1. Vinod Khosla Kleiner Perkins Caufield & Byers vkhosla@kpcb.com
Organizational Concepts for Entrepreneurial Technology Companies -the cathedral or the bazaar?
Vinod Khosla
Kleiner Perkins Caufield & Byers
Let me start by saying I only know the Silicon Valley style technology companies. 1

2. There’s change and then there is change!
“…every strategic inflection point [is] characterized by a ‘10X’ change …” “There’s wind and then there is a typhoon, there are waves and then there’s a tsunami” - Andy Grove
Andy Grove excerpt:
“... you can’t judge the significance of strategic inflection points by the quality of the first version. You need to draw on your experience. Perhaps you remember your reaction to the first PC you ever saw. It probably didn’t strike you as a revolutionary device. So it is with the Internet. Now, as you stare at your computer screen that’s connected to the Internet, waiting for a World Wide Web page to slowly materialize, let your imagination flow a bit. What might this experience be like if transmission speed doubled? Or better yet, if it were improved by “10X”?
---> the point is that there is still the vast majority of change yet to come with respect to the Internet… let me try and convince you that it is bigger than it seems! 2

3. Visible Signs: Wealth Creation
New company value in Billions
Lets start with the externally visible signs….
First wealth creation...
First 10 years of PC
First few years on Internet 3

4. Visible Signs: Corporate Tech Spending Continues to Rise
U.S.-based Information Technology Spending as a Share of Business Capital Equipment Spending to CQ2:1997
Source: U.S. Department of Commerce. 0% 5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
1960
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PC Introduction
Commercial Internet
The fundamental trend of technology investment as a larger and larger share of all cap ex spending in American business continues unabated.
Technology as a % of all cap ex spending has risen from about 15% in 1980 to over 45% today !
Note: Information technology spending includes purchases of information processing and related equipment (including office, computing, and accounting machinery), computers and peripheral equipment, communication equipment, instruments, and photocopy and related equipment. 4 3 1

5. Visible Signs: Public Pure Play Internet Winners - $ Billion Club
Market
Value (4/98)
Market
Value (3/99)
Yahoo!
Amazon.com
eBay
@Home
Netscape
Excite
$6.3
2.2
n/a
4.0
1.3 B
$34.2
20.8
18.8
14.9
9.7
5.7 B
… investors are voting with their wallets and billion dollar companies are being created. KPCB happens to have reasonable market share of these newly created ventures.
KPCB has 4 out of the 6 $5 billion-dollar market cap Internet companies…
Priced as of 4/22/98, 3/17/99 5 1

6. Visible Signs: Social Change
Years to reach 50M users: 30 60 90
120
‘22
‘30
‘38
‘46
‘54
‘62
‘70
‘78
‘86
‘94
‘02
Users (Millions)
Radio = 38
TV = 13
Cable = 10
Radio
Internet = 5 TV
Cable
Is this just another technology? Or is it a technologically driven social phenomenon? The fastest social change in human history?
I think we tend to overestimate the short run changes but grossly underestimate the long term impact --
Internet
Source: Morgan Stanley. 6 3

7. Behind the Scenes: Changes Economics of Reaching New Customers
Cost per Response/Click-Through
What’s causing the opportunity for these new companies?
A series of factors affecting all aspects of business…
…the cost to reach customers is declining enabling much more cost effective models
…as this curve shows at any reasonable response rate the cost to reach a customer is much lower on the net than through direct marketing
Even with lower click-through / response rates, Net advertising costs much less on a per-response basis!
Source: Direct Marketing Association, Morgan Stanley, KPCB analysis. 7 2

8. Behind the Scenes: Changes the Cost of Serving Customers
Source: Booz Allen Hamilton.
Cost / Transaction
Branch
Telephone
ATM
PC Banking
Internet
Net transactions cost far less than through traditional channels
Investment for a commercial bank to reach 10M potential customers
Bricks-and-Mortar: $900M
The Net: $1M
Even the cost of delivering products and services is declining in many areas..
….shown here is the cost of handling a banking transaction on the internet to the extreme right versus other methods 8 3

9. New customer acquisition
Behind the Scenes: Revolutionizing the way companies interact with customers
New customer acquisition
80% of Dell’s small business Web customers never purchased from Dell before
New channels to the customer
70% of Internet users plan to make travel plans and purchases on the Web
Increased availability to customers
40% of AOL’s merchant online sales took place between the hours of 10 P.M. and 10 A.M.
Building an online customer base
Amazon.com has 6.2M records – mailing addresses, addresses, credit card numbers – of customers who have made purchases on their site
The facts behind the overall statistics are equally surprising!
…80% of Dell customers who purchased on the web had never purchased from Dell before
….store hours are dramatically “extended” on the web, increasing customer convenience while decreasing costs
Source: Company reports. 9 4

