5 Steps to Start a Business: Lessons From Two Caltech Entrepreneurs

0:00 When do you fire a CEO?

Milton: When do you fire a CEO? When the CEO is finding excuses, that's time to fire the damn CEO.

John: It was a false sense of product market adaptation, but at that point I had already committed to 2,000 units.

Milton: I started two companies, built them up and took them public. From scratch. From scratch. I mean, that's you. But for me, I'm telling you... No, you're using isolated cases to justify.

John: Agree to disagree, 'cause I mean, you have...

Milton: No, no, you have to agree.

0:30 The startup pre-flight checklist

John: Welcome to another episode of Experience Matters with Milton and John. Today we have a very interesting topic, and that is how to start a business. I call it the pre-flight checklist. This is as if you're about to take off, and you need to make sure you hit some critical, critical areas before you take the leap. And so, before we start this topic...

1:03 Why listen to Milton & John?

John: Milton, why are you uniquely positioned to comment on this?

Milton: Yeah. I think the topic today is really, you know, how to think thoroughly, plan ahead of your business, so that you can enhance the chance of success, and then try to structure your business to be successful by understanding what are the basics of building successful companies. So that's the nature of today's podcast.

So you asked me, in some sense, what makes me qualified to talk about the subject, or you for that matter. And the point is that I started two companies, built them up and took them public, from scratch. From scratch. And then I have written, for 20-some years, a business column for Laser Focus World, because I was in the laser industry, and covered a variety of subjects on business matters. And then I've been mentoring and investing in startup companies, no less than 20. And I would say 80% of them are successful.

I wasn't very successful co-investing with VCs. I started a VC firm to co-invest with VCs, and that wasn't very successful. But on the other hand, as an angel investor, I'm very successful. I can tell you why someday. And more importantly, I helped another six companies go IPO. So I think I know a lot about business. And in fact, briefly, I served on the SEC's Advisory Committee on Small Business Administration.

John: Oh, fantastic. From my background, I did a number of startups back in my 20s. I was able to build these companies. I didn't get quite to the level that you did, but I had quite a lot of experience starting them, building up the infrastructure, going through the headaches of building out a team, pitching to VCs. So I know a lot about that. And I've been part of medium-size startups that have gotten acquired or had some level of liquidation event, positive and negative for that matter. So I have a lot of experience seeing both sides of the coin.

And this topic here is very near and dear to me. I do a lot of work now with my consulting company, where I'm helping service-based businesses grow, and I see a lot of headaches that they come up with. So let's dive into this topic a little bit.

Milton: Yeah. In fact, you're very modest, so let me do a plug for your business. Basically, John is very good with understanding AI and software and e-commerce, and so his service has actually helped companies penetrate markets. And so, for example, I started Bonsai Heirloom a few years back to promote the hobby of bonsai and to try to sell bonsai. And our website, and I do a YouTube... and my YouTube, oh, I had maybe a couple thousand viewers the first couple days. But John did this magic, and now all of a sudden, boom, I have like 6,000 views a day the first couple days. So John, his consulting company can really do magic to improve business penetration.

John: Thank you, Milton. That's very kind of you. So let's talk about our topic today. So do you have an overarching philosophy you want to go over first, or do you want to just go down your list?

5:01 Should you actually start a business?

Milton: Well, I think to provide a little context, I can say a little bit about the business I started up with.

John: Yeah, let's do that.

Milton: First of all, it's a very important thing. I was working a very good-paying job. At that time, it was very hard to find jobs. As a senior scientist at the aerospace company, developing defense technology. And, you know, after I worked there for two and a half years, I said, why am I going there? Where am I going from here? And so I felt very unrest. And then I decided to start, you know, an aquarium store selling tropical fish, or starting a nursery, because those are my passion. But instead, my Caltech schoolmate asked me to join a startup company as the seventh employee, and I just jumped at it.

And so the message there is: trust your heart. Starting a business is not for everyone, and you want to wait for the right opportunity, and don't be impulsive. And so in this podcast, we'll talk a little bit about better planning: how to evaluate your business and how to position your business. So that'll be part of the episode.

John: So I'll tell a little story about a startup that I've done, just because this is Experience Matters and people want to hear stories. So I started a website startup back in the 2000s, and a couple of mistakes happened there. I used family money to get it going, and I grew it aggressively. I had a pretty good network of people that joined me. And part of the mistakes that happened in that startup, which we can touch upon later, was I had a lot of learning lessons on kind of the downside. Like not having the hard conversations with people that weren't performing, not having even hard conversations about the business itself. But at the end of the day, I maintained my integrity, and I didn't ever take the easy way out. I had a soft landing for that, and I had a lot of learning lessons from there. So we can talk about that later in this conversation.

