MARY MEEKER IS A partner at the venture capital firm Kleiner Perkins Caufield & Byers. Every spring, Meeker issues her impressive and insightful “Internet Trends” report consisting of hundreds of slides identifying what Meeker believes are the most important developments and trends in the technology. These presentations are widely read and discussed. Meeker’s investments include Houzz, Instacart, LegalZoom, Slack, and Twitter. Before becoming a venture capitalist, she was a managing director, research analyst, and technology analyst at Morgan Stanley from 1991 to 2010, before which she worked at Salomon Brothers. Meeker serves on the boards of DocuSign, Lending Club, and Square. Meeker is a prolific writer and the coauthor of the industry-defining books The Internet Report (1996) and The Internet Advertising Report (1997). Meeker received a BA from DePauw University and an MBA from Cornell University.
1. “In a typical year, there are generally two technology companies that go public and become ten-baggers, which means they deliver a ten-times return on investment. We were trying to find those two companies.”
This statement of Meeker’s reflects a fundamental truth about the venture capital business. There are firms that follow a different venture capital model but what Meeker is describing here is the dominant model. The traditional venture business is all about the Babe Ruth effect; that is, that it is magnitude of success and not frequency of success that matters. As just one an example, the venture capitalist Fred Wilson has said that his firm loses all its money in over 40 percent of its venture investments. This is a normal and essential part of the traditional venture capital business. The number of times something like Facebook can happen in the global economy is constrained top down by a number of factors, including addressable market. It is simply impossible to have even a tiny number of Facebook-style financial outcomes every few months or even every few years.
2. “The race is won by those that build platforms and drive free cash flow over the long term (a decade or more). That was my view in 1990, 1995, 2000, 2005, 2010, and it remains the same today.”
The key word in this quotation is “platforms.” Platforms are increasingly dominating the world economy. While the platform value has been the same over the period Meeker notes, the payoff from owning shares in a successful platform has never been bigger. The grand-slam financial returns venture capitalists like Meeker seek are most often found in businesses that operate software platforms. To generate big returns, you need a business that scales amazingly well, and nothing scales better than software. A software business, like any other business, also needs a moat, and that can sometimes, with a lot of effort and luck, be created through network effects. When a platform is created in the right way, there is almost zero marginal cost to deliver the service and therefore very attractive margins.
3. “I read an article in the New York Times written by John Markoff about Jim Clark going to the University of Illinois at Urbana–Champaign to invest in a company selling a Web browser called Mosaic Communications run by Marc Andreessen. It was one of those moments. I picked up the paper and said, ‘That’s it.’ This was 1994. Morgan Stanley then raised money for Mosaic—I actually have that business plan somewhere. The company promised to ‘change the way the publishing world works.’ ”
Here Meeker is pointing to a major turning point in business history. The ability to spot a change as big as this one is a very valuable thing. What many people miss is that sometimes a change like this is mostly going to benefit consumers. The assumption that such a change will produce new gushers of profit is often mistaken, or at least the profit imagined is far more than is reasonable.
At the time Meeker describes, I was working for Craig McCaw, who is a good friend of Jim Clark. Jim Barksdale, who was running McCaw Cellular at the time, left McCaw to become CEO of Netscape in 1995. We were naturally very curious about what was going on at Netscape. McCaw sent a colleague and me from Seattle to visit Netscape. We were impressed by the products. Meeker is right that at that time, it seemed like something extraordinary was imminent. Each year after that visit in 1995, the startup launch parties grew bigger, and the spending on just about everything grew more lavish. Capital was flooding into the technology sector in ways that we had never seen before. In one sense, we were all frogs in a pot of water that was steadily getting hotter. Something that cannot go on forever will eventually stop, the economist Herbert Stein once famously stated.
4. “It is one thing to be wrong about the valuation and the timing. It’s another thing to be wrong about the business model.”
In evaluating a potential investment, it is possible to make a range of mistakes, including on valuation and timing. If an investor’s mistake involves missing that the business model is unsound, the mistake is usually fatal. Sometimes a business can correct that problem before they run out of cash, but it is not an easy task. A venture capitalist like Meeker will closely examine the unit economics of a business to determine whether it has a sound business model. Key in this analysis are the assumptions since most models can be made to work well financially if pretend assumptions are used. If you are looking at a spreadsheet model, the first thing to examine is the assumptions.
5. “In general, a good rule of thumb is that for an attacker to beat an incumbent, the attacker’s product typically needs to be 50 percent better, and 50 percent cheaper, and the attacker needs to sustain that competitive advantage for a year or two, to be able to gain material market share.”
