Ben Gilbert
Appearances
Acquired
The Mark Zuckerberg Interview
And I remember... For listeners, let's just be really clear. You guys shipped this product that I'm holding... before LLMs, or at least before the public consciousness was aware of the ChatGPT moment. And these were not manufactured and shipped as an AI device. That came later when they were already in market.
Acquired
The Mark Zuckerberg Interview
He was like, so I was on the highway with my kids, and I get this call on a Saturday from Mark, and he's like, those glasses... Could we put Meta AI in them running on device and ship that soon so we can see if that's a good idea or not?
Acquired
The Mark Zuckerberg Interview
First, though, a huge thank you to our partners this season. You know our presenting partner, JP Morgan Payments.
Acquired
The Mark Zuckerberg Interview
Okay, so... Thank you for opening up with a story. The question that I would like to try to answer tonight is why has Meta worked as spectacularly well as it has?
Acquired
The Mark Zuckerberg Interview
I mean, one of the most valuable companies in the world, through multiple iterations, multiple technology waves, fighting off, you know, maybe, let's name all the waves in which people said, oh, Facebook and Meta are so screwed, and yet, that is not the way it looks today.
Acquired
The Mark Zuckerberg Interview
That's mine. There is a widely held public narrative every single time Snapchat discovers stories or there's something where people are like, oh, the cool thing that Facebook, the company, did is just obsolete now and they're going to go away. You very much haven't gone away. What do you think is the through line of the DNA of the company that allows you to keep winning?
Acquired
The Mark Zuckerberg Interview
Sounds a lot like meta. And Crusoe, which is the world's best climate-aligned AI cloud and data center operator that is leading the industrial build-out of AI. Find out more about them at crusoe.ai. As always, come discuss this afterwards with us in the Slack, acquired.fm. And if you want to be notified when every new episode drops, sign up at acquired.fm.
Acquired
The Mark Zuckerberg Interview
In one of my research calls to prep for this, someone described you as a master strategist, which we all sort of acknowledge that at this point, but that the... I mean, except for all the stuff that I just thought was not going to be that important that ended up actually being the most important.
Acquired
The Mark Zuckerberg Interview
Like, the apple's gonna fall from the tree in some direction, and if you just set up the game that you have a hand close enough to catch it... The comment that someone made to me was, the reason Mark is such a good strategist is because he plays the company as if it's a turn-based strategy game, and he just makes sure he gets more turns than anybody else, and he makes sure that he learns more from each turn than the next player does.
Acquired
The Mark Zuckerberg Interview
Do you feel like that encapsulates Meta's product development? I do like turn-based strategy. But it does kind of feel like the way that you make bets is like, well, if we have great engineering, then that can kind of take care of the speed part. That's like many iterations or multiple at-bats.
Acquired
The Mark Zuckerberg Interview
And it's just about making sure that the thing that the company is known for or its brand can withstand all the little damage that you do to it by shipping stuff that's not quite ready.
Acquired
The Mark Zuckerberg Interview
Like when you're like, oh, I feel bad because I shipped a product that wasn't good enough, you're sort of...
Acquired
The Mark Zuckerberg Interview
So I'm building to this question of, to you, is product creation an act of invention or discovery? Like is David always inside that marble and you just need the very best tooling and ability to get things in market and get feedback to discover the statue of David? Or do you conceive of David in your head and I'm like, I'm going to make this and put it in the world?
Acquired
The Mark Zuckerberg Interview
That I'm like as I pour through all these historical examples There's like the market discovers some other participant in the Marcus discovers the stories format and suddenly the whole world is like oh my god That is the way that we all that's the social interaction mechanism, and that's like a pretty pure Discovery where you have products that have stories they perform very well
Acquired
The Mark Zuckerberg Interview
Yeah, for those who don't know about JPMorgan Payments, they empower businesses to accept money, hold money, send money, protect money from fraud, and gain unique insights from money flows to help your company grow.
Acquired
The Mark Zuckerberg Interview
that's been discovered. But there's other times, it feels like everything you're trying to do in Reality Labs, all, you know, 50 plus billion dollars that you've put into it, is like, we're gonna freaking will this thing into existence because I have an idea of the way that I want the world to be. I'm not really, like, asking for that much feedback. I'm putting it in the world.
Acquired
The Mark Zuckerberg Interview
David, you... I really am grabbing the wheel here. Is this connected, or did you just decide that it was your turn to talk?
Acquired
The Mark Zuckerberg Interview
Yeah, we've got more to share about their new payments products and technology this season, like the pay-by-face biometric payments that we saw live at Chase Center.
Acquired
The Mark Zuckerberg Interview
Yep, so that you can learn which may be the right fit to solve your payments challenges and grow your business.
Acquired
The Mark Zuckerberg Interview
So let's be clear. The feed ad had not been invented yet. Like, the ad unit of our time.
Acquired
The Mark Zuckerberg Interview
Anyway, where were we? So David asked, hey, can you help us with our research? Can I follow that thread that you just said, hey, that one wasn't so bad? There's been a lot of amazing things the company has done. There's also been like a lot of criticism.
Acquired
The Mark Zuckerberg Interview
Yeah. For the first time, we actually got to experience what it would be like if Acquired was a large world-class organization and not just, you know, our little team. And what happened at Chase Center is really the physical embodiment of that.
Acquired
The Mark Zuckerberg Interview
If you were to be self-critical of your own company, of your own creation, of all the criticisms that have happened over the years, which do you believe is the most legitimate and why?
Acquired
The Mark Zuckerberg Interview
Do you have a reasonable framework at this point for like, okay, here's the stuff where I feel like we actually do want to take responsibility for it, and here's the stuff where we're like, no, that's not our fault.
Acquired
The Mark Zuckerberg Interview
Yep. So please enjoy our conversation with Mark Zuckerberg and to take us in the chairman and CEO of JPMorgan Chase, Jamie Dimon.
Acquired
The Mark Zuckerberg Interview
This is the advantage of being a college dropout founder. Yeah, no, it is.
Acquired
The Mark Zuckerberg Interview
Wow. And being very cash-generative very early, such that you had a very real going concern on your hands, and you just didn't need to cut off your arm and sell it to someone in order to build your business. Yeah, totally. I think this is a fundamentally misunderstood thing about... Facebook the startup. It is the prototypical startup.
Acquired
The Mark Zuckerberg Interview
Of this century. And there's a lot of people that want to start a startup for a lot of the glamorous reasons of starting a startup. You hated being a startup and wanted to stop being a startup as fast as possible and be a going concern.
Acquired
The Mark Zuckerberg Interview
What is your advice to all these founders who sort of romanticize the idea of starting a company and kind of raising all this money? Obviously, starting a company is not bad.
Acquired
The Mark Zuckerberg Interview
It's not making that much money. So I'm going to play Mark back to you. Sure. It's not appropriate to have all these people and resources working on things for more than the stage warrants. I'm being a little facetious here, but I'm curious why you categorize it differently.
Acquired
The Mark Zuckerberg Interview
Was there a moment, like, what changed? Like, when did this become your priority and why? I can't, it feels so radical that it, how could it have possibly been gradual? Or was this just like, Mark all the time and we just couldn't see the real Mark?
Acquired
The Mark Zuckerberg Interview
We're starting to enter, looking at the clock, conclusion lightning round territory. I've had one lurking in the back of my head. It makes sense to me that you would rebrand the company something that is not Facebook, given how broad the family of apps was that you've got. Let's imagine you were going to rebrand it today. You've got AI going on. You've got AR going on. You've got VR going on.
Acquired
The Mark Zuckerberg Interview
Would you pick the name Meta if you were going to rename the company today?
Acquired
The Mark Zuckerberg Interview
And if I were to make the case to you, I feel... the core competency of Meta is you are able to discover products in the world. You have great ideas, you work on them, you discover interesting products. And you, Mark, are not someone who wants to define yourself by anything.
Acquired
The Mark Zuckerberg Interview
You want to have your hands on a bunch of great controls and maximize your degrees of freedom, see where the world's going, and then have the best freaking spaceship possible to go maneuver your way over there. It seems like I would pick a brand that almost doesn't pigeonhole me into a specific future. I might be looking for something that's more like, look, I want to maximize my maneuverability.
Acquired
The Mark Zuckerberg Interview
Oh, to prepare? Yeah. 30 to 40. The best ones are the 04 to 06 vintage, but they're also different. It's almost like every three to four years is a new era that is markedly different from all the previous eras.
Acquired
The Mark Zuckerberg Interview
And in many ways, doing what I just suggested would kind of be running. It's like, well, we don't believe in it that much. And you're like, no.
Acquired
The Mark Zuckerberg Interview
So we have a lot of builders in the audience tonight, a lot of founders. We're in probably the most interesting technology environment since the early mobile days in terms of opportunity.
Acquired
The Mark Zuckerberg Interview
It's been 20 years, you might have to go back a little bit, but what advice do you have for founders today on something that's different than trying to pattern match Mark Zuckerberg from 2004, given we live in a different world today?
Acquired
The Mark Zuckerberg Interview
We made you something that you already have a very amazing, well-designed shirt. I hope you have room in your life for more than one.
Acquired
The Mark Zuckerberg Interview
So David and I made you a custom one-of-one shirt that represents tonight.
Acquired
The Mark Zuckerberg Interview
It is size zuck. So no one else can, you know, it can never be made again. And we've got these coordinates on the back. The first one. GPS coordinates. GPS coordinates. The first one represents Kirkland House, where you wrote the first line of code for Facebook. And the second one is the Chase Center. Awesome. So thank you for joining us here tonight. Thank you for joining us. Wow. What a night.
Acquired
The Mark Zuckerberg Interview
Absolutely crazy. I mean, Mark has done many interviews this year, both with other podcasts and in traditional press, but that felt different. If for no other reason than it happened live in front of a 6,000 person audience in an arena, but I wasn't expecting it to feel that different.
Acquired
The Mark Zuckerberg Interview
Well, listeners, as you may have noticed, thanks to our sponsors, this conversation was uninterrupted. And we do want to reflect a little bit and share some of our thoughts and our, you know, how we're feeling looking back on this conversation with you. But first, we do want to share a word on Statsig and Crusoe. So Statsig.
Acquired
The Mark Zuckerberg Interview
How? Certainly not anymore. And really relative to its peers, not even throughout its past. Yep. Facebook invested hundreds of thousands of engineering hours in a set of internal tools. These tools let any engineer set up new metrics, ship new features, and measure performance in real time.
Acquired
The Mark Zuckerberg Interview
That means anyone could just ship a new feature, but they always had metrics to use as guardrails, and they could always roll back a feature if anything broke.
Acquired
The Mark Zuckerberg Interview
So you're stuck, right? Well, enter Statsig. Statsig has built the world's first product acceleration platform, combining tools like feature flags, product analytics, experimentation, and observability all in one place, helping you move faster and make smarter decisions.
Acquired
The Mark Zuckerberg Interview
David, every time we work with Statsig, this list gets more and more impressive. Like now it is purely, you know, A-list companies.
Acquired
The Mark Zuckerberg Interview
It's crazy. When Acquired first started working with Crusoe, this was a cool idea. Now they're like one of the most important companies in the world with an AI cloud that's superior to the hyperscalers and a whole bunch of the largest companies in the world trusting their AI infrastructure to them.
Acquired
The Mark Zuckerberg Interview
And Crusoe is powering that by producing or repurposing huge amounts of power. We are talking gigawatts in their development pipeline, which is nuclear reactor amounts of power for less cost than other providers and with zero or in some cases actually negative emissions. It's super important.
Acquired
The Mark Zuckerberg Interview
If you listen to Zuck and others talk about what the bottleneck to AI progress is, it's actually not compute, but energy. And Crusoe is solving that problem.
Acquired
The Mark Zuckerberg Interview
OK, so, David, reflections on this conversation. The biggest thing that I kept thinking going into the night as we're talking with Mark, as we're talking with his team, you know, people kept saying, we don't really do this. Mark doesn't really do this. And I kept thinking, yeah, he kind of does because he's done all these podcasts this year.
Acquired
The Mark Zuckerberg Interview
And he does Facebook Meta Connect like he's done big events before, of course. Right. And he does a good number of in-person press interviews, too. It's not like he doesn't talk to the traditional press, even though that has kind of become a narrative. It's not really true. However, Mark has not done an external several thousand person live thing like this.
Acquired
The Mark Zuckerberg Interview
This is a very unusual format and kind of an uncomfortable one, even for you and I. Like, we're so used to stopping, starting, being thoughtful in our answers. And, like, this is a show. You're performing. There are no breaks. There's no retakes.
Acquired
The Mark Zuckerberg Interview
Right. But Mark and, like, all the meta execs really embraced it. A bunch of the executive team came. Like, they took off this whole day and actually some stuff we did the night before, too.
Acquired
The Mark Zuckerberg Interview
Right. I thought this was a big deal for us. I was kind of shocked to the degree that Mark also thought it was a big deal for him.
Acquired
The Mark Zuckerberg Interview
That's one. I was also surprised and delighted that he was willing to dive into history with us.
Acquired
The Mark Zuckerberg Interview
Totally, because you could create these through lines. I mean, as funny as your interjection on let's go back to the IPO moment was, it opened up the door to have like these comparative moments to is what Meta doing today, is that similar to something that you've done over and over? Should we be watching for a pattern here? Or are you very different today than you were historically?
Acquired
The Mark Zuckerberg Interview
The way that he was talking about that stuff on stage felt very authentic. And I just haven't heard him speak in that way before, at least publicly.
Acquired
The Mark Zuckerberg Interview
Yeah, I think the casual observer to Meadow might observe like, you know, Mark's been running it for 20 years and most of the time these founders kind of like go and do something else. They become executive chairman or they like stepped into a board role or they own 4% of the companies. There's some pattern there. And for Mark, I think it was plain as day on stage. Yeah.
Acquired
The Mark Zuckerberg Interview
he is more in it than ever. And I don't think he thinks he's like halfway through his journey. Like, I don't think he's 20 years in. At 40, I'll be done. I don't get that sense either. I think meta is his vehicle by which he wants to live his entire life. And he wants to make things with this group of people that he wants to make, period. And that is kind of the product strategy.
Acquired
The Mark Zuckerberg Interview
Welcome to the fall 2024 season of Acquired, the podcast about great companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts. Listeners, we have something very special for you today. Our interview with Mark Zuckerberg from Acquired live at Chase Center. Mark is the iconic founder CEO of our time.
Acquired
The Mark Zuckerberg Interview
I was appreciative that he engaged with us on the be critical of the company, because honestly, I was asking that as research for when we inevitably do our meta episode. I think he gave us a regret, not a criticism, but we were live on stage in front of 6,000 people, and it's not really the right format for that.
Acquired
The Mark Zuckerberg Interview
I'm glad you caught this, too. Other big tech CEO founders... have their moment running the company, they take a board role, they go do another thing. And oftentimes it's big and important for the world and capital intensive. And Mark is doing that, but inside meta with Reality Labs.
Acquired
The Mark Zuckerberg Interview
I think it'll be super fascinating 20 to 50 years from now to reflect back and say, what were the unintended or perhaps intended outcomes of co-mingling multiple huge swings under one corporate umbrella versus having people who are either CEO of multiple companies concurrently or step down from one to run the other.
Acquired
The Mark Zuckerberg Interview
For Mark, I kind of feel like, again, meta is his vehicle for executing the things that he thinks are awesome products. And of course, it's not just awesome products, but things that could let him have more control over his universe. He's clearly a guy who values having a lot of degrees of freedom and doesn't like being boxed in.
Acquired
The Mark Zuckerberg Interview
Yes. But it'll be interesting to see the knock-on effects of having Reality Labs in the meta organization versus as a new venture.
Acquired
The Mark Zuckerberg Interview
which I think is probably true of like Apple, Steve Jobs, Bill Gates, Microsoft, NVIDIA, Jensen. Yes. But we are right up close to the ways in which meta is a sort of an amplifier, almost like it's a way for you to take the gain on Mark's output and turn it up, you know, 10,000x.
Acquired
The Mark Zuckerberg Interview
Are you saying Meta is still very much a Mark Zuckerberg production? I'll see myself out.
Acquired
The Mark Zuckerberg Interview
Well, listeners, thank you so much for joining us on this journey. Come talk about it with us in the Slack, acquired.fm slash Slack. Would love to hear all of your thoughts as well. Join our email list, acquired.fm slash email. That will let you basically know every single time a new episode drops or when we are doing something like Chase Center again to be the first to know about that.
Acquired
The Mark Zuckerberg Interview
Well, no, let's pull that thread. Yeah. No pun intended, I promise. What does learning through suffering mean to you?
Acquired
The Mark Zuckerberg Interview
God, if we ever do something like that again. We've got a merch store. Check it out on Acquired.fm. We've got ACQ2, our second show where we are always interviewing earlier stage companies than Meta, but where we think there are great, insightful conversations with founders and CEOs. And David, I know you've got some thank yous.
Acquired
The Mark Zuckerberg Interview
Yes, so fun. Thank you to Jamie Dimon, JPMorgan Chase, and JPMorgan Payments for making it all possible. It was truly a dream come true, and that is because of our incredible partnership.
Acquired
The Mark Zuckerberg Interview
Yes, in a couple of weeks with the full show. We are pumped to drop it. We'll see you next time.
Acquired
The Mark Zuckerberg Interview
And this conversation was just too good to hold on to any longer. So we are getting it out quickly before we release the full video of the entire show.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
And of course, that's going to take 10,000 person years, which would, of course, cost you not only billions and billions of dollars, but all that actual time. And even if you made all these investments and lined all of this up, you'd of course need to go and convince the developers to actually start using your thing instead of CUDA.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Well, NVIDIA also wouldn't be standing still, so you'd have to do all of this in record time to catch up to them and surpass whatever additional capabilities they developed before. since you started this effort. So I think the bottom line here is it's nearly impossible to compete with them head on.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
And if anybody's going to unseat Nvidia in the future of AI and accelerated computing, it's either going to be from some unknown flank attack that they don't see, or the future will turn out to just not be accelerated computing and AI, which seems very unlikely.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
They should have put every dollar of every fund that A16Z raised into NVIDIA's market price of the stock every single day.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
There it is. Well, listeners, I acknowledge that this episode generalized a lot of the details, especially for technical listeners out there, but also for the finance folks who are listening. Our goal was to make this more of a lasting NVIDIA Part 3 big picture episode than sort of a how did they do last quarter and what are the implications on that of the next three quarters.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
So hopefully this holds up a little bit longer than just some current NVIDIA commentary. But thank you so much for going on the journey with us.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
I mean, one, Ian Buck from NVIDIA, who leads the data center effort and is one of the original team members that invented CUDA way back when. Really grateful to him for speaking with us to prep for this.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Julian, the CTO of Hugging Face. Oren Itzioni from AI2. Luis from OctoML. And of course, our friends at NZS Capital. Thank you all for helping us research this.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
My wife and I have been on an alias binge. Oh, wow. Yeah. Jennifer Garner? Yes. I never saw it when it came out. It is like the perfect early 2000s junk food when you have one more hour at the end of the day and you're just laying on the couch.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
But that's research. I'm just checking out the latest graphics technology. So my review of Alias is it's a little bit campy. They repeat themselves pretty often. I mean, it's weird to observe how much TV has changed between now and then because they make very similar shows today, but they're just much more subtle. They're much darker. They leave much more sort of to the imagination.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
And in the early 2000s, everything was just so, like, explicit and on the nose and restated three times. I'm just glad the show doesn't have a laugh track, but it's well worth the watch. Sometimes you have to imagine it has a different soundtrack because every episode has, like, a Matrix-type song to it. Bomp-a-da-bomp-a-da-bomp-a-dump-a-dump.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yes, but it's great. I don't know. We're having a lot of fun watching it.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
It's not the guaranteed hit every time that it used to be.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
All right. Great. Adding it to my list. And it's got the rock. How can you complain? There you go. Well, listeners, our huge thank you to our good friends at Blinkist and Go1, at Statsig and at Crusoe. All the links to all of those phenomenal products and offerings are in the show notes.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
If you want to be notified every time we drop a new episode and you want to make sure you don't miss it and you want little hints to play a guessing game at our next episode or you want follow-ups from our previous episode in case we learn from listeners, hey, here's a little piece of information that we wanted to pass along.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
We will exclusively be dropping those in the email, acquired.fm slash email.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah. We have a hat. You should buy it. And this is not a thing that we make a lot of margin on. We just are excited about more people sporting the ACQ around. So participate in the movement. Show it to your friends.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
If you come on Acquired LP, you can come closer to the kitchen and help us pick an episode once a season. And we'll do a Zoom call every other month or so. Acquired.fm slash LP. Check out ACQ2 for more Acquired content in any podcast player. And come talk about this in the Slack. Acquired.fm slash Slack. Listeners, we'll see you next time.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
And I don't think you're exaggerating. I think that is literally what Instagram is worth to meta now. By the way, I have bought a lot of things on Instagram ads so that the targeting works.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
And not just a problem for like the other big tech companies, because you could make the argument it's a problem because like Siri's terrible. All the other companies that have lots of consumer touchpoints have pretty bad AI at the time. But the concern is for a much greater reason.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
It seemed like the whole tech economy and potentially a lot with it was heading into a long winter.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Hmm. That feels like an interesting question. It's probably a couple steps too far in the conclusion, but still sort of a fun straw man to think about.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
This is probably a good time to mention this founding of OpenAI was motivated by the desire to find AGI or artificial general intelligence first before the big tech companies did. And DeepMind was the same thing. It was going to be this winding and circuitous path at the time, since really nobody knew then or knows now the best path to get to AGI.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
But the big idea at OpenAI's founding was whoever figures out and finds AGI first will be so big and so powerful so quickly, they'll have an immense amount of control, and that is best in the open.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
But it does actually just show where the seeds of open AI come from. It is very different than this sort of organic scrappy way that the NVIDIAs of the world got started. This is powers on high and existing money saying, no, we need to will something into existence.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Including NVIDIA, who had that massive inventory write-off for what they thought was overordering.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
We've gotten to hire the people that we want. We've built these great teams. There's a money spigot pointed at our face.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
But by the fall of 2022, right when everything looked the absolute bleakest, a breakthrough technology finally became useful after years in research labs. Large language models, or LLMs, built on the innovative transformer machine learning mechanism burst onto the scene
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yes. And before we talk about what OpenAI would go on to do in its first chapter, which is quite different than today, this is a great time to tell you about one of our very favorite companies and actually the perfect fit for this episode, Crusoe.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yes, we talked about that on our ACQ2 episode with Crusoe CEO Chase Lockmiller, which, David, that actually ended up being very helpful for my research for this episode. InfiniBand is wild, and it's just one example of how NVIDIA has built such a dominant position in AI that we'll talk about later in this episode.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
We'll link to that interview in the show notes so you can hear what it's like for Crusoe actually deploying that technology in their data centers and the lengths that Crusoe goes to to maximize performance.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yep. Obviously, it's a huge benefit for the environment and for customers on costs since Crusoe doesn't rely on the energy grid. Energy is the second largest cost of running AI after, of course, the price you pay NVIDIA for the chips. And these lower energy costs get passed on to customers.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yep. If you, your company, or your portfolio companies would like to use the lower cost and more performant infrastructure for your AI workloads, go to crusocloud.com slash acquired, that's C-R-U-S-O-E cloud dot com slash acquired, or click the link in the show notes. Okay, so David, OpenAI is formed. It's 2015. Here we are eight years later, and we have ChatGPT.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
First, with OpenAI's ChatGPT, which became the fastest app in history to 100 million active users, and then quickly followed by Microsoft, Google, and seemingly every other company. In November of 2022, AI definitely had its Netscape moment. And time will tell, but it may have even been its iPhone moment.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Super linear path from there to here, right? Turns out, no.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
And this was both a hardware and a software constraint. On the software side, we just didn't actually have the algorithms to sort of suppose that we could be so bold to train one single foundational model on the whole internet. Like, it wasn't a thing. Yeah, that was a crazy idea. Right. People were excited about the concept.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
of language models, but we actually didn't know how we could algorithmically get it done. So in 2015, Andrej Karpathy, who was then at OpenAI and went on to lead AI for Tesla and is actually now back at OpenAI, writes this seminal blog post called The Unreasonable Effectiveness of Neural Networks.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
And David, I don't think we're going to go into it on this episode, but note that recurrent neural networks are a little bit of a different thing than convolutional neural networks, which was the 2012 paper.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yes. And right around that same time, there is also a video that hits YouTube a little bit later in 2016 that is actually on NVIDIA's channel. And it has two people in this very short 1 minute and 45 second video. One is a young Ilya Tsitskiver, and two is Andrei Karpathy. And here is a quote from Andrei from that YouTube video. One algorithm I'm excited about is a language model.
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The idea that you can take a large amount of data, and you feed it into the network, and it figures out the pattern in how words follow each other in sentences. So for example, you could take a large amount of data on how people talk to each other on the internet, you can train basically a chat bot, but you can do it in a way that the computer learns how language works and how people interact.
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Or at the very least, we should figure out some NVIDIA memorabilia to get on the wall at Bucks.
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Eventually, we'll use that to talk to computers just like we talk to each other.
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This is two years before the transformer, while Karpathy is at OpenAI. He both comes up with the idea or espouses the idea of a chat bot. So that sort of had already been discussed. But even before we had the transformer, the method to actually pull this off, he sort of had the idea that there's an important part here. it figures out the pattern in how words follow each other in sentences.
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So there's this idea that the very structure of language and the way to interpret knowledge is actually embedded in the training data itself rather than requiring labeling.
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Yep. Well, today we'll explore exactly how this breakthrough came to be, the individuals behind it, and of course, why the entire thing has happened on top of NVIDIA's hardware and software. If you want to make sure you know every time there's a new episode, go sign up at acquired.fm slash email. You'll also get access to two things that we aren't putting anywhere else.
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Ooh, yeah. Put a pin in that. Understanding versus predicting. It's a hot topic du jour. So, David, is now a good time to fast-forward two years to 2017 to the Transformer paper.
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Okay. So, Google, 2017, Transformer paper. Paper comes out. It's called Attention Is All You Need.
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Just left. Two years before to start OpenAI. So machine learning on natural language, just to set the table here, had long been used for things like autocorrect or foreign language translation. But in 2017, Google came out with this paper and discovered a new model that would change everything for these fields and unlock another one. So here is the scenario.
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You're translating a sentence from English to French. You could imagine that a way to do this would be one word at a time, in order. But for anyone who's ever traveled abroad and tried to do this, you know that words are sometimes rearranged in different languages, so that's a terrible way to do it.
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You know, United States in Spanish is Estados Unidos, so failure on the very first word in that example. So enter this concept of attention, which is a key part of this research paper. So this attention, this fairly magical component of the transformer paper, it literally is what it sounds like. It is a way for the model to attend to different areas of the input text at different times.
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You can look at a large amount of context while considering what word to pick next in your translation. So for every single word that you're about to output in French, you can look over the entire set of inputted words to figure out what words you should wait heavily in your decision for what to do next.
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Yes. Now, here's the magical part. While it does look at the whole input text to consider what the next word should be, it doesn't mean that it throws away the notion of position entirely. It uses a technique called positional encoding, so it doesn't forget the position of the words altogether.
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So it's got this cool thing where it weights the important part relevant to your particular word, and it still understands position. So remember I said the attention mechanism looks over the entire input every time it's picking what word to output?
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One, a clue as to what the next episode will be, and two, follow-ups from previous episodes from things that we learned after release. You can come talk about this episode with us after listening at acquired.fm slash slack. If you want more of David and I, check out our interview show, ACQ2.
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Yes. In computer science terms, this means that the attention mechanism is O of N squared.
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Oh, just wait till we get through this episode. It gets deeper. So obviously, yes, traditionally, you'd say this is very, very inefficient. And it actually means that the larger your context window, aka token limit, aka prompt length, gets... the more computationally expensive it gets on a quadratic basis.
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So doubling your input means quadrupling the cost to compute an output, or tripling your input means nine times the cost.
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Yeah, it gets real expensive real fast. But GPUs to the rescue. The amazing news for us here is that these transformer comparisons can be done in parallel. So even though there are lots of them to do, if you have big GPU chips with tons of cores, you can do them all at exactly the same time.
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And previous technologies to accomplish this, like recurrent neural networks or LSTMs, long short-term memory networks, which is a type of recurrent neural network, etc., those required knowing the output of each step before beginning the next one, before you picked the next word. So in other words, they were sequential, since they depended on the previous word.
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Now, with transformers, even if your string of text that you're inputting is a thousand words long, it can happen just as quickly in humid, measurable time as if it were ten words long, supposing that there were enough cores in that big GPU. So the big innovation here is you could now train sequence-based models in a parallel way.
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You couldn't train models of this size at all before, let alone cost-effectively.
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Yeah, I sort of did a sleight of hand there morphing translation to using words like context window and token length. You can kind of see where this is going.
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Our next few episodes are about AI with CEOs leading the way in this world we are talking about today and a great interview with Doug DeMuro where we wanted to talk about a lot more than just Porsche with him. But, you know, we only had 11 hours or whatever we had in Doug's garage. So a lot of the car industry chat and learning about Doug and his journey and his business, we saved for ACQ2.
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And super impressive stuff, like they beat the best Dota players in the world at Dota by literally just consuming computer vision, like consuming screenshots and inferring from there. And that's a really hard problem because Dota 2 is not a game where you get to see the whole board at once.
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So it has to do a lot of like really intelligent construction of the rest of the game based on just a single player's worth of input. So it's unbelievably cutting edge research.
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Maybe, yeah. I mean, they were also doing stuff like Universe, which was the 3D-modeled world to train self-driving cars. You don't really hear anything about that anymore, but they built this whole thing. I think it was using Grand Theft Auto as the environment, and then it was doing computer vision training for cars using the GTA world. I mean, it was crazy stuff, but it was kind of scattershot.
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Right. It's funny, David, you made this leap to expensive and large models. All we were doing before was merely talking about translating one sentence to another. The application of a transformer does not necessarily require you to go and consume the whole internet and create a foundational model. But let's talk about this.
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Transformers lend themselves quite well, as we now know, to a different type of task. So for a given input sentence, instead of translating to a target language, they can also be used as next-word predictors to figure out what word should come next in a sequence.
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You could even do this idea of pre-training with some corpus of text to help the model understand how it should go about predicting that next word. So backing up a little bit, let's go back to the recurrent neural networks, the state-of-the-art before transformers. Well, they had this problem.
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In addition to the fact that they were sequential rather than parallel, they also had a very short context window. So you could do a next-word predictor But it wasn't that useful because it didn't know what you were saying more than a few words ago. By the time you'd get to the end of the paragraph, it would forget what was happening at the beginning.
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It couldn't sort of hold on to all that information at the same time. So this idea of a next word predictor that was pre-trained with a transformer could really start to do something pretty powerful, which is consume large amounts of text and then complete the next word based on a huge amount of context.
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So go check it out. One final announcement. Many of you have been wondering, and we've been getting a lot of emails, when will those hats be back in stock? Well, they're back. For a limited time, you can get an ACQ embroidered hat at acquired.fm.store. Go put your order in before they go back into the Disney vault forever.
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We're starting to come up to this idea of a large language model. And we're going to flash forward here just for a moment to do some illustration, and then we'll come back to the story.
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In GPT-1, the first open AI model, this generative pre-trained transformer model, GPT, it used unsupervised pre-training, which basically meant that as it was consuming this corpus of language, it was unlabeled data.
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the model was inferring the structure and meaning of language merely by reading it which is a very new concept in machine learning the canonical wisdom is that you needed extremely structured data to train your smallish model on because how else are you going to learn what the data actually means this was a new thing you can learn what the data means from the data itself
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It's like how a child consumes the world where only occasionally does their parent say, no, no, no, you have that wrong. That's actually the color red. But most of the time, they're just self-teaching by observing the world.
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And then a second thing happens after this unsupervised pre-training step, where you then have supervised fine-tuning. The unsupervised pre-training used a large corpus of text to learn the sort of general language, and then it was fine-tuned on labeled data sets for specific tasks that you sort of really want the model to be actually useful for.
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It's scaling like NVIDIA's market cap. There is this interesting discovery, basically, that the more parameters you have, the more correctly you can predict the next word. These models were basically bad sub-10 billion parameters. I mean, maybe even sub-100 billion parameters. They would just hallucinate or they would be nonsensical.
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It's funny when you look at some of the 1 billion parameter models, you're like, there is no chance that turns into anything useful ever. But by merely adding more training data and more parameters... It just gets way, way better. There's this weirdly emergent property where transformer-based models scale really well due to the parallelism.
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Exactly. And the output sort of unexpectedly gets magically better. I mean, I know I keep saying that, but it is like...
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wait so we don't change anything about the structure we just give it way more data and let it run these models for a long time and make the parameters of the model way bigger and like no researchers expected them to reason about the world as well as they do but it just kind of happened as they were exploring larger and larger models
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Yeah. And importantly, they've at this point are getting ready to release TensorFlow to the public. So they have a framework where people can develop for stuff. And they're like, look, if people are developing using our software, then maybe it should run on our hardware that's optimized to work with that software.
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So they actually do have this very plausible story around why their hardware, why their software framework. It was kind of a surprising move when they open sourced it because people were like, gasp, you know, why is Google giving away the farm for free here? But This was three, four years early and a very prescient move to really get a lot of people using Google architecture compute at scale.
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Yes. Well, without further ado, this show is not investment advice. David and I may have investments in the companies we discuss, and this show is for informational and entertainment purposes only. David, history and facts.
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So there's this great explanation of what happened in the semaphore piece that we'll link to in our sources. The author says, "...that fall it became even more apparent to some people at OpenAI that the costs of becoming a cutting-edge AI company were going to go up. Google Brain's transformer had blown open a new frontier where AI could improve endlessly.
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But that meant feeding endless data to train it, a costly endeavor." OpenAI made a big decision to pivot toward these transformer models. On March 11, 2019, OpenAI announced it was creating a for-profit entity so it could raise enough money to pay for all the compute power necessary to pursue the most ambitious AI models. The company wrote at the time,
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OpenAI said it was capping profits for investors with any excess going back to the original nonprofit. Less than six months later, OpenAI took a $1 billion investment from Microsoft.
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Yeah, truly amazing. And their opinion at the time of why they're doing this is basically this is going to be super expensive. We still have the same mission to ensure that artificial general intelligence benefits all of humanity, but it's going to be ludicrously expensive to get there.
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Except that I know you're not going to start 18 months ago.
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And so we need to basically be a for-profit enterprise and a going concern and have a business that funds our research eventually to pursue that mission.
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Yes. So you're teeing all of this up. And so far I'm thinking, so this is like the OpenAI and Microsoft episode? Like, what does this have to do with NVIDIA? And God, there's a great NVIDIA story here to be told. So let's get to the NVIDIA side of it. But first, we want to thank our friends at Statsig. So we've been talking this episode about names in AI that you know, NVIDIA, Google, etc.
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But there's a name you probably don't know that's powering a lot of the AI wave behind the scenes, Statsig. A ton of big AI companies, anthropic, character AI, rely on Statsig to test, deploy, and improve their models and applications. And how this happened is crazy because Statsig did not start as an AI company.
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I went for the first time, what, two weeks ago when I was down for meeting at Benchmark, and the nostalgia in there is just unbelievable.
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Well, if you've ever built anything with these AI APIs, you know there are a ton of things to test, like the model version, the prompt, or the temperature. And adjusting these can have huge impact on the AI application's performance. So these AI companies have started using StatSig to measure the impact of changes to their models and the customer-facing applications using real user data.
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Even non-AI companies like Notion and Figma have been using StatSig to launch their AI features ensuring that these new features drive successful outcomes for their businesses.
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Right. There's these little workloads here and there that will toss you, Jensen, that we think can be accelerated by your cool GPUs. And then, you know, crazy things like crypto happened. And there was like AI researchers in academic labs that are using it as, you know, supercomputers. But for the longest time, the data center segment of NVIDIA
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It just wasn't clear that organizations had enormous parts of their software stack that they were going to shift to GPUs. Like, why? What's driving this? And now we know what could be driving it, and that is AI.
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Okay, so now it begs the question, why is it driving it? And David, are you open to me giving a little computer science lecture on computer architecture? Ooh, please do. All right, I need to do my best professor impression here.
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They were my favorite classes. I will say doing these episodes, this TSMC, it really does bring back the thrill of being in a CS lecture and being like, oh, that's how that works. Like, it's just really fun. So... Let's take a step back and consider the classic computer architecture, the von Neumann architecture.
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Now, the von Neumann architecture is what most computers, most CPUs, are based on today, where they can store a program in the computer's memory and run that program. You can imagine why this is the dominant architecture. Otherwise, we'd need a computer that is specialized for every single task.
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The key thing to know is that the memory of the computer can store two different things, the data that the program uses and the instructions of the program itself, the literal lines of code. And in this example we're about to paint, all of this is wildly simplified because I don't want to get into caching and speeds of memory and where memory is located, not located. So let's just keep it simple.
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So the processor in the von Neumann architecture executes this program written in assembly language, which is the language that compiles down to the bytecode that the processor itself can speak. So it's written in an instruction set architecture, an ISA from ARM, for example.
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Yes. And each line of the program is very simplistic. So we're going to consider this example where I'm going to use some assembly language pseudocode to add the numbers 2 and 3 to equal 5.
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And the argument is basically like, well, cars plus factories plus all these things added together is 100 trillion. And we can just take 1% of that because surely their compute will amount to 1% of that, which I'm not arguing is wrong, but it is a very blunt way to analyze that market.
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Well, it's pseudo assembly language code. So the first line is we're going to load the number 2 from memory. We're going to fetch it out of memory, and we're going to load it into a register on the processor. So now we've got the number two actually sitting right there on our CPU ready to do something with. That's line of code number one.
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Two, we're going to load the number three in exactly the same fashion into a second register. So we've got two CPU registers with two different numbers. The third line, we're going to perform an add operation, which performs the arithmetic to add the two registers together on the CPU and store the value in some either third register or into one of those registers.
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So that's a more complex instruction since it's arithmetic that we actually have to perform. But these are the things that CPUs are very good at, doing math operations on data fetched from memory.
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And then the fourth and final line of code in our example is we are going to take that five that has just been computed and is currently held temporarily in a register on the CPU, and we're going to write that back to an address in memory. So the four lines of code are load, load, add, store.
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So you can see each of those four steps is capable of performing one and only one operation at a time. And each of these happens with one cycle of the CPU. So if you've heard of gigahertz, that's the number of cycles per second. So a one gigahertz computer could handle the simple program that we just wrote 250 million times in a single second. But you can see something going on here.
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Three of our four clock cycles are taken up by loading and storing data to memory. Now, this is known as the von Neumann bottleneck, and it is one of the central constraints of AI, or at least it has been historically. Each step must happen in order and only one at a time. So in this simple example, it actually would not be helpful for us to add a bunch more memory to this computer.
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I can't do anything with it. It's also only incrementally helpful to increase the clock speed. If I double the clock speed, I can only execute the program twice as fast. If I need like a million X speed up for some AI work that I'm doing, I'm not going to get it there with just a faster clock speed. That's not going to do it.
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And it would of course be helpful to increase the speed at which I can read and write to memory, but I'm kind of bound by the laws of physics there. There's only so fast that I can transmit data over a wire
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Now, the great irony of all of this is that the bottleneck actually gets worse over time, not better, because the CPUs get faster and the memory size increases, but the architecture is still limited, so this one pesky single channel, known as a bus, I don't actually get to enjoy the performance gains nearly as much as I should, because I'm jamming everything through that one channel, and it only gets to sort of be used one time per every clock cycle.
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So the magical unlock, of course, is to make a computer that is not a von Neumann architecture, to make programs executable in parallel and massively increase the number of processors or cores. And that is exactly what NVIDIA did on the hardware side, and all these AI researchers figured out how to leverage on the software side.
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But interestingly, now that we've done that, David, the constraint is not the clock speed or the number of cores anymore. For these absolutely enormous language models, it's actually the amount of on-chip memory that concerns us.
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Yes. There's this amazing video that we'll link to on the Asianometry YouTube channel that we link to also on the TSMC episode. But the constraint today is actually in how much high-performance memory is available on the chip. These models need to be in memory all at the same time, and they take up hundreds of gigabytes.
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So while memory has scaled up, I mean, we're going to get flashing all the way forward, the H100s, on-chip RAM is like 80 gigabytes. The memory hasn't scaled up nearly as fast as the models have actually scaled in size. The memory requirements for training AI are just obscene.
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It's the toppiest down way I can think of to size a market.
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So it becomes imperative to network multiple chips and multiple servers of chips and multiple racks of servers of chips together into one single computer, and I'm putting computer in air quotes there, in order to actually train these models. It's also worth noting, we can't make the memory chips any bigger.
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Due to a quirk of the extreme ultraviolet photolithography that we talked about, the EUV on the TSMC episode, chips are already the full size of the reticle. It's a physics and wavelength constraint. You really can't etch chips larger without some new invention that we don't have commercially viable yet.
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So what it ends up meaning is you need huge amounts of memory, very close to the processors, all running in parallel with the fastest possible data transfer. And again, this is a vast oversimplification, but you kind of get the idea of why all of this becomes so important.
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Well, it wasn't little. They paid $7 billion for it.
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And actually, InfiniBand was an open source standard or managed by a consortium. There were a bunch of players in it, but the traditional wisdom was... While InfiniBand is way faster, way higher bandwidth, a much more efficient way to transfer data around a data center, at the end of the day, Ethernet is the lowest common denominator, and so everyone had to implement Ethernet anyway.
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And so most companies actually exited the market, and Mellanox was kind of the only InfiniBand spec provider left.
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Right. People thought, oh, sure, for supercomputers, for these academic purposes, but what the enterprise market needs in my shared cloud computing data center is Ethernet, and that's fine, and most workloads are going to happen right there on one rack, and maybe, maybe, maybe things will expand to multiple computers on that rack, but certainly they won't need to network multiple racks together.
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Yeah. Importantly, I felt like the way for them to become worth what they were worth at that time literally had to be to power all of this hardware in the physical world.
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And NVIDIA steps in, and you got Jensen saying, hey, dummies, the data center is the computer. Listen to me when I tell you the whole data center needs to be one computer. And when you start thinking that way, you start thinking, geez, we're really going to be cramming huge amounts of data through wires that are going between these.
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How can we sort of think about them as if it's all sort of on-chip memory or as close as we can make it to on-chip memory, even though that's in a box located three feet away?
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But Jensen, I thought all computing was going to be accelerated. What are we doing here on these ARM CPUs?
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This is the endgame of a ballet that has been in motion for 30 years. Remember when the graphics card was subservient to the PCIe slot in Intel's motherboard?
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And then eventually, you know, we fast forward to the future, NVIDIA makes these GPUs that are these beautiful standalone boxes in your data center, or perhaps these little workstations that sit next to you while you're doing graphics programming, while you're
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directly programming your GPU and then of course they need some CPU to put in that so they're using AMD or Intel or they're licensing some CPU and now they're saying you know what we're actually just going to do the CPU too.
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So now we make a box and it's a fully integrated NVIDIA solution with our GPUs, our CPUs, our NVLink between them, our InfiniBand to network it to other boxes and you know welcome to the show.
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Co-oss. When you start talking to the real semi-nerds, that's when they start busting out the co-oss conversation.
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Yes. So this gets to the point of why can't they seem to make enough chips right now? Well, it's literally a TSMC capacity problem. So there's these two components that are extremely related that you're talking about, the CoAus chip-on wafer-on substrate and the high bandwidth memory.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
So there's this great post from SemiAnalysis where the author points out a 2.5D chip, which is basically how you assemble this CoAus stuff to get the memory really close to the processor. And of course, 2.5D, it is literally 3D, but 3D means something else. It's even more 3D, so they came up with this 2.5D denominator.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Anyway, the 2.5D chip packaging technology from TSMC is where you take multiple active silicon dies, like the logic chips and the stack of high bandwidth memory, and they stack them on one piece of silicon. And there's more complexity here, but the important thing is CoaS is the most popular technology for GPUs and AI accelerators for packaging these chips.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And it's the primary method to co-package high bandwidth memory Again, remember, think back to the thing that's most important right now is get as much high bandwidth memory as you can closest to the CPU next to the logic to get the most performance for training and inference.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
So CoaS represents right now about 10 to 15% of TSMC's capacities, and many of the facilities are custom built for exactly these types of chips that they're producing. So when NVIDIA needs to reserve more capacity, there's a pretty good chance that they've already reserved some large part of the 10 to 15% of TSMC's total footprint.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And TSMC needs to like go make more fabs in order for NVIDIA to have access to more co-ops capable capacity.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yep. There are more experimental things that are happening. Like, I would be remiss not to mention, there are actually experiments of doing compute in memory. Like, as we shift away from von Neumann and sort of all bets are off now that we're open to new computing architectures, there are...
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
people exploring, well, what if we just process the data where it is in memory instead of doing the very lossy, expensive, energy-intensive thing of moving data over the copper wire to get it to the CPU? All sorts of trade-offs in there, but it is very fun to sort of dive into the academic computer science world right now where they really are rethinking, like, what is a computer?
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
I hear margins. But let's be clear, you don't need to offer some sort of solution to get high margins if you're Nvidia. Price is set where supply meets demand, and they're adding as much supply as they possibly can right now. Like, believe me, for all sorts of reasons, Nvidia wants everyone who wants H100s to have H100s.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
But for now, the price is kind of like, I'll write you a blank check, and NVIDIA, you write whatever you want on the check. So their margins are crazy right now, just literally because there's way more demand than supply for these things.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Welcome to Season 13, Episode 3 of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts. Today, we tell a story that we thought we had already finished, NVIDIA. But the last 18 months have been so insane, listeners, that it warranted an entire episode on its own.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And the people who are most likely to do this are the hyperscalers, or as NVIDIA refers to them, the CSPs, the cloud service providers.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Like NVIDIA, don't give me one of these DGX servers that you assemble. Just give me the chip and I will integrate it the way that I want to integrate it.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
But let's say you are an arbitrary company in the Fortune 500 that is not a technology company. And my God, do you not want to miss the boat on generative AI? And you've got a data center of your own. Well, NVIDIA has a DGX for you.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And it all runs CUDA. It is all speaking the exact language of the entire ecosystem of developers that know exactly how to write software for this thing.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And it's like 20 racks wide. Imagine an entire row at a data center.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Wild. Well, let's talk about the H100. I have the baseball card right here on this insane thing that they've built. So they launched it in September 2022. It's the successor to the A100. One GPU, one H100 costs $40,000. So that's how you get to that price point you're talking about...
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Right. And you mentioned that $500,000 price point. The $500,000 is the eight $40,000 H100s in a box with the gray CPU and, you know, the nice bow around it. Yep. Which, do the math on that. So eight times $40,000, that's $320,000.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah, sure. We shrugged it off and we were like, all right, carve outs.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And these $40,000 H100s have margin of their own. So like every time they bundle more, there's more margin in the fully assembled. I mean, that's literally bundle economics. You are entitled to margin when you bundle more things together and provide more value for customers. But just to like illustrate the way that this pricing works.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
So the reason you want an H100 is they're 30 times faster than an A100, which mind you is only like two and a half years older. It is nine times faster for AI training. The H100 is literally purpose-built for training LLMs, like the full self-driving video stuff. It's super easy to scale up. It's got 18,500 CUDA cores. Remember when we were talking about the von Neumann example earlier, like...
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
That is one computing core that is able to handle, you know, those four assembly language instructions. This one H100, which they're calling AGPU, has 18,500 cores that are capable of running CUDA software. It's got 640 tensor cores, which are highly specialized for matrix multiplication. They have 80 streaming multiprocessors. So what are we up to here?
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Close to 20,000 unique cores on this thing. It's got meaningfully higher energy usage than the A100. I mean, a big takeaway here is that NVIDIA is massively increasing the power requirement every time they come out with the next generation. They're both figuring out how to push the edge of physics, but they're also constrained by physics. Some of this stuff is only possible with way more energy.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
This thing weighs 70 pounds. This is one H100.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
It's got a quarter trillion transistors across 35,000 parts. It requires robots to assemble it. Not only does it require physical robots to assemble it, it requires AI to design it. They're actually using AI to design the chips themselves now. I mean, they have completely reinvented the notion of what a computer is.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yep. And by the fact that this is all accelerated computing, the things you're doing on it, you literally wouldn't be able to do otherwise or might take you a lot more energy, a lot more time, a lot more cost.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
There is a very valid story to buying and running your workloads here or renting from any of the cloud service providers and running your workloads here is more performant because the results just happen much faster, much cheaper or at all.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Oh, I totally buy it, though. I mean, I think there's a very real case around, look, you only have to train a model once, and then you can do inference on it over and over and over again. I mean, the analogy I think makes a lot of sense for model training is to think about it as a form of compression, right? LLMs are turning the entire internet of text into a much smaller set of model weights.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
This has the benefit of storing a huge amount of usefulness in a small footprint, but also enabling a very inexpensive amount of compute, again, relatively speaking, in the inference step for every time that you need to prompt that model for an answer.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Of course, the trade-off you're making there is once you encode all of the training data into the model, it is very expensive to redo it, so you better do it right the first time or figure out little ways to modify it later, which a lot of ML researchers are working on. But I always think a reasonable comparison here is to compress a zillion-layer Photoshop file.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
For anybody that's ever dealt with, oh, I've got a three-gigabyte Photoshop file, Well, that's not a thing you're going to send to a client. You're going to compress it into a JPEG and you're going to send that. And the JPEG is in many ways more useful as a compressed facsimile of the original layers comprising the Photoshop file.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
But the trade-off is you can never get from that compressed little JPEG back to the original thing. So I think the analogy here is like you're saving everyone from needing to make the full PSD every time because you can just use the JPEG the vast, vast majority of the time.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Oh, I just looked at the pricing pages on public clouds today. I think Azure and AWS were where I looked. You can get access to a DGX server that's eight A100s for about 30 bucks an hour, or you can go over to AWS and get a P5.48X large instance, which is eight H100s, which I believe is an HGX server for about $100 an hour. So about three times as much.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And again, when I say you can get access, I don't actually mean you can get access. I mean, that's the price.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah, and of course, you could rent these instances from Amazon, Microsoft, Google, Oracle, but like... You're not getting that full integrated solution. Right. And you're getting some integration the way that the cloud service provider wants to create the integration using their proprietary services.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And to be honest, you might not have the right people on staff to be able to deal with this stuff in a pseudo bare metal way.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Even if it's not in your data center and you're renting it from the cloud, you might actually need, based on your workforce, to just use a web browser and just use a real nice, easy web interface to load some models in from a trusted source that you can easily pair with your data and just click run and not have to worry about any of the complexity of managing a cloud application that's in Amazon or Microsoft or something a little bit scarier and closer to the metal.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Right. The boxes are sitting in the data centers of these other CSPs. Right.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
You log into the DGX Cloud website through NVIDIA, and it's all nice WYSIWYG stuff. There's an integration with Hugging Face where you can easily deploy models right off of Hugging Face. You can upload your data. Like, everything is just really WYSIWYG is probably the way to describe it.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And NVIDIA does have, I think, six data centers, but that I don't believe is what they're actually using to back DGX Cloud.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Which is crucially important because at this point, the CFO Colette Kress said on their last earnings call that about half of the revenue from the data center business unit is CSPs. And then I believe after that is the consumer internet companies, and after that is enterprises.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And David, you were telling me it's the largest ever use of Mechanical Turk up to that point was to label the ImageNet dataset?
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
So there's a few interesting things in there, one of which is, oh my god, their revenue for this is concentrated among like five to eight companies with these CSPs. Two, they don't necessarily own the customer relationship. They own the developer relationship through CUDA. You know, they've got this unbelievable ecosystem right now of NVIDIA developers that's stronger than ever.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
But in terms of the actual customer... half of their revenue is intermediated by cloud providers. The second interesting thing about this is even today in this AI explosion, the second biggest segment of data centers is still the consumer internet companies. It's still all that stuff we were talking about before of the uses of machine learning to...
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
figure out what should show up in your social media algorithms and match ads to you, that's actually bigger than all of the direct enterprises who are buying from NVIDIA. So the DGX Cloud Play is a way to sort of shift some of that CSP revenue into direct relationship revenue.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yes, it's amazing that in that Stratechery interview, when was that? In March of 2023, Jensen said last year was unquestionably a disappointing year. This is the year ChatGPT was released. It is wild the roller coaster this company has been on. The timeframe is so compressed here.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And part of that, of course, is Ethereum moving to proof of stay, the end of the crypto thing for NVIDIA, which I'm sure they're actually thrilled about. But part of it was they also put in a ton of pre-orders for capacity with TSMC that then they thought they weren't going to need, so they had to write down.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
So from an accounting perspective, it looks like a big loss, like a really big blemish on their finances last year. But now, oh my God, are they glad that they reserved all that capacity.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
This is a trillion dollar company, or at least this made them a trillion dollar company. But like a company that was previously valued at around $800 billion popped 25% after earnings.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah, and if I'm remembering from our episode, basically what happened is the AlexNet team did way better than anybody else had ever done. The complete step changed better. I think the error rate went from mislabeling images 25% of the time to suddenly only mislabeling them 15% of the time. And that was like a huge leap over the tiny incremental progress that had been made along the way.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
The thing that blows my mind the most is that their data center segment alone did $10 billion in the quarter. That's more than doubling off of the previous quarter. In three months, they grew from $4-ish billion to $10 billion of revenue in that segment. And revenue only happens when they deliver products to customers. This isn't pre-orders. This isn't clicks.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
This isn't wave your hands around stuff. This is we delivered stuff to customers and they paid us an additional $6 billion this quarter than they did last quarter.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
No, but in a new way that I think is a better way to slice it.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And the thing you have to believe now, because whenever someone paints a picture, you say, okay, what do I have to believe? The thing you have to believe is there is real user value being created by these AI workloads and the applications that they are creating. And there's pretty good evidence.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
I mean, ChatGPT made it so OpenAI is rumored to be doing over a billion dollar run rate now, maybe multiple single digit billions, and still growing meaningfully. And so that is like the shining example. Again, that's the Netscape navigator here of this whole boom. But the bet, especially with all these Fortune 500s, is that there are going to be GPT-like experiences in...
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
everyone's private applications in a zillion other public interfaces. I mean, Jensen frames it as in the future, every application will have a GPT front end. It will be a way that you decide that you want to interact with computers that is more natural. And I don't think he means like versus clicking buttons.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
I think he means everyone can kind of become a programmer, but the programming language is English. And so when you're sort of like, well, why is everyone spending all of this money? It is that the world's executives with the purchasing power to go write a $10 billion check last quarter to NVIDIA for all this stuff are
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
wholeheartedly believes from the data they've seen so far that this technology is going to change the world enough for them to make these huge bets. And the thing that we don't know yet is, is that true? Is the GPT-like experiences going to be an enduring thing for the far future or not?
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
There's pretty good evidence so far that people like this stuff and that it's quite useful in transforming the way that, you know, everyone lives their lives and goes about day to day and does their jobs and goes through school and, you know, on and on and on. But that is the thing you have to believe.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yes, absolutely. And listeners, you know we're doing something very cool with them this season. As you know, Blinkist takes books and condenses them into the most important points so you can read or listen to the summaries.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
There you go. So a couple of cool things we're doing, one of which is David and I have made a Blinkist page that represents our bookshelf. So if you want to read the books that influence us, you can go to Blinkist.com slash acquired. And for this particular NVIDIA episode, Blinkist has made a special collection for us.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Amazingly, there are not really books about the history of NVIDIA itself, at least not yet. Which is unbelievable. Yeah. But there are plenty on AI through the years. So if you go to Blinkist.com slash NVIDIA, you can find books by Garry Kasparov, Kai-Fu Lee, and Cade Metz, who we already mentioned earlier on the show.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yep. You'll, of course, get free access to that NVIDIA Blinkist collection, and anyone who signs up through that link or uses the coupon code NVIDIA will then get a 50% off premium subscription to all 6,500 titles in their library.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yes. Our huge thanks to Blinkist and their parent company, GoOne, where David and I are both huge fans and angel investors. GoOne and Blinkist are both amazing ways for your company to get access to the most engaging and compelling content in the world. Our thanks to both of them and links in the show notes. Okay, so David, analysis.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
We got to talk about CUDA before we even start analyzing anything else here. Talked about a lot of hardware so far on this episode, but there's this huge piece of the NVIDIA puzzle that we haven't talked about since part two. And CUDA, as folks know, was the initiative started in 2006.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
by Jensen and Ian Buck and a bunch of other folks on the NVIDIA team to really make a bet on scientific computing, that people could use graphics cards for more than just graphics, and they would need great software tools to help them do that.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
It also was the glimmer in Jensen's eye of, ooh, maybe I can build my own relationship with developers, and there can be this notion not of a Microsoft or an Intel developer who happens to be able to have a standard interface to my chip, but I can have my own developer ecosystem, which has been huge for the company.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
So CUDA has become the foundation that everything that we've talked about, all the AI applications are written on top of today. So, you know, you hear Jensen in these keynotes reference CUDA the platform, CUDA the language.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And I spent some time trying to figure out, like, when I was watching developer sessions and like literally learning some CUDA programs, what is the right way to characterize it?
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yes. So today, CUDA is, starting from the bottom and going up, a compiler, a runtime, a set of development tools like a debugger and a profiler. It is its own programming language, CUDA C++. It has industry-specific libraries. It works on every card that they ship and have shipped since 2006. which is a really important thing to know.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And if you're a CUDA developer, your stuff works on everything, anything NVIDIA, all this unified interface. It has many layers of abstractions and existing libraries that are optimized. So these libraries of code that you can call to keep your development work short and simple instead of reinventing the wheel.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
So, you know, there are things that you can decide that you want to write in C++ and just rely on their compiler to make it run well on C++.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
nvidia hardware for you or you can write stuff in their native language and try to implement things yourself in cuda c++ the answer is it's incredibly flexible it is very well supported and there's this huge community of people that are developing with you and building stuff for you to build on top of if you look at the number of cuda developers over time It was released in 2006.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
It took four years to get the first 100,000 people. Then by 2016, 13 years in, they got to a million developers. Then just two years later, they got to 2 million. So 13 years to add their first 13 million, then two years to add their second. 2022, they hit 3 million developers. And then just one year later, In May of 2023, CUDA has 4 million registered developers.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
So at this point, there's a huge moat for NVIDIA. And I think when you talk to folks there, and frankly, when we did talk to folks there, they don't describe it this way. They don't think about it like, well, CUDA is our moat versus competitors. It's more like, well, look, we envisioned...
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
a world of accelerated computing in the future, and we thought there are way more workloads that should be parallelized and made more efficient that we want people to run on our hardware, and we need to make it as easy as possible for them to do that, and we're going to go to great lengths and have
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
One, 2,000 people that work at our company, they're going to be full-time software engineers building this programming language and compiler and foundation and framework and everything on top of it to let the maximum number of people build on our stuff. That is how you build a developer ecosystem.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
It's different language, but the bottom line is they have a huge reverence for the power that it gives them at the company.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Right. Cisco doesn't really have developers. Intel never had developers. Microsoft had developers, and Intel had Microsoft, but Intel didn't have developers. NVIDIA has developers. I mean, they've built a new architecture that is not a von Neumann computer. They've bucked 50 years of progress, and instead, every GPU has a stream processor unit
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And as you'd imagine, you need a whole new type of programming language and compiler and everything to deal with this new computing model. And that's CUDA, and it freaking works. And there's all these people that develop their livelihood in it.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah, I mean, it's interesting. They're a platform company for sure. They're also a systems company. They're effectively selling mainframes. I mean, it's not that different than IBM way back when. They're trying to sell you a $100 million wall that goes in your data center, and it's all fully integrated, and it all just works.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yep. Okay, so a couple other things to catch us up here as we're starting analysis. One big point I want to make is, let's look at a timeline, because I didn't discover this until like two hours before we started recording. In March of 2019, Nvidia announced they were acquiring Mellanox for $7 billion in cash.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And I think Intel was considering the purchase and then Nvidia came in and kind of blew them out of the water. And it is fair to say nobody really understood what NVIDIA was going to do there and why it was so important. But the question is why?
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Well, NVIDIA knew that these new models coming out would need to run across multiple servers, multiple racks, and they put a huge level of importance on the bandwidth between the machines. And of course, how did they know that? Well, in August of 2019, NVIDIA released what was at the time the largest transformer-based language model called Megatron.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
8.3 billion parameters trained on 512 GPUs for nine days, which at the time at retail would have cost something like half a million dollars to train, which at the time was a huge amount of money to spend on model training, which is
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
what only four years ago but today that's quaint nvidia did that because they do a huge amount of research at the company and they work with every other company doing ai research and they were like oh yes this stuff is going to work and this stuff is going to require the fastest networking available and i think that has to do with why no one else saw how valuable the melanox technology could be yep
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And basically, the algorithm that other people had been trying over the years just wasn't massively parallel the way that a graphics card sort of enables. So if you actually can consume the full compute of a graphics card, then perhaps you could run some unique novel algorithm and do it on, you know, a fraction of the time and expense that it would take in these supercomputer laboratories.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Another thing that I want to talk about for NVIDIA's business today is this notion of the data center is the computer. And Jensen did a great interview with Ben Thompson last year where he talks about the idea that they build their systems full stack. Like their dream is that you own and operate a DGX super pod.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And he says, we build our systems full stack, but we go to market in a disaggregated way, integrating into the compute fabric of the industry. So I think that's his sort of way of saying, look, customers need to use us in a bunch of different ways. So we need to be flexible on that.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
But we don't want to build each of our components such that if you do assemble them all together, it's this unbelievable experience. And we'll figure out how to provide the right experience to you if you only want to use them in piecemeal ways or... You want to use us in the cloud or the cloud providers want to use us.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Again, it's build the product as a system, build the system full stack, but go to market in a disaggregated way.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah, you could imagine there are more NVIDIA data centers likely on the way that are fully owned and operated. Speaking of all of this, we got to talk some numbers on margin. This last quarter, they had a gross margin of 70%. And they forecasted for next quarter to have a gross margin of 72%. I mean, if you go back pre-CUDA, when they were a commoditized graphics card manufacturer, it was 24%.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
So they've gone 24 to 70 on gross margin. And with the exception of a few quarters along the way for these strange one-time events, it's basically been a linear climb quarter over quarter as they've deepened their moat and as they've deepened their differentiation in the industry.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
We're definitely at a place right now that I think is temporary due to the supply shortage of the world's enterprises, and in some cases, even governments. You look at the UK or some of the Middle Eastern countries, like, blank check, I just need access to NVIDIA hardware. That's going to go away, but I don't think this very high, you know, 65% plus margin is going to erode too much.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And by the way, Baidu has potentially the largest model of anyone. Their GPT competitor is over a trillion parameters and may actually be larger than GPT-4.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
David, they're export controls. Don't say bands.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Which I think they basically just crank down the NVLink's data transfer speeds. So it's like buying a top-of-the-line A100, but not with as fast of data connections as you need, which basically makes it so you can't train large models.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
So today is a part three for us with NVIDIA, telling the story of the AI revolution, how we got here, and why it's happening now, starting all the way down at the level of atoms and silicon. So here's something crazy that I did a transcript search on to see if it was true. In our April 2022 episodes, we never once said the word generative. That is how fast things have changed. Unbelievable.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And there's been even a more recent spike of them because a lot of Chinese companies are reading the tea leaves and saying, ooh, export controls might get even more severe, so I should get them while I still can, these 800s.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah, that's a great point. Talking about the rest of NVIDIA, just for a moment, I mean, this episode is about the data center segment, but... Oh, you mean they still make gaming cards, too? It is worth talking about this idea that Omniverse is starting to look really interesting. As of their conference six months ago, they had 700 enterprises who had signed up as customers.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And the reason this is interesting is it could be where their two different worlds collide. 3D graphics with ray tracing, which is new and amazing, and the demos are mind-blowing, and AI. They have been playing in both of these markets since the workloads are both massively parallelizable. That is the sort of original reason for them to be in the AI market.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
If you recall back to way back our part one episode, the original mission of NVIDIA was to make graphics a storytelling medium. And then their mission has expanded as they've realized, my God, our hardware is really good at other stuff that needs to be parallelized too. But fascinatingly with Omniverse, the future
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
could actually look like applications where you need both amazing graphical capability and AI capability for the same application. And, I mean, for all the other amazing uniqueness about NVIDIA that we've been talking about and how well positioned they are, adding this on top, where they're the number one provider for graphics hardware and software and AI hardware and software.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Oh, and by the way, there's this huge... emerging where you actually do need both, they're just going to knock it out of the park if that comes true.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Totally. Or, you know, an airplane that's in a simulation of not just a wind tunnel, but simulating millions of hours of flying time using real-time weather that's actually going on in the world and using AI to project the weather in the future. So you can sort of know the real-world potential things that your aircraft could encounter all in a generated graphical AI simulation.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
I mean, there's going to be a lot more of this stuff to come.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Another thing to know about NVIDIA that we really didn't talk about on the last episode, they're pretty employee efficient. They have 26,000 employees, and that sounds like a big number, but for comparison, Microsoft, whose market cap is only twice as big, has 220,000. So that is 5x the number of employees per dollar of market cap compared going on over at Microsoft.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And this is a little bit farcical since, you know, NVIDIA only recently has had such a massive market cap.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Right. They have $46 million of market cap per employee.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
well i also get the sense that it's a little bit of a do your life's work or don't be here situation like jensen is rumored to have 40 direct reports and his office is basically just an empty conference room because he's just bouncing around so much and he's on his phone and he's talking to this person and that person and like you can't manage 40 people directly if you're worrying about someone's career ambitions
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
It kind of feels like all of his peers have either decided to retire and relax or are, you know, relaxing while running their companies. I think there's another crop of people that are doing that. And that is just not at all interesting to him or what he's doing.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And I kind of get the sense, like, he's got another 30 years in him and he's architected the company in such a way that that's the plan, right? I don't think there's anyone else there where they're like getting ready for that person to take over. I think the company is a extension of Jensen's thoughts and will and drive and belief about the future. And that's kind of what happens.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And it's so interesting that there was this first market called graphics that was obviously parallel, where every pixel on a screen is not sequentially dependent on the pixel next to it. It literally can be computed independently and output to the screen. So you have however many tens of thousands or now hundreds of thousands of pixels on a screen that can all actually be done in parallel.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah, he's not buying social media platforms and newspapers.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
I mean, it is quite telling that when you watch one of their keynotes, it's Jensen on stage and it's some customer demos, but it's not like the Apple keynotes where Tim Cook's calling up another Apple employee. It's the Jensen show.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah, text him. Text him. All right, power.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
All right, so for listeners who are new to the show, this is the section where we talk about what it is about the company that enables them to achieve persistent differential returns, or in other words, to be more profitable than their closest competitor and do so sustainably.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And NVIDIA is fascinating because they sort of have a direct competitor, but that's not the most interesting form of competition for them. Disintermediation is. Sure, ostensibly there's NVIDIA versus AMD, but like, AMD doesn't have all this capacity reserved from TSMC, at least not for the 2.5D packaging process for the high-end GPUs. AMD doesn't have the developer ecosystem from CUDA.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
They're the closest direct comp, but it's Amazon building Tranium and Inferentia. It's if Microsoft decides to go and build their own chip as they're rumored to with AMD. It's Google and the TPU. Facebook developing PyTorch and then leveraging their foothold with PyTorch with the developer community to figure out how to extend underneath of PyTorch.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
There's a lot of competitive vectors coming at NVIDIA, but not directly.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yep. Now, all that said, they've got a lot of powers. So as we move through these one by one, I think let's just say them all and we can decide if there's something to talk about here. Counter-positioning is the one where I actually don't think there's anything here.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
I don't think there's anything that NVIDIA does where there's another company that's actively choosing not to do that because any company would want to be NVIDIA right now.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
But like right now, what do you think other data center hardware providers, what are they not doing? Yeah, fair point.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Everyone's just going to chase exactly what NVIDIA is doing years behind them. That's the market right now.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And the question is, will NVIDIA be able to stay ahead in ways that matter?
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
That, I think, is the entire analysis on the company right now, is in what ways that matter to customers at large scale and large markets will they be able to sustainably be ahead of people that are just chasing them and trying to copy what they're doing because the margin profile is so fat and juicy that people don't want to pay it. So the second one, scale economies. Yeah.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
This has CUDA written all over it. You can make massive fixed cost investments when you have the scale to amortize that cost across. And when you have 4 million developers who want to develop on your platform, you can justify whatever it is, 1,600 people who actively on LinkedIn at Nvidia today have the word CUDA in their job title.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And little did NVIDIA realize, of course, that AI and crypto and all this other linear algebra, matrix math-based things that turned into accelerated computing, pulling things off the CPU and putting them on GPU and other parallel processors was an entire new frontier of other applications that could use the very same technology they had pioneered for graphics.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
I mean, I'm sure it's actually even more than that who just aren't, you know, they're saying software or something like that, but thousands of people of an investment that they don't make any money on software. They make a de minimis amount on software, but that is amortized across the entire developer base.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
I think this is exactly the right framing here, that NVIDIA is the Apple of AI, and PyTorch is sort of Android because it's open source and it's got a bunch of different companies that care about it. OpenCL is the Android as it pertains to graphics, but it's pretty bad and pretty far behind. RockM is the CUDA competitor made by AMD for their hardware, but again, new, not a lot of adoption.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
They're working on it, but... They've open sourced that because they realize they can't go directly head-to-head with NVIDIA. They need some different strategy. But yes, they are absolutely running the Apple playbook here.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
I sent you this graph, David, of my estimated number of employees working on CUDA per year since inception in 2006. And then if you look at the area under the curve and just take the integral, it's approximately 10,000 person years that have gone into CUDA. Like, good luck.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Right. That is the interesting point, is every moat only works if the castle is sufficiently small. If the prize at the end of the finish line becomes sufficiently large, you're going to need a bigger moat, and you need to figure out how to defend the castle harder. I'm mixing so many metaphors here, but you get the idea.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
This was a perfectly fine moat when the addressable market was $100 billion. Is it at a trillion-dollar market opportunity? Probably not. Basically, it means margins come down and competition gets more fierce over time.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
We've built some structural ways to defend the business, but we need to continue running as fast as we've ever run to stay ahead because it's such an attractive race that we're in.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
So far, everything of consequence, especially model training, especially on LLMs, has been built on NVIDIA. And that alone is just a big pile of code and a big amount of organizational momentum. So switching away from that, even from the software perspective, is going to be hard.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
But there are companies today, in 2023, both at the hyperscalers and Fortune 500 companies that own their own data centers, making data center purchase and rollout decisions that will last at least the next five years. Because these data center re-architectures don't happen very often.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
So David, the last time we told this story in full, we talked about this team from Toronto. We did not follow what this team of three went on to do afterwards.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And so you better believe that NVIDIA is trying as hard as they can to ship as much product as they can while they have the lead in order to lock in that data center architecture for the next 10 years.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Who I stole many insights from for this episode.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
So even if we're sort of in this bubbly moment around the excitement of generative AI before we necessarily know the full set of applications, NVIDIA is leveraging this excitement to go get some lock-in. I've seen some people on the internet being like, they love how supply constrained they are. I don't think so.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
I think they're looking for capacity in every way they can get it to exploit this opportunity while it exists.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yep. But there's only one TSMC, and there's only so many fabs that they have that can do the, what do they call it, the 2.5D architecture, so.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah. This is probably the textbook cornered resource. NVIDIA has access to a huge amount of capacity at TSMC that none of their competitors can get their hands on. I mean, they did luck into this cornered resource a little bit. They reserved all that wafer supply for a different purpose, partially crypto mining, but AMD doesn't have it.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
AMD does have a ton of capacity, it's worth saying, at TSMC for their other products, data center CPUs, which they've actually been doing very well in. But NVIDIA did end up with this wide open lane all to themselves on co-op capacity at TSMC, and they got to make the most of that for as long as they have it.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
It's like an invention delivered by aliens that very few humans know how to actually do. Yes. It is worth acknowledging it's kind of a two-horse race for LLM training. I know we've been harping on NVIDIA, but Google TPUs are also manufactured at volume. You can just only get them through Google Cloud.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And I think, I don't know if you have to use the TensorFlow framework, which has been waning in popularity relative to PyTorch, but it's certainly not an industry standard to use TPUs the way that it is to use NVIDIA. NVIDIA's hardware, I suspect a lot of the volume of the TPUs is being used internally by Google for BARD, for doing stuff in Google search.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Like I know they've added a lot of the generative AI capability to search.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Right. And they run among the most profitable businesses the world has ever seen. So anything they can do to further advantage and extend that runway, they probably should do.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yep. The last one that I had highlighted is network economies. They have a large number of developers out there and a large number of customers that they can amortize these technology investments across and who all benefit from each other. I mean, remember, there are people building libraries on top of CUDA and you can use the building blocks that other people built to build your code.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
You can write amazing CUDA programs that just don't have that many lines of code because it's calling other preexisting stuff. And Nvidia made a decision in 2006 that at the time was very costly, like big investment decision, but it looks genius in hindsight to make sure that every GPU that went out the door was fully CUDA capable.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And today there are 500 million CUDA capable GPUs for developers to target. It's just very attractive. I'm putting this in network economies.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
I think it's probably more a scale economy than a network economy, but you could imagine a lot of people ho-humming around NVIDIA in 2006 to 2012 saying, why do I have to make it so that my software fits on this tiny little footprint and we can include CUDA taking up a huge amount of space on this thing and make all these trade-offs in our hardware so that we can, are people going to use CUDA?
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yep. They do have branding power, for sure.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
This is the nobody gets fired for buying IBM. I mean, NVIDIA is the modern IBM in the AI era.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
You're saying that they carried their consumer brand into their enterprise posture, right?
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah. There's a big strength leads to strength thing here, too, where I bet the revenue results from last quarter massively dwarf any brand benefit that they ever got from the consumer side. I think it's just the fact that like, hey, look, everyone else is buying NVIDIA. I'd be an idiot not to.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Right. Or taking a big dependency on them or targeting that development platform. It's just the like, if you're innovating in your business, you don't want to take risk on the platform you're building on top of. You want to be the only risk in the value chain.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah. And this is probably the weakest one, even though I'm sure you could make some argument that they have process power. It's just that all the other powers are so much more valuable.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
The question is, does that actually matter? There are so many people that are using A100s right now. And in fact, most workloads can be run on A100s unless you're doing model training of GPT-4 I just don't know that it actually matters that much, or as much as other factors. And I'll give you an example. AMD does have 3D packaging on one of their latest GPUs.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
It's a more sophisticated way of doing real copper to real copper direct connection Without a silicon interposer, I'm getting into a little bit of the details, but basically it's more sophisticated than the process that the H100 2.5D is using to make sure that memory is extremely close to compute. And does that matter? Not really.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
What matters is everything else that we've been talking about, and nobody's going to make a purchase decision on this thing because it's, you know, a little bit of a better mousetrap.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah. And in a strength leads to strength way. So you can see why they're trying to sort of seize this moment.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
So one thing that I want to point out is Jensen keeps referring to this as the iPhone moment for AI. And when he says it, the common understanding is that he means a new mainstream method for interacting with computers. But there's another way to interpret it. Does this sound familiar, David, when I say a hardware company differentiated by software that then expanded into services?
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
It's quite tongue-in-cheek to be referring to the iPhone moment of AI when referring to oneself, NVIDIA, as the Apple. Because I really think that the parallels are uncanny, that they have this vertically integrated hardware and software stack provided by NVIDIA. You use their tools to develop for it. They've shipped the most units, so developers have a big incentive to target that market.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
It's the best individual buyers to target because they're the least cost sensitive and they appreciate you building the best experiences for them. I mean, it's the iPhone, but in many ways it's better because the target is a B2B target instead of consumers.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
The only way in which it's different is Apple has always had a market cap that sort of lagged its proven value to users, whereas NVIDIA right now is exactly over their skis. Yeah.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Great. The second one is that they've moved on from becoming a hardware company to truly being a systems company. While Nvidia's chips are typically ahead, it really doesn't matter on a chip-to-chip comparison. That is not the playing field.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
It is all about how well multiple GPUs and multiple racks of GPUs work together as one system with all the hardware and networking and software that enables that. They have just entirely changed the vector of competition, which I think lots of companies can learn from.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And my third one here is this quote that Jensen had, again, from the same Stratechery interview, which is, you build a great company by doing things that other people can't do. You don't build a company by fighting other people to do things that everyone can do. And I think it's so salient.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
It comes out in all these interesting ways, one of which is, NVIDIA never dedicated resources to building a CPU until there was a differentiated way and a real reason for them to build their own CPU, which is now. And the way that they're doing it, by the way, is not terribly differentiated.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
It's an off-the-shelf ARM architecture that they're putting some of their own secret sauce on, but it's not like they're doing Apple-style M3 creation of a chip from scratch.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Right. There are many ways that NVIDIA sort of applies this where I think we talked about in the last episode, if they think it's going to be a low margin opportunity, they don't go after it. But the nicer way to say that is, we don't want to compete for things that anybody can do. We want to do things that only we can do.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Oh, and by the way, we will fully realize the value of those things when we do them.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
This guy was born to be a computer science researcher. Oh, my God. Right?
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
It is crazy. They used to have to plug into other people's servers. And then they started making servers that plugged into other people's racks and rows and architectures. And then they started making their own entire rows and walls. And at some point here, they're going to start running their own buildings full of servers too. And they're going to say, we don't have to plug into anything.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
You only get to do the stuff they're doing if you invested 10 years ahead of the industry, were wildly inventive and innovative in creating these like true breakthrough innovations, and were really, really right about huge markets.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
None of this stuff applies unless you're doing those three things.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Right. So there's this interesting conversation I wanted to have with you ahead of winding it up with the bull and bear case. So think back to our AWS episode. We talked a lot about how AWS is just... locked in. The databases are a ridiculously durable advantage. Once your data has been shipped to a particular cloud, often literally in semi-trucks full of hard drives.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
I also didn't know there were people named Boole, that that's where that came from. That's hilarious.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
It's hard to move off of it. There's this sort of interesting question of, will winning Cloud 1.0 for all these Google, Microsoft, Amazon, will that toehold actually enable them to win in the Cloud AI era? On the one hand, you'd think, yes, absolutely, because I want to train my AI models right next to where my data is. It's really expensive to move my data somewhere else to do that.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Right. On the other hand, the experience that customers are demanding is the full-stack NVIDIA experience, not this, oh, you found the cheapest possible cost-of-goods-sold way to offer me... something that's like the experience that I want.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And sometimes the cloud providers have to offer me an A100 or an H100 because my code is way too complicated to ever re-architect for whatever accelerated computing devices they're offering me that's first party and cheaper for them. I don't know.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
I just think for the first time in the last five years or so, I've sort of cocked my head a little bit at the moat of these existing cloud providers and said, huh, maybe there really is a vector to compete with them. And cloud is not a settled frontier.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yep. I bet the way it plays out is that where you landed in cloud 1.0 strongly dictates where you will land in this AI cloud era. Because at the end of the day, if customers are demanding NVIDIA stuff, then the cloud providers have every incentive in the world to make it so that you can run your applications great in their cloud.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Super true. All right. Let's do the bull case and bear case and bring this one home.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah. I mean, part of it is, is their existing moat big enough if GPUs actually become a $100 billion a year market? I mean, right now, GPUs in the data center are like a $30 billion a year market going to like a $50 billion next year. And like, if this actually goes the way that everyone seems to think it's going to go...
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
There's just too many margin dollars out there for these big companies to not invest heavily. Meta threw tens of billions of dollars making the metaverse. I mean, Apple's put $15 billion into, rumored, into their headset. Amazon's put tens of billions of dollars into devices, which by all means was a terrible investment. How is Echo paying anything back?
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Well, they need to train EM and Inferentia a little bit harder. Ah, Jesus.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah. I mean, never doubt big tech's ability to throw tens of billions of dollars into something if the payoff could be big enough. These are ludicrously profitable monopolies, except for Amazon's not that profitable.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah. But Google, Facebook, Apple, at some point here, there's a game of chicken that ends. And some of these companies go all in and say, yeah, we have smart engineers too. Like, we're going to figure this out.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah. Yeah. All right. So let's actually do this. Bear case. Let's start with the bear case.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yep. And to put a finer point on that, let's look at PyTorch for a minute. Now that all the developers or lots of developers are using PyTorch, it does enable PyTorch to aggregate customers, which gives them the opportunity to disintermediate. Maybe. You've got to write a lot of new stuff underneath and ship a lot of hardware. I mean, the cloud service providers have taken some steps here.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
It was originally developed by Meta, and while it's open source, it's still hard for all these companies to invest in it if it's really sort of owned and controlled by Meta. So now PyTorch has been moved out into a foundation that a lot of companies are contributing to. And again... It is a absolute false equivalence to be like PyTorch versus NVIDIA.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
But in real Ben Thompson aggregation theory parlance, if you aggregate the customers, you have the opportunity then to take more margin, to disintermediate, to direct where that attention is going. And PyTorch has that opportunity. That feels like the vector that a lot of these CSPs will try and compete on and say, look, if you're building for PyTorch, it runs really well on our thing too.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
The next one is, like, literally the market isn't as big as the market cap reflects. I think there's a pretty reasonable chance that there's some falter in the next 12 to 18 months where there's a crisis of confidence among investors where... At some point, something will come out where we all observe, oh, maybe GPTs aren't as useful as we thought. Maybe people don't want chat interfaces.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
And that crisis of confidence, that mini bubble burst will trickle out to America's CIOs and CEOs, make it harder to advocate in the boardroom, to make this big fundamental purchase and re-architecture of our whole budget from this year that we agreed on that I'm trying to propose us changing. There's a crypto-like element to...
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
a excitement bubble bursting that will, for some companies, slow their spend. And the question is sort of like, when that happens, because it's not an if, it's a when. I have a hard time believing that given all the hype around everything right now,
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
AI will be even more useful than everyone believes, and it will continue in a linear fashion where without any drawdowns, everyone's excitement only gets bigger from here. It may end up being way more useful than anyone thought, but there at some point will be some valley or trough. And it's sort of about how does NVIDIA fare during that crisis of confidence.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
And whatever they did, it was going to get acquired real fast.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
The most interesting thing about the overhype is that it's actually showing up in revenue. It's everyone who is buying access to all this compute believes something. And for NVIDIA, because it's showing up in the form of revenue, the belief is real.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Totally crazy. And the timing of all of this AI stuff in the world is unbelievably coincidental and very favorable. So recall back to 18 months ago. Throughout 2022, we all watched financial markets from public equities to early stage startups to real estate just fall off a cliff. due to rapid rise in interest rates. The crypto and Web3 bubble burst, banks fail.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
And so they just need to make sure that they smooth the gap to customers actually realizing as much value as the CIOs of the world are currently investing ahead of.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Well, David, I haven't asked you about this in like a month or so, but a month ago you were pounding the table insisting to me, like, I have no need for, I've never used ChatGPT. I can't find it to be useful. It's hallucinating all the time. I never think to use it. It's not a part of my workflow. Like, where are you at?
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Well, and we have no coworkers. There's so many things about our business that is weird. Like, we never have to prepare a brief for a meeting.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
I know people who use ChatGPT to set their OKRs, and I'm like, okay, what's an OKR? And they're like, I wish my life were like that too. That's why I have ChatGPT do it.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yeah, the LLMs are unbelievably good at writing and helping you write code. I'm a huge believer in that use case.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
yeah i think what you're saying is one could be a bear on your own experience every time you try to use a generative ai application it doesn't fit into your workflow you don't find it useful you're not sticky but on the other hand actually what ai will be is a sum of a whole bunch of niches there's a video game market there's a writing market there's a creative writing market there's a software developer market there's a marketing copy market
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
There's a million of these things and you just may happen to not fall into one of the first few niches of it.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Oh, the number of people who were like out raising a fund and they're like, the future is AI. Yeah, right. This is the best time ever to be investing.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
So this leads me to my next bear case, which is the models will get good enough and then they'll all be trained and then we'll shift to inference. And most of the compute load will be on inference where NVIDIA is less differentiated. There's a bunch of reasons I don't believe that. That is a popular narrative, though.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
One of the big reasons I don't believe that is the transformer is not the end of the road. In a bunch of the research that we did, David, it's very clear that there are things beyond the Transformer that are in the research phase right now, and the experiences are only going to get more magical and only going to get more efficient.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
So there's sort of a second bear case there, which is right now we threw a brute force kitchen sink at training these things, and all of that revenue accrued to NVIDIA because they're the ones that make the kitchen sinks. And... Over time, like you look at Google's Chinchilla or Llama 2, they actually use less parameters than GPT-4 and have equivalent quality.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Or, you know, many other people can be the judge of that, but we're high-quality models with less parameters. So there is this potential bear case around future models will be more clever and not require as much compute. It's worth saying that even today, the vast majority of AI workloads don't look like LLMs, at least until very recently.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Turns out individually serving advertising that's perfectly targeted on the internet through Facebook or Google or YouTube is an enormously profitable business and one that consumes a whole lot of Nvidia GPUs.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
LLMs are like the current maxima in human history of jobs to be done that require a ton of compute. And I guess the question is, will that continue? I mean, many other magical recent AI experiences
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
have happened with far less expensive model training, like diffusion models and the entire genre of generative AI on images, which we really haven't talked about a lot on this episode because they're less compute intensive. But many tasks don't require an entire internet of training data and a trillion parameters to pull off.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
A large market that they won't be able to address for the foreseeable future in a meaningful way.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yep, that's definitely one too. My last one is a bear case, but it ends up not being a bear case. For most companies, I would say that if they were trading at this very high multiple and they just experienced this tremendous real growth in revenue and operating profit, that that sort of spike to the system when it goes away will irreparably harm the company when things slow down.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Stock compensation's an issue, employee morale is an issue, customer perception's an issue, but this is NVIDIA.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
The number of times that they've risen from the ashes after, you know, years-long terrible sentiment with something mind-blowingly innovative, they're probably the best positioned company or the company with the best disposition to handle that when it happens.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
All right. Just to list the bulk cases, one, Jensen is right about accelerated computing. The majority of workloads right now are not accelerated. They're bound to CPUs. They could be accelerated, and that shifts from some crazy low number like 5 or 10% of workloads being accelerated today to 50-plus percent in the future.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
And there's way more compute happening in parallel, and that mostly accrues to NVIDIA.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yep. Also, just a general statement on software development, writing parallelizable code is really hard unless you have a framework to do it for you. Even writing code with multiple threads, like if anybody remembers a CS college in class where they had a race condition or they needed to write a semaphore, these are the hardest things to debug. And...
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
I would argue that a lot of things that could happen in an accelerated way aren't, just because it's harder to develop for.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
And so if we live in some future where NVIDIA has reinvented the notion of a computer to shift away from von Neumann architecture into this stream processor architecture that they've developed, and they have the full stack to make it just as easy to write applications and move existing applications,
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Especially once all the hardware has been bought and paid for and sitting in data centers, there's probably a lot of workloads that actually do make sense to accelerate if it's easy enough to do so.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Right. It's like this workload's not that expensive and I'm not going to pay an engineer to go re-architect the system. So it's fine how it is.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
I think there's a lot of that. So, bulk case one, Jensen is right about accelerated computing. Bulk case two, Jensen is right about generative AI. I mean, combined with accelerated computing, this will massively shift spend in the data center to NVIDIA's hardware. And as we've mentioned, OpenAI is rumored to be doing over a billion dollars in recurring revenue on ChatGPT.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
So I think there's, let's call it three billion, because that's the most sort of credible estimate that I've heard. And maybe that was a forecast for next year. But like... They're not the only one.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
I mean, Google with BARD, which I found tremendously useful actually preparing for this episode, is not directly monetizing that, but they're sort of retaining me as a Google search customer by doing it. There is a lot of real economic value even today.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Not nearly the amount that's sort of baked into the valuation, but I suppose the bear case of this is that everything has to go right for NVIDIA, but the bull case is indications are things are going right for NVIDIA. Third, bulk cases. NVIDIA just moves so fast. Whatever the developments are, it's hard to believe that they're not going to find a way to be really well positioned to capture it.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
That's just a cultural thing. Four is the point that you brought up earlier, that there's a trillion dollars installed in data centers, $250 billion more being spent every year to refresh and expand capacity, and that NVIDIA could take a meaningful share of that. I think today, what's their annual revenue at? Like $30 billion or something? Yeah.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
So right now that puts them at like 20% of the current data center spend. You could imagine that being much higher.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
All right, so 15, 18%. Yeah. But you could imagine that creeping up. Again, if the accelerated computing and generative AI belief comes true, like they'll expand that 250 number and they'll take a greater percent of it. An interesting way to do a sort of a check on this math is to look at what other people in the ecosystem are reporting in their numbers.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
TSMC, in their last earnings, said that AI hardware currently only represents 6% of their revenue, but all indications over there is that they expect AI revenue to grow 50% per year for the next five years. Wow. So we're trying to come at it from the customer workload side and say, is it useful there?
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
But if you come at it from this other side of what do NVIDIA's suppliers forecasting, and they have to put their money where their mouth is, building these new wafer fabs to be able to facilitate that, and packaging and all the other things that go into chips. So it's expensive for TSMC to be wrong.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
So that's another bull case. The last one that I have before leaving you with one final thought.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yes, is that NVIDIA isn't Intel. And I think that's the biggest realization that you helped me have. And it's not Cisco. Yeah, the comparison we were making in the last episode was wrong. They are Microsoft. They control the whole software stack and they simultaneously can have relationships with the developer and customer ecosystems.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
And I mean, it may even be better than Microsoft because they make all the hardware too.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Right. Imagine if IBM operated in a computing market of today's magnitude. Computing was tiny little market back then.
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Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yep. I suspect a lot of inference will get done on the edge. If you think about the insane amount of compute that's walking around in our pockets that is not fully leveraged right now, there's going to be a lot of machine learning done on phones that are going to call up to cloud-based models for the hard stuff.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
No, I certainly agree with that. All right, well, just like our TSMC episode, I wanted to end and leave you with a thought, David, of what it would take to compete with NVIDIA. Because my big takeaway from the TSMC episode was like, wow, that's a lot of things you'd have to believe about a government putting billions of dollars in and hiring all this talent.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
And I was like, what's the equivalent for NVIDIA? So here's what you would need to do to compete. Let's say you could design GPU chips that are just as good, which arguably AMD, Google, and Amazon are doing. You'd of course then need to build up the chip-to-chip networking capabilities like NVLink that very few have.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
And you'd of course need to build relationships with hardware assemblers like Foxconn to actually build these chips into servers like the DGX. And even if you did all that, you'd need to create server-to-server and rack-to-rack networking capabilities as good as Mellanox, who was the best on the market, with InfiniBand that NVIDIA now fully owns and controls, which basically nobody has.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
And even if you did all that, you'd need to go convince all the customers to buy your thing, which means it would need to be either better or cheaper or both, not just equal to NVIDIA.
Acquired
Nvidia Part III: The Dawn of the AI Era (2022-2023)
Yep. And even if you got the customer demand, you'd need to contract with TSMC to get the manufacturing capability of their newest cutting-edge fabs to do this 2.5D co-auth lithography and packaging, which there, of course, isn't any more of. So, you know, good luck getting that. And even if you figured out how to do that, you'd need to build software that is as good or better than CUDA.
Acquired
Chase Center + Summer Update
some hope of getting a little bit of relaxation in and everyone will have a good enough time like man it nails the center of that venn diagram it was truly like the very best trip we could have done at this stage in our lives That is great to know. Highly, highly recommend for anybody in the same life phase. Although there were people of families of all phases there.
Acquired
Chase Center + Summer Update
There weren't many non-families there, I will say. But there were big family reunions happening. There were parents with preteens. There were parents with teens. I was a little surprised by that. But I mean, hey, who doesn't love Disney and who doesn't love Hawaii? Yeah, I highly, highly, highly recommend it, especially with young children.
Acquired
Chase Center + Summer Update
Well, speaking of, I am intentionally wearing my Ray-Ban metas here to prepare.
Acquired
Chase Center + Summer Update
Independent. Wow. Wow. The question is, for how long? Well, to bring home on our summer carve-out theme, my carve-outs for everyone are it's summertime, which means, sadly, no NFL. But with the little baby, I finally got around to watching the Netflix quarterback series from last year and then the new receiver series. They're so good. I love them both.
Acquired
Chase Center + Summer Update
The quarterback series especially, there's no other position in sports, or at least sports that I am familiar with, that are like large team sports where so much of the game hinges on that one person. Just following like... the amount of mental work that goes into being an elite NFL quarterback, and then just the pressure that these guys are under is so immense. Receiver was funny, too.
Acquired
Chase Center + Summer Update
I am feeling as refreshed and relaxed as the father of a three-month-old and three-year-old can possibly be.
Acquired
Chase Center + Summer Update
I enjoyed Receiver... almost equally as much. But it's so funny to watch the difference between the preparation and the pressure that the quarterbacks are under versus what the receivers are doing. Very, very different stakes, although they are obviously the receiving end of what the quarterbacks are throwing.
Acquired
Chase Center + Summer Update
It's going to be great. Listeners are organizing a bunch of events around the show itself in the days before and after. It's going to be really kind of like the Omaha weekend. So if you want to stay up to date on all of that, look for announcements in the Slack in the coming weeks.
Acquired
Chase Center + Summer Update
Yeah, it's not just that their name is on the building, which it is, but they are performing a heroic amount of work and effort to make this hopefully the best live event that you've ever been to. And we cannot wait.
Acquired
Chase Center + Summer Update
The other thing we should say here, there's two ticket prices, all in price. It's $100 for floor seats, which are almost gone at this point in time, and $50 for everywhere else in the arena. That's it. That's all in. That includes Ticketmaster fees. We're pretty sure this is the cheapest event that has ever been put on. ticket price wise at the Chase Center.
Acquired
Chase Center + Summer Update
Definitely not the cheapest event production budget wise, but we're really proud of that. We want this to be open and available and accessible to everybody. We want as many of you there as can make it. This is like a party that we want to throw for everyone.
Acquired
Chase Center + Summer Update
It's been a hell of a ride the last couple of months, Ben. I don't think I've even really till leaving for Hawaii, whatever it was 10 days ago, had a chance to stop and reflect on this. My second daughter was born at the end of April. And then the Wall Street Journal article about us came out, I think like two weeks later. So it's just been a whirlwind.
Acquired
Chase Center + Summer Update
That is a mind blowing sentence. That is not something that we ever, ever thought would even be remotely within the realm of possibility.
Acquired
Chase Center + Summer Update
Yeah. Like all the companies we cover on the show, it's the exceptions that prove the rule here. It was a wonderful piece. Ben Cohen, who wrote it at the journal, is an excellent journalist. I have the utmost respect for him. He writes the science of success column at the journal that this was part of. It was just one of those lightning in a bottle moments.
Acquired
Chase Center + Summer Update
Hell yeah. Chase Center live show in partnership with our good friends at JPMorgan Payments. This is going to be, as many of you have already heard, the biggest thing that we have ever done. This is where the Warriors play. It's the brand new arena in the middle of downtown San Francisco. And Mark Zuckerberg is going to be there with us on stage. He's only one of the acts that we are planning.
Acquired
Chase Center + Summer Update
Totally. The other thing that was just so surprising about this, hell, I used to work at the Wall Street Journal a long, long time ago, briefly, early in my career. So I identify with it deeply and love the publication and was so glad they were going to cover us. But I at least have always believed that people aren't going to discover podcasts by reading about a podcast or in another medium.
Acquired
Chase Center + Summer Update
If you read about something, you're probably not going to go open up your phone and your podcast player and hit subscribe or you're in some other modality. Right. But... This proved us wrong.
Acquired
Chase Center + Summer Update
It feels like a visceral manifestation to you and me of this takeaway from all of our episodes. Every great success story is idiosyncratic. You can't plan this and they all are their own journeys. It's why we can make a four or five hour episode about all these different companies. And it's not just, well, they did the same thing that the other companies did.
Acquired
Chase Center + Summer Update
Yeah, we've had a few companies get in touch with us and say either they're remote first companies or they're located somewhere else. Like, oh, we're going to do our fall off site as a company in San Francisco for the live show, which is super cool. So yes, if you want to do anything like that, hello at acquired.fm, we'll make it happen. We'd love to have you here.
Acquired
Chase Center + Summer Update
We've been very, very busy. We're pulling out all the stops. It's going to be an amazing event.
Acquired
Chase Center + Summer Update
Indeed. All right. To bring us home here for our little summer session, carve-outs. Carve-outs. Ben, we were about to hit record, and you stopped and you said, wait a minute, I got to walk around my house. I am so excited to hear what you came back to us with.
Acquired
Chase Center + Summer Update
This is the most Ben Gilbert thing ever. I love it. Wait, was your Father's Day gift a stroller?
Acquired
Chase Center + Summer Update
It's funny, I never got into the running stroller, running with children thing. I think I would really enjoy it, but it's so hilly here in San Francisco.
Acquired
Chase Center + Summer Update
Yeah, I've been more in carrier mode and then doing hikes with the baby in the carrier, which I'm now back in that world with baby number two here. Well, okay, great. Well, trade off. You did your parent carve out. I'm going to do my parent carve out, then I'll kick it back to you. So mine actually is what you started the show off with was my time in Hawaii.
Acquired
Chase Center + Summer Update
So our second daughter just turned three months old. We wanted to do a family vacation while we're having this little acquired hiatus before Jenny goes back to work. And we were thinking, what could we possibly do with like a three-year-old and a three-month-old in tow that is going to be the least bit enjoyable or relaxing as a family vacation? And we scoured the earth.
Acquired
Chase Center + Summer Update
And the best idea that we came up with was the Disney Resort in Hawaii. And it was awesome. Let me tell you, this place, it's called Aulani. It was perfect. So it is not the nicest resort. It is not a Disney park. There's no rides or stuff. As far as Disney goes, it's actually fairly light touch. So it's not the best Disney experience. It's not the prettiest beach. But you are really selling it.
Acquired
Chase Center + Summer Update
It is not spiky in any category. But the Venn diagram of needs of like, you have a young family. You are a harried parent. You want something like a Hawaii vacation where you can have...
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Well, you guys entering the industry, for sure. But I think you hit on it with broad... When Ben and I started this, we used to talk about what our TAM was. We were venture capitalists. We're like, what's the TAM for Acquire? Not that we even thought about it as a business or a product. And we're like, I don't know, maybe there's... what's the population of students in business schools out there?
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Maybe that's our TAM. Then we were like, well, I don't know, maybe it's a little bigger than that. Maybe it's everybody who ever wanted to go to business school. I'm like, okay, what's that cap out that? A million people maybe? A million felt like our TAM.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
And what's happened to us, and I'm curious, I think you guys have probably seen the same thing, is that even though we think we're super nerds and we tell these very esoteric stories, they're just great stories. And people of all types want to listen to them.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
How should we as founders and- The original vision was you were music on Facebook.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
I think the other, you know, video, Ben and I talk a lot. We'll talk more about video throughout the evening here. You know, we've just always sort of been of the belief of like nobody wants to sit and watch us in our studios as talking heads going yak, yak, yak. But we've started to ask the question of like, is there...
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
For certain companies we cover, is there a rich visual tapestry that we could do at the same level that we try and create an audio tapestry?
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
We didn't need the thumb drive.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
It's funny, your question was what's next for Acquired. We're going to do a normal episode after this, after tonight. That normal episode... probably will focus on a Menlo Park-based technology company. And one of the lessons that we're already starting to learn from that... Spoilers!
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
This is live! This is live. It's just not holding the current state of things and vision of what you are too tightly. And... You've learned a lot from Mark over the years. You all have been very close. Spotify started on Facebook. And here you are. You're the biggest podcasting platform in the world. So you didn't hold onto that vision too tightly. Right.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Please. I wanted to leave you some space before we ask the question. Thank you. I appreciate that.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Woo! Wow. This is, uh... Wow, this is unbelievable. Thank you all for coming. We have a very, very special guest and surprise to welcome us all here tonight, the CEO of JPMorgan Chase, Jamie Dimon.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Oh, man. The currency of the Spotify invites.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
We remember that era.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Yeah. Yeah. I mean, this is all fun history. I'm curious though, we're going to talk to Mark later tonight.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Yeah. Yeah, definitely. You've had a relationship, a pretty close relationship for 15 plus years as fellow founders in the trenches. Yeah. What have you taken from him that you've brought into Spotify and how you run the company?
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
We haven't told you this, when we interviewed you 18, 24 months-ish ago in Stockholm, I'd never been to Sweden before. I don't think you had either. And we left, we thought just like, what a lovely country, what lovely people. Daniel is like the most generous person we could imagine. You're here tonight. And... That guy is a fierce competitor, and there is a reason why he has built Spotify.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Hey, so I know this isn't like the best time to bring this up, but did you bring the thumb drive with the Who Got the Truth MP3 for the sound crew?
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Which is funny, coming back to podcasting. You didn't enter the business until 2019. I assume you were thinking about it for a long time after that. And when, I'm sure you know, when did you become the market leader in podcasting?
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Yeah, why? That's the question. And did you expect that it would be that fast, given that you were so methodical and working so long to launch it?
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Well, there's 6,000 people out there waiting to hear it.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Thank you so much for being here.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Indeed. And Mark's most famous catchphrase is probably move fast and break things. But despite instilling this in Facebook's engineering culture, Facebook doesn't actually break very often. How, Ben?
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Ben and I did not put this on ourselves tonight. So what are we doing tonight?
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
So if you're ready to accelerate your growth and democratize product building at your company, just go to statsig.com slash acquired. And when you get in touch, just tell them that Ben and David sent you. Yes.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Yes, Crusoe is a cloud platform built specifically for AI workloads and powered by clean energy. They build and operate GPU data centers, with each one powered by low-cost, stranded energy that otherwise goes to waste or, worse, gets emitted as greenhouse gases.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Yeah, it's easy to think about AI as like, oh, that's a bunch of PhDs over at Meta or OpenAI or Anthropic tinkering with model weights and then going and hitting compute. But there's this whole other industrial side of AI that's everything that happens after they press go on model training. And that's energy, that's cooling, that's construction. It's literally like steel and pipes and wire.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
It's all the physical infrastructure behind AI. Crusoe has like hundreds and hundreds of construction workers, steel workers, plumbers, electricians, all building and operating data centers in some of the harshest locations on Earth to capture this energy.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Ooh! Ooh!
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
It's just an awesome company. We're super proud to work with them and also to be investors. The other big update that's happened since we started working with them last year is that you can now work with Crusoe either through their managed AI cloud, which you always could, and that's great for startups and enterprises who want a complete AI platform, or directly as a data center customer.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
which, yeah, several of the biggest companies in the world are now doing. So just go on over to crusoe.ai slash acquired. That's C-R-U-S-O-E dot A-I slash acquired. Or click the link in the show notes and tell them that Ben and David sent you.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Well, we've got a little more time before Mark comes on. And we have a couple more surprises planned. Um... I think it's time to talk about the next one.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Act two.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Episode requests. Episode requests. Number one. You go through the Acquired inbox, a lot of episode requests.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Hi.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Emily, thank you so much.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Well, amazingly, shockingly, we tell you all all the time that when we make an episode, we sit in our houses, in our studios. We record all day for nine hours. We turn that nine hours into three or four or five hours that you all hear. And we thought, yeah, that's probably not going to play here. But you keep asking us. You keep emailing us. So we want to put this...
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
The sad part is that we actually said that and decided to revisit this.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
This is where we fall on our sword.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Well, I think, okay, so for me, there's a lot to talk about with YouTube that we got wrong. This is the biggest thing that we've discovered since is, I think literally as we were making that episode, AI and social media feed recommenders were happening in that moment. And it was about to lead to everything that is happening today. And it was YouTube within Google and meta then Facebook.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
buying GPUs and building AI that turned feed recommenders into the ultimate destination site. And we just completely had no idea that that was happening.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Right. So here is, I think, our most legitimate defense. Google does not report YouTube profitability. They report YouTube revenue. So when we did the episode, YouTube was doing about $5 billion run rate revenue. It is now like $35 to $40 billion annual revenue run rate, which is incredible.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Yes, and it was losing a lot of money back then. Google does not report today, but here is what is unique about YouTube versus every other platform is they pay out 55% of revenue on long form and 45% on shorts directly to creators.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Request this question to bed once and for all here tonight. Here is what you are missing in the full nine hours of an acquired recording session.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
And the durability that they're building and the affinity from creators, we'll talk about creators on the platform in a minute. Yes, there's a reason why so many creators want to graduate to YouTube. And this is it.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
uh, great today. Oh, a plus. So here's the other thing we didn't mention. And I think this was true back then too. YouTube is both the second largest social media property in the world, uh, and the second largest search engine in the world. So yeah, a plus.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
On YouTube? I'm sorry, on LinkedIn. 16 billion plus in revenue today.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Of which 5 billion comes from advertising and content, which for all intents and purposes didn't exist when the acquisition happened. They have built that into a real business. I mean, for us on Acquired, I actually went and looked in preparation for this. We have about... relatively equal number of followers on LinkedIn as a platform versus any of the other social platforms out there.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
But engagement is like 5, 10x on LinkedIn. I mean, it's our most important social platform. And if you had said that eight years ago, it would have been crazy.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
It's really hot in here. And we've been going for five and a half hours.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Was it a good interview?
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
I watched it. You said it? Yeah, it was good.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
And Kevin Scott is the CTO of Microsoft now, who came from LinkedIn earlier.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
I had a similar thought. Pour some more champagne. Sorry about that. Hey, blue angels.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
The question is, did he listen to our Microsoft series?
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
We stopped grading at some point.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
But on top of the launch business... Yeah, the launch business is not the interesting part of the business.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
So when we did the episode, Starlink was like pie in the sky, literally. There was nothing. And now I'm pretty sure Starlink is the entire... SpaceX was valued at $36 billion when we did the episode. Starlink itself is worth way more than $36 billion today.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
The context on this is, it's a little weird because there's no enterprise value of Taylor out there that you can calculate. We're not talking about Twitter, I promise. There's no enterprise value of Taylor. The closest thing was when we did the episode, Forbes estimated her net worth at $550 million. Yeah. Not woo.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
By our calculations, we're pretty sure she generated on the order of $550 million of free cash flow this past year. This year. Last 12 months. That's a woo.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Yes, Taylor Swift Inc. So the big piece that I actually think is the most interesting piece that we got wrong in our episode, Ben did a... fantastic primer on the music industry and, you know, all the challenges for artists and et cetera, et cetera. And like, it's getting better and Spotify is doing great and Daniel's doing great and all that.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
The latest sort of reported talked about numbers was that Taylor was making like less than $5 million a year from streaming.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
This myth that streaming doesn't pay. Uh, last year Taylor made over well reported, reported, reported this reported, um, well over a hundred million dollars from Spotify streaming alone, alone, doesn't include any of the other platforms. So, you know, gross that up. Um,
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
And by nature of what she has been doing that we talked about in that episode, redoing her masters, like you think about what of the percentage of those streams that are happening are they on where she owns all the rights? Like, that is a very, very, very high gross margin number that is coming to Taylor every year.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
So the amount that she's getting just from streaming, like, eras tour aside, movie aside, she is getting paid more every year than any Hollywood actor, probably any athlete in the world. She could just sit at home.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
It's a new record.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
So last year, the Eras tour in calendar year 2023 grossed, I think, $1.1 billion. Wow. The previous... Which is a gross. Gross, gross. And tours are expensive.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Yes, there are. The previous record for highest grossing tour ever, I believe, was a billion dollars. So Taylor eclipsed that over multiple years that that was earned. So not only did she set the record for highest grossing tour, she did it within 12 months. Obviously, the tour has continued. Yeah.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
that's another 300, $350 million in cashflow every year.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
And then, and then there's the movie. Right. So the movie grossed, uh, $267 million at the box office. Highest grossing concert film of all time. Taylor went direct to the theaters with the movie. So paying less middlemen. Less middlemen. Then she did the direct deal with Disney for the streaming rights. That was another $75 million on top of that. So well over $300 million from the movie.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
I think I can simplify all this.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Obviously, you're not going to make a movie every year, but...
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
I think that is conservative for last year. I think if you were to say like, OK, what is a smoothed out steady state over a three year rolling average for Taylor Inc.? Well, you did used to be an investment banker. Half a billion plus cash flow every year.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
It's our gateway drug.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Okay, so this is the most important debate to all of this, which is if you're trying to value the enterprise of Taylor, what multiple do you put on that cash flow?
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
right right uh do you believe it is a durable business like some of the great content businesses of all time like the one that you put in our model which is disney yes disney trades at 20x free cash flow taylor is 550 million in free cash flow that's a 11 billion dollar enterprise value for taylor forbes currently estimates her net worth at 1.1 i think
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Okay, great. We can cut all that then. Cut that. Just cut it. Let's cut all that. Got that. Skip it. Skip it. Yeah. Let's skip it and keep moving. Okay. I think one of us has our timelines wrong. We've been so stop and start. Do you think we should just restart the whole thing?
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Right. So, okay, but I think Ben and I differ a little bit on this. I would argue Disney is the right comp.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Their multiple they're using is one.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Are we at peak Taylor? To me, I think the song that played before we started the movie and walking out here was Start Me Up by the Rolling Stones.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Taylor is the Rolling Stones.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Yeah. Peak Taylor or Just Beginning?
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
We won't keep you waiting too, too much longer, but we do have one more special guest, one more surprise update in a minute.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Uh... Yes, it is. Max and Umar are actually backstage. Oh, should we do it live? I think we should do it live. I think in the spirit of doing it live, please welcome the global co-heads of JP Morgan Payments, Max Nikurchin and Umar Farooq.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
I think what you're saying is replace all of what we did before.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Well, okay, so speaking of, we're here in San Francisco, in Silicon Valley, the tech and AI capital of the world. How is J.P. Morgan Payments keeping pace with the innovation that is happening in this room, all around us, the businesses that you all are building?
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Ah, great. Well, thank you so much for the great relationship.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Thank you.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
I think I've been like interrupting. No, I think it's great. Please keep doing it. No, no, I don't. I don't find it annoying at all. No, the goal is like make the best stuff.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
We have one more thing before one more thing.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Yes, yes. Feels good. We can officially correct the record on that one.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Mark, it's great to have you here.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Nah, just kidding.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Well, OK, wait, wait. Here's the question, if you knew what you knew today. What's up? If you knew what you know today, would you have started Facebook?
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Yeah, no, I mean, he started it.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Totally.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Well, on that topic, we have a lot to talk about. I think this is actually very appropriate. First, we have to ask you about your shirt and what you're wearing.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Was that your family saying growing up or is that your family now? I'm just doing what my sister says.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Dude, it is so hard to keep all this information in our heads. Like, I feel like I'm like out of RAM. What's going on? I just heard a beep on your end.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Speaking of facing challenges, we want to talk about a number of those because we counted. By our count, I think you have faced more existential challenges than any meaningful company in history through your first 20 years. First, though... Dubious distinction.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
So thanks to you guys, I got a pair of these this summer. And I genuinely love them. Tell us the story of how these came to be.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
So... Are you done or do you have more?
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
This is what Steven has to deal with every month. Yes.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Well, that's your answer of would you have started, you actually didn't try to start Facebook.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Well, tonight, we thought we are going to take the acquired playbook, and we're going to throw it out the window. and we are going to throw a party instead. It is a celebration of technology, of the San Francisco Bay Area, of... Woo! San Francisco! Yeah! some of the most important businesses of our time, and most importantly, it's a celebration of you all. We say you all on the show.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
He told us a much more high-stakes version of that story.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
MySpace, Twitter Gen1, Instagram, Snapchat, WhatsApp, TikTok.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
You could put in its own whole category. And now ChatGPT.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Yeah, actually, can you take us back? We want to ask you the story of that time. I mean, it seems quaint now, Friendster, MySpace, but... you study computer science, graph networking, social graphs, that is a very, very difficult computational calculation.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Usually you're not here. You're here.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
This is what Jensen told us.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Indeed we are. So to start... We wanted to spend a couple minutes at the top of the show here in our first act just giving you all an update on the state of Acquired. It has been quite a year for us. You and I have lived a lot of life in one year. We've both had kids. The Wall Street Journal wrote about us. And we've experienced some pretty amazing growth.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Which speaks to the thesis of Facebook as a technology company.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Meta is a technology company. We'll get to that later. Ben and I have been having a conversation. I want to take this to open source and open source technology and its importance to you. And Ben posited, first to me and then to many other people in our calls over the last couple weeks, that Meta has been the largest beneficiary of open source technology in the modern world.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
And I'm curious if you would agree with that and... if you would comment on your relationship to open source.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
I mean, you were partially the first big company built on the LAMP stack.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
OK. This is where we were going with this.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Can we take a real quick detour?
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
I really want to ask you something.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Okay. You took a detour. We're going to take a detour. Help us with our research here. The eve of the IPO. Yeah.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
I know. Open source and AI. We'll get back. We are right in Mark's wheelhouse. I think it's related. I do. I really genuinely do. Facebook on mobile is HTML5.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Yeah. Yeah. I want to ask you what you were thinking going into the IPO with Facebook on mobile being HTML5. And what happened? You IPO at $100 billion market cap over the next three months. You have a 50% drawdown. Probably because of that. But I guess the related question to what we're talking about now is... How much is that informing your approach here with AI?
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Ooh! Wow. Thank you so much. Daniel!
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
And that's your only business model.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Well, you've been after us to do more video for years. That is true.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
To me, this brings up another topic we wanted to talk about with you. 20 years isn't that long. I'm young. You're young. We all are.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
You set up the company. in a, especially at the time, truly unique way, where you can operate the company and take that approach. Do you mean super voting shares? Super voting shares is the technical aspect.
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
I think there are a bunch of technical aspects to it that we're not going to get into in this conversation, but effectively, you can take that perspective in a way that if you are a CEO, non-founder, without a structure that you've set up, you just can't.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
And I think, you know, in doing all the research for this, a thesis we've developed is that like that is just one of the core fundamental advantages that Meta has. So as you were setting up the company, you know, when you were so young, even when you went public, you were so young. Like, why was that so important to you?
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
It's a technical term.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
So we did the math, or Ben did the math, as he usually does. I believe that is over 400 years of Acquired. We feel like it was 400 years making the episodes in the last year, but that was listened to in the past year.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Longest single episode.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Speaking of lightning rounds and mark-shaped holes, You are accelerating what used to be your annual challenges. I mean, when we were all kids and we didn't know each other, I mean, I was so inspired. You would do your annual challenges. You would post about them. And I was like, wow, that's pretty damn cool. And then we all get a little older. And we all have kids on the stage now.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
And we all have companies on the stage now. Some large, some small. The demands on your time, like it... For me especially, I think lots of people, that's like, that space gets sucked. And you have expanded it. How?
Acquired
Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Well, you used to do annual challenges and I feel like you're now doing weekly challenges. You're designing t-shirts, you're making sculptures, you're raising paddles.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Who's your competition for this?
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
CHRIS BROADFOOTIS- Let's take it as it can be. Yeah.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Please. Thank you.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Love that. Well. Well. That is the perfect place to leave things.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
GPS coordinates.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Ever.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
We have a whole lot of thank yous. Making tonight happen has taken our entire summer. It's taken the entire summer of dozens of people. There were about 1,000 people working on tonight, and I just want to give them all a big hand. Thank you so much. Woo!
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Most importantly, thank you to our wives.
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Acquired LIVE from Chase Center (with Daniel Ek, Emily Chang, Jensen Huang and Mark Zuckerberg)
Exponential growth. I know we keep talking about it, but this literally has never happened in the decade of Acquired where a single event caused a kink in the chart. And that we see, you guys see it. It's crazy.
Acquired
Charlie Munger
I mean, people were like, it's Charlie, it's Warren, or it's Taylor Swift. And a lot of people were right.
Acquired
Charlie Munger
If you had used more leverage, do you think there's some chance that... We would have done a little better, sure. Do you think there's some chance that it wouldn't exist at all? That it would have cost you the franchise?
Acquired
Charlie Munger
Right, that's a good point. By the virtue of you owe a whole bunch of people money on day one for these goods that... Which turnovers are rapidly.
Acquired
Charlie Munger
isn't like we're the only ones that do it. Back to the point on partnership, David and I are coming up on 10 years as partners in this podcast we do together. Different than the investing business, but a compounding one nonetheless. After a 50-year partnership with Warren, what advice would you have for us interpersonally to make for an enduring partnership?
Acquired
Charlie Munger
Do you think it helps that when you do spend the time together, it's special rather than being common?
Acquired
Charlie Munger
Do you think the role of venture capital is being properly accomplished in society?
Acquired
Charlie Munger
Yeah, listeners, we knew we were going to have dinner. We were not sure whether we were going to be able to record it, and now we get to share it with all of you. With that, join the Slack. There is awesome discussion of every episode and the news of the day at acquired.fm slash slack.
Acquired
Charlie Munger
I've heard many comments you've made on Bitcoin. I'm curious if you have a thought on this particular angle. An easy way to transfer money in between countries, especially when those countries don't have a stable store of value within that country. Is it good to have an independent store of value that is not pegged to a nation state?
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Charlie Munger
And what about the common person in some of these less fortunate countries who don't have access to U.S. dollars?
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Charlie Munger
I'm curious, back to this point of the role of venture capital in a society, if you could design a perfect system to fund innovation.
Acquired
Charlie Munger
If you sign up for acquired emails, you will get episode corrections and follow-up from previous episodes, plus hints at what the next episode will be. That's acquired.fm slash email. And we have only one sponsor for this interview.
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Charlie Munger
And do you think that buy and hold, not only mentality, but demonstration is the key thing that aligns investors with managers?
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Charlie Munger
It was a direct copy of Costco. Do you think there are more opportunities to copy Costco?
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Charlie Munger
Yep. Tiny is the Berkshire Hathaway of the internet. Literally, they are such huge fans that they started a company that makes bronze busts of Buffett and Munger themselves. But more on that in a minute.
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Charlie Munger
Why do you think Walmart hasn't been successful once they saw Costco in competing?
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Charlie Munger
Do you think it's more investable today than it was 50 years ago because of the disruptive innovation of electric?
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Charlie Munger
If you are looking to get more publicity, we're open. Have Travis get in touch. All right, let's do it.
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Charlie Munger
It's interesting that it's paradoxical. You need Berkshire's credit, but at Berkshire's scale, it's actually hard to put enough money to work.
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Charlie Munger
It's definitely work. What do you think the durable value is in these, as you say, style companies of the very best one in the world, the Hermes or the LVMH? What makes them enduring?
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Charlie Munger
Our conversation then turned to comparing Kirkland's signature as a brand to Hermes.
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Charlie Munger
And so that buying opportunity only came about because the family needed liquidity to pay the death taxes. Yes, that's right.
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Charlie Munger
And it's because sauces have such a particular flavor that no one can imitate the trade secret?
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Charlie Munger
Yep. So Andrew and Chris took the extra cash flow from Metalab and their other businesses and created Tiny, the world's first and best permanent holding company for wonderful internet businesses. And boy, did it work.
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Charlie Munger
Yeah, sure. Charlie, I'm curious. At age 99, what is something that you believe today that 70-year-old Charlie would have disagreed with?
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Charlie Munger
I've heard you say, as soon as you're wealthy enough to self-insure, you should. Is there any insurance that... Well, that's about practically everything.
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Charlie Munger
Not to mention the overhead. Of course, the insurance company needs to pay all the people that work there. Yeah, yeah. No, no, I... It's crazy. Is there any insurance that you carry today? I carry no fire insurance anywhere. Do you carry auto insurance? Yeah, I have to. Well, you're legally. Yeah, yeah. I don't know. Charlie could.
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Charlie Munger
Making the list doesn't sound too hard. In fact, there are these acronyms, FANG or MAMA, Microsoft, Apple, Google, Facebook. But selecting the one and putting hundreds of billions of dollars into it.
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Charlie Munger
To create hundreds of billions of value, that to me sounds hard to pick the one. How did you guys pick the one?
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Charlie Munger
2015, I believe, was the first. Yeah. It's fascinating to me this concept of if you look at distressed debt or you look at, I think Warren in the last Berkshire letter pointed out, it's been a handful of really good decisions. Or you look at venture capital that's classically power law distributed.
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Charlie Munger
Any of these asset classes comes down to a few really good decisions with high conviction over an entire career.
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Charlie Munger
It's not smooth. There's no asset class where you can repeatedly just do okay.
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Charlie Munger
You mentioned this idea that when we were talking about Apple, there's a few companies that it's just really important to be in. Do you think these big tech companies being the winners where all of the pensions and Berkshire and university endowments and everyone's 401ks being concentrated in these companies, do you think that was the natural outcome? Did we have to end up this way?
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Charlie Munger
Will we have one $20 trillion companies and then the next biggest company is one?
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Charlie Munger
What about other geopolitical considerations? Like, would you hold TSMC at this point?
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Charlie Munger
Yep. For instance, they just bought the premier social network for film buffs, Letterboxd, which has been the founder's baby for 12 years and will stay so within Tiny. And this really reflects Tiny's whole ethos.
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Charlie Munger
One more question for you in this area. What is your favorite advice to give to young people?
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Charlie Munger
Where do the attractive opportunities hang out anymore? It sounds like everything in the whole world is overpriced. Could that be possible?
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Charlie Munger
How did the world get so rich if we have all this capital for so few opportunities?
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Charlie Munger
So over the last 100 years, we've brutally shifted all this value from labor to capital, and now capital is all competing to get into a very small set of opportunities.
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Charlie Munger
And if it continues to get harder, the natural end is that you have... Yes, an unpleasant blow-up of some kind.
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Charlie Munger
Is it too pessimistic of a view to say that the world seems to be out of good ideas to match the amount of capital out there looking for good ideas?
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Charlie Munger
Work with only the best internet businesses, commit to simple diligence, 30-day deals, and leave the business alone, either for you to operate or bring in new long-term oriented management. Up to you.
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Charlie Munger
So one Costco question that I've been wanting to ask you is all the puzzle pieces of the low SKU count and the high inventory turnover. And there's just so many things that fit together so beautifully. They're pretty obvious, though. But how come no one else can pull it off if they're so obvious?
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Charlie Munger
The one thing that fascinates me about Costco is they seem to only be able to grow 10% per year because they're not capital constrained. No amount of money, if they were to access it for free, could help them.
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Charlie Munger
You started agitating. Yeah, yeah. Who on the board could be excited about the Chinese market?
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Charlie Munger
One thing I found fascinating about Costco was the fact that even though they're at the lowest possible prices, their audience skews wealthy. Was that an accident that they figured out over time or did they know that?
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Charlie Munger
On some topics that are outside of Costco, you mentioned in the Daily Journal annual meeting this year that a young man knows the rules and an old man knows the exceptions.
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Charlie Munger
Oh, is that of Peter Kaufman? Yeah. What are some of the exceptions that you've found the most useful in life?
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Charlie Munger
A thing that I've never fully understood. I know you're a big fan of the company BYD that, of course, makes the Chinese company that makes batteries and electric vehicles.
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Charlie Munger
Oh, and one more thing. The bronze Charlie busts, the perfect daily reminder in your workspace to ask, what would Charlie do? Just head on over to berkshirenerds.store to buy your own. And they also have plenty of some guy named Warren, too. Okay, now without further ado, this is not investment advice.
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Charlie Munger
So do you think that companies should try to grow at a lower rate than they're capable of in order to be more durable?
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Charlie Munger
And it seems like there's a spectrum where on the one side, there's Costco that is just not a fast-growing company because it's very difficult to. And on BYD, like you're saying, they grew like crazy.
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Charlie Munger
Have you ever had an investment like that before? I think you've invested something like $270 million that's now worth something like $8 billion in BYD.
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Charlie Munger
David and I may have investments in the companies we discuss, and this show is for informational and entertainment purposes only. And on to Charlie Munger. Charlie, I was watching the NFL games last weekend, and it seems like every advertisement now is a sports betting advertisement. Is this good for America?
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Charlie Munger
Charlie, you turn 100, which is an unbelievable statement, on January 1st of next year. Do you have any plans?
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Charlie Munger
Is there a particular era that you remember the most fondly that feels like the good old days?
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Charlie Munger
Well, actually, when we examined Berkshire Hathaway on our podcast, our takeaway was that the whole franchise was at risk during Solomon Brothers, the entire Berkshire Hathaway name and future. Would you agree with that?
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Charlie Munger
What made the newspaper business so attractive at that point in history? It was a goldmine. That's attractive.
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Charlie Munger
Actually, do you still feel that EBITDA is a criminal the way that you've demonized it in the past?
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Charlie Munger
In many ways, EBITDA was the community-adjusted earnings of its era. Are you familiar with the community adjustment from WeWork? WeWork.
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Charlie Munger
Do you think most places had a lot of change and threatened their future even 50 years ago, and this story is overblown?
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Charlie Munger
Hmm. Charlie, I have a personal question for you. David has a two-year-old and I'm going to have my first child in a month. What advice do you have for us about building families?
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Charlie Munger
Listeners, the next topic that came up was retail stock trading and the idea that for many Americans, this is akin to gambling.
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Charlie Munger
With that, listeners, our huge thank you to Tiny for being the sole presenting sponsor of this episode. If you have or you know of a wonderful internet business, you should reach out high at tiny.com and just tell them that Ben, David, and Charlie sent you. Thank you. Thank you. Listen to ACQ2.
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Charlie Munger
This is typically where we talk about more up and coming companies who are earlier in their journeys or CEOs who are topic experts in important areas like AI. Search ACQ2 in any podcast player. After you finish this, join the Slack, acquired.fm slash Slack and discuss with the whole acquired community.
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Charlie Munger
And if you want to get some of that sweet acquired merch that everyone's talking about, go to acquired.fm slash store. With that listeners, we'll see you next time.
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Charlie Munger
Welcome to this episode of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts. This episode is a very unique one for David and I. Good friend of the show, Andrew Marks, organized a little dinner for us with Charlie Munger and a few other folks at Charlie's home in Los Angeles.
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Charlie Munger
I had the good fortune of speaking with someone you know well, Richard Galante at Costco and spending a few hours.
