Complexity As A Moat

Judy Faulkner, founder and CEO of Epic, had a good blog post the other day titled More Complex Than Rocket Science where she talks about the complexity involved in healthcare IT. From the post:

"My favorite t-shirt says, “Healthcare IT is more complex than rocket science.” The three Epic employees who used to work in rocket science agree."

Healthcare IT is absolutely super complex. And that complexity creates a ton of challenges for founders trying to get their idea into market. But that complexity is also an advantage in that it creates a moat around a business where it's very difficult for a copycat to come along and recreate what the company is doing. For example, if you're doing automated care management for cystic fibrosis (CF), you need to wrap your head (and your product) around specific nutrition insights, medications, lung function testing, infection management, psychological support, financial aspects of CF care, and then roll that into a service with some technology wrapped around it. And that's just to build a useful product, never mind the challenges associated with taking it to market.

The upside of the pain in taking a healthcare product to market is that often the product/market fit you’ve found is its own moat.

Perseverance As A Competitive Advantage

One of the questions startups frequently get from prospective investors is: why won't the big incumbents (Epic, Cerner, or whoever) just do what you're doing and put you out of business? This is always a difficult question for a founder to answer because the reasons often aren't obvious and can be hard to describe. The difficulty of bringing something new to the market is typically underestimated, and the details really matter. And often, these details aren't well understood by a casual observer. See this excellent post that Chris Dixon wrote back in the day on what he calls the Idea Maze to understand why the answer can be hard to understand from the outside.

I was chatting with an investor last week who had a good way of summarizing why startups have one fundamental advantage over incumbents: they simply can't afford to quit.

For a startup, failure isn’t just a setback—it can mean the end of the business, the loss of investor money, and reputational harm to the founder. This makes persistence almost a necessity.

Large companies, on the other hand, often have a lower threshold for pulling the plug. If a new product doesn’t show quick growth or the market looks small, they cut their losses and move on. For them, it’s just another line item in their budget; for startups, it’s survival.

This urgency forces startups to be more resourceful, nimble, and focused. Where big companies might give up too early, startups are far more likely to push through.

And very often, that’s where the real breakthroughs happen—not because they have more resources, but because they have no choice but to persevere.

Of course, this topic is way, way more complicated. And I'll write more about it at some point. But sometimes, it's simply the refusal to quit that makes all the difference.

Thoughts On Founder Mode

Paul Graham's essay on Founder Mode made the rounds around tech Twitter and other places this week. The thesis, in short, is that there are two distinct ways to run a company: "founder mode" and "manager mode." The latter — which says, broadly, hire good people and give them room to do their jobs" is the conventional method taught in business schools, but it often fails for founders. Founder mode, still largely undefined, involves more direct engagement and breaks traditional management principles. The founder should dig into all of the important stuff and, in a sense, micromanage it. 

There are a ton of opinions flying around about this, which is somewhat surprising given how short and vaguely the concept is described. After reading it, two thoughts came to mind:

1/ Leaders are measured on the output of their organization. There are multiple ways to achieve an outcome based on the leader's skills, talents, organizational structure, markets, competitors, environment, etc. Concluding that one style is better than another in all cases, or even most cases, seems like a mistake. 

2/ Personally, I've found that one of my greatest skills is recruiting, engaging, and retaining incredibly driven and talented leaders. I spend an enormous amount of time and energy on doing so. The result for me has typically been to have teams that don't need to be micromanaged and can produce results at extremely high levels while feeling empowered, engaged, independent, and supported to do great things. If I didn't have this skill — or I didn't focus on improving it — I might be more inclined to micromanage as that would be the thing that would drive results.

I wrote about my approach to this in my User Guide six years ago, most of which remains true today. Relevant excerpt:

“Micro-management vs. Hands-off:

I definitely fall on the hands-off side of this spectrum. My high-level theory is that I try to hire superheroes that are going to figure out what needs to get done and will go get it done. When we aren’t hitting goals I will seek more information and transparency. There’s a see-saw dynamic here: good results means I need less information and transparency, poor results means I need more information and transparency. Understand this and manage to it. Get ahead of my concerns.

