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Hedgehogs, foxes, and VCs
What matters in early-stage investing (and why I think "why now" is the most important thing).
“Hedgehog or fox” is one of my favorite mental models. It comes from an ancient Greek poem with the punchline "The fox knows many things; the hedgehog knows one big thing."
The hedgehog has a deep but narrow focus. The fox represents a broad but scattered approach to knowledge. Hedgehogs have one great idea, one ordering principle that defines how they see the world. Foxes are intellectually promiscuous — “strong views, weakly held”.
In art, Rothko is a hedgehog and Rembrandt a fox; in music, Bach is a hedgehog and Bowie a fox; in philosophy, Hegel is a hedgehog and Hume a fox. This applies to business and investing too. Rich Barton is a hedgehog: he’s started companies in different markets (Expedia, Glassdoor, Zillow), but all share the underlying idea of “making uncommon knowledge common”. Richard Branson is more of a fox, starting businesses across media, airlines, telecom, and more.
Why “why now” matters
As an investor, I started as a fox, but now find myself squarely in the hedgehog camp. There are tons of factors for foxes to consider: founders, market, product, competitors, pricing, etc. These are all important. But I’ve found myself more focused on one thing — not to the exclusion of all others, but as the highest order bit. I think all great companies must have a great answer to “why now?”, and specifically to “what makes NOW the uniquely right time to build THIS company?”
The “why now” puzzle piece has become so important to me because inertia is a crushing force. If there isn’t a powerful reason for a given company to happen now, inertia will prevail. An amazing and hardworking founder, a great product, a powerful distribution strategy, etc are all necessary but not sufficient conditions for success.
Large, existing incumbents have a big advantage by default—simply because they’re large and existing. Most of the time, the market is stacked in favor of these incumbents, if not simply in favor of the status quo and against startups. Founders must find something that tilts the playing field towards them temporarily. These windows are hard to recognize in the moment, but if seen and exploited, they give startups a fleeting but critical edge to overcome the inertia of the status quo.
New capabilities and market shocks
I think good answers to the question “why now” fall into two categories: new capabilities and market shocks.
New capabilities are new technologies, products, platforms, and/or business models that allow something novel to be created. These are typically terminal changes that aren’t reversed, but are eventually replaced with another new capability.
Broadband was a new capability that enabled a wave of companies from Youtube and Netflix to the broader cloud model and industry. No one switches back from broadband to dial up (although many are now switching to Starlink).
Other examples of new capabilities include:
Mobile phones overall, and specifically embedded with a series of ever higher quality, lower size/cost components, like GPS, cameras, accelerometers, and biometric ID.
The cost effectiveness and reach of performance-based social and search ad platforms, from SEO to AdWords to Facebook Ads and beyond.
Increased efficiency and decreased cost of ever smaller batteries that enable a greater number of cheaper, longer-lasting devices, like wearables and in-home devices.
The rise of the payfac-as-a-service and banking-as-a-service business and regulatory models in fintech.
Various country- or region-specific open banking and/or real-time-payments capabilities and requirements (SEPA, UPI, etc).
Market shocks occur when the supply or demand of a critical element changes suddenly and dramatically, creating unusually high or low prices. This is often temporary, as markets respond to high prices by driving up supply or to low prices with increased demand.
One such distortion was the high cost of software engineers in the early 2010s. Engineering was a bottleneck for an entire generation of tech companies. This high cost was a strong “why now” for a series of companies that (1) trained more engineers in bootcamps like General Assembly, (2) made existing engineers more productive with developer tooling, infra, and frameworks like Heroku, or (3) made engineers less necessary by making technical work more accessible to non-technical workers with low and no code tools like Zapier and Retool.
Market shocks can result from a lack of demand as much as a lack of supply. For example, many millennials shunned traditional credit products after living through the aftermath of the Global Financial Crisis and with rising amounts of student debt. This aversion to traditional credit created an opportunity for alternative, consumer-friendly credit options like buy-now-pay-later with Afterpay and earned-wage-access like Earnin.
Market shocks are by their nature temporary, and so are eventually solved by the market if they are large enough and exist long enough. A market shock opens a window of opportunity that can be a powerful “why now”, but it’s important to remember that these windows are fleeting. Being too late or too early to them is just as bad as not having them at all.
How to reverse engineer timing
Most great companies start with multiple “why nows”. Not all “why nows” are equally powerful or equally relevant to each company. Different “why nows” might be at different stages of potency and maturity. The more relevant waves a business can ride, the more tailwinds that push it along, the better. For example, Uber launched 2 years after the debut of the GPS-enabled iPhone (new capability) and subsequent price drops from new models (demand + supply shocks), 1 year after the launch of the App Store (new capability in distribution), and near the peak of post-GFC unemployment (supply shock).
Because “why nows” are by definition temporary, they decay over time and businesses must constantly find and ride new ones. This is best represented by the S curve model: technologies go through a period of incubation, rapid adoption, and then maturation and saturation. Lasting companies must stack various S curves over time, finding new growth enablers as the old ones degrade.
Facebook’s 10-year plan from 2016 is a great example of this. It shows how in order to stay relevant, Facebook expanded from being a desktop-dominant, US-focused social network, to being a more mobile-first and international app suite (Whatsapp, Instagram, telco infra, free basics). And now, following the roadmap, Facebook has expanded even further into new computing interfaces (VR/AR).
New capabilities are often more powerful than market shocks. Although both have a window of potency, new capabilities are often irreversible (though not irreplaceable), while market shocks are temporary if not cyclical. New capabilities are often overlooked or dismissed (“The next big thing will start out looking like a toy”), whereas market shocks (and the associated opportunities) are often more obvious to more people early on.
Because new capabilities are often tech-based, they benefit from network effects and/or economies of scale in the long term, whereas market shocks revert to an equilibrium in the long term. Taking the software engineer example above, if bootcamps are successful in producing engineering grads, and if they continue to scale that without doing anything differently, they’d eventually drive down prices in their own market. Conversely, if a developer tool like Vercel makes existing engineers more effective, it will gain traction and become a required part of the software engineering stack.
New capabilities and market shocks often interact with each other in the complex system of the market. To tie together a few examples from above, cheap and fast bandwidth was one of several contributing factors to the rise of cloud computing, which made startups cheaper and easier to start, which led to an explosion of startups that all needed to hire engineers, which drove up the price of engineering talent, which in part contributed to the explosion of low/no code companies. There isn’t an exclusive relationship between these factors, but the causality is there.
Some “why nows” apply to every business, and others are highly industry- or geographically-specific. For example, cloud computing makes all kinds of software businesses more cost effective, while payfac-as-a-service and banking-as-a-service models impact fintechs specifically but globally, while FedNow real-time-payments specifically affect US-based fintechs and associated businesses.
I love investing because it’s a series of interlocking meta games: you need to learn about, form opinions on, and compete in the market, while also watching and adapting your own decision-making. Time will tell whether the “why now” hedgehog or more fox-like approach is the better one.
In any case, it’s easy to get caught up in whatever the latest trend is (crypto! generative AI! probably AR in Q1 2024 thanks to Vision Pro). Instead, I hope to stay level-headed and recognize that great companies are built on the confluence of multiple temporary trends, many of which are overlooked or dismissed before they change entire industries.