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Charlie Munger
It's crazy. I mean, it seems like that's everyone on the executive team. They've all been there. I'm curious, how did you first come across Costco or Price Club at the time?
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Charlie Munger
You can hear Andrew a few times in the background asking Charlie questions. We are pretty sure that this is the only podcast that Charlie has ever done. Charlie, aside from being one of the most prolific investors of all time alongside his partner Warren Buffett, is 99 years old. He will turn 100 on January 1st.
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Charlie Munger
Wow. And with Diversified, most of the money was not on the retailing operation. You made a lot of that money through... What happened was very simple.
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Charlie Munger
In fact, it's very hard and rare. What was it about Costco that made you realize this is one of those few moments in a lifetime?
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Charlie Munger
Of course, our conversation was interesting because he's freaking Charlie Munger, but also because it was interesting to get the perspective of someone who has seen the last 99 years of human history. We talked with Charlie, of course, about Costco, his history investing in retailers over the last 50 years.
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Charlie Munger
They've got 900 warehouses around the world full of high-quality merchandise, none of which they have sitting on their books.
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Charlie Munger
Have you ever seen another business that takes advantage of the virtue of the low SKU count the way that Costco does?
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Charlie Munger
As you reflect back on one of these few great companies in a lifetime that you should bet big on, what advice would you have for David and I as young partners looking for a few of these in our lifetime, things to look out for?
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Charlie Munger
We also got to hear his views on what it takes to build a great partnership, what's gone wrong in the global securities markets these days, the concept of investing versus gambling, and where investment opportunities remain in the world today.
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Meta
$10 billion valuation with Yuri. Yep. And Yuri would actually also buy common stock through a secondary tender offer in that. So his dollar cost average would get down to more like six. So he got a screaming deal. But, you know, for the moment, like, there are no comps to this ever. Dotcom bubble, you name it, like...
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Meta
Never has been a comp like this for an investment in a private technology startup. The closest comp that I can even sort of think of was Google's market cap at IPO was $23 billion. So like higher, but not that much higher. And Google at IPO was a $2 billion revenue run rate spitting off hundreds of millions of dollars in free cash flow annually. Wow.
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Meta
Facebook at this point in time is basically breakeven and doing $150 million in revenue, most of which is Microsoft itself. All that said, Microsoft, this is a home freaking run. Like we've been saying all along, helps them spin up Bing, doing all the ad serving for this, getting into like real online services.
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Meta
teenage culture on the internet as we're growing up it's like all this personalization of like hey i don't want just what aol gives me i want to control this so for me i was downloading and using this stuff you might have been writing it although you might have been a little young no i didn't learn php until i was 15 or 16 so call it 2005 okay so yeah a little later yep
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Meta
And then B, you know, Microsoft is not a hedge fund as we talked about on that episode. But that $240 million investment, by the time they start selling it down years after Facebook is public, ends up being worth $8 billion. Wow.
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Meta
And then maybe the most important benefit to Microsoft out of all of this is like Microsoft and Facebook have always had a good relationship, unlike Microsoft has with Google and Apple.
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Meta
Yes, and I think, you know, there's two things here. Yes, I think that is true specifically at this moment in time. But this is where, you know, again, Mark is just master strategist, you know, kind of like calling it all the way back to civilization and the 4X strategy game. He's got multiple bets he's placing on the chessboard. One, as you said, is like platform.
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Meta
Like, hey, platform is rocking and rolling. We think we're building the next great technology company and the next great business model just on platform. Yeah. Also, yeah, we're a social media company that involves a lot of page views and engagement and like the right way to monetize that is advertising.
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Meta
So yes, we've just continued this big Microsoft partnership, but we have the right to sell our own inventory and we should probably start building that muscle too.
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Meta
Well, I'm smiling as you're saying that because... In practice, for this moment, yeah. In reality, they were trying to build their own native Facebook advertising unit, so to speak. It was just Beacon.
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Meta
Yeah. Okay, so Beacon. Well... First off, you were totally right, and I think you were foreshadowing Sheryl Sandberg there, of like, Mark wants somebody within the company to just, you know, run and manage this thing and build it. Great, world-class. Before Sheryl, do you know which Facebook executive led Beacon? I do not. Chamath Palihapitiya.
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Meta
This was Chamath's big thing before growth. And actually, the epic failure here of Beacon leads directly to growth, as we shall see in a sec. Now, what was Beacon? So, like you said, Mark is kind of allergic to traditional advertising. Yeah. But he's like, well, we have this incredible social activity happening on Facebook, and we know through newsfeed that people engage with and they love it.
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Meta
What if there were a way for a native ad baked into the very fabric of the product itself that brands could sort of control and monetize? Well, if we gave brands a way to essentially boost how people are already engaging with them, That might be the way to do this. And what this ends up being in practice is brands publishing your friend's e-commerce activity into your newsfeed.
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Meta
Mark is one of the kids that's writing this stuff. And, you know, I think that's where he got his start. He was doing ZuckNet. He was doing all these little projects. But like, you know, here's AOL, this sort of unintentionally, infinitely hackable and extensible canvas that he can play around on. So that's number two for Mark, you know, passion number two, computers and programming.
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Meta
Now, to be fair to Mark and Chamath and the company, we didn't know yet what the right advertising unit on Facebook was going to be. And this is probably as good an idea as any, because like the core thing that you do on Facebook is you engage with your friends and you engage with their stories on newsfeed. There's kind of no evidence really that people would want to do anything else but that.
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Meta
And so you're trying to kind of think of like, how do we shoehorn advertising and brands
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Meta
Well, I was trying to like think of how to be the most charitable possible to the company and how they can come up with it. But yeah, I have next in my notes here. To be clear, this was a truly, truly terrible head up your rear end idea. Yeah.
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Meta
Yep. Totally agree. That said, like, as soon as it's live, it becomes clear, like, one, nobody wants this, either of these things.
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Meta
Yes. Oh, yeah. I was going to say, I mean, this is number two, like the privacy implications here actually are like horrific. Yes. Like spoiling engagements like that's the wholesome, horrific privacy things like you can imagine the non wholesome publishing stuff that you're buying versions of this.
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Meta
Yep, totally. And Mark and the company is coming off the newsfeed experience where they're like, yeah, if we just give it enough time, users will get used to it. So they let it run for a couple of weeks. They run the newsfeed playbook of like, Yeah, yeah, yeah, we hear you, you know, but you'll get used to it. Here's some more controls.
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Meta
And then passion number three is classics. So Mark, when he enters high school, he'd gone to public school all through elementary and middle school there in Dobbs Ferry in Westchester County. He does two years at the local public high school at Ardsley High School. And after two years at Ardsley, Mark is like, well, you know, a couple things.
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Meta
Yeah, for Beacon. Ultimately, after a few weeks, they do acquiesce and they say like, okay, we will turn Beacon off. We'll make it opt-in as opposed to opt-out. And you can have a way to like completely turn off all Beacon tracking permanently from your profile. A lot of people do that. beacon activity basically drops to zero. And then, yeah, two years later, it's like completely killed off.
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Meta
And this sets the stage for Cheryl joining the company. Because I think, you know, Mark's takeaway from this is like, okay, maybe I don't understand, you know, advertising as well as I thought I did. Like, I thought I didn't like it, but I thought I could be clever and engineer this new thing. And like, actually, let's bring in somebody who like really, really does understand this.
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Meta
And Cheryl was the perfect person coming from Google. Cheryl joined Google in 2001, right as they were figuring out AdWords. I mean, that's like three years after the company was founded. Totally. And the company didn't figure out AdWords for a couple of years. So it was like that was like the key moment.
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Meta
And then Cheryl built and ran the whole self-serve business at Google, which was the most important and the most technology like enabled part of what they were doing.
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Meta
Yes. And I think that really is the quote-unquote deal they make. And they say, and Cheryl agrees too, it's not like, hey, Mark said, you're going to take this side of the company and I'm going to take that side of the company. She always reported to him. The whole company was his company. But Mark is really focused on product, engineering, and importantly, platform.
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Meta
Cheryl takes ads, Cheryl takes operations, et cetera. And when she comes on board, like you referenced this earlier, Ben, there's basically no ad targeting that's happening natively on Facebook. Like there probably is targeting that's happening through the third party Microsoft advertising network, but none of that is like technology that Facebook's building or value that's accruing to Facebook.
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Meta
And so the first thing Mark and Cheryl did when she joined was like, okay, Beacon was such a disaster. We've got this great partnership with Microsoft. Like, let's just do a full exploration. Should we be in the ads business at all?
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Meta
Yep. And, you know, ultimately they decide, yes, we are in a media business. Thus, we should be in the advertising business and we should do it right and we should make it work. And like, ultimately, that is going to be building a really, really, really great targeting engine, which is the thing that Facebook is like uniquely capable of doing. Yep. So, though, back to here where we are in 2008.
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Meta
Two, you know, seemingly unrelated, but about to get very related things are going on. One, after the Beacon fiasco when Cheryl joined, Chamath kind of needs a new job at the company. And, you know, like total credit to Mark, to Cheryl, to Facebook as a company. I think at most places, like Chamath would have been fired immediately for what happened with Beacon.
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Meta
I'm not sure that this is the right high school for me for the rest of my high school career. One, I think I would enjoy just being in a sort of like better school, like a higher level of competition, higher level of learning. You know, he's definitely at the top of the class at Ardsley. Two is, you know, I'm really into Latin and classics.
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Meta
But the culture at Facebook is like, nope, we move fast, we break things. And like, we're always on offense and this didn't work. Let's find the right thing for you to do. And thank goodness, because that brings us to number two. Right around this time, once again, user growth slows at Facebook.
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Meta
Yep. And this was like an incredible insight and was so perfect for Facebook because like, I think this growth insight of growth through product can apply to any company, but it especially applies to a virally growing social network like Facebook.
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Meta
And like, I'm going to tap out on that real fast here at Ardsley. There's got to be a place I can go where I can really study this. And that takes us to Phillips Exeter Academy. In New Hampshire, right? Yes, in New Hampshire. And so Exeter is one of these private boarding high schools that have existed basically as long as Ivy League colleges have.
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Meta
Yep. And that's what actually started even before the official growth team with Javi in that first hackathon. Yes. But that was the seed of this idea of like, oh, actually the way to get past this growth wall as people refer to it in retrospect that we're hitting is use the product itself. And internationalization, there's even more to it than what you said.
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Meta
One, when you have the users themselves who are translating a product as you're seeding it in these new markets, They're so much more bought in and feel a sense of ownership over it versus like, oh, I'm just airdropping this translated American product onto your country here. So it's not just that it's a better translation.
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Meta
It's that you're actually seeding those first power users who are going to be deeply engaged and feel ownership over the product.
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Meta
And then two, the nuance in like the local markets that might even be in the same language. I mean, Spanish is the perfect example. Spanish is spoken in so many places around the world, but like the local nuances and needs in Spain are like super different than Mexico or Argentina or Latin America, et cetera.
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Meta
Yep. It was that core initial team, all of them, of which Javi. Javi's now the COO. Alex. Alex is now the CMO of Meta. Naomi. Naomi is now Meta's longest tenured employee besides Mark and runs a ton of stuff at the company.
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Meta
And Chamath, who deserves so much credit for starting the team, pulling it together, protecting it, advocating for it within the rest of product in the way that only Chamath can. Yeah.
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Meta
Yeah. So there were a million things that growth did over the years within the Blue app and then ultimately within all the apps at Facebook. Growth today is a core center of excellence discipline that spreads across all the products at the company at Meta.
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Meta
But the other big thing in the early days besides internationalization is people you may know, which crazy, like the carousel of people you may know on Facebook is still a core part of the blue app to this day.
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Meta
And they're there just kind of as feeder schools into Ivy League colleges. So Mark applies to Exeter, gets in, and the summer before he's about to go, the school hosts an event in New York City, in the city, for incoming two years to meet each other, get to know the school, get ready, etc.
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Meta
Totally. People you may know become such an important lever. And I love it. I love it.
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Meta
Yes. For a whole bunch of reasons. The growth team discovers you were talking about analytics and data and really understanding what's happening.
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Meta
The key thing that they discover for new years who's joining Facebook about whether they become an engaged, active, you know, evangelizing user or not is how many friends they get in the first, like, I think it's 24 hours or 48 hours or like short period that they're joining the network. And there's like a certain number of active friends that you need.
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Meta
Yep, totally. The other thing is it marries perfectly with all of the investment that is going into the algorithmatization of News Feed because choosing who to show you in that carousel of people you may know is like all the difference in the world. Show you seven randos and you're going to churn. Show you your seven best friends and you're going to friend them all and become an engaged user.
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Meta
I think people caught on to that one a while ago. Yes. But yeah, like that's a super hard data problem of like cold new user coming into the network. How are you going to accurately predict who their best friends are who are already on Facebook?
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Meta
And there, Mark meets another kid who's a lot like himself, who also is really into computers, really into AIM and everything going on there. And Mark's like, yeah, man, I really made the right choice. Like, everybody here is going to be just like the two of us. And that person is Adam D'Angelo, future CTO of Facebook. Amazing they met in high school.
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Meta
So by the end of 2008, thanks to the growth team... growth is like really going again. They go from like just barely getting to 100 million users in August of 2008 to almost 150 million by the end of the year. So 50% growth in the last four months of the year. And then 2009 is just like... Lights out. They grow 250% in 2009 to 350 million users globally.
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Meta
Wow. Well, on the engagement front in 2009, the big thing that happens there is... Like button. You know where I'm going with this. Like button. Yep. And I know you know who invented the like button. Because it wasn't Facebook. I don't know. Friend feed.
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Meta
I suspect that's probably it. Like they probably felt like they needed some sort of like, hey, native mechanic on FriendFeed.
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Meta
Brett Taylor would become CTO when Adam D'Angelo left to go start Quora. And then when Facebook acquired FriendFeed, Brett became CTO.
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Meta
Yeah, he must not have stayed very long, if at all. Yeah. Because he went to YC, I think, after that.
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Meta
Now, the great irony of this story is that Mark and Adam ended up being like the only two kids who are really into computers in the class. It was just the two of them. They just happened to meet in New York City at the preschool event.
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Meta
Yes. The story as I understand it is that Facebook had been considering something like this for a long time. I mean, the benefits are obvious, right? Like if you have a lightweight way to engage and feed more data about marketing. vote positive votes on posts into the newsfeed algorithm. Like that's going to really turbocharge things.
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Meta
Exactly. And so ultimately they started running some tests with like small user groups and specific geographies. And they found that it actually often boosted engagement of comments. Fascinating.
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Meta
Exactly. So yes, it's, They launched the like button, and that becomes huge for overall engagement, but also, more importantly, for just improving the algorithm, which is now starting to kick in in newsfeed and making sure you're seeing stories that you really care about.
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Meta
Yes, you're exactly on the right track. Let's flip back now to Cheryl and building the advertising business. Right around this same time, we've decided like, okay, yes, we're going to be in the advertising business. And to do that right, to do that natively, to do that in a way that generates defensible, sustainable value for Facebook, that means targeting.
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Meta
And the like button is the perfect gift there. to this because all of a sudden there's this really lightweight way to engage with things, to signal your preferences about what you like.
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Meta
Yes, abso-freaking-lutely. So we talked about growth reigniting at the end of 2008 into 2009. The business is also on fire in 2009 in a good way. So platform still rocking and rolling. Microsoft display ad partnership still growing strong as growth is happening. Now under Sheryl, you finally got real native, highly targeted ads coming online in Facebook.
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Meta
Yes, I think in large part because of Mark and Adam, it's quite different these days. Yep. So the two of them, when they get to Exeter, become fast friends. They work on all sorts of computer projects together, software projects. And by the end of their senior year, to graduate from Exeter, you have to do a senior project.
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Meta
In 2008, the company had done $280 million in revenue, up from $153 million the year before in 2007. 2009, they do almost $800 million in revenue. He's crushing it. 2010, an even $2 billion in revenue. They're now very, very cash flow positive. Yes, absolutely. reaching the scale that Google was at their IPO. 2010, they hit 600 million users. 2011, 850 million users.
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2011, revenue grows almost another 100% to 3.7 billion. It's like, all right, time to start thinking about taking this company public.
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Yep. That seed from five years ago that has been growing of mobile is finally going to turn into a big, big, big problem for the company. All right. So let's just get into it. I thought it would be fun. I listed out all of the ways that I could think of that mobile was a big problem for Facebook. One, and I think this is kind of like the Uber problem that everything else is downstream of.
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iOS and Android are closed, proprietary ecosystems not controlled by Facebook. Yeah, you can argue Android is open source and all that, but for all intents and purposes, Google controls it and they control the Play Store.
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Yeah, and Facebook had kind of built this, you know, walled garden on the web, and it was pretty nice.
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And, you know, most people do this like a mini college thesis or they do something in the community, etc., etc., Mark and Adam are like, now we're going to build some software. This is what we do. So Mark one day is listening to music on his computer, I think probably on Winamp, which is how everybody listened to MP3s that you got from Napster back in the day.
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But, okay, specifically, why is iOS and Android being closed proprietary ecosystems such a problem? That means my number two reason is,
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platform which is you know 50 or more of the value of facebook in their minds at this point in time no longer works at all like full stop flip a switch does not work will never work at all ever again on these platforms and why is that the whole premise of platform is you can run apps inside of facebook On mobile, you will never be able to run an app inside another app. Just not going to happen.
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And there's technical aspects to this too, right? Like code runs in native code on these devices as opposed to open HTML on the web.
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Yep. So, okay. Greater than 50% of, you know, the revenue and the sort of like... Theoretical future value. Inherent theoretical value and strategy of the business. Kneecapped. It gets worse. Facebook and Mark and Cheryl have been hard at work building the other core pillar of the business, this new super sexy targeted ads business. Right. Well, guess what?
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All of the ads that are running on Facebook at this point in time are running on the right-hand column on the website. There is no right-hand column on a mobile app. There's only room for a feed, which to this point in time has never had advertising in it.
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This is why you can't make up this stuff in these stories that we tell. Facebook has, I kid you not, no way to make money at all on mobile. Here is an actual honest to God statement that is in Facebook's S1 that they filed before the IPO in 2012. I am reading as a quote. We had more than 425 million monthly active users who used Facebook mobile products in December 2011.
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We anticipate that the rate of growth in mobile users will continue to exceed the growth rate of our overall MAUs for the foreseeable future, and our users could decide to increasingly access our products primarily through mobile devices.
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Another way to simplify that is our desktop business is going to zero. Yes. Now, the kicker. This is a statement in the S1. Okay. By our stock. Yeah.
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Accordingly, if users continue to increasingly access Facebook mobile products as a substitute for access through personal computers, and if we are unable to successfully implement monetization strategies for our mobile users, our revenue and financial results may be negatively impacted. Yeah. No kidding. Okay. Oh, my God. I'm still not done. That's only reason number three. Okay.
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Reason number four. Another benefit of the open web is that you can push code whenever you want. You can make changes rapidly. You can move fast. You can break things and then you can fix them rapidly. This is how Facebook has always operated. On mobile apps, you can push code when Apple and Google tell you that you can push code.
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Not only was there a two-week delay, during that two weeks, Apple and Google are reviewing it. And if they see anything that they don't like for whatever reason, they are telling you, no, you cannot push that code.
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Yep. Okay, so that's number four. And then that brings me to number five reason that I could think of of why this is really bad for Facebook. the competitive field is about to get a total reset. On the web, Facebook is dominant. Network effects are super real.
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Everything we talked about in this whole first part of the episode, if they can suck up all of the new social functionality that they or anyone else invents, they can put it into the main Facebook app. Photos, chat, platform, newsfeed, etc. On mobile, though, Facebook is just one icon of many on the home screen.
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It's super easy for users to be like, hmm, okay, I get this utility from Facebook, but like... Well, I don't know. Here's this Instagram thing. Like, that's kind of cool. I get great photo utility from that, which also lives on my home screen right there. And I'll still use Facebook for seeing when my friends get married. But like photos, cool.
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And messaging, you know, this WhatsApp thing is super cool. Like maybe I'll just use that for messaging. It's super easy to use one app for one thing and other apps for others.
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Yep. Totally. Okay. Those are my short list of five reasons of why the shift to mobile is dangerous to Facebook. Anything else you would add?
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And in fact, AOL, I think, would acquire Winamp a couple years later. Ah. bring it all into the fold. So legend has it, Mark is listening to a playlist in Winamp one day during his senior year, and he gets to the end of the playlist. And he's like, why did the music stop? I listen to so much music all the time on Winamp. It should just know what I like and automatically pick the next song.
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Well, Facebook invested hundreds of thousands of engineering hours in a set of internal tools. These tools let any engineer set up new metrics, ship new features, and measure performance in real time. This meant that anyone could just ship a new feature. But they always had metrics to use as guardrails, and they could always roll back the feature if anything broke.
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They took this so far that they have every new engineer ship a feature on their first day at the company.
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Well, not anymore, thanks to Statsig. Statsig was founded by an ex-Meta team three years ago with a mission to make these same tools that Facebook has available to any company. Could there be a better sponsor for this episode, David? This is insane. I know, it's perfect. It's perfect.
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Today, they've done it, combining tools like feature flags, product analytics, experimentation, and observability into one connected platform that runs off one set of data and infrastructure. No more stringing together expensive point solutions and internal builds, and no more using technology vendors built five or 10 years ago
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And best of all, Statsig is pretty affordable. They have an insanely generous free tier for small companies, a startup program with 1 billion free events, which is $50,000 in value, and significant discounts for enterprise customers. To get started, just go to statsig.com slash acquired and remember to tell them that Ben and David sent you.
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Oh, man, which seems like a not very smart idea. Right. And, you know, like one thing about Mark Zuckerberg, you could say lots of things about him. But one thing I don't think anybody could say is that he's not smart. So what gives? Why are they doing this?
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Well, back then, once a company crossed 500 shareholders, the SEC actually mandated by law that you had to start reporting quarterly like a public company.
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Whether or not you were traded on an exchange. And at the end of 2011, Facebook crossed 500 shareholders. So for Facebook, this means that they were going to have to report like a public company anyway.
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And in practice, the common wisdom was you have to go public as part of this anyway, because otherwise you're going to report and then, you know, you're going to lose all the momentum and excitement about having an IPO and doing an S1 and having a big roadshow, et cetera, et cetera. So you might as well just do the IPO as long as you're going to have to do this.
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And I think Mark and Cheryl and the team like really debated like, well, should we skip the IPO? But like, well, shoot, then we're going to be reporting as a public company and heading into all of these headwinds without having actually gone public and raised the money that we might need to be able to make these investments. So they're like, nope, we got to just do it and go public.
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It should just be a DJ. And then inspiration hits and he calls up Adam and he's like, I've got our senior project. we are going to build an AI DJ plugin for Winamp. And they call this Synapse. And like, they did it.
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That actually is a really good point, though. Google Plus may or may not have been a good product and may or may not have succeeded, but the Facebook competitive response was like... Unbelievable.
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These two high school kids, they build an AI, you know, AI wasn't called AI at the time, but like a, you know, a recommender system that looks at the data of what songs you've consumed on Winamp and predicts what song you're going to like to consume next. I mean, it's basically Spotify today. What year is this? This would have been spring of 2002.
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Oh, man. Mark famously in an internal speech around this, you know, referenced, what was it? I think Cato the Elder. Yes. From ancient Rome of Carthage must be destroyed.
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Yep. It's such a good point. There actually was this little window here at the beginning of 2012 where desktop revenue hadn't yet been impaired so badly that they could still show growth. They had these couple little wins they could point to and say like, all right, not great, but like if we're going to do it, we got to do it now.
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So they build this thing, and then they release it to the internet, and people start using it. It starts getting some adoption, and a couple companies, including Winamp itself, reach out to Mark and Adam and are like, hey, do you want to come work here? Like, can we buy this?
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We're all good. Yeah. Well, we'll come back to that in a little bit. But for the moment, the IPO. And then... A week later, on April 9th, 2012, during the quiet period, Facebook acquires Instagram for a billion dollars.
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And they can't say anything about it besides what they file in the amended S-1 because they're in the quiet period. Amazing. The company's previous largest acquisition was $70 million. Obviously, this is a way different thing. Now, sitting here today, you might be really tempted to say, oh, well, there's the fix for mobile. They just bought Instagram. That solved all the problems. Except...
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Not because Instagram didn't have any revenue on mobile either. It's like, you know, you're tying one anchor to another here.
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Totally. I was just about to say that too. Also, not currently a fix to Facebook's major problem of the shift to mobile. My God, talk about the chutzpah of Mark to do this. You're already in a really challenging period for the company. a really challenging IPO process. You just entered the quiet period and you decide to spend a billion dollars on something with 27 million users and no revenue.
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And you're not going to be able to talk about it except what you file with the SEC. Wow. You got a really, really, really freaking believe in the future potential of your company and the combined companies of Facebook and Instagram here to make this move.
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And that ended up working out pretty well in the long run. In the short run, yet another question mark to add to the already very large pile around this company. Finally, long roadshow process. By the week of May 14th, they're ready to price the IPO. Pricing is set for Thursday night, May 17th, 2012. On Tuesday, May 15th,
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General Motors, GM, who, by the way, was not a particularly large Facebook advertiser, announces publicly to the world that they are pulling all their spend off of the Facebook platform because it's not effective. Not really what you want to have happen two nights before you price your IPO.
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Feels like it must have been. I've never heard one way or the other, but like, A, why would you announce that publicly? B, why would you announce it publicly right then? Like, there's for sure more to that story. Nonetheless, Facebook goes ahead. Thursday night, they priced the IPO at $38 a share at the very top end of the range after the roadshow. Again, the chutzpah here.
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They raise $16 billion at a $104 billion market cap, making it, I think, the third largest IPO of all time at that point behind Visa and, ironically, General Motors coming out of the bankruptcy during 2008.
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By far the largest IPO of a new startup company in history. Yeah. On Friday morning, trading starts. The NASDAQ is overloaded with so many orders for buying and selling Facebook that trading in Facebook stock doesn't actually open until 1130 a.m., which is, you know, two plus hours after the open of the markets.
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Right, in 2002. Yes. But yeah, this is really important because they're about to graduate. Adam is going to go off to college at Caltech. Mark is going to go off to college at Harvard in the fall. But Mark is not just like any student coming into Harvard. He's like, I can build these things and they have value and... Big companies are going to be willing to pay me for them.
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Yeah, that's pretty terrifying. Initially, it looks like, oh, that delay might have been good because the price shoots up to $45 a share from 38. But then it crashes back down. It is... One of the most volatile trading days in any stock, I think, in history on any exchange.
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Facebook shares end the day at $38.23, up 23 cents from the IPO price, but only because all of the underwriting banks in the IPO stepped in to buy shares and support the price, which was totally crashing throughout the day.
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Thank God they did it on a Friday so everybody had the weekend to breathe. Once trading starts again the following week, the price falls on nine of the next 13 trading days and ends up by the end of May down 25% from the initial IPO price of $38. Kind of in free fall at this point, the stock continues going lower and lower and lower.
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Ultimately, bottoms out on September 4th, 2012 at $17.68, down 53.5% from the IPO price. So market cap cut in, you know, over half in what's that... Five months since the IPO. It wouldn't end up reaching IPO price again until August 2013. Anyone who bought at the IPO was underwater for 16 months. Underwater for 16 months and five months later had lost half their money on Facebook.
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Totally. You've also got the employee lockup coming up around November. So like now you're staring down the gun of, shoot, I've already lost half of my value as a public company. And pretty soon all the employees in the company are going to be able to sell it. That's going to put more selling pressure on the stock. Holy crap. This is pretty darn bad. Yeah.
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I mean, losing 50% of your value as any company, public or private, but especially a public company, is a disaster of epic proportions. Having that happen immediately following your IPO, for most companies, there's no way to come back from that. You're entering a death spiral. You're going to end up being acquired or... you know, you're just going to get driven to zero basically. Yep.
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And just to be super clear, desktop revenue wasn't going to go to zero immediately, but Wall Street investors are really worried that like, hey, the world is transitioning to mobile. Eventually growth will start slowing and it will start declining, which it does fairly quickly here.
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And so like, if you can't show me that you're going to replace that with mobile revenue, why should I value your stock at anything?
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So Mark graduates. He goes off to Harvard. It's the natural choice on many fronts. I mean, one, Mark, of course, aces his SATs. I think he gets a 1600 on the SATs. There's this great legend about you had to take SAT twos to get into college back then. I don't know if you still do, but I think you had to have a minimum of three SATs. Mark doesn't study or prepare for them at all.
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Yes, totally. You have no choice but to do your best work. Boy, did it work out fabulously.
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Ben, nobody can fire you. Well, I guess you can't fire me either. But either way, if you're in, I'm in.
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But yes, totally. So when we say taking your best, most trusted engineers, taking them off whatever they're doing and putting them on ads, there's actually an amazing story around this. So Mark goes to someone within the company who he knows can just ship and get stuff done. And that happens. is Boz, Andrew Bosworth, his old TA from Harvard.
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Boz, at this point, is running the core profile and timeline within Facebook. And Mark goes and talks to him and says, Boz, I think you should come work on ads. To which Boz replies, okay. I mean, like I get we're in this situation, but you know, Mark, like I can't do this for too long because remember I'm getting married this fall and I've got this six month sabbatical plan for my honeymoon.
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And my wife and I, we're going to travel the world. It's all like booked and paid for. We're going to be out of the country. And Mark is like, Yes. Well, we've got a few months until then. I think you should come over and work on ads. Boz is like, okay, okay. I will do that. I will come up with something here before the wedding.
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So he teams up with Will Cathcart from the News Feed team, from Chris Cox's team, and they go get to work. By the way, Will is the head of WhatsApp today. And Boz, of course, is the CTO of Meta and head of Reality Labs.
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And the first thing they do during these couple months is like, all right, we just need like a Band-Aid to stop the bleeding and at least produce some mobile revenue. And what they decide to do is like, hey, we do have on mobile the carousel of people you may like.
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What if we just slot some brands into that carousel and say, hey, in addition to people you may like here, here are some brand pages you may like. Yeah. A reasonable first step. And look, they knew that this wasn't going to be the long-term solution and solve all the problems, but it did start to produce some mobile revenue that they could report.
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And this was super important because as I alluded to, the lockup on employees and insiders selling their shares expired in November. They had to get something out that was going to prop the stock price up a little bit before naturally employees are going to start selling here and that's going to put downward pressure on the stock price.
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He walks in the day of the test, says, I'm going to take all three that I'm going to take on the same day. He gets 800s on all of them. College admissions was not going to be a big deal. And his older sister Randy was already there at Harvard. So clearly, got to go to Harvard if he wants. Yes. And I think he wants enough.
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Yes, hopefully. And I think most people who were at Facebook at this time really did believe in the future of the company. At the same time, you have life circumstances. You might need to buy a house. You might need to do things for your family, etc. It's a tough spot. So fall rolls around. They've launched sponsored pages you may like. Boz gets married.
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They're still grinding on the big project, which is called Project Whale Shark. And that is getting real, honest-to-God native ads in the newsfeed, which, frankly, they should have done years ago on desktop. But now the gun is to their head. There is nothing in the mobile app except newsfeed. We got to put ads in newsfeed. Yeah. So finally, at the end of the year, they launch it.
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Boz is like, whew, okay, mission accomplished. I can now leave on my sabbatical. We can go on our honeymoon. But there's just one problem. Shipping this thing is only like 20% of the battle. Now you have to go sell it to advertisers, which this is a whole new ad paradigm.
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You got to like educate brands on why this is going to work for them, especially when your overall brand as a company and effectiveness of your advertising is kind of in the dumps right now.
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The job is never done here. So, of course, quarterbacking all this is going to fall to Cheryl and her team. But, again, as you said, Ben, this is an iterative process. You can't divorce product from the feedback from advertisers. And the big advertisers are sure as hell going to expect someone from product who is leading this thing to show up and tell them about it. Yep.
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So Boz kind of needs to come along to these meetings. So on December 18th, Boz remembers the exact day. Mark calls him up and is like, Boz, great job working on ads. Hey, I really still need you to come back and work on ads. Boz is like, no way, man. I did the past six months for you. I just got married. I'm going on my honeymoon. I'm out. Mark's like, okay, okay, okay.
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The next day, calls him back, December 19th, and he's like, Boz, I just want to say really, really great job again. And you know, the company's in a really tough spot. And like, I really think that you should come keep running ads here. And Boz is like, okay, all right. I will reduce my sabbatical from six months to six weeks. I'll take the holidays, the beginning of the year.
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I'm going to cancel the last four months of my trip. I will do six weeks with my wife and then we'll fly her friends out to the last two weeks with her. And then I'm going to go fly around the world with Cheryl on a very different kind of trip here. So that's what they do. And for most of 2013, Baz and Cheryl are out on the road. They're pitching advertisers.
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Like, I don't know that it's that important to him, but he's like, yeah, sure. Harvard, it's the best. I'm going to go there. Yep.
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They're explaining sponsored stories in the newsfeed, on mobile, why this is so important, etc. Not only do advertisers need education about this new Facebook ad unit, they also need education about mobile advertising in general. They'd only just gotten used to digital advertising on desktop.
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Yep. Totally. And it was the same story with desktop on the web for a decade before that.
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So what's interesting is, like, as they're getting going here, of course advertisers don't come in right away. But also the ones that do come in early are kind of, as you would imagine, not the best advertisers. And so... The whole effort starts to have this real problem where the ads that are now showing up in newsfeed are, like, pretty freaking crappy ads.
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And Mark keeps getting more and more pissed because, like, obviously this is really important. But he's like, Baz, Cheryl, like, why the hell is all this crap showing up in my feed? Like, if this keeps happening, I get that we have to save the business. But, like... I care more about the user experience and like, I'm going to dial this back.
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This was such a contrarian view and also right. And I think only could have come from someone like Boz being focused on this problem. Because as a product person and an engineer... It's the only way that you're going to have that insight that like, oh, this is the same problem we had when we launched News Feed.
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The way to fix News Feed and to make it really, really awesome is more News Feed, you know, is more data, right? The only way out is through. Yeah. If somebody had purely come, I think, from the advertising world, they would have been like, well, you know, that's just the nature of advertising, right? It's a tax on the users. And that's the way monetization of media works.
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kids for most people in the world you would look at that and be like what arrogance and look it's not like 18 year old mark is not arrogant but i think it's also this is why all this stuff we've been talking about is important it's just not that important to him you know he likes building stuff he likes making stuff he knows it has value he knows people will use it
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But like Bas was like, no, no, no, actually, this is a relevance problem and we can make this awesome. And in order to make it awesome, we need a lot more of it. Yep.
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Totally. It's actually kind of wild. I believe this is true. There are markets in the world today where I think Meta has run this test, where if you turn off ads in the Meta family of apps products, engagement in those products actually goes down, right? Which is just like freaking wild. You would think like, oh, wow, now I get to use Metaproducts without advertising. No tax on me.
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Totally wild. So by the fourth quarter of 2013... which honestly in the scheme of things is pretty freaking fast, the whole thing finally flips.
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Facebook announces that mobile advertising is now 53% of revenue and total ad revenue for the company grew 76% year over year in the fourth quarter, which of course is the most important quarter of the year, which means, I did all the math on that, that means that all of desktop revenue All of it.
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So the old platform business, the old ad business, the Microsoft third-party ad serving, all of that actually shrank in the fourth quarter of 2013. So that's the counterfactual here. If Facebook had not gotten mobile monetization right, that's what would have happened is Q4 2013, all of the growth momentum that it had would have flipped and it would have started the downward spiral.
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Eventually. Yep. Yep. So, man, it's like this wild 18-month journey, but it totally saved the company because now here they are. They've built this... unique, pioneering, and totally defensible native mobile ad unit in the feed. They defined the whole generation of monetization here.
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And, you know, I know we keep saying this and it sounds maybe sort of silly, but like really better for users, too. Before this paradigm that they invent here of, you know, algorithmically driven ads in the feed. the biggest monetizing thing on mobile was an interstitial, like, pop-up frickin' display ad that took over your screen, right? Like, what an awful frickin' experience for a user.
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Whether he goes to Harvard, doesn't go to Harvard, goes to college, doesn't go to college, it's just not that big a deal to him, I don't think.
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Totally. It's funny. I'm laughing. You know, the version of history that we just told is maybe slightly too charitable to Facebook and to Mark because, yes, it's absolutely true. They did the really hard thing. They took the pain. They invested in the future. They built, you know, everything that would become... Facebook and Meta today out of it.
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But the first reaction was to bet on hope as a strategy and bury your head in the sand and say, HTML5 is going to save us.
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So, OK, after the Q4 2013 earnings announcement, the stock pops way, way, way up to like one hundred and seventy five billion ish market cap. So up 75 percent from IPO. You know, what is that year and a half earlier? And from there, it's basically if you look at the market cap chart. Kind of a straight line journey from 175 up to half a trillion over the next couple of years.
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Yes, I think that is totally right. So Mark gets to Harvard in fall of 2002, and, you know, like you said, he goes to class, he does well, but... He wants to meet other people and be around other smart folks. He ends up joining the AEPI fraternity there, like my co-host here, my esteemed colleague Ben. Indeed. Also my father while he was in college. Ah, I didn't know that. Yeah, that's right.
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They eventually bring this whole native feed monetization engine over to Instagram. And that works obviously incredibly well there, probably better than even on the blue app.
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Totally. There's another element for a couple of years that's a big part of the native mobile revenue story, and that is app install ads. It actually is worth calling out because it plants the seeds of this much larger struggle that's going to come in a little bit.
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But a very large percentage of the inventory that they were selling, and especially the revenue of these native mobile ads in the beginning, was actually for app install ads that game developers and other folks were buying on Facebook. So it was kind of like our old platform business all over again. Facebook is actually the best place to discover apps on mobile.
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Put a pin in that. We are going to talk about Apple and Facebook in just a little bit here. Now, I said a minute ago that the journey to $500 billion in market cap from here is a straight line. If you look at the market cap chart, that's true. Internally within the company, I think almost certainly not. There are a couple of big challenges that come up along the way.
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During this period, you've got Snap and you've got WhatsApp, both of which are pretty big deals. Yep. We've covered both of those pretty fully on separate episodes that you can go listen to. But I think ultimately what they represent, and obviously Snap was more a competitor and WhatsApp turned into an acquisition and is now a big part of Meta and part of the company.
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But I think together what they represent was this next fundamental shift in the consumer social landscape of which Mark totally picked up on and ultimately announced as the core of the company's product strategy in 2019, which was the default social behavior was moving from town square, which was the old Facebook paradigm of like, hey, we're all in this together. This is our college network.
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That's right. AEPI. Adam, meanwhile, of course, goes off to Caltech, you know, 3,000 miles away in the opposite corner of the country.
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Yeah. As the stage got bigger in the town square, it's like, well, I'm not going to take the stage unless I like really have a great performance that I'm going to give.
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Yep. And Snap and WhatsApp were both really interesting data points about this. WhatsApp, obviously, with private messaging. Snap also, in its own way, there was the original Snapchat use case of disappearing one-to-one photo messaging. But Stories really is where it became clear, hey, this is widespread and this is a big problem that is going to threaten...
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Instagram, Facebook, the whole default motion of like sharing beyond just a one-to-one messaging platform. I want that to be much more private and locked down too.
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Okay, so now here's an interesting question, though. How would Facebook know that attention is really shifting to these apps? Because remember, we're now in the mobile paradigm, not on the open web where services like Comscore and Alexa and whatnot exist, and you can see traffic and engagement competitively on other apps. In the mobile ecosystem, it's all siloed and locked down.
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Right. Well, I was going to get into this in a sec. Adam has a very different experience at Caltech. He ends up graduating from Caltech. I think they probably do not have the same generous leave policy there that Harvard does.
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Yeah, but somehow Facebook was able to get pretty good insights on what was happening in the landscape.
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Well, in 2013, Facebook acquired a small Israeli company called Onavo. And Onavo was exactly what you just said, Ben. A VPN, actually, I think it initially started as like a data compression tool. So if you were worried about your data plan, which was really important in many parts of the world, you could install Onavo on your device and it would compress the data and then serve it to your apps.
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Eventually that morphed into a VPN tool. The net of that is that they could actually see traffic and usage data going into specific apps on mobile phones in their network.
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Right. They were just looking to compress their data or for a VPN service. Either way, Onavo ended up being like a hugely important acquisition for Facebook because it really tipped them off to WhatsApp and Snap too.
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Oh, we're going to come back to that in one sec. Put a pin in that. But for Adam at Caltech, he still finds time while he's there to keep working on these projects. So during his freshman year, he builds something called BuddyZoo, kind of building on Synapse and the success that they had in their senior project.
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Yep. And I already have my network in here. I already have my friends. I already have my connections. Totally.
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BuddyZoo takes your buddy list from AIM, from AOL, and effectively turns it into a social network. So you upload your entire buddy list to BuddyZoo. And then you get your friends to do so too. Buddy Zoo then analyzes and gives you a list of who are the friends of your friends, how many degrees of separation do you have to them,
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And here's what's really interesting about the Stories quote-unquote story in Instagram and then ultimately coming to the Blue app. Stories, as initially launched by Snap in the Snapchat app, was a separate tab with a list of your friends who had published stories. It was literally like a table, like a list.
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Yeah, yeah, yeah. And here's where the internal advantages that Facebook, the family of apps had, they already had this world-class ranking algorithmic expertise within the company that was being applied to newsfeed, that was being applied to ads, that was already starting to incorporate early ML and early AI. The beginning of FAIR, Facebook AI Research Lab, had already happened here.
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It automatically identifies clicks of like, oh, who of your friends are part of these clicks and who are their friends? It measures popularity among users. This is starting to sound pretty familiar here. And this is pretty advanced stuff for 2002, 2003. Very advanced stuff, especially for a side project for a very busy Caltech student. Yep.
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This was coming into the product. Well, now when you're launching a new feature like this, in this case stories, you can say, oh, great. Is this going to be made better by our algorithmic and AI expertise? Of course it is. Let's do that.
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Yes. So when Instagram, in those early days when it was launching stories, they were optimizing the ranking of heads at the top of the app by how likely you are to tap on that person's head.
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Habits are changeable. especially on a mobile phone where another app is just an icon away.
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Yeah, which is basically what has happened. But interestingly, TikTok and ByteDance, its parent company, as you point out, Ben, was so completely orthogonal to everything that Facebook had learned over the past 15 years. Because yes, number one, most importantly, it's not social media. It's media. There's no social. And your graph doesn't matter anymore.
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So BuddyZoo, pretty quickly in the months after Atom launches it, gets a couple hundred thousand users, there's gravity to this thing. It's becoming fairly big, especially given how small the internet was at the time. Yeah. And Atom is like, whoa. okay, this is interesting, so this is kind of what scale looks like.
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Yep. And I really want to keep hitting on this insight again that Mark correctly identified of social shifting from the town square to the living room. This is a second order effect of that shift, right? that the company didn't see coming. Because once you shift social from the town square to the living room, it now becomes possible to divorce media from social.
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You're already getting your social now in private, in your digital living room. The town square can become something that is completely not social.
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I will share that on WhatsApp or I will share that on iMessage or I will share that on, you know, whatever my actual friend living room network of choice is.
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Totally. The social and the media is now completely divorced. And that is because of the shift from town square to living room.
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Okay, so that, I think, is dimension one that TikTok is completely orthogonal to Facebook. Dimension two is actually organizationally. So TikTok, as we chronicled on our episode about it a couple years ago... came out of ByteDance. Well, it was an acquisition of Musical.ly by ByteDance and then ByteDance turned it into TikTok. ByteDance had Toutiao before having TikTok. ByteDance is an AI company.
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ByteDance is not a product company. And the core product that ByteDance makes is its AI, along with all sorts of other stuff. TikTok is like the product vector, one of many and the biggest, by which they deploy their actual product, which is AI. This is very, very different from Facebook, which has always been a product company.
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And so like organizationally, the way ByteDance is set up is there are these centers of excellence within the company where the algorithms, the AI, that is controlled by a centralized team within the company. At least that's my perception of how they're different organizationally from how Facebook used to be. Facebook and Facebook leadership was obviously watching this very, very closely.
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Synapse was cool, and we had a bunch of people downloading it, but this feels like something more on the order of aim itself. Like, this is really interesting.
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And if you look at how Meta is organized now, it looks a hell of a lot more like that. So Meta today is organized. There are centers of excellence across the company, same way that I was just talking about ByteDance. There's FAIR, that's the fundamental AI research team. There's infrastructure shared across the whole company, deployed to all the products and apps.
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There's revenue and monetization shared across the whole company, deployed to all the products and apps. There's growth shared across the whole company, deployed across the various products and apps. There's integrity and safety, which is a big, big, big advantage that Facebook has. They've reorganized how the whole company looks. There's still all the individual products in the family of apps.
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Those all have their own heads, and they all roll up to Chris Cox, who has had a product for the whole company, and AI, too, actually, reports to him. But all the infrastructure, all the revenue, all the growth, all the integrity and safety are decoupled from those actual products now and live in these centers of excellence across the company.
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Well, that is a great question, Ben. But first, we've got a brand new partner to announce that we are very excited to share with you all. Huntress. Huntress is one of the fastest growing and most loved cybersecurity companies today. It's purpose built for small to midsize businesses and provides enterprise grade security with the technology, services and expertise needed to protect them.
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So how does it work? Well, you probably already know this, but it has become pretty trivial for an entry-level hacker to buy access and data about compromised businesses. This means cybercriminal activity towards small and medium businesses is at an all-time high.
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In fact, there are over 125,000 businesses now using Huntress, and they rave about it from the hilltops. They were voted the industry leader in endpoint detection and response eight times. times in a row, and the industry leader in managed detection and response by customers in the G2 rankings for the second time this summer.
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Yeah. So I mentioned this organization FAIR a couple times. I think it's fair to go back and tell the actual origin of that because it's really interesting. It's Fundamental AI Research. Originally it was Facebook AI Research and now it's Fundamental AI Research given the company is now. Meta.
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Yes. Now, we say Atom, and Atom definitely built and launched it. But it's not like Mark wasn't involved. They're staying in touch the whole time and collaborating and working through coding challenges together on what else? On AIM. It's kind of serving its original use case. Like, they're collaborating through it across the country. Yeah.
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So back in like 2013 timeline, when the company was finally fixing mobile, coming out of the hellscape of 2012, of going through that transition during the IPO and the shift to mobile, Mark and the company's VP of engineering, Mike Schreffer, or Shrep as he's known, were trying to figure out like, okay, we've finally got a little moment to breathe here. The tiger isn't chasing us at the moment.
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Can we take a step back and try and figure out, like, when is the tiger going to jump out next and try and get us?
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Yeah. Basically, not actually owning the platform sucks. We've realized this now. How do we make sure this never happens again? Yes. And that spawns some of the early work on AR and VR. Come back to that in a sec. And even this early in 2013 on AI. And AlexNet had just happened right at this time.
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And for the whole history of AlexNet, go check out our NVIDIA series where we talk all about that and the importance to AI and ML. And Facebook actually had a small ML team already at this point.
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Yep. And AlexNet and those big AI ML breakthroughs in that era were all around image recognition. And so Facebook was kind of already attuned to this and like, oh, okay, there's like some pretty big technological stuff happening. Maybe this is going to be like...
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the next platform vector of the future we should get serious about this ai stuff yep so summer 2013 mark and shrep go out to recruit jan lacoon and convince him to come start an ai research lab at facebook and jan was then and is now one of the top ai luminaries in the field top academics out there and jan says like well i'm flattered that you would want me to come work here. That's interesting.
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But like, I live in New York. I teach at NYU. I don't want to leave. I don't want to quit teaching at NYU. And I'm pretty darn committed to open source and publishing all the work that we do. And Mark and Shrepp are like, one, sounds good. You can stay in New York. Two, okay, you can stay at NYU too. Three, yeah, we love open source. We were built on the LAMP stack. Great, publish everything.
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So that summer, 2003, after their freshman year, Adam comes to Boston and gets an internship at the MIT Media Lab. He discovers this thing called Friendster, another social network out there. And Adam is like, whoa, this is a dedicated standalone...
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Yep. So Yana's like, wow, well, okay, when you put it that way, sure. And what's really important about how they do this is this is not Microsoft research. This is not blue sky. Yeah, let's go focus on anything. This is a highly focused AI research group. We are going to research AI. And I think that has kind of made all the difference.
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It is super clear exactly how that is going to translate into helping Facebook and Facebook's products.
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And it was one of those earned secrets that Facebook had and Google had at this time, you know, 2013, 14, 15, of like, oh, we can very, very profitably apply this work to our current products, right? in social media feed recommenders.
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It's one of the fundamental advantages that Facebook has today relative to all other AI companies is that they are guaranteed profitable ROI on all of their AI spend. All of their research, all their infrastructure, all their GPUs, they have highly, highly profitable ways to put it to work today.
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kind of version of what i just built with buddy zoo this is like really interesting and it's all on the web now friendster was based out here in silicon valley had raised money from kleiner perkins and benchmark right oh benchmark too i didn't know yep
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It's funny, actually, thinking through this now, I think there are three dimensions to the payoffs from this investment in AI and FAIR back in 2013. One, One is the near-term and immediately and ongoing profitable paybacks to incorporating AI in existing Facebook products and social media feed recommenders. Highly, highly, highly profitable.
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Yes, 100%. Okay, then there's two, which is this, like, hey... AI might be the next computing platform. There's a lot of interesting stuff going on. This allows us to have a piece on the chessboard and be a player in the next platform transition, should it be to AI.
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Yep. And then three, they had no way of seeing this at the time. But FAIR and AI actually becomes the way that they can catch up and re-architect to compete with TikTok via Reels. Yeah. You know, no AI, no Reels. That's such a good point.
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Totally. Okay, so that's fair and AI. Let's jump forward now to 2016, 2017, 2018. And I think for our purposes here today... It's interesting to view the 2016 election, Cambridge Analytica, all the fallout that comes out of that, which much, much, much ink has been spilled through this lens of the consumer social transition from town square to living room.
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That's right. It's funny. I never even think about that because obviously Matt Kohler would go on to become an important partner at Benchmark. And of course, Matt was an early executive at Facebook. Yes, exactly. Interesting. So here's Friendster, this example of like a real standalone company, social network, growing virally, funded by venture capitalists, based in the San Francisco Bay Area.
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Yeah, quite ironic in that Obama totally doubled down on Facebook as a strategy and used it to great effect to win the 2008 and 2012 elections. Yes.
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Adam's like, oh, yeah. Maybe that's sort of what we should be focusing on. And by the end of the summer in 2003, Friendster had over 3 million users. So like really interesting, growing really quickly.
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Yep. All that aside, as we were wading through all of this and trying to make sense of it and think about how we're going to talk about this on Acquired, There is such an enormous, enormous disconnect between reading what actually happened and then how people felt and what the, like...
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But something is very, very wrong that like hundreds of millions of people believe that.
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So let's bring it back to my supposition here. which is that I actually think this paradigm shift that Mark identified from Town Square to Living Room was like way more right and way more powerful than even he realized. And this is one of the second order effects of it.
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The quiz that was the app on Facebook, that happened way back in the early platform days, totally solidly in the Town Square days. And then the election happened in 2016 when things are already starting to transition. WhatsApp exists. Snap exists. Snap has launched stories. Instagram has now copied Snap and launched stories in that very same year. Two more years go by.
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The Cambridge Analytica news doesn't actually hit until 2018. By 2018, we are solidly in the living room era. So all of the supposed real or imagined impacts of this Cambridge Analytica thing had their roots back in the town square era. We're now here in the living room era, and that is what people's expectations are of Facebook, of social media, of everything that they are sharing in their lives.
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True. So Adam's playing around with Friendster and Friendster had this feature called called Testimonials, which was kind of like a Facebook wall. But in the long run, one of the core problems with Friendster was it positioned itself as a social network and about friends. But really, it was kind of intended to be a dating site underneath it all.
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And I think this is, to my mind at least, where the disconnect is. People's expectations shifted. But now all of a sudden, all this stuff from the past becomes really, really relevant to the present. And when you look back at the past through this lens of what the present is, you're like, well, this is really effed up. Like, how the hell did the company do this?
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It's like this weird temporal and cultural like. mismatch of it all landing in 2018 when the world is a very, very different place.
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Yep, totally. Then there's this whole other layer, too, here of like, well, why did they do this in the first place? Why did developers have access to so much data? They were building platform. They were building an entirely different business with a different strategy. Now they are an advertising and media based business.
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We're almost talking about two totally different companies here, as I think we've told in the story.
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Well, I think you made the point, right, of like, Facebook had to kind of sell the platform to developers. Totally did. They didn't have the underlying hardware and technology and operating system to offer, so there had to be a really big sweetener.
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I think by the 20-year mistake, he meant much more of like the damage to Facebook's brand. Yes. That came out of this. Yes. And specifically the FTC settlement.
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Yep. So specifically when it comes to testimonials, the purpose of testimonials was supposed to be like why you should date somebody or why they would be a great partner, which is funny. So Adam, while he's playing around with this and he's telling Mark about it, He actually posts on Mark's Friendster profile a testimonial. And he says that, quote, Mark gets way too lucky.
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Totally. And a minute ago, when you asked the question of who is banging the privacy drum, and I said, it's Tim Cook's Apple. One of the reasons I said that is that, actually, I didn't know this until doing the research, Mark and Steve Jobs had a great relationship, which makes this story all that much more interesting. Mark is very Steve-like. Very, very Steve-like.
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And they actually met for the first time in 2007, right as all of this is coming together. And the first meeting was that Steve actually reached out to Mark and wanted to meet him and build a relationship, which I don't think Steve did that with too many people. And then so on the back of that...
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And he posted this in the summer of 2003. And Adam was telling me this story. And he was like, you know, I have thought about that post for 20 years since then. Because on the one hand, it was like a stupid throwaway, you know, double entendre that I put on there because it was a, you know, a dating site.
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The next year in 2008, when the iPhone SDK was launching and people were building apps, Mark and Facebook actually go to Apple and meet with Steve and they pitch Steve on exactly what you were just talking about, Ben. Like, hey, how about you let us bring our platform that we've just built that has all these developers into iOS, into your platform?
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Which, you know, from Facebook's part is kind of like a Hail Mary. Like, yeah, they're probably not going to say yes here, but this is really big risk to us. We might as well try.
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And social networks. Yes, totally. So Steve, supposedly the legend goes, Mark and the Facebook team make this whole pitch. And at the end of it, Steve just looks at Mark and is almost a little sheepish. And it's just like, thank you. we're just not going to let somebody else build a platform on top of our platform. And then he sort of pushes back in his chair and it's like clear that's the end.
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And he's like, hey, so by the way, what do you guys think about Microsoft and working with them? And then they just like have a really nice conversation supposedly for the next couple hours and shoot the shit and talk about Microsoft and computing history. It's this very cordial relationship. And I think The sense I get is that Steve really liked Mark and respected him.
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Meta
Totally. And clearly that is not the feeling today between the two companies. And I think what happened since, OK, if it had just ended, Apple isn't going to let Facebook build a platform on top of their platform. That might have been it.
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Meta
Yeah. And so then after everything that happened in 2016, 2018, Cambridge Analytica, privacy... To your point, Ben, part of this is that Apple has always cared about privacy and it's always worked well for them and it's part of their main product strategy. Part of it, too, is like, oh, great.
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Here is kind of the ultimate competitive vector that we can have against somebody we really don't like who we feel has profited off of our platform unfairly.
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Meta
On the other hand, it is both absolutely true about Mark that he always gets way too lucky and Facebook and Meta always gets way too lucky. But it's not luck. Yeah. It's actually Mark. There's something very different about the way he operates. And all the reasons that Meta and Facebook get lucky over the years, Mark was always that way. And it's always because of Mark.
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So now here we are in 2021 and Apple's like... We're making our move. Yeah. Facebook's been reeling. We've been beating the privacy jump for the last couple of years since 2018 in Cambridge Analytica. Now it's time to make the move.
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Meta
Ooh, all in the year 2022. It's crazy. And that is like NVIDIA levels of drawdown back in the crazy NVIDIA journey that we talked about.
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Mark is unbelievably good at positioning himself for luck to do its thing. And specifically at this point in time, what Adam talked about is he was always looking around. He was looking at Friendster. He was looking at what we did with Synapse. He was looking at what I did with BuddyZoo. He was looking about the projects at Harvard he did that we're about to talk about.
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It's just another episode of Mark making these sets of decisions because he's Mark, because he controls the company, and because he has the stomach to withstand it.
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Meta
I think Apple was sort of hoping in its heart of hearts that this would shift a lot of those dollars into ads in the App Store. And the reality is people just don't go to the App Store searching for apps anymore.
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Meta
changes with att just doesn't have the ability to react and build around it the way that meta had because they don't have the resources meta does yep so all of this finally brings us to the last piece of the story here that i'm sure listeners at this point you're probably saying like
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Meta
What the heck, where however many hours in you guys haven't said the words reality labs or Oculus or AR or VR once.
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And he was always thinking, like, how do I incorporate all of this and make whatever I'm doing better? This was the stew that Facebook is about to come out of. So this brings us to fall semester 2003-2004, Mark's sophomore year, and the famous Kirkland House suite H33 with Mark Zuckerberg, Chris Hughes, Dustin Moskowitz, and Billy Olson as the four roommates there.
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No, I didn't. I knew they were both in 2014, but I didn't realize they were a month apart.
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Meta
But I think actually the right way to think about this is through the same lens as FAIR. It's a research lab in the same way that FAIR is a research lab. And it was like, oh, great, $2 billion to kickstart the research lab. Fantastic. All right.
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Meta
And does that include the $2 billion for Oculus? I mean, either way, it's a rounding error. Who cares?
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I think that's very fair, knowing Meta and all of its capabilities and everything that we just talked about. Yes.
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Well, okay. That is the bet looking at through the lens that you posited of a purely financial investment perspective. Yes.
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Yes. So Mark is focused, heading into his sophomore year at Harvard. And he's not focused on classes. He's focused on projects.
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Meta
Well, they're running many hedges on this, of course. I mean, this is part of what FAIR is. This is what LAMA is, et cetera, et cetera.
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Meta
I think there is also potentially a third way to frame it. And it's funny. I think you put it in the emotional lens. I actually think less emotional, but more upside oriented of Facebook did have the taste of being a platform for those couple of years there from 2007 to call it 2010, 2011. And if they own the next platform and,
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Meta
not only will they do everything that you're just talking about of like, oh, they'll have an iPhone size business because if it turns into be glasses and reality labs, they're going to be selling the hardware and maybe they can make that profitable. Like the iPhone is profitable, et cetera, et cetera. Then there's also your point number two, which is like, this is a defensive play.
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Meta
Our core business right now is at risk because it's built on somebody else's platform and And Mark made the comment on stage with us that they've run the analysis. They think they could be twice as profitable in their core media products if they were on their own platform. Sure, great.
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Meta
But then there's like the big, big play is the third part of like, well, what if we actually built a platform again where we have millions of developers who are developing on us and we are participating in their business in the way that we used to participate when they were developing on us in the past? That's an even bigger point.
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Meta
There we have it. That is the story of Meta. I should probably say for a minute here too, my experience using Orion, you were talking about yours a minute ago, I thought it was unbelievably compelling. And before trying it, I never would have believed that any type of AR or VR would really have been the platform of the future. And then after trying Orion, I was like, Oh, yeah.
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I could wear these on my face all day, and I could replace a lot of what I do on the phone with just these lenses being in front of me all the time, and it would be way more efficient and way more enjoyable.
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Meta
It's funny. One thing that may be contributing to that, which we didn't put in the story, is Marketplace. I mean, for me personally, I have totally boomeranged all the way back around on the Facebook Blue app. And I am now a loyal DAU fan. Because of Marketplace. It's awesome.
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Yep. So the first of which, right as they're getting back to campus that fall, is Mark builds a tool called CourseMatch. Oh, yeah, that's right. And this is as students are shopping for classes for fall semester... You can upload which classes you're thinking of taking or which classes you've signed up for.
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Meta
I would say it's a whole set of things. The company calls them centers of excellence internally. It's the growth function. It's AI. It's the ads and the revenue team. All of this contributes to it. Yep. Fair.
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Meta
I almost asked you this question all the way in the beginning when you were teeing up the episode, but I'm glad we'll save it for here.
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Meta
And you can see who of your friends have also signed up for that class or are planning to sign up for that class. This is just text. All this is is a list of classes and a list of people who sign up. And it takes Harvard by storm. I mean, think about it, right? Like it's obvious in hindsight, a bunch of college undergraduates.
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Meta
I mean, that's probably being conservative. I think you could probably argue a much higher percentage of China is online.
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Meta
Just wild. Just wild. And then still, I think the craziest thing about the company is that... If you look at the daily active user figure, it's not that much lower.
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Meta
Right. I'm not sure that it's actually Google. I mean, it almost certainly is YouTube within Google, but I actually think it is other social platforms.
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Meta
Yeah, you want to take classes you're interested, but like really you want to make sure you take the classes with the people that you want to be around.
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Meta
Yes, and I think that scale economy is on the infrastructure side, on the GPU investment side. I think that scale economy is on the advertiser side and on the ad experience side. Just by having so much more scale, they are the default standard way to spend money for advertisers.
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Meta
Oh, I hadn't thought about that. Yeah, that really speaks to, again, you know, another shift we didn't really talk about in the evolution of what we call social media is the creator aspect of all of this. The whole idea of like a creator and influencer didn't exist in the early days of social media and Facebook. But now...
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Meta
You and me, our platform on the podcasting platform, like we have incredible switching costs. Somebody who has a ton of Instagram followers has incredible switching costs.
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Meta
I was actually having this discussion with Hamilton recently about the difference between process power and cornered resource. And a good test for this is when you bring somebody brand new into the organization and plug them in, does the power transfer to them as well? If no, then it's a cornered resource. If yes, then it's process power. And in this case, I think that's potentially true.
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Meta
Of course, of course. So Mark sees this and he's kind of like, You know, again, it's one of these learnings, an observation about the world. It's like, wow, people are spending a lot of time on this tool.
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Meta
Yeah, you can bring in new engineers. You can bring in new product people and transfer the advantage to them.
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Meta
Yep. And I suppose Google probably does similar type things in different ways, but nobody else really does.
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Meta
But no, I think this is a clear example of how strong the other powers in this company are, that despite the brand taking a 20-year hit in Mark's parlance, they're still today a $1.5 trillion company. Yeah. Yeah.
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Meta
I actually think there are some cornered resources here within meta. And ironically, I think one of the biggest ones is the integrity and safety team and all of the privacy controls and work and security that they have done.
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Meta
Totally. There's nothing visually compelling here. So he's like, well, okay, now it's time for my next project. You know, people have registered for classes. What if there was something visually compelling for people to spend time on?
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Meta
Yeah, even though this is also the source of so many criticisms about the company. It's now pretty robust. If you think about anybody that would start up to try and compete with them, somebody I was talking to put this to me like, imagine a startup trying to build a hate speech classifier in Farsi. Meta's got that.
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Meta
Yep. So while probably YouTube, to a certain extent TikTok perhaps, also have similar strengths here, I doubt there is any other company in the world capable of actually operating privacy, integrity, and security. And within that is also anti-spam stuff too, which is super, super, super huge at the level that Facebook is.
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Meta
Well, I think the network economies are still true relative to anybody who would compete in a social product. Yes. Which still exists. Totally. Social is just now divorced from media.
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Meta
Well, habit, but I think scale economies are really big for that too, especially in AI. I think the only way that this new paradigm exists is because of AI and because of GPUs specifically. And I'm not even talking about generative AI. I'm talking about like feed recommender systems and personalization systems.
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Meta
And so like there is a very, very large minimum barrier to entry there that keeps going higher as ByteDance and Meta keep investing in it.
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Meta
And this is Face Mash. Well chronicled in all the many books, stories. The Stephen Levy book, the David Kirkpatrick book. Movies. You know, whatever. Movies. Movie. Movie. Mark codes this up in one evening in his dorm in Kirkland House. And it's basically the website Hot or Not for Harvard. With a couple, like, actually interesting mechanical twists on it. Now...
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Meta
The two big problems with it are, one, this is probably just not a good idea or not, like, kind. Generally, it is a head-to-head voting mechanic on which picture is quote-unquote hotter than the other picture. The other thing that is really not great is rather than having users upload their own pictures...
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Meta
And also a way to guard against somebody in your supply chain kind of building platform power.
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Meta
As a consumer, you're always buying a solution. You're buying transportation or you're buying a technology product doing a job for you. And if AI is a required input to that solution, then like, yeah, you're thinking about that as a total purchase decision. Yes.
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Meta
Mark hacks into the Kirkland House servers and downloads the Facebook photos of all the students to populate the website.
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Meta
Right. Only a company of the scale of Meta can kind of run this playbook in quotes because no startup is going to be like, oh, okay, what is my strategy to make sure that OpenAI and Anthropic don't get leverage over me? Good luck with that.
Acquired
Meta
I love it. Well put. Okay, great. I think my first one is... Almost a different way of putting that, which is really like Mark and specifically his superpower of placing multiple bets on multiple chess boards, never wanting to be backed in to a corner. And I think he has done incredibly well. And I think the story of Meta shows that.
Acquired
Meta
All throughout, even in the very, very beginning as a tiny project, not even a startup where degrees of freedom were limited, he was always making choices and playing the game such that there were multiple options of how things could go right.
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Meta
Yes. So we should probably spend a minute and talk about what a Facebook was before Facebook. So my big question for you is, did Ohio State have a Facebook? It did not. It probably would have been like a telephone book size thing if they did.
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Meta
That is the biggest difference is they both went through this hellish period. Yep. And Mark came out of it and said, I'm more bought in than ever. Yep. And Bill came out of it and said, Steve, you're the CEO now.
Acquired
Meta
Yep. Are you going to talk about Mark's amazing line from the Harvard CS50 lecture in like 2005?
Acquired
Meta
Oh, it's so great. Mark's, what, 20 years old at this point, maybe? He spent the summer out in Palo Alto. He gets invited back to do a guest lecture as like a practitioner in the field at Harvard CS50 class. And he's talking about product strategy and he talks about how he really admires Microsoft's product strategy.
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Meta
And he thinks it makes a lot of sense of the first version is getting something out there and it's usually not very good. But by the third or fourth version, it's pretty darn good. And that makes a lot of sense to me as a good product strategy.
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Meta
I think that is right. And I think it is doubly so with Meta because of Sean Parker and because it was set up from the very, very beginning that nobody could ever get rid of Mark. that it was always going to be his decision.
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Meta
Yeah, this works if the founder is really, really, really smart and right almost all of the time.
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Meta
Yes, yes. It's not a causal relationship here that having founder control will lead to the right decisions.
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Meta
Well, I think most, if not all, Ivy League schools back in the day had these. Princeton, where I went, certainly had these when I showed up on campus.
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Meta
Oh, yes. I was actually talking about this with one of the execs at Meta the other day, and he brought this up and was saying that, like, this really feels like something very, very unique to Meta. And I thought about it for a minute, and I was like, actually... No, I think this is something that is unique to all great companies. If you look across the landscape out there.
Acquired
Meta
If you look at Nvidia, if you look at Apple, if you look at, you know, Microsoft in recent years, if you look at the original Microsoft. You look at Costco, like this is almost always true, really is true in every great company that I can think of. The core senior most executive team are all people who came up in the company or have been there for a very, very long time.
Acquired
Meta
I have some thoughts. It's funny. As we were preparing to interview Mark at Chase Center last month, this was the question that we kept asking people. In some ways, I think it's a little bit of a Rorschach test. Everybody's answer was different and it was always like what they think is the most important thing. Yep. I think my answer for this is going to be a version of Mark as the answer. Yeah.
Acquired
Meta
That's right. That's right. And I think if I remember right, at Princeton at least, they would republish the book every year, you know, for your class, because some people would leave, some people would join, etc., etc.
Acquired
Meta
And it kind of goes back to Adam D'Angelo's Friendster testimonial about him being way too lucky and then realizing it's not luck at all. And I think it is that... You know, as Adam was telling me as he's reflected on this, it's a very specific way of carrying yourself through the world where you don't hold too tightly to the path you're on.
Acquired
Meta
Obviously, Mark is incredibly driven to the goal of connecting all the people in the world and doing that through Meta. But he's very, very open and flexible to like the exact path that it's going to take to get there. Yes. And that combination, I think, has led over and over and over again to these threats emerging.
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Meta
And Mark and the whole team there at Meta saying like, okay, what is the way that we can neutralize this threat or defeat it? And we are open to anything on that front.
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I mean, hell, after trying Orion, I think there's a very plausible reality five years from now where this company looks very, very different than it does today.
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Meta
Which is so different from all of the other big technology companies out there. They are all wedded to a particular vision of what they are.
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Meta
Well, I think building a real honest-to-God platform with hundreds of thousands, if not millions of developers making money on it on the open web.
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Meta
But I take your point. It's certainly not every turn of the game where they're inventing. They're doing a lot of discovery here. Right.
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Yes, called FaceMash. Now, a couple interesting things about FaceMash. One, gosh, if Mark was blown away by the engagement of the Harvard population with CourseMatch, FaceMash... takes that to such a whole nother level that it actually melts down the servers in Kirkland House.
Acquired
Meta
Well, almost sort of the opposite of the failures. It's quite ironic that Facebook became the prototypical startup given that the goal was never to be a startup. Yes. The goal was first to be a project and then to build like… A very profitable business. The largest empire in the world. Yes. Yeah. There was no in between of like, we are building a startup here. It was like college project.
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Oh, let's connect all the people in the world and let's get big really, really, really fast and skip this whole small company thing.
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And all this whole generation, multiple generations now of startup founders that have really embraced and romanticized this whole startup thing. It's great. Silicon Valley is so much bigger and there's so much more investment and there's so many more VCs and all that. But it's also just all kind of ironic that it's glorifying this startup phase when that is not the point. Deeply.
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Yeah, I think that's right. And it will be very interesting to revisit this again in five years or 10 years.
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And the IT department at Harvard has to shut off internet within hours of it going live to all of Kirkland House, lest this like continue to spread virally within Harvard and take down like all of the servers.
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Meta
Yes. Yes, he does. So the other interesting thing from Mark's perspective about FaceMash is that it was the first time he was building a rich web app as one of these projects. You know, fully built on the LAMP stack. And he had probably used the LAMP stack... Linux, Apache, MySQL, PHP for course match.
Acquired
Meta
Yeah, it's funny. I think you could be listening and think like, oh, yes, there's always another platform battle ahead for meta, and that's probably true, but... I think you actually mean like another societal battle ahead for meta, right? Totally, yeah.
Acquired
Meta
Ah, well, I actually have a proposal for you, Ben. Ooh. I don't think we have landed, pun intended, on the right nomenclature here or the right, um...
Acquired
Meta
construct so i actually we've been calling this land the plane take away the splinter in our minds like what's the one thing that's knocking around for you yeah what is the essence of this company so i propose that we change the name of this final segment to quintessence what is the quintessence yes this is my inner french literature major
Acquired
Meta
I hadn't thought about this till now, but almost sort of tautologically, this is like the most important episode we'll ever do to try and understand this. Like it's the biggest company that has ever existed. It's the biggest thing that's ever existed.
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coming to bear here on acquired listeners what is the essence of this company we've just spent all this time all these months studying this company what is the very essence of this company that makes it different from any other out there all right i like it the quintessence ultimately my big takeaway is the company moves like water
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Meta
Yep. I totally agree. I can't think of a better characterization of this company and how they got to be so darn important in the world. Perfect place to end it.
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Yes, that too. All right. Quick carve-outs? Quick carve-outs. My quick carve-out is a Google product, actually. Notebook LM. This is freaking wild. Our friend Ben Cohen over at the Wall Street Journal, who wrote the great piece on Acquired a few months back, texted us, what was this, two weeks ago, maybe? Yeah. A week ago? Yeah. And I was like, have you guys tried this thing, Notebook LM?
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And I think you had, and me being me, I hadn't. I was like, no, let me check it out. I uploaded just the links to the sources that I used for my side of the research for the Microsoft Part 1 episode. Just links. And when it spat back out at me, I was like, holy crap.
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Yes. But this is the first time that he's building like a real rich consumer grade web app on top of the LAMP stack.
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Yeah, a few for me to Adam D'Angelo, obviously Facebook's first CTO, Dan Rose, early partnerships at Facebook, and big, big final thank you that we owe to Chris Cox, Meta's chief product officer and leader of the entire family of apps over there. Really, this whole past couple months at Acquired would not have happened without Chris cold emailing us, what, about a year ago maybe?
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And saying, hey guys, I love the Nintendo episodes. And because of that, we met Chris. And because of Chris, Mark joined us on stage at Chase Center. And now here we are doing this episode. So thank you, Chris, for making it all happen.
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Yeah, it's such a perfect example, despite its problematic nature, of this is like the first time in history where you need neither money nor permission to launch an application like this on the internet.
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Yeah, well, clearly the bandwidth was an issue because they shut down internet to Kirkland House.
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Yeah. Harvard, as you imagine, is not pleased about this. They hallmark in front of the administrative board, which is a disciplinary committee for students when things like this happen. He and his fraternity brothers are pretty sure that he's actually going to get thrown out of school for this. So the night before the ad board meets to make their final decision, A.E.
Acquired
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Pye, the fraternity, throws a goodbye Mark party that night. And legend has it that this is where Mark and Priscilla Chan meet for the first time. And Priscilla, of course, is now Mark's wife. Yep. So Dabward meets the next day and decides not to throw Mark out of school, but to put him on disciplinary probation for the rest of the year. Basically, don't do this again. Slap on the wrist.
Acquired
Meta
Slap on the wrist. So Mark doesn't end up getting kicked out of Harvard, but he does kind of end up becoming like the Harvard computer celebrity, even before Facebook. Right.
Acquired
Meta
Yep. And it just so happens that there's a group of upperclassmen at Harvard, led by two twins, the Winklevoss twins, who have an idea to digitize Harvard's Facebook page. and build an online version of it that they're thinking of calling the Harvard Connection. And they think maybe we could actually take that to other schools too and call it ConnectU as sort of the broader version.
Acquired
Meta
This was not at all a unique idea. Not at all. Lots of people at lots of schools had this exact same idea. In fact, Harvard itself had this idea. The IT department at Harvard had been promising for years in talking about how they were going to build a digital version of the Harvard Facebook.
Acquired
Meta
Totally not. I'm pretty sure Princeton had one too when I was there, pre-Facebook. Yeah, totally not a novel idea. Lots of people have it. Nope. The Winklevoss twins, though, you know, Mark is now this celebrity on campus. They need somebody to be a programmer to write the site.
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So they talk to Mark and Mark agrees that he's going to help them out and help code this site that they're thinking about.
Acquired
Meta
None. It's funny. I was going to save this for a little later, but let's talk about it now. In addition to technically, because of open source and the LAMP stack, and also socially because of AIM and everything going on, the world sort of, for the first time, something like Facebook being able to be built for no money and no permission.
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Also, this was the first time that a technical person, because of this, could just do everything. Like, Mark didn't need anybody. Mark didn't need a non-technical co-founder. Mark didn't need a CEO.
Acquired
Meta
Totally. So this takes us to Harvard's Christmas break. Now, at the time, Harvard did final exams for the fall semester after Christmas break in January. So the idea is all the students go home for Christmas break. You come back in January, and then there's a week of reading period where you re-familiarize yourself with all the material from your classes. Then you take final exams.
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Then there's a little break. There's a course shopping period for spring semester, and spring semester starts in February. So Mark has a few weeks to program a new idea. Exactly. To not study and program a new idea.
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And during Christmas break, he had actually come out to Silicon Valley, to the Bay Area, to hang out with some friends out here and seen, you know, the physical embodiment of all these great tech companies, Yahoo, early Google, et cetera, drove by them all. And so he comes back and he's like extra, extra motivated.
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He's like, you know, this digital Facebook idea, I think this is something that a lot of people want. I bet I can code this up in a week and just launch it.
Acquired
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Totally. Now, importantly, though, all the stuff he'd been doing throughout the year, he's like, well, I can incorporate that into this project too. It'd be pretty boring if it's just a digital Facebook. Like, I don't think people want that, but I've made all this other stuff that people really, really like and engage with.
Acquired
Meta
Right. Just like the physical version of like, here is a list of all the students in the class and here is their, you know, stock profile picture. Yeah. So later, after thefacebook.com blew up, Mark told the Harvard Crimson in an interview, I don't really know what the next big thing is because I don't spend my time making big things.
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I spend time making small things, and then when the time comes, I put them together. That's the kind of stuff I do. Small little projects, and eventually they all fit together. And that's what the facebook.com ends up being. So Mark gets back from reading period. Instead of studying, he dives in.
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He IMs his friend Andrew McCollum, who he knows from CS classes, and asks Andrew to do the page design. Andrew says, yeah, sure thing. I'll help you out. Andrew goes and fires up Photoshop. He finds an image on the Internet of some guy who looks kind of cool and puts it in the header of the design for the site. Behind a cloud of ones and zeros because it's cool. It's like the Matrix. Yes.
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And for like, you know, a year or two, however long the Facebook guy was at the header, everybody's like, who is the Facebook guy? People think it's Al Pacino. People think it's a student. Do you know who the Facebook guy was?
Acquired
Meta
Oh, man. So I have been listening the last 24 hours to 50 Cent Into Club because that came out my freshman year of college, same year as the Facebook.com. And like, man, 50 Cent, Facebook.com, can't get any better than that.
Acquired
Meta
So great. So great. So on the evening of February 4th, 2004, after final exams, right when students are coming back, getting into the mode for the new semester, starting to shop for spring semester courses, Mark Zuckerberg launches thefacebook.com. And right off the bat, from the moment somebody logs in, The functionality is like awesome.
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So the registration page reads, you can use the Facebook to search for people at your school, find out who are in your classes, course match, look up your friend's friends, buddy zoo, see a visualization of your entire social network. BuddyZoo plus graphics. And then at the bottom of every page is the famous Copyright 2004, the Facebook, a Mark Zuckerberg production.
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Meta
I don't think status updates were there yet. No. But all the lessons from all the other projects, all the elements of them are coming together here. So once again, registration is limited to email addresses on the harvard.edu domain. That was part of the magic of what had made all the other projects so successful is like, it's not randos in here. It's other people at Harvard.
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Meta
It's your classmates. It's the people you care most about. And by the nature of that, it's their real identities.
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coupled with super important learning number two from facemash it's all user submitted content so no pre-population with anything from harvard you know no scraping from harvard servers etc and like yeah on the one hand that prevents mark from getting into trouble on the other hand though
Acquired
Meta
It sets the expectation and the requirement and trains the behaviors of the users of you got to enter all the content into this site yourself. You put in your aim screen name, you put in your cell phone, you put in your interests, you put in your classes.
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Right. Well, again, think about the functionality and the utility to the users. On the one hand, you would never disclose your cell phone number to the general public. On the other hand, other students and your friends at Harvard knowing your cell phone number, well, that's actually pretty useful for getting in touch, for going out, for going to parties, for planning things, etc., etc.
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Meta
Totally. You would probably also give them your relationship status, which is in there. Formalizing your relationship status for the first time here on thefacebook.com. You can add a photo of your own choosing as your profile picture. So big difference from old school Facebooks where it's whatever the university chooses or it's a stock school photo or whatever.
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No, you get to express your personality. You get to Photoshop it as much as you want. And you can update it whenever you want.
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I would even go one step further than that. The actual nature of the seeding of the network here is maybe the most important thing. And here's what I mean by that. Once Mark launches this, it takes off like wildfire within Harvard. Of course, he's already a celebrity, already known for launching these projects. People are tuned in waiting for the next Mark Zuckerberg production.
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Within the first 24 hours, 650 people join. There's only 2,000 people in a class at Harvard. So I think there's about 7,000 or 8,000 undergraduates total there. Within two weeks, over half of the entire undergraduate population is active on Facebook. So now, here's what I mean and why the seeding is so important. This initial network is super dense, super engaged, and super active.
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Meta
That not only sets the norms for how you're going to behave on Facebook going forward— It also means that as the network grows virally, it radiates out from this nuclear reactor of a base. Contrast that with an approach of something like Friendster that's default open to everybody, backed by Silicon Valley venture dollars, trying to grow. They're doing marketing.
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Meta
Okay, let's say somebody in Ohio hears about Friendster somehow. Maybe they see an ad for it. They sign up. when they join the service, there's no friends there. There's nothing to do. There's no functionality. It's not alive. When you join the Facebook, even though it's limited to just Harvard students, You sign up and you're like blown away by how alive this site is.
Acquired
Meta
That's basically always true. And the moments when Facebook stops growing is when that's not true. And then they sort of refocus on it. And then that gets the growth back. Here's another thing that I think was really important about this seeding of Facebook was actually that it happened at Harvard. Harvard is the top global brand among universities.
Acquired
Meta
Yes. Just like how we say every company has a story, every company's story is powered by payments, and J.P. Morgan Payments is part of so many companies' journeys from seed to IPO and beyond.
Acquired
Meta
Whatever you personally think about Harvard, it's undeniable, especially back then, that it was like the top university. If you were a kid or a family pretty much anywhere in the world, you knew what Harvard was. This was really important as Facebook expanded because it had this patina to it. It was like elite, especially as they grew. There were clones.
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It's kind of like civilization. Nobody else could ever invade Facebook's turf, but they could invade other people's turf. So somebody put it to me in the research. There was a fairly big competitor in Germany, I think maybe called SteadyVice or something like that. Facebook could really easily go into Germany and people in Germany would be like, oh, Facebook, I've heard of that.
Acquired
Meta
And every single one of those clicks is a page view. So yeah, this hits Harvard like an earthquake. It's face mash all over again, except a good problem, not a bad problem. It's all legit. The servers are melting down. Even Mark is blown away by how big this thing gets so quickly.
Acquired
Meta
But to your point, very quickly, Mark is adding features, adding functionality, adding things to do to the site. The other thing that he does right off the bat is say, okay, we're taking this to other colleges too. So he recruits his roommates. Dustin Moskovitz comes on to help maintain the site. Dustin was actually an econ major. He had no idea how to code. He goes out and buys Pearl for dummies.
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And Mark's like, uh, that's great that you read that. The site is written in PHP. Yeah. So Dustin goes and learns PHP 2 and helps with coding the site and keeping up with everything.
Acquired
Meta
Chris Hughes joins too. Andrew McCollum joins. And then they need to keep buying servers to keep up with the traffic or else everything is going to melt down. So one of Mark's fraternity brothers in APIE is a guy named Eduardo Saverin. And Eduardo was, I think, part of the business and investing club at Harvard.
Acquired
Meta
No, man, we got to start in 1984 or we're never going to finish this episode. And really, I mean, where else can you start? I can make up, you know, Roman Empire, classics, Aeschylus, whatever t-shirt saying Mark has this day of the week. But Facebook has always started and ended with Mark Zuckerberg. So we start...
Acquired
Meta
So they recruited Eduardo in, and Eduardo invests $1,000 in infrastructure for the site. Mark invests another $1,000. So together, there's $2,000 of investment in the Facebook.com. And the deal they strike is that Mark gets two-thirds of the company, and Eduardo gets one-third of the company. And Eduardo sets up a business entity to formalize all of this as a Florida LLC. Eduardo was from Florida.
Acquired
Meta
And right away, as we were saying, Mark's like, great, this is not just a Harvard thing. We need to bring it to other colleges. And he specifically chooses Columbia because, Ben, as you said, there was an existing competitor there. And he's like, I want to see how Facebook competes. And like, I want to know right away, can we displace it?
Acquired
Meta
Which is so counterintuitive to how most people would think. They say like, oh no, this is a race. I'm going to go to the white space. I'm going to gobble everything up and then wait to take on competitors when I'm bigger and stronger. Like Mark's like, nope, right away.
Acquired
Meta
Yep. So there we have the initial crew. Mark, Dustin, Chris, Andrew, and Eduardo, the five co-founders of Facebook. The other interesting thing about going to Columbia, which they do three weeks after the launch at Harvard, 22 days. It was the same month all within February 2004. They set up Columbia as a completely different network than Harvard.
Acquired
Meta
So if you join the Columbia Facebook, you can't then go access all the profiles of Harvard students. Right. At first, there was zero connectivity between the two. Which is another sort of counterintuitive thing. You'd think like, oh, great. I want to build this as big as possible. Mark clearly wants to conquer all these other schools.
Acquired
Meta
The best way to do that is to have all this alive content come right back. to them from Harvard, I think he realized that had he done that, it would have socially inhibited sharing within Harvard.
Acquired
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In May of 1984, when Mark Elliott Zuckerberg is born as the second of four children to Karen and Ed Zuckerberg in Dobbs Ferry, New York. Small little suburban town, suburb of New York City. Yep. And his mom is a psychologist and his dad is a dentist. Is that right? That's right. Ed studied dentistry at NYU. He was always like really into math and computers, though.
Acquired
Meta
This is such an interesting point because technology infrastructure advantage has always been a core part of Facebook, even back to this very beginning. What's interesting is that it flips at some point as Facebook grows and eventually becomes open to everybody.
Acquired
Meta
Their competitive advantage becomes their tech is so good and their infra is so good that they can do everything you were just talking about that Friendster couldn't do and that MySpace couldn't do. But in these early days, their competitive advantage is actually like, no, we're scale out, not scale up. And then Mark was totally willing to just flip the bit later.
Acquired
Meta
Totally agree. Okay, fun bit of trivia about Harvard's leave policy that we referenced earlier. Do you know what else Mark does on the same evening that they launch Columbia? No idea. He goes to hear Bill Gates speak on campus.
Acquired
Meta
The same night during which speech Bill mentions that he actually felt comfortable dropping out of Harvard because he discovered that Harvard had this really generous leave policy. That you could take an infinite leave of absence and pursue something else and come back anytime you want.
Acquired
Meta
And Mark would actually say later that Bill saying that at the event was part of what got him comfortable doing the same thing.
Acquired
Meta
So next couple of days after Columbia launches, Facebook launches at Stanford, at Yale. By the end of the semester, they're in over 100 schools in like, you know, what, three, four months. Like the speed they're moving with is crazy.
Acquired
Meta
Yep, totally. Meanwhile, here we are at the end of the school year. The Winklevoss twins take the whole connect you situation to Harvard's president, Larry Summers, to adjudicate this dispute between them and Mark. Larry says, hey, Harvard is not going to get involved here. This is a business dispute between students. Eventually, the two twins sue Mark and Facebook.
Acquired
Meta
They settle for $65 million, $45 million of which is paid in pre-IPO Facebook stock. Obviously, that grows a large portion of that. Then I think they sell and put into Bitcoin in like 2011, 2012 timeframe. So they end up pretty, pretty fine out of all this. They did great. They did great. But here we are at the end of the school year.
Acquired
Meta
But growing up the son of Jewish immigrants in New York City, you know, the expectation was you're going to be a doctor or a lawyer. So he goes to dentistry school, becomes a dentist. He meets Karen. They get married. After Ed finishes dental school, they move up to Dobbs Ferry in Westchester County.
Acquired
Meta
Summer comes around, and Andrew McCollum has some connections out in the Bay Area. He had interned at Electronic Arts. Adam D'Angelo is going to be spending the summer from Caltech. So the crew all decides, like, hey, great, let's not get internships. Let's go rent a house out in Palo Alto. move to Silicon Valley and work on Facebook there for the summer and see what happens.
Acquired
Meta
And yes, the house did indeed have a pool. Yes, they did indeed install a zip line off the chimney. That was not fiction in the movie. That did actually happen.
Acquired
Meta
Now when we say crew who moves out, that crew did not include Eduardo. Eduardo had an internship in New York and decided that he was not going to move out for the summer.
Acquired
Meta
Not a great decision. On the other hand, he ends up with 2% of Facebook, so he's also fine.
Acquired
Meta
And Mark and his three sisters grow up as prototypical middle-class suburban American kids in the 90s. Life is good. Your grandparents worked really hard to make a bunch of sacrifices for your parents. Your parents are now professionals. They're also working hard to give opportunity to you. And the family is kind of leveling up in America. It's the classic story here.
Acquired
Meta
That person is the co-founder of Napster, Sean Parker, who would have a brief but very, very large impact on the company.
Acquired
Meta
Oh yeah, there are always bad actors on the other side of the same new technology, and this is especially true whenever money or value is exchanged, whether it be phone scammers taking advantage of international networks in the 80s and 90s, viruses spreading through the early internet... Or today's cybercrime like AI-powered identity theft. As technology gets smarter, so will the fraud tactics.
Acquired
Meta
One great example is a Fortune 500 global media company. They needed an automated solution for the thousands of influencers on their platform to do rapid onboarding, minimize errors, and ensure consistent validation of bank account information. They were able to compress validation times from days to minutes so they could scale.
Acquired
Meta
Developers can even integrate their preventative fraud solutions to act before an incident takes place. Sardine, a leader in financial crime prevention, collaborates with JPMorgan Payments and embeds its Account Validation Services API to analyze and protect over 2 billion devices for 300 companies with AI to the highest standards of fraud and compliance safety.
Acquired
Meta
So Sean Parker had, of course, started Napster with Sean Fanning back in the late 1990s. And after the whole Napster saga, Parker ended up starting the email contact list company called Plaxo, which was kind of its own proto-social network and... pioneered email address book exploitation and exporting.
Acquired
Meta
You can play sports and you can hang out with your friends and play video games. Indeed. And for Mark and for me growing up and maybe you too, like, it's kind of amazing. Like, there's no reason not to just explore your passions. And for Mark, those passions become threefold. One, turn-based strategy video games, most particularly Sid Meier's Civilization. Two, programming computers.
Acquired
Meta
Yep. So Sean and his co-founders at Plaxo raise money for Plaxo from venture capitalists. And not just any venture capitalists, the best venture capitalists from Sequoia Capital. And all is going well. Plaxo's going fine. Sir Michael Moritz is on the board of the company. Anyway, after a couple years, Sean Parker ends up getting kicked out of the company by the board. Now...
Acquired
Meta
Sean wasn't exactly the most, like, reliable employee and definitely was quirky. But the result of this is Sean's everlasting enmity for Sequoia and paranoid distrust of all venture capitalists and company boards. This is going to become very, very, very important here in a sec. So rewind slightly back to the spring of 2004 when the team is still at Harvard.
Acquired
Meta
Sean is living in Palo Alto and one of his housemates' girlfriends, who's I believe a student at Stanford, pulls up thefacebook.com on her laptop and And it's kind of like the scene where this happens in the Social Network movie. Sean is like, holy crap. This is it. This is the winning social network. And Sean, I believe, had actually been an advisor to Friendster as well.
Acquired
Meta
So he was like between Plaxo and Napster, Friendster, really believed social networking was going to become a thing. Totally.
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Right. Which you can't get past it and see how alive the thing is. Yep. So, Sean, being the enterprising person that he is, he cold emails the company's business email address and asks to set up a meeting. And Eduardo Saverin replies to Sean, he's like, oh, cool. You're the co-founder of Napster. Yeah. They set up a dinner in New York City.
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This is while the spring semester is still going on at Harvard. And Mark and Eduardo and Sean all get dinner together. And Mark and Sean really bond. Mark is super pumped to meet him. But that's about it. Like, there's no, you know, discussion about, you know, what's cool, a billion dollars, you know, et cetera, et cetera, as dramatized in the movie. That doesn't happen.
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No, totally not. So here we are now in June. The Facebook crew has moved out to Palo Alto. They're walking down the street one evening. Sean is also walking down the same street in Palo Alto, sees them, and is like... hey, it's the Facebook guys. And at this point, Sean Parker was living in a different house, specifically the house of his girlfriend's parents. Not a good situation.
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And he makes a split-second decision right there on the street to insert himself into Facebook and is like, hey, I'm actually looking for a place to stay. Do you think I can crash with you guys in the crash pad for the summer? Yeah. And he joins the crew. And this is how it all starts. That is wild.
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Yeah, it's like you ever play old school like Super Nintendo role playing games like Japanese RPGs like Final Fantasy or whatnot? It's been a while. I mean, it's just like you meet somebody on the street and they join the party. You always know the character on the street that's going to join the party because their pixel sprite is more highly detailed than the regular NPC pixel.
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I mean, this is exactly what it is like here. Sean Parker had a very detailed pixel sprite. Yes. So while he's there, you know, living in the house, crashing with the college students, he basically takes Mark aside and he's like, look... You've got something really special here. I have been in your shoes. Let me tell you exactly what is going to happen this summer.
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And three, as you mentioned and everybody who watched our Chase Center show knows, ancient Greek and Latin history. Classics. The classics. And pretty much in that order of importance, both to him personally and the future course of Facebook and meta. So let's start with Civilization. September 1991.
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You have created something magical. You're now out here in Silicon Valley. You are going to be the bell of the ball. All the venture capitalists out here, all the big companies, they're going to wine and dine you. They're going to court you. They're going to tell you you're great and they're going to want to invest in your company.
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And then they're going to turn around and they are going to screw you. They're going to take control of your board. They're going to force you to bring in quote unquote professional management. They're going to kill all the magic. Growth is going to slow. Then they're going to blame you. And then they're going to fire you. And then they're going to put the company up for sale.
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that was not the wrong playbook until this moment in time. Because as we've been talking about, until now, if you wanted to scale something, you needed money, you needed permission, you needed business people, you needed deals, you needed contacts.
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Yes. And I think, Sean... As bitter as he was about his own experience, I think he probably also recognized that and recognized that the Facebook and Mark had the potential to start a new paradigm of how to do this differently. So Sean says to Mark, look, if you just go out on your own, that's what's going to happen. I am going to take you under my wing and make sure that that does not happen.
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And I'm going to help you reset up the company so that you permanently control the board and no one can ever fire you because you are what is important here. And I'm going to help you go about fundraising, but I'm going to make sure we find the right people who are cool with that stipulation, number one, because if you go try and do it by yourself, like you don't know enough.
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You don't know these people. You're not going to find the right folks. And it's kind of wild. I mean, Sean was also in a position to take advantage of Mark and the company, and he didn't.
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Totally. But it would have been really easy for him to do one of two things. You know, one, obviously take advantage of Mark and the company and get a lot more for himself. Two, I think he also could have been so jaded by the Plaxo experience to say we shouldn't raise venture capital at all. But actually, what he counsels Mark to do is the right thing. No, we should raise venture capital.
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We should professionalize. And the whole Silicon Valley machinery really can help us. But we're going to do it in the right way on our terms. I think he just really wanted to help Mark win the game. I think you're right. The other thing that Sean does, by all accounts, is... He makes sure that everyone in the house that summer gets equity in the company.
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Yes. I really would love to know what Sean thought when Mark and the crew told them about Wirehog. Wirehog was basically going to be a captive Napster to Facebook. Everybody on Facebook, in these private networks, walled gardens, what is something that college students really, really wanted to do and was happening internally on college servers all the time? Share files, share music, share movies.
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Right? I mean, it's kind of laughable, but like, no, this is really important here. So September 1991, when Mark is seven years old, Civilization or Civ, as its fans call it, comes out for PCs and young Mark gets hooked. And for those of you who haven't played Civ, It is a very particular type of turn-based strategy game and is probably the foremost example of what is known as the 4X genre.
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Wirehog was going to be a product to make this happen. And actually, legend has it, I think in Stephen Levy's book, While they're talking about this, Sean Parker actually comes up with a name for the product. It's like, oh, if you launch this, you should actually call it Dropbox.
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Yes. So to the investors that Sean goes out and helps them find, Sean at this point knows basically everybody in Silicon Valley. And he's like, okay, I need the pretty tight window of people who A, have money, B, know what they're doing, and C, are okay with our terms that Mark is going to control the board and control the company. So we need an individual, not an institution.
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So he calls two angel investors who he knows pretty well and he thinks might be the right fit. One is Reid Hoffman, who Reid had been running LinkedIn and Sean had been in this early social networking thing. And he just started LinkedIn.
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So Sean calls up Reid and he also calls up Mark Pincus. Mark had been Sean's boss at an internship that he had in high school. And then Mark had gone on to invest in Napster when they started Napster as a company. And we should say who Mark Pincus is for anyone who doesn't know.
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Yes. Could become a very important person and company in the Facebook ecosystem. The maker of Farmville. Yes. So, Pincus and Reed meet up with Sean and Mark, and they're just blown away by the Facebook. And Ben, as you say, Mark starts talking about Wirehog, and apparently Reed is like, no, no, no, no. Stop talking about this Wirehog thing. Like, I'm running LinkedIn.
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I mean, amazingly, a couple years later, you know, Sean being so open-minded, I mean, he was one of the ones who really helped Spotify get going.
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Totally. So, okay, Reed, really excited. He's like, no, no, the Facebook. Focus on the Facebook.
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So Reed's like, look, I'm running LinkedIn. Pincus and I don't have that much money together. We'll give you some, but we can't fund a whole round for you.
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My old colleague from PayPal, who actually, as luck would have it, is thinking about starting his own venture capital fund. this could be a really good fit. Why don't you meet Peter Thiel? And Peter, yes, indeed, was just in the process of starting what would become Founders Fund. Ben, you already alluded to this, but like, Founders Fund was such a radical idea when Peter started it.
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The idea being baked into the name that they will always side with founders and never push a founder out of a company.
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And of course, PayPal has its own crazy history where you can understand why Peter would arrive at this conclusion. But he really was like...
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Maybe the only person in Silicon Valley that hit that Venn diagram that I talked about a minute ago of like super legitimate would actually help the company and help them navigate Silicon Valley had money because the PayPal exit had just happened and was going to be cool with Mark controlling the company.
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That's the number four, letter X. And 4X stands for Explore, Expand, Exploit, Exterminate. And despite that sort of nefarious sounding nature to the last one there, especially, Civ and 4X games were kind of this radical branch of video games at the time where the action of playing and the way to win wasn't just about like killing all the enemies on screen.
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Yep. But I don't think at that time, you know, Elon wasn't doing investing. I don't think there was anybody else who really could have done it.
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Right. But Sequoia wasn't going to do this deal under those terms. So Ruloff couldn't have done it. Yep. It was maybe one of two with the other one potentially being Elon. Wow. That would be a really different world that we would be living in today. Yep. Okay. So they take the idea to Peter. Yeah.
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In the meeting, Reid brings along a young guy who's working for him at LinkedIn named Matt Kohler to come help, you know, talk to Peter, evaluate this from an investing standpoint. They strike a deal. That Peter's going to lead a round of $500,000. Reed and Mark Pincus are each going to invest $37,500. Peter's going to do the rest at a $5 million pre-money valuation. So $5.5 million post.
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Which, you know, on the one hand is like laughable now. On the other hand, at this point in time, for a bunch of kids who started this a couple months ago, it's crazy that this would be worth $5 million.
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So that takes us to the end of the summer. So everybody now has to make a decision. Do they stay in Palo Alto and keep working full-time on Facebook, or do they go back to school? So Eduardo never came out in the first place, so he did his internship in New York. He goes back to Harvard and starts his junior year.
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Chris Hughes also goes back to Harvard, starts his junior year, graduates in 2006, and then rejoins Facebook after graduation. Andrew McCollum stays in Palo Alto for a couple years and then goes back to Harvard later and completes his degree. He takes the, you know, Bill Gates road not traveled option. Dustin never goes back, stays with the company until 2008 when he leaves to start Asana.
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Yes. And certainly at this point, the combination of Sean, Peter, Reed, Mark Pincus, all advising and being part of the company, they know. And they have certainly helped him realize that. Adam D'Angelo does go back to Caltech and then through AIM, I guess, remotely helps collaborate with the company until he graduates in 2006 and becomes CTO officially. Got it.
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Sean, like we said, his impact on the company was huge. I really want to underscore this again. Yeah. Mark having full control over the company, as we are going to see time and time and time again as we go through the story here, makes all the difference in the world. And that is 100% because of Sean Parker.
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Not very long, because at some point in time the next spring... So it's like nine total months at the company. Yeah, I think about nine total months. Sean ends up leaving the company after charges get filed against him as a result of some drug incidents at a house party during a trip to North Carolina.
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Yep. He immediately joins, where else? Founders Fund. Which Peter, partially on the back of this Facebook investment, has now set up and raised officially. And like we said, Sean goes on to find and fund and really help nurture Spotify through his role at Founders Fund.
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It's a lot more like a board game or like Risk, if you're familiar with that. It's about strategy. It's about growing and marshalling your resources effectively. And most importantly, there are multiple ways to win the game.
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Well, let's talk about other investors. By this point, kind of towards the end of spring semester 2005, Facebook had now dropped the the, become just Facebook. That was one of Sean Parker's Final impacts on the company is he actually negotiated the domain name purchase of Facebook.com. I didn't know that. Yeah. I believe they bought it for $200,000. Hmm.
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Most other games out there, you can win by defeating all the other players, but you can also win by completing a technology development tree and reaching like the peak of technology, which is in the game, launching a spaceship to go colonize a new planet. So that's another way to win. And in modern versions of the game, you can also win by diplomacy, by getting elected the leader of the UN.
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Nice. Spring 2005, Excel comes in, leads a Series A, $12.7 million at a $98 million post-money valuation. That's sort of like crazy in and of itself for the time. And though, still being okay with Mark having board control. Yes. Which, you know, one thing for like, okay, at the angel round, maybe like that's still pretty crazy, but whatever, this is angel round.
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But like, no, like a real venture capital firm, real series A, 2005. Yeah. A, $100 million valuation, B, being okay with that. That was wild. Oh, also C, getting less than 20% of the company. Like rule of thumb venture investing back in the day was you need at least 20% of the company, ideally more like 25 or 30.
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Totally. I was trying to think of... Were there any other deals like this that you could even kind of point to as a comparable from the past? And the only one I can think of was the Google Series A, which was $25 million at a $100 million post-money valuation split between Michael Moritz from Sequoia and John Doerr from Kleiner Perkins. But it was in the dot-com run-up. Exactly, exactly.
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It was a totally, totally different paradigm. And the... Legend has it, I don't know if this is apocryphal or not, is that after making the investment, Moritz told Don Valentine at Sequoia, never have we paid so much for so little. And I think he was actually referring to like the small amount of equity that they got by having to split the deal in Google.
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So yeah, in the dot-com bubble that happened, but like that this would happen in 2005. Yeah. Excel went way out on a limb for this.
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You can also win by dominating all the other players on either culture or religious dimensions, too. So it's kind of like this amazing simulation of what it's like to run one of the top 10 market cap mega capitalization companies in the world today. Yeah.
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Wow. I had no idea. Yep. Wow. I mean, add to the litany of things that were not done back then.
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Absolutely. Man, that is freaking wild. Yeah. Wow. Okay. Well, that is a lot of hype to live up to. Which brings us now to the summer of 2005, where Mark, motivated by this perhaps—I hadn't quite thought about that— announces to the company his product roadmap for the summer. And it is a six-point product plan. Number one, a redesign of the site. Bye-bye, Facebook guy.
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Yes. Move fast and break things. Yep. Number three, a personalized newspaper based on all of your friend's activity. Number four, an events feature. Number five, a local business product. And number six, a sort of vague idea for a feature called I'm Bored. which would let users on the site who were bored consume media and play games. That's a pretty big feature mandate. This is freaking wild.
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So now, OK, of that, I think only the redesign and photos would actually ship in 2005. Maybe events did, too. I'm not entirely sure. But this is incredible. Photos, newsfeed. platform, which is really what this I'm Bored feature is. Summer 2005, it's all right there in the vision. And Mark thinks they can accomplish all of this by the end of the summer.
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And the wild thing is they do accomplish all of this in the next two years, which two big points on this. For any other company, these are all like multi-year long development processes. Well, and each one is its own company.
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Miniclip, etc. Yeah. Flash games. What were some of the other ones? Events. Eventbrite. Yep. Personalized newspaper. Well, that becomes a true, true innovation in newsfeed. But I think at the time, there was a lot of... buzz and talk about personalized portals and like Yahoo was really big on this and Google was even kind of big on this. Like, oh, make this your homepage.
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Do you remember iGoogle? Yes, iGoogle. Exactly. And I think that might have been somewhat of the inspiration, although obviously Mark was thinking way bigger than that. But like, yeah, again, local business product, Yelp. Each one of these... under the old paradigm was its own company. And Mark was like, no, this is all part of Facebook. Crazy. Super crazy.
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And this really, I think, speaks to the genius of Mark as a product strategist. It's one thing to say, I'm going to add a lot of random features to my site and I'm going to throw spaghetti against the wall. This was not a random grouping of features. Everything reinforced one another and drove the engagement loop of the site.
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So just as one example, let's take from, you know, this roadmap that Mark lays out. Events. Let's start there. Events and parties planned on Facebook get tagged with who's going to attend the events. All of those tags get published out as activity to News Feed. That drives interest and FOMO among the friend network, so more friends come to the actual event.
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At the event, photos get taken, and now there's more people there. Well, those photos get posted back to the site afterwards, and they all get tagged with the people who were there who were in the photos. All of that becomes activity that then gets published to News Feed.
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That generates more desire from more people who see that on Facebook in the newsfeed to either engage with the photos and like and comment on them, or if they're hearing about it from their friends and they're not yet on Facebook, to now register for Facebook and get involved in this loop. All of that now gets published back to News Feed. So now it's time for the next party.
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And you can see how this just grows and builds on itself over and over and over again.
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Yes. So MySpace only allowed you to have eight photos maximum at the time. And this is, A, Ben, what you're describing of person tagging and photos. Incredible innovation. Right. That... Drives the whole viral loop.
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It's kind of funny. This is way too simplistic of an analogy and not fair to Mark on any dimension. But the whole construct here sort of reminds me of the book Ender's Game, where it's these kids growing up playing this game and they didn't realize all along it was actually the real game.
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To your broader point here, though, yeah, for the first six or seven years of its life, Facebook was a change maker, defining what social networking was. And then after that, it became a change taker. We'll talk about this when it happens, but like... Again, the mental flexibility of Mark and the company to be like, okay, I'm not going to have pride about that anymore.
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I'm going to adapt and still win is incredible. Very Microsoftian. Very Microsoftian. Okay. So even this, even though it takes two years to roll out the full roadmap... Photos, events, but especially photos. The 2005-2006 school year is just off the charts for growth, sharing, engagement among college students. Ben, you found an incredible stat about Facebook's page views, right?
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Right. Which was already the case when it was basically text only. But adding photos, I mean, oh, my God, every photo is a page view with such a small user base at that point in time. I think what probably certainly less than 10 million users. To have 200 million plus page views every single day and be passing Google in traffic is wild.
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I mean, certainly Flickr, MySpace, Friendster couldn't hold a candle to that type of engagement.
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So playing Civ and other video games when he's young, PC games, leads young Mark to want to learn how to program himself. So when he's 10, he has his parents take him to the local Barnes & Noble one day and begs them to buy him C++ for dummies. And he dives into the book, learns everything in there, and... He's like, I need more. I need more.
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Yes. Well, when you say figured out the advertising business model, they just had such a high volume of page views that they didn't have to figure anything out. Right. You just plug in some crappy ad networks and like print money. Fair.
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But they had a traffic machine. They were able to, through alchemy, turn page views into revenue. Yeah. But they had not, by any means, figured out their business model.
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Yes. So the 2005-2006 academic school year, incredible for the company, everything we just talked about. But there were a couple yellow flags, shall we say, that popped up. During that year, Mark, of course, was already starting to think about, well, how can this keep getting bigger? People graduate from college. This is great in colleges, but like, I don't want to just build a college site.
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I want this to be a lot bigger. And obviously that was what Excel was investing into at that valuation. Yeah. So they launched two sort of tests throughout the year. One was opening up Facebook to high school students, and the other one was opening Facebook up to workplace groups. And both of them kind of flopped.
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Yep. But the problem was going into workplace networks, people didn't want to share with their colleagues.
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And I think also just the density wasn't there. It was violating the principles that got them there of like this thing needs to be alive and every way we fractally spread out needs to be bringing that nuclear reactor of what's happening along with it. Going straight into workplaces like you've got 60-year-olds and they're like there's going to be nothing compelling for them right now.
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Yep. And that... was a very rational argument. Now, high schools, as you say, failed for a different reason. There wasn't the same standardized email architecture in high schools across the country. It was just way more fragmented, so you couldn't elegantly set up these private networks in the same way.
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So after that, his parents hire a local tutor to come and tutor him for an hour a week in programming and learning how to write software. And Mark has this quote that he says later, I'd go to school and I'd go to class and come home. And the way I think about it was... awesome, I have five whole hours to just sit and play on my computer and write software.
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I, oh man, I vaguely remember this of my younger friends who are still in high school asking for this.
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Right. Yeah, because there had to just be one hs.facebook.com for all the high schools.
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Yep. So the academic school year in the core college user segment went great. But once you hit summer 2006, all those kids go on break and college growth stops for the moment. So summer 2006 was kind of a scary moment for the company. The initiatives to expand outside colleges were not going super well. College growth had stopped for the moment.
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And yeah, Ben, like you said, like very rational argument that like, okay, this thing is going to be a really interesting niche site for college students. And how valuable is that? Well, Viacom, which owned MTV, said, thought that that was worth $750 million, which is what they offered to buy the company for in the summer of 2006.
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Well, there was another party that really, really wanted to own Facebook at this point in time, and that was Yahoo. And Yahoo was willing to top Viacom and pay a billion dollars to buy the company. So here we are, a billion-dollar offer on the table. And growth is slowing. Exactly, exactly. There's this existential question mark about the company. Growth has slowed a lot.
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You've got a billion dollars on the table, which is a lot of money, especially in those days. It was shocking six years later when Facebook bought Instagram for a billion dollars. This would have made the careers of everybody involved. Yep. And, you know, Mark, of course, controls the company, controls the board. Thanks to Sean Parker, he doesn't have to sell.
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And then Friday afternoon would come along and it would be like, okay, wow, now I have two whole days to sit and write software. This is amazing.
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But the whole management team is like, yeah, we should probably sell. And I think the board, you know, it's hard to know. They obviously know they can't force him to sell. But I suspect if you had asked all of their opinions, and certainly Mark did, they probably would have been like, you know, it's been a great run. We should probably hit this bid. Yeah. So Mark actually agrees to the Yahoo deal.
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Billion dollars. It's going to be all in stock. Yahoo's going to buy the company. In the interim between when they shake hands on the deal and while the docs are being drafted, Yahoo announces their quarterly earnings, and they have a bad quarter, and the stock drops 20%. And Terry Semel, who was the CEO of Yahoo at the time, said, okay, the deal is, you know, for the same amount of stock.
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So commensurately, the deal is now worth 20%. $800 million, not a billion dollars. And that was history turning on a knife point. And that was all Mark needed to say, you know what? Thanks, but no thanks.
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Yep, totally. That is not the way it gets talked about today. But I think actually makes the story like kind of even more powerful. It almost really did slip away.
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Yeah, I completely agree with you. And Mark has said so much in so many words to you and me personally that he's not optimizing for financial outcome here. He's optimizing for impact.
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Yes, totally. Also, though, to his skill as a strategist, even at this very young age, Yes, Ben, you and I just made a compelling argument about why you could have believed Facebook was going to top out with the college market at this point in time. Mark knew, though, and he had planted the seeds that both newsfeed and open registration were going to be coming later that year.
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And he was definitely making that calculus here, too, of like, well, I don't know what the probability necessarily is that those are going to hit. But Mark had the belief, like, A, if they do, they're going to be really big. And B, I think the probability is higher than the people around me think it is.
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Yeah. So, okay, to figuring out the business, coming out of this episode with Yahoo. They say no, the whole management team churns. The whole management team basically churns over the next set of months. Mark gets religion on a couple things.
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As it always is with Mark. So while he's a kid here in Dobbs Ferry, he codes up all sorts of little projects, including a family chat tool for all the networked computers in the house. And also his dad's dentistry office is attached to the house. So he builds this network called ZuckNet, which is family chat between all the computers. Very prescient here.
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Yep, totally. So, what are they going to do? The first thing is, I think, Mark had always operated the company this way, but now he gets real religion of like... We need to get more revenue and we need to focus on becoming truly cash flow positive so that we are never in a position again where we would even consider doing something like this.
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So in August of 2006, they do the first partnership with Microsoft. It's funny that, you know, the Microsoft Facebook relationship in some ways is sort of a precursor to the Microsoft OpenAI relationship today and how that gets built. Here's what it is. Microsoft says, we're going to take over selling all of the display ad inventory domestically within the US for Facebook.
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And we will give you a guaranteed CPM that we can sell. And then we are going to use this to help bootstrap our online services division, which, as we talked about in our Microsoft series, becomes super, super important, not only for their efforts launching Bing and making that into ultimately a successful business,
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But even more importantly for Azure that comes out of it, Microsoft knows they need some scale to bootstrap up and get started with both the ad business, but also just like the online services division, period.
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Yes. And Microsoft had been trying to do this. They tried to do this with MySpace a little bit earlier and they lost that deal to Google. So they really need Facebook.
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Outsource it to a good third party network. Right. So this is like basically all of Facebook's revenue for the next couple of years here. Yeah. So Facebook had made $9 million in revenue in 2005 when they were selling themselves. This is, Ben, as you were saying, like, hey, they're starting to turn on ads in 2005. It's starting to work like $9 million. That's amazing for year two as a company.
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Got to cash flow positive. Got to cash flow positive. In 2006, with this Microsoft partnership, that jumps to $48 million in revenue.
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Now we're talking. And then the next year in 2007, again, I think almost all of this is Microsoft, that goes to $153 million in revenue. So like, okay, we are way out of any league where we would consider selling ourselves here. Yeah. We can control our own destiny.
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Oh, and by the way, in the second iteration of this Microsoft partnership, which we will talk about in just a minute, it included an investment from Microsoft at a $15 billion valuation.
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Yes. Point being, though, Mark made the right decision for all shareholders of Facebook to walk away from the Yahoo deal.
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So how does this happen? Okay, Adam D'Angelo finally graduates from Caltech, joins Facebook full-time as CTO.
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And then, speaking of family and friends chat, in 1997, when Mark is 13 years old, AOL launches AIM. AOL Instant Messenger.
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Well, he was right there. I mean, they were at Exeter together. Like, I don't think you can separate it out.
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And, you know, I think here, part of the reason why Adam keeps coming into the story is he is a really, really great technologist. And even though he's young, same age as Mark, when he now arrives full-time as CTO, This is when Facebook starts to be taking the steps to be building, like, real technology infrastructure.
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So before Adam joins full-time, the team was shipping new code to the website, like, at a high velocity relative to everybody else out there. You know, it was weekly-ish, maybe every couple days, you know, maybe even up to daily.
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Yes. And when Adam becomes officially the CTO, he's like, actually, we should probably just ship multiple times a day. We should just be shipping all the time. And also we should probably start recruiting like a real top tier engineering team. Because remember, it's still kind of nuclear winter for startups. Great tech talent is available.
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So they start going and recruiting like really, really top tier engineering hires. And it's a pretty compelling offer. Like, A, we've got real revenue from this Microsoft partnership. We're the best funded startup in the valley. People want to buy us for a billion dollars. We turn them down. That's all sort of the financial reasons to take it.
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For a lot of people, too, it was like such a breath of fresh air. I think Facebook was potentially maybe the first company, first startup to have an open office plan. Like just everything about how they ran the company was different.
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Meta
I mean, there was Google out there, which had a lot of this element, but it was a very different thing. It was very academic, very wonky. These guys were hackers and they shipped, you know, and they were all in it together.
Acquired
Meta
So one of those super intelligent, super talented young engineers with a high slope who joined back in Fall 05 was an engineer named Chris Cox, who joined from the Stanford AI Lab. And Chris joins a team of other young smart engineers led by Ruchi Sangvi and Andrew Boz Bosworth working on Mark's personalized newspaper product idea.
Acquired
Meta
Richie was one of Facebook's very first engineers, and along with her husband Aditya Agarwal, they run South Park Commons now. Boz was two years ahead of Mark at Harvard and had actually been Mark's TA in the Intro to Artificial Intelligence CS class that he took. And then he later joined the company.
Acquired
Meta
Yes. Boz went to Microsoft, I think, before joining Facebook. Yeah. Just for a few years. So the three of them start working on News Feed. And so we've talked about things like photos and the fundamental architecture of the site. News Feed required, like, a whole new level of engineering prowess to get this thing to work. Like, you're not just going to code this up in PHP.
Acquired
Meta
Like, photos also required real engineering prowess. But News Feed was pushing the state of the art of what was possible in technology and on the internet.
Acquired
Meta
This was middle school for all of us, and this was middle school for Mark, too. The crazy thing about AIM, to go on just a quick little digression here, I had no idea until doing the research. It was actually like a rogue skunkworks project within AOL. Did you know this? Hmm, no. Yeah, so it was a couple engineers that just went off and built this, almost against the wishes of management.
Acquired
Meta
Yeah, it was four times a day when it initially launched. There was like a 4x a day refresh.
Acquired
Meta
Yeah, it was a cron job because they didn't have enough memory to run it in real time.
Acquired
Meta
Exactly. Then you need to make the feed actually compelling. Exactly. I don't really care about, you know, somebody who I'm tangentially connected to what they had for lunch today, but I really care about like a photo of Ben at the acquired meetup.
Acquired
Meta
Right. Totally. Who are your close friends? Who do you care about the most? You know, what general news do you care about the most? What types of stuff do you care about?
Acquired
Meta
Yes. So the team spends the better part of 2006 working on this. By September, it's ready. And so by September 5th, 2006, just in time for the new school year, they launch it. And people noticed because they launch it to everybody right away. And this is a massive paradigm shift.
Acquired
Meta
It was not originally intended to really be for social use or for kids at all. It was more like the idea they had was it was going to be kind of like Slack, like chat for workplaces. Oh, wow. They ended up using it internally at AOL to communicate. And that's actually where away messages come from.
Acquired
Meta
This is Facebook changing the game of social. Not opt-in. Everybody gets it right away. They get 30,000 angry emails to support on the first day from users who are really upset about this. 10% of the entire global user base signs up for a group, a Facebook group called Students Against Facebook News Feed. I'm pretty sure I was part of this group.
Acquired
Meta
The irony here is they had only just launched open groups across school networks days or weeks before. So like they enabled the tool of their own vitriol here.
Acquired
Meta
It went from pull to push. Yes. So it's the start of the new school year. We've just come off this sort of tumultuous summer. Growth had slowed, walked away from the Yahoo deal. Yeah. There's this revolt in the streets against newsfeed, which to Mark's mind, along with open reg, which was supposed to come like two days later of opening up Facebook to anybody.
Acquired
Meta
They delayed that because of the newsfeed reaction. But to Mark's mind, the two of these things are like the big growth levers to reignite growth for Facebook. The board, the management team, everybody's like, all right, we got to roll news feedback. People hate it. This is PR 101. We apologize. We roll it back.
Acquired
Meta
And to add a kicker, newsfeed actually significantly hurt Facebook's revenue because where do you think all the page views were coming from and all the refreshes? Oh, loading a new ad. Yep, loading all the profile views and clicking around. So page views are actually going to go down in this new paradigm. Every reason is aligned to roll this back.
Acquired
Meta
So they came up with away messages because people would be in meetings or, you know, this is the days of desktops. There's no cell phones, barely even laptops. People would go out to lunch and they'd have to put up a message so that when their colleagues were trying to communicate with them, they'd be like, no, no, I'm in a meeting. No, I'm away. Wow. That's the origin of away messages.
Acquired
Meta
So Richie and Chris and Boz, though, are looking at all the data and they're like, Holy crap. Engagement is through the roof. Yeah, people can't get enough of this. People say they hate it, but yeah, it looks like they can't get enough of it. So Mark decides that he is going to write a post on Facebook about this. And it's titled, Calm Down, Breathe, We Hear You.
Acquired
Meta
And he announces that they're going to launch a set of controls for you to control what of your activities get published to newsfeed and what don't.
Acquired
Meta
Yes. So it's kind of a brilliant strategy of like, hey, I acknowledge that this was surprising. We didn't handle the rollout right. I'm seeing that you all actually like this in the data. Let me give you some controls so that what you're really worried about, you have some control over. And then let's just see what happens. And within two weeks, it's like magic.
Acquired
Meta
Everybody just gets used to it and that this is now the way... Facebook and social media operates and engagement continues to skyrocket.
Acquired
Meta
Well, and I think to sort of set a theme here that we're going to come back to several times, the definition of what social media is, is actually very fluid. And it changes in the consumer's mind.
Acquired
Meta
Right. Inspired by a newspaper. Right. And I think when these paradigm shifts happen... People get upset because their expectations are being violated. So it actually doesn't really matter what the privacy is or isn't. It's the expectations. Right.
Acquired
Meta
Yep. Unfortunately for the moment, I think the lesson that Mark and the company took from this experience was... Well, we actually know what's best and the user base will just get used to it whenever we make a change. It just happened to be that that was true with News Feed, but that wouldn't always be true.
Acquired
Meta
So originally, the two big initiatives, News Feed and Open Registration, were supposed to basically launch together. And they chose to do News Feed first because it was going to be, A, a little bit easier to roll out and be more valuable to the core college audience that was just starting back for the new semester, the fall semester at school. So they launched that first.
Acquired
Meta
And then, yeah, the original plan was Open Registration, Facebook is now open to anybody in the world, was going to come two days later on September 7th. They obviously put that on the shelf for a long time. Two and a half weeks. At the end of September, open registration launches. Anyone can sign up for Facebook. This is another major, major change. Before, all these networks were siloed.
Acquired
Meta
It was the ultimate emo teenager thing. It was like, I am expressing my whole self through this one line away message.
Acquired
Meta
You had to be part of a verified email address network to join Facebook. Now anyone can sign up.
Acquired
Meta
Exactly, exactly, exactly. Which ultimately would be a problem because that's what created room for Instagram, for Snapchat, etc., etc., etc. But that would actually be down the line. In a weird sort of perverse way, I think because of all the controversy around News Feed, when Open Reg launched, there wasn't the same kind of controversy.
Acquired
Meta
People were already desensitized or they had just been through News Feed and they're like, all right, yeah, whatever. Nobody even really noticed that much, especially because the product experience didn't change for the already engaged users.
Acquired
Meta
Yep, yep. And now with News Feed, there is this mechanism that makes sure like, hey, even as randos from your perspective join Facebook, you're still seeing the updates of people you care about, right?
Acquired
Meta
So, I mean, for people all of our age, Mark's age at the time, I mean, that completely changed our social experience when that came out. So the other important thing about AIM when it came out that I had no real conception of at all as a kid. was that it was free. So my family was an AOL family, like we were AOL subscribers, we had the You Got Mail, et cetera.
Acquired
Meta
Right. The age of the network itself was only two years. So your friendships hadn't shifted that much. Right. Well, Open Reg, despite high schools and workplaces not working well, Open Reg works really well.
Acquired
Meta
So over the summer, Facebook was adding like 5,000 to 10,000 users a day. By late fall, after launching open registration, they're now adding 70,000 users a day. Wow.
Acquired
Meta
Wow. Growth really picks up. So this brings us now to spring of 07 and the final piece of Mark's original product roadmap. I'm bored, a.k.a. platform. And platform is this kind of forgotten thing right now. I mean, like, it's Farmville. It's Zynga. It's apps on Facebook. It's quizzes. It's quizzes. Yes.
Acquired
Meta
That'll come back. For a period of about four years, from 2007 to 2011, this is the most important thing in the company. And this is what everybody believes the core and future of the company is. Facebook has become a platform. This is the goal of a technology company. Become a platform. Be like Microsoft. This is now Facebook is like Microsoft. We are a developer company.
Acquired
Meta
A hundred percent. So May 24th, 2007, Facebook holds its first developer conference to launch their developer platform, F8, which again, let's take a step back. This whole idea is kind of wild. A developer platform on the web. The web is a developer platform. Facebook is now becoming a platform on top of an open developer platform.
Acquired
Meta
But you didn't have to be a paying AOL subscriber to download and use AIM and join the network. AIM goes on to become this total viral thing in North America. I mean, kind of concurrent with Napster a little bit before Napster. It's the first piece of consumer viral software.
Acquired
Meta
And it turned out that that was really attractive to developers. So at F8, they announced that the Facebook user base is now over 20 million and it is growing by over 100,000 users a day. So growth is accelerating.
Acquired
Meta
Yes. I mean, OpenReg had just launched a couple months before. So like this thing is really taking off.
Acquired
Meta
Yeah, pretty good. Wow. At a scale of over 20 million already. Wow. It is the sixth highest trafficked site in the world. And they're announcing to all the developers in attendance, the Facebook API, Facebook Graph is now open to you. You can build apps and publish and run them online. natively on Facebook. For users and part of Mark's original product roadmap from 2005, this is huge.
Acquired
Meta
Until this point in time, Facebook was about digitizing everything that happened in your offline life. Your real friends, your real parties you went to, the real photos you took. There wasn't anything detached from your offline reality to do on Facebook. Now, all of a sudden, you can play games on Facebook. You can take quizzes on Facebook.
Acquired
Meta
Yep. And I think it's also an early foreshadowing of the job that mobile and the smartphone would really do in people's lives, which is, hey, there's actually like a lot of white space online. where you're just bored during your day. I mean, Mark's original title of the feature of I'm Bored was perfect. This is the cure for boredom. It just so happened that it was on a desktop.
Acquired
Meta
And so when you were bored at your desk or bored at your home... mobile then opened that up to like, hey, I'm bored anywhere. Right.
Acquired
Meta
Yep. Oh, and by the way, developers on the platform will probably have their own business models where they'll make revenue. And especially if we ultimately introduce our own virtual currency, we can probably make revenue from their revenue too. So the internal goal of the company was to get 5,000 developers in the first year who would be making social apps on the platform. How many did they get?
Acquired
Meta
They got 5,000 in two days. Developers went freaking nuts. It was a great keynote. It was a great keynote, yes. You know, they went nuts because, yeah, Ben, as you say, like, oh, distribution to a lot of people and then like bringing along your friends and data on them, like that's very powerful incentive as a developer to go make an app or a game for the platform.
Acquired
Meta
And so by 2001, a couple of years after launch, it has 36 million users, including, as we've been talking about, basically every middle and high schooler with access to a computer. And, you know, 36 million users doesn't sound like a lot today. But you got to remember, the Internet was way smaller back then. Way, way, way smaller.
