readily available technologies.

The result is that our systems, organizations, headcount and budget – designed for 20th century weapons procurements and warfighting tactics on a predictable basis – can’t scale to meet all these simultaneous and unpredictable challenges. Today, our DoD and national security agencies are running as hard as they can just to stay in place, but our adversaries are continually innovating faster than our traditional systems can respond. They have gotten inside our OODA loop (Observe, Orient, Decide and Act).

We believe that continuous disruption can only be met with a commitment to continuous innovation.

Pete Newell and I have spent a lot of time bringing continuous innovation to government organizations. Newell ran the U.S. Army’s Rapid Equipping Force on the battlefields of Iraq and Afghanistan finding and deploying technology solutions against agile insurgents. He’s spent the last four years in Silicon Valley out of uniform continuing that work. I’ve spent the last six years teaching our country’s scientists how to rapidly turn scientific breakthroughs into deliverable products by creating the curriculum for the National Science Foundation Innovation Corps – now taught in 53 universities. Together Pete, Joe Felter and I created Hacking for Defense, a nationwide program to teach university students how use Lean methodologies to solve defense and national security problems.

The solution to continuous disruption requires new ways to think about, organize, and build and deploy national security people, organizations and solutions.

Here are our thoughts about how to confront the Red Queen trap and adapt a government agency to infuse continuous innovation in its culture and practices.

Problem 1: Regardless of a high-level understanding that business as usual can’t go on, all agencies are given “guidance and metrics (what they are supposed to do (their “mission”) and how they are supposed to measure success). To no one’s surprise the guidance is “business as usual but more of it.” And to fulfill that guidance agencies create structure (divisions, directorates, etc.) designed to execute repeatable processes and procedures to deliver solutions that meet the requirements of the overall guidance.

Inevitably, while all of our defense and national security agencies will tell you that innovation is one of their pillars, innovation actually is an ill-defined and amorphous aspirational goal, while the people, budget and organization continue to flow to execution of mission (as per guidance.)

There is no guidance or acknowledgement that in our national security agencies, even as we execute our current mission, our capabilities decline every year due to security breaches, technology timing out, tradecraft obsolescence, etc. And there is no explicit requirement for creation of new capabilities that give us the advantage.

Solution 1: Extend agency guidance to include the requirements to create a continuous innovation process that a) resupplies the continual attrition of capabilities and b) creates new capabilities that gives us a mission advantage. The result will be agency leadership creating new organizational structures that make innovation a continual process rather than an ad hoc series of heroic efforts.

Problem 2: The word “Innovation” actually describes three very different types of activities.

Solution 2: Use the McKinsey Three Horizons Model to differentiate among the three types. Horizon 1 ideas provide continuous innovation to a company’s existing mission model and core capabilities. Horizon 2 ideas extend a company’s existing mission model and core capabilities to new stakeholders, customers, or targets. Horizon 3 is the creation of new capabilities to take advantage of or respond to disruptive technologies/opportunities or to counter disruption.

We’d add a new category, Horizon 0, which kills ideas that are not viable or feasible (something that Silicon Valley is tremendously efficient at doing).

These Horizons also apply to government agencies and other large organizations. Agencies and commands need to support all three horizons.

Problem 3: Risk equals failure and failure is to be avoided as it indicates a lack of competence.

Solution 3: The three-horizon model allows everyone to understand that failure in a Horizon 1/existing mission activity is different than failure in a Horizon 3 “never been done before” activity. We want to take risks in Horizon 3. If we aren’t failing with some efforts, we aren’t trying hard enough. An innovation process embraces and understands the different types of failure and risk.

Problem 4: Innovators tend to create activities rather than deployable solutions that can be used on the battlefield or by the mission. Accelerators, hubs, cafes, open-sourcing, crowd-souring, maker spaces, Chief Innovation Officers, etc. are all great but they tend to create innovation theater – lots of motion but no action. Great demos are shown and there are lots of coffee cups and posters, but if you look at the deliverables for the mission over a period of years the result is disappointing. Most of the executors and operators have seen little or no value from any of these activities. While the activities individually may produce things of value, they aren’t valued within the communities they serve because they aren’t connected to a complete pipeline that harnesses that value and turns it into a deliverable on the battlefield where it matters.

Solution 4: What we have been missing is an innovation pipeline focused on deployment not demos.

The Lean Innovation process is a self-regulating, evidence-based innovation pipeline. It is a process that operates with speed and urgency, where innovators and stakeholders curate and prioritize their own problems/Challenges/ideas/technology. It is evidence based, data driven, accountable, disciplined, rapid and mission- and deployment-focused.

The process recognizes that Innovation isn’t a single activity (an incubator, a class, etc.) it is a process from start to deployment.
The canonical innovation pipeline:

As you see in the diagram, there are 6 steps to the innovation pipeline: sourcing, challenge/curation, prioritization, solution exploration and hypothesis testing, incubation and integration.

