“It is a fact that man can’t fly.” That’s what a Washington Post editorial confidently asserted in the early days of the 20th century. Please imagine the certainty about the impossibility of flight around the same time that the Wright brothers took their vision of air travel to Kitty Hawk. What must people have thought as the brothers watched birds in flight, flapping their arms along with them in search of clues about how to achieve the impossible?
This question came to mind while reading Sebastian Mallaby’s seriously great, and wildly important new book, The Power Law: Venture Capital and the Making of the New Future. While the author comes to a few odd conclusions, it would at the same time be difficult to find a more important book than Mallaby’s in 2022, and most any year for that matter. If read the right way, Mallaby’s brilliant book explains so much, and in the process discredits so much.
Mallaby is clear that true entrepreneurialism of the kind funded by venture capitalists is the marriage of capital with the different, the congenitally contrarian, and surely the unreasonable. In the book’s opening pages he quotes legendary investor Vinod Khosla as thrillingly asserting that “All progress depends on the unreasonable man.” Yes! Khosla would have plainly understood the Wright brothers in the way that a majority constrained by the known surely did not.
All of which speaks to the extraordinary importance of individuals like Khosla, and other venture capitalists. Their pairing of oddballs with intrepid savings is the source of progress. To use one of countless examples in this most unputdownable of books, in 2010 scientist Patrick Brown secured a meeting with Khosla to discuss his vision for plant-based meat. In Mallaby’s words, Brown’s aim was to “out-beef the beef industry,” and in Brown’s own words to Khosla, his desire to take on meat was driven by a desire to capture significant market share in “a trillion-and-a-half dollar global market being served by prehistoric technology.”
About Brown’s vision, your reviewer finds nauseating the mere idea of plant-based meat, and the pretense about replacing the cow to combat the theory that is “global warming” beyond silly. Except that my views are not the point. The point is that there are opposite-thinking investors out there eager to wholly transform tomorrow through investments in the improbable today. Plants replacing meat? In Mallaby’s account, Khosla proclaimed “That’s impossible!” during his meeting with Brown, but did so with delight. Khosla is not interested in copy cats, or of individuals presenting ideas that would make sense to focus groups. He wants people eager to redo the existing order, thus the funding of what became Impossible Meat.
Mallaby writes so well that “Reasonable people – well-adjusted people, people without hubris or naivete – routinely fail in life’s important missions by not even attempting them.” Mallaby has written a book about truly difficult, maladjusted, frustrating individuals who aren’t satisfied with how things are, and who are willing to risk it all in pursuit of something better. Mallaby articulates it wonderfully in a book that flows that “there is no glory in projects that will probably succeed, for these by definition won’t transform the human predicament.” Amen.
What’s so exciting about venture capital is that as evidenced by the ongoing flow of savings into the funds in pursuit of improbable and surely “impossible” commercial outcomes (Mallaby notes that VCs raised $171 million in 1969, $30 billion in 1998, and up and up), the unlikely is happening to all of our betterment. So while most startups “fail completely,” enough succeed against impossible odds such that savings aggressively pursuing an altogether different future continue to migrate to Silicon Valley and other locales where the commercially contrarian populate.
They’re in pursuit of that which title’s Mallaby’s book: the power law. In venture capital terms, the power law is the reality of Silicon Valley in action: since most of what’s funded there has “impossible” or “improbable” attached to it such that most startups will by their very descriptors “fail completely,” the very few successes will be astronomical. By definition, really. As Mallaby so correctly explains it throughout, “the future can be discovered,” which means it “cannot be predicted.” The latter is a confirmation of the exciting truth that when the future of commerce is discovered, the gains are astronomical precisely because they were wholly unexpected, and those gains will more than pay for the majority of failures. In numerical terms, the fourteen investments in Kleiner Perkins’s first fund “showed a combined profit of $208 million; of that, fully 95 percent came from Tandem and Genentech.” Without Tandem and Genentech, Kleiner Perkins’s first fund would have outperformed the S&P 500 via a 4.5x return. With those two, the return was 42x the S&P. Discovery of the future is lucrative, which means it’s logically rare.
