Sometimes things actually start to seem easy; you feel like you’ve made it. Maybe you even think you can stop to rest or at least take a moment to breathe. What I’ve learned is that you can never get too comfortable. Just when you think you’re at the top of your game, something comes along and challenges your position.

Things were finally going well, and we had seven years of success under our belt in which we identified a need no one else had, established an industry, and enabled the shift from manual to electronic trading, then something happened that changed everything. Microsoft Windows came out, shifting from ASCII codes and green-screen computing to a graphical user interface (GUI), which completely changed how people interacted with the computer. This new generation of software was light years ahead of MS-DOS, the system on which our order management system (OMS) application was built. Before too long, customers wanted a new Windows application. We were not yet offering one and didn’t have a solid plan to do so. We knew it would require a huge investment to completely rebuild our application on this new operating system. Competitors started entering our space—none of whom had any legacy systems to replace. They came out with new Windows-based applications. Their new product made ours look incredibly antiquated.

We hadn’t faced any competition for seven years. Now we were in a fierce war with the shiny new things, and we weren’t at all prepared for battle. Windows had been around for a few years, but the early releases were not-ready-for-prime-time, mission-critical applications. IBM also came out with an operating system called OS/2. We didn’t know which to adopt; there wasn’t a clear-cut decision. IBM was a much larger, competitive company back then, and Microsoft was fairly new. One of our largest clients backed OS/2 completely—much to its dismay years later as Windows evolved and completely cornered the market.

We said we would launch a new Windows product to meet the growing demand, but we didn’t. We were making money but not enough to invest in completely rewriting our product for an entirely different operating system. Our sales stalled. Clients grew impatient.

Every day, I went into the office and wanted to hide under the table after every nasty phone call or every time someone came to me with a new problem. It was exhausting. I would walk home 15 blocks and stop halfway to wallow in my depression. At home I would ask myself: What did I get myself into? I became incredibly depressed.

But that kind of reaction would not solve anything. I knew what we had to do. We needed to completely rewrite the application, while at the same time supporting the products we had. It wasn’t a choice. If we did not do this, we would go out of business.

It was incredibly expensive to go through a complete technology change and build a whole new product while keeping the existing one running. We knew we had to bite the bullet and create an entirely separate team to build a parallel product from scratch. Unlike the existing product, where the updated features were funded by existing customers, here we had to fund the entire development ourselves.

We had to continue to sell and customize the old system to keep the money flowing, but we were on a programming treadmill as each new feature we were being paid to add to the old system had to be programmed into the new product but totally at our cost. The more we enhanced the old system, the longer it took us to release the new one. It felt like we were chasing our own tail. It took three years to develop the new product, and it would take another three to get the product stable. It cost millions. We had the cash flow to cover it, but Merrin Financial’s profitability went to zero.

The long development time gave our competitors an opportunity to grab a decent lead and sign up the bulk of new customers. It also ate up all of our profits for the next few years. But we had no choice. This would be an enormous investment, but the consequence of not doing it was financial life or death.

It’s So Easy to Get Disrupted

We’re hardly the only company to have our own disruptive idea disrupted. We’ve seen this happen time and again. A company is first to market only to be bested by new competitors that attract customers with a shiny updated offering free from all the constraints of legacy products. It’s so easy for a company to lose its edge, especially in today’s world where the cost of technology continues to decline and the time to market is so much faster. Once others see you have a successful business model, you can count on competition coming in with something cheaper, faster, or differentiated in some way.

Take Sony and its iconic Walkman. A German-Brazilian guy by the name of Andreas Pavel invented the “Stereobelt,” a personal portable stereo audio cassette player in 1972. Sony came up with a royalty agreement and began selling it as the Walkman in Japan in 1979. It soon became one of the company’s most successful products ever.¹ The Walkman was revolutionary; it changed how we listen to music—making it portable and personal. Sony continued selling iterations of the Walkman, and a host of portable music innovations from other companies followed—the MP3 player, iPod, and iPhone. What’s important to note is that these new entries didn’t change the original idea. They still made music portable and personal. But they did it differently; they used the latest technology to make it easier to access a wider variety of music. With this evolution they were able to completely replace the Walkman, which is no longer manufactured and found today only in attics, on eBay, or at the Museum of Obsolete Technology.