Acquired
Meta
Right. Well, this is the amazing story that we're telling here of like they keep surviving and thriving despite not having the operating system.
Acquired
Meta
Either captively controlled hardware like Apple or open hardware like Android and Microsoft.
Acquired
Meta
I think that is totally right. But for the moment, thousands and thousands of both indie devs and venture-backed companies flock to the platform.
Acquired
Meta
Yep. It's a super great point. Now, also the reality was at the time, I think developers were getting plenty of value just out of the distribution. And that was coming from newsfeed. If a user starts using your Facebook app and then the activity that they're doing on your app is getting published to the newsfeeds of all their friends...
Acquired
Meta
You could build a whole Zynga on that interaction paradigm. Oh, yes, you can. There's this great quote from Josh Ellman in the Stephen Levy book. Josh says, if you're a developer and you can get someone to bother 10 friends to get one more user to join, you're very happy because you just got one more user.
Acquired
Meta
Not just in terms of number of people had access, but also number of people who were literate in how to use it.
Acquired
Meta
Facebook, though, has nine other people who've just gotten bothered and are quite unhappy about that.
Acquired
Meta
Yep. So for a year or two, that is the state of play. Facebook brilliantly for them eventually pulls back on organic news feed distribution for apps says, hey, like, we got to stop this. We got to take care of the problem.
Acquired
Meta
And that does effectively kill a large percentage of developers and apps on the platform.
Acquired
Meta
Absolutely. And it doesn't kill the platform, though. It actually makes it even more valuable to Facebook. Because for the developers and apps who have gotten to scale, they kind of look at this and they say, okay, my organic distribution just got kneecapped. But Facebook is still this pretty powerful platform. What if I just buy ads? How well would that work?
Acquired
Meta
Can I generate positive ROI if I buy ads to effectively accomplish the same thing natively on the platform and drive usage back to my app? Turns out that there was a very profitable arbitrage there still for many years to come. And for Facebook, they're like, well, hell yeah.
Acquired
Meta
Okay, we're monetizing the platform through user engagement and ads that we're showing on the right rail while people are using Facebook apps. We are also monetizing through currency and commerce that is happening in the apps where we're taking a cut of that through payments.
Acquired
Meta
Now we're going to monetize platform in a third way, which is the biggest scale developers and app distributors on the platform are going to use our native advertising as their primary form of distribution. I mean, you can see why for a couple of years here, Facebook is like, well, this is it. We've won. We are a platform. This is it. Yep. And then mobile comes along.
Acquired
Meta
Yes, Crusoe is a vertically integrated cloud platform built specifically for AI workloads that was recently named the gold standard of AI cloud providers by Dylan Patel over at Semi Analysis. And something that's new and really cool since we started working with Crusoe last year, They've opened up the raw metal in their data centers to customers.
Acquired
Meta
Yep. And basically all of them and certainly all the young people were on AIM. So the other important thing about AIM and AOL here is it was pretty easy to hack. But like, oh man, there was just a field day that kids and teenagers had with like AIM bots, punting software, wares, hacking programs, everything.
Acquired
Meta
So let's say you're a large enterprise who wants to run your own infrastructure and not use a cloud layer. You could actually now do that with Crusoe directly as a data center customer, which several of the largest companies in the world are now doing.
Acquired
Meta
Yep, that's important because power demand in GPUs is increasing dramatically, which means the traditional data center design and engineering of the hyperscalers is no longer optimal.
Acquired
Meta
So Crusoe's infrastructure, built from the ground up for GPUs with elements like high-density racks, direct liquid-to-chip cooling, that enables them to support the most demanding AI workloads that traditional data centers just can't handle.
Acquired
Meta
Yep. And it's also not just about the amount of capacity in the pipeline. It's about how fast it can come online. Crusoe's team has decades of experience constructing and operating data centers, which enables them to bring these new data centers online super fast.
Acquired
Meta
Yep. The net of all of this is that Crusoe can provide nuclear levels of power for far less cost than other providers and with low or in some cases actually negative emissions. And that's super important because the biggest bottleneck to AI progress is actually energy. It's not compute.
Acquired
Meta
Well, actually, ironically, no. Or at least not for quite a while. Yes, January 2007, Steve Jobs announces the iPhone. People forget, though, it took five years for mobile and smartphone adoption to really ramp up and, like, actually change the world. There was no SDK in that first iPhone and iOS. That didn't come until 2008. It was $700.
Acquired
Meta
So, yeah, I mean, hell, Facebook platform didn't even launch until May 2007, so after the iPhone announcement.
Acquired
Meta
So for the moment, platform is rocking and rolling. Like we were just talking about, Facebook is becoming the next Microsoft, which brings us to the second Microsoft partnership in October of 2007. So just five months after F8 and platform launch, Facebook now has like all of the leverage. Dan Rose has some great stories on Twitter about how this negotiation goes down.
Acquired
Meta
Oh, yeah, you spent time with Dan, didn't you, prepping for this? Yep, and I chatted with Dan about this. This is great. So Microsoft, perhaps obvious now in retrospect to everybody, really just wants to buy the company. But Mark's, of course, not going to do that after the whole Yahoo experience, etc. Microsoft is also happy, though, to just keep the partnership going and expand it.
Acquired
Meta
If you were someone like me, you were just downloading this stuff off of FTP servers on the internet and installing it on your machine. And it let you kind of be a punk and like kick people off of AIM by bombarding them with messages. You know, you could do some like teenage punk stuff. But it also let you extend the functionality of what AOL and AIM was. You could add graphics.
Acquired
Meta
Because, one, it is really helping them spin up their online services division and get really good at online ad sales and ad serving. And two, they know they made a huge error in missing search and letting Google get big. And social sure seems like it's going to be the next search-sized platform. So they're happy to just be in bed with Facebook in a way that they never will be with Google.
Acquired
Meta
Yep. So enter this second partnership negotiation. Yep. October 2007, Microsoft comes down to Palo Alto. Facebook tells them that, hey, Google is actually really interested in taking this partnership over.
Acquired
Meta
Larry and Sergey have been banging down the door and we've been trying to hold them off, but they're coming to meet with us tomorrow to talk about switching our Facebook ad serving partnership over to Google. Yeah. And this has been great. We love working with y'all. You are our preference, our preferred partner. We want to keep it going with you. But we need to get the deal done tonight.
Acquired
Meta
So they lock themselves all in a conference room. They start negotiating. It's getting late. 10 o'clock goes by, 11 o'clock. The Microsoft team, by Facebook standards, is all old guys. They're getting tired. God.
Acquired
Meta
and then you know old guys like you know 40 like oh it's so old and then at midnight this is amazing you can't make this up facebook probably planned this all of a sudden this really loud like house music starts blaring like with like heavy bass in the office and the office is hopping like everybody's there the whole company's there it's midnight the microsoft guy's like what's going on?
Acquired
Meta
And the Facebook side is like, oh, yeah, we have a hackathon scheduled tonight. And actually, Javier Olivan had just started at Facebook. Who's now COO. Who is now the COO of Meta, had just started at Facebook as an engineer. And he had organized this hackathon to begin work on on internationalizing the site.
Acquired
Meta
So tonight is the beginning of internationalization, which is a critical, critical part of Facebook's next chapter of growth. Yes. And it is beginning at the same time that this Microsoft partnership is happening in a conference room.
Acquired
Meta
Yes. Yes, it did. So they keep going. At one point during the night, one of the Microsoft guys, according to Dan, looks at him and says, wow, this is awesome. This is just like the old days of Microsoft. So they finish the negotiation at 6 a.m., They announced the new partnership that very same day, as promised with the threat of Google.
Acquired
Meta
Microsoft becomes the worldwide exclusive third-party advertising network for all display ads on Facebook. So it was domestic in the U.S. before. Now it's international, too, and domestic everywhere around the world. Facebook, of course, can still also sell their own inventory themselves.
Acquired
Meta
But anything that they don't want to sell themselves or that is excess inventory, Microsoft gets exclusive access to be the only ad network where you can access it. And the big kicker, Microsoft is going to invest $240 million in Facebook at a $15 billion valuation. This is like 13 or 14 months after the failed Yahoo deal for $1 billion.
Acquired
Meta
Yeah. Oh, the ASCII art in your profile and your away message. Totally. And, like, this becomes such an important part of...
Acquired
Meta
but turned it around into an investment at $15 billion. Yeah, it's crazy. The great thing is, like all great partnerships, everyone makes out wonderfully here. Except maybe the venture capitalists in Silicon Valley, because this just breaks everyone's brain.
Acquired
Visa
It's funny, when we picked this episode, I was like, oh, this is going to be pretty down the middle and easy. And then, of course, as we get into the research, as always, it's like, oh, nope, big story here. Yep.
Acquired
Visa
It turns out the world eventually did want to pay with frictionless, fast, and often credit-extending methods.
Acquired
Visa
Not many of those. It's amazing. The number of transactions they processed last year was over 190 billion. So that is 27 transactions per person on Earth, including young children, every single year. Hey, man, young children require a lot of commerce, let me tell you. So I hear. There are 4.1 billion Visa cards in circulation. Their net revenue is $29 billion. 29.
Acquired
Visa
That's up from $22 billion two years ago. So there's an interesting thing that I didn't really realize with Visa, which is it's had a hell of a decade. In my head, Visa has been this steady state thing in the world, as has MasterCard. But the last decade has been the story of Visa's incredible dominance in revenue and transactions and volume.
Acquired
Visa
It's just actually true that a lot of their growth has been recent in the last decade. Their value added services, this is an interesting thing that I want to come back to, was $6 billion. So look at their overall revenue number of $29 billion. Their value added services is $6 billion. We'll talk about what that means. The most shocking thing about the business is they have 50% net income margins.
Acquired
Visa
And you might say, so wait, if they have 50% net income margins, what is their gross margin? Because is it SAS level good at 75, 85%? Nope. Their gross margins are 98%. Unreal. There are no variable costs in this business. There are no costs of goods sold.
Acquired
Visa
unreal it's crazy so i think with 50 net income margins this is literally the most profitable large-scale company in the world i don't know of any other businesses of this size or even like five or ten times smaller that have over a 50 net income margin including mastercard which is 43%.
Acquired
Visa
And just to throw some numbers out for people that are not looking at financial statements all the time, Microsoft, 34% net income margins. Microsoft sells software. They ship bits. Apple, 25%. They have an incredibly marked up product that is differentiated wildly by brand. 25% net income margins. Google, Google has a monopoly in a market of information.
Acquired
Visa
Yeah, it's nuts. It's nuts. They do have 27,000 employees. In some ways, it feels like an oddly large number, and in other ways, it feels small. But I think we should talk about that in the context of the value-added services. Interestingly, there is another company that we have talked about recently on Acquired that does $30 billion in revenue and has 27,000 employees.
Acquired
Visa
Visa does 707 million transactions per day. That is 8,600 transactions per second, every second throughout the year. So a big takeaway should be like, my God, they have built. high throughput infrastructure globally. That's an unbelievably impressive thing with almost no downtime. It is 99.999% uptime, which I am not a site reliability engineer, but I think that is five nines.
Acquired
Visa
Right. So you have to spin up some kind of like shared organization that all the merchants are pulling their capital into in order to run the network on behalf of all of the merchants. It gets messy.
Acquired
Visa
Totally. That's 16,000 banks in 200 countries. They have six data centers distributed across the world. It's kind of amazing it's only six, to be honest, with that kind of reliability and uptime. You know, related to that though, you raised a good point earlier.
Acquired
Visa
Right. That is definitely why. Yeah. Lots of people in this ecosystem would love it if you could send entire receipts in machine-readable form across this network. You can't. We're stuck with a lowest common denominator protocol that we're shipping very crude pieces of information across.
Acquired
Visa
I will say there are other people that are participants in this ecosystem that are perfectly fine with it having almost no information or minimal information going across it. An example of which is the banks. The banks don't want to be sharing any of this information that could put them at a strategic disadvantage. Your bank knows your name, knows your social security number, knows your address.
Acquired
Visa
Visa, I'm running transactions across their network all the time. All it knows is my card number. It has no notion of identity. Isn't that crazy? I didn't realize that. Yeah, that is crazy. And the banks like that because then the banks get to say, no, no, no, this is my customer. Visa, we will use your network because it is the way that I need to accomplish something for my customer.
Acquired
Visa
But I'm not just going to like turn my customer into your customer. Why would I do that?
Acquired
Visa
It's pretty fascinating that debit came later. Functionally to me as a consumer, even though I get floated for a month, my credit card is essentially a debit card where if I want to, I can turn it into a loan at the end of 30 days. It's a debit card with a lot of benefits. Right. And obviously, like, I get to keep the money for 30 more days, so it's not quite the same thing.
Acquired
Visa
But debit is a simpler product. So it's so interesting that debit came decades after credit cards on the Visa network. You would think they would have started with debit, but of course they couldn't have started with debit. The banks would never have gone for that.
Acquired
Visa
But for many, many years, they weren't. And they certainly weren't back in Dee's day. Right.
Acquired
Visa
And I think part of the reason why debit cards were sort of like forced into existence was that consumers basically demanded it where they were like, look, if I can pay with a card for this high value purchase and I don't want to use credit, you're telling me that if I don't want credit, then I have to walk down the street, withdraw cash from my bank and bring the cash.
Acquired
Visa
Is there not something like a credit card but doesn't extend me a loan? So in closing on the numbers today, this is the important number to know and one that may make you uncomfortable, but I'm curious how this lands for you, David. U.S. merchants paid an estimated $93 billion in Visa and MasterCard credit card fees last year, according to the Nielsen Report and Industry Publication.
Acquired
Visa
That $93 billion was up from $33 billion in 2012. Wow. That's a lot more billions. That's a lot more billions. So we've talked a lot here about the interchange and how Visa makes money in the transaction. I will say half of Americans carry a credit card balance, which is absolutely brutal since those interest rates right now are around 22%. Oof.
Acquired
Visa
David, you and I learned in doing some research that the reason why we all get these credit cards from North Dakota is because every state used to have anti-usury laws. Like, no one was allowed to make usurious loans, and North Dakota was the first to drop them.
Acquired
Visa
And that's why all the banks issued all their card programs out of North Dakota, because you could do things like have 22% loans made to consumers and have that be entirely fine. So that's the sad history of why your credit cards always get mailed from there.
Acquired
Visa
Yeah, there's been downward pressure on interchange for a long time. I think industry average right now is down around 2.24, which is, you know, compelling considering we started at 7%. Right. That downward pressure has been easy to give on by Visa for things like in-person transactions with Card Present.
Acquired
Visa
But for a lot of their super high margin online transactions where the growth is, that's where they decide, oh, actually, we have a really high interchange for that area.
Acquired
Visa
So Visa is sort of a master of packaging, figuring out how can we take some things and sort of make them more affordable to our merchants or give them away for free, while also figuring out how can we sort of move things around or invent new products that are super high margin that give us a lot of room to run in the future.
Acquired
Visa
But you're paying just as much for that. Yeah, totally. Unless you are literally getting people to type in their account and routing numbers, you are paying credit card-like fees to accept payments on the internet.
Acquired
Visa
It's worth sharing. So while we're in the revenue streams here, the money that card issuers make, only a minority of it is actually from the interchange. And keep in mind, the card issuers are the ones that make that 1.6%, the bulk of the transaction. Most of the money that card issuers make is from interest payments. Right.
Acquired
Visa
Totally. Visa's incentives are more transactions because we want more 0.2%. And the issuer's incentives are carry a balance because that's where we make most of our money.
Acquired
Visa
And anti-fraud measures and other value-added services that they have to buy from Visa. Probably a good time to introduce that $6 billion that Visa is doing in value-added services. That is all brand new high-margin products that they've sort of invented in the last 10 years or so that they're trying to sell to merchants. High-margin product. There's no higher-margin product than the core product.
Acquired
Visa
Right. Brand new, also high-margin products. Right. Merchants, banks, they're basically trying to sell products to people in the ecosystem, anti-fraud, analytics, and it's working very well. They're making a lot of money on that and they view that as a high growth area in the future too. But again, it's a little bit of like shifting things around in the same picture.
Acquired
Visa
Like, look, there's downward pressure on interchange and we can demonstrate to you that interchange is going down. Oh, but we have this great product that is helpful and basically necessary that you also should buy. And there's a lot of that going on. All right.
Acquired
Visa
So that basically covers the high level stats on the business today so that we can go into analysis and you can have a general shape of the business we're talking about.
Acquired
Visa
But, you know, 11th largest company in the world valued at half a trillion dollars, around 30 billion in revenue, and they get to keep half of that at the end of the day and they take no financial risk and they are just moving information around. Mind blowing. They get to keep half of that after taxes at the end of the day. That's wild. There's actual cash in the bank. Right. This is not EBITDA.
Acquired
Visa
All right. So listeners, this is where we talk through Hamilton Helmer's seven powers framework, which is trying to figure out what is it about this particular business that enables it to achieve persistent differential returns and be more profitable than their closest competitor and do so sustainably. It's an interesting one here.
Acquired
Visa
Visa's brand is among the very most trusted in the world associated with reliability and security. But that said, if you asked most people what Visa does, they could not actually articulate it. Visa does not extend credit. They do not issue cards. They do not work directly with merchants. They do not work directly with consumers. They are not a bank or a financial institution.
Acquired
Visa
This is a lot like the Lockheed Martin episode where I'm actually not sure we can apply the formal definition where we say, like, what enables them to be more profitable than MasterCard? Because together, they're like this government-enabled duopoly.
Acquired
Visa
And the way that we did this in the Lockheed Martin episode was we said, let's look at the five defense contractors as one entity and say, what enables the five of them collectively to out-compete new entrants? And I think that's the right thing to do here with Visa and MasterCard too. At the end of the day, Visa and MasterCard have basically no sustainable competitive advantage over each other.
Acquired
Visa
It's just operational excellence who's slightly more clever on the bets they're willing to make for these value-added services or next product lines. So, yeah.
Acquired
Visa
It's funny, even though it's a commodity, like them and MasterCard are a commodity, they somehow position themselves as more premium. Well, sugar water is a commodity too. That's why brand matters in these markets. But you're literally never making, I guess it's for the banks, because consumers are never making a buying decision on whether it's Visa or MasterCard.
Acquired
Visa
No, they're just not differentiated enough to demand it. I just so don't see that any consumer ever has sway there. I got the Chase Sapphire Reserve card five years ago because it was by far the best rewards card for the type of thing that I spend money on, as probably with half of our audience.
Acquired
Visa
And I think it's a Visa Infinite, which I'm sure is one of their high-fee things, which is why they can pass on so many rewards.
Acquired
Visa
Yeah, it's interesting. It's funny how it used to feel more like you were getting a Visa card that was somehow like powered by a bank. And now it feels more like you are getting a custom proprietary product that a bank invented for you that happens to either say Visa or MasterCard on it.
Acquired
Visa
Or a merchant. I mean, when you have the Alaska card, you feel like you have the Alaska card. You're like, sorry, there's a bank behind this? And like, oh, is it Visa or MasterCard? I don't know. I don't care. It's the Alaska card.
Acquired
Visa
Yeah. I mean, in part, that's just bad strategy on Amex's part that, you know, eventually it was going to happen that they would not be the scale player. Being a closed loop network, you're just going to be a more niche player. And so how do you win as a niche player? You need to retain your highest value customers and your highest margin customers.
Acquired
Visa
Yeah, it's true. I think there are less affluent people in our generation who have Amexes versus the premium products from banks or merchants. Okay, so Visa and MasterCard together, which of the seven powers do they have today? And if you want to also do the analysis, which did they have early days? And I will start, I think there's an easy no-brainer that you have scale economies.
Acquired
Visa
Any investment that Visa or MasterCard make get amortized across 16,000 member banks, across 4 billion cards, across half the humans on the planet or whatever it is. I mean, just good luck competing with any fixed cost investment that Visa is going to make. It'll pay back instantly if it works to the extent that they can roll it out to any tiny fraction of their customer base.
Acquired
Visa
It's just so huge that it fits the scale economies thing where you know, if Netflix goes and buys a piece of content, they can pay more for it because they can show it to more people. Visa is the exact same thing with all of their fixed R&D costs. Tell me if you think otherwise on this.
Acquired
Visa
So nobody ever needs to bring their cash. And, you know, you could just imagine that like we're all in this club of diners where anywhere we dine, we can stand up, we can authorize the bill, we can leave, we can pay no dollars out of our pocket that moment. And we get one nice statement at the end of the month that importantly, we do need to pay in full. We cannot roll it over into a loan
Acquired
Visa
Right. It's almost stupid to say this one because it's like, okay, yeah, but that's actually not what gives the business, that's not what's so special about it. The network economies are what's so special about it. Yes, of course, of course.
Acquired
Visa
Where you have an amplifier on each side because you have the banks going and using all of their scale to amplify your own go-to-market motion.
Acquired
Visa
Right, because they're way harder to pull off, but they're so locked in once they're in. Yes.
Acquired
Visa
means that you have a five-sided network effect business and it's basically unbreakable yeah totally agree on network economies i don't think there's much process power i don't think there's really any switching costs i mean in fact that's probably a bear case to any card company today is that especially with digital payments you don't even have to carry cards with you anymore
Acquired
Visa
I should go get approved for 50 cards and write a script to make it so that whatever the most interesting card for that given transaction is pops at the top of my wallet.
Acquired
Visa
I think there's almost no switching costs anywhere, really, because when any of these banks have their contract up, they just go and talk to Visa and MasterCard and say, who gives me a better deal because you guys are both the same.
Acquired
Visa
Well, yeah. I mean, before then, there's interesting analysis to do between Visa and MasterCard. Now there is none.
Acquired
Visa
Yep. But yeah, is there a switching cost between the Visa-MasterCard oligopoly and someone else? I suppose, yes. There isn't another option. Yep. Like, if you were a bank that wanted to issue a bunch of cards that weren't Visa or MasterCard... I mean, I guess there's Discover... No, that's a closed-loop network, too.
Acquired
Visa
We must pay it. But that's nice because all of my business transactions are on one single statement. It's easy for my expense reports. It's easy for me to not have to carry a wallet around. And of course, I get to look super awesome in front of all of my colleagues.
Acquired
Visa
The first one is this business is a toll booth and toll booths make for great businesses, especially when everyone has to drive on your road or the road next to yours. And both of them charge the same toll. Well put. I'm going to do my best Charlie Munger.
Acquired
Visa
The next one that I think is pretty interesting is Visa, as I read their whole annual report, they have a narrative around these new things that they're launching, especially the value-added services, being good for consumers. And everything that is good for consumers, often for security and privacy, is also good for Visa.
Acquired
Visa
That is sort of the playbook that Visa runs, is they figure out what is something that we can sort of advertise as a benefit to you that also helps us either increase number of transactions, margin, or lock-in. And that is the way to analyze their entire product suite. You hear something is launched, you're like, okay, why, which of those three needles is it moving for them? That's my main one.
Acquired
Visa
Yeah. This is our whole global financial infrastructure that has decided to do this together. Right.
Acquired
Visa
Right. Especially when you're not starting from scratch. I mean, the 200 banks that they pulled it off with They all had a agreement in place where they owned a franchise and you had to go to them and say, you have to forfeit your franchise and instead sign this other agreement. It's like you're not starting from zero. You're starting from negative.
Acquired
Visa
Who would have thought? A success story out of Silicon Valley. They've gotten so beat up over the last few years.
Acquired
Visa
You would think. Every tech company would love to be Visa. The financial profile of Visa's business is more tech than any of the tech companies. It is what they all wish they could have. Yes. Fascinating. All right, you want to do value creation, value capture? Yes.
Acquired
Visa
So originally, Interchange was supposed to cover the costs of operating the network, creating a trusted system, preventing fraud, offering innovation every few years to improve the system.
Acquired
Visa
And with the incredible profit margin that Visa makes today, not to mention whatever the card-issuing banks make, it is very clear that the market has evolved such that these players can charge more in a transaction than is necessary to cover their costs. And like, I'm not sitting here demonizing anyone who doesn't use cost plus pricing. I am a capitalist.
Acquired
Visa
I fully embrace the idea that a business can and should achieve pricing power if it can position itself to do so in a market.
Acquired
Visa
And just to start tracking a certain number here, when we were talking about checks earlier that were getting a discount, and even in this era of early Diners Club, early American Express, we're talking about a 5% to 7% discount of what actually got remitted ultimately to the restaurant or the retailer versus what the bill was originally that the consumer authorized.
Acquired
Visa
Right, exactly. But it's interesting that because of the multi-layered network effect, David, that you brought up in the power section, it is not easy and potentially impossible for the free market to do its thing and have some new player that actually applies margin pressure here. The free market is clearly not playing out.
Acquired
Visa
And other than a big technology innovation that shifts the paradigm in a huge way, the These entities have massively optimized their costs and continued to scale in a huge way such that they just get to capture way more value than it costs them to create.
Acquired
Visa
Yes. I mean, the worst place that this kind of shows up is the couple percent plus 30 cents that kind of feels small. Yeah. The 30 cents is really pernicious. It's pernicious, especially for small transaction items. So like coffee shops, there's an example of a piece that we'll link to in the episode sources of a coffee roaster and shop.
Acquired
Visa
where their line item of what they had to pay in payment processing fees is actually larger than what they paid for beans.
Acquired
Visa
Even large retailers that run at pretty thin margins, it is often the case that their EBITDA is the same size as their card processing fees.
Acquired
Visa
That's where the $0.30 kills you. But any time that you are a low-margin business, which many retailers are, if you're a discounter, if you're a Walmart, you're paying 2%, 3% of the whole transaction. But when you look at the margin profile, the way that that gets amplified is that you're paying 15% or more of your available gross margin on that item.
Acquired
Visa
So the only place where this doesn't kill you is if you're a high gross margin, high ticket item business. That's when you can be like, eh, card fees, whatever. But if you're selling too high priced of goods, then you often get into a scenario where, you know, you are... doing less frequent transactions, more considered purchases, and you can go around the system.
Acquired
Visa
This is a bear case on Visa is, are they ever going to participate in real estate or cars or? No, not at these interchange rates. Why would anyone ever buckle to pay these sorts of things for things that cost $1,000 or more? Yeah.
Acquired
Visa
Because I don't think it would have happened without credit cards. Or at least it would have been many years behind because you needed to sort of invent some new mechanism to enable payments over the Internet.
Acquired
Visa
Yeah, that's a good point. Which, by the way, PayPal is on a shockingly large number of websites today. PayPal has a lot of market power because they have penetrated America. They are deep in terms of people's preferred payment method, which is something I've been kind of blind to. Really? Oh, I missed that in the research. That's quite surprising to me.
Acquired
Visa
Yeah. PayPal is an especially interesting company right now because they're strategically pretty well positioned, but they're going through a leadership transition. And so you don't actually know what the new strategy is going to be yet.
Acquired
Visa
Well, okay, bear. And before I actually go into it, a tongue-in-cheek joke is if they ever get to stop making the insane margins that they do on FX transactions, that's the ultimate bear case. It's something like a hundred times the margin that they make on domestic ones. Wow.
Acquired
Visa
If you look at how Visa breaks out segments, you're like, oh my God, the international transactions are ludicrously profitable whenever they have to do a currency conversion. So that's like worth knowing when you're trying to understand the shape of the business is the more international, the better for them.
Acquired
Visa
But my real bear case is that their business model has basically always been tied to the digitization of consumer payments ever since they rolled out the three key technologies you were talking about, David. I mean, at this point in global history, which is kind of amazing we're finally here, over 50% of consumer payments to merchants go on cards now.
Acquired
Visa
It took forever to get here, 40 years or something like that, 50 years. But... we will start decelerating because we've already shifted more than half the payments to happen on cards.
Acquired
Visa
Right. So that is this tailwind that has been with Visa forever. Like anytime you could come up with any bear case, it was always just trumped by the idea that, Well, more people are going to do digital transactions, so they're just going to outrun any headwinds in their way. That will start to slow.
Acquired
Visa
It's not like Visa's core business revenue is going to like flatline or decline or anything like that, but they will have less of the growth tailwind from this amazing secular thing that's been happening, which is people shifting payments to cards and digital methods, you know, as the years progress. My next one is closed-loop systems like Alipay and Tencent's ecosystem.
Acquired
Visa
To the extent that super apps actually happened in the US the way that they did in China, we would be telling a very different story. I mean, the amount of volume that flows in the mobile ecosystem there that is not a part of the credit card ecosystem I actually don't know if it could have happened here, but the rise of that is super dangerous.
Acquired
Visa
And people often will cite like, well, the Starbucks app is a very good example of people using a digital wallet that's native to a retailer here. How many people do you know that reload their Starbucks app with their direct checking account routing an account number? Everyone actually loads it using a credit card. Totally. That is not bad for them at all.
Acquired
Visa
It only becomes bad for them if they actually get disintermediated where a bank and a merchant go direct to the merchant's consumer and manage to initiate a payment flow digitally that doesn't involve a card network.
Acquired
Visa
two though maybe more important is just the government influence right i doubt the chinese government wanted visa uh you know ostensibly american corporation powering their payments there's actually this really interesting weird deal that got cut between china union pay and visa where yes if you use a cup card in china cup it uses the cup rails but if you go internationally where like there is no china union pay terminal at
Acquired
Visa
you know, my local coffee shop here in Seattle, if you were to travel here and swipe it, it runs on Visa. But they sort of have the national security benefit and the economic benefit of four people in China transacting in China that runs on China-owned payment rails.
Acquired
Visa
Yep. The next one is similar but a little bit different. Real-time payment networks are starting to become a thing. The instant bank transfers that these provide are not exactly a payment system. It lacks a lot of the features that you would need for payments, like the ability to refund is a prominent one.
Acquired
Visa
Like when you just initiate a bank transfer, there's no sort of insurance around the chargeback or anything. a refund or anything like that. But you could build payment type features on top of it. And real-time payments are starting to become a thing in a lot of countries. So in the US, of course, we have FedNow, but the adoption of that is slow because there's not a Fed mandate.
Acquired
Visa
for it to happen the way that it has happened in other countries. In Brazil, PIX, P-I-X, has had very fast uptake. UPI in India is another one. The UK has something called faster payments. And this can get especially scary for Visa when these start working across geographies. Like Singapore and India have already linked theirs up.
Acquired
Visa
And so that is a method of transferring money between countries that has nothing to do with Visa. And that's, I'm sure, something they're keeping a very close eye on and trying to figure out, is there a way that we can become the real-time payment system that governments decide that their country should adopt?
Acquired
Visa
Totally. Yeah. Apple, I just think is like a general bear case here. But here's my sort of specific implementation. Specifically Apple Pay, right? Yeah. So on a Apple Pay transaction, I'm pretty sure Apple makes about as much as Visa does.
Acquired
Visa
because they stack an extra 15 basis points on top of the other three fees that we talked about, the one to go to the issuer, the one to go to the merchant's bank, and the one to go to Visa itself. And so if Apple has convinced merchants that it's fine to lose another 15 basis points on every transaction because it's so freaking convenient that users get to tap their phone or their watch,
Acquired
Visa
That is just step one in an equation. Here's the really extreme Apple payment bull case. If Apple were to have payment terminals, then they could totally run all of those Apple Pay payments on their own network. As it happens right now, you need to have a... card issued by a bank that likely is issued on Visa or MasterCard or Amex or Discover. And then it goes over those payment rails.
Acquired
Visa
Apple just puts a little charge on top of it. And then it's the same way any other transaction happens. But if I were to Apple Pay with my Apple card at an Apple point of sale, why would that ever need to run on Visa's network?
Acquired
Visa
And so Apple doesn't make point of sale hardware today, but if they were to acquire Square or if they were to do something way out of their DNA and go acquire like Verifone or a legacy provider, they could create their own closed loop network where they're actually the payment method and the merchant's technology provider.
Acquired
Visa
Great point. So there's some incentivized sharing. It's almost like the reason to enter into a bundle for your most extreme fans, which are only going to be like the top 5% of your customers. Sure, you want some kind of exclusive relationship and you want to maximize the dollar value you can get out of them.
Acquired
Visa
No, that's too hard. That adoption curve sucks. I think they would pay the what's Square's market cap or blocks like 30 billion or something right now. Apple could totally just go buy block and do this overnight and light up all the existing merchants.
Acquired
Visa
Like what else are you going to do with 250 billion of cash? I mean, maybe they would try, but Apple is not going to be in the business of directly having a sales force to sign up all these merchants. I don't think.
Acquired
Visa
Okay. I mean, the other thing, the lighter weight thing on Apple is even if they don't try to build their own closed loop thing, who really cares what's in your wallet when your wallet is your phone? For consumers now, if you're using your phone, in your head, your payment method is your phone.
Acquired
Visa
And it's like the card underneath it is not terribly important other than the fact that you need to remember to auto pay it. And like, ideally, it has the one with the best rewards. And that's not what most people are thinking, because I think actually the majority of people don't have rewards based credit cards. But they loaded some card in there. They kind of forgot about it and they pay.
Acquired
Visa
And Apple is actually the means of payment, not the card. Even though it's flowing over their rails, consumers don't think of it that way. Yeah.
Acquired
Visa
So I don't know exactly how that will manifest in chiseling away at Visa's value, but it certainly is fair to say that the card network and the card issuer have less of a role in the consumer's mind than they used to based on the fact that we now have mobile payments.
Acquired
Visa
Yep. So my TLDR on the bear case is the core business matures, so that tailwind lessens. The debit networks get sort of chipped away at. More rails emerge for each use case that sort of, again, has further chipping away at their available use cases, even if not the actual ones that they're using today, but the ones that they could go tackle in the future might get eaten by other people.
Acquired
Visa
And they spend a bunch of wasted money trying to figure it out. But I don't know. Those are the best bear cases I can come up with. And the funniest thing is when I asked, we'll thank a bunch of people at the end of the show that we had conversations with, when we would ask people, hey, what's your bear and bull on Visa?
Acquired
Visa
But for your casual fans who like your business but aren't necessarily exclusively going to use your business, you should figure out some kind of bundling system that makes you work with complements of yours so that people can shop you and everything like you with the easiest way possible. And you can still make some money on everybody.
Acquired
Visa
Basically, everyone just gave us a bear case because they're like, the bull case is obvious.
Acquired
Visa
Yep. The corollary of that too is lots of people have had lots of similar bear cases that they've said five years ago, 10 years ago, and like none of those things have come true. Visa has just continued to grow at, you know, low double digit percent growth every single year, or I guess to your calculation of 17% over 51 years.
Acquired
Visa
People in the past have said many of these bear cases, but have never come true. Yeah. So that's kind of the most obvious. Here are the few that are most evident to me that are sort of potentials on top of their core business. Because it is true that Interchange is facing downward pressure. I mean, we talked about all the way from 7% down to 2% and change.
Acquired
Visa
And so they do these interesting other things. One interesting benefit to them of digital payments, we talked about the potential drawback with Apple being able to maybe disintermediate in some way that's not exactly clear yet, is tokenization. So the way that Apple Pay works is that your card doesn't actually get sent to the merchant, your card number.
Acquired
Visa
None of the identifying information on there goes. Instead, your card gets tokenized and a token representing your card does, which is, as Visa will tell you, amazing for security and privacy. What it also does is allows them to create more proprietary services.
Acquired
Visa
In the old card number system, there was a lot more flexibility in what a merchant and their payment processor could actually do with the literal information on the card. They could choose what network to run it on. There was sort of more optionality with it when you had the raw information. And now Visa's like, hey, we got your token.
Acquired
Visa
Do you want us to do any of the cool token-based services that we have with it? And like, those are high margin for us. And so that's sort of the tokenization is good for them. They now have more digital tokens than card credentials. That's been growing really fast. It doubled last year. They're sort of tokens on their network.
Acquired
Visa
So Visa's quote on this is, this marks a huge milestone both for the transition to digital and in our work to secure the wider payments ecosystem. And you better bet that that's good for long-term margins and layering products later on. Other bull cases. So this is like my favorite one from there. Remember the NVIDIA slide of the trillion dollar TAM? So here's Visa's version.
Acquired
Visa
Payments, all of payments is about $200 trillion of volume. And cards are only $20 trillion. So here we've been playing in this tiny little fraction of the available market. And there's a few things that they call out that they want to move into, that B2B payments is about $120 trillion if they can access it.
Acquired
Visa
B2B commerce is actually just much larger than B2C commerce if you think about the amount of money that flows over invoices that are paid via ACH or wire. Visa, I think, is intensely aware that they're not going to take 2.5% interchange on a company invoicing another company for a million-dollar services-provided thing. But there are elements of B2B that do have interchange.
Acquired
Visa
I mean, if you're issued a Ramp or Brex card and you go swipe that, that's a B2B transaction. So they're very excited about addressing B2B both in They're further pushing cards, but also developing B2B-specific products that have more appropriate monetization models. And then they also, we've been talking a lot about consumer-to-business, like when I decide to pay for something at a business.
Acquired
Visa
If you flip that, business-to-consumer, that is a $30 trillion TAM. or a $30 trillion volume addressable opportunity. And you can think of that as like an insurance company needs to like pay a payout after a car insurance, and they need to make that happen fast. Or refunds, let's say you never bought anything, but a company still needs to send you some money.
Acquired
Visa
Or like Uber needs to pay their drivers. This sort of thing is, there's a whole business they've created called Visa Direct, which is the business to consumer push-based payments, which is a kind of a new foray for them. And then the last one is just expansion of cross-border payments if they can do more international transactions. That is hugely, hugely profitable.
Acquired
Visa
So that is me trying to faithfully represent the bull case that Visa paints for their shareholders. Because, David, these bull cases are so easy. You should read the annual report. The whole thing's a bull case. Yeah, right.
Acquired
Visa
Does Apple want to be a bank? Well, they could become like a Stripe. Yeah, I guess so. Or like a Square. They're the technology providers and they have merchant acquirer banks behind them.
Acquired
Visa
It depends. Apple will eventually saturate their market and they are looking for what the next frontier is and $200 trillion of volume moving around the global economy.
Acquired
Visa
Well, I think they have to think that they can improve something. They won't go into this unless they think they can improve both the user experience and create a better business out of it. Great point. Great point. And they will. I mean, the Vision Pro will come out and we'll have to see if that is the future or not.
Acquired
Visa
But post that, like, they're going to do a car or they're going to go into payments. Right.
Acquired
Visa
You're right. You're right. The cute apple that we know of years past is gone. And we just have to think about like, what would a good capital allocator do with their strategic position?
Acquired
Visa
Yep, that's super true. Okay, I have one trivia thing for you before carve-outs. You may already know this, but did you know that you can get a Bank of America card today?
Acquired
Visa
It is a branded product from Bank of America, available on bankofamerica.com. There's no annual fee. Click on their website to apply now. And the beautiful irony that will tie a bow on this whole episode is the Bank Americard credit card by Bank of America runs on MasterCard's network.
Acquired
Visa
They don't ever bear any risk. They are merely a network connecting banks to other banks. David, it is insane.
Acquired
Visa
Interbank for the win. We'll link to it in the show notes. Get yourself a Bank of America card and run your transactions over MasterCard's beautiful stellar network.
Acquired
Visa
There can't be that many people that are applying for this thing, and you would think that Visa would try to go get this deal done just for nostalgia purposes.
Acquired
Visa
What a story, man. Ah, truly. Okay, carve-outs? Carve-outs. Mine is... Available on Netflix. It is a show called I Think You Should Leave. I have not laughed this hard in a long time. Each episode is like 15 minutes. It's like three comedy sketches with a guy named Tim Robinson as sort of the brains behind it and as in many of the episodes. Oh, we were talking about this at our drinks in New York.
Acquired
Visa
Yes. If I were you, listeners, and you haven't watched this yet, I would go to season three, episode one. My favorite skit of them all starts approximately six minutes in. Actually, the whole episode's good, but the skits two and three are the truly unbelievable ones. But it's just, he's so outlandish and so... I don't know.
Acquired
Visa
It's like everything that sketch comedy should be in the absolute highest production value you could possibly imagine, shot very convincingly, I think using the same cinematographer, but using a completely different set of lenses, lighting sets, post-production, such that everything that they're trying to emulate, whether it's a game show or a dating show or a commercial, feels like the appropriate thing that they're trying to emulate.
Acquired
Visa
And we should say this is pricing power in action to have those very high fees. It's also a necessity. The cost of running these networks in a previous technology generation was super high, and it was not at full scale yet. So it's just operating with a bunch of restaurants and retailers in New York City.
Acquired
Visa
Well, we definitely have a few thank yous on this one. A huge thank you to Dave Stearns for spending the time with us and recanting his academic thesis. And it was just awesome reading the book. I have a personal thank you to a good friend of mine, Jason Pate of Plaid. Very helpful to get just general high-level thoughts on payments industry. Thank you to Lisa Ellis from Moffitt Nathanson.
Acquired
Visa
Lisa did an amazing interview with Ben Thompson a few weeks back. If you are a Stratechry subscriber, that is totally worth reading. And I prefer listening. So go listen to that. After I read that, I shot her an email and I was like, we're about to do Visa. I would love to talk to you about some of this. So a huge thanks to her.
Acquired
Visa
Good friend of the show, Dimitri from Modern Treasury for helping us quickly get up to speed on payments. And good friend of mine and David's both, Ben Idelson, who is a former product person from Stripe. Our huge thanks to Blinkist, Statsig, and Crusoe. Click the link in the show notes to get access to each of their awesome offers.
Acquired
Visa
Sign up for emails to find out about the latest acquired episodes, to get in on our teasers of what the next episode is going to be, and hear the follow-ups and corrections after we learn them from you. should join the Slack, acquired.fm slash Slack. You should check out ACQ2. In particular, our next episode, it is not out yet, is going to be a follow-up to this episode on Visa.
Acquired
Visa
Our buddy Gaurav from Thrive Capital is joining us for a follow-up to analyze the payments landscape today. And Gaurav has spent his entire career as a founder and investor in fintech companies. And he actually gave a talk on the history of credit cards that we used for research in this episode. So Check out ACQ2, search and subscribe to any podcast player.
Acquired
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And then the next week, maybe two weeks, our interview with Gaurav will come out. And be sure to check it out. With that, check out the merch store, acquired.fm/.store. You can support some of this sweet, I'm wearing the shirt right now, sweet swag around. And pay some interchange fees. That's right. That's right. And with that, listeners, we'll see you next time.
Acquired
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So you actually need a lot of people, both because there's not a lot of technology, but you need a lot of people even though there aren't actually a lot of merchants. And so it turns out there's just a lot of cost in the system to run it.
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Which is the diners club of today. It's the favored card by businesses. It is the card that is most used for travel and entertainment and meals. Yep.
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It was something like they started American Express, but then had a conflict. And so they left and they started Wells Fargo after that.
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It's amazing. I think it's fascinating that Wells Fargo came after Amex. Like you think Wells Fargo as this old timey foundation of America. American Express is even older than that.
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Well, perhaps not underrated the last decade or so. If you listeners want to know every time an episode drops, you can sign up for email updates at acquired.fm slash email. Two new fun things. One, emails now include little hints and some teasers about what next episode will be. So if you want to play the guessing game, sign up at acquired.fm slash email. And the emails have another new feature.
Acquired
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Okay, so Amex observes Diners Club and says, hey, we need to get into this, and we actually have an ability to get into this fast. And they actually try to buy Diners Club, but they can't get there on price.
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And importantly here, the thing you're seeing is this is the first time a real financial company is coming into the industry. All of the we-know-you're-good-for-it-ness was happening directly from retailers before or by organizations that represented retailers and restaurants.
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And so now you sort of have not a bank but a bank-like entity that is starting to say, oh, this could be an interesting business.
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So this is where B of A, informed by their previous business model of lending to consumers, really paves the path of what credit cards would become today. Often in the past, before the Bank of America card, what would happen is you'd have this charge card, not a credit card, and the bill would arrive at the end of the month and then you would pay it.
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The innovation baked into the Bank of America card is they say, well, after the 30 days, you can get your statement, you can pay it in full, or you can roll it into a loan. And we love loans. We would be happy to extend loans to our customers. We can learn a lot about them. We can make a good amount of money on that interest. And so the modern credit card is born.
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We are including follow-ups from previous episodes when we learn new things from you after release. Come talk about this episode with us after listening at acquired.fm slash slack. And if you want more from David and I outside of these big, long, main Acquired episodes, check out ACQ2, our interviews on a second podcast feed. Now, without further ado, this show is not investment advice.
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This product is the combination of three things. The charge card that had been happening over in Diners Club, Amex, the gas stations, the retailer land. Then the second pillar is this consumer lending.
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And the third thing is it is now from a real and proper bank that you already have your primary financial relationship with, not from some industry association or hodgepodge of retailers, but now this is issued by your bank. The big takeaway for Bank AmeriCard is it really bundled two different things together. One was convenience and the other is credit.
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Well, in theory, if they managed to put any sort of financial controls or proper risk underwriting on this whole thing, but it turns out, David, as I'm sure you are about to tell us... That's exactly where we're going.
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When you mail 65,000 cards indiscriminately with the same credit limit to every single customer and say, have at it, guys, and this is a brand new consumer behavior that they've heard about and they might have witnessed in one form or another, but now they have a... bona fide charge plus credit cards sitting in their hands, you're going to lose a lot of money at first.
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So you probably shouldn't apply the assumptions about your loss ratios from secured lending to unsecured lending, but that is exactly what happened.
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Yeah, it is pretty crazy. So it's worth pointing out, you know, we're talking a lot about credit and debt at this point in time. And now in 2023, some of these kind of sound like bad words. And frankly, it's because of the situation that the society has sort of like pushed Americans to.
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But it was a very different time back when credit cards were first getting started and when this sort of practice of installment loans was extremely common in the pre-card era. So I want to read, there's a great passage from a piece of the action that I mentioned earlier that I just want to read here.
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David and I may have investments in the companies we discuss, and this show is for informational and entertainment purposes only. David Rosenthal, where are we starting today?
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Despite the denunciations, despite the free-floating anxiety, Americans have always borrowed money to buy things. If not from a bank, then from somebody. From a finance company or a credit union or an apartment store or a loan shark, for that matter. There isn't another Western country that has relied so heavily on consumer credit.
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Between 1958 and 1990, there was never a year where the amount of outstanding consumer debt wasn't higher than the year before. Years later, a Bank of America executive could look back on his lifetime in the credit card industry and say proudly, consumer credit built this country. Whatever one's feelings about personal debt is difficult to disagree with this assertion.
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So interestingly, what's basically happening here is people are using debt not because of this bleak, horrible time that they're in. It's actually because of their optimism. They believe that the future is brighter than the present, and so they're fine taking on debt.
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And that is sort of what has sort of led us to today, where because the growth of the American economy and the global economy has been so strong, people have always generally been fine, or at least we exist in a system that teaches you you should kind of be fine betting that the future is going to be better than today.
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Yep. And that may not be true on an individual basis, but it is absolutely true on a societal basis.
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This is like meta launching threads or Microsoft launching teams. You can sort of sit back for a while and watch the innovation and figure out what the very best product is that people want. And then you can go ram it through your distribution channels when you invent one of your own.
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So there's been all these newspaper articles about all this money that B of A is losing. So many banks that had been thinking about launching a similar program abandoned it because they were like, oh man, we thought this was going to work, but clearly it's not working for B of A. So people were shutting down their efforts.
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There was rumors that another bank was going to launch in LA, in San Francisco, and B of A had actually rushed theirs to market to go be sooner than these other banks that actually never ended up launching because the market perception was that it was such a gigantic failure. Here's a crazy stat.
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From 1960 to 1966, so this whole era is actually a profitable era for B of A, but no one else knows it. There were only 10 new credit cards introduced in the entire United States because they did such a good job keeping what became a cash gusher for them quiet.
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But Secret comes out in 1966, and from 1966 to 1968, just two years, approximately 440 credit cards were introduced by banks large and small throughout the country.
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Fellow Seattleite and the book, which is so wonderfully esoterically named Electronic Value Exchange, was his, I think, Ph.D. thesis that they sort of turned into a book. Correct. All right. Take us back in time.
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But listeners, before we talk about how the Bank AmeriCard Licensing Association morphs into Visa, now is the perfect time to tell you about one of our favorite companies, Blinkist, and their new parent company, GoOne, where David and I are proud angel investors.
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Yep. And they have also created something very cool that I never thought anyone would ask for from us. They created a page that represents David and my bookshelves.
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So if you want to read our favorite books broadly, having nothing to do with this episode, but like literally what's behind me on that bookshelf that I feel are kind of our trophies from all the episodes that we have researched, you can go to Blinkist.com slash acquired and look at Ben and David's bookshelf. And you can get those for free.
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So beyond that, Blinkist is always giving acquired listeners an exclusive 50% discount on all their premium content, which is really great stuff. All these summaries and especially the audio summaries of really important books.
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Yep. Our huge thanks to Blinkist and Go1. Go take advantage of all this free content by clicking the link in the show notes. Okay, David, so how do we get to Visa? You have been telling me about the Bank of America card from Bank of America, and I opened this show saying Visa's not a bank, and Visa doesn't have direct relationships. It's this big indirect thing where they work with other banks.
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Right, and one of the assumptions they made was correct, and the other one was too hubris. The first assumption is a good business model decision, which is, okay, we've now created this distributed asset, which is all these customers with our card that want to use our card at lots of merchants.
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People still weren't using credit cards the way we do today, just treating it like cash and using it for coffees and little things here and there. It was still sort of treated as, this is the card for big purchases, some of which I may want to finance and decide later.
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Right. It's a bit odd, but consumers clearly did want to use this thing for some subset of the purposes that they did today. And so Bank of America is kind of leaning into it and saying, we've got this asset. Surely we can leverage that for great gain.
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But the specific implementation of it was a bad assumption where they said the way that we can take advantage of the fact that now all these consumers have the card and all these merchants out there and accept the card is this weird franchising thing.
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Whoa. What year is this? This is like in the mid-60s. Whoa. That's way earlier than I realized for international expansion.
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Right. You know, B of A realized the sort of cardinal sin of many entrepreneurs, which is my particular situation is actually not a pattern of several other customers. It's actually an N of one. I'm idiosyncratic. So when I'm just making the same assumptions about all the future customers about serving my own needs, that's actually a false assumption.
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Yes. And these merchant banks, we'll come back to some of this terminology later, has gone on to become the acquiring bank because this is the bank that acquires the merchant relationship as a customer.
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Welcome to Season 13, Episode 4 of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts. Today, we tell the story of an absolutely incredible system. You can show up anywhere in the entire world with a piece of plastic and transact for anything you want in any currency.
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Yeah. And this is the first moment that we start to see a departure from what American Express was doing. The original Bank AmeriCard was very similar to American Express and Diners Club, where they were closed-loop systems. It was a bank that issued a card to be used at a payment terminal that all stayed within the bank's closed loop network.
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And now with this new Bank of America card licensee system that they're starting to sort of develop here that would become Visa, it's an open loop system. It's, hey, there's one bank on one side who owns the customer, who owns the cardholder, and one bank on another side. And we're going to enable those systems to talk to each other, but they're not the same party. This is open loop now.
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Oh, so the problem they're experiencing is like, hey, Bank of America, how did you build all the technology to do this?
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This sounds like a you problem, not a me problem. I see. So when these banks are coming to Bank of America, they're not actually complaining about price in any way. They're literally just saying, how do you solve this problem?
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I see. So it's like, you know, you buy a McDonald's franchise and they ship you some golden arches and they're like, good luck figuring out how to make cheeseburgers. That is exactly right.
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And of course, the ability to actually be on the network that sends those payments, right? Yes, of course.
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Yeah, it's one of these things, too. It's like one of the only essential pieces of financial infrastructure in the United States that is not run out of New York.
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I see. It's like when I'm trying to figure out, like, I have to keep pulling up Alaska Airlines partner network to figure out what international airline I should fly since I pay no attention to anything other than, well, it's Alaska. You know, is it One World? I don't I still don't even know what the One World.
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It's so funny. This is the original problem of Diners Club, too, because Diners Club, they I think it was Diners Club that originally shipped a little folded thing that fit in your wallet with the card that was a little booklet that was a list of all the merchants. So you could literally know if the card would be accepted at the restaurant you're at.
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And this would go on to be incredibly valuable to plaster on your storefront and say, we accept Bank of America card here. And that just means your sales are going to go up. Friction to purchase goods goes down. Customers are excited to spend with you because their shiny, cool thing that they like spending money on works there. And it's good for your business to be able to accept it.
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The Drop. This is the name of the title in this fantastic book, A Piece of the Action, How the Middle Class Joined the Money Class. And it's chapter one, The Drop, 1958. The Drop has become like, if you say The Drop to someone in the fintech industry, they're like, oh, September 1958, Fresno. Yep.
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Okay, so they got this marketing program. How did it literally work? Because this is pre magnetic stripe. Yeah, there's no technology here. I mean, this is literally like, cool. I've become a Bank of America licensee. What transactions does that let me do? And how does that happen?
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So the sales drafts get handed to the licensee. So you've got, let's say you're running a department store and keep going with the Illinois example that you said. So you're running a Chicago department store. After a whole day of sales, you've got a bunch of sales drafts where you say, all these customers came in with Bank AmeriCard. They said they're good for the money. So I gave them the goods.
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and now I'm holding the sales drafts. I actually have no idea if they were good for the money, but the fact that I have a sales draft and the fact that I, the merchant, have a contract with a bank, and that bank has a contract with Bank of America, means that I feel very good that I'm going to get my, you know, 93 cents on the dollar or whatever. So then the bank is responsible, probably.
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Yeah, whatever. For us, we just moved a few numbers internally. We actually didn't have to do any of this.
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And one of the most interesting characters in anything we've ever studied, because he's not a tycoon the way that most of these people are.
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And the reason it was named Bank of Italy was it was started by an Italian immigrant who wanted to create something for the underbanked Italians in his California community.
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Whole new system. And he has no power at this point, but he kind of thinks he does. And listeners, now is a great time to tell you about our next favorite company, Crusoe.
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So how do they do it? It is a little bit more than just saying they put data centers next to natural gas flares or stranded energy from wind turbines. I mean, that insight alone has value, but this is insanely difficult to pull off, to build this multi-tenant architecture at scale and implement things like InfiniBand with rail optimization.
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So here are some of the things that Crusoe's team has had to do and why it required people with backgrounds and data centers, oil fields, utilities, networking software, and manufacturing all working together to do it. So one, they have to trench high bandwidth fiber themselves.
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And as you might imagine, putting a data center in a remote location, that is not just magically next to an ISP that you get to plug it into and have redundancy. Two, rugged infrastructure. Not only do they need to custom design the data center architecture to let customers eke out every ounce of performance, it also needs to work in these locations.
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They initially worked with external vendors, but they've now started something called Crusoe Industries, which manufactures a majority of their mobile and modular data centers and electrical equipment themselves. And three is operations.
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Things go wrong out in the field, especially in remote locations, and Crusoe has a fault-tolerant organization that is able to plan for the maintenance and repairs and manage the failures when they do inevitably happen. So the team has deep data center operations expertise to ensure that customer AI workloads operate seamlessly when minimal disruption.
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And they really do plan for these things to happen and have great redundancy in place.
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If you, your company, or your portfolio companies could use lower cost, more performant infrastructure for your AI workloads, go to crusocloud.com slash acquired, C-R-U-S-O-E cloud.com slash acquired, or click the link in the show notes. Okay, so David, DeHawk thinks he's got a mandate to go change things up in a big way and create some big, crazy new proposal.
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And you basically want it to happen as fast as possible. So maybe if you only allow, you know, 20% of the banks in America or 20% of the banks in a state to be members of this thing, eventually they could sort of bootstrap the whole network. But it takes a lot of time to go door to door to door to door. And maybe that particular merchant doesn't want to take on a second banking relationship.
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And if we could grow the pie enough, would B of A be comfortable not owning the whole thing? That's the bottom line here.
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Importantly, though, fortune favors the bold who have done the work to figure out how to align incentives such that a logical person will think through and come to the same conclusion he has.
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Well, and certainly Nobody asked for them. There's this great quote, again, from a piece of the action that describes it and says, All right.
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I once had a Silicon Valley founder give a talk at a startup weekend I ran 10, 12 years ago, who said, until your company shuts down, you are just in the act of succeeding.
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And miraculously, that works. Like, would you rather own a few percent of something that is the default global way that commerce is produced? Or would you rather own 100% of, you know, Bank of America cards?
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I see. So he's basically coming to them with a waiver and saying, I want you to waive your exclusivity to some territory because in our new construct here where we're all working together, you and everyone else is agreeing that it's good for the value of us all if we waive our exclusivity.
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You'd rather be the Jets with their proportional share of the $14 billion a year TV deal that the NFL has today than whatever their very fat contract was alone in, what, the 60s, 70s. Totally. It is exactly the same thing here.
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So it's basically designed for you to kind of break even on it. If you're putting in 17% of the transactions on the whole network and you're paying in fees on 17% of the transaction, well, good news. For all of the leftover profits from running the network, 17% of them go back to you.
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Yep. Because this is the natural business model of interchange to do the exact same things that was being done with the sales drafts, where you sort of give a discount to the retailer. And when I say discount, I don't mean a beneficial one. I mean, I'm discounting the amount of money that I am giving you off of the 100% that you would have received by the customer.
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Basically taking that old check courier business model and carrying it into sort of a network form.
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There's actually another NFL analogy here. The NFL doesn't own the teams. The team owners own the NFL.
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That's actually probably the best analogy for Visa as the NFL league organization. I think it totally is.
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I see. So none of these banks are members of Interbank at this point. These banks are exclusively members of whatever the heck Visa's predecessor name is.
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Right. You're signing up for something that might change in the future and you don't get to know today if it's going to change in the future, but at least you have some say in it. That is exactly the pitch.
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Wow. Isn't that wild? I mean, once you get to like 70 or something, then it kind of seems likely that everyone's going to tip. But in those first 20, the fact that nobody was out is crazy.
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The merchant doesn't need to know you or trust you, and you do not need to know or trust the merchant. And Visa, along with just one other competitor, MasterCard, has tirelessly spent decades stitching together all the banks, merchants, and the relationships with consumers to make this possible.
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Wow. Yeah. It's just like the presidential exceptions for the NFL, like an antitrust exemption where, yeah, we're amenable to the fact that you're collaborating, potentially colluding, but it is actually one of the things that we believe will make the country better. So go for it.
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Well, and in most states, they would have restrictions on the number of branches that banks could actually have. In some states, I think Texas was one of them. You literally could only have one branch. Other states would limit them as something like three. Other states would limit them and say none outside the city. So you were sort of a bank of a city.
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And for many of them, they'd be right in saying it actually would be better to be singular and dominant. Like you look at China Union Pay. I mean, that is the dominant way of payments flowing in China. that was for them the right move.
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You could almost think about these more as credit unions than these sort of big banks that we think about today. California happened to be unique in that you could actually have branches all over the state. And California happened to have quite a large population. So it was kind of the only place you could pull off a large consumer bank.
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So he's basically saying, hey, whether you voted for this or not, you're getting to leave with something saying, I'm so great, I had the will to compromise, even if you didn't and you were the reason that you killed it. Dee is just such a character.
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Okay, so how does the name Visa come about? How does the sort of joining of the international and the domestic?
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Yeah, the universality, it's sort of a presumptive close. Because at this point, you know, they've got, what, three, four, five hundred banks. You know, and they have 16,000 today. It's quite the presumptive close that it will be universally accepted everywhere, the way that Visa would imply.
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So in the blue stripe on the top of the top third of the card, the banks start co-branding with the name of their bank and some affinity.
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Sign up with this. Nice of them to, at this point in history, offer applications. I think 100 million cards got dropped in the United States before the government made it illegal to just start randomly issuing credit to people without their awareness or asking for it.
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By the way, this is the thing that pushes Visa ahead of what was, I believe, then called MasterCharge. Yes. The interbank had changed to MasterCharge. They hadn't yet turned it to MasterCard. But in 1976, MasterCharge was actually bigger. They had 7,400 banks. And at this point in history, Visa had about 7,000 banks.
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MasterCharge also had more cardholders, 37 million versus Bank of America cards, 31 million before they changed to Visa. So this, despite all the deck chair rearranging between the member banks, it was great for Visa to leap ahead of MasterCard.
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Yeah, and it's worth a moment on Amex here because I would have thought just like Facebook or WhatsApp or Google, when you have this sort of winner-take-all massive network effect business, that the single centralized player network effect would win.
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Why wouldn't Amex win with their closed-loop system where they own the whole thing end-to-end and can provide the most incredibly custom experience for everyone on their platform, on the merchant side and on the consumer side? And one of the answers of why this open-loop system beat the closed-loop system is Visa adopts this strategy of the network of networks.
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they go sign up one bank, that bank can go sign up 100 million customers or 2 million merchants. They get so much scale leverage on signing up just one bank that this strategy makes it so that they have far more scalability than something like Amex. Amex also is a bank themselves, so is highly regulated. And they're a bank, by this point in history, I believe, on both sides of the transaction.
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They were doing like buy now, pay later. But instead of on the website, you would go to your local bank branch, you would schedule time, you would sit down with the bank manager, and he would authorize you to go spend $150 at some merchant and make you a loan that you would come pay back over the next few months in installments.
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So they're both a card-issuing bank and they are a merchant-acquiring bank. And so in terms of scaling internationally, you mentioned their name holds them back. Also, they have to become a bank in another country in order to expand to that country, whereas Visa just needs to go tap a few banks and say, why don't you go figure out how to grow for us there?
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So this network of networks thing, the open loop system, Well, it creates a little bit more of a kludgy user experience because they're sort of the lowest common denominator of data getting passed through the network. It's sort of open source versus something that's wholly owned and operated by a company or a protocol versus fully owned application.
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Anytime that you have something that's more distributed, you're going to be compromising a little bit on the user experience because you can't sort of rule by fiat when you want to make a change. But it does potentially come with much better scalability, which is the reason why Visa and MasterCard have become the dominant way versus the closed-loop systems.
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So Dee was right. Dee was right. And to this day, Dee has been right. There have been many attempts that we'll talk about toward the end of this episode of displacing Visa and MasterCard or inventing new payment systems. And like, they never work or they haven't worked yet.
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It's probably actually worth sharing the Amex thing. So Amex tried this crazy strategy in the 80s, and I'm flashing forward 10 years here, but they would basically cut their interchange, the discount rate that they were charging merchants, massively if those merchants would go exclusive to Amex.
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And every single time that you wanted to buy something now and pay for it later, you would repeat this very physical one-off manual process. Yeah.
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And this actually continued until 1991 for many of their merchants, and for Costco, went all the way to 2016, right? where they had the exclusive agreement with Amex, and if you were going to use a credit card at Costco, it had to be Amex.
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But interestingly, Visa and MasterCard cried foul when all of their banks were multi-homing, and Amex, with their virtue of a slightly different business model, was allowed to go and try to lock up merchants to be exclusive to them. So eventually, the whole thing kind of stopped, and flash forward to today, all cards are accepted at basically all locations.
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Yeah, as Dave puts it in Electronic Value Exchange, there's a socio-technical aspect to this company. And we've talked about the socio, but not the technical.
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who has also built a tremendously powerful piece of infrastructure focused, just like Visa, on reliability. As we will talk about later this episode, Visa never goes down, or basically never goes down. And that was a super important part of their strategy. But it is extremely hard for most companies to achieve this level of reliability in their technical infrastructure.
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Yep. Thanks to StatSig, though, it is now super easy to do this the right way. If you're building software products, StatSig is the one-stop platform you need for feature flagging, product experimentation, and analytics. The product just works. It makes it super easy to roll out features in stages and provides data on the impact at every stage of the rollout.
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Static is a critical part of how companies, including financial ones like Brex and also like Notion, launch their features to hundreds of millions of users without causing outages or hurting core metrics.
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Okay, so David, what does Visa's technical infrastructure look like and how did this come to be?
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Yes. And to illustrate, we will link this in the show notes, but there is an old TV segment from 1993. Not that old. Pretty recent.
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Not good. Not good, David. Not good. This 1993 TV segment, the news is that Burger King has just rolled out credit cards. That should tell you a lot. Burger King, prior to 1993, did not accept credit cards, or at least this commercial makes it seem that way.
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And they interviewed this woman, and she says, I think it's pretty sad when you have to use a credit card when you go to a fast food restaurant. That was a view of someone just sitting in a Burger King in 1993.
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And a second guy is interviewed and says something to the effect of, I just hope it doesn't slow things down because, you know, they'll have to call New York and then they'll have to do the thing. And I just hope it doesn't slow things down. And it's like the prevailing idea is that cash is fast. Cash is easy. Cash is respectable.
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Yes. But even at this point in history, it was viewed as this cumbersome thing rather than a convenient thing to bust out the card rather than, you know, like I actually think Burger King corporate crunched the numbers and they were like, geez, for the amount of time we spend handling change, we just want to encourage everyone to be swiping the card all the time.
Acquired
Visa
Oh, what are you doing? So start us back. I think the last time we checked in on how the settlement worked was around literally collecting paper sales drafts and then starting to mail it around. Yes.
Acquired
Visa
But importantly, you had a person at the merchant's bank calling a person at the cardholder's bank.
Acquired
Visa
Today, that is known as VisaNet. There's this piece of technology that sits in the middle that eliminates that bank-to-bank phone call.
Acquired
Visa
Now, this is just the rosy side of the story, and merchants may harbor far less rosy feelings about Visa given how much of their profits go to interchange fees, but the duality of the story is what makes it so interesting to understand.
Acquired
Visa
And it's true. It's not really like they're issuing new cards or acquiring new merchants. They're being a technology provider.
Acquired
Visa
And this is super important. This thing that we have today, interchange rates on credit cards, that was happening with checks too. There was really a lot of expense and risk in processing checks when they first got started. And like...
Acquired
Visa
Until, I think, next year, it's going to go back up to San Francisco when they finish a new building. That's right. I think it's going to Mission Bay.
Acquired
Visa
Fascinating. Okay, so they build what becomes VisaNet in-house. At this point, you know, there's no internet, so it's all just working over telephone communication.
Acquired
Visa
And so they're just operating the whole network out of this data center in California.
Acquired
Visa
Of course, you would take a discount out of the fact that you're taking risk and you're spending money to go and make sure that this check that someone handed you eventually turned into dollars that you could have in your possession.
Acquired
Visa
this gigantic list of a whole bunch of transactions just happened people just agreed to make them happen and now we need to settle up at the end of the day and if you paid me 100 bucks 500 times and i paid you 100 bucks 400 times what is the net that actually needs to get transferred and that is a far more efficient way you know batching them up is a far more efficient way than transferring the money back and forth every single time
Acquired
Visa
but still can be a complicated problem, especially when you have thousands of banks on each side of that equation.
Acquired
Visa
Right. If you're the one that owes the money, you kind of want the payment to take more time.
Acquired
Visa
Yeah. And until ACH, where the banks would sort of all meet once a day and decide, okay, how much do I owe you? How much do you owe me? In aggregate, okay, let's just settle one transaction and then we'll figure out all of our internal accounting ourselves. They were literally like check by check and saying, okay, I have this check. So you owe me $6.08. Okay, next check. Oh, I owe you $4.20.
Acquired
Visa
And invent the technology to keep these things synchronized so they are actually redundant.
Acquired
Visa
So this is actually every transaction now is running digitally for authorization over the network. Exactly.
Acquired
Visa
And it was this crazy system of individual couriers bringing checks to from the person who gave it to the merchant for the merchant to go and track down the money and bring the money back.
Acquired
Visa
And the nice thing about the embossing is that if you run a shunk shunk on it. A zip zap. With the zip zap or the card imprint reader, you actually can get the numbers off of it without writing it down yourself. That was a huge productivity gain when they launched the sort of imprint reader machines.
Acquired
Visa
And didn't they try to like hack the magnetic stripe and then they did just to prove that like the proprietary thing would have been more secure? Yes, but it was proprietary.
Acquired
Visa
I see. If you use this instead of the Zip Zap, you'll get cheaper fees. Yep, exactly. Which that business model carries through to today. I mean, the way that you charge a card massively affects the interchange that gets charged, whether it's keyed in with numbers or whether it's swiped or whether it's an e-commerce transaction. Totally.
Acquired
Visa
That's crazy. I had no idea. That's fascinating. Totally wild. Normally, you run into the problem with spare capacity, where the time where people want your extra capacity is when you have none. So it's kind of amazing to find two complementary use cases for the same infrastructure that when one is waxing, the other is waning.
Acquired
Visa
Which actually should totally justify a lower interchange. If you're not paying for all the fraud in the system, then the system should cost less to run. Absolutely. In many ways that, hey, we're going to reward you with lower interchange to install these terminals.
Acquired
Visa
At the end of the day, Visa probably could have maintained a margin and all the banks could have maintained a profit margin and not lost any margin percentage because just implementing this technology lowered the cost of running the whole thing.
Acquired
Visa
Yes. We will later talk about what a astonishing financial profile this business has. But for now, just know that at this point, they got to stop spending money and they got to only make every dollar after this basically fell to the bottom line. Yes.
Acquired
Visa
Now the tollbooth is fully built. It is a high-functioning tollbooth. It's an immovable tollbooth.
Acquired
Visa
Yep. Well, David, catch us up to today. I will give us a bunch of information about the business today, some changes to the business model, and then we can go into analysis. But before that, I know there's obviously the IPO event that we want to talk about in 2008 and sort of how the structure of the whole thing changed. But I think you've got a marketing thing that you want to talk about too.
Acquired
Visa
Today, we will explore how the whole thing came to be and try to understand the value that the credit and debit card system creates compared with how much it captures and by whom in what situations. So here are some astonishing stats on Visa. It is the 11th most valuable company in the world. It is worth more than any bank in the world, including every bank involved in creating it.
Acquired
Visa
Which is so interesting because a signature piece of the Bank of America card since it launched was that it is actually a charge card where at the end of the first month, you have the option to turn it into a loan. But I have never elected that option. I hold these things called credit cards, but that's a misnomer. I've never once used any credit.
Acquired
Visa
Which saves on operations for everyone. It's, oh, great, now we only need to move money once, we move it at the end of the month, and I trust you because I've seen you lots.
Acquired
Visa
Right. Although I should say, it's probably false to say I've never used any credit. The bank does float you the money for a month, but they have a one-month grace period where you have no interest. Yes. You are using debt. You're just not paying interest. Yes.
Acquired
Visa
Which that's not that big a deal because there's not that many people that go relative to the people that see the media and understand the brand association. Of course, of course.
Acquired
Visa
Love it. So David, take us to the IPO. This thing was an organization that was owned, but not with stock.
Acquired
Visa
Right. And now they're an enormously profitable public company. So how did we get from there to here?
Acquired
Visa
It actually is a class action lawsuit that the merchants brought. And they basically got fully fed up with Interchange. And, you know, every 10 years or so, there's some meaningful merchant push to try to change interchange. And they either do it in Congress or they do it in a class action case. You know, there's a variety of different ways.
Acquired
Visa
And this particular class action suit in 2005 is still running today. And the numbers have mostly been figured out of how much Visa will owe from a 2012 ruling that then got appealed. So it's sort of still going on. But basically, the there was a lot of uncertainty in the 2005 and 2006 timeframe of, geez, what's the liability here going to be?
Acquired
Visa
And MasterCard had gone public and did not sort through this issue at all. They just said, oh, we're going public and shareholders, yep, there's lots of uncertainty in our future and like, we'll see, but buy our stock. And that, as you can imagine, did not go well at all. And so as they're getting ready to go public for lots of reasons, basically it was time.
Acquired
Visa
They wanted to have some liquid currency that floated for acquisitions. They had to be competitive with MasterCard, who was going public. Amex was already public. You know, you can reward and retain talent easier. There's just like lots of reasons why you would want this thing to be sort of a standalone entity, especially at this point in history.
Acquired
Visa
Yep. In 1939, Standard Oil of Indiana sent 250,000 unsolicited cards directly to all of their customers.
Acquired
Visa
And what they had to do was they created these B shares and they isolated all the liability from this class action suit to the B shares.
Acquired
Visa
So while MasterCard had a pretty flubbed IPO, Visa had a great IPO because they said, whatever the courts rule, the banks who own the B shares, the pre-existing shareholders will own all that liability and all the A shares, the new people who are coming in as owners of the company will be protected.
Acquired
Visa
Yep. I mean, now Visa is owned mostly by big institutional shareholders, the vanguards and fidelities of the world. And the banks are much smaller shareholders.
Acquired
Visa
It's wild. I mean, DeHawk basically was right. That's the TLDR on this, is this thing, this information network that doesn't have to take on any of the risk of any of these transactions. It's purely about connecting buyers to sellers and moving information back and forth has proven to be maybe the best business model ever.
Acquired
Visa
Well, and interestingly, this is 20 years before. But again, this is not a bank. This is a single merchant mailing it out to all of their customers exclusively for use at their facility.
Acquired
Visa
And let's go through the shape of the business today, and listeners, you can decide. So, David and I have made passing references to the idea that this is this ludicrously cash generative business, and I think it's time to actually examine interchange fees today, how they've changed over time, how they flow, who benefits, what's visas cut, all of that, so you can kind of understand it. So...
Acquired
Visa
Visa's business model. The first thing to know is almost nothing has changed since the 80s to today on how the transactions work. So the authorization flow is exactly the same as it was, where all the auth flows upstream, the merchant runs the card, checks with their bank, who checks with VisaNet, who checks with the issuer's bank. is this account in good standing to make this transaction or not?
Acquired
Visa
And once they get the yes, then the response flows all the way back down the chain in the order that ultimately the flow of funds will happen later on. And, you know, within milliseconds, unbelievably short period of time, no matter where you are in the world, no matter what currency you are transacting in, your transaction can happen.
Acquired
Visa
Pretty unbelievable, amazing that within seconds you can know for certain that someone is vouching for the customer's money and paying in full. Well, nearly in full, minus a merchant discount rate. So what is this merchant discount rate? There are a few things at play here. There are interchange fees, and those interchange fees go to the issuing bank.
Acquired
Visa
There are assessment fees or network fees, and that network fee goes to Visa, MasterCard, etc. And then there are payment processing fees, and those go to the acquiring bank, the bank that acquired the merchant. This is the merchant's bank and the technology provider of whatever they're using to process their payments. So three fees, interchange, network fees, payment processing fees.
Acquired
Visa
Here's what those could look like. And again, I say could because they are different in every scenario. There's a very long PDF on Visa's website that is available with every different concoction you could imagine. So here's an example of a large merchant in the United States, so no foreign transaction, accepting a credit card.
Acquired
Visa
It is obviously different whether we're talking debit, smaller merchants, but large merchant, U.S. credit card. The merchant is charged a 2% discount off the sale price. So it was $100 pair of shoes. You're now making $98. And what happens to that 2%? So that 2%, the lion's share of it is the interchange, the 1.6%. That goes to the bank that issued the card.
Acquired
Visa
Right. So when everybody on the planet is marketing credit card offers to you, they get the lion's share of the interchange. So they actually have a lot to play with in customer acquisition for their cards because they make the lion's share of the transaction, the interchange. There's a lot of costs in there too, because they bear all the fraud risk.
Acquired
Visa
There's a lot of things they got to do, but you know, they get most of the money. A small amount on the order of like 0.2% or 20 bips for you finance people out there goes to the bank that acquired the merchant. This could be Chase, Pfizer, Wells Fargo. This is, you know, the merchant's bank. It is important to know this may also get split with a technology provider.
Acquired
Visa
So sometimes the financial institution directly has technology that you can use, but other times the checkout terminal or software that you're using is not actually the financial institution behind it. So that 0.2% can kind of get split between the financial institution and the technology provider.
Acquired
Visa
Yes. 0.15 to 0.2% goes to the network. This number is actually quite hard to find. You read Visa's entire annual report and you're like, wait, but what part of the split do you actually get? And it's because they get it in a variety of different ways.
Acquired
Visa
I would say, I don't know if the Visa people would tell you this is intentionally obfuscated or if it just ends up being kind of obfuscated, but it's not super easy to figure this out. So Visa, let's round it to 0.2%, gets $0.20 of that $100 shoe sale. But the cool thing about their $0.20 is there's basically no variable costs. It's not dealing with fraud. It's not moving heavy data around.
Acquired
Visa
I mean, merchants are allowed to have a 20-character name in Visa's network. Like, this is tiny amounts of data. Stack as much metadata as you want on top of that. We are not shipping around huge payloads here. There is not, like... NVIDIA chips that need to run in these data centers to do any crazy LLM processing. This is just shipping very small pieces of information around.
Acquired
Visa
The payload size of the data has remained infinitesimally small relative to the amount that technology has progressed. This 0.2%, the 20 cents on the $100 transaction, very low variable costs associated with that. So a few caveats on this. Debit is significantly less in most cases, and often thanks to regulatory reasons. And the logic here is nobody's actually taking any risk to extend credit.
Acquired
Visa
So banks should not get to make a bunch of money on debit. It's literally just moving money out of your account and into the merchant's account. So debit cards are going to be less. Smaller merchants often pay closer to 3% than 2% because they're just doing lower volume. And for these small businesses, the acquiring bank actually has to do a lot more work.
Acquired
Visa
Think about how difficult it is to market a credit card to an individual. Well, small businesses kind of behave like individuals. So because the acquiring bank actually has to do a lot more work and incur costs, they get to make more money. So there's sort of this very interesting thing that has happened where interchange is intentionally quite flexible.
Acquired
Visa
This is a playbook theme that I want to pull forward. This business is probably the greatest masterclass in the entire world on incentive alignment. And I was talking with Lisa Ellis at Moffitt Nathanson, who sort of woke me up to this idea. The interchange pool has an elegance to it.
Acquired
Visa
Since the money never actually gets sent to the merchant, the network and its partner banks or constituent banks can kind of figure out exactly how it should flow in each of these particular types of transactions. It's an envelope of value that the whole ecosystem can sort of play with. And I think that's an important thing to realize about interchange is that it's intentionally flexible. Yep.
Acquired
Visa
And Visa has created these products where, you know, it's not just a Visa card. You might get a Visa signature, a Visa signature business, or a Visa... I don't even know what they are. But they basically have said, why don't we come up with... other types of Visa cards that just have higher interchange. And merchants are like, what do you mean just have higher interchange?
Acquired
Visa
Your new product is you charge me more? And Visa says, well, the cool thing about higher interchange is that there's more... money in the envelope to play with to reward other constituents in the transaction. And so let's say we want to tell the issuing bank, hey, for this tier, this Visa signature, you actually get more money.
Acquired
Visa
Well, then they turn around and say, cool, I'm going to go and I'm going to give better rewards to higher spending, you know, more credit worthy customers. And then Visa's argument back to the merchant is, well, hey,
Acquired
Visa
Because we're actually taking more money on this fancier card, you're getting access to customers that we've now brought onto our network who are much better customers that you really want to have at your establishment.
Acquired
Visa
And so it's this very interesting, again, envelope of value, I think is the way to describe it, where I'm sure the merchants wish they could be more a part of the decision process, but it does... theoretically enable incentives to be spread around that benefit everyone in the ecosystem.
Acquired
Visa
Right. In the olden days, you know, if you're the Affinity logo that got printed in the top stripe, the way that works today is you have a special deal with the issuing bank where you're going to say, hey, we're going to help you get more card members by putting our logo on the card.
Acquired
Visa
And so even though oftentimes we're the merchant, well, actually what we're doing is we're helping you distribute cards on the issuing side. And maybe there's cool things we can do when those cards are spent at our establishment where we give extra awards, but it's effectively marketing channel for the issuing bank. So they get to split some of those economics.
Acquired
Visa
And not to mention, on top of this, there is the huge benefit of a shared credit history. Now, all these merchants who were losing money on people coming and getting a loan from them in the form of, I'm going to buy some goods, I'll pay you back later. But it turns out they had run up a tab all over town and weren't paying their bills anywhere.
Acquired
Visa
It is worth pointing out the system today is pretty tough to change absent government intervention. Consumers who spend the most love the system the way that it is. A huge amount of the fees that merchants pay come back to these consumers in the form of rewards. So the issuers and the networks end up with the consumer as their advocate for the system as it exists today.
Acquired
Visa
And meanwhile, no retailer owns enough of the total transactions to actually go invent their own better system. So when merchants have tried to go and get consumers to go direct and give them their bank account information, typically consumers won't do it unless they get some very high number of percent back. And that's actually more expensive than the interchange.
Acquired
Visa
The way that you end up having to pay your consumers in order to change their behavior away from credit cards that they love the rewards so much on is to do something non-economic. Like, you have to believe that there's some long-term benefit to doing it.
Acquired
Visa
Nope. And the reason is basically like no one can ever figure out how to incentivize all the parties that need to change behavior enough to change the behavior.
Acquired
Visa
Totally. I mean, the most negative way someone could paint the ecosystem as it exists today is that the whole credit card system is a wide scale bribe of the American consumer to like extort the world's retailers using the retailer's own money. But that is like a very cynical way to view it.
Acquired
Visa
So that's a strong argument. There's been independent research firms that have looked into this and basically determined that this is a reverse Robin Hood scenario, that the wealthiest consumers are the ones who have rewards cards. And because all the goods are marked up to accommodate interchange. Right.
Acquired
Visa
Now, with this idea of a shared card, you actually can have a shared notion of who a consumer is across locations and across different retailers.
Acquired
Visa
Right. If you aren't someone that has a rewards-based credit card, then your stuff just got more expensive. And so the research firm that looked into this, actually, I think it was the Fed, the Federal Reserve Bank of Boston, determined that on average each year, a household that uses cash to pay for things pays $149 inflated prices because all prices, no matter how you pay, have to go up
Acquired
Visa
Right. That is the other argument that this is like kind of net bad for the world is that it's regressive in who it rewards and who it penalizes. The other reason why it's really hard to change the system is this whole thing is a chicken or the egg problem. I mean, every two-sided marketplace is a chicken or the egg problem.
Acquired
Visa
Bank of America had solved this when there were no regulations by dropping 65,000 credit lines on unwitting Americans. And you can't do that now. So how do you bootstrap one side of the marketplace when you can't do something like a drop?
Acquired
Visa
Right. So what you're basically relying on now is... some sort of extrinsic paradigm shift, probably a technology paradigm shift that enables a new entrant to bootstrap one side of the marketplace in one way or the other to create a new system. And without a new paradigm emerging, this is the system. I'd say a new paradigm or the government intervention.
Acquired
Visa
This kind of is the system that we've made our bed and we're stuck with. For good and for bad. Yep. I mean, I love my rewards cards. Right. And look at all of the economic value that it created by enabling e-commerce. It is truly astonishing that without UPS to ship packages and without credit cards to let us pay for things on the internet, like it just wouldn't have happened.
Acquired
Visa
It's trillions of dollars of transactions in the economy that would not exist. So the arguments to merchants are, look, people spend more when they use a card. There's a broader range of buyers that use a card. Very cool feature of these credit card and debit cards is there's guaranteed payment with no risk. There's instant authorization for this consumer wants this thing.
Acquired
Visa
Now, they could return it, but you know for sure that they're good for the money and you're going to get the money very soon when they walk out the door, which that wouldn't happen in checks. There's a cost to checks.
Acquired
Visa
Yep. And if you're saying you better come in here bearing cash or a cashier's check, you're gonna have way fewer customers. Not to mention, like, there's totally a cost of facilitating cash. You know, it's one thing for a coffee shop, but let's say you run a running shoe store and everything you sell is $150 to $250. There's a pretty meaningful amount of cash that piles up in your establishment.
Acquired
Visa
And so you need to make sure that you have security or like, you know, let's pick an even higher ticket item thing, like a jewelry store. You need security, you need... to move that cash somewhere, you need to like make time to go to the bank to deposit it. Totally. The operational overhead associated with that.
Acquired
Visa
There is a value to providing payment and there is a cost to whatever the payment method is. And so am I saying that the cost is 3% or in the old days 5% or 7%? No, absolutely not. But there certainly is some cost no matter what form of payment is used.
Acquired
Visa
So the business today, what does Visa look like? Well, last year, Visa processed $14 trillion of volume through their network, which is an almost meaninglessly large number. How do you even think about that?
Acquired
Novo Nordisk (Ozempic)
All right, first episode back. Let's see if I can do this sleep deprived. Oh, you and me both, man. Welcome to Season 14, Episode 1 of Acquired, the podcast about great companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts. Today's episode is on the company behind these sensational diabetes and weight loss drugs, Ozempic and WeGoVie.
Acquired
Novo Nordisk (Ozempic)
Yep. the patents aren't just on the molecules. They also patent delivery mechanisms. And so they keep changing delivery mechanisms. You basically have the scenario where doctors don't really want to prescribe the old thing. And so when you introduce a new novel form of a pen, oftentimes doctors will say, well, that's the thing we need to be prescribing now. And so there's like a
Acquired
Novo Nordisk (Ozempic)
brand that gets built around the most current thing that's patented, even if it's not that much better than the old thing. And, you know, there's a lot of people in pharma that are going to get mad at me for that characterization. But in addition to patenting molecules, delivery mechanisms also provide defensibility.
Acquired
Novo Nordisk (Ozempic)
One question I had was, there might be like contractual things that entrench relationships too. Like when you get really big, and this would be a scale economy, are there contractual relationships with formularies that sort of entrench you and make it so that even if someone else comes out with something similar to treat any given condition,
Acquired
Novo Nordisk (Ozempic)
and your patent isn't defending you because it's a different molecule, well, sorry, you've locked up a distribution channel with the PBM and getting on the formulary in such a way that, like, good luck to anyone else.
Acquired
Novo Nordisk (Ozempic)
Right. And the gigantic amount of R&D, it literally is $2.3 billion to bring a drug to market on average. You need to make a lot of profit dollars on any given drug to benefit. You don't necessarily need scale of patients, but you do need scale of dollars in order to outrun the fixed costs of R&D production.
Acquired
Novo Nordisk (Ozempic)
Oh, I think there actually is. Normally there isn't. But that's one of the breakout things about Ozempic is there actually is brand power. The first time I heard about Manjaro was 18 months after I'd heard about Ozempic. And I was like, oh, it must be some kind of knockoff. You know, this is my first time studying pharma.
Acquired
Novo Nordisk (Ozempic)
I was like, oh, it's probably something crappy that's trying to ride this same wave, but isn't actually the breakthrough molecule. And like the studies show Manjaro helps you lose more weight and has a very similar mechanism plus another mechanism that together work. But like most people don't know that. Most people know I read on the cover of the New York Times that Ozempic is a breakthrough.
Acquired
Novo Nordisk (Ozempic)
And I heard about it at the Oscars because a joke was made on stage. Jimmy Kimmel was talking about it. Yeah. Yes. I think for the first time, and it's happened a little bit before, but for the biggest time in a while, Ozempic has actual brand power.
Acquired
Novo Nordisk (Ozempic)
Often in the same doses. It's technically a higher dosage, but you can get many different dosage levels of either drug.
Acquired
Novo Nordisk (Ozempic)
Yep. Vitamin O or Oz or yeah, there's all sorts of, I've been reading the Ozepic subreddit for a while to prep for this episode.
Acquired
Novo Nordisk (Ozempic)
Switching costs with any drug are a big thing because once you find something that works for you, you never change. Like I've been on citrazine hydrochloride for my allergies for 15 years. I think it's Zyrtec. And like, no, I'm not trying anything else. It works. Why would I try something else?
Acquired
Novo Nordisk (Ozempic)
Yeah. That's one of the worst things about it. I will also throw in network economies.
Acquired
Novo Nordisk (Ozempic)
Well, so I think most of the time in pharma, there's none. But with Ozempic, so I think there's two ways in which GLP-1s used for weight loss resemble consumer tech products. One is a tight feedback loop.
Acquired
Novo Nordisk (Ozempic)
When I start taking Lipitor, I don't like physically notice anything about myself, despite the fact that something that is potentially very dangerous to me has become less dangerous with cholesterol. When I lose weight, I immediately notice, like if I lose, what, six pounds in the first month, there is a super tight feedback loop there.
Acquired
Novo Nordisk (Ozempic)
And so in the same way that Zynga created these feedback loops for mobile gaming and that sort of psychology has been used in all tech consumer products now to create these gratification loops, that totally exists with Ozempic. The second one is what I think as a network economy, you kind of become a walking billboard.
Acquired
Novo Nordisk (Ozempic)
There's a little bit of a taboo around sort of saying I'm taking Ozempic, but people know you lost weight. It has almost like a shareable. Ozempic can go viral in a different way than most pharma describes going viral.
Acquired
Novo Nordisk (Ozempic)
I guess the only one would be like the taboo thing. If I'm taking Ozempic and I'm ashamed of it because I'm the first person, if a million more people start taking it, then it is actually better for me.
Acquired
Novo Nordisk (Ozempic)
Right. Not to mention ribelsis. That's the new oral one. They have figured out how to make semaglutide a once-a-day pill if you prefer taking that to a once-a-week injection. It's a little bit weird because you have to take it on an empty stomach and then not eat for 30 minutes afterwards. But if you don't like needles...
Acquired
Novo Nordisk (Ozempic)
And this is the kind of stuff that Novo Nordisk is so good at. It's all these decades of researching, how do we make this stuff break down differently in the body? Because the issue with the GLPs is it can't get absorbed into your bloodstream by you putting it in your mouth and then it going into your stomach and hitting the harsh environment of your stomach. So figuring out how to
Acquired
Novo Nordisk (Ozempic)
make something go from your stomach into your bloodstream for a sustained period of time.
Acquired
Novo Nordisk (Ozempic)
Is that how Nobel Prizes work? A previous winner nominates the current nominees? Or is that just like it certainly helps their case if a previous winner?
Acquired
Novo Nordisk (Ozempic)
Yeah, and counterpositioning basically always exists in the takeoff phase and never exists later. I think that we keep kind of finding that pattern over and over again is incumbents don't really counterposition, startups counterposition.
Acquired
Novo Nordisk (Ozempic)
Yeah, I think in the world of healthcare, there is a ton of power for basically any company that we would study because the returns over and over and over again keep going to these incumbents that keep getting bigger. And I know biotech investing in startups is a thing, and there'll be new disruptions on the horizon, CRISPR and gene and cell therapies and things like that.
Acquired
Novo Nordisk (Ozempic)
But the last 30 years at least of... healthcare has consisted of returns to scale, which would indicate lots of power.
Acquired
Novo Nordisk (Ozempic)
Yep, that's right. Or they do a deal, some kind of distribution deal, but a lot of the economics of that deal are eaten up by the big pharma company as the distributor. which really they're not the distributor. The PBM handles making sure that the reimbursements are there so doctors will prescribe them, and the wholesaler distributors handle physically moving the drugs.
Acquired
Novo Nordisk (Ozempic)
But when you do a quote-unquote distribution deal as a biotech company with a pharma, it's because the pharma has the relationship with those two other parties to ensure that you actually can be available at broad scale.
Acquired
Novo Nordisk (Ozempic)
So the first one that we've hit a few times but is just worth putting a fine point on is concentration. The focus of this company is unbelievable. 85% of their revenue is dedicated to metabolic disorders. They are the second largest market cap pharma, second only to Eli Lilly. It's crazy. They're that focused, but they have an ability to be that large by market cap.
Acquired
Novo Nordisk (Ozempic)
It is worth knowing they aren't in the top 10 pharma companies by revenue. In fact, they're 20th.
Acquired
Novo Nordisk (Ozempic)
Yeah, no, it's a multiples thing. Part of the reason why they're Europe's biggest company is people are very optimistic about their future and about their ability to be profitable in the future, not just make a lot of revenue. But it continues to blow my mind that they have had the huge success that they have had with how focused they have stayed.
Acquired
Novo Nordisk (Ozempic)
So the guy who would go on to found Novo Nordisk is the one that nominated Banting and McLeod for the Nobel Prize before starting the company.
Acquired
Novo Nordisk (Ozempic)
Well, but for 60 years, it wasn't actually that interesting of a market. That's the crazy thing. Like 1920 to 1980, it was type 1 diabetes, which, again, absolutely incredible for the world that they took children who had a death sentence, then gave them life, and they got to live basically a full life. But was type 1 diabetes actually this colossal, mega interesting market? No, not at all.
Acquired
Novo Nordisk (Ozempic)
What did Charlie Munger tell us? He said, there aren't many times in a lifetime where you know you're right and you know you really have an investment that's going to work. You may even find it five years after you bought it. Your own understanding gets better. And I think that's basically what happened with the Novo Nordisk Foundation.
Acquired
Novo Nordisk (Ozempic)
They realized, oh my God, this isn't just a service we're doing for the world. This is one of the most important markets in the world.
Acquired
Novo Nordisk (Ozempic)
Now, it's interesting that it qualifies as that because, yes, that is totally true. On the other hand, $120 billion is pretty neatly just a little bit larger than a quarter of Novo Nordisk's market cap. And so like the vast majority of that $120 billion is their ownership of Novo Nordisk. So it's not like, oh my God, they spat off $120 billion in cash that they're investing elsewhere. No.
Acquired
Novo Nordisk (Ozempic)
So if, you know, Jeff Bezos decided to put his, what does he have, like 9% of Amazon, decided to put that into a foundation and call it charitable suddenly, that would be the most charitable foundation or, you know, up there. Yes, correct. But the point stands.
Acquired
Novo Nordisk (Ozempic)
Yeah. While we're on the topic of the Foundation, before we keep going in playbook, it is worth pointing out that there are formally defined objectives of the Foundation, and those objectives do not include growth. So it's kind of amazing that they have grown the way that they have. The dual mission now is stability and supporting scientific and humanitarian causes. So what does stability mean?
Acquired
Novo Nordisk (Ozempic)
I suppose it means like ensure the longevity and duration of Novo Nordisk as a company. But it's interesting when your stated mission is stability and this humanitarian cause that is a byproduct, you could end up being this incredible market leader, innovator, super high growth company too. Yeah.
Acquired
Novo Nordisk (Ozempic)
And on the point of mission, Novo Nordisk has a stated mission that it's not just about supplying treatment, it's about eradicating diabetes. And so there was a 2014 paper that came out that suggested a real cure for diabetes using stem cells. I think it was out of Harvard.
Acquired
Novo Nordisk (Ozempic)
And at the time, the Novo Nordisk chief medical officer replied, we feel a responsibility for trying to prevent or eradicate diabetes. And if that means the dissolution of Novo Nordisk, that would be fine. I'm having such a hard time wrapping my mind around, like, is that actually true?
Acquired
Novo Nordisk (Ozempic)
Is all of the behavior of the executives actually in service of curing diabetes, even if it means that their revenue would go to zero? Isn't that at odds with the idea of stability of Novo Nordisk?
Acquired
Novo Nordisk (Ozempic)
I also found a stat that in the last six years, $4.5 billion of grants have been distributed. So I was a little tongue-in-cheek about like, well, geez, most of that is their ownership of Novo Nordisk. But like, that is a lot of outflows to research. And I think, importantly, that research often supports what Novo Nordisk, the corporation, wants to go do.
Acquired
Novo Nordisk (Ozempic)
Yes, which rolls up to the mission of stability. But yeah, they deserve to be applauded for the reinvestment.
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Novo Nordisk (Ozempic)
Yep. Okay, while we are in corporate structure land, alignment of incentives is pretty interesting among management. I don't know if you looked into this at all, but their executives are not meaningfully incentivized by stock price performance.
Acquired
Novo Nordisk (Ozempic)
Yeah. So they are sort of forced to think on a different time horizon than if your compensation came primarily in the form of stock options and you wanted to make the stock go up in a three to five year window. So executives and board members are not given stock options as a part of their compensation.
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Novo Nordisk (Ozempic)
And when you talk with folks in the industry, the employees reportedly have lower compensation than their counterparts at other companies. And I couldn't figure out if that was like a Danish versus American thing, or if they intentionally try to repel the idea of mercenary employees and attract missionaries.
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Novo Nordisk (Ozempic)
But it would seem that their excellence in pioneering diabetes medicine is really mission-driven. There's what they call their remuneration policy, which requires all board directors to hold stock. You know, you're not getting it as your comp, but you're required to hold it, which I think is kind of a similar idea to what Berkshire Hathaway has of, hey, we should have sticks, not carrots.
Acquired
Novo Nordisk (Ozempic)
And in Berkshire's case, there's no D&O insurance for board members. You actually have to own the liability of the company's actions yourself to be on the board. So they take it seriously. But in Novo's case, it's, hey, you don't get the carrot of big piles of free equity in our company.
Acquired
Novo Nordisk (Ozempic)
Yeah, you have to actually be aligned with the owners so you get the fruit of the appreciation or the punishment if it doesn't do well.
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Novo Nordisk (Ozempic)
Yeah, it's pretty crazy. Now, the question is, does that thinking lead to the GLP-1 breakthrough? Other pharma companies certainly didn't make these investments and these decisions on these time horizons. And so there's a reasonable narrative that it was actually Novo Nordisk's focus and their time horizon that led to the decades-long work to actually bear fruit.
Acquired
Novo Nordisk (Ozempic)
I mean, semaglutide isn't out of nowhere. It was built on all the work that went into liraglutide since the early 90s and incorporated all the clever ideas they had previously developing longer-acting insulins and things like that.
Acquired
Novo Nordisk (Ozempic)
There is a reasonable narrative of it's their long time horizon and their focus, their ability to learn from doing the same thing well and iterating over 100 years that actually led them to find this breakthrough when others didn't.
Acquired
Novo Nordisk (Ozempic)
Yep. Okay, there are a few unexplored areas that I think are interesting to know about healthcare as a whole and about Novo Nordisk that I want to talk about here in Playbook. One of them is a shift that Novo has done here to broad populations with relatively inexpensive drugs versus other pharma companies.
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Novo Nordisk (Ozempic)
And I know you're going to be allergic to the idea that I just told you $1,000 is an inexpensive drug, but... The crazy thing here isn't just that the revenue and the focus is so concentrated. It's concentrated in an area that other companies shied away from. Pharma over the last couple decades shifted away from these mass population drugs to specialty drugs.
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Novo Nordisk (Ozempic)
And these are often to treat specific forms of cancer or rare childhood diseases with super narrow populations and huge price tags. And to put numbers around that, we're talking like total market size of a couple hundred thousand people or fewer, as few as like 30%. 300 people in these super rare orphan diseases.
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Novo Nordisk (Ozempic)
Occasionally, these diseases are so rare and the treatment is so, you know, life-changing or life-giving that the treatment, like one dose of the pill or one infusion of the therapy or whatever it is, can be measured literally in the
Acquired
Novo Nordisk (Ozempic)
It's understandable why the other pharma companies went there for a few reasons, and this is a little bit of a walkthrough history, but it's been a while since we saw a breakthrough in a mass market drug. Really, the last one that we can point to is statins, which was to treat cholesterol, I don't know, 30 years ago is really when that was kind of the thing.
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Novo Nordisk (Ozempic)
Also, that tells you how long ago this was, that in my head, Niels Bohr is like someone from a long time ago, so it would be a descendant, but actually this is his father.
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Novo Nordisk (Ozempic)
HIV and hep C are examples we can point to, but again, it's been a while since.
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Novo Nordisk (Ozempic)
Well, compared to obesity, but they still qualify as large population. When you're treating millions of people with something, well, A, you can have a different pricing structure. Like you can have much cheaper drugs. But B, like you can just affect a huge swath of the population You know, it's not like we're discovering an antibiotic or a cure for polio every other year these days.
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Novo Nordisk (Ozempic)
In fact, the Alzheimer's researchers have really been trying, but the trials have just been disappointing. And so we had this great heyday 30 years ago of small molecule drugs that you could manufacture relatively easily by mixing chemicals, but...
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Novo Nordisk (Ozempic)
after those patents expired, and these could be manufactured by other companies as generics and sold to everyone for cheap, we really haven't discovered something like that since. So that's why the shift has really gone. And of course, we have new technology to do it too, but really shifted to biologics, the complex proteins that are, you know, harder to manufacture.
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Novo Nordisk (Ozempic)
And I think a way to summarize that is a lot of the low-hanging fruit has been picked. Compounding this problem, just because this is healthcare and you compound every problem. Yeah.
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Novo Nordisk (Ozempic)
Yes. The way that FDA approval works is that you get a label for a drug if you can prove with the right degree of statistical significance that the benefits outweigh the risks and that you are better than current alternatives by some measurable amount. So conditions with existing alternatives are harder to get approval for.
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Novo Nordisk (Ozempic)
And on the other side of things, in the weight category, Around a billion people suffer from obesity worldwide. A billion, including 40% of the U.S. population. If you expand that from obesity to overweight, 75% of Americans are technically overweight.
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Novo Nordisk (Ozempic)
A hundred percent. Going back to the piece that Alex wrote, he references this idea of the better than the Beatles problem. Like, what if it was a requirement to be releasing a new pop song in the market that it was better than Hey Jude or better than Here Comes the Sun? You'd have no innovation. Like, of course not.
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Novo Nordisk (Ozempic)
So the rule both makes sense and you understand why once we hit some minimum level of treatability for something, you're like, geez, is the juice really worth the squeeze there anymore?
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Novo Nordisk (Ozempic)
No, you go work on something that you're actually likely to get approved for and make your billions of dollars of R&D worth it. And your years and years of clinical trials and recruiting all the people for the study. And by the way, these studies have just gotten so insanely expensive to run.
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Novo Nordisk (Ozempic)
And, you know, it's not just the studies that cost money, but if you just look at the cost to bring a drug to market in 1953, it cost $40 million for an approval. And that's an inflation-adjusted figure. Today, it averages $2.5 billion.
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Novo Nordisk (Ozempic)
I don't know. It's easy to be kind of, like, disillusioned with, why would I go after something, large population, if there's already something else that treats a large population good enough?
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Novo Nordisk (Ozempic)
Right. That's super true. So this leads into this other playbook theme. Pharma is the most classic example of the venture business. It's super high risk, it's super high return if it works, and the winners need to subsidize all the failures.
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Novo Nordisk (Ozempic)
And in fact, it's even more sort of severe than typical venture capital because a lot of the research can take over a decade of investing before the winners bear any fruit at all. So everyone was like, oh my God, Figma spent four years writing code before they shipped a product.
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Novo Nordisk (Ozempic)
There's no MVP in semi-glutide. Like let's put a couple billion to work and then we'll check in a couple decades later and see if we've changed the world. And obviously there are stage gates along the way, but. you know, it's adding a zero or two to the venture business, to be honest.
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Novo Nordisk (Ozempic)
I think that the most illustrative stats on this are that the top decile of pharmaceuticals are what matters for the profits. So if you look at the pipeline of 100 drugs that enter clinical development, 10 actually make it to market, and one provides, get this, half the profits. One drug.
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Novo Nordisk (Ozempic)
Right. 10% of the ones that make it to market provide 50% of the profits. Most drugs, this is also a crazy stat, even after they are approved, do not earn back their R&D costs.
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Novo Nordisk (Ozempic)
That's exactly right. Yeah, you need to actually be able to pull risk or have some differentiated way versus all your other competitors of being more likely to create a hit.
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Novo Nordisk (Ozempic)
Yeah. You will not be a successful pharma company without blockbusters. And even then, blockbusters might not be enough. Wow. It's nuts. All right. So now we're into like healthcare as a whole land. So I have some commentary on this. I'm very excited about this.
Acquired
Novo Nordisk (Ozempic)
I think this is going to be a new chapter of Acquired because there's a lot of stuff to dive into here and we'll still never understand it all, but it's fun learning. So I think everybody is aware in some sense that for every dollar that we're investing into the healthcare system, we're getting less and less incremental utility out.
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Novo Nordisk (Ozempic)
People complain all the time that as a percentage of GDP, which by the way is something like 17, 18%, which is nuts, right? Our healthcare system costs us 17 to 18% of GDP. That goes up every year and the quality of care goes down or life expectancy goes down. So everyone sort of like heard some variation of this problem before.
Acquired
Novo Nordisk (Ozempic)
Yeah. The 17.3% of GDP that healthcare costs us, you should just know as a baseline that in 1960, that was 5% of GDP. This isn't like gone up a little bit. This is like, you know, one of the biggest line items for the entire country used to be fairly de minimis and is now enormous. So you should expect a lot of your healthcare system, given what it costs.
Acquired
Novo Nordisk (Ozempic)
On the one hand, this is really bad and like there's a zillion people to blame for it. So it's hard to blame one individual or one company. And so it's a little bit of like a tragedy at Commons where everyone throws their arms up and says, well, I'm going to go do the best I can and, you know, make sure I'm okay.
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Novo Nordisk (Ozempic)
Because I really don't know like who to point to and be like, this system is effed up for this reason. I mean, you could blame oligopoly, you can blame regulatory capture, you can blame too many middlemen, too high of hurdles to get new drugs in the market. But on the other hand, like, you would sort of expect this.
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Novo Nordisk (Ozempic)
I mean, a lot of the low-hanging fruit is picked, so it seems like it's going to require more money to go eke out more rewards. People always make fun of pharma with this thing they call Arum's Law, which is Moore's Law backwards. And the idea is like pharma for every next generation gets more expensive. But like semiconductors also require huge amounts of R&D.
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Novo Nordisk (Ozempic)
And just because we're getting that speed up every 18 months. Have you looked at EUV? It's an order of magnitude more expensive every generation to be able to make. processors like that. So I think that's a little bit of a false equivalence.
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Novo Nordisk (Ozempic)
I totally understand why, especially in heavy industry, it should be more expensive to get marginal benefit out once you have already picked the low-hanging fruit. So I have a little bit of pushback on the healthcare is getting more expensive and we're getting less out of it.
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Novo Nordisk (Ozempic)
The thing that isn't good is that the average life expectancies have actually declined in America the last few years, despite the fact that we're spending more money. So it's not just that our marginal dollars are earning us less. It's that we're putting more money in and life expectancy is actually decreasing. And unfortunately, it's kind of outside the health system's control.
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Novo Nordisk (Ozempic)
It's a lot of, like, mental health-related stuff, overdosing on drugs. A lot of things impacting the length of life are, you know, cutting 60 years off of people's lives when they're young, which obviously will massively decrease. affect the data. One other thought on this, though, is so from 1850 onward, we got these huge increases in life expectancy every decade.
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Novo Nordisk (Ozempic)
If you look at these charts, it's astonishing. You're like, wow, there's like a miracle drug every year, or there's a miracle process, or there's people are washing their hands, or there's indoor bathrooms, or whatever it is. Life expectancy is getting way better. We were like curing infectious diseases that killed kids all the time.
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Novo Nordisk (Ozempic)
But once we got those mostly covered, at least for the sort of big, large population ones, and we got antibiotics and insulin and all this, if you spend money to help a 75-year-old live to 80, it has a much different effect on the data than helping a 10-year-old live to be 75.
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Novo Nordisk (Ozempic)
And once you compound that with the low-hanging fruit, of course it's going to be really expensive to figure out how to make that 75-year-old live to be 80, especially if... there's a big fragmentation of disease.
Acquired
Novo Nordisk (Ozempic)
Right. We rarely are getting the silver bullets like we did with antibiotics. It's going to be $2.3 billion over here to cure this form of melanoma, and it's going to be $2.3 billion over there to cure this form of pancreatic cancer. It's just going to, I think, just going to keep getting more expensive to cure the more fragmented small population things.
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Novo Nordisk (Ozempic)
I think there's a reasonable question of like, what do we do about that as a society? Now that's on the benefit side. There might be some massive cost reduction side. Like you could imagine some technology comes along that makes drug development way cheaper or makes us able to like massively collapse the time and dollars spent in a clinical trial by using AI or something.
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Novo Nordisk (Ozempic)
Or there might be ways to collapse costs 10 or 100x somewhere in the healthcare system. But the current state of affairs is not very free market-y. So it's harder to imagine that happening versus other ecosystems the way it happens in tech.
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Novo Nordisk (Ozempic)
A couple other just like fun things that I heard from people during research, which I think are just like interesting problems to think about. The health system that was created over the last century was really designed to treat acute and infectious diseases.
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Novo Nordisk (Ozempic)
If you think about our healthcare system as it exists today, hospitals where you go in when you're sick, doctors that you see when you're sick, surgeries you have when you have an issue, pills that you take when you have an infectious disease, antibiotics that you take, you look at the chart of life expectancy, the people that designed that system and solved the acute infectious disease problems should just hang up a big mission accomplished banner.
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Novo Nordisk (Ozempic)
Human quality of life is just unbelievably high, and there's very little in common today on the list of things that will kill you versus 1850. It's a completely different set of things. So the next frontier then is chronic illnesses, and they catch up with us later in life, and they're basically undetectable for like the first 50 years or the first 30 years.
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Novo Nordisk (Ozempic)
I mean, obesity leading to diabetes or cardiovascular health leading to heart attacks and strokes. These are very different things to treat and require a very different way of thinking, of regulating, of paying for. You don't want to wait until people are sick to treat it because then it's too late.
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Novo Nordisk (Ozempic)
And so in many ways, this entire old system that we created that consumes 18% of our GDP may actually not make sense in this new world of treating the things that are more likely to kill us now, which is chronic illnesses.
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Novo Nordisk (Ozempic)
I don't really know what to do with that. I think it's a pretty interesting.
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Novo Nordisk (Ozempic)
Well, it's so hard in healthcare because there's so many buzzwords. Like there's a thing called value-based care, which in a sense, it makes sense. It's like, we shouldn't have to pay for every little intervention someone does. We should pay for them helping me cure the thing. Don't pay for the interventions, pay for the outcome.
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Novo Nordisk (Ozempic)
But in healthcare, the way everything gets built is on a cost basis, which we've talked a lot about cost plus pricing and the dangers of that on the show. So, I mean, to the extent that the value-based care stuff helps, no, I didn't hear any solutions.
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Novo Nordisk (Ozempic)
I did hear one credible pushback against why is healthcare getting so expensive as a fraction of GDP. We use a lot more healthcare. People just have a lot more life-bettering interventions, be it from doctors, from pills, from facilities, than we did a long time ago. And so, like... I don't know. I had two surgeries a few years ago, one of which was an ACL surgery and like a whole bunch of PT.
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Novo Nordisk (Ozempic)
And in 1980, would I have had those? Maybe the PT, probably a worse surgery because the procedures were worse back then. In 1950, would I have had an ACL surgery at all? No, I'd probably just limp around the rest of my life. There really is just actually a lot more care delivered now than there used to be.
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Novo Nordisk (Ozempic)
All right, we're kind of drifting into value creation, value capture here, because we're making sort of societal judgments around, you know, are the economics worth it? Do you want to formally enter that section of the show?
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Novo Nordisk (Ozempic)
Well, a lot of people talk about, does the pharma sector over-earn? This is sort of the way people talk about this. And on other episodes that we've done, there's far less of a value judgment. We're kind of like, yeah, companies should go be as profitable as they can be. My God, Visa makes so much money.
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Novo Nordisk (Ozempic)
And like, that's a little bit tongue-in-cheek, but in healthcare, it's sort of different because there's an expectation that you sort of start from a place of public good. And then when healthcare companies earn too much money, you sort of look at it and you're like, ooh, I don't know if I like that. which is so interesting, right?
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Novo Nordisk (Ozempic)
It's a very different starting place than I think a lot of people tend to look at businesses. But one thing that is true is that these businesses require a tremendous amount of investment. And so just merely looking at their margins is stupid. I alluded to that earlier, but like, of course they have high gross margins.
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Novo Nordisk (Ozempic)
For the things that they actually end up selling rather than killing, they should.
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Novo Nordisk (Ozempic)
all the research, because those are below the line costs, and all the failures, because they never sell those drugs. So you basically have to say, well, all the margin dollars they earn from the winners both have to cover all the fixed cost R&D of that drug, but they also have to cover all the failures of every other drug.
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Novo Nordisk (Ozempic)
So when you actually look at their return on invested capital numbers, the ROIC, they are not through the roof. They're like 13% industry-wide. But hold for Novo for a second. It's totally in line with other industries like trucking, broadcasting, electronics, when you sort of look at the federal data on it.
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Novo Nordisk (Ozempic)
I mean, the fact that on the blockbuster drugs, the companies earn a ton of money is not the whole picture. The picture really is like, as an industry, are they over-earning? No. They kind of used to until like 2000. But nowadays, the ROIC numbers are just actually not that interesting.
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Novo Nordisk (Ozempic)
And in fact, some would argue that as pharma gets less and less efficient, capitalists should just not allocate their dollars there. Because there's literally not enough incentive in the profit dollars that you get to earn from your drug after it's patented for many years. Like, should you actually index the pharma sector? Probably not.
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Novo Nordisk (Ozempic)
I mean, it's a little better than other sectors, but not necessarily enough to take the sector risk of putting all your dollars there.
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Novo Nordisk (Ozempic)
Now, Novo Nordisk, on the other hand, massively outperforms their peers. And there's been this really interesting trend where ROIC for pharma as an industry over the last 50 years has declined, but the variance between companies has increased. And so Novo far outperforms the median pharma company in terms of return on invested capital. But there's companies that way underperform too.
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Novo Nordisk (Ozempic)
And it's interesting that the good companies are getting better and the bad companies are getting worse while the whole industry declines in its ability to produce a return.
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Novo Nordisk (Ozempic)
Right. It may also be play compounding games in big markets. I mean, it's very clear, even if not intentionally, that a lot of Novo's historical work led to them understanding something important better than anybody else. And I think they might have lucked into how important it became, but play compounding games.
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Novo Nordisk (Ozempic)
It's pretty interesting. I mean, pharma as a whole of the medical pie only occupies about 13% of revenue. I really would have thought with all the hate toward big pharma that it would be higher.
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Novo Nordisk (Ozempic)
Right. If you could trade never having drugs again or never having doctors again, which one would you pick?
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Novo Nordisk (Ozempic)
Yeah, of course it is. But do you think drugs only provide 13% of the value to all of healthcare?
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Novo Nordisk (Ozempic)
especially incrementally. If the investments we're making going forward in improving humans and their quality of life, some amount of it comes from amazing new surgeries, some amount of it comes from amazing new medical devices, but some amount of it does not come from new administrative billing practices or
Acquired
Novo Nordisk (Ozempic)
Right. The improved ability to move a drug from place A to place B and come up with yet another clever way to build out the formulary so it moves money from this pocket to that pocket. Hospitals, if you back out the drugs they prescribe, hospitals are 28% of the revenue in all of healthcare. which is large, but hospitals provide a crap ton of value.
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Novo Nordisk (Ozempic)
Professional services like doctor's offices are 26%. They also provide a lot of value. Do both of them provide together four times as much value as the breakthrough drugs do? I mean, freaking health insurance, the administrative costs of health insurance are 8%.
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Novo Nordisk (Ozempic)
And pharma, I will say, like, who is taking any risk in this whole ecosystem? It's only pharma.
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Novo Nordisk (Ozempic)
Who's taking risk to innovate and make anything better? Every other bet that a hospital makes or that an insurance company makes is just probably going to pay off. This is actually pretty interesting. If you look at the net income of a pharma company, and let's just take the biggest one or a very large one, Pfizer, super spiky. Even though they're diversified, up, down, up, down, up, down.
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Novo Nordisk (Ozempic)
Some years they make very little profit. Some years they make a lot of profit. That is what you should expect from someone who is taking risk, trying to innovate. Sometimes they succeed, sometimes they don't. You look at an insurance company, and by the way, let's define insurance company.
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Novo Nordisk (Ozempic)
It's 100% right. So we just had the single greatest healthcare crisis in the last several decades with COVID. And what happened to the profits of the big health insurers? They stayed flat or grew. So, I mean, we aren't here unacquired to demonize people for making money or for being capitalists, but I do think we should call a spade a spade.
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Novo Nordisk (Ozempic)
The health insurance companies are not actually insurance. They're not actually holding the bag as the funder of last resort when calamity hits. It's the government. So really, it's the taxpayers. The big insurance companies and the PBMs make good profits in the good times, but the taxpayer funds the bad kinds.
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Novo Nordisk (Ozempic)
I would be kinder here to the middlemen of the industry if I thought they were innovating and taking risk the way that the drug companies are. But the incredible consolidation that's happened among insurers and PBMs and, I mean, frankly, even hospitals and pharmacies, too.
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Novo Nordisk (Ozempic)
Like, there's either local monopolies in the hospital case or kind of a three-race oligopoly in every other part of the value chain that really is just obfuscated and insulated profits. Hmm.
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Novo Nordisk (Ozempic)
Exactly. No matter what value judgments you want to place on them or anyone else. And there are years where pharma way out earns. And frankly, Novo Nordisk has way out earned many of their peers many years in a row. And it's like a very fine question to ask of like, does any healthcare company deserve to have such phenomenal returns on invested capital like Novo Nordisk does? But
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Novo Nordisk (Ozempic)
There are many players in the ecosystem for whom it is obvious to me that they should not be as large and not be as profitable as they are.
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Novo Nordisk (Ozempic)
Yes, and frankly, Team Pharma, at least relative to its reputation. I think there are many players in the healthcare industry that have a fine reputation, and they probably deserve a fine reputation, but it's weird to me what a terrible reputation Pharma has when they're the ones innovating and trying to massively affect the trajectory of humans.
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Novo Nordisk (Ozempic)
Yep. All right, so finally to wrap this section, listeners, this is all very, very complicated.
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Which is, by the way, amazing that a type 1 diabetic has made it sort of this far in life and is in the early 20s doing transatlantic travel.
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Every time I was tempted to say, well, XYZ party or XYZ mechanism is stupid, which I probably did too much on this episode, I discovered a very rational argument for why that thing exists and why it isn't all that bad, which is a little bit maddening to research and also explains how the system in America ended up the way that it did today.
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To close value creation, value capture, there is sort of an interesting thing that everyone should just noodle on and try to square the circle. People feel like drugs cost too much, and they don't understand how much they're going to cost, and they're upset because they can't get drugs that they want. They think they're being extorted in some way. This is patients generally.
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Shareholders in pharma companies feel like they're actually not making that much money. If you look at the whole industry, their return on invested capital is maybe slightly better, but pretty much on par with other industries. So square that circle. It's pretty weird. All right, bear bowl, David. And we can be reasonably quick in this since I think we've hit a lot of these points along the way.
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Right, even if Lily's Manjaro and Zepbound are like, I think they're like 30% cheaper, they might be better, but they can both make a ton of them and all of them will get pulled off the shelves right away.
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Yep. I think that is exactly the right way to put it. For some numbers, which I think are interesting and just sort of to illustrate, if semaglutide becomes truly a mega blockbuster, an example of this is Humira by AbbVie. That generated $200 billion in lifetime sales since Humira was approved for 11 different indications across this whole spectrum of inflammatory and autoimmune disorders.
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So it turns out you actually don't need a deep pipeline if you have a drug that you can be profitable on, where there's not a lot of competitors for it. Your patent actually gives you a good amount of room. You build a brand around it. You get approved for a ton of indications that all have large populations. I mean, there is such a blockbuster that for a decade...
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It doesn't matter how deep your pipeline is or how diverse it is. You just win. And there's a chance that with semaglutide and terzipatide, both Lilly and Novo Nordisk have that for the next decade.
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Yeah, Eli Lilly has this one in the pipeline called Retatrutride that is a triple agonist that adds yet another hormone to the mix. So I think, assuming that Novo stays sort of neck and neck with Eli Lilly as they both keep coming out with better and better versions, that this could be the next Humira, or potentially much bigger than Humira.
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And I think the defensibility is an open question for how many years, but at least the next decade. Yep. One other downside that I think you didn't point to specifically, but you sort of meant in saying there's some unknown downside to this. There are some early studies that are showing that you lose more lean muscle mass when you're on a GLP-1 than if you were just doing diet and exercise.
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When you're losing weight normally, you lose like 25% lean muscle. And these early studies are showing it's something like 40%. So that would be a bear case is that we learn a couple of years from now, like, oh man, this is actually way...
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Novo Nordisk (Ozempic)
worse for some set of people that could lose weight through diet and exercise but if you're obese it's still probably better to lose weight even if a disproportionate amount of it is lean muscle mass but i think there's sort of this open question of like is there a boogeyman in the closet like that or is that a significant enough boogeyman to really change things
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Novo Nordisk (Ozempic)
Yep. All right. Well, as much as I don't like leaving it there, I think we have beat this horse and we should do something fun like carve-outs.
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One is something that my wife got me as a Christmas present, which is the Knox Gear Tracer 2. And this is, I think, a Columbus, Ohio company. It is a running vest and some lights that are rechargeable with USB-C and waterproof. And so it's super lightweight. It fits really well.
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Novo Nordisk (Ozempic)
I know. I wear it on all my winter runs when I'm out walking the baby now. Oh, you sent me a photo and you were all lit up.
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Novo Nordisk (Ozempic)
It's pretty hard to hit you when you're this lit up. It also has a optional light you can buy that clicks into the front that's basically like a headlight, but you wear sort of on your chest. You don't really feel it when you're running with it, but you do light up the whole road in front of you. So when you live in a place like I do that is dark from 3.30 p.m.
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Novo Nordisk (Ozempic)
Yes. To our Danish friends and our Swedish friends at Spotify, I highly recommend this product.
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Novo Nordisk (Ozempic)
It is really hard to imagine a bigger market to go after, which is why Novo Nordisk has become Europe's largest company, surpassing even LVMH last year, David.
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Novo Nordisk (Ozempic)
All right, two is a recommendation from friend of the show, Ian McCormick. He texted me and said, I listened to the holiday special. I have a show recommendation for you. Go watch Drops of God on Apple TV+. I'm three episodes into it, and it is awesome. It is, like, thrilling. It's a little bit...
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Novo Nordisk (Ozempic)
unapproachable if you don't like subtitles because it takes place in france and japan and so parts of it are in french parts of it are in japanese and parts of it are in english and so you have to read subtitles for the majority of it but it is a beautiful story about wine and family and love and it's got some very unexpected twists and turns and drama to it so i highly recommend it oh Fun.
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Novo Nordisk (Ozempic)
Sounds like Apple TV's got some good shows these days. I've been liking it.
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It's funny. I've been holding off on reading the book because I don't want to spoil the show too much, but I hear it actually deviates pretty significantly from the show.
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Novo Nordisk (Ozempic)
So it was like a competitive advantage to be a Nobel Prize winner on an international lecture circuit because you got better, faster information about brand new medical advances.
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Novo Nordisk (Ozempic)
For listeners, Dave and Jenny lived in Seattle, and Jenny was involved in the ballet up here. And I went to an event held where the ballet performs. And it's immensely cool to be in there with the performers and at the place where they perform in a party setting. I highly recommend it for any of the before or after stuff, too.
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Novo Nordisk (Ozempic)
Although, did you just see the add-on keyboard you can get for your iPhone? Oh, no. Someone debuted a physical keyboard. So for you diehards out there who were Crackberry heads.
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Novo Nordisk (Ozempic)
You missed the clicks. I think it's actually called clicks, maybe. Oh, nice. With that, we have a bunch of people to thank who massively contributed to this episode. It's been fun doing more and more of this recently, so I think we'll keep doing it too. A huge thank you to the PillPack founders, TJ Parker and Elliot Cohen, for being so generous with their time and having conversations.
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Something like that. It became Amazon Pharmacy, which I actually know some people that use and rave about it. Also, thank you to the founder of Cover My Meds and AndHealth, Matt Scantland, the founder of BlinkHealth, Jeff Chaykin, the CEO of JP Morgan's healthcare arm, MorganHealth, His name is Dan Mendelsohn.
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Had an awesome conversation with him and the other folks I mentioned to kind of bounce some ideas around that we were thinking about as what are the main points that we really need to hit in this episode. Good friend of the show, Kate Karams, who spent her career at various pharma companies. And finally, thanks also to some of my favorite reading materials to prep for this.
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Out of Pocket, the newsletter from Nikhil Krishnan. Very approachable, fun way to read about the healthcare industry. A shareholder letter from Tom Williams, who's a friend of the show and a portfolio manager at Fidelity.
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Some blog posts from the Drug Channels Institute that were publicly available that I thought were great. Some very helpful DMs with Ashwin Varma. who pointed me to a lot of the great information about the profitability, or frankly, lack thereof, or the returns on invested capital for pharma industry.
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He's actually a med school student and former Lux Capital associate, so he's got a foot in both the capitalist and the medical camps. And a truly incredible long-form read on GitHub by Alex Telford. I think that helped frame my understanding of how we got here in drug development better than really anything else I read. So thanks, Alex, for that too.
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With that, our huge thank you to JPMorgan Payments, ServiceNow, and Vanta. You can click the links in the show notes to learn more. Sign up for notifications of when new episodes drop, acquire.fm slash email. You can also get our follow-ups and the corrections and teasers at what the next episode will be. ACQ2, you should go check it out.
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It is where we do follow-up interviews when we have topics we're more interested in. Perhaps we'll do that for healthcare or just CEOs or investors that we want to talk to. Look in any podcast player. After you finish this episode, come discuss it with us at acquired.fm slash slack. And if you want any of that sweet acquired merch, go to acquired.fm slash store.
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And this is a pretty similar deal that they cut with Eli Lilly. That was for North America. They basically gave him the same thing for Scandinavia.
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Novo Nordisk (Ozempic)
This is something. So you read more about the Novo Nordisk history than I did. Was it cows or was it pigs? Because I know that Denmark has an abundance of pigs, which actually made it pretty well suited to be an early insulin manufacturer.
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Novo Nordisk (Ozempic)
Right. This is like a very real problem for insulin all the way up until like the 1980s, which is you are scale constrained by the number of dead animal pancreases you can get your hands on and i found this wild stat it takes 8 000 pounds of pancreatic glands from 23 500 animals to make a single pound of human insulin
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Novo Nordisk (Ozempic)
Yeah. So why is today, in the early 2020s, the moment in human history for these new GLP-1 drugs? The crazy thing is, semaglutide, the molecule in Ozempic and Wegovy, was pioneered back by Novo Nordisk with the first trial in 2008 for type 2 diabetes treatment. And it was built on research started in the early 90s.
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Novo Nordisk (Ozempic)
And we'll talk about who the pioneers were and how we eventually got out of using animals to create insulin in the 80s. But that was also the moment in time where type 2 diabetes really took off. Yes. You're foreshadowing. It's been a 45-year massive issue. But we basically could not have continued to use animal-based medicine to treat diabetes once it really exploded.
