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- [00:01]
Hannah Bates
Why should you listen to the Worklab podcast from Microsoft? Because it delivers actionable insights for business leaders on how to leverage AI to access untapped value, turbocharged decision making and sharpen their competitive edge. That's W O R K L A B no spaces available Wherever you get your podcasts. Strategic growth isn't just about where you're going, it's about where you build. Global business leaders are choosing Ohio for its pro business, business climate, rapid innovation and tailored incentive packages. With Jobs Ohio, you'll find a partner that moves on your timeline, helping you scale with confidence. Make your smartest move yet. Get started@jobsohio.com before we begin, we have a couple of questions. What do you love about HBR on strategy? What do you want less of? What would make HBR on strategy even better? Tell us. Head over to hbr.org podcastsurvey to share your thoughts. We want to make the show even better, but we need your help to do that. So head to hbr.org podcastsurvey thank you. Welcome to HBR on Strategy. Case studies and conversations with the world's top business and management experts, hand selected to help you unlock new ways of doing business. Is your company slow to make decisions? Afraid of failure? Maybe to a fault? A risk averse mindset can thwart a company's growth and competitiveness. Stanford Graduate Business School professor Ilya Strebulaev says the antidote is for senior leaders to start thinking like venture capitalists. He talked to Kurt Nickish on HBR IdeaCast in 2024 about what the venture capitalist mindset is and and what it can do for businesses.
- [02:01]
Kurt Nickish
So let's dig into the VC mindset and what sets these decision makers apart. One thing that probably anybody would tell you if you ask them on the street is that this willingness to fail, comfort with failure is sort of at the heart of that mindset. Does your research bear that out?
- [02:20]
Ilya Strebulaev
It does, of course. Willingness to fail is one of the many principles that we identified that constitute the venture mindset. In fact, the way I think about failure is in terms of baseball. For venture capitalists, home runs matter and strikeouts don't. Out of 20 typical early stage venture capital investments, most may fail. A few will maybe return money back and maybe we'll earn a little bit. And it's only one out of 20 that becomes a home run. In one of my venture capital classes at Stanford, we had one quite famous venture capitalist and he was talking about one of his venture funds that he started back in 1999 and many, many years later, that fund was still going all of his companies, but one failed from that fund. And when students asked that venture capitalist, so that fund was unsuccessful, Right? And his reply was not at all, because there is still one company that actually is doing very, very well. And so that company might become a homra. It's easy to say let's embrace failure. It's much more difficult to implement it in a practical way. So we can think about specific, what we called playbook mechanisms of how you can implement every single principle of the VC mindset, including how you can implement your approach to failure so that indeed you concentrate on home runs and you decide to let go of your strikeouts.
- [04:03]
Kurt Nickish
Before we get into that playbook, let's just talk about this game strategy first. And that is that you're swinging for the fences, to use the baseball analogy of hitting a home run. I mean, that's an economic model that works. But is it wrong for companies to say, let's try 10 things and it's okay if only five of them are moderately successful, but they're not. None of them are big hits.
- [04:29]
Ilya Strebulaev
The way to think about this principle of home runs met and strikeouts don't is not to think about each individual project or each individual experiment, but think about a portfolio of bets that you have. I think when smartbench capitalists make decisions about how they are going to allocate their budget, very often the most important decision is not about a specific startup, but the most important decision about the portfolio allocation. My first reaction is, let's think about your strategy. Maybe you don't take enough risk. So recently I worked with one venture fund that's quite successful or used to be quite successful. And the fund increased almost tripled in size and almost tripled in terms of the number of partners. And the managing partner realized that, well, we're not as successful as we used to be. So they invited me and I looked at their data and I quickly realized that their portfolio allocation strategy changed. They no longer made a lot of risky bets. Well, behind that was another principle of the venture mindset, which is agree to disagree. In that venture capital fund, they used to have three partners, now they had eight or nine partners. And yet they continued exactly the same decision making process they used to have, you know, 10, 15 years ago. And one of the important principles they had is that every single partner should be very enthusiastic about the deal. And with, let's say, nine partners, it no longer works because that means that all nine partners must now consent to invest in the deal. And one of the Specific recommendations from me was you have to change this consensus culture. You have to agree to disagree. By the way, there is a specific playbook mechanism that I recommend, and not just for venture capitalists, but in fact for any organization. And it is called anti portfolio. And anti portfolio means look at the projects that you decided not to implement and have a look at what happened to those projects. And if you are anti portfolio performs better than your portfolio, I think there's a good reason to sit back and think what happened. And in a large organization, it's very similar. You have a lot of internal projects that you then decide maybe not to pursue. Well, have a look what happened to similar projects or similar ideas elsewhere.
