Learning from the Masters of Capital Allocation

Today I finished reading The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success. William N. Thorndike, Jr. profiled these CEOs:

The book describes how CEOs generated capital and executed creative approaches to capital allocation, and it reports their returns over a long period. I was familiar with Buffett but less so with the others. I took many notes on Murphy, Singleton, Malone, and Graham.

It was interesting to learn about Singleton’s strategy. It was the same as Buffett’s playbook, and Singleton was older than Buffett and deployed his strategies before Buffett did. Buffett has praised Singleton as one of the best businessmen ever, and I’d imagine many strategies that make Berkshire Hathaway successful were borrowed from Singleton’s playbook.

John Malone is the CEO I’m most unfamiliar with and most excited to learn more about. Malone recognized the predictability and high growth rate of the cable industry early. He used various strategies to build one of the largest cable distribution companies. He also helped seed various cable programming entrepreneurs, such as Bob Johnson of BET, and partnered with other cable entrepreneurs, including Ted Turner.

This book chronicles CEOs of publicly traded companies, so most examples don’t apply to early-stage entrepreneurs. But it does a good job of explaining capital allocation, including why it’s the most important job of a CEO, and quantifying the results of superior capital allocation by talented CEOs.

Capital allocation is a mindset and a skill all entrepreneurs should be aware of. For entrepreneurs seeking to grow their companies, capital allocation is a critical skill to master.

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Founders’ Most Important Job: Capital Allocation

I started reading The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success this weekend. The book, written by William N. Thorndike, Jr., and published in 2012, details eight CEOs' methods and why they led to outsize returns for their shareholders over a long period.

The central concept of this book is that capital allocation is the CEO’s most important job. Capital allocation is “the process of deciding how to deploy the firm’s resources to earn the best possible return for shareholders.” It’s investing to get the highest return, so CEOs are both capital allocators and investors.

CEOs need capital before they can deploy it. They can acquire capital in three ways:

  • Generating cash from company operations
  • Issuing debt (i.e., bank loans or bonds)
  • Selling equity (i.e., selling part of the company to VC, PE, or public investors)

When CEOs have capital, they can deploy it in several ways:

  • Investing in the company’s existing operations
  • Acquiring other businesses
  • Issuing dividends
  • Paying down debt
  • Repurchasing equity (i.e., buying back part of the company)
  • Launching new businesses (as the sole owner or in partnership with others)

These options make up a CEO's capital allocation toolkit. Figuring out what tools to use, if any, and when, is the skill of capital allocation. The book emphasizes that no courses are taught on capital allocation (as of 2012), so it’s a skill many CEOs lack. Now, though, Columbia Business School apparently covers this topic in its Security Analysis course.

Core to gauging the effectiveness of a CEO’s capital allocation in the long run “is the increase in per share value, not overall growth or size.” Long-term per share value essentially measures long-term value creation.

When I ran my company, I was focused on two things: running the company efficiently and generating cash. Getting the operations right consumed much of my time, and I didn’t think in terms of being a capital allocator.

So far, the stories of how these CEOs thought about and executed capital allocation strategies to generate high returns have been thought provoking. I’m looking forward to finishing this book.

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Pierre Omidyar’s Stubborn Vision

I finished reading The Perfect Store: Inside eBay, a detailed recount of eBay’s early days (through 2001). Pierre Omidyar worked in Silicon Valley in the early 1990s. He saw technology creating wealth rapidly. But that wealth didn’t accrue to the average person—market inefficiencies concentrated it with the well-connected. This bothered Omidyar. He believed the internet has the power to connect everyone on Earth, which would not only accelerate wealth creation but also distribute it more equitably.

Omidyar had a vision: an efficient market that empowers the average person financially, allowing them to take control of their lives. On Labor Day weekend in 1995, his vision for what the world could look like compelled him to act. His mission was clear: create a community-driven online auction.

Jeff Bezos famously said, “Be stubborn on vision and flexible on details.”