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And we should say around this time, I believe Eli Lilly was further along in terms of the volume that they had developed. I think they were making like hundreds of vials a week of usable insulin.
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Yes, we are excited to partner with J.P. Morgan Payments this season and discuss all the ways they are helping businesses grow and innovate across a broad industry landscape.
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Novo Nordisk (Ozempic)
So whether it's a startup that needs merchant acquiring, which you now know what that is from our Visa episode, or a company building a new multi-sided marketplace, or even a business expanding across borders and having to manage the complications of cross-border treasury and FX,
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The more we dug into the industry and the more we got to know JPMorgan Payments, the more we realized how relevant it is for founders, CEOs, and operators to be thinking about how to leverage payments as a source of revenue.
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But here we are in 2023, almost three decades later, talking about it as a weight loss drug that sort of magically appeared out of nowhere, or that's at least the public perception of it. Incredibly, the fact that GLP-1 drugs could be used to reduce food intake was actually discovered way back in the mid-90s in the first sort of scientific publication about it.
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Novo Nordisk (Ozempic)
Yep. So let's look at the healthcare industry through the lens of payments. There are multiple ways of innovation on the horizon with telehealth, preventative treatment, and new clinical trial processes. Seamless and secure payments are critical to the improvement of patient experience in unlocking innovation for businesses and providers.
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When you zoom out, this complicated ecosystem of payments, healthcare providers, insurance networks, specialists, health monitoring services, and more... It creates a complex and friction-filled payment experience. Who's paying who, when, under what terms, and then you layer data privacy requirements on top. You can understand why there are a lot of forces impeding change in this industry.
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Novo Nordisk (Ozempic)
Yep. Some of our listeners may have attended JP Morgan's healthcare conference earlier this month in San Francisco. So if you did, let us know in the Acquired Slack. Dave and I are curious what your takeaways were from the state of the ecosystem.
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To learn more about JP Morgan's end-to-end payment solution and how they could be used in your business today, head on over to jpmorgan.com slash acquired, which just feels good to say. I know. Stay tuned to discover how they're accelerating innovation across all the industries we are covering this season. Okay, so David, the founding of Nordisk, how does it happen?
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But only in 2021 did we finish the clinical trials that truly show how effective it can be.
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This is really important to know and really crazy how much this impacts in the future. This is still the corporate structure of the largest company in Europe. And we're going to get to this hours from now in Playbook. But this governance structure massively affects the incentives and the way that this company ends up developing products going to market with them.
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Novo Nordisk (Ozempic)
The future blueprint of the next hundred years is laid right here in this corporate structure.
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Novo Nordisk (Ozempic)
It's fascinating. By the way, this is not that uncommon in Danish companies. Lego, same structure. Maersk, the shipping company, same structure.
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Novo Nordisk (Ozempic)
Yep. Pharmaceuticals is without a doubt the most complex industry that we have ever studied.
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Novo Nordisk (Ozempic)
Yeah. So no shareholder activism in this company, or at least no one's effective in doing so.
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Novo Nordisk (Ozempic)
So to fully understand Novo Nordisk, we need to go back to a simpler time before the Food and Drug Administration, before all this industry consolidation and healthcare oligopolies, before there were treatments for everything we take for granted today, antibiotics, vaccines for polio, tetanus, measles, mumps, you name it. That is where we will start our story.
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Novo Nordisk (Ozempic)
So this schism happens like in the first year of Nordisk's existence?
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Novo Nordisk (Ozempic)
If you want to know every time an episode drops, you can sign up at acquired.fm slash email. These will also contain hints at what the next episode will be and follow-up facts from previous episodes when we learn new information. Come talk about this episode with us after listening at acquired.fm slash slack.
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It's amazing. I mean, it's the local and bitter competition. It's Ferrari and Lamborghini. It's Aldi and Trader Joe's. It's Adidas and Puma. You sort of create the seeds of competition early, and you can really infuse that into a company's DNA for decades.
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There's basically nothing other than food that you can sell someone for their entire life. But for diabetics, insulin absolutely has that scenario with a customer.
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And if you want more from David and I, you should check out our second show, ACQ2, where we interview founders, investors, and experts, often as follow-ups to the topics on these episodes. Before we dive in, we want to briefly share that our presenting sponsor this season, which we are so pumped about, is JP Morgan, specifically their incredible payments business.
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Like a glass syringe with a big needle. No pens, none of this fancy stuff we have today.
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Novo Nordisk (Ozempic)
Yep. And there's no measurement. I mean, there's no like one-touch pinprick. We get to see what your blood sugar content is right now. We're so far from that existing that you are guessing. You're throwing darts.
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We should say, listeners, and David, you know this, this is a topic that is super personal to me. A huge number of my family members are diabetic and actively suffer from the complications and actively benefit from all the advancements in it. And so this is something I've just had present around me my entire life with family members, as I'm sure many of you have too. Yeah.
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Or is pre-diabetic. When I was doing research for this episode, one of the people I talked to, and we'll thank a bunch of folks at the end, but pointed out we're all pre-diabetic in some way.
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And it's basically like the idea that, look, your A1C levels, if you live long enough, will eventually enter diabetes territory, especially with the food system today and all these foods engineered to leave us very unsatiated. All of our natural inclinations that we had as hunter-gatherers and farmers and, you know, imagine the paleo life long ago.
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All the things that served us evolutionarily to stay alive are now the very things that are killing us. So... Everyone's on the path. It just depends how long you live.
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Novo Nordisk (Ozempic)
All right. So Novo, scrappy upstart, counter-positioned, and competition drives innovation. So they create better product.
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which the pharma industry has a rich history of figuring out exactly how to do this. Because the thing about pharma patents, which is interesting, is they're fairly narrow. You can patent a molecule. I don't think this is quite true at the time, but the way it sort of works today is you patent a molecule, which is extremely specific.
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It's different than other industries where it's a system and a method for blah, blah, blah, and you can be very broad with it. So if you can accomplish a similar biological or chemical reaction in the body with a different molecule in basically any way, then unpatented. And so there's a rich history in pharma of doing exactly this.
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Novo Nordisk (Ozempic)
What is slightly next to the patent but does basically the same thing?
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Novo Nordisk (Ozempic)
Yep. We're pumped to explore payments through all these different industries this season through both a technology innovation lens, but also a business model innovation lens. Much more ahead. So with that, this show is not investment advice. David and I may have investments in the companies we discuss, and this show is for informational and entertainment purposes only.
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Novo Nordisk (Ozempic)
So Novo, not Nordisk, became the globally dominant. Really? I did not know that. I actually don't know the terms of the 89 merger. So I'm excited to listen just like everyone else, David.
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Novo Nordisk (Ozempic)
They basically cannot address the market of any allied countries anymore. Right.
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Novo Nordisk (Ozempic)
So just to make sure I have it right, it sounds like Nordisk is only making a small supply for Denmark, Novo is supplying all of Nazi-occupied Europe, and the Allied countries no longer have access to anything Novo or Nordisk makes, and so they're relying on their own suppliers like Eli Lilly.
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Oh, it's unquestionably a good thing. Again, I'm learning about this from the first time from you, but like an evil person commanding me to make more life-saving drugs and distribute it to more people is fine. It's the other things they command you to do that are not fine.
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So this is a pretty big breakthrough. And what you're seeing here is Novo and Nordisk having decades of experience researching mechanisms to slow the absorption of or lengthen the effects of their drugs in the human body and really developing this incredible competency around how do we sort of finely tune how we want injections to react in your body over a long period of time
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Novo Nordisk (Ozempic)
In a very complex environment, you know, you've got the human immune system wanting to react to anything foreign you put into it. You've just got a lot of systems that you sort of have to make sure that you're interacting well with to achieve something simple, like we'll make it dissolve slower. And I know that's not technically right, but that is kind of the blunt way to think about it.
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Novo Nordisk (Ozempic)
I'm really curious if the Eli Lilly folks would agree with that characterization. I know you read that great history of Novo Nordisk book, and I'm sure that's the way it paints it, but at some point we should dig into Eli Lilly a little more and see if that's how they think about it too.
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Novo Nordisk (Ozempic)
Interesting. So just like Novo Nordisk is majority controlled by the foundation's holding company, Novozymes still is also.
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Novo Nordisk (Ozempic)
Oh, interesting. If only they had a cash-rich partner without a lot of CapEx needs.
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Novo Nordisk (Ozempic)
So it's like they're coming to us hat in hand. Why don't we just put the pedal down now that we realize we have the advantage and press?
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Well, and you got to remember, too, in the 70s, there was still kind of a functioning healthcare market. There wasn't massive consolidation yet. And so every level was super fragmented. Manufacturers were fragmented. Insurance companies were smaller. Little doctor's offices existed everywhere. Neighborhood pharmacies were there.
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And so entering the American market, you didn't necessarily need huge scale to do it. And the other thing to note is it wasn't yet the heyday of drugs, like of pharma. There weren't that many drugs that people had high demand for. It wasn't like today where everywhere you look, there's some amazing drug that could save your life depending on what conditions you have that are on TV commercials.
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The federal government, and we'll get into this later, but Medicare Part D wasn't even a thing yet. Drugs were not plentiful enough and good enough yet for the government to cover them as an insurance benefit for people over 65. That's the era we're in, where if Nordisk wants to enter the American market, they kind of can without too many barriers.
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By the way, these numbers are staggeringly small. These are like Series C startup.
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Novo Nordisk (Ozempic)
Yeah, just look at pictures of people in the 70s and look at pictures of people today.
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Novo Nordisk (Ozempic)
Yeah. And to set some context for the time period here, 1921, the public is not aware of what insulin is. The public is, however, aware of what type 1 diabetes is. This is the juvenile form of diabetes. Only 5% of diabetes sufferers have type 1 today. But back then, this was the dominant form of diabetes.
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happened right here in san francisco venture-backed by kleiner perkins and it changed everything former kleiner perkins employee yeah was a co-founder of the company but before we talk about that yes now is the perfect time to introduce one of our other new acquired partners for season 14 an incredible company that we have gotten to know well over the last couple of years service now
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ServiceNow, as many of you know, is the cloud-based platform that automates and manages workflows across the whole enterprise, making everything about the way a company or organization works actually work better for 85% of the Fortune 500. It has also been one of the absolute best-performing technology companies over recent years.
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But what you may not know is ServiceNow is also an incredible Silicon Valley startup story that ranks right up there with Google, Facebook, NVIDIA, Genentech as one of the best venture investments of all time. Funnily enough, the ServiceNow campus is actually right next door to the NVIDIA campus in Santa Clara.
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So fast forward to 2004. Software as a service is just becoming a thing. And Fred is like, whoa, we now have a delivery mechanism that can take what I did for Phyllis back in 72 and scale it infinitely. Now, how many Phyllises are there in the world? Well, it turns out it's hard to remember because ServiceNow changed this forever.
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Every single company back then was filled with people just like Phyllis who spent hours every day on repetitive tasks that software could handle 80% of. So Fred started ServiceNow and took that same simple automation concept and brought it to IT, brought to customer service, HR, ops, risk.
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Kind of like AI is doing now, and ServiceNow is a part of that, they freed up knowledge workers to go create more knowledge across the whole enterprise rather than more forms and more individual point solutions.
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And like Novo Nordisk, it turned out that singularly focusing on eliminating suffering from just one pervasive worldwide disease, in this case, not diabetes, but repetitive manual office work, that was a path to becoming a $100 billion plus Fortune 500 company.
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Novo Nordisk (Ozempic)
And it was families whose kids had a death sentence, and there was basically nothing that could be done. And there were lots of rumors of people trying to figure out what substances you could inject or eat or anything to cure this sort of mysterious, horrible way to die. And people were so convinced in the late teens and early 20s that scientists were on the verge of a breakthrough.
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Novo Nordisk (Ozempic)
The company is Novo Nordisk. Now, when I first learned about Ozempic a few years ago, I thought, of course, this is going to be amazing for a lot of people. And could also completely destroy the market for insulin. Those insulin companies better watch out. But here is the fascinating thing, listeners. Novo Nordisk is the company behind insulin, or at least one of the few big ones.
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Novo Nordisk (Ozempic)
Yep. Okay, so David, the 80s are here. For some reason, in the early 80s, the world starts becoming more overweight. Addictive foods being the cause of this. Yes. More metabolically unhealthy.
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Novo Nordisk (Ozempic)
Yeah, and population growth was a lot slower than that. So definitely the share of the population is massively expanding. And at this point in time, we are still using pigs and cows to harvest pancreases and their islets and their extracts in order to make insulin, even with this incredibly refined process until Genentech.
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Novo Nordisk (Ozempic)
Absolutely. It was the founding first application of the idea that Genentech had of commercializing recombinant DNA. The first implementation was insulin. And to just paint a little bit of a picture of why this is so amazing, it's not just that we now had a way to not rely on animal pancreases. It's that for the first time, we actually had human insulin.
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Novo Nordisk (Ozempic)
It is insulin that is chemically identical to the insulin that naturally is produced by your body rather than injecting something slightly different, you know, from a pig or cow.
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Novo Nordisk (Ozempic)
Yeah, it's interesting that this ended up being more of a manufacturing and scale advantage than an efficacy advantage.
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that the common wisdom was to go on a diet of like 200 to 500 calories a day and starve yourself so that you could live long enough, even though you had a terrible quality of life, you could live the months or couple of years long enough when the treatment did arrive to finally get it.
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Which the timing lines up to really be a nail in the coffin for them. I mean, if this is right after everything you just described with Nordisk scaling up production and compounding at 30% per year and massively growing share, like this is not a good use of Novo's precious dollars right now.
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Sanofi today, yeah, the three of those companies are essentially the entire insulin market.
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Novo Nordisk (Ozempic)
And scale becomes important for R&D. Scale becomes important for trials and approval. Scale becomes important for negotiating with actually getting the product sold. Scale becomes important for everything in healthcare, starting around this time, the late 80s, early 90s, and obviously went nuts till today.
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Yeah, it's an interesting analogy. I hadn't thought of it that way. Yeah, this is a good place to try to understand the pharma value chain as it exists today. I think first off, we should say you basically can't.
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I'm actually not sure there's a human who can hold all of it in their head, and we won't promise to make this comprehensive, but it is worth knowing a few key concepts and the players involved. And I should say, this whole thing only applies to the U.S. market, which many of you listening in other places will be laughing and saying, like, why is this so complicated? But yes, this is how the U.S.
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market functions. So I wrote a sentence, David, that I thought would be a fun way to break it down. And that simple sentence is, a patient buys a drug. But really, actually, that's not how it works. It's like a butterfly flaps its wings. A person doesn't merely buy a drug. So let's actually name all the parties, starting with the manufacturer. A manufacturer like Novo Nordisk develops a drug.
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They sell it to distributors like McKesson or Cardinal Health, who then sell the drug to pharmacies like CVS or your local neighborhood store. The pharmacy then charges a price at the window to a customer. So so far, there's nothing different about how this is working from any retail supply chain. But here's where it gets weird.
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In healthcare, when a consumer goes up to the pharmacy window, they typically don't pay their own money for the price that the pharmacy actually puts on the register. Their insurance company does.
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Novo Nordisk (Ozempic)
Well, the insurance company doesn't want to pay whatever price the pharma manufacturer picked for their drug, and they have huge scale to throw around, so they go negotiate with the pharma manufacturer to try to get some kind of discounted rate. But rather than do that themselves, insurance companies outsource that task to a new type of company called a pharmacy benefits manager, or a PBM.
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Novo Nordisk (Ozempic)
The PBM negotiates with the pharma company for a discount, often in the form of a rebate, that the pharma company pays back to the PBM. They then take that discount, they keep some of it for themselves, and then they pass some of it back to the insurance company, who can then choose to share it with the employer in some way.
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Novo Nordisk (Ozempic)
And as you can imagine, when there are this many middlemen in a transaction... Yeah, so that's what...
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Novo Nordisk (Ozempic)
The PBM, the insurance company, the distributor, and for some reason employers are involved.
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Novo Nordisk (Ozempic)
Well, I don't think it's a sided market. There's two good diagrams that I found in the research that will put on the acquired Twitter account and the threads account to kind of get access to these visuals that I think are pretty good illustrations of the way the dollars flow and the way the product flows.
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Novo Nordisk (Ozempic)
But you can imagine when there are this many middlemen in a transaction, it's really hard to have a functioning market.
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Novo Nordisk (Ozempic)
to actually interpret demand signals and have them clearly flow all the way upstream and for the end consumer to really be treated as the customer versus just like a statistic in a large aggregated basket, we've sort of lost the plot in being able to actually have a functioning free market. But anyways, I want to do a little dive into each of the parties to understand what they do.
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Novo Nordisk (Ozempic)
The drug manufacturers, like Novo Nordisk, do all the R&D and they do all the production. They also own the responsibility of the clinical trial. So they work with partners to do this, but proving that the drug is safe and efficacious is up to them. there's the distributor wholesaler that does exactly what you think they do. They buy all the drugs from all the pharma manufacturers.
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Novo Nordisk (Ozempic)
They warehouse and distribute them. They actually do take risk. When I say they buy, they actually do buy them and hold them, and they end up distributing them to the pharmacies. Pharmacies do exactly what you think they do. Those companies have gotten merged into PBMs in some cases, and so it's, you know, thinking of CVS as just CVS is not really right anymore.
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Novo Nordisk (Ozempic)
It's CVS Caremark, so they're sort of with a PBM, there's the Walgreens Boots Alliance, which is the way they named it is sort of all you need to know. So the way to think about pharmacies is that there are a few big ones and that is kind of what matters, even though there are many people interested in keeping a thriving, independent set of pharmacies out there. Then there's the PBM.
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Novo Nordisk (Ozempic)
I mean, we're just not that many decades after snake oil salesmen, patent medicine. We talked on the Standard Oil episode about John D. Rockefeller's father literally selling snake oil, and that's just barely in the rearview mirror. This is one of the earliest breakthroughs in modern science.
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Novo Nordisk (Ozempic)
Yeah. Well, in the old days, there were lots of drug companies and lots of insurance carriers. And so it would be nice if every little insurance company or every employer didn't have to go negotiate directly with every drug company to get all the best prices. So PBMs provided value by doing that on everyone's behalf.
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Novo Nordisk (Ozempic)
PBMs created what's called a formulary, which is basically a big ledger, a big list of drugs and the prices. And obviously today, that is less necessary because there's less fragmentation given all the mergers that have happened. But the PBMs still establish themselves as a key sort of immovable piece of this puzzle. So are they sort of like agents now? Is that the right way to think about them?
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Novo Nordisk (Ozempic)
Agent implies that the principal can sort of make a decision to go elsewhere. You're not going elsewhere.
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Novo Nordisk (Ozempic)
Well, that's the key question. So maybe a little more context on PBMs, and then let's try to answer your question, David. So one, they're huge. PBMs manage pharmacy benefits for 266 million Americans. And that number's old. That's as of 2016. So think about, like, basically all Americans get their prescription drugs through a PBM.
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Novo Nordisk (Ozempic)
Despite there used to being hundreds of PBMs, there's now fewer than 30. And there's essentially three that cover about 80% of the market. And those are Express Scripts, CVS Caremark, and OptumRx, which is actually owned by United Health Group. So interesting to know that Caremark, that PBM, is... corporately bundled with CVS, a pharmacy, but OptumRx corporately bundled with an insurance provider.
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Novo Nordisk (Ozempic)
Yes. So if you want to be a little bit cynical about it, you can say they've really become kind of the gatekeeper for consumers getting access to drugs since a doctor is not going to prescribe a drug if only two of the three big PBMs have it on a negotiated agreement there. So each PBM individually has control or almost like a veto.
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Novo Nordisk (Ozempic)
If a PBM says, well, we're not going to work with that drug or that drug manufacturer, doctors aren't going to keep a big list in their head of what insurance companies work with what PBMs that have what drugs. So as a pharma company, you kind of need all three big PBMs to come to some terms with you to be on their formulary and handle the reimbursement for your drug.
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Novo Nordisk (Ozempic)
So one other way you can kind of think about it is a PBM is sort of like a health insurance company, but they just do it for the pharmaceutical benefit and not all the other stuff that the health insurance companies do. So you talked about prices. A major mechanism for the way that these prices are negotiated and set is the rebate mechanism that the PBM negotiates.
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Novo Nordisk (Ozempic)
We were still years away from antibiotics and certainly decades away from the popularization of antibiotics as a treatment. So this was the big breakthrough.
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Novo Nordisk (Ozempic)
So manufacturers usually have to pay the PBM a rebate, which lowers the net price of the drug. even though the list price stays the same. So there's a sticker price, but then there's a rebate that, you know, once the PBM pays the sticker price, actually the drug manufacturer... How does any of this get past the DOJ? Great question.
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Novo Nordisk (Ozempic)
So initially, the rebates worked well for drug manufacturers since there were a lot of PBMs and they could negotiate. But now that there are three big PBMs, the pharma manufacturers have essentially lost all their leverage in most cases. I'll say in most cases, and we should come back later to what are the exceptions. So rebates are extremely high.
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Novo Nordisk (Ozempic)
Eli Lilly has publicly claimed that the cost of these discounts and rebates accounted for 75% of the sticker price of insulin. If you're getting a rebate on 75% of the total price, the sticker price is not the price.
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Novo Nordisk (Ozempic)
Well, PBMs say that they tend to pass most of the rebate along to the health care plan.
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Novo Nordisk (Ozempic)
And the health care plan says they share it in some fashion with the employer in some part of their agreement to be the health care provider, the insurance provider for the employer. But this is a quagmire of a debate that is out of scope for this episode. And my favorite quote from one source that we talked to described rebates as a game of hide the sausage. Oh, gosh. Wow.
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Novo Nordisk (Ozempic)
But yes, you're right, David. Nowhere in there did I say, oh, the patient gets the rebate. You can see how demand signals from patient and actual sort of clearing prices of a patient and what they're willing to pay for a drug, all that signal just gets lost in all of this middleman mania. Wow. So that is the current state of what happens when many people or most people go and fill a prescription.
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Novo Nordisk (Ozempic)
It's crazy. The two guys that split off and went to be cowboys and start their own little competitor, even though they didn't have the license, ended up creating the bigger company.
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Novo Nordisk (Ozempic)
And to put a finer point on it, Banting and Best didn't even know what the hormone was. Even when they did figure out what to extract, they thought it was sort of this soup of a bunch of different chemicals mixed together. They wouldn't figure out for years and years and years, oh, this is like one very pure specific hormone that we are isolating here.
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Novo Nordisk (Ozempic)
So they think the writing is on the wall where we need scale in order to function in this changing marketplace. And so we're going to merge in. And what they didn't realize was that the market that they were on top of would actually, sadly, be a tailwind that gets them to scale without merging with anyone else.
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Novo Nordisk (Ozempic)
But this is like the whole C-suite of Meta deciding to sell the company to Apple, and then they just have to go get Zuckerberg's approval to do it. It's literally that scenario.
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Novo Nordisk (Ozempic)
My rubber stamp's feeling like it's not working right now. I'm not sure. Yeah.
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Novo Nordisk (Ozempic)
It's a fascinating analog. And this is, I think, one thing that makes this company really, really unique. But for having foundation control with a very specific charter and mission, this company gets rolled up.
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Novo Nordisk (Ozempic)
And I don't exactly know what the deal terms were, but basically in public company land, if anybody comes to you and offers you 25% to 30% higher than your shares are currently trading, congratulations, they get to own your company. And that didn't happen.
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Novo Nordisk (Ozempic)
So before we tell the story of how GLP-1s started being researched and the very unlikely place that they came from, we want to thank our longtime friend of the show, Vanta, the world's leading security compliance and trust management platform. Vanta automates your security reviews and compliance efforts.
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Novo Nordisk (Ozempic)
So frameworks like SOC 2, GDPR, FedRAMP for payments, and critically for healthcare, HIPAA compliance and monitoring. Vanta takes these otherwise incredibly time and resource draining efforts for your organization and makes them fast and simple.
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Novo Nordisk (Ozempic)
Yeah. I spent a bunch of time reading this book, Breakthrough, by Thea Cooper and Arthur Ainsberg, and they go way into this. Basically, this team was the first one to figure out you could target the pancreatic islets and isolate the extracts in a relatively pure form. And, you know, pure by their standards, not certainly by today's standards.
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Novo Nordisk (Ozempic)
So enter Vanta. Vanta takes all the spreadsheets, fragmented tools, and manual reviews that go into managing modern security and compliance requirements and turns them into a single software pane of glass that connects all of your services via APIs and eliminates 90% of the work for your organization.
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Novo Nordisk (Ozempic)
Yep, and it scales all the way up from seed-stage startups to large enterprises like Autodesk, Gusto, ZoomInfo, many large AI companies, and more. They have over 6,000 customers now and are quite a large enterprise themselves.
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Novo Nordisk (Ozempic)
So if your company is ready to automate compliance and go back to making your beer taste better, head on over to Vanta.com slash acquired and tell them Ben and David sent you. And thanks to our friend Christina, Vanta's CEO, all acquired listeners get $1,000 of free credit. Our thanks to Vanta. So David, glucagon-like peptide 1 receptor agonist. What is it and where did it come from?
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Novo Nordisk (Ozempic)
Yeah, remarkably, there is this paper, I guess it's a paper, called Inventing Liraglutide, a glucogen-like peptide, one analog for the treatment of diabetes and obesity, that was published in 2019. But it is a first-person account by Lata of the entire journey
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Novo Nordisk (Ozempic)
and her career and how all the research went down and where it came from that is published in ACS Pharmacology and Translational Science publicly available to everyone. Like she has just told the story and it's very academic scientifically written, but it's super cool that she's the hero of this story and sort of got to write how it all went down.
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Novo Nordisk (Ozempic)
But you're right, totally crazy extracting from these dogs and injecting in humans in extremely limited quantities. Once they figured it out, it was still hard to then go from there to like getting it to people because they're like, well, okay, we did this thing that kind of worked once from like one dog into one person. So where do we go from here?
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Novo Nordisk (Ozempic)
Seems pretty straightforward. In fact, why don't you just go eat some GLP-1? Just get it into your body however you want. I'm sure it'll work out.
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Novo Nordisk (Ozempic)
All right. And she's been doing research on this since like 91, I think is when her and the team started cranking away on GLP-1 research inside Novo.
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Novo Nordisk (Ozempic)
The mechanism... by which it does this is totally fascinating. So you mentioned that the fatty acid gets attached to the GLP-1 to create this GLP-1 analog. The way it basically works is it has to bind in a very specific location such that the receptor is not blocked, but it is sort of grafted onto that molecule so they can travel together.
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Novo Nordisk (Ozempic)
The fatty acids then make it so the GLP-1 can bind to another protein, which I believe is pronounced albumin, which is this really large protein that is very common in the bloodstream.
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Novo Nordisk (Ozempic)
And so it protects the GLP-1 molecule from the degradation by enzymes, and it protects it from being sort of quickly cleared in the kidney because that sort of bound molecule is now too complex, too large to be filtered. So it kind of makes it like... a big truck bouncing down a small highway in that the molecule is protected.
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Novo Nordisk (Ozempic)
Now, you might say, well, that's okay, because they're probably a big pharmaceutical company that's, you know, very diversified with lots of different drugs. Nope. No. Novo Nordisk is unique in that the vast majority of their revenue is concentrated in the category of metabolic health. They have been the insulin and diabetes company for the last 100 years.
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Novo Nordisk (Ozempic)
Yep. The fatty acid sort of, well, it makes it big and stick to stuff.
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Novo Nordisk (Ozempic)
Okay, so 13-hour half-life, you know, this liraglutide can become basically a once-a-day drug instead of an every-five-minutes drug?
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Novo Nordisk (Ozempic)
Not a novo drug, not from Latte's work, and developed in a completely parallel way.
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Novo Nordisk (Ozempic)
David, if I called you and said, ship me a lizard, this is important, would you do it?
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Novo Nordisk (Ozempic)
David, go get that poisonous lizard venom. Take all the poison out and inject it into me, please. That's what I'm asking you to do. Let's see if that works. I just, I have no idea how this got proposed and why people thought this was a good idea, but like incredible that it worked. Incredible.
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Novo Nordisk (Ozempic)
So in 1995, Daniel Drucker had a lizard shipped from Utah to his lab and he started experimenting with the deadly venom. David, aside from the research done at the VA, do you know where Daniel Drucker was a researcher?
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Novo Nordisk (Ozempic)
I'll give you a hint. Daniel Drucker was not a researcher at the VA. He was at a university. Ooh. Daniel Drucker, and I believe still to this day, was a researcher at the University of Toronto.
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Novo Nordisk (Ozempic)
And he owns the domain glucagon.com to establish some extra credibility.
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Novo Nordisk (Ozempic)
Yeah, so it seems best I can tell that there were sort of parallel research efforts being done on the early GLP-1 and sort of place to find GLP-1 in the world to eventually turn it into a product.
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Novo Nordisk (Ozempic)
I can barely remember to take my multivitamin orally once a day. Asking anybody to do something, especially invasive, twice a day is a big behavior change.
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Novo Nordisk (Ozempic)
And it's important to remember what these GLP-1 agonists are actually doing. It's just generally raising the baseline of your body's own ability to secrete insulin. It's sort of making you behave more like a person without diabetes than you otherwise would. Yes, correct. But many people still would need insulin on top, depending how far along the spectrum you are. Yes.
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Novo Nordisk (Ozempic)
And you can imagine the incredible high wire act in the early days where they've extracted from literally one dog. They've kind of written down the process. Strangely enough, somewhere along the way, the process was forgotten. Someone else had to replicate it. And then they took his notes, combined them with the original researchers, and then figured out a path forward.
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Novo Nordisk (Ozempic)
Yep. And for those who have heard these phrases before, phase one, phase two, phase three, and never knew what they meant, phase three is the really big, really expensive one. And I'm going to quote Alex Telford, who wrote this really amazing, long blog post sort of explaining how the clinical trial process works and why drug development has gotten so expensive and all that.
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Novo Nordisk (Ozempic)
We'll link to it in the show notes. It's one of my primary sources. He says, typically phase one trials focus on safety and finding an appropriate dose, often in healthy volunteers. Phase two on establishing preliminary evidence of efficacy in patients. Phase three on confirming efficacy in a larger sample of patients and collecting robust safety data.
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Novo Nordisk (Ozempic)
And it is worth pointing out when I say the expensive one, 29% of all R&D for a drug is spent right here. So phase one is 9%, phase two is 12%, phase three is 29% with the rest of it sort of coming from that early basic research, drug discovery, preclinical studies, and a little bit later with the regulatory review.
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Novo Nordisk (Ozempic)
But like almost a third of the entire spend of the whole R&D pipeline for a drug is here. So big freaking deal to go through a phase three trial.
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Novo Nordisk (Ozempic)
It's a great question. Thanks to Alex, we have the data right in front of us. So here's the probability that a preclinical study even makes it to the phases. That's 69%. So... You're a little over two-thirds once you enter a preclinical study to graduate to phase one, two, and three. But in phase one, two, and three, about half of them get weeded out each time.
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Novo Nordisk (Ozempic)
So 52% make it through phase one, 36% through phase two, and only 62% through phase three. And once you get into regulatory review, then there's a 90% chance that you get approved. But each one of these gates filters out about half of the drugs that enter.
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Novo Nordisk (Ozempic)
So of the 69% that even make it into clinical development, you've got 36% left at graduating phase one, then 13% left graduating phase two, Then all the way at the end, 8% graduating out of phase three. So it gets pretty winnowed down over that course. But to your point, it's a big deal to enter phase three because it shows that you are one of the 13% that have made it this far.
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Novo Nordisk (Ozempic)
I mean, we discovered the process for refining insulin enough to put it into humans and then lost it and then found it again. This was the state of medical science. And so you have people ringing off the hook, newspapers reporting, the breakthrough is here, the breakthrough is here.
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Novo Nordisk (Ozempic)
Which wasn't a guarantee because there's lots of rat behaviors that then don't replicate in human trials. And so while they were not specifically studying it in this trial, they were studying the effects on type 2 diabetes, the early reports of this might be replicating in humans was promising and surprising. But it wasn't happening to huge degrees.
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Novo Nordisk (Ozempic)
Like with the dosage of liraglutide that they were planning to sort of make the approved dose, it's not like you were seeing this crazy dramatic weight loss. It was just like, oh, that's interesting. You also eat a little bit less when you're on this liraglutide drug.
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Novo Nordisk (Ozempic)
Which in FDA speak is an indication. You're trying to get it approved for a second indication.
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Novo Nordisk (Ozempic)
Yes, the stigma is real. But there's also an interesting product efficacy thing here. So Vox.com put it really well. They said... Not only do weight loss medications have a dangerous history, but there is also a persistent bias and stigma against the disease that now afflicts nearly half of Americans.
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Novo Nordisk (Ozempic)
Obesity is still widely viewed as a personal responsibility problem, despite scientific evidence to the contrary. And history has shown that the most effective medical interventions, such as bariatric surgery, which is stomach stapling, effectively the gold standard in treating obesity, often go unused in favor of diet and exercise, which for many don't work.
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Novo Nordisk (Ozempic)
And they've got like, you know, single digits or dozens of vials of usable insulin, each of which need to be injected into a single patient every few hours in Toronto. So there's not enough to go around. The path forward is super unclear. And this is foreshadowing a little bit, but the era that we're in here in 1921, there is a firewall between industry and medical science.
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Novo Nordisk (Ozempic)
And this is proven over and over and over and over again. You can't just tell people, change your lifestyle. Most people literally can't. There's too many things working against it, including their own biology. Additionally, this is pretty interesting, researchers thought it was actually impossible to create a weight loss drug that was both safe and effective.
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Novo Nordisk (Ozempic)
Yes. I mean, it dates way back even before fen-phen to the amphetamines in the 70s. People are taking speed because that's like the accepted weight loss drug.
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Novo Nordisk (Ozempic)
Yeah, so that scared the crap out of the FDA, out of companies that are pursuing weight loss drugs.
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Novo Nordisk (Ozempic)
It's awful. I mean, that was the worst one, but there's like seven or eight over four decades of these either dangerous or just completely ineffective weight loss drugs. So most pharma companies completely steered clear of the black hole budget item that was weight loss research and development.
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Novo Nordisk (Ozempic)
Totally. And to illustrate this numerically, the annual obesity drug sales were only $744 million up until 2020. The market for weight loss drugs, you know, was just tiny because basically nothing worked and everyone was scared of it. That $744 million included... the commercial sale of liraglutide for weight loss, which had, you know, already been on sale for six years.
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Novo Nordisk (Ozempic)
So why is everyone freaking out about Ozempic now? Like, does it feel like basically nothing worked before? It was true. Nothing worked before in a safe way. So there is sort of this like magic number around if you can actually safely enable someone to lose 10% of their body weight or more, then there's a market.
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Novo Nordisk (Ozempic)
But otherwise, it basically rounds to zero because people just don't think it's worth the trouble and neither do the companies.
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Novo Nordisk (Ozempic)
Now imagine Yerlata and her team trying to get the company to release Alleraglutide for weight loss when that is the company's official position.
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Novo Nordisk (Ozempic)
And it was perceived to be unethical to make money on taking your medical breakthroughs and sort of turning them into companies. And so there's this extreme culture at the University of Toronto around we have to protect anyone from making too much money off this thing.
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Novo Nordisk (Ozempic)
Totally. We still don't know the super long-term effects of it, but we certainly know that months after taking this thing, large populations of people are not having heart attacks.
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Novo Nordisk (Ozempic)
So we got to be really careful and potentially even slow down its development and be really thoughtful about how we distribute it to the world so that nobody takes it and makes too much money.
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Novo Nordisk (Ozempic)
Which is just like a statin or, you know, there's a lot of treatments for chronic diseases that we give people that are drugs that you have to take for the rest of your life. Yeah, you're right. It's like totally different than making a vaccine or making a, you know, hepatitis C cure or something like that. It really is a, for better or for worse, a durable, ongoing, recurring revenue stream.
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Novo Nordisk (Ozempic)
Sort of like the tech industry calling it a unicorn with a billion-dollar valuation. Exactly.
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Novo Nordisk (Ozempic)
And these are like Lipitor, Humira, Atavir. There's a bunch of examples, but that really are a huge breakthrough, address a large enough population. There's a bunch of ways to sort of slice it, but usually they're drugs you've heard of.
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Novo Nordisk (Ozempic)
And you might be asking yourself, how does that work? If the FDA has only approved it for diabetes, what's going on there? Well, it is actually at the doctor's discretion if they want to prescribe an off-label use. So if a doctor does enough independent research or reads a study or... Technically, I don't think the drug companies can provide any marketing materials or sway the doctors in any way.
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Novo Nordisk (Ozempic)
So the information can't come from the drug manufacturer. But should the doctor... believe that this drug would be good for their patient, even though their patient doesn't have the FDA-approved illness, or I guess whatever the indication is.
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Novo Nordisk (Ozempic)
I saw an ad that said, ask your doctor if Victoza is right for you. So I'm asking you if it's right for me.
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Novo Nordisk (Ozempic)
We should say everything in healthcare has a modifier of sometimes, and everything I just said is true sometimes. It's not always true that the doctor has complete control to prescribe off-label, but I think it's a reasonable way to think about it.
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Novo Nordisk (Ozempic)
But David, it's not that effective. You can lose weight taking Victoza, but it's not necessarily a life-changing thing.
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Novo Nordisk (Ozempic)
In research, it is crazy. I heard over and over again physicians and other people in the industry echo this kind of magical 10% weight loss reduction number where there was always this belief in the industry that if something could reliably help you lose 10% or more, then it sort of tips. And Saxenda just didn't get there.
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Novo Nordisk (Ozempic)
Yeah, and right around the same time, you've got the insulin pricing scandal where America is waking up to the idea that insulin is getting more and more expensive and it's becoming more and more essential for a huge population of people. And this is across the whole industry. It's Sanofi, it's Nova Nordisk, and it's Eli Lilly.
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Novo Nordisk (Ozempic)
Everyone's insulin has gotten more expensive and they come under fire in the public eye. And so this sort of Saxenda not being the blockbuster drug that expectations had trumpeted it up to be, plus this increasing pressure around Insulin and I think a CEO change.
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Novo Nordisk (Ozempic)
Yep. But there was that really dangerous narrative that these GLP-1s aren't going to be as crazy as everyone, at least everyone in the know, thinks. And also, their only franchise of insulin is suddenly under fire.
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Novo Nordisk (Ozempic)
Which makes sense, you know, coming out of liraglutide and I believe there's a duaglutide. So we're rolling with semaglutide.
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Novo Nordisk (Ozempic)
Yep. It moves from the domain of irrelevancy to the domain of, is this a miracle drug? In the press.
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Novo Nordisk (Ozempic)
Yep. So a few words on how it affects weight. The natural GLP-1 produced in your gut travels to your brain. This is a hormone that moves throughout your body, much like many other hormones. And it triggers a response to tell your brain, hey, I'm satiated. It tells you that you've had enough, that you feel full, and it can cause you to stop thinking about your hunger.
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Novo Nordisk (Ozempic)
And if you're someone that's constantly fixated on food and restraining yourself from indulging, it can quiet that impulse. or at least reports are that that is sort of what people feel. It can also slow digestion. So not only does your brain think you're full, you literally are now full since the food takes longer to move through your digestive system.
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Novo Nordisk (Ozempic)
You literally have presidents and secretaries of state trying to call in favors and successfully calling in favors to get access to the limited vials that the
Acquired
Novo Nordisk (Ozempic)
And David, you mentioned that 15% weight loss. They're still studying exactly why it works, but it's believed to be that it's sort of these two mechanisms working in action together. And as you can imagine, food taking longer to move through your system kind of can make you feel gross. Like the side effects naturally include things like nausea, vomiting, constipation, things like that.
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Novo Nordisk (Ozempic)
But these reports of side effects are pretty widespread. I listened to a bunch of things, one of which was a TIGAS call with a professor of cardiology that cited about one out of six patients have side effects that are so severe that they discontinue the drug. So it's sort of this, we don't exactly know why it works. We have studied it a bunch, so we know that it works.
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Novo Nordisk (Ozempic)
But you can sort of imagine why the side effects might be linked to the idea that if you're eating, you know, really calorie-dense food, really fatty food, hard to digest food.
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Novo Nordisk (Ozempic)
The thing that's really fascinating to me about semaglutide as a weight loss drug is that you can't just sit around eating pizza and ice cream and lose weight. The laws of thermodynamics in the universe still apply. Your body will always retain the difference between the digestible calories that you eat and the calories that you burn. But the reports from those who are taking it, it's
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Novo Nordisk (Ozempic)
Really more like you just don't want to eat large quantities. You don't want to eat really calorie dense food. And it sort of just changes your habits without you trying or at least you having to try as hard as you did in other attempts to lose weight. You know, it sort of solves the debate that had been going on for decades of is it a behavioral problem or is it a medical problem?
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Novo Nordisk (Ozempic)
Well, if you're taking medicine that changes the way that your body chemistry works, but also literally causes you to naturally change your behavior, it really actually addresses both concerns.
Acquired
Novo Nordisk (Ozempic)
Which, by the way, on earnings calls, the company says, yeah, that's going to be true for a long time. The demand for this drug will continue to massively outpace our supply. And we will be here on earnings calls over and over and over again telling you that no matter how many factories we build, we are supply constrained still.
Acquired
Novo Nordisk (Ozempic)
Well, in February of 2021, after the clinical trial finishes on semaglutide for weight loss, so for Wegovy to hit the market in the U.S., the New York Times runs a story and just calls it a game changer. They say, for the first time, a drug has been shown to be so effective against obesity that patients may dodge many of its worst consequences, including diabetes.
Acquired
Novo Nordisk (Ozempic)
So, like, with the biggest megaphone you could possibly point at people, they're being told, this thing freaking works and it's a miracle drug.
Acquired
Novo Nordisk (Ozempic)
Yep, that is pretty crazy. David, you mentioned it as the GLP-1 company already, and that sort of transition has already occurred. You're totally right looking at the numbers. 51% of their revenue comes from diabetes-focused GLP-1 drugs, and an additional 18% from obesity-related GLP-1. So 69% of their revenue comes from semaglutide or liraglutide. I mean, it's crazy. That happened in a decade.
Acquired
Novo Nordisk (Ozempic)
Insulin has become, to your point, it's still a part of the business, a smaller share of the business. Again, this is of revenue, not of profits. But 22% of their revenue today comes from insulin. That leaves about 9% from the other efforts that they're putting energy into, rare diseases, things like hemophilia. They continue to be a ridiculously concentrated company.
Acquired
Novo Nordisk (Ozempic)
They make about $10 billion a year in net income. So they're also a very, very profitable company, among the most profitable in all of pharma. the 55,000 employees. So it's a huge international company at this point. And I want to talk briefly about margins.
Acquired
Novo Nordisk (Ozempic)
Later, we will talk about why margins are actually not the most interesting measure to look at, but it's worth knowing them because we talk about them on every other episode. Gross margins are better than software. They run about 84%. Lilly is also a very high margin company running about 80%. For context, Microsoft has a gross margin of 70% and Google is 56%.
Acquired
Novo Nordisk (Ozempic)
I assume all the billions they pay Apple comes out of cost of goods sold. All the traffic acquisition costs.
Acquired
Novo Nordisk (Ozempic)
Yep. So at 84% gross margins, you should know they're 10 percentage points higher than your average successful big pharma company. They're concentrated in terms of what they actually focus on, but they're enormous and more profitable than everybody else. So they've sort of threaded a needle that if you were pitched a blank canvas, you would say like, well, it's impossible.
Acquired
Novo Nordisk (Ozempic)
Indiana's got a lot of cow farmers. And so the clever, really startup Eli Lilly, I mean, the company had been around for a while, but this idea of taking on real R&D risk was sort of a new concept. So the sort of startup Eli Lilly is going around hiring salespeople to bang down the door of slaughterhouses all over Indiana and say, hey, I know your waste product includes pancreases.
Acquired
Novo Nordisk (Ozempic)
You need to make a trade-off somewhere. If you're going to be so narrowly focused on just one or two conditions and really one singular interrelated condition of metabolic disorders, either you can't have all the revenue or you can't be so ludicrously profitable. And turns out the thing that they picked, they can be both.
Acquired
Novo Nordisk (Ozempic)
Could be. Everything is really early, but it really might earn the title of miracle drug.
Acquired
Novo Nordisk (Ozempic)
No doubt about that. Well, this is a very good place. I've got a couple of broad topic areas that I want to hit here. Let's start with the general state of affairs of GLP-1s today. So the first thing to know is sticker price. The price of Ozempic to treat diabetes is north of $1,000, and WeGoV for weight loss is north of $1,300 per month before insurance, and this is in the U.S.,
Acquired
Novo Nordisk (Ozempic)
So expensive, right? That's a lot of money. In Canada, of course, Ozempic is $147 a month. In the UK, it's $93 a month. So everything that I'm about to talk about is a uniquely American problem, much like most problems in our healthcare system. So how do these drugs get paid for in the U.S.? Well, that depends. Rich people, just out of pocket if they don't have coverage.
Acquired
Novo Nordisk (Ozempic)
We've seen all the headlines about it being rampant in wealthy New York neighborhoods or around Hollywood, but let's segment that away for a moment and say, well, okay, outside of that. Well, first let's talk about private insurers. You might have coverage by your company's insurance, and this is a good place to talk about the two most pernicious issues in the entire U.S.
Acquired
Novo Nordisk (Ozempic)
And perhaps even more surprising, this pharma giant is unique in that they are owned and controlled by a non-profit foundation. The stats around weight, diabetes, and its impact on our society are staggering. There are 38 million Americans with diabetes. That's one in 10 people. Globally, that number is over 500 million with the disease. Diabetes costs the U.S. alone more than $327 billion a year.
Acquired
Novo Nordisk (Ozempic)
healthcare system that are deeply intertwined. One, incentive alignment, and two is time horizon. So, the average American in the private sector holds a job for 3.7 years.
Acquired
Novo Nordisk (Ozempic)
Insurance companies are going to churn you every 3.7 years or sooner if your company changes the insurance plan. So their incentive is to cover you only in two categories of things. One, things that pay themselves back in less than 3.7 years. Or two, things that have such an overwhelming demand from employees that their employers think that they absolutely have to cover them to stay competitive.
Acquired
Novo Nordisk (Ozempic)
Now, you're sitting there thinking exactly the right thing, which, David, you already acknowledged. But if I lose weight today, I'll benefit in the long run. But will my insurance company lower their costs in some way? I mean, if I'm obese, I'll almost certainly have complications later that'll cost hundreds of thousands or millions of dollars once those become acute conditions. But those costs...
Acquired
Novo Nordisk (Ozempic)
won't be realized by your current insurance or your current employer.
Acquired
Novo Nordisk (Ozempic)
Exactly. The insurers are not really holding the bag for this class, you know, these chronic conditions. This is the crux of the incentive problem in our healthcare system. There is just a mismatch in time horizon. You are invested in your own health for your whole life, but your insurance carrier is not.
Acquired
Novo Nordisk (Ozempic)
Exactly. So what is the exception? The exception is if your carrier is the U.S. government. So let's talk about Medicare. And Medicaid is a whole different discussion that involves states and is unbelievably fragmented, so we'll just not actually talk about it right now. But let's talk about Medicare. So Medicare is through the U.S. federal government.
Acquired
Novo Nordisk (Ozempic)
And it's actually not an easy sale because those farmers are like, it's going to slow down my process if I have to figure out how to separate the pancreases, and this is already a real tight ship. So there's a real entrepreneurial tale of Eli Lilly sort of convincing large, large numbers of slaughterhouses to do this.
Acquired
Novo Nordisk (Ozempic)
It is a health insurance for people who are over 65. Basically, the U.S. federal government funds that plan with taxpayer dollars. And so a while back, which was actually not that long ago, just like 20 years ago, Medicare did not cover prescription drugs at all. Medicare Part D was passed into law in 2003 and took effect in 2006.
Acquired
Novo Nordisk (Ozempic)
It allowed Medicare to cover drugs, not just hospital and doctor visits, which was Part A and Part B. So today, Part D, interestingly enough, is legally prohibited from paying for weight loss, and it is specifically called out that it is legally prohibited. There have been efforts to change this, but there was a bill introduced in 2013 that basically has never been passed to try to get through.
Acquired
Novo Nordisk (Ozempic)
That's part of it, but I think a lot of it is really just this stigma of like, well, you really should be taking care of that yourself. You really should be making lifestyle changes.
Acquired
Novo Nordisk (Ozempic)
Totally. The Wall Street Journal has this great quote, "...the scientific foundation for treating obesity as a disease rather than a lifestyle problem was solidified in the mid-1990s when researchers discovered that fat tissues release proteins that act as hunger and fullness signals to the brain."
Acquired
Novo Nordisk (Ozempic)
This system is out of balance in people with obesity, making it more difficult for them to lose weight. And for those who do lose weight, there are biological mechanisms making it hard to keep it off. So what is so interesting about Medicare is that we will all end up on it one day. when we retire and we get off of our private insurance.
Acquired
Novo Nordisk (Ozempic)
So it does mean the government is left holding the bag with our health for the long term. So there are really two parties with aligned interests for us to stay healthy, ourselves and Uncle Sam. And for us, it's actually quite hard to look out for long-term interests because the feedback loop is too long. So like,
Acquired
Novo Nordisk (Ozempic)
I go out and drink even though I'm going to have a hangover the next morning, and that's only a 12-hour feedback loop. Like, lots of times you make long-term bad decisions. So the question is, can Uncle Sam fix that problem in some way? Well, it is far too early to say whether these recent GLP-1s are actually miracle drugs that massively reduce the complications later in life.
Acquired
Novo Nordisk (Ozempic)
And David, you mentioned there's research being done to figure out It might reduce heart attacks meaningfully and strokes and liver and kidney disease. But if all of these things turn out to be the case, the American taxpayer has a huge benefit in investing early to keep all of our health care bills down later in life.
Acquired
Novo Nordisk (Ozempic)
The other interesting thing to note about the Eli Lilly license, David, which I thought was really clever, is it's a one-year exclusive license where there's two conditions, and the conditions are a trade. One... Eli Lilly has to report back any advances that they make to the University of Toronto. It's almost like a little Operation Warp Speed going on, kind of analogous to COVID.
Acquired
Novo Nordisk (Ozempic)
So I don't have a specific proposal. I'm not saying the government should pay for every single person in the country to be on Ozempic. We'll have to see where the studies kind of net out on the benefits of these long-term things.
Acquired
Novo Nordisk (Ozempic)
And taking the sort of moral thing aside of, like, does everyone deserve a miracle drug if it exists, even if there is no economics around it, it might just be ROI positive for Medicare to do this if... everyone's going to need knee replacements and hip replacements and diabetes treatment and amputations and cardiovascular interventions.
Acquired
Novo Nordisk (Ozempic)
Right. So last thing to say here, payers are scared and rightly scared of how much it will cost them in the short term if they do start covering these drugs. 40%, as we keep saying, of the population today is obese. And the list price of these drugs is over $12,000 per person per year.
Acquired
Novo Nordisk (Ozempic)
So insurance companies, employers, Medicare, they literally don't have the budget right now to fund all the demand for these drugs. So even if we had all the supply, so there's a lot of intentional slow rolling and campaigning to try to get people to look at other interventions first before these drugs, given how colossally expensive it would be right away.
Acquired
Novo Nordisk (Ozempic)
And terzipatide is basically the same. It's a GLP-1 receptor agonist, but it is also a GIP, which is basically bundling two hormones together that act in concert to be certainly a little bit more effective on weight loss from the early trial data, but also potentially more effective on helping your body produce insulin as well.
Acquired
Novo Nordisk (Ozempic)
As they figure stuff out, they have to share it back with the University of Toronto to improve the manufacturing yields of whoever else will be developing the drug. In exchange, the thing that Eli Lilly does get to retain and protect on their own is a brand.
Acquired
Novo Nordisk (Ozempic)
Yep. And it really also just goes to show like it was time. Multiple researchers arrived at similar ideas concurrently, which we see over and over again in the world. Uber and Lyft is sort of our modern canonical example. Cellular connectivity plus GPS plus iPhone sort of made it possible to do something for the first time. Multiple parties were arriving at the same time to do that.
Acquired
Novo Nordisk (Ozempic)
And I think science had sort of just arrived at a place where multiple parties could develop similar things side by side. And so now there's certainly a catch-up race among other pharmaceutical companies who weren't doing this to now try to get into it and see if they can compete. Other things to know about these GLP-1 drugs today.
Acquired
Novo Nordisk (Ozempic)
For diabetes, I try to basically figure out from asking around, what are people actually paying for this? Like, what are most people actually paying? Because list prices of drugs, as we discussed earlier, is stupid.
Acquired
Novo Nordisk (Ozempic)
Yes. So there are a lot of reports of people paying somewhere in the neighborhood of $300 a month after insurance as their actual cost. And to corroborate that, a different way to arrive at that number, one person told me that it is common for most employers to put between a 20% to 50% copay on these drugs. So at $1,000, that's $200 to $500.
Acquired
Novo Nordisk (Ozempic)
So on the one hand, it's still very expensive, $3,000 to $4,000 out of pocket per year. That's probably like... my entire out-of-pocket healthcare spend in an expensive year. You know, that's a big price tag. But on the other hand, if that's the thing that changes your life, that could be seen as an easy choice.
Acquired
Novo Nordisk (Ozempic)
Now, it's easy for us sitting here to say something like that because there's a lot of people that don't have that kind of cash to spend on something that could potentially change their life. So there's definitely a meaningful access problem, not just the supply constraint on the Even at a highly subsidized rate from insurance, a lot of people still can't actually afford the drugs.
Acquired
Novo Nordisk (Ozempic)
Eli Lilly saw it really important early to say, hey, we want to build a brand around insulin so that people know it's coming from us, that it's of a certain quality. And even when we lose our one-year exclusive license and even when we stop contributing the manufacturing IP back to you, the brand actually stays ours.
Acquired
Novo Nordisk (Ozempic)
The last thing I want to say on the current state of GLP-1s is that not adherence is a bigger issue with these drugs than many other drugs that have come before it. There's some research that points out that as many as 68% of people roll off it after a year.
Acquired
Novo Nordisk (Ozempic)
And part of this is related to price or changing insurance that doesn't cover it or that it's hard to find since they're still supply constrained. Or maybe there are side effects that a doctor is not sort of like staying on top of with you. So you just get fed up and you're like, screw this, I'm off.
Acquired
Novo Nordisk (Ozempic)
but a lot of employers and insurance companies are sort of waving their arms around and saying, why are we covering this expensive thing when people don't even stay on it and all the benefit goes away when they get off of it, or at least 90% of the benefit goes away and your weight yo-yos back up.
Acquired
Novo Nordisk (Ozempic)
So there's some very real things to figure out in making sure that you can prescribe these GLP-1s in a way that come with enough hand-holding to help you understand and manage the side effects and make all the behavioral lifestyle changes that you sort of need to to make them be effective and sustainable.
Acquired
Novo Nordisk (Ozempic)
Yeah, it came up in a bunch of Tegas calls. There must have been some hedge fund investor trying to dig into building a model of non-adherence into their DCF.
Acquired
Novo Nordisk (Ozempic)
Well, before we go into analysis, there is a little bit of catching up to do on the insulin market because we kind of left it as, hey, it's still 22% of revenue in Novo's business and, you know, big three companies, Sanofi and Eli Lilly and Novo really compete here and they've iterated to become great products over time.
Acquired
Novo Nordisk (Ozempic)
Well, one thing that we didn't talk about is the complete destruction of how attractive it is to operate an insulin business. And this is super recent. So if you would have asked any of these companies 10 years ago, how durable is this revenue stream and how durable are the profits from the revenue stream?
Acquired
Novo Nordisk (Ozempic)
they probably would have told you that it's pretty durable because we have things like delivery pen mechanisms that we keep improving over time that are proprietary, that give us some pricing power, that we keep revising the formulation so we keep getting the ability to patent new things. It's kind of difficult to manufacture because it is... developed from living cells.
Acquired
Novo Nordisk (Ozempic)
So we're not just pouring chemicals into a vat. We do have to do some complex work to produce the insulin. So somebody is not just going to waltz in here and figure it out. And that was a pretty widely held view. And one of the reasons why I think these companies thought they had so much pricing power, which they got in trouble for.
Acquired
Novo Nordisk (Ozempic)
So one thing that happened was a big controversy over pricing that we talked about. In 2021, U.S. officials alleged that Novo Nordisk increased prices more than 600% between 2001 and 2019 in lockstep with competitors to the detriment of diabetics. Now, Novo, of course, denied this, and they pointed out that the net prices had actually decreased since 2017.
Acquired
Novo Nordisk (Ozempic)
So very convenient that they just talked about the last two years of that 18-year accusation. So my read into that is, yeah, prices were really rising, and yeah, we all thought we had a lot of pricing power, and we don't want to dig too much into it.
Acquired
Novo Nordisk (Ozempic)
Now, if you look at the last five years, and especially the last two, the opportunity to sell insulin for a profit has basically completely fallen apart. So you've got regulation that came in after the public outcry, so there's real price caps on what you can sell insulin for now. Biosimilars also came in.
Acquired
Novo Nordisk (Ozempic)
Biosimilars are effectively what people call generics, but for the category of drugs that involve live cells rather than mixing chemicals together. So traditional drugs have generics and biologics have biosimilars. Biosimilar insulin became a thing. And so a lot of the profits just got completely arbitraged away. And GLP-1s are here, so those are reducing demand for insulin too.
Acquired
Novo Nordisk (Ozempic)
Those three things in the last like five years or so created this complete perfect storm for insulin to be a super unattractive business.
Acquired
Novo Nordisk (Ozempic)
In many ways, they disrupted it just in time. In some ways, you could say, wow, it's so courageous of them to come in and disrupt themselves.
Acquired
Novo Nordisk (Ozempic)
Right. Yeah. Was it courageous, or did they see the writing on the wall that eventually we're not going to make any money from insulin, and so it's time to really start putting our foot on the gas on this thing where we could have bigger market, differentiated profitability? I kind of think it was a happy accident that the timing worked out, but there are different ways to look at it.
Acquired
Novo Nordisk (Ozempic)
Yeah. It's interesting to think about the fact that these companies thought that biosimilars weren't just going to waltz in and, you know, eat their lunch and arbitrage all the profits away. Over time, the market for insulin became sufficiently large that they just had a target on their back. The prize became worth it.
Acquired
Novo Nordisk (Ozempic)
Yeah. $700 million to $2.6 billion. It's just an illustration of how large and how interesting that revenue stream became for other people to go after.
Acquired
Novo Nordisk (Ozempic)
All right, should we get into power? We're kind of there anyway. We're kind of in analysis land here.
Acquired
Novo Nordisk (Ozempic)
Yeah, or put another way, how to be more profitable than their closest competitor and do so sustainably. So the seven powers are counter-positioning, scale economies, switching costs, network economies, process power, branding, and cornered resource. So the first thing I want to say is we are in the pharma industry. And so the one that has a blinking red light around it is Cornered Resource.
Acquired
Novo Nordisk (Ozempic)
Yes. Novo Nordisk has the patent on semaglutide until 2032. And this is an industry where when you have the patent and you are able to make an N of 1 drug, and we're not quite seeing an N of 1 drug here, but it's an N of 2 drug.
Acquired
Novo Nordisk (Ozempic)
you get the profits and frankly the crazy thing is when you look at some of the analysis the profits evaporate within two years of your patent going away now that was from the previous era before biologics so now that things are harder to copy because the molecules themselves are more complex and they require growing living tissue more engineering
Acquired
Novo Nordisk (Ozempic)
Yeah, that would fall more under process power and, frankly, scale economies because it requires more capital. But right now, like historically, pharma is a patent-driven cornered resource industry.
Acquired
Microsoft Volume I
They made the decision not to go to 386 and to discourage it in the marketplace because they didn't want PCs to start creeping into the core enterprise, mainframe IBM workloads, their core business. If that was going to happen, they wanted it to be IBM proprietary closed system. So I think that was a big part of the impetus for this OS2 initiative.
Acquired
Microsoft Volume I
predictably as you can imagine here it's not very good the market does not like it thank god for microsoft and i think again this probably was bill's strategy all along that they hedged with windows with the mac that's clearly the future like the market is not going to accept os2 and a re-centralization on ibm microsoft's just crushing it on the revenue side even though os2 is a failure
Acquired
Microsoft Volume I
Yes. So fiscal 87, Microsoft does $350 million in revenue. Fiscal 88, they do $600 million in revenue. Basically, none of this is from OS2 and the IBM world. And then towards the end of 1988 is when... the wind starts really blowing away from IBM here.
Acquired
Microsoft Volume I
In June of 1988, Microsoft hires Mike Maples, who is IBM's director of software strategy, away from IBM to come head Microsoft's application software. And what is Microsoft's application software strategy right now? It's the graphical user interface. It's everything that IBM isn't. The writing is starting to be on the wall here that divorce is coming between IBM and Microsoft.
Acquired
Microsoft Volume I
And then finally, a year and a half later in 1990, Windows 3.0 comes out. And this is when they get it right. This is when there's enough installed base of 386 and 486 machines out there in the open PC ecosystem that you can have a really good, true multitasking, good UI, graphical user interface running on top of DOS.
Acquired
Microsoft Volume I
DEC had been started by this guy, Ken Olson from MIT. And what they did, he had this brilliant insight that would play out over and over and over again in technology that... I'm not going to go compete with IBM head on. I'm not going to make ENIAC. I'm not going to make mainframes.
Acquired
Microsoft Volume I
So Windows 1.0 and Windows 2.0 only ever achieved 5% penetration of the DOS installed base. Windows 3.0 doubles that in the first six months. PC Computing Magazine writes about Windows 3.0, May 22nd, 1990 will mark the first day of the second era of IBM-compatible PCs. Microsoft released Windows 3.0, and on that day, the IBM-compatible PC
Acquired
Microsoft Volume I
a machine hobbled by an outmoded character-based operating system and 70s-style programs was transformed into a computer that could soar in a decade of multitasking, graphical operating environments, aka everything OS 2 is not. Windows 3.0 gets right what its predecessors got wrong. It drives adequate performance. It accommodates existing DOS applications.
Acquired
Microsoft Volume I
That's what the press thought. Ben, I know you talked to a really important person in the Windows ecosystem and Microsoft internally at this time. What do you have for us?
Acquired
Microsoft Volume I
But computing has advanced enough that there's an opportunity to make something smaller, less powerful, more sort of toy-like. And there's enough demand out there that I think they can find some new markets for people who will buy those types of computers. And it's smaller businesses, but in particular, it's like branch offices of the big companies.
Acquired
Microsoft Volume I
This was, I think, the moment when Microsoft started to believe in themselves, like, Like, you look at the facts, and as we told the story, it was like, oh, yeah, like, Bill did this great business deal with IBM and anticipated the rise of the clones in the first PC and 1, and then, like, Microsoft now was the thing, and IBM was, like, the old thing.
Acquired
Microsoft Volume I
But it wasn't until this when, like, in this whole OS 2 thing, I think you can see, like, they sort of felt like they were still little brother, and they had to go along with what IBM dictated. And now they're like, whoa. Why do we again? Yeah, we're in control. Yeah.
Acquired
Microsoft Volume I
Totally. I've got some fun stats on money and revenue around all this. So in fiscal 1990, the year that Windows 3.0 shipped, Microsoft does $1.2 billion in revenue, making them the first software company ever to pass a billion dollars in revenue. Fiscal 91, they do $1.8 billion. Fiscal 92, they finally win the Apple copyright lawsuit around the GUI.
Acquired
Microsoft Volume I
That's right. like we've been saying too like they both stole from xerox yes fiscal 92 though this is when microsoft just blows the doors off they do 2.8 billion dollars in revenue in fiscal 92 up from 1.8 the year before and that year 1992 in october is when gates finally passes john kluge but
Acquired
Microsoft Volume I
acquired OG fans back to the LVMH episode Gates passes John Kluge of Metro Media fame media mogul to become the wealthiest person in America and so everything you're talking about all the press comes around that and then January 93 the crowning moment, it happens. Microsoft passes IBM in market cap. And it's like, they have inherited the earth. They have inherited computing.
Acquired
Microsoft Volume I
Supposedly, I don't know if this is 100% true. This is written in one of the books I read. I read this. The folks involved will have to confirm or deny. Supposedly, The next month after Microsoft passes IBM in market cap, so we're now in February 1993, the IBM board is in disarray. The empire is going down. They fired the CEO.
Acquired
Microsoft Volume I
So, you know, I am sure General Electric bought lots and lots and lots of IBM mainframes and products at their headquarters. But the GE field office in Seattle, they're not going to truck in a mainframe.
Acquired
Microsoft Volume I
Tom Murphy of Capital City's fame, who is on the IBM board, supposedly he comes out to Redmond to sit down with Bill and personally ask him to come and be the next CEO of IBM. No way. Yes. This is what I read. I don't know if this actually happened, but this is what I read. Is that in hard drive? That's in hard drive, yeah.
Acquired
Microsoft Volume I
Yes. Gates obviously declines that. But whether or not that actually happened, spiritually, you could believe that happened. Bill and Microsoft are the new emperor here. I mean, this carries through to this day. We're going to tell in the next episode here, the antitrust and the fall and all. But not really. Microsoft's still the most valuable company in the world.
Acquired
Microsoft Volume I
Right. Because developers were targeting DOS at this point. They were probably preparing for OS2. Some of them were targeting the Mac, like Microsoft itself, but nobody was targeting Windows.
Acquired
Microsoft Volume I
Well, yeah, and there's some people installing nothing. We should mention here, around this same time, this era, they move a lot of their OEM deals to a per-processor licensing fee arrangement, which gets them in a lot of hot water with antitrust a few years later.
Acquired
Microsoft Volume I
Well, here's how Microsoft, I think, would position it to their OEM partners. You could pay us, you know, a license fee for every machine you ship with DOS installed on it or DOS and Windows. And, you know, you can offer other OSs too. But rather than that arrangement, we'll give you a cheaper per unit deal because you're going to ship DOS on everything.
Acquired
Microsoft Volume I
DOS is the standard and we want Windows to be the standard and Windows is going to be the standard. We'll make it more economically attractive to you, give you a lower per unit rate if we just kind of change the terms and say instead of every unit you ship with DOS or with Windows, every machine you ship, period. Every microprocessor-based machine that you ship, no matter what
Acquired
Microsoft Volume I
operating system is installed on us, just pay us a per processor rate. So if you do that, you'll be paying us for every machine, whether you ship DOS or Windows on it or not, but you're going to ship DOS and Windows anyway. So you may as well take the cheaper rate. May as well take the cheaper option, right? And obviously, what effect does this have on competition?
Acquired
Microsoft Volume I
Well, there's now a very, very, very strong incentive never to ship any other operating system.
Acquired
Microsoft Volume I
Totally. And while antitrust in the government would seize onto this as like a smoking gun, like, I think the reality is this was kind of irrelevant in terms of the forces that made DOS and Windows the winners. They were already the winners by the time they started doing this. So...
Acquired
Microsoft Volume I
Yes. Now, speaking of this sort of new customer-friendly, buyer-friendly business practice... from Microsoft, which I think is how they thought about it.
Acquired
Microsoft Volume I
Yeah. As this changing of the guard is happening from IBM to Microsoft, I think part of this new self-confidence from Microsoft is, wait a minute, why can't we go win the Enterprise 2 and take that from IBM? We don't have to get in bed with them to sell to the Enterprise. We should sell to the Enterprise.
Acquired
Microsoft Volume I
Totally. And this is the first half of the original Microsoft vision statement coming true. A PC on every desk and in every home. Desk means work, means enterprise. Yeah. And this era, everybody we talk to... gives 100% of the credit to Steve Ballmer.
Acquired
Microsoft Volume I
Steve took it on his shoulders at this point in time when Microsoft is passing IBM to say, I am going to build and we are going to learn as a company how to sell to enterprises. And Ben, like you're saying, it's impossible to imagine now Microsoft not like this. But there's so much that they needed to do that they didn't have.
Acquired
Microsoft Volume I
Yep. And that meant selling to the C-suite at global Fortune 500 companies, most of whom did not use computers. Correct.
Acquired
Microsoft Volume I
Right. And to the extent members of the C-suite, like CIOs, you know, or proto-IT organizations used computers or were the computing centers in the company, they hated the PC. It made their life hard. This was like when employees would bring a PC to work and plop it down on their desk and start mucking around with stuff. It made things hard.
Acquired
Microsoft Volume I
Right. There's no email. So this really was like a business transformation task for the global Fortune 500.
Acquired
Microsoft Volume I
Right. This was partnering with the consulting firms. This was building a direct sales force within Microsoft. This is building an indirect sales force within Microsoft to partner with distribution partners, with channel partners, with independent software vendors. This is building a customer service organization.
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And specifically, why are they not going to care about it? I don't know exactly what an IBM mainframe system, system 360, 370, whatever cost. I'm imagining tens of millions of dollars all in total cost, maybe hundreds of millions of total dollars to run a system like that and buy it. So the first DEC machine, when it comes out, the PDP-1, a few years before this time, it was priced at $120,000.
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This is building the executive briefing center on the Microsoft campus and bringing CEOs and other C-suite folks there to Microsoft. It's building solutions for them. It's becoming a partner. It's everything that Steve is, frankly, just born to do.
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Yeah. And how it actually goes down, and we sort of heard this from Steve and you heard it from other people, is so fitting. So by the end of 1990, the Microsoft-IBM divorce is official. IBM takes full control of OS2 development back from Microsoft. Microsoft ceases involvement. The breakup is official. This now gives Microsoft and Steve hunting license in the Enterprise to go compete against IBM.
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But they have a secret weapon that is going to enable them to come take the Enterprise from IBM. And Ben, tell us what it is.
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One, it's the legacy of this bet on the Mac, bet on Excel, and, you know, bet on Windows, you know, shortly thereafter, that enables Microsoft to go into the enterprise because, yeah, even though they've just broken up with IBM and OS2 isn't going anywhere, it's not like Steve can just go knock on the door of some banking CEO or, you know, C-suite and be like, I'm Microsoft, come talk to me about how you're going to use Microsoft products in your organization.
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Right? But rather, it's like, hey, thousands of people in your organization are already using Excel. Let's have a conversation about how we can make that work better for your organization and what else Microsoft can do for you.
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So like an order of magnitude, maybe two below a system that you would buy from IBM. obviously still a long, long, long way from the personal computer. People are not buying these things for their houses. But, you know, yeah, GE will buy one for the field office in Seattle, or universities will buy them for research, for their students, for their professors. And so DEC...
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Perfect, and it's intertwined with the beginning of all this enterprise-ification of Microsoft. Okay, so Windows NT. Remember, IBM's whole goal with OS 2... was that they saw the trajectory of the PC was going to eat into traditional mainframe-type applications in the enterprise, and they wanted to re-centralize and own the PC enterprise-ification of workloads.
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NT is, after the divorce, Microsoft being like, screw that, we're going to do the same thing and eat your lunch. And so the initial work kind of starts out of the work they had been doing on OS2 with IBM. But then in October 1988, as they're heading towards divorce, Microsoft hires Dave Cutler away from DEC. And Dave is an absolute just beast and legend.
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Like he's still writing code at Microsoft today, which is amazing. Isn't that crazy? It's like in his 80s. Amazing. Dave at DEC wrote the whole operating system that DEC ran on, VACS. And so poaching him away to come work at Microsoft, both like he's the guy that's going to build an enterprise ready, take share away from the way traditional enterprise computing is done onto the PC.
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You know, like he's got the chops to do this. He's also got the credibility to do this.
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Yes. Him coming to Microsoft, him leading and building this effort gives Steve and the sales force so much legitimacy when they're going in and talking to the C-suites and the CIOs and the IT departments at enterprises.
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I think it was Dave and also Mike Maples coming from IBM, too. And Mike obviously wasn't a technical leader, but on the business and strategy side, too. So NT, we'll talk a lot more about it on the next episode. But spoiler alert, it is the vision of what IBM wanted OS2 to be, but it's Microsoft's version of it.
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Yeah. Soon with the internet coming, it'll enable servers that face externally from your company. The punchline here is that NT becomes the seeds of Windows Server, the business line, which become the seeds of Azure today.
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kind of creates a new market for computing. And Bill, he's so studied in business history, the founder, Ken Olson, Ken is Bill's hero. He totally looks up to DEC and what DEC's done. Hmm. Now, the DEC and minicomputer UI is still the same as the mainframe. You're still using a teletype. There's no innovation in terms of what the computing is or how you use it.
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And we just spent a bunch of time talking about the enterprise-ification and all the amazing enterprise stuff that the seeds get sown for Microsoft at this point in time. This era is also the heyday of the consumer PC, right? 93, Jensen starts NVIDIA, graphics cards are becoming a thing, PC gaming is becoming an industry.
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You know, that goes all the way back to, you can even look at Minesweeper as being a seminal moment in terms of the consumerization, these devices, these personal computers becoming... companions to people's lives like the phone is today. I mean, you've got CD-ROM technology, multimedia, Encarta. The heyday of the consumer PC is here in this era.
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It's just cheaper and more people have access to it. Yep. So back to Lakeside and the Mother's Club raising money for this access here for the school. Bill, remember, he's just started. He's in seventh grade. And Lakeside is a middle school and a high school. The high school is actually in a separate building.
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There is no other word to describe the Windows 95 launch besides glorious. I am so glad that this stuff is preserved on the internet and on YouTube and that we could experience it ourselves over the past month.
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It's amazing. A software company licensed Start Me Up by the Rolling Stones as the official theme song of an operating system. Yes. The idea that this would be happening, certainly back in 1975 when they were moving to Albuquerque, but even just a couple years earlier, this is breaking new ground. Yeah.
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The computer room that gets installed with the teletypes, that's over in the high school. But Bill, he doesn't care. He gets exposed to it, I think, in a math class one day, and he's like... Oh, I'm hooked. So he goes over, he's hanging out with the high schoolers, teaches himself how to program. And pretty quickly, he becomes known as one of the very best programmers there.
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And there's so much about Windows 95 too that I'm sure you're going to get into, but like the start menu. It was so perfect because this was the peak of the PC going fully mainstream. Nobody had ever treated software like this before.
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Totally. The Mac obviously shared a lot of these elements, but it was at so much a smaller scale.
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Computer companies love F1 cars for demos. Totally. It's the ultimate aspirational demo.
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And he and three other kids form what they call themselves the Lakeside Programmers Group. And one of his buddies who he forms it with is, of course, the high schooler, I think the 10th grader at the time, Paul Allen.
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Having this discussion now makes me think. What Microsoft in this area, Windows 95, they did what Apple tried to do in bringing Scully in. Scully came from Pepsi. Obviously, that didn't work. But Microsoft, they're the ones who did it. They're the ones who mass-marketified the computing vision.
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Sidebar, that Alan Kay quote about if you really care about software, you do your own hardware makes so much more sense to me now having done this episode because he's coming from having made the Alto and the graphical interface there. The only way that he could have made the GUI on the Alto was basically building a mini computer. Yeah. Isn't that crazy? Makes so much more sense now.
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Yeah. And just to put some numbers on this. So August 24th, 1995 is the launch event, the glorious day Windows 95 comes out, sells a million copies in the first week, 7 million copies in the first month.
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fiscal 95 so this is the 12 months ending in june before windows 95 comes out microsoft did 5.9 billion dollars in revenue fiscal 96 they did 8.7 fiscal 97 when windows 95 is really going they do 12 billion dollars in revenue first software company to pass 10 billion dollars in revenue already the most valuable company in the world. I mean, they are a monster. There is no other way to put it.
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I mean, we knew this was going to happen, right? This is why we waited 10 years into Acquired's life to cover Microsoft. It's the most important company in the world still today. Yeah. It was so fun researching, going back and doing all this because, A, there's so many different perspectives and so much has been written.
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But I don't know if we've gotten it right here, but I feel like every other major attempted storytelling at this has not gotten it right. And so getting to go talk to all the people who were part of this.
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So these high school kids, they start the Lakeside Programmers Group. They call it the programmers group because they are programmers. This is another super important thing to learn. To use a computer at this time meant to be a programmer. There was no packaged software that you bought. The software that IBM was selling was the operating system to make the machines actually function.
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Yeah, like, we really got that sense of like, you know, there's still a story to be told here. And it's never been more relevant again than, you know, today. All that to say, I'm glad we waited 10 years.
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Right. That's the amazing thing. The option pool doesn't get created until so late in Microsoft's life. All those Microsoft millionaires only came from that, you know, whatever size that was, 5% of the company or whatever.
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Yep. This is Bill's company. This is their company in a way that no other company is these days. No venture backed company going through the modern era is like that. By the time you get to be public, you may still be the largest shareholder as a founder or CEO, but it's not your company. Far from it.
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And it was the programming languages that you could then program on, but you weren't clicking around and using Excel or pulling up apps. Everybody who used a computer wrote their own software.
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I totally think it's the latter. And I think it's that the minimum fixed cost threshold to be that, you know, in Bill's words, slightly better than your competitors and get the positive spiral going was low enough that it could be paid for just in Bill and Paul's time and effort.
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And it was that unique moment at the beginning of the software industry where that was true, you know, and that would never be true again.
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You couldn't buy the experience having written emulation software for microprocessors that Paul had.
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Yeah. Well, I think there are two freak laws of natures. One, there was Moore's law that they were benefiting from, but then two, there was the zero marginal cost of software. Yeah.
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Yes. Even though they raised money, not a single dollar of investment actually happened at this company.
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Also, Microsoft needed to be a public company. If you're going to be an important company in the world at this scale, if you're going to first ride the bear with IBM, but then inherit the earth from IBM, you got to be a public company. You can't be a private partnership. You're not going to go have conversations with C-suites and CEOs of Fortune 500 companies if you are a private partnership.
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So the goal of the Lakeside Programmers Group, remember Bill is this business prodigy, is to use their very valuable and very rare skills as programmers at this time to, you know, make money. Yep. Do a business. So, turns out... At the same time, I mean, the coincidences here are just crazy.
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Yeah. It's funny, this playbook theme. This was a moment in time and a set of factors where this worked. I mean, I guess the lesson is find an industry in its infancy and be capital efficient and run the table.
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That's what I was going to say. It did happen again. It happened with Google.
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Good point. Still, unlikely we'll ever find another Microsoft opportunity.
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There is a local startup coming out of the University of Washington called the Computer Center Corporation or C-Cubed. And the business plan behind C-Cubed was that they were going to get a bunch of decks, a bunch of PDP 8s, 10s, 11s, whatever. And they were going to be like AWS. They were going to just be a computer time sharing company.
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Yeah, which I'll jump in with a playbook theme that we referenced a little bit in the episode, but we really got to highlight here. Bill and Steve and Paul and everybody at Microsoft, they were incredibly talented, incredibly smart. They saw the future in a way nobody else did. But they also were willing to hedge their bets. It's not like they just got everything right.
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I mean, they were going to get things wrong with OS2, but they hedged the bets with Windows. I think that is such a key lesson of when you're in a really dynamic market like this, in our ecosystem right now, you know, in tech, venture capital, startups, whatnot, people put so much value on conviction. I have conviction. This is what the future is going to be like.
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And I think the Microsoft story is the opposite of that. They had conviction that... Software. Software was going to be big.
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Yeah. But beyond that... But the exact path of how that was going to play out, they had very little conviction in and were willing to be very flexible.
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Totally. Ooh, I can't wait in the next episode to talk about the internet tidal wave memo. Yes. But that's related to your playbook theme too. You can't really do that if you don't own 49% of the company, you know, if it's not your company.
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I sort of intentionally didn't look up revenue because it made the story muddier. But wow. Yeah, there you go.
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So C-Cubed hires the Lakeside programmers group, these kids, to come in and find and document bugs in the system. And they're going to pay them directly in computer time. So when they come into C-Cubed, they learn Fortran, they learn Lisp, they learn machine language for the PDPs. Back at Lakeside, they were just using BASIC, the programming language.
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Well, that also just speaks to the nature of the enterprise business too.
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You know, IBM was the enterprise business. Right. And today Microsoft is the enterprise business.
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A playbook theme that I want to highlight that really, really came out in our conversations is Microsoft was not just a talent magnet, the talent magnet during the PC era. If you were an ambitious young person, this is where you wanted to be. And it was on every dimension. If you were an ambitious young technical person, that's where you wanted to be.
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If you were an ambitious young salesperson, if you were an ambitious young marketing person, that's where you wanted to be. And they just had this culture there, which is so funny. We'll talk in the next episode of how that culture really fell apart for a while there. But I asked a lot of these early people that we talked to, like, what was it like being there?
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I mean, you guys worked yourselves half to death. Were you mad about that? Did you resent it? Were you like, we're just making bill rich. They're all like, no. Yeah. We neglected every other part of our life, but that was the good old days. This was the magic. We were making it happen.
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Anybody you talk to from this era at Microsoft, this was their life's work. No doubt about it.
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I mean, no matter how much time and money and resources you have to spend to localize Microsoft Word into Kanji, it's a lot less time and resources and money than developing Microsoft Word.
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Well, so I do agree with your premise with all of this. I think doing this episode, though, has made me think there's a little more nuance to it. Yes. And in broad strokes, you can say that's what Microsoft's strategy was with applications over the years. But the Microsoft versions never actually won until there was a platform shift that they could take advantage of to beat the incumbent.
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Like, Microsoft wasn't going to beat Lotus 1.2.3. until the graphical paradigm came along and then Excel being graphical was just obviously so much better. They tried with Multiplan. They failed. Multiplan was fine, but 123 was the winner.
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The nuance to me is, yes, but it's more like with the resources of Microsoft and the timeframe that Microsoft can afford to have, they can afford to start building the application, start building the product, get it into market, start learning, be positioned that then when the paradigm shift comes, leap ahead.
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Yeah, I'm curious your thoughts on this. I'm so surprised. One thing that you have not brought up yet on this episode is you were a PM at Microsoft for several years.
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Okay, great. I've got one more playbook theme before we move on to power. And that's that, well, Microsoft figured out software before anybody else. And they figured out so many aspects of what it means to be a software business before anybody else. But they figured out that software is never done. Yes.
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Yes. But basic, we don't want to give the impression that it is just basic or just for kids. No, it's widely used. It's going to become hugely, hugely important. Like it is both the gateway programming language for everybody, but like it's a real programming language and a lot of stuff is done in it.
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I do think a lot of their competitors, you know, we obviously didn't study Lotus to the same degree that we studied Microsoft here. We didn't study WordPerfect, you know, etc., But I think there was a mindset a lot of other folks that like you ship software and then the software was done. And that was not the culture at Microsoft. This is related to what you were just saying.
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Shipping software is the beginning. You are always working on that software. Yeah, you're working on next versions and stuff. But even before the next version, the work of software is never done.
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And I think you still see the legacy of this right to this day in Apple versus Microsoft. Apple still is on a yearly software release cadence, which is kind of ridiculous. Whereas Microsoft's on the cloud. It's all constant. It's all constantly shipping and like, look at AI, look at open AI. The software is never done is so deeply in the software business model.
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All right, let's run through each of them and do a quick 45 seconds on each.
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Yep. And, you know, actually related to that, I can't believe we haven't talked about this in the episode until now. Microsoft could enable other companies to be successful. You talk to Microsoft people, they always talk about themselves as a platform. Like we're a platform. Other companies grow on the back of Microsoft. That was not true for IBM. Totally not true. Right.
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But Microsoft could make Compaq successful. Microsoft could make Lotus successful. Microsoft could make Intuit successful. Microsoft could make Netscape successful. Right.
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I don't think we need to say any more on this. The whole episode's about scale economies.
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That's a good one. Yeah. This one's pretty related to network economies for me with this one of, okay, sure, you can switch to another operating system. Good luck getting other applications that you know and love to run on that. Yeah, that's the answer. Yep. Speaking of network economies, developers, applications, OEMs,
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Although actually, I think once they start getting into the enterprise workplaces in general, organizations in general, there is the user network effect. Like, I want this Microsoft Word document that I just worked on for you to be able to open it and use it too.
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Yeah. And it's inter-organizational too. If I'm a law firm, you know, I want my clients to be able to open my word docs.
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Totally. When Bill and Paul and their buddies come into C-Cubed, they're now getting access to learn real hardcore systems programming. languages, including machine code for the PDP-10. They're becoming pretty prolific engineers here.
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Yeah, totally. This exists, especially by the time you get to the Windows 95 era, the end of this episode. It's like Rentech. The amount of stuff and process within Microsoft, you know, the device drivers, the middleware, the programming languages, the dev tools, the machine there to make all this computing work. It was like a miracle that this stuff worked, you know?
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Okay, branding, for sure. For sure. Don't get fired for buying Microsoft.
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Yeah, it's both fronts. It's their brand and the enterprise that is an amazing story that they built. They were branding consumer that was the easiest to point to instantiation is like the Rolling Stones and Jay Leno, but they had a software brand that nobody had that.
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Yep. Well, that brings us to the last one, which I think is a super strong one, at least in this era, cornered resource, DOS, full stop.
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The dramatic tension for you all to come back for our next episode on Microsoft here is not because you want to find out what happens.
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Okay. Takeaway. Splinter. We've spent the last probably six weeks deep in this. We've talked to everybody. What are you thinking about in the middle of the night?
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Yes. And they're getting mentored. One of the executives at C-Cubed is a guy named Steve Russell. Did you find this, Ben? Do you know about this? No. This is amazing. You're going to die. Steve Russell was the guy who wrote Space War when he was at MIT on the first PDP, the PDP-1. He's like a computer science legend.
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Maybe Bill was playing 3D chess. I mean, this is the thing about it, though. We got to give IBM so much credit for Project Chess and the PC. That they even did what they did was huge. That a big entrenched corporation like that could ship a Skunk Works project in a year, revolutionize the industry.
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Yeah, I think you might be right. I think that might be the single best business deal negotiation of all time.
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Right, right, right. No, a lot more than that, because this is the point about Microsoft being a platform. Microsoft is worth $3 trillion, but how much value has been created on top of Microsoft? No matter what you think, good, bad, or ugly of Microsoft, you can't deny that.
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Yep, totally. That's super related to my kind of takeaway here. You know, the moment for me in the research and then when we were telling the story along the way is when they start to believe in themselves that they don't need IBM. Just the audacity, and I mean that in a pure good way, of these kids. These kids, they changed the world. That's so trite to say.
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My book we read, My Daughter at Bedtime, somebody gave us. It's like the most Silicon Valley tropey thing ever. It's like, what do you do with an idea? And the punchline at the end of it is you change the world. And like, it's become such a trope. But these kids in the 70s, they did it. And they, like, believed in themselves in the beginning and then more and more and more over time.
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And then there's just this moment that I think where they started to, like, really truly believe that they were going to change the world. Yeah. again, good, bad, and ugly come out of that. Mostly good, I think. But yeah, just the level of ambition and audacity of these people is staggering.
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Yeah, I mean, this company's 49 years old and it's still the most valuable company in the world.
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Yes. Space War was the first video game, first computer game ever written. It was written as a fun side project by some MIT engineers in the early days of DEC. And then that became Nolan Bushnell's inspiration for starting Atari and Pong and Space... Like, yeah, Steve Russell, that guy. Yeah. He mentored Bill Gates.
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Amazing. Well, when we were talking about the letter that Bill writes to the hobbyist community decrying piracy and software, he's basically writing it to the homebrew computer club. He believed that those were the people who were ripping off his software.
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All right. Carve outs. All right. Carve outs for new listeners. At the end of every episode, Ben and I just chat about one or two things that we've been enjoying personally lately that usually have nothing to do with the episode. In my case, I have two. The first one has a lot to do with the episode. I have discovered slash rediscovered the LGR YouTube channel. Are you into this, Ben? No.
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Clint and LGR. It stands for Lazy Game Reviews, which I think is how it started, but then it became so much more, and now it's just LGR. Clint is this awesome dude, and I think he lives in North Carolina. He is dedicated to basking in the glory and restoring and reliving and preserving computer history, hardware and software from this era.
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The YouTube channel is all like unboxing a compact PC from 1992. Like restoring a Windows 3.1 machine. Oh, that's awesome. It's so good. He's got like the best, most soothing voice in the world. He just seems like such a nice dude. And he's dedicated to preserving the era of computing that we are talking about on this episode. It's so fun.
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Yep. Super cool. My other carve out is Andre 3000 from Outkast. Do you know what Andre 3000 is up to these days? Not at all. No. Oh, my God. Okay. So GQ just did a big interview with Andre 3000 because he just released a new album. this is not what you think. Ooh. So Andre, you know, a lot of people say consensus top five rappers of all time.
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And Big Boi and his counterpart Nowcast, you know, also great too. But they basically went out on top. So they did Speakerboxx, The Love Below. Yeah, of course. Which was their double album. I think it came out like 2004, maybe. I was a freshman in college. Hey Ya was on that, right? Hey Ya, yeah, everything was on that. They did one more album and then they stopped.
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And Andre would like be featured on some other rappers tracks over the years, but didn't put out another album for close to 20 years. He just put out an album and he just did this big interview, video interview with GQ. The album is a flute album. He got really into like woodwind instruments.
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He had come out to the University of Washington and then left and was part of one of the execs starting this company. Wow. That's like a mile from my house. Right? Crazy. Wow. So after a little while at C-Cubed, all of this real expertise that these kids are getting leads to another opportunity at another timeshare computing company based down in Portland.
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This has been his life. He reveals in the interview that he has put out other songs and other albums over the years under pseudonyms. And it's like, this interview is so great. It's so unexpected because the interviewer keeps asking like, you know, you're Andre 3000. You didn't, why'd you stop rapping? He's like, well, I don't have anything to say.
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Like, what am I going to rap about getting a colonoscopy? Like, this is where my life is right now. And I never wanted to put out any work that wasn't both authentic and great. I just didn't have anything to say anymore.
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Yeah. Yeah. And that's kind of what they did. Idlewild, which was the album that came out after Speakerboxx, The Love Below. Like, you know, this was great. Yeah. But it wasn't that. And yeah, that's exactly what he did.
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Yeah, it's the same thing as what Seinfeld did. Fascinating. Yeah, super fun. We'll link to it in the show notes.
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Ooh, yes! I was talking with the team at Meta about them. They're doing great.
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They ask the kids to write a real piece of software, to write a payroll billing program for all their clients that are using the timeshare system. And
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Amazing. Well, I'm going to have to subscribe. We've referred to this before. I think this will probably be the last episode that comes out while I'm still the parent of just one child. Wow. We have number two coming soon. So if it may take a little longer than usual for the next Microsoft episode to come out, our next six-hour opus on Microsoft, don't get too mad. That is the reason why. Yeah.
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Bill, now who's the de facto leader of this group, he negotiates a deal with the help of his dad, Bill Gates Sr., prolific corporate attorney in Seattle, that rather than just being paid hourly for their time, they're going to get a royalty on the revenue that their client makes on the software. I can't believe it. These kids are teenagers.
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Yes. Also, speaking of former Microsoft folks who are very active on and prolific on Twitter, we talked to Steven Sanofsky, who had lots and lots of great perspective, and we can't wait to share more of it on the next episode.
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Yeah, so much fun internet stuff to talk with that Stephen was right there for. I spoke with other people who ran Windows, Terry Meyerson, who's a great friend and a supporter of the show. Terry ran Windows for quite a long time, right?
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Yeah, Terry was very generous. And he was actually the first person that clued us into just how key Steve's role was in building the enterprise for Microsoft.
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They're figuring out the whole software business model here. They end up making at least $10,000 from these royalties, which the average household income in the U.S. at the time was below $10,000. These kids are rolling in money.
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Yep. Speaking of strategy, Charles Fitzgerald, who's OG, OG Microsoft and a great platform strategy guy, prolific angel investor in Seattle now. I was fun chatting with him about the early days.
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Yeah. Soma's just such a legend at Microsoft and in the industry too. There's so many people who Soma made their careers, plucked them out of school, saw something in them that maybe they didn't even see in themselves. And then they went on to be big executives or venture capitalists at Microsoft or elsewhere. Yeah.
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Absolutely. It was so fun talking to Steve. He was so gracious with his time. And it must have been just super special for you, too. Like, he was the CEO when you worked there. Yeah.
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Yeah. Forethought was the company that made PowerPoint, Microsoft acquired. The first major acquisition for the company.
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So the next year, Paul graduates from Lakeside and goes off to college at Washington State. But he and Bill decide to team up on a new venture that they're going to do together called Traf-O-Data.
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And if you're not at all interested in technology or software, but have somehow managed to get through all these hours with us, give a listen to our LVMH and Hermes episodes, even if you do love technology and software, which obviously you do if you're still here. There's so much to learn from that world.
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Yes. So the business plan is that municipalities count cars that go through intersections, use that to make decisions about how they're going to do city planning. Bill and Paul are like... we can take this new thing that's coming out of Intel, a microprocessor, which is promising to be a full computer on one chip. And we can use that.
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We can build a machine that is going to be a computer and it'll process and analyze that data. And then we can sell it to governments like,
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It wasn't until we started doing research for this episode that I finally realized, oh, microcomputers, which is the original term for the personal computer for the PC. It was called microcomputers before PC caught on. They're called microcomputers because they're based on the microprocessor. Yes, absolutely. It's not just that micro is smaller than mini.
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Right, yes. So while they're waiting for the AD-08, this new first microprocessor from Intel, to come out, or at least for them to get access to it, They want to get a head start on programming their traffic data machine and programming this microprocessor. So Paul's like, I got this. I can find a way to make this happen.
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He takes the PDP-10 at Washington State, and he writes a whole emulator program to mimic the instruction set for the AD-08 from the manual. And they get a full emulator up and running, and they can code even without... the microprocessor actually being there and having access. It's just like NVIDIA, you know?
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Like when Jensen was like, no, we got to build an emulator and simulate this, and then we're going to ship it sight unseen.
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Yes. And this is going to become very important to Microsoft in just a second. Yep. So traffic data is not a huge success. I think I read a few places they make about $20,000 in revenue from it. So like, again, great money for high school and college kids, but, you know, not world changing stuff here. This is not what Bill aspires to for the company he's going to start.
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But Bill and Paul are getting experience with the microprocessor. Bill actually has the idea for Microsoft when they're working with it. He's like, Oh, this is a computer, why don't I go off and write an interpreter for BASIC here, and we can sell the BASIC interpreter for the microprocessor and build a big business. The AD-08 just wasn't powerful enough yet to do that.
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Yep. And, you know, Bill and Paul are not the only ones having this insight here, too. Another Seattle guy named Gary Kildall, who they had intersected with, who they knew from C-Cubed and the University of Washington, he kind of had the same idea here. We're going to bring up Gary and his company Digital Research a little bit later.
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Yep. But Bill and Paul, they absolutely see the vision for what this can grow into and become. Bill has a great quote. Paul and I had talked about the microprocessor, and it was really his insight that because of semiconductor improvements, things would just keep getting better. I said to him, oh, exponential phenomena are pretty rare, pretty dramatic. Are you serious about this?
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Because this means, in effect, that we can think of computing as free. It was a gross exaggeration, but it was probably the easiest way to understand what it means to cut costs like that. And Paul was quite convinced of it.
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Yes, just like how we say every company has a story, every company's story is powered by payments. And JPMorgan Payments is a part of so many journeys from seed to IPO and beyond.
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This moment is the genesis of the vision for Microsoft. Even though Bill doesn't say the words in this quote, the vision of a computer on every desk in every home, that's the famous part. And then the part that got left off later when the DOJ started sniffing around was running Microsoft software. But that is the vision here.
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And it is crazy at the time, like a computer on every desk and in every home. Bill sees that this is what this exponential phenomenon, what Moore's law means, that that is going to happen. You know, we're still in the era of teletypes. Nobody else sees this.
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So all that said, even Bill and Paul know the ADO8 It's not there yet. It's not powerful enough to really be a general purpose computer on a chip, but they know it's coming. So in the fall of 1973, Bill goes off to college at Harvard, famously. It's funny, at Harvard, kind of like Jim Simons that we talked about at MIT on the Rentech episode.
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Bill thinks he's going to be like a world-class mathematician and set the world on fire.
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Yes. So while Bill's at Harvard, he's also doing a bunch of the typical college kid stuff. He's playing poker. He's cutting classes. He's making friends. And one of the friends he makes there is a kid down the hall from him named Steve. Steve Bomber. And Bomber, everybody knows Bomber. He's kind of everything that Bill is not. He's super social. He's super outgoing.
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He's in a final club, which is like a big thing in the social scene at Harvard.
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Totally. So then in the spring of 1974, Bill's freshman year, Electronics Magazine publishes big news about a new Intel chip, the next generation, the next turn of the crank on Moore's Law, the 8080. And in Bill's words here, all at once, we were looking at the heart of a real computer. and the price was under $200. We attacked the manual. I told Paul, DEC can't sell any more PDP-8s now.
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It seemed obvious to us that if a tiny chip could get so much more powerful, the end of big unwieldy machines was coming.
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We're right down the middle on this one. We're going to start in 1955 in Seattle, Washington, with the birth of Bill Gates III, or Trey, as he's known growing up. It's so confusing because his dad is the second, but he goes by senior, and Bill is junior slash the third slash Trey. So Bill, in 1955, is born as the second of three children to Bill and Mary Gates. Now, Bill Gates Sr.,
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So they think, okay, what's clearly going to happen here is all the big computer companies, you know, IBM, DEC, the big Japanese computing companies are They see this, they're going to get into this business. They're going to make machines and they're going to make microcomputers. Surely they will jump on this opportunity, right?
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Exactly. So Bill and Paul kind of are sitting around waiting through 1974 and 1975 being like, hey, when are the 8080 computers going to come out? Where are they? It's just crickets. Yep. Paul is so convinced that the revolution is coming that he actually drops out of Washington State, moves to Boston to be close to Bill so that they can be ready when it happens.
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And that summer, they both get summer jobs at Honeywell as programmers. Paul stays on into the next school year when Bill goes back to school. He's just like waiting, waiting, waiting. And then... In December 1974, Paul is walking across Harvard Square and he sees in a newsstand the January issue of Popular Electronics.
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on whose cover is the Altair 8800, the world's first real, honest to God, commercially available for sale microcomputer. And the legend has it that Paul grabs the magazine, runs over to Bill's dorm, throws open the door, throws the magazine on the desk, and is like, it's here. And Bill just says, oh my God, it's happening without us. We need to get on this right now.
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And this is it. This is the moment. The revolution is here. Microsoft is about to be founded. But first, this is a great time to thank our presenting partner this season, J.P. Morgan Payments.
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And scale is really the key word here. Every episode we talk about Hamilton-Helmer's seven powers, and boy, does JP Morgan have scale economies. What's unique about their position in payments is that they can make massive infrastructure investments that benefit their customers in the near term, in addition to the long-term technology bets like blockchain or quantum computing.
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Since they move $10 trillion a day in 160 countries, these investments create a lot of shared value across their large customer base.
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Yep. If you're a JPMorgan Payments customer, whether you're a startup or a Fortune 500, you can access their Payments Partner Network. This is a set of third-party integrations across virtually every industry and payment use case. It makes it easy to discover what specific set of tools are best for your business.
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Let's take Visa, for example, which listeners may remember. We talked a lot on that episode about the power of a network. Well, Visa works with J.P. Morgan to provide global payment processing services. And now through the partner network, you can easily add Visa as an acceptance method through a streamlined implementation with consolidated reporting.
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his father is from bremerton the navy town just across the sound from seattle where he grows up in a family that owns and runs a furniture store there a long way from the software king of the world here now bill gates senior slash the second after high school he joins the army during world war ii serves during world war ii and then he goes i presume on the gi bill to the university of washington where he's the first member of his family to go to college
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Other companies in the partner network include Oracle, American Express, MasterCard, Accenture, and many more, including friends of the show, Modern Treasury.
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So before we jump back into Bill and Microsoft, who essentially wrote the modern playbook on building platforms, be sure to check out jpmorgan.com slash acquired or click on the link in the show notes.
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Well, they do the natural thing that two super excited, ambitious, high-octane college kids would do. They call up the main phone number of Altair's manufacturer, a company called MITS, M-I-T-S, and ask for the president, a man named Ed Roberts. And Bill and Paul, they get him on the phone and they say, we have a basic interpreter ready to go, ready to ship for the 8080 Intel chip.
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And we want to provide it for you, for your machine, which of course they don't. They don't have a single line of code written. They don't have anything.
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Ed, he's a bit of a character himself. He says, okay, well, guys, a lot of other people are calling me and saying the same thing. What I'm telling them, and I'm going to tell you too, is that anybody who can come here to my office in Albuquerque, New Mexico, and demonstrate a working version of BASIC on my Altair will get a contract with us to distribute it when they go on sale.
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And so Bill and Paul, they say, okay, great. We'll see you soon. And hang up. And by see you soon, they mean, let's go get to work.
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I was going to talk about this in a minute, but let's talk about what the Altair is. What did they just announce in the magazine here? This is, the Altair is the first mass market commercially available personal computer.
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Yeah, does not have a screen, does not have a keyboard, doesn't have a display of any kind. What it does have is it has a set of 16 lights on the front of the machine, like Christmas lights, and 16 switches. And you can flip the switches to flip bits, and then the machine will respond by lighting up different patterns of lights. It doesn't come with any software. There's nothing. That's all it is.
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Now, back to the TRAFO data days and Paul writing the emulator for the AD-08 at Washington State. Paul's like, we got this. I'll just write an emulator on the Harvard PDP-10 for the AD-80 instruction set.
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Yep, Bill writes the basic interpreter. And in a couple weeks, they've got it working. And Ned's like, okay, come on out to Albuquerque. So Bill and Paul, remember, Bill still looks like he's 12 at this point in time. They decide that just Paul should go.
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Oh, Paul is super 70s. He is like into it. And as we'll see, he's going to fit right in at Albuquerque in myths. So Paul gets on a plane. flies from Boston to Albuquerque. And, you know, in a total, like, epic legend moment, they didn't have a bootloader written for the basic interpreter. So they had the basic. It was all written. They'd done it on the emulator.
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And there he gets an undergrad and a law degree in four years and then decides to stay in Seattle with his new family and become a practicing attorney. Now, I say family because at the UW, he meets and marries one Mary Maxwell. And Mary, I don't know how to put it other than that she is a force. Yes.
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And Paul's flying out with the tape, the computer tape with the code of the basic interpreter on it. But he's like, oh, shoot. We can't just feed that right into the machine. There's got to be a bootloader to load up this thing. So he writes the bootloader on the plane.
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Yep. So he lands in Albuquerque, drives out to MITS, They load the bootloader onto the prototype Altair there that loads up the basic interpreter and it fails. It doesn't work. Paul's like, let's try it again. Let's try it again. So they try it again. You know, this is how early computing is. Like it works the second, like who knows what the bug was the first time. They didn't change anything.
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It just didn't work the first time and it worked the second time. So it loads up. Paul writes in the instructions, print two plus two. It spits out four and by spits out, I mean like the lights light up and say, you know, four and both he and Ed, their jaws are on the floor. Paul's like, oh my God, the basic works. And Ed's like, oh my God, the Altair works.
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The Stones though, man, like it's crazy. They're in their 70s, 80s. Amazing. Man, I hope we're in our 70s and 80s dancing on stage.
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Yes. So now is the time to say a few words about Ed and Mitt. It's like, what is this company? Bill and Paul originally thought that it was going to be the IBMs, the DEX, the Japanese companies who are going to make the first microcomputers. MITS is about as far away from IBM as you can possibly imagine. MITS basically was a model rocket company.
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Ed Roberts, the founder, he had been in the Air Force and stationed in Albuquerque. And that's how he got involved in model rocketry. And the reason that they're introducing the Altair and they made this big splash in the magazine was this is a last ditch gambit to try and save the company. So you got like a bankrupt model rocketry company.
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Totally. And, like, why did it work? They had two things going for them that really Ed, I think, probably personally made happen. One, they got this splashy Popular Electronics magazine cover. That was through a relationship that Ed had. And two, the sticker price was $397. which is about $2,300 in today, $20, $24.
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Yes, that's a lot of money, but the next cheapest computer that anybody could buy at this point in time was like a deck, you know, like $120,000 mini computer. So the idea that somebody could buy a computer for for $400. I don't care who's selling that thing. Like, I want that. So what, did they get some kind of sweet deal from Intel? Yes. So this is all Ed's doing.
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The list price from Intel for the 8080 chip was $360. So I think this is part of what was deterring the market of how would anybody sell a kit that was affordably priced when so much of the cost of goods would go to Intel with the processor deal. He managed to negotiate a volume deal with Intel to get 8080 chips at 75 bucks a pop.
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So Mary's family had founded National City Bank, and her father was a senior executive at First Interstate Bank, which later became a big part of Wells Fargo. Now, Mary, despite being the daughter of a successful business family in that day and age, was not cast aside like so many other daughters we've talked about on the show.
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And that was the key unlock. That's like a 5x price reduction. Totally. Huh. Yeah. I wasn't able to find how that negotiation went down or why like Ed Roberts in Albuquerque, New Mexico got this sweetheart deal from Intel.
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I like that. I have no idea, but that's a totally viable, I think, train of thought here. Yeah. Either way, he gets the sweetheart deal. And not only does it make computer history and enable and create Microsoft, it saves the company of myths. So they were on the edge of bankruptcy.
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After the Popular Electronics article comes out, they get 4,000 pre-orders in the first month or two, which is $1.5 million in revenue, cash paid up front. That is pure cash hitting the bank account.
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And also just proves, hey, 4,000 people just paid cash sight unseen for 16 lights and switches. There's a lot of demand for a home computer here.
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I think they're selling direct. I think people are just sending money orders.
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So Paul and Ed, they kind of hit it off. Paul decides to move out to Albuquerque to be close to the action here. And he actually joins MITS as their vice president of software. No, he's vice president of a software department of one. He is the software department.
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Yes. So Bill stays at Harvard, but keeps cranking on enhancing the BASIC interpreter and adding more functions and functionality to the version of BASIC that they had just written for the Altair. And then once the school year is over, he comes out to Albuquerque too for the summer. Now the Altair is getting ready to ship with the BASIC, the Microsoft BASIC included in it.
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Bill and Paul kind of need to set up a company. But Paul is an employee of MITS at this point. So what did they do? They set up a partnership. So the founding of Microsoft, at this point, micro-soft, is a two-person partnership between Bill and Paul.
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Microsoft has become like Kleenex. But like, no, no, it's like Microsoft means microprocessor software.
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No. So after she graduates from the UW, she becomes first the president of the Seattle Junior League, and she starts joining nonprofit boards in Seattle. As a very young woman, she joins the Seattle Symphony Board, the Chamber of Commerce, the Children's Hospital, the King County United Way.
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Yeah. Oh, okay. Well, let's talk about business model here in one sec. First, though, on the partnership. Again, we've been saying all along that Bill is clearly the leader here. They set up the partnership. Initially, it's 60-40 ownership. Bill is 60%, Paul is 40%. Later, it gets changed to Bill is 64% and Paul is 36%. So like, yep, Bill is the leader here.
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You know, in the long run here, everybody gets rich. So it's all sort of a rounding error. But to that point, back to the business model. So once the partnership is set up, they sign an exclusive licensing arrangement with MITS. This is super important. This is a big lesson that young Bill and Paul are going to learn here.
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So MITS gets exclusive license to the BASIC interpreter, to the BASIC, as they call it, for the 8080. And MITS is the one that can then decide whether to sub-license the BASIC out to other companies or not. Essentially, this is a distribution deal with MITS where MITS becomes the exclusive seller and distributor of Microsoft's BASIC. Microsoft doesn't have any direct sales control here.
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That's going to become a big, big, big issue. And the terms of the deal are Microsoft is to get $30 for each copy of BASIC that MITS sells, plus 50% of the revenue that comes from these sub-licensing deals that MITS may or may not do with other companies who want to use the BASIC.
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Yeah. This is a big, big, big diverging of interest between Microsoft and MITS. And the kicker on this contract is that the total amount of lifetime revenue that Microsoft can make from the basic from MITS is capped at $180,000. Wow. Huh. So Ed and Mitts really have the upper hand in this deal.
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Yeah, that is another way to frame it. So definitely a great deal for Mitts. On the other hand, what are Bill and Paul going to do here?
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And she's such a force on these boards that she starts getting asked by her fellow board members to join their company's boards, too, like the corporate boards. They're so impressed with her. So first she joins the board of First Interstate Bank, the bank that her family is a part of. Then she joins the board of Cairo Television in Seattle.
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Now, there is one very, very important clause in the contract, though, protecting Microsoft's interests. And that clause is that MITS must use its best efforts to license, promote, and commercialize the BASIC. broadly in the marketplace, and that any failure to do so by MITS would be grounds for termination of the contract by Microsoft.
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So the Altair comes out for sale later in 1975. Microsoft does $16,000 in revenue that year from their $30 a pop, the basics that are getting sold with the Altair, which is great, especially the first year that they're starting.
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And the next year in 1976, everybody's so excited about this new market, the vision that's happening, the demand, the Altair, the sales, that Paul Allen resigns from MITS to join Microsoft full-time. Bill drops out of Harvard officially. He moves to Albuquerque. They're all in on this. But for the year in 1976, Microsoft's revenue is still only $22,000.
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This is less than they were making in high school. Like, what is going on here? One is sort of like MITS is the one at the controls of sales, not Microsoft. But two, MITS is selling 1,000 computers a month. This is taking off. This is creating a new industry. Despite MIT selling thousands of computers a month, only a few hundred copies of BASIC are selling per month. What's going on?
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People are pirating the software. This is the discovery of software piracy.
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Yeah. Eventually she joins the Board of Regents of the University of Washington and the whole entire national United Way board. So she never works full time in a corporate setting. But it is not an overstatement at all to say that Mary Gates became one of the most powerful business people in the Pacific Northwest, period.
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That's exactly what I was going to say here. This is the other element of what's going on. This is the first time software has ever been sold. Right. Other than the IBM accounting machinations to protect themselves from antitrust, which was just accounting, nobody had ever sold software before.
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Right. The law isn't going to change until 1980. Microsoft would be dead if they didn't figure out a solution to this before 1980. So this is when Bill ultimately kind of realizes, shoot, we did the wrong business deal with MITS here. MITS has to sell and customers have to make the decision to buy our basic products. is a key critical part of the value of the computer. It's like the whole thing.
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It makes that machine useful. Right. Without it, it is not useful. It's totally setting up the wrong incentives and value equation that customers should be buying this themselves. It should be included by the hardware OEM in the machine that they are selling and in the total purchase price.
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And then if that happens, we no longer have a piracy problem because we're just getting paid as part of the purchase of OEMs.
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MITS pretty much had this new microcomputer market all to themselves. There were a couple other competitors who sprung up, but, you know, nothing made, like the Altair and MITS was the microcomputer company. All of that changes though, in a big way in 1977, when what Byte Magazine calls the 1977 Trinity hits the market. And that is three machines,
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the RadioShack TRS-80, Tandy slash RadioShack TRS-80, the Commodore Personal Electronic Transactor, or the acronym PET, and the Apple II. All three of which machines were like the Altair, low cost, mass market. Unlike the Altair, they were not kits. They were fully assembled, fully functional, right out of the box. And they each had their own major distribution advantages.
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And in Bill's words, these three machines, the 1977 Trinity, ignite volume in the market. Bill loves these really dramatic verbs, like we attacked the manual, they ignite the volume in the market.
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Ben, it's like you're reading my script here. Yes. We don't want to give Bill Sr. the short shrift here either. He becomes a superstar lawyer, and he becomes a co-founding partner of the firm Preston, Gates, and Ellis, which today, I didn't even realize this until I dug in the research, that is K&L Gates today, one of the largest law firms in the world. Yep.
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So great. Now, earlier, during 1976, Microsoft had started getting approached by a few of the bigger computing companies like NCR, National Cash Register, GE, Control Data Systems... I want to license Microsoft Your Basic for the 8080 microprocessor here so that we can experiment with these things. And each of these deals would have been revenue to Microsoft of like $100,000-ish.
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But Ed and MITS, they keep dragging their feet on negotiating these. They've got the exclusive license. Everything's got to go through MITS. And most of them, they're turning down because, Ben, like you said, they don't want anybody to come in and compete with them.
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There's the misaligned incentive, and there is the clause that Bill and Microsoft, and I presume Bill Sr., put in the original agreement. Is MITS using its best efforts to commercialize the BASIC and gain adoption in the market? And you can make a pretty strong argument that they're not.
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So Ed, though, unbeknownst to Bill and Paul, he has another reason that he's dragging his feet on these deals, which is that he's about to sell the company. So in May of 1977, Mitts gets acquired by the tape drive manufacturer Pertek for six and a half million dollars. And Ed kind of rides off into the sunset.
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And Pertek, they know about this dispute with Microsoft, and they sort of come in and they figure, like, who is this Bill Gates? He's a 21-year-old kid, a college dropout. Like, we're a big company. We can deal with this. And Roberts has an amazing quote later. He says, Pertek kept telling me they could deal with this kid.
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It was a little like Roosevelt telling Churchill that he could deal with Stalin. Oh, boy. And I also don't think they realize that this kid's dad is one of the best corporate attorneys in the country.
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Right. I mean, Microsoft next year is going to have its 50th anniversary. And I believe that'll also be the same year that Bill turns 70. That's wild. Yeah. So that fall in 1977, the dispute between MIT slash Pertek and Microsoft goes to arbitration in Albuquerque. And the interim months while this arbitration is happening are the only moment in Microsoft's history where like cash gets tight.
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And another fun fact that you probably know about Bill Gates Sr., but we got this being acquired to talk about, do you know what corporate board he joined later in life? I do not. Costco.
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They're sort of running out of money because they can't really make any sales here.
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People aren't paying MITS for the basic. They're quote unquote pirating the software. They can't do deals with all the other computer companies that want to come licensed directly. And so things get a little tight. Yeah.
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Microsoft ends up winning the arbitration, I believe in maybe like November 1977, meaning they are now totally free to go license basic to anybody who wants to buy it on any terms that they want. So they turn around, they immediately license it to the Trinity, you know, Apple, Commodore, RadioShack, and Tandy.
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They license it to all the big companies, the GEs, the NCRs who want to experiment with microcomputers. There's a really funny story with Apple that apparently Woz had more or less written like 95% of their own basic, but it didn't have floating point numbers. It only had integer numbers. And Jobs is like totally writing Woz. And he's like, the basic, it's really important.
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Like, can you just finish it? Can you do floating point? And Woz just doesn't do it. So Jobs has to go license Microsoft's basic. Amazing.
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Yep. So Bill and Paul and Microsoft, they do all these deals and they do them all as cash up front, fixed cost, all you companies, you're going to pay us. And then you include the basic in the machines that you're selling. And we're going to get all the money up front. Super presciently, though. Bill does not value maximize on these deals.
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So like the Apple deal is $31,000 for eight years of access for Apple, for the Apple II to Microsoft's basic. They're not price gouging here because Bill sees, he's like, the play here is we want to make it a no-brainer for everybody, everybody who's selling a microcomputer to have Microsoft's basic on it because we want to set the standard.
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If we are the standard programming environment that anybody who's using these computers, and again, anybody who is using these computers is programming them, they're used to the Microsoft version of BASIC, we're going to have so much power that it'll become a self-fulfilling prophecy. All of our competitors will just wither away.
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Nobody will want them because it's not going to be compatible with the language everybody knows. And then once people start trading and then ultimately developing and selling software that they've written... It's only going to run on our basic interpreter, not anybody else's.
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Basically, his vision is, I want to remove any oxygen from any argument anyone could have about not using Microsoft's BASIC on a microcomputer. He thinks about this concept as a positive spiral that he really, in his mind, is the reason for Microsoft's success. He says, success reinforces success. In a growing market, one way of doing something gets a slight advantage over its competitors.
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This is most likely to happen with high technology products that can be made in great volume for very little increase in cost. And if you get that slight advantage, it'll compound. And this is what he's playing for here.
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Right. The Apple story is the perfect example. You know, the Woz thing is cute and it makes for a good story and like, oh, he didn't finish the basic. But when Microsoft sold them the basic, which was already getting established as the standard for $31,000. Sure. Why not? No brainer. Apple could have gone out and hired another programmer to finish the basic.
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But they're like, wait, we could do that. Or I could just get the standard one for $31,000. I'm gonna do that.
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So yeah, even though it takes until the very end of 1977 when the MITS dispute gets resolved and Microsoft can actually, you know, make money again, they end 1977 with $381,000 in revenue, despite zero for the first like 11 months of the year. Yeah. They're just rolling in cash.
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This is when Bill famously goes out and buys a green Porsche 911 and is motoring around Albuquerque getting all sorts of speeding tickets, you know, hilarious stuff.
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Yeah. And there's funny stories of the Albuquerque police thought this, you know, how is a kid driving a Porsche 911? He must be like a drug dealer or something.
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It's like, do you even have a driver's license? Wild. But back to what you're saying is a really, really important point. To make this dynamic work, you need to be able to afford the investment in the fixed cost for the software, for the technology, to make it that little bit superior, like Bill's talking about, the slight advantage over the competitors.
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And that's the point we want to land here is for young Bill, Trey, growing up here, he's growing up in like a pretty unique household. He would later talk about being like nine or 10 years old. And most nights at dinner at his house, there would be a CEO or a senator or a governor or somebody who's just...
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And at this moment in time, the industry is completely brand new. Like the software industry is brand new. So the amount that that fixed cost takes, the cost is quite low. Really, it's just Bill and Paul's time and dedication to this industry that nobody else is making that investment. You can't run this playbook today because...
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In any market, even a branding market, even a speculative market, the minimum viable fixed cost is billions of dollars. Right.
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Yes. They also do another really prescient thing the next year in 1978, which is they go global. Yes. Nobody else was going global yet. And the way that this happens is so fun. Bill gets a call one day.
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Yes. Now, the way this happens is one day, Bill gets a call from a guy named Kazuhiro Nishi, or K. Nishi, who's a computer enthusiast in Japan, has gotten a hold of Microsoft Basic, to totally shares the same vision as Bill and Paul. He doesn't have a Paul, you know, nor is he technical himself. He's like, I'm going to bring you guys to Japan.
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I'm going to bring you to all the big computer companies. They agree that Kay will become Microsoft's exclusive distribution partner in Japan. And by the next year in 1979, half of Microsoft's revenue is coming from Japan, which is wild.
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Yes, totally. So revenue in 1977, you know, that like last month of revenue was almost $400,000. 1978 revenue is $1.3 million. They have 13 employees at this point. 1979 revenue is $2.4 million. And at the end of that year, they're like, all right, we got to get out of Albuquerque. And they've got 25 employees, I believe, at that point. Yeah, something like that.
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over for dinner and bill would sit there and absorb the business conversation you know it's like the hermes family the dumas family that we talked about on that episode you know this whole thing it makes me think of paul the main character in the dune movies in the book like he's kind of bred from birth to be this incredible business mind
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And this is when they moved to Seattle. And it's interesting to hear Bill talk about this. He actually really liked Albuquerque. And specifically, there weren't any distractions there. No distractions. Weather was great. Yeah. Everybody was happy there, but the big problem was recruiting. Yeah.
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He was like, you know, if we're going to build this into the opportunity that I see, the vision that I see and that Paul shares with me, there's no way we're going to do that in Albuquerque. We got to move to a hub.
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Right. But not really, though, because pretty quickly, I mean, Microsoft is such an important part of the industry. They recruit from Silicon Valley, too. We're going to talk about some of the people who come up. But you're totally right. People stay at Microsoft. They don't leave. This continues right through to this day.
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And the other thing that I think is really important to say that makes it work for Seattle in a way that I don't know that this could have worked in too many other places in the country is the University of Washington. Yes. The computer science department there was really good. There were great people. Steve Russell had come out there.
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There was real talent, and they were churning out graduates out of the UW that would go on to populate Microsoft for decades to come.
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Yeah, I think the only thing... Even close to it is Berkeley in the Bay Area with a lot of the same dynamics. But there's Stanford there, too. So it's kind of like a dual university system in the Bay Area. But yeah, you cannot overstate how important the University of Washington was to this decision and an ultimate success of coming to Seattle. Yep. So this brings us to 1980.
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in the beginning of the year when they move to Seattle, just in time for, I think you can make a very strong argument, the single most important deal ever done in the history of technology. Absolutely. The Microsoft-IBM. I mean, it's crazy to even say it now. The Microsoft-IBM PC partnership. Yeah.
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And just like those companies, ServiceNow has AI baked in everywhere in their platform. And they're also a major partner of both Microsoft and NVIDIA. I was at NVIDIA's GTC last week, which, by the way, was insane. I felt like a VIP at a Taylor Swift concert. Like, it was crazy. And Jensen brought up ServiceNow and their partnership many times throughout the keynote.
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So why is ServiceNow so important both to NVIDIA and to Microsoft? Well, AI in the real world is only as good as the bedrock platform infrastructure it runs on. And for enterprises around the world, ServiceNow manages that infrastructure. So all the AI applications for enterprises
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Whether that's supercharging developers with generative AI, empowering and streamlining customer service, allowing HR to deliver better employee experiences, ServiceNow has already done the hard technical work to make rolling them out not just possible, but easy and fast.
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They've built AI directly into their platform. So all the integration work to prepare for it that otherwise would have taken you years is already done. So if you want to learn more about the ServiceNow platform and how it can turbocharge the time to deploy AI for your business, go on over to servicenow.com slash acquired. And when you get in touch, just tell them that Ben and David sent you.
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Yes. And it just turned out that he would be the CEO and founder of the biggest company in the biggest industry ever to exist. The other thing that we got to say about Bill growing up, he is insanely competitive. So he did not and does not like to lose at anything. And that is putting it mildly, whether it's sports or swimming or computers or school or the classroom.
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So the IBM PC. Why is IBM getting into the personal computer here in 1980? A fun quote we heard in our research was that IBM was the sun, the moon, the stars of the computing industry, and that meant the hardcore enterprise mainframe computing industry.
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All right. I think it's time. We talked to probably 10 early Microsoft people in research and preparation. And one of those folks was Steve Ballmer himself. And he used those words in describing IBM.
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This is the year. Yes. I mean, every year for Microsoft until this point is the year, but like 1980 is big.
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So all the early microcomputers we were just talking about, you know, the Altair, the Apple II, the TRS-80, these are all 8-bit machines. They're running the Intel 8080 processor or competitor making a similar 8-bit processor.
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The problem with an 8-bit processor is that the maximum data size for a given instruction cycle in the processor, this is called a data word in computer science terminology, is 256, two to the eighth. You can't represent any number greater than 256 in any given CPU clock cycle in an 8-bit machine.
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Totally. You could think of it like an hourglass or something. There's like all the data sitting there in memory at the top of the hourglass. And then there's this small little, you know, funnel that it goes through. That's the processor. And then it comes out.
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It's going to take forever. Yeah. Into the application of the software that the user sees. You're just not really going to process it that fast. Very primitive machines. Yes. And so for a company like IBM, they eclipsed the 8-bit computing cycle a long, long, long time ago.
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Mainframes and even mini computers with DEC, you know, all these machines are at least 16-bit, if not 32-bit computing machines. So 8-bit just, it's not interesting.
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Intel announces that they're coming out with the 8086 processor, which is a 16-bit microprocessor. With 16 bits, you can really start to do some damage here in terms of the applications that you could put on this thing to eat into bits. business software use cases.
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There's some really, really fun aspects to this. If you look at pictures of these processors, what did the 8080, the 8-bit processor, look like? And then you look at what did the 8086, the 16-bit processor, look like? You can see this in the 8008 processor that's only 8 bits. You see only 9 pins coming off of the little chip.
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There's a quote in one of the books we read from a childhood friend of his who says, "'Everything Bill did, he did competitively and never simply to relax.'" I think this used to be more than today. There's kind of this image of Bill Gates that he was a computer nerd, that he was like this shy little skinny kid. And the way he looks doesn't help this. But that is not the case at all.
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You know, there's the 8 pins for the data bits, and then I think there's one more control pin. If you look at the 8086 processor, it's a much longer rectangle with 16, 17, maybe like 20 pins coming off of it. Like you see this physically represented in the chip.
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Yeah. Back to 1980. The 8086 has been announced. 16-bit microprocessor is coming. IBM has already lived through missing a computing expansion era once with DEC and the minicomputer. They just let DEC take that market. Of course, that didn't really hurt IBM, but man, it would have been nice to also have that market too.
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They're finally observing the same thing that Bill and Paul did, you know, all the way back in the TRAFO data days of this is an exponential cycle. Like Moore's law, this is exponential and exponential gets real big very quickly once you get a few years in. Yep. And the mini computer cycle never was that.
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So it's hard to remember today, but just to underscore this again, in 1980, IBM was the most valuable company in the entire world. The highest market cap company, bigger than all the oil companies in 1980. The sun, the moon, and the stars. Yes. Do you know what their market cap was? In 1980? No. $150 billion. You are almost an order of magnitude off. $34 billion.
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That was the most valuable company. It is wild what a different world we live in today.
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So that company, the most valuable in the world, they're going to tiny little Microsoft that's just moved to Seattle for this partnership. What's going on here? So what IBM decided, this is just so amazing. Like they deserve so much credit here. They got the Clay Christensen disrupt yourself, disruptive technology thing intuitively decades before Clay writes any of this stuff.
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The way that they decide to compete is they're like, all the things that Clay wrote about are working against us here. What we need to do is we need to create essentially a skunk works division, just like our Lockheed episode. We need to do something outside the company, completely removed from the politics, sure, but like the business incentives not to disrupt ourselves and create a new division.
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This guy had a competitive fire in him. I'm sure still does like none other.
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They call it the entry level systems division. Actually, it may have existed before, but they repurpose it. This is in Boca Raton. In Boca Raton, Florida. Very nice place. We were just there a couple of months ago, but not a technology hotbed in the world. And they create a secret project called Project Chess. Secret from the rest of the company, the whole world.
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And the goal is to develop the IBM microcomputer or the personal computer, as people are starting to refer to microcomputers.
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And this is wild. They're going to do it in secret with a small team with no other IBM resources. And so that means this small team, the only way they can do it is to use all off-the-shelf components from technology providers, basically play on the same level playing field as all the other microcomputer manufacturers out there. And, oh yeah, one more thing.