I don’t like micro-management and I don’t need all the detail. I’ll generally let you decide how much detail I need. I prefer that you consider me your thought partner and you should provide me with enough detail to do that. I don’t want to measure your inputs but I want to understand them.

Frameworks are very important to me. I’ll often be less interested in the decision you made and more interested in the framework you used to make the decision.”

As leaders, we need to leverage our strengths, minimize our weaknesses, and operate in a way that's going to produce results. There are probably a thousand different styles and equally as many ways to brand those styles. The fact is, most of us pick from them as needed. The real skill isn't in choosing a management style and sticking to it; it's using the style and management tools that work for us in the right place at the right time to produce the most optimal outcomes.  

Growth Endurance, Benchmarks, & Horizontal SaaS vs. Vertical SaaS

Investors will often refer to SaaS benchmarks to gauge how well their portfolio companies are performing. They'll look at things like growth rate, CAC/LTV, gross margin, EBITDA margin, net revenue retention, etc. They'll often cite the most successful companies like Monday.com, Zoom, Hubspot, ServiceNow, and Zendesk. These are all top-tier SaaS companies, and investors like to have their companies aspire to have similar metrics. 

These companies, and nearly all of the top-tier SaaS companies, have two important things in common:

1/ They can sell into virtually any company in any industry (horizontal SaaS). 

2/ They can sell into virtually any country. 

As an example, in theory, Zoom could sell a license to everyone over the age of 18 with an internet connection — let's call that about 3.5 billion people. So their overall total addressable market (TAM) is 3.5 billion multiplied by, say, $100 per year. So Zoom's TAM is something like $350 billion.

Now consider a healthcare technology company that operates within the complex, highly regulated US healthcare system (vertical SaaS). They have a much smaller TAM than Zoom. There are about 21 million US healthcare workers, so, in theory, if a health tech company could get its product into every healthcare worker’s hands at $100 per year, their TAM would be $2.1 billion, about 0.6% of Zoom's TAM. Obviously, I'm using ridiculously simplistic numbers.

This becomes relevant when we start thinking about benchmarks, particularly with regard to growth and growth endurance (the ability of a SaaS company to sustain consistent growth over time).

Consider Everett Roger's Technology Adoption Curve, which illustrates how different groups adopt new technologies over time. 

You start by acquiring the innovators, then the early adopters, etc. As you move through the curve and gain more and more customers, each sale typically gets more and more difficult. The first two parts of the curve (innovators and early adopters) generally represent about 16% of the addressable market for the technology.

So, using the examples above, when the health tech company gets to 16% of the market, its revenue is $336 million. When Zoom gets to $336 million in revenue, it hasn't even made a dent in the innovators and early adopters. It has another $349,664,000,000 in innovator/early adopter revenue to go get. 

If an investor benchmarked the health tech company against a horizontal SaaS company like Zoom on things like growth, growth endurance, or the cost of acquiring a marginal customer, they'd be very, very disappointed. To say the least!

Now, obviously, it’s on the health tech company to figure out how to innovate, sell its product to a wider audience, and go international, but the point here is that we're not talking about apples to apples. Benchmarks that don't take into account the uniqueness of a business or a particular industry are, at best, a waste of time and, at worst, create really bad incentives for founders and management teams. 

Who Should A Company Serve?

A reader responded to my Hospitals & Financial Engineering post, where I made the case that hospitals should be protected from various financial engineering tactics that allow for short-term profits for investors that result in major challenges for the company in the long term. From my post:

”I'm a big fan of capitalism, and I generally support the work of private equity firms in delivering returns to their shareholders, many of which are large pension funds, endowments, and foundations. But Steward's collapse is an important signal that our most important and prized institutions shouldn’t be operated as attractive targets for short-term, financially engineered profits.

