(2025-04-21) Chin Vanguard As A Demandside Mystery

Cedric Chin: Vanguard as a Demand-Side Mystery. At the end of Part 2, I presented you with the setup for a mystery: The two frameworks that we’ve explored together actually rests on a common premise: both frameworks assume that demand is a function of pain — a customer only becomes a customer when they experience some lack in their lives; something that they want to make progress on.

But if you pause for a moment, you’ll realise that this framing is simply … incomplete

The basic premise that pain is what matters when looking at demand is why we have bromides around “sell painkillers, not vitamins” ignoring the very fact that over-the-counter vitamins outprice and outsell over-the-counter painkillers by 2.5x.
No, ‘demand is solving customer pain’ is ultimately an incomplete theory of the world.

When a venture capitalist or a startup advisor says things like “sell painkillers, not vitamins” — what they’re trying to do is to tell you to “find real demand, not ‘fake’ demand.” That is, find the kind of demand that pulls product out of your startup, that fierce hunger for your solution.

for the longest time — I’d put it from the 80s onwards, till perhaps as recently as 2020 — the predominant theory of demand has been pain-related.

In Ted Levitt’s 1983 book The Marketing Imagination, for instance, Levitt writes (all bold emphasis mine): [The marketing imagination] resides in its implied suggestion as to what to do — in this case, find out what problems people are trying to solve.

built around a notion of progress, that ‘customers are customers because they want to solve some problem in their lives.’

Thinking that demand is only about pain will lead you to two problems:

Pain does not always lead to a purchase. Think about your own life: there are plenty of things that trouble you, that you wish to make progress on, that irritate you, that you do nothing about.

the big flaw with JTBD: the framework is premised on a purchase already happening — meaning that you are certain that a solution was pursued, and you are merely working backwards to the demand that originated it.

Some forms of demand exist when there is no pain. This is the scenario that I described in the previous instalment

All ridiculously successful businesses are built on top of real demand. But not all ridiculously successful businesses are built on top of a pain point.

You can get very far with Sales Safari and JTBD alone.

But, often, at the very early stages of a new product or a new startup, it is not clear what demand even looks like. If pain is not a clear indication of demand, what can we use to tell us that we’ve found authentic demand?

if you are a founder you might think: “well, if I don’t see Instagram-like adoption, I should just shut my startup down and have another go. Isn’t that good enough?” Well, yes, perhaps. But that also means that you will miss out on some absolutely ridiculous businesses. I shall demonstrate this with a case.

Let’s talk about Vanguard

Today, Vanguard is a registered investment advisor with about $10.4 trillion dollars in global assets under management.

And yet, when it first launched, it looked like an absolute failure.

I want you to read the case below, and pretend that you are an early investor, a board member, or John C. Bogle himself, founder of the Vanguard Group. Think about what you might use as an indicator of demand.

Bogle’s Start At Wellington Management Company

When Bogle joined Wellington in July 1951, there were a total of 125 mutual funds in America, and Wellington was one of the ten that collectively represented nearly three-fourths of the industry’s assets

Wellington had assets of $150 million, while the biggest fund, Massachusetts Investors Trust, had $438 million.

Bogle’s enthusiasm didn’t go unnoticed, and by 1955, he was made Mr. Morgan’s personal assistant, with a broad mandate to examine the fund’s activities. Three years later, in 1958, Bogle helmed the launch of the Wellington Equity Fund, which was structured to invest only in stocks. This was significant because at the time, most firms, including Wellington, only managed a single fund. The success of the Wellington Equity Fund made Bogle Mr. Morgan’s heir apparent

Wellington had built up a reputation for being a very conservative fund because of their policy to balance their stock portfolio with bonds.

Wellington’s motto, on the other hand, was the promise of “a complete investment program in one security.” This did not bode well for the firm in the “Go-Go” years of investing in the 1960s.

We could only watch helplessly as the balanced-fund share of industry sales fell from a high of 40% in 1955 to 17% in 1965 to 5% in 1970. By 1975, it would tumble to a mere 1%

Bogle would soon get the chance to put this strategy into practice. In the spring of 1965, Mr. Morgan handed over leadership of the fund to Bogle

To extend Bogle’s culinary metaphor, he determined that the best way for a bagel shop to pivot to donuts was to merge with a donut shop.

