Curtis Arledge: [00:40] I am Curtis Arledge with the Forum and I am pleased to be joined today by Nate Redmond, who is calling into our studios here at Klarman Hall. Nate is the managing partner at Alpha Edison, a venture capital firm he co-founded in Los Angeles. He’s been a venture capital investor for 15 years and he got his MBA here at Harvard Business School in 2001 where he developed a deep interest in the theories he learned while in Clay’s course Building and Sustaining a Successful Enterprise known affectionately as BSSE. Nate, thank you so much for joining us here today. It’s great to have you.

Nate Redmond [01:10] Oh, thank you so much Curtis, it’s a pleasure to be here.

Curtis Arledge: [01:13] Let’s just get started simply talking about your journey and how you have taken what you learned at BSSE and through out all the things that you’ve done in your career.

Nate Redmond [01:21] I recall first meeting Clay and getting immediately struck by his clarity of thinking and ability to connect really at a human level and really above all his integrity that he brought it into everything that he does. He invited me to work more closely and help take a body of research and apply it in the context of thinking predictably and applying it in the context of investing and really building businesses. So this began at HBS but I was really fortunate to spend two very formative years post HBS working with Clay, and obviously this continues to guide my work today.

Curtis Arledge: [2:02] So Nate, when you and I first met, I had just gotten involved here in the forum and your name was a name that was floating about often as we talked about people who had been influential and how the forum was taking shape. And for disclosure, I’m also an investor in one of your funds, a very happy LP.

Curtis Arledge: [02:19] One of the things that when I first saw your pitch book, it actually reminded me a lot of the course materials and the work that had been done here and that you really do use a lot of theory that has been developed here at HBS by Clay and his team. But I’d be very interested in hearing you talk about how you describe Alpha Edison’s investment approach, how do you communicate to investors and what do you communicate to investors about your investment approach? What theories do you find are most influential? How do people take them? I mean, a part of what you’re doing is educating a potential LPs about a lot of what is being taught here. I’d just love to hear you talk about Alpha Edison as a firm and your overall investment process and approach.

Nate Redmond [03:02] So at the foundation Alpha Edison invests in companies that unlock new markets and the way in which we understand those new markets, parameterize them, map the right approach, and then fundamentally enable and partner with our entrepreneurs to help unlock those markets are really core what we do. Maybe as a way of shaping the thought process that really formed this strategy, I’ll start with just kind of an observation which is something that we all know but is yet hard to wrap your head around on a consistent basis. We live in a power law, meaning almost everything is noise and only a few things really matter.

Nate Redmond [03:45] And I really believe this is true in life and it’s also true in investing. And the by product of that is that a job as an investor, and it’s even more so for any gross investor and including venture capital, is not about selecting among that and good companies. It’s really about selecting between the good and the great because the great are worth so much more than the good. And the challenge of that is that these great companies just are not obvious early on. We know that it’s not obvious because the most successful venture back companies all had many people pass on them early on.

Nate Redmond [04:26] Brian Chesky CEO of Airbnb has shared publicly the first seven rejections he received from institutional investors back a decade ago and many more followed those and I was one of those and it’s really helped to shape that among other errors that I’ve made, has really helped to shape the strategy. And so what we found is that if you study the errors that investors make you can distill them really into two categories, what we call type one and type two. Where type one errors are really these acts of commission. You see a company, you choose to act and then it goes on to be not successful or fails in some form or fashion.

Nate Redmond [05:07] And the error rate for the industry is somewhere along the order of 50%, some measure it a bit higher. And lots of time, energy and effort goes into optimizing around loss ratio and reducing that ultimately. By the way, this is shaped by a lot of internal partnership dynamics and other cognitive biases. Type two errors or errors of omission are errors where you see a company and you don’t act either because you fundamentally don’t have clarity or you’re too slow, in either case you don’t have sufficient conviction and the company goes on to be very successful. And the interesting thing about these type two errors is that not only are they more expensive.