- [07:12]
Kurt Nickish
So let's dig into one thing that you just talked about a bit, which was this agree to disagree, which goes against, you know, a lot of companies that are consensus driven. And it goes against just this idea, I guess, that if it's a good idea, everybody should recognize it and come around to it. But if you really try to go with consensus, then you tend to not have very pathbreaking, groundbreaking investments or ventures that you're developing inside your firm. Is that right?
- [07:45]
Ilya Strebulaev
That is right, Kurt. I think consensus is very important in the era of stability, so that when we all know the final goal, we all have more or less the same information, and none of us expect dramatic changes, then consensus is likely the right approach. But once we face what I call unknown unknowns, once in fact the end goal is unclear, for example, maybe we're entering the new market, for example, we are trying to adopt a new technology, then consensus is dangerous.
- [08:22]
Kurt Nickish
I'm curious what specific things venture capital firms do then to get around this inertia, I guess, of consensus? What do they do to actually support that kind of disagreement and that kind of environment where disagreement can thrive and still let people proceed?
- [08:41]
Ilya Strebulaev
They use several very practical mechanisms. The first one is they sign a devil's advocate. You kind of appoint one person or a small group of people to take the opposite view. In fact, in a group decision making, it's very often difficult for people to say, I disagree, especially if somebody else is very enthusiastic about the deal or maybe if the boss is enthusiastic about the investment. So you appoint somebody and let's say, I'm going to say, Kurt, tomorrow we're going to discuss this specific project, and it is your responsibility to come up with all possible weaknesses, all possible reasons why we should not pursue this project. For example, Andreessen Horowitz, a large venture capital firm, also known as a 16Z, very often designates what they call a red team. So they have a blue team that argues for the deal and they have a red team tasked with arguing against a deal. Now, in large organizations that decide to implement a devil's advocate, make sure that you alternate who the devil is. If you are going to be appointed as a devil again and again and again, then in fact your influence is going to be diminished over time. Another mechanism that venture capital firms use is what I call a consensus minus X rule. So let's say, going back to example I gave earlier about a partnership of nine decision makers, consensus minus X. Let's say consensus minus two means is that the investment will be approved even if only seven people are in favor. So you can set this number depending on the size of the investment.
- [10:40]
Kurt Nickish
Aha. So you might even make it smaller than for smaller investment so that even if one person was in favor of doing it, you could do a seed stage investment, for instance.
- [10:50]
Ilya Strebulaev
That is true. That is correct. And in fact, it's not just about seed investment. Let me give you an example. Venrock, which is a very storied venture capital firm, the firm behind investments in Intel, Apple, DoubleClick, and many, many other companies. There are a number of partners and they vigorously debate every deal. And then the partner who initially presented the idea, who is the pioneer of the idea, will have to make the final decision unilaterally. Think about this, Kurt. There are nine partners and one partner will hear all the feedback. In fact, you are facing now eight devils. And then you will have to make your own decision.
- [11:36]
Kurt Nickish
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- [12:22]
Hannah Bates
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- [12:57]
Kurt Nickish
I'm going to mention just a couple of other things that I thought were noteworthy in your article about, you know, improving this decision making process. Number one, a lot of VC partnerships try to keep the team small, right? You just improve communication, you improve the speed. And that adding a lot of people to the decision making process doesn't actually help you that much. They ask for feedback in advance, some of them, so that people can read up on the companies, see the decks ahead of time and then weigh in with their thoughts before they discuss as a group. And they also allow junior members of the team to speak first just so that when the boss speaks it doesn't bias people's opinions or influence the real feedback that they wanted to give. Some of those maybe are good practices that people know about, but I guess it's important to underline, right?
