Does "Financial Gravity" Corrupt? - Lean Startup author Eric Ries on staying Incorruptible

0:00Eric, thank you so much for joining us on Giant Ideas. It's great to have you with us. Nice to be here. Let's start by talking about Lean Startup. This was a book and a philosophy that really profoundly shaped so much of Silicon Valley and startup culture around the world. Maybe before we talk about lessons learned all this time that's passed, could you just distill down what was the key message of Lean Startup? Sure. Yeah. So much of how we used to teach entrepreneurship really was based on 20th century general management principles, principles that every one of us has learned if we've had any kind of a job.

0:35Right. You, you know, you do better than expected. You're doing a good job. You do worse than expected. You're doing a bad job, which requires you to have a manager. Your manager has to know what's supposed to happen. and then you could be judged based on how what you did compares to what you were supposed to do. If you study 20th century general management, you will learn that this was a big breakthrough, actually, in the early 20th century to figure out how to create forecasts of what is supposed to happen. Taking macroeconomic data and sales data and all kinds of stuff, you put it together, you make a plan, the plan gets decomposed down into a series of metrics, or OKR as we call them these days where each middle manager is assigned to some med, right?

1:16You know what I'm talking about? You're familiar with this idea? Yeah, of course. If you pay attention closely though, you'll see that in order for that whole system to operate, we have to have a long and stable operating history from which to extrapolate the forecast. Otherwise, the targets are all arbitrary. And in entrepreneurship, we by definition never have such a forecast because we're trying to do something new on purpose. The whole point of it is to do something new where nobody knows how to make an accurate forecast. So, so much of business planning in an entrepreneurial situation is trying to figure out how to cope with the underlying uncertainty of doing a startup.

1:56That's actually, to me, the definition of entrepreneurship, to create something new under conditions of extreme uncertainty. And so the idea of Lean Startup was to borrow ideas from a bunch of different fields, from lean manufacturing, from a scientific method, from maneuver warfare, from customer development, from all kinds of places, to try to put together a system that would allow us to evaluate and judge progress even when we didn't have enough stable operating history to make a forecast. And that's where the famous terms, like the terminology of Lean Startup comes from, the minimum viable product or MVP, that first increment of work that you have to do to run that first experiment.

2:33One of the most underrated concepts in Lean Startup is that the unit of progress is not stuff. You know, AI lets you make stuff, more stuff faster. Congratulations. That's been the trend of technology for going on 100 years now. You can make more stuff faster. Good job. But the question of our time primarily is not how do we make more stuff, but what's the right thing to build in the first place? So learning how to operate the business, learning who the customers are and what they want, learning the economics and the business model. a little bit like that learning is actually progress and making the things is not and that is super counterintuitive for most people we call it validated or scientific learning like how do we prove to ourselves and then to investors and everybody else how do we prove that we actually are making progress we are learning how this business really operates eric is there anything that you regret from lean startup or that you think you go wrong regret no but you know i know so much more now that i did then so of course a lot of things i didn't quite get right um you know the biggest one and obviously this is this ties into the themes of the new book one of the funny one of the funniest jokes on the internet at least i thought so for a long time you've seen the reddit meme that is anakin and padme no and anakin says i'm gonna change the world oh yeah that's that's frame one of the cartoon padme says for the better right that's frame two in frame three, Anakin says nothing at all.

4:00He just grins. And then in frame four, Padme says for the better, right? And this question of when we try to change the world, do we have an obligation to change it for the better? I definitely thought that was obvious. We all were on the same page about that. Of course, everyone was trying to make the world a better place, right? Right? Surely, right. But in, you know, I used to think that joke was really funny in the last few years. I don't find it that funny anymore. I think a lot of people who got seduced by the idea of changing the world, like actually just assumed that if they had more power and influence over the world, that would be on its own a good thing without really thinking too deeply about what kind of effects they were going to have.

4:38And if you go back, if I was going to change one thing in lean startup, it would only be this. I actually went back a couple of years ago and checked. Did I say that people should change the world in the book? And I did. It's like a throwaway line at the end of the introduction. It just says such and such a thing so that the next generation of entrepreneurs will have the tools they need to change the world. Period. I forgot to specify for the better. I love that. Do you think that you've been at the heart of Silicon Valley culture and you know a lot of the top founders now and then. Do you think that Silicon Valley founders on average are less driven by desire to change the world for the better now than they were then?