Another example is Digital Equipment Corporation, which was founded by MIT electronics engineers Kenneth Olsen and Harlan Anderson to build high-performance, low-cost computers—minicomputers—in an era of expensive and enormous mainframe computers. The company enjoyed a rapid rise and made it to the number two computer maker, right behind IBM, and even challenged Big Blue’s most powerful mainframes.²

But it didn’t keep that top position secure. In the 1990s it lost market share to Hewlett-Packard and Sun. Why? Both of those companies adopted newer technologies, specifically the nonproprietary UNIX operating system that made far more software applications available than what was on Digital’s proprietary system. The market responded: Digital didn’t make a profit between 1990 and 1995.³ Compaq Computer bought Digital Equipment in 1998 to help it move into enterprise services and compete against IBM, but discontinued Digital’s PC manufacturing. Compaq was then acquired by Hewlett-Packard and sold some of Digital’s products, but under its own logo.

Or what about Atari, which started the home game console craze and brought us some of the most well-known games of all time, including Pong, Space Invaders, and Pac-Man. The company employed Steve Wozniack and Steve Jobs⁴ and skyrocketed to success. Its console, called VCS, was the best-selling holiday gift in 1979, and that year it also released Asteroids, Atari’s most successful game of all time. (It was so popular in arcades that operators had to install larger coin boxes to accommodate all of the money spent by players!⁵) With its next game, Tempest, it pioneered multiple difficulty levels, and with the launch of Centipede, it built a large female fan base.⁶ It became the fastest-growing U.S. company in history.⁷

Then in the early 1980s, Atari had a huge flop with its E.T. video game, which many publications labeled as the “worst video game of all time.”⁸ And it also had to contend with the crash of the video game market, resulting in a massive recession of the industry. Revenues that had peaked at $3.2 billion in 1983 fell to $100 million by 1985. Time Magazine as well as other publications said that video games were a fad destined to go the way of the pet rock.

But just then, when it all seemed to be over, Nintendo made its U.S. debut. Nintendo understood that stores were spooked by lackluster sales so they devised a new marketing strategy: It included a robot called ROB with the Nintendo Entertainment System and stores began selling it in the toy section. It sold over 30 million consoles, eventually topping out with 61 million. Nintendo became number 1; Sega, another post-Atari entry, was number 2; and Atari slid down to number 3.⁹ Nintendo continued to innovate with the Game Boy and DS, but its console couldn’t stay on top forever. New entries like Sony’s PlayStation 2 and the XBOX started to best it. But Nintendo didn’t want to end up like Atari—and because it continued to innovate and adopt new technology, it didn’t. It launched the Wii in 2006, a new system that let gamers control the action on screen with their hands and body as opposed to only a controller. It was an immediate hit. It leapt to the top spot, and Nintendo’s stock skyrocketed from $19 a share to more than $120 a share.¹⁰ Atari? It went bankrupt.

More recently, we all witnessed the social network MySpace disrupting Friendster, only to be disrupted by Facebook. And we saw Google disrupting Yahoo, which disrupted Excite and other early search engines. Of course, it’s not only tech companies. Disruption to the industry leader—and the category maker—can happen in any industry. Think about how the big box retailers disrupted the neighborhood stores. Barnes & Noble displaced the local bookstores, and then Amazon and e-readers disrupted Barnes & Noble. Blockbuster Video wiped out local video stores, and then Netflix came along and disrupted Blockbuster. Walmart destroyed downtown stores, but now Amazon is worth more than Walmart. These are ever continuing trends.