Hospitals are different. They're a special thing. And regulators should ensure they're treated that way.”

The reader asked: Shouldn't these regulations apply to every company? Why just hospitals? Should private equity investors be allowed to hurt any company in the interest of taking their own short-term profits?

It was with this question in mind that I came across this piece in the WSJ, titled Private-Equity Firms Desperate for Cash Turn to a Familiar Trick. The piece points out that private equity deal volume is way, way down since the increase in interest rates. There just aren't that many deals happening in this environment which is making the investors that invest in private equity firms rather anxious. They'd like to start to see some returns and get some liquidity. Because private equity is illiquid and doesn't trade in the public markets, these firms can't get their investors liquidity until they sell the companies they invested in. But this isn't a great time to sell; it's hard to do because of the low volume, and you might not get a great price. 

So, to give their investors liquidity, private equity firms are doing what's called a dividend recapitalization. That is, some firms are having their companies take on a large amount of debt and then taking the cash and giving it to their investors in the form of a dividend. From the piece:

”Among the largest dividend recaps so far this year is a $2.7 billion recapitalization by auto-body repair center Caliber Collision, according to data from PitchBook LCD. The company is backed by investors including the private-equity firm Hellman & Friedman. A report from S&P Global Ratings said the money was used to pay existing debt and distribute a $1 billion dividend to its equity holders.

In March, rail and transportation services company Genesee & Wyoming completed a roughly $2.7 billion recapitalization. The company, backed by investors including Brookfield Infrastructure Partners, used the transaction to pay a $761 million dividend, according to S&P.”

So investors get some short term return and liquidity without the PE firm having to sell the company. This leaves the company with a new, potentially very large debt obligation without a corresponding asset to show for it. So you're potentially hurting the company in the long term in the interests of short-term profits for investors.

Similar to the point I raised in the hospitals post, are these transactions that benefit investors in the short term at the cost of the company's health in the long term ethical?

Rather than answering that question directly, I think it's worth first asking who a company is meant to serve. A company isn't a living thing, so it technically can't be hurt by or benefit from such decisions. What a company actually is is a set of stakeholders who have an interest in it: leadership, employees, investors, vendors, customers, and the community. 

That's a lot of stakeholders with different incentives and different desires and timelines for the company. Who should the company serve first?

The technical, business school answer is that a company's purpose is to maximize returns for shareholders. Not employees. Not management. Not future investors. So if you believe that, and the company's board believes that taking some cash out of the business — by putting a lot of debt on the balance sheet that might harm employees in the long term and might result in less return for future investors — is good for current investors, then that's what they should do. 

Again, without taking a side in these debates, the point I'm trying to get to is that as an investor or operator, it's important to zoom out and remember who the company is trying to serve. The answer can be different depending on a variety of factors such as its industry, stage, and the way it’s financed. And seeing these very public financial engineering tactics brings this issue front and center. Getting alignment and transparency around this point is crucial in aligning all stakeholders and managing difficult tradeoffs so management and boards can make good, consistent, clear-minded decisions in the short and long term.

Growth, Innovation, And Knowing Who You Are

On a podcast the other day, Ben Thompson made the point that Meta (Facebook) has taken a lot of heat in that they haven't innovated and built a great new product in a long time. Sure, they have Instagram and WhatsApp, but those were acquisitions, they didn't build those products themselves. 

He made the point that the mistake wasn't that Meta didn't create great new products; it's that they even tried.

Thompson noted that creating big, new products that scale is not only extremely difficult but also almost never works. Of all the ideas that new founders have and that existing companies try, very, very, very few make it. A better strategy for a mature and cash-flush company like Meta is to let its innovative employees leave, raise venture capital, build great products, and acquire the ones that work.

This last point is so important and can’t be overstated. Startups have such an advantage when it comes to innovation.