5:20I don't think it's that different now. I think two things are happening. One, we have a kind of very performative class of very rich people who've just decided to give up on that project and have just embraced cynicism and nihilism kind of as their brand. And so, yeah, those people are very loud. They consume a lot of attention. They have a special talent for pissing off the rest of the public, making everyone worried about Silicon Valley. So I don't think those people are having a very positive effect on the ecosystem or on its branding, but it's been helpful to them, so they keep doing it. That really didn't exist when I was coming up in the industry.

6:00And then, of course, we have this set of founders now who have really lost control of their own creations and therefore have become villains. Like not just people, like not just having bad PR, but they've been complicit in bad stuff. and they've had a really hard time reconciling that with their own self image that they're supposed to be the heroes. So that the fact that they're like publicly struggling with this tension, like, I think that is also very different than what we had before. But no, in terms of why people become entrepreneurs in the first place, like I don't detect much difference in how mission driven or idealistic they start out as because it's just why, why else would you become an entrepreneur?

6:44Like, that's what's so interesting to me. It's like it's not actually a profession except during like the height of bubbles and peaks like what we're going on right now. Generally speaking, entrepreneurship does not attract people who are in it for the money because there are just better ways to make money, way better ways, ways with a way higher probability of success. Generally speaking, like unless you're a very, very cynical person, entrepreneurship tends to attract people who want to accomplish something in the world and have been thwarted in being able to accomplish that through traditional channels.

7:12So, you know, over time, the financial gravity of this system does tend to corrupt people. That's obviously a big issue, but they don't start out that way. Generally speaking, they start out very, very naive, very idealistic. You've written a second book, you know, a couple of decades on called Incorruptible. And it in many ways, I think, deals with a lot of the problems, not just with Silicon Valley, but with business more generally across the world and when things go wrong with business. Eric, could you just give us a quick version of the thinking, the main vision behind the book? So yeah, the new book is called Incorruptible.

7:45And it's about this double mystery that is at the heart of modern life. We all know, although we don't really have language for it, that quite often when companies become successful, they get ruined. And this is not the same as they get disrupted by some competitor. You know, like I was having dinner the other day and one of the people who was at dinner was like, I'm sorry I recommended this place because the food tastes disgusting. I'm like, yeah, why did you recommend it? They're like, yeah, hold on one second. They're on their phone. I'm like, yeah, sorry, guys. I didn't realize this place had been taken over by private equity.

8:19I could taste it. How can the capital structure of a company have a flavor? And like think about your favorite brand that got acquired or that went public. Have you ever been like, well, maybe with all the vast financial resources of the private equity firm, the food will taste better? You know, maybe it'll be like, it's never good. It's always, why does it always get worse? And I just, someone called me now, you know, because the book has been out for a little while now. People are trying to tell me their horror stories. I was someone who went to a membership club, like, you know, an athletic club.

8:53And they were thinking about becoming a member. And they were like, God, everything about this place just screams they're trying to squeeze every last dollar out of me. And they left and they'd be like, they looked it up and they're like, Google the thing. Is this thing owned by private equity? Oh, look. Oh, look, it is. Like, it's just somehow we've gotten used to the idea that when companies get bigger, they get ruined. So many stories in the book are about companies that are destroyed by their own investors in the name of profit. What's going on? and we have this like, it's like a mystery. Why are we destroying value in the name of profit?

9:27In the book, I show that it's been going on for hundreds of years. But there's a second mystery buried in that one, which is if you ask most normal people, why does this happen? I'll be like, well, it's inevitable. It's inevitable. Why are there exceptions? Why are there some companies that this doesn't seem to happen to? And so if you take those two mysteries as our jumping off point, that's what the book is about. And what are the companies that manage to buck the trend? If you play this game with people, even the people that say it's inevitable will be able to name exceptions because they'll have a Vanguard mutual fund or they'll own a Patagonia fleece.