Omidyar was stubborn on vision and flexible along the way. He made numerous decisions others would not have but that supported his vision:

  • eBay was a cash register. It was profitable the first month. It raised $5 million in venture capital funding (which it never touched). Despite the abundant capital, Omidyar insisted on everyone being frugal and spending money like it was their own. He called this being “ebaysian.” This was during a time when unprofitable venture-backed companies spent $250,000 on launch parties. Omidyar didn’t spend lavishly because he wasn’t building eBay to flip or be acquired (though he came close to selling a few times). Omidyar wanted an ebaysian team to ensure that everyone focused on the goal: building a company that would last so his vision could become reality.
  • Omidyar was technical and recognized that his business gaps could hinder his mission. He brought on Jeff Skoll in 1996 as cofounder a year after he’d launched. They were polar opposites, but Omidyar respected what Skoll’s skills contributed to the mission. Omidyar assumed that his year’s worth of work was worth 15% of the total company value. He split the remaining equity evenly with Skoll, which surprised Skoll. Omidyar was generous in issuing title and equity, something many founders would not have done.
  • In 1997, two years after launching, eBay grew so quickly that Omidyar realized he himself couldn’t (or didn’t want to) level up fast enough to take the company to the next level. That fall, the decision was made to hire a CEO. Meg Whitman was the most ebaysian and qualified candidate. She started as CEO in February 1998. Omidyar moved aside and let Whitman take charge. He cared about the company reaching its full potential, not his title.

Omidyar’s focus on vision and flexibility in details led him to make decisions most hard-charging CEOs wouldn’t have made. eBay is almost thirty years old and has been a public company for over two decades. It has over 130 million active users globally in 190 markets. Users create 2 billion auctions/listings, which resulted in a transaction volume of $18.6 billion in Q4 of 2023. I’d say his vision is now a reality, and his approach worked well.

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Weekly Reflection: Week Two Hundred Twelve

This is my two-hundred-twelfth weekly reflection. Here are my takeaways from this week:

  • Writing challenge: I challenged myself to consistently share my takeaways from books I read. It took more experimenting than I’d planned for. This week, I found a good groove. I wrote five posts inspired by two books. I’m posting one takeaway after every hundred pages or so. That means I’ll share three takeaways from a three-hundred-page book. That rhythm feels about right.
  • Audio blog – I made a decision: I’m going to make it possible to consume my posts via audio. I did some test recordings this week. Listening to them confirmed that this is an area I want to work on.
  • eBay – I enjoyed reading about eBay’s first few years. That story is an example of the impact the twin tailwinds of product–market fit in a rapidly growing market can have on a company. I learned more about the founder. I admire his approach to building the company.

Week two hundred twelve was another week of learning. Looking forward to next week!

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Build vs. Buy: What eBay Learned the Hard Way

I’m wrapping up reading The Perfect Store: Inside eBay, which describes eBay’s early days (through 2001) in great detail. eBay’s growth was astonishing. In September 1999, four years after Pierre Omidyar created an online auction in his spare time, the company had 1,500 employees (half of whom had been hired in the last six months) and hosted $5 billion in annual auctions.

International growth was a significant growth strategy, and lessons can be learned from eBay’s experiences:

Germany

  • In March 1999, six friends studied eBay and decided to launch a German version. They called it Alando.
  • Alando acquired 50,000 users and 250,000 listings in two months, which indicates that Germans were adopting the internet rapidly.
  • eBay took notice. In June 1999, eBay bought Alando for $42 million in stock.

United Kingdom (UK)

  • UK consumers paid their phone company to surf the web by the minute, an expensive proposition.
  • eBay decided to hire UK talent and build a site from scratch. It launched eBay UK in July 1999.
  • Within a year, eBay UK surpassed its main competition, QXL.

Japan

  • Japan was the second-biggest internet market in the world and growing.
  • In 1999, Yahoo offered to partner with eBay on a Japanese auction site. Softbank, a Japanese telecommunications company, was a major Yahoo investor and understood Japan. eBay declined to partner, perceiving the terms as unfavorable.  
  • In the fall of 1999, Yahoo Japan launched its auction site.
  • In February 2000, eBay launched its auction site.
  • In 2001, eBay Japan had 4,000 listings and was ranked fourth in the country, while Yahoo Japan had 2 million listings and ranked first.

By the first quarter of 2000, eBay UK and Germany realized $87 million in combined auction volume, double the volume of European rivals. eBay deemed its upstart European sites successes. Japan, however, was a disappointment and a missed opportunity.

When a company expands outside its core geography, it often evaluates building versus buying. Cultural and other factors must be considered. One that’s important is the growth rate in the target geography: how fast is the number of people experiencing the problem growing?