I think the first thing we want to talk about is the idea, right? About defining the idea. That's one thing that you had mentioned. Tell me about your thoughts on that.

7:50 Step 1: Start with what you know

Milton: Yeah. So again, referring back to my experience, I think we need to, in some sense, use our experience to build our case, right? Build our story, the podcast. So Newport, the first company I joined, where I was the seventh employee: we built laser research equipment. And the equipment that we built was actually the equipment we used in a research lab in graduate school.

And so I think the extrapolation from that is that when you start, there are these flashes, or wild ideas. Some of them may work, others may not. But usually the good ideas come from your area of insight: you have deep insight of what is needed, what the market is and so forth, and that's how you start. In the absence of that, if you have wild ideas (sometimes wild ideas could be very big), it's to really do homework, which we'll talk about: how you evaluate the idea. So that's my first experience in terms of an idea.

And the second company, again, is that, you know, the idea has to be serving customer needs and capitalizing on your strengths. And by then, I had 20 years of experience serving the customer base. I know what they want, how they like to be treated. And so I offer them products they really want. So it's really the same thing. It's really a very systematic way of approaching whether you have a good idea and how you go about building it up. And that's what we will talk about in this podcast.

John: Right. So my observation of your success was that you have a PhD from Caltech in electrical engineering, right? And you started your very first company, which was in that industry. You did well with it. And you did another company based on that. And now it seems like a wild idea to do bonsai, but you actually have been doing bonsai for many decades before you even started this thing. So you actually are a subject matter expert in that as well.

And I think that's a very good lesson for people to understand: you can have an idea. It's even better if you have deep experience in that specific area, so that you can speak authoritatively. And that passion for that specific area will see you through the low times, right? Because with a business, there are lots of highs and lows.

Milton: Right. Yeah, that in fact enhances your likelihood of success, because, given all the same, you have the insight of the product, or the knowledge, or the customer interaction of the industry. That's extremely useful.

And thank you for bringing up Bonsai Heirloom, in a sense, bonsai, as a plug. I started at age 80 to sell bonsai. First of all, it takes time to grow bonsai, so I'm only beginning to have trees for sale, right? So it's been five years. Yeah, and I love it. And I've been doing the podcast, in fact, to wind up building a brand. People love me. Someday they will buy from me because they like my videos. And so right now I have 220,000, 210,000 subscribers on my YouTube channel. So to me, it's an area you love, an area you have insight in, and you go do all the right things, which in this case is build a brand first, before you try to push a product that isn't quite ready, and so on and so forth. So you've got to have a good idea, and you've got to do it right.

John: So just be extra cautious if you get an idea that's outside your expertise. This is something I've come up against many times, where just because I notice that there's a market inefficiency, like, "Oh my gosh, I really wish this product existed for this specific user experience," that I'm not an expert in, I stop myself, and I take five minutes and do the research, and it's like, "Oh, there are six other companies that are trying to do the same thing." You're not an expert in it. It's going to be a long road ahead. Unless you really want to do this, you have to come to that realization before you take that on, right?

Milton: Yeah. So, summarizing what you said, it's basically: you have to do homework before you jump.

12:23 Step 2: Validate before you jump

John: Correct.

Milton: And so let me give you a couple of examples. The point is that we all wake up in the morning, have a great hot idea, and we're all anxious to take it on. And, you know, wait a minute, do some homework, right?

So I'll give you a couple of examples. About 30 years ago, I got to know a Bank of America banker really well, down in Newport Beach. And he was hot on starting a business: have a truck to cash checks. And he really thought it was a good idea, because he knew how much arbitrage is involved in that. And I listened to him. I finally said, "You know, hey, by the way, most people cash checks on Friday. The rest of the four days, your truck will be sitting there doing nothing. So you cannot make ends meet with such a short period of cashing checks." And he figured that out. He said, "Oh, shucks, I didn't think about that," right?

John: Right.

Milton: So to me, then, it's really essential to temper your enthusiasm and do some market research. So, A, do a little back-of-the-envelope calculation to figure that out. B, like John said, do some research. AI is really powerful to help you define whether the idea will work, and what it takes to be successful, and whether you have it and whatnot. And then, once you decide the numbers kind of pencil out, then you need to do a really, really detailed business plan. And the business plan basically allows you to do a dry run, a test flight, to see how the business will play out: a work-through scenario, so you can find all the pitfalls and deal with them.