Nate Redmond [05:46] So in other words instead of missing and losing your $5 million investment, you’ve missed out on making $100,000,000 or 20X return on the investment or more. But the error rate is actually much higher. And the byproduct of that, and by the way, from our work and research it shows that the error rate for type two is over 90%. And so what flows out of that is that even the best investors who are known for their outside success or successes still miss most of their best opportunities. And why is that? This is a foundational question that I think has been very hard for the industry to wrap its head around and really create a systematic solution and that’s what we’ve set out to do.

Nate Redmond [06:34] And so one of the things that if you’ve watched the industry evolve over the course of the last 25 years, there was a period of time where you could really differentiate on the basis of the access. So I have opportunity to meet an entrepreneur, no one else does or a few others do. I can spend a lot of time with that entrepreneur developing a point of view and will have an edge on actually making an investment and that’s changed now. Just think for a moment on the number of items that are in your inbox relative to 10 years ago, let alone 20 and you get a sense for the flow of deals that come into any one of these firms and the byproduct of that is noise.

Nate Redmond [7:17] And so access is necessary but no longer sufficient and what investors must do is be able to have a point of view, clarity and conviction before these become obvious. And so how do investors try to do that? Well, typically it’s through one of two paths. The first is that they are assessing market and the market opportunity through what most people describe as TAM, or total addressable market. Now, as we all know TAM are really estimates produced around the market size that are essentially linear projections based on actual and historical spend. From our vantage point that’s an approach that is fatally flawed and that TAM looks at the way things are and yet are really blind to the way customers want them to be that any change to the current is seemed to be incremental and too small. And yet we know that when change does occur, it does not happen on a linear basis.

Nate Redmond [8:21] Meaningful change, change we’d like to invest in, it’s much more a non linear exponential basis. And that ultimately the biggest companies aren’t built solely by taking share from incumbents, but by unlocking a new market. And just to use a quick example that we’re all familiar with, you take ride sharing and the power that has driven the growth of ride sharing companies such as Lyft and Uber is not the market of taking share away from taxi and limousines, which by the way was the analysis that all investors made at the outset.

Nate Redmond [8:57] But instead it’s really been the enablement of net new trips. And these are trips that people weren’t otherwise making either because they were driving themselves or they just weren’t going at all. And this has led to a huge growth in the total spend. The Bay Area is one measure where we’ve already seen a six or seven X growth relative to what the total spend is on taxi and limousine and we’re still at the early stages of this. So I mentioned there two areas, thinking about the second that investors tend to chase momentum. When you’re uncertain about the future, people tend to look for shortcuts, there’s sort of a frantic search for a rapid monthly life growth and that search is very quickly overcome by cognitive biases and fear of missing out and a set of other psychological dynamics.

Nate Redmond [9:52] And the issues from that is that by the time you’re investing in a momentum driven company, typically they’re fully priced, many of them are false positives that you fail to understand how fast or far this can run and ultimately it needs to and creates kind of a bubble. And so our focus, which kind of comes back to and very much resonant with the seeings from BSSE is that it’s really about finding companies that are unlocking new markets. And I just want to make a distinction here because there’s much of conversation around what many call market creating innovations and I think that’s right at the core. We use the language around unlocking which we think is a very important distinction and that the market opportunity actually exists before the companies are founded to exploit them.

Nate Redmond [10:46] So in other words a company is not creating the market, the market’s there, the demand exists, but the problem as we talked about, it precedes the project. But it takes the company and the innovation around the business model to produce and provide an experience that really comes in and allows this new market to really show itself and that demand to the expressed. And the creativity in the entrepreneurs here is really driven by a conviction the way things should be rather than the way things are. So just to distill that into our approach is that we fundamentally follow a formula that we’re first looking at the context of how an industry or a sector defines itself and there are very clear vulnerabilities that fall out of that.

