When you start looking at a problem and it seems really simple, you don’t really understand the complexity of the problem. Then you get into the problem, and you see that it’s really complicated, and you come up with all these convoluted solutions. That’s sort of the middle, and that’s where most people stop… But the really great person will keep on going and find the key, the underlying principle of the problem — and come up with an elegant, really beautiful solution that works.
When I talk to most companies, I do think their leaders are pretty short-term focused. Imagine you’re running Exxon, what do you do? Say you want to do something good with the most valuable company on earth. A lot of people think probably, it’s not doing good things – worried about the environment and so on. But if the company has a lot of capabilities–worldwide operations and manufacturing, government relations, probably could do a lot different things, if you took a 20-year view.
If you took a four-year view, that’s a pretty hard question to answer. What are you doing in the next four years, which I think is about the average tenure of a Fortune 500 CEO. So if you’re being measured quarterly– obviously, it’s good to have some pressure so you actually do things, make money and improve things. But I think the four-year horizon for leaders is pretty difficult.
It’s pretty difficult to solve big problems in four years. I think it’s probably pretty easy to do it in 20 years. I think our whole system is setup in a way that makes it difficult for leaders of really big companies. Eventually, what you’re doing doesn’t makes sense over time, for whatever reasons – environmental or social or whatever it is. I think companies have a big problem making a big transition, so leaders get replaced.
A huge advantage of companies like Google, Facebook, and Amazon is that they have CEOs with the gravitas (and, sometimes, control provisions) to operate on a very long-time horizon.
In the past year, Samsung went from being a moderately successful electronics manufacturer to the leading non-iOS mobile device maker. Together, Apple and Samsung earn 98% of the profits in the smartphone market. MG Siegler echoed a common sentiment when he wrote that Samsung is now the “fifth horseman” of tech, alongside Apple, Google, Amazon, and Facebook.
The mobile device industry is still in its infancy. Samsung’s fate depends largely on how the industry evolves. If the computer-in-your-pocket (smartphone/tablet) business ends up being like the computer-on-your-desk (personal computer) business, Samsung is on track to be the modern Dell. Dell had a good run as the low-cost provider in a highly commoditized business, but the vast majority of the industry profits went to Microsoft.
So the big questions for Samsung are:
1. Will the smartphone/tablet industry stratify the way the PC business did?
The dominant view is that technology markets inevitably stratify. Clay Christensen is the most sophisticated proponent of this view. In his theory (more here and here), every tech market eventually “overshoots” the needs of its customers, at which point the benefits of horizontal specialization outweigh the benefits of vertical integration.
A minority view, held mostly by Apple faithful, is that Christensen et al are guilty of over-theorizing. Apple lost the PC business simply because, when Steve Jobs was fired, they stopped innovating. When Jobs returned, Apple started gaining PC market share again. In this view, the future mobile industry structure mostly depends on whether Apple management is innovative enough to keep making superior vertically-integrated products.
2. If the industry stratifies, will the lion’s share of the profits go to the OS and application layers as it did for PCs?
Generally, technology businesses that are defensible have network effects, and network effects usually arise from products with significant software components. Samsung’s competitors like HTC are just one hit product line away from stealing Samsung’s position. Eventually, handset designs will converge and, as happened in the PC market, consumers will stop paying premiums for performance improvements (arguably, this has already started happening). The OS and apps layer, on the other hand, are very hard to replicate. If you invest enough money you can usually build or acquire decent software, but it takes more than just capital to build a vibrant developer ecosystem (just look at Microsoft).
Samsung’s predicament is: their current strategy succeeds only in the scenario where both (a) the industry stratifies, and (b) significant profits flow to hardware. Samsung seems to understand the improbability of (b), which is why they’ve been hinting at throwing serious support behind a new OS. Getting traction with a new OS will be difficult, to put it mildly. Google and Apple have vastly more experience making software and a huge head start with developers. Moreover, Google’s strategic position is even stronger today than Microsoft’s was in their heyday. Google makes so much money from web services (mostly search, for now) that they can afford to lose money on handsets and OSs indefinitely – a very scary fact for Samsung and everyone else in the mobile hardware business.
“Agency problems” are what economists call situations where a person’s interests diverge from his or her firm’s interests.
