Why success destroys the companies we love, with Eric Ries

24:08She goes with him. They're having dinner one day. I think it was in Boston. And the person at the table is telling them about this new research that's being done in Canada. Someone has figured out how to synthesize insulin and that could be a cure for diabetes. They go and they meet the Canadians. They're blown away that this fatal disease is going to have a cure. And they ask the Canadians if they can license the technology and bring it back to Denmark and start producing insulin in Denmark. And they had this fear that if you were making medicine and charging people money for it, you might be in a situation where you'd be tempted to exploit them.

24:39Because if I have your life-saving medicine, you'll do anything for it. I can make a fair profit if I sell it to you in a fair way, but if I wanted to, I could charge you 10 times. Anticipating Martin Screlli by a lot of years, I could charge you 10 times more. Yeah, I was going to say, that never happens, right? What could you do? So they agreed that what they would do is they would create the Nordisk Insulin Laboratorium as a nonprofit foundation that would own a for-profit subsidiary. And what's really interesting about it is that Nova Nordisk is still going 100 years later. The foundation they set up is now the largest foundation in the world.

25:12And Nova Nordisk is a publicly traded company. So I hear people tell me all the time, oh man, once you get large, Once there's investors involved, once you go public, once you this, once you that, you're doomed. Corruption is inevitable. It's like, but if that's inevitable, how come it hasn't come from Nova Nordisk? I've been pitched founders who are like, I want to do drug discovery. Do the Nova Nordisk thing. And I'm like, great. And tell me about the corporate structure. It's going to be a regular old Delaware C Corp, shareholder primacy to the max. And I'm like, who told you that? I talked to this investor, and I talked to this MBA, and I talked to this lawyer, and blah, blah.

25:47And I'm like, look, I'm sure those people all seem really smart. But before you go listening to them, I just want you to ask me this one question. Are you sure you're smarter than a Nobel laureate? Because Marie and August Crowe worked this out 100 years ago, and it totally worked. And now this is not just one company, by the way. There's enough of these companies in the world that the great researcher, Steve Thompson, at Copenhagen Business School, has actually built a data set of these companies to see if they perform economically better or worse than conventional companies. Everyone I talk to about this is always like, well, they're nonprofit-owned.

26:16They probably are inefficient. They probably, you know, they can't raise, they're not disciplined by the market. They can't raise capital attractive rates. They can't this, they can't that. Our modern finance theory, it's really important to understand this. Our modern finance theory makes very concrete and specific predictions about what should happen to these companies. And they're all wrong. Actually, these companies outperform. Actually, they have better financial performance. Actually, they don't need the market discipline. They actually create a lot of shareholder value that for-profit companies, normal for-profit companies can't touch.

26:44They have better return on invested assets. They have better Tobin's Q, if you know what Tobin's Q is. They're better in all these different dimensions. But it sounds like heresy, right? It's so different. It's 100 % heresy. It shouldn't work. But it does. Except it does. Except it does. Are you open to the possibility that you were taught something in business school that was a lie? It's actually very challenging for people. And again, the effect is not marginal. For example, one of the best stats about these companies is they're six times more likely to live to year 50. We're talking about 10 % versus 60%.

27:19It's a huge difference. So it's not just that, oh, there's this acute exception, how interesting. When the empirical evidence says that the theory is wrong, we have to be willing to say that not only is this a better way, but it also should call into doubt our conviction that our modern doctrines about value creation, about governance, about finance are correct. I think it's actually very clear that they are incorrect and that we've been taught, I would say, indoctrinated into a set of best practices that as a whole are value destroying. And it's time for us to just say, no, we're going to have our own better new best practices.

27:54Among the cautionary tales in the book, you cite Whole Foods. And, you know, Whole Foods at least first came to me, it seemed like a sort of real mission driven company. company. So what went wrong or what? Whole Foods is a very important story to study, not least of which is because John Mackey is awesome. I really like him. I know him and he's a really great entrepreneur. And he had, I think, a tragic experience. And if you talk to him about it, he blames himself. But I think it's important to move the story away from the personal drama and start to focus on the structural aspects. People today know Whole Foods mostly as a gourmet grocery store, but it was originally not even really about gourmet food at all.

28:34It was really about health, and environmental consciousness. The original store in Austin was like a community center. People loved that store, so much so that in the early days of Whole Foods, there was flooding in Austin, and the store was completely saturated with mud, and the company would have absolutely gone bankrupt, except that the whole community showed up with buckets to bail them out. Their banker personally guaranteed them a loan to go buy new inventory. This is at a time when John and his then girlfriend had to like live in the store. They were bathing with the dishwasher hose, okay?

