Studies have shown that founder-led businesses outperform other companies in the S&P 500 at a staggering rate. What gives these companies such a competitive edge?
In a well-cited study conducted back in 2016, consulting firm Bain & Company completed a performance analysis of all the S&P 500 firms and found that founder-led business outperformed all others by more than three-to-one between 1990 and 2014.
But what it it that makes founder-led companies so successful?
Amazon founder and CEO Jeff Bezos publishes his annual letter to shareholders every year and in 2016, he spoke about the reasons why he believes that founder-led businesses are usually better businesses. This small excerpt from that letter is one of the most poignant statements ever made about business and investing:
“One area where I think we are especially distinctive is failure. I believe we are the best place in the world to fail (we have plenty of practice!), and failure and invention are inseparable twins. To invent you have to experiment, and if you know in advance that it’s going to work, it’s not an experiment. Most large organizations embrace the idea of invention but are not willing to suffer the string of failed experiments necessary to get there. Outsized returns often come from betting against conventional wisdom, and conventional wisdom is usually right. Given a ten percent chance of a 100 times payoff, you should take that bet every time.”
The business world tends to punish failure, particularly when it comes to big publicly traded companies. In reality, failure is an essential part of innovation and companies with a passionate founder tend to be far less averse to getting things wrong because they have plenty of experience with it.
Simply put, founder-led businesses tend to perform better because their leaders are not just professional CEOs tasked with maximizing shareholder return, but passionate entrepreneurs who know that taking a calculated risk is necessary for the long-term success of their company.
1. Tesla Motors
Elon Musk is one of the world’s most noted entrepreneurs and has said of Tesla Motors (NASDAQ: TSLA) that, “failure is an option here. If you’re not failing, you’re not innovating enough”.
When you’re disrupting an industry as old and embedded as the auto industry, it’s always going to be a tough ride. Tesla is a company that’s certainly no stranger to failure. Short term goals, particularly in terms of the production and delivery of the all-important Model 3, have been missed more often than not, but in the business of changing the way the world fundamentally works, the significance of quarterly goals should not be of primary concern for investors.
Musk now believes the future of Tesla lies in a fleet of robo-taxis, allowing Tesla customers to generate income from their vehicles when they don’t need them. If that sounds pretty farfetched to you, you’re not alone, but Musk’s track record on this kind of stuff is pretty remarkable, if somewhat a bit behind schedule.
The appointment of new Chairman Robyn Denholm late last year will hopefully sort out some of the governance issues at Tesla and allow Musk to do what he’s best at — harnessing that incredible imagination to build the world of the future.
2. Planet Fitness
Most people wouldn’t have believed that there was any real way to differentiate yourself in the world of gyms. What the founders of Planet Fitness (NYSE: PLNT) — Michael and Marc Grondahl — realized back in 1992, however, was that most gym users only use a small subsection of the available equipment. In addition to this, they figured that many casual or first-time gym-goers can find the experience of going to the gym quite intimidating.
With a radical reimagining of the gym experience, they risked massive failure. What they got instead was an entirely new concept that focused on just the simplest equipment and creating the “Judgement Free Zone”, where people could feel comfortable working out.
What they did was to carve out a blue ocean opportunity for themselves — one with a lot fewer competitors. Suddenly, even though what they’re selling is a gym membership, it’s actually a totally different thing, appealing to a totally different type of consumer.
Planet Fitness now has more than 13.6 million members and 1,806 locations across the U.S., Puerto Rico, Canada, the Dominican Republic, Panama, and Mexico. While the Grondahl brothers left back in 2013, the company is now run by their partner Chris Rondeau.
From inception, virtually all the big business decisions made by Netflix (NASDAQ: NFLX) and CEO Reed Hastings carried significant risk: becoming the first online DVD rental store in the world, dropping the option to pay for single rentals and charging a flat monthly subscription fee instead, introducing a streaming service in 2007 that eventually became the company’s primary business.
Possibly the biggest risk taken by the company, however, was to start getting involved in the creation of its own original content. Beginning with ‘House of Cards’ in 2013, Netflix has grown to become one of the biggest producers of TV shows and movies, with $12 billion spent on content in 2018 alone.
This strategy is paying off though, with original programming dominating the company’s most-watched lists, despite making up only 11% of Netflix’s entire U.S. catalog at the end of last year. Netflix has also adopted a ruthless approach to failure with its original content, with the notoriously data-driven company basing the decisions to cancel shows based on algorithms.
But in talking about Netflix and the importance of embracing failure, let’s not forget what might have been one of the most fortuitous failures in business history of the 21st Century: having Blockbuster reject an offer buy the company for $50 million in 2000.
See? Failing isn’t always a bad thing.
Correction: This post was amended on 9/7/19. In the original article, the Grondahl brothers were described as still running Planet Fitness. In fact, Chris Rondeau has been CEO since 2013.
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MyWallSt operates a full disclosure policy. MyWallSt staff currently hold long positions in Netflix and Tesla Motors. Read our full disclosure policy here.