Nate Redmond [11:41] But then where we look through a set of horizontal themes that allow us to begin to map and provide early indications of this notion of latent demand that allows and sits behind unlocking new markets. We then focus on parameterizing it, sizing and shaping it, identify the best way to unlock it and then hunt the companies doing that.

Curtis Arledge: [12:05] Are there examples of companies that you’ve invested in that bring all this to life?

Nate Redmond [12:10] Yeah, absolutely. Why don’t I just describe one of our themes and share a couple of examples of companies that fit into that theme. One of the themes that we look at and think about in the context of understanding of this latency around a demand and the new markets that can be unlocked is a concept that we described as silent suffering - the idea that customers are inherently unhappy or dissatisfied with the status quo, but importantly, the silent portion is really the fact that they’ve resigned themselves to the notion that it’s not going to change.

Nate Redmond [12:48] Rarely did we have grouse about the fact that there was not a better option to taxis or to limousines because it always been that way. And so how do you go in and understand this opportunity before the solution exists and actually causes it to be expressed? We really focus on this kind of gap between what we define as an actual behavior and an intentional behavior. And so the themes that we use to really help to see these new markets. One is something that we call democratize decisions. And so this theme is really built around the idea that data is pervasive and exploding and many investors who described investing in big data kind of stop there in describing what is it about the data that is actually relevant and interesting.

Nate Redmond [13:39] We’ve really focused on the dimension of data that allows these new markets to surface and ultimately to be unlocked. And one of the powers of the growth of this data is when you pair it with the right set of analytics, you’re able to put it in the hands of many many more people and then allow them to make better decisions thus the democratization effect. And so we take these themes and apply them in a horizontal fashion across industries and we’ve invested in a company called House Canary, which is applying this construct into residential real estate and ultimately therefore into financial services because mortgage lending really sits at the heart of real estate transactions.

Nate Redmond [14:25] And by arming and enabling people with the type of data and sophistication that typically exists among the few in Wall Street and bringing that to the many, the100 million households across the country, we believe deeply that not only can you begin to address the fundamental transaction process itself, but that you are able to enable people to behave differently around of where they live and how they live. Another example here is a company called Neural Analytics which has taken a core technology which has been around for decades called Transcranial Doppler. That technology uses an assessment of your brain health by watching the brain waves and is built around ultrasound.

Nate Redmond [15:26] And the power of that technology as this company has gone in and invested over the last four years, miniaturizing it and then carrying it with a set of core robotics and then machine learning algorithms, enables not just the 10 or 12 specialists who exist in Los Angeles who are able to successfully administer a Transcranial Doppler test, but the doctors and care providers in secondary and tertiary hospitals and out into the first responders to assess brain health. Think about in the context of a stroke or a concussion or a series of other events that people run into and where it is very difficult to assess early and quickly how productive an individual is.

Nate Redmond [16:21] And so pairing this assessment, miniaturizing it, pairing that with both the robotics and the machine learning enables many more people to make much better decisions and therefore you’re not going in and replacing the devices that exist within the few hospitals, but really unlocking a whole new market.

Curtis Arledge: [16:43] So Nate, how often does the team at Alpha Edison get involved with your portfolio companies in assessing their strategy, you talked about it obviously when you think about investing and after investing. But, just really curious how often the theories that you describe and the ones you learned, including those of BSSE, have actually gotten into the room with founders, who know generally what they’re trying to do, but maybe they aren’t tapping into the Job to Be Done or they aren’t thinking through the disruption in their industry might work. How involved do you get with them, and if there are any examples there?

Nate Redmond [17:15] So all the time, it’s a short answer. So let me share a couple of examples around this, Curtis. One of the things that we hear consistently back from conversations with entrepreneurs, frankly those who we’ve invested in as well as those who we just have a privilege to spend time with is that, gosh, you guys really are thinking differently and I think that’s really manifest in the sense that we are bringing a point of view around the development of markets and the demand that exists underneath that. And ultimately the business models that come about that are most effective and efficient in unlocking that demand, that they just don’t hear from others.