29:08Like this was an act of tremendous love. And that was his goal. He said, my goal is to make the best workplace in America. I want to be a place that people love to work. They love to shop. So it was like a very mission-driven company. And it expanded and it raised money and it had a bunch of success. And Mackie kept talking about at each stage, if you look at what he wrote about it, he said like when I got VCs involved, I felt like I'd taken on hitchhikers with credit cards. They were, as long as we were going where they wanted to go, they were willing to pay for gas, but they really weren't fundamentally aligned with us in the same way.

29:43And so he was actually, he was eager to take the company public to get those people off his board. And he talked about how going public was like the greatest day of his life, not only because they had made a lot of people rich, but because like now he was moving on from those investors. But Whole Foods was a bad fit for the public markets from the beginning. They had high margins because it was a premium product. that their margins would go down even a little bit, their stock would collapse as the market would punish them. And so they really got this strong message from the market that you have to defend these margins at all costs, and they did.

30:12Now, here's what's really interesting about it. The whole time they're a public company, they are just obsessed with keeping the stock price up. But why? Normally, we say, why is it important to have a high stock price? Well, you're greedy. If you have stock options, you're greedy. But Mackey donated all his stock options to charity. He said he didn't want to work for money anymore. He wanted to work for the love of the thing itself. So that wasn't it. He said, well, it's important to have a high stock price because what if you need to raise money? Most today, like a lot of tech companies that go public, they're like money losing machines.

30:44Whole Foods during this whole period never had an unprofitable year or an unprofitable quarter. So they never needed to raise money or really needed anything from the markets. And yet the psychological compulsive need to keep that stock price high drove all their decisions. And in particular, it drove the decision not to lower prices. They couldn't bear the trauma of the stock price going down. But this wasn't just like, oh, they're being weird. They understood that the cheaper the company would be, the cheaper it would be to buy up the shares and take control of the company, take it away from them.

31:12Which would make them vulnerable. Which would make them vulnerable. So they felt like high stock price was the kind of success you needed to be successful. This is that same fallacy we talked about before. We have success. Success will give you power. Use that power to do what you want. But unfortunately, because they couldn't lower prices, eventually their foot traffic started to decline. and now their stock price is going down anyway, which allowed, in fact, allowed activists to come in, buy up a small percentage of the company and force them to sell it. Mackie, to thwart the activists, like made a absolute Hail Mary of a phone call to Jeff Bezos.

31:45I said, look, could I sell the company to you instead because you're more long-term and that's ultimately how the deal went down. The activists who did this, by the way, they made$500 million for six months of work applying the pressure campaign to force this sale to happen. I quote an article that's like the Green Bastards won, and they were like, look, Mackey wants to have it both ways. He wants to be this avatar of being mission-driven and conscious capitalism and doing right, but he also wants to run a standard issue publicly traded company. And is that what, when you say he blames himself, is that what he blames himself for?

32:20Yeah, yeah. He feels like he should have been able to figure this out. I'm more sympathetic to his situation even than he is. I think he was caught in a trap that had no solution because it needed to have been solved years earlier. Whenever he took those hitchhikers on with their credit cards, he was busted from that point on. Absolutely. He definitely had no idea what he was really signing up for then. And I wouldn't say it was too late because actually I've worked with companies that have adopted these structures at many different ages and structures. But yes, one of the ideas in the book is that it's generally always too early until it's too late.

32:54so you talk to people about this and then you get this pat on the head you or your lawyers like I think I want to do this thing I heard Eric was on this awesome podcast with Bob and he says I should do this thing like Novo Nordisk go try it you will get the most condescending pat on the head you've ever had in your life which is like oh that's sweet that you think that like good for you don't worry about it you don't have to do that now you can always do it later it's absurd it's just like what are we doing when the evidence that these companies outperform is staring us all in the face it's not just Novo Nordisk anyone have a Vanguard mutual fund Anyone ever bought furniture at Ikea, you know, Patagonia, you know, Hershey chocolate, for God's sake, has this structure.

33:29It's a very simple, very simple idea, yet it is very difficult to adopt because there's all this gravitational pressure to conform, conform, conform to the so-called best practices. And many board members, many investors, many founders for that matter, have become convinced to become more loyal to the best practices than to what actually would serve the organization's health. if you're a business and you say, okay, I'm going to put my mission first, what are the frictions or the trade-offs that I should expect if I do that? I'm going to push back on your question a little bit. Okay. Because it was the most common piece of reader feedback I got while working on this book, bar none, is people are like, you're not being honest enough about the trade-offs.