Peter Thiel (an iconoclast among iconoclasts) perhaps unsurprisingly has an expansive vision of the power law. To him it’s a very natural occurrence in commerce, and in life. Explained through the genius of the late Warren Brookes (who saw a metaphysical future taking over the physical in his 1981 book The Economy In Mind), “we’re blessed by the genius of the relatively few.” Describing Thiel’s view of the Law, Mallaby explains that “it was not just a curiosity that a single venture capital bet would dominate a whole portfolio” simply because “a startup that monopolized a worthwhile niche would capture more than millions of undifferentiated competitors.” Yes! Put another way, what’s the point of going into business unless the goal is discovery (or from the entrepreneur’s perspective, a revelation) of a so far unmet need? VCs are funding the individuals pursuing these rare finds, they’re in pursuit amid major skepticism, but that just means the rare discoveries will result in valuations that dwarf those of the undifferentiated.
Where it gets extra fun is in how Thiel’s view of the world informs his Founders Fund versus other Valley-style VCs. While all-too-many seek to mentor their entrepreneurs, including placing adults in rooms defined by juvenile qualities, Mallaby writes of Thiel’s view that it makes “no sense to suppress idiosyncrasies.” Instead, the goal should be to give wide latitude to the “arrogant, misanthropic” and “borderline crazy” given the basic truth that the highest returns will spring from the minds least like others. Thiel was clear in Zero to One (review here) that successful startups escape competition, which means odd must be embraced. The very different are most likely to happen on odd commercial approaches that maneuver around what’s similar, and by extension, what’s heavily populated with competitors.
Thinking about these unreasonable people whom venture capitalists match with courageous capital, the combination exists as the ultimate myth buster. There are so many places to start, but let’s begin with the narrative that just won’t die about excessive “market power,” or the need for politicians to step in and break up the most prominent corporations. A recent report from the once credible Heritage Foundation says it all: “Combating Big Tech’s Totalitarianism.” Oh dear….
Back to reality, there’s a reason Valley technologists are viewed as “unreasonable,” and a major factor here is that in seeing the world in ways entirely different from the masses, they believe deeply that tomorrow in a commercial sense will look nothing like today. And as evidenced by the copious funds flowing into the Valley, investors share their view. Unless “unreasonable” and “impossible” weren’t sometimes exposed as reasonable, possible, and ultimately can’t-live-without by the different in thought, VCs wouldn’t exist. Neither would these clusters of odd, but otherworldly talent. Put another way, the days of extraordinary dominance by Facebook, Google, Amazon, and Apple are numbered. Their remarkable, some would say “monopoly” profits and valuations are what ensure the previous truth. Since the gains from discovering new ways of meeting the needs of others are enormous, so is the investment focused on doing just that. Funny here is that seemingly the only entities that know this truth are the entrepreneurs themselves, the venture investors in those entrepreneurs, along with Facebook, Google, Amazon, and Apple. They invest many billions each year in new concepts and nascent companies given their awareness that stasis renders them sitting ducks.
Despite the market truth about looming change at the top of the tech team picture, why is it that politicians, pundits and economists continue to bite their nails about “concentrated market power”? The answer is very simple: the nailbiters are constrained by the known. Even though what’s known is constantly changing thanks to the expansive minds in technology, it’s impossible for the conventional in thought to see beyond the present, or for them to imagine that there’s anything beyond the present. They view the technology of today as the frontier, and since we’re there, they must make sure that the businesses at the frontier don’t restrain competition.
