Making industries “garage ready” for startups

One of the most important events in the history of modern computing was the advent of “fabless” (“fabrication-less”) semiconductor companies.  The story of fabless semis is similar to the recent history of internet startups: various forces led to an order-of-magnitude reduction of startup costs, which then led to a surge of innovation.

Before the 1980s, if you wanted to invent a new semiconductor, you had to both design and manufacture it. This meant you had to build a large manufacturing plant, something only large companies like Intel, Motorola, and IBM could afford. Hence, semiconductor design was generally too expensive for venture-backed startups.

In the 1979, two computer scientists published a seminal book that argued for the separation semiconductor design and manufacturing. Followed by years of investment by DARPA and others, an industry emerged where chip designers used software (“EDA software”) to design and test semiconductors, and then sent standardized specifications to “foundries” that did the manufacturing (most of which were located in Taiwan – the largest in the world to this day is Taiwan Semiconductor Manufacturing Company).

This dramatically lowered the cost of starting semiconductor design shops, and in turn led to a massive wave of startup innovation. These startups designed chips for cell phones (Qualcomm), Wifi (Atheros), computer graphics (Nvidia), and much more.  Most were funded by venture capitalists and located in Silicon Valley.

Tech sectors tend to get really creative when they become “garage ready”:  a Steve Jobs and Steve Wozniak, or a Larry Page and Sergey Brin, can, with very little capital, change the world. It happened with semis in the 80s and happened in the 90s and 2000s for internet companies.

Eventually every vertically integrated, capital-intensive sector becomes garage ready. Someday, for example, we will have “fabless” gadget design and biotech research, enabling a small shop in Brooklyn or SoMa to create an iPhone killer or next-generation cancer drug.

Do you want to sell sugar water or do you want to change the world?

“Do you want to sell sugar water for the rest of your life or come with me and change the world?” – Steve Jobs

I sometimes wish that instead of working on internet and software projects, I worked on cleantech or biotech projects. That way, when I came home at night, I’d know that I had literally spent my day trying to cure cancer or prevent global warming.  But information technology is what I know, and it’s probably too late for me to learn a new field from scratch.

That doesn’t mean information technology can’t improve people’s lives. Google’s search engine helps people find information, which, for example, makes cancer and cleantech researchers more productive. Skype allows companies to collaborate remotely, and connects people with friends and family around the world. In the area of information technology, we create infrastructure and hope that people use it for more good than bad.

That said, the best entrepreneurs seem to follow a path of increasing gravitas. Scott Heiferman started out selling online ads and is now creating new communities. Jack Dorsey created Twitter and is now democratizing payments so sole proprietors can compete on a level playing field with large companies. Elon Musk started with online payments and is now developing electric cars and space programs.

Founders of large companies sometimes also follow the path of increasing gravitas. Google is developing new energy technologies, self-driving cars and other world-changing technologies. Bill Gates devotes almost all of his time and money to charity.

The tech press is preoccupied with investments, trends, exits, and other “inside baseball” topics. But these are all means to an end. Investments provide fuel for entrepreneurs to convert ideas into products. Trends shape the terrain that entrepreneurs navigate. Exits provide financial incentives for investors and entrepreneurs.

Tim O’Reilly says that entrepreneurs should try to create more value than they capture. You can make money selling people obfuscated financial products, entertaining them with mind-numbing TV shows, or selling them sugar water decorated in elegant designs.

Alternatively, you can make something that matters and — if you are lucky and smart — change the world.

Apple and the TV industry

The TV industry is a major segment of the consumer electronics industry and Apple is the leading consumer electronics company in the world. Thus far Apple has entered the TV market with a stand-alone device, Apple TV. There has been speculation about whether Apple might enter the TV market by creating an actual TV. The most convincing objections to that idea cite the unfavorable industry structure: the power of the cable operators, the low margins on TVs, the infrequency of people buying new TVs, etc.