34:14So I went and I interviewed, re-interviewed a whole bunch of the mission-driven CEOs. and I said, look, I need to know more about the trade-offs. And they all looked at me like I was a total lunatic. They were like, the what? I'm like, the trade-offs. They're like, the trade-offs of what? And it was as if I had asked them, what are the trade-offs between eating food and eating poison? They're like, it's not a trade. You are foregoing the right to eat poison in the future. So you're taking options off the table, that's true. But that's not really a trade-off. it's actually just it's the thing that we do we can't imagine doing it any other way and i'll just i'll give you another example i was i met a company called grunfos um they're they're a danish water pump company another danish company and they were like the first company i'd ever actually like gone to do a workshop with their executive team that had this structure i didn't know they had the structure at the time but i got there and it was like very weird i was like well everything is different at this company why they're like look you need to understand we have this unusual structure were owned by a nonprofit company.

35:14And I was like, oh, I'm so sorry. You must be at such a competitive disadvantage. Nonprofit. Oh yeah, you must not be able to raise money. And I was just like, I'm giving them my condolences. And they were like, really offended. Like, what are you talking about? I was like, wouldn't you rather trade places with someone who follows all the best practices? And the room erupted in laughter. Like I just said, the dumbest thing they'd ever heard. Nobody who works at one of these companies would ever trade. really the only trade-off is that if you do this stuff or try to, people will incessantly try to talk you out of it.

35:48But those people do not have your interests at heart. They are talking their book, as we say in finance. They have their interests in mind. I tell the story in the book of a founder I worked with. I tried really hard to get him to adopt these things. He came to me like 12 months, 18 months before his IPO. And he was worried about this kind of stuff. And I was like, yeah, you should be worried. You have a structure that is weak and rickety and you are going to get absolutely screwed. Okay. So just, I was just giving him the history, giving the data. And he was like, alarm. He's like, oh man, this is terrible.

36:17I need to go do something about it. He calls me back and he's like, you know, I talked to my board. I talked to my investors. I talked to our investment bankers. I talked to our lawyers about it. And they were all just like, Eric is such a downer. That guy really, if that guy really believed in your vision, he wouldn't understand you're the exception. You're such a killjoy. Yeah, he was just like, you know, man, I hear you, but our company is special. We're unique. And I was like, listen, I hope you're right. And he was fired from his company five months after the IPO. He didn't even make it six months.

36:47Those other players, you know, the investors and the board members and whatever, like they are so invested in the idea of success for like it's defined them. So they. Oh, sure. They see that as the framework of like, well, this this is good because it's been good for me. in their mindset. So it must be good. Oh, absolutely. No, that's absolutely right. Hang on, everyone. Eric isn't done ripping into our assumptions. Coming up, he shares an insider's view on what happened between Anthropic and the U.S. government. And he explains what he thinks is necessary to reframe business and capitalism toward better outcomes.

37:26We'll be right back.

37:34so far we've heard eric reese talk about how the pursuit of every dollar can lead to unsavory outcomes now he applies that lens to the realm of ai where he has an insider's view of anthropic versus open ai and he offers his prescriptions for how to correct misplaced priorities in the investment world and for each of us personally. Let's get back to it.

38:01There's this declaration in the book where you say, shareholder supremacy is over. And it doesn't feel that way to me. So what makes you feel like shareholder supremacy is over? Maybe it should be over. No, no, no. I think it looks my personal view is that this is actually, this fight has already been lost. First of all, shareholder primacy was supposed to be for investors. But like I said, it's actually turned out to be really bad for investors. And I think we're actually kind of in a world of extraction primacy now. Well, I always think which investors? The investors today? Yeah, we're running for the benefit of the shortest term, most extractive investors.

38:41Secondly, there's a generational thing. The new generations that are coming to the workforce now have lived only under this idea. Okay, like this idea is very recent. I always tell people, If you can see a park with a tree in it, you're probably looking at something older than shareholder primacy. The key date of the adoption of shareholder primacy in Delaware is 1986. 1986, not that long ago. We're talking about Depeche Mode, not monks in some monastery, right? Like a very recent occurrence. But we now have people entering the workforce who have lived under this idea their whole lives. So when I teach them about the collapse of trust, for example, it's like you look at the data on trust, trust in governments, trust in big business, trust in doctors, trust in hospitals, trust in journalism.