The UK market grew slowly, so eBay could afford to build a solution from scratch. But in the rapid-internet-adoption markets of Germany and Japan, building from scratch meant ceding market share to competitors who had closely watched eBay’s success in the U.S. and understood their home markets better.

eBay learned from its Japan experience and, in 2001, bought the majority of Internet Auction Ltd, South Korea’s largest online auction. This gave eBay a dominant position in Asia’s second-largest internet economy—but even that couldn’t make up for eBay’s decision in Japan. Without that country, the second-largest internet market in the world, eBay couldn’t have a dominant position in Asia when the book was written. That title went to Yahoo, and so did the revenue and profits associated with it.

eBay CEO Meg Whitman openly regretted not partnering with Yahoo. Opting to build rather than buy meant that competitors satisfied consumers’ needs while eBay was building and figuring out cultural norms. Convincing them to switch after their needs were already being met proved difficult and cost eBay revenue and profits.

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Help Me Count the Money: eBay’s Product–Market Fit Story

I’m reading The Perfect Store: Inside eBay by Adam Cohen. The book, which was published in 2002, recounts eBay’s early days through 2001. eBay’s story is a remarkable example of the power of product–market fit.

Frustrated that markets favored the elite and weren’t efficient, Pierre Omidyar created an online auction in his spare time. Over a long Labor Day weekend in 1995, he wrote the code for AuctionWeb and launched the site as a free service. To keep costs down, the site was hosted as part of a website dedicated to Omidyar’s freelance consulting company, Echo Bay Technology Group—eBay for short—for $30 a month.

By the end of 1995, traffic was increasing quickly. In February 1996, his hosting provider forced him to upgrade to a business account for $250 per month. His fun hobby was becoming expensive, so he started charging sellers a percentage of each sale (i.e., a take rate). Envelopes of dollars and coins began showing up at his house, and by the end of that month, customers had sent him more than $250. He was profitable his first month!

In March, Omidyar took in $1,000; in April, $2,500; in May, $5,000, and in June, $10,000. His hobby was bringing in more than his day job, so he quit. So many envelopes were coming in that Omidyar hired someone to open them and make deposits. Think about that: his first hire was someone to help him count the money.

In 1996, the first full year of existence, AuctionWeb recorded $350,000 in revenue. In 1997, the name was officially changed to eBay, and revenue reached $5.3 million. In 1998, revenue soared to $41.7 million, and the company held an IPO that September. In just three years, the company went from a side project to a publicly traded company with tens of millions in annual revenue and millions in annual profit.

eBay was cash-flow positive immediately and never needed capital to grow, but Omidyar lacked experience in scaling rapidly and struggled to recruit talented people despite the company’s remarkable growth and financial success. In June 1997, the company raised $5 million from Benchmark Capital. But eBay never touched Benchmark’s money; it just sat in the bank account. Benchmark acted as a behind-the-scenes partner, filling the eBay founder’s gaps with its own relationships and wisdom accumulated from a portfolio of investments and years of experience.

Omidyar stumbled onto a painful problem and solved it in a way that was tremendously valuable to consumers and businesses. Customers rewarded him by happily paying for the value they received. eBay made many mistakes along the way, but the problem was so painful, and the market grew so quickly, that the company was wildly successful. eBay’s first few years are an example of the best thing that could happen when you find product–market fit: customers rip the solution out of your hands!

eBay is almost thirty years old and has been a public company for two-and-a-half decades. As of this writing, its market capitalization (i.e., valuation) is roughly $26 billion.

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Thoughts After Reading Getting Things Done

Today I finished reading Getting Things Done: The Art of Stress-Free Productivity. Here are some high-level thoughts:

  • Ă€ la carte – Allen’s complete system, as described in the book, isn’t something I’d fully implement given my digital workstyle and other factors. However, as an Ă  la carte framework, I see lots of value. Allen details several concepts that can add immediate value. I implemented his 2-minute rule years ago and will implement others now.
  • Locus of control – People who want to drive the direction and outcome of their life (rather than having life happen to them) may see immediate value in several concepts in Allen’s framework.
  • Brain – Allen believes the brain is better suited to making connections between ideas and creating new ideas than to storing information. He cites a study to support this. I agree. I’m more creative and insightful when I’m not worrying about everything I’m managing. Allen’s framework is good for generating more ideas and insights.
  • Wisdom – Wisdom is the ability to apply knowledge in a manner that aligns with the desired outcome. Wisdom means changed behavior and improved decision-making—knowing what to do and when to do it. President Hoover once said, “Wisdom consists not so much in knowing what to do in the ultimate as knowing what to do next.” Allen’s ideas around continuously and quickly identifying next actions can be powerful and accelerate the acquisition of wisdom.

