Steve Blank's Blog, page 5

Why The Pentagon Can’t Count: It’s Time to Reinvent the Audit

This article previously appeared in War on the Rocks.

In the past, headlines about the Pentagon failing its financial audit again would never have caught my attention. But having been in the middle of this conversation when I served on one of the Defense Department’s advisory boards, I understand why the Pentagon can’t count. The experience taught me a valuable lesson about innovation and imagination in large organizations, and the difference visionary leadership – or the lack of it – can make.

With audit costs approaching a billion dollars a year the Pentagon had an opportunity to lead in modernizing auditing. Instead it opted for more of the same.

Auditing the Department of Defense
By law, the Department of Defense has to provide Congress and the public with an assessment of where it spends its money and to provide transparency of its operations. A financial audit counts what the Department of Defense has, where it has it, and if they know where its money is being spent.

Auditing the Department of Defense is a massive undertaking. For one thing, it is the country’s largest employer, with 2.9 million people (1.3 million on active duty, 800,000 in the reserve components, and 770,000 civilians.) The audit has to count the location and condition of every piece of military equipment, property, inventory, and supplies. And there are a lot of them. The department has 643,900 assets, from buildings, to pipelines, roads, and fences located on over 4,860 sites, as well as 19,700 aircraft and over 290 battle force ships. To complicate the audit, the department has 326 different and separate financial management systems, 4,700 data warehouses and over 10,000 different and disconnected data management systems.

(BTW, just like in the private sector, financial audits and audits of contracts are separate. While the DoD Office of Inspector General is responsible for these financial audits of trillions of dollars of assets and liabilities, the Defense Contract Audit Agency is responsible for auditing the hundreds of billions of dollars of acquisition contracts. They have the same issues.)

This is the fifth year the Department has undergone a financial statement audit – and failed it. The audit was not a trivial effort, it required 1,600 auditors – 1,450 from public accounting firms and 150 from the Office of Inspector General. In 2019, the audit cost $428 million in auditing costs ($186 million to the auditors along with $242 million to audit support) and another $472 million to fix the issues the audit discovered.

Let’s Invent the Future of Audit
The Defense of Department’s 40-plus advisory boards are staffed by outsiders who can provide independent perspectives and advice. I sat on one of these boards, and our charter was to leverage private sector lessons to improve audit quality.

With defense spending on auditing approaching a billion dollars a year, it was clear it would take a decade or more to catch up to the audit standards of private companies. But no single company or even entire industry was spending this much money on auditing. And remarkably, the Defense Department seemed intent on doing the same thing year after year, just with more people and with a few more tools and processes to get incrementally better. It dawned on me that if we tried to look over the horizon, the department could audit faster, cheaper, and more effectively by inventing the future tools and techniques rather than repeating the past.

Nothing in our charter asked the advisory board to invent the future. But I found myself asking, “What if we could?” What if we could provide the defense department with new technology, new approaches to auditing, analytics practices, audit research, and standards, all while creating audit and data management research and a new generation of finance applications and vendors?

The Pentagon Once Led Business Innovation
I reminded my fellow advisory board members that in 1959, at the dawn of the computer age, the Defense Department was the largest user of computers for business applications.

However, there was no common business programing language. So rather than wait for one, the Defense Department led the effort to create one – the COBOL programming language. And 20 years later, it did the same for the ADA programming language.

With that history in mind, I proposed we lead again. And that we start an initiative for the 5th generation of audit practices (the Audit 5.0 Initiative) with machine learning, predictive analytics, Intelligent sampling and predictions. This initiative would also include automating ETL, predictive analytics, fraud detection, and a new generation of audit standards.

I pointed out that this program wouldn’t need more funds since the Department of Defense could allocate 10% of the $428M we were spending on auditors and fund SBIR (Small Business Innovation Research) programs in auditing/data management/finance to generate 5-10 new startups in this space each year. Simultaneously we could fund academic research, to incentivize research on Machine Learning as applied to Audit 5.0 challenges in finance, auditing and data management.

In addition, we could create new audit standards by working with existing government audit standards bodies such as (The Generally Accepted Government Auditing Standards (GAGAS), Yellow Book, the GAO’s Standards for Internal Control in the Federal Government, Green Book and the Federal Accounting Standards Advisory Board (FASAB). We could collaborate with civilian audit standard bodies (ASB (Auditing Standards Board) and PCAOB (Public Company Accounting Oversight Board). Working together, the defense department could create the next generation of machine-driven and semiautomated standards. Furthermore, it could help the Independent Public Accounting firms (KPMG, EY, PwC, Deloitte, et al) create a new practice and make them partners in the Audit 5.0 initiative.

By investing 10 percent of the existing auditing budget over the next few years, these activities would create a defense audit center of excellence that would fund academic centers for advanced audit research, standup “future of audit” programs that would create new 5-10 startups each year, be the focal point for government an industry finance and audit standards, and create public-private partnerships rather than mandates.

Spinning up these activities up would dramatically reduce the department’s audit costs, standardize its financial management environment, and provide confidence in their budget, auditability, and transparency. And as a bonus, it would create a new generation of finance, audit and data management startups, funded by private capital.

The Road Not Taken
I was in awe of my fellow advisory board members. They had spent decades in senior roles in finance and accounting in both the public and private sectors. Yet, when I pitched this idea, they politely listened to what I had to say and then moved on to their agenda – providing the DoD with Incremental improvements.

At the time I was disappointed, but not surprised. An advisory board is only as good as what it’s being chartered and staffed to do. If they are being asked to provide a 10 percent incremental advice, they’ll do so. But if they’re asked for revolutionary i.e. 10x advice, they can change the world. But that requires a different charter, leadership, people, innovation, and imagination.

In the end, the Department of Defense, the largest purchaser of accounting services in the world, whiffed a chance to be the leader in creating the next generation of audit tools and services, not only for financial audits, but for the hundreds of billions of dollars of acquisition contracts the Defense Contract Audit Agency audits. By now the department could have audit tools driven by machine learning algorithms, ferreting out fraud by vendors or contractors and anticipating programs that are at risk.

Lessons Learned

If you only get what you ask for you haven’t hired people with imaginationAmerica’s defense leaders ought to ask and act for transformational, contrarian and disruptive adviceAnd ensure they have the will and organizations to act on itMove requests for advice for incremental improvements to the consulting firms that currently serve the Defense DepartmentDefense leaders need to consider whether spending a billion dollars a year for an audit is causing the department to become appreciably more efficient or better managedOr whether there might be a better way

The 6th Lean Innovation Educators Summit – Education and Innovation in the Age of Chaos and Disruption

Join Jerry Engel, Pete Newell, and Steve Weinstein for the sixth edition of the Lean Innovation Educators Summit December 14, 1-4 pm Eastern Time, 10 am-1 pm Pacific Time. Register here.

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This virtual gathering will bring together entrepreneurship educators from around the world who are putting Lean Innovation to work in their classrooms, accelerators, venture studios, and student-driven ventures.

The summit topic is “Education and Innovation in the Age of Chaos and Disruption.”

Our students will be facing the challenges of a world that’s rapidly changing, chaotic and uncertain. A world undergoing climate change, supply chain disruptions, political instability and continual technology innovation and disruption. It’s incumbent on us as educators to provide the next generation of innovators with the tools and mindset to meet these challenges.

Among the questions we’ll address in this short summit:

How do we as entrepreneurship and innovation educators best prepare the next generation?What role should our institutions help us do this?What are the other systems and partnerships that we need to take advantage of?