10. Behind the Scenes: Brand Building is Changing
Amazon vs. Barnes & Noble
Yahoo vs. Mickey Mouse
SportsLine vs. ESPN
e-Trade vs. Merrill Lynch
C|Net vs. CNBC
CD Now vs. Tower Records
One of the most interesting questions in the consumer market. Brands are being created very rapidly on the net … contrary to conventional opinion
Brands fundamentally replace real information in “product or utility” markets.
When we talk about “image” brands I really view the brand itself as the product (not the underlying pair of jeans which is just a delivery mechanism), and those clearly should be treated differently.
Other than this large exception, will the notion that brands take decades and billions of dollars to build continue to be true?
I heard a statistic a few years ago that 8 of the top 10 brands on AOL were new brands. The traditional brands like Time and CNN did not “take” 10 5

11. Behind the Scenes: Internal Operations are Changing
Savings
$ M
(3 yrs.)
$360M
(annually)
6 Million calls per year
Procurement: GE purchases $1B in supplies over the Internet in 1997
Customer Service: Cisco reports customer service productivity has improved % from using the Internet
Logistics: FedEx reports that PC and Web interfaces are used by 950K customers to track 12M packages annually
Equally important, the internal cost of company operations is being revolutionized by innovative companies like Cisco and Fed Ex.
Source: Company reports. 11 6

12. Behind the Scenes: Communications Networks are Changing
Qwest changing the rules on backbone fiber capacity
Level 3 investing $10B in an all IP network
DWDM growth causing dramatic changes in available capacity
Voice over IP projects proliferate at Lucent, Nortel, Cisco
What is surprising is that we have barely started to see the fundamental enablers of this change manifest themselves - bandwidth and enabling network services will become a lot more prevalent, sophisticated, and affordable
…networks are in for much more change and development in the next five years than we have seen in the last five years! 12 7

13. And at the macro level….
We have a new economy... 13

14. 40% of GDP growth from tech
The New Economy
Conventional wisdom: American dream over. “I’m OK, but my kids...”
40% of GDP growth from tech
Silicon Valley is symbol: <3% unemployed, high wages, every segment moving up
Silicon Valley is state of mind: it’s everywhere, for everyone... 14 8

15. Old versus New economy The New Economy a skill life long learning
managers entrepreneurs
labor v. mgt teams
bus v. environ encourage growth
security risk taking
monopolies competition
job preservation job creation
wages ownership, options
plant, equipment intellectual property 15 8

16. Old versus New economy The New Economy status quo speed, change
standardization custom, choice
top-down distributed
hierarchical networked
regulation pub/private partners
zero sum win win
sues invests
standing still moving ahead 16 9

17. What goals are we designing the organizational form for?
I will mostly speak to the “differences” from traditional organizational requirements…. 17

18. The “Environment” Change as a “process”
A new Competitiveness -Adam Smith II
Technology : “driver” or “tool”
People
Whose Rules?
Static vs. Dynamic - Creation of new markets
Amplification of Events & Time Compression
A “winner take all” economy
In this world managing based on what worked in the past is a recipe for failure… The environment is radically different, and fundamental changes in the assumptions can occur overnight. 18

19. Diseconomies of process / hierarchy
Pace of Change
Diseconomies of scale
Diseconomies of process / hierarchy
Timeliness of information disbursement
The role of standards 19

20. Success Factors - Old & New
People vs. Organization
Process vs. Instinct
Questioning vs. Hierarchy
Leverage vs. Entrenchment
Managing Risk vs. Risk avoidance
Paranoia & Persistence vs. History
Role of Trial vs. Consistency
Best of breed Offerings
1. People - “goose that laid the golden egg”
2. Key questions: “open systems”, “Objective at CV”
3. Leverage - riding somebody else’s wave
(standards & UNIX, XCIT/AMZ -> web)
4. Managing Risk - market, financial, technology...
5. Offerings: Best of breed, Habit preservation
6. Paranoia & Persistence- if at first you don't succeed
7. Role of trial- key especially to new markets and "needs";
most start-ups iterate to success 20

21. A detailed look at the factors….21

22. People: Building the “balanced” team Culture
Internal Factors
People: Building the “balanced” team
Culture
Technostructure & Infostructure
Engineering Methodology
Organized Chaos : Execution vs. innovation.
Pull vs. Push
About Customers & Marketing
Planning & process
1. chain is only as strong as its weakest link
2. misreading your liabilities is more damaging
(your strengths only make you feel good) 22