10:04They'll have shopped at John Lewis Partnership or they'll have taken a Nova Nordisk medication. And you go through the list of companies that aren't seen as the exceptions that have managed to sustain an ethos, Mondragon in Spain. Some of these companies have been able to maintain this ethos for 50, 75, 100 years more. And you say, well, what do all those companies have in common? You will discover that every single one of them violates what we consider to be the best practices of how companies are supposed to be built, structured, and governed. So in some way, we have gotten ourselves into an economy where we have built a whole playbook of best practices that, as far as I can tell, are value-destroying.

10:49And yet we treat them like they're pillars of capitalism that are sacrosanct, when in fact, they're quite bad. What is the element across all those different examples that is not present in most companies where things go wrong? So there's a blueprint that these companies share that, broadly speaking, has two elements. One is an inner element, the element of alignment or ethos is the word I use in the book. They have a character to them. They stand for something. The original concept for Costco was that it should be a fiduciary to the customer, meaning if you put customers first, you put their interests first, eventually shareholders and everyone else will prosper.

11:26You treat employees with respect. You pay them above market wages. That is going to lead to good things. It's a more enlightened view of capitalism. and under conventional structures, those insights, that ethos test, the thing that tends to get destroyed. So there's this spark, this thing that makes companies worth creating in the first place that we have to protect. We protect it first and foremost by getting everyone aligned around that common vision or goal. And the second dimension is we learn to build the company with structural integrity. We make sure that if they try to get bullied or tempted to betray or defect, there's something that interrupts that process.

12:01So the companies that I mentioned that are these exceptions, they all have some mechanism for being a mission guardian, someone or something whose job it is to make sure that the company cannot deviate from its mission over time. And those two things together, ethos plus integrity, are the blueprint for building an incorruptible company. And you seem to think a systems-based approach works best, but I would probably counter that the best safeguard for that is an empowered founder, strong incentive alignment, and you just hope that the founder stays mission aligned and uncorrupted. Sure. So here are the problems with that.

12:37First thing is, even if I grant the premise of your question, that will only protect the company up to the maximum of the human lifespan. yeah which is not that long though in your yeah that's a long it's a long run if you start the company yeah sure if you start the company when you're 20 and you you know stay at it um so that is one possibility but i don't think i don't think that's that great first of all the idea that the founder will remain incorruptible runs into the problems of human psychology like we all know that absolute power corrupts absolutely so like if you watch some of these guys like they the psychology research they have a term for this they call it hubris syndrome they tend to become arrogant.

13:14They tend to become divorced from reality. And it's actually like, statistically speaking, like, works out sometimes, but it doesn't work out every time. The second problem is, it's not enough to protect the founder. Because in a modern company, you'll have thousands and thousands of employees who all have short term stock options. So we have a lot of companies where like the founder is up there protected and thinking long term, but their actual systems and procedures that run the company deviate from that vision. That's actually why we have the whole discourse recently about founder mode. And the other problem with it, I think this is a little bit more subtle.

13:52A lot of these founders are trapped. At a certain point, this ceases to be your dream job and becomes a job you can never quit. You basically become an indentured servant. If you leave, the thing will fall apart. So you must stay. And I think the psychological toll that that takes. Look, these guys are rich beyond belief. So, you know, I know that we don't have a lot of sympathy for them, but like, it's kind of a hostage situation. Like, do you really want a hostage running your company? I just think we could do better. And the fact that we have these examples of companies that have been able to sustain an ethos over generations, to me, points the way towards a much more humane way of working.

14:32And so Eric, just to clarify that the problem here, the kind of bugbear is shareholder primacy. It's the profit motive. It's quarterly reporting. What specifically do you think is at fault? Yeah. So all of those things are symptoms of a phenomenon I call financial gravity. There's a literal force that financial systems exert that can drag companies down into mediocrity or worse. So yes, the financial gravity is the root cause behind, for example, shareholder primacy, the idea that, oh, you think your company is a beautiful living organism designed to create quality products that make your customers' lives better, like a sucker jokes on you.

15:13Oh, no, my friend. No, no. Didn't you know your company is nothing more than a financial instrument to profit shareholders? Oh, good to know, right? That is certainly one of the problems. That's one of the dumbest ideas in the world. And people are taught that that's some kind of ancient pillar of capitalism, but it mostly dates to the 1980s. It's a relatively recent addition to our theories of the corporation and one that has not worked very well. So that's one thing we can easily reverse and undo. Yes, you talked about the profit motive. Most companies, in my opinion, do not understand what it means to make a profit.