We will have concurrent breakout sessions so participants have the opportunity to choose their own path to explore. We’ll then going to pivot to hear from colleagues across three broad categories of innovation:

Curriculum – We’ll discuss how best to equip educators with the tools they need to cultivate and guide student teams around solving mission-driven problems.Ecosystems – We’ll explore partnerships that engage and inform positive student engagement and outcomes and how to support diversity of thought, background.Trends – The rate of technological disruption shows no sign of slowing down. Climate change was a hypothesis for our generation but will be the facts on the ground for our students. The struggle between great powers and a fluid global landscape will accelerate. All of these will shape what future curriculums our students need and educators must deliver.

Alexander Osterwalder, the creator of the business model canvas and Strategyzer co-founder will join the discussion about the intersection of education, innovation and entrepreneurship

During the breakout sessions, you will have the opportunity to contribute to the conversation via Chat, Q&A, and an online community bulletin board. We will close out the Summit with Alex Osterwalder’s fireside chat moderated by Dr. Jerry Engel.

How to register

When you register, you will receive a link to an online collaboration space where you can submit questions, challenges and feedback. This feedback will inform the content of the presentations, post-event white papers, and the curriculum delivered to our educator community.

This session is free but limited to Innovation educators. Register here and learn more on our website: We look forward to gathering as a community of educators to shape the future of Lean Innovation Education.

The Three Pillars of World-class Corporate Innovation

My good friend Alexander Osterwalder, the inventor of the business model canvas (one of foundations of the Lean Methodology) has written a playbook (along with his associate partner Tendayi Viki,) From Innovation Theater to Growth Engine to explain how to build and implement repeatable innovation processes inside a company. 

Here’s their introduction to the key concepts inside the playbook.

Over 75% of executives report that innovation is a top three priority at their companies. However, only 20% of executives indicate that their companies are ready to innovate at scale. This is the challenge for contemporary organizations: How to develop a world-class ecosystem that can drive repeatable innovation at scale.

The playbook describes the three pillars of corporate innovation: Innovation Portfolios, Innovation Programs and a Culture of Innovation. Under each pillar, the playbook describes three questions that leaders and teams can ask to evaluate whether their company has the right innovation ecosystem in place.

Innovation Portfolio: what are your company’s portfolio of innovation projects?

Are your company’s innovation efforts exploring or exploiting business modes?Does your company have a balanced portfolio of projects that cover efficiency, sustaining and transformative innovation? What is the health of your innovation funnel or pipeline?

Explore: Search for new value propositions and business models by designing and testing new business ideas rather than execution. 

Exploit: Manage existing business models by scaling emerging businesses, renovating declining ones and protecting the successful ones.

Innovation Programs: how are your company’s innovation programs are structured and managed.

Do your leaders get excited about the wrong innovation programs?What results are your innovation programs producing? Are your company’s innovation programs interconnected in a strategic way?

To close the innovation capability gap, companies can evaluate their innovation programs by asking whether they’reinnovation theater or producing tangible results for the company.

Value Creation: Creating new products, services, value propositions and business models. These programs invest in and manage innovation projects that create value by producing new growth or cost savings.Culture Change: Transforming the company to establish an innovation culture. This may include new processes, metrics, incentive systems, or changing organizational structures. These transformations help the company innovate in a consistent and repeatable way.

Innovation Culture: What are the blockers and enablers of innovation in your company –

How much time does your leadership spend on innovation?Where does innovation live in your organization and how much power does it have? What is your kill rate for innovation projects?

To overcome the innovation capability gap, companies need to create a culture that enables the right behaviors to produce world-class innovative outcomes. A reliable indicator of the quality of your innovation culture is how innovation teams would describe it. Is it a culture that is dominated by blockers of innovation or enablers of innovation?

Leadership Support: How can corporate leaders have the biggest impact on innovation in terms of time spent, strategic guidance, and resource allocation.Organizational Design: How to give innovation legitimacy and power, the right incentives, and clear policies for collaboration with the core business.Innovation Practice: How to develop people’s innovation skills and experience and acquire the right innovation talent. How to ensure that we are using the right tools, processes, and metrics to test and adapt ideas in order to reduce risk.

  Lessons Learned

The three pillars of an innovation ecosystem:Innovation PortfoliosInnovation Programs a Culture of InnovationDownload the Osterwalder Playbook here

A Simple Map for Innovation at Scale

An edited version of this article previously appeared in the Boston Consulting Group’s strategy think tank website.

I spent last week at a global Fortune 50 company offsite watching them grapple with disruption. This 100+-year-old company has seven major product divisions, each with hundreds of products. Currently a market leader, they’re watching a new and relentless competitor with more money, more people and more advanced technology appear seemingly out of nowhere, attempting to grab customers and gain market share.

This company was so serious about dealing with this threat (they described it as “existential to their survival”) that they had mobilized the entire corporation to come up with new solutions. This wasn’t a small undertaking, because the threats were coming from multiple areas in multiple dimensions; How do they embrace new technologies? How do they convert existing manufacturing plants (and their workforce) for a completely new set of technologies? How do they bring on new supply chains? How do they become present on new social media and communications channels? How do they connect with a new generation of customers who had no brand loyalty? How to they use the new distribution channels competitors have adopted? How do they make these transitions without alienating and losing their existing customers, distribution channels and partners? And how do they motivate their most important asset – their people – to operate with speed, urgency, and passion?

The company believed they had a handful of years to solve these problems before their decline would become irreversible. This meeting was a biannual gathering of all the leadership involved in the corporate-wide initiatives to out-innovate their new disruptors. They called it the “Tsunami Initiative” to emphasize they were fighting the tidal wave of creative destruction engulfing their industry.

To succeed they realized this isn’t simply coming up with one new product. It meant pivoting an entire company – and its culture. The scale of solutions needed dwarf anything a single startup would be working on.

The company had hired a leading management consulting firm that helped them select 15 critical areas of change the Tsunami Initiative was tasked to work on. My hosts, John and Avika, at the offsite were the co-leads overseeing the 15 topic areas. The consulting firm suggested that they organize these 15 topic areas as a matrix organization, and the ballroom was filled with several hundred people from across their company –  action groups and subgroups with people from across the company: engineering, manufacturing, market analysis and collection, distribution channels, and sales. Some of the teams even included some of their close partners. Over a thousand more were working on the projects in offices scattered across the globe.

John and Avika had invited me to look at their innovation process and offer some suggestions.

Are these the real problems?
This was one of the best organized innovation initiatives I have seen. All 15 topic had team leads presenting poster sessions, there were presenters from the field sales and partners emphasizing the urgency and specificity of the problems, and there were breakout sessions where the topic area teams brainstormed with each other. After the end of the day people gathered around the firepit for informal conversations. It was a testament to John and Avika’s leadership that even off duty people were passionately debating how to solve these problems. It was an amazing display of organizational esprit de corps.

While the subject of each of the 15 topic areas had been suggested by the consulting firm, it was in conjunction with the company’s corporate strategy group, and the people who generated these topic area requirements were part of the offsite. Not only were the requirements people in attendance but so was a transition team to facilitate the delivery of the products from these topic teams into production and sales.

However, I noticed that several of the requirements from corporate strategy seemed to be priorities given to them from others (e.g. here are the problems the CFO or CEO or board thinks we ought to work on) or likely here are the topics the consulting firm thought they should focus on) and/or were from subject matter experts (e.g. I’m the expert in this field. No need to talk to anyone else; here’s what we need). It appeared the corporate strategy group was delivering problems as fixed requirements, e.g. deliver these specific features and functions the solution ought to provide.

Here was a major effort involving lots of people but missing the chance to get the root cause of the problems.

