Bill Gurley: All Things Business and Investing – Invest Like the Best

Check out the Invest Like the Best Episode Page & Show Notes

Key Takeaways

  • Picture an X-Y graph
    • Y axis = the value to the customer, X axis = the penetration into the market
    • If the trend is up and to the right, you have a network effect business
  • To get a marketplace or a user-generated content business off the ground, you need to do things that are unsclabale
  • “If you’re in an advertising-orientated world, you should not try to monetize until you’re north of 10 million users”
  • The internet allows perfect information to be available about an individual with an certain skill set and connects them with someone with a need for that skill set 
    • While we’ve done it with cars (Uber/Lyft) and homes (Airbnb), there are other areas waiting to be taken advantage of:
      • Medical expertise
      • What if you want help with your car?
      • Connecting tutors and students
  • The features of a healthy marketplace:
    • A high fragmentation of supply
    • Certain businesses are prone to monogamy (like babysitters, hair stylists) – these are tougher for marketplaces
    • The user experience has to be multiples better than the status quo
  • In the age of the internet, it’s easy to know more about a particular subject matter than anyone else
    • Just keep narrowing the scope of that subject until you’re the one that knows the most

Books Mentioned

  • Bill is a huge fan of Complexity by Mitchell Waldrop, which details the rise of the Santa Fe Institute
  • Paradox of Choice by Barry Schwartz

Intro

Increasing Returns

  • Increasing returns is synonymous with network effects
  • What does it mean? – It’s the idea that a company that rises to a certain level finds it even easier to rise to the next level
    • For example, with Microsoft – the more of their OS that existed the more people wrote apps for the platform, and the more apps people wrote for the platform, the higher the value of the platform
    • Bill expands – “It’s a main stage mental model that I’ve kept in the back of my mind at every single investment decision we’ve ever made”
  • Many of the companies that become platform-based companies are exposed to network effects, but there are things you can build into a product that might make the network effects stronger/weaker
    • Just as Eugene Wei discussed in Status as a Service, creating more status surface with the addition of different types of validations/scoring systems (like social media likes) can tip up the network effect
  • Picture an X-Y graph
    • Y axis = the value to the customer (or the supplier), X axis = the penetration into the market
    • If the trend is up and to the right, you have a network effect

The Internet’s Effect on Increasing Returns

  • With the internet – something can be instantly known and draw tons of sign ups over night
  • Bill mentions how Quora, Pinterest, and Twitter are tilting at, but haven’t quite nailed, the idea of network effects
  • Bill gives an example:
    • Imagine a mountain biking app where it instantly groups you with riding partners of your same skill level and geographic location
      • “If you could come up with a concept like that, it would monetize like crazy, the user-generated content (UGC) opportunities would be incredible”
  • Glassdoor (it’s a website where people review their place of work) is a prime example of something that ties the relationship between UGC and network effects

Are there certain teams/leaders that are more conducive to leading a network effect company?

  • The founder has to be hyper-sensitive to the system/playbook
    • (They have to be aware of the fact that the value of customer # n+1000 is higher than customer # n)
  • “You have to understand what the end game is and whether you’re building the system where things tip into one another which allows the business to start to take off”

Do the Unscalable

  • “One of my rules for getting a marketplace off the ground, or a UGC play, is do tons of unscalable things”
    • But this is contrary to what’s learned in business school in relation to scale
    • Why do this? – To get the flywheel spinning
  • For example, the first company reviewed on Glassdoor was Cisco (the founders went to a Starbucks near Cisco and interviewed Cisco employees to gather the reviews)
  • Or with Yelp:
    • The founders would go to nightclubs in San Francisco with t-shirts to elicit reviews and encourage people to use the platform
      • They started in a small niche (nightclubs) doing something unscalable and eventually broadened out
  • Doing the unscalable early on raises what Bill terms the  “liquidity quality” of the business
    • It’s essentially the “fire” of the business (AKA the passion of early users)

How important is the revenue model early on?

  • It’s highly dependent on the situation
    • Uber had a business model from day 1
    • Snapchat, Instagram and Twitter did not
  • “If you’re in an advertising-orientated world, you should not try to monetize until you’re north of 10 million users”
    • Why? – Your ability to get a decent CPM isn’t high enough to warrant losing the screen real estate and whatever other growth mechanism you could have put in there

A Little Bit About Nextdoor

  • It’s a private social network for your neighborhood community
    • (a social network tied to your address)
  • You might use it to hire a babysitter, find a lost dog, or hire someone to fix your roof
  • Bill says there are many directions the business can take from here:
    • “There’s a really strong recommendation product inside the system today”
      • Expanded – “The tools and technologies of the internet are going to help people make choices and reduce the set of options available to them”
    • “I also think Nextdoor has a pretty interesting opportunity in the sharing economy”
      • (neighbors sharing their ladder or a chain saw – something they buy once and don’t use all that frequently)

Marketplaces

  • Check out this recent article Bill wrote about marketplaces
  • Exchange of goods marketplaces (i.e., e-Bay) have created more market cap than any other type
    • Next would be the sharing economy (i.e., Uber, Airbnb)
  • On a basic level, Uber connects someone with marginal time through an algorithm with someone that wants their help
  • The internet allows perfect information to be available about an individual with a certain skill set and connects them with someone with a need for that skill set 
    • “While we’ve done it with cars and homes, there are other areas waiting to be taken advantage of:
      • Medical expertise
      • What if you want help with your car?
      • Connecting tutors and students

Has technology changed the world of value investing?