There is a lot of inertia in human behavior. Consumers do not always rationally address decisions like which products to use. In the mass market, people generally want a margin of safety when asked to move to a new product. The greater the value differential between the new and existing product, the lower the cost required to move the customer to a new product with sales and marketing. This challenge ratchets up the value that a challenger must deliver to generate customers at a reasonable cost. The greater the value differential between the new product and the incumbent’s product, the lower the customer acquisition cost and the less cash that will be burned in getting the business to critical mass.
6. “Technology stocks are volatile.”
J. P. Morgan once said the same thing about stocks generally: “The stock market will fluctuate.” Technology stocks can be especially volatile. Or not. The best way to deal with volatility is to remember that you can make it your friend. If stock prices were not volatile, there would not be as many bargains. Remembering that risk is not the same thing as volatility is very important. Why are technology stocks more volatile?When conditions impacting a business change more often owing to changes in technology, prices are going to be more volatile. If technology falls within your circle of competence, the sector can be a great place to invest.
7. “You never want to catch a falling knife.”
The metaphor of a falling knife is used to describe a situation in which the price of an asset has fallen significantly over a short period and in which there is significant uncertainty about how much further it will fall. Because momentum and emotion are involved when a knife is falling, the risk of mistiming the bottom is significant. Making accurate predictions about human behavior is difficult, especially after transactional costs are deducted. It would be great if someone could ring a bell when a knife hits bottom, but that never happens. Knives can continue to fall further longer that you can remain solvent. However, if you stay focused on valuation relative to a benchmark like intrinsic value, you are far better off than you would be trying to time markets. One way to reduce the risk of catching a falling knife is to have a margin of safety when buying assets. The idea is simple: With a margin of safety, you can make mistakes or have bad luck and still do fairly well. Having a margin of safety when buying assets is like keeping a safe driving distance between you and a car ahead of you when driving at 70 miles an hour.
8. “One of the greatest investments of our lifetime has been New York City real estate, and investors made the highest returns when they bought stuff during the 1970s and 1980s when people were getting mugged. The lesson is that you make the most money when you buy stuff that’s out of consensus.”
It is mathematically provable that to outperform a market-average result, an investment must be contrarian in a way that is correct. Buying when other people are fearful can produce great bargains. It can also produce great losses as well. You must buy assets that are out of consensus, and you must be right to outperform the market average. This reality is true in both venture and value investing, and in fact true in all investing.
9. “Buy technology stocks when no one is interested in them. Sell when everyone is interested in technology (or when attendance at technology conferences reaches record levels or when your grandmother wants to buy a hot technology IPO).”
This is a restatement of the Mr. Market metaphor. Be greedy when others are fearful and fearful when others are greedy. Meeker makes the additional point of the folly of following a crowd into hot sectors when valuations get too high. When the shoe shine operator at the airport or your Uber driver tells you what stocks you should buy or what “hot” sectors are best for venture capital investments, that is a “tell” that the market is overheated.
10. “Don’t fall in love with technology companies. Remember to view them as investments.”
This statement is a bedrock tenet of value investing. A share of stock is not a piece of paper to be traded but instead a partial interest in a real business that must be understood fundamentally to be properly valued. The business should be evaluated dispassionately based on sound data and analysis, and only once it is within your circle of competence. There is a significant danger in getting swept up in the madness of the crowd by an interesting story.
11. “I’ve made my best personal investments when I’ve been a user of the product.”
The famous investor Peter Lynch takes pains to keep people from misrepresenting his views, most notably by saying, “I’ve never said, ‘If you go to a mall, see a Starbucks and say it is good coffee, you should buy the stock.’ ” What he actually said was, “People seem more comfortable investing in something about which they are entirely ignorant.” Meeker is saying that this idea also applies to venture investing: People seeking a solution to a real problem that a startup is trying to create will make better investments. Actually using a product that can be improved is one very important source of research. Lynch also said,
Investing without research is like playing stud poker and never looking at the cards. You can’t understand a business and its place in an industry without doing some research. And the objective in doing the research is to find something that the market does not properly discount into the price of the stock or bond.
As an example, a venture capitalist who uses databases in his or her work is more likely to make better decisions about a startup trying to improve databases. This is circle-of-competence thinking. Risk comes from not knowing what you are doing.
12. “I love data. I think it’s very important to get it right, and I think it’s good to question it.”
The amount of data in Meeker’s massive slide decks is legendary. Some of that data are from companies making self-serving statements (e.g., talking about their books), and some are not. Meeker believes that you need to think carefully about all data to make sure they do not lead you to make a false conclusion. For example, it is easy to confuse correlation with causation. In thinking about data, it is best to avoid acting like the drunk who uses lampposts for support rather that illumination. Sometimes the data you need are in a dark corner of the parking lot where there is no light. In that case, you may need to put your decision in the “too hard” pile.