Managing the Risk: Characteristics of Entrepreneurs, Lecture by William A. Sahlman / HBS (2007)

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Lecture 1
The Best Money Comes from Customers
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The Best Money Comes from Customers

William Sahlman, professor at Harvard Business School, argues that revenue generating business models are the best source of funding and that entrepreneurs should focus on generating income from customers rather than on raising VC funding.




Transcript



The best money comes from customers, not venture capitalists. And to the extent you can get your customers to pay you early, it's an indication that you have that product that is compelling to them, that adds value to your customers. And so I encourage everyone to think hard, not about the process of raising money, but about the process of acquiring customers and getting them to provide your capital.

Lecture 2
Choose Venture Investors Carefully
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Choose Venture Investors Carefully

William Sahlman, professor at Harvard Business School, suggests that when raising money, entrepreneurs should carefully select venture investors based on the quality and value of the partnership not funding terms alone. Specifically, Sahlman argues that although all VCs claim to be value-added investors, the entrepreneurs job is to find the investors who add rather than subtract value.




Transcript



It is clearly the case that from whom you raise money can be as important as the terms. And certainly, I ascribe to the view that in some cases you should take money at a lower valuation from one group than from another group. But I remind us all that all venture capitalists have a common phrase, which is: we are value added investors. So go search the websites. Every single one says, "We have proprietary deal flow, and we are value added investors." And it is absolutely the case, that they're value added investors. But in my experience, only about 10 % get the sign right. And your goal is to find those who can add value, not subtract.

Lecture 3
Opportunity Recognition and Leveraging One's Experience
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Opportunity Recognition and Leveraging One's Experience

William Sahlman, professor at Harvard Business School, provides an example of opportunity recognition by relating the story of how John Osher, the creator of the Spin Pop, leveraged his experience into a new market--spin toothbrushes. Sahlman highlights how Osher and his team took their experience and applied it in a new setting by proactively searching to identify a gap in the current market that had potential for high profit.




Transcript



But what he is really famous for turns out to be the Spin Pop. And what I want you to do is to think about America: a country so lazy that people need a battery-operated lollipop. Think about that for a moment. You are so lazy you are not going to turn the lollipop. You need a battery. And you all are laughing at this product, but John sold 100 million of these devices. For $3 million, he had them all manufactured in China, and it was all terrific. Think about that, 100 million. And he sold the company for a very large price to Hasbro. And again, he went off. And he discovered what we all discovered, that golf sucks. Golf is a short-term kind of a thing where you think you're going to improve, you never do. And he and his team got a little bored, so they said, "Well, what do we know?" They said, "We know small battery-operated electrical motor driven things you can put in your mouth. What do we do? And we have this relationship with a Chinese partner that's been unbelievably productive for both parties, and we know something about distribution. So what should we do, and how should we do it?" And the first thing I want to bring up is, John had written down a list of 16 mistakes, and these he would use at his speeches, "16 mistakes you don't have to make." Now, I know that no one in this crowd has made any of these mistakes. So this is for people who are not represented here. And you can imagine, who made these mistakes? Well, John made these mistakes. And he wrote them down. And he tried to design a company that wouldn't have any of these mistakes. So I've just given you 6 out of the 16. But it was a very conscious process, about trying to say what's worked and what hasn't worked. We will come back to that theme in a moment. Now, John and his colleagues went to Wal-Mart, and they observed the following. They said, on the one end you have manual toothbrushes. There have been no innovations in manual toothbrushes for 100 years. On the other hand, you have electric toothbrushes. That was the last innovation in the oral care market. But there seems to be some kind of gap between these two, roughly the size of the Grand Canyon. So John thought, what if -- well, no, I'll stuff in two. One other thing, he also noted that Braun, which made electric toothbrushes, seemed to have a profitable replacement business. How much does these three replacement heads cost? Okay. So the answer is $32. I want you to tell me what profit margin you think they have. So this is the way to think about it. Whenever you have a business that has a very large profit margin, or very high cost, it becomes a target. And so John took these two things, the gap between the manual toothbrush and the electric, and the fact that people were making huge amounts of money and said, "What if I take the manual toothbrush and the electric lollipop and created a battery driven toothbrush?"

Lecture 4
Four Key Elements of an Entrepreneurial Venture
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Four Key Elements of an Entrepreneurial Venture

William Sahlman, professor at Harvard Business School, talks about the four key elements of an entrepreneurial venture: 1) People, 2) Opportunity, 3) Context and 4) Deal. He illustrates with the example of John Osher who developed the spin toothbrush.