  • Patrick says the 4 most dangerous words in investing are – “It’s different this time”
  • “The propensity with the internet being there for network effect businesses is higher than it’s ever been”
    • Ideas can spread fast
    • You can gather users for a platform very, very quickly
  • We’re creating more connectivity every day which allows ideas to flow even faster
    • “I’m amazed at the quality of high-value conversations I have over Twitter DM. These pathways didn’t exist 5 years ago.”

Hyper-Niche and Labor Marketplaces

  • Perhaps we’ll soon see the rise of vertical LinkedIns (everyone in a certain occupation being connected in some way)
    • Sort of like RigUp – a labor marketplace for anyone who works in oil field services
  • Labor marketplaces have been the hardest to prove the idea of network effects
  • But there are exceptions – like Upwork 

User-Generated Content (UGC) Businesses

  • For the most part, these are “scale it first, monetize it later” type businesses
  • Benchmark has had massive success with UGC businesses – Yelp, Twitter, Quora, Instagram, and Nextdoor as examples
    • “If any entrepreneur out there has a UGC idea, come to us”
  • One of the early keys is to get people contributing 
    • But this is difficult and results in the cold start problem – people come for the content and are then encouraged to contribute content 
      • (This is why you originally need to do unscalable things at first – see above)
  • “I find that the number of entrepreneurs who are capable of successfully launching a UGC play is a very small fraction, maybe <1% of all entrepreneurs”
    • This small subset just tends to have a nuanced feel for what it takes to make something come alive and the feature sets that matter

Factors of a Healthy Marketplace

  • A high fragmentation of supply
    • Take the restaurant industry as an example – there are many suppliers/restaurants
  • Certain businesses are prone to monogamy – these are tougher for marketplaces
    • Ex. – Babysitters, hair cutters, doctors, dentists
    • Look at the opposite – with restaurants, you’re prone to promiscuity (you go to your favorites, but want to frequently try new ones)
  • The user experience has to be multiples better than the status quo
    • Take OpenTable for instance and how easy it is to use (compared to calling up a variety of restaurants trying to get a reservation for a large dinner party)
  • The friction of supplier sign up has to be low

How has the influx of cash impacted the marketplace business landscape?

  • Because the money is available to do things like fund payables/receivables or write loans, entrepreneurs are using the capital in those ways
    • “It causes me some concern”
  • “I’ve always felt Silicon Valley has a very crude understanding of valuation. Most entrepreneurs all think they deserve 10x revenue.”
  • “I’m fairly confident that in the long-run companies that are very good allocators of capital and are able to have a very high return on invested capital are going to trade at much higher multiples”

Thoughts on the IPO Market

  • Many people talk about how Lyft/Uber were broken IPOs because they finished opening day 5% below where they was priced
    • Same with Spotify (but there wasn’t an uproar because they set their IPO price with a direct listing method)
  • On the other hand, companies like Zoom and CrowdStrike saw an 80% increase in their stock prices on the first day and are thus celebrated (which is nonsense)
    • Bill has a good point – Had they priced the IPO at the price of first trade, they would have $600 million more each in the bank with no incremental dilution
  • Perhaps more IPO prices should instead be set using the Dutch auction method
  • “I’m super excited about the Slack direct listing this week and I’m hopeful that everyone comes to realize this is a way smarter way to go about doing things”
  • “I’m actually surprised there hasn’t be a derivative lawsuit brought against a board for pricing their equity of half the real value”

How did Bill find his passion?

  • Check out this speech Bill gave at the University of Texas to MBA students
  • Bill’s older sister was a electrical engineer and became employee # 63 at Compaq
    • She ended up doing well off her stock options and Bill was intrigued 
  • To add – Bill also went to work at Compaq and because infatuated with both the stock market and counting cards in Las Vegas in his free time
  • “I had a love affair with tech, I had seen my sister do well off of options, and I had this gambling bug… I became very curious about venture as a result of that”
    • Bill went on to business school in Austin and then went to work on Wall Street
    • Eventually, he made his was to join Frank Quattrone as a market analyst 
      • In exchange for coming to work to him, Frank promised to introduce Bill to every VC he knew in order to get Bill intro the industry

What’s Bill’s favorite part of working with entrepreneurs?

  • Being able to sit down with someone, come to a common understanding about the objective, and then teaming up to make it happen

Honing Your Craft

  • In the age of the internet, it’s easy to know more about a particular subject matter than anyone else
    • Just keep narrowing the scope of that subject until you’re the one that knows the most
  • In your study of a particular field, start with the historians of the industry/craft and then expand towards the current day
  • Be hyper-curious 
    • Find someone you can share books/ideas with continuously
      • Bill calls himself an obsessive reader

Mentorship

  • What makes for a good mentor?
    • You have to make yourself available
  • Most of the time, if you approach someone in a reasonable way and ask them to respond to an email or have a 5-minute call with you – you can pretty much get in front of whoever you want
  • The goal – getting a mentor to really care about your outcome and have them take pride in your success

Additional Notes

  • Check out the book Paradox of Choice
  • Patrick has been DMing with modest proposal on Twitter
  • “Banks, instead of making it easy to one-click move your money around the internet, have made it hard. No one deserves to be disrupted more.”
    • Banks have “regulatory capture” – what does this mean?
      • It’s the idea that the companies supposedly being regulated end up with so much face time and interaction with the regulators that they have more of a voice in the regulation than the regulators themselves
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