Thorndike, Doran, Paine & Lewis, Inc., a small Boston firm that ran a successful Go-Go fund called Ivest accepted Bogle’s offer

The merger was off to a strong start. Ivest’s assets grew from $50 million at the end of 1966 to $340 million by the end of 1968, and Wellington created many new funds aimed at leveraging the market conditions

The Go-Go years — where speculative funds were all the craze — turned into the Nifty Fifty era — where the market was singularly focused on growth at any price, often ignoring metrics like valuation. And then, finally, the bubble burst. After peaking in early 1973, the American stock market fell by 50% to its low in October 1974... under its aggressive new managers, the asset value of the once-conservative Wellington Fund tumbled big time.

look at how mutual funds were typically structured at the time.

The conflict in question was one that every management company in the traditional mutual fund structure experienced. They had two, somewhat conflicting obligations:

• The management company must maximise value for their (management company) shareholders
• The management company must maximise investment returns within the mutual funds, for the sake of mutual fund shareholders

Bogle proposed a solution: "I then suggested that one way of resolving this conflict could be a mutualization, whereby the funds acquire the management company…or internalization, whereby the active executives own the management company." (mutual company)

This did eventually happen, but not in the way he expected it would.

For reference, mutual funds structured as per Bogle’s solution would look like this

The conflict between the partners became public knowledge, and the five partners attempted to clearly split responsibilities and declare a truce in 1972. This did not work either

In November 1973, the partners asked Bogle to leave Wellington, offering him a $20,000-a-year annuity for the next fifteen years to exit without a fuss. Bogle turned them down, saying “I’ve heard of few stupider things than that.” To Bogle’s horror, when he called on Wellington’s directors, he realised that the partners had enough votes to fire him. Instead of backing down though, Bogle’s resolve grew stronger; he dug his heels in and refused to resign.

Things came to a head at a board meeting on January 23 1974.

Bogle presented a 20-page memo to the board that he hoped would save his job. The memo proposed that the funds should acquire the management company, or in other words, Wellington should mutualize itself

Bogle’s proposal was shot down. The board gave him another chance to resign, and when he refused, they voted to fire him. Bogle was replaced with Robert Doran as the president of Wellington

He got his hands on a legal technicality to claw his way back into the company.

On January 24 1974, a day after Bogle had been fired, he called a meeting of the directors of the funds, and proposed the same radical solution: mutualisation of the funds and independence from the investment managers.

Bogle came back to the board with a 250-page memo titled “The Future Structure of the Wellington Group of Investment Companies.” This listed the following seven options

Bogle favoured Option #4 — which advocated his radical solution of mutualization — but he was aware that the board was unlikely to approve it.

Bogle strategically pushed for Options #2 and #3 of the list above, both of which offered the funds progressive degrees of independence

On June 20 1974, the board made a decision. They chose Option #2 — Wellington funds would set up a subsidiary to handle all internal administrative tasks. Bogle would claim that the decision had him fired up with enthusiasm, however, in truth Bogle was angry and humiliated

An acquaintance of Bogle’s who happened to meet him around this time said: “He was bitingly angry…I think these guys [Thorndike, Doran, Paine, and Lewis] were essentially the founders of Vanguard because they made him angry enough that he wanted to prove that what they thought was just the tail of the dog was going to wag the dog.”

Vanguard was incorporated on September 24 1974, with a 27-person team led by Bogle as chairman and chief executive.

Vanguard’s official mandate was narrow, looking after things like “bookkeeping, filing tax returns, government reporting duties, and handling shareholder records

One month after Vanguard’s incorporation, in October 1974, Nobel laureate Paul Samuelson published an article that — much like the Fortune magazine piece which brought the mutual fund industry to Bogle — changed the course of Bogle’s life, and Vanguard’s trajectory. Dr. Samuelson wrote that he couldn’t find “brute evidence” that investment managers could beat the returns of the S&P 500 “on a repeatable, sustained basis”

Samuelson came to the conclusion that given the costs of trading, the efforts of managers to beat the market was a waste.

Samuelson went on to say: As yet, there exists no convenient fund that apes the whole market, requires no load, and keeps commissions, turnover and management fees to the feasible minimum.

Index-like portfolios had existed within pension funds, but the mutual fund industry remained entrenched in its expensive, traditional models.

Along with his associates at Vanguard, Bogle, Jan Twardowski and James Riepe set out to make a case for an index fund modelled on the S&P 500.

The board was dubious of the proposal, and found fit to remind Bogle that Vanguard’s mandate limited the company from engaging in investment advisory. Bogle had a response ready: Vanguard’s operating an index fund did not violate the ban on our providing the investment advisory services to our funds. It would simply own all 500 stocks in the S&P 500 Index. It would employ no investment adviser, and so would not be ‘managed.’

He writes in his autobiography: Disingenuous or not, my argument that the index fund was not managed carried the day. With less controversy than I had expected, the board approved my proposal by unanimous vote.