- [13:51]
Ilya Strebulaev
These practices might be well known. It doesn't mean though that they are frequently implemented in large organizations. You mentioned keep teams small. In all venture capital firms, teams are always kept very, very small. But in large companies, very often you go into a meeting room and there will be a lot of people. And sometimes you might ask, what on earth are all these people doing here? In practical terms, think about the following rule that is implemented in Amazon. Now, Amazon is one of those venture backed companies that retained its venture mindset. Amazon has a very simple two pizza team, so that if you're still getting hungry after you consume two pizzas, then the team is too large. It's around eight or 10 people. And I think that there is in fact a lot of research that supports this notion. In fact, there is a lot of research suggesting that maybe the teams should be even smaller. But in a large organization, every single time your decision making team is more than 10, you have to ask a question, why? And most often that will not be an efficient decision. Now you also mentioned asking for feedback in advance. And in most successful venture capital firms I observed that by the way, it is done for a number of reasons. One is because they would like to minimize the influence of authority. Because Kurt, if you're my boss, let's say you are the senior managing partner of the venture capital firm and I'm a junior and I maybe know something very interesting about this startup or about the founder. I have some really value add soft information. If you speak before me, then it's very difficult for me to provide this information if it somehow disagrees with your assessment.
- [15:45]
Kurt Nickish
Yeah. It becomes like you're arguing with that person.
- [15:47]
Ilya Strebulaev
That's right. In fact, where large organizations I think can and should use it is not just when they decide on investments or on projects, but also in the interview process in hiring decisions. Google again, another venture backed company that retained its venture mindset, has a policy. There is an interview committee when you hire people. The policy is you ask members of those committees to record their comments on each candidate individually in advance of the meeting, so that when you meet, you can have a look at what every single committee member independently said. By the way, sometimes venture capital firms go even further. They request anonymity. And there is something else which in my experience I find very counterintuitive for say corporate leaders, is that if we have an expert in the room, the natural tendency is to ask the expert first. I'm sure you've been Kurt in the meetings where people said, well, Kurt is the expert, so let's hear from what he has to say on this topic. Venture capitalists very often do exactly the opposite. They will say, Kurt is the expert on this specific technology or this specific space. You know what, he is going to speak last because, well, you are the subject matter expert, Kurt, which means that if you say something and I happen to disagree with you, it will be much more difficult for me to talk.
- [17:18]
Kurt Nickish
Yeah. So much of decision making in organizations is often about repeating past performance, right? Finding previous patterns and trying to repeat them. It sounds like you're saying the venture mindset is almost trying to divorce yourself from that and be open to exceptions and be open to what's different and what's new.
- [17:41]
Ilya Strebulaev
In the large organization that deals with innovative projects, you always have to think about designing an efficient portfolio allocation and try to avoid making an individual micro decisions on every single investment. So in the corporate VC environment, I think the parent company executives should decide on the total budget. They should decide on the number of investments that can be made. They should overall impose criteria what kind of startups you can invest in, what kind of startups you can't invest in. That depends on the overall strategy of the firm. But my advice is try to avoid making individual decisions.
- [18:30]
Kurt Nickish
The other tip that you have in the article is just to set ambitious timelines. And one thing I hadn't really understood is that a lot of venture capitalists know that these are highly uncertain deals, right? You really don't know how these are going to turn out and in all likelihood most of these are going to fail. So spending a lot of time finding, thinking about it, trying to game it in all these different scenarios, it doesn't actually help you reduce the risk. You Just have to make a decision and move on. And so that's a big recommendation of yours, is just to set ambitious timelines, make decisions quickly on these companies that come to you or these investment opportunities, and just move on and not overthink things.
