"The Founders" and finding success in innovation (Part 1)

Lessons learned from my summer read on the start of PayPal

Quick summary:

• July’s theme is Lessons Learned from Successful Innovation

• PayPal’s founding, turbulent beginning, and subsequent success provides a terrific template for many valuable insights on successful innovation

• While timing and luck played a big role in PayPal’s success, there are 12 principles that your organization can apply to boost your innovation efforts

• This edition covers the first 6 lessons learned; the next edition will cover 6 more

"MWC Barcelona 2013 - eBay, Paypal" by Janitors is licensed under CC BY 2.0.

Revisiting key lessons learned from PayPal

In the last edition of Forestview, I outlined the differences between offensive and defensive innovation which kicks off this month’s theme around Lessons Learned from Successful Innovation. Today, I’m going to provide a deep dive on my takeaways from a recent summer read: The Founders by Jimmy Soni. As mentioned in the last edition of Forestview, the origins of PayPal are worth examining in detail because in many ways the founders and original employees went on to have an outsized influence on Silicon Valley over the past two decades. The windfall that founders such as Peter Thiel and Elon Musk, among others, gained from PayPal’s IPO and later acquisition by eBay directly provided the capital for subsequent startups such as Palantir, SpaceX, and Tesla and their learnings shaped the approach at their new firms to help ensure they would also prove successful.

While the book provides a narration of many twists and turns in the story of PayPal, it also highlights some key success factors that still resonate today. Over and over again, the founding team cited the important of timing and luck in their success: if they had started a bit too early or too late, there is a high probability that PayPal would not have been as successful as it has proven to be. This is true of any organization: unlike science, in business the exact conditions that a firm faces cannot ever be replicated entirely and so we cannot repeat the “experiment” of a startup. Having said that, in my reading I believe there are 12 factors that are replicable from PayPal’s success.

Here are my initial 6 key takeaways and how they can be applied in your organization. I will share the final 6 takeaways in Part 2 which will be delivered next week.

1. As technology progresses, new possibilities emerge

The late 1990s saw the widespread adoption of the Internet and the first handheld mobile devices, the most popular being the PalmPilot. The initial insight from PayPal co-founder and CTO Max Levchin was that these mobile devices had virtually no security and were easily hacked; his initial work was centered around making them safe. The move to mobile was evident to many industry observers, yet corporations were just exploring their use. Established firms were not thinking ahead to the question of security, including hardware and software firms building the technology.

Alongside the need for security was another need: secure payments to enable e-commerce, which was just starting to take off. While some early adopters showed no hesitation in putting credit card information online, many people were concerned about having their information stolen. Security solutions could both prevent hacking and facilitate payments between sellers and buyers. New technological advances are continually being made, which creates new possibilities and market opportunities for firms.

2. Make a big splash to gain attention, attract talent, and secure funding

PayPal was formed by a merger between two startups: Confinity and X.com. Both firms were master of public relations and gaining media attention. Perhaps counterintuitively, by seeking attention early the firms were able to stand out from a crowd of competing firms, which then helped them attract top talent and secure funding from investors. This goes against the tendency of many startups to begin in “stealth mode” today. Far from the traditional advice to “under promise and over deliver”, PayPal looked to stand out from the crowd early on. Even the name “PayPal” came from research by a firm specializing in branding to easily convey to users 1) the value proposition (help facilitating payments) and 2) culture difference compared with traditional banks and credit card firms (to be seen as an ally, not a large company).

3. Identify a core user group, then slowly expand over time

PayPal initially had grand visions of helping users transfer money using mobile devices or being the digital equivalent of a financial supermarket. But most of these big dreams got put aside in favor of the clearly defined needs of a core group of users who were grossly underserved by traditional firms: small sellers on eBay. These individuals were not large retailers but rather hobbyists and budding entrepreneurs that did not think of themselves as classic merchants. Traditional pricing and underwriting processes did not look favorably upon this group, so finding ways to take payments cheaply and easily became a big problem for them.

After pivoting to leverage e-mail as a primary authentication ID, PayPal became an ideal solution for these power users and the feedback from the user community helped the firm develop new features and services to solidify their growing market share. Over time, PayPal saw their outsized reliance on eBay sellers as both an opportunity and a threat, but they never turned away from this core group even while looking to expand to other markets.