Vanguard signed a deal with S&P to licence their index for a nominal sum

The next step was to raise enough money for the fund to invest in all the stocks on the index, and a team of reputed brokerage firms and underwriters was assembled to lead the offering. Bogle was confident that he would be able to raise $150 million

FIIT was only able to raise $11.32 million, which wasn’t even enough to buy all the stocks on the S&P 500.

Bogle directed Twardowski to adjust the index so that they could replicate the S&P 500 with their limited resources. The algorithm was tweaked such that FIIT would invest in 200 of the largest stocks on the S&P 500 that represented 80% of the index on a weighted-basis, and another 80 smaller companies that were selected for their ability to best mimic the rest of the index — and with that, FIIT was off to the races.

didn’t help that the S&P 500 itself fell behind the returns of the average fund manager — after outpacing 70% of all equity funds from 1972 to 1976, it outperformed just 25% from 1977 to 1982

The lacklustre launch of FIIT deterred competitors from starting an index fund of their own for several years. It wouldn’t be until nearly a decade later that a second index fund entered the market. It took a long time — 15 years, by some counts — for the index fund model to be successful enough to pose a threat to other managers.

In these early years, Vanguard was fuelled by the success of the money market fund which the company launched in 1975. A money market fund is one that invests in short-term, high-quality debt that typically matures in under nine months. This type of fund became popular when the Federal Reserve increased interest rates in the 1970s to reduce inflation in the American economy. By the end of 1981, the total assets of the Vanguard funds rose from $1.47 billion in 1974 to $4.11 billion in 1981.

When traditional mutual funds began to shift to no-load structures in the 1970s, Bogle was only too happy to join them.

FIIT charged just 0.3% a year, but investors would have to pay an additional load of 6% to a broker every time they transacted. They were not willing to do that for a fund which was passively managed

Bogle addressed a letter to the directors proposing that Wellington funds terminate their distribution agreement with the Wellington Management Company and shift to a no-load structure.

Bogle’s old merger partners opposed the proposal, but their arguments fell flat, and the board gave Bogle the green light on February 8 1977.

Bogle hadn’t won the battle just yet. He needed to get the SEC’s approval to shift to a no-load structure. At the time, regulations prohibited funds from using their own assets for distribution.

Bogle requested an exemption from the SEC, asking permission for their funds to spend a limited amount directly on distribution. This sparked a series of complex legal challenges — including opposition from a Wellington Fund shareholder, and a formal hearing — until February 25 1981 when the SEC granted Vanguard its approval

In 1980, the Vanguard team grew dissatisfied with Citibank’s management of the Warwick Municipal Fund. Bogle was equally unhappy about the high fees that Vanguard’s money market fund was paying Wellington Management Company

Bogle made a bold proposal to the board. He suggested the termination of the municipal fund’s relationship with Citibank and the creation of a management team within Vanguard. This in-house team would be compensated with a fixed salary and in addition to managing the municipal fund, would replace Wellington as the manager of the money market fund

These triumphs were momentous for Bogle, but the growth of FIIT was slow. A year into its existence, in 1976, FIIT’s assets were $14 million

By the end of 1982, this number had increased to $100 million, ranking it 104th among 263 funds. FIIT reached the $1 billion mark only six years later in 1988, ranking 41st among 1,048 funds.

by 1990, the number of index funds had only grown to five, with total assets of $4.5 billion, still just 2% of the assets of all equity mutual funds.

As of mid-2018, assets of Vanguard 500 Index Fund totaled $640 billion, second in asset size only to Vanguard Total Stock Market Index Fund, among 5,856 equity mutual funds

Imagine, for a moment, that you’re a VC. Imagine that you’re looking at Vanguard as a potential investment, and that it had just launched FIIT.

Are you going to invest?
The answer, if you’re being honest, is no. There is no demand framework that explains Vanguard’s growth. There was no pain for their proposed solution, and no clear buyer’s journey. (Made/Paid/Laid?)

FIIT was a failure at launch, and was so bad that Vanguard had the entire index fund market to itself for nine years. By 1990, 16 years after launch, Vanguard was one of a stable of only five index funds, representing less than 2% of all equity mutual funds.

Vanguard, of course, is more than large — it’s world dominating.

In order to explain Vanguard, we need another theory of demand.

In the next instalment, it is finally time to look at The Heart of Innovation — the first new contribution to the art of demand since the Jobs to be Done framework. In that book lies an explanation for the mystery of Vanguard, and the most complete theory of demand we’ve yet to find.