That they’re misguided it putting it mildly. For one, there’s the massive capital flows in search of tomorrow’s disrupters. For two, they fall for the expert fallacy that Khosla and his ilk plainly do not. As Khosla explains it to Mallaby, “If I’m building a health-care company, I don’t want a health-care CEO. If I’m building a manufacturing company, I don’t want a manufacturing CEO. I want somebody really smart to rethink assumptions from the ground up.” Business history supports just such a view. Certainly it wasn’t banks that created the credit card, certainly it wasn’t one of Blockbuster’s brick & mortar competitors in the video space that put it out of business, and then Khosla explained to Mallaby that it was Amazon, not Walmart, that revolutionized retail, it was an outsider like Elon Musk, not GM and Volkswagen, that created the next generation car. This is important in consideration of the thoroughly pointless exercise in neutering the great that is antitrust, along with ranting once again by the similarly small-minded about the so-called “totalitarianism” of Big Tech. Constrained by the known, they can only imagine competition (or lack thereof) from what they know. But as Netflix, Amazon, and Tesla (among many others) remind us time after time, the replacement for today’s dominant sector player is likely going to strike from outside that space.
Looking at antitrust more broadly, this comically awful form of law is rooted in the presumption that commerce has reached the frontier, and that there’s clarity about the future. Break up what exists, because what exists is forever. Except that it’s not. On so many levels. Consider Atari. Not only was its funding not a foregone conclusion, one of the barriers for what became a producer of home videogaming was distribution. Don Valentine, the founder of Valley VC-eminence Sequoia, worked to help Atari in this process. Mallaby reports that Toys ‘r Us was approached to no avail, followed by Radio Shack, only for Sears to order hundreds of thousands of the gamer’s early home models. Please read the previous sentence again if the point of it doesn’t sink in. Then try again if you fail the second time.
The simple truth about commerce in a dynamic economy is that nothing lasts forever. Giants stumble. Always. After which, giants themselves are similarly often constrained by the known. They too have historically focused on the existing competition, only to miss the arrival of outside thought. In this sense, it becomes rapidly apparent that tomorrow’s greats don’t look great now. Readers know this by now since it’s the basis of the The Power Law, and the how behind VC investment, but it’s worth noting that Tom Perkins and Eugene Kleiner (the founders of previously mentioned Kleiner Perkins, and easily one of the most prominent names in all of VC) “refused to even meet with Steve Jobs,” while Bill Draper “sent an associate to visit Apple.” And while Arthur Rock did take a piece of Apple in the 1970s, he did so with great skepticism and after selling off $10,000 tranches of the investment to quite a few others. Who could have known that he would make 378x on his initial Apple investment after the latter’s IPO became the largest since Ford Motor Company? Certainly not Rock, and that’s not an insult. It’s just the norm. Accel Capital passed on Cisco, while Don Valentine sold Sequoia’s shares in Cisco way too soon. That Peter Thiel got 10.2 percent of Facebook is all the evidence one would need that more than a few investors passed. Atari founder Nolan Bushnell actually employed the always in need of a bath Steve Jobs, but he too passed on Apple. The stories on are endless. The future is uncertain, which is what gives power to the power law.
This simple truth about the future; one that has long ensured very expensive capital in Silicon Valley, speaks loudly to the total waste of time that is a focus on the Federal Reserve. Interesting there is that Mallaby’s previous book was a biography of Alan Greenspan (my review here), and Mallaby’s reverential treatment of the former Fed Chair as some kind of economic maestro “who knew” came to mind with great regularity during the reading of The Power Law. It did because Mallaby’s latest thoroughly discredits the popular notion of Fed importance. That’s the case because capital in the Valley is once again very expensive. Since the companies frequently have no earnings or products, corporate loans are the microscopic exception to the rule. If you want capital in the Valley, you will give up equity. Period. $100,000 purchased 25% of Genentech for Tom Perkins. Engineer and sales executive Mike Markkula purchased 26% of Apple for $91,000, Don Valentine paid $2.5 million for 33% of Cisco. Benchmark got a fifth of Uber for $12 million. Hopefully readers get the picture. Since failure is very likely, investors command ownership over future income streams that bring new meaning to speculative. Please keep this in mind with breathy focus on the Federal Reserve and other central banks top of mind. Supposedly their fiddling with the short rate for credit (the view here is that the Fed is a rate follower, even on the short end) has an impact on the economy and valuations? Let’s please be serious. Not even close. The companies that are the source of economic dynamism (Mallaby is correctly clear in the book that technology is the big driver of growth) attain financing that has nothing to do with bank credit, or bank interest rates, or stodgy banks in the first place. To pretend as some do that a movement up or down in Fed rate targeting has an impact on VC allocations of capital is the height of fabulist thinking. Future generations will marvel that so many wise minds spent so much time on the Fed. Did researching this book change Mallaby’s mind? It’s hard to say. Occasionally he slips into Fed-speak about allegedly “easy money” driving a rush to “yield,” but he doesn’t linger there. There’s no basis for it. If there were, Japan’s stock market would be the most highly valued in the world.