15:45We don't define it correctly. As a result, we're living in a world where the very idea of being for profit is under attack. You see people who are kind of reflexively suspicious of any for profit company always assume that it has malign intentions. I don't blame them. that is a pretty reasonable guess these days because statistically speaking, that's what we're doing. But again, it doesn't have to be that way. And yeah, quarterly reporting like that. Anyway, each of these are like examples of so-called best practices that we have really good evidence destroy value. So there's pretty good evidence that companies that have to report four times a year are 5 % less valuable in total market cap compared to reporting twice a year.

16:25Like it's incredibly powerful effect. companies today that are rated to have bad governance have outperformed companies rated to have good governance since 2008. Like we have, we're starting to accumulate this data that these practices are not only immoral and unethical and bad for the environment and bad for human welfare and all this other stuff, but also fail on their own terms because they're fundamentally value destroying. So, I mean, we back companies, the giant that we believe are going to be very big companies, but we have conviction that they will also make the world a better place. So we're very aligned with the vision, but trying to have a dual purpose for companies, whether it's been the B corporation or kind of some of the ESG efforts have struggled and faltered in the last years, just because it can be hard to kind of objectively talk about non-financial results.

17:13So, I mean, do you have any suggestions on how we could move this forward? We had Andrew Yang on the podcast a couple of months ago, and he has a vision for society where we really do try and compensate people for their contributions that are non-financial, whether it's taking care of a loved one or contributing to the community. But how we kind of make that a reality and a practice is where we kind of falter somewhat. Yeah. I'm not a big fan of some of these double and triple bottom line initiatives that have happened before. Not that they were ill-intentioned, but simply for the reason you're saying that it's just very difficult to serve multiple masters.

17:48I'm really believer in a single bottom line. I just think we don't define that bottom line correctly. So we have so many examples, like I could just give you company for company for company where the profit motive proved unprofitable because thinking in a short-term way, thinking in a narrow way, like caused the company to miss out on the value creation that is available if you can see things in a more broad way. So, so yeah, I think we have the evidence to support the idea that working in this way, being mission-driven, being long-term, making what I call fiduciary commitments to more than just shareholders.

18:24Those choices, the evidence shows, leads to more commercial success. They're sources of competitive advantage, not disadvantage. So no one's asking anybody to sacrifice or give up on their dream of changing the world for the better and being handsomely rewarded for it. This is actually the path by which that can happen. My experience about Eric having written another book called Connect, and it was all about how, There's a huge amount of value at stake from companies in terms of their interactions with societal stakeholders, not just shareholders. And there's a real competitive advantage to be gained by engaging radically with society.

18:57When we took that around the world and we interviewed 80 CEOs, everyone from the big banks, the consumer goods companies, they kind of intellectually got it, but their heart wasn't really in it. And they kind of nod along and then nothing really changes. The kind of old ways of doing capitalism don't change. You're unusual in that you have not just written about this stuff. You very actively tried to change it with a long-term stock exchange. Maybe tell us a little bit about what that stock exchange is, how it works, but also crucially kind of has it worked and what's been your experience in reality of trying to get people to adopt these new ways of valuing profit and valuing contributions to society?

19:36Yeah, well, it has not been easy, of course. Yeah, yeah. So for those who don't know, long-term stock exchange, LTSC, is an idea that I first floated in the lean startup in the final chapter. I think somebody should really do this. I didn't think it was going to have to be me. I figured, you know, the mythical somebody would do it. It is a national securities exchange. So it is a direct competitor to the New York Stock Exchange at NASDAQ, the first to list and trade multiple stocks since the creation of NASDAQ in the 70s. So first time someone's tried this in a really long time. And the idea is to have listing standards that align with long-term value creation.

20:08So companies to list on LTSC have to adopt our principles as really doing the things that we've talked about happening. And the evidence shows that companies that do that make more money. They attract more long-term investors. They're more commercially successful. So we view it as a way of protecting or enhancing the success of the companies that list. It took an immense amount of time, money, and effort to get that company built, to get the legal approvals to run a new stock exchange, to build it from scratch. to get the first companies to list, to trade. I mean, it's been an uphill battle for many years of my life.