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IBM leadership tells this team in Boca they have to ship the PC to customers within one year. It's a crazy constraint. It is a total crazy constraint. A couple quotes on this.
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Don Estridge, who was one of the leaders of Project Chess, he would later say that the company realized that if you're going to compete against people who started in a garage, obviously a reference to Apple here, you have to start in a garage yourself. And then Lou Gerstner, who later would take over IBM, would describe this whole Boca project as, quote, the way you get an elephant to tap dance.
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Hmm. Well, let's tell the story and then come back to it. Great. Okay. So what do they do? The hardware aspect of this is trivial, basically. Hell, Ed Roberts could put together the hardware to sell a microcomputer and do this deal with Intel. Like, I think IBM can do a deal with Intel. The, you know, not necessarily trickier, but the more important part is the software.
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And thanks to Bill's genius strategy about be the volume player, don't optimize on per unit price, set the standards out there. They were like the world's leading provider of programming language interpreters, right? A hundred percent. There is one game in town and one game in town only, and that is Microsoft in Bellevue, Washington at this point in time.
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Oh, yeah. Obviously, operating systems are going to become really, really big here in just a sec. But again, the 8-bit generation, operating systems weren't that important because people were writing their own software. The standardized software packaged application software doesn't happen until the 16-bit era and doesn't really, really happen until the 16-bit era and the IBM PC.
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So that's why the basic, the interpreter, is so important. So what happens? IBM calls up Bill Gates. And by August 1980, the two companies are in serious talks to partner and work together on the IBM PC. And we referenced Steve Ballmer a minute ago. The timing is just crazy. Steve had just joined the company. in June of 1980. He's employee number 30.
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The Microsoft team of 30, which the whole company of Microsoft pivots to work on the IBM PC partnership, is bigger than the Project Chess team in Boca.
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Wow. So, OK, Bill has just convinced Steve to drop out of business school at Stanford and come help him and Paul run the company. So Microsoft at this point in time is still a partnership. Steve is the first person besides Bill and Paul to get equity in the company when he joins. And it's eight and a half percent. And it's a handshake deal at this point.
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But he's the perfect person for this point in time. Bill was like the only salesperson doing these OEM deals. Now they're dealing with IBM. They're entering the enterprise world. This needs to be a real business. Yes. So back to the IBM negotiations. Obviously, Microsoft is very interested. IBM is not just very interested in working with Microsoft. They have to work with Microsoft.
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That sounds about right. So famously, speaking of Paul and where Bill and Paul meet, when Bill is in seventh grade, his parents enroll him at the Lakeside School, which now I think is internationally famous because of Bill, but it is a super rigorous college prep school, middle school and high school.
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Yep. FORTRAN. Like, give us the whole thing. And there's some debate on whether it was the Microsoft side or the IBM side that really saw the vision of, hey, the 16-bit generation is going to enable real business software use cases on the personal computer. But it doesn't matter. That's the plan here, and that is absolutely what happens.
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So these initial discussions are for the programming language. Microsoft doesn't make an operating system at this point because in the 8-bit generation, the operating system... I think it was kind of like a glorified bootloader to just get into the programming environment so that you could either write or load up the basic programs that Microsoft was going to interpret and then run.
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And in the 8-bit generation, most, if not all, hardware providers of microcomputers just wrote their own operating systems. It just wasn't a big deal. Now, there was one off-the-shelf operating system out there from a company called Digital Research, which was run by Gary Kildall, who I think, as we talked about earlier, Bill and Paul had actually intersected with back in Seattle.
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I think they were reasonably friendly. Yeah, I think they were quite friendly because they partnered. You know, you needed the operating system to get into the programming environment. It wasn't that big a deal. And so, yeah, whenever anybody needed one off the shelf, Bill and Microsoft would just refer people over to digital to get it. Yep. CPM, right? Exactly.
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CPM, CP slash M, which I think is maybe... Control Program for Microprocessors, I think is the abbreviation there.
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Bill, and I'm sure Paul too, but Bill is the only person in this industry that has the vision for what this can become. Even Intel, and Bill talks about this, he doesn't think that Intel even realizes what's happening here. They're just like, oh, we're just making more chips, you know, and like people use them for stuff.
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Okay, so the IBM-Microsoft discussions are going along and IBM's like, oh, hey, yeah, we need an operating system. So Bill, I think from everything we've read and folks we've talked to, kind of in good faith just does the standard thing he's always done in these situations. He's like, oh yeah, go talk to Gary. Go talk to Digital Research. He can probably do that.
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And Bill ends up writing the scheduling software for class scheduling that he puts himself in the classes with all the girls. Yeah. Oh, funny. But y'all like this, Bill, 13 years old, seventh grade Lakeside. This is when it starts. Obviously, Microsoft doesn't start. But during that year, Bill is 13 years old. The Lakeside Mothers Club raises money to buy the school a teletype.
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So what happens next is unclear. But what is clear is, however it goes down, this is one of, if not the biggest business blunder in history. IBM, that team from Project Chess, flies down, I think directly from Seattle and talking with Bill and Steve, to Monterey, California, where Digital Research is based at this point, to meet with Gary and his wife, Dorothy, who run the business together.
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And Bill's called them. He's like, hey, got a big OEM client coming down, needs an operating system.
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Right. So the team comes down. Obviously, they show up there from IBM. There's a big snafu where Gary does not attend the meeting. And there's conflicting reports about what happened.
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Yeah. So I'm pretty sure he was flying his personal airplane while this happens. Some reports are he was just out joyriding and missed it. Some reports are, no, he was like on a business trip and knew it was happening, but he had another important business meeting and he didn't know that this was IBM that was coming. Regardless, it doesn't really matter because IBM just wants the operating system.
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Dorothy does meet with them. She's unwilling to sign their NDA. There's a lawyer from digital research who gets involved and he doesn't really understand what's going on. The punchline is that IBM sort of leaves this interaction with the belief that Gary and digital research aren't up for working with them and like aren't capable of producing here.
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And producing is important because it's not like the existing CPM OS that they made would work here. They would have to write a new version, a 16-bit version. Yes. And they hadn't done that yet.
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Oh, that's amazing. I didn't know that. We'll talk about that when we get to the business terms of the Microsoft-IBM deal in a minute. Yes. But for the moment, there's no deal yet because an operating system needs to be provided here. So IBM goes back to Microsoft and they're like, hey, this guy you referred us to ain't going to work.
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The way that I read some quotes from the IBM people here was like, we just threw the problem back in Microsoft's lap of you guys deal with this. You source an operating system.
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Well, I'd like to say that Bill and Steve and Microsoft, you don't need to give them an opportunity twice. In this case, you kind of did need to give them an opportunity twice because they almost flubbed it and sent IBM down to see Gary. This time they don't flub it. They're like, okay, we'll get you an operating system.
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Yes. So it just so happens that right down the road from Microsoft in the Seattle area, I think they, despite being named Seattle Computer Products, I think this company was actually based in Tukwila, Washington, a programmer named Tim Patterson had just written a 16-bit operating system for the 8086 that Intel had just announced.
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And he was calling it the Quick and Dirty 16-Bit Operating System, or QDOS for short. Yeah. and had it ready to go. Now, why had he written this? What was this company Seattle Computer Products? Why did they have an operating system? They were a component provider to microcomputer manufacturers. They essentially made motherboards.
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And so when Intel now has announced this new 16-bit processor generation that they're coming out with, Well, Seattle Computer Products, they want to sell motherboards and have them ready for 16-bit. They kind of need to test and play around with these things and their customers are asking for it.
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So they had been going to Kildall and Digital Research too and badgering them to like, hey, write the 16-bit version of CPM. And Gary just didn't. So Tim's like, fine, I'll do a quick and dirty version myself. And thus DOS is born.
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No, no, no, no, no, no. So Bill and Paul and Microsoft, they've learned about this. They know Seattle Computer Products. They know Rod Brock, who's the guy who owns the company. They get in touch with him and they say, hey, can we license QDOS from you and Tim? We've got a big OEM customer that wants a 16-bit operating system.
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and connect it up and rent computer time from a DEC PDP-10 that is located in downtown Seattle and owned by the branch office there of General Electric. Now, probably a bunch of you are like, I have no idea what any of those words mean. So we got to set some context. This is 1968. 1968, you know, the Beatles, Vietnam, the Summer of Love. This is not the computer age.
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So they work out a deal whereby Microsoft pays Seattle Computer Products $25,000 for the rights to adapt and sell Q-DOS to the one unnamed original equipment manufacturer who they're working with. Tim actually, he's jazzed about this. He ends up leaving SCP Computer Products and joining Microsoft.
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And so he, with the rest of the team, he's part of building DOS, taking his initial work and turning it into real DOS. Later on, before this all gets announced and the PC ships, Microsoft would pay Seattle Computer Products another $50,000 for full rights to own 86QDOS, sell and license it to anybody else indefinitely. So I believe the total amount of dollars that changed hands here is $75,000.
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Unbelievable. This is DOS. Now, look, one programmer wrote a, quote, quick and dirty operating system, and Microsoft bought the license to that and adapted it into DOS. Tim, when he was at Seattle Computer Products, definitely did not write DOS as DOS becomes. It's not like Microsoft bought all of DOS for $75,000. They did a lot of work on it. But yeah, this is how it all goes down.
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It's just crazy. I mean, it really illustrates how fast things were moving, how much all this was getting invented and discovered real time that even to this point, Bill Gates isn't thinking that operating systems are that important. This is just a shortcut to get the deal done with IBM to make it happen.
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All right. Well, the rent can't be like that expensive then. So like, let's do it. Correct. Correct. Hell yeah. Well, you know, we've been joking for years about making the acquired museum. We might have a location. Okay. So now they've got the operating system. They've got QDOS in place to license to IBM. The only thing that is left to formalize the partnership is the business terms.
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And Ben, if what you said is right about the Gary Kildall IBM negotiations... This is just a masterstroke from Bill here in the licensing with IBM. Because there's two really, really big levers that it looks like Bill is giving big time on one of them, but he is winning big time on the other one.
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So the one that it looks like he's giving on is he does another fixed cost OEM deal with IBM.
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Yes. No per copy royalties. Yes. Every copy of DOS that IBM sells, either included as part of systems that they're selling, or they're free to charge independently for DOS, whatever amount they want, Microsoft gets zero dollars. And if it's true that this is where things fell apart with Gary Kildall, crazy that Bill is willing to do this.
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2001, A Space Odyssey had just come out. Nolan Bushnell has not founded Atari yet. Bob Noyce and Gordon Moore are only just leaving Fairchild Semiconductor to start Intel. Silicon Valley is still dominated by Lockheed. There is no such thing as a microprocessor.
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On the one hand, this is what he was doing with Apple and others. He was doing these fixed cost deals. You would think like, man, IBM, like this is the time. People aren't going to pirate IBM software. Now's the time to really grab the money bags. But Bill saw something that no one else did.
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In exchange, I don't know if it was directly in exchange in the negotiations, but the other lever that he saw that he pulled was Microsoft retained the rights to own DOS and to own their languages and license it and them to anyone else they wanted at any price on any terms.
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So I think there are two things going on here. One small and one big. The small thing is actually related all the way back to the beginning of the episode, what you said, Ben, about the antitrust concerns within IBM. To hear them say it, they actually didn't want ownership of the software. They wanted it to be separate because it would sort of look better.
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And that may well be true. I think the bigger thing that just wasn't in their consideration or mindset was... They, I think, assumed that once they entered the PC market, IBM was going to be the dominant player. So it didn't matter. Once IBM is selling PCs, who's going to buy a PC from anybody else? IBM is going to win this market.
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Totally. But the way computing worked back then, it was basically still the ENIAC days. A computer meant two things. It either meant a massive room-sized machine that had about the computing power of a calculator, or it meant a human. People talked about computers as humans. Did you ever see the movie Hidden Figures about the black women who did the calculations?
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And what Bill saw was he really made a bet that the same dynamics that played out with the Altair were also going to play out with the IBM PC. That there would be a million hardware manufacturers' flowers blooming here. Building to the same spec. And building to the same spec. Using the same processor. Which, of course, they could because it was all off-the-shelf components.
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And IBM either didn't see or didn't believe that that would actually happen.
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experience to pattern match off of of what does the world of microcomputers look like and how is that fundamentally different than the world of mainframes totally and in a way that you know the mini computer generation like we've been saying it was like a half generation it wasn't it wasn't actually fundamentally that different other than deck gained a foothold
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Right. So let's say a little bit about why. I mean, maybe it's obvious, but here now is IBM, most valuable company in the world. They're going to come out with the PC platform. They are going to build the market. And Microsoft is going to own the linchpin sort of Hamilton-Hellman terms, like where the power is in the market.
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And they're going to be free to license it at whatever terms they want to any other player who wants to enter. So they signed this agreement in November 1980. The IBM PC ships in August 1981. Just incredible. Almost exactly a year, a little more than a year from the time Project Chess starts to when they actually ship the PC.
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Truly incredible. It changes the world. That's such a trite thing to say, but everything that everybody's imagining happens.
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Totally. They sell 13,500 IBM PCs within the first couple months after they announce it. Over the next two years, they sell half a million of them. Makes them unquestionably the largest personal computer, microcomputer manufacturer, market leader. Everybody at IBM is celebrating. The clones haven't arrived yet, and maybe they won't. It'll play out like they think. Not exactly.
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Now, before we talk about the clones... This is really just a footnote because, of course, all the incentives are aligned for IBM to push DOS as the operating system for the PC. I mean, they've done this whole deal with Microsoft. They have a royalty-free deal with them. When they launch the PC, customers actually have a choice of which operating system they want on their IBM PC.
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They don't have to go with DOS. Consumers can choose between DOS, 16-bit CPM. By this point in time, Gary and Digital Research have gotten their act together. They've written a 16-bit version of the CPM operating system. Or another 16-bit operating system called Pascal that came out of the University of California at San Diego.
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And the price sheet for the operating system option is Pascal is an extra $450 with your IBM PC. CPM is an extra $175 with your IBM PC. And DOS, which was developed specifically for the PC as the best way to run it, is only $60. So IBM is making $60 of full 100% margin on top of their hardware for the PC by selling DOS because they don't have to pay Microsoft any of that.
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They were called the computers. Yes. Because they would sit there and compute. This was a totally different era. So the idea that a 13-year-old kid in this high school, this middle school would get access to share computer time. I can't imagine there are many other secondary schools in the country that were doing this.
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And they've set up the incentives that like, obviously, everybody's going to choose DOS.
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It just turned out that the effort required to reverse engineer the IBM BIOS was trivial, basically.
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Ooh, well, I know the Compaq story, but I don't know the story of the BIOS specifically. Enlighten us.
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The Compaq story is amazing. So the three people who start Compaq in 1982 are actually Texas Instruments engineers who left and they wanted to start a company. And I believe as the legend goes, they were like trying to decide what to start. They were considering like a restaurant chain and like a bunch of different business ideas. And then the IBM PC comes out at the end of 1981.
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And they're like, oh, we can clone this and do everything. You know, the story you just told. So, yeah, it's wild. They start the company in 1982. And within the first year, they do $111 million of revenue of selling IBM PC clone hardware.
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Microsoft Volume I
on a per machine sold basis. This is when they grab the money. The operating system is so deeply embedded and needs to get shipped with the computer itself. Yeah, consumers can go buy operating systems to upgrade and whatnot, but no hardware manufacturer is gonna ship a 16-bit PC without an operating system. So piracy is not an issue here.
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Microsoft Volume I
Microsoft can now do a per copy sold, per machine sold license with all these clones. My God, it's just like a geyser of money.
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Microsoft Volume I
Yeah. So I think I have these numbers and timeframes right. I believe that for calendar year 1982, Microsoft's revenue was $25 million. Yeah. And I think this must have been when they switched to fiscal year end and June 30th. So Microsoft's fiscal year end starting then and up through now is June 30th. So they're fiscal 1984. So the year ended June 30th, 1984. So 1983 midpoint to 1984 midpoint.
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Microsoft Volume I
Microsoft does $98 million. In an 18-month period from the end of 1982, they go from 25 to 98. It's all on the back of the clones. And unlike Compaq that, you know, yeah, they did $111 million of revenue their first year, they're selling hardware, which has serious cogs associated with it. Microsoft, 100% essentially gross margin, software revenue, more than doubling year on year.
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Microsoft Volume I
So meanwhile, in the computing industry background, while all this is going on with the launch of the IBM PC and then the clones, Apple had gone public at the end of 1980 in, I think, the biggest and most successful IPO of all time at that point. Remember, we talked about Genentech on the Novo Nordisk episode. They went public like right before Apple and then Apple was bigger. Yeah.
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Microsoft Volume I
So they're valued at $1.8 billion at IPO. Steve Jobs is this multi-hundred millionaire, like media darling, all this stuff. The next year in 1981, Microsoft reorganizes from the partnership between Bill and Paul with the handshake deal that Steve's going to be cut in on the partnership into a stock company, a C corporation.
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Microsoft Volume I
And as part of doing that, the venture firm Technology Venture Investors or TVI invests $1 million, I believe for 5% of the company. Yep. This is crazy. That's a $20 million post-money valuation. It's a one-on-20 post when Microsoft is doing how much in revenue? That year, they did $17 million in revenue, and they're about to do the IBM deal. Like, this is absolutely absurd.
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Microsoft Volume I
Yeah. Venture capital sucked back then. Yes. There's no other way to put it.
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Microsoft Volume I
You know, even among people who should be in the know, the beauty of the software business model still is something people don't understand.
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Microsoft Volume I
The hotness is the hardware. It's like Apple just IPO'd. Apple's worth $1.8 billion. Like, ooh, that's the industry. Ooh, it's IBM, et cetera, et cetera. When Microsoft itself would go public a few years later in 1986, they actually go public the same week that they moved to the big campus in Redmond, where they are to this day.
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Microsoft Volume I
Their market cap at IPO is only $750 million, despite having done $200 million of very high margin software revenue in the trailing 12 months up to that, growing 100% year over year. It's insane.
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Microsoft Volume I
Well, it's funny. I've thought about this a lot, and I actually watched that interview years ago. It's so good. There are elements of truth to this, too. And I think it's that for most technology companies, that is totally true. Yep. And then for a few technology companies that have true power and true scale, the exact opposite is true.
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Microsoft Volume I
He and Paul got a sneak peek into the future there at Lakeside. Now, it's funny, you said the personal computer era. We are so far away from the personal computer here. I mean, we got us at the stage. What is computing? I mentioned ENIAC and these room-sized things. Computers did not have screens. You didn't have cursors. You didn't have lights. You didn't have pixels.
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Microsoft Volume I
Everything was done on a teletype. They kind of looked like typewriters. And they were wired up remotely, either in the same facility or like what Lakeside is doing. You could be remote. I mean, it's almost like the cloud today. And it called over a phone line? That was the teletype? Yeah, exactly. It got wired over the phone line, hooked up to these mainframes.
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Microsoft Volume I
And that's what I had always read about the TVI investment. Yeah, obviously, Microsoft didn't need the money. They liked Dave. But also a big part of it was this was a catalyzing function to do the conversion into a C Corp.
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Microsoft Volume I
Yeah, we should say too, vis-a-vis Paul, tragically, and I believe it was 1982, 83, he's diagnosed with Hodgkin's disease and he ends up taking a leave and then fully leaving the company. I think he did go on and off the board at various points in time.
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Microsoft Volume I
But yeah, he's no longer a full-time member of the company after his diagnosis.
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Microsoft Volume I
And I've always heard wonderful, wonderful things about Dave. And I think everybody really did love him and see his value. But man, to be a venture capitalist in the 1980s and 1990s, like, oh man, you couldn't lose.
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Microsoft Volume I
Oh, Don Valentine famously had the rule, they didn't invest in any company that you couldn't bicycle to from Sand Hill Road.
Acquired
Microsoft Volume I
Okay. Back to the story. There's a couple more really, really key things that happen in the PC era. And particularly now, once we're into the IBM PC era and the clones, the 16-bit era. And let's start with applications. So, you know, kind of like we've been saying all along, the 8-bit era, applications, package software... aren't really a thing.
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Microsoft Volume I
In 1979, kind of at the tail end of the 8-bit era, two programs come out for the Apple II, VisiCalc and WordStar. VisiCalc is the first software spreadsheet application, and WordStar is a word processor. These applications, by today's standards, are super simple, like Stone Age type stuff. But they're the first of their kind, particularly VisiCalc and the spreadsheet.
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Microsoft Volume I
They sort of established the potential for business applications on personal computers. There's a joke at one point in the industry that the Apple II was a quote-unquote visit calc accessory for small businesses. And I think that is part of what IBM is seeing and why they're deciding to now get into the industry with the personal computer.
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Microsoft Volume I
Around this time, Microsoft starts the quote-unquote consumer products division to compete and make application software themselves.
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Microsoft Volume I
And so you typed commands into this teletype. And then the response came back over the phone line or over whatever cable from the mainframe. And it got printed out on a spool of tape on the teletype. But this is power that normal 13-year-olds don't come anywhere near accessing. Yeah. Yep. What is the computing market at this time?
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Microsoft Volume I
Right. So one of the first people that they hire into this new division to get it going is an engineer, Ben, who you referenced just a minute ago, named Charles Simone. And they poach Charles, perhaps with Dave Marquardt's help, away from the legendary Xerox Palo Alto Research Center or Xerox PARC. And I think this is one of the great misconceptions in technology history. Yes.
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Microsoft Volume I
I've heard it characterized as something like Xerox hosted a picnic in Silicon Valley and Steve Jobs attended and dined lavishly at the feast. Which all of this is true. Which is true. That is true. All of that is true. But it's half the story. He was not the only person who dined lavishly at the feast.
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Microsoft Volume I
Microsoft did just as much directly from Xerox, and Charles was one of the main vectors by which this happened. So here is the list of things that were invented or basically invented at Xerox PARC. The graphical user interface... The desktop, the mouse, object-oriented programming, Ethernet, laser printing, along with a whole host of other things.
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Microsoft Volume I
Like, this is everything about modern computing invented there. Who are the people who were at Xerox PARC? Well, there was Alan Kay. There was Bob Metcalfe, who would go on to found 3Com. He invented Ethernet, you know, Metcalfe's law.
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Microsoft Volume I
Yeah. Bob Metcalf, Xerox PARC. Larry Tesler, who would join Apple. John Warnock, who started Adobe. Eric Schmidt worked at Xerox PARC. Everybody was there. It was a lavish picnic. And Charles Simone. And Charles Simone. Now, the thing about PARC and the computer that they built there to instantiate all these concepts, which was named the Alto... is it really was a research center.
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Microsoft Volume I
So the Alto, go look it up on Wikipedia, go look at pictures. It's the Mac. The Alto is the Mac.
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Microsoft Volume I
They start making it in 1973. So you might be like, wait a minute, what's going on here? The Mac doesn't come out until 1984. 11 years earlier. How on earth is Xerox making the Mac in like the pre-8-bit era, the pre-microprocessor era? Well, it's not a microprocessor. The Alto is not a microprocessor architecture.
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Microsoft Volume I
So what you see when you look at photos of the Alto is you see the Mac. What you don't see is under the table or behind it is a mini computer.
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Microsoft Volume I
It is pretty much, we'll come back to the pretty much in a minute, 100% dominated by IBM. Oh, yes. IBM, big blue, you know, big iron is what it was referred to, like the products that they would produce. They were the industry. Yeah.
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Microsoft Volume I
So it is not a personal computer architecture at all. It is a 16-bit essentially mini computer that costs tens of thousands of dollars to make each one of them.
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Microsoft Volume I
Totally. The time was not right. It was not possible. It wasn't even conceived of in the microprocessor architecture because the microprocessor basically didn't exist when they made it. Interesting. So in 1980, again, this year for Microsoft, same year Microsoft joined, same year they signed the IBM partnership, Charles Simoni comes up from Xerox PARC.
Acquired
Microsoft Volume I
And he's, of course, bringing all this same knowledge, all this same experience that Steve Jobs is bringing into Apple. He's bringing all that right into Microsoft, too. And the first thing that he gets tasked with is working with this new consumer products division to build application software to compete with VisiCalc and WordStar to compete with spreadsheets and to compete in word processing.
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Microsoft Volume I
Now, remember, we're still at the end of the 8-bit era. The graphical user interface doesn't exist yet other than on the Alto in Xerox PARC.
Acquired
Microsoft Volume I
Yes, it is command line interface. So the vector that they think they're going to compete, at least in spreadsheets with VisiCalc, is that they're going to be on every platform out there. VisiCalc, I believe, was more or less basically only on the Apple II. Well, that doesn't end up working too well. And then the next generation, the IBM PC era, they sort of make the same mistake.
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Microsoft Volume I
The application business stays focused on being on lots of machines, making software that's compatible with everything. A new company pops up called Lotus.
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Microsoft Volume I
And Lotus makes the radical decision that they are going to make a spreadsheet that only for the IBM PC. And this was genius. This is the one, two, three spreadsheet. And it goes on to become at that point in time, the most successful software ever. This is wild. I can't even believe I'm about to say this, and it blew my mind when I found it in research.
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Microsoft Volume I
There are a couple of years in the late 80s where Lotus has more revenue than Microsoft and is valued higher. Yep.
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Microsoft Volume I
Yes. And how it applies to applications. Yes. You always got to target the next platform.
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Microsoft Volume I
This is the dawn of horizontal software. You can have a whole company or a whole division of a company in Microsoft's case that makes this tool. And that tool will be so much better than anything that even the largest companies could have their own software developers write. General Electric isn't going to write a better spreadsheet than 123. Right.
Acquired
Microsoft Volume I
And then so I think that the technology complement to this sort of law is the killer app.
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Microsoft Volume I
Finally, we're like 10 years into acquired here. We're finally doing it.
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Microsoft Volume I
You need to be the killer app on the next platform. And that's what Lotus 123 did with the spreadsheet on the IBM PC and IBM compatible PC. And that's what Microsoft decides, hey, we got to do this in the graphical interface.
Acquired
Microsoft Volume I
Also, we have to give our good buddy and pilot CEO, Waseem Daher, a special shout out here because I think he is now the only acquired sponsor CEO who is also a source for an episode. Because back when Waseem was a student at MIT, he interviewed Bill Gates for the school paper and he dug up the PDF and sent it to us. And we're going to link to it in the episode sources.
Acquired
Microsoft Volume I
Yep. So enter Pilot. Pilot both sets up and operates your company's entire financial stack. So finance, accounting, tax, even CFO services like investor reporting from your general ledger all the way up to budgeting and financial sections of your board decks. And they've been doing this now for years across thousands of startups in Silicon Valley and elsewhere.
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Microsoft Volume I
There's nobody better who you can trust to both get finance right and make it easy and painless for your company.
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Microsoft Volume I
Because I think it's fair to say that the Mac made Microsoft Office and Microsoft Office made the Mac. I don't think that is actually a controversial statement. No. Although it probably sounds crazy to many of you listening.
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Microsoft Volume I
Yeah. System 360 was a line of solutions, I would say, offered by IBM. And it consisted of the thing, the room size thing, the mainframe and the software, which was System 360 and the consulting and the implementation. You know, you couldn't just call up UPS and forklift one of these things into a company and expect it to work. No, you got to operate this thing, too.
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Microsoft Volume I
And one thing just to underscore here, Excel is the world's first graphical spreadsheet program. And that's why it wins. And that's why it's so important. Like imagine trying to use Excel in the command line interface. That's what VisiCalc was. That's what even 123 was. Yeah. Useful. Better than nothing. But graphical charts, cells, visual relationships. This is so important.
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Microsoft Volume I
Yeah, that gets kind of rechristened as like, that's the original Mac, right? And the original original is the Mac 128 or something like that.
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Microsoft Volume I
Right. Writing hello in script is, you know, cool, but kind of like a lot of VR stuff. You're like, oh, that's a cool demo. But like, you're going to do that every day? Like, no.
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Microsoft Volume I
Right. Yeah, it was all being figured out. I think it is also really fair to say Microsoft was right there with Apple in the Mac development phase. Obviously, they're working on Excel, working on other, you know, what would become the Office Suite applications, you know, together for Mac. Steve Jobs shows Bill Gates the Mac project in 1981, three years before it ships.
Acquired
Microsoft Volume I
And Microsoft and Apple signed an agreement to work together on applications for it in 1982. They were very deeply embedded on this. It's amazing. Which is going to make the lawsuit and what comes up in a minute here all the more sort of funny.
Acquired
Microsoft Volume I
Yep. And soon to come, we'll get into Windows here in a second, one of the big, this killer app for productivity in particular for business productivity is With a graphical user interface like Windows and true multitasking, you can get copy paste from like Excel into PowerPoint.
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Microsoft Volume I
You know, Lotus and the world back in the command line interface where you've got these programs running on top of DOS, that is like a completely foreign concept.
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Microsoft Volume I
And at this point in time, the actual boundary between an operating system and an application is very fluid. You've got a mouse that works for one program. Totally. You know, Lotus would really go down a dead-end evolutionary path with Notes, you know, later in its life, in its final chapter, where the application was going to be the operating system.
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Microsoft Volume I
Yes. And it itself was an application. It's crazy. Not an operating system. So yeah, it was all kind of dynamic. Speaking of, though, Microsoft here is in bed with Apple working on the Mac. Bill and the company are big believers in the future of the graphical user interface. Starting in 1983, they're like, we got to do our own. graphical operating system or at least user interface.
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Microsoft Volume I
And this is the origins of the Windows product. And they actually announced it in November 1983 before the Mac ends up shipping, which their partner Apple is, of course, not happy about. Yep. Now, just like development of the Mac was rocky, development of Windows was super freaking rocky within Microsoft too.
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Microsoft Volume I
This is around that same time when Paul Allen gets Hodgkin's disease and leaves the company. So his presence as sort of great technical leader is very much missed, but they bring in someone from Xerox to manage the development of Windows. That person ends up not working out. He gets fired.
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Microsoft Volume I
Steve Ballmer gets drafted to come in and be the dev manager for the final push to release Windows 1.0, which is hilarious. You can find amazing YouTube videos from the launch and all joking about how like non-technical Steve coming in to save the day and dev manage Windows to launch.
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Microsoft Volume I
It's bad. November 1985. Windows 1.0... is a very, very different thing than you imagine a graphical user interface is today or what you know of as Windows. It was tiled. It was not overlapping windows that you can drag around and have one over the other. When you opened a program in Windows 1.0,
Acquired
Microsoft Volume I
The system created a literal window of it on your screen and then it dynamically resized the windows as you open other applications. And so nothing could ever be on top of each other. So as you open more and more stuff, the windows get smaller and smaller and smaller. It's very bizarre.
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Microsoft Volume I
Yes, 100%. And so I believe Microsoft and Apple actually did like a licensing agreement while they were working together during this time that said, hey, Microsoft can use a lot of the stuff that's being developed for Mac for Windows 1.0.
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Microsoft Volume I
Yeah, interesting. It cracks the door for Microsoft like 15 years later, 20 years later. Yeah.
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Microsoft Volume I
Also, by the time that this agreement actually happens, I think Steve Jobs has been ousted. And so it's Scully who does this agreement. And people in Apple would look back on this for years and be like, this was a huge error. The other important thing about Windows during this sort of awkward teenage phase is it's not an operating system. It's just a graphical interface on top of DOS.
Acquired
Microsoft Volume I
Well, obviously that's a setup there. Here's the other thing that's happening in the company at this time. And it's the bigger thing. It's the next phase of the IBM relationship. Windows, the Mac, all of this, these are hedges for the company. Microsoft and Bill in particular were masters of hedging their bets in an uncertain technology future.
Acquired
Microsoft Volume I
Interesting. Now, back to the timing thing for Bill and Paul and Microsoft. I mentioned when we were setting this up that there's something else to talk about here. IBM was facing a disruptive force at this moment. I think probably for the first time in its history, certainly in the computing era of IBM's history, and that was the Digital Equipment Corporation, or DEC.
Acquired
Microsoft Volume I
He was so great, the company was so great at making sure that whichever way the Apple fell from the tree, as Jetson Huang put it to us in our interview, Microsoft was going to be positioned to catch it. A lot of people, including Bill and Microsoft themselves, believe that the way the Apple was going to fall from the tree here was IBM and OS2.
Acquired
Microsoft Volume I
So what's going on here? IBM, obviously the PC was a huge success, but losing dominance of the ecosystem to the clones... This was bad. And so IBM wants to find a way to evolve the PC ecosystem back to being more IBM proprietary. And they're going to make Microsoft come along for the ride here.
Acquired
Microsoft Volume I
And the way that they're going to do this is with the next generation of the PC ecosystem, they are going to make a whole new modern operating system. They're going to get rid of DOS. They're going to make this operating system in partnership with Microsoft, and it's going to be called, fittingly, OS2. And they are going to lock Microsoft up that they can't license it to anybody else.
Acquired
Microsoft Volume I
OS2 is going to be proprietary to IBM hardware, just like the Mac operating system is proprietary to Apple hardware. And as powerful as Microsoft's become here, they're still the little brother to IBM. And this is not great news for Microsoft.
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Microsoft Volume I
On the other hand, it's much better for them to be on the inside here with IBM working in bed with them than it would be to be on the outside looking in if... IBM's vision comes true and they recapture control of the PC ecosystem.
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Microsoft Volume I
So Bill and Microsoft and the company and Steve too, as sort of the manager of the account with IBM commit themselves to Microsoft is all in on this vision of the future of OS two and IBM is our horse in the race.
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Microsoft Volume I
This is a re-centralization attempt. Bomber has this great, great, great quote about it. He says, this, the IBM partnership at this time, it was what we used to call riding the bear. You just had to try to stay on the bear's back and the bear would twist and turn and try to throw you off. But we were going to stay on the bear because the bear was the biggest, the most important.
Acquired
Microsoft Volume I
You just had to be with the bear. Otherwise you would be under the bear. And like that was IBM at this point in time. I mean, really, I think it was IBM essentially putting a gun to Microsoft's head and being like, well, you can be in bed with us on this future that we're going to re-centralize everything, or you can be like everybody else and not be, and you'll lose.
Acquired
Microsoft Volume I
And certainly Bill, and I think Steve too, they needed to tow the party line politically of expressing that, nope, OS 2 is the future. And what we're doing with Windows and with the Mac is, you know, those are small things within the company. It's a super bizarre period in history. But IBM had also kind of...
Acquired
Microsoft Volume I
Notice when we said earlier that Lakeside is renting computer time from the General Electric Computer in downtown Seattle. Yeah. I said, it's a DEC PDP-10. It's not an IBM product. So what's DEC? They're the mini computer company. Mini in quotes. Yeah, mini, quote unquote. Mini meaning it was the size of a closet, not the size of like a room. It's all relative.
Acquired
Microsoft Volume I
made a bit of a power play too with the later generations of the 16-bit era, a product they called the PC-AT. They used the Intel 286 chip instead of the Intel 386 chip. And the 286 chip, this was an intentional decision on IBM's part. The 286 chip was good, but it wasn't great.
Acquired
Microsoft Volume I
I mean, I think it certainly was more powerful than the 8086, 8088, but it was nowhere near what the 386 could do. You know, there's a bunch of technical aspects to this, but the most important takeaway is that the 286 was not really powerful enough to do a graphical user interface or to power true multitasking in a way that the 386 and then later the 486 would be.
Acquired
Microsoft Volume I
And so a big part of actually the Compaq story about how Compaq and the clones leap ahead of IBM is they're not deterred from coming out with 386 machines, which are way more powerful, can run Windows, can do all this stuff. And so that's how they start to separate from IBM.
Acquired
Microsoft Volume I
This is the thing. Bill and Steve and the company, they're having to tow the party line of expressing commitment to IBM. But really, they're like, no, no, Compaq, go do the 386. We're going to do Windows. They're like riling up the rebels. Exactly. They are the rebels versus the empire here. So anyway, IBM, of course, sees all this.
Acquired
Costco
I don't think I have ever been more in love with a company and a business model. What are you, Charlie Munger? It's just the deeper you dig, the more good things you find. And usually it's the exact opposite of that. It's like the opposite of being an early stage venture capitalist.
Acquired
Costco
Costco cuts a deal with those companies to say, we're going to send you traffic as long as the traffic we send you, once you verify it, you give those people a discount.
Acquired
Costco
Yes. So Costco looks at it like, oh, great, we get to give yet another value to our members without having to take on the e-commerce logistics that they hate, that complicates their business, that changes people's impression of what Costco is.
Acquired
Costco
It's like the obvious way for them to play this market for anyone who's willing to partner with them.
Acquired
Costco
It's like selling through Costco without having to sell through Costco, without having to physically drop stuff at their warehouse. And it's the internet way to sell through Costco.
Acquired
Costco
So my last bull case really is Costco's culture. It just outlives any given quarter, year, economic cycle, or even any CEO. Normally, when companies get bigger, things get worse. Standards of excellence fall and execution gets sloppy. And Costco has just been exactly the opposite of that.
Acquired
Costco
Yeah, hard to see that working. But actually, it's not so different inflation-adjusted from REI's membership today. Very clearly, REI is not interested in making money off the membership program. I pay, what is it, $85 or something once just to grant me sort of a higher affinity to the store, and the money is not really relevant.
Acquired
Costco
All right. Costco is the largest seller in the world of fine wines. Fine wines are defined as $20 to $300 bottles. Like, what? Costco? But they're just the largest seller of things.
Acquired
Costco
No questions asked. How long do you think it lasts? Infinite. infinite. There is an exception on things like electronics. Those are 90 days, but that's 75 more days than anywhere else.
Acquired
Costco
If I buy a MacBook Pro at Costco, it's a 90 day return policy. If I buy it at Apple, it's a 14 day return policy.
Acquired
Costco
In fact, I'm sitting here, I really want to buy a 13-inch MacBook Air, but I'm afraid that the 13-inch MacBook Air is about to become the M3 later this year. I should just go buy it at Costco. Now, that is not really the behavior that they want to encourage.
Acquired
Costco
And I do know that if you sort of take advantage of it over and over and over again, they do sort of take you aside and say, hey, it seems like we're not providing enough value to you. Let us refund the membership. We're so sorry. We couldn't do a great job. Yeah.
Acquired
Costco
Last year, they sold a 10-carat diamond ring. And that diamond ring, to my knowledge, has a lifetime, no questions asked, full value return policy.
Acquired
Costco
It's funny, I didn't know, but it's just Nordstrom is such a famous local story around their favorable return policy.
Acquired
Costco
It may not be real, but at some point, somebody brought tires back to Nordstrom and said, I'd like to return these. And instead of saying, well, we don't sell tires, the person thought about it for a while and said, well, could you just tell me a little bit more information? And they said, well, I bought these here and they named a year.
Acquired
Costco
And it turns out that before that real estate was a Nordstrom, it was actually a tire center. And Nordstrom gave the guy money and took the tires.
Acquired
Costco
But what really makes it work are the 50 clever innovations that they've refined over the years that all work together like an orchestra that's been rehearsing for decades. Nothing about Costco is an accident, from the extra-wide parking spaces to the whole rotisserie chickens.
Acquired
Costco
Oh, wow. I do know, by the way, Nordstrom has since adjusted its return policy to actually be capped, not infinite, and so now Costco has a better return policy than Nordstrom.
Acquired
Costco
Wild. All right, more stats, just for fun. They sold 2.2 million pumpkin pies in the three days leading up to Thanksgiving last year. They sell one-third of the jumbo cashews in the entire world. They, of course, sell eyeglasses, and this is one of the areas where they felt they should vertically integrate.
Acquired
Costco
I actually don't know why, but I suspect it's because prices are artificially high in the entire glasses supply chain.
Acquired
Costco
So Costco now owns and operates three optical grinding labs to make prescription eyeglasses. Wow.
Acquired
Costco
It's the craziest thing. And then lastly, here's an illustration of their culture. I think they definitely believe that you must work long, smart, and hard if you're going to be a leader there. And none are optional. You just have to do it. And... To illustrate this, all of their market managers and country managers come to headquarters for two days every single month.
Acquired
Costco
So no matter what market you manage, you fly to Issaquah, that's 160 people, to all sit in a room for two days and just talk about what's working, what's not, what you're seeing, and how the whole company can get better and share learnings.
Acquired
Costco
The dedication's incredible. Crazy. All right, carve-outs? Carve-outs. All right. I have... two, and I'm going to do them both because they're fast and small. The first one, there's a brand called Tifosi, T-I-F-O-S-I, that makes sunglasses for running.
Acquired
Costco
And you can wear them for other stuff too, but I love them because they are sunglasses that don't slip off my face when you're running or doing something and you get sweaty. They have these little grippy pads that sit on the nose, and I feel like I've solved this thing that was mildly annoying in my life for a very long time, which is just continually pushing up my... sunglasses while running.
Acquired
Costco
So highly recommend Tifosi. They're also pretty cheap. I bought like three pair and they're goofy and different colors and they're fun.
Acquired
Costco
Yes, exactly. The second is a mashup that I found last night when I was looking for cool stuff to listen to while finishing the research and editing the script. Thank you to Jason Kotke, author of Kotke.org, for posting this. There is a New York City DJ named Dwells who released a mashup about four months ago of Everything in Its Right Place by Radiohead and Kendrick Lamar's N95.
Acquired
Costco
It's probably because I'm like a huge, I don't listen to Radiohead that much anymore, but like in college.
Acquired
Costco
Seven hours a day or something. Yeah. Like whenever I was programming, it was just Radiohead all the time. But it like instantly took me back to that place in my life and is honestly one of the best mashups I've ever heard.
Acquired
Costco
In some like DJ subculture. I mean, it is crazy how mainstream like Girl Talk and what was the other one? The White Panda were for a while. Mashups, I love it. Yeah. Radiohead and Kendrick Lamar.
Acquired
Costco
And this conversation, I'll tell you, is exactly like hanging out with Jeremy, but in higher density. His personality is exactly how he comes across on the podcast, but it's definitely a best of. You know, whenever I hang out with Jeremy, I get like six or seven kind of mind-blowing one-liners, these like insights that just come to him out of nowhere. And the podcast has 30 in an hour and a half.
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Costco
But Fedco's a nonprofit. They're not looking to, like, expand and build this huge empire. Exactly.
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Costco
Dogpatch Labs on Peer... I'm trying to remember the actual number. But yeah, there was a co-working space when I worked at CoTweet. Actually, they condemned the Peer and took it down because it was like, we were the last year that it was still... I don't know, we probably shouldn't have had an office in it. But yeah, I worked at CoTweet.
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Costco
Thank you for saving me from, I was going to stay at a hotel on Market Street and you were like, do not do that.
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Costco
Airbnb is a thing. Airbnb. All right. With that, our thank you to Blinkist and Go1 with some awesome, awesome links that you can check out in the show notes to see David and my personal bookshelf and also get the blink of the Sol Price book at Blinkist.com slash Costco. Thanks also to Statsig. You can supercharge your ability to launch features, measure them, see the impact.
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Costco
and collaborate better with your team around being data-driven in your decisions. And Crusoe, if you're doing anything in AI, check out their cloud. Click the link in the show notes and get just better AI data centers that are better for the world. Sign up for notifications of new episodes. We just flipped this thing live, acquired.fm slash email.
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Costco
We are going to be including little tidbits after we release episodes, including listener corrections and little fun stories that we didn't have in time for recording. We'll also be teasing future episodes. So if you want to play a little trivia game with us to try and guess what next episode is going to be, that is where we're going to be dropping those hints.
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Costco
You can become an LP, acquire.fm slash LP, become closer to the show, do Zoom calls with us every other month or so, and at least once a season, help pick the next episode, acquire.fm slash LP.
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Costco
They did. Oh, one thing we should say in case you don't follow us on social media and didn't see the tweets about it. Friend of the show, David Lidsky, did an awesome, truly awesome piece in Fast Company about Acquired. And we're super grateful that he took the time and dove deep and spent many hours with both of us.
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Costco
Lots and lots of time basically tracking us as we were preparing the Nike episode. And since he's been listening since 2017, 18, he knew a lot of the history of the show. And so he wrote this really cool piece.
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Costco
If you are one of the people who has emailed us over the years and said, it'd be great if you guys did something talking about how your research process for acquired works, David chronicled that and much better than David or I ever could have. So thank you, David Lidsky. Really appreciate it. We will link to the Fast Company piece in the show notes too.
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Costco
Look for ACQ2 if you want to learn more about AI in any podcast player. And check out the Slack. Come discuss it with us. Acquired.fm slash Slack. Listeners, we'll see you next time.
Acquired
Costco
I'll see you there and get a chicken bake. How much are the chicken bakes? More than $1.50. But, you know, it's more substantial than a hot dog.
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Costco
It's like 900 calories. Wow. But yeah, you're not doing a lot of other eating that day.
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Costco
Yeah, on the one hand, you might think Saul Price, not a very savvy business person, just take the gift and go with it. On the other hand, ridiculously principled guy.
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Costco
And if your goal is to offer extremely great value to your customers on high-quality products at the lowest possible prices, there are a lot of ways that you could go about doing that. And today, we will walk through the very specific path of decisions and trade-offs that Costco has chosen to accomplish just this. So listeners, remember that.
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Costco
And so very specifically, we are not talking about what Costco is today as a wholesaler. FedMart is not big pallets with enormous quantities of things. It is much more like a Walmart. You want to go grab a can of beans off the shelf, you grab a can of beans off the shelf. And importantly, it is both packaged food and sundries or general merchandise under one roof.
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Costco
That makes sense. And so just to put some other fine points around what it is and what it isn't, it is still only for federal employees, right? Yes, at this time. Okay. And it's not a membership club.
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Costco
Extreme value, high quality products, lowest possible prices. And David, my God, does this method work well. There is a reason Charlie Bunker loves this business.
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Costco
Right. Not the same, but kind of rhymes. Put a pin in it. When it comes to Costco, we'll bring those up and go into each of them in depth.
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Costco
Sam Walton bragged about it in Made in America about we could get this, you know, incredible number of, I don't even remember what the thing was, but build a pyramid of them in the parking lot and blow them out to get people to come and participate in the spectacle.
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Costco
Totally. That's exactly my read on this, too. I feel like David, acquired number one tenant, treat the audience like they're smart. If you're going to ever do loss leaders, you're sort of violating that tenant and saying like, eh, we're going to get one over on our customers.
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Costco
Oh, that is awesome. I mean, Charlie Munger, of course, on the board of Costco and longtime fan of the bottle, as you should be too. So here are some insane stats. Costco has grown revenue right about 10% for over 30 years in a row. Their revenue per square foot of their warehouses belongs more in a conversation with Tiffany than Walmart.
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Costco
Which for listeners, if you want those numbers today, Costco's average hourly wage is $26 and Walmart's is $19.50. So huge, huge difference if you are going to go get an equivalent job at one or the other. On top of that, at Costco today, you also are eligible for a 401k with a match and very, very good healthcare. Shockingly good healthcare, even for hourly workers.
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Costco
So if you're going to go work at one or the other today, you'd be very lucky to go work at Costco.
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Costco
Yep, totally. But what are the benefits? And this is where we get this beautifully interlinked set of trade-offs that play well together. So what do you get? Well, you get low employee turnover. And when I say low, I mean very low. After the first year, Costco today has only a 7% attrition rate among their workforce.
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Costco
Yes, typical retail is 20%. So it is a meaningfully lower cost to onboard and train new employees. Like you normally have to spend a lot of your money ramping people to get them up to speed. Costco, Price Club, FedMart doesn't have to do any of that because they're really rewarding their employees. Employee loyalty also reinforces the idea that people shouldn't steal.
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Costco
They feel grateful for this job. They're excited to be in it. The shrinkage or the unaccounted for merchandise at Costco today is astonishingly low. It is 0.15% of sales. That's crazy. So merchandise does not walk out the door. Their strong bias also is to promote internally. So if you look at Costco today, 36% of U.S. employees have over 10 years of service.
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Costco
If you look at their executive team at Costco today, basically all of them have been there for over 25 years. The only vice presidents at the company who have not are the digital e-commerce people that they had to bring in to address some issues.
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Costco
They seem to have incredible running room ahead of them to expand internationally and here in North America. And David, here's one that is just for you. Their store brand, Kirkland Signature, does more revenue alone, not including anything else in the store, than all of Nike.
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Costco
So they need capital or they need to sell the business, one or the other. And it seems like what they kind of did was accidentally both.
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Costco
Yeah. So what we're about to get to is where they're sort of looking for a capital partner, and I think they accidentally find themselves selling the business. But before we tell that story, it's time to thank one of our favorite companies, Statsig.
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Costco
And one common thread from all the retail companies that we've talked about, Walmart, Amazon, and now Costco, is their obsession with making decisions based on data, even decades ago. At the time, this was not cheap. Remember Amazon's early Oracle database or that Sam Walton built out a private satellite network to get real-time sales data?
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Costco
But their approach made it possible to take huge bets, reinvest in the things that worked, and shut down the projects that failed. These practices are now table stakes for great retailers.
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Costco
Yep. So one of the world's largest retailers, Flipkart... Part of the Walmart empire. That's right. Actually uses Statsig today to run experiments and ship features to hundreds of millions of users. When they started working with Statsig, Flipkart already had a strong data-driven culture, but they needed better experimentation tools.
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Costco
Today, they have hundreds of engineers, data scientists, and PMs who use Statsig, and it's helped them dramatically increase their pace of launching new things and measuring them. The Statsig team has a crazy amount of expertise in this area.
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Costco
We did a whole ACQ2 episode in February with Vijay Raji, their CEO, and the rest of the team is also made up of people who built things like Facebook ads, Office 365, and Facebook Marketplace.
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Costco
Which is funny. You would have assumed that the Americans would pioneer that. It's hilarious that the French did.
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Costco
And we might all be shopping at FedMart's. Totally. In practice, what ended up happening is this weird thing where Sol Price was an innovator and a great merchant, but not a deal guy. And so it seems like there's two cardinal sins that get committed. One, not really asking Hugo Mann, why do you want to do this deal? And what is interesting about this to you?
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Costco
And what do you want to do with the combined company? And then two, selling the majority of it and treating them like a minority investor.
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Costco
but they're $52 billion a year that they sell, which inches by Nike by just about a billion dollars doesn't even include the Kirkland Signature gas. All right, listeners, if you want to know every single time a new episode drops, you can sign up for email updates, acquire.fm slash email, and two brand new things.
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Costco
Oh, that is crazy. And I think what was going on here is Hugo Mann just realized that FedMart was sitting on a gold mine of real estate and just wanted the real estate portfolio. And what Sol and Robert wanted was operating capital from the parent company, from Hugo Mann, to invest more in aggressively opening more FedMart stores. And pioneering hypermarkets in America.
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Costco
By the way, FedMart within five years was like completely dead after this acquisition. Totally ran into the ground. And Hugo Mann did make a fortune on the real estate, but yeah, FedMart's dead.
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Costco
We will be including little hints at what the next episode will be to the email list now. And two, we'll be including follow-ups from episodes when listeners share things with us after release, be it little corrections or just additional insights. So sign up acquired.fm slash email.
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Costco
I didn't realize that they thought to sort of slice the margin up into those two, almost like places in the value chain.
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Costco
Right. And to put a finer point on it, the reason why it's awesome to just run warehouse operations is because the logistics are simple. You are taking pallets of stuff and you are moving it to a location in a warehouse, and then the customer comes and takes a huge amount of it off your hands. You don't really have to...
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Costco
Come talk about this episode with us at acquired.fm slash slack and learn from other listeners who may be closer to these topics than even David and I are. If you want more from David and I, check out our second show, ACQ2, available in any podcast player. Just search ACQ2. And our next few episodes are about AI with CEOs who are leading the way as the world very rapidly changes in front of us.
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Costco
turn and make sure the labels are facing out and you don't have to deal with, oh, little one-off, you know, we've only sold 16 units, but there's actually 127 units on this thing. So that you just, everything is nice, easy, big quantities, doesn't require a lot of attention from your staff.
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Costco
Being in the wholesale business is good if you can get it, but their inclination at this time is, well, the only people who would be willing to shop and buy in that way are business owners. This would never work as a consumer concept.
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Costco
Right. And the business owners just come to you and pick it up right from the warehouse where it was delivered right from the manufacturer. Totally.
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Costco
Totally. But if you're only selling to businesses and they have small stores, it's not like we need to stock basically everything under the sun. It just needs to kind of be sufficient. Right.
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Costco
And there's not like a viral word of mouth necessarily among these business owners. They're not just encountering each other everywhere all the time. Exactly.
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Costco
So without further ado, this show is not investment advice. David and I may have investments in the companies we discuss, and this show is for informational and entertainment purposes only. David Rosenthal, what are the history and facts?
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Costco
Which allows for not only volume, but word of mouth. This is the seeds that are sown of, Costco today doesn't really advertise. And this is the first moment that they realize, oh my gosh, consumers are going to tell each other about this thing.
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Costco
Where's my card? Actually, I think you need to go in and have your picture taken. I was on a personal one before, but while I was there, I was like, you know what would be appropriate this week? So we now have a business membership.
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Costco
There's a decent chance this is the one and only loss leader that Costco sells today.
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Costco
That's not all in America, but if it were, that's like a third of America going to Costco and getting a hot dog every year.
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Costco
So there is this interesting question that has now been answered, which is there's this kind of horrible way of shopping where I need to go buy in bulk directly from the warehouse. No good retail experience. Are consumers actually going to do that? You know, this whole thing was intended for business owners. And there's all these benefits that come from selling to business owners.
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Costco
Again, you don't need a separate retail area and wholesale area. The logistics are all much easier. You know, you don't have to ever have your own logistics to move stuff from your warehouse to a different store to sell it. But are consumers going to do this? And they learn immediately, yes.
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Costco
It's sort of this shocking thing where it's like, whoa, consumers are willing to just go to a warehouse and buy stuff right off the palette. That's a pretty unexpected thing that happened.
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Costco
Yep. One other fun thing. Do you know what the building that this warehouse was in was previously?
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Costco
So let's just follow the cash flow cycle. They deliver to the warehouse. The moment they drop off that pallet, is when they invoice Price Club. And invoices tend to be about net 30. So that means the pallet gets dropped off and you have 30 days to pay the supplier.
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Costco
No more internal supply chain, no more unpacking, no more shelving. It's just available to buy now.
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Costco
It's amazing. All right, David, I got a bunch of great stuff for you on this one. So we're going to flash forward a little bit to today, but I have a huge thank you for the Costco chief financial officer, Richard Galante, spent an entire afternoon with me walking through a lot of these characteristics that really make Costco work.
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Costco
So I got a bunch of great tidbits while I was hanging out in their campus outside Seattle. Where was my invite? I invited you. You could have gotten on a plane. All right. So here's how it all works today. So Costco actually turns their inventory 12.4 times per year. And just for comparison, Walmart turns their inventory eight times per year. Home Depot is more like five times per year.
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Costco
So at this number, north of 12 times a year, David, exactly what you're saying. It means Costco can sell through its inventory faster and more often than every 30 days. To be specific, they're on about a 26, 27-day sale. This is amazing. So with typical payment terms being net 30, it means they literally have zero dollars tied up in inventory.
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Costco
And in fact, they're able, to your point, to make a few bucks on the float. So this is, of course, an average. There are some things that will sell in a week or two. Other big ticket items might sit for a month or two. Sometimes Costco can even turn things two or three times before they have to pay a supplier for it.
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Costco
Welcome to Season 13, Episode 2 of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert.
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Costco
So this is called a negative cash conversion cycle, where vendors effectively finance Costco's inventory for them.
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Costco
So there's a couple interesting components here. There are companies that can achieve a negative cash conversion cycle, but the way they do it is by having predatory terms where they go to their suppliers and say, I'm not going to pay you for like three or six months. And that is one way to do it. Costco's using standard payment terms here. Right, 30 days.
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Costco
And so there's two unique things that enable them to do it. One is this warehouse model where things are instantly available for sale. Customers come right to the place where they were dropped off. Not quite anymore, and we'll get to that later. But at Price Club, that's definitely what it was. And grab stuff right off the pellet. The other thing that makes it all work is...
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Costco
To this day, Costco has kept their SKU count very low. SKU, S-K-U, being a unique item that a store has for sale. I think, David, you mentioned before about 3,000 at Price Club is what they had available for sale. If you look at a Walmart today, they have something like 100,000 to 150,000 different SKUs that they sell. Supercenters, indeed. Costco in the last 10 years was around 4,500.
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Costco
And then they sort of looked and said, can we bring it down and went to 4,000? And today they're sitting at 3,800. So this number is still going down, not up. And if you do the math and you start thinking, well, geez, if you're not selling a lot of SKUs, but you have a lot of customers coming through your stores, what does that mean? It means that any given item is going to turn faster.
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Costco
It's sort of this magical unlock. In addition to the instantly available for sale in the warehouse thing, it is the low SKU count that directly gives you the ability to turn your inventory over quickly.
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Costco
And of course, today, as Costco opens new warehouses, they can very tightly predict how they'll perform because they know how all the other ones perform. And so, sure, there's a lot of upfront money in opening a new store. But once it happens, you sort of know exactly what it's going to mature to and exactly how you're ROI positive on all your fixed costs to invest in that new location.
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Costco
And you have this negative cash conversion cycle with all of your inventory being effectively free, if not profitable for you while it sits there. Amazing.
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Costco
Totally. We have a couple of very cool things to announce today. One, David and I have made a Blinkist page that represents our bookshelf. So if you want to read the books that influence David and I, you can go to Blinkist.com slash acquired. For this particular episode on Costco—this is point two—
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Costco
We mentioned that there's basically one book about Costco and Price Club, and it is self-published by Sol Price's son, Robert Price. As you can imagine, it's out of print. We managed to get our hands on three of them. Two of the copies are held by David and myself to do the research, and the third is at Blinkist HQ.
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Costco
And Blinkist has turned this book, Sol Price, Retail Revolutionary and Social Innovator, into a Blink. where you can get access for free at Blinkist.com slash Costco. They're also including other books in that collection that are about doing a few things but very well, like the book Essentialism, which is from friend of the show Brad Gerstner. That is one of his favorite books.
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Costco
If you click the link, you will get free access to Costco Blinkist Collection, and anyone who uses that link or uses the coupon code Costco will get 50% off a premium subscription to all 6,500 titles in their library.
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Costco
Our sincere thanks to Blinkist and their new parent company GoOne, where David and I are huge fans and angel investors. GoOne and Blinkist are both amazing ways for your companies to get access to the most engaging and compelling content in the world. Click the links in the show notes. Okay, David, so take us from the first Price Club through to Costco.
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Costco
Sure. We don't need the money. That's crazy. So they're registered with the SEC, but they're not listed on a
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Costco
Wow. So for those first three years, I need to know a Price Club shareholder in order to buy the shares.
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Costco
In some ways, we sort of have to tell a whole industry history here, but in other ways, these kind of are all the same company because they're all stacked learnings from Saul Price and his various brain children over the years to create the Costco that it is today.
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Costco
Which we have heard from listeners 10 times that we need to do the Home Depot story at some point. I actually did not know Bernie Marcus's name or that he was the founder of Home Depot. So I think now we have to.
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Costco
And Jim really is Saul's protege. It's like Clone Price Club, but with a guy at the helm who is built for scale and absolute focus on the details.
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Costco
And so, listeners, you might be realizing now, when we were saying at the top of the episode, this really is kind of all one company story. It really is. There is a straight line through from Fedco to FedMart, or let's even just start it at FedMart, since it's all the same people, through to Costco today. So Jim moves up to Seattle.
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Costco
Yep. They sell 50% of the company to do that. They recruit eight people immediately, mostly from FedMart, some from Price Club, and they're all sort of 40s and 50s. This is like a gang of 10, 12 people who have all worked together before. Industry veterans have shorthand, and they are just like, we've got the money. Okay, go. We know exactly what to do.
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Costco
Or like the Zoom story. It's like Eric Yuan finding 40 people who knew exactly how to build Zoom and then just doing it.
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Costco
This is in the 80s! And $3 billion in less than six years, which is the first company ever to hit that milestone, too.
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Costco
No. And it does, if you kind of read between the lines in some of this stuff, it does kind of seem like Costco wasn't poaching people from Price Club, but a lot of really good people sort of found their way and went and got jobs at Costco. So Costco definitely had at this point the base of the sort of most aggressive, talented wholesalers of the West Coast.
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Costco
And at the end of the day, Price Club was either going to land with Walmart or with Costco. And Sol Price didn't want it to be Walmart and very, very much wanted to join forces with Jim Senegal. And so they sort of made that happen. This was the natural successor for this combined business in Jim Senegal.
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Costco
And we are your hosts. What if I told you that there was one place where you could get all these things under one roof? A two and a half pound container of cashews, prescription eyeglasses, a tank of gas, new tires for your car, 96 rolls of toilet paper, a new refrigerator, an outdoor shed, a 10 carat diamond ring, some fresh prepared sushi, fine wine at a great price.
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Costco
Yeah. And you sort of get the sense that the Costco folks were being very respectful of the Price Club folks because I believe it was something like a 30-plus percent premium paid for Price Club stock. And so I think it was everyone sort of looking at each other and Costco sort of knowing that they could really... by Price Club for a much smaller relative percentage in the future.
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Costco
But why don't we just do this today? I know it's a good deal for Price Club folks. And let's just say pseudo merger of equals. Let's call it and let's be one team from now on.
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Costco
Fascinating. Which is so funny because it's a much less disciplined business. Every bit of DNA in Costco and Price Club is just so unbelievably disciplined and an admirable way to run a business. And Sam's Club strikes me as a bunch of cowboys who are changing strategies all the time.
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Costco
Yep. So they really are, when I say ideologically similar or the natural successor or almost like another son of Sol Price, Jim Senegal and Sol Price really are of one mind in many ways.
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Costco
All right, so let's talk about the execution of this business a little bit. And there's some concepts that I think we've talked about at a high level, but we haven't really drilled into why they work so well. And honestly, I have like 10 or 12 of these, David. So we're going to talk about two important ones now, and then we'll get into more as we sort of make our way to modern day a little bit.
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Costco
So one that we haven't talked about is the economics of membership. And there's the obvious ones that everyone sort of realizes. Today, the base level membership is $60. And as a consumer, I assume I'm getting some kind of good deal by paying $60.
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Costco
And that even before learning too much about Costco, I'm aware that that $60 is something I'm paying up front to get the benefit of some low prices later. But let's analyze some of the second order effects of membership, which I think are potentially even more interesting than the obvious ones.
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Costco
As does buying in bulk. So the items that you're buying are literally cheaper per unit, so you're saving money, but you need to buy a lot of it up front, just like you need to pay a membership fee up front, which means that they tend to get members who are not sensitive to cash flow, and they also tend to get members who have space to store stuff at home.
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Costco
And so I looked into some of the data on this to try and put some numbers to it. There was an independent research firm that found that the typical Costco consumer makes about $125,000 a year in household income and has a four-year degree. Walmart, by comparison, has a median income of about $80,000. And keep in mind, the median U.S. income is $71,000.
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Costco
Yes, it's totally fascinating. And very smart consumers, people who can kind of look at the deal and go, actually, I know I'm coming out ahead on this. Another interesting psychology around this is when you pay $60 up front, it encourages you to come and use the membership. You are more likely to shop because you've prepaid some of your margin dollars.
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Costco
Yes. You just sort of assume that you're getting some kind of good deal by prepaying for a membership up front. So you want to go maximize the margin dollars that you're able to get on their discounts, which is totally fascinating. Yeah. Another one is that membership further decreases shrinkage.
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Costco
We already talked about the fact that employee retention is great for making sure people don't steal things. So members don't want to lose their membership. You sort of feel like you're part of some sort of club. On top of that, these items are huge. They're hard to steal. How do you steal a TV? How do you steal a two and a half pound thing of nuts? And so there's like all these factors.
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Costco
Yes, this is super interesting. So Costco basically wants to provide insane value to consumers. They want you to get a better deal as a member than you could possibly get by shopping anywhere else. And so how do they go about doing this? They have enforced a strict cap on the margin that they are willing to make on any product.
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Costco
So they have decided internally that they are not allowed to mark up anything more than 14% above what the suppliers sell it to them for. And I'll tell you, they are tough but fair with their suppliers in making sure that they get a great price for their members. And so Costco decides we will only mark up anything a maximum of 14%.
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Costco
They actually do mark other things up less than that because things like electronics, they actually can only mark up 6, 7, 8%. So maximum 14%. The only exception to this is Kirkland Signature, where they cheat a little bit and let themselves go up to 15%. Quite indulgent. So how does this compare? I think that's the interesting thing here.
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Costco
A common practice at department stores is literally 100% markup. Someone gets a good for 50 bucks, they sell it for 100 bucks. I mean, even at Walmart, a discounter, quote unquote, marks up 25%, which is almost twice as much as Costco's margin. And so Jim Senegal has a great quote on this.
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Costco
He was asked about it, and his response was, you could raise the price of a bottle of ketchup to $1.03 instead of $1, and no one would know. Raising prices just 3% would add 50% to our pre-tax income. Why not do it? It's like heroin. You do it a little bit, and you want a little more. Raising prices is the easy way.
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Costco
You're exactly right. The value proposition 40 years ago was you are going to get the very best deal possible on the goods that you're buying here. Extreme value proposition is what they like to say. And the fact that they've just made that true every year for 40 years is something that really does stick in people's psyche. And I totally get the heroin line.
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Costco
I think it's so easy to decide to cheat one year and then in all the future years, you're going to cheat because you've broken expectations with customers, with shareholders.
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Costco
There's something kind of magical, even in the relationship between Costco and a supplier, where a supplier knows that when Costco is being really tough on them to give the lowest price, Costco is not going to turn around and then market up 50% and make a bunch of money. Costco is going to make the same margin that they've always made on that good.
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Costco
Yep. Okay. I was going to save this for later, but we got to do it now. The Costco Code of Ethics, as it exists today, largely inspired by the FedMart values from 40, 50 years before, are in order, obey the law. Number one, first and foremost, obey the law. And we will save that for a moment. I've got a fun story of how that came to be. Number two, take care of our members.
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Costco
And listeners, when you're listening through these, the order is important, the subject of each statement is important, and the phrasing of each statement is important. So one, obey the law. Two, take care of our members. Three, take care of our employees. Four, respect our suppliers. And I find it fascinating that they use the word respect because they have a posture of tough but fair.
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Costco
Wow. And you say one of the most influential. I do think he's top two, top three with Sam Walton, of course.
Acquired
Costco
And so there's this great anecdote. And I mean, I heard one, but there's 50 examples of this that you can find in various Tegas calls or talking with people who are suppliers to the company where Costco buyers always ask why when a supplier tries to increase the price. And that part's not that novel. I imagine a Walmart buyer also tries to ask why. the buyers are very deep.
Acquired
Costco
So they actually know the commodity prices of ingredients from suppliers. So let's take like a chocolate company, for example, that sells a chocolate product. If the chocolate company said, hey, the chocolate costs more now, the Costco buyer would say, well, I know the price of cocoa. I've been watching the commodities market. I understand milk, sugar, butter. Why is it more expensive?
Acquired
Costco
Just give me feedback on that. And a lot of the times it is like a commodity price has gone up or they use labor in a certain area that's gone up. Or maybe they have a long-dated contract with a supplier of their own that has an artificially high price for some reason until the contract expires. And so the Costco buyers will write all of this down, will keep track of it.
Acquired
Costco
And because they manage so few accounts, they actually can keep track of it. Each buyer is only really adding 3, 5, 10, maybe 15 new SKUs a year, but you manage a very tight set of relationships. So... they'll just call the supplier back and say, hey, last time we talked, you'd mentioned that cocoa prices were high. I've noticed they've gone down.
Acquired
Costco
Are you lowering the prices so that we can lower it for our members? It's like this really amazing side benefit of having the low SKU count is that they can be tough but fair with suppliers and really stick to it.
Acquired
Costco
And because of Costco's gross margins always being targeted at 11%, capped at 14%, this means that for every dollar that Costco gets a supplier to reduce the price on something, again, tough but fair, the customer actually sees most, you know, 89% of the benefit. And so Costco really does just get to pass whenever they get a benefit, 89% of that benefit goes to the member.
Acquired
Costco
So the way I look at this is some companies always look for ways to make more margin. Costco specifically does the opposite. They look for ways to provide more value to members and retain them for members as longer and get them to get their friends to be members.
Acquired
Costco
All right, so very credible argument that he is the most important American retail capitalist.
Acquired
Costco
And they try hard across the board to get lower overhead costs through cleverness and efficiency, not through squeezing or underpaying or anything like that. Yeah.
Acquired
Costco
Wow. That's awesome. So on this point number four of suppliers, here's some quick math that illustrates why they do have to be so careful and why they do wield such an enormously large stick. So Walmart's revenue today is about three times Costco in the U.S., But since Costco sells so few items, they are a massive customer for any given supplier. They always have this super lopsided relationship.
Acquired
Costco
The average revenue per product, because of the SKU count, at Costco is about 10 times Walmart. Wow. So anytime they're in a negotiation, I mean, like almost every time, the person sitting across the table is looking at Costco like, you are my largest customer.
Acquired
Costco
I think they try not to have that be the case, but it's very easy for it to become that. So it is really important that they have it as one of their sort of four main tenets, respect our suppliers. Now, notoriously missing from these four is the notion of a shareholder.
Acquired
Costco
And Jim Senegal articulates, if we do these four things throughout our organization, and again, those four things are obey the law, take care of our members, take care of our employees, respect our suppliers, in that order. then we will achieve our ultimate goal, which is to reward our shareholders.
Acquired
Costco
And that really is the same thing at Costco. 100%. So fun story of how these code of ethics came to be. So in the mid 80s, the Washington State Liquor Control Board was putting Costco through the ringer when Costco was applying to sell alcohol. And I think at the time it was just beer and wine. And basically, the Liquor Control Board was looking for any possible reason to deny them.
Acquired
Costco
And I think there might have been some corruption going on. The state had a vested interest in preventing very large retailers from becoming the volume of selling beer and wine. And Costco, because they were started with this ethos, came through squeaky clean and actually got the permit. There was literally nothing that you could sort of drudge up on them to deny them.
Acquired
Costco
And so the company was fortunate to realize at very early days how much it would pay off to be truly above reproach. No matter how tempting anything was, they had to build a culture that was completely obsessed with this code of ethics. And you just see it everywhere.
Acquired
Costco
I mean, the wages, the way they treat suppliers, the fierce fixed cap on markups, the discipline not to raise memberships constantly. I think it's been like six years between the last two times they raised the membership, even $5. It's a ludicrously squeaky clean and long-term oriented mindset.
Acquired
Costco
It sounds so generic. Like, I didn't even put it together when I first moved to Seattle 12 years ago that the Kirkland over there was of Kirkland Signature because Kirkland kind of just meant nothing to me. It meant, you know, what's the Whole Foods version, the 365... Interestingly, over time, Kirkland Signature has come to mean something, and that is a certain level of quality.
Acquired
Costco
Nobody is attesting that this Kirkland Signature sweatshirt is a Lululemon sweatshirt that has fancy materials and the most cutting-edge technology in it, but it is of a certain bar of quality that is sufficient for Costco members. And that is sort of the ethos that Costco has around Kirkland Signature. Yeah.
Acquired
Costco
That we're only going to put something out there if we feel that we can create value for you, that it's going to be a lower price than what you could get otherwise, or the flip side of that, that we can make a better product than you could get from any of these branded products that we were either previously stocking or evaluating stocking.
Acquired
Costco
Oh, and especially for these things that are very clearly difficult to make and therefore it's made by one of a few people, like made by a real winemaker or like the batteries definitely made by a company that makes other batteries. It's not like they're low quality batteries.
Acquired
Costco
So I do think much like their 11% target gross margin on everything, Costco looks at their house brand as an opportunity to provide value to members, not an opportunity to capture more margin for themselves.
Acquired
Costco
one of one. I mean, if you go buy the Mixed Nuts, the Mixed Nuts are Kirkland Signature Mixed Nuts. The Jumbo Cashews are Kirkland Signature Jumbo Cashews. And in part because the buyers were evaluating the whole landscape and they determined we can do something better for less. I think the Costco Fancy Mixed Nuts is the best mixed nut blend.
Acquired
Costco
But I think that that was an enterprising buyer who was being creative and working with suppliers and thought like, I actually think we can provide a better product for a lower price than what exists on the market. And I don't know. I think there's a lot of scenarios where they have. Certainly, consumers agree. $52 billion of Kirkland Signature sales were done last year.
Acquired
Costco
That does not include the Kirkland Signature gas product. So out of Costco's $230 billion top line, a little under a quarter of it was Kirkland Signature sales, and closer to a third if you include the gas. Wow. That's incredible. It's America's largest consumer package brand.
Acquired
Costco
Yes. I was texting David before this, listeners, and I was like, I don't think a lot of people are going to be able to get this book if they want it. And Blinkist agreed to order a copy and then turn it into a Blink. So you can get the Blinkist summary. We'll link to the show notes on how to do that.
Acquired
Costco
Yeah. I mean, at the end of the day, people really like value. High quality products at a great value is a super compelling value proposition for anyone in the entire world.
Acquired
Costco
I want to go back to something that we've been wading into in the discussion of Kirkland Signature, which is why is it okay that at Costco they can only have 3,800 SKUs? Like, why are people okay with this deal when where I don't need selection when I shop here. And I think there's a few illustrative examples of the story from here that get into that.
Acquired
Costco
But first, this is a great time to thank our final sponsor of this episode, Crusoe, which is honestly one of the coolest companies in the world right now. Crusoe is a cloud infrastructure provider, just like AWS and Azure, that is 100% purpose-built for AI training and inference.
Acquired
Costco
Yeah, the way they do this is nuts. First, on the quality front, they're specifically for AI. Literally, their data centers are nothing but rows and rows of the latest NVIDIA A100s and H100s, so they have the benefit of focus and specialization.
Acquired
Costco
Crusoe was also among the first to deploy cutting-edge networking fabrics like InfiniBand, which accelerates performance of large AI trading clusters dramatically. Think 200 movies per second between servers. Crazy fast stuff. And two, this is what is very special about Crusoe, they use energy that would otherwise be wasted or stranded to power the data centers. Here's what Crusoe does.
Acquired
Costco
But David, the other crazy thing is I think Robert may have signed every copy of this book because he signed yours and he signed the one that I got.
Acquired
Costco
We discussed all of this in-depth over on ACQ2 with Crusoe's CEO, Chase Lockmiller. Funny, we had reached out to Chase two years ago to have him on ACQ2, and it took us this long to actually get it scheduled. So go give that a listen. We've been fascinated by this company for a long time. We will link to it in the show notes. His and Crusoe's story is totally amazing.
Acquired
Costco
And if you or your company or any investments you've made have AI workloads that could use lower cost and more performant infrastructure, which is all of you, go to crusocloud.com slash acquired. That's C-R-U-S-O-E cloud.com slash acquired or click the link in the show notes. So David, let's talk about low selection and how that's okay.
Acquired
Costco
So Walmart and other retailers operated under the assumption that shoppers require selection. It seems like a reasonable assumption unless you started your life as a B2B wholesaler that then fell backwards into consumer and then realized it was fine for consumers too.
Acquired
Costco
So obviously, if you have selection, it makes the life of a retailer very difficult in a lot of ways, but it was just assumed that you had to. But Costco makes the opposite bet. They bet that you don't need selection as long as you ensure that everything you can buy is high quality. And that is the crazy thing that has worked.
Acquired
Costco
Costco essentially has its entire buying team's ethos sort of shopping for you. They're pre-selecting the best one or two items in every category, and consumers are because they do all that work ahead of time, are basically just okay sacrificing selection entirely and saying, yeah, as long as you give us good value on great stuff, we're totally okay with that. That's an important unlock.
Acquired
Costco
You can't just have low selection and be like, well, it's all cheap stuff. It has to be high quality in its category and the best deal on the market in order for people to be okay with low selection, which drives low SKU count, which drives all the amazing things we've talked about so far.
Acquired
Costco
I mean, yes. You and I have been trying to do this without having a name for it for years. People sponsor acquired seasons. There are lots of other podcasts that let you do all kinds of crazy stuff. And we're just like, look, we have a SKU. It's called The Season. We would love to work with you on that.
Acquired
Costco
And it makes our lives so much better and we can run our business in a completely different way by having a low SKU count.
Acquired
Costco
Right. This stuff is all about the trade-offs you are willing to make and just daisy-chaining them together such that the benefit of each trade-off plays into the benefit of another trade-off that you are making in a way that's aligned.
Acquired
Costco
Honestly, it's like maybe my favorite business that we've studied. Let's wait till the end to talk about that. But there's a few more things along the way that happened in the 90s and 2000s before we get to today that I think are important to touch on. We've mentioned logistics a few times, and that the low SKU count means that they can meaningfully simplify their logistics.
Acquired
Costco
And to put a point on that, they only have so many suppliers who are bringing goods to Costco. The fact that they sell in bulk means that they can bring a whole pallet into a warehouse and consumers just sort of come and pluck it off the pallet. It's wholesale. It's a wholesale club. But there's something we haven't talked about, which is Costco's distribution centers.
Acquired
Costco
So they use something called a cross-dock system for their distribution centers, and Now, remember I mentioned back in the Price Club days, it's a little bit more complicated today. Not all the suppliers just show up to the one store, the one warehouse with all the goods. They actually do need some system to receive things from suppliers and bring them to stores.
Acquired
Costco
Exactly. But here's how the distribution centers work. trucks pull up on one side and unload pallets, and that's where the supplier's trucks are. On the other side of the warehouse, there are Costco trucks. And so what happens is, since they move stuff entirely by the pallet, no partial pallets, no these few things go to this store, these few things go to that store, the supplier trucks...
Acquired
Costco
unload the pallets, they just get scooted across the dock to go directly to a Costco warehouse. And then within minutes to hours, that truck leaves and there's no unwrapping of individual boxes. There's nothing sitting overnight in the facility. This is so much simpler and it really plays into that cashflow dynamic where things can be available for sale so fast.
Acquired
Costco
And just to underscore how differentiated the system is, 92% of Costco's merchandise is cross-stocked. Only 10% of Walmart has cross-stocked merchandise on a pallet system like this.
Acquired
Costco
Totally. It's just that Costco has made a trade-off that makes it so that they just have a much simpler operation. And they've got all the downsides that come with the trade-off, no selection, but they get all the upside that comes from it, too. And so this also plays into this labor thing. You can totally pay your employees more when you need less people to generate the same amount of sales.
Acquired
Costco
You don't have wasted manpower unwrapping items from pallets, no one turning the labels out to look pretty. The customers do all of this. So it legitimately means they just need less people. And this is why they generate over $730,000 of revenue per employee. They're just efficient in aligning their trade-offs.
Acquired
Costco
Yeah, even though Costco is only an 11% gross margin business and only ever will be an 11% gross margin business, it's still a pretty amazing business to own.
Acquired
Costco
And $7.5 billion of operating income off that. So again, tiny little sliver margins, but $7.5 billion of operating income falling out the bottom is pretty awesome.
Acquired
Costco
Yeah, seriously. And, as you've been talking about because of the way that their inventory is financed, a reasonably capital-light business, all things considered. I mean, they're building these warehouses on huge pieces of real estate, you know, with gigantic shelving and all this headcount. And it's an amazingly capital-efficient business. It's weird. Yeah.
Acquired
Costco
Right. And psychologically, they're one thing. It's one experience for the customer. But financially, it's two entirely different things.
Acquired
Costco
So a lot of people like to make a lot of hay about the idea that Costco generates all their profit on memberships and that retail is just a break-even business. And this has been popular to say because they run the retail business at such thin margins. And memberships are nearly a 100% margin business. I mean, really, what does it take to run a membership business?
Acquired
Costco
Yeah. But it's not quite true. It is accurate to say that membership fees represent about 70% of the company's operating income, with the other 30% of the profit margins coming from retail. It's been a little bit more than 30% in recent years, but that's sort of the historical split. Think about it as sort of a 70-30 thing.
Acquired
Costco
It really is staggering that a business that does $230 billion top line, 70% of the profits can come from the $4 billion of revenue they generate from memberships. That tells you how razor thin the margins are on their retail business, almost to the point where you're like, why do they care about growing sales at all? All they should care about is increasing retention of members.
Acquired
Costco
The split is just significant enough for the retail business where you're like, okay, yeah, we should care about growing sales in the retail business. But if it wasn't 70-30, if it was 90-10 or 95-5, you'd kind of be like, well...
Acquired
Costco
I'm actually not sure why we care about making a single another sale of toilet paper, because unless it is increasing the likelihood someone retains, I don't care about it. And they're not quite there, but they're almost there.
Acquired
Costco
Right. But for the last several years, they have totally been growing retail sales per member. And if it was like a 95-5 split, you sort of could make the argument of like, why do they care about growing the retail sales per member? But at this sort of more 70-30-ish split, there's just enough profit dollars coming from the retail side of the house where you care about that too.
Acquired
Costco
Yes. In the last 25 years, membership has grown from nearly nothing, if you look at what the numbers were in the early 90s, compared to today, $4.5 billion. Yeah.
Acquired
Costco
Right. To quote our friend Andrew Marks, I basically think that Costco has decided to only be a decent return on invested capital retailer, which allows them to have an insane return on invested capital membership club business.
Acquired
Costco
It's so true. Again, to quote Andrew, insanely stable growth on a huge capital light fee stream.
Acquired
Costco
Is that right? Yes. 1998, the executive membership. So what is the executive membership and why are we bothering to spend time on it? Isn't it just a second higher price membership? It is super illustrative of management's thinking. So I love this as a microcosm for all of Costco. So you can spend an extra $60, so total $120 instead of $60.
Acquired
Costco
And what you get for that is 2% cash back on your transactions. Now that 2% cash back is limited, but it's limited at something crazy. Like you can only get $1,000 back.
Acquired
Costco
Right. And if you actually hit that $1,000, it would mean you're spending $50,000 at Costco a year. Oh, wow. Yeah.
Acquired
Costco
So the break-even point of this $60 is $3,000, which is not that hard to hit. In fact, it's right around, and I suspect this is why management priced it that way, it's right around the average household spend at Costco. So they want to make it basically break-even for basically everyone.
Acquired
Costco
A hundred percent. And other people might invent something like this to say, well, we're going to bet that they won't use it. They won't shop here enough. And we'll get to make some money on the people who are infrequent shoppers. And we're excited about that. And we'll basically get the breakage on people who pay for the upgraded membership but don't shop enough.
Acquired
Costco
That's not at all what Costco is doing here. And to illustrate that, here's the insane part of it. If you do not use it, they will refund it.
Acquired
Costco
Is there anything more Costco than that? It is an amazing value for members. It is such a good value that 55% of US members now do it. But much like everything else we've talked about with Costco, it is also amazing for Costco because they get your money at the beginning of the year, further advantaging their cashflow position.
Acquired
Costco
And it gets even better because it makes you more likely to go shop there now since you get even better deals with the cashback. You effectively, instead of getting the 14% gross margin, Costco is now only making a 12% margin on you when you shop there. So as long as you're spending $3,000 or more, it basically just makes Costco's margin even lower for everything you purchase.
Acquired
Costco
Interestingly, 45% of paid members worldwide are executive members, but those members represent 73% of sales. So whether by causation or correlation, executive members just spend more, and estimates are that regular members buy less than one-third of what executive members do. So it's this fascinating customer segmentation thing where Costco just...
Acquired
Costco
gets to know and reward the most frequent shoppers who do the highest volume purchasing. Executive members, as you would guess, also renew at a higher rate. And so it helps with retention. On top of that, which they call the triple play membership.
Acquired
Costco
If you get the Costco-issued Citi Visa card, you renew at an even higher rate. So they have these layers of letting you opt into loyalty. And all of this, David, as you mentioned earlier, is on top of a high renewal rate anyway. 93% of members in the U.S. renew every single year.
Acquired
Costco
It keeps you in the Amazon ecosystem and it makes sure that you're buying more stuff.
Acquired
Costco
Amazon makes money on the stuff, Costco makes money on the membership, but at the end of the day, it is nice to retain a loyal customer. To contextualize the 93% member retention, again, that's just all members. That's not even the executive members or the credit card owners. Subscriptions to streaming services renew like half of their customers every year.
Acquired
Costco
So consumer subscriptions retaining at 93 plus percent is nuts. That's the monthly retention of most streaming services. It's crazy.
Acquired
Costco
On top of all of this, I'm pretty sure that this has never been disclosed and I haven't asked anyone about it, but if you sort of read trade publications, people seem pretty convinced that Costco is making money, which of course they are, on the deal that they cut with Citi and Visa in order to have the Costco card be the Citi Visa card.
Acquired
Costco
I mean, most of the time when you are processing payments, you owe 2% to 3% of each transaction to the issuer of the card. I think the dynamics are actually the opposite way with Costco, where Costco gets to hold an auction and say, we have an enormous amount of payment volume with enormously good customers with good credit. Would you like to do business with us?
Acquired
Costco
And that's the importance of doing the hard thing first. By proving that they could exist and set customer expectations around where only cash and check, it meant that they never had some scary moment where if credit card companies were putting the screws to them, they had a bunch of fear around, will customers not shop here?
Acquired
Costco
they were just from the very beginning getting 100% of the dollars rolling in. And so they knew the counterfactual. They knew customers are going to shop with us no matter what. Credit card companies, if you want to work with us, you're welcome to, but we do not need to pay for the privilege because we know that our customers are not going to leave us for a fact.
Acquired
Costco
It's crazy. Of course, with Costco's margin structure, they literally couldn't. I mean, speaking of trade-offs, they literally couldn't ever accept credit. How, with an 11% gross margin, are you going to go give three percentage points of that 11% to a Visa? Like, it actually would flip the business upside down. We talked about it a minute ago.
Acquired
Costco
They make, what, $7.5 billion of operating income on $230 billion of sales. The credit card companies eat all your profitability if you let them in the door. And so it's a pretty incredible position, toughing it out and doing the hard thing first and then being able to sort of flip to the other side of the table. Yep. Anyway, I love that point on the payment processing.
Acquired
Costco
I think it's an amazing playbook that Costco ran over the years and a necessary one. Every single time Costco does something amazing, they needed to because of the trade-offs that they chose.
Acquired
Costco
Definitely. So, David, to your point, we talked about very few things between, to be honest, like the late 80s and today, and it's because the model was basically cast in stone. I mean, they added things like gas, they added ancillary services, and you can go get glasses, and you can go buy diamond rings, and I don't know, maybe some of that was done earlier. Yeah.
Acquired
Costco
And you could even grab a hot dog with a soda and a free refill on your way out for just a buck 50. Ben, I don't believe you. Hey, it has been the same price for 40 years now?
Acquired
Costco
I think a lot of that was from the Fedmark days. Big yard goods. I bought a shed there. But the story is intentionally boring. It's what if you grow at 10% for decades, doing exactly the same thing, having a well-understood set of trade-offs and a strong culture? Where does it go?
Acquired
Costco
Right. And you're the third biggest player in the largest market, you know, America, behind Amazon and Walmart. So this Acquired episode is different because so much of it is just
Acquired
Costco
nerding out over the awesome nuances of Costco's business model and actually less of, and then this crazy thing happened because it was a bunch of like stand-up guys making an intelligent set of trade-offs, really thinking hard, and then a whole bunch of people working hard for a long time. That's the story.
Acquired
Costco
So I don't think people realize, maybe by this point of the episode they do, but certainly not before, how big Costco is. It's sort of a sleepy story since it's tucked away in a Seattle suburb. They don't do a lot of chest pounding. They just are quiet. And they do $230 billion in revenue. They're the third largest retailer in the U.S. They have 124 million members worldwide. One third of U.S.
Acquired
Costco
shoppers are Costco customers. They have a little over 300,000 employees at 860 stores. We talked about this. They do $750,000 of revenue per employee.
Acquired
Costco
Yeah, so Costco is doing somewhere between a third and a half the total revenue of Walmart, but they're doing it with, what, almost an order of magnitude fewer people.
Acquired
Costco
It's crazy. They have the highest revenue dollars per square foot of any wholesaler or discount store. Target's about $450 per square foot of revenue. Walmart's about $600. Costco is $1,800 per square foot of revenue. Wow. Wow.
Acquired
Costco
And they have a lot of square feet. Yeah. And this is up from, let me look at this graph. In 1998, they had $600 a foot, and now they're at $1,800 a foot. So meaningfully grown it. It's important to point out, you've made the comment about Apple. Costco's margins are a lot lower than Apple.
Acquired
Costco
So they're generating a huge amount of revenue dollars, not so much on the margin dollars, but as we've been talking about, that's the point.
Acquired
Costco
Yeah, $269 million of sales per store on average per year. nuts so just for fun let's go north of 1800 just to see who else is out there tiffany is 3000 so kind of within spitting distance like it's only 2x or it's less than 2x and they sell diamonds well so does costco yeah it's true apple of course is the goat at 5500 a square foot with high margins i mean apple is just a nuts business
Acquired
Costco
But it's worth pointing out Lululemon is approaching Costco level two. They're around $1,600 a foot, but of course, much smaller stores than Costco. Costco is just unbelievably efficient. We talked earlier about how that's illustrated in the headcount efficiency, but now we see it in the real estate efficiency too.
Acquired
Costco
This point on growing revenue per foot is interesting. You know, I mentioned it went from 600 to 1,800 over the last 25 years because it reminds us to look at an important similar metric in retail, which is same store sales. So Costco grew this by 14% last year. Same store sales, 14%, which is how you get to that $269 million of revenue per store.
Acquired
Costco
David, you and I were just down in San Diego doing our episode with Doug DiMero, and I went and stopped by the Midway Museum because we had just done our Lockheed Martin episode. And you can feel the history dripping off that thing on all the old airplanes and everything. San Diego has been, obviously, a huge Navy culture for 75 years now. Totally.
Acquired
Costco
They are so good at this that they actually publish their stores by cohort year in their annual report, which almost no other company and certainly no other retailer does. And they clearly illustrate that not only does the average store increase meaningfully over the previous year in most years, but new stores also inherit a lot of the learnings.
Acquired
Costco
So the first year of a new store is dramatically better than... what first years of stores were years ago. And to illustrate this, year one of a store opened last year was better than year five of a store opened in 2014. Wow. It's crazy.
Acquired
Costco
Right? It's crazy. I mean, part of it is the addition of gas and the other big ancillary items they're selling, but part of it also is just being really good merchants and finding these little things that members love and find value in and doing little optimizations everywhere.
Acquired
Costco
Huh. I did not realize that. I mean, I know they've sort of learned a bunch of things over the years, like when they brought in fresh food for the first time, they didn't optimize the place in the store where they put that, but they still saw a huge spike because it drove repeat. When you have fresh food, people come in, they want to buy that, they add some other stuff.
Acquired
Costco
But they've been very clever in figuring out where to put it in the store to make sure that you have to walk by a bunch of other stuff to get. I mean, the fresh food is in the back. Right. It's like if you're coming in for fresh food, congratulations. You get to see all these other cool things that our buyers have managed to find out in the world for you. And of course, you get some of those, too.
Acquired
Costco
Because we haven't been analyzing this business yet. Yeah, so the first segment that we're going to do in our analysis here is power, which is adapted from Hamilton Helmer's Seven Powers book, which is an amazing framework for business strategy. The question here is, what is it that enables the business to achieve persistent differential returns?
Acquired
Costco
Or put another way, how can a business be way more profitable than their closest competitor and do so sustainably? The seven options are counter-positioning, scale economies, switching costs, network economies, process power, branding, and cornered resource.
Acquired
Costco
There is one here that is so painfully obvious that it has been observed over and over again over the years, and the original credit goes to investor Nick Sleep. And the power is scale economies. It's Hamilton Helmer's notion that Costco has the ability to
Acquired
Costco
Leverage their scale to compete for items that their competitors can't get or perhaps get a better price from suppliers than any of their competitors. Nick Sleep has this phrase that I think is possibly the best way to describe Costco, scale economies shared with customers. And the flywheel looks like this. Costco has enormous volume.
Acquired
Costco
And what they do with that volume is they go to the supplier and they say, what is your absolute lowest price where you're still making an honest margin on this, but you're willing to sell it to us? And then Costco makes sure of that and they do their research and they come to a price and they say, great.
Acquired
Costco
And then Costco looks at their own business and they say, how can we have the lowest possible overhead? What is the smallest amount of dollars we can spend at our head office, turning the lights on at facilities? What is literally the leanest we could possibly run and still break even or generate a small profit? That's how they come up with this 11% target gross margin number.
Acquired
Costco
And so what they do then is they mark up the goods, literally the smallest amount that they can in order to share the most value with their shoppers, with their members, and And then the cycle repeats. They get more members. They get better deals from suppliers.
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Costco
And to be honest, this scale economies that they then share with customers, I don't know how anyone could ever catch them in this moat that they've built from that.
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Costco
And that is an investment in their enterprise value. Costco is choosing to invest those dollars in making the franchise more durable by getting more customer love.
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Costco
Yes. In fact, it's what Jeff Bezos meant when he said, your margin is my opportunity. But Costco just runs the playbook so consistently.
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Costco
And when you look at their overhead, the fact that Costco runs at 10%, 11% overhead and Amazon runs closer to like 30% overhead, Costco has chosen a business model where they actually can just have lower margins on stuff because they don't need to do things like ship goods to your home. They need way fewer people.
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Costco
They need way fewer investments in technology to do crazy robotic sorting at warehouses, picking and packing. The Costco business model is one where they've just gotten rid of all of that. They say, we're not even going to play that game. Our goal is to lower our overhead so we can pass along the most savings to customers.
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Costco
Yes, different set of trade-offs, for sure. But it is rare that as an incumbent, you have the counter-positioning power. It's usually a thing that startups do against incumbents, but Costco is a $230 billion company that none of the other big companies can copy. I mean, Walmart is trying and still is not succeeding at it.
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Costco
Which I think that also is kind of true. Like 15 years ago, I think they thought the internet was going to be a fad, which is why they missed it at first. And now they're sort of intentionally missing it. But I will get into it, but they're doing it in their own way. But I actually do think they underestimated it at first.
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Costco
Or the brand. Very often I will buy something that's a little bit more expensive on Amazon because I'm like, well, it's going to be easy to return. Or, well, I trust this company. That's a very different premise than the original idea.
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Costco
Yeah, that's a good point. Switching costs, I guess there's some. I'm not going to go join BJ's Wholesale Club or Sam's Club when I already have a membership. So to some extent, but I don't think that's the reason that they win. Network economies, not really. No, I think it's scale economies. Yeah. Process power, definitely.
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Costco
I mean, there's a culture at Costco that others have failed to replicate or haven't tried hard enough to replicate.
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Costco
Right. So recently, a bunch of folks from Costco got to go ring the bell at the NASDAQ, and they're all wearing their Kirkland Signature sweatshirts. And a joke is made about the idea of Kirkland couture. And... It's worth footnoting this.
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Costco
It's not the main point here, but it is weird how Kirkland sort of has a passionate following in a way where it's turning into a real brand when that was not the intention.
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Costco
Right. There's a lot about our current consumerism climate that I think fuels that. Also, quick aside, Costco has never tweeted. The account has a lot of followers and zero tweets. They're not really a participant in social media, but they have a massive tailwind from all the Costco TikTokers.
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Costco
There's people constantly sharing videos about, here's this amazing thing I found, or here's how I've structured my day to work Costco in, or... Here's my haul.
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Costco
All right, David, while we're here, we have to tell the hot dog story. So this comes up literally every time there's any sort of writing or podcast or book or anything about Costco. Very famously, as David and I talked about, the hot dog and drink combo has been $1.50 for many, many years. And when Jim Senegal handed over the reins to Craig Jelinek, Craig went to him and said, you know, hey...
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Costco
We're close on margin here, or maybe we're upside down. Nobody really knows. On the hot dogs, we might need to raise the price. And of course, Jim Senegal looks at him and goes, if you raise the price of the hot dog and drink combo, I will effing kill you. So that is why it is still priced the way it is today. And this story has gotten so much airtime.
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Costco
Right. He would have known. Anyway, back to branding, you know, earned media branding. There's this kind of interesting thing where it's almost like Nike, where I think they have latent branding power. And I'm not talking about Kirkland here. I'm talking about the buyers, like trusting the buyers. Members trust the pre-selected inventory from Costco. And I don't know where that shows up.
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Costco
It definitionally doesn't show up in price. Costco will never generate excess margin because of their brand. But their brand earns them something. I mean, people become members and trust them, and that leads to something. I assume it leads to volume. It leads to willingness to buy, which leads to volume. Or it leads to retention.
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Costco
So this is the second episode where it's not branding power under Hamilton's definition. It's latent branding power.
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Costco
Yep. In a lot of ways, I think what Costco is sort of doing is they realize that they have latent branding power and latent scale economies, and they sort of choose not to recognize short-term profits from those. And I think it's all this super long-term game where... This is why the market is willing to pay a much higher multiple for Costco than any of their competitors.
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Costco
There are a lot of ways that if Costco wanted to, they could make more money today than they currently do, but they've decided not to.
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Costco
And so it's the same result, whether you look at it as, let's assume that they did take a little bit more margin, or let's assume that they did raise prices on members, or let's assume that they leaned into their branding power in some way and actually charged the prices that they've earned would the multiple then be reasonable? Yes, absolutely.
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Costco
Or the other way to look at it is, is this business just going to be around predictably for a longer period of time than any of their competitors because they're doing all these things? You get to the same answer, which is, it is worth paying a higher multiple of the dollars they're recognizing today for a company that has made these choices.
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Costco
I think that's exactly right. And you can see it in the numbers. They do very well in every economic environment.
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Costco
Awesome. Well, to start, I want to say a huge thank you to Alex Morris, who writes the investment substack, The Science of Hitting. He has two pieces that were just excellently written, analyzing Costco's financials. And he was also very kind, David. I spent a lot of his Sunday, last Sunday, emailing him and asking clarifying questions. And he shared a bunch of data with me. It was super helpful.
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Costco
So thank you, Alex. We'll put a link to The Science of Hitting in the show notes. To open this section, I want to say a Jim Senegal quote. This isn't a tricky business. We just try to sell high-quality merchandise at a lower cost than everybody else. And I think it's hilariously farcical. He's both right and so cheeky. This is a extremely tricky business.
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Costco
We've talked about a bunch of them on this episode. It's the 50 little things that they do that all sort of synchronize with each other that makes it work. You don't do one of those, it falls apart. Oh, I want 10,000 SKUs. Oh, I want to be a leader in e-commerce. Oh, I don't want a membership fee. Oh, I want to blow out a bunch of merchandise and do a sale.
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Costco
Any of these trade-offs, you break them, the whole thing breaks. Yep. There are so many fun little paradoxical things about this company. They sell goods at the lowest possible price, but that means that they have a wealthy customer base. It always breaks my brain when I keep coming back to this point.
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Costco
And I think it broke the brain of a lot of name brand companies too, who refuse to sell at Costco. I mean, until like 10 years ago, a lot of brands, they just had this idea that low prices had too much of a negative signal about their brand. And it took decades for Costco to prove that they really did care about quality. That was part of their value proposition.
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Costco
And also, it took decades to prove that they could facilitate a huge amount of volume. And, you know, they've won over everyone from Apple to Dom Perignon.
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Costco
Yes. Most of you are very familiar with this Disneyland of consumer value that I'm referring to. It is Costco. This company seems very simple on the face of it. If you sell in bulk, you have the opportunity to offer great deals to your customers.
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Costco
A hundred percent. You can go and buy right now $500 on Southwest Airlines for $450. That's at Costco. You can literally buy dollars for smaller dollars. And with an enormous company that a huge swath of the U.S. uses, it's not so obscure a restaurant or movie theater or something.
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Costco
It's like, here's a thing that you're likely going to spend money on anyway, and this company has decided to put it in here for a lower price. And that works somehow. Yeah. And another big piece of this is that for the majority of suppliers, Costco mandates that the item you sell them is a unique SKU that the shopper can't buy anywhere else. So there's not even any comparison shopping.
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Costco
If you're buying a blender, the Costco version will come with, you know, some extra cups or maybe a two pack of Sonic hairs comes with a bunch of extra toothbrush heads. You know, it's these things that are custom, uniquely made for Costco shoppers. It is such a walled garden. David, check this out. Nike normally refuses to sell at Costco because of course they do. They're Nike.
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Costco
They won't even sell on Amazon. Except right now, as we talked about on our last episode, they have a lot of inventory and they need to discount it to move it through the channel. Nike can't really discount anywhere. I guess they have their Nike outlets, but for the next couple of years, they're going to be moving a lot of merchandise through Costco because... You know, it's Costco.
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Costco
It's, oh, it's different. Oh, people pay to get in there. It's a whole different thing. This isn't just like, whatever the psychology is, Nike is actually willing to sell through Costco until they work through these inventory challenges. And then I'm sure that they won't do business with Costco again for a while. But even Nike, the most brand conscious company in the world, plays ball sometimes.
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Costco
You buy iPads there, buy computers there. Okay, so there is a thing that we haven't addressed yet, and that is the conflict between operationally light, you know, low overhead, and a tremendous amount of vertical integration. And when you're selling $50 billion of Kirkland, you have some vertical integration. You do some things yourselves. The finest illustration of this is chickens.
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Costco
I know, right? We should ask him. Okay, so when do they vertically integrate? They will do it when they can provide enough value to members to make it worth increasing their overhead. And so here's the chickens example. They sell 500 million chickens a year. Not pounds, chickens.
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Costco
That is exactly right. And don't think about it too much. That's also the thing with the chickens. 130 million of which are rotisserie chickens. So even just the rotisserie chicken business alone, that's a third of the U.S. eats a rotisserie chicken every year. The rest, of course, are chicken breasts, chicken thighs and legs and everything.
Acquired
Costco
The chicken's used in the food court for the chicken bake because, of course, when they make stuff, they actually make it themselves. When you go buy muffins, those are baked at Costco in their bakery. There are really only four or five chicken processing companies in America. And when you have supplier concentration like that, Prices can get artificially inflated.
Acquired
Costco
You know, you could be on the wrong end of the stick as the buyer when there's so few suppliers. So Costco decided, we're going to be doing this for a long time. We think our members might be getting a raw deal, so what should we do? We can provide more value to members by doing the insane work of processing this ourselves.
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Costco
So first they sort of figured out we can rent 100% of the capacity of a plant in Alabama to kind of learn the ropes of like, you know, we're warehouse merchants, now we're becoming chicken processors? How does this work?
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Costco
They learned, and then they proceeded to build their own fully owned facility in Fremont, Nebraska, outside of Omaha, and build relationships with 150 local farmers in the surrounding area. I mean, this is nuts. That facility processes 2 million chickens a week now. It worked.
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Costco
To take that even further, there's two other dedicated facilities that they don't fully own, but that just are for Costco. They can now process 200 million chickens a year. So while they're still working with the other big chicken processors, at least Costco can keep them honest on pricing now by taking on this huge amount of vertical integration themselves.
Acquired
Costco
Okay, let's move on. Let's move on. So a much nicer example is like the fancy mixed nuts that I was talking about earlier. Saw an opportunity to make a better product, work directly with farmers and suppliers and kind of clean up that whole supply chain. They do the same thing in coffee, bring down the price, increase the amount of fair trade stuff going into the little Keurig pods.
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Costco
It is just like fascinating to watch when they are willing to leverage their scale to take on additional complexity, like when they feel that's in the interest of members versus when they say, you know what? I think we're going to be a merchant on this one.
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Costco
So that's the chickens. One thing is whenever you talk to any of these current or former Costco employees, or you watch any of the YouTube videos of the talks, or you read anything, they talk in cents. It's the craziest thing. You hear most executives talk and they talk in dollars, especially like Jensen and NVIDIA. You listen to him talk. He has CEO speak.
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Costco
I can't remember exactly what he says, CEO language, something like that. But it's all in these plus or minus 10% swags.
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Costco
Yes, exactly. I love the concept previous to this episode of CEO math. It's like, get the high-level concepts right and the rest will follow. You talk to someone at Costco and what they tell you is that that costs $3.89. And it's not just $3 things. They'll tell you that that costs $180.89. It's ingrained in the culture that every cent matters.
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Costco
You bet. The thing that kept echoing my head is that these people, and you know, this isn't quite a hero's journey the way that some of our episodes are. It's not the same person all the way through because it's Sol Price, it's Jim Senegal, it's all the executives who are currently on the team today because most of them have been there for 30 plus years.
Acquired
Costco
The way that all these people think and act are sort of a different type of hero's journey because they're a different type of hero. I mean, a lot of the times in our society, the people we've built up are these crazy sociopath shoot-the-moon type people.
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Costco
And this is just a group of people who spent their life's work all working at the same combined company just trying to improve the model in little ways. There's so little personal ambition. I mean, none of these people have LinkedIn profiles. They do, but like they have one job on it and no picture and no description. Or like, you know, the Costco Twitter account made no tweets ever.
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Costco
There's a crazy consistency to the culture. I walked into the headquarters and the coffee was Kirkland pods from a Keurig. Like when you sit down in the lobby and, you know, someone says, oh, would you like a water? And like, you bet the water that they hand you is a Kirkland signature water bottle. I mean, the executives, you walk by the executives, they're in cubicles.
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Costco
It's amazing. I will say, too, that there's this famous quote about Amazon being a charity that's run for the benefit of customers. Do you remember that? I do. It's actually Costco. It's actually Costco, right? On $230 billion of sales, they keep $7.5 billion in operating income. I've just never seen a company give more consumer surplus than Costco.
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Costco
And they're a very noble company and all the decisions they make are very noble. And you get the sense that they're having a lot of fun being noble, but you only earn the right to be noble if your machine works. and their machine really works. And I think that's kind of the point, is they've earned the right.
Acquired
Costco
Acting this nobly partially got them to where they are, but where they are earns them the right to continue to be noble. The company has never done a layoff. If they needed to, they would have done a layoff, but they've run the business in such a way and figured out the way that they've never needed to do that, even after they did a merger.
Acquired
Costco
That's wild. It's crazy. So, amazing management. All right. My last big playbook item is an old quote. There was a Deutsche Bank analyst that said, it is better to be an employee or a customer than a shareholder, which Costco management would say, yeah, that's literally like we've printed it. It's in a PDF on our website that's called our code of ethics.
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Costco
So in the short term, maybe. That is a totally reasonable thing to say, and no one would argue with it. But in the long term, it has been fantastic to be a shareholder. I did the math.
Acquired
Costco
If you bought $10,000 of shares in their IPO in 1985, you would have $3.3 million today, a 330x, and this does not include the dividends you would have earned along the way, which they've actually done a lot of dividends, including four-ish special dividends, too, that were huge. I don't know.
Acquired
Costco
It's funny how if you want to dip in and out of the stock in a year or two, it's not going to be great for you. It'll be predictable. It'll be high-priced when you come in, but it's not going to be world-changing. But there's a chance that over 30 years, it is world-changing for you.
Acquired
Costco
Those are the ones that are the most enduring, as our friends at NCS Capital would remind us.
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Costco
It's also like, okay, how are they doing so much volume? You should go check it out and see what's going on.
Acquired
Costco
And we talked about most of it, but there's a thing that we haven't really discussed yet, which is Amazon's overhead is like 30%. Target and Walmart's is something like 20%. The fact that Costco needs to run at 11% for it to work really did blind them to e-commerce. I don't think this was a conscious choice.
Acquired
Costco
This was a miss that they got really lucky on and happened to work out well for them where they could continue to run their same playbook and kind of skip e-commerce for a long time. I mean, they were 15 years late to e-commerce. And structurally, Costco can provide things at a far lower cost than Amazon.
Acquired
Costco
But at the end of the day, there really is no way that Costco can do e-commerce like these other companies. I mean, even Walmart's figured it out. Walmart is as good for most use cases as Amazon, but they're paying the price. It is a huge amount of overhead to set up the infrastructure to do home delivery.
Acquired
Costco
So one of the things we're going to talk about here in Bear Bull, and I think we should transition, is what Costco is doing that is Costco-flavored e-commerce instead of Amazon-flavored e-commerce. But I will save that for my bull case. A second bear case, it was popular in the past to say that Costco would have an issue with young people. But, I mean, I guess this isn't really a bear case.
Acquired
Costco
I know. Costco has been blowing up on TikTok, as we've talked about. But also, from all available data, young people are getting memberships at the same rate they always have. Like, of course, the bulk of members will be people in their 40s and 50s with a family and a house. But... That hasn't really changed over time.
Acquired
Costco
If you liked the Costco business in the last decade of an investor, all signs are it's going to be pretty similar in the next decade, too, in terms of the ramp of when people become members. There's another one that's like, I'll put it in bear case, but again, I'm not really sure it's a bear case. It is worth pointing out.
Acquired
Costco
It is either true that this business cannot grow at more than 10% per year on average. They've had little years where they've spiked, but sort of on average. Or management just doesn't want it to, which also would be fine because there are lots of benefits to slow, steady, durable. But the company has a lot of cash on the balance sheet and regularly does dividends and buybacks.
Acquired
Costco
there's this crazy stat from the science of hitting that the company has returned 80% of net income to shareholders in the last decade, rather than reinvesting it in growth. And the key reason for this is that it's just really, really hard to expand. They need to hire the people, like the right people, train them well, promote internally. And the work to scale is so physical.
Acquired
Costco
The new construction, expanding suppliers, shipping large pallets into new geographies. I mean, cash is not the constraint stopping them from expanding. There is a physical limit to the speed at which this company can grow. So I'm calling that a bear case because it's more like, you know, you should be aware that this thing can't scale like Zoom scaled during the pandemic.
Acquired
Costco
That's like the polar opposite of the spectrum. Zoom or Slack or any of these has like... Basically, no bottlenecks to infinite instant growth or Instagram launching threads, you know, instantly has 100 million members. Costco is the literal opposite. There are bottlenecks everywhere to scaling and no amount of cash is going to solve that problem.
Acquired
Costco
I thought you might go there. All right. Bull case. I mean, the biggest one is the flywheel is spinning, and I'm not really sure who can catch them. So here's, again, from the science of hitting, Substack. Quote, Which explains why Sam's Club has a smaller unit base today than it did a decade ago. Crazy, right? Over the same period, Costco increased its U.S. warehouse count by one-third.
Acquired
Costco
And to be more fair, this is no longer a market share fight for the warehouse retail business. This is global retail. And then the question is, how much of global retail can Costco's model address? It's not Costco versus a specific competitor. It's Costco versus human behavior.
Acquired
Costco
So this is my second bull case, which you touched on the domestic thing, just as an aside. Every five years on earnings calls and in annual letters, Costco management reveals that they're surprised by how unsaturated they are in the U.S. market. They'll open a store in a city where they already have three or four stores, and they're like... And this one did just as well.
Acquired
Costco
And of course, it doesn't have as many members because you do actually saturate the population of a city. But the convenience of having the store closer means that, you know, it hits the payback targets that you'd want it to hit just as fast as a store that was in a brand new market for them. And at some point, they'll stop being surprised.
Acquired
Costco
Or at some point, they actually will saturate the North American market. But it's amazing that they keep thinking it's soon and it's never soon.
Acquired
Costco
My third one is international expansion, exactly as you're saying. In particular, China. There is incredible pent-up demand. So here's an illustration from The Science of Hitting, which is just so good. The average U.S. store has 68,000 members. The first store in China opened in 2019, which popped to 400,000 members within two years. The U.S. at maturity is at 68,000 members.
Acquired
Costco
If you can operate there. I mean, that's the big thing is like for U.S. companies, it is very complicated to operate there. So there's going to be six stores in China within the next year. And all indicators are that this concept performs just as well, if not better than it does in the U.S. They have a lot of running room.
Acquired
Costco
And they've been very deliberate about the China strategy. They got a permit to open their first store 20 years before they actually did. The Chinese government issued them a permit. What is more Costco than waiting 20 years after you're allowed to do something to do it when you feel you're in a good place to do it?
Acquired
Costco
Oh, it's awesome. All right, here's my fourth bull case, and it's actually e-commerce. Bear with me for a minute on this. They're approaching e-commerce in a very Costco way, and they have a bunch of different approaches, but there's two specific ones I want to highlight. One, where they have differentiation, which is on big and bulky items, that's where they're putting a lot of their energy.
Acquired
Costco
They spent a billion dollars to buy a company that became Costco Logistics, and they do things like deliver sheds to your house. And this is a pretty difficult thing to do from a traditional e-commerce company or an e-commerce native company.
Acquired
Costco
Yep, that's exactly right. And so I do think this is an interesting area for Costco and e-commerce. The second one is CostcoNext.com. Do you know what this is, David? No, I didn't find this. It allows you to shop directly on other websites and put in your Costco number and get a discount.
Acquired
Renaissance Technologies
I always used to misspell Renaissance as I was typing it out, R-E-N, and then I would sort of like not really know what came from there. But I learned a mnemonic to make sure I get it right.
Acquired
Renaissance Technologies
So whoever is in charge of the financial controls and safety systems at Rentech, that's a huge job for someone in this industry. Totally. Totally. All right. To kick off value creation, value capture, I have a provocative statement, which is, David, Renaissance Technologies is actually not in the investment business. They are in the gambling business. And in particular, they're the house.
Acquired
Renaissance Technologies
I'll say this. They're not investors and they're not in the investment business. There is investment going on all around them in the markets that they trade in. But the fact that they're in those markets, they're not there as investors. They're there setting up shop as Caesar's Palace, letting everyone come in and do business with them while they have a slight edge.
Acquired
Renaissance Technologies
And they'll lose sometimes, but most of the time, they're going to come out slightly ahead. And I think, let's say they do have a 50.01% chance of being right. They're just there to collect their vig on everyone who is willing to trade with them over all these years. And at scale, it really worked.
Acquired
Renaissance Technologies
Jim Simons managed to drain $30 billion into his own pocket out of everybody that he ever traded with.
Acquired
Renaissance Technologies
Well, I mean, the investment business, it sort of depends how you define investor. If you want to be like all hoity-toity about it, which I'm, you know, in this illustrative example, I'm kind of being one and saying an investor is someone who provides capital, you know, risk capital to a business for that business to create value in some way in the future.
Acquired
Renaissance Technologies
Or you lend money to some intrinsic underlying asset so that it can be productive with that capital and produce a return for you as an investor. And of course, lots of things are called investing that are not that. Is it investment if I put money to work and then I get more money back later and I don't actually care how the money got made and it's actually zero sum?
Acquired
Renaissance Technologies
Correct. But it's literally the same business model as a casino. You have a slight edge and you let a whole bunch of patrons come in and lose money to you in your slight edge.
Acquired
Renaissance Technologies
This is a guy with an MIT undergrad and master's and a Berkeley PhD in theoretical math. Who's now a professor at MIT. Who is taking a year off to go work on a flooring company in Bogota.
Acquired
Renaissance Technologies
Absolutely. That is the undeniable, yes, quant funds create value in the world thing, which I think it's very easy to say quant funds provide no value because it's like it's zero sum. They're not actually providing the capital to businesses to do something with. They're purely looking to do an arbitrage or any of the strategies we've talked about this episode.
Acquired
Renaissance Technologies
But you're totally right that there is a value to market liquidity. Creating more depth to a market makes it so that if we go back to the era that Renaissance was started, there's no chance that retail is able to function like it does today with zero transaction fees and people able to invest in all these different companies at near real time.
Acquired
Renaissance Technologies
The fact that there is a whole bunch of quant funds, hedge funds out there that are ready to be willing counterparties to anyone who wants to trade, that is a service. You're right. They're also not all medallion. They actually don't all have an edge, even though they might purport to. Lots of them are going to lose money to you.
Acquired
Renaissance Technologies
Right. On average, Medallion will not lose money to you. But, you know, there are plenty of other hedge funds out there and high frequency shops and counterparties for you where you could take them. It's just not Jim Simons.
Acquired
Renaissance Technologies
What should we do? Yeah. All humans are fallible. Totally. A couple of other squintable value creation exists. It's easy to knock that all these smart people are going into finance and you wish they were doing something more productive for the world. At the end of the day, humans are going to do what they are incented to do.
Acquired
Renaissance Technologies
And so absent a larger global concern that is incredibly motivating to people, I mean, you look at World War II, people's level of patriotism and wanting to go save the world from evil was a huge, unbelievable motivating factor to move mountains. When that is absent or when people feel that there's some existential thing that is absent, they're going to go do what's best for them and their family.
Acquired
Renaissance Technologies
And if they're an empire builder, go build empires. And if they're a fierce capitalist, go make a bunch of money. And so the system is set up the way that it is. So like you can be mad about that. Given that, okay, people are going to go engage in quantitative finance as a lucrative profession. Fortunately, there's a bunch of valuable stuff that comes out of that.
Acquired
Renaissance Technologies
And I think that is often missed, is that these really lucrative businesses professions and businesses can often produce R&D that becomes valuable elsewhere. For example, we just did this big NVIDIA series. What do you think Mellanox was used for before large language models?
Acquired
Renaissance Technologies
Well, there's not much to it other than a huge amount of InfiniBand was used by high-frequency trading firms. And I don't know for sure, but I kind of think Mellanox built their business on quant finance. Yes. That's one of many examples. But now, you know, that has limits. But I think it goes overlooked that there's a lot of technology innovation here.
Acquired
Renaissance Technologies
But does it create anywhere near as much as it captures? That said...
Acquired
Renaissance Technologies
There's a great Always Sunny in Philadelphia where Frank, Danny DeVito, sort of goes back to his whatever business he founded in the 80s. And he's like dressing in his pinstripes and stuff again. And he's taken back over. He brings Charlie with him. And Charlie, you know, he's like, so Frank, what is the business? What do we do here? What does the business make?
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Renaissance Technologies
And Danny DeVito looks at him and he goes, what do you mean? We make money. He's like, no, no. Like, what do you build? He goes, we build wealth. I think that's a pretty good meme for kind of what's going on here.
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Okay, bear, bull. So this was a section that we had for a long time that we did not put in the last episode. And boy, did we hear about it. So listeners, thank you so much for expressing your concern. Bear versus bull is unkilled and it is back. Resurrected like a phoenix. Resurrected. However, this is about the lamest episode to resurrect it on. What's the bull case for Rentech?
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Right, like they're going to keep attracting all the smartest people in the world. They're going to have the ability to keep their incredibly unique culture. They're not going to get tempted to let the business of institutional funds become the dominant business. You know, keep on keeping on is basically the bull case. Maybe that they're actually still ahead of
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Yeah. The bear case is things are changing. And I think things are changing basically on any axis is the bear case for them. So things are changing where competitors are catching up. Maybe. Maybe the fact that the tech industry has figured out these large language models, maybe that trickles into making it easier to compete with Rentech. It's a blurry line, but it is plausible.
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Like maybe Rentech actually was here a decade before everyone else, and now everyone else has arrived to the party. And there's things that are changing maybe about their culture, like Jim Symes has been gone for a long time. Bob Mercer is no longer a co-CEO. Peter Brown is a co-CEO, and they just announced that they're making the guy who was in charge of the institutional funds.
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David Lippe, he is becoming a co-CEO as well. So maybe there's a bear case around that, that someone from the institutional side of the house is becoming the current co-CEO and maybe eventually CEO if you believe the medallion is the special thing and the institutional funds are sort of a blemish on the business. They're the Hermes Apple Watch strap in David's parlance. Maybe that's a bear case.
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Maybe there's a bear case that their talent is becoming kind of the same as everyone else's talent. When you look on LinkedIn, I recognize a lot of the companies that people worked at who are more junior at Rentech. And in the past, I think it would have been all people just out of university research shops. So I think...
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If it's true that they're starting to see the same talent flow as everyone else, that would be concerning. These things are all sort of narratives you can concoct and really no way to know if they're true or not.
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The one thing I can't stop thinking about is the idea of the complex adaptive system that I was talking about earlier. I think, from everything we can tell from the outside, Renaissance actually has built a large-scale computer system that discovers relationships between different entities in the world. Stocks, commodities, bond prices. And whether it can explain them or not, it is...
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correct most of the time and it might be a small most but all you need is most and then you can operate a casino business that is my takeaway is that they are the house and they have an edge and that edge is predicated on a graph of all the relationships between these entities that we think are just noise and they know the signal
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Yep. All right. Should we have some fun? Carvouts? Let's have some fun. Sweet. All right, listeners, I have three. People have been expressing that they're loving the Carvouts section, so I decided to load them up a little bit more. That's right. Let's indulge. We'll spin off a whole new podcast called Carvouts. 44% carry. Let's go.
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So I have one announcement, one TV show, and one other fun thing for listeners. So first, the announcement. David and I are gonna be emceeing Modern Treasury Transfer again this year. And so if payments are your thing, you should come join us. It was awesome last year. It'll be May 15th, 2024 in San Francisco. And we'll put a link in the show notes to register. We would love to see you there.
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Can't wait. My second one is a TV show, and it is actually Acquired-related. It is called The New Look on Apple TV+.
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Exactly. So for anyone who listened to the LVMH episode, remember we were talking about the groundbreaking thing that Christian Dior did was his collection, The New Look, that was a post-World War II explosion onto the scene. Celebration of life. Yes. Gone are the days of the militaristic, boxy clothing, and now we're in with these... seductive and, dare I say... Sumptuous materials.
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War rationing is over. Exactly, yes. Provocative dresses. The Apple TV show is this incredible drama of kind of flashbacks to the wartime experiences, harrowing wartime experiences of Christian Dior, of Balenciaga, of Coco Chanel, and everything they went through and how all their paths crossed. Oh, Coco's in it. Yes. Oh, wow. How do they treat that?
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It was basically formed with this idea that one, across various branches of our government, we need better collaboration and cross funding of the same initiatives. And two, there are going to be a lot of people who don't work for the government that we're going to want to hire to do some pretty secret work.
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It will be very interesting if a lot of people watch this show to see if that affects product sales of Chanel. I'm also very curious, for people who are watching, feel free to put a thing in the Slack in Carvouts. Do you think she's a sympathetic figure? Do you think she's a villainous figure? I'm curious how you think of her portrayal versus reality.
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The Wertheimers, indeed. God, we got to do a Chanel episode at some point. But the new look on Apple TV+, I promise you, whether or not fashion and luxury is your thing, it's a beautiful and harrowing story.
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The whole thing, it takes place in wartime Paris. All right, I got to watch it. You got to watch it. Okay. My third one is a fun thing for listeners. So after our Nike episode, the president of Cole Haan, which if you listen to the episode, you now know is its own company, spun out from Nike years ago.
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The president of Cole Haan reached out and it turns out he, like all of you, is also an acquired listener. And so we were chatting and he brought up the idea that they'd be happy to create a specific Cole Haan deal for acquired listeners. And I told him, frankly, if it's good enough, then I'll share it on air. To be clear, this is not a sponsorship. No, no.
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reached out to us. And I've owned a bunch of Cole Haan products over the years and I've really liked them. So for 35% off anything, you can go to colehaan.com slash acquired or use the code acquired35 at checkout. And thank you to Dave for providing this to us. This is only live, I think, for a couple weeks. So if you're listening to this episode soon after it drops, go check it out.
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I think they intentionally want to cut it off at some point so it doesn't get shared around all the coupon sites. But fun thing for acquired listeners. Super cool. He likes Acquired and wanted to share the love back. Love it. I love it. All right, David, your carve-outs.
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David, you and I go to Palm Beach for two days and you get hooked on.
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And David's like, I'm a thousand. I have no idea what you're talking about, Jenny. Yeah, right, right, right.
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Look at David opening up our Instagram account. You're so youthful. I know. All right, listeners. Well, a huge, huge thank you to JP Morgan Payments, ServiceNow, and Vanta. You can click the link in the show notes to learn more. David, I know you've got some thank yous from folks you talked with and a few of them we did together.
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It is crazy. Everywhere you hear that 66% number quoted, and that is from Greg's analysis.
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And there's a few other primary sources. There's really not much, so we can actually list all of them here. There's a congressional testimony of Peter Brown about the basket options thing. There's Peter Brown doing an interview at GS Exchanges, which, again, many of the questions were straight out of Greg's book and the stories told. Yeah.
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There's a great book called The Quants, which is a little bit earlier. I think it's 2011. So it's not as updated as The Man Who Solved the Market. And there's only sort of a couple chapters about Rentech, but some good stuff in there. And then there's a good Bloomberg piece from 2016 that we'll link to that.
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I think between that and The Quants, it was sort of the first time there was really anything at all that was published about Rentech. So all those will be in the show notes. Other people to thank, David.
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Yeah, it's a pretty wild charter and especially how special of an organization it was like the way these people would spend their time is part code breaking but part kind of goofing around because the creativity of mathematicians working together on passion projects is important to discovering clever new algorithms.
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Awesome. Well, if you liked this episode, you should check out our Berkshire Hathaway episodes from a few years ago for a very different style to investing. You can sign up for new episode emails at acquired.fm. We'll be including little tidbits that we learn after releasing each episode, including listener corrections. You can listen to ACQ2.
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Search and subscribe in any podcast player and listen for our most recent episode with the, well, really creator or person who led the team that created Lyra Glutide, which went on to become Semiglutide, which of course is Ozempic, Wegovi, etc. all modern GLP-1s. Lata Bjarneudsen from Novo Nordisk was awesome to have her on the show.
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And after you finish this episode, come talk about it with other smart members of the Acquired community at acquired.fm slash slack. If you want some merch, we've got some. Acquired.fm slash store. And with that, listeners, we'll see you next time.
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Or if you have, why don't you know much about them? Well, their eye-popping performance is matched only by their extreme secrecy, and they are unusual in almost every way. Their founder, Jim Simons, worked for the U.S. government in the Cold War as a codebreaker before starting Renaissance.
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And importantly, it couldn't have been a government division if they were going to be doing that because there's very specific congressionally approved budgets for payroll. Exactly.
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Just 20 years before Rentech. It's crazy. 1964, this was published? Yes.
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You're effectively looking at the intrinsic value of an asset, trying to assign it a value and make investments based on that.
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None of the founders or early employees had any investing background, and they built the entire thing by hiring PhD physicists, astronomers, and speech recognition researchers— They're located in the middle of nowhere in a tiny town on Long Island. They don't pay attention to revenues, profits, or even who the CEOs are of the companies that they invest in.