Transcript



So over a long period of time, I've come to decide that there are only really four elements of any venture. And we've talked about them several times this morning. But one is the people. And they're a set of people, not just John Osher, but the whole team that has reassembled to work with him: there's a great intellectual property lawyer, a great design team, some marketing, finance people. And then there's the specific opportunity that they're going after. And there's a tactic, which is, "We're going to produce a battery operated toothbrush that's going to sell at this price. It's got this kind of market, it's very large." Certain characteristics of the opportunity. There's the context, the set of things outside of your control. For example, the oral care market, you don't control your competitors or how competition takes place. You don't control the legal world. And finally, there's the deal. And deal turns out to be not just how you get money, but rather all of the deals: the deals you cut with your distribution channel, the deal you cut with your partner, the deal you cut with your employees. And we could study each of these in isolation, but the most interesting thing is: how do they relate to each other?

Lecture 5
Changing the Game
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Changing the Game

After discussing the four key elements of any entrepreneurial venture (people, opportunity, context and deal), William Sahlman, professor at Harvard Business School, argues that the greatest value can be achieved by "changing the game," that is changing the relationship of the core elements to one another. Sahlman illustrates this strategy with the example of John Osher and the spin toothbrush. To change the game, Osher brought in the most relevant people for the job, experimented to find a great opportunity, and reshaped the context in which he, his team and his partner operated to quickly capture the new market.




Transcript



Now, one of the things you can do is, if each and every one of you sat down and said, "Who are the people on your team? What's the opportunity, what's the context? How do these all relate to each other?" That would be one thing. But what you really want to do in life is to change the game, to improve each of those elements and their relationship to each other. So John hired ... the next person he hired was a salesperson. Now, this man had sold $1 billion a year in products, from Clorox, to a little company called Wal-Mart. And he lived in a small town called Bentonville, Arkansas. So if you're going to hire a sales guy for a mass market product, Bentonville, Arkansas is the place you want to go. And this guy was loved by the Wal-Mart buyers. So he had great relationships. That's the only sales guy John ever hired. The second thing he did was, he ran some experiments. He produced some prototypes. He tried them out in the retail channel. And it turned out, they sold through at 50 times the sell-through rate of manual toothbrushes. So he had some evidence, on the basis of which he was able to get his Chinese partner to increase the level of production. The other thing he did was, he came up with a two-year product plan, because he knew someone would copy his product. And he wanted to be able to introduce a new product when they did. So he had already designed a series of follow-on products that were intended to be better than the first. I'll come back to Crest in a second. So let me tell you what happened and why this turned out to be an interesting story. First year sales were $45 million. Pretty good, right? First year income: $20 million. Now, I know for you all, this is small potatoes, and really not very interesting. It got my attention. He had nine people in the company. I liked that too. And he sold it to Procter & Gamble. So what did he sell it for? Well, let's see. He got $165 million cash down payment. Then he had a little earn out. And when it was all done, John and his colleagues, on $1 million in capital, had gotten $475 million in cash. That's a lot of money.

Lecture 6
Three Factors to Improve Entrepreneurial Success
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Three Factors to Improve Entrepreneurial Success

William Sahlman, professor at Harvard Business School, reflects on three things that helped John Osher, the developer of the low-cost spin toothbrush, succeed. Sahlman identifies three factors: 1) Reflecting on your experience to improve your understanding, 2) Looking at the situation differently to successfully innovate, and 3) Scanning your environment to find new opportunities.




Transcript



I've often thought about John and what lessons you can learn. Because we all go through life, we have these experiences, but what do you take away? One is that John is a reflective practitioner. He goes through life, he says, "What worked and what didn't work? And how do I make better decisions in the future?" And he puts that into practice. He writes down that list of 16 mistakes he doesn't want to have to make. The second issue is that he always had the option to walk away. And I'll describe that in a second. But it means, if you don't have the option to walk away from something, if you can't produce a product you could sell for under six bucks at retail, then this wasn't a viable market. It wasn't a big idea. And John and his colleagues were prepared to walk away. Second, it turned out Procter & Gamble had spent five years and $20 million trying to design an electric toothbrush. Now, they focused on creating a less expensive but better version of the Braun or Sonicare $80 product. So they were trying to have a $40 or a $50 product instead of an $80 product. John was trying to create a better version of a spinning lollipop. So he came at it from a completely different frame. And entrepreneurship often is about thinking about things very differently. Scanning process: John, when he goes to Wal-Mart, he doesn't just look to buy things. He looks for gaps. He looks for opportunities. He looks for situations in which people would buy something at a different price point. And he's very good at it. It turns out that low price, and therefore, by implication, low cost and low breakeven are critical. Because we are in a world in which prices are headed in two directions: everyday low prices, and everyday high prices.