23. Top 5% - “winner take all” Instinct & Vision Personality mixes
People
Top 5% - “winner take all”
Instinct & Vision
Personality mixes
Role of the “Flakes”
Leading vs. managing 23

24. Persistence & iteration Tolerating mistakes & rewarding failure
Culture
Setting the goals
Managed Conflict
Persistence & iteration
Tolerating mistakes & rewarding failure
Sense of urgency
Paranoia
Success & Complacency
1. Setting the goals:
-Think big act small
- Strong belief in oneself & the role of foolishness
3. Tackling problems head on - Highsiding in rafting
4. Persistence: if at first you don’t succeed....
5. Tolerating mistakes - Iterating to success
6. Sense of urgency: Ready, Fire, Aim!
7. Paranoia - Sense of vulnerability (Andy Grove)
8. Success & complacency 24

25. Technostructure & Infostructure
Specialization and complexity of technology
Decision-making: top down or bottom up?
The role of the “fringe” employee.
Nuances as Pitfalls
Horizontal and vertical communication & cooperation.
Andy Grove excerpt:
One last lesson, and this is a key one:
It seems that companies that successfully navigate through strategic inflection points have a good dialectic between bottom-up and top-down actions. Bottom-up actions come from the ranks of middle managers, who by the nature of their jobs are exposed to the first whiffs of the winds of change, who are located at the periphery of the action where change is first perceived (remember, snow melts at the periphery) and who therefore catch on early. But, by the nature of their work, they can only affect things locally: The production planners can wafer allocation but they can hardly affect marketing strategy. Their actions must meet halfway the actions generated by senior management. While those managers are isolated from the winds of change, once they commit themselves to a new direction, they can affect the strategy of the entire organization.”
...while Intel’s business changed and management was looking for clever memory strategies and arguing among themselves, trying to figure out how to fight an unwinnable war, men and women lower in the organization, unbeknownst to us, got us ready to execute the strategic turn that saved our necks and gave us a great future. 25

26. Engineering Methodology
Evolvability
Specialization
Experimentation
Change isolation 26

27. Organized Chaos: The Shepherd or the Sargent?
The Flakes vs. Engineering vs. Marketing
Experimentation
Execution
Budgets, Schedules, Tasks vs Project Stage 27

28. Push vs. Pull
Products
Brands
People
Leverage 28

29. Changing Roles: Marketing & Customers
Listening to the customer
Participants in Design / Experimentation
Meeting vs. Teaching Requirements
Discovering “Applications”
Growth Patterns: the “stairstep”
Perception & Reality; the Halo effect
Momentum 29

30. Risk Balancing & Burn Balancing Risk Balancing of Projects
Planning & Process
Process vs. Instinct
Risk Balancing & Burn Balancing
Risk Balancing of Projects
Planning & Variability
Andy Grove excerpt:
“Simply put, in times of change, managers almost always know which direction they should go in, but usually act too late and do too little. Correct for this tendency: Advance the pace of your actions and increase their magnitude. You’ll find that you’re more likely to be close to right.
“But you can’t wait until you do know: Timing is everything. If you undertake these changes while your company is still healthy, while your ongoing business forms a protective bubble in which you can experiment with the new ways of doing business, you can save much more of your company’s strength, your employees and your strategic position. But that means acting when not everything is known, when the data aren’t yet in. Even those who believe in a scientific approach to management will have to rely on instinct and personal judgment. When you’re caught in the turbulence of a strategic inflection point, the sad fact is that instinct and judgment are all you’ve got to guide you through. 30

31. “The early movers are the only companies that have the
Optimized for what?
“The early movers are the only companies that have the
potential to affect the structure of the industry and to define how the game is played by others.”
-Andy Grove
Andy grove-
Being an early mover involves different risks. The biggest danger facing an early-mover company is that it may have a hard time distinguishing a signal from a noise and start to respond to an inflection point that isn’t one. Moreover, even if it is right in its response, it is likely to be ahead of its market and will run a greater risk of getting caught up in the dangers of the ‘first instantiation,’ as described in Chapter 6.
But offsetting these dangers is the possibility of greater rewards: The early movers are the only companies that have the potential to affect the structure of the industry and to define how the game is played by others. Only by such strategy can you hope to compete for the future and shape your destiny to your advantage.” 31

32. Case Study: Open Source32

33. Evolvable Systems: Cathedral-building
The traditional development model reflects the “cathedral-building” model...
Follow a single approach and vision
Optimize for performance
Release only bug-free products
Products and technologies are developed in isolation
Examples: IBM System/360, MSFT Windows platform, Intel Pentium, AT&T network 33

