From time to time, I have a conversation with someone—usually from New York—about how to “fix” a Web-based company that seems to have lost its way. For years these conversations were about Yahoo, or more recently Twitter. I suspect the same conversation will soon be about some faltering private “unicorns.”
My answer uniformly is that they can’t be fixed.
I believe that much of what allows great technology companies to grow incredibly fast and become so valuable also makes them almost impossible to turn around when they falter in any sort of traditional sense. It also makes it extremely hard for the capital markets to strip and recycle their assets, as normally happens when big companies fail.
Once a giant falls, it never gets back up again. It just bleeds out.
Three Ingredients
In order to understand why technology companies are impossible to resurrect, we should think about how they become successful in the first place. They require three interrelated ingredients: people, product and growth.
Starting with human capital, the greatest thing a technology company can achieve is a formula for attracting, retaining and making productive great people who are willing and able to work very hard. To accomplish this companies need a compelling mission, a great product and a business model which allows them to compensate people insanely well. Companies need both a technical and social environment that allows individuals to have an impact they can be proud of. But setting all that aside, to get great people you need to have great people. The best only want to work with the best from whom they can learn, and with whom they enjoy collaborating.
When a company achieves a human-capital flywheel, the results can be stunning.
The second thing that helps companies drive hyper-growth is product.
Great products inherently have a lot of option value, which means they can evolve extremely quickly. This comes from the nature of the product itself, where some products lend themselves much more easily to logical and systematic line-extensions than others.
When a company has a product that is easy to market, good for customers, and easy to evolve, the product can help further draw in the right type of high quality and hard working human capital and drive the business. This is usually what is happening in the fastest growing companies. When the product misses the mark it obviously becomes a drag both for human capital and users.
The third reinforcing cycle is return on scale and growth. The most successful technology companies generally are in businesses with a high return on scale: the bigger you are, the more valuable your product is to users, the better your intelligence and data, and the more profitable you can be.
Return on growth is a related but distinct concept. Very successful businesses don’t just need to be big, they also need growth to lead to more growth because new users help your product evolve.
For human capital, ROS and ROG allow people to feel impactful even as a company becomes very large, and of course also allows companies to stay competitive on compensation even after the appreciation in equity prices slows.
When Things Go Wrong
So, what do you do when things start to go poorly? As an operator, the fact that people, product and growth are so deeply interrelated makes it extremely hard to move forward once something isn’t working well.
On the talent front there are a few moves to pull. You can try to poach great leaders from elsewhere, usually by overcompensating them, and then hope you can get them to bring others with them and help retain the talent you have. This becomes an uphill battle both because overcompensating people is harder in a world where the value of your equity is declining, and because the key ingredient to attract most people is the other people they get to work with.
This talent issue is compounded by the fact that the best people willing to leave the best companies usually want to found or join something in its early stages where their chances of success can be higher and it is a lot more fun than a struggling older company. So, the leaders who end up being willing to take on a company in distress are usually not the leaders those companies actually need.
You can lay off weak performers to make the environment more attractive to existing people and new hires. A big part of me suspects the Twitter layoffs reported to be happening are as much a recruiting stunt as they are anything else. The issue with this is usually practicality. Cutting back to just the most talented team members would require abandoning more of the company’s offerings than is possible.
On the product side, if you have product that is uninspiring to your teams and to users you can try shutting things down; however, it is usually harder than it might appear to cleave off parts of an existing product ecosystem. Not only do you have to deal with the sometimes painful employee and customer outcry, products are often interwoven in a way that complicates pulling out a single component.
You can acquire new products, but if you have your own product and human capital issues the chances are you are going to need to massively overpay vs. competitors for the privilege to acquire great teams and companies, and retaining an acquired team's focus and attention is extremely hard to impossible.
When those options don’t work, “It is time to get the consultants out and the bankers in,” a friend once said to me. Only, the bankers can’t really help here.
First, most technology companies don’t really have traditional assets worth selling. The fact that they use so little capital means there isn’t much in the way of hard assets worth selling piecemeal. If you wanted to sell specific properties (perhaps the way a media company might sell specific newspapers or magazines off), you run into the fact that usually the technology on the backend and the user-flows on the front end are so deeply intertwined that it is impossible to cleanly cleave them off.
And the worst part, of course, is that competitors won’t consider buying a distressed company until things are truly ugly, if ever. Even if a company sees an opportunity to make more money by acquiring, stripping and turning around a competitor, the acquirer generally also sees them as toxic and not worth the energy and distraction from their own mission to fix.
Non-technology acquirers might be an option, but most savvy ones know to stay away. And so long as valuations are locked far above reasonable profitability multiples, financial sponsors aren’t really an option.
So, larger technology companies find themselves rudderless ghost ships. The captains might know what needs to be done, and they might have cash to make moves in theory, but in practice they can’t steer.
Apple Exception
In writing this I am waiting, of course, for the first subscriber comment to be about Apple, which certainly came out on the bright side of some very dark days—or perhaps Amazon. Those businesses were different. Amazon, which can now be called a technology company, wasn’t. It was a retailer that weathered the storm, came out stronger, and is becoming a tech player.
Apple is the anomaly that proves the rule; it is in the hardware business with much more traditional suppliers, distribution, etc. Even when the company was struggling, it had real assets and relationships. It also didn’t hurt that Apple probably had the single most iconic technology brand in history.
The upshot of all of this is that, if you look at too many new startups, technology might easily be mistaken for a hits driven business where everyone is just one successful move away from being at the center of things. People believe the various giants are just one hit product away from being back on top.
But the reality is that, just because a young startup can be initially sparked by a single product innovation, doesn’t mean that giants can generate or be saved by singular moves.
So, perhaps we should see the valuations of companies that aren’t winning, collapsing by orders of magnitude just as quickly as some stars now rise.