1/ They have full focus from their best people. When companies get big they have so many competing priorities that have nothing to do with innovation. I imagine a top 3 priority for Meta right now is dealing with international regulators. What an incredible distraction that no startup has to deal with.
2/ Failure isn’t an option. If a product leader inside a large company fails they move on to the next thing. If a startup fails, the company dies.
3/ They have unlimited freedom. They’re not constrained by customer commitments or burdens and processes and systems that were setup in the past. They have full freedom to be flexible and innovate.

All of this is to make a larger point. You have to know who you are. I see this challenge a lot with companies that succeeded through the low interest rate period and are looking to get back to high growth. They look at Rule of 40 and say, let's get to 30% growth and 10% operating margin because investors still favor growth companies over profit-focused companies. Related, see this great chart from Logan Bartlett at Redpoint. It shows the multiple of the importance of growth vs. profitability. In February of this year, the market valued a point of growth 2.9x more than a point of free cash flow. Obviously, it's nothing like it was in 2021, but you can see that investors are still very growth-focused. 

Boards and leadership teams know this and are setting their companies up to plug into higher valuations. But, many of those companies have saturated the market for their core products and don't have a great second act. It's time for many of these companies to flip the switch to a focus on EBITDA and free cash flows. 

Obviously, every company is different. And if you have a great idea and a great team that can execute on innovative growth and the management capacity to go all in and the risk appetite for it, then, by all means, go for it. But remember that we all have egos, and it’s easy to get caught up in what’s exciting versus what we’re capable of and what’s best for the company. We all want to be on the growth side of Rule of 40. Operational efficiency isn't as exciting as launching a giant new product. That's a lot more fun, and you'll get a lot more credit. But it might not be right for you right now. 

You have to know who you are.

SaaS vs. SaaS Margins

The concept of SaaS was launched in the 1960s, though it didn't really gain traction until Salesforce was founded in 1999. It didn't get widespread adoption until the 2010s. Today, it's a standard for how businesses use and buy software. 

SaaS was distinct from traditional, on-prem software in 4 main ways:

1/ Deployment location. The software was hosted on the vendor's cloud servers rather than the customer's servers. 

2/ Subscription pricing. SaaS typically uses a subscription model where users pay a recurring fee that includes maintenance, updates, and support, as opposed to on-prem where there's a large one-time fee, and then additional charges for updates. 

3/ Accessibility. SaaS products can be accessed from any internet connection, whereas on-prem typically can only be accessed inside a company's network.

4/ Customization. SaaS customers rely on the vendor for new features and configurations, whereas on-prem offers far more flexibility to meet specific customer needs. 

As a result of these and other distinctions, SaaS has become extremely attractive from an investor perspective. These companies generate recurring, high margin revenue that grows consistently as the company's customers grow. That equates to higher cash flows than traditional software products, which result in revenue multiples of around 10x for high-growth (30%+) SaaS companies.

Regarding these attractive margins, the most relevant feature is the fourth point: customization. Internet-based companies can become enormously profitable because the marginal cost of adding an additional customer is near zero. It costs Google almost nothing to add an additional user or search advertiser. SaaS is similar. Adding a new customer to Zoom costs Zoom next to nothing. Compare that to an office supply company. In order to add a new printer, the customer has to source parts, manufacture, sell, and ship a printer to the customer. That's a lot more work than adding a new user to Zoom. 

In order to maintain SaaS-like margins, SaaS companies have to limit and constrain their customers' ability to customize the product, ideally down to zero. The moment a SaaS product starts to build custom features for its big, important, strategic customers is the moment the company starts to lose the high-margin, near-zero marginal cost benefits of the SaaS model. Even if it charges very high prices for these customizations, the margins can get lost over time because the customizations have to be serviced in perpetuity and aren't amortized across thousands of customers.