20:43I'm happy to say that I do not run the company anymore. So I have got to get out of the habit of saying, we did this, we did that. But if you saw in the news recently, there's been a lot of discussion about the US SEC switching from quarterly to semiannual reporting. That's the result of an LTSC petition that was filed last year. So the company sees itself as on a mission to try to influence in a positive way these rules that govern so much of our financial life. And how's it going? You know, I don't know. I think a very common problem with these kinds of projects is simply how do you know how well it's supposed to be going?

21:21So the company, you know, three amazing companies are listed in LTSC. You could say, well, that's a lot less than the thousands that are listed on the New York Stock Exchange and NASDAQ. True, that's 100 % true. On the other hand, no one has ever gotten three companies listed on a non-NASDAQ, exchange ever, ever. So, you know, it's, it's glacial tectonic type progress. Is it enough? Will it ultimately lead to success? That's actually not up to me, but up to everybody listening. People have to vote with their wallet to say, yes, this is the vision of the world that I want to see. If you wait, people who wait to see and say, well, let's see after it becomes successful, I'm happy to jump on the bandwagon.

21:58If that's how people respond to it, then ultimately, no, it won't succeed. This is going to require people that, I mean, founders, leaders, board members, investors to stand up and say, yes, this is the world we want. And we're willing to put our money where our mouth is to say, this is how it should be. And I think time will tell if we get it right. I think it does require leadership. One of the best stories I've heard about this is Paul Polman, who was the CEO of Unilever, this enormous consumer goods company. And when he was the first appointed CEO, he was a big believer in all the stuff you're talking about, long-term capitalism and purpose-driven capitalism.

22:31And he really, really hates quarterly reporting and so on day one as ceo of unilever he said to the hedge fund shareholders i fire you i don't want you i don't you want you as shareholders anymore and he said he could only do it on day one because he couldn't possibly have been fired by the board on day one i've been too embarrassing um so he took that opportunity to do it but ultimately you know paul put forward that view of of long-term capitalism and and it was he was a poster boy for it for a while and you know unilever now has kind of rejected what the new ceo described i think as a kind of woke capitalism and has gone back to the old way of doing it.

23:06What do you think, as you kind of assess all the work you've done with long-term stock exchange, with the writing, what makes you hopeful that this all can change in a very radical but also kind of mass way where it's not a few pioneers like Paul and others and it actually changes how everyone does capitalism? I think ultimately the generational shift is the mega trend. If you talk to younger people about this, They're not confused. They have no debate. Like they just think the system sucks and they're very hungry for change. And I think the question of how radical that change will be and exactly, you know, how it will happen, how painful and wrenching will it be versus how smooth and gauderly that's up to older people to decide.

23:52And I think it's interesting. Like when I, if I, people project their ideas, their preexisting ideas about capitalism onto the book. So a lot of test readers would say things like, I had an economics professor who called me up. He's like, look, you're too harsh on capitalism here. Capitalism is a lot better than you make it sound in this book. And I was like, that's interesting because I don't even mention capitalism in the book. I just present the evidence of what is going on. If you perceive this evidence as a critique of capitalism, doesn't that say something about your own beliefs? I wanted something to do with me.

24:22I just gave you the evidence. You don't like it? What are you going to do about that? But for younger people who read the book, I had test readers who would say things to me like, this is the first book I've ever read in my life that defends capitalism. Right? So compare like, so it's all a question of what, what do you, what is your preconceived notion about where we are as society? All my goal is only to present the evidence. It's not really up to me whether the system changes. Like I said, it's up to those who are listening. I, in a later chapter of the book, really explore this idea that we as employees, we as customers, we as shareholders, we have more agency than we realize.

25:00And we live in this very cynical age where people are constantly trying to tell you that your vote doesn't matter, your voice doesn't matter, what you do doesn't matter, you don't have any power. And it's like, those people are awfully rich. They could be off on an island, just partying by themselves. Why are they spending all this money trying to convince you that you have no power. Like, isn't that interesting? Does it seem a little bit strange that people spend so much time and energy trying to convince you, you have no agency. Maybe they're afraid of something. Maybe they know something that they're not willing to admit.