39:18The graph is just straight down. They don't really understand how trust can have collapsed because they can't imagine living in a world where anybody trusted any institution for any reason. They're like, you would trust your doctor? You would trust your government? You would trust big business? And I'm like, look at the data. Like 70 % of Americans used to trust big business. Now it's like 20%. They're like 70%. They can't imagine it because all they've ever known is extraction, exploitation, and weakness for all their power and all their like money that they're making. They are the most inconstant, pathetic organizations ever.

39:56Think about what people who've like succumbed to public pressure in just the last couple of years. So when you talk to younger people about shareholder primacy, they're just like so over it. It's unbelievable. So I think the argument is already lost. So we better get busy thinking about what comes after shareholder primacy. What is the new thing that we're going to do? The number one protection that investors want the most is limited liability. Ultimately, our entire economic system is powered by the fact that investors are not liable for the actions of the companies that they invest in. We are putting that protection at risk.

40:27Our modern ideas of fiduciary duties rest on both trust law, the idea that a director is a trustee of the corporation, but also on what's called agency law. When you're my agent, your job is to maximize your outcomes for me. Whereas if you're a trustee, your job is to protect the thing that is held to you in trust. So shareholder primacy is just basically taking out the trustee aspect of fiduciary duty and being all agency all the time. The idea is that every corporation is obligated to maximize returns for its investors. But the most ancient legal traditions, the entire common law going back to the Roman era, is that if you are my agent, then I am liable for your actions.

41:06Because you walk into the marketplace and to maximize returns for me. You stabbed somebody. That's my responsibility because I sent you as my agent to do that. It is intellectually incompatible to have both shareholder primacy and limited liability. We can't have completely unaccountable corporate behemoths accountable to no government, no process, no nothing, doing whatever they want. And investors saying, I wash my hands of this, but also I insist everything be done for my benefit. Sorry, It doesn't work that way. In the context of all this, I have to ask you about AI. OpenAI and Anthropic have clashed over how they engage with the U.S.

41:42government, the Department of Defense, Department of War. Where do they fall in the sort of incorruptible lexicon between positive model and cautionary tale? Oh, yeah. Listen, I happen to know the Anthropic story better because I was involved, although I'm not an investor or anything, but I helped them set it up. The conflict between Anthropic and the DoD. I think this is really instructive. Anthropic was put into an absolutely untenable situation by an unprecedented act of government overreach. Given that the government did this thing, and you could debate whether they did the right thing or the wrong thing, it's kind of irrelevant, I think, actually, for our analysis.

42:15It's unequivocal to me that Anthropic did the right thing in resisting. And we have to ask ourselves, in order to make a statement like that, what does it mean for an organization to do the right thing? we can say three things. One, they acted in a principled way in defense of their own values. Two, their values align with a notion of human flourishing. I think companies that have purely extractive values and wear it proudly on their sleeves can never be said to do the right thing. And the third thing is they had the courage, the institutional strength to resist outside pressure. That's what makes them trustworthy.

42:50When I talk to normal people, not the excessively online hyper posters who are trying to win a culture war every five seconds, normal people, they are perfectly capable of saying that they trust a company who did the right thing, even if they disagree with the decision. I know people who are like, I don't agree with what Anthropic did. I personally think it would have been fine for them to sign that contract. But I respect that they had the courage, the strength, and the principled consistency to stand up for their own values. And I loathe the companies that rushed in to grab that contract. Again, even though I think it was a perfectly fine thing to do, simply because the opportunism of it makes me suspicious of their motives.

43:33If they would do this, if they'll betray their principles for$200 million, will they find the principle one day, right? Anthropic was consistent in its decision in the way it approached this. And in some ways, OpenAI was consistent with its history and culture in jumping in. Well, yeah, consistent with its behavior, but not with its stated principles. I think that's really the issue. Its behavior really is, I mean, what you state is your principles. It's what you do that matters, right? Just think about like law firms, universities. I can't remember how many big companies in the last two years you would have thought were like big enough and strong enough to resist outside pressure, have basically proven that they'll do anything for a dollar.

44:17it's pathetic. It's sad. And there's very few companies that are on the other side of that ledger. Now, here's what really blew my mind. Anthropic did this, and I wasn't involved. They didn't consult me about it, okay? I was not an insider to the decision. But I know for sure, because I know the people they go to for advice. I'm sure a lot of people they went to for advice were like, don't make a stink. This is the US government. Who are you? You can just imagine the advice that they got. So I don't think there was any way they could have anticipated that as soon as they did this, Claude would go to number one on the App Store.

