Ben Horowitz: Venture Capital Investor, Proponent of Rap

Ben Horowitz is a prominent venture capital investor. He started the venture capital firm Andreessen Horowitz with Marc Andreessen, the co-founder of Netscape, and the firm made vast amounts of money on investments in companies like Groupon and Skype (and will make even more when Facebook files for IPO).

But it’s his stance on the importance of rap in teaching business lessons that is intriguing. Throw business classes and books out the window, Mr. Horowitz says, and listen to rap lyrics instead:

Mr. Horowitz uses rap as an introduction as he philosophizes about business challenges like how to fire executives, why founders run their companies better than outside chief executives and how to stand up to difficult board members.

“All the management books are like, ‘This is how you set objectives, this is how you set up an org chart,’ but that’s all the easy part of management,” Mr. Horowitz said in an interview in his spacious office here on Sand Hill Road, the epicenter of tech investing.

“The hard part is how you feel. Rap helps me connect emotionally.”

How to deal, for instance, with the stress of the 11th-hour, late-night auditing mishap that almost stymied the $1.6 billion sale of Opsware?

Listen to the Kanye West song “Stronger”: “Now that that don’t kill me/Can only make me stronger/I need you to hurry up now/’Cause I can’t wait much longer/I know I got to be right now/’Cause I can’t get much wronger.”

Much of rap is about business, whether the drug business, the music industry or work ethic, said Adam Bradley, an associate professor specializing in African-American literature at the University of Colorado at Boulder who wrote “Book of Rhymes: The Poetics of Hip Hop” and co-edited “The Anthology of Rap.”

Read more at The New York Times.

Profile of Manoj Bhargava, Creator of 5-Hour Energy

Fortune has a profile of Manoj Bhargava, the creator of the 5-Hour Energy drink. At $3 a bottle, creating this concoction has made Bhargava billions (he claims that he’s the wealthiest Indian in America). The energy drink is sold under the company Living Essentials, which doesn’t report revenue or profits (but a source with knowledge of its financials says the company grossed above $600 million last year on that $1 billion at retail).

Early on he realized he didn’t much care what sort of business he was in as long as he was winning at it. At 17 Bhargava noticed that blocks of low-­income homes in the roughest North Philly neighborhoods were being razed and cleared. Bhargava bought a 1.5-ton 1953 Chevy dump truck for $400 and started clearing out debris from the demolition. He’d find rats bigger than cats among the garbage and rubble. “The stench was mind-bending,” he says. He remembers hearing gunshots outside a crumbling house on crime-ridden Girard Avenue and learning an old man had been killed for $5. Still, Bhargava made $600 that summer—and resold the Chevy for $400. He didn’t care if the work was unglamorous. It was profitable.

He won a full scholarship to the Ivy League feeder Hill School before heading to college at Princeton in 1972. Bhargava lasted a year. The pretentious eating-club culture wasn’t really for him, and he didn’t find his math classes particularly challenging. “‘Annoyed’ would be a mild word for my parents’ reaction,” he says. He returned to Fort Wayne, Ind., where his parents had settled and his father owned a plastics company. “There were no jobs; it was a disaster,” he says. “It was right before the oil embargo, the stagflation era.” He started reading books about a Hindu saint who’d spent his life on a spiritual quest. That, he thought, was something worthwhile. In 1974 he moved to India.

Bhargava says he spent his 20s traveling between monasteries owned and tended by an ashram called Hanslok. He and his fellow disciples weren’t monks, exactly. “It’s the closest Western word,” he says. “We didn’t have bowler haircuts or robes or bells.” It was more like a commune, he says, but without the drugs. He did his share of chores, helped run a printing press and worked construction for the ashram. Bhargava claims he spent those 12 years trying to master one technique: the stilling of the mind, often through meditation. He still considers himself a member of the Hanslok order and spends an hour a day in his Farmington Hills basement in contemplative silence.

Bhargava would return to the U.S. periodically during his ashram years, working odd jobs before returning to India. For a few months he drove a yellow cab in New York. When he moved back from India for good, it was to help with the family plastics business at his parents’ urging. He spent the next decade dabbling in RV armrests and beachchair parts. He had no interest in plastics whatsoever but devoted himself to buying small, struggling regional outfits and turning them around. By 2001 Bhargava had expanded his Indiana PVC manufacturer from zero sales to $25 million (he eventually sold it to a private equity firm for $20 million in 2006). He decided to retire and moved to Michigan to be near his wife’s family. “Nobody moves on purpose to Detroit,” he says. His retirement lasted two months. He knew from his plastics success that the chemicals industry was ripe for exploiting. “Chemicals are really simple,” he says. “You mix a couple things together and sell it for more than the materials cost.”