Nate Redmond [17:56] There’s another piece of this that is worth sharing, that comes to mind here. There’s a quote that I learned from Clay from my time working very closely with him and it’s just one of those very simple but powerful ideas that has stayed with me. Clay often talked about the idea and the importance of being patient for growth but inpatient for profits.

Nate Redmond [18:23] And that seemed to make sense at the time, but it’s really over the course of the last 15 years here so that I really understood the power of that and the applicability. The challenge for most companies is that they define a plan and they may see very clearly the potential even for new markets and how to unlock them. Invariably, an entrepreneur and most companies tend to fall behind their plan at one time or the other and the byproduct of that is that they are chasing revenue to come and catch up. Of course, the problem with chasing revenue is that the easiest revenue to be had is was from current demand or an existing market and this falls back into this notion of TAM.

Nate Redmond [19:10] And so we get into this dynamic where managers then become rewarded for hitting revenue targets by going back through this current demand and that reward reinforces the behavior. And slowly but surely, slowly at first and then very quickly, the products, the people, the strategy, they all begin moving to support this management approach. And now suddenly you found yourself with the disruptive potential of a company co-opted by a sustaining path. And I’ve lived through this experience multiple times and I think I learned a lot around what to spot as an early indicator and how to bring this forward to an entrepreneur in a way that then allows them to see it and to steer clear of it.

Curtis Arledge: [19:56] So Nate, Clay talks a lot about the idea of people getting the categories wrong. Talk a little bit about what that means to you, how you’ve seen it, not only just now companies that you’ve look at to invest in, how you think about what categories maybe they either are getting right that’s appealing or getting wrong and how you can help them, but also maybe more broadly how the industry, how LPs who are allocating some of their capital to venture capital, are they doing it along the lines of categories that potentially limit their own returns because of how they’re defining categories?

Nate Redmond [20:27] A couple of examples come in mind here. So the first is that nearly everyone uses some form of attribute based segmentation, whether you’re segmenting people, for example, demographics, age, gender, race, geography or products where a lot of people will take features and functions and think about the traditional comparative or competitive analysis where a company lays out where they are relative to others and it’s almost always a feature function matrix. And invariably the company presenting has a set of bullets or filled in circles that others don’t. And the problem with this approach is that ultimately this attribute based segmentation are really proxies.

Nate Redmond [21:07] And this is, again, very much influenced from my time with Clay and there’s been lots of focus and research done around other approaches here, whether it be behavioral or psychographic segmentation and they create different insights. And yet I’ve been struck by how few or how infrequently people actually approach these problems through a unique or differentiated lens. I vantage view Jobs to Be Done and the framework around that as understanding, defining the context or the categories in a very different way. It’s not so much the feature function of that product, but really what a customer hires that product to do and ultimately the behavior that it enables.

Nate Redmond [21:54] A example of this in the context of one of our investments is a company called Aspiration. Aspiration is a consumer financial services company that has built a set of early products around banking or sort of a checking account and investment products that from a feature function perspective look not too dissimilar to others in the industry. And in fact it’s one of the interesting challenges of financial services is that you have a very large space that’s frankly just be getting to go through a massive transformation. And the experience that most customers have between Wells Fargo or BofA or Citibank is very much the same, there’s almost no difference.

Nate Redmond [22:42] And that experience is a reflection of the products and the pricing of those products. Aspiration understood and identified that the dissatisfaction that is increasingly resonant among consumers is not necessarily a dissatisfaction with the features of the products themselves, but has to do with really the approach that that company takes to interacting and servicing with them. More specifically that the trust that once existed between a community banker and an individual and then was over time transitioned from that community individual to the institution, has now begun to breakdown and real cracks have emerged in that trust.

