How To Spot a Breakthrough: Tips from Early Amazon Investor Nick Hanauer

Last night, I attended an inspiring talk by Nick Hanauer of Seattle-based Second Avenue Partners. The venue was Seattle University, and the topic was “breakthrough thinking and ideas”—what they are, how to find them, and which companies have developed (and will develop) them. The event was organized by the Northwest Entrepreneur Network.

Hanauer knows a thing or two about business breakthroughs. He was the first non-family investor in, circa 1995. (Some nice nuggets from Amazon’s early strategy coming below.) He founded Avenue A Media in 1996, which was later renamed aQuantive and bought by Microsoft for $6.4 billion in 2007—Microsoft’s biggest acquisition to date. And he led an investment in Insitu, the maker of unmanned aerial vehicles that Boeing bought for some $400 million last July.

I’ll give a few highlights here from Hanauer’s talk, which he delivered to a jam-packed room of about 130 people. The start was delayed by a technical glitch in getting Hanauer’s slides loaded onto the right computer. (Insert obvious irony about a room full of techies.)

The key elements of a breakthrough idea, Hanauer said, are value creation and social disruption. “Value is difficult but possible to quantify—it’s the ratio of benefits to cost, divided by those of the alternatives,” he said. Benefits are things like a product’s durability, speed, and appeal; costs are things like price, distribution, and training. “Is this thing in some way 10 times better than the existing alternative?” he said. “No breakthrough idea has ever delivered less.”

He gave some examples. “Amazon offered 10 to 100 times the selection of any other bookstore, charged far less, and was much easier to search. It was the first real e-commerce business,” he said. “Insitu was started by some windsurfing freaks from Hood River. They were aeronautical engineers. They delivered 1,000 times the surveillance per dollar that Predator did.” Insitu’s UAVs were smaller, which made them harder to shoot down, and could fly lower, which made their cameras smaller and cheaper. They were effectively invisible at 1,500 feet, could read a license plate, radio it back to a base station, and locate it to within a few feet—all for $75,000, versus $10 million for a Predator drone. “That’s a transformational amount of value creation.”

As for social disruption, Hanauer gave a quick summary of what he meant:

—If everyone thinks it’s a great idea, it probably sucks.
—If people understand it, you’re too late.
—If people don’t like it and don’t understand it, it probably still sucks.

So entrepreneurship is a dangerous field, he said. “The difference between being an idiot and being a genius is very, very thin.” And keep in mind, he pointed out, “you can be very successful without being socially disruptive. Great fortunes have been made doing incremental things. Burger King, which came after McDonald’s, was not transformational, despite what they tell you…But they made a great fortune.”

Hanauer said the “most transformational idea” he’s working on right now is a Seattle healthcare company called Qliance, which has a plan for “how to fix healthcare in America.” The problem, as he explains it, is that “insurance mediates every healthcare transaction.” And that leads to huge administrative costs around every visit to a primary care doctor. “Incentives get inverted, so everyone behaves badly…Insurance consumes 40 cents of every [medical] dollar.” You can’t call or e-mail your doctor, or see them for more than a few minutes, he explains, because they can’t get paid for it.

Qliance’s idea is to make a distinction between catastrophic and non-catastrophic medical problems, and to introduce a payment model similar to that of a health club, where you pay a monthly fee and no administrative costs for routine visits. The company has been open for a year, and is currently working on sales in what Hanauer called a $300 billion market. “It’s a great example of turning a huge industry upside down,” he said. “The entrenched interests hate this. They hate it. The big companies don’t want the world to change. It never fails to amaze me how dug in companies are around their strategy.”

A few more closing thoughts from Hanauer:

—If you have a breakthrough idea, you don’t need a breakthrough way to get it to the market. “If you have transformational value, people will beat down your door…Focus on the product. If the product is good enough, marketing will take care of itself. If the product sucks, no amount of marketing will get you over the hump.”

—“I’m not a technologist. From my point of view, technology is simply a thing that allows you to bring transformational things to customers…People get excited about a particular technology, and they forget the question: what does this do for people? It’s about what the customer gets compared to the alternatives.”

—“As an entrepreneur, I’ve never been concerned about competition. If you’re early, run like hell. It’s all about execution at the end of the day. It’s about having a great idea, executing like hell, and delivering value to customers.”

—As for walking a different path, “I was difficult for my parents, and for my teachers. I’m incredibly uncomfortable in crowds, I never go to sporting events…What that allows is for you to have an idea and be comfortable with people not liking it. Jeff Bezos calls me a high-functioning contrarian.”

—Hanauer grew up in the family business of home furnishings (pillow-making), and started working in it when he was six years old. The business started small and eventually grew to $300 million a year, he said, and yet “it is a shitty business—it’s super hard to transformationally differentiate bed pillows…You grow by taking market share.” By comparison, he said, tech businesses are “like taking candy from a baby”—like “strawberry fields” with high profit margins, great market demand, and strong talent.

—Because of his deep knowledge of what it takes to get a product from the factory to retailers and into the hands of customers, Hanauer looked at Amazon and thought of its traditional retail competitors, “They’re dead.” (He also noted that Jeff Bezos “dynamited” Scott Lipsky out of his role as chief information officer at Barnes & Noble and hired him at Amazon, which helped slow down the competition on the Internet.)

—All of that said, Hanauer never expected Amazon to become as big as it is. “Good luck makes everybody look like a genius,” he said. “I’ve been extraordinarily lucky.”

Gregory T. Huang is Xconomy's Editor in Chief. E-mail him at gthuang [at] Follow @gthuang

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13 responses to “How To Spot a Breakthrough: Tips from Early Amazon Investor Nick Hanauer”

  1. Lauren M says:

    Very good article. Nick is a talented guy with good instincts. He is right about it all coming down to execution in the end. Great ideas are not hard to figure out but building a team and executing without bankrupting yourself is another story. Very inspirational. Thanks

  2. If they were spending 40% of revenue on billing and collection, their costs were completely out of control. For primary care practices, ALL overhead runs around 40%.