Lecture 7
Characteristics of Entrepreneurs
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Characteristics of Entrepreneurs

William Sahlman, professor at Harvard Business School, argues that entrepreneurship is not about possessing the right psychological traits, but that it is about a way of managing that is focused on opportunity pursuit, future orientation and relentless execution regardless of the resources one actually possesses. Sahlman emphasizes that relentless execution is the most important part?there are many ideas but what matters is who most successfully executes.




Transcript



When you raise the word "entrepreneurship," many people talk about psychological traits. There was research some years ago that said, "You have to have a domineering mother to be an entrepreneur." How many of you have a domineering ... no, I really don't want to know. My mother won't let me raise my hand at that question. There's also the notion that entrepreneurs are risk seekers, or risk bearers or something. I really don't know anybody who gets up in the morning and says, "Where can I find risk?" It's sort of, "Where can I find reward? And on whom can I foist all of the risk?" My colleagues and I like to think about entrepreneurship in the way Edgar described it, frankly, which is: "Relentless pursuit of opportunity beyond the tangible resources currently controlled." The basic idea is not to focus on what's there from the past, what you've accumulated and what you need to protect, but to always think about opportunity looking outwards, and looking at what customers are doing, and understanding how that process evolves. And indeed, success becomes your enemy and causes you to protect what you've done before. We have the view that in today's world, you actually can't protect the status quo. It simply is not possible. And we think of entrepreneurship not as a personality trait or as an economic function like innovation, but rather as a way of managing. And it's got some differences from being a bureaucrat or an administrator, and we'll try to describe some of how that operates. I'll also tell you ... I've now screwed up the picture ... but it's "Believe, Listen, Act." I was trying in real time, Edgar, to capture your definition because I actually think it has a lot of wisdom embedded in it. Because entrepreneurship, at the end of the day, is not about thinking of outcomes, but it's about acting. And indeed, I'll try to make the argument that ideas are a dime a dozen, and execution is all that matters. I've seen so many people with the same idea, and I have seen a team, like John Osher's team, outexecute every time.

Lecture 8
Opportunity Driven Entrepreneurship
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Opportunity Driven Entrepreneurship

William Sahlman, professor at Harvard Business School, asserts that entrepreneurship is about being opportunity driven: recognizing opportunity in all types of circumstances. Specifically, being opportunity-driven is about looking at a bad situation and turning it around to see the opportunity.




Transcript



I also think it's a state of mind. It's a state of mind in which crisis and opportunity are the same. So on the one hand, you see situations in which everything looks horrible, the economy, the people default on the debt, and all of a sudden, you say, "Well, I could view that as the end of my business career and something that's horrible and why did this happen to me?" Or you could say, "Where is the opportunity there? And how can I create products or services or take advantage of temporary insanity in the capital markets?" So every disgruntled customer is an opportunity. So if you find situations in which people hate the relationship they have with a company, you can organize to take advantage of that. So I think it's turning things around and viewing opportunity everywhere and then trying to figure out what resources you need to meet that need.

Lecture 9
New Ventures Must Adapt
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New Ventures Must Adapt

William Sahlman, professor at Harvard Business School, observes that almost all entrepreneurs and their ventures must inevitably change and adapt. In all the business plans Salhman has seen, he says that almost every single business has had to change as they discover their customers, their market, etc. So the key to successful entrepreneurship is anticipating and dealing with change.




Transcript



The other thing I've learned about entrepreneurship, when you read 5,000 business plans, I'll tell you a couple of things. One is, I have seen three companies exceed their plan. That's three out of 5,000. Now, I know everyone in the room has exceeded their plan, and I've just been talking to the wrong people. But the fact is that you have to change what you're doing because you have to get into the marketplace. You have to discover what things really cost. You have to go where the customers are. You have to respond to competition. So entrepreneurship is not about your ability to write a pretty business plan, or to be great forecasters. It's about your ability to deal with change and to make things happen. So one of the things we know that each of the elements of a venture has to change, and therefore I have to anticipate and respond.