Aside from this feature on him, you won’t really find Bhargava on the internet:

His paper trail is thin, consisting primarily of more than 90 lawsuits. This is his first press interview. “I’m killing it right now,” he says, adjusting a black zip-up cardigan from behind the table of a soulless conference room in a beige low-rise building in a suburban business park in Farmington Hills, Mich. “But you’ll Google me and find, like, some lawyer in Singapore.”

What’s most interesting to me is that Bhargava’s idea for 5-Hour Energy wasn’t new (he went to a trade show where he tasted an energy drink and copied its ingredients in 5-Hour Energy). What was novel was his idea of incorporating energy drink ingredients in a tiny package and effectively selling the product (having it on Wal-Mart store shelves certainly helped).

The Case Against Private Equity Firms

James Surowiecki has a brief but illuminating post about private-equity firms. He explains that while some private-equity firms do make the companies that they purchase better off, they do so by gaming the system:

Given the weak job market, it makes sense that the attacks have focussed on layoffs. But the real problem with leveraged-buyout firms isn’t their impact on jobs, which studies suggest isn’t that substantial one way or the other. A 2008 study of companies bought by private-equity firms found that their job growth was only about one per cent slower than at similar, public companies; there was more job destruction but also more job creation. And, while private-equity firms are not great employers in terms of wage growth, there’s not much evidence that they’re significantly worse than the rest of corporate America, which has been treating workers more stingily for about three decades.

The real reason that we should be concerned about private equity’s expanding power lies in the way these firms have become increasingly adept at using financial gimmicks to line their pockets, deriving enormous wealth not from management or investing skills but, rather, from the way the U.S. tax system works. Indeed, for an industry that’s often held up as an exemplar of free-market capitalism, private equity is surprisingly dependent on government subsidies for its profits. Financial engineering has always been central to leveraged buyouts. In a typical deal, a private-equity firm buys a company, using some of its own money and some borrowed money. It then tries to improve the performance of the acquired company, with an eye toward cashing out by selling it or taking it public. The key to this strategy is debt: the model encourages firms to borrow as much as possible, since, just as with a mortgage, the less money you put down, the bigger your potential return on investment. The rewards can be extraordinary: when Romney was at Bain, it supposedly earned eighty-eight per cent a year for its investors. But piles of debt also increase the risk that companies will go bust.

This approach has one obvious virtue: if a private-equity firm wants to make money, it has to improve the value of the companies it buys. Sometimes the improvement may be more cosmetic than real, but historically private-equity firms have in principle had a powerful incentive to make companies perform better. In the past decade, though, that calculus changed. Having already piled companies high with debt in order to buy them, many private-equity funds had their companies borrow even more, and then used that money to pay themselves huge “special dividends.” This allowed them to recoup their initial investment while keeping the same ownership stake. Before 2000, big special dividends were not that common. But between 2003 and 2007 private-equity funds took more than seventy billion dollars out of their companies. These dividends created no economic value—they just redistributed money from the company to the private-equity investors.

As a result, private-equity firms are increasingly able to profit even if the companies they run go under—an outcome made much likelier by all the extra borrowing—and many companies have been getting picked clean.

I also highly recommend reading venture capitalist Fred Wilson’s post “Why Taxing Carried Interest as Ordinary Income Is Good Policy.”

Advice for Buying and Selling Things on Craigslist

Ryan Finlay makes a living buying and selling items on Craigslist. It’s the only business in which he hasn’t failed. He has some good advice for others if they want to get into a similar business:

Buy what you know. Of the 600-plus items I’ve purchased, I’ve lost money twice. Once I called some kid about a pile of old baseball cards. I asked him what year they were and he told me they were 4 years older than they actually were. I looked them up and thought I was going to make some money. When I showed up and looked at the cards, I noticed they were newer than he had told me. I didn’t have my tablet computer at the time and couldn’t look them up, so I drove the price down and took a lesser risk.  Back at home I immediately found out the cards were worthless. I had paid the kid $100 for the cards, and eventually pestered him into taking the cards back and trading for an SD card and iPod nano. I still lost around $30 but learned a valuable lesson: don’t take risks on items you don’t know.