I’m glad I revisited this book. I’m looking forward to testing ideas it triggered.

This book contains ideas that are useful for anyone looking to be highly productive and approach work in a disciplined way.

For founders looking for a better way to manage the inevitable chaos of company building, wanting more creative or strategic time, or wanting to be more in the driver’s seat of their life, the ideas in this book are a great starting point, and many are worth cloning.

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David Allen’s Bottom-Up Productivity Framework

I’m finishing David Allen’s Getting Things Done: The Art of Stress-Free Productivity. Allen shares great concepts in his book. After reading more of his book, I picked up on a core concept, one I alluded to yesterday: his framework – working bottom up.

Allen believes it’s hard to take on new responsibilities, be creative, or think longer term until you’re effectively managing what’s already on your plate. To manage what’s on your plate, you must know the totality of what has your attention. Allen suggests capturing all lingering physical, digital, or mental “incompletes” and recording them in a system. This will give you a clear picture of everything on your plate.

After that, you’ll “clarify,” which I mentioned yesterday, then “organize” to put everything where it belongs, and then “reflect” periodically to review and update your incompletes. I won’t get into the specifics of each step. But notice that everything so far has focused on current, ground-floor activity.

After this, you’re ready to “engage” and start making action choices. Allen provides three priority frameworks to help manage action in a bottom-up manner. This is counter to how many approach this. Here they are (listed bottom up, of course):

Now: Choosing Action in the Moment

When you have time to accomplish something, this framework helps pinpoint what to work on.

  • Context – What are your circumstances? Are you at your desk in the office, on a plane, or in a lobby waiting for a meeting to begin?
  • Time – How much time do you have available?
  • Energy – What’s your energy level? Are you in top form or in low-energy state?
  • Priority – What’s the most important task?

Many people waste time trying to figure out what to work on. Going through this framework sequentially helps you quickly identify what to work on (you will have already categorized tasks that can be only done in a particular context, for instance, so you can ignore everything else for the time being). It’s helpful when you have free time you didn’t anticipate.

Today: Evaluating Daily Work

Throughout the day, you’ll likely be engaged in one of these three work types:

  • Doing predefined work – Doing something on a next-action list is a good example.
  • Doing work as it shows up – Having an impromptu chat with a direct report or responding to an email requesting a status report are examples.
  • Defining your work – Reviewing a project and adding tasks to your next-action list is a way to define your work.

The goal is to manage your total inventory of work in a balanced manner, instead of only reacting to unexpected work. Deciding what to work on is a balancing act that relies on your intuition. But having the habit of defining and refining your work helps your intuition by crystallizing what you’re saying no to when an unexpected task arises.

Reviewing Your Work

On a regular basis, you should review your work. Starting at the bottom, of course.

  • Ground – Confirm that all your lists of next actions are current. You want to make sure you’re not missing anything. For example, call brother.
  • Horizon 1 – Confirm that your projects list captures all commitments requiring more than one action. The goal is to capture short-term commitments so you can free your mind. For example, onboard new hire.
  • Horizon 2 – Confirm that all your areas of focus and responsibilities are captured on a list. For example, parenting. This level will determine what projects you start.
  • Horizon 3 – Define your direction and intentions over the next one to two years.
  • Horizon 4 – Paint a vision of life in three or more years.
  • Horizon 5 – Define your life’s purpose.

Horizons 3–5 focus on the future; the others, more on the present. The goal is to get and keep the nearer horizons current so you have the mental bandwidth to think about the more distant horizons.

I see the value for most, not all, people in Allen’s bottom-up process. It’s a great approach to working productively and intentionally by getting the mundane under control so you’ll have the bandwidth to gain clarity in the long term. His approach is well suited for those working for an organization.

For entrepreneurs creating and growing companies, tweaking is required. Entrepreneurs usually start with a problem and craft a vision of what the world could look like if they solve that problem. Then, they figure out how to solve that problem and craft a mission to scale that solution. After that’s done, that’s when embracing Allen’s bottom-up work approach and iteratively turning a vision and mission into reality makes sense for entrepreneurs.