It's also hard not to wonder if the writing of The Power Law changed Mallaby’s view about government spending since the author is broadly a man of the Left. He’s certainly clear at various points in the book that reductions in penalties placed on investment (the capital gains tax) had created greater willingness on the part of investors to put money to work in high-risk fashion. Not discussed was government spending itself. It rates discussion given Mallaby’s routine statement about the high failure rate among Valley companies. That more than 9 out of 10 startups “fail completely” speaks to an obvious truth about investment in these companies: it’s somewhat of a roll of the dice. Indeed, while Arthur Rock’s first VC partner Tommy Davis said success was about backing “the right people,” and Tom Perkins observed that “you succeed in venture capital by backing the right deals,” the failure rate is what it is. So is the power law. High returns are a consequence of the very, very few. Since they are, what a shame that more wealth isn’t put to work where the talent is greatest, and most opposite in thought. In other words, how many great, thoroughly transformative business concepts never got to startup stage due to a lack of capital? Government spending is a tax. And it’s a cruel tax. That it’s not visible doesn’t make it less so. It makes it crueler. Again, what staggering advances haven’t taken place as a consequence of government existing as such a gargantuan consumer of precious wealth?
Mallaby’s chapter on China is spectacular. And it is in so many ways. For one, the author doesn’t fall for the nonsensical claim (increasingly embraced by U.S. conservatives who should know better) that China’s growth is a consequence of the CCP aggressively subsidizing its companies. Such a view is thoroughly mindless. As The Power Law makes plain, the future is discovered by opposite minds. To pretend then, as conservatives do, that China’s prosperity is a consequence of government support is for conservatives to reject much that they’ve long believed about free markets and limited government. In short, the state did not create China’s happy economic rise. Mallaby agrees. In his words, it wasn’t the CCP; rather “China’s technology boom was forged to a remarkable extent by American investors.” About Alibaba, Mallaby is clear that “the Chinese government had played no direct role in launching” it, but that “U.S. finance had made all the difference.” Amen.
The above truth naturally wrecks the other popular conservative narrative about how the Chinese are “stealing” our wealth, ideas, or both. It’s not serious. Again, most technological ideas fail as is. The Chinese are not stealing as much as wealth goes where it’s treated well. The potential in China is vast, and American wealth is funding this growth. It’s a good thing. Let’s embrace it. When Americans call for U.S. politicians to “get tough” on China, they’re abusing themselves. As for Xi Jinping being a “communist” in ideology, Mallaby notes that when he visited the U.S. in 2015, his “first meeting was with the tech executives in Silicon Valley and Seattle, not with the politicians and bankers of Washington, D.C. and New York City.” Something to think about. It says here we’re erring by making China the enemy. Prosperity is the fix for the country’s undeniable demerits, not trade wars.
