The returns to entrepreneurship

I was at dinner the other night with a group of entrepreneurs. One told the story of a 27-year-old whiz kid whose company will likely exit for $500M – $1B – the business now being less than two years old. You can imagine the effect that this had on the brilliant, hardworking 35+ entrepreneurs in the group, who have had their share of hits, but not at that magnitude and not that quickly.

These stories are getting more commonplace. It seems that the entrepreneurs who “hit” these days are doing it more quickly, making more money, and doing it at a younger age. Back in the 70s, it took a decade plus to build a company and $10M, even in today’s dollars, was a big victory for an individual. Up until the late 90s dot-com boom, even though these stories existed, they were less common and took longer.

The storyteller explained that this 27-year-old is more brilliant and more hard-working than the previous entrepreneurs he’s seen.

That can’t be it. There are only so many hours in the day, and the entrepreneurs of yesteryear worked just as hard as the entrepreneurs of today. And the ones who came before were just as brilliant. Human intelligence has not evolved that dramatically in 10-20 years.

Rather, I posit that the amount of leverage available to a modern Internet entrepreneur is far, far greater than was available to entrepreneurs of previous generations. The number of entrants has dramatically increased as well. The overall hit rate might be lower, but the ones who win, win bigger and faster thanks to the leverage.

Gone are server farms, telesales and support, marcom material, tradeshow booths, direct sales forces, licensed software, mountains of code, reseller agreements, plane tickets, hotel rooms, printing CDs, voicemail systems, and so on and so forth.

Modern Internet entrepreneurship starts with a few engineers working for nothing and carrying latops and cellphones. They coordinate with Skype and GTalk and wikis and bug tracking sytems. The company itself is snapped together with outsourced HR, cookie-cutter incorporation, and outsourced finance / payroll. Marketing is done virally, or through SEO, or SEM. Customer service is handled via the community and forums. PR and outreach through tweets and blogging. Payments come via Paypal. Ads are served up by third-party ad networks. Storage goes on Amazon. Computation scales via Amazon, Softlayer or Rackspace. Code is built upon stacks of open source, SaaS, and $10/month services.

What used to cost $1M-$2M to set up, now costs $10K. What used to cost $5M to build, now costs $250K. What used to cost $20M to go to market now costs $1M.

But the upside hasn’t gone down. It has gone *up.* The 3 billionth person will be online shortly. They can all use the product. Network effects are stronger than ever, and some businesses become natural monopolies very quickly. Most web products have no marginal cost of replication, so adding a new customer is pure profit.

Less labor required. Less capital required. Less cost to scale. Larger markets. Cheaper marketing. No cost to ship more product.

No, people aren’t getting any smarter or harder-working. But the amount of leverage is obscene. The hits – Yahoo!, EBay, Google, Skype, MySpace, YouTube, Facebook, Twitter, Zynga, are each arriving faster than the previous one did. And the leverage is increasing, not decreasing.

The returns to scale for being smart, young, skilled, and high-energy have gone up tremendously, and that has profound implications for society. The smart are getting richer.

Update: An insightful comment on Hacker News: Basically, the Internet is a wide and deep place. The depth creates a few huge winners and the breadth creates a large number of small winners (who would have been losers in the old system, but due to the above-mentioned low costs, can still win). What’s missing is the traditionally fat middle. We’ve gone from a normally distributed set of outcomes, to a power-law distribution. The median is a small fraction of the mean. This is bad news for anyone who has built their business predicated on their achieving mean outcomes. That includes mid-stage VC funds, moderately-capitalized companies (traditionally speaking), and societies that care about “equal” outcomes.

30 thoughts on “The returns to entrepreneurship

  1. Naval —

    You’re absolutely right about this. Leverage has increased exponentially for the same amount of work. There has never been a better time to be a (tech startup) entrepreneur, or a worse time to be an entrenched business whose model is being threatened by the barbarians at the virtual gate.

    Thanks for articulating this so well!

  2. Great post. It is incredibly easy to start a company these days, and its not even limited to just tech startups. The costs for biomedical and even automobile startups has been dropping. While those industries are still not nearly as cheap as a tech startup, their respective industries are starting to adopt a model to get products to market quicker.

    With all this talk of a recession it excites me to see the implications of what it may bring to the global table. Only time will tell…

  3. Is this the exception or the rule? Or are we starting another bubble?

    The 500M exit in less than 2 years is exceptional, in the plain meaning of the word: an exception.