I thought it would be interesting to go back and look at the reasoning analysts used to predict the failure of the iPhone before its launch in 2007. Some predicted it would fail because the other handset makers would successfully compete with Apple:

The iPod also conquered the problem of small screens and cheesy navigation. With its newfound popularity, the company was also able to get music publishers to agree to its terms. Unfortunately for Apple, problems like that don’t exist in the handset business. Cell phones aren’t clunky, inadequate devices. Instead, they are pretty good. Really good. Why do you think they call it a Crackberry? Because the lumpy design and confusing interface of the device is causing people to break into cars? No, it’s because people are addicted to it. Samsung has scoured the world’s design schools and hired artists on three continents to keep its phones looking good. Motorola has revived its fortunes with design. KDDI, a Japanese carrier, has a design showcase in the teen shopping area of Tokyo just to be close to trends. And Sharp doesn’t skimp when it comes to putting LCD TVs on its phones. Apple, in other words, won’t be competing against rather doltish, unstylish companies like the old Compaq. The handset companies move pretty quick and put out new models every few weeks. [emphasis added]

Other analysts predicted Apple’s phone was doomed because of the mobile phone industry structure – mobile operators commanded so much power via subsidies, retail distribution etc:

Apple will launch a mobile phone in January, and it will become available during 2007. It will be a lovely bit of kit, a pleasure to behold, and its limited functionality will be easy to access and use. The Apple phone will be exclusive to one of the major networks in each territory and some customers will switch networks just to get it, but not as many as had been hoped. As customers start to realise that the competition offers better functionality at a lower price, by negotiating a better subsidy, sales will stagnate. After a year a new version will be launched, but it will lack the innovation of the first and quickly vanish. The only question remaining is if, when the iPod phone fails, it will take the iPod with it.  [emphasis added]

I am not citing these analysts to mock them. Hindsight is 20/20 and it was quite reasonable at the time to assume that a new phone from Apple would confront the same issues that new phones from other companies confronted. What Apple ended up doing, however, was creating a phone that was so incredibly desirable to consumers that it completely restructured the industry, causing a massive shift of power away from the carriers.

Regarding the TV industry, here is what Steve Jobs said last year at AllThingsD:

Q: Is it time to throw out the interface for TV? Does television need a new human interface.

A: The problem with innovation in the TV industry is the go-to-market strategy. The TV industry has a subsidized model that gives everyone a set top box for free. So no one wants to buy a box. Ask TiVo, ask Roku, ask us… ask Google in a few months. The television industry fundamentally has a subsidized business model that gives everyone a set-top box, and that pretty much undermines innovation in the sector. The only way this is going to change is if you start from scratch, tear up the box, redesign and get it to the consumer in a way that they want to buy it. But right now, there’s no way to do that….The TV is going to lose until there’s a viable go-to-market strategy. That’s the fundamental problem with the industry. It’s not a problem with the technology, it’s a problem with the go-to-market strategy….I’m sure smarter people than us will figure this out, but that’s why we say Apple TV is a hobby.

So Jobs doesn’t believe an “additional box” is a viable strategy for seriously entering the TV industry. This leaves three places to enter: 1) integrating into set top boxes, 2) integrating into other TVs, or 3) Apple creating its own TV. Regarding #1, the last thing the cable operators want is for internet-delivered programming that bypasses their cable channels to become widespread – they see that as the fast track to become a dumb pipe. Re #2: This just seems very unlike Apple – the most vertically integrated company in tech, and famous for wanting to control every aspect of the product and user experience.

Re #3, let’s imagine Apple develops a TV that is as groundbreaking as the iPhone was. The biggest problem “smart TVs” have today is that they need clunky IR transmitters to control set top boxes because the cable operators won’t willingly interoperate. So a new Apple TV would have to drum up such incredible consumer demand that the operators would feel compelled to support it. This does indeed seem harder in the TV than in the mobile industry. At least in the US you had 4 nationwide mobile operators at the time of the iPhone launch. In TV, consumers normally have at most two real choices for traditional cable programming – cable and satellite – and two real choices for two-way internet – cable and DSL/FIOS.