4. Be proactive about significant competitive threats

Startups tend to be paranoid about competitive threats while incumbents tend to be more sanguine. PayPal saw a myriad of competitive threats in its early years. Originally, prior to their merger, Confinity and X.com increasingly fought to win the online payments space after originally pursuing different strategies. This quickly became an expensive “race to the bottom” as each firm tried desperately to build up market position through unsustainable bonuses and referral incentives. Eventually , both firms realized each would benefit from combining efforts rather than pursue a “death match” strategy that could have bankrupt both firms. After joining to form PayPal, there was another existential threat from eBay itself which had a competing product named Billpoint and tried hard to put PayPal out of business. As they approached their IPO in 2002, PayPal was also on the lookout for patent infringement lawsuits and regulatory concerns since they did not abide by traditional banking laws.

Each threat PayPal faced was taken seriously and treated as an existential crisis. As a result, PayPal was very proactive in combating competitive threats which became a key reason for their ultimate success. All the while, PayPal worked hard to stay in the good graces of their customer base. After some initial missteps, they quickly stood up a top-notch call center to handle complaints in Omaha, Nebraska and made sure that their offering was superior from a pricing and servicing standpoint to any competitor, even when having to increase fees or tighten usage policies. Their paranoia resulted in the burnout of many employees over time, but served PayPal well early on to ensure its ultimate success.

5. Focus on distribution and achieving scale first, seek profits later

PayPal’s initial approach to gaining market size was quite costly, and this approach became very challenging after the dot-com bust in 2000. However, the leaders properly recognized the power of network effects in the payments space: the more that merchants accepted and embraced PayPal, the more new users would sign up. If few merchants accepted PayPal in the first place, it would be challenging to grow the product. PayPal used cash bonuses, payments for referrals, and low underwriting standards to try to achieve growth. This resulted in a lot of signups - and a lot of fraud. Ironically, the large amount of fraud led PayPal to develop best-in-class fraud detection programs and processes that later became adopted by the FBI to help fight financial crimes. All throughout, there were concerns about profitability, high customer acquisition costs, and a high burn rate that necessitated regular infusions of funding. (A big part of PayPal’s luck had to do with securing significant funding right before the downturn in 2000.)

However, what PayPal’s leaders recognized was that once they achieved scale and sizable adoption by a core group of users, the firm could them raise prices and introduce tighter underwriting restrictions and terms of service that still beat any alternative offered by a competitor. Their plan to achieve profitability was methodical and well thought-out after the environment forced constraints on them in terms of financing constraints. PayPal worked hard on their communication strategy and change management and were meticulous in rolling out changes periodically rather than all at once. While PayPal didn’t hit their initial target date to be profitable, they did not miss by much and they were able to achieve significant profitability long-term.

6. Act with urgency

One key theme from the story of PayPal’s early days is the avoidance of “analysis paralysis” that characterized much of the financial incumbents that PayPal was seeking to crowd out of their online niche. Many early employees cited a culture of empowerment and lack of micromanagement, and founders often cited the desire to move fast rather than attempt to make a non-existent “perfect decision”. Staff meetings were rare; all hands e-mails were more common (and today you can imagine this being replaced by Slack or similar collaboration tools).

Yes, employees worked exceedingly long hours and many slept in the office when it was demanded, which can be typical of early startups. But perhaps the best contrast that showcased the power of PayPal’s culture was the shock many employees faced after being acquired by eBay. While eBay was also a relatively new startup that had scaled quickly, they had many more meetings, formal processes, and supervisor oversight and approvals than PayPal. This led to disillusionment among many of the PayPal employees, some of whom left to form new startups or become investors. While PayPal was perhaps over the top in the creation of their “World Domination Index”, employees acted with a sense of urgency born of the competitive threats they faced and sense for how limited they existence might be and the real costs they bore while iterating through challenges and seeking to achieve profitability. The PayPal mindset compared quite differently with counterparts at traditional banks who moved much more slowly and with less purpose to seize on new opportunities in the market.

In Part 2 coming soon, I will share 6 more lessons learned from the early days of PayPal that are noteworthy for organizations seeking to boost their innovation efforts.