Know how Craigslist works. Whoever emails/calls first wins.  If it’s free, you need to pick up the item almost immediately. Good free items are spoken for within seconds. Depending on the city, there are hundreds of people sitting around trying to snag free items. Same for cars, electronics, computers, and other highly competitive sections. Good pictures are extremely important, as are clear descriptions. General sections are refreshed just under 10 minutes, sub-sections about every 15 minutes.

Value your time. Figure out how much you want to make each day and break your day into sections. Average profit for items I pick up ends up being $60-$70. I aim to pickup 3 items a day. I’m not worried how many I sell each day because everything eventually sells. When I arrive at someone’s house, I’ll ask if they are selling anything else or giving anything else away in case I can boost my profit per trip.

Selling advice. There will always be someone that will buy your item. It might take another hour. It might take another day. It will sell. If you are getting calls on your item then you probably have it priced right. Remember that you don’t need to sell to the first caller. Or the second. What you need is to make the most money possible on your item. 

Buying advice. Ask lots of questions on the phone and be very specific. There’s nothing I hate more than showing up at someone’s place only to find out there is some deal-breaking problem I wasn’t told about. Negotiate over the phone/email or plan on paying full price. When I’m not paying close attention, I make mistakes. Profit is in the details.

Patagonia, a Benefit Corporation

Patagonia, the maker of outdoor clothing and gear, has long stood for its environmental philanthropy championed by founder Yvon Chouinard. The company has redirected a portion of profits to green causes since 1986 and discloses the chemicals it uses in its products. And beginning this year, according to Bloomberg, it has officially been designated as a Benefit Corporation:

The company, based in Ventura, announced it will become one of the state’s first “Benefit Corporations,” a new legal structure that gives directors legal cover to consider social and environmental missions over financial returns. The law creating the Benefit Corporation is one of two state measures that went into effect January 1. They’re each designed to embed goals beyond profitability into companies’ missions. 

Benefit Corporations such as Patagonia must commit to creating an overarching “general public benefit.” Companies that incorporate as Benefit Corps must consider an array of stakeholders beyond shareholders, including workers, suppliers, the environment and the local community. They must measure their progress toward that goal against a third-party standard.

Patagonia is the highest-profile business to adopt this new business structure. Currently recognized in seven states, here’s to hoping that this type of structure expands further.

Meaningless Expressions, Abstractionitis, and More

Dan Pallotta has a fun rant about jargon titled “I Don’t Understand What Anyone Is Saying Anymore.” He explains how business conversations use such buzzwords as “paradigm shift” and “synergy” without true substance. He mentions five “strains of this epidemic” such as:

Abstractionitis
We have forgotten how to use the real names of real things. Like doorknobs. Instead, people talk about the idea of doorknobs, without actually using the word “doorknob.” So a new idea for a doorknob becomes “an innovation in residential access.” Expose yourself repeatedly to the extrapolation of this practice to things more complicated than a doorknob and you really just need to carry Excedrin around with you all day.

Acronymitis
This is a disease of epic proportions in the world of charity. I was at a meeting just two days ago at which several well-meaning staff members of a charity were presenting to their board, and the meat of their discussion revolved around the acronyms SCEA and some other one that began with “R” that I can’t recall. In the span of three minutes these acronyms must have been used eight times each. They were central to any understanding of the topic at hand, but they were never defined. So I had not the vaguest idea what the presenters were talking about. None. Could have been talking about how to make a beurre-blanc sauce for all I know.

Dan concludes:

You will gain tremendous credibility, become much more productive, make those around you much more productive, and experience a great deal more joy in your working life if you look someone in the eye after hearing one of these verbal brain jammers and tell the person, “I don’t have any idea what you just said to me.”

Sounds like a good resolution to take up this year. Click over to the article to read it in entirety. And don’t forget to vote for your least favorite buzzword/expression (as of this writing, “thinking outside the box” leads as the least liked expression with about 18% of the vote).

Thinking Strategically: Book Review

I finished reading Thinking Strategically by Avinash K. Dixit and Barry J. Nalebuff in March 2010. Subtitled “The Competitive Edge in Business, Politics, and Everyday Life,” Thinking Strategically is an international bestseller and a classic, having been published in 1993. My motivation to read it was because I saw this book listed on numerous forums which listed excellent business books.

The book is organized into three parts, with a total of thirteen chapters. After reading the preface (with the moniker: “Thinking Strategically—Don’t Compete Without It”), the authors explain in the Introduction that the aim of the book is to improve the reader’s “strategy I.Q” while not promising to “solve every question you might have.”

