Some thoughts on incumbents

Reposted from Oct 7, 2010 from cdixon.posterous.com

By “incumbents” I mean the big companies that are loosely competitive to your startup.

– The first thing to do is try to understand the incumbent’s strategy.  For example, see my analysis of Google’s strategy.

– Being on an incumbent’s strategic roadmap is a double-edged sword.  On the one hand, they might copy what you build or acquire a competitor.  On the other hand, if you build a valuable asset you could sell your company the acquirer at a “strategic premium.”

– Incumbents that don’t yet have a successful business model (e.g. Twitter) might think they have a strategy, but expect it to change as they figure out their business model.  An incumbent without a successful business model is like a drunk person firing an Uzi around the room.

– Understand the incumbent’s acquisition philosophy. More mature companies like Cisco barely try to do R&D and are happy to acquire startups at high prices.  Incumbents that are immature like Facebook only do “talent acquisitions” which are generally bad outcomes for VC-backed startups (but good for bootstrapped or lightly funded startups). Google is semi-mature, and does a combination of talent and strategic acquisitions.

– Understand the incumbent’s partnership philosophy.  Yahoo and Microsoft are currently very open to partnerships with startups.  Google and Facebook like to either acquire or build internally. If you don’t intend to sell your company, don’t talk seriously about partnerships to incumbents that don’t seriously consider them.

– Every incumbent has M&A people who spend a lot of their time collecting market intelligence. Just because they call you and hint at acquisition doesn’t mean they want to buy you – they are likely just fishing for info. If they really want to buy you, they will aggressively pursue you and make an offer.  As VCs like to say, startups are bought, not sold.

– Try to focus on features/technologies that the incumbents aren’t good at.  Facebook is good at social and social-related (hard-core) technology.  Thus far they’ve kept their features at the “utility level” an haven’t built non-utility features (e.g. games, virtual goods, game mechanics).  Google thus far has been weak at social and Apple has been weak at web services.

– Try to focus on business arrangements that the incumbents aren’t good at.  Facebook and Google only do outbound deals with large companies.  With small companies (e.g. local venues, small publishers) they try to generate business via inbound/self service. Building business relationships that the incumbents don’t have can be a very valuable asset.

– Be careful building on platforms where the incumbent has demonstrated an inconsistent attitude toward developers. Apple rejects apps somewhat arbitrarily and takes a healthy share of revenues, but is generally consistent with app developers.  You can pretty safely predict what they will will allow to flourish. Twitter has been wildly inconsistent and shouldn’t be trusted as a platform.  Facebook has been mostly consistent although recently changed the rules on companies like Zynga with their new payment platform (that said, they generally seem to understand the importance of partners thriving and seem to encourage it).

– Take advantage of incumbents’ entrenched marketing positioning.  The masses think of Twitter as a place to share trivial things like what you had for lunch (even if most power users don’t use it this way) and Facebook as a place to talk to friends.  They are probably stuck with this positioning.  Normals generally think of each website as having one primary use case so if you can carve out a new use case you can distinguish yourself.

– Consider the judo strategy.  When pushed, don’t push back.  When Facebook adds features like check-ins, groups, or likes, consider interoperating with those features and building layers on top of them.

Competition is overrated

Your #1 competitor starting out will always be the BACK button, nothing else. – Garry Tan

Suppose you have an idea for a startup, and then do some research only to discover there are already similar products on the market. You become disheartened and wonder if you should abandon your idea.

In fact, the existence of competing products is a meaningful signal, but not necessarily a negative one.  Here are some things to consider.

1) Almost every good idea has already been built. Sometimes new ideas are just ahead of their time. There were probably 50 companies that tried to do viral video sharing before YouTube. Before 2005, when YouTube was founded, relatively few users had broadband and video cameras. YouTube also took advantage of the latest version of Flash that could play videos seamlessly.

Other times existing companies simply didn’t execute well. Google and Facebook launched long after their competitors, but executed incredibly well and focused on the right things. When Google launched, other search engines like Yahoo, Excite, and Lycos were focused on becoming multipurpose “portals” and had de-prioritized search (Yahoo even outsourced their search technology).

2) The fact that other entrepreneurs thought the idea was good enough to build can be a positive signal. They probably went through some kind of vetting process like talking to target users and doing some market research. By launching later, you can piggyback off the work they’ve already done. That said, you do need to be careful not to get sucked into groupthink. For example, many techies follow the dictum “build something you would use yourself,” which leads to a glut of techie-centric products. There are tons Delicious and Digg clones even though it’s not clear those sites have appeal beyond their core techie audience.

3) That other people tried your idea without success could imply it’s a bad idea or simply that the timing or execution was wrong. Distinguishing between these cases is hard and where you should apply serious thought. If you think your competitors executed poorly, you should develop a theory of what they did wrong and how you’ll do better. Group buying had been tried a hundred times, but Groupon was the first to succeed, specifically by using coupons to track sales and by acquiring the local merchants first and then getting users instead of vice versa. If you think your competitor’s timing was off, you should have a thesis about what’s changed to make now the right time. These changes could come in a variety of forms: for example, it could be that users have become more sophisticated, the prices of key inputs have dropped, or that prerequisite technologies have become widely adopted.

Startups are primarly competing against indifference, lack of awareness, and lack of understanding — not other startups. For web startups this means you should worry about users simply not coming to your site, or when they do come, hitting the BACK button.

The tradeoff between open and closed

When having the “open vs closed” debate regarding a technology platform, a number of distinctions need to be made. First, what exactly is meant by “open.” Here’s a great chart from a paper by Harvard professor Tom Eisenmann (et al).:

(Eisenmann acknlowledges the iPhone isn’t fully open to the end user – in the US you need to use AT&T, etc.  I would argue the iPhone is semi-open to the app developer and mobile app development was effectively closed prior to the iPhone. But the main point here is that platforms can be open & closed in many different ways, at different levels, etc.)