Today, young people are impatient. You know, quote-unquote, "Just do it, damn it." You know? And if it doesn't work, you try again. You do something differently. If it doesn't work, you try again, until you get it right. It is an extremely inefficient process. And the opposite is: write a business plan. It's a lot easier to spend time doing that than to try it, and it didn't work, and you try it again differently. And so that's what I advocate. Until everything pans out, then you get going. So it's a very systematic approach that I'm advocating.

14:59 Step 3: Plan the business

John: So I have a slightly different approach to how I would do it. And I think we should go through the use case of: you're a director of engineering at a company and you have a novel idea. We have slightly different approaches for low-tech versus high-tech, right? There's a lot of...

Milton: Yeah, they're different, totally different.

John: In fact, even in high-tech, there's a different approach with hardware and software. That's very different, because I have experience doing a hardware startup, and it's very expensive. So all the research that you had mentioned earlier, Milton, is even more critical before you start with hardware, just because you can't recall 200,000 hardware units easily. But with software, you can ship a patch.

Milton: That is my starting point, right? Because hardware is my background, and you have more of a software background.

John: Yeah. Right. So, a slightly different emphasis on what you had said: for me, I have a very high emphasis on, do you have a distribution unfair advantage that you can leverage, that you can get through to your customers? It'll be kind of the rising tide that'll smooth over inefficiencies in your business, if you have a very, very strong sales group or some distribution strategy that you can leverage.

Because right now, from a software standpoint, it's very expensive to buy users, because everything is out there. And there's a concept where AI is making the software development threshold even lower. However, there's sloppy software out there. There's a story where a guy created a dating website, and he used all AI to create it, but he didn't do the best security protocols, and people just literally hacked his backend and released the entire user base, and it killed the startup. And so I think the idea is: if you have a strong distribution channel and you can demonstrate that people want your product, those are my two critical goals prior to launch.

17:22 Different businesses need different strategies

Milton: Yeah. Let me approach the topic systematically. Let's talk about three kinds of business. One is the general business, consumer business.

John: So it's like a service-based company?

Milton: Yeah, service, or a restaurant, or whatever, you know, everyday business. And then we talk about the technical product business, and we can talk about the software business, right? So that more or less covers the entire gamut. So I think what makes each of these businesses successful is very different. And so you've got to know what is the key ingredient that makes this business successful, and build it into your business idea.

So I always like to use the restaurant business. A, because I like cooking. B, it's serving everyday needs, so lots of people think about that. And so let's just play a game. What is most important in terms of starting a restaurant business, or a service business, a bakery or whatever, right? What does it take to be successful?

Well, first of all, it's not what you like to taste, but how many people in the general public like to taste that kind of food, right? So you've got to do a little bit of market research. But if nothing else, show it to five different people. It's much better than not showing it to anybody and saying, "Just because I like it." But your statistics get much improved if you show it to 50 people. But nonetheless, showing it to five limited people gives you a lot of feedback. And so the product has to be good.

And then, am I in close proximity to my customer base, right? If I'm in Timbuktu, there's nobody nearby to drive 20 miles to my restaurant, I'm not going to make it, right? And so now you see a lot of restaurants are very close by. And then you say, let's see, what is it that will make people come back? What is it that will make them try my food? What is it that will make them come back? So you start to talk to John about getting his AI, e-commerce techniques to spread the word. And then you say, well, you know, they like the food, they like the ambiance, and they like my service. These are the things that make it work for me. And therefore, I'm going to broadcast to get the customers, and then serve them particularly well, so they will become repeat customers. And if you run the numbers, work them through, you will have a successful business.

And so today, if you're out of business, out of a job because of AI replacement, you can think along those lines: consumer product, service, restaurants, anything, right? But you've got to go through a little rigor to know if you really can have a successful business.

John: Well, so the other aspect is, if I wanted to, say, open a coffee shop, those are extremely competitive, right? There's a Starbucks on every corner. If I wanted to open something like a UPS Store type of thing, you have to know what areas would support your local business.

Milton: Yeah. Is there enough business nearby that will buy, to get started, and then attract them to come back again, right? So I'm being very simplistic. I think it takes a lot more than that to do it. But we can then talk about your experience and talk about how to start a hardware and software business, if you like.

21:19 Starting a software company

John: Yeah. So I can speak to software a little bit better than hardware. I did try hardware once, and it was very, very difficult. And the reason why it was difficult is because, with hardware, you have to commit to a minimum order quantity to sell it. And so you negotiate with the factory...

Milton: No, let's have you talk about the software.

John: Okay, let's talk about the software first. So with software, you can do a website, you can do an app, and the app can be like a phone app, or it could be like a Chrome store app, so that goes on the browser. And what's recently going on now is there's a glut of people developing software, such that it becomes very hard to get noticed, and the price of getting noticed is extremely high. But to actually develop the app is a lot easier. It's a lot more straightforward. And so the competition has now gone up.