Nate Redmond [23:22] And we’ve seen studies showing four the 10 least liked brands among millennials are major banks or more than 90% of millennials have actively distrust their bank. And so Aspiration really went about building trust with these consumers in a very different way. They’ve done that through understanding this notion of segmentation and that there’s what they describe as values based decision makers. In the US today that’s somewhere between 40 and 50 million consumers and growing very rapidly. And the power here is not that they necessarily all hold the same values, but specifically that their values are very important to each one of them.

Nate Redmond [24:05] And consequently they shape the decisions around who they do business with, not just the bank but what transaction they make, other businesses that they choose to work with and so forth. And this has led a fundamentally different quality and durability of relationship with extraordinary low churn and a demonstration of customer love that is very very hard to replicate. So we’re very excited about this and it’s very much a reflection of looking at a company through a different segmentation or category lens. You asked also about investors or Lps. The traditional measure of how, let’s say a venture capitalists invest is ...LPs and frankly GPs themselves put themselves into one of multiple buckets, segmenting by stage or sector or even technology type.

Nate Redmond [25:00] So I’m a mobile investor or I invest in big data or AI. And we fundamentally believe that, for example, if you take stage and you look across need and venture and growth, these are really the wrong categories. And it in some ways structures and impacts how investors structure their time. But fundamentally LPs are hiring managers for access to their best ideas and those ideas are moving quickly through stages. You may have both insight and clarity and conviction out of seed stage, our traditional seed stage, or you may not actually see that or have conviction on it until would otherwise fall into the traditional growth stage.

Nate Redmond [25:41] But it’s really about that insight and that conviction that’s differentiated from the market and therefore isn’t fully priced in. And I think that impacts falsely how LPs are viewing the world and ultimately how many GPs orient their teams in time. So the last thing I’ll just add in quickly here is that we fundamentally believe that diverse teams make better decisions. And it’s been a foundational principle for how we have built our team and how we’ll expect to see our team continue to grow going forward. The important measure here for us is cognitive diversity, sort of the mental models that you bring to the table, how you actually turn through perceive and code, analyze and organize the information.

Nate Redmond [6:31] When we talk about diversity, most of us use language that tends to be really about identity and other ways of shaping and managing that identity. And while identity diversity is a driver of cognitive diversity, it’s foundationally different. And so this is I think again an example of using the right category. By the way, Scott Page wrote a wonderful book on this called the Diversity Bonus that calls this out and really highlights this differentiation in the categorization of diversity.

Curtis Arledge: [27:01] So Nate, here at the forum we are very focused on who is funding and how are they funding innovation, especially innovations that create new markets or as you said, unlock markets. And a lot of times you’re looking for investments in uncertainty. When one looks back at the history of the venture capital business and you really got started investing in ideas and technologies that had tremendous uncertainty and in much of the success of Silicon Valley and beyond has come from investments that few people would’ve thought were rational at the time. But the venture capital business has clearly evolved through time. How has it evolved? Do you find that venture capital is really a place where the financing of tomorrow’s great innovations is going to take place or have they moved towards focusing on less risky innovations that guaranteed more certain returns and why has this happened and what are the implications of it?

Nate Redmond [27:56] So if we look at the evolution of the industry, it really very much began as individuals or kind of a craft, if you will. And over the course of particularly the growth that happened in the bubble period, the late ’90s forward, even through a couple of cycles, it’s really much more moved from these individuals to institutions and the description of it as a “asset class.” As you would expect, it went through that evolution, as you would expect, managers pursue metrics, as with any other industry for which they’re measured and rewarded. As you go into this institutional asset class, what are those metrics? And the how does that play out?

Nate Redmond [28:39] Nearly all venture capital investors should describe this as longterm returns and therefore multiple and invest in capital. But in reality, it really comes down much more so to these quick hits or quick wins which translated into IRR. And if you think about it, it takes 7 to 10 years to build a company, but funds are raised every two to four years. And really that timeframe between funds has compressed relative to 10 or 15 years ago. And the by product of that is that managers are looking to show quick wins. It gives them the notion of value creation within the portfolio that attracts the interest from your investors.