Inevitably, every SaaS company will feel pressure from customers to customize. The high-margin, successful SaaS companies have resisted this pressure by creating roadmaps and features that satisfy most customers and/or have built configurable products where the customer can make their own customizations. Ideally, the customer actually likes the lack of customization because they pay less, but that won’t always be the case.

You could break software up into three distinct categories based on the amount of customization allowed for and the corresponding margins. 

SaaS software - High Margin (Hubspot, Zoom, Docusign)
Enterprise software - Medium Margin (SAP, Cisco, Oracle)
Custom software - Low Margin (Accenture, Infosys, Tata)

All of this is to say that there's nothing wrong with lower-margin software as there's an enormous market for it, and the growth inside of those markets could easily offset the lower margins in terms of cash flows. But it's really important to know which market you want to serve and to make a deliberate decision and stick to it. I've seen lots of companies that think of themselves as SaaS because their software runs on the cloud and their revenue is recurring have a roadmap full of customer customizations. I suppose you can call that SaaS, but it won’t have traditional SaaS margins. And that’s ok. But the decision to do so needs to be made deliberately with eyes wide open to manage the difficult tradeoffs associated with growth and profit.

Hospitals & Financial Engineering

I haven't written much on the business of healthcare lately, but this Steward Healthcare situation is both fascinating and troubling. For those that haven't been following, Steward recently filed for bankruptcy and is threatening to close hospitals in high-need parts of Massachusetts, and a formal federal investigation into the actions of the CEO and private equity firm that formerly backed the health system seems likely. This news raises real questions about the appropriateness of hospitals operating as private equity-backed for-profits and the financial engineering that comes with such transactions, especially hospitals that operate in underserved communities.  

Steward Healthcare

Steward Healthcare, a for-profit hospital chain, launched in 2010 when private equity firm Cerberus Capital Management (named after Cerberus, the three-legged dog that guards the gates to hell) acquired the failing non-profit Catholic healthcare system Caritas Christi located in Massachusetts. The CEO of Caritas, Ralph De La Torre, became CEO of this new health system. Steward’s name was a symbol of how it promised to be a good steward of the hospitals formerly owned and operated by the Catholic church.

Steward's Strategy

Hospitals might not strike you as a great investment for a private equity firm, so you might wonder what the appeal was for Cerberus. Hospitals have very low margins (generally less than 5%) and sometimes operate at a loss through government subsidies. But Cerberus saw that one could think of Steward, or any hospital chain, as two separate things: 1/ a large hospital operation serving patients and 2/ a highly valuable set of real estate located in population centers that the hospitals sit on. 

Real estate as an investment is a much more lucrative business than a hospital operation. A real estate investment trust (REIT), a company that owns, operates, or finances income-producing real estate, sees 25% to 50% margins. Cerberus saw that Steward could get significant and quick liquidity by selling the real estate that the hospitals were sitting on to a REIT, in this case, a firm called Medical Properties Trust (MPT), and then leasing the property back. This is known as a sales-leaseback. To juice the price of the real estate, Steward agreed to very favorable leases. MPT paid $1.2 billion for the initial properties and also took a 5% stake in Steward. All of the details of these leases aren't clear, but these were expensive, long-term leases with escalator clauses and with other terms that MPT must have liked, including a triple-net lease where Steward would be responsible for the cost of insurance, property management, and maintenance, in addition to the rent.

The strategy was clearly great for MPT as it immediately expanded its assets under management with reliable, lucrative leases. And it was also good, in theory, for Steward. Steward would gain instant liquidity to help it pay down its debt from the Caritas Christi purchase and acquire more hospitals and medical offices across the country. The properties, as they were acquired, were promptly sold to MPT and leased back. And by not being burdened by managing the real estate, Steward could focus on optimizing its hospital operations. 

Steward aggressively pursued this strategy, growing up to 40+ hospitals across multiple US states and even expanding the strategy internationally into Colombia, Malta, and the Middle East.