Which brings us to money itself. VC investors are seeking returns in dollars. That’s particularly true in this book. The focus is largely on American VCs. This is notable for what Mallaby leaves out. About what he leaves out on the matter of money, it’s not a surprise. Mallaby is a senior fellow at the Council on Foreign Relations, and CFR generally views the very notion of commodity-defined money as the lowest of low rent. Economists don’t need to follow market signals, don’t you know? Still, it’s worth noting that in 1969, per Mallaby there were over 1,000 IPOs, but only 15 in 1974. As for venture capital funds, there was $171 million invested as previously mentioned in 1969, but $57 million in 1974 versus $10 million in 1975. Investors are once again in pursuit of returns, in the U.S. it’s returns in dollars, but the dollar was severely devalued starting in 1971. No correlation, or no correlation in the eyes of Mallaby? The hope here is that at least he would think again. As mentioned previously, he acknowledges the role of a lower capital gains tax in stimulating investment. Ok, no disagreement there. Lower the cost of investing and you’ll get more of it. But devaluation is a tax like any other. It would have been great had Mallaby at least paid lip service to not inconsequential monetary decisions made in the 1970s.
Instead, the author in a sense glossed over them. Worse, he attached his good name to the myth that the “Arab oil embargo of 1973 had entrenched a depressing mix of low growth and high inflation.” Except that’s not what happened. With trade, there’s no accounting for the final destination of any good. By extension, the embargo was wholly symbolic. Americans consumed every bit as much “Arab” oil amid the embargo as they did before. Arab countries (this didn’t include Iran, which isn’t Arab) continued to sell their oil, and U.S. refiners continued to purchase it from those they sold it to. Mallaby’s analysis also leaves out that non-oil, non-Arab commodities across the board were soaring in the early ‘70s. Logically they were. President Nixon’s decision to sever the dollar’s link to gold was a very explicit devaluation. This wasn’t an “Arab oil” problem; rather it was a weak-dollar problem. Devaluation is inflation, at which point Mallaby reversed causation. Devaluation was the inflation, higher oil prices were the effect. To finger rising oil prices as the cause of inflation would be the equivalent of a weatherman blaming rain on wet sidewalks. Needless to say, that which devalues the currency in which returns are denominated is logically going to deter commitment of capital in pursuit of returns; particularly when the pursuit is for returns in the high-risk technology space.
About the disagreement about the meaning of 1973, it’s small relative to a book that’s amazing. Still, there are three areas of bigger disagreement that rate mention. The first would have to be Mallaby’s decision to spend time on “diversity” within the VC space. He notes with disdain on p. 267 that by the end of the 1990s, women “accounted for only 9 percent of new recruits at venture partnerships,” and while Sequoia is featured throughout Power Law as the best of the best, Mallaby describes it as “woefully late” on the matter of women in its employ. This narrative seemed empty, and Mallaby has to know why. He must simply because VC success over the decades has been by his own description a function of its investors matching highly unreasonable, extraordinarily odd individuals with capital. About Steve Jobs, the view among the VCs who met him in the 1970s was that “he needed a bath.” When Mark Zuckerberg and Andrew McCollum showed up at Sequoia’s office for a meeting with the firm’s partners, Mallaby reports that they were wearing pajama bottoms and t-shirts, while Yahoo’s offices were littered with “unwashed cloths and pizza cartons.” When the VC crowd migrated to China in the late ‘90s and early 2000s, Mallaby notes about a visit of financial types to Jack Ma’s Alibaba that Ma and his employees were “too obsessive to worry about hygiene.” Mallaby quotes Thiel on p. 211 as observing that “the best startup founders were often arrogant, misanthropic, or borderline crazy.” Back to Jobs, one of his first bosses was Nolan Bushnell at Atari. Bushness conducted business meetings in his hot tub.
It’s all a long or short way of saying that the mere hint of discrimination or attempted discrimination on the part of the VCs or those they invest in defies basic common sense. To be clear, the remarkable people in The Power Law were the ones discriminated against per the power law itself. Goodness, the very definition of a true entrepreneur is someone who believes deeply in something that an overwhelming majority disdainfully reject.