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Yeah, using the phrase technical might be a little generous. But what they're looking for basically trying to mine trading behavior for Signal about the way that it will trade in the future rather than mining the intrinsic information about an asset for what you think it will do in the future.
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And importantly, you might say, why is it this group of people that came to that conclusion of applying computational signal analysis to investing? Well, it's effectively the same thing as code breaking. You are looking for signal in the noise and trying to use computers and algorithms to mine signal from something that otherwise kind of looks random.
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Which is not an insight other people had. That was the amazing thing about his background, priming him to realize that.
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So mathematical models, statistical analysis, we actually hear a lot of that in the world today because machine learning is a thing.
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Yes. The finance industry has a rich history of innovating dating all the way back to the literal renaissance where double-entry bookkeeping and letters of credit revolutionized global trade and economic development. And J.P. Morgan Payments really continues that tradition in their technology investments today. They move $10 trillion a day securely. That is a quarter of all U.S.
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dollar flows globally. Just think about the sheer volume of data at 5,000 transactions per second and how important that is to the global economy.
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Well, there's that too. But you ready for this? You can't spell Renaissance without A-I. Oh. Touché, touché. All right, let's do it.
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Yep. So also unsurprisingly, JP Morgan was ranked number one in a recent global banking index of AI capabilities, with Fortune saying they were, quote, head and shoulders above the others. Their customers get AI-powered payment solutions for fraud prevention, customer insights, and treasury insights, all of which grows the bottom line.
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And at any given time, they probably couldn't even tell you what actual stocks they own. Now, you may be thinking, okay, great, I just learned about this insane fund with unbelievable performance. And to be specific, listeners, that's 66% annual returns before fees. And, you know, well, I want to invest. Well, you can't.
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They can even analyze transaction data to predict and mitigate fraud patterns in real time with their validation services, helping stop millions of dollars for customers in attempted fraud.
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Yeah. One more playbook theme in common between Rentech and JPMorgan Payments, they both analyze data to uncover patterns and insights you may never think to look for. One of their clients, a furniture store, discovered a correlation with customers who also shop at pet stores where shoppers spent 76% more than the average customer when this was the case.
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So the furniture store launched a line of pet-friendly furnishings for that audience. These are the sorts of insights that drive growth with JPMorgan Payments as your partner.
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To learn more, check out jpmorgan.com slash acquired. And fun fact, listeners, it is Fraud Prevention Month. So listeners can learn even more by following J.P. Morgan on LinkedIn. Okay, David, so this paper is published. They're going to trade and make a whole bunch of money in the stock market by applying this code-breaking, signal processing, data analysis approach to investing.
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To add to everything else that I just said, Rentech's flagship medallion fund doesn't take any outside investors. The partners of the firm have become so wealthy from the billions that the fund has generated that the only investors they allow in are themselves.
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So the great example that Greg Zuckerman gives in the book is, yes, a baseball game. There's three balls and two strikes. That state has a narrow set of states after it. It's going to be a strikeout. They're going to get on base. It's going to be a walk or maybe they foul it off and it keeps going. There's only really a narrow set of things that could happen after that.
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Whereas when it's zero balls and zero strikes, there's a lot that could happen. They could just keep pitching. And if you don't know the rules, you're like, why do they just keep pitching?
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And so it's this sort of great way to explain this idea of the black box that if nobody tells you the rules to the game by observing the outputs enough and observing, okay, in this state, these outputs are possible. you actually can kind of get pretty good at at least, if not predicting, understanding the probability distribution of the outcomes for any given state in the game.
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And obviously, they're much fancier than that. But that is kind of the underpinning of it all. I mean, I remember in my sophomore year of college computer science class, I had a Markov chain assignment. And it was basically write a Java program to ingest this public domain book.
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And then I would give it a seed word, you know, the first word of each sentence and press return, return, return, return, return. And it would scan through the probability tree and give me the most probable word based on the corpus of the book that it just read to create some sentence. And it feels like magic.
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And of course, in these early rudimentary Markov chain things like the one I did in college, it kind of spits out nonsense. But that would evolve to be the LLMs that we know of today.
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Exactly. And the way that this applies to investing is just like you might not know the rules of baseball, but if you've watched enough baseball, you can kind of guess at what the probabilities of the next thing to happen are based on the state. Investing is kind of the same thing, or at least the stock market movements are, where you don't know the future. You don't know what's going to happen.
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You don't know if stock X affects stock Y in some way because you don't know in what way those companies do business together or who holds both stocks. Are they overlapping investors? You don't know the relationship between those companies. So you can't forecast with 100% certainty what is going to happen.
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However, if you suck in enough data about what has happened in the past and the probability distribution from every given state in the past, you probably could make some educated guesses or at least understand the probability of any individual outcome based on a state today of what could happen next.
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Certainly, we're going to be successful at raising that fund. And certainly, we're going to be very profitable because we've got this great idea. Totally. What could go wrong?
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Ooh, yeah. Cliffhanger, David. I'm excited. So what exactly does Renaissance do? Why does it work? And how did it evolve to be the way it is today?
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Right. This was decades before it became high pedigree to come from a technical computer science background in the world of investing.
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Right. It's a little bit of a clown show on the operational side, even if the idea is good.
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And while the resources out there are scarce, because for one, employees sign a lifetime non-disclosure agreement, David and I are going to take you through everything we've learned about the firm from our research dating all the way back before Jim Simons started as a math professor to understand it all. This episode was selected by our Acquired limited partners.
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Which is so naive thinking you can write an op-ed in the New York freaking Times and that's not going to create issues for you in your job.
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And to be honest, I didn't think enough people knew what Rentech was to pick it. But when we put it out for a vote, the people have spoken. So if you want to become a limited partner and pick one episode each season and join the quarterly Zoom calls with us, you can join at acquired.fm. If you want to know every time a new episode drops, sign up at acquired.fm slash email.
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Yeah, I mean, it was really viewed in the math community as anyone who's going to do investing is throwing away their talent. And it wasn't even that it was common the way that it sort of is today. Right. Jim was the first one.
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Yes, exactly. And leaving to do anything, sure, but leaving to do investing was almost just seen as dirty. Like it's this rich person's game that provides no value to society.
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Academics tend to be much more motivated by prestige than money. So I could totally see this other people being like, oh, I could do that if I wanted, but I have this higher calling and everyone respects me for this higher calling. And my currency is the papers I publish and the awards that I win. And that's what I want. Yep.
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These emails also contain hints at what the next episode will be and follow-up facts from previous episodes. For example, we had a listener, Nicholas Cullen, email us this time who found the actual document with the bylaws of Hermes' controlling family shareholder, H51, which we linked to in this most recent email. Come talk about this episode with us after listening at acquired.fm slash slack.
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But they're more loyal right now to academia than they are to finance. This is not a paved pathway until Jim paves this pathway.
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So having Baum and Axe and Simons, it's like suddenly this extremely credible team in the math world. Yes, beyond credible. Right. All the theorems that a lot of mathematicians are using every day are all named after these three guys who are now at the same firm trading.
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And it seemed to me like a lot of the trading of currencies they were doing was basically based on feelings that they had around how a central bank was acting. Like if the head of state of a certain country was going to do something or not. It's basically like betting on how one single actor who was in control of currencies at governments would act.
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So to your point about very few signals impacting price, it's knowing what one person is going to do.
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If you want more from David and I, check out ACQ2. Our most recent episode was with Lata Bjeric-Nudsen, who led the team that created the first GLP-1s at Novo Nordisk. So awesome follow-up to the Novo episode if you liked that one. Before we dive in, we want to briefly share our presenting sponsor this season is JP Morgan, specifically their incredible payments business.
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Which is very different than we'll cram a huge amount of data in and then whatever the data suggests, we know it's true because the data suggests it, which is sort of where they would end up many years later once they had both the hardware you're referring to, sophisticated computers, the clean data that would be required to make all of those incredibly numerous and fast calculations, and also the real computer engineering architecture to build these scale systems to actually...
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act on large amounts of signals and understand them all to come up with results. They just didn't have any of that at the time. So it was hunches and chalkboards.
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Which was essentially spun out of Renaissance. Like it was kind of the venture capital work that they were doing at Renaissance that didn't fit with the rest of Renaissance.
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I could not, when we figured this out in the research, I could not believe that this is not a more widely understood story, that this is the origins of what is today a fantastic venture capital firm, first round capital. But you could not name two more different strategies in investing. I mean, a
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long-term illiquid thing like venture capital, highly speculative versus, you know, we're going to trade whether we think the French franc is going to go up or down tomorrow based on the whim of some government leader. It's unbelievable these were under the same roof. Totally.
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Yeah, when they say multi-strategy, this is really multi-strategy.
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And because we quickly got to this point in the story, it would be easy to say, well, that's a clause that has a lot of teeth. There were many sort of rumbles of something like this potentially happening. Simon's going to Lenny and saying, hey, maybe we should cut some of our losses and it's okay to trade out of these positions. And Lenny was just very dug in on I'm a true believer.
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And that's how you can get into a situation where you trigger a covenant like this.
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Yep. So with that, the show is not investment advice. David and I may have investments in the companies we discuss or perhaps wish we did. And this show is for informational and entertainment purposes only. David, where do we start our story today?
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Well, I mean, it's the only thing where they actually had an edge from Howard's access to deal flow because they certainly didn't have an edge in the global currency markets.
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So it's this interesting arm's length thing where Jim strikes a deal where he's going to own a part of Axcom in exchange for this very favorable contractual relationship where they're going to hire them to be the manager for this pot of money that Renaissance has raised. But, you know, it's technically not Renaissance. It's Axcom. Right.
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It's another company that is now doing the quantitative trading. Yep. And I think Jim owned a quarter of it. Is that right? Yes, that's right. And importantly, I don't think anyone had any idea what Axe Com would become or how unbelievably profitable it would be.
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Not only that, he's getting historical data that predates what your traditional data providers would give you and then ingesting it into computers and cleaning the data to get it into the same format as the tick data. So he's getting early 1900s, even 1800s stuff to try to just say, at some point, hopefully we'll be able to make use of this.
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And I want to have this just really, really clean data set about the way that these markets interact.
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Yes. I think before anybody knew what ETL was. Again, no one told him to do that. That was just a self-motivated, almost like obsession of like, well, if we're going to have data, it should be well-formatted and well-understood and labeled and all that.
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I love that Claude Shannon is coming in again. I know. We talked about it a lot on the Qualcomm episode. father of information theory, really the center of gravity for attracting tons of talent to MIT and kind of paving the way for what would become phone technology and telecommunications broadly in the future. But the fact that Burlakamp is crossing paths at MIT with Claude Shannon, so cool.
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Well, that's the thing. They don't know how reliable yet. They know they've done it kind of a few years in a row here. But the question is, how uncorrelated to the stock market over a long period of time and how predictable are these returns? Or is it just super high variance?
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That's wild. Isn't that amazing? Yeah. Wow, that is a untold story about Jim Simons. I think I read basically every primary source thing on Jim or Renaissance on the whole internet, but I assume you got that from Howard.
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I also didn't realize that first rounds fund one was a 50x on $125 million fund.
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And listeners, we've arrived. This is the part of the story that matters. The Medallion Fund is the crown jewel, or you might even say actually the only interesting thing about Renaissance. And it is born out of this observation that, oh my God, what they're doing over there at Axe Com is really interesting. maybe they shouldn't be doing it all the way over there.
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Maybe that should be a deeper part of the fold here at Rentech and we shouldn't have let that get away or frankly given up on the quantitative trading strategies too early. And again, still just currencies, still just commodities futures, not playing the stock market at all, but the seeds and the ideas, the huge amount of clean data and
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the robust engineering infrastructure to process all that data, the mining of signals from data to figure out what trading strategies to execute, that is really starting to form here in this new joint venture, this Medallion Fund.
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And frankly, that computers got good enough to actually do it too. That's another big piece of this.
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Yep. ServiceNow digitally transforms your enterprise, helping automate processes, improve service delivery, and increase operational efficiency all in one intelligent platform. Over 85% of the Fortune 500 runs on them, and they have quickly joined the Microsofts and the NVIDIAs as one of the most important enterprise software companies in the world today.
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And help fact check a few of our assumptions of what happened after the book came out.
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Yep. And that's been true for us here on Acquired too. David, if we didn't name it Acquired and cover technology acquisitions that actually went well, we never could have broadened and become the podcast that tells the stories of great companies. You can't just start as that. Totally. Well, this is what's so cool and where I think the playbook lesson really is for listeners.
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Because you can't just pick any use case, you have to be strategic about it. And IT was the perfect vertical because every other department has to interface with them from the CEO on down. So they're going to notice when IT's service management rapidly improves. All of those support tickets that used to take forever are now just magically resolved.
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And that greases the wheels for the other departments to say, hey, maybe we should adopt ServiceNow to turbocharge and digitally transform our service levels too.
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Yep. So if you want to learn more about the ServiceNow platform and playbook and hear how it can transform your business, head on over to servicenow.com slash acquired. And when you get in touch, just tell them that Ben and David sent you.
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It's that and it's two other things. One is the further into the future you look, the less certain you can be about it. If you know something is worth $10 right now, what you know five minutes from now is it's probably going to be worth about $10. the most likely situation is it's within 5% of that. If you ask me three years from now, I have almost no intuition about that.
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And a state machine is the same way. If you flash forward a whole bunch of states, you sort of lose predictability as you sort of continue down that chain. The second thing is, if your models are showing that you're going to be right, call it something like 50.25% of the time, then the amount of money you can make is gated by the number of bets you can make at a quarter percent edge.
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If I walk up to the casino and I think I'm right about this particular roulette wheel, which of course you're not, 50.25% of the time, and I decide to play once or play twice or play five times, there's a chance I could lose all my money. Or if I have tiny little bet sizes, then I'm just not going to make that much money.
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But if I walk up to said game with a little bit of edge and I use small bet sizes and I play 10,000 times, I'm going to walk out with a lot of money.
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And I do think he's making up that number. I think it's illustrative.
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It's so true. When you have that little edge, it's about making sure that you're not betting so much that a few bets that don't break your way can take you down to zero and to make sure you can just play the game a lot.
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Now, of course, this is all great in the abstract if it's that you're literally sitting at a casino and you're somehow perfectly making these bets and you're just sitting right there at the table and then you can walk over to the cashier. It gets a little bit different in the market.
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For example, there are real transaction costs, especially at this point in history before some of these more innovative trading business models with pay-for-order flow and zero transaction fees and all this stuff. There's real transaction costs to putting on these trades. And of course, you're going to move the market when you put on these trades.
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There's all sorts of practical consideration. You could get front run by other people. It's not just a computer program that gets executed. You actually have to meet the constraints of the real world when you're deciding instead of a few big bets, we're going to have 100,000 tiny bets.
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So the deeper you get into the order book, like let's say you want to buy $5 million of something, maybe your first $100,000, you're pretty sure you can get the quoted price. But by your last $100,000 of that $5 million buy, the price might have gotten pretty different already.
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Renaissance Technologies
Yep. And David, in a very crude way, calls back to last episode on Hermes. The idea that the price would be highest for the family member that is willing to sell now and sort of goes down over time. If the family was going to sell to Bernard Arnault, it would behoove you to be first in the order book, not last in the order book. Yes.
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Renaissance Technologies
Exactly. Yes, looking at the quoted price of an asset is wrong. You actually should be looking at what is the volume that is willing to buy and what is the volume that is willing to sell. And for all of those buyers and all of those sellers, what are the price at which they are willing to transact? And the way that tends to manifest on a stock chart is here's the price of a share right now.
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Renaissance Technologies
But that's not actually what's going on under the surface. It's a whole bunch of buyers and sellers who have different willingness to pay and have different amounts that they're trying to buy or sell.
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Renaissance Technologies
I mean, either one of those numbers is shooting the freaking lights out. Assuming that this is not a crazy high risk strategy that they executed and it'll completely fall apart under different market conditions. Like if this is an actual repeatable strategy that produces the numbers you just said, Unbelievable. World changing.
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Renaissance Technologies
So the numbers you quoted me, the gross and the net sounded quite different. Talk to me about the fees in Cary.
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Renaissance Technologies
And so the pitch they're making to the investor base is like, if you believe that we should be able to massively outperform the market doing quantitative trading, well, we're going to need a lot of fees to do that. And so the investors basically took the deal if they thought about it enough. Yeah. Okay, so that's the fees.
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Renaissance Technologies
On the performance, that 20 or 25%, it's just not actually that far above market, if it's above market at all. What you're seeing is a high fee, normal-ish performance fee fund at this point in time.
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Renaissance Technologies
So it's now the Jim Simons show in New York with Strauss building the engineering systems and Axe, I think, still had a small stake.
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Renaissance Technologies
Which I think he probably would say that thousands of times the rest of his life. I think so.
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Renaissance Technologies
This is way more fun than teaching. And listeners, I imagine this is probably the point where you're starting to get confused and saying, there are so many people in this story. I think we're on eight or nine. We just keep introducing more people. And that is the story of Renaissance. It is not this singular, clean narrative.
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Renaissance Technologies
It is a very complex reality of a whole bunch of different people that came in and out at different eras where the firm was trying different things and eventually became phenomenally successful with a very particular approach. But while they were figuring it out along the way, it took a lot of people.
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Renaissance Technologies
And we haven't even introduced the two people who would become the co-CEOs of this company for 20 years. Yes. Yeah.
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Renaissance Technologies
Welcome to Season 14, Episode 3 of Acquired, the podcast about great companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts. They say, David, that as an investor, you can't beat the market or time the market, that you're better off indexing and dollar cost averaging rather than trying to be an active stock picker.
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Renaissance Technologies
Three packs of merits a day. Unbelievable. Although I think he quit later in life, but he definitely chain smoked the better part of the first, call it 75 years or something.
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Renaissance Technologies
And we should say the years of modest performance are behind them. From every single year forward, they shoot the lights out. From 1990 onward, they never lose money. And on a gross basis, they never even do less than 30%. It's working. It's going. The whole rest of the story is about hold on, keep the machine working, and we're on the train.
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Renaissance Technologies
And the performance fees on this are $7 million, $13 million, $52 million. The free cash flow flowing to partners here is certainly becoming real, too.
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Renaissance Technologies
Right. The computer model spits out, we should go buy this huge amount of something at this price. They go to do it. They can only buy 10, 20, 30 percent of the amount they want at that price. And then suddenly the price is very different.
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Renaissance Technologies
Right. There's so many buyers and sellers every day showing up to trade so many different companies at such high velocity. It's almost this honeypot for Renaissance's systems. This is sort of their moment. This is what they were built for. And it's kind of funny that they've just been in kid glove land the whole time with these thinly traded markets with minimal data.
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Renaissance Technologies
Yeah. And it's interesting that you talk about speech recognition as the perfect fit for what they were doing. And you might say, why is that? Well, the actual work that goes into speech recognition, natural language processing is kind of the same signal processing that Renaissance is doing to analyze the market.
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Renaissance Technologies
Right. Speech recognition is a hidden Markov process where the computer that's listening to the sounds to try to turn it into language doesn't actually know English, right? Obviously. But what it does know is when I hear this set of frequencies and tonalities and sounds, there's a limited set of likely things that could come after it. And in Greg's book, he greatly points out this perfect example.
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Renaissance Technologies
When I say apple, you might say pie. The probability that pi is going to be the next word following apple is significantly higher. And so these people who have spent their careers not only doing the math and the theoretical computer science behind speech recognition to help figure out and predict the next words that you have a narrow set of likely words to choose from.
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Renaissance Technologies
So when you're listening to those frequencies, you can say it's probably going to be one of these three rather than search the entire dictionary for any word that it could be to narrow the processing power. It's not only the theoretical side, but it's also people who have built those systems at IBM, like a real operational computer company.
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Renaissance Technologies
And the world that they're entering is just exploding in complexity and dimensionality. And when I say that, here's what I mean. The data that they are mining, that they're looking for, is this intraday tick data between every stock trading.
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Renaissance Technologies
So they're in this sort of trying to map the relationship between one stock and every other stock, not just at that moment in time, but every time before it and every time after it. They're also, once they do identify patterns, which this is key, the algorithms identify the patterns. It's not a human with a hunch saying, I think when... oil prices go up, the airline prices are going to get hit.
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Renaissance Technologies
It's computers doing machine learning to discover the patterns in the data. Then there's the second piece of, well, what trades do you actually put on to be profitable from... the probabilities that you just discovered, all these weights of relationships between all of these different companies. You're not just putting on one trade.
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Renaissance Technologies
You're putting on 10, 100, thousands of simultaneous trades, both to hedge, to be able to isolate some particular variable that you're looking for. Again, not you, but a computer is looking for. And you also need to do it in such specific bite sizes so that you don't move the market.
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Renaissance Technologies
So you're looking for a super multivariate, multidimensional problem, both on the data ingestion side and on the how do I actually react to it side. And all of this computation can't take a long time because you must act, you know, not in milliseconds. It's not a high frequency trading that's front running the market. That's not actually what they do.
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Renaissance Technologies
A lot of people think it is, but we'll get to that later. But they do need to act with reasonable quickness, probably on the order of minutes. So these need to be really efficient computer systems too.
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Renaissance Technologies
Yes. Important to tease out the difference between those two things.
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Renaissance Technologies
And just keep adding layers of complexity here. Keep adding new things to multiply by. Many of these are traded on multiple exchanges. So you might also be looking for pricing disparities on the same equity on different markets at different points in time. So there's just dimensions upon dimensions of things to analyze, correlate, and act upon.
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Renaissance Technologies
Right. But if you can nail it, it means that you can do interesting things like, hey, we don't have a lot of data on this particular market. But it looks a lot like something we do have data on. So if it's all part of the same model, we can kind of just apply all the learnings from this other thing onto this brand new thing that we're looking at with little data for the first time.
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Renaissance Technologies
And because we're putting it all in one model and no one else in the world is, we can discover patterns that no one else knows about.
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Renaissance Technologies
work that was happening by another team on another model they did have the cultural element where it was encouraged that you share your learnings but someone would have to take the time during their lunch break and go learn from you about those and then implement it in their version there's a lag and it may actually not get implemented yeah this is wholly unique and revolutionary
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Renaissance Technologies
Yep, this is great. The basic gist of Zeno's paradox is if you are always taking a quantity and dividing it by two, you will never hit zero. You will asymptotically approach zero, but you will never actually touch zero. You need to do addition or subtraction to do that. Division won't cut it.
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Renaissance Technologies
Yes. And before we talk about the impact of that, we want to thank our longtime friend of the show, Vanta, the leading trust management platform. Vanta, of course, automates your security reviews and compliance efforts.
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Renaissance Technologies
So frameworks like SOC 2, ISO 27001, GDPR, and HIPAA compliance and monitoring, which is quite topical if you are in the heavily regulated finance industry and you need a lot of security and compliance. Vanta takes care of these otherwise incredibly time and resource draining efforts for your organization and makes them fast and simple.
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Renaissance Technologies
Vanta takes care of all of it for you. No more spreadsheets, no fragmented tools, no manual reviews to cobble together your security and compliance requirements. It is one single software pane of glass, just like one model, that connects to all of your services via APIs and eliminates countless hours of work for your organization.
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Renaissance Technologies
There are now AI capabilities to make this even more powerful, and they even integrate with over 300 external tools. Plus, they let customers build private integrations with their internal systems.
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Renaissance Technologies
So whether you're a startup or a large enterprise and your company is ready to automate compliance and streamline security reviews like Vanta's 7,000 customers around the globe, and go back to making your beer taste better, head on over to vanta.com slash acquired and just tell them that Ben and David sent you.
Acquired
Renaissance Technologies
And thanks to friend of the show, Christina, Vanta's CEO, all Acquired listeners get $1,000 of free credit. Vanta.com slash acquired. So David, the equities machine.
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Renaissance Technologies
And yeah, just imagine the computers that you were using during 1994 and 1995. It is astonishing the level of computational complexity and coordination and results that they are pulling off, again, in real time, analyzing these markets with the technology that was available during those years.
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Renaissance Technologies
And so Jim, as a four-year-old, when he observes they need to go to the gas station to fill up the tank, he throws out the idea, well, let's just use only half the gas in the tank because then we'll still be able to, after that, only use half the gas in the tank. And, you know, the funny thing that doesn't occur to a four-year-old is, well, then we're just not going to get very far.
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Renaissance Technologies
Yep. And David, if you just kind of look at this and do the math, okay, so 94, their AUM was 276 million and they grew 93%. and then their AUM the next year was $462 million, and then they grew 52%. And their AUM the next year was $637 million. You kind of quickly get where I'm going here, which is, oh, they're scaling AUM not by bringing in new investors. Right, it's closed to new investors.
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Renaissance Technologies
It's all just compounding. This is the same capital that they had in 1993 that has gone from $122 million at the beginning of that year to 1999 being $1.5 billion.
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Renaissance Technologies
They grow the fund from $1.9 billion to $3.8 billion of asset center management. Again, purely by investing gains, not by getting any new investors. The year the tech bubble burst.
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Renaissance Technologies
And here you go. uncorrelated. They have their final stamp of approval right here of not only are we a money printing machine, we are a money printing machine in all environments, regardless of the state of the broad market. And David, as you said, volatility actually makes their algorithms work even better because what are they doing?
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Renaissance Technologies
They're looking for scenarios where the market's going to act erratically and they can take advantage of people making decisions that they shouldn't. And anytime any investors are under pressure, There's a little bit of edge that's going to accrue to a medallion that's saying, oh, okay, you're fear selling right now. Well, I can determine if you should be fear selling or not.
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Renaissance Technologies
And if I determine that you shouldn't be dumping that asset, I'm buying it from you.
Acquired
Renaissance Technologies
It's fascinating. It's such a good insight. That illustrates Jim as a leader right there.
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Renaissance Technologies
It is so true, though. I even find this about myself that I will naturally take the position of the foil to the person across from me. So if somebody is being pushy in some way, I'll find myself taking a position where if I pause and reflect, I'm like, I don't think I expected to take this position coming into this conversation.
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Renaissance Technologies
But, you know, you naturally want to sort of play the other side to balance out the person sitting across from you.
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Renaissance Technologies
Yeah. And Jim would go on to finish his undergrad at MIT in three years and get a master's in one year.
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Renaissance Technologies
And I think people grasp it intuitively. We've mentioned this concept a couple times this episode where, okay, great. It's amazing to have a fund that 25Xs or a year where you have 100% investment return or I bought Bitcoin yesterday and it doubled overnight. Does that make you one of the best investors in the world? We all intuitively know, no, it doesn't, because maybe that was a fluke.
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Renaissance Technologies
Maybe you're taking on an extreme amount of risk. And then the question is always adjusting for the risk that you're taking. Can you produce a superior return taking the risk into that account? And so you basically can provide value to investors as a fund manager in two ways. You can outperform the market, or you can be entirely uncorrelated with the market and get market returns.
Acquired
Renaissance Technologies
Or what you can do as rent tech is both. You can be uncorrelated and massively outperform, which is effectively the holy grail of money management.
Acquired
Renaissance Technologies
Exactly. So it's named after the economist William F. Sharp. It was pioneered in 1966. It is effectively the measure of a fund's performance relative to the risk-free rate. So if you performed at 15% that year and the risk-free rate was 3%, then your numerator is going to be 12%. And it is compared against the volatility or the standard deviation is technically what it is. But effectively...
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Renaissance Technologies
how volatile have you been the last X years? And typically it's looked at as a three-year sharp or a five-year sharp or a 10-year sharp. The sharp ratio represents the additional amount of return that an investor receives per unit of an increase in risk. And so, David, you're starting to throw out numbers. Low Sharpe ratios are bad.
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Renaissance Technologies
Negative Sharpe ratios are worse because that means you're underperforming the risk-free rate. High Sharpe ratios are good because it means that you're producing lots of returns and your variance or your standard deviation or your sort of risk is low. So in 1990, they had a sharp of 2.0, which was twice that of the S&P 500 benchmark. Awesome. Yep. Good. 1995 to 2000, sharp ratio of 2.5.
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Renaissance Technologies
Really starting to hum. Pretty unbelievable. Good. Where do I sign up to invest? At some point, they added foreign markets and achieved a sharp ratio of 6.3, which is double the best quant firms. This is a firm that has almost no chance of losing money, at least historically, and massively outperforms the market on an uncorrelated basis.
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Renaissance Technologies
There's two interesting ways to look at this. One, they're just trying to jack it up so high that they just purge their existing investors out, where they're saying, we're not going to kick anyone out yet, but we've been closed to new business for a long time now. You should see yourself out at some point.
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Renaissance Technologies
The other way to look at this, which I think is probably the right way to look at it, is investors are arbitragers. They see a mispricing, they come into the market, they fix that mispricing.
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Renaissance Technologies
So anytime that there's an opportunity to bring the way that a currency is trading on two different exchanges closer together, investors are serving their purpose of coming in, arbitraging that difference, taking a little bit of profit as a thank you, and then sort of fixing the market to make the market a true weighing machine, not a voting machine, but making it so that all prices reflect the value of what something is actually worth.
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Renaissance Technologies
And in some ways, that's what Renaissance is doing here to themselves or to their investors. They're coming in and saying, look, this is obscene. We so clearly outperformed the market. You're still going to take this deal even if we take more of this because there's just a mispricing here. This product should not be priced at 20%, 25% carry.
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Renaissance Technologies
This product should be priced at a much higher carried interest, and you're still going to love it.
Acquired
Renaissance Technologies
Totally. So I have to imagine it didn't go over well with the existing investors, but they just have so much leverage that what's going to happen?
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Renaissance Technologies
And not all alumni get to stay. There's select alumni that get grandfathered in.
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Renaissance Technologies
This is the problem that Warren Buffett talks about all the time and why he has to basically just increase his position in Apple rather than going and buying the next great family owned business. The things that move the needle for them are so big that that's really all they can do. And when you are big, you're going to move any market that you enter into.
Acquired
Renaissance Technologies
And the strategy that Rentech is employing right now, they're just deeming doesn't work at north of $5 billion. Yeah.
Acquired
Renaissance Technologies
Right. Which is, you know, what do you do with that information? You realize you have to add a few of your skills together to become the best at something. You have to be smart and something else.
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Renaissance Technologies
So what do they do? Well, time to start another fund. So they start the Renaissance Institutional Equities Fund. And there's a couple of things to add a little bit of context to really why they decide to do this. Well, the first one is sometimes there's just more profitable strategies than they had the capital to take advantage of in Medallion, but they weren't sure it would be on a durable basis.
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Renaissance Technologies
If they were sure that they could manage 10, 15, 20, 25 billion in Medallion all the time, then they would grow to that. But if just sometimes there's these strategies that appear, well, we don't want to commit to a much higher fund size and then not always have those strategies available. The other thing is that a lot of the times those strategies aren't really what Medallion is set up to do.
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Renaissance Technologies
They require longer hold times. And so there's a little bit of downside to that because these new strategies, the predictive abilities are less because they have to predict further into the future to understand what the exit prices will be on these longer term holds.
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Renaissance Technologies
But they still figure, hey, even though it's not quite our bread and butter with the short term stuff, we should be able to make some money doing it.
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Renaissance Technologies
That's not a great risk-adjusted return. And these guys are very used to sharp ratios that are far better than the S&P 500. Right.
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Renaissance Technologies
Right. And so that's basically what they come up with is, can we create something that's like an S&P 500 with a higher Sharpe ratio? Can we beat the market by a few percentage points or frankly even match the market each year with lower volatility than if they were buying an index fund? And you can see who this would be very attractive to.
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Renaissance Technologies
Pensions, large institutions, firms that want to compound at market or slightly above market rate but don't want to risk these massive drawdowns or frankly, just big volatility in general, should they need to pull the capital earlier. And the nice thing about being invested in a hedge fund versus a venture fund is you can do redemptions.
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Renaissance Technologies
Like if you look at the 13Fs, the SEC documents that the Renaissance Institutional Equities Fund files over time, it changes every quarter because there's new people putting money in, there's people doing redemption. So it's a pretty good product, or at least the theory behind it is a pretty good product of a lower risk, similar return thing to the S&P 500.
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Renaissance Technologies
Right. It's really funny. There's all these stories about how the marketing documents literally say, this is not the Medallion Fund. We don't promise returns like the Medallion Fund. In fact, we're not charging for it like the Medallion Fund. You know, David, you said that the fees and carry on Medallion went up to, what, $544,000. Well, on the institutional fund, the fees are 1 in 10.
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Renaissance Technologies
But people did not perceive that. People were very excited. It's a renaissance product. It's the same analysts. They're using all their fancy computers. I'm sure we're going to get this crazy outperformance. And at the end of the day, it is an extremely different vehicle.
Acquired
Renaissance Technologies
Correct. Has it served its purpose? Yeah. But is it Medallion? No. It's not special in the way that Medallion is special. Yes. A couple other funny things on the institutional fund. So I spent a bunch of time scrolling through 13Fs over the last decade from the Medallion filings, and they're all from, I think they have two institutional funds.
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Renaissance Technologies
So the funniest thing is they file these 13 Fs. And David and I are very used to looking at the 13 Fs of friends of the show who run hedge funds, who we've had on as guests, or perhaps really just any investor where you want to see like, or what are they buying and selling this quarter? And usually you see 15, 25, maybe 50 different names on there.
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Renaissance Technologies
Well, the 13F for Renaissance has 4,300 stocks in these tiny little chunks. And there's a little bit of persistence quarter to quarter. For example, weirdly, Novo Nordisk has been one of their biggest holdings. Biggest, I say, at like 1% to 2%. That's their biggest position for several quarters in a row. Hey, they've been listening to a choir. That's right. That's one of the signals in the model.
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Renaissance Technologies
You kind of get the sense from looking at these filings that these things were flying all over the place, and this was just the moment in time where they decided to take a snapshot and put it on a piece of paper. And even though this is the end-of-quarter filing of what their ownership was, if you had taken it a day or a week earlier, it could look completely different.
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Renaissance Technologies
And frankly, it just looks a lot like the S&P 500. Like when you look at as of November 23, so 11 of the 12 months of the year had happened, they were up 8.6%. Okay, that sounds like an index type return.
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Renaissance Technologies
You look at the first four months of 2020, right after the crazy dip from the pandemic, they were down 10.4%, less than the broader market, but they still were sort of a mirror of the broader market. So I think the RIEF, their institutional fund, yes, it works as expected. No, it's not Medallion.
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Renaissance Technologies
By the way, this is exactly the same thing as Jeff Bezos in college realizing he wanted to be a theoretical physicist. He met some of the extreme brainpower people that would go on to become the best theoretical physicist in the world. And he said, I'm smart, but I'm not that smart. And so switch to computer science.
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Renaissance Technologies
And if it were standing on its own, there's zero chance that we would be covering the organization behind it on Acquired.
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Renaissance Technologies
And so this really does illustrate where do they make their money from, who is on the other side of these trades. It's people acting emotionally. They have effectively these really robust models that are highly unemotional, that are making these super intricate multi-security bets.
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Renaissance Technologies
And they are putting on exactly the right set of trades to achieve the risk and exposure that the system wants them to have. And who is on the other side of those trades? It's panic sellers. It's dentists. It's hedge funds who don't trust their computer systems and are like, ah, crap, we got to just take risk off, even though it's a negative expected value move for us.
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Renaissance Technologies
They're basically trading against human nature. And importantly, in this business versus every other business that we cover here on Acquired or most other businesses, this is truly zero-sum.
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Renaissance Technologies
It's not like they're here in an industry that's a growth industry and lots of competitors can take different approaches, but the whole pie is growing so much that I don't care if, no, you're fighting over a fixed pie here. I'm trading against someone else. I win, they lose.
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Renaissance Technologies
Yeah, but I think the important thing is, can you and your adversary both benefit? And I think in this case, you and your counterparty, the person you're trading against, yes, you have two different objective outcomes. Like, can I get a penny over on Warren Buffett by managing to take him on this one trade? Sure. But his strategy is such that that is irrelevant.
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Renaissance Technologies
Right. They gained confidence that they had enough profitable trades they could make that they could raise the capacity without dampening returns. Yes. And perhaps they could have done it earlier and they just didn't have the confidence that it would work at larger size. But I bet they're very good at knowing how large can our strategy work up to before it starts having diminishing returns.
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Renaissance Technologies
They say there's no persistence of returns for hedge funds, that this year's big winner can be next year's big loser, and that nobody gets huge outperformance without taking huge risk.
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Renaissance Technologies
It's amazing. And we weren't able to tell. There's some sources that report that they've grown from $10 billion in the last few years to being comfortable at a $15 billion fund size. And if so, that just means that they continue to find more profitable strategies within Medallion to keep those same unbelievable returns at larger sizes.
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Renaissance Technologies
That is a lot of money. Also, David Rosenthal, good spreadsheet work on this. You have not done a spreadsheet for an episode in a while, so I admire your work on this one.
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Renaissance Technologies
Yeah, Henry Laufer and other folks are also huge donors, approximately to the same tune as what Bob Mercer is on the right.
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Renaissance Technologies
Especially once people realized he was the through line through Breitbart, Cambridge Analytica, the Trump election, and Brexit.
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Renaissance Technologies
Ultimately, the thing that surprised me the most is how these people all still work together despite having about the most opposite political beliefs you could possibly have. Yeah, understatement of the century. And all being extremely influential and active in those political systems. Yes, Bob Mercer is no longer the CEO of Renaissance Technologies or the co-CEO. He still works there.
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Renaissance Technologies
He's still associated. They all still speak highly of each other. It's unexpected. Yeah.
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Renaissance Technologies
Like everything with Renaissance, it works a little bit different than the rest of the world.
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Renaissance Technologies
Yeah, that's a good point. The whole code base is completely visible.
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Renaissance Technologies
So why is that different than if I roll some of my compensation into a multi-strategy hedge fund that I work at? Don't I love other teams creating high performance also?
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Renaissance Technologies
Oh, yes. This is a big thing. You intend to have a job after that job at most places most of the time. So you care about credit and you care about smashing the pinata and then going elsewhere or building reputation and then going elsewhere. Most of the people at Rentech are not going to have another job.
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Renaissance Technologies
Yeah, I just got LinkedIn premium and you can see median tenure. And it's crazy. There's only like three, 400 employees at Renaissance. And the median tenure, at least as reported by LinkedIn, is like 14 years. Yes.
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Renaissance Technologies
And lest you think that it's like a capital-based thing, no, the institutional funds have gotten big. They peaked at over $100 billion, but they're currently between $60 and $70 billion that they manage on top of the $10 or $15 that's in the Medallion Fund.
Acquired
Renaissance Technologies
Yep. They put right on their website, there are 90 PhDs in mathematics, physics, computer science, and related fields. The About page has these 10 kind of random bullet points, and that's one of them.
Acquired
Renaissance Technologies
Totally. And since Renaissance doesn't recruit from finance jobs... it's kind of unlikely that you know someone else in finance. You came out of a science-related field. You now work in East Setauket, Long Island, which has, it's like 10,000 people or something or less that live there. So you're in this little town. You're not actually going into the city that often.
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Renaissance Technologies
And if you are, it's, again, not to grab drinks with other finance people. So even if you didn't have a many-page non-compete and a lifetime NDA, You're very unlikely to be in the social circles. You're just not getting exposed. Exactly.
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Renaissance Technologies
Have you seen the pictures online? Yeah. If you look up Renaissance Technologies at Google and you go and look at the photos on campus, it's a little courtyard and winding walking path and woods all around it, tennis courts.
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Renaissance Technologies
So it's not like a prop shop or like proprietary, it's just one pot of money. It's literally a GPLP, even though the GPs and the LPs are the same people.
Acquired
Renaissance Technologies
Right. They've already kicked out most of the LPs, if not all. So why are they raising the carry?
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Renaissance Technologies
Yes. It's always a funny argument. It's like, who are you paying the fees to? Right. So I was like, what is happening here?
Acquired
Renaissance Technologies
That's crazy. So it really doesn't take more than a few years before you're set for life.
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Renaissance Technologies
Right. It's funny. I think it's a good insight that it's structured like a university department tenure. Yeah. Well, I just kept asking myself, why?
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Renaissance Technologies
And I actually think it's kind of genius. Yeah, it's more elegant than it's all one person's money and they're deciding to bonus out the current team every year and just give them enough money to make sure you retain them.
Acquired
Renaissance Technologies
Yeah, so essentially, David, the real magic is they've got one fund, it's Evergreen. And when you start at the firm, you're only getting sort of paid the carry amount. But over time, you become a meaningful investor in the firm, and you sort of shift to that 51%, you're kind of the LP. And then over time, you eventually graduate out entirely, and you're only an LP. And so you're right.
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Renaissance Technologies
It's a value transfer mechanism from the old guard to the new guard in a way that is clear, well understood, probably tax advantaged versus just doing, I'm the owner and I'm giving everyone arbitrary bonuses.
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Renaissance Technologies
Yep. I think that's right. Okay, there's a few other parts of the story that we skipped along the way because there was no real good place to put them in. But these are objectively fascinating historical events that are totally worth knowing about. And the first one is called basket options. So the year is 2002. Rentech has 13 years of knowing that they basically have a machine that prints money.
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Renaissance Technologies
So what should you do when you have a machine that prints money? Leverage. Now, there are all sorts of restrictions around firms like this and how much leverage they can take on. You can't just go and say, I'm going to borrow $100 for every dollar of equity capital that I have in here.
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Renaissance Technologies
So you need to sort of get clever to borrow a whole bunch of money from banks or from any lender to basically juice your returns. If, again, you have a money printing machine that's reliable, most people don't. Most people probably shouldn't take leverage because they're just as likely to blow the whole thing up as they are to be successful. So, basket options.
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Renaissance Technologies
I am going to read directly from the man who solved the market because Greg Zuckerman just put it perfectly. Basket options are financial instruments whose values are pegged to the performance of a specific basket of stocks. While most options are based on an individual stock or a financial instrument, basket options are linked to a group of shares.
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Renaissance Technologies
It's honestly crazy that this group of people took this type of risk.
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Renaissance Technologies
If these underlying stocks rise, the value of the option goes up. It's like owning the shares without actually doing so. Indeed, the banks who, of course, loaned the money, who put the money in the basket option, were legal owners of the shares in the basket. But for all intents and purposes, they were Medallion's property. So this is very clever.
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Renaissance Technologies
Medallion saying, well, the way we're going to lever up is there's a basket. We have an option to purchase that basket. Most of the capital in that basket is actually the bank's capital. But the bank has hired us to trade the options in the basket. And then after a year, Medallion when long-term capital gains tax kicks in, we have the option to buy that basket.
Acquired
Renaissance Technologies
So anyway, all day, Medallion's computer sent automated instructions to the banks, sometimes in order a minute or even a second. The options gave Medallion the ability to borrow significantly more than it otherwise would be allowed to. Competitors generally had about $7 of financial instruments for every dollar of cash.
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Renaissance Technologies
By contrast, Medallion's option strategy allowed it to have $12.50 worth of financial instruments for every dollar of cash, making it easier to trounce rivals, assuming they could keep finding profitable trades. When Medallion spied an especially juicy opportunity, it could boost leverage, holding close to $20 of asset for every dollar of cash.
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Renaissance Technologies
In 2002, Medallion managed over $5 billion, but it controlled over $60 billion of investment positions. David, this exposes something we haven't shared yet on the episode, which is it's not just that they could find $5 billion worth of profitable trades. It's that they want to deliver the crap out of $5 billion and find $60 billion of profitable trades to make.
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Renaissance Technologies
And basket options gave them a legal way to have an incredible amount of leverage in a way that they felt safe about.
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Renaissance Technologies
Yeah. So a big piece of this playbook that we didn't talk about is leverage. But every quant fund does leverage. And so Renaissance was just more clever than everyone else.
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Renaissance Technologies
Right. I mean, you could imagine, let's say it wasn't they were right 50.25% of the time, but they were right 50.0001% of the time, they would need to do a ton of trades in order to generate enough profits. So that's why you need, you know, $60 billion of cash to actually execute the strategy to produce the returns that they were looking for.
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Renaissance Technologies
on $5 billion of equity. Anyway, there's a second chapter to this, which is it's all well and good that this is how they get a bunch of leverage. That's one piece of it. The other piece is they thought this was a remarkably tax-efficient vehicle. The way that they were filing their taxes said, oh, sure, there's stuff in that basket.
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Renaissance Technologies
But the thing that we actually own is an option to buy that basket or sell that basket. And we only exercise that once every 13 months or so. I don't know the exact number, but something like that over a year. And so therefore, we're buying something, we're holding it for a year, we're selling it.
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Renaissance Technologies
Oh, of course, there's millions and millions of trades going on inside the basket, but we don't own that basket. The banks do. We're just advising them. You can kind of see the logic here. Over time, eventually in 2021, the IRS said, no, you made all those trades. That was not a completely separate entity. And so you guys owed $6.8 billion in taxes that you didn't pay.
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Renaissance Technologies
You're going to need to pay that with interest, with penalties. And by the way, Jim Simons, we're going to want you and the other few partners to really bear the load of that. And they did. So for Simons alone, he paid $670 million to the IRS in back taxes for this basket option strategy that turned out not to be a long-term capital gain.
Acquired
Renaissance Technologies
All right. So numbers on the business today, and then we will dive into power and playbook. So today we've talked about Medallion, $10 or $15 billion, depending on who you ask. Historically, it was more like $5 or $10 billion. The institutional fund is about $60 to $70 billion, and at one point was $100 billion. The total carry generated, David, you said is $60 billion.
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Renaissance Technologies
Forbes estimates that Jim Simons alone is worth about $30 billion today, which kind of pencils with a bunch of other stats over the years that he owned about half of Renaissance. The returns, obviously, the Medallion Fund generated approximately 66% annualized from 1988 to 2020 after those fees was about 39%. Wild.
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Renaissance Technologies
So an interesting thing to understand, I ran a hypothetical scenario of how much money do you think Renaissance the business makes a year in revenue? And so the institutional fund, let's call it 10% on 60 billion of assets. So that's 600 million from fees and 600 million from performance. So $1.2 billion a year in revenue to the firm from the institutional side of the business.
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Renaissance Technologies
Because I always ask myself the question, does that actually matter? They did all this work to stand up the institutional side. Who cares? Well, let's say Medallion does their average 66% gross on $15 billion. That is $750 million in fees and $4.3 billion on performance. Yeah. So a total of $5 billion from Medallion and $1.2 billion from the institutional side of the business.
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Renaissance Technologies
Now, of course, the employees are the investors in Medallion. So you could just argue it's actually silly to cut them up. But I don't know. It's a $7, $8, $9 billion revenue business. Right.
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Renaissance Technologies
Yes. Yeah. But it's kind of interesting just to compare it against other companies to have this in the back of your head. This is a $7, $8 billion a year revenue business.
Acquired
Renaissance Technologies
Totally. That was another thing I wanted to talk about. The fact that they do, let's say, Medallion alone. So they have $750 million in fees. I don't think they come close to $750 million a year in expenses, but they are running who knows what infrastructure, some kind of supercomputing cluster. What does it cost to run one Amazon data center? I mean, it's, I think, much smaller scale.
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Renaissance Technologies
I don't know. I mean, you're talking about a lot of data here. Yeah, it says right on their website, they have 50,000 computer cores with 150 gigabits per second of global connectivity and a research database that grows by more than 40 terabytes a day. That's a lot of data. Right.
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Renaissance Technologies
I don't think so. They're certainly not losing money on the fees, but there are actual hard costs to this business. Right.
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Renaissance Technologies
That feels like it's right. If you're someone who has done a data center build out before or has any way to sort of back into what the costs of Medallion's operating expenses are on the compute and data and network side, we would love to hear from you. Hello at acquired.fm. Okay, power? Power. This is a fun one.
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Renaissance Technologies
Yeah, so listeners who are new to the show, this is Hamilton Helmer's framework from the book Seven Powers. What is it that enables a business to achieve persistent differential returns to be more profitable than their closest competitor on a sustainable basis? And the seven are counter-positioning, scale economies, switching costs, network economies, process power, branding, and cornered resource.
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Renaissance Technologies
And David... My question to you to open this section is specifically about Rentech's lifelong non-competes. That feels like a big reason that they maintain their competitive advantage. And I'm curious if you agree with that, what would you put that under?
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Renaissance Technologies
Yep. I think that's right. I also had my biggest one being process power. You actually can develop intricate knowledge of how a system works and then build processes around that that are hard to replicate elsewhere. I think these systems have been layered over time also, where anyone who's come into the firm in the last five years doesn't know how it works start to finish.
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Renaissance Technologies
I didn't ask anyone to verify that, but it's over 10 million lines of code. And the level of complexity of the system of when it's putting on trades, what trades it's putting on, why, the speed at which they need to happen, I actually don't think anyone holds the whole model in their head. And so I think there's process power just because it's 30 plus years of complexity that's been built up.
Acquired
Renaissance Technologies
I am going to argue that the data is a cornered resource. I don't know for sure about the model, maybe. I mean, I guess that's the same thing as saying the knowledge of what the 10 million lines of code does, that's the model. But I actually think the fact that they have clean data and they've been creating systems, like they have the best PhDs in the world thinking about data cleaning.
Acquired
Renaissance Technologies
Which is so interesting to think about because at that point in time, there was such an advantage to just being there. This wasn't even the trading floor, but information is all so manual and all so relationship-driven in the markets that there was basically no way to be in on the action unless you were physically there in on the action.
Acquired
Renaissance Technologies
That's not a sexy job. And yet they have probably the treasure trove of historical market data in the best format that nobody else has. That's an actual cornered resource. I have a couple nuances on this.
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Renaissance Technologies
Right. There's one particular relationship between types of equities that they've just been exploiting and no one can figure out except them.
Acquired
Renaissance Technologies
Right. Don't look at the relationship between soybean futures and GM. Just don't do it.
Acquired
Renaissance Technologies
So that would be an argument then that the people actually could, with five people left, they probably could go recreate it and all they would need is the data.
Acquired
Renaissance Technologies
I bet the data is, though. Let's say you've been working there for 10 years. You don't know how the 1955 Soybean Futures data ended up in the database. Even if you're used to using that data and you're able to go recreate the model elsewhere, you don't know how it originally found its way in.
Acquired
Renaissance Technologies
And people are looking for alt data everywhere. The Bridgewaters of the world are paying gobs of money for things that you would never dream could possibly have an effect on the stock market. And yet they're paying millions or tens of millions or hundreds of millions of dollars for it.
Acquired
Renaissance Technologies
Oh, yes, there's totally, there's diseconomies of scale. Your strategies stop working when you get too much AUM.
Acquired
Renaissance Technologies
Although, well, they do have some very well-established relationships with electronic brokerages and different players in the trade execution chain. I think they have very good trade execution and very fast market data. Their ability to pull data out of the market is very high quality. Do you think it's actually better than their competitors, though? I don't know.
Acquired
Renaissance Technologies
That's probably not the secret sauce. Yeah, I don't think so. It's the table stakes.
Acquired
Renaissance Technologies
The fee stream on the institutional fund may entirely belong to branding. Yes. But I think there's a lot of public equity firms and a lot of hedge funds that have a lot of branding power that have, on average, market returns with decent Sharpe ratios and are able to raise because they've built a brand.
Acquired
Renaissance Technologies
Tell me about your counter positioning. Who is being counter positioned in what way?
Acquired
Renaissance Technologies
Well, David, it turns out they were wrong. Today, listeners, we tell the story of the best-performing investment firm in history, Renaissance Technologies, or Rentech. Their 30-year track record managing billions of dollars has better returns than anyone you have ever heard of, including Berkshire Hathaway, Bridgewater, George Soros, Peter Lynch, or anyone else. So why haven't you heard of them?
Acquired
Renaissance Technologies
Right. even though the dollars would continue to rise because they get fee dollars from more money in the door, they are incentivized in a unique way that makes it so they're not willing to trade the dampener on performance to get those dollars.
Acquired
Renaissance Technologies
Oh, we keep going round and round that axle. I loosely buy the counterpositioning thing. I just think the answer is disgustingly simple and kind of annoying here, which is they're just better than everyone else at this particular type of math and machine learning, and they've been doing it for longer, so they're just going to keep beating you.
Acquired
Renaissance Technologies
I mean, honest to God, it could just be that the culture is set up in a way that continues to attract the right people and incentivize them in a sort of fake altruistic way. Like, this is just a fun place to do my work. And yeah, the outcome is getting really rich, but I wouldn't go work at Citadel.
Acquired
Renaissance Technologies
For me, it is process power and cornered resource. Yeah. Okay. I buy that. And a thing that's not captured in Seven Powers is tactical, like execution. The whole point of Seven Powers is strategy is different than tactics. And I think legitimately, Rentech may just have persistently been able to out-execute their competitors. There's part of it that's just like, they're smarter than you. Yeah.
Acquired
Renaissance Technologies
And there's remnant knowledge. Like if you started building a machine learning system in 19-whatever it was- 64, you're going to be really good at machine learning today.
Acquired
Renaissance Technologies
And the people that you've been spending time with for the last 15 years, learning all of your historical knowledge and working in your systems are also going to be better at machine learning than probably the other people who are out in the world learning it from people that just got inspired to start learning machine learning based on the new hotness. So learnings compound is my answer.
Acquired
Renaissance Technologies
Okay. Playbook. So in addition to the three-part David Rosenthal tapestry that you have woven... I have nothing more to add. There are a handful of things that I think are worth hitting. So the first one is signal processing is signal processing is signal processing. They, by not caring... about the underlying assets.
Acquired
Renaissance Technologies
They literally don't trade on fundamentals, except in the institutional fund when they trade on fundamentals a little bit. They use price-to-earnings ratios and stuff like that in the institutional fund, which is kind of funny because that's a completely different skill set. But if you just look at Medallion, It's all just abstract numbers.
Acquired
Renaissance Technologies
You don't actually have to care about what underlies those numbers. You just have to look for, whether it's linear regression or any of the fancier stuff that they do, just relationships between data. And once you reduce it to that, it is so brilliant that they can just recruit from any field.
Acquired
Renaissance Technologies
It's not relevant how someone has done sophisticated signal processing in the past, whether it's being an astronomer and trying to denoise a quote-unquote photo of a star super far away, or whether they've tried to do natural language processing. It's just signal.
Acquired
Renaissance Technologies
It's so funny. It's a whole bunch of people who are in the investment business, none of which are investors. Yes. Another one that you can decide if this fits or not. I was thinking a lot about complex adaptive systems. It's always been on my mind since we had the NZS Capital guys on a few years ago and read their work and the Santa Fe Institute's work on this.
Acquired
Renaissance Technologies
In a complex adaptive system, it's really difficult to actually understand how one thing affects everything else. Because the idea is the relationships are so combinatorially complex that you can't deterministically nail down this one thing as the cause of that other thing. It's the butterfly flapping its wings. But there are relationships between entities that...
Acquired
Renaissance Technologies
you can't understand or see on the surface. Do you remember way back when we did our second NVIDIA episode, I opened with the idea that when I was a kid, I always used to look at fire and think like, if you actually knew the composition of the atoms in the wood and you actually knew the way the wind was blowing and you actually knew that, like all the, could you actually model the fire?
Acquired
Renaissance Technologies
And when I was a kid and you always just assume no, but actually the answer is yes. Yeah. this is a known thing of what will happen when you light this log on fire for the next three hours and can you see exactly the flames. I think Rentech has basically... They haven't figured that out for the market. They can't predict the future. But if they have a 50.01% chance of being correct...
Acquired
Renaissance Technologies
then they can sort of take a complex adaptive system and say, we don't really care that it's a complex adaptive system.
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Renaissance Technologies
Our models understand enough about the relationships between all these entities that we're just going to run the simulation a bunch of times, and we're going to be profitable enough from all the little pennies that we're collecting on all the little coin flips where we have a slight edge over and over and over and over again.
Acquired
Renaissance Technologies
They're sort of the closest in the world to being able to actually predict how the complex adaptive system of the market will work. Now, I don't think they can back out to it. No person could explain it, but I think their computers can.
Acquired
Renaissance Technologies
But it does know it has a slight edge. And so it should trade on it, even though it can't explain why. Yes. Speaking of models, I've been trying to nail down an answer to this question. Do you think Rentech was the birthplace of machine learning?
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Renaissance Technologies
Right. It's like the principles certainly came out of the same math community that spawned machine learning, but is what rent tech has figured out over the last couple of decades. in Google's Gemini model and in ChatGP. No, it's not because they don't contribute any research back.
Acquired
Renaissance Technologies
It may be the case that actually Rentech has beat everyone else to the punch and they have a strong AI or something that is actually much more sophisticated than all the AI we have out in the world today. And they've just chosen that they'd rather keep it locked up and captive and make a
Acquired
Renaissance Technologies
I mean, it could just be the case that Renaissance is just taking in as much unstructured data as it possibly can, and they sort of were just a decade or two ahead of everyone else in realizing that you can have unstructured, unlabeled data, and if you have enough of it, you can make it, in the case of an LLM, say things that sound right or sound true, or in the case of these trades, be right more than 50% of the time.
Acquired
Renaissance Technologies
Right. Make trades that sound right. right, they figured out this big unsupervised learning thing before anybody else all the way up until last year when the AI moment happened.
Acquired
Renaissance Technologies
To illustrate this point, it's quite interesting. Peter Brown's academic advisor was Jeffrey Hinton.
Acquired
Renaissance Technologies
The other person, just for people who are like, why are you saying that? To make it super explicit, the other person whose academic advisor was Jeffrey Hinton is Ilya Sutskiver, who is the co-founder of OpenAI. I mean, many years later, but still.
Acquired
Renaissance Technologies
Yep. Okay, another big one is this concept that you should trade on a secret that others are not trading on. So on the face of it, it seems obvious. Of course, I should come up with some strategy to trade on that other people aren't trading on. But I said a couple of words there, which is, of course, I should come up with... And therein lies the fallacy.
Acquired
Renaissance Technologies
I think most investment firms try to get their ideas out of people and then do an incredibly rigorous amount of data analysis to figure out if they should put those trades on or not. I could be wrong, but I do not think modern rent tech does that. I think all of their investment ideas come from data and come from signal processing.
Acquired
Renaissance Technologies
And so therefore, you are going to put trades on that make no intuitive sense. And so when you're putting trades on that are profitable and make no intuitive sense, you aren't going to have competitors.
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Renaissance Technologies
If you find a relationship between two things that a human could never come up with or dream of those relationships, and we're saying two, end things, you know, 10 things, 20 things, 100 things, and in various different weights at various different timescales, that is a killer recipe to exploit a secret that no one else knows and be able to beat other people in the market.
Acquired
Renaissance Technologies
Yes. And to be super illustrative, because I think your natural tendency is like, oh, I can understand why these two things would be related. The relationship may not be what you figure. For example, there could be two things that always move together, Tesla stock and wheat futures. And you might try to, because humans are storytellers, concoct some story in your head of why those move together.
Acquired
Renaissance Technologies
And if you believe it, then you might decide there's some date where they should stop moving together. Well, it could very well be that some other big hedge fund just owns both of those things. And when they rebalance, it causes those assets to move together. But you would never think of that.
Acquired
Renaissance Technologies
you would think these things have a direct relationship with each other, not just that there's liquidity in the market from both of them at the same time because someone else owns both of them. So I think what Rentech sort of admitted is we have no idea why anything is actually connected, but it doesn't matter.
Acquired
Renaissance Technologies
Okay. My next one is brought to you by a friend of the show, Brett Harrison, who has worked in the quant trading industry for a long time and shared an idea that he has with us, which is that there's basically this two-by-two matrix where You have on the one axis, fast and slow in terms of trade execution. And on the Y axis, you have smart versus obvious.
Acquired
Renaissance Technologies
Right, it's the obvious trades. And the high level point is all quant funds are not high frequency trading firms and vice versa. And this is something that I didn't know not coming from this industry and now makes total sense to me. I think I thought they were the same thing, but- Fast and obvious is your classic high-frequency trader. They're front-running trades.
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Renaissance Technologies
They're locating in a data center that's really near the, you know, this is Flash Boys. Or they've got a microwave line between New Jersey and Chicago, and they're trying to arb the difference between two markets. You need to have the fastest connectivity in the world to pull this off. Yeah, this is Jane Street. Yes. There's fast and smart, which you kind of don't need to be both.
Acquired
Renaissance Technologies
You don't need the fastest connectivity in the world and the most clever trades to put on. So people kind of tend to pick a lane that they're either a high frequency trader or they're trying to make the smartest, you know, most non-obvious trades possible. And that, of course, leads us to Medallion, which is in the slow and smart quadrant.
Acquired
Renaissance Technologies
All the machine learning system discovered the relationships in the data. So there's a huge amount of compute. The non-obvious trades. Exactly. That goes into finding the non-obvious trades. But then they're actually made reasonably slowly. They still have to happen within seconds or minutes. But the advantage isn't that they're high frequency, the way that all the Flash Boys stuff is.
Acquired
Renaissance Technologies
When I read this, I couldn't believe that this was Jim Simon's first business venture. Like, it's so random, but it really is emblematic of just how much he was thrill-seeking and just looking for anything that was unexpected, different, exciting. He just gets bored fast.
Acquired
Renaissance Technologies
Greg has a quote in his book, they hold thousands of long and short positions at any given time, and their holding period ranges from one to two days or one to two weeks. They make between 150,000 and 300,000 trades a day, but much of that activity entailed buying or selling in small chunks to avoid impacting market prices rather than profiting by stepping in front of other investors.
Acquired
Renaissance Technologies
Yeah, they can make it so that they don't move the market and you don't know who is acting or when. And this is because in the early days, they weren't good at this. And people basically intercepted the trades that they were making and were front-running them.
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Renaissance Technologies
And they had to adapt and develop these clever systems to make it so you don't know who's buying and you don't know in what quantities and you don't know if they're going to keep buying.
Acquired
Renaissance Technologies
My last one before we get into value creation, value capture is that this is a terrifying business to be in. The amount of controls and risk models that you need and kill switches are just so important. What if the software has a bug? Is it possible to make a ton of unprofitable trades in a matter of minutes and lose it all?
Acquired
Renaissance Technologies
You know, that wasn't possible in the old world where you're calling your broker. That totally is possible here. And it happened. Yeah. And while it's never happened to Rentech, there was a company called Knight Capital in 2012 that lost $460 million in a single day. There was a bug in their process to deploy the new code. And basically what happened, it was a simple flag error.
Acquired
Renaissance Technologies
a misinterpretation of setting a bit from zero to one that caused this infinite loop to run, where once a certain trade happened, it was supposed to flip the bit. It flipped a different bit. The systems were not looking at the same location and memory for the same bit. And so it basically thought it was never flipped.
Acquired
Renaissance Technologies
This infinite loop ran four million trade executions in 45 minutes, and there wasn't the appropriate kill switches built in, and they basically watched it all to just drain out, and there was nothing they could do.
Acquired
Renaissance Technologies
Yes. Well, I don't know if it's the whole portfolio, but it was enough that they lost a huge amount of the LP capital, and then they were a publicly traded firm. Overnight, their equity traded down 75%, and then someone stepped in and bought them.
Acquired
Holiday Special 2023
I think the most interesting businesses or businesses that sort of tickle me are Costco and Visa because there's a purity to them. Costco's is the purity of the way that the puzzle pieces fit together. in a way that is just artful. It's almost like a discovery of laws of physics, the way that Saul Price and Jim Senegal and the rest of the crew have sort of built that business over the years.
Acquired
Holiday Special 2023
It's just beautiful. It's like watching a ballet. I think that we likened it to that in the episode. Visa, on the other hand, is like the best operating leverage business. I mean, they have over 50% net income margins. They seem like they're locked in forever, you know, for better or for worse, as we described on the episode.
Acquired
Holiday Special 2023
But if you wouldn't ask someone like, what is the best at scale business model? It's probably Visa to do this sort of least work for the most free cash flow. You look at Costco. Not that much free cash flow, crap ton of work. It's almost like the complete opposite over in Visa land. Total opposites.
Acquired
Holiday Special 2023
But you asked me what my favorite episode was, and my favorite episode was LVMH because it was so not on my radar at all and not something that I valued at all. And I scorned luxury before doing the research, and I didn't understand any of the history. And now I feel like a whole new world has been opened to me of understanding brand and value.
Acquired
Holiday Special 2023
But the minority of the episodes that we did in 2023 were tech companies, which is a very fascinating evolution to me based on where Acquired started analyzing technology acquisitions that actually went well. But of course, we will keep doing deep episodes on tech companies since we are nerds, and that's where we've spent our whole careers so far.
Acquired
Holiday Special 2023
I do not. I do not. I only own one thing from one luxury brand in all my possessions. And actually, that item is not made by LVMH.
Acquired
Holiday Special 2023
Yes, absolutely. And I should say, I own probably a lot of things that are LVMH, but none that I would consider luxury. I don't mean like a Louis Vuitton suitcase. I mean like I have some Woodinville whiskey in the closet that LVMH somehow over the last few years came to own Woodinville whiskey.
Acquired
Holiday Special 2023
I think there's a lot of those sorts of things where I've bought a lot of things at duty-free shoppers or...
Acquired
Holiday Special 2023
I'm curious, would you describe anything that you own that way, other than things that are obviously that way, other than some like Louis Vuitton suitcase that you have or something? I don't know what you have, but you've got some Rolexes.
Acquired
Holiday Special 2023
Yep. I guess any jewelry would count as that. Oh, yeah. And these things may not be branded the way that we're talking about luxury branding, but like a diamond engagement ring is inherently not premium, but luxury.
Acquired
Holiday Special 2023
Which, by the way, I think is actually the best way to think about diamonds. I spent some time recently looking into lab-grown versus mined diamonds, and there's sort of an interesting... I know we're on a diatribe here, but you asked me about my favorite episode, and LVMH came up, and here we are. So there is a fixed supply... of diamonds in the world.
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Holiday Special 2023
And there is a rate at which humans can mine them. So regardless of the intrinsic qualities of diamonds, it is a thing that can only come out at a certain volume. And largely they go through the GIA to be identified with a serial number and it actually gets laser etched microscopically onto the diamond.
Acquired
Holiday Special 2023
So these things are like, you know, verified that they came out of the ground and you know the year they were mined and you know where they were mined and all that stuff. Yeah.
Acquired
Holiday Special 2023
Totally. And the lab-grown diamonds are chemically identical, and it's a huge accomplishment of humankind that we've figured out how to do this. And on the one hand, they're identical. You look at them, you right-click, you download the JPEG, and these things are identical. But on the other hand... We are only going to get better, Moore's Law style, at creating lab-grown diamonds.
Acquired
Holiday Special 2023
And so they will asymptotically approach zero. Maybe not zero, but some number. Every year, presumably, they should get cheaper and cheaper and cheaper. Whereas for something where there's a known finite supply of them, like GIA-certified number-etched diamonds, there's a strong argument for that to hold its value, to the extent that you care about an engagement ring holding its value.
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Holiday Special 2023
So if you liked the programming and assembly language on air from NVIDIA, or I guess assembly language pseudocode, or our Qualcomm episode where we tried to describe how the CDMA protocol works, we're still here for you. We're just going to do a lot of LVMH, NFL, Visa, Costco, Nike, and mixed in there. So what are we doing here today?
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Holiday Special 2023
much longer or much more durably and truly the best way to articulate it is well if you believe that this jpeg has value but that other jpeg doesn't have value and that other jpeg is the exact same bitmap as this one like why do you believe that oh i see it's got an on-chain location and it's literally the exact same thing with diamonds all right we're gonna have to do a debiers episode at some point because this warrants a full acquired deep dive i think yep i agree
Acquired
Holiday Special 2023
Hmm. Which may not come out in the final edit. I gotta be honest, if you go back and look, listeners, you may not hear it. I could hear it in the first edit. And certainly while we're recording here live, I mean, the number of things that we end up cutting is massive. But David, I completely agree with you. Until this year, I don't think I would have agreed with the statement...
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Holiday Special 2023
that the quality of our episodes is governed just as much by our headspace the day of recording as it is by the quality of the research that we did. And now I believe that that is immensely the case.
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Holiday Special 2023
The flow of the episode, the excitement about the topic, the clarity of the points that we're trying to make, it's about treating it like Sunday if you're an NFL player and having a game day routine in the way that teaches you how to perform at your highest. Yeah.
Acquired
Holiday Special 2023
Well, David and I are going to bring you good tidings, good cheer, hopefully, and keep you company. Yes.
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Holiday Special 2023
All right, I wasn't going to share this, but now that we're on the topic. So at the top of my show notes document for every episode, there's two things written. One is... what should the listener take away from this? And I have some bullet points of make sure you nail these points and are clear about these things.
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Holiday Special 2023
And the other one is a one-liner that I have written that says, have fun, laugh, you're good at this. Mantras are powerful.
Acquired
Holiday Special 2023
Well, that's exactly the headspace that I get into that causes episodes to be bad. When we restart an episode, and listeners, we restarted this episode. We got 15 minutes in and we were like, eh, it feels forced. And we restarted it. I can guarantee you that the quality of this episode is already better. But yeah, that's the sort of negative self-talk that I start getting into. Who are you?
Acquired
Holiday Special 2023
What are your credentials? What qualification? Are you sure you looked under every rock? Those are the things that start ripping me apart if I start thinking them moments before recording.
Acquired
Holiday Special 2023
It is funny how doing the episodes and studying these people in these businesses teaches us things that we internalize in our own business. I would not have been able to describe Acquired as a luxury brand or a luxury product prior to LVMH. And luxury is probably still not right. It's probably, I don't know if it's ultra premium or if it's just like a prestige brand.
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Holiday Special 2023
Ooh, you're feeling very festive. Yes, we are here to keep you company on your long drives or flights or workouts or house cleaning or whatever over the holidays. On our agenda today is a recap of Acquired this year, both the state of the franchise from the board of directors themselves.
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Holiday Special 2023
Yeah, scarcity is kind of the biggest one. And that's a thing where I was unable to understand what to do with our scarcity before studying LVMH. But then afterwards, I sort of came to the realization of, oh, we should embrace the fact that we only have the throughput to be able to do one episode a month. And rather than trying to figure out how to scale that,
Acquired
Holiday Special 2023
There is a very fair path to owning it and staying a boutique little shop that's you and I and Steven, our wonderful editor who worked with us on a contract basis. And this is the team. This is what we do. And we can only make so much. And if we make more, the quality drops or we have to scale in some way that feels unnatural to us. And that's okay.
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Holiday Special 2023
rather than every other person in the podcast ecosystem that we had spoken with up until that point was, well, you have to figure out how do you layer that second show, or how do you introduce more hosts, or how do you get research assistance so you don't have to do that? And the boutiquiness is one of our greatest strengths, and it was something I think I was trying to run away from for a while.
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Holiday Special 2023
And now people ask, what's going to be different for Acquired when you go full-time? You're doing way more episodes. No, absolutely not. We're going to make the same number or fewer of even better episodes.
Acquired
Holiday Special 2023
And we happen to be in a particular business that scales extremely elegantly. with a word of mouth go to market and a product that is infinitely replicatable and a revenue stream that scales nearly in lockstep with the size of the distribution. And I say nearly is important. We should talk about nearly later.
Acquired
Holiday Special 2023
And I think I wore it last year, too. I feel like you did. Yeah, we were right behind me. I wish we were doing it again this year, but it seems prudent to not have a father of a toddler hopping on an airplane and then sit in a confined space with me for five hours right now.
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Holiday Special 2023
But we do have a business model that lets you grow the business indefinitely without compromising at all. And like if you are an LVMH, you do have to go build another factory in order to go serve more customers. There's not sort of that infinite scaling that can happen by the virtue of the Internet and media on the Internet.
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Holiday Special 2023
We will also be giving you some new tidbits on our favorite episodes behind each one of them, why we picked them, how they came to be, what listeners helped us select, that sort of thing. We're going to talk about how we see Acquired fitting into the broader media landscape, how our views about the show and the stuff that we cover have changed over time, what's in store for Acquired in 2024.
Acquired
Holiday Special 2023
Yeah. It's the ones where we didn't put too much pressure on ourselves that I think came out the best.
Acquired
Holiday Special 2023
Yep. All right. Well, David, before we move out of talking about our season episodes this year to the interviews that we did, this is the perfect time to talk about one of our favorite companies, Statsig.
Acquired
Holiday Special 2023
This is where we get lucky in being very choosy with our sponsors. Sometimes these things happen to them while we're mid-flight. Yes.
Acquired
Holiday Special 2023
Yes. And it's funny, I hadn't thought to make this comparison until right now. So you said 1.7 million events a second. If you look at the Visa numbers, I just pulled up my Visa notes, Visa does 8,600 transactions per second. So that's what, 200 times as much throughput at Statsig than at Visa?
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Holiday Special 2023
new carve outs, and answering listener questions from the Slack. And then at the end of the episode, we're going to share a little bit about David and my investing lives and how those will be changing in 2024. As David, you and I are going to get to do much more of our investing together.
Acquired
Holiday Special 2023
Yep. We can't wait to see where they're going in 2024. So if your team wants the best platform in the world for making data-driven product decisions, you should reach out. Statsig.com slash acquired. And as always, there is special white glove onboarding for all acquired listeners. Our huge thanks to Statsig.
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Holiday Special 2023
So in January, David and I looked at each other and we said, we should stop doing specials.
Acquired
Holiday Special 2023
Yep. And the reasons that we decided we wanted to discontinue them were, as David, you said, they're almost always an interview. And what is an interview? An interview is an episode where you have a person who is not a part of... your enterprise, something you control, come on the show and say something that they very likely are going to say somewhere else too.
Acquired
Holiday Special 2023
So by their very inherent value of it, it is not an end of one product. Whereas when we make a Costco episode, that's an end of one product. And so no matter how good you do the interview, you are starting on your back foot in terms of can you create this diamond, this unique thing in the world the way that we can on a season episode.
Acquired
Holiday Special 2023
Yep. And you can see it in the numbers. Every time we would do one, even with the biggest names, you know, these people where you're like, I imagine that really moved the needle for you. No, it didn't. Every single time we did a special, it had less downloads than the most recent season episode we did. Which is crazy. Never once was a special our biggest episode ever.
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Holiday Special 2023
Which is, when you make a unique product, that is the thing that people are here for. You have a format and a product that people want, so make that. Don't go do something that's one click over in the commodity spectrum. And we tried all sorts of things. We tried to do the ACQ sessions where we really like, you know, tried to make it feel more casual and we'd pour wine.
Acquired
Holiday Special 2023
And I think all the different specials we did and sessions we did and collabs we did, there's something to be learned from to bring into mainstream acquired.
Acquired
Holiday Special 2023
Yes. So here's where the lesson we learned around don't clutch your pearls too tightly. We swore them off. We said, you know what? We're done.
Acquired
Holiday Special 2023
This is going to be a great year going forward where once a month we have this very pure thing that we do that's release a LVMH style episode. And then we have the opportunity to fly to Stockholm and interview Daniel Ek about Spotify. Yeah. And then we get the opportunity to interview the CEO of the then $80 billion market cap Uber.
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Holiday Special 2023
And we would call each other and say, we said we weren't going to do this, so what do we do?
Acquired
Holiday Special 2023
Right. We are getting far too precious. And I think our preciousness has made Acquired what it is. I believe that. But you can get too precious. ACQ2 is awesome, but it has one-tenth the distribution of Acquired.
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Holiday Special 2023
We will. But first, listeners, I mentioned in one quick line on the Charlie interview and have not said anything on any social media or anything like that since, but I am a parent. I'm joining David on the parenting journey with approximately a one-month-old here at the Gilbert household.
Acquired
Holiday Special 2023
And that's great because it lets us play around with stuff and it lets us do follow-ups to episodes where we don't feel like every single person that listened to this big episode would want to listen to the follow-up and we get to talk about up-and-coming companies. It's a lower-stakes... thing for us to do an ACQ2 episode, which is great to have as a part of our ecosystem.
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Holiday Special 2023
But it was really dumb, and I'm really glad we didn't go through with it to put the CEOs of Spotify and Uber there. And so the year went on. We had the opportunity to then interview Jensen as he's becoming the most highlighted CEO of one of the top five most important companies in the entire world.
Acquired
Holiday Special 2023
And then, of course, we got to spend time with Charlie Munger, gosh, a month and a half before he passed away, which is... I feel so unbelievably lucky. Yeah. Well, we'll come back to Charlie. But it turns out with interviews, the answer is we still don't do interviews. We don't do specials. Acquired is what it is. Except for, you know, Charlie and Jensen.
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Holiday Special 2023
Right. This is something that my dad would always say to me when I was younger. He's like, I legitimately don't think I'm the smartest person, but I do think I'm the hardest working. And whether it was in school or whether in his career, The answer was grind for more hours and become the most knowledgeable to make the most informed decisions. And I kind of feel that way as an interviewer.
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Holiday Special 2023
I'm not Andrew Ross Sorkin, you know, plain vanilla walking into a pretty new subject. He's going to be just a lights out interviewer. But the place where I can be one of the best in the world is if I have done hundreds and hundreds and hundreds of hours of research on a topic, you know, we can start with Jensen on the Riva 128. And that's not how other interviews are going to start. Right.
Acquired
Holiday Special 2023
Right. You can't know a story as well as the protagonist knows the story, but try to get as close as you can.
Acquired
Holiday Special 2023
Yep. So you might be wondering, Charlie and Margaret was by far our biggest episode ever. Jensen was bigger than any previous season episode. Dara and Daniel were right around the ballpark of what our season episodes were doing at that point in time when we had interviewed them. We sort of figured out there is a style and a... type of person where the episodes behave as N of 1 episodes.
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Holiday Special 2023
The sort of decay curves look similarly over time of people seeking them out in an evergreen way. You know, we have seen just as many people 92 days later, which is what today is, referencing the Jensen interview that we would see referencing the Nike episode 92 Days Later. These things, if we do them right, stay just as evergreen.
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Holiday Special 2023
And so, you know, we want to stay as precious as possible about them. And so what does that mean? Like, how can we change Acquired's business to make it so that the answer is we don't do interviews on the main show, unless, of course, it's an interview that we need to do on the main show. And
Acquired
Holiday Special 2023
After some early conversations we've had with some of the sponsors for next year, we just sell them differently. I think that was a key insight for us. We used to do, in a season, six main episodes and six specials. And we would sell them both and say, here's what you'll get in this period of time. And that's still how we sell the sponsorships for the season.
Acquired
Holiday Special 2023
You know that it's going to happen over six months. You know it's going to be about once a month. we'll give you a heads up as soon as we know the topic that we're going to be covering. And we would try to do the same thing with specials. And that drove us to create specials, which is entirely the wrong thing to do. Right.
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Holiday Special 2023
If you're sitting around waiting serendipitously for a Charlie Munger or a Jensen interview to happen, which is basically what we've decided the strategy is for guests.
Acquired
Holiday Special 2023
so stay tuned for how this will work in practice but the way we're thinking about it for next year and some early conversations seems like this is going to work is you get the next three interviews we promise you they're going to be world class and we have no idea when they will come out and they're probably going to come out next year but we can't tell you much beyond that and i think that to the extent that we find and continue to find great partners who want to work with us as sponsors in that way that works really well to make sure that the content bar is where it needs to be the audience is happy
Acquired
Holiday Special 2023
I think that's right. I think any words that I would say about what it's been like so far are words that other people tried to use to describe it to me, and I found them largely meaningless. I mean, I could say the same things that everyone else always says. And there have been some amazing things written. I think I read the Paul Graham article on kids.
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Holiday Special 2023
and that we can frankly blow it out of the water the way that we do on the season episodes for our sponsors. So what does that mean for ACQ 2? I should say ACQ 2 next year is going to be so much better because there's all this inbound that we get for Acquired that we've decided doesn't make sense on Acquired. And what that means is we are getting crazy good guests for ACQ 2.
Acquired
Holiday Special 2023
So it would feel silly not to point people toward that when I know it's coming next year. So yeah, I'm excited about that too.
Acquired
Holiday Special 2023
Well, David, I think that's the right question. And I think the answer is sort of obvious. You just have to look at our episode list. I mean, who are the people that we feel like we've studied the way that we studied Jensen, but we haven't had a conversation with yet? I mean, it's Bernard Arnault. It's Morris Chang. It's Phil Knight. It's Bob Iger.
Acquired
Holiday Special 2023
I think there are people whose stories we know, but we don't know. And those would make for special interviews.
Acquired
Holiday Special 2023
We'll go to the Long Pond Studios. We can meet you, you know, anywhere at a posh restaurant around New York City.
Acquired
Holiday Special 2023
I feel like Andrew sends us more research material than like Andrew is like a source for every episode. We're not just going to write his name in the sources, but like 10 sources from every episode are things that Andrew texts us. Like, have you found this? Have you found that? Have you found that?
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Holiday Special 2023
Not to mention, he's got like a 20-company-long request list with a reason for why each of those companies should be acquired episodes, kind of making the appeal. And so he always celebrates when we pick one off of his list.
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Holiday Special 2023
I read the fourth trimester Wait But Why piece. I've read... You read the Michael Lewis book, right? The Michael Lewis book. Yeah, that was good. But like... I don't know, the words kind of bounce off you. You're like, well, why would that be fun? Why would that be rewarding? Why would waking up at 3 a.m. to change a diaper ensue the, you know, screaming? Like, why is that?
Acquired
Holiday Special 2023
There's a strangeness that comes, and if anybody who is listening to this is like a long-form journalist, like a New Yorker writer or something like that, or has written a book on a company, or maybe even like a PhD research dissertation, you sort of know this feeling where even though something happened in real life, you've done enough research about it where it feels like a story to you. Yes.
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Holiday Special 2023
And at some point, you meet the protagonist, right? And you're like, oh, right. You're like a person in addition to being the main character of a story that I know very well. And that in Berkshire's case, there's a cult following of millions and millions of people who all know the story, who can all cite passages from, you know, scripture. It is. It's like a religion.
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Holiday Special 2023
Charlie is a person, a wonderful person, in addition to being this character.
Acquired
Holiday Special 2023
Yeah. The serenity of the moment, I think, hit me the most when there was a question we asked Charlie and he responded, I'm not interested in being any more of a guru than I already am. Yes.
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Holiday Special 2023
And you could sort of see that even though it's worked so well for him to get so much of his wisdom to the masses, and he has, he and Warren both have been these incredible teachers their whole, you know, last 50 plus years. in addition to their main job of being great investors, capital allocators, operators, they're sort of these educators on the side.
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Holiday Special 2023
But that education and universe that they've created has blown up to the point where I think it weighs a little bit heavy, at least on Charlie. It's almost like the burden he carries to get his wisdom out is that he has to sort of be treated as a guru or a character in a story rather than just a person.
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Holiday Special 2023
It's almost like the Batman thing. What's the line from Batman Begins where he's talking about the sort of frailness of being a person, and then when he becomes Batman, he says, as a symbol, I can be incorruptible, I can be everlasting, something elemental. It's that sort of idea. Totally.
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Holiday Special 2023
But it's actually Morgan Housel put it to me in a really lovely way where he just said, what greater gift could you have than helping another human, another member in your family who's new to the world in their most intense time of need? And, you know, that intense time of need comes a dozen or two dozen times a day, but the sort of privilege of being able to
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Holiday Special 2023
One other behind-the-scenes point to make, which I think listeners might find interesting on these four, Daniel, Dara, Jensen, and Charlie, they all were these massive lead-time interviews. They don't just get coordinated a couple weeks before. And the story behind each of them was Charlie was a... maybe six-month thing. It was once we started digging into Costco.
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Holiday Special 2023
Andrew suggested, hey, what if you interview Charlie for a follow-up? Jensen, I think we originally reached out to NVIDIA before we started our NVIDIA Part 1 research almost two years ago and said, hey, would Jensen... And this was a very different time for Acquired.
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Holiday Special 2023
We thought the dream is to interview Jensen, not the dream is to go learn as much as we can about NVIDIA and tell the story ourselves. And we reached out and said, can we interview Jensen? And even though we had a good friend of the show who was able to introduce us to someone on their executive team, we got a canned response of, it's very busy, this sort of thing.
Acquired
Holiday Special 2023
And it wasn't until, like, we did the work, and then we made part one and part two, where then it caught NVIDIA's attention. And the folks there were like, geez, we should do something together. And it still took another year to figure out exactly what the thing was to do together and when. And same thing with Dara at Uber. We met...
Acquired
Holiday Special 2023
uh actually friend of the show brad gerstner had his investor day for altimeter and i met dara there and i think it took probably nine months after that to figure out a good time to you know on the earnings calendar on the pr calendar when it could actually make sense to the interview the way it happened with daniel was we said uh daniel was the quickest what did we say like next time we're in stockholm we'd love to do it and he was like oh yeah next time you're here let's do it
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Holiday Special 2023
So we happened to find ourselves in Stockholm, which... That actually was a highlight for me this year. I know it was only three days, David, but that crazy... I mean, we had three beautiful days in May in Stockholm. What a gorgeous, gorgeous city. The run... We did a couple runs around the city while we were there and just made sure to kind of take it all in.
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Holiday Special 2023
Yep. By the way, I just want to say, I know a lot of people are lambasting Spotify's podcasting strategy. I think people are entirely missing the forest through the trees on calling that a failure. Completely agree. I think Spotify, in their music business... has gotten to scale and has no potential to create a high operating leverage business.
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Holiday Special 2023
soothe someone when they're experiencing that sort of intense emotion. You know, they may not be fully formed, but babies are people too.
Acquired
Holiday Special 2023
They're always going to be giving the same percentage of the profits to the record labels who have an unbelievable amount of bargaining power over them. So the question is, what do you do next? Audiobooks is a good bet. Podcasting is a good bet. Something where you can eventually gain operating leverage. And the fact that they did the huge Rogan deal, they bought The Ringer, they bought Gimlet,
Acquired
Holiday Special 2023
Well, if you look at the dollars and cents today, you're like, geez, they've spent a lot of money, but they haven't generated a lot of profit from podcasting yet. They totally bootstrapped their way to become the scale player in podcasting.
Acquired
Holiday Special 2023
So to the extent that there is a big pile of money waiting to be the scale player in podcasting, they're well positioned to make it given the half billion dollars or three quarters of a billion dollars that they spent on content. They now have bootstrapped to scale.
Acquired
Holiday Special 2023
No, it is our largest single player, but I don't think it's over 50% yet. But one stat that's interesting is from Spotify wrapped for podcasters. They make a wrapped to give to you in addition to the ones to distribute to your audience is that 76% of the people who listen to Spotify acquired on Spotify found us this year. That is crazy on platform growth.
Acquired
Holiday Special 2023
Yeah. So, I mean, in many ways, I'm predisposed to think podcasting is more interesting and important in the world than it is. But if you sort of write off the idea that Spotify will ever make podcasts decent margins in music. They needed to make another bet. This feels like a pretty good bet. This and audiobooks.
Acquired
Holiday Special 2023
Yep. If you can figure out how to make being the scale player translate into lots of profits, which no one has done yet.
Acquired
Holiday Special 2023
Apple, yeah. Which, as we've talked about before, we are immensely grateful for because it enabled this open free podcasting medium that we have today, which is to our advantage. Yes. All right, so David, that was the content this year. And before we shift over to the state of the franchise here at Acquired, we want to tell you listeners about our friends at Crusoe.
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Holiday Special 2023
Yep, Crusoe's strategy is super straightforward. Make the best AI cloud solution for customers using the best available GPU hardware on the market and invest heavily in an optimized cloud software stack.
Acquired
Holiday Special 2023
Yep. As an AI company, Crusoe, like Acquired, has had a great 2023 with pretty incredible growth. So to wrap up the year, they and we wanted to highlight one of their customers that started building on Crusoe the beginning of this year just as a baby startup and closed a $102 million Series A. Series A!
Acquired
Holiday Special 2023
Series A from a whole bunch of great venture investors at Kleiner, Emergence, Lux, and NVIDIA itself called Together AI.
Acquired
Holiday Special 2023
Yep. There are a bunch more stories like this coming. So if you, your company, or your portfolio companies could use lower cost and more performant infrastructure for your AI workloads, check out crusocloud.com slash acquired. That's C-R-U-S-O-E cloud.com slash acquired, or click the link in the show notes. Okay, David, let's talk about acquired the franchise.
Acquired
Holiday Special 2023
Yeah. So my thinking on this has gotten simpler, which is basically I am extremely open to fully saturating the niche of smart people who care about what makes businesses work and great technologies successful and durable in the world. And I think last year, again, I was being too precious about like, I don't think it's good for our lives if we become too famous.
Acquired
Holiday Special 2023
I mean, a byproduct of podcasting is you're not on video that often. So you actually do get to stay less famous than YouTubers or less visually recognizable, which is good. I just kind of generally believe recognizability is fun until you get to a certain level and then it's bad and then you can't put the genie back in the bottle and your life's horrible. And I would like to not become that.
Acquired
Holiday Special 2023
But if we can keep doubling and doubling, doubling, and it turns out the set of people who like studying business history and being thoughtful about it and can write us with little tidbits saying, oh, I happen to think about it this other way and have thoughtful responses and want to be a part of the acquired community. If that turns out to be 5 million people or 10 million people, great.
Acquired
Holiday Special 2023
You and I are so just fired up to double down on Acquired, and it feels very fun to be going all in on it together. And... On the one hand, it feels like it's been a long time coming. On the other hand, Acquired has been such a slow burn over the last eight plus years that there was not like an obvious moment to do it.
Acquired
Holiday Special 2023
That's only goodness. But I think my view on growth is we have a natural governor to our growth, which is
Acquired
Holiday Special 2023
the universe of that set of people is a fixed number and i'm just not interested in discovering a second market outside of that so to the extent that we can stay true to making the stuff that we love to make and serving that group of people awesome and i just don't ever want to like you could say lower the bar or create some different product or whatever but to appeal to a different mass audience that part is not really interesting to me
Acquired
Holiday Special 2023
Right. And I'm not trying to be pretentious. I'm not saying, like, you must have thought about it as much as I have in order to be a part of that. No. No. I feel like this has been an eight-year journey for us. And for me, a 20-year journey of learning about what makes these technologies and these businesses become powerful forces in our world.
Acquired
Holiday Special 2023
Anyone who is anywhere on that journey, including far past you and I, David, on that journey, I would love to have a relationship with either two-way through the Slack or even if it's just one way through people listening to Acquired. So I'm not saying like, I just wanna appeal to the people who are like, ah, here's a gotcha on, there actually is an eighth power. It's not that.
Acquired
Holiday Special 2023
It's the curious, thoughtful people who are not in the YouTube comments of the Portia episode.
Acquired
Holiday Special 2023
So it was one of these moments where you sort of look back and you're like, whoa, how am I not spending all of my waking time and energy on this when, you know, it is something that is just, you know, it's our life's work. As our friend Patrick O'Shaughnessy likes to say about the types of entrepreneurs he's looking for, like, this is definitively our life's work.
Acquired
Holiday Special 2023
Nothing had algorithmically blown up and reached a lot of people quickly. The only way anybody had really heard of Acquired until this year was their friend told them. And that is always going to be a really high quality way to grow your audience. But if an audience grows quickly, it's like the masses just enter and you get who shows up.
Acquired
Holiday Special 2023
Yeah. Well, and last year, I think we were talking about, we were getting a little bit shaky about the impact on our business from growing the show because getting larger wasn't equating to growing the size of our revenue. And it also was creating problems for the classic sort of
Acquired
Holiday Special 2023
startup and growth stage companies that had been our longtime sponsors where we were going to them and saying okay the audience is four times bigger than when we worked with you two years ago let's have a conversation about what it should cost to sponsor the show it was just like an immovable object meeting an unstoppable force there just wasn't anything to be done and so we've had to get creative in figuring out what do we do to continue to grow the business and
Acquired
Holiday Special 2023
Well, it doesn't have to be commensurate with the audience, but the audience growing should make Acquired a more viable platform for larger sponsors, deeper partnerships, ways that we can sort of increase both the size of our business, but also like the durability and importance in the world of our business.
Acquired
Holiday Special 2023
Thank you for your precautions. Welcome to Season 13, Episode 5, the season finale and holiday special of Acquired, the podcast about great companies and the stories and playbooks behind them. I'm Ben Gilbert.
Acquired
Holiday Special 2023
Right. We should say the teams that have decided to partner with us from each of those companies have been longtime Acquired fans, and we've gotten to know over the course of years and years and years. And the answer has sort of always been, hey, we should do something together. And then we talk about it for a while, and then the answer is always kind of like,
Acquired
Holiday Special 2023
And it wasn't when we started and somewhere along the way, gradually, it just became that.
Acquired
Holiday Special 2023
okay, you're sort of this like little niche, maybe there's something to do. And now the conversation is very much like, oh, wow, you show up in the world in a big way with an important set of people. And you're now in this category that we can totally work with you as a durable partner that we want to like build this deeper relationship with. And especially now that we're in our eighth year,
Acquired
Holiday Special 2023
It's a very different thing to be partnering with Acquired than it was when we were in our third year. It's not like a scrappy startup thing. It's a trusted entity in the world.
Acquired
Holiday Special 2023
And the way it's going to work, I'm transitioning to a venture partner at PSL at Pioneer Square Labs here in Seattle. So still get to keep my board seats, which I think keeps me sharp for the show and stay a friend of the family there. So I'm excited to sort of change my role at PSL. But of course, all of my real time and energy going forward is acquired.
Acquired
Holiday Special 2023
Yep. And it's an intensely coordinated effort with a calendar that is already full by the time you're finishing 2023. 2024 is largely known. There's a whole set of events. There's a set of campaigns that are going to happen at different times. And these things are adaptable.
Acquired
Holiday Special 2023
But my gosh, the level of foresight and planning that we've gotten to work with from those teams has just been like a whole different animal than what we're used to. And we love the nimbleness of small companies, and that enables us to do special things together.
Acquired
Holiday Special 2023
And sort of our fun task for next year, which I'm excited to unveil some of the stuff we're doing, will be to bring that custom thing that we're able to do with these small companies and create native...
Acquired
Holiday Special 2023
content for the medium and do other collaborations with them as a company for example the way that we invest in our sponsors or the way that we speak at their conferences and things like that to bring that to like large fortune 500 enterprises and that's such an amazing dance like the way that these marketing organizations are able to figure out Okay, can we talk about this partner of ours?
Acquired
Holiday Special 2023
And in what way can we talk about it? And how much leeway can we give Ben and David to natively work in an acquired theme from six episodes ago and trust them that in this episode, it's going to come across right on air?
Acquired
Holiday Special 2023
It takes a very special marketing department to be able to behave the way that the Vantas and the modern treasuries and the vouchers of the world do while stewarding a 20, 30, 100 year brand. And a few other things we've got up our sleeve. I think the goal is to be able to continue to work with these sort of recent product market fit, you know, series B-ish companies that we've always worked with.
Acquired
Holiday Special 2023
So between the back catalog, between interviews, we will figure out ways that we can still work with those companies. Because frankly... those are the types of companies that David and I love using for Acquired. I mean, we're customers of Vouch and we use Modern Treasury. We like playing with it. We like following the founders on their journeys.
Acquired
Holiday Special 2023
We like having the founders on ACQ2 so we can kind of learn about how they're building their companies. We also like getting the exposure to be able to invest. So it's awesome to be able to build these really tight relationships with those companies, especially when they're founded. Like I just keep going back to
Acquired
Holiday Special 2023
Dimitri and his co-founders coming up to us at our very first live show after they had come out of YC and telling us about this tiny little modern treasury at the time. And you just look at the behemoth amount of money that they move now.
Acquired
Holiday Special 2023
There are dozens of companies in the acquired ecosystem that we have relationships with that we want to be able to continue to be a partner to and just figure out the right way to structure that.
Acquired
Holiday Special 2023
Yeah, David, what you're getting to here is now that we're both full-time on Acquired, we finally have the opportunity to do our investing together and then do it in a way that's uniquely Acquired and that is sort of native to Acquired.
Acquired
Holiday Special 2023
And so there's no big announcement or anything, but that's the thing to share with the Acquired community is I've been writing these little angel checks into probably 10-ish of our sponsors at this point and ACQ2 guests and companies we've gotten to know. And we're finally going to be able to kind of do that at scale and do it together in a way that
Acquired
Holiday Special 2023
We're not spending a lot of our time hearing early stage pitches or anything like that. But for companies that we already know well, David and I are going to join our investing forces and invest more in those growth stage market leading tech companies.
Acquired
Holiday Special 2023
more and together and specifically as a part of Acquired. I just have this funny thing that's happened so much over the last two, three years, which is a company is raising great up round from, you know, one of the best few investors in the world in technology companies and says, would you like an allocation? I can give you one or two or $10 million in this big growth round.
Acquired
Holiday Special 2023
And I, you know, write some little angel check and like, that's been great, but it's time to do more with that opportunity.
Acquired
Holiday Special 2023
Yep. It's time. So that's sort of the state of what we're thinking about for investing, which we'll put into action early next year, and sort of the direction that our sponsorships have been going to. And we should say, we're excited to welcome back for next season. In the third slot, friends of the show Pilot and Vanta are splitting slot number three.
Acquired
Holiday Special 2023
So first three episodes are going to be Vanta, second three are going to be Pilot. And... I think we figured out a nice balance to be able to work with Fortune 500s as sort of a scale platform and also to be in business both investing and on a sponsorship basis for their go-to-market with growth stage companies.
Acquired
Holiday Special 2023
Right. It's... what we're most excited about, but it's also, if you just think about the mongerism, you know, you show me the behavior and I'll show you the incentives, it's literally the thing that makes it all work. If you look at the acquired flywheel, it is produce unbelievably high-quality deep dives
Acquired
Holiday Special 2023
on these companies and try to create some of the deepest business content in the world in a very, very approachable, fun, conversational way and share the learning journey that we're on with everyone. And like you said a minute ago, we're really clear with each other. Like I feel like that mantra comes up on our phone call once a week or something. And it's like,
Acquired
Holiday Special 2023
the quality of the episodes is all that matters. And, you know, we just spent 10 minutes talking about how we're evolving the franchise and working with Fortune 500s and, you know, how we're going to be doing more investing together and all this stuff. The only thing that matters that drives all of it is quality of episodes.
Acquired
Holiday Special 2023
So we should say before we get too far in, this is not investment advice. This whole show, Dave and I may have investments in the companies we discuss in the show is for informational and entertainment purposes only. Somebody here has to follow the rules and keep us. I've got a nice script that's well built out in front of me. I also must apologize to listeners.
Acquired
Holiday Special 2023
And it's one of the largest categories of spend for most countries' GDPs in the world. Yeah.
Acquired
Holiday Special 2023
It turns out there's a lot of them out there. We often get the question, are you afraid you're going to run out of episodes to do? No, everywhere we look, there's like some new fascinating multi-generation business that you'd never expect could have thrived through all these times that they have and have five unique, amazing vignettes to tell through their whole history to today.
Acquired
Holiday Special 2023
Like, as long as we want to keep doing this, there will be fuel to keep doing it.
Acquired
Holiday Special 2023
We'll hit some big tech. We have to. It feels like a obligatory nod. We'll hit something in the sort of entertainment, gaming, streaming world. And we could keep naming categories, but one listener question that we got that I think is worth chatting about here is how do we handle current events? Because there are lots of episodes that would be very appealing to do.
Acquired
Holiday Special 2023
For example, the dozens of requests we got two weeks ago or three weeks ago for OpenAI after the boardroom drama. We very much have moved away from current events. And I think that is in part because of what we talked about earlier.
Acquired
Holiday Special 2023
that we want to create n of one content and the way to create the most possible commodity content is to try to cover the current news cycle that literally everyone else is covering concurrently i think that's a way to get completely drowned out in the noise create something that's not special and create something that even if you blow it out of the water has a shelf life in this world of about eight hours
Acquired
Holiday Special 2023
And so we have decided to move as far away from that as possible. And the other reason, I think, is a little bit our disposition, where, David, when you and I are looking at something brand new that's unfolding in real time, I think we've really started trusting our gut that there's probably more here than there seems to appear on the surface. And years ago, I don't think we felt that.
Acquired
Holiday Special 2023
I think we thought, Uber's going public? Cover Uber. Even three years ago, Airbnb has gone public. Cover Airbnb. And there was an acquired way to do it where most of the episode could actually focus on the last 10 years and only a little bit at the end was focused on the last few months. But the more current an event is, the less evergreen value there is. that it will have.
Acquired
Holiday Special 2023
I am coming in hot from podcaster paternity leave here. And if anything I say is completely incoherent, I am on pretty minimal sleep. So thank you for bearing with me.
Acquired
Holiday Special 2023
And the more likely it is that you could really blow it. Like, I feel super self-conscious that we interviewed Sam Bankman-Fried. And like, you know, we're not investigative journalists. We weren't going to spend the time to like try to unfold and dig up, hey, is this all legit? It's like Sequoia had just invested a huge amount of money.
Acquired
Holiday Special 2023
Like everyone and all the possible signals had validated this person in this company. It was seemingly enormously free cash flow positive.
Acquired
Holiday Special 2023
So the question becomes, what should you do? And what we are structurally well set up to do is these huge retrospectives where the story is written and the story is known, and it's about really synthesizing it and applying it to today's world, where...
Acquired
Holiday Special 2023
there is just no way that we are ever going to do the sort of investigative journalism and, frankly, like investment diligence, often with private information, that you need to do to get a real-time story right. It is structurally impossible for us, so swear it off. I think that's the answer.
Acquired
Holiday Special 2023
Yeah. To revisit the SBF interview in particular, I haven't listened to it in a long time. I do think we've generally had our wits about us enough to always sort of be question askers in terms of like, hey, this seems really crazy. How did that happen?
Acquired
Holiday Special 2023
And you and I have sort of never been the types to be like, everyone should be extremely excited about this, and we urge you to go get involved with this now. I always sort of chuckle when we say the not investment advice, but that's more my demeanor. I truly mean it. I was like, hey, I've done a certain amount of work on this. I'm going to tell you what I learned.
Acquired
Holiday Special 2023
And also, I am not recommending you act on this in any way ever. And I think that, fortunately, our disposition... especially among some of the crypto and Web3 mania, was a little bit more of that. But we've learned lessons from that. And those lessons are you get to choose the games you play, and we don't need to play the current mania's game.
Acquired
Holiday Special 2023
Thank you. And if we didn't have you, then we would just tell stories of old retailers and old oil companies that, you know, carry no risk associated with them.
Acquired
Holiday Special 2023
Yeah. Thank you. I'll take the compliment. And you do need both. You need someone who's staying attuned to like, maybe this is this new thing everyone is talking about is a breakthrough, interesting thing. And you also need the, hey, let's pay attention to history. And I think someone asked a question in the Slack, do you consider yourselves journalists?
Acquired
Holiday Special 2023
And I, if anything, because we've gotten the question, are you analysts? Are you journalists? We're certainly not reporters. But I think on that spectrum, we've shifted much more toward historians than journalists.
Acquired
Holiday Special 2023
I don't ever expect that we are going to get a story right about something in flight, but hopefully given, you know, a couple months to prepare, we can get the story right about something that's happened over a long period of time with a lot of perspectives where people are willing to share everything they sort of know since the hatchets are buried.
Acquired
Holiday Special 2023
And like, does anyone have the story right on what happened in the OpenAI boardroom right now? I don't think so. I don't think so either.
Acquired
Holiday Special 2023
It's also very nice because what it does is it puts most things in your too hard pile. Like the fact that your main job isn't to go pick early stage companies. Like when the whole world is your too hard pile because you need to research an acquired episode, only the no brainers end up actually grabbing your time. A hundred percent.
Acquired
Holiday Special 2023
No, I worked it backwards one time. I think it was like $500 to $1,000 or something. Actually, I should crunch that number. But there is a number you can figure out in year one since you know what our current numbers are. Yep. But small base. It was like small base, kind of small base, still pretty small base, you know.
Acquired
Holiday Special 2023
The no-brainers that don't take up weeks and weeks of your time to decide if you should do it or not are the ones that end up actually becoming the investments that you do. And especially when you can sort of take something you've learned from history and apply it to the present. I think that's the David Rosenthal sweet spot.
Acquired
Holiday Special 2023
It's funny. Marketing in particular, I think doing Acquired has made me such a more savvy marketer. Perhaps the most useful that I am in boardrooms now is being like a reality check on are you actually reaching people, A, in a medium that's going to convert to what you want them to do, and B, with a messaging that people will care about.
Acquired
Holiday Special 2023
Because most of the time, most people are creating lots and lots of copy and work product that nobody cares about at all. And that goes for podcasts and that goes for startups. And I think breaking through and creating something where people know, oh, I should pay attention to this. That's still so rare.
Acquired
Holiday Special 2023
Yeah, I am not actually a huge book gifter. I love the practice. I just never remember to do it. It's great that when people are able to do that. I think a huge one for me is Psychology of Money. There's a recency bias on it. And we mentioned Morgan Housel at the top of the show, good friend of the show, great, great human. I mean, truly, I massively changed the way that I personally invest.
Acquired
Holiday Special 2023
Yeah, me too. Based on that book and the way that I just think about spending my time and family and demeanor throughout the day. Another one is this book, and I haven't read it in probably 12, 14 years. It's called The Artist's Way by Julia Cameron. Oh, yeah. Tim Ferriss loves this book, right?
Acquired
Holiday Special 2023
Yeah, I read it as a part of a college class, a cool class at Ohio State called Personal Creativity and Innovation. And one of the mechanics in the book is called morning papers. And the rule is you must write three pages stream of consciousness before getting out of bed in the morning.
Acquired
Holiday Special 2023
and it is so cool because it flushes out all the crap from your head so that you can go and have a clean slate to start the day and you're not wasting your time processing you're not like wasting cpu cycles in your brain processing something and ruminating on something that you really just need to get out get on the page and then you can focus on other things or perhaps focus on that thing but at least now you have a little bit of clarity on it because you've written
Acquired
Holiday Special 2023
I should do it more often, but I think it's an amazing practice and kind of like a, I hate the phrase, but life hack that I remember feeling like it really worked for me while I was doing it. David, while you give your answer, I'm going to turn around and look at my bookshelf to find a third one.
Acquired
Holiday Special 2023
It's not like anything's randomly showing up to my house three times a day from Amazon right now.
Acquired
Holiday Special 2023
All right, that's awesome. I will watch my front doorstep. My third one is a classic, Thinking Fast and Slow by Kahneman and Tversky. It's just everything you think you know about the way your brain perceives the world and how you make decisions is wrong.
Acquired
Holiday Special 2023
And reading it doesn't make you get any better, but at least makes you aware of how wrong your decision-making is unless you pay unbelievably close attention and write down exactly why the decision is being made and look at all the data. And even then, you'll probably get it wrong.
Acquired
Holiday Special 2023
Awesome. Mine might be a pair of Nike shoes. So living in Seattle, it rains all winter, or at least it's wet all winter. And there's a particular pair. I'm going to look up what it actually is so that if you want to buy it, you can. Called the Nike Men's Pegasus 4 Gore-Tex. And the Gore-Tex is so good. It makes winter running possible.
Acquired
Holiday Special 2023
do that. Right. You were like, you should stop saying that because it's eventually going to not be true. Yeah, because it's about to end. Which is true. Eventually it will not be true.
Acquired
Holiday Special 2023
And they even have a few of the colorways that are not like totally insane so that you can kind of wear them as everyday sneakers. But I basically wear them all day, every day in the winter. And it makes me far less afraid to go out in the world because I don't like having wet feet.
Acquired
Holiday Special 2023
I love that. I actually don't have my own answer to this question. There is someone else that I know that has an answer to this question that I quite like, so I'm just going to recant their story, but I should go find some words to live by. A good friend of mine, his dad had a saying when he was growing up, that he would always remind his kids, just be kind.
Acquired
Holiday Special 2023
Hey, whatever the thing is, just be kind. Someone might be being a jerk to you, and they deserve some kind of repercussion, but you should just be kind, and certainly the world will figure out a way to deal with this person's action at some point. And the thing my friend did is at some point as his dad was getting older, he asked him to write down the motto on a piece of paper and sign it.
Acquired
Holiday Special 2023
Yeah, and the question is, how big is the addressable market for people who want to, in an audio-only medium, consume four-hour, essentially books, conversational audio books about business histories, often in kind of an esoteric way? And granted, you and I have gotten much better at becoming storytellers over time, but each one of those sort of concentric circles niches it down.
Acquired
Holiday Special 2023
And he went and got a tattoo on his back of Just Be Kind signed by his dad's name. And I love that.
Acquired
Holiday Special 2023
Yeah, I just think that's the coolest. I often remind myself of that, of there's almost nothing to be gained by me exuding anything but kindness in this moment. And it doesn't mean let someone roll all over you, but it does mean just always realize that it's kind of the Michelle Obama thing of when they go low, we go high. You going high is never going to hurt you in the long run.
Acquired
Holiday Special 2023
cultivating the relationship with my wife, hands down, 100%. And the second best is cultivating the relationship with you, which has led to so many things that have made my relationship with my wife and building a family possible. And there is no ifs, ands, or buts about that. The house I'm standing in is thanks to Acquired. The lifestyle I enjoy is 100% Acquired.
Acquired
Holiday Special 2023
The fact that I wander around all day listening to audiobooks, the thing that it's done to my demeanor and my personality, truly the life that myself and my family enjoy is because of what you and I have built, and thank you.
Acquired
Holiday Special 2023
And if you feel like it's not helpful, just switch therapists. You'll eventually find someone who's helpful for you.
Acquired
Holiday Special 2023
I eat a Starbucks spinach, feta, and cage-free egg white bite wrap every single day. And I have for years and years and years. And I actually go to Starbucks and buy them still in the package cold. I buy them like 10 at a time, and then I'll just make them every morning at home.
Acquired
Holiday Special 2023
I'm going to guess around 10 years ago. I mean, I think it really ramped like seven-ish years ago. So maybe 2000, 2500. Wow. Yeah, pretty much every day. Breakfast or lunch.
Acquired
Holiday Special 2023
In the last five years, what new belief, behavior, or habit has most improved your life?
Acquired
Holiday Special 2023
And I think you and I just thought that that addressable market was 100,000 people or something at first, but now we know it's at least half a million.
Acquired
Holiday Special 2023
Yep, I like that. And just being more aware of it. I think you have a good sense of that too. If somebody is a 1% huckster, I notice you get like physically uncomfortable and try to create distance between you and them. Yes.
Acquired
Holiday Special 2023
I think mine is a thing that I'm still working on, but the amount that I have done it has dramatically improved my life. Be more present. Be a better listener. The answer is almost always tune in more to the person that you're talking to and really understand them. And I think listen harder is usually the way to better understand what someone else around you wants.
Acquired
Holiday Special 2023
And it's often not what they're saying, it's what they're feeling. My therapist regularly uses the phrase, it's about the feelings, not the content. And if you can figure out how to be present, listen better and meet someone else at their feelings level and figure out how do I, you don't even have to make their feelings feel better because they might feel fine.
Acquired
Holiday Special 2023
But how do I tune into you emotionally and not try to just have a conversation about the content you're saying? You're much more likely to both have a positive outcome and have a better rest of your day.
Acquired
Holiday Special 2023
Oh man, let's see. Some advice I gave like three years ago that I really deeply believe in is harvest when everyone else is harvesting and build skills when there's no harvesting to be done. And in particular, this person had the opportunity to go work at, I think it was a big consulting thing and make good money first year.
Acquired
Holiday Special 2023
And they were thinking about doing that or working for a nonprofit as their first job because their heart was in the right place. They just wanted to do good-for-the-world work. And I was like, we're in a weird time where I don't know when it's going to end, but everyone's making stupid money right now. Just like, while there's harvesting to be done, go participate in that.
Acquired
Holiday Special 2023
And you should build the best foundation you can, but I promise you... there will be a time where this job opportunity is not available to you and you will look back at a few years of making a small salary in your first few years out of school and kind of wish that you had built a little bit more of a foundation because I just think this time is going to end.
Acquired
Holiday Special 2023
And like, it sort of flies in the face of be fearful when others are greedy and greedy when others are fearful.
Acquired
Holiday Special 2023
And be mindful that you're in this temporary moment, but when there's opportunity to harvest, harvest.
Acquired
Holiday Special 2023
Which at some point I do want to stop making, because I said last year on the show, like, at the holiday special, I don't think growth is inherently virtuous for us, for the goals of our business here. And yet I am the person who's sort of obsessively trying to compile the numbers and figure out, is it going to double again organically since we don't advertise or anything?
Acquired
Holiday Special 2023
Yeah. Rick and Paul are investors and capital allocators and great partners to the people that they work with. But even their demeanor in one-on-one conversations is that of a learner and a teacher. Yeah. So wonderful.
Acquired
Holiday Special 2023
Yep. People are underrated. Like, in my harvesting comment, it was interesting that what I did was to describe two job opportunities. I think there's another way to make decisions, which is surround yourself with, if you're an ambitious person, with the most intelligent person
Acquired
Holiday Special 2023
people you possibly can who are the closest to ground zero for your industry be where the interesting thing is with the people who are the best at it this is the mark andreason uh i totally go to denny's yes always go to denny's always go to denny's and they can't just be smart they have to be like unbelievably trustworthy people worthy of your time and partnership and that's the harder thing i think to suss out over time that's hard advice to give a college student yep
Acquired
Holiday Special 2023
I don't think they're at odds either, but your circle of opportunity gets smaller when you require more constraints, when you require both of them.
Acquired
Holiday Special 2023
Oh, man. David, there's a thing that you do that I'm so much worse at, which is you never feel compelled to respond. You never feel like somebody else can give you a task to do. Yeah. It's not my most flattering quality. But it's the thing that allows you to give energy to the people in your life that matter the most to you. That's the thing that I've long been jealous of.
Acquired
Holiday Special 2023
I'm very okay with somebody emails me a form email that I've never heard of them or their name. It's very easy to archive that. It's harder when it's somebody that I met three years ago that I really enjoyed getting coffee with.
Acquired
Holiday Special 2023
And now I have eight of those in my inbox and I just, I want to at least say I don't have the bandwidth for this right now, but like you do those eight times and suddenly two hours have gone by. It's actually taken away some of your, your energy and your life force. Exactly. Yeah. And you do it to me sometimes. So like, I sort of know like what it feels like to be on the receiving end of it.
Acquired
Holiday Special 2023
But you have a remarkable tendency to truly wake up every morning and say, what actually is important and needs to get done? And you don't do the other stuff, and it's kind of okay if that has a little bit of collateral damage.
Acquired
Holiday Special 2023
And so do I want to be known for the Ben Gilbert chart? I don't really think so because it's actually antithetical to how I think about what we do. But I do make the chart. I do put a lot of thought into it and what episodes will do what and trying to predict the numbers. I think a lot of people describe it as virtuous to, oh, I don't pay attention to the analytics.
Acquired
Holiday Special 2023
Yep. And everything's a trade-off like in a vacuum. Sure. You should give your time and your life force to everyone, but you have a finite amount. And so it's a priority thing.
Acquired
Holiday Special 2023
Oh my gosh, yeah. Yeah. What do you mean? Just go do a good deal. And that way, in 10 years, you'll know if it was good or not.
Acquired
Holiday Special 2023
it's an interesting derivation that i want to take this down i've had this life advice that i've been thinking about to give to my son when he's old enough to understand life advice which is not right now oh you could have to wait a while you'd scream in my face and which is interesting that he can listen to all of this i don't think he ever will but it's crazy that there's like hundreds of hours of his dad talking
Acquired
Holiday Special 2023
Like, do you ever think about that? Yeah. That our kids will get to watch us sort of grow up. I guess there's not video until year five or so, but still like listen to us sort of form who we became, assuming that we do this for decades and decades to come. But one of the pieces of life advice, and David, I was telling you about this on our walk in LA up Runyon Canyon.
Acquired
Holiday Special 2023
We were down there interviewing Charlie, was that when you're a young person, you should try to become singularly productive, right? And I mean productive in the economic sense, that you are able to soup to nuts within your control, make something of economic value and put it in the world in a way that you own the design, engineering, creation, marketing, distribution, monetization.
Acquired
Holiday Special 2023
And everybody shouldn't do that. The corporation is a great structure that enables people to work together in a creative way to produce an output. But your life is way better if you have the capability to singularly produce something on your own, and then it's always your choice of how much stuff outside your control you want to let in.
Acquired
Holiday Special 2023
I think to each his own, I pay a lot of attention to the analytics. I think that helps you become better at making a product that people like. I don't understand why you wouldn't immerse yourself in every single number you possibly could all the time. It may lead you to a different outcome, but that outcome... as long as you're measuring correctly, seems to be make something that people want more.
Acquired
Holiday Special 2023
You might be a singularly productive individual who then goes on to be Craig Federici and run all of Apple software. But then it's your choice. You're not reliant on a bureaucratic structure for you to thrive and politic inside of.
Acquired
Holiday Special 2023
Yeah, Mark is a absolute legend in sort of value investing circles, right up there with Warren and Charlie. And if you don't know Mark or know of Mark, it's worth looking up Constellation Software. Anything you can glean on the internet is going to be totally fascinating about the company that they've built.
Acquired
Holiday Special 2023
So yes, I obsessively look at the numbers. I look at the completion rates. I think that's super important.
Acquired
Holiday Special 2023
And we are your hosts. You see what I did there, David? I did. I did. No technology. No technology. No technology. Yes, I motion to, you know, the whole board of directors here that we drop technology from our intro since I crunched the numbers and four of the 14 episodes we did this year were technology companies.
Acquired
Holiday Special 2023
Well, David, so fun for you and David Senra to get to have that conversation. Love, David. Wish I could have joined you, and thanks for doing that while I'm on podcast or paternity. You can find his bookshelf at Blinkist.com slash Senra, and our thanks to Blinkist for allowing us to share our good friend's bookshelves with you for the holidays.
Acquired
Holiday Special 2023
All right. I'm trying to decide if like your problems are real problems at this point or if you're like you've gotten so comfortable in life that you're like solving these like really.
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Holiday Special 2023
But it's a great one. I mean, yes, I recognize the value of good gadgets. I've been using a June oven for the last six months. Also life-changing. You might be like, why do you need a small oven instead of your big oven? And why does it need to be on the counter instead? Spinach feta wraps. Oh, every morning. Spinach feta wraps in the June. It's perfect. Okay, I have a litany of carve-outs.
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Holiday Special 2023
Go for it. I'll save my baby-related ones for later. My TV show, my wife and I just binge-watched, is like holy crap good. Some of the best TV I've watched in a long time. Very different genre than Succession, but like Succession-level quality. It's called Silo on Apple TV. It is excellent. It's based on a book, maybe book series. And the 4TV adaptation is just very good.
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Holiday Special 2023
Dialogue, the cinematography is good. The sets are really impressive. The premise is just beautiful and so simple. And the premise is, this is going to be spoiler-free. There is a civilization of humans that exist in a silo, like a big silo. I don't want to say the exact number of people because some might consider that a spoiler, but like, you know, a civilization in a silo. Okay.
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Holiday Special 2023
And... On Earth or in outer space or... presumably on earth is the premise. And it is all about people trying to figure out what's going on because it opens with this idea that at some point it will be safe to leave the silo. We don't know when that day will be, but we know that day is not today. And it's a whole civilization of people living in a silo.
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Holiday Special 2023
That's the setting. And I'm giving no plot details about what then transpires, but it's awesome. And it's great sci-fi.
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Holiday Special 2023
The female lead is the woman from the most recent, the last two Mission Impossibles, who's a really good actress. And who else is in it? The woman from The Office, Rashida Jones, is also in it. It's a good show. Highly recommend it. She's Quincy Jones's daughter? Is that right? I think that's right.
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Holiday Special 2023
So that is awesome. For less good TV, but still very entertaining, part of our maternity leave has been watching Alias. Neither of us watched it back in 2002. And it's like a J.J. Abrams, early J.J. Abrams. Jennifer Garner's the lead. You've already done this as a carve-out, but I like the... Have I? Yeah, re-carve-out. It's fine. It's great.
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Holiday Special 2023
I mean, it gets worse as the seasons go on, but seasons one, two, and three are great. Very worth watching. A product that I've been loving, I just got some new Warby Parker glasses. I believe they're made out of vinyl, but the frame is called Amari, A-M-A-R-I.
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Holiday Special 2023
They are much lighter than any other glasses frames that I've ever gotten, and it's like totally game-changing to feel like they're sort of just floating on your face all day. Some might view them as not as stylish as some of the more stylish options, but they're my at-home glasses for sure.
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Holiday Special 2023
Well, happy to recommend. Another one is a feature of a product that I found a couple days ago that is frigging insane. So I've had this thing where as iPhone cameras have gotten better and better, the computational photography, like what Apple does to photos makes them look a certain way. And I've sort of gotten used to that way that photos look.
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Holiday Special 2023
And now that I'm using the big camera again, because we have a baby, I've gone back to, I'm using the Alpha 7Cs and this kind of like, very flexible lens that can either be a wide or a zoom lens that we're going to use actually for some upcoming interviews next year to get a tighter shot on the subject. I've been using that. And I've been feeling like, God, these images are so grainy.
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Holiday Special 2023
Like basically anything that I shoot indoor feels like it has this really... terrible grain and you look and of course it's like the super high ISO but the iPhone does so much smoothing that I've like forgotten that film grain is a thing and so Lightroom shipped this unbelievable ML powered denoise feature
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Holiday Special 2023
I found out about it because Nilay Patel was just on the talk show with John Gruber, and he is right to say it totally pegs your GPUs while you're using it, but it is pure magic. You open up Lightroom, you select the photos, you can even select ones that don't seem noisy to you, and you come back, and it's like... Unless you crank the setting way up, they look totally realistic.
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Holiday Special 2023
It doesn't look overly AI'd, but your photos just all get like magically way better. So huge kudos to the Adobe team. I've been so impressed with everything that they're cranking out on the AI side. Like I think they're the enterprise company that is probably the best at rapidly commercializing these generative AI advancements.
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Holiday Special 2023
This one is immediately useful for me for everything that I shoot, not with my iPhone.
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Holiday Special 2023
Totally agree. I think I may have made this a carve-out at some point, but I want to re-highlight it because it's been at least 12 months, because I remember reading it over Christmas last year. It's an article by Derek Thompson called The Eureka Theory of Everything is Wrong. Yes, this is awesome. It's so good. I just re-read it.
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Holiday Special 2023
It's just such a pleasant reminder that it's not about the idea, it's about the implementation, and it's often about the unsexy distribution work.
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Holiday Special 2023
The article highlights a number of different instances where we know the famous inventor, but we don't know about the heroic effort made by governments around the world to actually roll things out like vaccines and things that are a huge part of the public good. I highly recommend reading it if you're in for sort of a perspective-changing read on what is important to advance society forward.
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Holiday Special 2023
It's interesting. Growing from a podcast about great technology companies to a podcast about great companies is certainly a growth strategy or a byproduct of doing that is growth because the addressable market is larger. But I think it would fail if that wasn't just you and I following what our natural interests were. People ask us all the time, how do you pick episodes?
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Holiday Special 2023
I can't wait. That's totally been a thing that we've done this fall as, you know, we were getting ready for the birth of our son. And then as we've been on the couch a lot is like watch an insane amount of college football and NFL games. Yeah, I'm all over this YouTube channel.
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Holiday Special 2023
Yes. The production of football and the storylining around the teams and the players, it's the great at-scale storytelling of our time. And to your point, there's a whole other thing going on underneath it all. It's funny, the carve-out I was going to do next before you jumped in with a couple is Monday Night Football Manning cast.
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Holiday Special 2023
It's been so good this year. I actually didn't get into it until this season. I just didn't watch that much NFL until this season because I grew up a Browns fan and...
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Holiday Special 2023
enough said well yeah but I've watched a lot of NFL this year and Eli and for anyone who doesn't know about Manning cast when you're watching Monday Night Football you can choose either to watch the normal announcers or there's a completely second production using the same cameras and
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Holiday Special 2023
plus a couple of cameras in Peyton Manning and Eli Manning's homes where they're basically just like watching the game on Zoom together. It's a holdover from the pandemic and they have guests on, like they had Will Ferrell on, but I think it's actually better without guests. Like even when it's just Eli and Peyton analyzing the game, it's similar to what you're talking about, David.
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Holiday Special 2023
It's a little bit of like helping you understand what's going on behind the scenes, but of course by two brothers that are very fun to be around and they often act like they're still, you know, eight and 10 years old.
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Holiday Special 2023
Cool. All right. I'm pumped. Okay. We're entering the baby product section of recommendations.
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Holiday Special 2023
I haven't watched it yet. Oh, you haven't watched it yet? Oh my God. It's available at home now, right? Also, did we call that or did we call that? It's been two years since we did the T-Swift episode.
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Holiday Special 2023
And the answer is you and I talk for hours a day. We wander around our house and our neighborhoods putting on AirPods and calling each other and talking about, you know, What's currently in our email inbox, what we're researching, what we need to do to ship an episode, prep for guests, that sort of thing.
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Holiday Special 2023
I feel like I finally have strollers dialed. Now, granted, I only have a one-month-old, so the needs massively change over time. But forever, I was trying to figure out, for non-parents out there, figuring out the right car seat-stroller combos for all the different needs, like at home, travel, when they're different ages, you have different needs. Right now, we have a lean setup.
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Holiday Special 2023
There's a way to be dialed in your setup by just having four strollers, but I'm pretty pumped where we landed with two.
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Holiday Special 2023
All right, so here's the current setup. And this is after buying a few other strollers and returning them because there were things I didn't like about them ergonomically. So the Uppa Baby Vista is the home stroller. That's the one that's like big. You don't want to be in the business of like folding that and taking it. And that has the newborn bed in it.
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Holiday Special 2023
Yes. Oh, you do not ever want to pick this thing up. But it's got great shocks. We take it on a trail near our house in the Arboretum in Seattle. And the fact that it has a huge bassinet on it, a lot of his naps happen there. So I can go on walks while the baby's napping, even as a newborn, which for a lot of strollers, newborns can't nap if they're sort of like upright.
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Holiday Special 2023
Or newborns can't even sit, you know, in a normal looking stroller. So you need a bassinet stroller. So that's the home situation. The travel situation, and we haven't like flown anywhere yet, but we will in a month or so, is the Jools, J-O-O-L-Z, Air Plus, A-E-R Plus. Okay, I've not heard of this device. I hadn't either, but we went to Nordstrom and we tested all the strollers. Amazing.