The Curse of the S Curve

What all of these businesses also demonstrate, and what we did, too, is the typical cycle of business—the S curve. The S curve describes a product’s acceptance by the market over time. It starts slowly and takes time to get off the ground, but once it does, it quickly ramps up. Revenue then goes into hyper-drive, but it doesn’t last for long. Sales stabilize as the product gets to saturation or maturity, and eventually revenue flattens out or declines.¹¹

The concept of the S curve is easy to understand, but knowing where you are on the curve is very difficult. As companies enter their growth phase, all too often people start thinking trees grow to the sky. But they never do. History is littered with examples of companies blowing up after achieving great heights: Control Data Corp., Hewlett-Packard, and Tandem Computers were innovative tech companies that couldn’t sustain their dominant positions. So were great retailers of old—Sears, Kmart, Gimbels, Alexander’s. We see this in almost every industry throughout history.

S-Curve Adoption Model

But, on the flip side, if you really perfect your understanding of the S curve, you introduce a new product at the right time during your S curve so revenue will not flatten out, but instead continue to grow. Apple became the best example of managing the S curve, certainly in recent history and perhaps of all time, after Steve Jobs returned to Apple in 1997. Apple went from a computer company with declining market share and margins to becoming a consumer products company and the most valuable company in the world.

Apple’s product introduction timeline, when it started to effectively manage its S curve, is fascinating to analyze. Take a look at the time frames: it reveals that in order to create such bold new technologies and brand new product categories, Apple is constantly working on the next big thing.

• 2001—Apple introduces the iPod music player, kick-starting a whole new product category for Apple.
• 2003—The iTunes Store opens, allowing users to buy and download music, audiobooks, movies, and TV shows. The ability to cheaply and easily download music to the iPod further differentiates the iPod and sales take off.
• 2005—The iPod category adds product extensions of the lower-end iPod shuffle and iPod nano.
• 2007—Apple announces the iPhone smartphone, another new product category.
• 2008—Apple opens its App Store as an update to iTunes.
• 2009—Apple releases the iPhone 3GS, with more than twice the speed, improved performance, and a better camera with video capability and voice control.
• 2010—Apple begins selling the iPad tablet, another new product category, and gains an 84 percent share of the tablet market by year’s end.

These innovations resulted in constant revenue increases for Apple, as you can see in the charts below. But strategizing right for the S curve is massively challenging. Almost every company in history has had to contend with it. And almost every company has gotten it wrong. It’s endemic in the pharmaceutical industry. Every time a company has a blockbuster drug that goes off patent, it needs to have the next billion-dollar drug ready to go—but more often than not, it doesn’t.

Source: Company filings (Jan. 24, 2012)

Apple’s Revenue by Product

Source: Jay Yarrow and Kamelia Angelova, “Chart of the Day, The Evolution of Apple’s Business.” Business Insider, July 19, 2011; www.businessinsider.com/chart-of-the-day-apple-revenue-by-product-2011–7

Extending the S Curve: Apple’s Revenue from 2000 to 2012

Source: /static.cdn-seekingalpha.com/uploads/2012/2/20/863379–13297742350656683-Richard-Bloch.png

Companies must innovate continuously and map out the right strategy for the next big thing as soon as its latest launch is almost complete. When the initial launch gains traction is the right time to determine the next growth driver. Anything later is too late, as it always takes time for new products to gain traction. To time it perfectly, the new product’s revenue has to grow faster than the old product’s revenues decline.

I’ve found the biggest impediment to managing the S curve in my companies and others is the reluctance of the business managers to want to focus or invest in anything other than the biggest opportunity right in front of them, which is both correct and critical. They have to be focused on executing the current growth strategy for their business line. But the fact is that every new big opportunity can take years to validate, incubate, execute, and grow the revenue to the point that it can take over as the growth engine from the product or products that are maturing. When you see your growth slowing, it’s too late to begin to invest in your new new thing. All too often, a company is faced with a flattening or declining growth curve, and it is at that point that it tends to make a “transformational acquisition,” an acquisition designed to greatly diversify revenue or add a new business segment or technology designed to quickly jump-start growth.

The problem? According to collated research and a recent Harvard Business Review report, the failure rate for mergers and acquisitions (M&As) sits between 70 percent and 90 percent.¹² I wouldn’t take those odds to transform my business.