44:45people that night, their headquarters in San Francisco, the sidewalk was chalked up with thank you messages all around the office. They got very unanticipatable benefits, so much so that a couple people have argued that they cynically did this virtue signaling, knowing that this somehow way would benefit. Nobody could have predicted that this would go as well as it had. You stand for what you stand for. You think it through. You try to make the best decision you can, and you live with the consequences. And people respect that because they can trust that if you'll do it in this situation, you'll probably do it in the situation that affects them too.

45:17Incorruptible is a rallying cry of sorts. And I'm curious what you hope listeners here, business leaders do differently. You know, I mean, you've spent your career in some ways arguing that the system matters more than the individual, but individual actions are required to change the system. I mentioned very briefly this academic idea called structuration. Organizations shape your behavior, but you also shape their behavior at the same time. And I had this realization studying not just the good companies that we've talked about, but also the bad companies, the Philomorises, the Facebooks, the companies that are creating addictive products.

45:55To me, that's like one of the darkest parts of modern capitalism. But what I realized in studying these organizations is that they're addicts too. In the modern world, because of surveillance capitalism, every decision you make, I don't care if you're an important person or just a regular old consumer, citizen, board member, middle manager, every decision you make is somebody's personal metrics target. Every decision, there's someone in the world whose job is to watch you very carefully to see if you'll do the thing they want you to do. And of course, there's probably multiple people whose job on multiple sides of that issue.

46:32So every choice you make ripples out in gravitational waves through these organizations. And when you realize that, you realize that you feel so powerless with these huge, massive organizations. But like, they're obsessed with you. They're addicted to you. Their algorithms, their analysis. I've been in the room, literally been in the room where this happens, where people are debating some arcane product management decision. Like, should we make it with a slightly healthier ingredient or should we go for the cheaper ingredient? It's like, well, it's going to add three cents to the unit cost, the bomb, the bill of materials will be increased by three cents.

47:14Someone else is like, well, but what about the willingness to pay? The most important phrase in business is actually willingness to pay. Will the customer pay the three cents or not? You can't imagine the amount of energy and time that is spent analyzing whether you will pay the three cents or you won't. So every time you cynically say, well, I guess it doesn't matter, you are actually lending your gravitational force to a system you hate. You are helping make it more powerful. And every time you resist and you do just in your own small private way the right thing, you are strengthening untold, unknowable allies who think the way that you do.

47:52So I don't mean to say like, oh, good, we can solve climate change with recycling. I'm not saying that individual power is everything, because of course systematic forces are important too. But we have to remember that systems are made up of people. We are the people who make them up. We consent or not to their hegemony. And one of the biggest things I learned writing this book is that we all have far more power than we realize. I got into business journalism because I believe that business can be a catalyst for positive societal change. But listening to you sometimes, I think like, am I just being naive?

48:29How optimistic are you that business can truly be incorruptible? if human civilization is going to endure on this planet then it needs to be the technologies that we have learned that we are learning to harness are now in the catastrophic range i meet startups every day it's like two guys in a garage with something that could change the world like the anthropic co-founders are wielding a force that could be civilization ending i'm really optimistic about it because i think it's an existential necessity and i think anybody who actually has a stake in the future survival of the species like ought to take it seriously.

49:06Anyone who's giving you a message about it's naive, you got to ask themselves, are they in fact committed to the future of our civilization? Now, it turns out that many of those people own a bunker in a remote desert. So I think they're actually telling on themselves quite explicitly that they don't view that as their problem. And why you would listen to, buy from, give your attention, energy, or support in any way to such a person, like I think is deeply anti-human. So maybe don't do that. Well, Eric, as always, talking to you is thought-provoking. This was great. Thanks so much for doing it.

49:39Oh, man, it's such a pleasure. This was really fun.

49:44It's hard to pick just one takeaway from Eric's stories. We could emphasize everything that's screwed up about the system, and there's plenty to point to. But Eric is ultimately upbeat because there's clear data that what's good for society and fairness and trust is actually good for business too, that the shortcuts people are drawn to actually leave us shortchanged. Remember his early observation that the ultimate asset for any business or brand is trustworthiness. I totally agree. And the more we safeguard that trustworthiness, the more we lean into it without exploiting it, the more value we actually create.

50:23I don't agree with everything Eric says, but this vision of business, this is what motivates me. And if I'm being naive sometimes, so be it. I'm Bob Safian. Thanks for listening.

50:45Rapid Response is a Wait What original. I'm Bob Safian. Our executive producer is Eve Trow. Our senior producer is Alex Morris and our associate producer is Masha Makutonina. Mixing and mastering by Aaron Bastinelli and Brian Pugh. Our theme music is by Ryan Holiday. Our head of podcasts is Lital Moolad. For more, visit RapidResponseShow.com.