34. Evolvable Systems: the Bazaar model
The new development model is evolving to the “bazaar” model...
Optimize for evolvability
Adopt new approaches and agendas regularly (“plan to throw it away”)
Delegate/buy/outsource everything you can
Be open to the point of promiscuity
Release early, and often
Products and technologies have to exist in a dynamic community
Examples: Linux, Apache, Sendmail, Excite, Microsoft (the company), QWEST/Williams networks
Only thing certain is Uncertainty
Remember Video-On-Demand, OS/2, Lotus 1-2-3, Interactive TV….
Applications (pull) NOT technologies (push) drive demand
Some examples: MVP voting, application outsourcing, compute farms, Hotmail…
Rate of change is accelerating!
Plenty of market & technology inflection points remain
Implications: Design for flexibility & adaptability 34

35. Innovation, opportunities & entrepreneurship will thrive
Weather Forecast
Rate of change will accelerate - life will be more complex, more busy...
Innovation, opportunities & entrepreneurship will thrive
Fun & fortunes will be in abundance
Adaptability, agility & momentum will be the key to success!
remember - it is not the only thing, not even the main thing….family , relationships, enjoyment are to me at least more important
story of the lawyer (Stevens story) 35

36. -F.E.Terman, Vice President, Stanford University
“As long as we maintain the practices that have us made us what we are today, there is no limit to the longevity of this situation”
-F.E.Terman, Vice President, Stanford University 36

37. Comments? vkhosla@kpcb.com37

38. KPCB
Who we are:
a handful of professional technologists and operating execs - not financiers
portfolio of 340+ companies with $244B+ market cap, $61B+ revenue, 162k+employees, 127 IPOS
Forbes 500: Sun, Compaq, LSI Logic, Ascend, Quantum, Linear Technology, Amazon, Tandem, Lotus, Netscape, Intuit 38

39. What we look for: KPCB People Unfair advantages Risk up front
Characteristics: sense of urgency, corporate partners, home run swings
Defensibility in critical mass, technology, franchise, content, distribution
Shared upside & simple structures 39

40. What we do: KPCB Technology oriented, pioneering industries
IPO oriented big companies
Incubations, early stage, speedups
Co-ventures 40

41. What we bring: KPCB Company building experience
Experience with pitfalls of new markets, technology management...
Credibility
Relationships
Repertoire of mistakes
Knowledge of industry trends 41

42. 42

43. The Internet: Does It Change Everything?
First two way mass communication medium
The phenomenon: fastest social change, largest legal creation of wealth
Adam Smith II - efficiency & economics revisited
Role of information & infomediaries
Changing economics: distribution, specialization, narrowcasting
Technology driving business strategy
New Models: Excite, Amazon, Priceline, Ebay, Preview, Home Grocer, Della&James... 43

44. The Internet: Does It Change Everything?
Corporate culture & infrastructure: “real time”
Fastest social change and largest legal creation of wealth (Cisco, Dell)
Tight feedback loops
Ideal for experimentation (Vs. planning)
Leverage
People as the killer app 44

45. The Internet: Does It Change Everything?
This is a winner-take-all economy ...
Winners and losers diverge quickly
Adaptability, agility, momentum, and execution are the keys
Examples: Amazon/Barnesandnoble.com, MSFT/Apple/IBM/Lotus, Cisco/Bay
Andy Grove excerpt:
in this hyper-competitive horizontal world, opportunity knocks when a technology break or other fundamental change comes your way. Grab it. The first mover and only the first mover, the company that acts while the others dither, has a true opportunity to gain time over its competitors--and time advantage, in this business, is the surest way to gain market share. Conversely, people who try to fight the wave of a new technology lose in spite of their best efforts because they waste valuable time. 45

46. Knowing what you don’t know Whose opinion ?
Key Principles
Knowing what you don’t know
Whose opinion ?
Identify your liabilities & assets
Knowing what you don’t know: biggest asset; common mistake
Everybody has an opinion: value of differing, source of opinions
(Excite sale story)
Minimize your liabilities & maximize assets- more on this later
Assess the Costs
-Personal time, effort
-Risk
-Do you really want it
Being Realistic: Questions
Scale of thinking: $0 Vs. $0M Vs. $0B
What is your competitors view of you
Competitors present Vs. your future
How would you compete against yourself?
Why are you better & why are you worse?
What are outsiders opinions : VC’s, recruits? 46

47. Comments? vkhosla@kpcb.com37