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hi welcome back this is the third in a series of four webcasts that I'm doing on tech companies and in particular what I view as the compressed life cycle at tech companies let me back up and explain I believe that all businesses go through a life cycle they started they grow they mature and then they decline tech companies go through the same cycle but they go through it much faster than typical companies and the rationale is very simple what allows tech companies to grow fast is they can enter businesses easily they can scale up fast and they can get customers to switch their products much more easily than in other business that's what allows them to grow fast this is great right but those same features work against them once they become mature because other companies can enter easily scale up fast and switch their customers away from them which means that if you're a typical tech company your life cycle happens in compressed form in my in the words that I used in my in my in the webcast I did on this particular topic I describe tech companies as aging in dog use now what I'd like to talk about though in this session is the challenges that management at these companies founders owners these companies face because of the compressed life cycle as I see it there are three choices you have if you run managed own a tech company the first is to accept reality which is this is a short life cycle you can enjoy it while you can and you can live a short but glorious life and you're going to make decisions ingly so I'm gonna start with that and I'm going to talk about the potential dark side of that which is you have a short life cycle but you live in denial acting like you have a long life the second is you argue that it's tech products that have life cycle life cycles not tech companies that if we can create a portfolio of tech products in other words you can take a successful tech product and use it to reseed the growth machine then you can keep going back to the growth machine and maybe keep creating products that will allow you to grow for a much longer period and there's a third possibility you could try to change the business you're in to make it look more like a non tech business so let's start with the first one in the acceptance strategy is what you do you accept the fact that you have a short life cycle and you manage the company coordinate which means that during the high growth phase all focus on is growth growth and still more growth you don't get distracted by control or debt or any of the other issues that can take your focus away from growing once you get to the mature phase you know you don't have long to live there so you enjoy yourself to the maximum you make the most money you can you you you essentially live through the mature phase knowing that it's not gonna last very long and they are the advice that most mature companies get which is to borrow money use it with restraint if you're a tech company because you're but your face is not going to last as long as a coca-cola or a consumer product company and in decline you know things are gonna happen very fast so your cash flows have to go into hyperdrive you got to return a lot more cash than typical companies and dividends alone probably won't do the trick you got to supplement them either with special dividends or stock buybacks so you have a short life you live like you have a short life and you manage your company well given that short life the dark side of this particular strategy is you accept the fact that even shortly but you live as if you have a long life that's denial so what you do is you go out and borrow money like a non tech company when you're mature you refuse to return cash when you're in decline those things can happen so think of that as the dark side of this particular strategy the second strategy is what I call reseed and regrow what and as I as I described it earlier what you do is you take a successful product and you've been successful with it you use the cash flows and earnings from that product to reseed the growth machine what does that mean you try to come up with a second and a third and a fourth product sounds promising right lots of companies try it but there are two things I would like you to keep in mind first is reseeding the machine can extend your life but it can increase your value only if the cost of reseeding the machine is less than the benefits you get so if you go out and you try to keep acquiring new products with acquisitions it's true you can extend your life as a growth company but you'll be paying out so much in the process of acquisitions that you'll have a longer life but a lower value the other thing to be worried about is remember that that this strategy is going to get more and more difficult or more successful again let's let's see why you have a successful first product adding a second product might not be such a big deal you have two successful products adding a third product is going to become more difficult because each new product will have to be more successful than the previous one just have an impact on your growth because you're scaling up in fact here's one of the great ironies the most successful your initial product is the more difficult it is to pull off the strategy so if you have an incredibly successful first product coming up at that second product might be very very difficult to do because to make an impact it's got to be a really large second product and those are tough to pull off there's a third strategy to me this is the place to go through the management or a founder of a company remember those three things that made it easy for you to grow that you could enter the business easily that you could scale up quickly and that you could get customers to switch to you because they were not sticky they were not sticking with existing products what do you want to do now that you've crossed though in a sense you crossed the river where the bridge is to burn the bridge down what you've effectively got to do is make the business more difficult to enter how by bringing in maybe maybe adding patents legal protections against entry maybe adding gatekeepers to the game gatekeepers weren't there when you enter the business but then you created to keep new and new entrants out maybe you can increase the cost of scaling up maybe you can change a product or your distribution system your marketing to increase the amount of money that your competitors will have to spend to enter the same business and whatever you can do to make your customer or your product more sticky where customers are motive and find it more difficult to leave your product though essentially you're extending your lifecycle and how can you make customers more stuck on your product well you can add features that in a sense acquire information about them whether they use it so when they leave they that information all goes to waste or creates a work product that does not easily translate into a new product I'll give you a personal example I've been frustrated Microsoft Office at different times in two different degrees over the last 15 years I've thought about leaving but the longer I stay with office the more difficult it becomes for me to leave because I think about those thousands of files that I have that are PowerPoint Excel in Word files and I think about the potential problems I will have and I try to convert them I mean every new product claims that can convert things painlessly but I've done this before and I know there's no such thing as painlessly when it comes to conversion the difficult it becomes for me to leave Microsoft Office that stickiness is what's kept Office or Microsoft is successful in that business for as long as it has so three choices either live the life of a short life cycle in a management company for a short life cycle the second is trying to extend that life cycle by coming up with new products and the third is to change a business model you know what I'd like to do is frame this actually in terms of of what you see often used by value investors to explain what kinds of companies have invested and the analogy the uses the analogy of a moat they want invest in companies that have mulch you think what the hell are you talking about a moat essentially is a competitive advantage that's so strong that your competitors can't come across so with bad investors the argument