It feels like the world has taken a turn for the surreal. Public markets seem to be pretending that this pandemic isn’t having an impact on our economy. That 45 million Americans haven't been out of work. That industries core to our economy, like travel, retail, and hospitality, haven't been decimated. That trillions in stimulus can make all the pending changes we face recede from whence they came. But change is upon us. Like the root system of a massive tree, our economy, splits and twists and interconnects in countless ways. The pandemic severed huge sections of these roots. No amount of stimulus can change that. The severed roots can regrow, but they will not be the same, and the entire system will feel the burden. The silver lining is this regrowth, and the sweeping changes that come with it, painful as they may be, can result in a stronger system than the one we had prior.
Changes that impact broad aspects of our economy, like a recession or a paradigm shift in technology, can feel like chaos. When the moorings to the status quo give way to uncertainty, people often gravitate to an extreme response, either panic or denial. Denial is pretending that change isn’t happening. Panic manifests as blind reactions, with little strategic thought or control. Neither response is productive. There is an inevitability to these types of changes, even if the effects don't happen immediately. Like the moment you realize you've leaned too far back in a chair, you can flail your arms or pretend the laws of gravity won’t apply, but you are not going to change the outcome. It seems obvious that panic and denial are impotent strategies for dealing with change, but they are hard to avoid. Even large public businesses fall victim to these tendencies. Traditional media companies spent years denying that Netflix was eating their lunch, only to realize their folly and go on a panic-driven consolidation spree. Neither tactic served them well. Successfully adapting to change is hard. It requires decision making in the face of uncertainty, with feedback loops that can extend years. But it's these attributes that make chaotic environments fertile soil for new growth. If sweeping changes are upon us, if chaos in some form is inevitable, how do we avoid the pitfalls of panic and denial? First, we need to acknowledge its existence. Coming to terms with chaos is the first step in adapting to it. Second, we need to see chaos for the opportunity that it is. Viewing a chaotic environment as an opportunity for decisive action, instead of an unfortunate thing that is happening is vital to adapting successfully. Chaos is a ladder. But only when we see it as such can we begin to climb.
"Chaos isn't a pit. Chaos is a ladder... Only the ladder is real. The climb is all there is." - Littlefinger
What does it mean to climb the ladder of chaos? It can't be done passively. It doesn’t just happen. You climb the ladder only by actively attempting to do so. By fueling the chaos, you position yourself to climb the ladder. You lean into the shifts as they happen instead of fighting them. You critically question your assumptions, control what you can, and keep moving. Netflix saw the impact that the internet, and YouTube specifically, was having on video consumption. Instead of fighting the changes, it embraced them. Launching a streaming service, which cannibalized its core offering (DVD rentals) and dramatically slowed its near-term revenue growth, in order to better position the company as video consumption continued moving online. It seems obvious in hindsight, but at the time it was not widely held that streaming was the future. Netflix announced its streaming service six months before Steve Jobs unveiled the first iPhone. Making it more precarious was Netflix's size; at that time, less than 1% of US media companies' cumulative market cap, far from the media giant it is today. By working to accelerate the changes that were happening, by fueling the chaos, it helped facilitate the disruption of incumbents and took the first steps on its path to massive growth. In other words, Netflix started to climb the ladder. Navigating chaos doesn't require us to predict the future, but it does require that we clearly see the present. Chaos is a call to action if we listen. It is an opportunity, if we can discern which way the winds are blowing. Having a clear view of the present doesn't mean the climb won't be fraught with self-doubt and fear, especially when it feels like the world is burning. But that is when it's most advantageous to climb.
Netflix was a large company when it made its climb, but the lessons learned are especially relevant for anyone starting a business in the midst of chaos. The rationale rests on the asymmetrical outcomes that exist in dynamic environments. Building a company is always risky; a turbulent climate doesn't really change the downside math. But it does provide additional opportunities, as incumbents with scaled operations and higher fixed costs fight inertia as they try to adapt. We've seen examples of this play-out over the last few months. Businesses with remote-only workforces were better prepared for the pandemic than incumbents that worked in traditional offices. Companies that had their entire stack in the cloud faced less disruption than businesses with on-prem or hybrid solutions. To be clear, building in these environments is not easier, it's harder. But the increased opportunities more than offset the increased challenges. A highly dynamic environment often plays in favor of new entrants, effectively lowering the barrier to entry and increasing the likelihood that new businesses can thrive. Younger businesses, by nature, have less, and thus have less to change should it become necessary to do so. Less technical debt, less fixed overhead, less process and workflow that needs to be reworked. Smaller businesses can also react faster. This inherent agility means they're better suited to adapt in chaotic environments and emerge primed for growth. Economic hardships have produced some extremely successful companies. Airbnb, Github, Slack, Stripe, Square, Uber, Venmo, and WhatsApp were all founded at the nadir of the Great Recession [2008-2009]. Constraints breed creativity, force efficiency, and help build a foundation of good habits that serve a business long after the turbulence subsides. Chaotic environments also weed out weaker competitors or keep them on the sidelines altogether. Combined, these factors make chaos a great time to build.
At El Cap, we are investors, but we are also builders. A new firm is a startup like any other company, and it faces many of the same challenges: honing your narrative, finding the right co-founder, raising capital, and refining your go-to-market strategy. Our journey building El Cap hasn’t been easy, and it is far from over. At times, it felt like we were holding this thing together merely by force of will. I'm not sitting in a position of security and safety, suggesting others get into the fray and take risks. We are in it. Out here scraping and building. And despite all the challenges, I’ve never felt so invigorated. Much of that is the nature of our work, and the excitement of building. But the added challenge of navigating the current environment plays a huge role in energizing me each day. Is building a new fund in the midst of the most severe GDP contraction since the Great Depression a good idea? By conventional wisdom, no. But conventional wisdom's track record is abysmal, so it didn't get a say.
We have a great team, we work our asses off, and regularly ask critical questions about our assumptions. The tumultuous environment we face is the same as every other fund, regardless of size or reputation. So instead of waiting it out, we are leaning into the storm and trying to climb the ladder.