Oct 29, 2019

6 min read

The Ethics of VC — when blitzscaling pirates don’t become the navy (quickly enough)(#4)

Imagine an environment that is built around a massive multi-billion-dollar market; there can only be one winner (or perhaps two but not many) and scale (and the network effects that come with it) is a dead-certain part of the winning strategy. Think social networks, food delivery, ride sharing, now also micro-mobility; think Facebook/LinkedIn, Deliveroo/Doordash, Uber/Lyft. The strategy that all these winners, which many of us use on a day to day basis now, applied was described as blitzscaling in a 2018 book by entrepreneur-turned-Greylock-VC Reid Hoffman.Blitzscaling is about moving fast with the goal of virality, high retention and high margins based on network effects — or in Hoffman’s words: “to grow at furious pace that knocks the competition out of the water” (12).

Hoffman argues explicitly that for the sake of growth and hence winning and surviving, morals can (and at times have to) be disregarded; “many startups are like pirates: they lack formal processes and are willing to question and even break rules” (179). As part of the different phases of blitzscaling, certain stakeholders might have to be disregarded. At least in the beginning, it is fine to not think about your employees too much (“turnover might happen quickly”), to not think about all your customers’ needs and definitely to not think about the regulators and their rules (if it doesn’t come with a high risk of breaking you altogether).

Uber got stuck in the pirate phase

Hoffman himself wheels this argument back in towards the end of the book after spending almost 200 pages on explaining the intricate details of operational, strategic and people management across the different phases of a blitzscaling company. In a short section he goes on to address the issue of ethics explicitly: “While start-ups and their founders may benefit from behaving like ethical pirates they should never behave like sociopathic criminals” (180). In short, he claims that while being a pirate is necessary and even good at times, one should never become a psychopath (“go afoul the law”, be too “deviant”). One should also know when to turn from being a pirate into a navy officer.

Sticking with the language of war just as with the title, what Hoffman does here feels a little bit like covering his back: you can be bad, but you have to stop at one point and you also mustn’t kill people. Or to put it into the ethical terms I laid out in my previous posts: you can stop reflecting for the sake of speed but you need to know when to switch your brain back on and you must also never completely lose your heart.

He goes on to analyse the example of Uber-pre-2017 under the leadership of its founder Travis Kalanick. The Uber CEO, argues Hoffman, lost track of building the right culture, subverting free competition, regulation and the press (185); in short: he forgot that both you shouldn’t be a psychopathic pirate and that being a pirate has to end at one point. Uber had a sexual harassment, a sexism and an IP theft problem (just to refer to some of the publicly known ones). And Kalanick didn’t really get it, it seems (so he was made to leave). That’s blitscaling gone wrong in its purest form — and Hoffman admits it.

What Hoffmann doesn’t mention is that the company didn’t just turn itself around. It was a more thoughtful and reflective VC who managed to ultimately get Kalanick voted out in 2017 after supposedly several years of internal struggle. Early investor Benchmark in the person of Bill Gurley was aware of Uber’s pirate-problem early on (see a fantastic Information investigation of the tension between Gurley and Kalanick). Sitting on Uber’s board, he was pushing Uber to go public (and hence be forced to become more disciplined, or in Hoffman’s words: more like the navy) much more quickly; he was against Uber’s aggressive growth-over-everything strategy as early as 2014. In other words: Gurley really was against the kind of scrupulous blitzscaling that Hoffman prescribes. What made Gurley different from Hoffman here? Was it values or ultimately that he thought that breaking things (like employees and regulators’ rules) was not going to be a good thing longer term economically (i.e. Uber wouldn’t become an internally sustainable and societally impactful company as I explain in my post #3)? I find it worthwhile to further think about these competing ethical claims. What motivations are they based on?

Let’s look at another puzzle: why is Hoffman so critical of Uber but doesn’t seem to think that Facebook has done anything wrong and just went through the blitzscaling model like a poster child? Did he miss the news about Cambridge Analytica and the most recent $5bn fine based on the privacy breaches? Similarly, there is no mention of Theranos, the fraudulent blood-testing startup that went bust in 2018 (and is still going to go through a massive law suit starting only next year), in the whole book. Isn’t that also a kind of blitzscaling case gone psychopathically wrong? Arguably Theranos in fact missed an investor like Gurley overseeing its operations (the only VC among its investors was Tim Draper who is in fact still defending Holmes). I guess Google did not exactly blitzscale when it first started so let’s leave an analysis of them for a later post (possibly based on a review of The Age of Surveillance Capitalism).

Who is Blitzscaling really good for

I want to offer another thought: Is it accidental that an entrepreneur-turned-Greylock-VC writes a book called Blitzscaling given the current market environment of lots of money and bigger and bigger rounds? When you come in late and write a massive check as an investor — despite your usually relatively long 10-year investment horizon — you almost need the company to scale quickly in order for it to be a potential fund-returner for you.

In a reply to the Blitzscaling book, internet pioneer Tim O’Reilly makes a strong case against it (and in a sense against aggressive VC investing overall). While he believes in part of the argument (and also in the economic successes it has created), there are two major question marks for him.

1. Most markets are not winner-takes-all-markets and the co-existence of Uber and Lyft is a good example. Blitzscaling to be the first — against ethical standards — is hence not necessarily a requirement for the company to become successful (just for the investor?).

2. What might look like blitzscaling in fact wasn’t really blitzscaling (but much more sustainable scaling) as in the case of Google and Facebook that raised comparatively little cash and were profitable before going public.

In fact, I fully agree with O’Reilly on this last point and on the major flaw with blitzscaling: we are forgetting the profitability at times — and hence the long term sustainability (and potential positive impact) of a company. Many of the companies likely to follow the Blitzscaling model are “financial instruments instead of businesses, designed by and for speculators” as O’Reilly goes on. And this is a strong critique of VCs pushing for blitscaling, VCs that benefit from the explosive growth that blitscaling can produce. Sustainability — or profitability — for startups has become something to think about for the far-away future. As long as the prospects are good — and they will be when you are the market winner and can starve possibly niche-players easily — don’t worry about it now. The VC then just needs to make sure that they can cash out — in a sale or an IPO.

And that is where it has started to become tricky recently: Softbank for instance has had massive problems with its investments in Uber, Slack and obviously WeWork. Other IPOs got cancelled or have not returned the expected money for its investors recently (e.g. Peleton or Endeavour). In fact, the market seems to be cooling down altogether making it hard to get the necessary payout. Does this mean that blitscaling at all costs doesn’t work out — even financially — as easily as it used to do and as some, like Hoffman or Softbank’s Son, might like (and need)? Did Gurley foresee that — and if so, what did he really care about ousting Kalanick: money or values, or both?

This takes us to what is at the heart of this conversation: while Hoffman argues that — at least temporarily — behaving badly can lead to enormous returns (in the form of monopoly rents), we are starting to see more and more cases where that doesn’t seem to hold. Is good business (= big returns) becoming actually good business (= sustainable) and does that mean that pirate-like blitscalingis starting to make less and less sense?