But your principles still apply. You need to talk to people you can get hold of, to say, "Can you try my app? Tell me what you think." And with modern apps, you can put in little tracking software to see how much people are using it and what pages they use and all that stuff, and you can just see. And I would even encourage you, if the cost of developing the app is relatively low, or even the website, just buy users early on, even if you overpay for them. You can buy them with Google ads or Facebook ads. Buy them early on just to see if they're using it properly and if you want to further invest in the business. If it's within your budget to do so, it could be a couple thousand, it could even be a couple hundred to do that. If you don't want to do that, then you get your friends and family to use it, and have them give you an honest review of it, to see if it actually makes sense.

But all of your principles apply. Instead of saying, "Are there other Starbucks around?" you need to say, "Are other websites doing the same thing? Are there other 800-pound gorillas that could easily pivot and open up a feature that would supplant my concept?" And so those are the things you have to keep in mind.

However, if you're two degrees away from a very powerful influencer, like, if you could get through to an influencer, that's a huge advantage, because then you can cut through a lot of that noise. I know a lot of people are adjacent to well-known athletes or well-known YouTube streamers or whatever. And if you can get them to buy into your product, and even give them equity in it, and it's a huge channel that will pump users to it constantly, that might be something that's very, very valuable for you to consider.

Milton: Well, John, you know the field so well. You did a spiel. You can similarly do that for hardware. No, let me generalize what you said, even though I know nothing about software, okay? Because the principles are the same.

So my take from what you said is the following. It's a lot easier to start with a software business, because the capital investment could be low, because you can just, you know, work overnight, and pretty soon you've got software, right? But I never liked the software business, because I think with software, it's very difficult to convince people of the superiority of your product differentiation. It's not so obvious. It takes time to convince people that you've got something good, whereas hardware is a lot more solid. You know, this is more intangible.

So I think the first thing, if I'm doing a software business (which I'm an amateur at, so please pardon me, okay?), is that I would develop the software, and I would work with five customers until I get the software really, really good. Because until you get all the bugs out, and all the ifs and buts in terms of serving the customer needs, it's really hard to define. And then I would start to offer it free or whatever, you know, just to get people's foot in the door, until you find a real application. And then you apply what you have to that one specific application, serving that one customer particularly well, and then extrapolate from there. So that's how I see, you know, how we'd go about it. And once you're successful, then you use influencers and all that to promote it.

But that sequence is still not very much different from the restaurant business: get the product down really pat, figure out what customers need and give it to them. But software has one really big advantage. That is, once you find the magic, you can scale very quickly.

John: Correct. And the other thing about software is it's not capital-intensive. If you get it 80% correct, and that last 20% is preventing your hypergrowth, you can invest a little bit to get that 20% right. But if you have a cookie company and it needs to be a pizza company, you have to reinvest in all sorts of equipment. So it becomes very difficult.

Milton: Well, I wouldn't come to that conclusion so quickly. I think every business has its own issues and difficulties.

John: No, no, that's the only advantage with software. But the advantage of what you described earlier, with the local service-based business, is it's always baked in that local people need local services. They just need it. You can't easily...

Milton: Yeah. So in the software business, you apply that. You basically say you want to find one customer and serve him particularly well.

27:10 Step 4: Product-market fit and distribution

John: So the concept that I was taught is called product-market fit. If you know that there is a niche of people that really, really want your product, then you win. And then it's just a matter of getting to them, finding ways of getting the message out to them. And so that's everything, right? Figure out the product-market fit, figure out a distribution strategy, and then you're good to go.

27:34 Stop looking for the perfect idea

Milton: Yeah. One other insight I'd like to share with you that's less obvious, okay? In the early days, when I tried to invest and all that, think of ideas (I do that all the time, constantly), I would more or less look for the perfect idea. Is this a good idea? Is it a bad idea? In the sense that a good idea is one where there are a lot of people, everybody wants it. A bad idea: very few people need it. And as I get older, I've changed my mind. And the way I look at it when I invest in a startup company is: can this initial business succeed? Is there enough of a customer base for the business to succeed? It may not be satisfying everybody's needs. It may be a very imperfect idea, but it's got enough customers that need it. And once you get your foot in the door, you can expand. So the foot in the door is a really essential part of success.

John: Can you talk about that some more? Give an example.

Milton: I'll make up a really silly story.

John: Sure.