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Holiday Special 2023
And the one that we had ordered, I really hated the way that the handlebars sat and made my wrists feel. So we got the Jules Air Plus instead. And it has adapters for the car seat that we bought, the Kleck Link.
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Holiday Special 2023
And it just snaps right in. So this Jules Air Plus is super light. It's 11 pounds. It fits in the overhead of a airplane. So when we travel starting in a month, we'll be able to do that. When we're home, it always sits in the back of the car.
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Holiday Special 2023
And one of the conversations that always is happening is, what are you interested in right now? How have your views shifted over X period of time? What is fascinating to you now? And I think the growth is sort of a byproduct of our obsessions shifting and becoming these durable businesses and trying to understand what makes a company worthy of being a century-long company.
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Holiday Special 2023
And so like whenever we take the baby out, we leave the baby in the car seat and we just snap the car seat, which by the way is like the safest, you know, the Kleckling is like the safe car seat.
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Holiday Special 2023
No. So the car seat just snaps right in. And so for like doctor's visits and stuff, we just take the travel stroller with the car seat snapped in. No interruption to sleep. It took a lot of finagling, but this is where we've arrived for now. The optimizations are some people recommend the Thule running stroller in addition to this. We'll have to see if that's a category we dip into.
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Holiday Special 2023
Yeah. And other people are swearing by this. In fact, a listener to the show, Alex, I think texts me, I don't know, he texts me a lot about this stroller. And I think he's probably their number one fan. There's a car seat that converts to a stroller.
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Holiday Special 2023
Yay! Congratulations. I was wondering if you were going to talk about it.
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Holiday Special 2023
So the DUNA is sort of like a different philosophy of what if your car seat could become a stroller? And so that way, when you're going on vacation, you actually don't bring a travel stroller. You just keep the baby in the car seat all the way until you get to gate check. Then you check the DUNA. Or if you're so bold as to get a seat for your newborn, then I think they can stay in it.
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Holiday Special 2023
I'm not exactly sure how that works. And then when you get there, so the trade-off then is like, is the Duna actually a good enough stroller for like five mile walks? And that I don't know. When we go on vacation, we just try to do like tons and tons of walking. And so that's the thing that I'm playing with. Is the Duna going to enter the rotation or do we rely on the air?
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Holiday Special 2023
Yeah. Stay tuned. At the risk of Acquired getting a lot more boring, I think we have to keep discussion of baby products to a minimum.
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Holiday Special 2023
Yep. Either spinoff show or we're gonna have to keep these, like, we'll create, like, a bonus section at the end of the episode or something. Yeah, yeah.
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Holiday Special 2023
You sent me that picture of her eating a Costco hot dog. Oh, yeah, totally.
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Holiday Special 2023
regardless of where it came from or how it was funded or what technologies were used in creating it.
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Holiday Special 2023
And for people who are curious about how this works, Stephen does a first pass after we send him eight, nine hours of raw audio and turning it into sort of a candidate episode. And that's getting rid of likes and ums and all that, but it's retakes, it's redos, it's David and I saying, ah... I feel like that didn't come across right. I didn't make the point succinct enough.
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Holiday Special 2023
Why don't I try to make it more succinct? Then he sends us back this release candidate, which we then also tear apart and has, you know, a hundred more edits of, like, this fact is wrong. This little part of this sentence is extraneous. Delete this number. hey, can we move this section to this part?
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Holiday Special 2023
And then does a complete second pass after a week's worth of work to deal with us on a complete second copy edit. So thank you so much, Stephen. You're the best. And it comes out just sounding immaculate.
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Holiday Special 2023
Oh, while we're thinking thought partners, we should thank friend of the show, Mark Bridge, who is a good friend of mine up here in Seattle, a good friend of David's as well. He gave me transitions. Runs a very cool, is a founder of a very cool company called At Present, which is a marketplace for very unique and cool jewelry pieces for women.
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Holiday Special 2023
David and I are actually both small investors in the company. And customers. And customers, that's right. Probably the most expensive thing I ever bought, I bought through at present. But Mark has been a thought partner on tons and tons of episodes, especially Berkshire. He actually suggested LVMH, good thought partner on Nike.
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Holiday Special 2023
So Mark, thank you for everything you've done and helping Acquired too.
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Holiday Special 2023
Yep, the whole team at NVIDIA, initially the people that were willing to speak with us about the episodes we were doing just to help with the research for the episodes and make sure we got it right, but then subsequently their entire communications team for hosting us and putting up with all of our requests and being willing to build the insane three-screen setup and film it with three cameras and do everything we wanted to the production standards we wanted and way more at NVIDIA HQ.
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Holiday Special 2023
So thanks to the awesome team there. Thank you to Doug DeMuro for consenting to join the crazy acquired episode process for Porsche.
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Holiday Special 2023
No, but he did all the research too. And, you know, for someone who has two businesses that he's trying to, you know, run at the same time, you know, he started with a head start on the history of Porsche, but he really did a ton of work to prepare for that and had all of his facts and figures ready at hand.
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Holiday Special 2023
Yeah. Doug rocks. Also, I'm thinking about buying my next car, and I've been watching so many Doug videos to prepare.
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Holiday Special 2023
like an expert guest host. We loved that format. We'd like your feedback on it too, but we thought that was the perfect amount of guest research and what they brought to the table and how we looped them in with the episode and interacting with David and I, we were just like, this is a 10 out of 10.
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Holiday Special 2023
And for most of these folks, they do it because they listen. And so they sort of know the product that's going to come out the other side. Thank you also for listening, because I think that's sort of the superpower of Acquired, is the fact that now there are people who listen who can really help us make sure that we get episodes right. So we love getting these notes.
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Holiday Special 2023
I mean, we can't respond to them all, but people who join the Slack or email us, acquiredfm at gmail.com and say, hi, here's a thing that I know a lot about in my industry experience. If you ever do it, feel free to reach out. We totally do when we do those episodes. So thank you.
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Holiday Special 2023
And with that, our huge thanks to Statsig, Blankist by Go1, and Crusoe. You can click the links in the show notes to learn more. If you want to know every time an episode drops, you can sign up for email updates at acquired.fm slash email. We added two new things recently. Emails include little hints at what the next episode will be.
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Holiday Special 2023
And they're also where we're putting follow-ups and corrections to previous episodes. So thanks to the two listeners who recently wrote in correcting me on Visa that it was not North Dakota but South Dakota that first changed their usury laws to support credit cards, which is why all of your credit cards, or so many of them, are bailed from there today. So we'll be including...
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Holiday Special 2023
I don't know, we've got three or four more Visa tidbits that we'll toss in the email for that. Come talk about this episode with us after listening at acquired.fm slash slack. Check out ACQ2. We just did this awesome Visa follow-up with our good buddy Gaurav Ahuja from Thrive Capital.
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Holiday Special 2023
He's been in the payments industry for over a decade, founding companies, investing in companies, and helped put a finer point on a lot of the things we were describing in the current ecosystem today. If you want some merch, we've got a sweet merch store, acquired.fm.store. And with that, listeners, we'll see you next year. We will see you next year.
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Holiday Special 2023
Right. It is kind of strange becoming canon. I never thought Acquired would get to the point where when we do an episode on something, it has the possibility to become canon. an undertone of themes that people are discussing. And certainly years one through six or seven, that was never the case. But with LVMH, with Costco, maybe with Porsche, certainly with Nike,
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Holiday Special 2023
I think there was an element of we released the episode and suddenly we noticed the discussion, especially amongst the tech sphere, about that topic massively picked up. Or people would go on CNBC and make a point that we made. And I'd call you, David, and go like, I wonder how that comparison got made.
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Holiday Special 2023
Yes. I don't want to overtoot our own horn on this, but that has been a huge change this year that we have never seen in previous years is once we do an episode, it sort of gets in the water.
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Holiday Special 2023
That's true. And I don't think our charter really actually ever accounts for what to do in that circumstance. So Yes, listeners, if you count Lockheed Martin, it's five. If you count Visa, it's six.
Acquired
NVIDIA CEO Jensen Huang
I will say, David, I would love to have NVIDIA's full production team every episode. It was nice not having to worry about turning the cameras on and off and making sure that nothing bad happened myself while we were recording this.
Acquired
NVIDIA CEO Jensen Huang
I started at Microsoft in 2012, so right after AlexNet, but before anyone was talking about machine learning and even the mainstream engineering community.
Acquired
NVIDIA CEO Jensen Huang
How sure are we of that? And if so, can NVIDIA actually maintain their ridiculous dominance as this market comes to take shape? So Jensen takes us down memory lane with stories of how they went from graphics to the data center to AI, how they survived multiple near-death experiences.
Acquired
NVIDIA CEO Jensen Huang
He also has plenty of advice for founders, and he shared an emotional side to the founder journey toward the end of the episode.
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NVIDIA CEO Jensen Huang
It even seems like within the industry, from some researchers we spoke with, it seemed like no one predicted how useful language models would become when you just increase the size of the models. They thought, oh, there has to be some algorithmic change that needs to happen.
Acquired
NVIDIA CEO Jensen Huang
But once you cross that 10 billion parameter mark, and certainly once you cross the 100 billion, they just magically got much more accurate, much more useful, much more lifelike. Were you shocked by that the first time you saw a truly large language model? Do you remember that feeling?
Acquired
NVIDIA CEO Jensen Huang
Turns out the protagonist actually knows more. Yes. All right, well, listeners, join the Slack. There is incredible discussion of everything about this company, AI, the whole ecosystem, and a bunch of other episodes that we've done recently going on in there right now. So that is acquired.fm slash Slack. We would love to see you. And without further ado, this show is not investment advice.
Acquired
NVIDIA CEO Jensen Huang
I even remember that from my first operating systems class in college when I finally figured out all the way from programming language to the electrical engineering classes bridged in the middle by that OS class. I'm like, oh, I think I understand how the Von Neumann computer works soup to nuts. And it's still a miracle. Yeah. Yeah.
Acquired
NVIDIA CEO Jensen Huang
Now is a great time to talk about one of our favorite companies, Statsig, and we have some tech history for you.
Acquired
NVIDIA CEO Jensen Huang
when the research team created a new model product engineers would deploy the model to a subset of users and measure the impact of the model on core product metrics great experimentation tools transformed the machine learning development process they de-risked releases since each model could be released to a small set of users they sped up release cycles researchers could suddenly get quick feedback from real user data and most importantly
Acquired
NVIDIA CEO Jensen Huang
They created a pragmatic, data-driven culture since researchers were rewarded for driving actual product improvements. And over time, these experimentation tools gave Facebook and Google a huge edge because they really became a requirement for leading ML teams.
Acquired
NVIDIA CEO Jensen Huang
Yep. So whether you're building with AI or not, Statsig can help your team ship faster and make better data-driven product decisions. They have a very generous free tier and a special program for venture-backed companies, simple pricing for enterprises, and no seat-based fees. If you're in the Acquired community, there's a special offer.
Acquired
NVIDIA CEO Jensen Huang
You get 5 million free events a month and white glove onboarding support. So visit statsig.com slash acquired and get started on your data-driven journey. We have some questions we want to ask you. Some are cultural about NVIDIA, but others are generalizable to company building broadly.
Acquired
NVIDIA CEO Jensen Huang
And the first one that we wanted to ask is, we've heard that you have 40 plus direct reports and that this org chart works a lot differently than a traditional company org chart. Do you think there's something special about NVIDIA that makes you able to have so many direct reports, not worry about coddling or focusing on career growth of your executives?
Acquired
NVIDIA CEO Jensen Huang
David and I may have investments in the companies we discuss, and this show is for informational and entertainment purposes only. On to Jensen. So Jensen, this is acquired. So we want to start with story time. So we want to wind the clock all the way back to, I believe it was 1997.
Acquired
NVIDIA CEO Jensen Huang
And you're like, no, you're just here to do your freaking best work and the most important thing in the world, now go. A, is that correct? And B, is there something special about NVIDIA that enables that?
Acquired
NVIDIA CEO Jensen Huang
All right, red cameras for the home studio starting next episode. Yeah, great. All right, let's do it.
Acquired
NVIDIA CEO Jensen Huang
You're getting ready to ship the Riva 128, which is one of the largest graphics chips ever created in the history of computing. It is the first fully 3D accelerated graphics pipeline for a computer. And you guys have about six months of cash left. And so you decide to do the entire testing in simulation rather than ever receiving a physical prototype.
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NVIDIA CEO Jensen Huang
What are the trade-offs associated with that versus the traditional structure?
Acquired
NVIDIA CEO Jensen Huang
A large tech company shipping two flagship products or their flagship product twice per year.
Acquired
NVIDIA CEO Jensen Huang
You commission the production run sight unseen with the rest of the company's money. So you're betting it all right here on the Revo 128. It comes back, and of the 32 DirectX blend modes, it supports eight of them. And you have to convince... the market to buy it and you got to convince developers not to use anything but those eight blend modes. Walk us through what that felt like.
Acquired
NVIDIA CEO Jensen Huang
It's a good reminder. The data center segment of NVIDIA's business to me has become synonymous with How is AI going? And that's a false equivalence. And it's interesting that you were only this ready to sort of explode in AI and the data center because you had three plus previous products where you learned how to build data center computers. Exactly.
Acquired
NVIDIA CEO Jensen Huang
Even though those markets weren't these like gigantic, world-changing technology shifts the way that AI is, that's how you learned.
Acquired
NVIDIA CEO Jensen Huang
So speaking of the speed of light, InfiniBand. Yeah. David's like begging me to go here. I was having the same thought. You totally saw that InfiniBand would be way more useful, way sooner than anyone else realized. Acquiring Mellanox, I think you uniquely saw that this was required to train large language models, and you were super aggressive in acquiring that company.
Acquired
NVIDIA CEO Jensen Huang
But frame this way, you were standing near where the action was, so you could figure out as soon as that Apple becomes available to purchase, like, oh, LLMs are about to blow up. I'm going to need that. Everyone's going to need that. I think I know that before anyone else does.
Acquired
NVIDIA CEO Jensen Huang
What you just said reminds me of a great aphorism from Buffett and Munger, which is it's better to be approximately right than exactly wrong.
Acquired
NVIDIA CEO Jensen Huang
That's a good one to live by. Yeah. All right, listeners, we are here to tell you about a company that literally couldn't be more perfect for this episode, Crusoe.
Acquired
NVIDIA CEO Jensen Huang
Yep. To illustrate, they already have several customers already running large-scale generative AI workloads on clusters of NVIDIA H100 GPUs, which are interconnected with 3200 gigabit InfiniBand and leveraging Crusoe's network-attached block storage solution.
Acquired
NVIDIA CEO Jensen Huang
And because their cloud is run on wasted, stranded, or clean energy, they can provide significantly better performance per dollar than traditional cloud providers.
Acquired
NVIDIA CEO Jensen Huang
Amazing. If you, your company, or your portfolio companies could use lower cost and more performant infrastructure for your AI workloads, go to crusocloud.com slash acquired. That's C-R-U-S-O-E cloud.com slash acquired, or click the link in the show notes.
Acquired
NVIDIA CEO Jensen Huang
I want to move away from NVIDIA, if you're okay with it, and ask you some questions, since we have a lot of founders that listen to this show, sort of advice for company building. The first one is, when you're starting a startup in the earliest days, your biggest competitor is you don't make anything people want.
Acquired
NVIDIA CEO Jensen Huang
Like, your company's likely to die just because people don't actually care as much as you do about what you're building. That's right. In the later days, you actually have to be very thoughtful about competitive strategy. And I'm curious, what would be your advice to companies that have product market fit, that are starting to grow, they're in interesting growing markets?
Acquired
NVIDIA CEO Jensen Huang
Where should they look for competition and how should they handle it?
Acquired
NVIDIA CEO Jensen Huang
Yeah, no, it's cool. It's cool. So let's say you do get this great 10-year lead, but then other people figure it out, and you've got people nipping at your heels. What are some structural things that someone who's building a business can do to sort of stay ahead and you can just keep your pedal to the metal and say, we're going to outwork them and we're going to be smarter.
Acquired
NVIDIA CEO Jensen Huang
That works to some extent, but those are tactics. What strategically can you do to make sure that you can maintain that lead?
Acquired
NVIDIA CEO Jensen Huang
So this is an important lesson. We were always a developer-oriented company. The initial attempt was we will get the developers to build on Direct NV, and then they'll build for our chips, and then we'll have a platform. Yeah, exactly. What played out is Microsoft already had all these developer relationships, so you learned the lesson the hard way of like, Yikes, we just got to slide into that.
Acquired
NVIDIA CEO Jensen Huang
Do you remember any moments in Nvidia's history where you're like, oh, we made a bunch of wrong decisions, but somehow we got saved because, you know, it takes the sum of all the luck and all the skill in order to succeed.
Acquired
NVIDIA CEO Jensen Huang
Once you pull out all the stops and you see what you're capable of, why would you put stops in next time? Exactly. You're like, let's keep the stops out all the time, every time. That's right.
Acquired
NVIDIA CEO Jensen Huang
Yeah. Well, as we start to drift toward the end here, we spent a lot of time on the past and I want to think about the future a little bit. I'm sure you spend a lot of time on this being on the cutting edge of AI. We're moving into an era where the productivity that software can accomplish when a person is using software can massively amplify the impact and the value that they're creating,
Acquired
NVIDIA CEO Jensen Huang
has to be amazing for humanity in the long run. In the short term, it's going to be inevitably bumpy as we sort of figure out what that means. What do you think some of the solutions are as AI gets more and more powerful and better at accelerating productivity for all the displaced jobs that are going to come from it? Well, first of all, we have to keep AI safe.
Acquired
NVIDIA CEO Jensen Huang
That's true. Technology is a lever. And the place where the idea kind of falls down is that we would be satisfied.
Acquired
NVIDIA CEO Jensen Huang
No, humans will always expand and consume more energy and attempt to pursue more ideas. That has always been true of every version of our species. Yeah. Over time.
Acquired
NVIDIA CEO Jensen Huang
Yes. So personal story time. I, a few weeks ago, was scouring the web to find Jensen's favorite business books, which was proving to be difficult. I really wanted Blinkist to make blinks of each of those books so you could all access them. And I think I found one or two in random articles, but that just wasn't enough.
Acquired
NVIDIA CEO Jensen Huang
So finally, before I gave up, as a last resort, I asked an AI chat bot, specifically Bard, to provide me a list and cite the sources of Jensen's favorite business books. And miraculously, it worked. Bard found books that Jensen had called out in public forums over the past several decades.
Acquired
NVIDIA CEO Jensen Huang
So if you click the link in the show notes or go to Blinkist.com slash Jensen, you can get the blinks of all five of those books, plus a few more that Jensen specifically told us about later in the episode.
Acquired
NVIDIA CEO Jensen Huang
And just like all other episodes, Blinkist is giving acquired listeners an exclusive 50% discount on all premium content. This gives you key insights from thousands of books at your fingertips, all condensed into easy-to-digest summaries.
Acquired
NVIDIA CEO Jensen Huang
And if you're a founder, a team lead, or an L&D manager, Blinkist also includes curated reading lists and progress tracking features all overseen by a dedicated customer success manager to help your team flourish as you grow.
Acquired
NVIDIA CEO Jensen Huang
Welcome to this episode of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert.
Acquired
NVIDIA CEO Jensen Huang
We'll open with an easy one based on all these conference rooms we see named around here. Favorite sci-fi book?
Acquired
NVIDIA CEO Jensen Huang
I saw V'ger out there on the way in. It's a good conference room name.
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NVIDIA CEO Jensen Huang
I know we already talked a little bit about business books, but one or two favorites that you've taken something from?
Acquired
NVIDIA CEO Jensen Huang
What is something that you believe today that 40-year-old Jensen would have pushed back on and said, no, I disagree?
Acquired
NVIDIA CEO Jensen Huang
And we are your hosts. Listeners, just so we don't bury the lead, this episode was insanely cool for David and I.
Acquired
NVIDIA CEO Jensen Huang
Do you have any suggestions on any kind of support system or a way to get through the emotional trauma that comes with building something like this?
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NVIDIA CEO Jensen Huang
This is old hat. You guys are familiar with these large swings in amplitude.
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NVIDIA CEO Jensen Huang
Yep. Well, Jensen, thank you so much. Thank you. Woo, David. That was awesome.
Acquired
NVIDIA CEO Jensen Huang
Well, listeners, we want to tell you that you should totally sign up for our email list. Of course, it is notifications when we drop a new email, but we've added something new. We're including little tidbits that we learn after releasing the episode, including listener corrections. And we also have been sort of teasing what the next episode will be.
Acquired
NVIDIA CEO Jensen Huang
So if you want to play the little guessing game along with the rest of the Acquired community, sign up at acquired.fm slash email. Our huge thank you to Blinkist, Statsig, and Crusoe. All the links in the show notes are available to learn more and get the exclusive offers for the Acquired community from each of them. You should check out ACQ2, which is available at any podcast player.
Acquired
NVIDIA CEO Jensen Huang
As these main Acquired episodes get longer and come out, you know, once a month instead of once every couple weeks. It's a little bit more of a rarity these days. We've been up-leveling our production process, and that takes time. Yes. ACQ2 has become the place to get more from David and I, and we've just got some awesome episodes coming up that we are excited about.
Acquired
NVIDIA CEO Jensen Huang
If you want to come deeper into the Acquired kitchen, become an LP, acquired.fm slash LP. Once every couple months or so, we'll be doing a call with all of you on Zoom just for LPs to get the inside scoop of what's going on in Acquired land and get to know David and I a little bit better. And once a season, you'll get to help us pick a future episode. So that's acquired.fm slash LP.
Acquired
NVIDIA CEO Jensen Huang
Anyone should join the Slack, acquired.fm slash Slack. God, we've got a lot of things now, David. I know, the hamburger bar on our website is expanding. Expanding, I know. That's how you know we're becoming enterprise. We have a mega menu, a menu of menus, if you will.
Acquired
NVIDIA CEO Jensen Huang
All right. With that, listeners, acquire.fm slash Slack to join the Slack and discuss this episode. Acquire.fm slash store to get some of that sweet merch that everyone is talking about. And with that, listeners, we will see you next time.
Acquired
NVIDIA CEO Jensen Huang
After researching NVIDIA for something like 500 hours over the last two years, we flew down to NVIDIA headquarters to sit down with Jensen himself. And Jensen, of course, is the founder and CEO of NVIDIA, the company powering this whole AI explosion. At the time of recording, NVIDIA is worth $1.1 trillion and is the sixth most valuable company in the entire world.
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NVIDIA CEO Jensen Huang
So is the lesson for founders out there, when you have conviction on something like the Revo 128 or CUDA, go bet the company on it. And this keeps working for you. So it seems like your lesson learned from this is, yes, keep pushing all the chips in because so far it's worked every time.
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NVIDIA CEO Jensen Huang
So every time we see you make a bet the company move, you've already simulated it. You know. Yeah, yeah, yeah. Do you feel like that was the case with CUDA?
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NVIDIA CEO Jensen Huang
And that is true if there was a large market of machine learning practitioners who would eventually show up and want to do all this great scientific computing and accelerated computing.
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NVIDIA CEO Jensen Huang
But at the time when you were starting to invest what is now something like 10,000 person years in building that platform, did you ever feel like, oh man, we might have invested ahead of the demand for machine learning since we're like a decade before the whole world is realizing it?
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NVIDIA CEO Jensen Huang
And right now is a crucible moment for the company. Expectations are set high. I mean, sky high. They have about the most impressive strategic position and lead against their competitors of any company that we've ever studied. But here's the question that everyone is wondering. Will NVIDIA's insane prosperity continue for years to come? Is AI going to be the next trillion-dollar technology wave?
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NVIDIA CEO Jensen Huang
It can be an incredibly lucrative market. If you can predict what the next best performing feed item to serve into a social media feed, turns out that's a hugely valuable market.
Acquired
Lockheed Martin
That gets revised down, again, an airplane has not flown yet, just before 1997 to 339 planes, that's going from 750 to 339, for $62 billion in total program cost. That cost went up, even though the number of planes dramatically went down to like half. I was wondering, I was like, did Ben misspeak there? Nope. Then the F-22 program is over.
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Lockheed Martin
It was a big thing in the Obama administration where he basically said, I'm going to veto anything that comes to my desk for any more Raptors. Like, we're done with this. But it's not as good as it sounds. It's not as noble. The final down from 750 to 339 is 187 planes delivered. They kept the $62 billion total program cost fixed. They managed to do that. Wow.
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Lockheed Martin
So each plane ends up costing $360 million if you amortize all the R&D against the very few airplanes that they ended up making. Wow. And... I mean, the F-22, much like the SR-71, there's not much we can complain about with the plane. It is a badass plane. In fact, for Seafair here in Seattle, the last few years they've had an F-22, it is an unbelievable thing to see live.
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Lockheed Martin
It is a completely transformative process of how the engine uses the air in order to create thrust that is much more sophisticated than just a propeller.
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Lockheed Martin
It performs maneuvers that just look alien. I mean, you just don't understand how the physics makes it work. It was all about air superiority. It was all about speed. They took all of the stealth lessons from the F-117 and put it into a very fast, air-dominating airplane.
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Lockheed Martin
They used it in the arcade cabinets, right? The cutting edge, better than home consoles, computers.
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Lockheed Martin
In order to model the stealth airplanes. Yes. Unbelievable. That is insane. So fun. So what we can see here is that sort of the classic modern, boondoggle is probably the wrong word, but program gone awry, where there's a sensible total program cost for making a lot of airplanes. And then as there's more pressure on the budget over time,
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Lockheed Martin
and there's cutbacks that happen, you end up making less and less airplanes. And so it's really hard to amortize all the R&D costs. And because of the way that these contracts work, it's not the tech company that's left holding the bag. It's not the contractor holding the bag. It's total cost plus... model, the company, the contractor, Lockheed, doesn't take any risk.
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Lockheed Martin
The company is, of course, critical to defending the American way of life, and most of these things they make, fortunately, are used as deterrents to keep peace. But we should not mince words. They make weapons synonymous with phrases like overwhelming force and air superiority. You may feel, and probably should feel, conflicted as you learn about this company.
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Lockheed Martin
And so who's holding the bag? The government's just paying more for each airplane rather than, you know, you could imagine if I was Apple and I sunk a billion dollars into developing the next great device and then no one bought them, I'm out a billion. But in this scenario, the government's like, look, I told you I'd pay that much. I'm paying that much.
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Lockheed Martin
Right. Following Ben Rich's sort of, hey, I think this is how airplanes are going to be made in the future, this happens in 46 states.
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Lockheed Martin
Yes. And it requires 95,000 jobs, which in some ways is good. It's good to employ people. In other ways, the reason that some of these projects get funded is because it creates these jobs. And the reason that it's in 46 states is because that way, basically every member of Congress is incented to vote for it. You're talking about pork barrel politics. Exactly.
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Lockheed Martin
Totally. So we're observing overseas our enemy has a completely new technology that we have not tamed and mastered yet. We're at a disadvantage.
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Lockheed Martin
So I think Lockheed has become world-class at understanding where their bread is buttered. Yes, their customer is the U.S. government, but the people approving their funding are individual people, these members of Congress who all want to get reelected.
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Lockheed Martin
And so Lockheed spreads all these operations around, they employ all these people, and members of Congress love nothing more than creating jobs for their constituents, and they hate nothing more than participating in a vote that eliminates jobs. And so Congress can kind of be simplified to 538 principal agent problems.
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Lockheed Martin
Yep. So then there's the next program that comes along, the F-35 Lightning II, the Joint Strike Fighter. And so, you know, the mindset here is, well, we finally get it. We need to make a lot of these things if we're going to make a big investment.
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Lockheed Martin
The government sort of pools its resources and the DOD sort of works across the armed services and they reach out to all of our allies, Britain and others, and they say, what's like a common platform that we can develop and so that we can get the best economies of scale out of this thing. That's the right thing for the American taxpayer.
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Lockheed Martin
And so they come up with this idea for the F-35 Lightning II, and they're going to make three models, and each of the models are for a different purpose. It's this incredible piece of technology. One of the three models can actually angle its engine down and take off vertically using its engine to reposition. I don't think they can use this in combat, but they can use it
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Lockheed Martin
move itself around on an aircraft carrier and stuff like that. It's pretty incredible to watch videos of it if you just go search on YouTube. It interestingly has a different aim and mentality than the F-22. It's less about being sort of the fastest plane in the skies and much more about having the technology and the visibility to have the best information at all times. It's sort of
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Lockheed Martin
looking to the future of information-based warfare more than pure air superiority and speed. It's not all the way to like a drone future or a cybersecurity future, but you can see it drifting there. Really intense communications between a whole squadron of fighters, intense heads-up displays with digital stuff for the pilots in the cockpits and in their helmets.
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Lockheed Martin
And so it's sort of like the most technology-forward plane program ever. So when I say big, I mean really big in terms of the number of orders that are going to be placed. The initial order book is approximately 3,000 airplanes worth a potential $200 billion for the total program cost. Wow. In practice, it's kind of as pork-barley as the F-22.
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Lockheed Martin
Lockheed won the contract, but, you know, it's subcontracted. It's peanut-buttered out to all the other big programs, too. The fuselage is Northrop Grumman. BAA Systems from the UK makes the rear fuselage. These pieces are shipped all over the globe before final assembly.
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Lockheed Martin
So we've sort of expanded it even from pork barrel in the US to like, which of our allies can participate in making this thing and thus benefiting in their area too. So here's some of the stats from Lockheed's 2022 annual report. The USA's F-35 order is a $30 billion order, just from the US, $30 billion. That's 398 airplanes. That is $750 million per airplane.
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Lockheed Martin
The Swiss have placed an order for $6 billion for 36 airplanes. Finland bought 64. Germany, 35. Greece, 20. The Czech, 24. Canada, 88. Poland, 32. Lockheed Martin, this is an enormous win to win this program. And it is, among us and our allies, the largest ever purchase anyone has ever made for any piece of defense equipment.
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Lockheed Martin
Yeah, put a pin in that for the moment. I'll finish rounding out the national defense budget, just to put all this in context of what Lockheed sort of represents here. So our national defense budget in the United States is $800 billion. As you would expect, that's more than any other country in the world. It's three to four percent of our GDP we spend on defense.
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Lockheed Martin
Interestingly, it is down on a percentage basis of when you think about like the percent of federal revenue spent on defense, it's actually down. Back in the 60s, we spent half of our federal revenue on the military. And in recent years, it's fluctuated between 12% and 20%.
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Lockheed Martin
So I think that's a little bit of a counter-narrative to people that like to complain about how much money we spend on the military.
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Lockheed Martin
Exactly. The military industrial congressional complex has really, it's almost like what's happened to the banking system. We like pseudo nationalize a few companies. There's these too big to fail entities that are like in cooperation with the government. Neither can really exist without each other. And we just are okay with that. We say, okay, that's how the system works.
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Lockheed Martin
And for better or for worse, private industry and the government are tied at the hip there.
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Lockheed Martin
So a few more stats on this. So I said in recent years the government's DOD or defense spending is between 12% and 20%. The total U.S. government budget is $6 trillion. So defense in there at $800 billion clocks in. It's actually lower than Social Security, health care, and income security.
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Lockheed Martin
but it's 12% to 20% of the federal budget. So, OK, we know that of the $6 trillion budget, defense is less than Social Security, health care, and income security. It is more than Medicare, education, or transportation, just so people sort of know where it kind of sits there. So of that $800 billion, about half of the defense budget is spent on contractors like Lockheed Martin.
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Lockheed Martin
And of that $400 that's spent on contractors, $50 billion goes to Lockheed. They are the single largest recipient of federal spending as a contractor, full stop.
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Lockheed Martin
Yep. Lockheed, then Boeing, then General Dynamics, then Raytheon, then Northrop, then McKesson. Wow, you get to five before you even get to a healthcare. Wow. So you've got that $50 billion that goes to Lockheed Martin from the federal government. How much of their total revenue do you think that is?
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Lockheed Martin
It's close. It tends to hover around 75%. So $66 billion was Lockheed's total revenue last year, of which $50 billion came from the U.S. federal government. Makes sense. And again, the rest, I would assume, would come from foreign governments. Correct. Yeah, our allies. Because the U.S. government basically has a rofer on anything and can put the kibosh on Lockheed exporting to anyone. Right.
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Lockheed Martin
It's not terribly profitable. Their net income margin is 8%, as we've been sort of talking about the whole time. You can sort of like see the cost plus pricing right there at the bottom line of the company. Lockheed Martin makes a bunch of money, and at the end, they only have 8%, and that's basically contractually figured out. I think whenever one of these contracts gets bid out,
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Lockheed Martin
The big defense contractor says, I'm going to slap 8%, 9%, 10%, 11% on top of it, and that's going to be the cost. And that is exactly why their financial statements look the way they do is because that's exactly how the government decides to fund it.
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Lockheed Martin
But it doesn't make sense when the government's buying more modern things. Like we're buying software as a service. Let's say I'm making Slack and I'm selling that to the government. If the contract to procure something that looks like Slack requires me to bid on it in a certain way, and I'm using Slack, there's lots of defense software you could sort of think about here. Palantir, for example.
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Lockheed Martin
contract to bid on that's structured a certain way, when the way that you've decided to structure your company, where you do R&D up front, you're willing to take on some of the risk, and then you want to sell something and amortize your R&D across all of your customers the way that every tech company does, and the way that you sort of get operating leverage on your company, that doesn't fit in these gigantic cost-plus contracts.
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Lockheed Martin
In fact, What it ensures is you cannot get operating leverage on your company. No matter how large you scale, you will never have big fat gross margins that outrun your fixed costs. It's like the opposite of what every tech company is trying to do.
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Lockheed Martin
Yeah, someone told us as we were preparing and researching this episode that Palantir figured out that what they had to do was sell laptops to the government that came preloaded with their software so they could sell a physical thing that had a cost of goods sold associated with it such that it could be bought in a cost-plus way.
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Lockheed Martin
They're not selling software solutions. Yeah, I'd say we're in the first out of the first inning in trying to figure out how to sell software to the Department of Defense.
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Lockheed Martin
Yeah, and it's probably fair to say I didn't talk to anyone at Lockheed. I'm not judging anyone who works at Lockheed. But I think the reputation in the industry is if you're a fantastic software engineer, you're probably going to go to a more interesting modern company.
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Lockheed Martin
And that's why you see the Andurils of the world and the Palantirs of the world kind of sucking up top talent that has this as a thing that they're really passionate about working on.
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Lockheed Martin
Very different time we live in. Very, very different time. Or at least there's a perception that it's a very different time that we live in. I don't really know for sure if it is or not.
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Lockheed Martin
It is in the government's interest for everyone to feel safe and secure and so you can sort of rise above Maslow's hierarchy and do other stuff with your life and like create, innovate, and live happy, prosperous, enjoyable lives and go to work and do things that aren't for defense and drive the economy forward.
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Lockheed Martin
It is also in the interest of the country to make everyone a little bit aware of how we have this incredible quality of life in the U.S. And I don't think we're indexed in that direction even 1%. I think as you talk to people, there's a lot of reasonably oblivious but well-intentioned people who are not willing to give the credence to America's incredible military and
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Lockheed Martin
of why we get to enjoy such charmed lives in this country. And a lot of people that want to like go, la-da-da-da-da, we live in this amazing, globalized, wonderful world where no one needs to think about the military at all. And you're like, do you live on this planet? I love peace as much as anyone, and that should be the goal. And also, the default state of humans.
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Lockheed Martin
Right. Unfortunately, there's some set of people who want to, like, come and take your stuff. And in the same way that price is set in a market by the person who is willing to pay the most, the need for security in the world is set by the person who's most willing to come take your stuff. And that's how much defense you need to have in order to stop them from coming and taking your stuff.
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Lockheed Martin
And for those tracking along at home, 600 miles per hour, not quite the speed of sound, not quite Mach 1, but approaching that, something like 80-ish percent to Mach.
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Lockheed Martin
And hopefully, you don't need to get into armed conflict over it. But... I do generally feel that there is a disconnect between people who enjoy the way of life that we have but are unwilling to acknowledge why we have it. And I think that is extremely different today than it was 60 years ago.
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Lockheed Martin
Yeah. Well, we've already done a bunch of playbook stuff. So before we get into that formally codified analysis section, let's just talk about, real quick, the segments of Lockheed Martin today. So people understand, like, what do they actually do today? Because we've talked about a lot of this stuff. There's aeronautics, which in theory contains skunk works. So that's F-35s, F-22s, the old F-16s.
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Lockheed Martin
the C-130J Hercules airlifter. The F-35, I believe, is the largest program generating 20% of all net sales across all segments.
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Lockheed Martin
Right. It's 66% of 2022's revenue in that aeronautics division. So like aeronautics equals F-35. There's also missiles and fire control. Then there's three rotary and mission systems, which contains helicopters. They bought Sikorsky, so it contains Sikorsky, the other helicopter company.
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Lockheed Martin
And then four is space, which includes the Orion capsule that's evolved over the decades and is now part of NASA's Artemis moon program. It also includes ULA, which is the joint venture that we didn't talk about with Boeing, which that was sort of forced upon both Boeing and Lockheed Martin, where they both independently were developing launch capabilities for the U.S. government.
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Lockheed Martin
This is especially pre-SpaceX or before SpaceX was as powerful as it is today. The U.S. needed to contract launch services from someone. And so Lockheed and Boeing were both developing them. That didn't go terribly well. And they ended up asking for bailouts from the government. And the government said, can you two combine?
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Lockheed Martin
And Lockheed Martin and Boeing came back and said, are you kidding me with that guy? No, these companies hate each other. And so but they agreed to do it because they kind of had to. And so ULA is sort of this shotgun wedding between the two companies.
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Lockheed Martin
Totally. And the reason they didn't go well was because in sort of the pre-SpaceX era, there were all these companies that wanted to put stuff in space that all ended up going out of business. You think like Teledesic, Iridium, a lot of bankruptcies. And so Boeing had tooled up this huge factory. Lockheed had done this too. And so they were left holding the bag. And it got really ugly.
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Lockheed Martin
Boeing was caught trying to steal proprietary data from Lockheed Martin. Ultimately, this JV has gone well. ULA is going to 2x their capacity to 25 launches a year, which is way more than they used to do, but still way less than SpaceX over the next five years or so with this Vulcan rocket. Still more expensive than SpaceX, but they started from big incumbents rather than starting from a startup.
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Lockheed Martin
So it's just sort of a different disposition. Joint ventures are not permanent things, and these companies kind of can't continue to be in business together. So ULA is up for sale, and it'll be very interesting to see if one company or the other ends up buying it. But it is an important part of NASA's Artemis program and others moving forward. It's also important to Amazon.
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Lockheed Martin
Neither company will really say anything about that. There's got to be something in there.
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Lockheed Martin
Yes. So those are the four segments. Much like our Sony episode, and I'm pulling forward a playbook thing here, this is a pretty well-diversified conglomerate. I mean, fighter jets are their bread and butter at 40% of overall revenue, but missiles and space are each 17% and rotary mission systems are 26% and all of them are 9 to 14% margins.
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Lockheed Martin
So they all are double digit percentage of revenue and double digit percentage of profit. So congratulations. We've got a conglomerate. All right, well, let's head into our analysis section. And this will be to kind of pull together a lot of the strings that we've mentioned on this episode, but codify, like, what are the real takeaways?
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Lockheed Martin
And like, let's understand this business and this institution and what it is in our world today to kind of tie together some of the things we've teased at over the course of history here. And again, few caveats. One, we know we did not tell the entire Lockheed Martin story, nor could we. Two, this is not a political or defense podcast. You can tell that I'm a conflicted person on this.
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Lockheed Martin
Let's start our analysis section with power. So what we do in this section is we analyze what it is about a business that enables it to achieve persistent differential returns, or to put it another way, to be way more profitable than their closest competitor and do so sustainably. And this is adapted from a framework that Hamilton Helmer created in his book, Seven Powers.
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Lockheed Martin
The seven are counter-positioning as a startup versus an incumbent, scale economies across a broad customer base, switching costs versus other near competitors, network economies, process power, branding, and cornered resource. Okay.
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Lockheed Martin
I don't know that there's really a market here. Yeah. And power kind of comes only in markets.
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Lockheed Martin
I can't believe it's not all made by the same company. The fuselage is made by a different company than the wings? Are you freaking kidding me? And that thing works?
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Lockheed Martin
Yeah, there's 100 years of know-how and 50 years of very well-honed ways of engaging with the customer here. The customer, again, being the Pentagon. Right. The customer. It's like Big Brother. The customer. I think you're right that we should think about it as the primes versus everyone else. It's really hard to become a new prime.
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Lockheed Martin
The $50 billion of spend that the one customer has with the one company. Yeah, it's really hard to break in and be a prime. Yeah. I mean, it's funny, like, Lockheed versus Northrup, there's not counter-positioning, really. There's not scale economies because there's one customer to amortize costs across, but you're actually not doing any fixed-cost stuff.
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Lockheed Martin
Your customer is absorbing all the fixed-cost stuff, too. switching costs, I guess, but every time there's a new program, they re-bid it out, and the government's typically excited to give it to not the incumbent because they actually want to rotate these programs around.
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Lockheed Martin
So fighter jets are typically not made by the same company two generations in a row, although Lockheed Martin has sort of shown with the F-22 and the F-35 that they have won that. I think you're right on process power broadly, but Is Lockheed Martin's process versus Northrop Grumman's process? No. Branding, I don't think matters here, really.
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Lockheed Martin
I mean, in cost plus contracting, you're just actually not willing to pay more to one company than the other. So cornered resource? No. Not versus each other. Yeah. Right. So there really isn't power. Yeah. Within the industry. But to the extent that you have already become one of these five, then together the five have power versus new entrants.
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Lockheed Martin
So as we drift into playbook, I think the lens I kind of want to take on this since we did so much analysis over the course of the episode is what are the big takeaways? Like if I'm really sitting here stewing on all this, thinking about like what matters in this episode, one of the big ones is that Lockheed Martin has a dual purpose for existing.
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Lockheed Martin
There's all the normal stakeholders involved, customers, employees, and shareholders that they want to produce value for. But there's this second thing, where they exist for the good of America and its interests, which causes some interesting second-order effects, and one being, what is the optimal number of competitors in the space?
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Lockheed Martin
The government tries to optimize this as a heavily interested party. But before 1993, there were way too many competitors. After 1998, they determined we don't want to have any fewer competitors. But it's sort of odd that there is a force that is not the market that is dictating how this plays out. Because that force, in this case the U.S.
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Lockheed Martin
government, is sort of in charge of all of our well-being in a way where they don't trust that the market will look out for that. And when I say that, I mean if you left a free market to play out, what would happen is, A, you'd sell arms to our enemies, which the government doesn't want. B, a bunch of companies would put each other out of business and we might lose our industrial base.
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Lockheed Martin
People would start outsourcing to other countries. We would potentially lose capability if the government stopped buying it for 10 years, but we wanted it 10 years later and we got in a war. Oh, this almost happened, right?
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Lockheed Martin
Right. So a market cures a lot of problems, like price, serving the best product to customers. You know, there are exceptions on all these things, but it doesn't solve for making sure that America stays globally competitive. And so the government has to put their hand on the scale in all these different ways in this market. for that reason.
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Lockheed Martin
There's a second thing here, which is we literally fund these companies to keep them alive so that they keep employees trained should we need the employees trained, which is like something that doesn't really exist in other markets.
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Lockheed Martin
Right. Of the two million people employed by the military in the United States, do we need all two million of them today? No. It's to keep people in reserve, literally.
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Lockheed Martin
Right. Yeah, this gets into sort of the like arguments for and against the military industrial complex generally. So there's this like, A, keep the industrial base strong. It's good that we have this big spend on industry because like we need to have lots of people employed there and know all this stuff.
Acquired
Lockheed Martin
There's this second one, which is like, it's literally a jobs program, where you have Congress people, as we mentioned earlier, voting affirmatively for things because it puts jobs in their state. This is kind of the most pernicious argument of any of them for a pro-big military-industrial complex. And in particular, in this book that you and I both read, Prophets of War,
Acquired
Lockheed Martin
The book basically just argues that this is all a massive misappropriation of funds and a whole bunch of people acting in their own self-interest and not for the country's self-interest.
Acquired
Lockheed Martin
Right. So this is an excerpt from that book. The irony is that almost any other form of spending, from education to healthcare to mass transit to weatherizing buildings, even a tax cut creates more jobs than military spending. And that just falls on deaf ears over and over again with these programs, F-22 in particular, as that book points out. It creates lots of jobs.
Acquired
Lockheed Martin
That argument continues to win the day. This 95,000 people are required to build the F-35. It's like, ooh, good, jobs for Americans. And that is a terrible reason to fund something.
Acquired
Lockheed Martin
Yeah. I Google sort of cornering resources on really smart people, despite the fact that they weren't getting any economic output out of them. Right. I mean, the biggest argument against dates all the way back to 1961 in Eisenhower's farewell address.
Acquired
Lockheed Martin
He gave this sort of legendary military industrial complex speech where he says, in the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought by the military industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.
Acquired
Lockheed Martin
Like, no. Right. That's not a good outcome either if everyone's preoccupied and keeping an eye to make sure big complex doesn't get too complex-y. Right. Yeah.
Acquired
Lockheed Martin
There's another one I've been thinking about, which is a parallel to our SpaceX episode, where if you'll remember on the SpaceX episode, we talked about, and gosh, that was a lifetime ago, three years, about how NASA prioritized safety over everything else. And so they took that to such an extreme where things could happen on a 20-year time span instead of a five-year time span.
Acquired
Lockheed Martin
And SpaceX came in and said, what if we do it on a two-year time span? And we figure out how to be much more iterative in our development and we're happy to explode some rockets, not with people on them. And you sort of take this, again, much more Silicon Valley approach to rapid iteration, testing your own prototypes internally,
Acquired
Lockheed Martin
being okay showing off your failures and gathering data from them whereas nasa couldn't do enough calculations before it finally was willing to do something to let something go to a launch pad and that would cause extreme delays massive budget overruns and at the end of the day it actually wasn't safer that's the important thing here in 130 or whatever it was space shuttle missions there were two that were tragic loss of life calamities
Acquired
Lockheed Martin
And so you look at that, you're like, that's actually not a great safety record. So maybe this isn't the right way to do it. Maybe calculating something to 15 significant digits of unlikely to fail is not actually the best outcome. And it sort of seems like the same thing in the military industrial complex, where we're willing to sign a contract for airplanes that we get in 25 years.
Acquired
Lockheed Martin
Because there are these like big, huge productions and it's just the opposite of the Skunk Works way of operating where test your own prototypes, do it rapidly, start moving up and up and up, crash some planes in the desert. But overall, we're going to get to the same outcome much faster on a much lower budget and maybe with equivalent or better safety. A hundred percent.
Acquired
Lockheed Martin
there are really no easy answers to the question, is what they make right or good? And that's why we entrust the decision to use their products to the office of the President of the United States. But this company's history is absolutely fascinating. There's stories of hardcore engineering, daring innovators, and it's frankly just inspiring.
Acquired
Lockheed Martin
Seriously. So this 180 day thing is a very interesting constraint placed on them. And it means that they immediately need to go to an acquired axiom that we've talked about forever. Don't do something that's not your core competency.
Acquired
Lockheed Martin
That's so true. Otherwise, you get to this thing that Norm Augustine said, how unbelievably expensive these things get if you do it the non-Skunkworks way. And we just move into this larger and larger morass that we're sort of, the direction we're basically going in, in these 25-year programs. And he says, in the year 2054, the entire defense budget will purchase just one aircraft.
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Lockheed Martin
This aircraft will have to be shared between the Air Force and the Navy three and a half days per week, except for leap year, when it will be made available to the Marines for the extra day. He really is such a character. Truly. But the craziest thing is, much like Moore's Law, he accurately predicted the rate at which aircraft prices would continue to grow starting way back in 1983.
Acquired
Lockheed Martin
He actually wasn't far off on the F-35 on sort of his prediction on how expensive it would be on the cost curve. To exactly your point... If you continue at current course and speed, we basically will have only billion-dollar airplanes going forward. They'll be made by everybody. There will be no new entrants.
Acquired
Lockheed Martin
Very slowly. When you look at Lockheed Martin as a business, they're going to do just fine for a long time. No doubt about it. They're an incredibly protected, insulated business with an unbelievably wedded-to-them customer. And the creative destruction cycle will happen on other frontiers.
Acquired
Lockheed Martin
There will be some existential need to create something that these companies are bad at creating and the U.S. government doesn't know how to buy from them. And the United States will have to figure it out another way. And whether that's cybersecurity or whether that's information warfare or whatever it is, whatever threatens the American way of life.
Acquired
Lockheed Martin
I have pretty high confidence the American government will figure out some way to make sure that we prepare for that issue, whatever that issue is. And it may or may not be from one of these companies. And it's very likely that the Skunk Works mentality ends up solving more problems for our country, but probably not from the Skunk Works division of Lockheed Martin.
Acquired
Lockheed Martin
Totally. Yeah. Operation Warp Speed is a great example of rip down all the barriers and figure out how to do something, even if there's some risk.
Acquired
Lockheed Martin
Exactly, and outsource everything else. And if you only have 180 days to do it, you are not going to become an engine manufacturing company. You are going to look around and say, okay, which of my allies has the capability to just give me an engine? So they find this British company, Halford, and they take the Halford H-1B Goblin engine, and that is what they put in this prototype.
Acquired
Lockheed Martin
Yeah, I think you're right. I think we're quickly sort of teasing out. There's sort of like two different things here. It's Lockheed Martin exists to ensure the Americanness continues. As we know it today, current course and speed as protected as it needs to be with the types of protections we need. Great. We know where to get that. And I have no doubt that will continue happening.
Acquired
Lockheed Martin
And also there will be other motivations for people to form tight knit teams and accomplish great things. And like Lockheed, Those are going to be for other threats and happen by other groups of people. And I want to hear your thoughts on that. Maybe this is the place to leave it. Rather than grading this time, let's come up with kind of the main takeaway. But I'm curious what you think.
Acquired
Lockheed Martin
All right. I think that's the right place to leave it. You want to do carve-outs?
Acquired
Lockheed Martin
Nice. You'll have like a whole niche of people that are listening to your carve outs for video game, video game recs.
Acquired
Lockheed Martin
I have two. One is something that didn't quite fit anywhere in this episode, but if you love airplanes and you are excited about the SR-71, you should Google the SR-71 Blackbird speed check story. It's an awesome story that I'm not going to spoil for you, but is about pilot jocks at their finest and a triumphant blackbird. It's a joy to read. It takes like two minutes. I think you'll like it.
Acquired
Lockheed Martin
We'll also link to it in the show notes. The second one I have... is very, very boring carve out, but it's something I've found surprising. Ego Lawn Tools, E-G-O is the brand. They make effectively the Tesla of lawnmowers. And growing up, I had like a big gas lawnmower and you'd like pull a cord to start it and it was loud and it was...
Acquired
Lockheed Martin
smelly and it was dirty and it was like gas and these are battery powered lawnmowers that are insanely powerful i have a leaf blower also that lasts like 30 minutes off of just a battery look at you you're just becoming a dad i'm finding some like very good catharsis in i just throw on audiobook and as i'm researching an acquired episode and like go do lawn work for six hours and i find that to be like greatly gratifying to get away from a screen
Acquired
Lockheed Martin
More systems integration. All right, listeners, thank you so much for joining us. If you want to become an LP, we would love to have you. Help us pick more episodes like this one in the future, acquire.fm slash LP. And when I get back from Berkshire, I think we'll do an LP call here in the next month or so. You should totally check out ACQ2 if you like hearing us interview other people.
Acquired
Lockheed Martin
I can assure you the next few interviews are going to be... Oh, they are going to be great. Even the ones that are live now, the one we just did with Jake, the one with Avlak from AngelList, the one with David from Retool, fantastic. Kamakshi with her company, Samuha, all like really fascinating discussions. Look up ACQ2 in any podcast player.
Acquired
Lockheed Martin
Now that you're done with this episode, come discuss it with us. Acquired.fm slash Slack. We'd love to have you.
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Lockheed Martin
And that is true across the aerospace industry. That's interesting that the value chain evolved this way, where basically no aircraft manufacturers to this day make their own engines. In commercial, you've got Rolls-Royce, GE, but every single one of these Lockheed planes, the engines are made by someone else.
Acquired
Lockheed Martin
So the P-80 would eventually give way to the F-104 Starfighter, which was another invention from Kelly and the team. Kelly would win the Collier Trophy for this.
Acquired
Lockheed Martin
Well, The funniest thing is when it was delayed for whatever years during coronavirus, the fighter that Maverick is in is an F-18 Hornet, the Boeing plane. And by the time the movie gets released, it's basically discontinued. Within a couple of years, that's when they end of life the F-18 Hornet for the Navy. Yeah. Did you catch the Lockheed thing in Maverick?
Acquired
Lockheed Martin
It's insane. This not taking too much money thing does become a core tenet of the Skunk Works operation because you can sort of get around management's ire and management's need to report to shareholders and things like that if you're doing amazing things and pulling rabbits out of hats. not a huge burden.
Acquired
Lockheed Martin
Yes, I love this. I think this is a huge learning. Keeping your designers as close as possible to production so the game of telephone is as short as possible and is incredibly valuable. And having the designers being able to glance up at their desk and see like literally the way things are being manufactured so they can say, oh, that looked good in the diagram.
Acquired
Lockheed Martin
But in practice, you have to bring this big thing around over here. Maybe we can make that better the next time we design it. It's just such a great key insight. The other thing on the small number of people, this gets to the Skunk Works rules. And Kelly created this incredible document, 14 rules that we'll link to in the show notes. Oh, yeah. The third of which, I mean, they're all incredible.
Acquired
Lockheed Martin
The third of which really applies here. And I quote, the number of people having any connection with the project must be restricted in an almost vicious manner. Use a small number of good people, 10% to 25% compared to the so-called normal systems.
Acquired
Lockheed Martin
And you see this in products in the future, too. The iPhone, the iPod. I mean, you read the stories about the early teams. There are six, eight, ten people. They're all full stack. So there's these unicorns that cross disciplines and they're 10x, 100x engineers. So you really only need a handful of really good people.
Acquired
Lockheed Martin
And speaking of Microsoft and ServiceNow, they just announced a huge expansion of their partnership, specifically integrating the two companies' enterprise AI assistants. Starting in the fall, customers will be able to interact with ServiceNow's NowAssist AI assistant directly within Microsoft Copilot.
Acquired
Lockheed Martin
Yes. ServiceNow's Now Assist will be integrated with Microsoft Copilot and will be available directly from Office apps, starting with Microsoft Teams. The AIs are integrated into one seamless user experience without actually sharing data.
Acquired
Lockheed Martin
So if, for example, a user asks Copilot in Teams about how the company's laptop policy works, behind the scenes, Copilot shares that request and context with Now Assist, and Now Assist accesses internal company policy with the right permissions for that user and returns the answer to Copilot in a rich card with options for the user to kick off a workflow via Now Assist.
Acquired
Lockheed Martin
In the future, Microsoft Copilot will also be integrated the other way into Now Assist so it can automatically generate Office files like PowerPoint presentations and Excel spreadsheets directly from assets and knowledge in the ServiceNow platform.
Acquired
Lockheed Martin
And you rarely have an existential threat that you must cut through all the red tape. It's like Operation Warp Speed, the way that we got the vaccines as fast as we did. If the world is on the line, what can you do away with in your processes and which people can you hand select to solve it?
Acquired
Lockheed Martin
I want to... Did we pick the same ones? I'm so curious. Yeah. We got 14 to pick from. Let's see. Let's pick three that we're going to highlight here. We already talked about number three. What are your others?
Acquired
Lockheed Martin
Yeah, I mean, this is like the auteur theory. Like, you have to have a single person's vision and the buck stopping with a single person who has ultimate control and isn't a squeezed middle manager. He's the program manager for any given program that they're working on, any new aircraft. And also, he's the guy flying to Washington to interface with the government.
Acquired
Lockheed Martin
It's not like he's dealing with the engineers and then calling the sales force and being like, hey, can you go to a steak dinner with our guy in Washington? No, it's Kelly.
Acquired
Lockheed Martin
Yep, totally agree. And in fact, it's thinking like a capitalist too. I mean, it's really like, how can we achieve the most with the least, not how can we achieve a fixed amount with a fixed margin?
Acquired
Lockheed Martin
Totally. And you got to think back. This was a time where American superiority was not guaranteed. I think we have a reasonable amount of complacency today. Americans feel very secure. Sure, there are enemies, but are we going to be fine? Totally. We don't need to think about this that much.
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Lockheed Martin
We can decide to prioritize other things and have passions and say, yeah, other people can take care of the national good because like, we'll be fine either way. That was not the belief at the time.
Acquired
Lockheed Martin
Yeah, and the war we're coming out of is World War II, but of course the Cold War against the Russians is just starting.
Acquired
Lockheed Martin
Yeah, that's a great point. When the Americans entered World War II, we had reason to believe that we could come in and win. The Cold War, I think to the American psyche, felt very different.
Acquired
Lockheed Martin
Ooh, quite the teaser, David. Well, listeners, this episode was selected by acquired LPs. So if you want to help pick an episode for next season, you can become an acquired limited partner, come closer to the show in other ways, including a private Zoom call with us every month or two for all the LPs. You can join anytime at acquired.fm slash LP.
Acquired
Lockheed Martin
Yes. So this brings us to the U-2 spy plane. And this plane serves such an important purpose that ended up being brought into service in 1955 and was only decommissioned in 1989. Yeah, incredible. Now there are many airplane programs that have 10, 20, 25 year timeframes. For very different reasons. Yes, that we will talk about in the military industrial complex.
Acquired
Lockheed Martin
But the U-2 was basically the first time that America found a plane that it could use for a long time and wasn't rapidly replaced by the next best thing.
Acquired
Lockheed Martin
If you want more from David and I, you should check out our interview show, ACQ2. Our last episode was on the topic of how generative AI can be valuable specifically to B2B SaaS companies, and probably more importantly, where it cannot. And listeners, you can just search ACQ2 anywhere podcasts are found.
Acquired
Lockheed Martin
We're not technically at war, so it would violate international treaties to go into their airspace. We would start the war by doing that.
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Lockheed Martin
Edsel Skunk Works, being the ambitious organization that they are, tries for option one. And we don't frankly know very much about what Russia's capabilities are. So we're pretty sure that we can build some airplane that flies high enough that their radar systems won't detect us. And great. So let's do that.
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Lockheed Martin
The U.S. thought that the Soviets' best interceptor fighter aircraft could get to about 45,000 feet.
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Lockheed Martin
We were like, all right, as long as we clear 65,000, we should be higher than their radar could even detect and certainly higher than their fighters could come get us.
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Lockheed Martin
So certainly you need a pressurized cabin, but if something were to happen and you needed to be out of the cabin, you know, cold, no air, blah, blah, blah.
Acquired
Lockheed Martin
Incredibly top secret. We wouldn't reveal the fact that this existed to the Russians, our own people, for years and years and years.
Acquired
Lockheed Martin
Yep. Join the Slack, acquire.fm slash Slack. We'll be discussing this episode there afterwards. And without further ado, David, take us in. And listeners, as always, this show is not investment advice. David and I may have investments in the companies we discuss, and this show is for informational and entertainment purposes only.
Acquired
Lockheed Martin
So they're flying higher than any plane has ever flown before. They're using a different type of fuel. People are flying in spacesuits for the first time. Feels like to be a reconnaissance aircraft, you would also need one other key component in order to achieve the mission of spying on the enemy.
Acquired
Lockheed Martin
Indeed. And you would need an all-new type of camera with all-new type of lens capable of taking photographs of something 70,000 feet away from you through, you know, a whole bunch of atmosphere. Gosh, if only the U.S. had someone who was just incredible at this sort of pioneering optics technology.
Acquired
Lockheed Martin
This blew my mind. It's so cool to see the intersections of different innovators throughout history. I mean, Edwin Land is the man who inspired Steve Jobs, and he's building the U2's camera.
Acquired
Lockheed Martin
Yeah. This thing, if you saw it taking off, you would be like, okay, I've seen airplanes. That thing is completely different. So it's not like they could disguise it. Like you need to figure out somewhere in the United States where there's basically nobody so that you can test this thing.
Acquired
Lockheed Martin
And then they get an idea. And that idea is, where is a place... where even if there were people before, there sure aren't people now because nobody in their right mind would want to be anywhere close to where we just tested our nuclear bombs. And they go, oh, as long as we figure out that it's safe, that would be a perfect place for us to test this airplane.
Acquired
Lockheed Martin
How insane is it that this is where we were testing nukes? I actually do not understand how there was not radiation poisoning. And I don't fully understand the half-life and all that needs to be done. But like, how is that safe?
Acquired
Lockheed Martin
100%. It's the craziest thing. They had to like sometimes take some time between the most recent nuclear test and when they wanted to go fly because these sites are like, I don't know, 12 miles away from each other or something pretty close.
Acquired
Lockheed Martin
If you're curious, listeners, there's this great documentary on Amazon called Secrets in the Sky, the untold story of Skunk Works that has a bunch of footage of all of this.
Acquired
Lockheed Martin
And of course there's rumors of UFOs there. They want to keep everyone away. For the people who they can't keep away, they're going to see some really weird flying stuff. So of course the rumors are going to start. It's all goodness for Skunk Works. This cover is great.
Acquired
Lockheed Martin
Right. It would be another 10 years before we would have the moon missions.
Acquired
Lockheed Martin
The prep work that the pilots had to go through before getting on these planes, too, were nuts. They needed to breathe pure oxygen for two hours straight. to remove all the nitrogen from their blood in case they had to eject. Because remember, these are test pilots on a super experimental aircraft. They were often ejecting or they were often, you know, things went wrong in these tests.
Acquired
Lockheed Martin
Yeah, a bunch of people died doing this, like we should say. Yeah, I mean, a great sacrifice to bring this program and subsequent Skunk Works programs into the world. But basically what was happening is if you didn't breathe pure oxygen for two hours, you could get the bends, you know, for anyone who scuba dived and you can't fly right afterwards from ejecting.
Acquired
Lockheed Martin
And so it's like, well, if you manage to get out of the aircraft before it crashed, then that could kill you. So you needed to make sure that this sort of oxygenating of your blood and getting rid of all the nitrogen made it so that if you did need to eject, then you would survive this as well.
Acquired
Lockheed Martin
We were super wrong about their radar. They didn't just have low-altitude radar. They were capable of radar that could see straight up into space. Wherever we were flying, they were going to see us.
Acquired
Lockheed Martin
But at least we get the intel now in the U.S. that, okay, they can see up here. And so it's probably just a matter of time before they're capable of shooting something down up here, too.
Acquired
Lockheed Martin
And neither country really wants to be at war. So we're both maintaining this. We're not at war, you know, and we're not going to tell you that we're preparing for if we need to be. But of course, we're going to do whatever we can to understand the best about our enemy or not our enemy, other countries that we're not at war with.
Acquired
Lockheed Martin
The other crazy thing is this camera is incredible. If you look up photos taken by the U-2 spy plane, it is remarkable what in the mid-50s this thing was capable of taking photographs of from 70,000 feet.
Acquired
Lockheed Martin
And it basically works. They find a whole bunch of nuclear test sites. They find where missiles are kept. We basically have a real-time count of the Soviet Union's warheads, the Soviet Union's fighter jets, the capabilities that they have with their radar because it's painting our airplanes. So we now know that that exists. Mission accomplished in spades on this thing.
Acquired
Lockheed Martin
Which is great. He didn't just rename Lockheed the company. He's like, yeah, I'm actually going to change my own name spelling to match it.
Acquired
Lockheed Martin
All we know is we've lost contact with our pilot and we didn't see them come back and land. So we presume that they shot down our pilot, but they're not saying anything.
Acquired
Lockheed Martin
The U-2 becomes quite useful for other locations around the globe, but not over the USSR itself.
Acquired
Lockheed Martin
Yes. And this, listeners, is where, if you've read Skunk Works or watched documentaries about Skunk Works, what we're about to talk about is not in any of those. This is a completely separate story that takes place in a different place in California that is a detour from our Skunk Works story. And we'll be back because, my God, did Skunk Works do some incredible things after the U2.
Acquired
Lockheed Martin
But before we do that, we want to take you to Northern California and the origins of Silicon Valley and Lockheed's participation in that. We want to thank our longtime friend of the show, Vanta, the leading trust management platform. Vanta, of course, automates your security reviews and compliance efforts. So frameworks like SOC 2, ISO 27001, GDPR, and HIPAA compliance and monitoring.
Acquired
Lockheed Martin
Vanta takes care of these otherwise incredibly time and resource draining efforts for your organization and makes them fast and simple.
Acquired
Lockheed Martin
Vanta takes care of all of it for you. No more spreadsheets, no fragmented tools, no manual reviews to cobble together your security and compliance requirements. It is one single software pane of glass that connects to all of your services via APIs and eliminates countless hours of work for your organization.
Acquired
Lockheed Martin
There are now AI capabilities to make this even more powerful, and they even integrate with over 300 external tools. Plus they let customers build private integrations with their internal systems.
Acquired
Lockheed Martin
So whether you're a startup or a large enterprise, and your company is ready to automate compliance and streamline security reviews like Vanta's 7,000 customers around the globe, and go back to making your beer taste better, head on over to vanta.com slash acquired and just tell them that Ben and David sent you.
Acquired
Lockheed Martin
And thanks to friend of the show, Christina, Vanta's CEO, all Acquired listeners get $1,000 of free credit. Vanta.com slash acquired. Okay, David, so I had forgotten about this story. I knew a little bit of it from watching Steve Blank's great talk maybe five, eight years ago, The Secret History of Silicon Valley.
Acquired
Lockheed Martin
But you sort of found the last 20 minutes and then just dug in like a splinter on this particular moment in history and how it is all tied into Lockheed Martin. So where are we going?
Acquired
Lockheed Martin
Yes. In typical David Rosenthal fashion, you sent me a note the other day and said, you have to listen to this starting at eight minutes and 50 seconds. And I was like, what is this? And I click and it's a guy at a podium with a terrible recording setup from the IEEE Silicon Valley history video. So industry association, this thing has 124 views after being posted seven years ago. Incredible.
Acquired
Lockheed Martin
And the government allocated millions and millions of dollars of funding to Harvard and MIT and something like $50,000 to Stanford. All of the funding for this was Harvard and MIT.
Acquired
Lockheed Martin
And he gives them tenure immediately, right? Yes. He's like, I want to make this deal as sweet as possible for you because I want to will Stanford into existence as an engineering institution.
Acquired
Lockheed Martin
The classic story is Stanford owned 1% of Google at spin out, which ended up making them an ungodly amount of money because of how big Google became. And if that were at other universities, they would have said 50% is what we need to keep or 33% is what we need to keep. And they would have smothered the innovation before it could become commercially viable.
Acquired
Lockheed Martin
As if this somehow existed a priori because it was just in the water and came from nowhere. Yeah.
Acquired
Lockheed Martin
not to make money, but to be like in the nation's service. Take the research and the people who are doing the research out, start a brand new company. He would try to help you find funding, which at that point, venture capital didn't exist. So he was introducing you to customers who could sort of pre-order from you to fund your research.
Acquired
Lockheed Martin
And he basically believed that a commercial ecosystem leads to more innovation than one that is purely happening in academia and thus could better serve... the needs of the nation. Customers. Customer. Customer. Hang on to that thought for one second. If you were doing all of this 10 years before, the university would have looked at you and said, what are you doing?
Acquired
Lockheed Martin
You're encouraging this stuff to go away from us. Oh, it would have been career suicide in academia to do this.
Acquired
Lockheed Martin
There are a lot of Skunk Works devotees, David. That is quite the assertion to say that this is a bigger deal.
Acquired
Lockheed Martin
Interesting. And this is cool. This is a part of the research that you did that I don't know much about. Yeah, this is great.
Acquired
Lockheed Martin
I didn't realize that. Wow. So how many people would eventually work in Sunnyvale at Lockheed?
Acquired
Lockheed Martin
Whoa. Oh, my God. It's a funny story. I knew at least as of 2009 that the Lockheed campus in Sunnyvale was large because when I was interning at Cisco, I went on a run one morning and I was just sort of like exploring around and I ran into Lockheed's campus and I got chased down by a security guard who's like, well, you can't just run in here. And I had my headphones in.
Acquired
Lockheed Martin
And you mentioned they need radio and they need computing. Computing basically wasn't a thing yet. I mean, Shockley co-invented the transistor just a few years before, started Shockley Semiconductor in 1955. The same time as Lockheed is coming to Silicon Valley. Right. And of course, Shockley is a predecessor to Fairchild Semiconductor, which is a predecessor to Intel.
Acquired
Lockheed Martin
So like they've got Terman's radio background, but there really weren't any people with compute experience yet. That was all happening concurrently all around them in Sunnyvale and Palo Alto.
Acquired
Lockheed Martin
I can't believe that there were 10 times more employees at Lockheed in Silicon Valley than at HP in the late 50s.
Acquired
Lockheed Martin
Oh, that is awesome. No Lockheed, no Woz in Silicon Valley, no Apple. No Apple. Crazy.
Acquired
Lockheed Martin
Not to mention, there's a really interesting point here, which is you wouldn't have this open commercial spirit to Silicon Valley without Terman and without the belief that the right thing for America was for all these companies to become companies instead of academic research or spread around in other parts of the country.
Acquired
Lockheed Martin
It creates the Silicon Valley ethos and creates Silicon Valley as the place where that ethos would thrive. And it's worth pointing out for people who don't spend a lot of time in the Bay Area, this has absolutely nothing to do with San Francisco. Nowadays, it's sort of this big blended soup of companies that have offices in both places and you can drive or take the TACAL train between them.
Acquired
Lockheed Martin
Yeah, that's a recent phenomenon. San Francisco is a completely different universe at this point that is in zero part responsible for the growth of Silicon Valley.
Acquired
Lockheed Martin
You could imagine another issue, which is these things have rockets on them. So you have to not destroy the launch pad, which is the submarine full of American humans while launching it.
Acquired
Lockheed Martin
And the craziest thing, this price that he bought it for, $40,000, was so low that Alan Lockheed actually considered bidding to buy his company back when they had it on the auction block. And his considered bid was $50,000. But he thought that is so low that it might be insulting. There's no way they'd ever sell it. So he didn't actually bid. And the winning bid was $10,000 less.
Acquired
Lockheed Martin
I'm assuming Lockheed doesn't actually make the nuclear warheads, right? Like that was still happening in national labs at Sandia and all the places that were pioneered during World War II.
Acquired
Lockheed Martin
Which weirdly, Lockheed for many years actually had a contract to manage Sandia because there's some sort of strange partnership that happens where the federal government hires government contractors to manage national labs.
Acquired
Lockheed Martin
Man, I just got to say, it is so fortunate and insane to me that neither side ever launched. All the deterrence for all the scary things that could have come out of it and all the itchy trigger fingers and everybody getting close, it never happened. That is a big applause to humanity that we could have done this and no one did.
Acquired
Lockheed Martin
Yeah, it's crazy. Okay, so Lockheed, after four years successfully, does the underwater ICBM launch. Yes.
Acquired
Lockheed Martin
In fact, we probably should have bragged about this even if it wasn't real. Right. Maybe it wasn't. Who knows? We should have had inflatable subs floating around that we thought were nuclear. Maybe it's all the cover.
Acquired
Lockheed Martin
Speaking of cover, do you know about the things we did on top of the factories when we were building airplanes? Oh, yes. And Disney was involved.
Acquired
Lockheed Martin
Yeah, starting way back in World War II, but I think continuing after that, in the Burbank facilities at Lockheed, I know Boeing in the Seattle area and other places too, built basically these burlap cities on top of factories that looked like suburbs, complete with 3D cars and trees and stuff, so that anybody who was creating a spy plane and flying overhead would mistake...
Acquired
Lockheed Martin
It's crazy how sometimes it's in our best interest to make the adversary aware of our capabilities, and sometimes we want to disguise capabilities. It's really interesting. Super interesting.
Acquired
Lockheed Martin
And you might know that eventually after the U-2, Skunk Works would create the next great spy plane, the SR-71, which we will get to. But that wasn't for a little while. So this intelligence gap was filled by this secret, not very well-known project.
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Lockheed Martin
Yeah, I downloaded it and I have it open my computer. It's pretty crazy. It says secret. It has the classification on it and then it's struck through. Yeah. It's literally the document that was prepared in secret and then declassified.
Acquired
Lockheed Martin
Wow. Just amazing. But on the declassification website, which we'll link to in sources, you can see a bunch of the pictures that the Corona satellite took, including of the Pentagon. So you can see like something, you know what it looks like, and you can see the level of fidelity that this 1959 satellite got of that.
Acquired
Lockheed Martin
And listeners, you know this plane. It's one of those romantic early aircrafts that were always sort of perched up at an angle where if you saw it standing still on a runway, it looked like it could just take off at any moment.
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Lockheed Martin
Unbelievable. There's a crazy stat. Over 800,000 images would be taken by these satellites over the course of the program. They got an enormous amount of coverage.
Acquired
Lockheed Martin
Which they literally did. And how did they do it? They dropped it. Okay, so this is the craziest thing. They dropped from space a canister with film in it. Mind you, they can't mess up and expose the film and ruin it. This is very delicate film. They drop it in a canister from orbit. It enters the atmosphere and during all the heat and everything.
Acquired
Lockheed Martin
Right, because if you just drop it out behind you, then it stays in orbit. It needs to decelerate its rotational velocity so that it does move closer to the Earth. It is in a custom-designed canister called the film bucket that General Electric designed. It would separate and start falling to the Earth
Acquired
Lockheed Martin
After the incredible heat and violent action of moving through the atmosphere, the heat shield that surrounds the vehicle is jettisoned at around 60,000 feet. So again, where the highest airplanes can start to fly and parachutes would be deployed. So you've got this film canister.
Acquired
Lockheed Martin
Coming down with a parachute. The capsule is designed to be caught in midair by a passing airplane towing a claw. The claw grabs the parachute and they use a winch to bring the film capsule into the airplane.
Acquired
Lockheed Martin
Unbelievable. You might say, what if the C-130, which, by the way, a Lockheed airplane that still flies today, the C-130J, what if the airplane misses it? Seems like that's a pretty reasonable probability when this thing's falling from space and you're trying to catch it with a moving object.
Acquired
Lockheed Martin
It can land at sea, and there's sort of a self-destruct mechanism where there's a salt plug in the base that dissolves after exactly two days, which if that happens, then the film sinks forever to the bottom of the sea. So if the Navy can't retrieve it within 48 hours, the salt sort of dissolves enough.
Acquired
Lockheed Martin
Right? The whole thing is genius, crazy, and absolutely insane that it actually worked.
Acquired
Lockheed Martin
You would need to. Because how else are you... I mean, when you have a satellite orbiting the Earth that fast at, I don't know what it is, Mach 20-something, it's pretty hard to predict exactly where your tiny film canister is going to come back and land.
Acquired
Lockheed Martin
And this is great because before I started the research, I was loosely aware that Lockheed had the first Skunk Works. Now it's become almost like Kleenex when someone says Skunk Works. Oh, we're going to start a little Skunk Works division. And like, it was not a thing until Kelly Johnson started the Skunk Works.
Acquired
Lockheed Martin
And I think they sort of pioneer the concept of a second stage. Like we need a first stage to get us up and then we need a second stage to get us to a very particular orbit that we care a lot about being in.
Acquired
Lockheed Martin
By the way, they returned 39,000 man-made objects from space. They took 2.1 million feet of film of photographs in 39,000 cans.
Acquired
Lockheed Martin
Yeah, it's the first obviously mapping of Earth from space. It's this first stereo optical data from space. It's the first reconnaissance program to fly 100 missions at all, let alone one in space. I mean, this thing operated for 12 years.
Acquired
Lockheed Martin
You basically would need larger format film with a wider angle lens if you don't want to increase your number of satellites.
Acquired
Lockheed Martin
Yeah, Lockheed built all this in Silicon Valley. Wow. By the way, you keep saying Google Maps. There's a fun piece of trivia that I'm curious if you know. Do you know, I think it was the code name, the original name for the Corona program?
Acquired
Lockheed Martin
Yep. Different keyhole. Different keyhole. But I'm pretty sure Keyhole Inc., which became Google Maps, was named after this keyhole program. Ooh.
Acquired
Lockheed Martin
Well, that's when you get into like all the synthetic aperture radar and all the other types of sensing that you have in satellites now that are not just the visible light spectrum in order to get visibility of stuff on the ground, no matter the conditions.
Acquired
Lockheed Martin
Did you know that? I did know that. And Martin Marietta, future Martin and Lockheed Martin, built the large orange fuel tank for the space shuttle, which took the Hubble telescope to space. Haha, that's so awesome. Different companies at the time, now the same company. Yep. All right, listeners, our next sponsor is an old friend of the show, Modern Treasury.
Acquired
Lockheed Martin
As you may know, Modern Treasury is the payment operations platform for faster payments.
Acquired
Lockheed Martin
Yep. And money is moving to a real-time future. In today's world, consumers expect instant access to goods and services, and businesses need real-time ways to track revenue, respond to customers, etc. So with software-powered business models, markets that never sleep, and faster ways to pay, it is clear that the instant economy is here.
Acquired
Lockheed Martin
To stay ahead, businesses just need to move, track, and reconcile their payments at real-time and at scale.
Acquired
Lockheed Martin
If you, your company, or your portfolio companies want to transform your payment operations and join the instant economy, head on over to moderntreasury.com slash acquired, or click the link in the show notes and tell them Ben and David sent you.
Acquired
Lockheed Martin
Huh. Which isn't true anymore. Or at least it's not their largest business today.
Acquired
Lockheed Martin
Welcome to Season 12, Episode 5 of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert.
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Lockheed Martin
Wow. It really is a completely different company today. And I want to save why as we drift toward today and analysis and all that, but that's crazy how big the LMSC business was at the time.
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Lockheed Martin
Or so they thought. I mean, if they knew about this robust spy satellite system... Well, this is the argument. Maybe it wasn't that important.
Acquired
Lockheed Martin
Yeah. Okay, we have not talked about the SR-71. Can you please take us back to Skunk Works? I'm like dying for my Mach 3 airplanes and ribbon engines here.
Acquired
Lockheed Martin
Was there a threat-based need? Okay. Okay. So, Skunk Works, the greatest airplane ever built. Gee, it sure would be nice if we had a plane that couldn't be shot down.
Acquired
Lockheed Martin
So it's not very fast, and it doesn't fly high enough to evade missiles. So kind of useless? Yeah.
Acquired
Lockheed Martin
And then three. Make it go so fast that even if they do fire at you, it just falls behind and then explodes miles behind your incredibly fast airplane.
Acquired
Lockheed Martin
It has an even better camera, I think also designed by Edwin Land, and it can get these incredible photos flying really, really fast.
Acquired
Lockheed Martin
If you fire a rifle, that bullet doesn't go Mach 3. If you're standing on the ground and you pick up a rifle and you shoot it and an SR-71 flies over your head, the SR-71 will beat the bullet.
Acquired
Lockheed Martin
This thing also is not very good at turning, as you would imagine. So there's a fun stat about the SR-71. It cannot turn around in the state of Ohio. Its turn radius to change direction by 180 degrees is a wider turn than the state of Ohio. Oh, wow. Its decommissioning mission, just to show off how fast it ever went, was one hour and five minutes from LA to DC.
Acquired
Lockheed Martin
Totally. It flies at 84,000 feet. Up looks black to you. Straight basically looks black to you. You can see the curvature of the Earth. You can't navigate really by Earth-based landmarks because... the Earth-based landmarks are moving by you too fast. So the best you can do is be like, the Rockies are in front of me, oh, the Rockies are behind me. And that's not terribly useful.
Acquired
Lockheed Martin
So they had to invent a new navigational guidance system that sits on the top of the plane, R2-D2 style, looking like an astromech from Star Wars, to navigate by the stars.
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Lockheed Martin
I mean, it is like 50 concurrent miracles that went into making this thing possible.
Acquired
Lockheed Martin
And these aren't rocket engines. These are jet engines that they figured out how to make go Mach 3. Yep.
Acquired
Lockheed Martin
You should Google a picture of this dude. He is just a 1930s man's man at his finest.
Acquired
Lockheed Martin
It is still to this day, unless there are classified programs we don't know about, the highest and fastest humans have ever flown without rocket propulsion. Yes. Okay, so how are you going to do this?
Acquired
Lockheed Martin
The skin of the airplane gets to 500 degrees Fahrenheit. The area near the engines on the airframe itself gets almost to 1,000.
Acquired
Lockheed Martin
And when you hear the stories about him, he could intuit the answer to difficult math problems in his head. And not just math problems, but like physics problems and applying Bernoulli's principle in his head and come up with an answer that was 5% off from the actual answer.
Acquired
Lockheed Martin
And by the way, you can't machine titanium with regular tools. Right. Titanium is so hard that it will damage your tools. So they had to machine new tools for the Blackbird itself out of titanium in order to manufacture the titanium plane.
Acquired
Lockheed Martin
Totally. And I think traditional materials like aluminum would lose its strength around 300 degrees. So like you actually need a different material. Otherwise, the whole plane would just dissolve when it got that fast.
Acquired
Lockheed Martin
So there's another funny thing here, which is metal expands when it gets hot. And normally your airplane materials don't get that hot because you're not going that fast. So it's fine if the metal expands a little bit. Except when it's getting this hot, the panels, the skin of the airplane is going to expand quite a bit. So that means if... They expand a lot. You have to leave a lot of room.
Acquired
Lockheed Martin
So how do you leave room? So what they want it to do is fit together really snug while the plane is flying, which means the panels have to fit together kind of loose when the plane's not flying.
Acquired
Lockheed Martin
The Blackbird had panel gaps and to add insult to injury, there are a variety of reasons they decided not to have custom fuel tanks. They literally just made the skin of the aircraft, the fuel tank itself. So you didn't need sort of multiple, you needed it to be light. Yeah. And you needed a lot of fuel in there. Right.
Acquired
Lockheed Martin
And so when it was on the ground after you fuel it up, because there's gaps in the fuel tank, it would just leak fuel while it was sitting on the ground. So to solve this problem, they went to Shell and had a custom fuel created for it that was not flammable on the ground.
Acquired
Lockheed Martin
Like you could smoke a cigarette next to it and it wouldn't burst into flames because after you fuel this thing before it took off, it's just going to leak fuel all over the tarmac.
Acquired
Lockheed Martin
And someone else would go spend hours and hours and hours with pencil and paper and slide roll to come to basically the same number.
Acquired
Lockheed Martin
And we should tell people the Blackbird, the SR-71, was the two-seater Air Force version of the single-seater A-12 CIA airplane. Yep. So even the J-58s,
Acquired
Lockheed Martin
If you live in Seattle, go to the Museum of Flight. There's a handful of these at various museums around the country.
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Lockheed Martin
Obviously, Dave and I are fanboying this thing. It's really easy to feel good about this airplane because it also never carried guns. It only carried cameras. You couldn't shoot bullets out of it because it's faster than the bullets. Right. Right. But they did consider, I think Kelly and the Skunk Works team were really advocating to build a tactical aircraft that was based on this or a bomber.
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Lockheed Martin
And that never happened. So every version of the SR-71 or their early prototypes of the Archangel or the CIA spy plane, they're only ever badass airplanes that carry cameras.
Acquired
Lockheed Martin
And we are your hosts. Today's episode is on a critical piece of American infrastructure, Lockheed Martin. They are the nation's largest defense contractor. They're actually the federal government's largest contractor, period. The American taxpayers pay Lockheed Martin around $50 billion a year. And just to state this early and clearly, Lockheed Martin makes, among other things, killing machines.
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Lockheed Martin
Yes. And the SR-71 is strategic reconnaissance, but it ended up being backwards. Yeah, so funny.
Acquired
Lockheed Martin
It, I believe, has never been shot down. There were some accidents in test piloting. But yeah, it's never been hit by an enemy. I think it took four years to ever even be detected by radar for the first time, all the way until 1968. Yeah. It has played roles in surveillance in Vietnam, Korea, Arab-Israel conflict in the 70s, obviously the USSR.
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Lockheed Martin
It is just such an awesome, badass thing to say the way that we're going to get around getting shot down is just to be faster than the missiles and be right about that.
Acquired
Lockheed Martin
Man. So this is a good time to talk about that. You keep saying that I had no idea until you brought that up, what, an hour ago. I think you're right.
Acquired
Lockheed Martin
So the Blackbird doesn't fly today. Civilians are unaware of something that has flown faster. There's a crazy stat, a little bit of trivia about the SR-71. And this really puts into context... how early this was and how strange it is that we've had nothing faster since, the SR-71 first flight was closer to the Wright brothers than today. Yeah, wild, right? It's totally wild.
Acquired
Lockheed Martin
And I mean, this whole thing was built with slide rules. I had a very controversial tweet get community noted where I said that it was before the invention of the desktop calculator. It's like mostly true. There's technicalities to it. But, you know, Kelly and team basically did this thing independently of computers and calculators and figured out all the unbelievable aerodynamism stuff about it.
Acquired
Lockheed Martin
Of course, there's also, it's the first stealth airplane. I mean, that's the other thing that we didn't talk about is the reason this thing wasn't detected on radar for four years because they figured out how to fly and start to evade radar.
Acquired
Lockheed Martin
It's not that, I don't think. It's more around the shape because radar will just go unimpeded, you know, out into space. There's famous stories about detecting where people's radar transmitters are by bouncing them off the moon and figuring out the patterns of bouncing off the moon.
Acquired
Lockheed Martin
It's more, I think, that the SR-71's bottom was one of the first airplanes with a flat bottom rather than a rounded fuselage. And so imagine I'm shooting a set of waves at a round sphere in front of me. Well, some of those waves are going to bounce back because some of that sphere is exactly perpendicular to me broadcasting it. There's one particular point that's exactly perpendicular to
Acquired
Lockheed Martin
And I can kind of tell the radius of the thing by how I'm detecting waves that are bouncing back at me. But if it's all flat, there's only one very specific angle for which I can shoot waves at it where I'm perfectly perpendicular. And every other angle that I shoot radar at it, it's going to bounce off and not come back to me as a transmitter. You'd need transmitters...
Acquired
Lockheed Martin
coating all over the earth to figure out where all those waves are bouncing. And so by making the bottom flat, they made it so that if it was truly flat, then there's only one exact moment in time that a given radar transmitter is useful.
Acquired
Lockheed Martin
They also did a whole bunch of work around making the rivets exactly flush with the skin. So it basically didn't have a whole bunch of rounded parts that could risk bouncing radar waves back at the transmitter receiver.
Acquired
Lockheed Martin
And it's like, we're serious about telling you we're done ordering these things and we don't want political maneuvering to spin it back up. So we're going to be prohibitively expensive for you or for anyone to ever think about starting the program back up.
Acquired
Lockheed Martin
And it is still, they call it out in their earnings like today. They're still selling F-16s today.
Acquired
Lockheed Martin
Like the idea of Skunk Works losing a contract, this is crazy. And in particular, he didn't really want to play ball the way the government was trying to bid out the contract. He looked at the requirements. He said, this is stupid. I'm going to design you an airplane that I think meets the needs of how this will be used in the field rather than what these technical specifications say here.
Acquired
Lockheed Martin
And over the long run, he was right. As the program evolved, the specs actually changed to what Kelly decided to build their prototype airplane to do. But the prototype they produced was not in spec for the original F-16 requirements.
Acquired
Lockheed Martin
Not to mention, all military muscle is very unpopular in America. And so any politicians who are seeking to sort of expand the might and budget and proactivity of the military are facing a lot of resistance at home. And that is probably a good thing for our society that that was happening. And at the same time, it made Kelly kind of a relic.
Acquired
Lockheed Martin
Back to Skunk Works. There is one more great Skunk Works airplane, and it is under the administration of Ben Rich, Kelly's successor.
Acquired
Lockheed Martin
So there's a math paper published in a Russian journal. Around mid-1970s, right around this time. Which I think gets published because the Russians don't really see anything of value in there. They don't really know exactly what these particular equations that are getting published could be applied toward.
Acquired
Lockheed Martin
Yeah, this is a thing that was eye-opening to me doing the research. Lockheed's big customer in World War II before the U.S. enters was Britain's Royal Air Force. They were a way bigger customer than the U.S. was for many, many years.
Acquired
Lockheed Martin
But somebody at the Skunk Works reads the paper and says, huh, I think all the ways that we've been thinking about trying to make an airplane stealth, like the SR-71, with flattening the bottom a little bit and trying to use particular materials and paint and stuff like that, I think it's good. But if I apply these equations to make a stealth aircraft...
Acquired
Lockheed Martin
then I think we can do something two orders of magnitude better than anything we've done before. And I think we can make an airplane go from looking smaller than it is, like a bird on a radar, to something like a BB on a radar.
Acquired
Lockheed Martin
And he's told, don't stick your neck out. No one's getting the crazy amount of rope that Kelly had. So prepare to just be Lockheed's yes man. And we're going to use the Skunk Works for branding and marketing, but we're not doing anything too nutty in your little shop over there.
Acquired
Lockheed Martin
And in particular because when you apply these equations to design an aircraft, the way you have to design it makes it incredibly not aerodynamic. If it works, it will be a thing that is invisible on radar, but Kelly sort of looks at some of the early sketches of what you would have to do to make this thing into an airplane and basically thinks, that's not an airplane. That won't generate lift.
Acquired
Lockheed Martin
And it's not just that it doesn't look beautiful. It's that literally there's like only a hint of Bernoulli in there. The way that it's shaped is unclear that it will generate enough lift to lift itself.
Acquired
Lockheed Martin
Yeah. So what's being proposed here is basically an enormous looking cockpit, this big globular fuselage, and you can Google the F-117A. The name is the Nighthawk. stubby wings, these two little super thin, tall tail fins. It looks super unstable, and the whole thing has basically zero round surfaces on it. It's faceted. I mean, it looks like a diamond.
Acquired
Lockheed Martin
In fact, its codename, or I would say probably not its codename, but its nickname internally, was the Hopeless Diamond.
Acquired
Lockheed Martin
But it doesn't look like it'll fly or fly in a controllable way. It looks like you made an airplane, like a paper airplane, and then you put a rock on top of it and you were like trying to get that thing to fly.
Acquired
Lockheed Martin
Right. Yeah. So Ben Rich decides that he wants to put his career on the line.
Acquired
Lockheed Martin
Which this is not something that defense contractors do. No. We'll talk about this as we get into Playbook, but it's not like a tech company where you do a bunch of forward-looking R&D and then amortize it over a bunch of customers later. You go bid on a contract, you get that contract, and then you build the thing.
Acquired
Lockheed Martin
No, it's like, what does the Pentagon think? Which is a good and a bad. They're unbelievably customer-focused. Lockheed Martin doesn't build stuff unless the U.S. government says, I'll order it, which means they don't have to take a lot of risk. But on the other hand, they also don't get the upside from taking risk, typically.
Acquired
Lockheed Martin
It's unbelievable. The thing is all flat surfaces. So it basically bounces the radar everywhere except for the transmitter receiver that is actually shooting the radar waves at it. So will it fly and can you control it are still open questions, but we now know that it is like, oh my God, radar invisible.
Acquired
Lockheed Martin
It's abstracting away your inputs and doing the thing that is optimal based on what it's pretty sure your inputs want it to do.
Acquired
Lockheed Martin
I don't blame all these people with the binoculars who are pretty sure there's aliens.
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Lockheed Martin
Side note, I will say last week, partly in preparation for recording this, but partly because it's something that I've always wanted to do, I went to Pearl Harbor. And there is truly nothing like... being there and experiencing that. Growing up in America, we basically haven't had attacks on our soil. It's 9-11 and Pearl Harbor, period.
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Lockheed Martin
So that's what, six years that they keep it undeployed where they have it, but the U.S. government has decided that we want to save it right now.
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Lockheed Martin
I think that's right. I mean, yeah, the F in F-117 is fighter. The SR-71 was not an F plane.
Acquired
Lockheed Martin
They came in under the dark of night. No one knew they were coming. They hit a bunch of the high value targets. And then these wars now tend to be these overwhelming force at the start and then long, long drawn out. battles after that, but this set the stage for what the modern military engagement looks like.
Acquired
Lockheed Martin
And so while this plane was a massive success for what it was intended to do, this is where I sort of want to stop glorifying some of the military might the way that we did in the Cold War, which was like, obviously for deterrent. This is when the foreign policy sort of changes a little bit in a way where you're... Yeah, people are dying here. Yeah.
Acquired
Lockheed Martin
So it's a very unusual thing to see in your own country the remnants of an attack. And being over the sunken USS Arizona from the Japanese bombing, it's harrowing and heavy. But I think that that's an experience I'd recommend to anyone.
Acquired
Lockheed Martin
For the F-117A, 10,000 people worked on this airplane, the Nighthawk, and kept the secret for 21 years until it was declassified.
Acquired
Lockheed Martin
And Boeing today, which is not Boeing, but Boeing and McDonnell Douglas and this incredible era of consolidation.
Acquired
Lockheed Martin
Yeah. And then you have Raytheon and General Dynamics, which have eaten their fair share of all the other competitors, too.
Acquired
Lockheed Martin
And we need to start nuclear disarmament. We need to start destroying a lot of the nuclear warheads that we build.
Acquired
Lockheed Martin
This doesn't happen in America. Very explicitly. And this was rumored for a long time. People were like, wait, did this really happen? The U.S. government instructed these big companies to become anti-competitive, to all merge together? Yeah. And this 1993 thing really kicks off an era of intentional government policy around combining companies. Yeah, which is very odd.
Acquired
Lockheed Martin
And in part, they're basically saying, look, it's an acknowledgement that a lot of the times companies thrive because they're in growing markets. And this is now a shrinking market. And so what do you do if you want to
Acquired
Lockheed Martin
maintain America's military industrial base but you know for a fact the market is shrinking this year and likely every year for the next decade or two like what do you actually do and so I think the intent here is to say we don't want to lose capability we want the US to remain a a country that has a whole bunch of people that know how to build this stuff.
Acquired
Lockheed Martin
So if we need it, it's there, but you're gonna put each other out of business because we just won't have enough for you. So you need to like merge and get more efficient so we don't lose the muscle But, you know, you all have real businesses, real going concerns.
Acquired
Lockheed Martin
And this whole, like, so you don't lose the muscle thing, that is unique on this episode versus any other episode because the government is an indifferent player in almost every episode, every company that we talk about. But in this one, they're an extremely interested party where it is in the national interest. They are the customer. Right.
Acquired
Lockheed Martin
It is in the national interest for us to maintain this capability, or so that's the sort of policy.
Acquired
Lockheed Martin
Except they didn't merge everything about. There's two spin-outs of the Lockheed Martin combination. One is there's another set of things that Martin Marietta does around minerals and mining. And so there's literally a Martin Marietta company that's publicly traded today that still exists that's around mining raw materials. Do you know this because you looked up the mine safety disclosure?
Acquired
Lockheed Martin
I was disappointed to see that there were no mine safety disclosures in Lockheed Martin's financials. There's another thing that spins out called L3 communications, which is the set of things that won't be combining into Lockheed Martin. And this has actually become a fairly formidable competitor today.
Acquired
Lockheed Martin
There's the five big primes, Lockheed Martin, Boeing, Raytheon, Northrop Grumman, and General Dynamics. And L3 is kind of... growing, which is fairly unprecedented in this era of primes. But you might be saying, what is the L3? Well, there were three Ls involved in creating this company. One of them was the investment bank that helped combine them, Lehman Brothers. Lehman Brothers, yes.
Acquired
Lockheed Martin
Right. This is like Lockheed Martin sort of like looks at the DOD and they're like, are we supposed to keep going? Yeah.
Acquired
Lockheed Martin
Yeah. I mean, the thing with the five big primes is they're all very good at a certain bucket of things. And so if you start combining Lockheed and Northrop, which are the two that really kind of like bid against each other at this point in history, I mean, like the B-2 bomber and the B-21, like there's often this face-off between Northrop and Lockheed.
Acquired
Lockheed Martin
Do you know why that happened? Oh, I do not. So we're going to talk here in a second about the F-22 program and the F-35 program. We'll skip over the F-22 for the moment just to hit this point. For the JSF, the Joint Strike Fighter, F-35 program, this is going to be like the biggest ever military contract. And so it's really worth going for.
Acquired
Lockheed Martin
And there's three companies that are worth gunning for in the mid-90s. There's Lockheed Martin, right after their combination. There's Boeing. And there's still independent McDonnell Douglas. And... McDonnell Douglas is eliminated from competition. So it just comes down to Boeing and Lockheed as the two finalists. Within a month, Boeing announces that it's buying McDonnell Douglas.
Acquired
Lockheed Martin
Exactly. This contract is so big and they were betting so heavily on it that basically Boeing and McDonnell Douglas after McDonnell Douglas loses kind of need to just combine and size up in order to be a formidable competitor to Lockheed Martin going forward.
Acquired
Lockheed Martin
I do. It is a $30 billion DOD contract for 398 airplanes just for the U.S. We'll talk about that in a minute, but it was a prize worth going for.
Acquired
Lockheed Martin
Yeah, and you basically have a situation where all these contracts kind of go to all of the contractors. They just rotate around who's the prime on it, and the prime makes the most money, and then it has the most sort of sway, and you don't want to be with a subcontractor. You'd rather be the prime contractor. But still, this current military-industrial complex is very...
Acquired
Lockheed Martin
All five players are basically in on all the big contracts and the government's very aware of that and the companies are all very aware of that and it's sort of reached this stasis.
Acquired
Lockheed Martin
So Ben Rich basically called it in 1992 when he was talking about, this at the end of the Skunk Works book, about the end of the B-2 bomber program. Which, by the way, the B-2 was kind of a make-good when they gave that to Northrop Grumman. This is the stealth bomber? Yeah. By all means, that should have gone to Lockheed Martin. They had the expertise from the F-117A, Nighthawk, and...
Acquired
Lockheed Martin
I mean, this is the Lockheed side of the story, but they beat the B-2 in a lot of the early competitions. But the government still gave the award to Northrop Grumman because there was some particular plane that the government said Northrop could manufacture a bunch of and then sell internationally and then change their mind. And so then Northrop was sort of left holding the bag.
Acquired
Lockheed Martin
And so it's the Department of Defense being like, all right, you can win this competition. And who knows if any of these things are true? That's Lockheed side of the story.
Acquired
Lockheed Martin
But anyway, Ben writes, under the current manufacturing arrangements for the B-2, Boeing makes the wings, Northrop makes the cockpit, LTV makes the bomb bays, and the back end of the B-2 airplane, in addition to 4,000 subcontractors working on bits and pieces of everything else.
Acquired
Lockheed Martin
Because of the tremendous costs involved, this is probably a blueprint for how big, expensive airplanes will be built in the future. For better or for worse, this piecemeal manufacturing approach, rather than the skunkworks way, will characterize large aerospace projects from now on. With many fewer projects, the government will have to spread the workaround across an even broader horizon.
Acquired
Lockheed Martin
And for anyone who's not an av geek out there or an aviation geek, it's worth knowing going from a prop airplane to a jet airplane is not just incremental. It's an entirely different technology. You may have heard the phrase, if you've looked into this before, suck, squeeze, bang, blow.
Acquired
Lockheed Martin
What will happen to the efficiency, the quality, and the decision-making? At a time of maximum belt tightening in aerospace, those are not just words, but may well represent the keys to a company's ability to survive. Yep. So I think that sort of 1992 Ben Rich publishing the Skunk Works book, then The Last Supper, it basically marks the end of Skunk Works.
Acquired
Lockheed Martin
Skunk Works is still a term that is used to describe a part of Lockheed Martin, but is it the Skunk Works of the 50s, 60s, 70s? No, not at all. It's a completely different thing. And airplanes are just not built by small teams in this sort of auteur way, the way that they were in Kelly's era. So let's talk about some of these huge programs, these large fleets of planes that the U.S.
Acquired
Lockheed Martin
government has bought in recent years. And we'll start with the F-22. And this gives you a sense of how freaking long these timeframes take. So in 1981, the Air Force identified a requirement for an advanced tactical fighter to replace the F-15 Eagle and the F-16 Fighting Falcon. So that sort of kicks off this, we're going to need some future thing.
Acquired
Lockheed Martin
In 1985, the initial order, and I don't know if it's technically an order or how it sort of changes over time, but the initial pseudo commitment is for the U.S. government to buy 750 planes of what becomes the F-22 Raptor for $44 billion in the total program cost.
Acquired
Porsche (with Doug DeMuro)
It's definitely Porsche. Porsche. Porsche. Yeah, definitely don't say Porsche. Definitely don't say Porsche.
Acquired
Porsche (with Doug DeMuro)
Yeah. And it's fair to be like, are you a 911 plus supercar person or a Ferrari person? But the rest of Porsche shares the name Porsche, but is a completely different thing.
Acquired
Porsche (with Doug DeMuro)
It's almost like Porsche should go get even more aggregate market cap by like spinning out just their like hyper car there. The 911s. Yeah. Like just the real sports car.
Acquired
Porsche (with Doug DeMuro)
It's the funniest thing, because David, my closest friend, drives a Porsche Macan, and his wife drives an Audi. Oh, this is a totally different thing. This says something very different about who I am. She was driving his car the other day, and she was saying, ugh, I hate being seen in there. or that you don't want to be driving around a $75,000 Porsche, and yet this thing that you have.
Acquired
Porsche (with Doug DeMuro)
Right, it's like getting the Masters logo embroidered on your golf clubs. It's like, okay, I know you didn't play in the Masters, but like... Okay, that's cool.
Acquired
Porsche (with Doug DeMuro)
Model 3. That's a good guess. That's what David drives, and that's probably what I would. Mazda CX-5.
Acquired
Porsche (with Doug DeMuro)
Okay, so more back to Porsche. A couple other interesting observations just for listeners trying to keep track of home of like, what are the profiles of these businesses look like?
Acquired
Porsche (with Doug DeMuro)
I always think gross margin is an interesting place to look to understand the strength of a brand, because it's basically showing like, what can you mark up over your cost of goods sold and sell it to people and still have them swallow that price? Right. BMW, as we mentioned, 10 times more units of BMW sold than Porsche's, are down at 17% in terms of gross margin.
Acquired
Porsche (with Doug DeMuro)
So they really aren't marking up much above their cost of goods in order to ship those cars. Mercedes is a little bit better at 23%. Porsche is at 29%, so about 50% higher than BMW. Ferrari is 48%. So people who are buying Ferraris do not care what it costs.
Acquired
Porsche (with Doug DeMuro)
And to put it another way, because let's round 48% to 50%. If you have 50% gross margins, it means you go buy a bunch of stuff, you assemble it, and then whatever it costs you, you double that to sell it to the customer.
Acquired
Porsche (with Doug DeMuro)
So switching gears, but staying on gross margins, because David, you brought up LVMH earlier. LVMH's gross margins, 68%. It turns out you can mark up leather way more than you can mark up cars. Like, at some point, there is some sensitivity to, like, you can't just make every Ferrari cost $8 million. Because, like, there's so much real hard costs in cars that are just not in other luxury goods.
Acquired
Porsche (with Doug DeMuro)
And so you have this opportunity to generate— Carbon fiber ain't cheap. Unbelievable price premiums in all the stuff LVMH owns. If you can touch it, if it feels good on your hands or it looks good to your eyes or it smells nice, you have the opportunity to market up way more than sitting in something that is going to thrill you. How interesting.
Acquired
Porsche (with Doug DeMuro)
This is really interesting trying to understand which of these businesses you'd sort of rather own. And gross margin isn't everything, but it is amazing that LVMH is truly in a league of their own on gross margins. Yeah. Yeah.
Acquired
Porsche (with Doug DeMuro)
Yes, and it takes a really special type of person and team to run it. I mean, it's engineering and art, whereas there's not engineering in anything that LVMH owns. I mean, I'm sure there's people who work there whose title are engineer, but... No, it's crafts. Yeah. It's craftsmen. 68%, that's... Yeah.
Acquired
Porsche (with Doug DeMuro)
So if I were to guess, I would say maybe Bernard Arnault has kicked the tires on like Ferrari, Lamborghini, but more on like licensing agreements than trying to own those businesses. Because I just don't think it actually works into the rest of the flywheel in the same way. Like you got to own a factory that makes these cars. You got to do all the R&D.
Acquired
Porsche (with Doug DeMuro)
Should we talk power? Let's talk power. Yeah. So for any listeners who are new, and based on the Lockheed episode, a lot of listeners are new, there is a section we do called Power, which is a way that we try to figure out what enables a business to achieve persistent differential returns above their nearest competitors.
Acquired
Porsche (with Doug DeMuro)
So why are they more profitable on a durable basis than other people who compete against them? And this is always a fun thing to try to analyze because you're like, what actually is it for a business that has pricing power that they get to mark up their goods? And so we just talked about Porsche having better gross margins than BMW or Mercedes, but not as good as Ferrari.
Acquired
Porsche (with Doug DeMuro)
Ferrari couldn't make the number of cars that Porsche does and maintain those margins. So that's not really a fair direct comparison in terms of who their competitor is. But BMW also makes 10 times more cars, so that may not also be the right comparison. And this, I think, is an interesting point, which is Porsche's kind of in a league of their own in making the number of cars that they do.
Acquired
Porsche (with Doug DeMuro)
It's like this magical sweet spot where they get to be a luxury brand car. without making so few things that you can barely even work with the company.
Acquired
Porsche (with Doug DeMuro)
I think you're right that scale economies enable them to be in the SUV business, which has great margins. And that's a thing that you would need to have all these deep partnerships with other car brands in order to do that or be owned by one.
Acquired
Porsche (with Doug DeMuro)
There's a specialness to it. Okay, so moving through them. Branding, yes, obviously. Especially if you're trying to enter any space and compete with a luxury brand, you don't have the heritage. There's just no way that you have the 75 years of people believing in your brand and thus willing to pay extra margin dollars for it. So that's the obvious one. And you can't manufacture it either.
Acquired
Porsche (with Doug DeMuro)
Yeah, but there will be another racing event. There's another thing. I think that's myopic to think that 75 years from now, people won't obsessively care that some new brand was forged in the 2020s that had some other je ne sais quoi about it that's like the equivalent of racing versus production cars. You could imagine at some point, Tesla is a heritage brand.
Acquired
Porsche (with Doug DeMuro)
People are going to be like, there was this crazy eccentric founder.
Acquired
Porsche (with Doug DeMuro)
Brand scale economies enabling the SUV line. I think that was a good one. There's not really counter positioning. I don't think there was in the younger days, especially the racing younger days, especially with the aggression of Porsche's advertising.
Acquired
Porsche (with Doug DeMuro)
And they were brash. The reason it's counter-positioning is because a lot of very high-end cars would never dream of showing their brand in such a gritty way and giving their brand voice such a risky proposition. Yeah.
Acquired
Porsche (with Doug DeMuro)
which is a great example of no other luxury brand would no way touch that yeah but that yeah i loved uh david i had the same favorite one of nobody's perfect because what they did is the bulk of the ad when you look vertically down is the top 10 winners at lamar and porsche has nine of the 10 and it's just porsche porsche porsche porsche porsche like number eight yeah
Acquired
Porsche (with Doug DeMuro)
And then it's Porsche to Porsche. Nobody's perfect. Nobody's perfect.
Acquired
Porsche (with Doug DeMuro)
All right. So that's modest counter-positioning, but not really anymore. Switching costs. I actually don't think there are switching costs in the car industry. I think there's this really interesting thing where like... Doug, you're going to laugh. My car before the Mazda CX-5 was a Honda CR-V. And like I... I completely re-evaluated it with fresh eyes.
Acquired
Porsche (with Doug DeMuro)
There was nothing about being a part of that old ecosystem that carried forward to the new ecosystem. Unlike Apple, where you're dialed into everything.
Acquired
Porsche (with Doug DeMuro)
Yep. There's no network economies. There's really no benefit to you own a Porsche, therefore I own a Porsche, and I get value out of you owning a Porsche. It's not particularly a thing, other than we can go to cars and coffee together. Process power, this is probably where I would slot German engineering of all the things that we've talked about.
Acquired
Porsche (with Doug DeMuro)
then the last one cornered resource i don't think there's a particularly cornered resource here it's not like the the square footage and stuttgart that they own is like some magical thing yeah so all right that does it for power playbook we've talked a lot of playbook along the way but i'm curious for ones that jumped out at you that we uh we haven't hit yet yeah i know we just talked about it a bit but um
Acquired
Porsche (with Doug DeMuro)
Or industries that have like a showcase, like a very expensive showcase where you have to go build a completely different product line.
Acquired
Porsche (with Doug DeMuro)
One of the biggest ones that jumps out for me is the brand continuity. This idea that if you loved anything we've ever done, we should be able to fulfill that dream for you today. And not with the exact same thing necessarily. We're not going to sell you the exact model that rolled off the line in 1977.
Acquired
Porsche (with Doug DeMuro)
But you get to participate in the feeling and you get to feel the same way about our brand today that you did then. And we're going to find all these interesting ways to provide you fan service. It's almost like going and watching the new Star Wars movies.
Acquired
Porsche (with Doug DeMuro)
Where if you like the original films, even though these aren't the highest grade directing and writing in the world, we are delivering all sorts of fan service moments to you. And I'm not saying that Porsche is not making the best cars in the world. They make some of the best cars in the world, but they also provide all these opportunities for fan service.
Acquired
Porsche (with Doug DeMuro)
It's worth a huge multiple of what you invest in it if you can align everything correctly. Right.
Acquired
Porsche (with Doug DeMuro)
I love it. All right. Well, grading feels a little bit odd on this episode. And we killed grading. But we do have Doug DeMuro with us. So we are going to give Portia a Doug score. And it's an acquired adjusted Doug score. It's, you know, we can't grade the entire company on handling. So we got to figure out some categories that we can evaluate them on as a company.
Acquired
Porsche (with Doug DeMuro)
All right. So David, what, what criteria you think acquired adjusted Doug score?
Acquired
Porsche (with Doug DeMuro)
Sort of closing your eyes to where they're trading today, because you always have to evaluate entry price and all that. Yes, yes. Are you excited about the company's prospects 10, 20, 30 years from now? Yeah.
Acquired
Porsche (with Doug DeMuro)
But it has not always been this way, and it certainly didn't start this way. Today's story has Nazis, tanks, the first electric vehicles, and, like most luxury brands, some misadventures in the 1980s. Oh, yes. And if you like quirks and features, you're going to be pumped about our partner in crime to help us tell this story, Doug DeMuro.
Acquired
Porsche (with Doug DeMuro)
I basically agree with you numerically. I have one knit on them versus other luxury manufacturers. It sort of depends how you define luxury. I think they'll fare better than Mercedes and BMW in a downturn and way worse than Ferrari. I think they're in this interesting place where they have... It's like Louis Vuitton. They have some cash-sensitive buyers.
Acquired
Porsche (with Doug DeMuro)
There are Macan buyers who will become Q7 buyers. Yeah. Q5 buyers.
Acquired
Porsche (with Doug DeMuro)
Oh, yeah. I'd rather own Porsche in a recession than, like, almost any other car company in the world.
Acquired
Porsche (with Doug DeMuro)
That's right. We didn't say that earlier, but Porsche is a 29% gross margin. Apple's a 43% gross margin. Right.
Acquired
Porsche (with Doug DeMuro)
I mean, I'd love to own a business that has 20% of every dollar that I earn coming out the bottom. That's a great business.
Acquired
Porsche (with Doug DeMuro)
It's a nine for the auto industry. And it's like a four compared to most businesses that we study on Acquired because we only study the very best businesses in the world.
Acquired
Porsche (with Doug DeMuro)
for the ease of the episode, we're agreeing on a score here. It's a consensus score. Five feels like a good score. And honestly, like I think five is the highest score you can give in the auto industry on profitability. Unless we're talking about Ferrari, apparently. Yeah. Which is like almost not in the auto industry. It's like a completely different luxury category. Yeah, that's so true.
Acquired
Porsche (with Doug DeMuro)
So I am giving, because cars, you cannot give a 10, 9, 8, 7, or 6, I am going to give Porsche a 5 in terms of profitability. Yeah, right. That makes sense. What was the last one? Defensibility. Yeah. So this is the biggest question. Does Porsche's margin profile and customer love and brand value just only go down from here as they continue to grow?
Acquired
Porsche (with Doug DeMuro)
Like, will we think of them as a BMW in 10 years when we see them around the streets?
Acquired
Porsche (with Doug DeMuro)
I think you put it really well earlier when you said people are like, oh, are you a Ferrari person or a Porsche person? And like the fact that Porsche gets to be in that conversation.
Acquired
Porsche (with Doug DeMuro)
It's like they're getting away with murder by being lumped in right there.
Acquired
Porsche (with Doug DeMuro)
I'm like literally a 10 out of 10 on this because I think this is a thing that I still don't really understand how they executed this so well. And they've done it better than any other company in the world. Right, right. It's probably true. They went from making the 911 the everyday supercar to now they're like an everyday supercar company.
Acquired
Porsche (with Doug DeMuro)
They have a whole gradient of everyday supercars that you can buy, but they're all everyday supercars.
Acquired
Porsche (with Doug DeMuro)
Yeah, out of 100. You can't get any better than that. So, Porsche is at the top. Yeah. Quick carve-outs. I'll start. Because I've had no opportunity to consume any media in the last three months that is not specifically for acquired research, I have a... random website that I haven't used in six months, but I used six months ago and it was awesome to recommend. And that is resortpass.com.
Acquired
Porsche (with Doug DeMuro)
Have either of you ever been to resortpass.com? No. It's like Airbnb for amenities at resorts.
Acquired
Porsche (with Doug DeMuro)
How did I not know about this? When I go on vacation, I typically won't stay in the really fancy hotel. My wife and I will just book a condo or an Airbnb or something. And they're right next to really fancy hotels. Right. And so what ResortPass does is they go to the hotels, they say, look, I know your pools are like not full most of the time.
Acquired
Porsche (with Doug DeMuro)
Can we have some, and I don't exactly know how real time their inventory is or if they are able to like buy big blocks of it up front, but for like a hundred bucks a day or 200 bucks a day, you can go and get a day bed or a cabana or, you know, amenities of the resort.
Acquired
Porsche (with Doug DeMuro)
The biggest difference. Have you seen that bit on Curb? No. On Curb Your Enthusiasm? There's this whole arc of the show about how...
Acquired
Porsche (with Doug DeMuro)
jason alexander is not at all like george and how dare you perceive him that way and then it's like jason alexander is insinuating to larry david what a loser the george character is and larry takes it personally because it's based on him i should have said five larry david is in this compilation of charlie rose conversations too yeah it's so good it's so good i think it's about an hour 20 total but it's worth it interesting jerry's in there too jerry's in there yep they're all in there
Acquired
Porsche (with Doug DeMuro)
That's actually a great... Doug, we have not talked about, like... Everything that you do give us like a little bit of insight and I think David T's we're gonna do an interview together as a as a separate episode But like give us a little insight into the Doug de Miro Empire and what do you have going on at work? Where can people check it out?
Acquired
Porsche (with Doug DeMuro)
It's the bias that you got to worry about. Yeah. Totally imagine.
Acquired
Porsche (with Doug DeMuro)
check out our second show, ACQ2, if you want more Acquired. We just recorded a couple more episodes, actually, that we have getting ready to come out that I'm very, very excited about. That, of course, is a way for you to go deeper and nerdier into topics that just... either aren't ready for the main show or perhaps are too current for the main show.
Acquired
Porsche (with Doug DeMuro)
Since what we try to do here is tell the big canonical stories, oftentimes there are stories in flight where we just want to talk to experts about what's happening, like Jake Saper in AI talking about what it's doing to the B2B SaaS landscape right now and where profit pools may emerge in that.
Acquired
Porsche (with Doug DeMuro)
All the hits, David. We've got a Slack. We would love to see you there. We're going to be talking about this episode, acquired.fm slash Slack. And if you would like to come deeper into the Acquired Kitchen, you should become an LP where we will, at least once a season, have you help us select one of the episodes. In fact, completely defer to you to select one of the episodes.
Acquired
Porsche (with Doug DeMuro)
And beyond that, we also will be doing bi-monthly Zoom calls so we can get some feedback directly from all of you and get to meet more of you. So acquired.fm slash LP if you would like to become an LP. Now with that, listeners, and a huge thank you to our partner in crime on this episode, Doug DeMuro. We will see you next time. We'll see you next time.
Acquired
Porsche (with Doug DeMuro)
And 50 years, that's about how long they would make that one model of the Beetle.
Acquired
Porsche (with Doug DeMuro)
Doug is one of David and my favorite YouTubers and content entrepreneurs. He operates the largest independent YouTube channel focused on car reviews with millions of subscribers. He also used to work at Porsche Corporate and is about as big of an enthusiast of the brand as you'll find anywhere.
Acquired
Porsche (with Doug DeMuro)
So after the war. And we should say during the war, Ferdinand Portia was designing tanks. Yes. And other military transport.
Acquired
Porsche (with Doug DeMuro)
More than a couple years. And also some of the very first hybrid and electric cars in history. But at that time, battery technology wasn't advanced enough. And so you're lugging around this huge weighted battery pack to get almost no juice out of it. And so it didn't really go into production.
Acquired
Porsche (with Doug DeMuro)
Yeah, I think the technical thing they got them on, which is why they only had two years, was for the forced labor that they took the imprisoned Jews and forced them to work in the factories. But all the other war crimes that were stacked against them ended up not being charged. And so quick trip in and out of prison.
Acquired
Porsche (with Doug DeMuro)
In fact, we are filming this episode now sitting in his garage in front of a very special Porsche, Doug's Carrera GT. Welcome to Acquired, Doug. Thank you for having me. It's wonderful to have you here. To set the stage a little bit,
Acquired
Porsche (with Doug DeMuro)
Yeah. And David, are you getting all this from, I know you read like $500 worth of textbooks on Porsche.
Acquired
Porsche (with Doug DeMuro)
I read a coffee table book that was like the complete illustrated history of the 9-11. Because for this episode and this topic,
Acquired
Porsche (with Doug DeMuro)
Doug, can you contextualize what a big moment in world history this is?
Acquired
Porsche (with Doug DeMuro)
If you say Porsche with a German accent, it comes out like Porsche. Yeah. So I think it's almost like.
Acquired
Porsche (with Doug DeMuro)
Totally. And David, you said a word there that if people aren't into cars, they may not know this supercharged Doug. What does it mean to supercharge a car?
Acquired
Porsche (with Doug DeMuro)
And for those following along at home, this is like end of the 40s, 1947 type era. Yeah.
Acquired
Porsche (with Doug DeMuro)
Right. Doug, why is the desirability of these cars so different today?
Acquired
Porsche (with Doug DeMuro)
Sorry, the deal is we want your Austrian company to distribute our Volkswagens. And in order to coerce you to doing that. And the consulting work. We also want the consulting work.
Acquired
Porsche (with Doug DeMuro)
Doug, the way the value chain evolved for selling cars, there's this very clear delineation, in the U.S. at least, until Tesla, of separating the dealership from the manufacturer. There is no direct-to-consumer. Was that already obvious at this point in history when Porsche has these two different companies?
Acquired
Porsche (with Doug DeMuro)
And speaking of Microsoft and ServiceNow, they just announced a huge expansion of their partnership, specifically integrating the two companies' enterprise AI assistants. Starting in the fall, customers will be able to interact with ServiceNow's NowAssist AI assistant directly within Microsoft Copilot.
Acquired
Porsche (with Doug DeMuro)
Yes. ServiceNow's Now Assist will be integrated with Microsoft Copilot and will be available directly from Office apps, starting with Microsoft Teams. The AIs are integrated into one seamless user experience without actually sharing data.
Acquired
Porsche (with Doug DeMuro)
So if, for example, a user asks Copilot in Teams about how the company's laptop policy works, behind the scenes, Copilot shares that request and context with Now Assist, and Now Assist accesses internal company policy with the right permissions for that user and returns the answer to Copilot in a rich card with options for the user to kick off a workflow via Now Assist.
Acquired
Porsche (with Doug DeMuro)
In the future, Microsoft Copilot will also be integrated the other way into Now Assist so it can automatically generate Office files like PowerPoint presentations and Excel spreadsheets directly from assets and knowledge in the ServiceNow platform.
Acquired
Porsche (with Doug DeMuro)
And it's not just, we'll pay you for the cars you distribute that we make. We will pay you for all cars that we make, every Beetle, regardless of whether you distribute it or not.
Acquired
Porsche (with Doug DeMuro)
It totally is. Yeah. You kind of see this trend, this moment where you see the bifurcation between anybody can do it and what the very best of the world kind of look like.
Acquired
Porsche (with Doug DeMuro)
That seems to be true across everything in the world today in the way that like what Taylor Swift is doing on the stage on her tour has nothing to do with like a person who picks up their guitar and is talented and plays at the local bar. Like,
Acquired
Porsche (with Doug DeMuro)
She is the SR-71 pilot, and playing on a local bar stage is flying a Cessna, and the machinery to do so is entirely different in the same way that you're talking about car racing splitting at this moment in the early 50s.
Acquired
Porsche (with Doug DeMuro)
What do you think? Yeah, absolutely. It's a, you buy those watches to wear them. You don't buy them to keep them in a case and ogle at, you know, they're steel. They're originally made for people who are swimming the English channel or scuba diving. I think it's reasonable to also compare it to like continuing in the luxury world, like a Ramona suitcase. Those aren't that expensive.
Acquired
Porsche (with Doug DeMuro)
They're three times, four times more expensive than regular luggage, but like... They're not a Louis Vuitton truck. Right. And so... But they're a lot more usable. You buy it to use it. It can kind of get a little beat up. That's why it's made out of stainless steel also. I think that's probably the right... It's not a Birkin bag. I feel like brands like this... are so valuable.
Acquired
Porsche (with Doug DeMuro)
Because it has both the breadth and the depth. There are enough people who are like, I love Porsches because they're my cars I can actually drive, but they are supercars.
Acquired
Porsche (with Doug DeMuro)
No, this thing behind us is a little bit of a different thing. It's not a different one.
Acquired
Porsche (with Doug DeMuro)
Yeah. Doug, one question for you. I'm going to keep going to you for terminology. David mentioned Le Mans. What is that?
Acquired
Porsche (with Doug DeMuro)
With forced reinvention. So you're doing stuff like racing. You're doing stuff like looking international. You're like, what can we invest in that we're not sure if it's a ROI positive investment?
Acquired
Porsche (with Doug DeMuro)
Wow. I mean, I feel that way. Every time I see a Panamera drive by, I'm like, why does Porsche make this car? But I see them driving by, so that's why they make the car.
Acquired
Porsche (with Doug DeMuro)
It's like when you're starting a new company and you're sending your first invoice, you don't call it invoice number one.
Acquired
Porsche (with Doug DeMuro)
Right. So funny. And to be clear, so I admired designs of Porsche cars before doing the research for this, but knew basically nothing about the company or its lineup. I've certainly never owned one. And it took me a long time in the research to realize that there are a lot of car designs that start with nine that are all 911s. There's like... I don't know.
Acquired
Porsche (with Doug DeMuro)
And not all 911s say 911 on the back. So you can't even use that as your reference.
Acquired
Porsche (with Doug DeMuro)
So the plan was originally to have some of the 914s be branded VW and some of them be branded Porsche?
Acquired
Porsche (with Doug DeMuro)
So we're starting to re-intertwining these companies just a little bit here. That deal is an enormously wide-ranging partnership because you're trading... distribution from one side of your business with the ability to create a product on your other side.
Acquired
Porsche (with Doug DeMuro)
I mean, it's basically merging the companies because it's so massively intertwined now in this partnership where it's not like, oh yeah, we partner with them on this one small little thing. It's like, no, our car that we expect to sell more of than any other car is made by this other company.
Acquired
Porsche (with Doug DeMuro)
Meanwhile, on the VW side of things, it's like America, the most important and largest growing car market in the world, we now own the distribution for Porsche. Like this, even if it's not structured this way, this is a merger.
Acquired
Porsche (with Doug DeMuro)
Yeah. This isn't like one of those people that you hear, oh, well, you know, at that point in time, the Nazis were so big and powerful, they kind of just got, you know, coerced or they collaborated. It's like... No, this dude was a real big Nazi.
Acquired
Porsche (with Doug DeMuro)
And when you say mid, this basically means that it's still obviously behind where the passengers sit, but in front of the rear axle? In this case.
Acquired
Porsche (with Doug DeMuro)
Yeah, I don't know, Doug. I feel like I've seen multiple the best on your channel.
Acquired
Porsche (with Doug DeMuro)
Welcome to Season 12, Episode 6 of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts. Today, we tell the story of Porsche. If you liked our LVMH episode, you are going to love this one. And not just because it's a European luxury brand.
Acquired
Porsche (with Doug DeMuro)
And this is German Ferdinand. This is German Ferdinand. The one who's working, actually producing the cars.
Acquired
Porsche (with Doug DeMuro)
This is crazy. I would be so fascinated to get video footage of what actually went down in that room and the logic that they could walk themselves through to this is actually the best outcome.
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Porsche (with Doug DeMuro)
The same thing happened in the Gucci family. For anyone who's seen the Gucci movie with Adam Driver, there's sort of a family member who wanders off and does some effectively brand licensing. He's like, I'm going to take the family name and make some money off it. Which is obviously what was happening here.
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Porsche (with Doug DeMuro)
And Doug, at this point in history, what does the Volkswagen group own brand-wise?
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Porsche (with Doug DeMuro)
But Volkswagen, much bigger company than Porsche, right? Yeah. He got kicked out of his own company. So he went and ran a much bigger one that competes with it. And then he grew even bigger. Yeah.
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Porsche (with Doug DeMuro)
It's the quiet part loud. Yeah, geez. Can you come up with something that is not using the word not to describe who wants it? How about you say who would want it?
Acquired
Porsche (with Doug DeMuro)
And unsaved at any speeds, that was like a federal report that came out that said like basically all cars on the market are unbelievably unsafe and people, our citizens should not be driving around in them and so all cars need to change.