The first chapter sets an excellent tone for the rest of this book; this chapter profiles ten interesting “tales” of strategy. The book leads of with the phenomenon of the “hot hand,” commonly observed by sports fans and sports analysts. In fact, hot hands in such sports as basketball are actually a fallacy, most likely observed because we (humans) have a tendency to focus on streaks of occurrence rather than non-occurrence…

In the first chapter, the authors also explain so-called zero-sum games: one person’s gain is another person’s loss (basketball, football, poker all fit this description). So what isn’t a zero-sum game? The most inviting example is that of the prisoner’s dilemma, where the payoffs of the two participants do not necessarily offset. In part II of the book, the authors have a lengthy chapter entitled “Resolving the Prisoner’s Dilemma” in which they elucidate a few excellent examples (they use OPEC to build the case). The authors explain that participants of a prisoner’s dilemma may try to achieve cooperation, but that there is a large underlying incentive to cheat even if an agreement is made.

The examples in this book are interesting. For example, in Chapter 2 (“Anticipating Your Rival’s Response”), the authors feature the recurring theme in the cartoon strip Peanuts, in which Lucy holds the football and invites Charlie Brown to run up to the ball and kick it. Of course, we all know Lucy’s intentions, but it’s worthwhile to create a decision tree and deduce what Charlie Brown should do (the authors do admit that the story of Charlie Brown is “absurdly simple,” but that this example allows the reader to become familiar with decision trees for more complex situations). Another example in this chapter is the game of chess, in which the players try to envision how their opponent will play a few moves into the future. I found it interesting that the authors pondered about solving chess, something I wrote about when I linked to the Garry Kasparov article, “The Chess and the Computer.”

In the chapter “Strategic Moves,” you’ll learn about unconditional moves (an example of a TV race between United States and Japan is presented), threats and promises (while an unconditional move gives a strategic advantage to a player able to seize the initiative and move first, you can establish a similar strategic advantage through a response rule—either a threat or a promise), warnings and assurances (a warning is when it is in your interest to carry out a threat while an assurance is when it is in your interest to carry out a promise).

Other chapters in the book include “Credible Commitments” (in which you will learn about “apparent irrationality,” contracts, and why it would make sense to burn bridges), “Unpredictability” (in which you will learn about the min-max theorem and the usefulness of surprising others by surprising yourself), “Brinkmanship” (please note that “brinksmanship” is not a word), “Cooperation and Coordination” (with a most interesting case about stock markets and beauty contests: how do they relate?),”The Strategy of Voting” (with considerations about median voting, the so-called “naive voter,” and how it may occasionally behoove to vote for an enemy to see a result you desire), “Bargaining” (with a discussion of handicap system in negotiations), and “Incentives” (an excellent chapter which sets the case for merit-based bonuses in jobs).

I think the best part of this book are the number of examples and the cases at the end of the chapter which reinforce the ideas discussed. Each case has a thorough solution, and so you can definitely learn a lot by reading through these cases. Speaking of cases, the last chapter of the book is entirely devoted to them; there are a total of twenty-three additional cases to go through which further reinforce the concepts covered in the book (again, solutions to the cases are also provided).

Quotes

Some interesting quotes from the book follow.

Setting the tone for the book:

You must recognize that your business rivals, prospective spouse, and even your child are intelligent and purposive people. Their aims often conflict with yours, but they include some potential allies. Your own choice must allow for the conflict, and utilize the cooperation. Such interactive decisions are called strategic, and the plan of action appropriate to them is called a strategy. This book aims to help you think strategically, and then translate these thoughts into action.

On threats and promises:

Is is never advantageous to allow others to threaten you. You could always do what they wanted you to do without the threat. The fact that they can make you worse off if you do not cooperate cannot help, because it limits your available options. But this maxim applies only to allowing threats alone. If the other side can make both promises and threats, then you can both be better off.

How do I know this book is dated? Reference to the Cold War on page 3 of the book:

As the cold war winds won and the world is generally perceived to be a safer place, we hope that the game-theoretic aspects of the arms race and the Cuban missile crisis can be examined for their strategic logic in some detachment from their emotional content.

On De Gaulle’s rejection of friendship:

A compromise in the short term may prove a better strategy over the long haul.

On Khrushchev’s silence:

Khrushchev first denounced Stalin’s purges at the Soviet Communist Party’s 20th Congress. After his dramatic speech, someone in the audience shouted out, asking what Khrushchev had been doing at the time. Khrushchev responded by asking the questioner to please stand up and identify himself. The audience remained silent. Khrushchev replied: “That is what I did, too.”