Milton: You can say, "I want to make this coffee cup, and I want it to be a perfect color that everybody wants." And in reality, that really doesn't exist. Not everybody wants the same color. So you say, but if I make a white cup, many ladies will like it. And if I've got the ladies' business, I now make a blue cup, where they will buy one for their...

John: So that's the beachhead concept.

Milton: The what?

John: Beachhead. You penetrate the market with one product.

Milton: Now, it's not intentionally focused on a market, but rather out of practical consideration: I only have enough money to make one cup of one color. What do I do? And I know that people like the white cup the best. Therefore, I offer the white cup, penetrate the market, and then expand from there. So in that sense, the motivation to grow is really important. Get your foot in the door, get the business launched, and then you've got opportunities.

29:53 Why hardware startups are hard

John: Do you want to talk a little bit about the hardware side of the startup?

Milton: Yeah. The hardware business is a lot more difficult. A stupid example: I was saying, you know, I really love my coffee in the morning. I have a way of making concentrated coffee and then diluting it as I drink all through the day. Well, it turns out there are hundreds of coffee pot ideas out there, and so that would obviously be a stupid idea for anybody to pursue, right?

So I think technology business, hardware business, that's mostly technology. I'm really now talking from an investor perspective, which is no different from a guy starting a business: distinguish my competitive advantage. Is it engineering, or science, or technology? When you have a product, you say, you know, "I can make this really very successful very quickly, because I'm a really good circuit designer, and I can introduce it in a month and start to ram the business really high." Great starting point, right? But that's inadequate. You know why? Because your engineering advantage will soon be overcome by a big company with a lot more engineering capability. So it's not a sustainable competitive advantage. But on the other hand, you say, "If I have a product that has an engineering advantage that introduces me into the marketplace, and I have six more follow-on products to expand further," then maybe you have a business. So there's no simple answer.

John: Yeah. So I agree. I think right before Apple came out with the Apple Watch, there were a couple of startups that did a smartwatch. And they had just enough to demonstrate that people really wanted it, but they didn't have the resources of an Apple to execute it at that level.

Milton: Yeah. Whatever you have, Apple spends two months, and how do you...?

John: Right. So what is it that you can do to protect yourself against that?

Milton: Well, in this case, obviously, having patent protection is a good one, but that's a very simplistic one. Even a patent you can overcome, right? Somebody with more resources, more creativity, they can work around it. So I don't know.

We are talking about ideally. Ideally, you have an impenetrable technology advantage, and an example of that would be Google. The founders of Google were basically doing research in search engines, and they had PhDs in search engines. And therefore, they did it with a bang. They dominated the market with a search engine, in terms of search, right?

John: Yep.

Milton: So they own the business. So it's a combination of technology and a significant amount of funding, to quickly get to the market and then keep driving it.

John: Well, a more recent example is Ring. I don't know if you're familiar with Ring, but they're the doorbell, the doorbell camera. It was started by a guy, and at some point he got bought out by Amazon for a billion dollars. But it seems like a relatively simple concept, right? It's just a camera on a door that's hooked up to the cloud. That's basically what it was. But he had enough momentum through the distribution to keep him...

Milton: A consumer product is a little different, right, than a technology product, which I'm thinking about as a technical product for technical applications, right? But with a consumer product, a lot of the advantage is momentum and time to market. And so you cannot be simple-minded. You really need to analyze the situation from multiple angles to see if you really have a business that can succeed. And, I don't know, I have advised hundreds of companies. And I think, of the 20 companies that I incubated as an angel investor, I made a major contribution to their success, because the little pointers make a big difference, you know.

34:22 John's 2,000-unit startup mistake

John: I want to tell a story about when I did a hardware startup. I tried to get product-market fit as soon as possible. So the concept was a smart router that allowed...

Milton: A smart what?

John: A smart router. So it would allow moms and dads to filter out pornography for their kids, with the touch of a button. And using my gaming industry background, I gamified it a little bit. And what I found with that product was that I had a social media campaign, and I had all these moms going thumbs up, thumbs up. But a thumbs up on a hardware product, where you have to bring it home and you have to program it and all that stuff, that's very different. So it was a false sense of product market adaptation. But at that point, I had already committed to 2,000 units, and I had committed to the whole infrastructure of building the hardware, the software stack, everything. And I was hand-assembling the first 100 units and all that. And I did everything right, and it just didn't work out, because I didn't get the right product market feedback on that. And so I think it's even more critical, in the hardware sense, to be really buttoned up, to understand what people want.

Milton: Yeah. The point is, chalk that up: one more data point that you need is the market feedback, right?

John: Yeah. And time to market.