Lecture 10
Managing the Risk / Reward Tradeoff
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Managing the Risk / Reward Tradeoff

William Sahlman, professor at Harvard Business School, maintains that entrepreneurs must manage the relationship between risk and reward, illustrating his point with the example of John Osher, creator of the very successful spin toothbrush. Specifically, Sahlman argues that entrepreneurship is fundamentally about decreasing risks and increasing the chances of success?an issue that is fundamentally related to the people in the venture.




Transcript



So what you really have to do is to think about: how do I understand the relationship between risk and reward? Not, "How do I deal with a certain amount of risk or a certain amount of rewards?" I'll give some examples. One thing that clearly could go wrong in a venture is that the founder dies. And if the founder's the critical cog in the wheel, that's bad. What could you do? Well, you could buy the key person life insurance. Now, I want you to think, there are only some circumstances in which there's a minor conflict of interest. If the company's not doing well. So you also need to think through the incentive effects of whatever you do. But that's an example of managing risk and reward. In John's case, you could sit at the beginning and say, "What can go wrong?" and write a list of things. You can sit and say, "What can go right?" and I can promise, most of us are great at coming up with a list of what can go wrong. We are terrible at "what can go right." And entrepreneurship is about "what do I do? How do I respond if I have this mix of potential good news and bad news?" John, I think, said it very well. He's not a big risk taker. There are people who succeed, having taken very big risk. But the fact is, they're the exceptions. And we don't see the stories about the people who took those same very large risks. So I think John's a perfect example of someone, at each step, trying to manage the relationship between risk and reward. Now, this is an obscure graph that on the left hand side, shows the probability of some payoff in year 5. So what's your company going to be worth in 5 years? And my experience with ventures is that there's some likelihood the venture will fail. Maybe it's 30 % maybe it's 50 % I will tell you, every entrepreneur I've ever met says zero is the right assessment. But my experience suggests some higher number is appropriate. Typically, it's hard to create a small company. So the most interesting thing about the world is, what's the right hand tail look like? What's the upside, and how do I balance the risk? But the more important issues is: how do I change the odds? Because your goal, as entrepreneurs, is to lower the likelihood of failure and to move the entire curve to right, increasing the upside, increasing the likelihood that you'll have a positive outcome. There are lots of ways you do that, although people will turn out to be critical. So in my experience, and this is a theme that has come up a couple of times: all successes are attributed to people, and all failures are attributed to people. And sure, we've seen bad ideas but frankly no bad idea is unfixable. So it's a bad idea that wasn't fixed, and that's a people problem, not an idea problem, typically.

Lecture 11
Four Qualities to Look for When Hiring
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Four Qualities to Look for When Hiring

William Sahlman, professor at Harvard Business School, highlights for critical elements to observe in the process of hiring people: 1) Integrity, 2) References, 3) Attitude and 4) Adaptability. He highlights the importance of seeing through a resume to the core of the person underneath, one way of which is to use your network of contacts to get the back story on an individual.




Transcript



In my experience, the thing you have to pay most attention to--and Edgar touched on this as well--is integrity. In the 118 companies I've been involved in, I dealt with three bad people. To say that those were painful experiences would be an understatement. But we'll try to give some questions that might help you in catching them. One is, when confronted with a decision in which it could benefit the person, or the company, or the group, how will they behave? And in my experience, people who always make the decision in their own best interest are the most dangerous people possible. And so I encourage you to think hard about hiring and not ending up having those people on your team, because they are absolute poison. And whether you are investing in a company, you're working with a partner, you're hiring someone in a critical role, integrity has to be at the forefront of your thinking. I will say conflict is everywhere. And indeed, a colleague says, without conflict, there is no interest. So you have to deal with situations where people could do things that are in their best interest, not in yours. So if you don't trust them, don't hire them in the first place. For me, I try to come up with a set of characteristics of an individual that I'm trying to explore. And I've now read I don't know how many resumes, thousands and thousands of resumes. What is a resume? ... This is the audience participation part of it. ... It's a marketing document. It's designed to sell you something. I always look at their ... there are huge gaps in resumes. Sometimes you look in there, five years, not accounted for. Because they don't talk about failures. They talk about a description of how they would like to be seen, not how they are. So your job, in hiring, is to actually dig deeply and understand their track record, what they accomplished, not what a rising tide enabled them to do, but rather what they accomplished. The other thing is, clearly, it's useful to have people who have some expertise, some wisdom, some competency in a critical area. Michael Klein talked about that. Networks is critical, because indeed, it's at the core of what Endeavor is, which is you've been invited into a different network, so you now know a bunch of people or can touch people who will affect your success and failure. So when you worry about hiring someone, you need to say, "Who did they know, and what do those people think of them? And how does relate to exactly what I'm trying to accomplish in this business?" And finally, attitude. This also relates to character, because a person's attitude is actually what will happen, what will affect, in many ways, how productive they are in your venture. Now, the other thing I would just comment on is, given that you know everything will change, it's useful in a venture to have people who are capable of change. Because in reality, your description of your product and your pricing and your distribution channels are all likely to be thrown up in the air. So trying to anticipate people's ability to change is critical.