Large companies are in a constant state of agency crisis. A primary role of senior management is to counter agency problems through organizational structures and incentive systems. For example, most big companies divide themselves into de facto smaller companies by creating business units with their own P&L or similar metric upon which they are judged. (Apple is a striking counterexample: I once pitched Apple on a technology that could increase the number of iTunes downloads. I was told “nobody optimizes that. The only number we optimize here is P&L in the CFO’s office”).
If you are selling technology to large companies, you need to understand the incentives of the decision makers. As you go higher in the organization, the incentives are more aligned with the firm’s incentives. But knowledge and authority over operations often reside at lower levels. Deciding what level to target involves nuanced trade offs. Good sales people understand how to navigate these trade offs and shepherd a sale. The complexity and counter-intuitiveness of this task is why it’s so difficult for inexperienced entrepreneurs to sell to large companies.
Agency problems also exist in startups, although they tend to be far less dramatic than at big companies. Simply having fewer people means everyone is, as they say in programming, “closer to the metal”. The emphasis on equity compensation also helps. But there are still issues. Some CEOs are more interested in saying they are CEOs at parties than in the day-to-day grind of building a successful company. Some designers are focused on building their portfolio. Some developers are only interested in intellectually stimulating projects. Every job has its own siren song.
One of the reasons The Wire is such a great TV show is that it shows in realistic and persuasive detail how agency problems in large organizations consistently thwart well intentioned individual efforts. The depressing conclusion is that our major civic institutions are doomed to fail. Those of us who are technology optimists counter that the internet allows new networks to be created that eliminate the need for large organizations and their accompanying agency problems. Ideally, those networks recreate the power of large organizations but operate in concert like startups.
A common way to think of business regulations is by analogy to sports: the rules are specified up front, and the players follow the rules. But real regulations don’t work that way. Regulations follow business as much as business follows regulations.
Sometimes the businesses that change regulations are startups. Startups don’t have the resources to change regulations through lobbying. Instead, they need to start with regulatory hacks: “back door” experiments that demonstrate the benefits of their ideas. With luck, regulators are forced to follow.
Nextel was one of the all-time great regulatory hacks. In the late 80s and early 90s, the FCC’s rules banned more than two cellular operators per city. As Nextel’s cofounder said, “the FCC thought a wireless duopoly was the perfect market structure”. Nextel (called Fleet Call at the time) circumvented these rules by acquiring local (e.g. taxi, pizza truck) dispatch radio companies, which they then connected to create a nationwide (non-dispatch) cell phone service.
Predictably, the cellular incumbents tried to regulate Nextel out of existence. From a 1991 New York Times article:
In a move that could threaten cellular telephone companies, the Federal Communications Commission may decide on Wednesday to grant a small radio company’s request to provide a new form of mobile telephone service in six major cities, including New York. If the request is approved, the action could inject new competition into the industry. At the moment, Federal rules permit only two cellular systems to operate in any city. But the new proposal could open up a regulatory back door, allowing companies that provide private radio service for taxi fleets and delivery services to offer mobile telephone services to individuals…. The proposal has alarmed the industry, which has heatedly opposed it and enlisted support in Congress late last year to delay the F.C.C.’s decision.
The incumbents argued that Nextel’s service would interfere with public safety frequencies and therefore endanger the public. They also argued that Nextel’s service would be too expensive:
Some analysts contend that the radio handsets for Fleet Call and its imitators will be more expensive than cellular units. The technical features of cellular equipment are now standardized nationwide, making it possible to bring down costs through higher selling volumes. Specialized mobile services are currently different in each city.
And their call quality would be inferior:
Some analysts contend that Fleet Call’s local service is likely to be inferior as well. “It is highly unlikely to be as good as cellular service,” said Denise Jevne, telecommunications analyst with T. Rowe Price Associates in Baltimore.
The FCC eventually decided not to block Nextel. Nextel grew to become a top five US cellular operators before it was acquired by Sprint in 2004 for $35B. Their service turned out to be cost-competitive, high quality, and safe. The only thing endangered were the incumbents’ profits.
What Nextel faced in 1991 is very similar to what many startups face today. Uber is being threatened by the taxi industry, Aereo by the TV broadcasting industry, and Airbnb by the hotel industry. Some industries, like finance, are so heavily regulated that almost any new idea runs into regulatory objections.
Of course regulations that truly protect the public interest are necessary. But many regulations are created by incumbents to protect their market position. To try new things, entrepreneurs need to find a back door. And when they succeed, it will all look obvious in retrospect. Today’s regulatory hack is tomorrow’s mainstream industry.