I told John and Avika that I understood some requirements were known and immutable. However, when all of the requirements are handed to the action teams this way the assumption is that the problems have been validated, and the teams do not need to do any further exploration of the problem space themselves.

Those tight bounds on requirements constrain the ability of the topic area action teams to:

Deeply understand the problems – who are the customers, internal stakeholders (sales, other departments) and beneficiaries (shareholders, etc.)? How to adjudicate between them, priority of the solution, timing of the solutions, minimum feature set, dependencies, etc.Figure out whether the problem is a symptom of something more importantUnderstand whether the problem is immediately solvable, requires multiple minimum viable products to test several solutions, or needs more R&D

I noticed that with all of the requirements fixed upfront, instead of having a freedom to innovate, the topic area action teams had become extensions of existing product development groups. They were getting trapped into existing mindsets and were likely producing far less than they were capable of. This is a common mistake corporate innovation teams tend to make.

I reminded them that when team members get out of their buildings and comfort zones, and directly talk to, observe, and interact with the customers, stakeholders and beneficiaries, it allows them to be agile, and the solutions they deliver will be needed, timely, relevant and take less time and resources to develop. It’s the difference between admiring a problem and solving one.

As I mentioned this, I realized having all fixed requirements is a symptom of something else more interesting – how the topic leads and team members were organized. From where I sat, it seemed there was a lack of a common framework and process. 

Give the Topic Areas a Common Framework
I asked John and Avika if they had considered offering the topic action team leaders and their team members a simple conceptual framework (one picture) and common language. I suggested this would allow the teams to know when and how to “ideate” and incorporate innovative ideas that accelerate better outcomes. The framework would use the initial corporate strategy requirements as a starting point rather than a fixed destination. See the diagram.

I drew them a simple chart and explained that most problems start in the bottom right box.

These are “unvalidated” problems. Teams would use a customer discovery process to validate them. (At times some problems might require more R&D before they can be solved.) Once the problems are validated, teams move to the box on the bottom left and explore multiple solutions. Both boxes on the bottom are where ideation and innovation-type of problem/solution brainstorming are critical. At times this can be accelerated by bringing in the horizon 3, out-of-the-box thinkers that every company has, and let them lend their critical eye to the problem/solution.

If a solution is found and solves the problem, the team heads up to the box on the top left.

But I explained that very often the solution is unknown. In that case think about having the teams do a “technical terrain walk.” This is the process of describing the problem to multiple sources (vendors, internal developers, other internal programs) debriefing on the sum of what was found. A terrain walk often discovers that the problem is actually a symptom of another problem or that the sources see it as a different version of the problem. Or that an existing solution already exists or can be modified to fit.

But often, no existing solution exists. In this case, teams could head to the box on the top right and build Minimal Viable Products – the smallest feature set to test with customers and partners. This MVP testing often results in new learnings from the customers, beneficiaries, and stakeholders –  for example, they may tell the topic developer that the first 20% of the deliverable is “good enough” or the problem has changed, or the timing has changed, or it needs to be compatible with something else, etc. Finally, when a solution is wanted by customers/beneficiaries/stakeholders and is technically feasible, then the teams move to the box on the top left.

The result of this would be teams rapidly iterating to deliver solutions wanted and needed by customers within the limited time the company had left.

Creative destruction
Those companies that make it do so with an integrated effort of inspired and visionary leadership, motivated people, innovative products, and relentless execution and passion.

Watching and listening to hundreds of people fighting the tsunami in a legendary company was humbling.

I hope they make it.

Lessons Learned

Creative destruction and disruption will happen to every company. How will you respond?Topic action teams need to deeply understand the problems as the customer understands them, not just what the corporate strategy requirements dictateThis can’t be done without talking directly to the customers, internal stakeholders, and partnersConsider if the corporate strategy team should be more facilitators than gatekeepersA light-weight way to keep topic teams in sync with corporate strategy is to offer a common innovation language and problem and solution framework

Mapping the Unknown – The Ten Steps to Map Any Industry

A journey of a thousand miles begins with a single step

 Lǎozi 老子

I just had lunch with Shenwei, one of my ex-students who had just taken a job in a mid-sized consulting firm.  After a bit of catching up I offered he was looking a bit lost. “I just got handed a project to help our firm enter a new industry – semiconductors. They want me to map out the space so we can figure out where we can add value.

When I asked what they already knew about it, they tossed me a tall stack of industry and stock analyst reports, company names, web sites, blogs. I started reading through a bunch of it and I’m drowning in data but don’t know where to start. I feel like I don’t know a thing.”

I told Shenwei I was happy for him because he had just been handed an awesome learning opportunity – how to rapidly understand and then map any new market. He gave me a “easy for you to say” look, but before he could object I handed him a pen and a napkin and asked him to write down the names of companies and concepts he read about that have anything to do with the semiconductor business – in 30 seconds. He quickly came up with a list with 9 names/terms. (See Mapping – First Pass)

“Great, now we have a start. Now give me a few words that describe what they do, or mean, or what you don’t know about them.”

Don’t let the enormity of unknowns frighten you. Start with what you do know.

After a few minutes he came up with a napkin sketch that looked like the picture in Mapping – Second Pass. 
Now we had some progress.

I pointed out he now had a starter list that not only contained companies but the beginning of a map of the relationships between those companies. And while he had a few facts, others were hypotheses and concepts. And he had a ton of unanswered questions.

We spent the next 20 minutes deconstructing that sketch and mapping out the Second Pass list as a diagram (see Mapping – Third Pass.)

As you keep reading more materials, you’ll have more questions than facts. Your goal is to first turn the questions into testable hypotheses (guesses). Then see if you can find data that turns the hypotheses into facts. For a while the questions will start accumulating faster than the facts. That’s OK.

Note that even with just the sparse set of information Shenwei had, in the bottom right-hand corner of his third mapping pass, a relationship diagram of the semiconductor industry was beginning to emerge.

Drawing a diagram of the relationships of companies in an industry can help you deeply understand how the industry works and who the key players are. Start building one immediately. As you find you can’t fill in all the relationships, the gaps outlining what you need to learn will become immediately visible.

As the information fog was beginning to lift, I could see Shenwei’s confidence returning. I pointed out that he had a real advantage that his assignment was in a known industry with lots of available information. He quickly realized that he could keep adding information to the columns in the third mapping pass as he read through the reports and web sites.

Google and Google Scholar are your best friends. As you discover new information increase your search terms.

My suggestion was to use the diagram in the third mapping pass as the beginning of a wall chart – either physically (or virtually if he could keep it in all in his head). And every time he learned more about the industry to update the relationship diagram of the industry and its segments. (When he pointed out that there were existing diagrams of the semiconductor industry he could copy, I suggested that he ignore them. The goal was for him to understand the industry well enough that he could draw his own map ab initio – from the beginning. And if he did so, he might create a much better one.)

When lunch was over Shenwei asked if it was OK if he checked in with me as he learned new things and I agreed. What he didn’t know was that this was only the first step in a ten-step industry mapping process.

Epilog

Over the next few weeks Shenwei shared what he had learned and sent me his increasingly refined and updated industry relationship map. (The 4th  mapping pass showed up 48 hours later.)In exchange I shared with him the news that he was on step one of a ten step industry mapping program. Other the next few weeks he quickly built on the industry map to answer questions 2 through 10 below.

Two weeks later he handed his leadership an industry report that covered the ten steps below and contained a sophisticated industry diagram he created from scratch. A far cry from his original napkin sketch!

Six months later his work on this project convinced his company that there was a large opportunity in the semiconductor space, and they started a new practice with him in it. His work won him the “best new employee” award.