Nate Redmond [29:25] They raise more capital into subsequent funds and this comes back to this notion of IRR. And so what’s the best way to show quick wins? Is to be in momentum or sort of well known TAM, that you’re quickly grabbing share because that is the easiest revenue to hold onto. And so this all sort of fulfills this notion of funding sustaining companies. And while I think that’s generally been the case with venture, I think it’s become worse actually as a by product of this institutions and the metrics associated with that. The consequences of this is that the industry returns really trailed the S&P and you would never want to buy the index and venture.

Nate Redmond [30:04] And so as an investor, kind of picked back up and think ahead to the solution. Most investors still are sprain and frame, meaning that they are building a large portfolio of many different companies rationalized on the basis of portfolio and diversification theory. But I think really because they lack conviction and a differentiated insight or fundamentally too lazy or both. And companies from our perspective really are not lottery tickets. The idea that, gosh, it could be really big, but it’s probably a small probability means that you resigned yourself to the fact that you’re writing cheques really without thinking. And at the end of the day, that’s a recipe for losing money. You may get lucky once or twice, but there’s no repeatability in it.

Nate Redmond [30:52] And so we’ve really taken an approach of an anti-lottery ticket which really means being concentrated, forcing a high level of conviction before writing a cheque of any size. And the way in which we did do that, I’ve described here somewhat, but if you’re right and consensus, it’s really hard to make money. And so you can know that your non consensus, but it’s really hard to know early on if you’re right. So really the question back to an investor is so what risks do you want to take? And this asymmetric risk that we seek exposure to really requires understanding the full potential of business, creating exposure to that and much of that ties back to this notion of understanding the unlock or new markets.

Curtis Arledge: [31:32] So Nate maybe I’ll finish up here where we started. You came here and you spent time with Clay and I think anyone who’s been here and been part of this environment, and been fortunate to spend time with Clay eventually crosses paths with the book that he wrote, How You Measure Your Life. And I’m just really curious when you think about all the things that you do professionally, all the companies you look at and all the trends you think about and how they’re going to change the world. How do all of these things actually play out in your life with your family, with what you’re trying to accomplish beyond your professional aspirations? Anything that you learned while you were here that has really changed who you are.

Nate Redmond [32:08] One of the wonderful opportunities that comes with sitting in the vantage point that we have is that you have an opportunity to sit face to face with an entrepreneur who’s taken an idea and a construct and a conviction around the way things should be and are really going out to bend the world around that concept and how to hopefully unlock this latent demand. And it’s a wonderful experience. There’s an incredible amount of new exposure that we have to ideas and how they fit into the fundamental changes that are occurring both across our economy, across the underlying technology infrastructure and really the applicability of capital over time.

Nate Redmond [32:58] I think the power of entrepreneurship and not just the drive and desire to make things happen, but to really have an impact on lives and the social constructs within which we live is something that I’ve really enjoyed and appreciated.

Nate Redmond [33:17] So that has rolled into my life in thinking on the opportunities for my children, for this next generation and the type of impact that they can have. The ways in which we’ve thought about the categories of the how you treat people and ultimately the kind of long-term pace of learning and growth, these are all things that really shape and impact my life every day and I hope to be able to continue to take the set of ideas and research and work that I’ve learned to extend and to expand them and to be able to fold them back into this body of research and to others who are really exploring this topic and to develop new knowledge in a new way of thinking that ultimately cannot just shape how people invest, but ultimately how companies are built. And I think that’s ultimately going to translate into professional satisfaction in a way that simply returns better wealth.

Curtis Arledge: [34:15] Well Nate listen, you’re a great friend to the forum for growth and innovation here. I want to thank you tremendously for all of your time and your insights and to all of our listeners, thank you very much for the time you spent with us today. Take care and have a great day.