Innovation sourcing: a list of problems/challenges, ideas, and technologies that might be worth investing in. These can come from hackathons, research groups, needs from operators in the field, etc.

Challenge/Curation: innovators get out of their own offices and talk to colleagues and customers with the goal of finding other places in the DoD where a problem or challenge might exist in a slightly different form, to identify related internal projects already in existence, and to find commercially available solutions to problems. It also seeks to identify legal issues, security issues, and support issues.

This process also helps identify who the customers for possible solutions would be, who the internal stakeholders would be, and even what initial minimum viable products might look like.

This phase also includes building initial minimal viable products (MVPs.) Some ideas drop out when the team recognizes that they may be technically, financially, or legally unfeasible or they may discover that other groups have already built a similar product.

Prioritization: Once a list of innovation ideas has been refined by curation, it needs to be prioritized using the McKinsey Three Horizons Model.

Once projects have been classified, the team prioritizes them, starting by asking: is this project worth pursing for another few months full time? This prioritization is not done by a committee of executives but by the innovation teams themselves.

Solution exploration and hypotheses testing: The ideas that pass through the prioritization filter enter an incubation process like Hacking for Defense/I-Corps, the system adopted by all U.S. government federal research agencies to turn ideas into products.

This six- to ten-week process delivers evidence for defensible, data-based decisions. For each idea, the innovation team fills out a mission model canvas. Everything on that canvas is a hypothesis. This not only includes the obvious – is there solution/mission fit? — but the other “gotchas” that innovators always seem to forget. The framework has the team talking not just to potential customers but also with people responsible for legal, support, contracting, policy, and finance. It also requires that they think through compatibility, scalability and deployment long before this gets presented to engineering. There is now another major milestone for the team: to show compelling evidence that this project deserves to be a new mainstream capability. Alternatively, the team might decide that it should be spun into its own organization or that it should be killed.

Incubation: Once hypothesis testing is complete, many projects will still need a period of incubation as the teams championing the projects gather additional data about the application, further build the minimum viable product (MVP), and get used to working together. Incubation requires dedicated leadership oversight from the horizon 1 organization to insure the fledgling project does not die of malnutrition (a lack of access to resources) or become an orphan (continue to work with no parent to guide them).

Integration and refactoring: At this point, if the innovation is Horizon 1 or 2, its time to integrate it into the existing organization. (Horizon 3 innovations are more likely set up as their own entities or at least divisions.) Trying to integrate new, unbudgeted, and unscheduled innovation projects into an engineering organization that has line item budgets for people and resources results in chaos and frustration. In addition, innovation projects carry both technical and organizational debt. This creates an impedance mismatch between the organizations that can be easily be resolved with a small dedicated refactoring team. Innovation then becomes a continuous cycle rather than a bottleneck.

Problem 5: The question being asked across the Department of Defense and national security community is, “Can we innovate like startups in Silicon Valley” and insert speed, urgency and agility into our work?

Solution 5: The reality is that the DoD/IC is not Silicon Valley. In fact, it’s much more like a large company with existing customers, existing products and the organizations built to support and service them. And much like large companies they are being disrupted by forces outside their control.

But what’s unique is, that unlike a large company that doesn’t know how to move rapidly, on the battlefields of Iraq and Afghanistan our combatant commands and national security community were more agile, creative and Lean than any startup. They wrote the book on how to collaborate (read Team of Teams) or adopt new technologies (see the Rapid Equipping Force.) The problem isn’t that these agencies and commands don’t know how to be innovative. The problem is they don’t know how to be innovative in peacetime when innovation succumbs to the daily demands of execution. Part of the reason is that large agencies are run by leaders who tend to be excellent Horizon 1 managers of existing people, process and resources but have no experience in building and leading Horizon 3 organizations.

The solution is to understand that an innovation pipeline requires different people, processes, procedures, and metrics, then execution.

Problem 6: How to get started? How to get leadership behind continuous innovation?

Solution 6: To leadership, incubators, cafes, accelerators and hackathons appear to be just background noise unrelated to their guidance and mission. Part of the problem lies with the innovators themselves. Lots of innovation activities celebrate the creation of demos, funding, new makerspaces, etc. but there is little accountability for the actual rapid deployment of useful tools. Once we can convince and demonstrate to leadership that continuous innovation can solve the Red Queen problem, we’ll have their attention and support.

We know how to do this. Our country requires it.
Let’s get started.

Lessons Learned

  • Organizations must constantly adapt and evolve, to survive when pitted against ever-evolving opposition in an ever-changing environment
  • Government agencies need to both innovate and execute
  • In peacetime innovation succumbs to the demands of execution
  • We need explicit guidance for innovation to agencies and their leadership requiring an innovation organization and process, that operates in parallel with the execution of current mission
  • We need an innovation pipeline that delivers rapid results, not separate, disconnected innovation activities
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