With the acceleration of new technologies and product development, the declining cost of technology, the world getting smaller (i.e., more closely connected), and the growth in venture capital investment, the disrupter can get disrupted very quickly. It’s critical to carve out some time, a person or two, and some investment to search for, validate, and begin working on the next phase of your S curve—or you will undoubtedly face the fate that has claimed the lives of most companies that have come before you.

On the other hand, my excitement and interest comes from building new products and disrupting industries, and I’ve been guilty of spending too much of my time and too large an investment on creating the new new thing at the expense of managing our current business. I’ve found that it takes great discipline to manage the day-to-day conflict of running your current business and looking for and investing in the next big idea. It’s important to note that if you’re doing it right, you will be in constant conflict with your leadership team. The simple way of managing the conflict is being disciplined in managing the amount of time and money that you or others spend on the next big idea relative to your current business and sticking to it in good times and bad. If everyone on your leadership team understands the inevitability of the S curve and agrees on the importance and a time frame for coming up with the next big idea, you will be way ahead of the game.

In our case, the change in technology in the 1980s with the roll-out of Microsoft Windows created an opportunity for new competitors to launch with new technology, which gave them an unfair competitive advantage over us. Our only savior for the long period of time it took us to rewrite our software was the stickiness of our product and the large switching costs built in. During that period, we remained the largest player in the market and did not lose customers, but we did not add a lot of new customers, either. Our competitors won the bulk of the new clients.

Attention has to be paid to the S curve, as it is much faster and cheaper to develop technology and new software today, and the switching costs are generally much lower as well. I don’t think we would have survived in today’s technological environment. The time frames within the S curves have sped up, and being first to market no longer has the clear first mover advantage it once had.

The Best Way to Predict the Future Is to Invent It

Henry Ford famously said, “If I had asked people what they wanted, they would have said faster horses.” Inventing the future way of thinking led Ford Motor to introduce something entirely new in 1908, the first mass-produced, mass-market automobile, the Model T. But once Ford had customers, he should have listened to them.

In 1920 General Motors, which was a distant second to Ford, hired Alfred Sloan. Sloan’s first task was to devise a strategy to crack Ford’s lock on the market. He quickly ruled out head-on price competition, concluding that a capital fund the size of the U.S. Treasury would be required to do so. So Sloan determined that GM should not offer cheaper cars, but compete another way: offer better quality cars and a greater variety¹³. By 1923 he gave up on better quality and built a Chevrolet with nine-year-old technology but with a new body of the latest style. This gave the mass-produced car the impression of an expensive luxury car, with a sleek look and more rounded lines. It resonated. With sales surging, Sloan became convinced that to compete with Ford it was not necessary to lead in engineering but merely to offer customers better-looking cars with more choices. GM then developed a paint called Duco, which enabled it to offer cars in multiple colors. Ford’s basic black cars were eclipsed by GM’s new variety of brightly colored models.

We don’t know if Ford was serious when he said “a customer can have a car painted any color he wants as long as it’s black” (as discussed in Chapter 2), but if he meant this sincerely, he made a critical and costly error. At that point he should have listened to his customers. GM’s sales surpassed that of Ford by 1927. Ford invented the mass-produced car, and his lead in the industry lasted all of 19 years.

I didn’t ask my prospective customers if they wanted an OMS. They didn’t know they had a problem and therefore didn’t know they needed a solution. I delivered the first version, and I had no idea what Merrin Financial would turn into. What I did know is that once you have a customer base, you have a growing source of free ideas on how to make that product or service better. All you have to do is listen to those actually using the products. Not all ideas will be good, but that’s where your judgment comes in. If you start to hear the same idea over and over again, that’s probably one you should listen to. But if I implemented every idea that was followed by “if you do this one thing, everyone will use your product,” we would have implemented a huge amount of one-off features and the opportunity cost of not implementing more value-added features would have stunted our competitiveness and creativity. When you have a client base, listen to them and involve them in idea generation and validation and testing beta versions.

A great example of this was our compliance system, which was the idea of one of our clients. Eric LeGoff, who worked for Michael Price, came to me with this idea: “Compliance is a serious headache and no one does it well. We only know we have a serious problem a quarter or two after we violate a compliance regulation. The regulators often find the problem before we do, and then it costs us big money in fines and reputational damage.”