    Your analysis is correct though: it costs less, and the upside is higher. But how do you factor increased competition and reduced barriers to entry? If everyone can do it, shouldn’t competitors fight and neutralize each others? But I don’t see that happening.

    • Alain,

      That’s a very astute observation. I think that many of the recent “hits” in the consumer web markets have network effects associated with them – either due to user-generated content, friend graphs, virality, or messaging. In those cases, there will be one, highly leveraged, exceptional winner – and many low-cost losers. In the parts of the consumer market where there are no network effects, you are correct in that the benefits of leverage will mostly flow to the consumer. For example, iPhone utility apps are mostly free…

      • I tend to agree with Alain’s logic – given a free market, if barriers to entry drop there will be increased competition. Your argument that there are network effects is valid, but let’s not forget that these network effects can be utilized by anyone, including the competition. I think we’re seeing a temporary arbitrage opportunity that allows for huge ROI, and once the industry matures the increased competition will drive ROI back to normal.

        It’s also not so much the network effects, as brand and first-mover-advantage…given that an internet business has no physical location – if you build the first starbucks – everyone will go there. And keep coming there, due to brand awareness.

        It’s like a local business, except you have 3 billion people within the block. This will cause the barriers to entry to go up yet again (think taking on google, facebook, twitter, etc now) as existing companies look to push new entrants out of the market (or acquire them).

    • I’d take your conclusion a step further, Alain. The observation here is tinted by survivor-bias. In actuality the winners are neither younger nor making more money.

      The fact is that exits are taking waaay longer – IPOs climbing to 10 years since the A round, and acquisition over 7. This valley has always been speckled with a few quick exits, but the average is lagging.

      I can recall exactly one exit this year that fits the “hit” criteria above. Admob. But remember back 10-12 years ago. Those exits were everywhere.

      Further, I’d argue that the entrepreneurs aren’t making more money. The change in the venture business in the last 10 years means that they’re taking more cash (even though the costs are ostensibly less) and getting diluted more. (Look at Mint or admob this year. Both raise $40+mil.) in 1996 that same smart, hardworking kid founders would have raised <$10mil. I can't think of a single "hit" recently that had small VC. Did you have some examples? Certainly all the biggies today pre-exit are packing more VC than ever.

      I know what you're saying about the youth thing though. I *feels* like the big stuff is being done by the kids. But is that different? Is Zuck any different than any of the other Harvard dropouts that preceded him? I don't think so.

      The good news is that the observation of this post still *can* happen some time in the future. The costs to scale a company (both tech and sales costs) are indeed so low that once liquidity loosens again, Naval, your vision may come true.

  4. great post, this pumped me a lot. I’m a great advocate of SaaS and all the online tools available out there to built something bigger.

    still I think we will see great amount of young entrepreneurs doing 1M quickly, that matter more than 1 exception at 500M. exciting time

  5. It took Microsoft 25 years to reach 100B market cap. Then Cisco did it in less than 13 years. Google broke the record again in less than 9 years. The next 100B hit might happen in less than 7 years…will it be Facebook? Whoever it is, it will happen faster than ever.

  6. Completely interesting observations.. they make a lot of sense… so the real question then is when do you get back out of the investment game and into the startup game, again? :-)

  7. Alain is correct, the $500M exit is exceptional, and will stay exceptional. It requires finding an untapped marketplace with significant network effects, and probably a bit of bubbly excitement on the part of people paying $500M for your two-year-old business. I wonder Naval can share the category this startup was in.

    The most exciting benefit of this leverage is the ease of getting to a $10M exit, getting there quickly and without diluting outside funding. That is threatening to entrenched models of new product development (It’s going to get progressively easier to buy new products than to develop them internally) and also to entrenched models of innovation funding, like venture capital.

  8. After seeing the news this morning, I’m guessing that the exit you were talking about was AdMob? Amazing to see $750M price tag on a company founded in 2006 by an MBA student. Great exit for Sequoia and 2nd nice exit for Accel today.

  9. I think that leverage is the wrong term. Leverage typically means taking on debt, margin or even an option. I don’t think that leverage is in the picture anywhere. In fact, that is why the VC model exists: entrepreneurs can’t get loans from banks. Instead, entrepreneurs put $10K of their own money down. You simply seem to be arguing that payoffs are bigger and investments amounts are lower.

    This paper demonstrates just how risky it is to be a VC-backed entrepreneur:

    http://www.stanford.edu/~rehall/HallWoodward6.pdf

  10. Nice article. This reminds me of Taleb’s description of “extremistan”, a place governed by power laws vs. “mediocristan”, the old world which is best described by the normal distribution (fat middle).

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