The Ten Steps to Map any Industry

Start by continuously refining your understanding of the industry by diagramming it. List all the new words you encounter and create a glossary in your own words. Start collecting the best sources of information you’ve read.

Basic Industry Understanding

Diagram the industry and its segmentsStart with anythingBuild your learning by successive iterationWho are the key suppliers to each segment?How does this industry feed into the larger economy?Create a glossary of industry unique termsCan you explain them to others? Are there analogies to other markets?Who are the industry experts in each segment? For the entire industry?Economic experts? E.g. industry analysts, universities, think tanksTechnology experts? E.g. universities, think tanksGeographic experts?Key Conferences, blogs, web sites, etc.What are the best opensource data feeds?What are the best paid resources?Overlay numbers, dollars, market share, Compound Annual Growth Rate (CAGR) on all parts of the industry diagram. That will inform velocity and direction of the market.

Detailed Industry Understanding

Who are the market leaders? New entrants? In revenue, market share and growth rateIn the U.S.Western countriesChinaUnderstand the technology flowsWho builds on top of whoWho is critical versus who can be substitutedUnderstand the economic flowsWho buys from who in this industryWho buys the output from this industry.How cyclical is demand?What are the demand drivers?How do companies inside each segment get funded? Any differences in capital requirements? Ease of starting, etc.If applicable, understand the personnel flow for each segmentDo people move just between their segments or up and down through the entire industry?Where do they get trained?The beginner’s forecasting method is to simply extrapolate current growth rates forward. But in today’s technology markets, discontinuities are coming fast and furious. Are there other technologies from adjacent markets will impact this one? (e.g. AI, Quantum, High performance computing,…?). Are there other global or national economic initiatives that could change the shape of the market?

Forecasting

What’s changed in the last 10 years? 5 years?Diagram the past incarnations of the industryWhat’s going to change in the next 5 years?Any big insight on disruption?New entrants?New technology?New foreign suppliers?Diagram your model of the industry in 5 years

National Industrial Policy – Private Capital and The America’s Frontier Fund Steps Up

This article previously appeared in The National Interest.

Last month the U.S. passed the CHIPS and Science Act, one of the first pieces of national industrial policy – government planning and intervention in a specific industry — in the last 50 years, in this case for semiconductors. After the celebratory champagne has been drunk and the confetti floats to the ground it’s helpful to put the CHIPS Act in context and understand the work that government and private capital have left to do.

Today the United States is in great power competition with China. It’s a contest over which nation’s diplomatic, information, military and economic system will lead the world in the 21st century. And the result is whether we face a Chinese dystopian future or a democratic one, where individuals and nations get to make their own choices. At the heart of this contest is leadership in emerging and disruptive technologies – running the gamut from semiconductors and supercomputers to biotech and blockchain and everything in between.

National Industrial Policy – U.S. versus China
Unlike the U.S., China manages its industrial policy via top-down 5-year plans. Their overall goal is to turn China into a technologically advanced and militarily powerful state that can challenge U.S. commercial and military leadership. Unlike the U.S., China has embraced the idea that national security is inexorably intertwined with commercial technology (semiconductors, drones, AI, machine learning, autonomy, biotech, cyber, semiconductors, quantum, high-performance computing, commercial access to space, et al.)  They’ve made what they call military/civil fusion – building a dual-use ecosystem by tightly coupling their commercial technology companies with their defense ecosystem.

China has used its last three 5-year plans to invest in critical technologies (semiconductors, supercomputers, Al/ML, quantum, access to space, biotech.) as a national priority. They have built a sophisticated public/private financing ecosystem to support these plans. The Chinese technology funding ecosystem includes regional investment funds that exceed 700 billion dollars (what they call their Civil/Military Guidance Funds). These are investment vehicles in which central and local government agencies make investments that are combined with private venture capital and State-Owned Enterprises in areas of strategic importance. They are tightly coupling critical civilian companies to their defense ecosystem to help them develop military weapons and strategic surprises. (Tai Ming Cheung’s book is the best description of the system.)

The U.S. has nothing comparable.

In contrast, for the last several decades, planning in the U.S. economy was left to “the market.” Driven by economic theory from the Chicago School of Economics, its premise is that free markets best allocate resources in an economy and that minimal, or even no, government intervention is best for economic prosperity. We ran our economy on this theory as a bipartisan experiment in the U.S. for the last several decades. Optimizing profit above else led to wholesale offshoring of manufacturing and entire industries in order to lower costs. Investors shifted to making massive investments in industries with the quickest and greatest returns without long-term capital investments (e.g. social media, ecommerce, gaming) instead of in hardware, semiconductors, advanced manufacturing, transportation infrastructure, etc. The result was that by default, private equity and venture capital were the de facto decision makers of U.S. industrial policy.

With the demise of the Soviet Union and the U.S. as the sole superpower, this “profits first” strategy was “good enough” as there was no other nation that could match our technical superiority. That changed when we weren’t paying attention.

China’s Ambition and Strategic Surprises
In the first two decades of the 21st century, while the U.S. was focused on combating non-nation states (ISIS, Al-Qaeda…) U.S. policymakers failed to understand China’s size, scale, ambition, and national commitment to surpass the U.S. as the global leader in technology. Not just in “a” technology but in all of those that are critical to both our national and economic security in this century.

China’s top-down national industrial policy means we are being out-planned, outmanned, and outspent. By some estimates, China could be the leader in a number of critical technology areas sooner than we think. While Chinese investment in technology at times has been redundant and wasteful, the sum of these tech investments has resulted in a series of strategic surprises to the U.S.– hypersonics, ballistic missiles with maneuverable warheads as aircraft carrier killers, fractional orbital bombardment systems, rapid advances in space, semiconductors, supercomputers, and biotech …with more surprises likely – all with the goal to gain superiority over the U.S. both commercially and militarily.

Limits and Obstacles to China’s Dominance
However, America has advantages that China lacks: capital markets that can be incented not coerced, untapped innovation talent willing to help, labor markets that can be upskilled, university and corporate research that still excels, etc. At the same time, a few cracks are showing in China’s march to technology supremacy; their detention of some of their most successful entrepreneurs and investors, a crackdown on “superfluous” tech (gaming, online tutoring) and a slowdown of listings on the China’s version of NASDAQ, the Shanghai Stock Exchange’s STAR Market – may signal that the party is reining in its “anything goes” approach to pass the U.S.  Simultaneously the U.S. Commerce department has begun to prohibit export of critical equipment and components that China has needed to build their tech ecosystem.

Billionaires and Venture Capital Funding Defense Innovation
In the U.S. DoD’s traditional suppliers of defense tools, technologies, and weapons – the prime contractors and federal labs – are no longer the leaders in many of these emerging and disruptive  technologies.  And while the Department of Defense has world-class people and organizations it’s for a world that no longer exists. (Its inability to rapidly acquire and deploy commercial systems requires an organizational redesign on the scale of Goldwater/Nichols Act, not a reform.)

Technology innovation in many areas now falls to commercial companies. In lieu of a coherent U.S. national investment strategy across emerging and disruptive technologies (think of the CHIPS Act times ten), billionaires in the U.S. have started their own initiatives – Elon Musk – SpaceX and Starlink (reusable rockets and space-based broadband internet), Palmer Lucky –  Anduril (AI and Machine Learning for defense), Peter Theil – Palantir (data analytics). And in the last few years a series of defense-focused venture funds – Shield Capital, Lux Capital, and others – have emerged.