The next important distinction is whose interest you are considering when asking what and when to open or close things.  I think there are at least 3 interesting perspectives:

The company: Lots of people have written about this topic (Clay Christensen, Joel Spolsky, more Eisenmann here).   In a nutshell, there are times when a company, acting solely in its self-interest, should close things and other times they should open things.  As a rule of thumb, a company should close their core assets and open/commoditize complementary assets. Google’s search engine is their core asset and therefore Google should want to keep it closed, whereas the operating system is a complement that they should commoditize (my full analysis of what Google should want to own vs commoditize is here). Facebook’s social graph is their core asset so it’s optimal to close it and not interoperate with other graphs, whereas marking up web pages to be more social-network friendly (open graph protocol) is complementary hence optimal for FB to open.  (With respect to social graphs interoperating (e.g. Open Social), it’s generally in the interest of smaller graphs to interoperate and larger ones not to – the same is true of IM networks).  Note that I think there is absolutely nothing wrong with Google and Facebook or any other company keeping closed or trying to open things according to their own best interests.

The industry: When I say “what is good for the industry” I mean what ultimately creates the most aggregate industry-wide shareholder value.  I assume (hope?) this also yields the maximum innovation.  As an active tech entrepreneur and investor I think my personal interests and the tech industry’s interests are mostly aligned (hence you could argue I’m talking my book).  Unfortunately it’s much easier to study open vs. closed strategies at the level of the firm than at the level of an industry, because there are far more “split test” cases to study.  What would the world be like if email (SMTP) were controlled by a single company?  I would tend to think a far less innovative and wealthy one. There are a number of multibillion dollar industries built on email: email clients, webmail systems, email marketing, anti-spam, etc.  The downside of openness is that it’s very hard to upgrade SMTP since you need to get so many parties to agree and coordinate.  So, for example, it has taken forever to add basic anti-spam authentication features to SMTP.  Twitter on the other hand can unilaterally add useful new things like their recent annotations feature.

Here’s what Professor Eisenmann said when I asked him to summarize the state of economic thinking on the topic:

With respect to your question about the impact of open vs closed on the economy, the hard-core economists cited in my book chapter have a lot to say, but it all boils down to “it depends.” Closed platform provides more incentive for innovation because platform owner can collect and redistribute more rent and can ensure that there’s a manageable level of competition in any given application category. Open platform harnesses strong network effects, attracting more application developers, and  thus stimulates lots of competition. There’s some interesting recent work that suggests that markets may evolve in directions that favor the presence of one strong closed player plus one strong open player (consider: Windows + Linux; iPhone + Android). In this scenario, society/economy gets best of both approaches.

Society:  I tend to think what is good for the tech industry is generally good for society.  But others certainly have different views.  Advocates of openness are often accused of being socialist hippies.  Maybe some are.  I am not.  I care about the tech industry.  I think it’s reasonable to question whether moves by large industry players are good or bad for the industry.  Unfortunately most of the debate I’ve seen so far seems driven by ideology and name calling.

Underhyping your startup

I recently tweeted:

New early-stage start up trend: get big quietly, so you don’t tip off potential competitors.

Chris Sacca agreed:

@cdixon Agreed. As of this morning, I have four companies who don’t want investors mentioning that they’ve been funded.

Business Insider took these tweets to mean “Stealth mode is back.”  But that’s actually not what I meant.  The companies I’m referring to (and I think Chris is referring to) are publicly launched, acquiring users and generating revenue. They are modeling themselves after Groupon, where the first time the VC community / tech press gets excited about them, they are already so successful that it’s hard for competitors to jump in.

This trend strikes me as a response to the fact that 1) raising money from certain investors can be such a strong signal that it triggers massive investor/tech press excitement, 2) things are “frothy” now – meaning lots of smart people are starting companies and easily raising lots of money, 3) word seems to travel faster than ever about interesting startups, and 4) there are big companies like Facebook and Google who are good at fast following.

I don’t know what to call this but it’s not stealth mode.  Maybe “underhype” mode?

The importance of institutional redundancy

Every system built by a single institution has points of failure that can bring the entire system down.  Even in organizations that have tried hard for internal redundancy – for example, Google and Amazon have extremely distributed infrastructures – there will always be system-wide shared components, architectures, or assumptions that are flawed.  The only way to guarantee there aren’t is to set up completely separate, competing organizations – in other words, new institutions.

This insight has practical implications when building internet services.  One thing I learned from my Hunch co-founder Tom Pinckney is, if you really care about having a reliable website, always host your servers at two data centers, owned by different companies, on networks owned by different companies, on separate power grids, and so forth.  Our last company, SiteAdvisor, handled billions of requests per hour but never went down when the institutions we depended on went down – which was surprisingly often.  (We did have downtime, but it was due to our own flawed components, assumptions etc.).

The importance of institutional redundancy is profoundly more important when applied to the internet at large. The US government originally designed the internet to be fully decentralized so as to withstand large-scale nuclear attack.  The core services built on top of the internet – the web (HTTP), email (SMTP), subscription messaging (RSS) – were made similarly open and therefore distributible across institutions.  This explains their remarkable system-wide reliability.  It also explains why we should be worried about reliability when core internet services are owned by a single company.

The principle of not depending on single institutions applies beyond technology.  Every institution is opaque to outsiders, with single points of failure, human and otherwise.  For example, one of the primary lessons of the recent financial crisis is that the most important form of diversification is across institutions, not, as the experts have told us for decades, across asset classes.  The Madoff fraud was one extreme, but there were plenty of cases of lesser fraud and countless cases of poor financial management, most of which would have been almost impossible to anticipate by outsiders.