It was a little like putting on a seatbelt after you’ve gone through the windshield. What if we could warn them before there was a violation? I thought this was a gold mine and would be another major advantage of our computer system over the paper tickets; it also offered another reason for customers to buy our products.

Anybody who managed money and had regulatory oversight should have wanted and needed a compliance system. But, of course, like everything we launched, no one wanted our big ideas in the beginning. Nobody had done this before, and once again we had to educate our prospects as to the advantages, and winning customers was very slow going. Our customers were traders and portfolio managers who were not directly responsible for compliance. And compliance departments didn’t seem to care.

Again, we had a very strong conviction that this product was a must-have and had huge advantages over the manual process, which clearly did not work. It took five years from when we first offered our compliance system until it became our biggest competitive edge. It eventually became a major reason to implement an OMS, and often it was the product we led with to make the sale.

But it wasn’t going to be enough to secure our future.

Our S Curve

You’re probably wondering what all this talk about S curves and finding the new new thing has to do with knowing when it’s time to sell. The fact is, I wasn’t thinking about selling throughout most of the time I was building Merrin Financial. I was always consumed with thinking about what came next.

In fact, I had never even heard of the S curve when I was building Merrin Financial, but I’ve since come to learn what we went through are fairly normal business problems and technology cycles. Still, it didn’t make it any less painful. There’s a difference in slopes of the S curve between new product enhancements, features, and even adjacent products that you sell to existing customers and new products that create new revenue streams, address a different set of customers, or create a different business model.

Adding new features and add-on products accelerated the growth in our S curve and probably would have extended the curve further had the technology shift not occurred and stopped us in our tracks. While I knew nothing about the S curve at the time, we were working on our next big thing anyway. We were constantly adding new modules to appeal to and attract more users. We started with U.S.-based equities and then we added international capabilities. We added the compliance module I described earlier, and then got into fixed income. But we needed a bigger idea.

I knew that we could create a whole new competitive advantage and potentially a much larger opportunity if we could extend the order management system to encompass the entire trade cycle by connecting to the brokers who actually executed client trades. It would be Wall Street’s first electronic trading network. We called it, appropriately, E-Trade. Unfortunately, we did not register the name so when the online broker E-Trade came on to the scene, we had to change the name to the Intermarket Trading Network (ITN). (Lesson learned: Register everything.)

Even with the OMS in place on our customers’ desks, trading was still manual and prone to error once an order was given to brokers to execute. A single order could end up having 50 or more steps involved from order placement through execution and allocation into separate accounts and input into all the systems that require the trade information. Our plan was to go to the relatively few brokerage firms that had enough technology on their side to accept electronic orders and charge the brokers a small fee for access to our network of customers. This would leverage our growing customer base while providing us with a new revenue stream from brokers who were on our network. In order to do this, we had to get a broker-dealer license, convince our existing customers that this was a good thing for them, and get the brokers to agree to pay us to be on the network. The value proposition for our clients was a vastly streamlined workflow with less manual entry and fewer costly errors. The value proposition for the brokers was direct connectivity to our mutual customers and to make it easier for many of their largest customers to do business with those brokers on our network.

This was long before the Internet was available at everyone’s fingertips and way before business models were created to take a piece of every transaction done across their platforms, like apps sold in the App Store or music sold on iTunes. We began discussions with the brokers, but their response was extremely negative and they went straight to our clients to protest. While our customers for the most part had endorsed the idea when we talked to them, the level of negative reaction from the brokers turned them against the idea.

This was very bad. It couldn’t work without the participation of the brokers and clients. We were forced to abandon our next big thing and what I was convinced would be an even larger opportunity for Merrin Financial. Being in the software industry was never my ultimate goal. The real opportunity on Wall Street was transaction revenue. Facilitating electronic trading would enable us to leverage our current client base and create additional revenue from each new client that came on board. It would be infinitely scalable, widen our margins considerably, and would fuel our growth for years to come. We had invested a lot of time, money, and energy into our transaction network and with the next big opportunity gone, I figured it was time to sell. But like everything else, I had no idea how to do that either. I had to learn on the job.