However, depending on billionaires interested in defense is not a sustainable strategy, and venture capital invests in businesses that can become profitable in 10 years or less. This means that technologies that might take decades to mature (fusion, activities in space, new industrial processes, …) get caught up and die in a “Valley of Death.” Attempts to bridge this Valley of Death often find technology companies relying on Government capital. These programs (DIU, In-Q-Tel, AFWERX, et al), are limited in scope, time and success at scale. These government investment programs have largely failed to scale these emerging and disruptive technologies for four reasons:

Government agencies have limited access to top investment talent to help them make sophisticated technical investment decisionsGovernment agencies lack the commercialization skills to help founders turn technical ideas into commercial ventures.While the Dept of Defense has encouraged starting new ventures, it has failed to match it with the acquisition dollars to scale them. There’s no DoD coherent/committed strategy to create a new generation of prime contractors around these emerging and disruptive technologies.No private or government funds operates as “patient capital” – investing in critical deep technologies that may take more than a decade to mature and scale

America’s Frontier Fund
Today one private capital fund is attempting to solve this problem. Gilman Louie, the founder of In-Q-Tel, has started America’s Frontier Fund (AFF.) This new fund will invest in key critical deep technologies to help the U.S. keep pace with the Chinese onslaught of capital focused on this area. AFF plans to raise one billion dollars in “patient private capital” from both public and private sources and to be entirely focused on identifying critical technologies and strategic investing. Setting up their fund as a non-profit allows them to focus on long-term investments for the country, not just what’s expedient to maximize profits. It will ensure these investments grow into large commercial and dual-use companies focused on the national interest.

They’ve built an extraordinary team of experienced venture capitalists (I’ve known Gilman Louie and Steve Weinstein for decades), a world-class chief scientist, a startup incubation team, and they come with a unique and deep understanding of the intersection of national security and emerging and disruptive technologies.

AFF is the most promising effort I have seen in tackling the long-term challenges of funding and scaling emerging and disruptive technologies head-on.

At stake is whether the rest of the 21st century will be determined by an authoritarian government wiling to impose a dystopian future on the world, or free nations able to determine their own future.

These are tough problems to solve, and no single fund is can take on the massive investments China is making, but it’s possible that the AFF’s market driven approach, when combined with the government’s halting steps reengaging in industrial policy, can tip the scale back in our favor.

Here’s hoping they succeed.

Finding and Growing the Islands of Innovation inside a large company – Action Plan for A New CTO

This post previously appeared in Fast Company.

How does a newly hired Chief Technology Officer (CTO) find and grow the islands of innovation inside a large company?

How not to waste your first six months as a new CTO thinking you’re making progress when the status quo is working to keep you at bay?

I just had coffee with Anthony, a friend who was just hired as the Chief Technology Officer (CTO) of a large company (30,000+ people.) He previously cofounded several enterprise software startups, and his previous job was building a new innovation organization from scratch inside another large company. But this is the first time he was the CTO of a company this size.

Good News and Bad
His good news was that his new company provides essential services and regardless of how much they stumbled they were going to be in business for a long time. But the bad news was that the company wasn’t keeping up with new technologies and new competitors who were moving faster. And the fact that they were an essential service made the internal cultural obstacles for change and innovation that much harder.

We both laughed when he shared that the senior execs told him that all the existing processes and policies were working just fine. It was clear that at least two of the four divisions didn’t really want him there. Some groups think he’s going to muck with their empires. Some of the groups are dysfunctional. Some are, as he said, “world-class people and organizations for a world that no longer exists.”

So the question we were pondering was, how do you quickly infiltrate a large, complex company of that size? How do you put wins on the board and get a coalition working? Perhaps by getting people to agree to common problems and strategies? And/or finding the existing organizational islands of innovation that were already delivering and help them scale?

The Journey Begins
In his first week the exec staff had pointed him to the existing corporate incubator. Anthony had long come to the same conclusion I had, that highly visible corporate incubators do a good job of shaping culture and getting great press, but most often their biggest products were demos that never get deployed to the field. Anthony concluded that the incubator in his new company was no exception. Successful organizations recognize that innovation isn’t a single activity (incubators, accelerators, hackathons); it is a strategically organized end-to-end process from idea to deployment.

In addition, he was already discovering that almost every division and function was building groups for innovation, incubation and technology scouting. Yet no one had a single road map for who was doing what across the enterprise. And more importantly it wasn’t clear which, if any, of those groups were actually continuously delivering products and services at high speed.  His first job was to build a map of all those activities.

Innovation Heroes are Not Repeatable or Scalable
Over coffee Anthony offered that in a company this size he knew he would find “innovation heroes” – the individuals others in the company point to who single-handedly fought the system and got a new product, project or service delivered (see article here.) But if that was all his company had, his work was going to be much tougher than he thought, as innovation heroics as the sole source of deployment of new capabilities are a sign of a dysfunctional organization.

Anthony believed one of his roles as CTO was to:

Map and evaluate all the innovation, incubation and technology scouting activitiesHelp the company understand they need innovation and execution to occur simultaneously. (This is the concept of an ambidextrous organization (seethis HBR article).)Educate the company that innovation and execution have different processes, people, and culture. They need each other – and need to respect and depend on each otherCreate an innovation pipeline – from problem to deployment – and get it adopted at scale

Anthony was hoping that somewhere three, four or five levels down the organization were the real centers of innovation, where existing departments/groups – not individuals – were already accelerating mission/delivering innovative products/services at high speed. His challenge was to

find these islands of innovation and who was running them and understand if/how they

Leveraged existing company competencies and assetsUnderstand if/how they co-opted/bypassed existing processes and proceduresHad a continuous customer discovery to create products that customers need and wantFigured out how to deliver with speed and urgencyAnd if they somehow had made this a repeatable process

If these groups existed, his job as CTO was to take their learning and:

Figure out what barriers the innovation groups were running into and help build innovation processes in parallel to those for executionUse their work to create a common language and tools for innovation around rapid acceleration of existing mission and deliveryMake permanent delivering products and services at speed with a written innovation doctrine and policyInstrument the process with metrics and diagnostics

Get out of the office
So with another cup of coffee the question we were trying to answer was, how does a newly hired CTO find the real islands of innovation in a company his size?

A first place to start was with the innovation heroes/rebels. They often know where all the innovation bodies were buried. But Anthony’s insight was he needed to get out of his 8th floor office and spend time where his company’s products and services were being developed and delivered.

It was likely that most innovative groups were not simply talking about innovation, but were the ones who rapidly delivering innovative solutions to customer’s needs.

One Last Thing
As we were finishing my coffee Anthony said, “I’m going to let a few of the execs know I’m not out for turf because I only intend to be here for a few years.” I almost spit out the rest of my coffee. I asked how many years the division C-level staff has been at the company. “Some of them for decades” he replied.  I pointed out that in a large organization saying you’re just “visiting” will set you up for failure, as the executives who have made the company their career will simply wait you out.

As he left, he looked at a bit more concerned than we started. “Looks like I have my work cut out for me.”

Lessons Learned

Large companies often have divisions and functions with innovation, incubation and technology scouting all operating independently with no common language or toolsInnovation heroics as the sole source of deployment of new capabilities are a sign of a dysfunctional organizationInnovation isn’t a single activity (incubators, accelerators, hackathons); it is a strategically organized end-to-end process from idea to deploymentSomewhere three, four or five levels down the organization are the real centers of innovation – accelerating mission/delivering innovative products/services at high speedThe CTO’s job is to:create a common process, language and tools for innovationmake them permanent with a written innovation doctrine and policyAnd don’t ever tell anyone you’re a “short timer”

Lessons for the DoD – From Ukraine and China

 Portions of this post previously appeared in War On the Rocks.