Milton: So, yeah, a hardware product is very hard. But I think technology is one advantage. If it took somebody five years to come up with an algorithm for a better search engine, and it's truly superior, it's hard for people to beat it quickly. And couple that with the momentum, with the capital structure available down in Silicon Valley: that's what made Google successful.

John: Right. So there's a little bit of a fickle thing, where sometimes consumers prefer not to go with the big company, because they think it's selling out. For example, when Facebook was first on the scene, it was considered the cool thing to do, because the Harvard students got at it first. And MySpace was there already, and it was considered kind of not so cool to be with MySpace, but cooler to be with Facebook. And Facebook had a meteoric rise, because I remember back in the day, they were like, "Okay, we just accepted Stanford students now." And then people were like, "Oh, wait, when's my turn? When's my college's turn?" And so, getting through on the consumer side: if you have kind of a genius marketing plan, you can actually make a go of it and transcend the 800-pound gorilla's advantage over you.

Milton: Well, in short, I think every business has its own quirks. And you've got to do homework, going through the rigor that we talked about, in terms of writing a business plan and talking to customers, doing research, et cetera, to find out whether you really have a good product or not. It's not an impulsive thing, because, like you said, you probably spent a lot of money building a thousand little prototypes. And, you know, so that's a lesson to be learned.

37:59 Should you buy a business instead?

John: Yeah. I have a slightly different concept that I wanted to get your thoughts on. It was written by a Harvard professor, I think, of the MBA school. The modern influencer that is a proponent of it, her name is Codie Sanchez. It's called "buy then build." And so her concept is: take an existing business that has proved some level of success, you take it, and then you systematize it. You put your advantages onto it. So 80% of startups that go from scratch... you're an exceptional unicorn, in that you were able to take it from scratch to IPO. That's exceptionally rare. But for the average person, why not have them look at businesses and buy them out, and then build them up, right? You can buy websites, you can buy a service business, you can buy anything, right?

Milton: Yeah. Well, I think the professor really didn't... I mean, sorry, I don't mean to be disparaging, but I mean, what else is new? She's just talking about the leveraged buyouts that are happening every day.

John: Right, but this is for the average blue-collar worker, not a big corporate hedge fund, right?

Milton: No, no, I'm saying it's the same idea. No big deal. But let me extrapolate. It's a good idea, okay? It's a good idea, right? But don't present it as a breakthrough theory. I mean, come on, guys. And that's the problem with academicians. They make a big deal of what they do, right?

So to me, every business goes like this. It takes time to build, you know, a little ups and downs, and then it starts to take off, and then it's exponential. Almost every business. And the Crossing the Chasm theory, which is really true: when you have a good idea, whichever business you talk about, it always goes like this. You know, never mind this curve, but it goes like this. Because the early adopters tend to buy quickly. And then the early adopters get wiped out, in the sense that enough of them bought it. Then it starts to slow down, and in fact decline, and then gradually build up again, where the common user buys it. Now it's more publicized and all that.

So, summarizing what the professor said, which is really wise: most businesses go like this. And if you buy at the inflection point by putting capital into it... Because a lot of startup businesses don't have enough capital, so they think small. They don't want to give up ownership and all that: incorrect assumptions, beliefs. And therefore they are starved of the capital to drive the business at the right point. So if you can figure out those opportunities, where the business is starting to take off, and you decide to put some money in and drive it this way quickly, you can make a lot of money. It's just correct.

John: Okay. No, I appreciate that. And I think what they try to impress upon the average person, I'm talking not a hedge fund type of guy: if you find the right business... Their thesis is that a lot of businesses that were started by baby boomers, especially service-based businesses, if they can't find a buyer, they will just shut the business down, right? And so there's a big... they call it the silver tsunami, where the baby boomers are going to be retiring en masse, and they don't have the energy to support some of these restaurants, laundromats, whatever. And so you can take an SBA loan out, take that leverage, and buy these businesses up. And some of the younger folks that are listening have the ability to put software on it, to make it more efficient across multiple businesses, and do some wonderful things.

Milton: Absolutely. If you have the magic to understand what, you know, ads or promotion or something would really drive the business, that's absolutely a wonderful approach. But that's pretty theoretical, and it takes a lot of work and specificity to make it all work. I think it's fundamentally a good idea.

42:27 Step 5: Build a business that can survive

John: So Milton, we talked about the mechanics of the pre-flight checklist. Let's talk about what makes a business successful. What are you looking for as an entrepreneur when you are running the business?

Milton: Yeah. In some sense, now you want to start a business, you raise money and all that. And the next episode, we'll talk about how to raise money, right? That's a big deal.

John: Absolutely.

