Originally published at www.sleeperthoughts.com on November 19, 2017.
There’s been a spate of hand-wringing in Silicon Valley as the crop of mobile/internet/cloud-driven startups matures and giant companies that needn’t be named reach levels of scale and influence not seen since the days of Standard Oil). The “age of startups” is over, the refrain goes, swept aside by a new corporate era in which the startup/venture ecosystem is replaced by suitless corporate development people, well-funded internal projects and sniper-like acquisitions of threats. My view is that we’re at a historic apex in the power of these firms, and that the coming decade will demonstrate that some of the reasons startups succeed and big companies fail endure.
To understand how and why, it is helpful to tell the story of why startups are a successful model for innovation, explain how today’s giants are subverting that paradigm and discuss what might bring that to an end.
The recipe for why startups exist looks something like this:
1) Diseconomies of scale. In many areas of tech (especially software) the focus and cohesion of a small, smart team can build faster and better products than a larger team. It is much more difficult for large organizations to seek the truth about their own businesses once internal tribes form and bicker. It is even harder for them to act quickly and nimbly to respond to those truths.
2) Ownership. All else equal, people capable of driving products to the cutting edge will gravitate to where this leads to the best outcomes for them- and founding a startup is a great way to capture the lion’s share of the value star performers produce when they are at the cutting edge of a platform shift or disruptive wave.
3) Juniority benefits. Once a firm has stopped growing, the dynamics that help it attract and retain top talent fade away. A company growing headcount 20%+ can reasonably assure new employees that there will be exciting opportunities available for them over time- in mature organizations that career updraft dynamic is gone. Younger companies also get the benefit of a “blank sheet of paper” to build businesses with full awareness of the technology available to them- in many cases it is easier to start from scratch than drag a legacy company into the future.
4) Profit motives. Most firms end up being valued on their ability to generate profits (once growth slows, this is all that really matters). In such an environment, major investments impart a painful short term hit and can upset internal stakeholders. These are the environments where classic “professional managers” thrive and add value: navigating internal politics, cutting in the right places and leading incremental investments. That same style tends to preclude the bold bets that venture-backed startups often represent.
What stands out from the list is that, though some seem inevitable, all of the reasons startups exist relate to failings of large firms. Looking at these factors, we can start to see how Google, Amazon and Facebook especially have managed to subvert them and remain dominant:
1) They aren’t exiting growth mode, instead reinvesting in their businesses. Each has a core business with a fantastic, nigh-monopolistic market position to help fund this growth.
2) That re-investment involves paying lots of money for talent and competing against startups, such that the very existence of Goliaths both soaks up top talent and discourages investment in companies that are likely to compete with them over time. The result is that VCs ask “why won’t Amazon/Google/Facebook just do this?” in a form of deference that big companies don’t seem to have earned in prior eras.
3) They have a keen awareness of the risks of losing their growth culture, and strive to maintain it.
4) They pay employees in stock at scale, which both handcuffs employees to them and has worked out handsomely given the dramatic increases in their share price.
All in, they are using the economic benefits of their market positions and a strong economy/stock market to do everything possible to limit the effects of the startup ingredients I listed before. Most would agree that it is largely working so far.
How can startups compete, then? I see three main strategies:
1) Flee to the margins, building tech in categories the big players won’t play. SaaS software is a prominent example, with a healthy ecosystem of startups focused on various industries and business problems without much interference from the powers that be- Cloud City pre-ESB, if you will. Of course, diseconomies of scale are most pronounced in software- in many other categories this strategy means being pushed to the fringes of productization, or what I call “content creation,” in which startups take advantages of the platforms of the big players but are kept at arms-length from market positions that build sustainable, defensible, scalable businesses.
2) Get to deep tech early. Another way for startups to compete is to identify a promising area of disruptive tech before the big players have taken notice and build a market-leading team and product. These companies are often formed so early that the product is years from being a technically viable mass-market product, and as a result they often end up as acquisition targets once big companies see the potential in their products. Oculus and Magic Leap are two companies that fit this bill.
3) Charge straight at them. Finally, some startups have opted to play the role of David and take out their slingshots. Often, this approach requires a killer team and intense initial funding to compete against such a well-entrenched and tech forward company. Some examples of this strategy include Essential, Jet.com and Snap. Doubtless there are plenty of others that have failed.
For my part, I think there are business to be built in each of the strategies. I’m particularly eager to see more companies swing boldly and launch themselves into category #3. Though the Goliaths seem insurmountable now, over the next decade I bet we’ll see at least one succumb to age and slow-down, opening up tens if not hundreds of billions of dollars of opportunity for startups. Here are some potential catalysts (a brainstorm, not a point of view):
1) A retreat of asset prices, which would remind employees that RSUs are not riskless and could force companies to exit growth mode as their stock prices plummet and investors demand profitability.
2) Blockchain powered decentralized applications that enable the disruption of network effects.
3) AI could render the business models of Google and Amazon obsolete by abstracting away the consumer attention capture that drives value for them. If comparison shopping becomes effortless (for both consumer goods and compute), it could devastate Amazon’s gross margins. If the static search page evolves to a form-factor that doesn’t play as well to PPC advertisements, Google may see its primary revenue stream dry up. In each case, the key is that the companies will be trapped in a classic innovator’s dilemma: Google couldn’t afford to truly push a product that monetizes at half the rate of visual search, nor could Amazon afford to admit that retail gross margins may have another leg down.
4) Mega-investors could increasingly fund big, aggressive “take-down” bets. The rise of investors like Softbank makes it more possible to go after Goliaths than every before- as we’ve seen in the case of Uber, promising companies can raises billions rapidly. With over $1Tr of market value at stake, billion dollars bets are easier to stomach.
5) Core businesses will slow, making it harder to invest with their profits. For all their investing, the giants are mostly powered by their core businesses. It is inevitable that these will slow- if nothing else because they are coming to dominate their end-markets so much that there isn’t much headroom. If Amazon retail growth slows into the teens, or Facebook core growth goes negative, or Google search growth slows into the single digits, it will test the perpetual growth mindsets that each companies has adopted.
All in, I’m willing to take the contrarian bet that some of these play out and the age of untouchable Goliaths comes to an end- if you’re involved with a startup that’s going to help make that happen (or benefit from it), let’s discuss.