At which point, Mallaby is similarly clear throughout The Power Law that it was always and everywhere the goal of VCs to be ranked at the top, and for obvious reasons. If you were seen as the best, your odds of getting to pitch the next big thing were much greater, after which your odds of getting to invest in the presumed next big thing were much greater. In that case, can Mallaby seriously believe that VC firms would risk achievement on some overwhelming need to not hire women? It’s not serious. Silicon Valley is a meritocracy. Nothing else. Where merit reigns, there’s no room for discrimination.
Taking the subject of women further, the view here is that Mallaby went overboard in his criticism of Elizabeth Holmes, along with those who backed her. He described her investors as “venture tourists,” seemingly not schooled in the ways of capital allocation that venture capitalists were. Really? Most generally don’t reach billionaire status because they don’t know a thing or two about investing.
And while Mallaby cites one VC as having interrogated Holmes to the point that she exited their offices, he seems to forget his earlier anecdotes about how Eugene Kleiner and Tom Perkins wouldn’t even meet with Jobs, how Bill Draper sent an associate to see Apple, about how Accel passed on Cisco, about how Goldman Sachs turned its nose up to Alibaba, and about how the Valley is littered with VCs that passed on its greatest corporate achievements. This is important given his critique of the “venture tourists” who seemingly weren’t “inclined to cross-examine” Holmes in the way that VCs supposedly would have. Again, really? Assuming they had cross examined her, does Mallaby seriously think that someone so compelling as to raise hundreds of millions would have proven unequal to all her interrogators from the world of VC? The question answers itself, or it should.
If Mallaby possesses real evidence of broad and documented VC skepticism about Theranos before its decline, he should produce it rather than just write in dismissive fashion about Holmes and her investors. Of course, assuming there’s lots of documented skepticism pre-decline about Theranos, what would it really mean as is? By Mallaby’s own admission, most venture startups “fail completely.” Which is the point. Mallaby seems to want to have it both ways. Failure is the norm for venture capitalists, but when Holmes’s vision didn’t work out and her non-VC investors lost out, somehow this failure was born of naivete and manipulation, but not the 90%+ dry holes drilled by the VC elite? The thinking didn’t read true.
The view here is that with time, Theranos and Holmes will be properly viewed in a much better light. Really, what entrepreneur doesn’t have a messianic, grandiose view of his or her technology? If that’s not enough, let’s quote Mallaby writing about Khosla’s opinion of Impossible Meat’s Patrick Brown in the book’s early pages: “Brown should be hailed as a hero, whatever happened to his company.” Yes. The future per Mallaby is discovered by truly different people trying to do things in all new ways. Naturally they believe deeply in their product. They wouldn’t be where they are if they didn’t believe deeply. Holmes deserved better from the author. Much better. The bet here is that in time she’ll get better.
Which brings us to the narrative that won’t die about government and the internet. To Mallaby’s credit, he’s not the Washington Post’s Allan Sloan in his belief that absent the government, Amazon wouldn’t exist today. Mallaby recognizes that government is uncoordinated, to say the least. In his words, “The government was good at basic science. It was not good at turning breakthroughs into products that changed society.” Good, in a sense. Government never saw the potential of the internet. Not even close. Still, Mallaby falls into the trap of endorsing government’s work in “basic science” as some kind of instigator of great private sector advance. Put another way, let government do the early work only for entrepreneurs to take its crude discoveries to a previously unimagined level. No thanks. It’s unnecessary. If we ignore that government only had the resources to create a crude internet insofar as the private sector produced taxable wealth in the first place, we can’t ignore that capitalists are by their very name relentlessly searching for ways to bring themselves closer and closer to customers. In other words, the internet was happening with or without government; the only difference being that it would have likely reached us much sooner if government hadn’t long been consuming copious amounts of precious wealth.
About these critiques, it’s important to stress that they’re small in the bigger picture of what Mallaby has created. The Power Law is spectacular, and it’s a book that will inform my writing and analysis of all things economic for many years to come. The importance of Mallaby’s latest cannot be overstated.