Perhaps Apple won’t enter the market due to its structure. But that didn’t stop them in mobile phones where the structure was similarly difficult. The mistake analysts made about the iPhone was to assume the current industry structure would be sustained after Apple’s entry. I’d be wary of making the same assumption about the TV industry.

Steve Jobs single-handedly restructured the mobile industry

With the introduction of the iPhone, Steve Jobs achieved something that might be unique in the history of business: he single-handedly upended the power structure of a major industry.  In the US, before the iPhone, the carriers (Verizon, AT&T, Sprint, T-Mobile) had an ironclad grip on the rest of the value chain – particularly, handset makers and app makers.

Ask anyone who ran or invested in a mobile app startup pre-iPhone (I invested in one myself). Since the carriers had all the power, getting any distribution (which usually meant getting on the handset “deck”) meant doing a business development deal with the carriers. Business development in this case meant finding the right people at those companies, sending them iPods, taking them to baseball games, and basically figuring out ways to convince them to work with you instead of the 5,000 other people sending them iPods and baseball tickets.  The basis of competition was salesmanship and capital, not innovation or quality.

The carriers had so much power because consumers made their purchasing decisions by choosing a carrier first and a handset second. Post-iPhone, tens of millions of people started choosing handsets over carriers. People like me suffer through AT&T’s poor service and aggressive pricing because I love the iPhone so much.

I’ve talked to a number of mobile app startups lately who say their former contacts at the carriers are shell shocked: no one is knocking on their doors anymore. I guess they have to buy their own iPods and baseball tickets now.

Yes, Apple has rejected some apps for seemingly arbtrary or selfish reasons and imposed aggressive controls on developers. But the iPhone also paved the way for Android and a new wave of handset development. The people griping about Apple’s “closed system” are generally people who are new to the industry and didn’t realize how bad it was before.

Should Apple be more open?

It is almost religious orthodoxy in the tech community that “open” is better than “closed.” For example, there have widespread complaints about Apple’s “closed” iPhone app approval process. People also argue Apple is making the same strategic mistake all over again versus Android that it made versus Windows*. The belief is that Android will eventually beat the iPhone OS with an “open” strategy (hardware-agnostic, no app approval process) just as Windows beat Apple’s OS in the 90′s.

With respect to requiring apps to be approved, consider the current state of the iPhone platform. There are over 100,000 apps and thus far not a single virus, worm, spyware app etc. (I don’t count utterly farfetched theoretical scenarios). As a would-be iPhone developer, I can report firsthand that the Apple approval process is a nightmare and should be overhauled. But what’s the alternative? Before the iPhone, getting your app on a phone meant doing complicated and expensive business development deals with wireless carriers. At the other end of the spectrum: If the iPhone OS were completely open, would we really have better apps?  What apps are we missing today besides viruses?

With respect to the strategic issue of tightly integrating the iPhone/iPad software and hardware, a strong case can be made that Apple’s “closed” strategy is smart. Clay Christensen has given us the only serious theory I know of to predict when it’s optimal for a company to adopt an open versus closed strategy for (among other things) operating systems. The basic idea is that every new tech product starts out undershooting customer needs and then – because technology gets better faster than customers needs go up – eventually “overshoots” them. (PC’s have overshot today – most people don’t care if the processors get faster or Windows adds new features). Once a product overshoots, the basis of competition shifts from things like features and performance to things like price.

The key difference today between desktop computers and mobile devices is that mobile devices still have a long way to go before customers don’t want more speed, more features, better battery life, smaller size, etc. Just look at all the complaints yesterday about the iPad – that it lacks multitasking, a camera, is too heavy, has poor battery life, etc. This despite the fact that Apple is now even building their own semiconductors (!) to squeeze every last bit of performance out of the iPad. Until mobile devices compete mainly on price (probably a decade from now), tight vertical integration will produce the best device and is likely the best strategy.

*It’s worth noting that Steve Jobs wasn’t the one who screwed up Apple. Jobs co-founded Apple in 1976. He was pushed out in in May 1985 when the company was valued at about $2.2B. He returned in 1996 when Apple was worth $3B. Today it is worth $187B.