Lecture 12
Challenges of Hiring Good People
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Challenges of Hiring Good People

William Sahlman, professor at Harvard Business School, argues that recruiting good people is hard and while an entrepreneur is bound to make mistakes, fixing those mistakes is critical. Sahlman suggests that interviewing is difficult because of the impetus to assume the candidate is the right fit, but entrepreneurs must expend extra effort to assure they have the right person or it can cost the whole company. And in the cases where a mistake is made, entrepreneurs must be ruthless in fixing that mistake quickly.




Transcript



I don't know how many of you really love to interview people. Is that something you get up every morning and say, "I'd really love to go have to hire someone new, an assistant or salesperson, a product manufacturer, or a product manager?" So we always want the person to be the right person. We look them in the eye, and we assume they're the right person, because we don't want to interview the next 50 people. And then we ask questions that guarantee they are the right person. Hiring is a 50 % probability gain. I don't know what you all, or what your odds have been, but if you just go back in history and say, "How many mistakes did you make out of the percentage of people you hired?" The fact is, it's a risky business. And so you have to take that into account. And I think you have to spend a lot of time in particular, trying to make sure that you don't make a mistake. Because it turns out, mistakes in people are what cause companies to go bad. So someone did some research with a group of young presidents' organization people. And the estimate was that bad people hire, person hire cost $500,000. But in my experience, it very often costs the whole company. You lose the company because people who are bad turn out to make bad decisions, and they hire other bad people. And so one of your tasks as an entrepreneur is to recognize that you might make the mistake, and then be pretty quick at trying to solve that mistake. People don't change. You do need to treat them with respect, you need to give them the opportunity. You need to give them feedback. But in the end, your organization depends on having great people. And so you have to be ruthless.

Lecture 13
Three Most Critical Elements of Venture Success: People, Customers and Sales
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Three Most Critical Elements of Venture Success: People, Customers and Sales

William Sahlman, professor at Harvard Business School, states that people, customers, and sales are the critical ingredients of venture success. Specifically, Sahlman states that, 1) having the right people, 2) focusing on customers rather than technology, and 3) concentrating on sales instead of marketing, are critical elements of corporate health and longevity.




Transcript



People, people, people. It just turns out to be, business is simple. It's all about people. And then people do the right things. You have to give them guidance and you have to have ideas, and you have to have all sorts of things to be successful. But the most important thing is to have the right people. Customers. It's amazing, when I talk about Dean Kamen and Segway; I spent four years working with Dean on a variety of projects, and he is a magnificent inventor and a wonderful man. He does some great things in the education field. But the fact is, he thought people ought to buy it because it was cool. And people don't buy products because they're cool. They buy them because they have some tangible benefit to them. It could be psychic, it could be something in their business. So customers are critical. We often talk in business schools about something called marketing. Marketing is irrelevant. Sales counts. And so selling things is really important. In fact, you're in the selling business. So when you try to get money, you are selling yourselves and selling your ideas and the combination of the two. So selling is what is an essential skill for every entrepreneur.

Lecture 14
Teams Are More Important than Individuals
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Teams Are More Important than Individuals

William Sahlman, professor at Harvard Business School, asserts that although individuals are important, teams are the central unit of entrepreneurial success. Indeed, Sahlman argues that the reason why many companies succeed is because of the team, not any particular individual, and so entrepreneurs should think carefully about breaking up teams as well as the effect that replacing an individual has on a team.




Transcript



But I guess what I was really trying to get people to think about is, the individual is a terrific unit. And we hire individuals, and we think of our organization as individuals. But the reason why Endeavor works, the reason why companies work is not because of single individuals. It's because teams make things work. And so it's just an appreciation, as you think about changing people's responsibilities, that you worry a lot about the team that you're breaking up. And you try to replace the person with the team in mind. Not so much about the individual characteristics. We care a lot too much about individuals.