Milton: But in a sense, what do you need to build into the business to be successful? So let's talk about that. So you know you've got to have a great product. And how do I have a great product? I've got to engage customers from the very beginning. I've got to have good engineering from beginning to end, in terms of product definition, to product execution, to manufacturability, you know, to cost-effectiveness. All of that: the product has to be good. So you've got to figure out how to do all of that. Supply chain: you know, if you don't have manufacturing, you've got to figure out a way of getting a low-cost, reliable supplier. And then, you know, how do I keep my customers happy by providing the right services and all that.

And what is really important at the end... I'm not talking about having to compete on low price. You should get as much as you can justify, right? Because consumers are smart. You're not going to charge them more than you can get away with. But the single, single most important ingredient when the chips are down is to be the low-cost producer. Because at the end of the day, competition gets really tough. If it costs them 100 bucks to make a product and it costs you 98 bucks, you can prevail. Otherwise, you cannot. So having an efficient operation is a really key ingredient to success.

Then you say, how do I do it? Well, you've got to have good engineering from the start, right? So the products are manufacturable and all that. Then you have to have loyal employees, trying to maintain efficiency and come up with their own ways to keep the company efficient.

44:51 Lowest cost doesn't mean lowest price

John: Well, can I ask you a question on that, then? As I understand it, it's not healthy for a business to always try to position itself to be the lowest cost, right?

Milton: No, no, no. I didn't say lowest cost. I said the lowest production cost. You can sell it at a price the market can bear, right? Because profitability is a measure of success.

John: Right. So the reason I'm asking that is, I'm talking to other entrepreneurs, and their knee-jerk reaction to get cheap users is, "We'll be the cheapest." And I don't think that's a healthy way of doing it.

Milton: No, no. You should shoot to be the higher end, but you should shoot for being the lowest-cost producer. Because when the chips are down, it gets tough. Everybody's lowering their price to get customers, which happens in the technology business a lot. To get a customer, you offer the lowest price for the product. You've got to have a competitive product to justify a price. But if your production cost is the lowest, you survive.

John: Right. And one thing I wanted to emphasize is that when you build a product, your business is the brand, and that will help you fight off cheap competitors. Because if people feel like you have quality...

Milton: It's all true. It's all true. But on top of it all, you've got to be the lowest-cost producer, because efficiency is everything. A company can be... you know, I think it's really essential in building a company: the speed of decision is really important. Procrastination is so costly, right? So everything you do has to drive for cost efficiency.

46:51 Ship it or wait until it's perfect?

John: And I do want to emphasize that point about procrastination. I think Mark Cuban had mentioned that one of the lethal habits of some startups is that they want a perfect product to be shipped. And I think you need to ship a product that is good enough for the customer, and you can iterate on it later. But you have to be in a position to constantly put out improvements, and you can't have it perfect. Not everybody can be Apple. Apple tries to be perfect, and they made a living off of it. But I think the average entrepreneur should strive to just get a product out.

Milton: No, in fact, Apple is not perfect, right? Because when you look at it, a lot of their phones are behind other phones, Android and all that. But their reason for success is they get the market presence. They lock up the customer.

John: Well, their brand means everything.

Milton: Yeah. So to me, I don't think we can generalize on any one thing that will make a company successful. But the challenge to the entrepreneur is to understand exactly what that one thing is that enables the company to prevail. It could be my design capability: I design the most artistic product. Or it's the lowest-price item. Or it's the highest-price item, because people like the luxury aspect of it. Whatever it is, best customer service, but you identify that one key and drive it.

John: My preference is marketing, distribution, sales. That's my preference.

Milton: Oh, that's very essential. No, nothing preferred. They all are important. It's all adding up.

48:42 What makes a great leader?

Milton: So, going on: how do you have an excellent operation? Well, leadership. And what is leadership? Very simple. What makes a leader? You've got to be really good at what you do, know where you're going, communicate well what you want to accomplish, so that people will follow. And on and on, it goes on ad infinitum. But one of them is really taking care of your employees, so that they will work for you willingly. And in the future, I'll talk about the so-called self-actualization organization and all that. But the leader has to know exactly what makes a business successful.

So, and I'll tell you a funny one that people were a little bit shook up by when I said it. Oftentimes, when a company is not doing well, right... and Sears, Roebuck would be a good example: a dominant company that went out of business, essentially, right? What is the problem? It's the lack of leadership. These are hired hands trying to maximize profit, and they forgot about making the hard decision to reinvent the company, right?

50:02 When should you fire the CEO?

Milton: So, in fact, when the chips are down, the question is: when do you fire a CEO? When? What's your guess? What is the time to fire a CEO?

John: When they stop innovating.