Looking at a satellite image of Ukraine online I realized it was from Capella Space – one of our Hacking for Defense student teams who now has 7 satellites in orbit.

National Security is Now Dependent on Commercial Technology
They’re not the only startup in this fight. An entire wave of new startups and scaleups are providing satellite imagery and analysis, satellite communications, and unmanned aerial vehicles supporting the struggle.

For decades, satellites that took detailed pictures of Earth were only available to governments and the high-resolution images were classified. Today, commercial companies have their own satellites providing unclassified imagery. The government buys and distributes commercial images from startups to supplement their own and shares them with Ukraine as part of a broader intelligence-sharing arrangement that the head of Defense Intelligence Agency described as “revolutionary.” By the end of the decade, there will be 1000 commercial satellites for every U.S. government satellite in orbit.

At the onset of the war in Ukraine, Russia launched a cyber-attack on Viasat’s KA-SAT satellite, which supplies Internet across Europe, including to Ukraine. In response, to a (tweeted) request from Ukraine’s vice prime minister, Elon Musk’s Starlink satellite company shipped thousands of their satellite dishes and got Ukraine back on the Internet. Other startups are providing portable cell towers – “backpackable” and fixed.  When these connect via satellite link, they can provide phone service and WIFI capability. Another startup is providing a resilient, mesh local area network for secure tactical communications supporting ground units.

Drone technology was initially only available to national governments and militaries but is now democratized to low price points and available as internet purchases. In Ukraine, drones from startups are being used as automated delivery vehicles for resupply, and for tactical reconnaissance to discover where threats are. When combined with commercial satellite imagery, this enables pinpoint accuracy to deliver maximum kinetic impact in stopping opposing forces.

Equipment from large military contractors and other countries is also part of the effort. However, the equipment listed above is available commercially off-the-shelf, at dramatically cheaper prices than what’s offered by the large existing defense contractors, and developed and delivered in a fraction of the time. The Ukraine conflict is demonstrating the changing character of war such that low-cost emerging commercial technology is extremely effective when deployed against a larger 20th-century industrialized force that Russia is fielding.

While we should celebrate the organizations that have created and fielded these systems, the battle for the Ukraine illustrates much larger issues in the Department of Defense.

For the first time ever our national security is inexorably intertwined with commercial technology (drones, AI, machine learning, autonomy, biotech, cyber, semiconductors, quantum, high-performance computing, commercial access to space, et al.) And as we’re seeing on the Ukrainian battlefield they are changing the balance of power.

The DoD’s traditional suppliers of defense tools, technologies, and weapons – the prime contractors and federal labs – are no longer the leaders in these next-generation technologies – drones, AI, machine learning, semiconductors, quantum, autonomy, biotech, cyber, quantum, high performance computing, et al. They know this and know that weapons that can be built at a fraction of the cost and upgraded via software will destroy their existing business models.

Venture capital and startups have spent 50 years institutionalizing the rapid delivery of disruptive innovation. In the U.S., private investors spent $300 billion last year to fund new ventures that can move with the speed and urgency that the DoD now requires. Meanwhile China has been engaged in a Civil/Military Fusion program since 2015 to harness these disruptive commercial technologies for its national security needs.

China – Civil/Military Fusion
Every year the Secretary of Defense has to issue a formal report to Congress: Military and Security Developments Involving the People’s Republic of China. Six pages of this year’s report describe how China is combining its military-civilian sectors as a national effort for the PRC to develop a “world-class” military and become a world leader in science and technology. A key part of Beijing’s strategy includes developing and acquiring advanced dual-use technology. It’s worth thinking about what this means – China is not just using its traditional military contractors to build its defense ecosystem; they’re mobilizing their entire economy – commercial plus military suppliers. And we’re not.

DoD’s Civil/Military Orphan-Child – the Defense Innovation Unit
In 2015, before China started its Civil/Military effort, then-Secretary of Defense Ash Carter, saw the need for the DoD to understand, embrace and acquire commercial technology. To do so he started the Defense Innovation Unit (DIU). With offices in Silicon Valley, Austin, Boston, Chicago and Washington, DC, this is the one DoD organization with the staffing and mandate to match commercial startups or scaleups to pressing national security problems. DIU bridges the divide between DOD requirements and the commercial technology needed to address them with speed and urgency. It accelerates the connection of commercial technology to the military. Just as importantly, DIU helps the Department of Defense learn how to innovate at the same speed as tech-driven companies.

Many of the startups providing Ukraine satellite imagery and analysis, satellite communications, and unmanned aerial vehicles were found by the Defense Innovation Unit (DIU). Given that DIU is the Department of Defense’s most successful organization in developing and acquiring advanced dual-use technology, one would expect the department to scale the Defense Innovation Unit by a factor of ten. (Two years ago, the House Armed Services Committee in its Future of Defense Task Force report recommended exactly that—a 10X increase in budget.) The threats are too imminent and stakes too high not to do so.

So what happened?

Congress cut their budget by 20%.

And their well-regarded director just resigned in frustration because the Department is not resourcing DIU nor moving fast enough or broadly enough in adopting commercial technology.

Why? The Defense Ecosystem is at a turning point. Defense innovation threatens entrenched interests. Given that the Pentagon budget is essentially fixed, creating new vendors and new national champions of the next generation of defense technologies becomes a zero-sum game.

The Defense Innovation Unit (DIU) had no advocates in its chain of command willing to go to bat for it, let alone scale it.

The Department of Defense has world-class people and organization for a world that no longer exists
The Pentagon’s relationship with startups and commercial companies, already an arms-length one, is hindered by a profound lack of understanding about how the commercial innovation ecosystem works and its failure of imagination about what venture and private equity funded innovation could offer. In the last few years new venture capital and private equity firms have raised money to invest in dual-use startups. New startups focused on national security have sprung up and they and their investors have been banging on the closed doors of the defense department.

If we want to keep pace with our adversaries, we need to stop acting like we can compete with one hand tied behind our back. We need a radical reinvention of our civil/military innovation relationship. This would use Department of Defense funding, private capital, dual-use startups, existing prime contractors and federal labs in a new configuration that could look like this:

Create a new defense ecosystem encompassing startups, and mid-sized companies at the bleeding edge, prime contractors as integrators of advanced technology, federally funded R&D centers refocused on areas not covered by commercial tech (nuclear and hypersonics). Make it permanent by creating an innovation doctrine/policy.

Reorganize DoD Research and Engineering to allocate its budget and resources equally between traditional sources of innovation and new commercial sources of innovation.

Scale new entrants to the defense industrial base in dual-use commercial tech – AI/ML, Quantum, Space, drones, autonomy, biotech, underwater vehicles, shipyards, etc. that are not the traditional vendors. Do this by picking winners. Don’t give out door prizes. Contracts should be >$100M so high-quality venture-funded companies will play.

Reorganize DoD Acquisition and Sustainment to create and buy from new 21st century arsenals – new shipyards, drone manufacturers, etc. that can make 1,000’s of extremely low cost, attritable systems – “the small, the agile and the many.”

Acquire at Speed. Today, the average Department of Defense major acquisition program takes anywhere from nine to 26 years to get a weapon in the hands of a warfighter. DoD needs a requirements, budgeting and acquisition process that operates at commercial speed (18 months or less) which is 10x faster than DoD procurement cycles. Instead of writing requirements, the department should rapidly assess solutions and engage warfighters in assessing and prototyping commercial solutions. We’ll know we’ve built the right ecosystem when a significant number of major defense acquisition programs are from new entrants.