The problem was that as Steward was rapidly acquiring and selling real estate, much of the proceeds from these real estate sales never got to Steward. Some of it went to hospital operations and paying down debt, but large amounts of it went back to Cerberus in the form of management fees and dividend payments. And that left Steward without much of the proceeds of the sale and with highly burdensome lease obligations. 

Cerberus Exits 

In 2020, Cerberus exited its position in Steward by selling its stake to De La Torre and other Steward physicians via a loan from MPT. Over the course of its ownership, it was reported that Cerberus made a profit of $800M. 

It was downhill from there. Steward quickly began to downsize, selling off hospitals across the country. By January of this year, Steward was facing a financial crisis. It owed MPT $50 million in unpaid rent, among several other vendors. MPT, presumably to keep the gravy train running, stepped up and offered several loans to Steward to keep the health system solvent. It was soon reported that Steward would be forced to file bankruptcy and close a number of hospitals, which then launched a series of investigations into Steward's operations and financials, which brings us to today, where hospitals in high-need areas are at risk of closing, creating a potential public health crisis in Massachusetts. 

What's Next

What happened here, in short, is a smart private equity firm saw an opportunity to buy up a struggling health system for small dollars, sell off the valuable real estate it sat on, and maximize those sales by saddling it with costly leases and using the proceeds from the sales to pay itself and expand this strategy across the country and the world. Then it sold off the entire asset, leaving the real estate owner (MPT) and Steward's management and employees in the lurch.

To be clear, It's not obvious that any of this activity is illegal (it's probably not). And in most industries, you could argue business is working as it should. Steward likely wasn't a great business at the start, and finding a way to maximize the assets of an investment seems like good old-fashioned capitalism. If Steward was a tech company or an apparel company, it’s likely nobody would know about this mess.

But it's not. It's a health system that operates dozens of hospitals in high-need areas. Hospitals that represent our society at its best. These are places of healing for humans facing the worst moments of their lives. They restore health, reduce human suffering, and support the overall well-being of the communities in which they operate. Not to mention, they generally receive at least half of their revenue from tax payer-funded healthcare. Because of that, I think regulation of these kinds of transactions and even for-profit hospitals, in general, are set to receive some intense scrutiny from regulators in the coming months. De La Torre is scheduled to testify in front of Congress in September.

I'm a big fan of capitalism, and I generally support the work of private equity firms in delivering returns to their shareholders, many of which are large pension funds, endowments, and foundations. But Steward's collapse is an important signal that our most important and prized institutions shouldn’t be operated as attractive targets for short-term, financially engineered profits.

Hospitals are different. They're a special thing. And regulators should ensure they're treated that way.

Risk, Reward, And Working In Tech

The other day, I was chatting with a guy who works at a restaurant down the street in the South End of Boston. He was telling me it was his last couple of months at the restaurant as he had just graduated from college.  He said he wanted to get his money's worth for all the money he spent on college, so he was going to get a higher-paying job in residential property management. He seemed like a sharp guy, so I had this impulse to tell him to get into tech. But I hesitated and decided not to. 

I sometimes forget that tech requires a certain personality. A high tolerance for risk. And I didn't really know the guy, so it didn't feel right to try to direct him one way or the other. 

With the relatively high salaries in tech, flashy products, and nice perks, it's easy to forget how volatile and risky the space actually is. It's definitely not for everybody. And if you're not the type of person who can handle booms and busts, stay away. There are plenty of other less lucrative but far more stable jobs to get into. 

It's worth remembering why this is. Tech companies, by definition, are investing in high growth that comes from new ideas. Investing in new ideas is risky. They often don't work. The greater the risk, the greater the potential reward. In boom markets, working in tech is great. In busts, it's not. I’ve been through 4 of these downturns in my career — the 2000 dot-com bust, the 2008 Great Financial Crisis, Covid in 2020, and the end of the low interest rate period in 2022. None of these were fun, and all of them came with a great deal of professional stress and anxiety.