is you should invest in companies with wide moats I'm gonna draw that analogy and I think I'm gonna enrich it may be extended beyond its breaking point but think about it this way think about this originally as a as a lush island in the middle of nowhere nothing on it surrounded by a waterway filled with crocodiles and horribly dangerous waterway so your group of adventurers who see the island they say look you know I'd like to get across the island so over decades they build this drawbridge it takes up a lot of pain a lot of effort a lot of resources and finally they get the drawbridge done they walk across the dangerous waterway now they're on the island they draw up the drawbridge and they build a castle it's their Island they control it and they live I would say happily ever after but they have to live happily for a period in fact they're so comfortable in the island that they forget about the fact that they have to maintain the water went feed the crocodiles they essentially let their weapons become a ancient convinced that the drawbridge is strong nobody can come across it at some point in time the waterway becomes a little stream see the stream over here and the barbarians notice that it's just a stream they realize the drawbridge is up but they don't care about the drawbridge so think of the barbarians as the tech disruptors and think of the people on the island as the incumbent businesses in non-tech incoming companies and non tech businesses the barbarians start coming across the water initially the incumbents don't even notice that they're coming across and then they noticed oh my god they're coming across the water say they tell their gods to fire the crossbows remember there were their weapons they're ancient ancient the crossbows might take out a few barbarians but they're too many of them some of them make it into the island they come with advanced weapons they blow away your defense they take over the island they now own the island this is techn instruction in a nutshell right the island used to be car service the drawbridge used to be regulations and rules the car service companies came across they controlled the island they thought they control the island and to Luber and left a DD quad a decided that they could cross the water now of course that the tech companies on the island they have a choice to make they can say look you know there's only a stream out there a tiny stream other barbarians are gonna come across we're gonna eat and be merry while we have a chance that's the first strategy acceptance strategy you know you will not be in control of the island for very long the second is maybe you can go pay for extra advanced weaponry the weapon makers of course love this this will of course be doing acquisitions hiring bankers doing what you need to do to keep the barbarians at bay that's the second strategy extend your growth strategy the third of course is to change the business which means take the moat make it deeper create your own drawbridge that's effectively what I'm talking about in terms of the three strategies that tech companies have now let's bring this all together if you think about what what I've just said and you buy into my argument that tech company life cycles are short and there's a story to be told about management as well because the kind of skill set you need at each stage and the life cycle is different early in the lifecycle Meniere's startup you need a visionary CEO somebody can tell a great story sell an idea as you go into growth you need a builder somebody can take that great idea and make it into a product or a service and start building growth building markets as those markets get built up you need an opportunist somebody can see look around say hey that's a great growth potential and go for it but go for it selectively once you've built up your business and become a mature business you got to defend the business so you need a CEO is a defender who could come up with competitive advantage is to keep the competition up as that mature phase starts to ease your growth starts to go away you are to become realistic you can't grow anymore you gotta accept the fact that you're now a mature company and the last face winter decline you need to get out of the business you need a liquidator but here's the challenge in a typical non tech company this can take decades so the visionary CEO gets a chance to live out is 20 or 25 years and pass the baton on to the Builder the opportunist the defender so by the time you get to the decline phase it's a very different scene you're running the company so you have a chance at least of having a natural transition from one manager to another but imagine being a tech company where all of this happens in compressed time maybe in 25 years you could actually have the same person be CEO of this company who has the CEO of the startup now still remain the CEO and you can already see the problem it's going to create if you're a great visionary CEO but you cannot bring yourself to being a realist or to liquidate you're going to be the wrong CEO for your company so essentially I think a tech companies you have more of the makings of a problem with founder CEO stake staying on well beyond their expiration date if I can put it that way which also means that you can the implication that come out of there pretty strong first is you're going to see more value destruction at tech companies in their mature and decline phases because many of these companies are still run by founder CEOs in management who grew with these companies as a growth company and still bring those bad those old habits to a company where it's no longer appropriate so this is going to show up in lots of different ways the friction between management and investors at tech companies is going to come to the surface sooner rather than later because of the short life cycle and here's how it's going to manifest itself you're far more likely to see tech companies going to value destruction mode when they keep trying to grow or when growth is gone partly because the founder CEO and the management of this company still the same management found a CEO that push the company to growth and cannot give up on the fact that the company no longer its growth it's almost personal the second is you're more likely as a result of this to see more CEOs removed at tech companies because they're beyond the due date investors look at them and say you're no longer the right CEO for the company and this could happen very early in the process because a tech company can go from being a great company incredible growth company to mature declining company in four to five years you're also going to see it and this is a natural follow-up that activist investors are going to start targeting tech companies a lot more than they have historically because we're starting to see tech companies age in front of our eyes this is in fact the first generation of aging tech companies so don't be surprised to see what's happening at Yahoo happen and other tech companies and finally this is one reason to be wary about all these new this new class of voting and non-voting shares you've seen a tech companies in the last decade starting with Google of course but going all the way through the social media companies investors of course right now don't seem to care about the fact that they don't get the voting rights of the insiders of these companies because these companies are in the growth phase and in a sense you're saying as an outsider I don't know much about growth I'm gonna let these guys make the decisions but there will come a day when the growth drops off and the same founder CEOs that you reveal right now as great managers are going to do things that you wish they wouldn't do and you're going to be you're gonna promote the fact that you no longer have the voting rights so if you give up forwarding rights today I'd like to think about that tomorrow when you will be wishing for those voting rights because that tomorrow will come sooner than you think as most tech companies managing tech companies is not easy I'm not claiming it is but in in a sense you have to take into account this shortened life cycle in how you approach managed with the companies because almost everything we know about management was it it was in a sense taught to us from a non tech business version where life cycles last in a long period I hope you enjoyed the session