Studies have shown that founder-led businesses have outperformed other companies in the S&P 500 at a staggering rate. But what gives these companies a competitive edge?
In 2016, Amazon founder and CEO Jeff Bezos published his annual letter to shareholders. In this edition, he spoke about something that I’ve always believed in strongly myself—why founder-led businesses are usually better businesses.
It used to be common practice that once a company had reached a certain level of success, the founder would step aside and hand the reins over to a ‘professional CEO’.
Today, investors are far more open to the idea of a founder-led business thanks to the success of so many entrepreneurs, mainly in the tech industry. And they’ve been proven right.
In 2015, consulting firm Bain & Company completed a performance analysis of all the S&P 500 firms and found that founder-led business outperformed all others by more than three-to-one in the past 15 years.
But why are founder-led businesses more successful?
Not Afraid To Fail
Here’s one thing I can attest to from personal experience – starting your own business is no simple task.
To be successful, you need to have a great understanding of your industry, an innovative idea that separates you from the herd, and a willingness to fail.
It’s that last characteristic which is most important.
We tend to punish failure in the business world, particularly when it comes to big publicly traded companies. In reality, failure is an essential part of innovation.
Companies with passionate founders tend to be far less averse to getting things wrong because they have plenty of experience with it. Setting up a company is more of a trek through a jungle than a walk in the park. Many times, you’ll hit an impasse and have to turn back to find a more viable route.
Elon Musk, one of the world’s most noted entrepreneurs, has said of Tesla Motors, “Failure is an option here. If you’re not failing, you’re not innovating enough”.
We see this type of attitude with founder-led businesses all the time.
Mark Zuckerberg was openly mocked by peers when he purchased Instagram for $1 billion. Reed Hastings of Netflix took his very successful DVD delivery business and completely reinvented it for over-the-top streaming. And of course, Steve Jobs undid years of hard work at Apple, taking a massive risk to transform it into the biggest consumer electronics company the world has ever seen.
For a founder, their business is their life’s work. This allows them to think ultra-long-term about the business and make investments necessary to ensure they are still competing decades into the future.
But when an outsider CEO is brought in to a company, they are subject to much more scrutiny from the board of directors and are often forced to measure their success in years (sometimes quarters).
They are also often motivated by performance bonuses that reward cutting costs or maintaining a current market position. This will never lead to any long-term vision as the upfront cost and disruption that comes hand in hand with great innovation is too risky.
Amazon: A Case Study
Amazon is far more than the online bookshop it started out as twenty years ago. In his 2016 letter, Bezos noted that their Amazon Web Services segment is now bigger than the core business was at that age and is growing much faster.
Amazon Web Services is as successful as it is because Bezos led the way in reimagining what Amazon could become and invested heavily in its development. Even by conservative estimates, it would appear that AWS will soon be bigger than Amazon’s core retail business. That was all made possible because Bezos took a big risk, one that an outsider CEO would probably have steered clear of.
When looking for a company to invest in, you can’t underestimate the power of a strong founder.
To finish, here’s an excerpt from Bezos’ 2016 letter that I believe is one of the most poignant statements ever made about business and investing (emphasis my own):
“One area where I think we are especially distinctive is failure. I believe we are the best place in the world to fail (we have plenty of practice!), and failure and invention are inseparable twins. To invent you have to experiment, and if you know in advance that it’s going to work, it’s not an experiment. Most large organizations embrace the idea of invention, but are not willing to suffer the string of failed experiments necessary to get there. Outsized returns often come from betting against conventional wisdom, and conventional wisdom is usually right. Given a ten percent chance of a 100 times payoff, you should take that bet every time.
But you’re still going to be wrong nine times out of ten. We all know that if you swing for the fences, you’re going to strike out a lot, but you’re also going to hit some home runs. The difference between baseball and business, however, is that baseball has a truncated outcome distribution. When you swing, no matter how well you connect with the ball, the most runs you can get is four. In business, every once in awhile, when you step up to the plate, you can score 1,000 runs. This long-tailed distribution of returns is why it’s important to be bold. Big winners pay for so many experiments.”
Rubicoin operates a full disclosure policy. Rubicoin staff may currently hold long positions in some of the companies mentioned in this article.