- [19:16]
Ilya Strebulaev
Kurt, it is my recommendation, but note that I'm not saying that because you have to make decisions quickly, your decisions are going to be inefficient. In fact, venture capitalists came up with ways to make fast decisions very efficiently. And the chapter is titled how to say no 100 times. We do say 100 times because my research shows that for every startup that venture capital firms invest in, on average, they say no. So they turn down hundred opportunities. Just think about this, think about all those thousands of startup investments that they decide not to invest in. And they do it quite efficiently. So very quickly how they do it is that they, the venture mindset thinks about the funnel of all the deals in two different. The first at the top of the funnel, you have a lot of deals. And I think of this as a hundred to ten. Using the automobile terminology, you are going to use a fast lane, which means that you are trying to make a very fast decision here as efficiently as possible. And here is one specific trick that venture capitalists use that I found amazingly efficient. And in all my work with large organizations, I observed that they don't use this trick. Typically, before I explain this to them, they ask a different type of question. The typical question that you would ask, Kurt, is okay, here's an investment, why we would like to proceed with this investment. But in the first lane, 100 to 10 lane, venture capitalists ask a different question. They ask why we should not proceed with this investment. And just by adding not, it completely changes the picture. So that as long as you find a red flag or a critical flaw, you decide not to proceed with this deal and just move on to another investment. But once you go into what I call a slow Lane or 10 to one lane, you switch. And venture capitalists, very often subconsciously, they, in fact they don't realize themselves, they switch from asking one question, why we should not invest, to asking another question, which is why we should invest. Or in fact, as one of my VC friends told me, why are we greedy to invest? And then they proceed into relative slow, still fast, but relative slow, due diligence. And I think that in large organizations you can really implement that approach 100 to 10, 10 to 1, fast lane, slow lane. And so that the questions you are asking or ask your team to investigate are going to be different at the different levels of the deal or project funnel.
- [22:18]
Kurt Nickish
Ilya, I want to ask you something about taking on this VC mindset at companies because it's different for them, right? Like venture capitalists in some ways have it easy because they're not employing those people that are doing this. When those companies fail, they've lost their money, but they don't have to pay severance. Often at companies when you're deciding on an internal venture, there is opportunity cost. You're taking some of your employees who aren't going to be working on other things and then performance engine, I guess, instead of innovation engine to keep running, knowing that these decisions are a little more complex just because of the nature of their business. What do you tell them when they feel like it's just harder or I have these realities that I have to pay attention to. That just doesn't seem to factor for a company that's just investing in companies and doesn't suffer the same externalities that a corporation does with its own employees.
- [23:16]
Ilya Strebulaev
That's a great question, Kurt. First of all, we talked today about several principles of the venture mindset and specific mechanisms, specific ways to implement it for large organizations. Specifically, I think you have to take a parsimonious view. In our book the Venture Mindset, we in fact discuss nine principles. And what I observed especially for large organizations is that all those principles are interconnected. So that you might want to, as a chief executive officer, let's say, or a leader in a large company, you would like to get acquainted with all of them to start with. Because I think that will give you a much fuller picture with how to deal with all those complexities. Another point to keep in mind is that if you change the culture of your organization so that people are incentivized both financially and non financially to pursue home runs in projects in project teams, then it will be much easier to reallocate teams within your company so that if a project fails, as many projects in a large company should fail, it doesn't mean that there will be layoffs, it doesn't mean that there will be severance or separation from workers. It means that your team members are going to be relocated. And indeed many large companies pursue this strategy quite successfully in various industries, not just in technological industries. So in a way I think large organizations, and this might sound counterintuitive, but that is both my observations and outcome of my research, large organizations in fact could use the venture mindset more efficiently than venture capital firms. Exactly. Because first, unlike venture capital firms, they have a lot of resources. They have the budget, they have the people. Also, unlike venture capital firms, in fact they can control better what those internal startups, let's say those intrapreneurs are doing. So in fact, if you exercise just the right dose of control while at the same time allowing a lot of flexibility, in fact, I think the venture mindset in a large company can flourish much more than even in a venture capital firm.
- [25:48]
Kurt Nickish
Ilya this has been really, really interesting with a lot of great takeaways for companies to copy something that's successful in an industry that we can all learn a lot from. Thanks so much for taking the time to share your research and your insights with our audience.
- [26:04]
Ilya Strebulaev
Thank you. Kurt.
- [26:11]
Hannah Bates
That was Stanford Graduate Business School Professor Ilya Strebulaev in conversation with Kurt nickish on HBR IdeaCast. We'll be back next Wednesday with another handpicked conversation about business strategy from Harvard Business Review. If you found this episode helpful, share it with your friends and colleagues and follow our show on Apple Podcasts, Spotify, or wherever you get your podcasts. While you're there, be sure to leave us a review. And when you're ready for more podcasts, articles, case studies, books and videos with the world's top business and management experts, find it all@hbr.org this episode was produced by Mary Dew and me, Hannah Bates. Kurt Nikish is our editor. Special thanks to Ian Fox, Maureen Hoch, Erica Truxler, Ramsey Kabaz, Nicole Smith, Ann Bartholomew and you, our listener. See you next week.