Because of things outside of your control, such as interest rate changes, investor sentiment changes, geopolitical events, new technologies, government policies, etc., tech markets are inherently cyclical. And the risk takers that are putting capital into new ideas always feel downturns first, because that's the capital that investors will pull out and put into safer, less risky investments.

Before embarking on a new career in tech, make sure you understand this reality and are up for the dramatic ebbs and flows in your day-to-day life that are a natural, unavoidable part of working in this field. 

Investor Alignment

Managing different investor priorities, objectives, and incentives is one of the most difficult things to do when leading a company. I wrote about the importance of understanding your investor's context and incentives a while back. Even at the venture stage, your angel investors and VCs may have very different ideas on how they define a good outcome. Depending on their own situation, some may be taking a very long-term view of the investment; others may want a shorter-term win. This intensifies significantly as you transition into the growth stage and, ultimately, an IPO, at which point you can literally have millions of investors with competing needs and priorities.  

To help manage this, someone once told me that in a board meeting, I should try very hard to step out of my own incentives and not behave on behalf of Brian Manning but instead behave on behalf of the company. The company has no voice. Everyone in the room has their own incentives and that's typically what they represent. It's important for someone to step up and speak for the company. 

This sounds like great advice, but it's almost impossible to do because how does one define the incentives of the company when the incentives are really a bundle of competing self-interests? This makes driving investor alignment extremely difficult. 

As a leader, your job is to maximize shareholder value, but on what timeline? Should you optimize valuation for a year from now or 3 to 5 years from now? Depending on your answer, your short-term goals and actions will vary significantly. You might say your job is to drive value over the long term. But what is the long term? Should companies seek to stay in business forever at the cost of shorter-term returns?

In the early stages, to help manage this, I've found it's enormously useful to optimize around funding rounds — seed, Series A, B, C, etc. Leaders should set specific goals associated with the next raise. As an example, a team at a high-growth startup might say they want to raise their Series A in December of 2025, and by that point, they want to have:

• $X in the bank

• $X in revenue

• $X in monthly burn rate

• X% growth

• X in headcount

• X in number of customers

• X, Y, and Z in product milestones

• $X in company valuation (this one will obviously be a loose estimate based on some market-driven multiple)

• X gross margin, Y operating margin (though these should be prioritized after product/market fit, burn rate, and cash are more of the focus early on)

Leadership should then be transparent with the board and investors about these metrics so everyone knows what the company is chasing. Leaders and even front-line employees should know these metrics and keep them top of mind. While this approach is far from perfect and won't align all of the different competing interests, transparency and disciplined tracking against clear metrics is a huge step forward in managing the day-to-day tradeoffs and difficult decisions that come with running a company. 

Capital Markets & The Technological Surge Cycle

As the stock market continues to reach record levels despite a number of economic headwinds, I can’t help but think back to a framework offered by Carlota Perez known as the Perez Technological Surge, first introduced to me by Fred Wilson. Perez studied all of the technological revolutions of the past and found that there are two phases in every major technological revolution: the installation phase and the deployment phase. The installation phase is when the technology comes to market and is often coupled with a big boom as investments pour into the hot new thing, followed by the deployment phase, where all kinds of applications are built on top of the underlying technology that actually delivers on its promise. But between the two phases, there’s a turning point that leads to a substantial crash in capital markets associated with the technology as the hype and capital inevitably get ahead of the practical use of the technology.

I started my career almost right in the middle of the turning point of the internet’s deployment and installation. Everyone knew what the internet was, and the world was enormously excited about it. The cables had been laid in the ground, broadband was widely available, and the NASDAQ was at its all-time high as capital poured into unprofitable and pre-revenue internet companies. I had recently graduated from college and was living in San Francisco when the turning point hit: markets crashed, we felt lots of pain, and then we moved to the deployment phase where all kinds of applications that we never could’ve imagined and, in many ways, changed our lives were built on top of the rails of the internet (Uber, Airbnb, Netflix, Zoom, etc.).