Acquire with a commercially oriented process. Congress has already granted the Department of Defense “Other Transaction Authority” (OTA) as a way to streamline acquisitions so they do not need to use Federal Acquisition Regulations (FAR). DIU has created a “Commercial Solutions Opening” to mirror a commercial procurement process that leverages OTA. DoD could be applying Commercial Solutions Openings on a much faster and broader scale.

Integrate and create incentives for the Venture Capital/Private Equity ecosystem to invest at scale. The most important incentive would be for DoD to provide significant contracts for new entrants. (One new entrant which DIU introduced, Anduril, just received a follow-on contract for $1 billion. This should be one of many such contracts and not an isolated example.) More examples could include: matching dollars for national security investments (similar to the SBIR program but for investors), public/private partnership investment funds, or tax holidays and incentives – to get $10’s of billions of private investment dollars in technology areas of national interest.

Buy where we can; build where we must. Congress mandated that the Department of Defense should use commercial off-the-shelf technology wherever possible, but the department fails to do this (see industry letter to the Department of Defense).

Coordinate with Allies. Expand the National Security Innovation Base (NSIB) to an Allied Security Innovation Base. Source commercial technology from allies.

This is a politically impossible problem for the Defense Department to solve alone. Changes at this scale will require Congressional and executive office action. Hard to imagine in the polarized political environment. But not impossible.

Put Different People in Charge and reorganize around this new ecosystem. The threats, speed of change, and technologies the United States faces in this century require radically different mindsets and approaches than those it faced in the 20th century. Today’s leaders in the DoD, executive branch and Congress haven’t fully grasped the size, scale, and opportunity of the commercial innovation ecosystem or how to build innovation processes to move with the speed and urgency to match the pace China has set.

Change is hard – on the people and organizations inside the DoD who’ve spent years operating with one mindset to be asked to pivot to a new one.

But America’s adversaries have exploited the boundaries and borders between its defense and commercial and economic interests. Current approaches to innovation across the government — both in the past and under the current administration —  are piecemeal, incremental, increasingly less relevant, and insufficient.

These are not problems of technology. It takes imagination, vision and the willingness to confront the status quo. So far, all are currently lacking.

Russia’s Black Sea flagship Moskva on the bottom of the ocean and the thousands of its destroyed tanks illustrate the consequences of a defense ecosystem living in the past. We need transformation not half-measures. The U.S. Department of Defense needs to change.

Historically, major defense reforms have come from inside the DoD, at other times Congress (National Security Act of 1947, Goldwater-Nichols Act of 1986) and others from the President (Roosevelt’s creation of the Joint Chiefs in 1942, Eisenhower and the Department of Defense Reorganization Act of 1958.)

It may be that the changes needed are so broad that the DoD can’t make them and Congress needs to act. If so, it’s their time to step up.

Carpe diem. Seize the day.

Cram Down – A Test of Character for VCs and Founders

This article previously appeared in TechCrunch.

Cram downs are back – and I’m keeping a list.

At the turn of the century after the dotcom crash, startup valuations plummeted, burn rates were unsustainable, and startups were quickly running out of cash. Most existing investors (those still in business) hoarded their money and stopped doing follow-on rounds until the rubble had cleared.

Except, that is, for the bottom feeders of the Venture Capital business – investors who “cram down” their companies. They offered desperate founders more cash but insisted on new terms, rewriting all the old stock agreements that previous investors and employees had. For existing investors, sometimes it was a “pay-to-play” i.e. if you don’t participate in the new financing you lose. Other times it was simply a take-it-or-leave-it, here are the new terms. Some even insisted that all prior preferred stock had to be converted to common stock. For the common shareholders (employees, advisors, and previous investors), a cram down is a big middle finger, as it comes with reverse split – meaning your common shares are now worth 1/10th, 1/100th or even 1/1000th of their previous value.

(A cram down is different than a down round. A down round is when a company raises money at valuation that is lower than the company’s valuation in its prior financing round. But it doesn’t come with a massive reverse split or change in terms.)

They’re Back
While cram downs never went away, the flood of capital in the last decade meant that most companies could raise another round. But now with the economic conditions changing, that’s no longer true. Startups that can’t find product/market fit and/or generate sufficient revenue and/or lacked patient capital are scrambling for dollars – and the bottom feeders are happy to help.

Why do VCs Do This?
VCs will wave all kinds of reasons why – “it’s my fiduciary responsibility (which is BS because venture capital is a power-law business, not a “salvage every penny business”) or “it’s just good business” or “we’re opportunistic.”  On one hand they’re right. Venture capital, like most private equity, is an unregulated financial asset class – anything goes. But the simpler and more painful truth is that it’s abusive and usurious.

Many VCs have no moral center in what they invest in or what they’ll do to maximize their returns. On one hand the same venture capital industry that gave us Apple, Intel, Tesla, and SpaceX, also thinks addicting teens is a viable business model (Juul) or destroying democracy (Facebook) is a great investment. And instead of society shunning them, we celebrate them and their returns. We let the VC narrative of “all VC investments are equally good” equal “all investments are equally good for society.”

Why would any founder agree to this?
No founder is prepared to watch their company crumble beneath them. There’s a growing sense of panic as you frantically work 100-hour weeks, knowing years of work are going to disappear unless you can find additional investment. You’re unable to sleep and trying not to fall into complete despair. Along comes an investor (often one of your existing ones) with a proposal to keep the company afloat and out of sheer desperation, you grab at it. You swallow hard when you hear the terms and realize it’s going to be a startup all over again. You rationalize that this is the only possible outcome, the only way to keep the company afloat.

But then there’s one more thing – to make it easier for you and a few key employees to swallow the cram down – they promise that you’ll get made whole again (by issuing you new stock) in the newly recapitalized company. Heck, all your prior investors, employees and advisors who trusted and bet on you get nothing, but you and a few key employees come out OK. All of a sudden the deal which seemed unpalatable is now sounding reasonable. You start rationalizing why this is good for everyone.

You just failed the ethical choice and forever ruined your reputation.

Cram downs wouldn’t exist without the founder’s agreement.

Stopping Cram Downs
In the 20th century terrorists took hostages from many countries except from the Soviet Union. Why? Western countries would negotiate frantically with the terrorists and offer concessions, money, prisoner exchanges, etc. Seeing their success hostage taking continued. The Soviet Union? Terrorists took Russians hostages once. The Soviets sent condolences to the hostage families and never negotiated. Terrorists realized it was futile and focused on western hostages.

VCs will stop playing this game when founders stop negotiating.

You Have a Choice
In the panic of finding money founders forget they have a choice. Walk away. Shut the company down and start another one. Stop rationalizing how bad a choice that is and convincing yourself that you’re doing the right thing. You’re not.

The odds are that after your new funding most of your employees will be left with little or nothing to show for their years of work. While a few cram downs have been turned around, (though I can’t think of any) given you haven’t found enough customers by now, the odds are you’re never going to be a successful enterprise. Your cram down investors will likely sell your technology for piece parts and/or use your company to benefit their other portfolio companies.

You think of the offer of cram down funding as a lifeline, but they’ve handed you a noose.

Time to Think
With investors pressuring you and money running out, it’s easy to get so wound-up thinking that this is the only and best way out. If there ever was a time to pause and take a deep breath, it’s now. Realize you need time to put the current crisis in context and to visualize other alternatives. Take a day off and imagine what’s currently unimaginable – what would life be like after the company ends? What else have you always wanted to do? What other ideas do you have? Is now the time to reconnect with your spouse/family/others to decompress and get some of your own life back?