Just Say No

The enterprise software business is a very difficult business. The transition to Microsoft Windows taxed the company in every way and especially financially—this affected bonuses, which affected our retention, our service and support, quality, and, ultimately, my love of the business.

I was keeping Merrin Financial going, but it was not easy. Our contacts at our largest customer told us they were looking for other systems. Another large customer stopped paying us and quit. The bank pulled our line of credit. My accountant said, “You’re essentially bankrupt.”

I had to figure out what to do—fast.

I knew that things were terrible, so this wasn’t news to me, but it just added to my depressed state. The good news was that we had built a very unique franchise, so much so that various companies were poking around interested in buying a piece of the company. None of them would turn out to be the right partner, but the multiple inquiries validated that we had something of value. We built a business creating the trading infrastructure for many of the largest asset managers in the United States and England. Our systems captured the most valuable piece of information on Wall Street—the order before it has been executed. Most of Wall Street was built around getting access to that order and collecting the commission for executing the order. It was roughly a $15 billion business for equities in the United States alone. While we had competition, we were by far the leaders in the space and had an excellent reputation for innovation, as we created every new product in the space.

But I knew I needed to extricate myself, and what happened next still amazes me. A corporate strategy executive at ADP, a large public company that was the leader in payroll services and had a large and growing financial services division, called and said, “We’d like to come in and talk to you about your business.” Since we had gotten these calls before, I suspected it really meant they wanted to come in and talk about buying our business.

We had a very good meeting where I told them about our strategy. Two weeks later they returned and told me how they viewed the industry. It was everything I had told them, now reflected back in their own words. I, of course, thought it was brilliant. They believed we both held the same view for the future; that’s why they said they wanted to buy a piece of our company.

I needed an option like this. Desperately. I was dancing behind the scenes. But I played hard to get.

“I’m not interested in selling,” I said. “I’m not interested in having a partner.”

Although I knew what was happening—and it was not good—from an outside perspective, we looked incredibly successful; we had a roster of major clients, and we were expanding globally. We were the market leader in a fast-growing sector. ADP kept calling.

“Look, I’ve been getting lots of phone calls from lots of your competitors. I’m not interested in selling a piece and then running it,” I said. “If you want it, you’re going to have to buy the whole thing or you can buy nothing.”

Maybe this sounds risky, but I thought that was what they wanted because they had told me their whole strategy. They had a whole financial division that needed exactly what we had. Buying Merrin Financial would be incredibly synergistic with their business.

We started negotiating for the sale of the whole company. This was my first major negotiation, and again I went to my dad for guidance. We sat for hours role-playing the scenarios. What is their position? we asked ourselves. We would think of the different things they could possibly say and write them down and then prepare our responses. Then we would think about how they would respond to our responses. It became a script. It was almost unfair because we had done such a good job prepping and role-playing that the real conversations went exactly as we had practiced. We had anticipated every scenario, every argument and position they would have during the negotiations. This was a stark revelation of how role-playing and being better prepared than your prospects, customers, partners, or potential acquirers can become an unfair competitive advantage. This type of preparation led me to develop the 3×3 negotiating style that is discussed in Chapter 8.

We went back and forth for months. We agreed that they were going to buy Merrin Financial for $23 million. But it wasn’t just about the money. If I were going to continue to run it for a couple of years, I also wanted full autonomy. This seemed to be a bigger issue to win.

I was on a family ski vacation in Colorado, about to leave the house with my kids, when I received a call from the president of ADP. He told me the corporate lawyer took out the autonomy provisions so I should look at the rewritten documents.

“Well, then, the deal’s off,” I said. “Thank you very much.”

I hung up and went out on a ski run, nervous that the whole thing just blew up. What would happen in the long term? Or even the short term? I remember sitting on the chair lift thinking, “We can’t afford this vacation!”

A couple of runs later, I got a call on my cell phone from the president of the Financial Markets division at ADP. “The corporate lawyer’s on vacation,” he said, “but I tracked him down and we put back every word.”

The deal was done.

Now what?