The most interesting thing about the deployment phase is how many applications and businesses you never would’ve imagined or associated with the technology get built on top of the technology. Perhaps the best example of this is the automobile. With the deployment of the automobile came the typical hype and over-investment and then a long and fruitful installation phase where an enormous number of applications were built thanks to human creativity and ingenuity. Consider Walmart, which at one time was the largest US company. Walmart was an output of the deployment phase of the automobile. Without the automobile highways couldn’t have existed and without highways suburbs couldn’t have existed and without suburbs Walmart and large shopping centers couldn’t have existed. Surely, Henry Ford wouldn’t take credit for inventing Walmart, but perhaps he should have.

Coming back to present day, the stock market continues to thrive through all kinds of headwinds and setbacks and I can’t help but think much of this is still the exhaust of the technological deployment of the internet that may be more impactful than any other technological revolution in world history, especially given its size, speed and global nature.

And, of course, now the internet has led to things like crypto and artificial intelligence, which are going through their own Technological Surge.

So when we look at unemployment and inflation and productivity metrics to try to figure out what’s going in capital markets, it’s important to consider the backdrop and the larger context and the size and scale of the technological revolution and the deployment of the internet that we’re still experiencing. It’s hard to know whether we’re still in the deployment phase of the internet or if we’re in the installation stages of another revolution with artificial intelligence. Or both. When investing in technology markets, it’s crucial to have a sense of the cycles we’re living through and what phase we’re in. The Technological Surge Cycle is a very helpful framework to help do just that.

Bookings As A Lagging Indicator

Bookings (the value of contracts signed within a specific period) is a crucial metric for companies to watch. Investors watch this number very, very closely. Boards will put enormous emphasis on it. When a deal is booked, the product then gets delivered to the customer, which turns the booking into revenue generated in a specific period, which equates to the top-line growth of the company. Bookings are the tip of the spear. It’s a leading indicator for revenue.

Investors will also look closely at qualified pipeline (the pool of potential sales opportunities that are deemed highly likely to convert into bookings) as that is a leading indicator of bookings.

Bookings and qualified pipeline are watched closely and are heavily scrutinized.

The problem with placing too much focus on these numbers is that a sales and marketing team is limited in how much they can move these numbers one way or another in a specific period. If a company crushes their bookings in a period, it generally means that there was a bluebird deal or that goals weren’t set accurately or that there was an external macro event that caused a large swing. Rarely are sales and marketing teams able to swing these numbers up and beyond expectations in a major way. The reason is that bookings are capped by the TAM (total addressable market) or, more specifically, SAM (serviceable addressable market) available to them. I wrote about TAM, SAM, and SOM a few years ago, find that post here. So, the reality is that while sales and marketing teams can do great things, they are limited by the stuff they have in their proverbial bag that they can sell. To really move these numbers and continue to grow, companies need to create new SAM at a high rate. So, while pipeline is a leading indicator for bookings, SAM creation is a leading metric for pipeline.

To make this point more concise, bookings growth is dependent on product investment decisions that were made 1, 2, 3, or even 5 years ago.

So, while it’s obvious that companies should be focused on in-period bookings and retention and profitability metrics, arguably it’s more important for companies to be focused on in-period SAM creation such that the cap on bookings growth in future periods gets higher and higher. The reason this is arguably more important is that product investments made now can drive far larger swings in growth in future periods than a sales and marketing team can in the current period. If two years ago a company made large investments in new products and new SAM creation, bookings will be high in the future. If two years ago they made no investments in new products and new SAM creation then bookings will be low in the future.

So, while obviously investors should be asking companies how bookings are going in a specific period, they’re really looking at a lagging indicator for good or bad investment decisions that were made in the past. They should place equal emphasis (arguably more) on how much new SAM is being created in that same period, as that’s the number that’s going to drive material and sustainable growth.