Milton: Yeah. And when the CEO is finding excuses: "Yeah, I can kind of grow the business profitably, 2 or 3% a year." Well, that's time to fire the damn CEO, right? He has no vision of what to do to reinvent the company to be successful. So to me, the only reason why a company fails is the CEO starts to lose the vision. Other than that, it's got the resources to reinvent. It takes some hardship, for sure.

John: Right.

Milton: Well, I think we can go on and on and on. But having an efficient operation, strong leadership, strong organization is really a key to success.

51:08 Obsessing over your customers

John: Yeah, I wanted to reemphasize one of the other points on that list. I prefer a maniacal dedication to your customers. Make sure that they are absolutely happy with your product. It's harder to get a new client than it is to maintain an existing one. So make sure they're happy, and the word of mouth will probably...

Milton: I think that's essential: keeping customers happy, in a rational way. I went beyond that at the companies I built, New Focus and Newport. At New Focus especially, the second company, our business served the research market, right? How do I serve the research market? A, I participate in the professional society. I rub elbows with the researchers. And we serve them particularly well. They want a discount so they can get a grant? We help them, right? And not making sales based on discounts, but trying to find ways to help them succeed, right?

And not only that, we partner with them. So we know what products they need, and we develop them for them. They become our first customers. So we are in the infrastructure of our customers themselves, right? And, you know, so really, that's how you gain customer loyalty, and that's how you build your business in the technology world. Well, customer loyalty is in every business, really.

52:47 Costco vs. Sears: a business lesson

Milton: I think, in summary of what makes a business successful, I like to contrast strongly Costco and Sears, Roebuck, because I love to shop at Costco. And I can imagine... Costco was started by a couple of guys in Seattle, I think. And I believe one of them is still the leader, or at least still actively involved in the company. So these guys own the company, in the sense of heart and soul, and so they are committed to the company's success. So they know what they're doing. They have a strategy of distribution, lower cost, an efficient operation to maintain low cost, and they get a little bit of feedback by having a membership and all that, et cetera. The strategy. But the point is, I bet you the leader knows what they're doing.

They treat their employees particularly well. There's no turnover. In the retail business, it's like 80% a year turnover. That's extremely costly. It's penny-wise to pay a little bit lower wage. And you go into Costco, you're well taken care of. Efficient. Everybody's trying to figure out how to be efficient. They own the company, they feel, right? I mean, they act like they're the owners of Costco. And if you ever try to return something to Costco? Yeah, no problem, because they make the manufacturer eat the cost, right? No questions asked.

And so, good products. They have extremely good buyers around the country, around the world, to get good products at a good cost, at volume, because they are big now. I think the company will own retail in time. I can't imagine it doesn't. So there are only two places I shop: Costco, and if I can't find it, I get it from Amazon, for convenience.

John: Right. Right.

Milton: So to me, that is the ultimate, in my mind, the role model of successful companies, never mind startup or not. It's really: be efficient, give customers what they want. Be efficient, so that you can give customers what they want at the lowest cost possible, if necessary, and still remain profitable. And that's through good organization, taking care of your employees and, you know, making them loyal to the job.

55:13 Product vs. marketing: the disagreement

John: My takeaways... I think you and I have had a lot of discussions about this. Obviously, if you're about to jump into a business, you need to de-risk yourself. And to do that, you absolutely have to find ways of getting feedback from your customers on product-market fit. And then the other aspect is that marketing and distribution and sales is one of the most critical things that I've seen. I've seen companies with inferior products survive.

Milton: I really don't want to emphasize that. I mean, that's you. But for me, I'm telling you... No, you're using isolated cases to justify. Marketing and distribution is always wonderful, but with a good product and good service.

John: Agree to disagree, 'cause I mean, you have...

Milton: No, no, you have to agree. That's motherhood.

John: You have influencers with substandard products, like, "Hey, I'm a famous celebrity, buy my widget." And then the widget sells out.

Milton: But look what happened to Sears, Roebuck.

John: But they don't have marketing distribution. They don't have it.

Milton: Sears, Roebuck, no market distribution?

John: Not in the modern economy.

Milton: I know, I know.

John: But anyway, we're arguing. We're basically in agreement. So those are my main takeaways. I love what you said. I just have a visual reaction to a lot of the mistakes I've made, and I don't want to see people make those mistakes. Anyway, this is a great conversation. [laughs] I love our spirited, violent agreements. And make sure to like and subscribe to our channel. We hope to see you next week.

57:03 Next: how to raise money

Milton: Yeah. And next week, probably, we're going to talk about how to raise money, which is really essential. And I've got some really good tips that are really obvious, but it's good to emphasize. So I hope to see you guys next week. All right. Thank you.