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Porsche (with Doug DeMuro)
It is astonishing how much safer cars have gotten. Astonishing. You look at these like cute old Porsches, they're so much smaller. Right. And you look at the big ones today and you can lament, oh, cars have gotten so big. But cars have also gotten so much safer. Far.
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Porsche (with Doug DeMuro)
Lots of disposable income. Wall Street is ripping. A lot of pinstripes. Yeah, it seems like actually a really good time for fast cars.
Acquired
Porsche (with Doug DeMuro)
And that's what was said. Like, there's a thing in German culture where, like, when something has been decided, it's been decided.
Acquired
Porsche (with Doug DeMuro)
He drew the line, right? And there's a perfect line, which is, Schutz just looks over at the chief engineer and goes, do we understand each other? Right. And then he walks out.
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Porsche (with Doug DeMuro)
That's awesome to get that validation, because there's so many of these stories that we tell on the show where, like, this is probably apocryphal, and there's really no way to verify it.
Acquired
Porsche (with Doug DeMuro)
Tech in 2021. Yeah, exactly. In fact, I think Schutz was like, let's make airplane engines.
Acquired
Porsche (with Doug DeMuro)
So they literally only made three cars, and they were all three number nine cars?
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Porsche (with Doug DeMuro)
And it was literally like you have empty production lines. So even though you're not going to make a lot of margin on this, let's at least like
Acquired
Porsche (with Doug DeMuro)
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Acquired
Porsche (with Doug DeMuro)
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Acquired
Porsche (with Doug DeMuro)
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Acquired
Porsche (with Doug DeMuro)
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Acquired
Porsche (with Doug DeMuro)
And thanks to friend of the show, Christina, Vanta's CEO, all Acquired listeners get $1,000 of free credit. Vanta.com slash acquired. So David, this thing that Doug just referenced to me, the money they charge for colors, you can do a thing today where... You go to buy a Porsche and their online configurator, and they have the paint from every single Porsche ever produced in history.
Acquired
Porsche (with Doug DeMuro)
There is possibly even more family drama, creeping takeovers, and complex corporate structures at play. But why is Porsche, the brand and the product, so special? The company has struck an incredible balance of both building some of the world's finest supercars while also being a great daily driver, unlike, say, a Ferrari or a Lamborghini.
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Porsche (with Doug DeMuro)
And so you're like, you know, there was really something about this particular 911 in this year. I really loved this paint. You can pay them something like $15,000 for your Porsche to be in that particular color.
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Porsche (with Doug DeMuro)
Yeah, why not? The other thing that it's emblematic of, which I think we haven't really talked about yet of what makes Porsche special, is this unbelievable heritage. like the design language that they use, what the 911 is. You mentioned earlier, they don't really change it that much from generation to generation.
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Porsche (with Doug DeMuro)
There's this sort of obsession with put something out there and then spend years and years and years, tiny little tweaks and refinements, making it the like platonic form of what it can be. And there's this like obsession with if you loved Porsche in any given year, we want to make sure that we keep you along for the ride continue to love us today.
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Porsche (with Doug DeMuro)
So Doug, this thing that we're talking about, this idea that if you loved Porsche ever, we want to deliver on that promise today. Do you feel like that consistency has been there since the very beginning? Or do you feel like that's something they learned in their like rise from the ashes
Acquired
Porsche (with Doug DeMuro)
Yeah. Wow. Yeah. I mean, if you look up like the stock of Porsche and you pick the right Porsche and there's a couple we'll talk about, that's still the full name of the company is all of his honorary things.
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Porsche (with Doug DeMuro)
Also, what kind of company makes one product? Right. I mean, seriously, do they believe that this is a transitionary period, or do they believe this is the long-term strategy?
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Porsche (with Doug DeMuro)
Right. So, Doug, what's the difference then at this point in time between the 911 and the new Boxster?
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Porsche (with Doug DeMuro)
Like, who on earth would buy a Porsche SUV? Also, I got to say, like, maybe all cars were kind of ugly in this period, but I remember when I looked at the first Cayenne, I was like... So it's like a Toyota?
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Porsche (with Doug DeMuro)
It also just doesn't look like a Porsche to me. Like there's not enough that's brought through from the heritage of the... How do you describe the back on a 911?
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Porsche (with Doug DeMuro)
And also there's a practicality of, I kind of need a minivan, but I don't want to drive a minivan. And so I'm driving this new emerging class of SUV and, But if I have money, I kind of want the Porsche version of that thing.
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Porsche (with Doug DeMuro)
And the danger here, if you're at home and you didn't know how this ended and you were a smart business person, you'd be thinking, well, this is going to borrow against their brand equity. Like this is going to drain the bucket, not add new love to the brand bucket. And the magical, incredible, amazing thing about Porsche is they have doubled down on this strategy.
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Porsche (with Doug DeMuro)
It has become a huge part of their business. They generate a ton of margin on the SUVs, and it has not borrowed against their brand equity. It has increased the love for the brand.
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Porsche (with Doug DeMuro)
Yeah. The weirdest thing about high-end cars that have lore associated with them is typically when someone high-profile dies in it, the value goes up. Right.
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Porsche (with Doug DeMuro)
So this point is an interesting one because it is something that other luxury brands do as well. I remember reading when Louis Vuitton first started coming out with the more approachable wallets and clutches and ways that you could tiptoe into participating in the brand story.
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Porsche (with Doug DeMuro)
They were also releasing $100,000, $200,000 special handbags that were new products or new collaborations with other designers that sort of told you, no, we're still Louis Vuitton. We just have this other way to be a part of our brand. Right.
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Porsche (with Doug DeMuro)
So they never had to have any help once they scraped that bottom of whatever it was, $400 million market cap? Nope.
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Porsche (with Doug DeMuro)
There's another chapter to the story. So that's 100x market cap growth. Is that right? Did you say 300 million to 32 billion?
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Porsche (with Doug DeMuro)
occasionally there are these hundred baggers available in the public markets. And like, you only know about them looking backwards. But like, it's crazy. You don't have to be an early stage venture capitalist to find these. They exist elsewhere sometimes. And it was Porsche. It was Porsche of all things.
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Porsche (with Doug DeMuro)
It's like buying Amazon in 2001 or 2002 when things looked the absolute bleakest. Like, that's how you could have gotten a hundred bagger in the public markets. Maybe even a thousand at this point. But like, come on, who would have actually done that? Who would have done that?
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Porsche (with Doug DeMuro)
Turns out these SUVs and making only supercars is a very profitable, a lot of margin there.
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Porsche (with Doug DeMuro)
Right, it is the thing. Yeah, Facebook, I feel like that has some kind of like Zuckerberg association, but I've never really put it together.
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Porsche (with Doug DeMuro)
And what do you think changed in the corporate psyche going from we have a very particular way that we do things in a very particular market we serve with a very particular type of product to like, let's have a full product suite just like everyone else? Probably that 100x growth.
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Porsche (with Doug DeMuro)
I just got to say this early in the episode, we may as well like point it out already. It is crazy how comfortable we all are driving Volkswagens and Porsches when it was like not just a little Nazi affiliated, like founded by Nazis. And yet the way the world has evolved, like people kind of became okay with it.
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Porsche (with Doug DeMuro)
Worked the first time to pull the best guy over at Porsche over, let's do it again.
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Porsche (with Doug DeMuro)
Yeah, the sitting active CEO of Volkswagen as a family member of the Porsche Piëch family has voting shares in Porsche. Yeah.
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Porsche (with Doug DeMuro)
So isn't it obvious then that it would be hard for Porsche to take over Volkswagen? Well...
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Porsche (with Doug DeMuro)
And that's usually ways to get around regulatory stuff, right? Like then you're not exceeding caps if you're buying derivatives rather than the shares themselves.
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Porsche (with Doug DeMuro)
I'm literally going to read from the Wikipedia here because the Wikipedia is extremely well written. Under the Volkswagen law, no shareholder in Volkswagen AG could exercise more than 20% of the firm's voting rights regardless of their level of stock holding. This law was supposed to protect the Volkswagen Group from takeovers. In October 2005, Porsche acquired an 18.53% stake in the business.
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Porsche (with Doug DeMuro)
And in July 2006, Porsche increased that ownership to more than 25%.
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Porsche (with Doug DeMuro)
Because they had kept buying after that 25% using all the cheap debt, and they got all the way up to 50%. Right.
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Porsche (with Doug DeMuro)
through the roof. Because there's all the demand for borrowing the shares to do the short selling.
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Porsche (with Doug DeMuro)
Freaking Adolf Hitler founded Volkswagen. So the Beetle, this people's car, Doug, you might know this. Did it go on to become the most popular car ever in the entire world?
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Porsche (with Doug DeMuro)
Why can't they sell? Because if they sell, they get a bunch of cash by not liquidating that many shares because it's so valuable.
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Porsche (with Doug DeMuro)
Oh, I see. Right. So they basically can't get... Because who's going to be buying?
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Porsche (with Doug DeMuro)
Who hasn't moved a single piece on the chessboard. No, he's just been sitting there.
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Porsche (with Doug DeMuro)
Wait, and just to unpack the statement a little bit more, what he's basically saying to make it more explicit is a key partner of ours went so deeply into debt
Acquired
Porsche (with Doug DeMuro)
Buying our shares that they can't service that debt and are now about to be insolvent and default on loans. Yes. So therefore, we will help them out by, what is it, buying them for?
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Porsche (with Doug DeMuro)
Whoa. This is literally Ferdinand saying to Vita King, if you come at the king, you best not miss.
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Porsche (with Doug DeMuro)
So Porsche SE, this new holding company they created that was buying VW shares. Yep.
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Porsche (with Doug DeMuro)
Of course, these are expensive daily drivers with the average Porsche costing $110,000. But they have managed to nail being a prestige brand with pricing power and make a ton of cars at $350,000 per year. Today, we'll study how they cultivated such a vibrant community, which conveniently for them is comprised of extremely wealthy people.
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Porsche (with Doug DeMuro)
oh my god so posts both tranches after Porsche AG the operating company is fully owned by VW what does the family own and
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Porsche (with Doug DeMuro)
It's so crazy. VW, the company bought Porsche, the company, but really Porsche, the family owns it all.
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Porsche (with Doug DeMuro)
Talk about supercars for a minute, because I think it's important to understand, like, they don't always make a supercar, right? Right.
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Porsche (with Doug DeMuro)
And so this supercar was a plug-in hybrid. I don't think I ever knew that.
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Porsche (with Doug DeMuro)
They keep finding rich people. They only make, what, 13,000 cars a year at Ferrari? Yeah, it's a small operation.
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Porsche (with Doug DeMuro)
What's the rule of luxury? Dominate your customer. Ferrari was owned by somebody at some point, though, right?
Acquired
Porsche (with Doug DeMuro)
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Acquired
Porsche (with Doug DeMuro)
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Porsche (with Doug DeMuro)
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Acquired
Porsche (with Doug DeMuro)
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Acquired
Porsche (with Doug DeMuro)
Electric vehicles, I don't know. I don't know. And a lot of people were slow as a result.
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Porsche (with Doug DeMuro)
In fact, entire nations were. Japan is five years behind everyone in electrics. It's the weirdest thing. It's like they just woke up last year and were like, oh my God, this is going to happen. In the car world, I mean, at least five years back.
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Porsche (with Doug DeMuro)
So the Taycan comes out, it's a very phenomenal car. Like I think people are a little unsure at first, but then it's super well received within like three years.
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Porsche (with Doug DeMuro)
They have no plans for an electric 911, right? I mean, that's what they would tell you if you asked them.
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Porsche (with Doug DeMuro)
Interesting thing about the Taycan. So you mentioned the next supercar will be an all-electric one. I haven't driven in a Taycan. I have watched videos of people driving in it. I'm like, what else do you need to do to make this a supercar?
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Porsche (with Doug DeMuro)
But isn't it also like tuned to drive like a track car where your 15th lap is going to be just as performant as your first?
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Porsche (with Doug DeMuro)
as the investment bankers would say. There was a lot of value unlocked by making this its own company, which I think is legitimate. I think there's an element to being able to own one of the premier luxury companies in the world without having to commingle it with a bunch of other stuff. And so like all shareholders of Porsche can purely just be shareholders of Porsche.
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Porsche (with Doug DeMuro)
And you, when you look at the financials and you understand like, okay, they have incredible margins relative to you. Look at the rest of VW's portfolio.
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Porsche (with Doug DeMuro)
It's all intermingled. So yeah, if it's not actually operationally any different, then you do have this question where you're like, okay, value was unlocked by just looking at the market caps. But like, actually what happened there is you got better at marketing a security, not you literally created value inside the company.
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Porsche (with Doug DeMuro)
And by the way, you can choose to buy Porsche AG, the independent spin-out of VW, or you can also, on the stock market, go and buy Porsche SE, the family holding company. Oh, I didn't realize that it's still on the market. So some other interesting things about Porsche today. The family, as we mentioned, is complete control both of VW and Porsche. Yeah.
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Porsche (with Doug DeMuro)
So in some ways, it's still the same old Porsche, even though it's all commingled. Here's the sort of nail in the coffin, in my opinion, argument on is it a separate company or not. Oliver Bloom is both the current CEO of VW Group and Porsche. Yeah.
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Porsche (with Doug DeMuro)
When you share production facilities and you share distribution and you share a CEO and you share components and you like at what point in what way are these separate companies? Right.
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Porsche (with Doug DeMuro)
Hitler created it. And not just Volkswagen, but like the Volkswagen Group, one of the largest car conglomerates in the world that owns many other brands you're familiar with. All out of Wolfsburg.
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Porsche (with Doug DeMuro)
Fascinating. So digging into the business a little bit, they do over $40 billion a year in revenue right now. When you look at the breakdown of that, interestingly enough, two-thirds of it has come from SUVs, and there's a good amount of it that comes from the Taycan too. So the 911 has sort of grown slowly over time. The 718, that's the Boxster Cayenne. Not a lot of revenue coming from that.
Acquired
Porsche (with Doug DeMuro)
Yes. And the Panamera does have pretty decent sales, but still nothing compared to the monster that is the SUVs. When you look at where they're sold, this is quite interesting. China is, as Porsche would account for it, their largest market. But the reason that I put that caveat in there, because it's at 26% is China, they split out Germany from Europe and call them two different regions.
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Porsche (with Doug DeMuro)
So they have Germany... True Germans, like a true German would. Like, Germany is 10%, and rest of Europe, excluding Germany, is 23%. So, you know, it's... All of Europe together would be bigger than China, but Germans.
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Porsche (with Doug DeMuro)
Right. Wow. Yeah, I mean, we're used to it now, but I remember the first time I was seeing Porsche SUVs. It's like, well, that's a sports car brand. This is weird. Right. But for them, they never had the sports car brand, so it's just like normal. It's crazy. North America is very close to China. It's 24% in terms of sales, and then the rest of the world is about 16%.
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Porsche (with Doug DeMuro)
So interesting thing when you start to look at both the amount of cars that they make now, because it's huge, and the margin structure associated with that. So last quarter, they delivered 80,000 cars, and that's growing about 20% year over year. Last quarter, they delivered 80,000 cars? Yes. Wow. So... Last year, they delivered about 350,000 cars.
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Porsche (with Doug DeMuro)
So this really is a scale organization at this point. This is not Ferrari. This is not Lamborghini. These are mass-manufactured vehicles. And I know they would say, oh, we're not a mass-market thing, which is true in some ways when your average selling price is $110,000. But if you're making 350,000 of something... That's a mass market brand.
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Porsche (with Doug DeMuro)
This is the correct analog. So I had this in my notes much later, but I want to bring it forward right now. Porsche is Louis Vuitton. Ferrari is Hermes. Yeah. And I think that this whole time while researching, I just had this like broken thing in my brain where I was like, how do they make so much stuff when they're Hermes and they're not Hermes?
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Porsche (with Doug DeMuro)
They were once Hermes, but as soon as they started making the SUVs, that's not who they are. They have tiered access to luxury, like different luxury products with a shared brand that unifies them.
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Porsche (with Doug DeMuro)
Right, right. On the scale thing, though, there is another order of magnitude up. And these other brands do feel much cheaper. So at around $2.5 million a year is BMW and Mercedes-Benz. And it does feel like Porsche is in a much different class than BMW or Mercedes-Benz in terms of the sort of hoity-toityness associated with it when you get to drive it and you get to own one.
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Porsche (with Doug DeMuro)
And I think that clearly shows. And the question is if... they made 10 times as many Porsches, would we all feel the same way that, oh, it's just a BMW? Probably.
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Porsche (with Doug DeMuro)
Like there should be an inverse relationship between scale and brand perception, but they have managed to find this like mismatch or like, to your point, it's like skating under the radar where they are able to make a lot of SUVs and still maintain what they have. And the question is for how long?
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Nike
Listeners, you should know David and I were texting before this debating, do we change this thing around? Do we play with this? Should we reorganize this section? And he texted me, let's just do it. So in the honor of Bad Jokes by David Rosenthal, here we go.
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Nike
So they're perfectly happy with this arrangement. They're happy to cut him $300 million checks. I would be too if I was earning the other side of the $6.6 billion. But Jordan totally has had to shape his life in order to be the dream Michael and continue to be that. He is so synonymous with the brand that he has to be perfect to keep the brand doing what it's doing.
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Nike
That's a great point. So off the back of the Rise of the Jordan brand, in 1988, they launched the Just Do It campaign with the very first, I think this is the first Wyden and Kennedy ad, right?
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Nike
And so they're kind of finding their footing again. They're realizing that, okay, we can diversify outside of running. We can find a lot of places to sell the dream. We can make different products to monetize the dream, to let people participate. Their market cap hits a billion dollars at this point in 1988.
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Nike
So investors are starting to wake up to like, huh, they're building something really special here. They opened their first Nike town in Portland. The early 90s, late 80s, early 90s are just all good for Nike. I think by 91, their market cap hit $5 billion. By 96, their market cap hit $10 billion.
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Nike
And they're really just executing the strategy that we talked about, but at scale until they get hit with everything we already talked about on the labor challenges and that controversy. Yep. So that's a tough few years. Interestingly, like right around the dot-com crash is also kind of tough for them. Their market cap drops from $20 billion to $8 billion.
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Nike
They weren't in any way yet a tech company, but tough times right around the same time period.
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Nike
Yes. Really big. And people forget this. People forget that Kobe was an Adidas athlete first. Yes. In the same way that people forget that Kanye was a Nike athlete or a Nike... Right.
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Nike
Oh yeah, I have the numbers. So Kobe was with Adidas from 96 to 2002, and he hated the Kobe 2s so bad that it's rumored that he paid $8 million to get out of his contract so he could move over to Nike. Yeah. That was a huge win for Nike and a big turnaround. Like 2002 is really when it started to get good again for them.
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Nike
Oh, and right around the same time in 2003 is when LeBron came into the NBA and Nike signed him out of high school.
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Nike
Okay, so 2002, they get Kobe. 2003, they get LeBron. They've cleaned up their image. They're cleaning up their factories. They're cleaning up their supply chain. In 2003, they acquire Converse for $309 million. They're once faux and now Nike's in the multi-billion dollar market cap and Converse is a tiny fraction of that size. 2003, Michael Jordan retires.
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Nike
And it's fascinating, just to get a quick data point, the Jordan brand that year in 2003 is doing $700 million a year. And today it's doing $6.6 billion. And that's been the delta since he stopped playing basketball.
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Nike
Yeah, Jordan has completely transcended a sponsorship deal and turned into a brand. The notion, the platonic ideal of Jordan is a brand more than a human. So in 2006, another important thing happens. And most people didn't realize it at the time, because keep in mind, 2006, over in Apple, Steve Jobs is still the CEO.
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Nike
So not a lot of people know this guy named Tim Cook's name, but Tim joins Nike's board. I believe in like late 2005, he joined the board. He immediately starts helping Nike into understanding how to use digital technology to transform their business. And in 2006, they launched the Nike Plus iPod. Yes, yes.
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Nike
Which was not a terribly successful product in the market, but man, did it help Nike understand where the puck is going.
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Nike
It was interesting because it was this little, like, thing that you would put in the insole of certain shoes and it would measure your stride length and your, you know, all the metrics about running and it would report it to your iPod because it had a little, like, 30-pin connector thing you could put into your iPod. It was the most clunky, kludgy thing ever.
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Nike
But as that evolved into the FuelBand and then as the FuelBand evolved into apps on your iPhone... Nike started really building a way to have a relationship with their customers directly and not just through their products, but with this sort of suite of services. And 2006, and then again in like 2013, 14, they had sort of a new strategy start.
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Nike
There's really these clear moments in time where the company changed its DNA. And I go all the way back to 2006 on the technology one. It also completely changed their acquisition strategy. Because up until then, they had been acquiring brands. They bought Converse. They had bought Starter. Starter was going to kind of be their like Walmart brand. Oh, that's right. Cole Haan. Cole Haan. Yeah.
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Nike
And I think this sort of... aha moment happened where they realized, actually, what we want to be doing is pouring everything into the flywheel of the Nike brand. They divested a bunch of stuff, but they started acquiring capabilities from a bunch of these other companies to help them make this tech migration.
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Nike
It's like a two-decade thing where they have these two different strategies that are happening at the same time. One is the digitization. And to give you a stat on how impressive that is, across the four mobile apps that Nike operates today, they have 500 million users a quarter who are now using Nike digital apps, from their e-commerce app to their running app. RunClub, TrainingClub, Sneakers...
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Nike
and the Nike Mobile store. Huge user base. All sort of started at this moment in time where they realized, A, we should be in technology, and B, we should be making acquisitions not of other brands, but of technologies that we can integrate to help us extend our brand and participate more in the lives of our customers.
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Nike
The other thing, and this is a little bit later, this is more of the 2013, 14 era. They pull the trigger on this big strategy shift away from what Phil Knight had sort of pioneered with the retail relationships to go direct.
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Nike
And Nike started to realize in this new era, this internet era, this global era where you have to be at scale to execute certain strategies, they're going to be the player at scale that can execute a direct strategy, that can operate Nike.com to sell shoes directly to customers, that can operate retail stores and all these different places to go directly to customers. And
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Nike
They're not all the way there. And I think there's a lot of, like, we'll talk in their sort of bare-bull case about where they are in that transition and how successful it will be. But there is this tipping point where a brand becomes the scale player. Like, think about Disney in media. They've become the scale player.
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Nike
They can run a different playbook and go directly to customers in a way where other places that make content need to integrate with the existing distribution channels. Disney can make a 10, 15-year transition, especially with the right technology to go direct. Nike's basically betting that they're also one of these hero brands that can run that playbook.
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Nike
Okay, so that's like the 2014 era where they really start to execute this digital and direct migration. Around this time, you have this very old idea of sneaker heads starting to take root in a big way, this huge growth category where the secondary market for shoes, in most situations, you would think like used shoes are worthless.
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Nike
And like, I'm being tongue in cheek here because most, you know, secondary market shoes are not used.
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Nike
Right. But there became, David, to your point about Jordan and Nike creating culture and participating in cultural movements and changing the way that people move around in the world and having a sneaker as a thing that defines you rather than a sneaker as a thing you throw on for the tennis court, but you wear proper shoes anytime you go somewhere else.
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Nike
They really have figured out how to reach an audience and tap into their identity in a way that the original Phil Knight track shoe thing never could have dreamed. And shoes have become this method for self-expression. And the secondary market is huge. It's like some estimate $2 billion, some people estimate $6 billion category. Keep in mind, all of athletic shoes are, what did I say, 150-ish?
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Nike
You know, somewhere around there. So still a tiny fraction compared to the athletic sneaker market broadly. But who would have thought that used special edition shoes or secondary sales of shoes could possibly be a single-digit billion-dollar ecosystem?
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Nike
Yeah, I'm fascinated by that. I think they've figured out clever ways to make a bunch of money on limited edition sneakers without having to be the marketplace for all the secondary sales.
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Nike
It's pretty crazy. I don't think there is anything that I can buy from Nike that costs $500. Yeah.
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Nike
And like, it's not even a high number. It's not like, oh, I can't buy something from Nike for $10,000. Like, I really can't think of a single thing I could possibly purchase for them, even for $500.
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Nike
All right, here's what I can buy. For $490, I can get American and National League jerseys for the All-Star game.
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Nike
And they have some football shoes that cost $300. Curious. Wow. Crazy. But the point still stands. They make it up in volume.
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Nike
Yeah. Just like a luxury brand, they have to market the dream, but their mechanism for capturing value is entirely different. Yep. Okay, I'm going to move us quickly here through 2018 to today so we can analyze the business in its current state. So in 2018, something pretty special happened. They pulled the trigger on a Wyden & Kennedy ad with Colin Kaepernick about standing for something.
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Nike
Yep. The text of which obviously was just Colin Kaepernick's face and says, believe in something, even if it means sacrificing everything. They accompanied it with a commercial. It launched online. Kaepernick tweeted it. Then they did these big billboards in every major city. I remember the first time I saw it and I was like, whoa.
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Nike
Nike executed perfectly on exactly what they were trying to do here. It strikes you emotionally, much like many of the Nike commercials. It was at a particular moment in time
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Nike
where they saw an opportunity to do something that they felt was right and become the center of media conversation for like months like this was the advertisement of the year and in fact i know that when they launched this they actually scrapped their plans for the whole rest of the year for a whole bunch of ad campaigns that were already ready for a different way that they were going to do the 30th anniversary relaunch of just do it and instead
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Nike
made everything in this new tone. This Kaepernick ad struck such an incredible chord and made a lot of people super angry on the sort of other side of the political aisle of this particular issue that Nike was supporting that like it entirely changed Nike's media plan in every geography for every sport for the rest of the year.
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Nike
They would have been just like every other company. Just like everyone else. And it's quite illustrative that we aren't really talking about anything that Kaepernick did. We just assume that the whole audience has seen this ad, understands the power of this ad. That says a lot about the ad itself, the meta context around how we're talking about it.
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Nike
I do think this is a good place to open up what is Nike's media strategy, because it's very clear, especially over the last 20 years, that they pick a social issue that they feel strongly about and they drive a truck through it in the American media market and say, hey, we want to prioritize this and we want to say we stand for this and we want to say we stand for and support something.
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Nike
And there's a cynical way to take that, which is like, they've done the analysis and they believe that in doing this, they're going to build more love than they're going to piss people off from, you know, those people are worth losing because we prefer these people instead. And we think these people's disposable income is high enough or there's enough of them or whatever.
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Nike
I actually don't think that's the way that it operates. I think it is like an executive and creative gut feel. This is a set of values we feel are right, and we're going to continue to bet the company on the people that identify with that set of values are a great customer segment for us, and we can grow within it. I really do think it's quite touchy-feely.
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Nike
It wasn't about football. He was sitting there on the Nike roster getting paid. There was a bunch of press about how they were thinking about actually cutting him. And then someone internally was like, whoa, what are you thinking? This is a huge opportunity for us. But like, it's hard to be a Nike athlete when you're no longer a professional athlete.
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Nike
Despite that going really well for them in 2018, they did just have a whole bunch of other controversies. Big Me Too issues at the executive level, the person that everyone thought was going to be the CEO and next after Mark Parker and many of his people around him were shown the exit. There was the whole Oregon project.
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Nike
That's their competitive running group with doping and all the alleged abuse going on there. So there's these sort of like... Coming out of 2019, they really did kind of just need to like clean things up and right the ship. And it was very fortunate that while all of this was going on, their big competitors were all kind of screwing up.
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Nike
Well, this is the other side of Phil's personality, where he's sort of a tortured soul. He's introverted, but he's unbelievably driven. He has a splinter in his mind where when his buddy's like, actually, this is pretty good. I'm going to stay in Hawaii. Phil's like... but I'm longing for something. Yes.
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Nike
And especially going into COVID, like none of their competitors figured it out. There's these smaller shoe brands and you look at Ahn or Hoka or Brooks. A lot of these niche players have done well in growing, but Nike hasn't had a formidable scale competitor. Adidas has just been nothing but mistakes over there the last few years. And so Nike has had some of these issues, but...
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Nike
has kind of been fine. And after they brought in John Donahoe, they've been able to clean up the organization, reset for the next chapter, execute this shift to a direct and digital strategy. While I think they take a little bit of a breath and say like, okay, what does Nike in 2030 look like? And how can we make sure that we don't sort of stagnate here?
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Nike
Yep, which is basically, what is it that enables a business to achieve persistent differential returns and be more profitable than their closest competitor on a durable basis? So, David, I think there is a trap laid for us on this episode. But I'm curious. Oh. You said you had a transition to power, so I'm curious where you were going. Okay.
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Nike
Yes. After that is Skechers, then Puma, then Asics, Converse, Under Armour, but like massively declining market share curve. Yep.
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Nike
That's wild. It's totally wild. It also is massively scale economies driven because the way that you acquire customers and retain customers is with this brand halo of sponsoring these big athletes and putting on these large, very expensive branded events and competitions. And small companies can't do that.
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Nike
There's something wrong with my existence in the world that needs to be fixed and I need to go and find out where I belong and what to do and how to change the world and how to build something. And I think he's got a motor that's just different than the way that other humans operate.
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Nike
The primary way that you get someone to be a 20-year customer of Nike is to go and spend money on the biggest athletes in the world. And the whole game, just like Netflix, is Nike's acquiring content. Nike is acquiring the LeBrons of the world to be Nike athletes. And the LeBrons of the world are going to go where there's the most dollars flowing to them. And who can give them the most dollars?
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Nike
And that is huge power. Yeah, it's fascinating. I mean, the game is figure out how to have the most customers that you can sell apparel to, and then you get to buy the biggest billboards. And you get to align interests with the biggest billboards. It's a content game on the customer acquisition side. And you can make the best commercials that are the most inspiring.
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Nike
I mean, that, I guess, doesn't take as many dollars. You know, you can produce an incredible commercial for $100,000, but the talent in it is going to cost you millions. The Super Bowl slot is going to cost you millions. I think a lot of Nike's power on a go-forward basis is totally the scale economy stuff. Yep, totally agree. And they had lots of counter-positioning in the old days.
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Nike
Yeah, they had too much to lose. Yep. So, Brand, I think this is a trap on this episode. I think Nike is a brand. First and foremost, what they do is build this incredible brand, sell the dream, support athletes, inspire people. But when you literally understand how Hamilton defines brand power, and the perfect example is the Tiffany ring.
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Nike
You get a Tiffany ring versus an unbranded diamond ring of the exact same caliber. You're probably paying $10,000 to $30,000 more for the Tiffany engagement ring. And there's a pureness to that brand premium concept. Does Nike really have a brand premium concept?
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Nike
Right. As Trent Griffin would put it, wholesale transfer pricing, where actually the athletes are the ones that sort of hold the power and Nike's happy to pay up for it and pass through all the profit pool to the pinnacle athletes.
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Nike
Right. But let's look at an Air Force One or a Dunk, you know, the Dunk Lows that everyone's wearing right now. They're not really generating pricing power on that. Maybe off of something purely unbranded, but off of Adidas, people are more likely to buy the Dunk Low SB than whatever the Adidas equivalent is, but the prices are pretty equivalent. Right. Yeah, they're not paying more for them.
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Nike
Right. For whatever reason, Nike has either decided not to or can't raise the prices where their brand differentiates them. And I think it's fascinating. The Nike running shoes that I buy that are, what, $160, $180, the equivalent Adidas pair is $160, $180. Same with the equivalent New Balance pair. And so if you assume that they do have brand power, Nike's making a conscious choice
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Nike
Yeah. It shows up in a different way. It shows up not in pricing. It shows up in the fact that I often don't look at a competitor. I will only go buy the Nike thing.
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Nike
Oh, you don't think Nike's going to be here in 100 years? I think you could totally kill Nike in the next 30 if you wanted to. I also don't like your premise. I disagree with your Dior thing, that the really good brands or the way you can tell if something's luxury or a durable brand is like if you couldn't kill it if you tried. I think that's too squishy. Okay, fair enough.
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Nike
And we'll be dropping little Easter eggs and hints in those emails to tease about what the next episode is going to be. So that's acquired.fm slash email. Don't miss a new episode. And lastly, make sure you check out ACQ2, our second show where we interview people who are building their companies today, available in any podcast player.
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Nike
Yeah, it's a sleight of hand. What Nike is first and foremost is a brand. What the entity is is a brand because they don't make sneakers, which we'll talk about in a second here. They don't seem to charge more than their competitors. I'm literally looking at Adidas' gross profit margins are on average higher than Nike's. Nike's current rolling last four quarter gross profit margin is 44%.
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Nike
Adidas is 46%. And Adidas, every single quarter for the last 10 years, has had a higher gross margin. What is going on here? Why isn't Nike, with a better brand than anyone else in their space and one of the hero brands in the entire world, they don't seem to be getting a special Nike markup?
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Nike
And this unbelievably competitive spirit is the founding element of Nike's culture that permeates to this day. At Nike, you play to win. And I think everyone shows up to work and you wear Nike stuff and you don't ever wear any of the competitors. Not to, hey, I want to try out this stuff. It's like, hey, We don't do that here. That's playing for the other team. Get off the other team.
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Nike
I'm not talking about $5,000 items. I'm talking about charging $200 instead of $180 because there's a swoosh on it when the market price for those shoes seems to be $180 no matter who makes them. Why don't they do that? Is it because of what it says right at the top of their IR website, which is Nike Inc. is a growth company and they care more about growth than harvesting profit dollars?
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Nike
Yeah, I don't know. I don't have a clear answer here. I think my best answer is they want the most swooshes out there in the world.
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Nike
And there's some sweet spot where they're willing to trade off profit dollars for that, for the sort of continued brand presence where the swoosh feels like a ubiquitous thing and a brand people celebrate and are excited about, and they just want it reinforced on everyone everywhere. So they're willing to give margin dollars for that.
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Nike
Yeah. I don't think the rest of the powers are particularly worth talking about. The most interesting thing is there's not any switching costs. There's not any network economies. There's not a cornered resource. I frequently switch shoe brands all the time. And that would be like one of the things that I'm least excited about about any shoe or apparel company is...
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Nike
Unlike tech businesses, there's no potential for any form of lock-in, and there's no potential for really any form of network effects. Like, come on, how am I going to benefit from other people wearing Nikes? Maybe like in the Nike Run app, being able to share stuff with my friends who also have the Nike Run app, but it's thin. That's not how they make their money.
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Nike
Agreed. So, interestingly, I guess what I would conclude on power is Nike is first and foremost a brand that, from a Seven Powers perspective, most leverages scale economies to get their outsized profitability. Totally agree with that. Nice. Okay, I will catch us up now and give us the numbers on the business today and then we can go into playbook. So Nike is at absolutely astonishing scale.
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Nike
They are a $51 billion revenue business growing 10% year over year. As I mentioned at the top of the show, they're the largest apparel company in the world except for the luxury category. LVMH and Hermes got them beat. Nike's sales to women alone are bigger than all of Lululemon's revenue. Take that in for a minute. That's shocking. I feel like that's an illustrative stat.
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Nike
You're on our team. And you wake up every day and you show up to go to work and kick your competitors' asses. And sometimes that takes them to questionable places that we'll talk about later in the episode. But Nike is among the most competitive cultures in the world.
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Nike
And Nike has really lagged in developing products for women. That's exactly what I was going to say. It's just $8.6 billion of their $50 billion of revenue. Wow. It's like every corner of Nike is bigger than the brand that you associate with that space, you know? Yep.
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Nike
The Nike brand does $49 billion, so there's some other revenue in there, Converse, and I think there's some other catch-all, but basically there's Nike and Converse, and Nike includes Jordan. So I mentioned earlier this shift to direct that Nike has been in the midst of for basically like a 10-year journey, right? About 60% is still wholesale, is still sold through retailers.
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Nike
And impressively, 40% of this very large business, this $50 billion revenue business, is now done selling products directly to consumers, either in stores or on their website. I can't imagine how difficult that transition is to make when you forge these long partnerships with retailers. Come back to that in a second. Their gross margin profile, 44%. So it's sort of interesting looking.
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Nike
Historically, David, we've been a tech podcast and we've looked at lots of software businesses that have these 70, 80% gross margin businesses. You know, Nike has real costs, as you would expect with materials, labor, logistics, cost of storing all this inventory. 44%, not bad. Let's just remember luxury, right? LVMH is a 68% gross margin business. Hermes is a 71% gross margin business.
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Nike
So Nike does $6.4 billion in operating income, so that's their income before taxes, 12.5% operating margin. So that's sort of what you should think about their sort of take-home. Not a software company. Yeah, lots of costs involved in this business. they have $8.5 billion sitting in inventory, which even for Nike is high. That's a point we'll revisit in our analysis here.
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Nike
Unlike the Nike of old, they also, in addition to that inventory, have $10.7 billion in cash and similar equivalents. So the company is no longer constrained by how much capital they have available to them. While it's been a growth company, they kind of don't know what to do with the cash.
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Nike
It's sort of this interesting question of, well, the way they started is that they could use 100% of their cash all the time to go buy more inventory and reinvest that in the business. And that was true for like a couple of decades. They've now had 30 consecutive quarters of increasing dividend payouts.
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Nike
So it's a dividend stock with 11 billion of cash on hand in addition to continually paying these dividends.
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Nike
So you might think it seems like they could reinvest more in the business to grow faster. They already spend $4 billion a year on demand creation. And I assume that's like their sports marketing budget. I think the wording on the financial statement is interesting too. They literally look at it as, We're basically going out and buying media to create demand for our products.
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Nike
Right, they just monetize in a different way. Yep. Footwear is almost 3x the apparel business on a revenue basis. So at least by revenue, footwear is still their bread and butter. And in part, it's just selling sneakers to people that go wear sneakers every day and wear them out once or twice a year and then need to go buy some more sneakers. And that's like most people in the world.
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Nike
It's a pretty incredible market that they now get to address, you know, $150 billion athletic footwear market. It's crazy.
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Nike
When you look at this pretty interesting thing that they list, which is their wholesale equivalent revenue breakdown, which is basically saying, yeah, we sell some of this direct, but we want to put apples to apples and make these unit sales sort of adjusted as if they were all sold through our wholesale channel. Men's is 51%. Women's is 21%. Kids is 12%.
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Nike
And the Jordan brand, broken out separately, like all of this excludes Jordan. The Jordan brand is the $6.6 billion business that makes up the other 16% of that pie chart. Holy God. Yeah. Yeah. Men's inclusive of Jordan, if you just assume Jordan is three-quarters men, that means that they're selling 64% of their product to men. So remember when I said at IPO they sell sneakers to men?
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Nike
It's kind of the same business as it was, but a super different business than it was at the same time. Yes. In some sports specifically, like just to dive into one example, they have a near monopoly in basketball shoes. Nike and the Air Jordan brand's share of performance basketball was 86%. And the stat's a few years old. It was right before the pandemic.
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Nike
But the dominance was even more prevalent in the lifestyle basketball category, where they have 96% share. I have to wonder...
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Nike
But like, why? I mean, I just think it's a bad move for Under Armour. I think this is the classic thing that we've talked about in 11 different industries of don't get caught in the middle in the age of the internet. It's so obvious in media. It's becoming obvious in universities. But be the New York Times or be acquired, but don't be the Cleveland Plain Dealer. Or be Disney or be Doug DeMuro.
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Nike
Or in this world, be Brooks or be Nike. Right. But don't be Under Armour, who's not a platform brand. They don't have the size and scale and everything that accrues to a Nike, but they're trying to run a mini Nike playbook. And they need to run a completely different playbook. Yeah, totally agree. So Nike is just leaning into this in a big way.
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Nike
They're now the official uniform supplier of the MLB, the NFL, and the NBA. And they're throwing huge dollars. Like the NFL deal alone is something like a $200 million a year deal. And David, you were telling me Nike doesn't even get to sell the jerseys to customers. It's literally just to get the swoosh on the game day jerseys.
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Nike
Which in many ways, that's part of why Nike is willing to pay to sponsor the NBA is because the replica jerseys get more swooshes out there in the world, even if it's not on things that they sell. It's a billboard, even if it's not on things that they make. Right. That's wild. It's totally wild.
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Nike
You would think the value chain would flow the other way, where you would make money from the jerseys sold because you are an apparel company, but instead you're paying to put your swoosh on jerseys made by other people. One final thought on this athletic shoe market being a $130 billion market. I mean...
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Nike
nike totally participated in a world change and helped to change the world that we all wear sneakers all day what an insane market to address that there are 14 billion feet in the world and we all wear out the shoes it's just a thing we need to just keep replacing what a fantastic thing to get to sell it really is surprising to me that they haven't quite figured out price discrimination
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Nike
With the exception of some of these very specialized shoes, which I'm probably not going to go buy. I'm just not a sneaker head. So I'm not going to go buy any of this limited edition color, this, that, and the other thing, or something I have to keep in a closet in a bag. It's not my bag.
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Nike
But so if you exempt away that part of the market, there's probably some shoes that I should and would pay $500 for. And yet those shoes don't seem to exist. And that's very surprising to me. Yeah. Okay, so those are the numbers on the business today. You want to go to playbook? Let's do it. Okay, playbook. The first one, I know I've said it a few times on this episode.
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Nike
I totally want to like ingrain it in the ears of listeners where Nike will come up with the most creative, clever way to win. And even if it's breaking a little bit of a rule, it's fine. The best illustration of this is Breaking 2. Did you watch that, David? Oh, yeah. So good. It was compelling. Unbelievably compelling. But they said, what are all the rules to competitive running?
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Nike
If you're going to have a pacer on a run with you, it needs to be the same pacer the whole time so that you can't cheat and rotate in pacers. You can't wear certain types of shoes that have ill-defined rules. And so Nike stages this event with their shoes that provably make you 4% faster than you've ever been before. And they drive a Tesla with a laser and a whole bunch of pacers around this guy.
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Nike
And they're like, you know what? We're going to make this big media spectacle out of this guy setting the world record and breaking the two-hour record.
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Nike
marathon time and like he came close and it was an unbelievably entertaining event to watch and what they said was we don't care if this is legal or not in competition we're just doing a stunt you know and you guys can debate afterwards if this actually set the world record for the marathon time or not and i just thought it was like there's nothing more perfectly nike than saying like well those rules are like quite cute but nike is a growth company i
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Nike
It's actually better if you open it on mobile because the sub headline goes away. So it's literally just a black and white picture of Serena Williams. It says Nike Inc is a growth company. The first time I opened it on my phone, I was like, that is a, okay, all right. I'm making that pretty clear. So I don't know.
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Nike
I think you sort of see some of that in the best DNA of Nike and in the crappy DNA of Nike, like the Oregon project stuff. So it's important to understand that to understand the company. Hey, Ben, break the rules, fight the law. That's right. Another big one is the things that are your very strength can go too far and become your weakness.
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Nike
And they totally pioneered outsource manufacturing in Asia, which is also why they got hit so hard and deserve to get hit so hard when that became an issue. I always think everyone should always just be aware in your business that your greatest strength is also your greatest weakness. And you just have to factor it in. You just have to know
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Nike
It was weird to me how wildly caught off guard they were by like, oh, well, we're not a shoe company. Come on. Can't say that. Yeah. On the note of not a shoe company, there's a great analogy here to TSMC. And in fact, there's a great analogy here to the NVIDIA and Qualcomm's of the world and Nike. Nike is a fabless shoe company.
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Nike
Yes. And unlike TSMC, semiconductor manufacturing is wildly differentiated. Shoe manufacturing, there's like two or three really big ones that Nike works with. They're unbelievably prescriptive. They source all the materials. They do lots of audits, stuff like that.
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Nike
But it runs quite differently than their apparel business, which has like thousands of manufacturers that they work with, which are all custom for all the different fabrics and stuff that they need to make. And so in some ways, it's like the fabless semiconductor industry. But unlike semiconductors, the manufacturing isn't as CapEx intensive to start, and there's not as much process power in it.
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Nike
So you actually do have this like highly fragmented foundry equivalent, like manufacturing ecosystem of people who can make your stuff.
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Nike
Yep, that's exactly right. While we're on manufacturing, sort of a funny note, Nike manufactures zero shoes, but they manufacture 100% of the nitrogen-filled little airbags. They do it in Oregon because that's trade secret, and then they ship those over to their Asian manufacturing facilities to put them in the shoes.
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Nike
I don't know. I don't think so on Flyknit. I don't know. If you're going to make the Flyknit in the U.S., you may as well assemble it. Yeah, I would assume not. So I also think it's one of these interesting things where Nike gets hit. Basically, all shoes are made the same way. There's some companies that like to claim credit for, oh my gosh, this one's made in the U.S.
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Nike
Well, part of it's assembled in the U.S., but basically everyone... you know, either makes the whole shoe or the upper outside the U.S. And I think New Balance is a U.S. brand, but like it's not, to my understanding, it's not all made here. It's like designed by Apple in California.
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Nike
The other huge theme that I think is important to take away here is for the first 15 years of Nike, it was a story of leverage. Every single point along the way up until 1981, they took the highest leveraged route they possibly could. The whole thing was betting the farm on top of betting the farm. And... We are telling Nike because it is the survivorship bias story.
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Nike
And there are many that would have failed along the way because at any given point, they would have gotten slightly ahead of their skis and the 100% debt to assets ratio would have caught up with them. And then poof, they go out of business. And Phil Knight even put up he and Penny's house to guarantee a loan. If it came down, it all would have come down. There's no slack in the system at all.
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Nike
Yep, exactly. So Phil Knight basically never took on any equity investors, and so he took no dilution. He and his management team and Bill Bowerman owned 56% at IPO, him owning 46% because he just kept betting the farm all on debt and basically had no buffer at all. So what that means is on IPO day, he was worth $178 million, and today he's worth about $40 billion.
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Nike
When you own 46% of your company at IPO and it goes on to become a top 50 company in the world, that is how you become the 25th richest person in the world. He shot the moon and he kept ownership the whole way. Yep. Okay, so we talked a lot about this brand halo idea. I want to put a specific fine point on what the strategy is. They create pinnacle products for athletes.
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Nike
I think oftentimes without even thinking about how does this translate to something the ordinary person could buy or wear. The athletes find their way to it either through a brand deal nowadays or in the early days through their local running shop who has something cool and exclusive.
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Nike
You build brand with that niche athletic community by being obsessed with that particular athlete's journey and designing products for them and customizing experiences for them. That brand then seeps out into the broader consciousness, either through paid media or through just organic word of mouth, that Nike stands with athletes. They're obsessed with it.
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Nike
They make the experience of being an athlete the best thing possible. And then they extend. And when I say they extend, they figure out what products that need to make that fit into the universe of the consumer psyche of how could I be like that dream that I'm watching? How can I participate in this feat of athleticism and show that this is like me too?
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Nike
And the hardest thing is figuring out how to extend that audience and make products for them to buy without compromising the
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Nike
That step one, that belief that you make pinnacle products and what Nike has been able to do and thread that needle and figure out how to make the $15 t-shirt that you get at Dick's Sporting Goods with the swoosh on it and also convince me that the very best shoes to run in is the, you know, Nike Vaporfly, Next Percent, whatever, whatever.
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Nike
Again, just like our LVMH episode, it's amazing that they can make a little wallet clutch for a credit card and an ID and a $200,000 handbag.
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Nike
You want to hear an insane quote that dates all the way back to 1983? Rob Strasser wrote this in an internal memo. Individual athletes, even more than teams, will be the heroes. Symbols more and more of what real people can't do anymore. Risk and win. Yes.
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Nike
Yes, I love it. Side with the athletes, sell the dream, people will buy products. Yes. Interestingly enough, too, in this Rob Strasser quote, where he says individual athletes even more than the teams, this was the big takeaway from our NBA episode that is about marketing the athletes, not marketing the teams.
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Nike
Right. Yeah, basketball is quite helpful in that there's a reason to buy those shoes just to wear them around. Like, you don't have to invent a new product for people to buy to participate in the brand story like you do with football.
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Nike
Right. I don't have any pads. I don't have a helmet. I have nothing in common with Pat Mahomes. No shoes will change that. Yep. I have one that I've been trying to think on. And at one point in the research, I wrote down, when you sell commodities, brand matters a lot. Is Nike differentiating a commodity with their brand, or are they not in the commodity business?
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Yeah, bifurcating it like that does make sense. Someone told me that in many years, the Monarch has been their best-selling shoe, which is this crazy high-margin dad barbecue shoe that no athlete has ever worn for anything. Everyone should just Google Nike Monarchs, and you're like, oh, yeah, no, my parents wore that. I don't know, it's like the ultimate barbecue shoe.
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And that's kind of what America buys. And so they've sold enormous volumes of this thing online.
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Ironically, it's actually caught on with Gen Z. And so there's this weird thing now where like people are wearing Monarchs ironically. So the Monarchs, are objectively a commodity product, and they're super differentiated by having the Nike brand on them.
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Whereas the Vaporfly, for the two years that it came out, the next percent thing that the Breaking 2 Marathon got ran in, it was like by far the best running shoe on the market for two whole years. That is actual R&D product that differentiates itself. So Phil Knight has the final word on this.
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In an interview maybe eight, 10 years ago, he said, when directly asked the question, are you a product company or a marketing company? We're a marketing company, and the product is our most important marketing tool. I disagree. I think the athletes are your most important marketing tool. I think the product is a monetization method for the marketing that you do through athletes.
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But if you admit that, then you're saying that we don't have differentiation in our product. But I do think it's quite telling that they started distributing someone else's product. And yeah, they do lots of R&D.
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But at the end of the day, they succeed because they have built the best brand in the world, the most amazing distribution in the world, and the most tear-jerking marketing that anyone ever watches. And they have a 30-year enduring brand. For 30 more years, Nike will be, I can't predict after that, but Nike will be a brand that people look up to and are inspired by.
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Right. Being a soap opera keeps them in the spotlight and keeps the opportunity to have more impact with sponsor eyeballs. Yep. This whole sponsor celebrity thing is both a asset if you do it well and a massive liability if you do it wrong. Nike's strategy has very clearly been celebrate athletes.
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Adidas has had this strategy that seems to be like celebrate eyeballs, where they'll sponsor anyone with attention. It's rappers, it's musicians. Oh boy. It's some athletes, it's celebrities, it's... Do we want to talk about Kanye? Well, this is quite interesting. So I think Nike was smart. I think they legitimately premeditated, ooh, we don't want to be associated with this person.
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And so they drove a really hard bargain. And notoriously in 2015, Kanye walked away from Nike and said, they refuse to give me creative control.
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I think Nike didn't see exactly what was coming with Kanye, but I do think they realized, hmm, our entire brand is built on celebrating athletes, and while we should be in business with celebrities in some way, shape, and form, I mean, there's these great old stories of Rob Strasser making sure that movie stars were wearing Nikes and driving around Hollywood.
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we're here to celebrate athletes and stand by athletes. And, like, we would stand by Tiger Woods. We did in some really trying times in his life where a lot of people turned against him. Would we stand by Kanye? No. We don't know what to celebrate about him. And so, I don't think they had too much foresight and knew exactly what was going to happen. But...
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I think they've clarified their strategy that they're athlete-focused. And for anyone who hasn't been paying attention, he blew up Adidas' year. Adidas' net income has basically evaporated and gone to zero. They used to make over $2 billion a year in profit, and the last four quarters on a rolling basis, they've made less than $100 million. So $2 billion down to $100 million.
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And they claim around $500 million of this is the Yeezy write-down. They posted an actual net loss last quarter. It is a pretty disastrous situation over there. And there's a full-out slide in their deck where they admit, we think we're better than this and we're not. I didn't realize it was that bad for Adidas. It's bad. It's really bad. They're in a complete reset year.
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Right. And the running craze or the fitness craze hadn't really started yet. So to give you a sense, David, I think you're probably spot on with that. Maybe a hundred million, maybe 200 million for track shoes in the U.S. The branded athletic shoe market all up, including all sports for the whole U.S. across all age groups, everything, two billion dollars.
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Yeah, there's a lot of different ways to play it and Nike seems to have played the chessboard quite intelligently.
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All right, so here we are at the end of analysis, the bear case and the ball case. So there's a bear case that we haven't talked about, which is Nike's in a weird place when Mark Parker retires. He was supposed to have a successor. The successor is out for Me Too reasons. and a bunch of other people too. They're theoretically thin on people who could take the job. They bring in John Donahoe.
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John was the CEO of ServiceNow, was the CEO of eBay, and was the CEO of Bain. So not from the sneaker business. But was a board member. He was a board member, so he knows Nike's history from that level, but different than... I mean, Mark Parker started as a sneaker designer. Very different sort of lineage coming in.
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Oh, that's amazing. So John comes in and is sort of this external hire. I get the sense, I'm not sure he'll be a 20-year CEO. I get the sense this is sort of like figure-it-out time for Nike, stabilize things, get them set in a good direction, and then figure out who from the bench is the right next person. I don't know how long it'll be, but it's just like a vibe that I get from reading stuff.
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Yeah. So COVID happened around the same time that he's coming in to take over. And they've sort of decided to do this big reorg where they used to have an org structure super focused on each sport. And that meant that it was people's jobs and whole team's responsibilities to track the athlete's journey through their experience playing that sport. And they provided critical
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crazy amounts of support to athletes. And like, here's an example. At the last Olympics, they wanted every single sport to have the option to be wearing Nike shoes, every athlete. Well, many sports don't require shoes. And Nike said, that's fine with us. We just want to have a presence and we want to support those athletes.
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They did a bunch of R&D on all sorts of crazy things, including like a gymnastics partial shoe thing. for one specific gymnastics event because they're just obsessed with how do we make the athlete experience better? If they end up in swooshes and people understand what we're all about, they'll want to participate in our brand story too.
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Well, this reorg was sort of intended to realign teams at Nike with the way that they actually interface with the outside world. So now it's men's, women's, and kids. because you go into a Nike store on Fifth Avenue in New York, and there's a floor for men's, women's, and kids. And you go into a Dick's Sporting Goods, and there's a men's, women's, and kids. And so it kind of makes sense.
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You shouldn't send 12 people from Nike, one representing every sport, to go meet with the one buyer at the menswear department of that shoe store. But Nike's an incredibly matrixed organization, and so that's sort of the thing that was happening. The bear case in this is what has kind of gotten lost is an obsession and focus on these individual sports and the journeys in these sports.
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Let's look at the trainers, like just a little example in running. As we learned in the Brooks episode, the business... for them is in the trainers. It's not the race day shoes. It's what you're wearing to get your three mile or your five mile in a few mornings a week. And you wear those out and then you buy another pair and it's a great business.
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So there's some Nike running department who needs to be sort of obsessing over that journey and growing their sales and their share in not just race day shoes with this amazing Vaporfly stuff, but like the trainers. But look at what's actually happening in the running market. You've got Brooks, Ahn, and Hoka, all becoming billion-dollar revenue run rate companies in the last 18 months.
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Nike, fortunately, their big competitors like Adidas have just been out to lunch. But these little competitors who are all nipping at their heels are doing a great job focusing on their niches.
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And when you simplify an org in the way that Nike has, there's a little bit of a concern around, are they still focusing on the niches and are they still focused on serving athletes in the same way, in an obsessive way that they have been in the past? Okay, I buy that as a bear case.
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So there's a lot of nuance there, but I think that in the same way as that old Disney quote, so with Disney animation goes the company, sort of like so with running goes Nike, that's a bellwether.
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Right. They had a large hand in growing. And I'll spoil it for listeners. The branded athletic shoe market in the U.S. today is...
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And I don't see them slowing in basketball. Well, I mean, that's the thing is it's like kind of hard to come up with a bear case. There are all these like little nitpicky, like I listen to a bunch of Teague's calls and I listen to the earnings calls on quarter and like in doing my like investor diligence on this, these are the sorts of things that people are concerned about.
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A big one is like this potential reversal of strategy on D2C. Like they reopened Macy's and they put more inventory in Foot Locker in the last couple quarters. And that's sort of concerning because the whole narrative has been, we're going direct. But also, uh-oh, we have too much inventory, so we got to blow it out and discount it through our retail channels.
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There's lots of questions to management about if that sort of thing is happening right now. Big slowdown in China, not just them, but all the big brands. It seems like the Chinese market is shifting to Chinese native brands, or there's a lot of signs that that might happen. And so the China market is a huge, important set of consumers to Nike. So I think them figuring out
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especially how their social justice stances fit in with the CCP-controlled China, that's a huge open question. And are they going to be able to address that biggest market in the world for feet or not, you know, at scale is sort of the question. Yep. Makes sense. Honestly, that's the best I got for Bearcase.
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is a hundred and thirty billion dollars now obviously not all of that is track and running but like a large part is running shoes and that's growing five percent year over year so still a growth market even at that scale which by the way that number 130 billion just to like compare it against some other things that is bigger than the video game market wow hey i mean not everybody has to play video games but everybody's gotta wear shoes
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Yeah. I mean, that's the bull case. These scale economies are super real, and they're in pole position to just keep spending and keep investing in building this incredibly durable brand. And products will come and go. There will be five-year stints where they have the most amazing running shoes that everyone needs to marathon in, and there'll be years where they don't.
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But the Nike brand and their media strategy and their brand voice and the way that they deploy into all these local markets and tweak the messaging to be local appropriate in every corner of the world and manufacture at scale, like, it's just...
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the nike brand means something to billions of people and nike knows how to make it keep meaning something to them yep like i said earlier there are a lot of swoosh tattoos on bodies around this planet that is a bull case right there yep in the world of globalization and the world of the internet returns to scale are a big deal and they're in the scale position
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Yeah, completely agree. Yeah. I mean, you listen to these Tegas calls with Adidas people, and they're like, our issue is how to figure out how to make the brand cool again. And that does not show up in any way, shape, or form in the Nike interviews.
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All right, well, that closes out Baron Bull. I have some fun trivia for you, David. Love it. So I saw you tweet something about some person in this episode being related to a person in a previous episode. I think Daniel Ek commented on it, and I was trying to figure out what you had just found, and I'm wondering if this is it. So I'm going to read from Wikipedia.
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Nishio Iwai was involved in a corruption scandal in 1979 after it passed on a $500 million yen bribe from McDonnell Douglas to the director of the Japanese Defense Agency in an attempt to influence the sale of the F-4 Phantom aircraft to the Japan Air Self-Defense Force. The scandal was uncovered only three years after a similar scandal involving Lockheed conspiring to bribe Prime Minister Tanaka.
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For anyone who didn't listen to our Lockheed episode, we talked about this bribe bringing down the prime minister of Japan, and oh my God, it happened through Nisho.
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All right, quick carve-out. I think you should go listen to Marc Andreessen on Lex Friedman, and then you should listen to him again on Ben Thompson in that order. He's been on a little bit of a media tour since he did the... It's the Andreessen-Horowitz strategy. It's like everything we talked about on the episode with them and how they're...
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the most media savvy in the game, in part because of working with Margeet there. But like, oh my God, he's so smart. And it's just a privilege to get to listen to him talk every once in a while. And it's fun that he's out talking right now because his perspective on AI is also, yes, he's talking his book, and also all of his arguments are extremely compelling. He's very smart.
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Right. It's like, oh, listen to the venture capitalist who has $30 billion under management, where a lot of it is like betting on the future that AI is going to be this big thing that's good for the world. Talk about how AI is good for the world. Yes, I can acknowledge that and listen to him and then be like, and I completely agree with almost everything you're saying.
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I thought so. I was like, she doesn't need to do this anymore. She's got the leverage.
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Yeah. That's cool. I got to listen to it. I literally haven't done anything other than read about Nike.
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I'll enter my three-day window right after we finish recording where I can pay attention to other things again before starting research for the next one. Yeah. Speaking of, we should pick a topic. There's like a thousand I want to do. So after this, I'll give you a call and we can talk about it. With that, our thank you to Blinkist by Go1, Statsig, and Crusoe.
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All the links, all the discounts, all the free audio content, everything that we talked about are available by clicking the links in the show notes. You can get notified, new feature that we just launched, of all new episodes launching. Go to acquired.fm slash email, and we will include some fun Easter eggs in there in addition to just telling you the episodes live.
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But that's the way to get on the email list. Many of you are already on that. Thank you for doing that. It is awesome to be able to have that direct connection with you and not rely on a Twitter algorithm or anything letting you know that we're live. Anything subject to change. Yes. Become an LP, acquired.fm slash LP. ACQ2 is in any podcast player.
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Dave and I have a couple of fun interviews queued up for that. So ACQ2 should have some good stuff coming soon. And join the Slack, acquired.fm slash Slack. With that, listeners, thank you for going on this blue ribbon journey with us. We'll see you next time in Dimension 7.
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And this is just to like get some samples to see if he can sell $50 worth of shoes. That takes over a year.
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The naivete is just dripping off of Phil at this point. It's like, oh, good, I have a business, so surely I will make enough money to be able to quit my job and hire people. Yes, and now he doesn't have enough money to open a retail outlet.
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And without further ado, listeners, as always, this show is not investment advice. David and I may have investments in the companies we discuss, and this show is for informational and entertainment purposes only. David Rosenthal, what is that stack of books on your desk?
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Pretty awesome. That's like legitimately doing the shoe leather work that no one else is willing to do and getting through that hard part to get your business off the ground. Establishing proprietary distribution channels.
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And so let's just take a quick pause and recognize this company that would eventually become Nike started A, not as Nike, B, not with a swoosh, C, not making a product. It's literally just importing and reselling someone else's product. And the plan is to build a big business off the back of not actually making things.
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But maybe that penciled more at the time. Being in this super globalized world that we're in now with the internet and companies with these massive resources that can scale immediately. And venture capital. Exactly. And venture capital, which can just supercharge a company's growth if something's working.
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The idea that your core competency is just distributing someone else's product among a geographic area where you have a relationship with customers, that might have actually been a pretty good plan and much more defensible in a way that it's much harder to build something like that from scratch now.
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And like real partners, 50-50-ish. It's not like I want you to like toss me a percent here or there for being an advisor or something. It's like, okay, great, co-founders, just like that.
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Yes. So I was thinking about this. After reading Shoe Dog, I was like, hmm, because I just read it for the second time. It just feels a little weird that Bowerman would just kind of immediately be like, yes, I'll go into business with you, person who ran for me that I never had a particularly close relationship with. And so I've always wondered, like, why was he so eager to do this?
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I thought there was just Shoe Dog. I didn't realize there was the literally over a dozen that you and I collectively read.
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And as part of the research, I stumbled upon this guy named Scott Reams, who was formerly a Nike historian. He worked in the marketing department and then for over 20 years worked at Nike and became the company historian. He has an epic set of LinkedIn posts that are really like these incredible gems pointing out things in company history. And so he's got this post. He says...
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Based on letters in the University of Oregon and Nike archives, Bill Bowerman corresponded directly with many footwear manufacturers in the 1950s, so like 15 plus years before this, including Adi Dassler, directly to Adi Dassler. trying to purchase shoes for his runners directly to avoid retail markup. He made it clear he had ideas on how to make running shoes better.
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Remember, these are in letters to Adidasler years before. But the responses he received referred him to footwear distributors in the United States for Adidas and ignored his design offer. So Bowerman is sitting there and he is primed. He's like, oh, you're going to import foreign shoes and give me a deal? I'm in.
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Nike
Oh, did you read his post too? I sent you his LinkedIn. Did you look through them all too?
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That is so awesome. Oh, that's so cool. I guess I should tell you. So listeners, we talked to like nearly a dozen people to prepare for this episode. I also want to thank Eric Sprunk, who is a 27-year Nike veteran. And David, you know that I chatted with him, but he was COO until a couple of years ago and very cool to get his perspective and Scott's perspective.
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Well, there's a few problems, one of which is they're not making that much money. It's not a great gross margin business. You have to pay to import these shoes from Japan. How much can you really mark them up to sell them?
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And if you're making, I don't know, two, three bucks profit, something like that on each pair of shoes, you have to sell a lot of shoes if your only way to get money to buy more inventory is the profits from the shoes that you sold last order. I don't even know how you double year over year because where's the money coming from to get the inventory?
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And he has an irrational passion for running, which basically no one else did at the time. Here's a great quote from Shoe Dog, so it's in Phil Knight's voice. In 1965, running wasn't even a sport. It wasn't popular. It wasn't unpopular. It just was. To go out for a three-mile run was something weirdos did. presumably to burn off their manic energy.
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Running for pleasure, running for exercise, running for endorphins, running to live better and longer, these were things that were unheard of. People went out of their way to mock runners. Drivers would slow down and honk their horns. Get a horse, they'd yell, throwing a beer or soda at the runner's head. And he goes on to say that Johnson had many sodas thrown at his head while he was out running.
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Yep. And by the way, when you're going to get money from the bank, it's not equity capital. They're not saying like a venture capitalist would say, oh, I'll buy a piece of your business and value it at this and give you the money at that. It's just pure loan that you owe back to them at some point in time with interest.
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They're going to be quite risk-averse. So there's another good passage that I grabbed from Shoe Dog that explains this. Phil Knight. I was projecting $16,000 in my second year, and according to my banker, this was a very troubling trend. A 100% increase in sales is troubling, I asked. Your rate of growth is too fast for your equity, he said. Growth off your balance sheet is dangerous.
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And this is where Phil Knight's complete opposite approach comes in. He goes, life is growth. Business is growth. You grow or you die. And the banker says, that's not how we see it. And there's a couple important points to make in here, one of which is this equity they're referring to. We refer to equity these days, especially in startup land, as percentage points in a startup.
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And what he's talking about here is the technical definition of equity. The book value of equity. Right. Your total assets minus your total liabilities is your equity. And in many cases, you can sort of squint at this if you don't have a lot of liabilities or a lot of debt on your books and say, okay, so it's basically like the cash in the bank. It's the assets you have on hand as your equity.
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So what this banker is basically saying to Phil Knight is, I will only loan you up to the amount of money that I already know you have. Now, that's not terribly helpful. It's basically a cash advance. It's like, well, the money that I have is sort of tied up in other stuff, like inventory, and you're just loaning me enough money for me to make my next order.
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But there's not actually any real new capital. It's not like there's a post-money valuation. You're basically just saying, you can borrow these dollars, then you can give them back to me, and I'm going to cap your dollar limit super low.
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Because everyone's telling him that he needs to do advertising. Phil Knight, to this point, which is hilarious given Nike Today, doesn't believe in advertising. And so he's like, fine, I'll give in to some other people who are advising me that I should make some brochures or something.
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Nike
Ooh, David, you teaser. What else could anyone possibly design for Nike that would change Phil Knight's life? It's a great story, and there's more to it than I think you've heard before. So what sponsor are we talking about? Brand new one for us, a company called Blinkist. We are doing something pretty special with them here at Acquired.
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Blinkist, as you might know, takes books and condenses them into the most important points.
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Yes, it lets you read or listen to the summaries. So it's great for people who want to read more books, but you might not have time to get to your whole dream bookshelf. Now, we told the good people at Blinkist how we go about researching for Acquired, and they had an idea, and we're running with it.
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So if you go to Blinkist.com slash Nike, or click the link in the show notes, you can get Blinks for the Nike books that we use to research this episode. And many of them, they are making custom for you guys in real time, So expect more Nike books to be showing up as they're literally making these for the acquired audience.
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And not only that, if you use the link, you'll get the whole Nike collection for free as these books get added. And Blinkist has told us anyone who signs up through that link or uses the coupon code Nike will then get an additional 50% off a premium subscription to all 6,500 titles in their library.
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So for those of you who lead companies and organizations, I know there's a lot of founders and executives listening, Blinkist also lets your company become a customer with Blinkist for Business. So 1,500 different organizations use this worldwide.
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This gives you not only access to condensed books, but also courses and coaching pathways like Leadership from Simon Sinek or courses on mindfulness or communication and history. It's awesome for teaching new skills or for the learning and development department at your company.
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So a fun way this came about, a little acquired behind the scenes, Blinkist was just acquired by Go1, which is a friend of the show where the founder and the leadership team have been longtime acquired listeners. David and I are both investors in Go1 and now Blinkist.
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Nike
And we'll share more about Go One later this season, but know that they are an amazing one-stop shop to get all the content that you need for your company, like for your whole workforce, from HR trainings to specific skill development classes. And they get that content from the best places in the world to produce that content. It's not like they're making something you've never heard of.
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They probably have awesome content that you're looking for just bundled into one easy subscription. So back to Blinkist. To join the 27 million people who use Blinkist, go to Blinkist.com slash Nike or click the link in the show notes to get access to what we use for research. Pretty cool. Okay, David. So should we share the Carolyn Davidson thing now?
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Or don't we need to evolve Nike a little bit more before it really comes into play? Yeah, put a pin in it. We'll come back to it.
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Exactly. Well, that would be for the courts to decide. Is it like the Blue Ribbon Shoes design company owns the design and they hired a contract manufacturer? Or is it more like, oh, we just gave you a little suggestion idea and like we BRS don't own anything?
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I bet someone out there is wearing Nike Cortezes right now. It's become like a lifestyle shoe and less of a running shoe because the definition of a running shoe has changed dramatically. And so the fascinating thing is if you look down at your Nike Cortez or you Google a picture of it, it's basically exactly the same as the thing that they came out with.
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All right. I'm going to read a paragraph from Shoe Dog here. This is Phil Knight. He told me, on top of everything else, he was also writing a book. A book, I said, about jogging, he said gruffly. Bowerman was forever griping that people make the mistake of thinking only elite Olympians are athletes. But everyone's an athlete, he said. If you have a body, then you're an athlete.
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Now he was determined to get this point across to a larger audience, the reading public. Sound interesting, I said, but I thought my old coach had popped out a screw. Who the heck would want to read a book about jogging?
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Yep. It's the craziest thing. I keep going back and forth when looking at Nike and say, did they benefit from this enormous wave that they were riding? Or did they create a wave? And I think it was actually both.
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I love it. Here's a crazy bit of trivia, David. So for me, when I reflect back on like the birth of the jogging movement, because I'm a millennial and I wasn't there, I think of Forrest Gump. You know, he's running across America and all these people are running with him. And that time and that aesthetic to me is like, oh, that's when jogging sort of really took off. He was wearing Nike Cortez's.
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And the fact that Blue Ribbon really did have starting to become pretty real distribution at this point to the West Coast, they actually had built a brand and a trustworthiness with customers and coaches and that sort of thing for themselves that not only could Bowerman write the book and evangelize and have the idea, but they could actually get shoes onto the feet of people because out of this budding company, they actually had a little bit of distribution.
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Nike
Welcome to Season 13, Episode 1 of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts. There's an age-old question in business. What is more important, a great product or great marketing? Well, today we have literally the perfect case study in that very question in Nike.
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Yeah. So, Strasser, we'll get into his contributions, but he is probably second only to Phil Knight in willing Nike into existence. Yeah.
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Surely you could assign some value to that contract, if not to our brand and our team and all these other intangibles. You won't just treat us as if we're book value now. Like we'll have some real enterprise value because you can invest in our enterprise here, our enduring institution.
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We're done. I'm just fascinated by this concept of it's almost as if the idea of enterprise value didn't exist, that literally a company could only possibly be thought of as its assets minus its liabilities. So what that meant was if you want to grow your company and you want to grow it as fast as possible, then it means you can only take out as much debt as you have assets in the company.
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But you probably shouldn't because then if anything goes wrong, your company is like immediately wiped out because your debt to assets ratio is like literally 100. And what Phil Knight did was all of the time kept it at a 100% ratio or close to it, like a 90% ratio.
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He'd look and see how many assets they had and say, great, we should have exactly that much debt too so I can grow as fast as possible. And so it kind of becomes this game of musical chairs where when you're levered that hard,
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you need to be growing super fast because you need to get that inventory off the boat, sell it so you can as fast as possible go and pay off the bank so that A, the interest doesn't pile up and you don't trip a bunch of covenants, but B, so that then you can go ask them for another loan to do the same thing again. And you literally need growth as the only way to keep the lights on.
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Nike
It's not just growth as a virtue, it's growth as a necessity. And this, in addition to the competitive thing I mentioned earlier where Nike is a competitive company. Nike is a growth company. And if you go to their investor relations page to this day, across the top in big bold letters, it says Nike Inc. is a growth company.
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Nike
They were born out of this is the only possible way to continue our existence is grow so we can pay off the bankers. Two things here.
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Nike
Right. It's like many of the stories we tell that it's path dependent. The only way to have built what they built was to have endured what they endured in a system that was stacked against them. Yes.
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Nike
Plenty of other companies maxed out their available credit and debt all the time and had a 100% liabilities to assets ratio and went out of business. And went under, yes.
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Nike
people are getting financing for their business in the form of equity capital where they're willing to assign a valuation to the company and regardless of what your current sales and assets look like that sort of takes your potential future growth into account and gives you capital in exchange for that what they want is a percent of the upside you know equity investing as we know it today in startups and all of that is happening in northern california into tech companies as we chronicled on the sequoia episode with don valentine it's that era
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Nike
So what I've never been able to figure out is did he change it to Sports Tech Inc. and then change it back to Blue Ribbon Sports? Or did they sort of like... I'm trying to figure out if they ever literally changed the name on documents.
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Nike
Well, and Phil Knight undersells it, too. Before you learn some of his later lessons, it's his super humble, you know, I'm not a very good runner. I'm only a 413 miler type attitude.
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Nike
It's amazing. Yeah, the way that he was financing this was basically through convertible debt. And so all the pre-IPO little friends and family financings that he's doing here are convertible notes. So this brings us...
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Nike
And what they are is this very strange type of company that we don't really have, at least in the tech ecosystem today.
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Nike
And it's sort of a hybrid between a lender and a supply chain partner, where it's a company that has some primary business that they're doing. Slash private equity firm slash holding company. Yes. It's a company that, in this particular instance, has a business that they're in and generates a bunch of cash. So what do you do with the company's treasury?
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Nike
Well, you could do boring stuff with it, or you could make strategic investments with it, or you could operate a financing business
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Nike
where you leverage all of the unique relationships you have from the parent company to do diligence, to advantage your investments, to put your foot on the scale, and you're using the fact that you have a large treasury to open a competitively advantaged bank, especially in sourcing international goods.
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Nike
And it could have gone either way. That was the thing with these Japanese trading companies, is if you weren't super clear on exactly what you wanted up front, it could totally go the way of private equity, where, oh, you tripped one covenant, or, oh, you this, that, the other thing, and suddenly...
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Nike
they're able to own a controlling interest of your company, or they're able to take over management and install their own people. It was a PE-style financing where oftentimes they would sort of take over and absorb the businesses that they were financing. So Phil Knight was going into this saying, okay, That really, really, really can't happen to Blue Ribbon.
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Nike
What can I possibly negotiate with these guys to make it so that their interests are aligned with mine, but not in a way that could compromise my control?
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Nike
Right. They're a little too eager. This can't be that good of a deal. What's going on here? It turns out, ultimately, it's a great deal. And why is it a great deal? Well, the first thing you have to know is Nisho knows Japanese manufacturers. And so they start asking Phil Knight questions like, well, who do you work with in Japan? And like, would you ever make your own shoes?
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Nike
And are you looking for relationships with more factories? And so they start to get the sense that like, maybe eventually... we could put our foot on the scale in certain ways and help this company win. And so if we're doing business with them as their financing partner, this could be really good for us too.
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Nike
Yes. And before we get into exactly how this all plays out and effectively the real founding of Nike, creating their own shoes and how that all goes down, with this financing as a key part of it, this is a great time to tell you about our next brand new sponsor of Acquired, Crusoe.
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Nike
Yeah, so the way they did this is genius and kind of insane. So one, they get better performance just by building their infrastructure specifically for AI. So like literally their entire data centers are nothing but rows and rows of NVIDIA A100s and H100s. So they have the benefit of focus and specialization. And two, this is what's really special about Crusoe.
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Nike
A single NVIDIA H100 under full load consumes about the same amount of power as 10 US homes.
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Nike
Okay, so Blue Ribbon's in this interesting situation where they've been kicked out of their bank from a lending perspective. They can still keep their money there, they still have the operating accounts, but they can't get any more debt there to finance their inventory, which they need to buy. You know, they need this cash to be able to buy their next round to grow the company.
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Nike
Yes. And one thing I was trying to figure out, so in Shoe Dog, it doesn't give a value. Phil just says that his contact at Onitsuka offers to buy 51% of Blue Ribbon and keep him as a minority partner. And from some other sources, what Phil Knight says in interviews is that they offered to buy it for book value.
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Nike
So it's a pretty terrible deal because what is the book value of a company that 100% of the time has its capital tied up in inventory?
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Nike
So it's zero, or most generously, it's the value of the inventory. So in 1971, I believe they did $1.3 million in revenue, which best estimates would be that their cost was something like $600,000, $700,000. Right.
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Nike
Right. So it's a terrible deal. It's a takeover. And so Phil Knight's basically just like, I don't want to piss them off by declining, so I'll just say nothing.
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Nike
And by the way, this relationship so far has been unbelievably fruitful. They're at the point now where because of Blue Ribbon, 70% of runners in the U.S. Mind you, runners is not a large category yet, but runners in the U.S. have Onitsuka shoes.
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Nike
Literally, the guy gets up to go to the bathroom or something, and Phil grabs it out of a folder and photocopies it.
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Nike
Yeah. There's a paragraph in the written agreement that gives Phil Knight three years or whatever it is of exclusive distribution. In exchange, he is forbidden from importing other brands of track and field shoes. And so, theoretically, he thinks as long as they're not track shoes, it's fine.
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Nike
And you can actually hear quotes from Phil Knight in interviews and a little bit in Shoe Dog where it disputes other records of how this all went down. And people care a lot about this because obviously what we're getting here is the origin of the swoosh and of Nike. And so how does this end up happening?
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Nike
The most interesting thing is from Scott, he put this on LinkedIn, he talked to Carolyn herself about this, her recollection is that Originally, in the request to create what became the swoosh, they wanted structural support as an element in the design. And she came back with some designs. They didn't like any of them.
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Nike
And so in the second revision, they dropped the requirement that it be supportive in any way and that it's just about having the brand sewn onto the outside. Right.
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Nike
Right, so it's literally not inspired by the Greek goddess of victory. Like, I was just in France. I just stood in front of the winged victory statue. It's this beautiful, incredible thing in Paris. There's this myth running around forever and ever that the swoosh is inspired by one of those wings.
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Nike
The name Nike came after the design of the swoosh, which, by the way, also was not called a swoosh yet.
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Nike
Which also, she said she spent way more than 17 and a half hours, but it was just kind of coming up with some price to charge. Fun thing about, I did the math on the IPO shares. When Nike went public, they did give her 500 shares. The stock price today is around 110, and it has split seven times. So two to the seventh times $110 a share times her 500 shares is worth $7 million today. Nice.
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Nike
Well, it's interesting. Phil Knight would describe himself in his prime as an okay runner because he was running with the best collegiate runners in the world, coached by Bill Bowerman, who barely gave Phil Knight the time of day. I get the sense he was not a man of many words and certainly almost no words of encouragement other than run faster. And so you've got Phil Knight.
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Nike
That they weren't even sure was going to work. Right. And it didn't work. Turns out this factory, not very high quality.
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Nike
Yeah, it's kind of amazing that they even continued after that or that they didn't just give up and say, okay, shoe distribution sounds a lot better than making shoes. Yes.
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Nike
Yeah. And this, to me, is a little bit of a thing in Nike's DNA where they are competitive all the way up to the line and then one toe over.
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Nike
It's very much that. We are fiercely competitive. And at this point in time, it was to stay alive, so I get it. But for their whole existence, it's like, is there anything we can do that other people aren't doing because they kind of think you can't, but maybe we'll do it anyway and deal with the repercussions. That kind of happens with Nike over and over and over again.
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Nike
And that's on top of the financing. So they already owe interest on borrowing the money, but now they additionally owe a 4% royalty.
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Nike
Wow. I mean, at this point in history, to have the House in order with a strong financing partner, there's crazy stuff we didn't even cover. Like, he got kicked out of multiple banks. The FBI got involved. They were playing it a little bit too fast and loose where they were using every available penny to buy inventory. And so there would be checks that bounced for payroll and things like that.
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Nike
When these things topple, they topple all at once. And so they had like a day where they got called into the bank and then the bank called the FBI and then they got investigated for fraud. It was an insane few years there. Yeah.
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Nike
They can kind of... take a deep breath and say, well, the business ahead is still really hard because now Onitsuka is going to be working against us. We have to figure out how to design and make shoes ourselves. But at least we have a real financing partner that has struck a deal to work with us.
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Nike
What an amazing way to do business. Because he had met with all these other factories. They were like, yeah, we'll get back to you in a few weeks. And like over lunch, they built one.
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Nike
And these are Nike franchises that stood the test of time. Many of these shoes are still made.
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Nike
Yep. And there's kind of this funny thing where it is still Blue Ribbon Sports. So in 1971, they do create Nike Inc. It is a wholly owned subsidiary of Blue Ribbon Sports, and it is responsible for manufacturing Nike. well, or contracting with manufacturers to make this line of shoes, this Nike-designed line of shoes owned by Blue Ribbon Sports.
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Nike
Of course, later on, these would flip and Nike would become the parent company. But for now, it's a subsidiary of Blue Ribbon. Amazing.
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Nike
Yeah. And a lot of the CEOs that show up in these acquired episodes are deeply private people, but it's mostly because they want to stay out of the limelight. And when they're in the limelight, you can see that they can turn it on and they're bright and shiny and they're sort of loving working the room. That's not Phil Knight at all. Not at all.
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Nike
Which has two problems. Yes, the shape is... Yeah, you can imagine how that could grip a track well. There's two problems. One, hot polyurethane, super toxic. The man, for many years of his life, because he's been experimenting forever, is like breathing in all these hot, terrible chemicals.
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Nike
Yes. And two... Pouring hot polyurethane into a waffle iron is going to permanently glue the iron shut. Yes, which is exactly what happens. So apparently the first actual waffle trainer shoe was inspired by this design, but like he literally couldn't make one in a traditional waffle iron.
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Nike
And I think the waffle trainer is starting to be worn outside of track situations. Like, this is the first hint of a lifestyle sneaker. Yes.
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Nike
Nike is designing their own shoes and going direct to the manufacturer. I think the benefit to the business at this point is not margin expansion. It's purely aliveness. And can we convince people to buy things from us that aren't Onitsuka Tigers?
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Nike
Because to this point, it's still unproven if it's, hey, Blue Ribbon has great distribution and people will buy anything from these guys because we trust the company. Or if it's, People really wanted Onitsuka Tiger because they were really good shoes for runners, and I don't really want whatever this new thing you're selling is.
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Nike
Which is kind of amazing. That is completely opposite to what my intuition would have suggested. I would have definitely believed there's these shoes that are popular among other competitors, so I should be wearing them to be as competitive as them. If I run in them myself, I learn to like them. It's very strange that it ends up being the relationship that matters.
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Nike
Does breakthrough innovation drive that business? Or is their core competency really around their profound advertisements and their sponsorship deals with athletes and teams or their probably best in the world brand positioning? To understand it, we have to examine Nike's entire 60-year history, of course, because this is acquired. And because Shoe Dog is so good. That's amazing.
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Nike
Like thinking, oh, I trust whatever this running shoe distribution company is now making because they say it's good. I'm sure it's good.
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Nike
You can't script this any better. And in fact, he was not allowed to take a paid endorsement due to AAU rules.
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Nike
Just like snatching the document out of the briefcase, whatever it takes to win, Phil Knight figures out a way to A, make sure that he's running in Nikes, and B, make sure that he doesn't need to worry about money by finding a clever way to not do a paid endorsement, but something else.
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Nike
And Nike was on the side of the athlete, which is a thing that they've always been and is a huge part of their strategy.
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Nike
It's Phil Knight basically inventing sports marketing. I mean, there was a sort of nascent idea of athlete sponsorship at the time, but it really, this is the invention of it as we know it today. And all athletic brands are defined by athletes, and this is really the first instance. Yeah.
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Nike
And this really starts Nike down a path of their distribution strategy being a wholesaler. They sell to retail chains. And for decades, starting here in the early 70s, they are predominantly someone who reaches their customers through an intermediary, through retail. Yes. So that's the second piece.
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Nike
Kind of a hedge, too. It was a hedge, yes. And it was a secret hedge. Again, break the rules, fight the law. They used Nishio's money, which was supposed to be to buy inventory, instead to plow it into CapEx of buying and rehabbing a factory. And then they were secretly operating their own factory with money that was not supposed to be used for that purpose.
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Nike
But again, Nike, break the rules, fight the law. And here they are today, a huge and successful company.
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Nike
Totally. Well, let's flash forward to the 90s here where this really hits a flashpoint. And then I think we'll come back to the story. While we're here, we may as well be here. So stories hit the news of some really horrible things like child labor, stitching soccer balls on dirt floors in high temperatures, toxic glues. Carcinogens. Et cetera.
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Nike
Nike fans looked at this as, oof, the company really has a black mark on their otherwise great reputation. But it kind of was the natural endpoint of an idea that had been in the company's DNA the whole time. I mean, literally, Phil Knight's Stanford paper is about arbitraging cheap labor from imported goods and selling into markets willing to pay higher prices.
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Nike
They should have realized this is where it could have gone if left unchecked. So to add insult to injury, Nike wildly mishandled this. They tried to act like it wasn't their problem. They literally said to the press, oh, we don't make shoes. Mark Parker later walked this back with a stance where he said, ignorance is not bliss.
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Nike
You have to understand the systemic issues and work with factory partners to solve them. They did do a huge amount of work to clean up their act. They created new standards for factory partners. They published supplier lists. They have third-party audits of factories.
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Nike
They do huge investments in R&D and invented things like new types of glue that weren't toxic, which they then went on to share with their competitors. But David, I don't know, there is still this interesting and more theoretical question. What is the line of acceptability and who should determine it?
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Nike
Obviously, when a company trips a clear, bright line like child labor, there is appropriately public outcry. But what about when the lines are blurrier? Are 75-degree factories okay? Or are $3 wages fine if the local average is $2 an hour?
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Nike
At the end of the day, there's a discomfort of sitting with the idea that in order to manufacture a product that you are buying, from shoes to smartphones, somebody has to work in conditions you wouldn't endure even if it's better than all of their other options. And companies need to grapple with a spectrum that they sit on. On one end, there's making the absolute maximum margin.
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Nike
And on the other end, there's creating labor conditions that customers would totally be fine with if they learned every single little detail. And in the 90s, Nike chose to sit too far on maximizing the margin side of things, and they intentionally turned a blind eye to what was going on in the factories, and they were in the wrong because it led to exploiting people.
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Nike
And the technology that Bowerman was experimenting with was crazy stuff. He would rip shoes apart and he would rebuild them, this is from the Nike website, with snake skin, deer hide, or fish skin. Goofy, crazy stuff. And his guinea pig was Phil Knight because Phil wasn't at the front of the pack so he could sort of afford to experiment on him.
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Nike
Yeah, they sort of discovered they couldn't have their cake and eat it too of saying, we are the brand that inspires you. Oh, but by the way, anytime there's an issue, oh, that's one of our supplier's problems. We simply don't make shoes. Even though it is technically correct, the court of a public opinion will find you guilty.
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Nike
So very fortunate for Phil Knight and his future that he was not the fastest runner on the Oregon team.
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Nike
You can pay them whatever you want, right? And they can tell their teams to do whatever they want. There's no contract between the team and the coach about wearing shoes. But if the coach says, hey, I really like this shoe company, you should wear the shoes on court. What do you think the players are going to do? It actually a team policy.
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Nike
A lot of eyeballs on those swooshes. Lot of eyeballs on those swooshes. And this is so clarifying of what their sports marketing strategy is. These endorsement deals are not about the sneakers that that basketball player is going to sell or, oh, I want to buy the cleats that my favorite college football team is wearing on the field.
Acquired
Nike
No one else plays football other than college football students and the very few NFL players that exist. So there's really nothing to buy. But what you do see are these swooshes. And it's cementing that brand in your head of this is what real athletes wear.
Acquired
Nike
Right. The funnel is every single one of those is a brand impression. So consider them all billboards. And then they just need to manufacture enough products to meet needs in your life that you can go and participate in the brand story by buying things that you need in your life.
Acquired
Nike
And you're inspired to do that because what you saw on those moving billboards and all the players running around, but the products that the players are wearing are made for them in their athletic journey. And the products that you're buying at the store are things that are made for you in your athletic and increasingly lifestyle journey. But you're inspired by what you see on the billboards.
Acquired
Nike
You're buying victory. Right. And so their whole business eventually becomes figuring out this multi-sided equation of can we create enough demand? Like it literally on their income statement says demand creation by doing these sponsorships. And then can we create the right product mix for people to participate in our brand by giving us their dollars?
Acquired
Nike
Right. Keep in mind, they still only make running shoes. There's no apparel. There's no shoes for other sports, really. There's like some things on the margins, but 90 plus percent of their revenue is running shoes.
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Nike
So through the late 70s, revenue just doubles year over year over year. They go from $14 million in sales to $29 million in sales to $71 million in sales, finishing out in 1979 with $150 million in sales.
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Nike
And we should say, for anybody who doesn't know, everything that you hear of now, the Air Max, the Air Jordan, the Air Force One, it is a literal air bag. Actually, it's a nitrogen bag that sits in the midsole. So think about the thing between the lower sole, the rubber on the bottom, and inside of the insole, basically the part of the shoe that you can't get to that's underneath your heel.
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Nike
and sometimes that runs all the way across, all the way up to the toe, that replaces foam cushioning instead using a little airbag that magically doesn't pop.
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Nike
Yeah, it's going around the internet, but it's going around the internet described in the following way. Here is the document that Phil Knight wrote articulating Nike's principles. Here are the things that are wrong with that statement. One, Phil Knight did not write it. Rob Strasser did. Two, Nike's principles. Also incorrect.
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Nike
When this was written, it was actually still Blue Ribbon Sports, so that it was not yet the Nike Corporation. Three, the top of the document has this, like, thin, wispy swoosh. That was never the Nike swoosh. This is someone's attempt who doctored this at some point to make it look like some old version of the swoosh. There is an old version of the swoosh, which we will link to in our sources.
Acquired
Nike
It is still in the USPTO for the swoosh trademark. It is a hand-drawn version, Carolyn's hand-drawn version of the swoosh that looks nothing like this weird thin wispy thing that was like doctored and added to the document. So not Nike Inc., Not the swoosh. There was never a swoosh on the document. It was done on a typewriter. How are you going to do that? And three, not Phil Knight.
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Nike
But yes, oh my God, these principals are amazing, and we're going to go through them. But first, we want to tell you about our third favorite company of the episode. David, who is it?
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Nike
Yes, back in action with Acquire. This is their first time being a full-season sponsor. Yes. Statsig empowers modern day visionaries to transform the way that they develop software. The highest performing product teams run multiple experiments every day. If you're at a company that uses Statsig and is sort of versed in modern product development principles, you know this.
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Nike
Statsig provides all the tools that you need to build, measure, and learn faster as a product organization. They integrate feature flags, they have an unbelievably powerful proprietary stats engine, and they have robust analytics.
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Nike
They make it so that you can 10x your experimentation velocity at your company while providing near real-time visibility into how these features actually impact your business metrics.
Acquired
Nike
Yep. Acquired community members can take advantage of a special offer, including 5 million free events per month, including white glove onboarding experience and migration support. So you can visit statsig.com slash acquired to learn more and 10x your product experimentation velocity. Oh, and one more thing.
Acquired
Nike
David and I are going to be doing an event with Statsig live in San Francisco, a product growth forum. Honestly, it's going to be an amazing speaker lineup. The chief product officer from Brex, the chief marketing officer from Instacart, and the CTO of Figma are all going to be there.
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Nike
Vijay Raji, the CEO and founder of Statsig, who many of you know well at this point from our ACQ2 episode with him, also going to be there. And it should be pretty great. So if you want to hang out with David and I August 10th in San Francisco, you can click the link in the show notes to register. It is selling out fast, so make sure to grab a spot. We'd love to see you at the Statsig event.
Acquired
Nike
So, I read these differently than I used to read them. Because when I didn't know Nike's journey, I sort of would just read them and be like, yeah, that's awesome. Or like, wow, that's so pithy. I can't believe their official corporate values are in such a pithy way. No, this is stream of consciousness, all from Rob Strasser, all into the typewriter. And like, some of them...
Acquired
Nike
are things that Nike would never say today because it shows the trade-offs inherent in their business. I mean, live off the land, it's cringeworthy, right? It's almost like, you guys, you had this huge labor issue. It's not good. So you sort of see where some of this stuff comes from. Break the rules, fight the law. I think there's also something very clear.
Acquired
Nike
Dangers, bureaucracy, personal ambition. Like, this is a foreshadow of Rob Strasser... hating the bureaucracy at Nike after its IPO that we'll talk about in a second, clashing with Phil Knight. Developing his own personal ambition. And developing his own personal ambition, leaving and going to Adidas.
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Nike
So there's like so much in here that when you really start to know the company's history and story and the headspace that he was in when he punched this out, it reads entirely differently to me than I sort of used to just read it as a, hey, I love Nike, a brand, wow, so cool. I wish I could work at a company that had these pithy, punchy values.
Acquired
Nike
Yeah, but man, they're awesome. The one that is still in Nike's maxims today that they distribute to employees that is, David, something you and I both hold near and dear and think of with acquired is, we're on offense all the time. You don't win by playing defense. Nope. Okay, so we're approaching 1980. They're about to go public, and they are entirely a running shoe company.
Acquired
Nike
Still no sign of the Nike that they are today, where they have apparel, where they're diversified across a zillion sports. And from their revenue, they're basically a running shoe company that makes shoes for men. That is where their revenue comes from.
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Nike
You get all the way through Shoe Dog, there is basically no mention of market cap at IPO. It's the craziest thing. Like it really underscores how much nobody believed enterprise value mattered then.
Acquired
Nike
And the craziest thing is like one of the richest people in America then was $178 million. Yes, quite different.
Acquired
Nike
Very much so, especially because right after they go public, Phil goes on sabbatical for a year. It's sort of like, you know, the job's done. Wash my hands of it.
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Nike
There you go. But like the whole company, there was a lot of hubris going on. They're on top. We own the running shoe market. We've been in this magical, secular, growing trend forever, and it's just surely going to continue, right? And the fitness boom continues, but running is not exactly the thing that keeps carrying.
Acquired
Nike
I mean, they have 50% market share in running shoes at this point in America, and yet their growth in the future is going to be dictated by where they go from there, because it's really hard to have more than, you know, 50% market share in an industry like this.
Acquired
Nike
It's fascinating. I mean, in 1980, Reebok USA is founded... And by 1988, Reebok eclipses Nike in sales. Yes, at well over a billion dollars. And it's not like Nike fell out of favor in running. And it's not like people who were running stopped running. But Nike had ridden the running boom at this insane growth rate of running.
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Nike
And even if running continued, its growth rate was going to massively taper off and they were going to stop growing their market share. So they really did need to look elsewhere. their next market.
Acquired
Nike
So financially, they're sitting pretty pretty. They've just raised $22 million in the IPO, which then was a lot of money. They basically wouldn't need any more money after that. They raised one smaller pipe later in their history. But the company was basically built on debt financing and this $22 million in the bank from IPO. And you can see how they got fat and lazy.
Acquired
Nike
Their whole life they were starved for capital. Finally, they had it. Their whole life they were the underdog. They're not the underdog. They've got half the running market and this dominant brand where they just steamrolled the competition to get into all these sports deals. But right at the same time as the aerobics boom is coming up,
Acquired
Nike
Adidas is becoming a very real competitor in the sports marketing deals too. And so Nike is kind of realizing like, ooh, we are not nearly as well capitalized as them. And they're kind of going to come eat our lunch and all these deals where we just figured out that you can pay people and they'll wear your stuff. So our cheap brand advertising is kind of going away. Yeah.
Acquired
Nike
You got to start at the beginning. So really, the question is, what makes this company the single largest apparel business in the world today, outside of luxury, of course? And how is it possible to be a shoe company that does over $50 billion in revenue when they technically don't make a single shoe?
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Nike
Almost all wrong. There's a lot of little dynamics that we can be mad about. Like, it was kind of Strasser's baby to do the deal, not Vaccaro's baby to do the deal. You know, Vaccaro never flew to North Carolina to negotiate at Michael's house with Michael's mother. All of this doesn't actually happen. They weren't going to fire everyone in the basketball division if this didn't work.
Acquired
Nike
But again, factual inaccuracies are fine. It's the characters that they messed up that really bothered me. I know I'm doing a review of a movie that maybe not all of you have seen, so spoilers, but like, God, they make Phil Knight just not at all who Phil Knight is.
Acquired
Nike
They make him out to be kind of a rube, and after watching every interview he's ever given and reading all this stuff about him, and I just don't think that the Ben Affleck character is anything like Phil Knight. Anyway, air is entertaining. Here's the real story.
Acquired
Nike
So Nike takes a chance. There's a kid out of North Carolina. He's picked third in the draft. He's really good. He just took the game-winning shot to win the NCAA Final Four. But, you know, he's not LeBron in high school. Yeah, he was picked third. Right. I remember going to see LeBron as a high school athlete because I live near Akron, Ohio, and he went to St. Vincent St. Mary's famously.
Acquired
Nike
And, like, he was very obviously one of the best NBA players as a freshman in high school. Jordan wasn't quite that. He was a different type of player. He was not as big and as physical as a lot of the guys dominating the NBA at the time. And so doing a big deal with Jordan really was more of a gamble for Nike than they would do with really any athlete today.
Acquired
Nike
I think if I remember our NBA episode, the NBA was really getting going like post-war, so like the 50s. I'd guess he was an early 50s NBA player.
Acquired
Nike
It's almost like the way the book industry works. They gave them an advance guarantee on the first 500K a year, but once he sold through the advance, he was gonna get a 5% participation on any of the shoe sales.
Acquired
Nike
And... It's brilliant counter-positioning because all their competitors basically couldn't do it. Converse has too many stars to go all around signing these, A, you get some of the upside deals. Like Nike had freaking nothing to lose. Of course they could give away some of the upside. If Converse is going to do this or Adidas is going to do this, they actually do have quite a bit to lose.
Acquired
Nike
By giving away upside. Of course, Nike, it turns out, it was a big paycheck that they cut Jordan for years and years and years. But Nike was truly doing something here that their competitors could not. And it was smart to figure out what are the things that by being small and cash-constrained and under-penetrated in the NBA, what strengths do we have?
Acquired
Nike
So there's something kind of interesting here, which is I was trying to figure out if I would describe this as a partnership. David, you and I are partners in Acquired. We together benefit from the upside and the downside. That is what makes a partnership. Is this a partnership? Is there any scenario where Jordan has any downside or is all of the downside owned by Nike?
Acquired
Nike
And so to put a finer point on this here, Jordan didn't want to be Nike's partner, so he basically wasn't, and they backed up the truck for him. And some of that truck was in variable comp, and some of that truck was in cash. But make no mistake, that is what this is, is Nike having no leverage, Jordan having all the leverage, and getting...
Acquired
Nike
A landmark, unbelievable deal still to this day unmatched in terms of the amount of dollar outflows that has gone to an athlete because of it.
Acquired
Nike
Well, Jordan also is on offense all the time. This is a guy who plays to win. So you give him the incentives, he and Phil Knight are going to get along real well. So here's what happens.
Acquired
Nike
In the first year, they sold 1.5 million pair in the first six weeks after releasing them.
Acquired
Nike
Wow. I always wanted to think of the story as like, wow, Jordan took some risk and it paid off big on the back end. It's like it paid off immediately and he had to make no trade-offs to do it. He got the cash guarantees and he got the royalty upside and it happened immediately and it only got bigger from there.
Acquired
Nike
Totally. And in fact, that's literally true. If he wasn't, what were the three clauses? If he didn't either win Rookie of the Year or win the NBA Finals or win the MVP or something, there was an out in the contract. Oh, interesting. I didn't know that. They were basically like, we will give you the entire farm, or 5% of the farm, if you are a phenom, and if you're not... Interesting.
Acquired
Nike
So there was some protection for Nike. Yes. And I think he's Michael Jordan, so whatever the thing was, he got all three of them. Oh! It wasn't the NBA Finals. It was Become an All-Star.
Acquired
Nike
Yeah, David, you're so right. Imagine that I come to you and I say, hey, I'm going to pay you and give you revenue upside. And all you have to do is do the thing that you're already good at and work hard at the thing you're already passionate about. By the way, I'm going to use your face on $5 million of media, of paid media in the next few months. It's like, whoa, what?
Acquired
Nike
So why did they sell so well? That's sort of this interesting $126 million in the first year. Like, why was the demand for them crazy? Did people just love Michael Jordan? Nike, this is, I think, the first time they really flex their ability to recognize an opportunity for an incredible marketing moment.
Acquired
Nike
So back in 84, Jordan starts wearing in preseason and in warmups some modified airships because Nike's actually not done making the Air Jordan 1 yet. And so he's wearing these black and red shoes that are now called the Jordan Breds, B-R-E-Ds. And these shoes are black and red. And in the NBA, you wear white and that's it.
Acquired
Nike
And so Jordan's getting ready to play in the league with these black and red shoes, which again, he hasn't actually worn on court. And to this day, no one can find footage of him wearing the black and red precursor to the Air Jordan 1, these modified airships on the court. So we're not actually sure that it happened.
Acquired
Nike
Right. But this black and red catches the league's attention. David Stern says, hey, you can't wear those. We're going to fine you if you do. In fact, this results in literally writing a letter that doesn't state the dollar amount, but does say, hey, it's against league policy to wear. the black and red shoes. It doesn't mention the Air Jordan. It doesn't mention the Air Jordan 1.
Acquired
Nike
It just says those black and red shoes. And this gives Nike this incredible opportunity to make a marketing moment out of it. Now, it would have actually been very expensive because the way that the fine worked technically after you dig into it for a while is $1,000 for the first infraction, $5,000 for the second infraction.
Acquired
Nike
It may have even been the case that it was $10,000 for the third infraction. over an 82-game season and facing possible ejection, it's a big tab for Nike and it's a big problem for Jordan. And before he could even wear these black and red shoes in a game or have the opportunity to, they switched. The Air Jordan 1, they made white and red.
Acquired
Nike
The one that is iconic that you can go buy and then they make all the remakes out of. The AJ one is not the bread. And the bread is the thing that kicked up the big issue.
Acquired
Nike
Anyway, so Jordan, they just film him in this incredible commercial where he's just standing there and the camera pans down from his head to his feet where he's wearing the black and red and it just goes bong, bong and puts these black bars over the shoes. And they make a whole big deal out of the fact that these shoes are so great, they are banned in the NBA.
Acquired
Nike
And the coda to all this is, even after reading all these books and watching all these videos and these interviews, I actually don't know what dollars ever changed hands. Some people said it was $5,000 times an 82-game season. Some people said it was $1,000 ever and then nothing after that. I have even heard...
Acquired
Nike
Right. Think about how you would define a market size. There's not that many track athletes at any given point in history, so not that interesting.
Acquired
Nike
that no dollars ever exchanged between Nike and the NBA or Nike and Michael Jordan because the fine was never levied. It was a threat that then Nike made that Eric Jordan won before anything could be enforced. If anybody knows, please join the Slack and shoot us a DM or put it in the general channel. I'm very curious.
Acquired
Nike
Right. They just put it in a freaking Hollywood movie that it was 5,000 times 82 games, and that's all anybody's going to remember.
Acquired
Nike
then when rob dies phil does not attend his funeral it's really just heartbreaking there's a quote that sums it up in this portland monthly article that talks about why strasser isn't known to many people outside the companies and why his role sort of fades into history and they say why because his work was vital to both which makes it incredibly difficult to neatly write him into the mythology of either one
Acquired
Nike
For Adidas, it was a brand revival, conceived and executed by a fat American ex-Nike guy and his artsy partner. For Nike, Strasser's overachievements are overshadowed, if not severely tarnished, because he was a traitor. From Phil Knight, it might have been okay if he had just quit, but he went to work for Adidas. An intolerable betrayal. I never forgave him.
Acquired
Nike
Tinker Hatfield. Formally of Nike's architecture and building planning team. He wasn't even hired as a shoe designer.
Acquired
Nike
adidas shoes to someone who could get them to jesse owens like the night before his race and jesse owens was like oh these are actually awesome and so it was like a big sort of uh-oh is this going to be a problem for audi when it comes out that the american one wearing german shoes interesting i didn't know that part of the story that makes sense because adi's older brother rudy worked with him in the business as did adi's wife and son
Acquired
Nike
That's like heretical at Nike at this point to not have the swoosh be the main character. But Michael Jordan didn't really want to be a Nike. So the only way to keep him is to kind of hide the swoosh.
Acquired
Nike
Yeah, it's pretty crazy because the whole point of these deals is to get swoosh impressions. And they were willing to say, we think it's going to be profitable enough in the long run to be in business with you that we will not put the swoosh on the side of these shoes. And they were extremely right to do that.
Acquired
Nike
The University of Michigan, for some reason, is Jordan, not Nike, as their official uniform supplier.
Acquired
Nike
In his total career from basketball contracts, he made something like $90 million. Wow. So, I mean, you even said it in that first year, just from the get-go with his Nike earnings were way outpacing his NBA earnings. Yep.
Acquired
Nike
But this is 1988, 1989. Right. Okay. That makes sense. All right. So you mentioned how much he made at the end of that seven-year contract. There's something mind-blowing going on today in 2023 with the Jordan brand. And I don't think people quite have a handle on what has happened in the last three years. So the Jordan brand is the fastest growing part of Nike. Nike grows like 10% a year.
Acquired
Nike
So you may think you know Nike from the movie Air or Shoe Dog, but what hasn't been told is how those old stories tie to the gigantic shift in strategy that Nike is really in the middle of right now. Well, LPs, we got to thank you for voting for this episode. David and I have had it sort of in our episodes.
Acquired
Nike
The Jordan brand over the last three years keeps growing at like 35%. And it does billions in revenue growing at 35%. So this past year, they just reported, FY22, the Jordan brand did $6.6 billion in revenue. Let's assume that the 5% figure is still accurate enough. It's accurate-ish. Jordan's making over $300 million a year from the Jordan brand at a 5-ish percent royalty.
Acquired
Nike
He retired for the last time 20 years ago. There is no athlete making $300 million a year. Michael Jordan will make five, maybe $10 billion over his lifetime from the Jordan brand. Absolutely unprecedented for an athlete. He's effectively a founder of a brand that is growing 35% at six plus billion dollar revenue scale.
Acquired
Nike
It is unfathomable. So he did active work for many years in order to build the brand equity, but he does passive work now to keep it alive. Of course, he has sort of input on who they're signing to the Jordan brand. He has sort of a vote in that. But in Michael staying out of trouble and Michael staying the dream... he builds a tremendous amount of brand equity. And Nike reaps 95% of that.
Acquired
Uber CEO Dara Khosrowshahi
And they've divested anything hardware, international, or that's too far in the future or speculative. They're even doing something we couldn't imagine at IPO time, which is profitability. Now, it's very modest at this point, but we wouldn't have dreamed Uber could even get to break even back when they burned, David, what was it, $3 billion the year before the IPO?
Acquired
Uber CEO Dara Khosrowshahi
And speaking of Microsoft and ServiceNow, they just announced a huge expansion of their partnership, specifically integrating the two companies' enterprise AI assistants. Starting in the fall, customers will be able to interact with ServiceNow's NowAssist AI assistant directly within Microsoft Copilot.
Acquired
Uber CEO Dara Khosrowshahi
Yes. ServiceNow's Now Assist will be integrated with Microsoft Copilot and will be available directly from Office apps, starting with Microsoft Teams. The AIs are integrated into one seamless user experience without actually sharing data.
Acquired
Uber CEO Dara Khosrowshahi
So if, for example, a user asks Copilot in Teams about how the company's laptop policy works, behind the scenes, Copilot shares that request and context with Now Assist, and Now Assist accesses internal company policy with the right permissions for that user and returns the answer to Copilot in a rich card with options for the user to kick off a workflow via Now Assist.
Acquired
Uber CEO Dara Khosrowshahi
In the future, Microsoft Copilot will also be integrated the other way into Now Assist so it can automatically generate Office files like PowerPoint presentations and Excel spreadsheets directly from assets and knowledge in the ServiceNow platform.
Acquired
Uber CEO Dara Khosrowshahi
All right. So we're going to catch back up to that Expedia era. 13 years, you have a pretty wild competition with Booking.com. And I think you learn a lot of lessons from watching Booking just crush it. Top line, profit margins, rate of expansion, everything about it. Booking built a hell of a company. Incredible.
Acquired
Uber CEO Dara Khosrowshahi
when you're on the Expedia side of things, and then you get a fresh start at Uber, how do you take those lessons with you? And what did you learn?
Acquired
Uber CEO Dara Khosrowshahi
Well, today's discussion, of course, is partly about Uber, as we're alluding to here. But as David and I evolve the interview format, we're putting more of a focus on Dara as a person and sharing some of his craziest stories from throughout his whole career.
Acquired
Uber CEO Dara Khosrowshahi
It's been, what, four years? That is crazy. All right. Yeah, let's do it. I ordered some food. I hope that's okay. Oh, yeah, yeah. Maybe we can eat while we... Oh, dear. Oh, dear. Is someone in order of greets? Oh, yeah, that's me. All right, cool.
Acquired
Uber CEO Dara Khosrowshahi
So this is a candid conversation that dives into moments like buying Expedia right when 9-11 happened, how he first met Barry Diller at Allen & Company, and what the financial mechanics are actually like of replacing Uber's entire shareholder base or close to it anyway, almost in its entirety since joining the company.
Acquired
Uber CEO Dara Khosrowshahi
Oh, yeah, yeah, totally, totally. Well, it's an advertising business, right? So it's an ad unit like any other.
Acquired
Uber CEO Dara Khosrowshahi
I was reading through the most recent earnings and you have a chart where on average over the last five years or so, drivers make more money per hour.
Acquired
Uber CEO Dara Khosrowshahi
If we entered some economic environment where a whole bunch of people were out of work and they wanted to become Uber drivers, but that would make it so that the average earnings across the whole platform would plunge because you have a whole ton of new drivers coming on, would you guys sort of gate it and be like, hey, we want to make sure that we don't sort of flood the supply side of the marketplace?
Acquired
Uber CEO Dara Khosrowshahi
No, I don't think so either. Well, if you are not already in the Slack, you totally should join. So many smart folks commenting on episodes and bringing new information after we record that we didn't find in the research because many of you work in the fields that we're actually covering on episodes. So you can join at acquired.fm slash Slack.
Acquired
Uber CEO Dara Khosrowshahi
Right, so it's sort of the invisible hand of the market theory that sort of self-regulates this for you. Yeah, it's not a theory, it happens. Yeah, I guess like, yeah.
Acquired
Uber CEO Dara Khosrowshahi
Economists like to talk about things in theory, but you actually have one of the largest data sets in human history of people doing work and other people consuming services.
Acquired
Uber CEO Dara Khosrowshahi
So what do you do then? Like you have to have some levers at your disposal. You're getting a lot more profitable. Yes. I mean, certainly I think in 20, whenever we did the IPO episode, Uber had lost like close to $3 billion the year before going public.
Acquired
Uber CEO Dara Khosrowshahi
Depending on what profitability metric you look at, you guys are a break-even or slightly positive business and increasingly getting more profitable and looking like a self-sustaining business. So what can you do then if you aren't in the business of deciding what a ride should cost?
Acquired
Uber CEO Dara Khosrowshahi
Listen to our other episodes on our second show, ACQ2, like a great episode we just did with Jake Saper from Emergence on AI moats in B2B SaaS. And without further ado, this show is not investment advice. David and I may have investments at the companies we discuss, and this show is for informational and entertainment purposes only. On to our conversation with Dara. Cheers. Dara. Cheers.
Acquired
Uber CEO Dara Khosrowshahi
So then just to make sure I'm understanding right, the reason why, because you talk to anybody and you're like, oh, what should I ask Dara? And they're like, ask them why Ubers are more expensive than they used to be. And I'm like, because it's a good business now.
Acquired
Uber CEO Dara Khosrowshahi
But actually, I don't think, it sounds like that's not actually the right answer, that the reason rides have gotten more expensive over time is A, inflation, but B, just that there is more demand for those rides than there is supply to serve them.
Acquired
Uber CEO Dara Khosrowshahi
Pretty cool. Well, specifically not thank you, thank the invisible hand at work.
Acquired
Uber CEO Dara Khosrowshahi
Appreciate you swinging by the home studio on your way home from Expedia board meeting. Is that right? Yes. How'd that go?
Acquired
Uber CEO Dara Khosrowshahi
So David asked this interesting question that I want to dig a little bit deeper on. Were you ready for it? What kind of diligence did you get to do on the opportunity when this job came on the market in the national news in a very prominent way, in a very short time period?
Acquired
Uber CEO Dara Khosrowshahi
Actually, Expedia is a good place to start. For folks who don't know about your pre-Uber background, you were the CEO of Expedia from 2004 to 2017. Is that right? Yeah, 13 years. 13 years. That's a long time. And... When you became the CEO, your previous role was you were at IAC with Barry Diller, and you guys had bought a controlling interest in Expedia. You took it private.
Acquired
Uber CEO Dara Khosrowshahi
It was at Microsoft with Rich Barton. He spun it out. It went public. You made a bid to take it private. I think over like two tranches, there was like a controlling interest and then a full buyout.
Acquired
Uber CEO Dara Khosrowshahi
Yeah. And there's an element to it, too, where if he got to collaborate with you on it, then there was a chance you would stick around on the Expedia board and remain a friend of the company, even though you're not in the seat.
Acquired
Uber CEO Dara Khosrowshahi
Did you consider, I mean, this sort of famously was an issue in the Microsoft transition and has been an issue in the Disney transition. Did you consider, hey, actually, maybe it would be better for the company if I didn't serve on the board just to give enough space for new leadership?
Acquired
Uber CEO Dara Khosrowshahi
I bet. We want to thank our longtime friend of the show, Vanta, the leading trust management platform. Vanta, of course, automates your security reviews and compliance efforts. So frameworks like SOC 2, ISO 27001, GDPR, and HIPAA compliance and monitoring, Vanta takes care of these otherwise incredibly time and resource draining efforts for your organization and makes them fast and simple.
Acquired
Uber CEO Dara Khosrowshahi
Vanta takes care of all of it for you. No more spreadsheets, no fragmented tools, no manual reviews to cobble together your security and compliance requirements. It is one single software pane of glass that connects to all of your services via APIs and eliminates countless hours of work for your organization.
Acquired
Uber CEO Dara Khosrowshahi
There are now AI capabilities to make this even more powerful, and they even integrate with over 300 external tools. Plus they let customers build private integrations with their internal systems.
Acquired
Uber CEO Dara Khosrowshahi
So whether you're a startup or a large enterprise and your company is ready to automate compliance and streamline security reviews like Vanta's 7,000 customers around the globe, and go back to making your beer taste better, head on over to vanta.com slash acquired and just tell them that Ben and David sent you.
Acquired
Uber CEO Dara Khosrowshahi
And thanks to friend of the show, Christina, Vanta's CEO, all Acquired listeners get $1,000 of free credit. Vanta.com slash acquired. All right, so back to the reverse diligence question. Yes. What did you get to learn about Uber? And I mean, to directly ask, did you get to talk to Travis? Like, did you get to talk to any of the sort of departing leadership?
Acquired
Uber CEO Dara Khosrowshahi
So this being acquired and us wanting to dive into a story, there's one moment in particular that was pretty insane. The term sheet was signed for IAC to buy Expedia before September 11th, like earlier in 2001. The deal hadn't closed yet. I think there was some kind of material adverse change clause that allowed- That clause, they called it, yes. You were allowed to pull out of the deal.
Acquired
Uber CEO Dara Khosrowshahi
It's so funny you say turnaround. I literally, it never occurred to me that you could construe Uber as that, but it might be the only turnaround in history where it was growing incredibly fast, had 10 billion of revenue, had some of the smartest people in the world working at it, had all this momentum, of course, burning money, catastrophe in the boardroom, catastrophe in the C-suite.
Acquired
Uber CEO Dara Khosrowshahi
Tell me if you agree with this statement. In the US, you no longer really have a formidable competitor in ride sharing. But in food delivery, you have a tremendously formidable competitor.
Acquired
Uber CEO Dara Khosrowshahi
And this is like a 2013 to 16 decision that everyone's still sort of living with now.
Acquired
Uber CEO Dara Khosrowshahi
I'm curious, there's so much of this strategy that if you connect the dots looking backwards, and to use the Steve Jobs parlance, it just makes so much sense. This expand internationally, leverage the fact that you're sort of the leading global player, generate cash, use it to compete domestically. Eats feeds ride sharing, which feeds, you know, you can sort of use this flywheel.
Acquired
Uber CEO Dara Khosrowshahi
We haven't talked about freight yet, but I'm curious, like of the three pillars today of ride sharing, Uber Eats and freight and divesting everything else, all the autonomy, all of the self, I guess, self-driving cars is autonomy. What else did you guys divest? All the international bikes and scooters.
Acquired
Uber CEO Dara Khosrowshahi
What of today's strategy was in your pitch to the board when you were joining as CEO? And what is an emergent thing that's happened while you're in the seat?
Acquired
Uber CEO Dara Khosrowshahi
Are there activities that you've sort of thought about where you used to need to do something different or counter position the market in order to be successful, where now you sort of look around and you're like, actually, in this area, we're the incumbent. So there's a different strategy that we need to lean into as an incumbent.
Acquired
Uber CEO Dara Khosrowshahi
That is cool. I have another sort of corporate structure question that I'm curious about. I think you guys, between when you took the job and today, turned over basically the entire Uber shareholder base. I'm sure there's some people that still hold their shares from those early days.
Acquired
Uber CEO Dara Khosrowshahi
But what is that like at the scale of a $70, $80 billion market cap company turning over a shareholder base in its entirety? Very painful. Yeah.
Acquired
Uber CEO Dara Khosrowshahi
And fund of funds where compensation had already been paid out as if this was a liquid security, but it's not a liquid security.
Acquired
Uber CEO Dara Khosrowshahi
Because if anyone said, actually, I'm going to move in my own self-interest here, actually, long term, it would have blown up the deal.
Acquired
Uber CEO Dara Khosrowshahi
Humility is great and all, but, you know, were you proud of yourself when that went through?
Acquired
Uber CEO Dara Khosrowshahi
All right, listeners, our next sponsor is an old friend of the show, Modern Treasury. As you may know, Modern Treasury is the payment operations platform for faster payments.
Acquired
Uber CEO Dara Khosrowshahi
No changes to the deal at all? Like exactly as... No changes to the deal.
Acquired
Uber CEO Dara Khosrowshahi
Yep. And money is moving to a real-time future. In today's world, consumers expect instant access to goods and services, and businesses need real-time ways to track revenue, respond to customers, etc. So with software-powered business models, markets that never sleep, and faster ways to pay, it is clear that the instant economy is here.
Acquired
Uber CEO Dara Khosrowshahi
To stay ahead, businesses just need to move, track, and reconcile their payments at real-time and at scale.
Acquired
Uber CEO Dara Khosrowshahi
If you, your company, or your portfolio companies want to transform your payment operations and join the instant economy, head on over to moderntreasury.com slash acquired, or click the link in the show notes and tell them Ben and David sent you. I'm very curious about how you operate your Twitter account. On the one extreme, there's like an Elon Musk type operating a Twitter account.
Acquired
Uber CEO Dara Khosrowshahi
There is one in, I don't know how many MDOWs they have, but one in some hundred million data point of tweeting whatever comes to your mind, no matter the consequences.
Acquired
Uber CEO Dara Khosrowshahi
Like, you definitely operate your public persona with sort of a head of state grace. And I'm curious if you ever think about letting it fly a little bit more. Do you have a full drafts folder? Like, do you ever wish you could express yourself a little more?
Acquired
Uber CEO Dara Khosrowshahi
All right. Next, we're kind of in like a lightning round here. So next random lightning round topic, you were on the board of the New York Times.
Acquired
Uber CEO Dara Khosrowshahi
What are some of your biggest learnings from being involved with that company?
Acquired
Uber CEO Dara Khosrowshahi
Do you think that could have happened in a company that wasn't family controlled? Like, did that have something to do with how they could make a bet like that without the data to support it?
Acquired
Uber CEO Dara Khosrowshahi
Yeah. I mean, there's a graveyard in the middle between the independent publisher with a low-cost structure and the New York Times, and there's not much in between. The middle is where you go to die.
Acquired
Uber CEO Dara Khosrowshahi
More lightning round. I remember hearing in 2013 that it was cool that I was in 2013 because 2014, one year away, was going to be the year of self-driving cars. And here we are in 2023. Is next year the year? How close are we?
Acquired
Uber CEO Dara Khosrowshahi
And I think highway accidents are one of the top two or three causes of death in the United States, period. Yeah, period. So like something 10 times safer?
Acquired
Uber CEO Dara Khosrowshahi
You could own a business with a 20% take rate or a business with a 30% take rate. Which one would you rather own?
Acquired
Uber CEO Dara Khosrowshahi
Yep. I asked in a tongue-in-cheek way, but I completely understand that. NCV, it's the NZS capital thing.
Acquired
Uber CEO Dara Khosrowshahi
Right. Yeah, exactly right. You build more durability by leaving more on the table for your ecosystem partners.
Acquired
Uber CEO Dara Khosrowshahi
Cool. Well, the last segment that I have here is giving you the floor. You know, we're at the end of a long form podcast. So anybody that's still listening appreciates nuance.
Acquired
Uber CEO Dara Khosrowshahi
And so if there's something that you feel is often misunderstood or that you want to say to people that are willing to let a long form argument soak in, what do you think is misunderstood about the company or you or the industry or this time that we're in right now? Really anything you want to talk about?
Acquired
Uber CEO Dara Khosrowshahi
Before I let David bring us to today already, let's go back down memory lane. So how did you meet Barry Diller?
Acquired
Uber CEO Dara Khosrowshahi
Yeah. Because the largest companies who, like even if you just look at employees, companies that employ people employ max like 2 million. Max, yeah.
Acquired
Uber CEO Dara Khosrowshahi
That's a lot of earners. What does the federal government employ? It's like on par with, it's gotta be on par with that.
Acquired
Uber CEO Dara Khosrowshahi
Well, no, I mean, you treated us and I'm glad you decided to stay after dropping it off.
Acquired
Uber CEO Dara Khosrowshahi
Oh, David, that was a blast. So fun. Funny. It's like you were just here next to me in Seattle and now you're there in San Francisco. The magic of the internet.
Acquired
Uber CEO Dara Khosrowshahi
I know. Listeners, you can tell us if you liked that bit or not, or if it was too campy. If you want more of David and I, we recently did an episode on My First Million, and it was really fun. We went behind the scenes of Acquired, and we sort of talked about Acquired's business, our journey turning it from a podcast into a business, why we think the podcast works.
Acquired
Uber CEO Dara Khosrowshahi
And listeners, you might have your own ideas, but where our differentiation is in the market of content out there today. And I know it's just a blast. Sam and Sean are really fun to talk to. So if you are interested in hearing that, you can click the link in the show notes to specifically go to that episode or search any podcast player for My First Million.
Acquired
Uber CEO Dara Khosrowshahi
They also did episodes recently with a couple of friends of the show, David Senra from the Founders Podcast. And actually, David, one of you and my favorite YouTubers, Doug DeMuro in the car category for anyone interested in cars.
Acquired
Uber CEO Dara Khosrowshahi
Yeah. Check out ACQ2. It's our interview show where we talk to folks who are on the cutting edge of what's next, figuring out things like where is the defensibility in AI for B2B SaaS companies, or our interview with the CEO of AngelList talking about how they're deploying AI at their company.
Acquired
Uber CEO Dara Khosrowshahi
I know AI is a buzzword, but it is just dominating how every company is making moves these days, and it's great to talk to the protagonists who are actually in the arena right now making all of these moves. So that's on ACQ2. Check out the Slack. It's where we're talking about this episode and every other. Acquire.fm slash Slack.
Acquired
Uber CEO Dara Khosrowshahi
And if you want to come closer into the kitchen and be a part of what David and I are building here, become an LP. Acquire.fm slash LP. Current benefits include once a season, you guys will pick an episode. y'all picked Lockheed Martin, which is shaping up to be one of our biggest episodes ever. So thank you. And I had a blast researching that one. So thanks to our LPs.
Acquired
Uber CEO Dara Khosrowshahi
And David, we got to schedule an LP call here in this month or so. Let's get it on the books. Yep. With that, listeners, thanks so much. And we'll see you next time. We'll see you next time.
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Uber CEO Dara Khosrowshahi
God, to be in the room with those two characters as they're negotiating.
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Uber CEO Dara Khosrowshahi
Welcome to this episode of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts. Today's episode is an interview with Uber CEO Dara Khosrowshahi, where he joins us from the Acquired home studio in Seattle. And it's been a while since we checked in on Uber.
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Uber CEO Dara Khosrowshahi
Do you think there was something about you and the way you presented that made Herb Allen believe that you would be customer ready and you could go and speak to one of the biggest media moguls of our time?
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Uber CEO Dara Khosrowshahi
They've gone through quite the transformation since our 2019 episode on IPO day. In the past 12 months, they've done over $30 billion in revenue, up from just $10 billion two years ago. And that's not GMV. That's revenue. That is revenue. And they have two businesses, as many of you know, that complement each other nicely in eats and mobility.
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Uber CEO Dara Khosrowshahi
How did you find your way to Allen & Company? I know I'm just pulling at threads going backwards here.
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Uber CEO Dara Khosrowshahi
But based on observing you and your history and everyone else in your family, it would become like a paint factory that would then like buy all the other paint factories and then expand up and down the stack and then figure out how to add like 15 other businesses. And it would become this like beautiful conglomeration of something. I don't know.
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Uber CEO Dara Khosrowshahi
So that's like a nice thing to say. There are a lot of other people that could have lucked their way into an Allen & Company job and then not turned it into an incredible performance with one of the most important people where your model needs to hold weight, which is Barry Diller in that exact crucible moment in time.
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Uber CEO Dara Khosrowshahi
What do you say to young people when they sort of ask you this question about how much does luck have to do with it and how should I be the most prepared and how can I seize opportunities when they come up?
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Starbucks (with Howard Schultz)
Who got the truth? Is it you? Is it you? Is it you? Who got the truth now?