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David Allen’s Ideas about Getting Things Done

Reading about personal knowledge management (PKM) and reading books by Tiago Forte, I became interested in how PKM and productivity can help get more done. I decided to read up on productivity frameworks. Years ago, I read Getting Things Done: The Art of Stress-Free Productivity by David Allen. I remember it only vaguely and decided to revisit it. Learning that an updated version had been released, I bought it.

I haven’t finished it yet, but a few of the concepts he writes about have caught my attention. Here are two:

Clarifying

Allen evaluates incoming information based on its actionability, who should execute a task, and how long it will take to accomplish. If something isn’t actionable, trash it, “incubate” it until it becomes actionable, or store it for reference. He has a 2-minute rule for actionable items: anything actionable that you can do in less than 2 minutes should be handled on the spot. Anything that can’t be handled in 2 minutes should be delegated to the appropriate person or deferred to a time when you’ll do it. He has a nice flowchart in the book that simplifies his clarification process.

I’ve used this approach to handling email for some time, aiming to be inbox zero every day. I’m a big fan of my email app’s “remind me” feature. I queue up tasks and email responses that will take more than 2 minutes and handle them at times I’ve dedicated to this predetermined work. This approach has helped keep my inbox tame, ensure that nothing falls through the cracks, and allowed me to be more proactive by doing this kind of work as I deem appropriate.

Identifying Next Actions

For projects with multiple steps and a clearly defined goal, Allen advocates constantly asking, Is there something someone could be doing on this right now? Asking this question continuously surfaces the next actions, keeping a project moving forward.

People sometimes have project plans defining actions to take and when to take them. However, the problem with those plans is twofold. First, they’re hypothetical. Those plans are often crafted before execution begins. They don’t consider current real-world reality. Second, if a team is involved, they’re likely to be top-down. The people executing the work have little or no input into how they achieve the goal for which they’re responsible.

Allen’s approach is more of an iterative bottom-up approach. It reminds me of Coinbase CEO Brian Armstrong’s analogy of climbing a mountain shrouded in fog. The goal is defined, but the path to get there is flexible. The next action always reflects the current realities and incorporates learnings from previous actions. For teams, this approach empowers members closest to ground level to pinpoint and take the best action at any given time.

The iteration that results from Allen’s approach of asking this question constantly is more powerful than most people realize. This approach is how the impossible becomes possible. It’s how people successfully navigate uncertainty. It’s progress toward a stated goal with constant recalibration.

I hope to share other good concepts from the book in another post. I’m looking forward to finishing the book.

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Getting Top-Tier Service for Less

An early-stage founder recently told me that he got a legal bill that exceeded $100,000 for work on two legal matters. Both matters were standard, but it was the first time the founder had navigated them. He needed experienced lawyers to help him. He enlisted a top-tier firm with deep early-stage experience without realizing the cost would be that high.

While bootstrapping my company, I quickly learned that I couldn’t afford well-known service providers. I also couldn’t afford to get work done by inexperienced service providers. The downside to mistakes in things like legal work is high (as I found out the hard way). I had to try to get the highest-quality providers I could while staying within my bootstrapped budget.

It occurred to me that top-tier service providers are a collection of people. The knowledge and experience the top-tier firms are known for reside within the people doing the work. If I could find someone who used to work for a top-tier provider, I could likely get high-caliber expertise for significantly less.

In a specific legal situation, I pinpointed a firm known for handling the type of matter I had. I then looked for lawyers who had worked at that firm and now had their own practices (or were part of a virtual practice). I figured that if they’d left recently—within the last few years—and started their practice, they were hungry, entrepreneurial-minded practitioners. A partnership could be a win-win for both of us. The strategy worked. I found a great lawyer who’d left that firm a year earlier. He started a solo practice and was looking for new clients. He got a new client and I got a rate I could digest because his overhead was significantly lower than that of his previous big law firm. With a little bit of digging and hustling, I found a diamond in the rough. He was less known, but I got the caliber of work I needed in a timely manner without breaking the bank. And I supported another founder. It was a win-win.

I now think of hiring service providers for early-stage companies or small projects as being just like hiring team members. Start with a budget and try to find the best provider with the desired experience (or capabilities) within the budget. This often means identifying people with relevant expertise who don’t have the packaging of elite firms. It’s more work, but it’s worth it when resources are limited. It’s also a great way to build relationships with great service providers early on.

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