On rules of the game:

There are two general features of bargaining that we must first take into account. We have to know who gets to make an offer to whom, i.e., the rules of the game. And then we have to know what happens if the parties fail to reach an agreement.

On taking risks (this conclusion follows after a case study of the 1984 Orange Bowl game between the Nebraska Cornhuskers and the Miami Hurricanes):

If you have to take some risks, it is often better to do this as quickly as possible. This is obvious to those who play tennis: everyone knows to take risks on the first serve and hit the second serve more cautiously.

An explanation of a dominant strategy with a baseball analogy (situation: one or more players on base, there are two outs in the inning, and a batter is facing a 3-2 count):

We say that running on the pitch is the dominant strategy in this situation; it is better in some eventualities, and not worse in any. In general, a player has a dominant strategy when he has one course of action that outperforms all others no matter what the other players do. If a player has such a strategy, his decision becomes very simple; he can choose the dominant strategy without worrying about the rival’s moves.

What is the dominance in a “dominant strategy”?

The dominance in “dominant strategy” is a dominance of one of your strategies over your other strategies, not of you over your opponent. A dominant strategy is one that makes a player better off than he would be if he used any other strategy, no matter what strategy the opponent uses.

Another revelation of the age of this book:

As we write this, the Iraqi invasion of Kuwait has shot the price of oil up to $35 per barrel and experts are divided about the future of OPEC.

On an interesting police tactic:

Police have been known to scare drug dealers into confessing by threatening to release them. The threat is that if they are released, their supplies will assume they have squealed.

How to deter cheating with punishment (you have to read the book to find out the problem with the approach listed below; alternatively, respond with your thoughts in the comments, and I will make note of the correct response):

Next we ask how severe a punishment should be. Most people’s instinctive feeling is that it should “fit the crime.” But that may not be big enough to deter cheating. The surest way to deter cheating is to make the punishment as big as possible. Since the punishment threat succeeds in sustaining cooperation, it should not matter how dire it is. The fear keeps everyone from defecting, hence the breakdown never actually occurs and its cost is irrelevant.

Threats and promises versus warnings and assurances:

Threats and promises are truly strategic moves, whereas warnings and assurances play more of an informational role. Warnings or assurances do not change your response rule in order to influence another party. Instead, you are simply informing them of how you will want to respond based on their actions. In stark contrast, the sole purpose of a threat or promise is to change your response rule away from what will be best when the time comes. This is done not to inform but to manipulate. Because threats and promises indicate that you will act against your own interest, there is an issue of credibility. After others have moved, you have an incentive to break your threat or promise. A commitment is needed to ensure credibility.

On burning bridges:

Armies often achieve commitment by denying themselves an opportunity to retreat. This strategy goes back at least to 1066, when William the Conqueror’s invading army burned its own ships, thus making an unconditional commitment to fight rather than retreat.

On the element of surprise:

If you choose a definite course of action, and the enemy discovers what you are going to do, he will adapt his course of action to your maximum disadvantage. You want to surprise him; the surest way to do so is to surprise yourself. You should keep the options open as long as possible, and at the last moment choose between them by an unpredictable and therefore espionage-proof device.

The essence of brinkmanship:

The essence of brinkmanship is the deliberate creation of risk. This risk should be sufficiently intolerable to your opponent to induce him to eliminate the risk by following your wishes. This makes brinkmanship a strategic move. Like any strategic move, it aims to influence the other’s action by altering his expectations. [Question for the reader: is brinkmanship a threat?]

On inferior technologies:

Our greater experience with gasoline engines, QWERTY keyboards, and light-water nuclear reactors may lock us in to continued used of these inferior technologies.

Final Thoughts

Most books on strategy and game theory can be dry and/or inaccessible to the general reader with overwhelming mathematics. This book is excellent (and interesting to read) because it has an amazing diversity of illustrative examples drawn from political campaigns, corporate relations, sports, OPEC, the military draft, the Cuban Missile Crisis, the Cold War (especially the Cold War, if I may so myself), speed limits, and other interesting topics. The book is mostly self-contained but it does require multiple sittings to go through it (I spent over a week reading this book), especially if you’re careful to go through the cases and work through some of the solutions to verify the authors’ findings. Do keep in mind that this book was published in 1993, so some of the topics are dated. Nevertheless, if you’re at all interested in strategy, game theory, and are comfortable with basic mathematical concepts, this book is definitely worth a read.