Don’t get trapped in your own head thinking you need to solve this problem by yourself. Get advice from friends, mentors and especially your early investors and advisors. There is nothing worse that guarantees you permanently ruin relationships (and your reputation) is for early investors and advisors to hear about your decision to take a cram down is when you ask them for signatures on a decision that’s already been made.

Being able to assess alternatives in a crisis is a life-long skill. Life is short. Knowing when to double down and knowing when to walk away is a critical skill.

In the long run, your employees, and the venture ecosystem would be better served if you used your experience and knowledge in a new venture and took another shot at the goal.

Winners leave the field with those they came with. 

Lessons Learned

Cram downs are done by VC bottom feedersTaking an “unfair advantage” and contributing to the toxicity of the startup ecosystemFounders often believe they need to take a cram down rationalizing “I’ll never have another good idea, I have so much time and effort sunk into this startups, I don’t have enough energy to do it again, etc.”Founders rationalize it’s good for their employeesTake time to think about alternativesDon’t get trapped in your own head thinking you need to solve this problem by yourselfYou’re burning the very people who were your early supportersWalk awayYou can do another startup again with your head held highP.S. if you’re prepared to walk away there are pretty good odds you’ll end up with a much better deal (if you want one)

Here’s What Happened When Deputy Secretary of Defense Dr. Kathleen Hicks visited Stanford’s Gordian Knot Center for National Security Innovation

It was an honor to host US Deputy Secretary of Defense Dr. Kathleen Hicks at Stanford’s Gordian Knot Center for National Security Innovation.  (Think of the Deputy Secretary of Defense as the Chief Operating Officer of a company – but in this case the company has 3 million employees (~1.4 million active duty, 750,000 civilians, ~800,000 in the National Guard and Reserves.)

She came to the Gordian Knot Center to discuss our unique approach to national security and innovation, and how our curriculum trains the next generation of innovators. The Deputy also heard from us how the Department can better partner with and leverage the U.S. innovation ecosystem to solve national security challenges.

Our goal for the Secretary’s visit was to give her a snapshot of how we’re supporting the Department of Defense priority of building an innovation workforce. We emphasized the critical distinction between a technical STEM-trained workforce (which we need) and an innovation workforce which we lack at scale.

Innovation incorporates lean methodologies (customer discovery, problem understanding, MVPs, Pivots), coupled with speed and urgency, and a culture where failure equals rapid learning. All of these are accomplished with minimal resources to deploy at scale products/services that are needed and wanted. We pointed out that Silicon Valley and Stanford have done this for 50 years. And China is outpacing us by adopting the very innovation methods we invented, integrating commercial technology with academic research, and delivering it to the Peoples Liberation Army.

Therein lies the focus of our Gordian Knot Center —connect STEM with policy education and leverage the synergies between the two to develop innovative leaders who understand technology and policy and can solve problems and deliver solutions at speed and scale.

 What We Presented
A key component of the Gordian Knot Center’s mission is to prepare and inspire future leaders to contribute meaningfully as part of the innovation work force. We combine the unique strengths of Stanford and its location in Silicon Valley to solve problems across the spectrum of activities that create and sustain national power. The range of resources and capabilities we bring to the fight from the center’s unique position include:

The insights and expertise of Stanford international and national security policy leadersThe technology insights and expertise of Stanford EngineeringExceptional students willing to help the country win the Great Power CompetitionSilicon Valley’s deep commercial technology ecosystemOur experience in rapid problem understanding, rapid iteration and deployment of solutions with speed and urgencyAccess to risk capital at scale

In the six months since we founded the Gordian Knot Center we have focused on six initiatives we wanted to share with Secretary Hicks. Rather than Joe Felter and I doing all of the talking, 25 of our students, scholars, mentors and alumni joined us to give the Secretary a 3-5 minute precis of their work, spanning across all six of the Gordian Knot initiatives.  Highlights of these presentations include:

Hacking for Defense Teams – Vannevar Labs, FLIP, DisinformatixCONOPS Development National Security Education – Technology, Innovation and Great Power CompetitionDefense Innovation Scholars Program – 25 students now, 50 by the end of the yearPolicy Impact and Outreach –ONR Hedge Strategy, NSC Quad Emerging Technology Track 1.5 ConferenceInternships and Professional Workforce Development – Innovation Workforce Vignettes

Gordian Knot Center Roundtable with Dept SecDef from Steve Blank

If you can’t see the slides click here

Throughout the over 90 minutes session, Dr. Hicks posed insightful questions for the students and told our gathering that one of her key priorities is to accelerate innovation adoption across DoD, including organizational structure, processes, culture, and people.

It was encouraging to hear the words.

However, from where we sit..

Our national security is now inexorably intertwined with commercial technology and is hindered by our lack of an integrated strategy at the highest level.Our adversaries have exploited the boundaries and borders between our defense and commercial and economic interests.Our current approaches – both in the past and current administration – to innovation across the government are piecemeal, incremental, increasingly less relevant and insufficient.

Listening to the secretary’s conversations, I was further reminded of how much of a radical reinvention of our civil/military innovation relationship is necessary if we want to keep abreast of our adversaries. This would use DoD funding, private capital, dual-use startups, existing prime contractors and federal labs  in a new configuration. It would:

Create a new defense ecosystem encompassing startups, scaleups at the bleeding edge, prime contractors as integrators of advanced technology, federally funded R&D centers refocused on areas not covered by commercial tech (nuclear, hypersonics,…). Make it permanent by creating innovation doctrine/policy.

Create new national champions in dual-use commercial tech – AI/ML, Quantum, Space, drones, high performance computing, next gen networking, autonomy, biotech, underwater vehicles, shipyards, etc. who are not the traditional vendors. Do this by picking winners. Don’t give out door prizes. Contracts should be >$100M so high- quality venture-funded companies will play.  Until we have new vendors on the Major Defense Acquisition Program list, all we have in the DoD is innovation theater – not innovation.

Acquire at Speed. Today, the average DoD major acquisition program takes 9-26 years to get a weapon in the hands of a warfighter. We need a requirements, budgeting and acquisition process that operates at commercial speed (18 months or less) which is 10x faster than DoD procurement cycles. Instead of writing requirements, DoD should rapidly assess solutions and engage warfighters in assessing and prototyping commercial solutions.

Integrate and incent the Venture Capital/Private Equity ecosystem to invest at scale. Ask funders what it would take to invest at scale – e.g. create massive tax holidays and incentives to get investment dollars in technology areas of national interest.

Recruit and develop leaders across the Defense Department prepared to meet contempory threats and reorganize around this new innovation ecosystem. The DoD has world-class people and organization for a world that in many ways no longer exists. The threats, speed of change and technologies we face in this century will require radically different mindsets and approaches than those we faced in the 20th century. Today’s senior DoD leaders must think and act differently than their predecessors of a decade ago. Leaders at every level must now understand the commercial ecosystem and how to move with the speed and urgency that China is setting.

It was clear that Deputy Secretary Hicks understands the need for most of if not all these and more. Unfortunately, given the DoD budget is essentially fixed, creating new Primes and new national champions of the next generation of defense technologies becomes a zero-sum game. It’s a politically impossible problem for the Defense Department to solve alone. Changes at this scale will require Congressional action. Hard to imagine in the polarized political environment. But not impossible.

These are our challenges for not just the Gordian Knot Center for National Security Innovation but for our nation. We’ve taken them on, in the words of President John F. Kennedy,  “not because they are easy, but because they are hard. because that goal will serve to organize and measure the best of our energies and skills, because that challenge is one that we are willing to accept, one we are unwilling to postpone, and one which we intend to win.”