Do Startups Stand A Chance Against Valley Incumbents?

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A few weeks ago, I was talking with an entrepreneur in the search space who had a simple question: “Can Google ever be beat?” The question is actually quite profound, and is at the heart of everything we do in startups. Is it possible to defeat the incumbent players, even when they are essentially monopolies? I answered with the usual Silicon Valley rhetoric and bravado, arguing that every company will eventually be disrupted – particularly the largest ones – and that you very well could be the startup to make it happen.

I used to fervently believe those words, but as I was saying them, they seemed to ring less true than they have in the past. Whether it’s the news about Facebook’s acquisitions of Oculus Rift or WhatsApp, the developments at Google X, or just the sheer size and profitability of the leading technology companies, it increasingly seems unthinkable that any of Silicon Valley’s Big Tech companies are going to face disruption anytime soon.

This should be obvious to anyone looking at the list of billion-dollar-valuation startups, where the only major tech company I could identify that seems to face a competitive threat is PayPal/eBay, from Square and Stripe.

One reason that Big Tech is locked in is that there doesn’t appear to be a new wave of technology that is sweeping through Silicon Valley.

That’s a fundamental change for a region in which creative destruction has been the byword for more than six decades. One theory of Silicon Valley posits that the region has gone through “waves” of innovation, going from vacuum tubes on through microwaves, integrated circuits, semiconductors, computers, and today, the Internet. Few remember the industry leaders of the past, like Shockley Semiconductor or Eitel-McCullough. Even the ones who have survived like HP and Intel have fallen on tougher times.

One reason that Big Tech is locked in is that there doesn’t appear to be a new wave of technology that is sweeping through Silicon Valley. Expectations were high just a few years ago about clean tech and biotech, but neither has truly materialized in a significant way beyond a handful of companies. Hardware/software hybrid companies seemed a great bet to make, but with the acquisitions of Nest and Oculus, it seems unlikely that this area will be the next wave.

Instead, software continues to eat the world, as it has for the past three decades, and it doesn’t appear to be slowing down anytime soon. The next major companies coming out of Silicon Valley are software companies like Dropbox, Airbnb and Uber.

One reason for the staying power of these businesses is simply that software may well be the most profitable business model in technology ever conceived. NYU’s Aswath Damodaran analyzed 96 different industries, and his results show that computer software enjoys some of the highest margins outside of financial services. Unlike yesteryear’s semiconductor and computer companies, today’s tech companies have the money to spend on research and product development, allowing them to lock in their leads.

And speaking of lock-in, it’s hard not to point out that today’s companies have enviable levels of stickiness built into their business models. Cloud services in particular force consumers to continue to use their products since transitions to upstart competitors are exceedingly difficult. In addition, many of the major tech companies spend hundreds of millions of dollars on marketing and branding campaigns, giving them incredible built-in advantages in terms of consumer awareness. In many ways, companies like Amazon and Facebook are quite similar to Coca-Cola or Pepsi – blue-chip brands that endure more through recognition than any other property of their products.

One of the benefits of having multiple types of voting shares is that executives can make self-disrupting decisions more easily than if they have to get permission from Wall Street.

And if disruption finally arrives, it seems that the Big Tech companies are ready to handle it in a sophisticated manner. Clayton Christensen popularized the term “Innovator’s Dilemma” through an eponymous book about his research into the hard disk industry, among others. Technology companies are constantly disrupted by startups that introduce inferior products, but that eventually improve them to compete with the incumbent’s offerings but at a lower cost structure. In order to continue competing, an incumbent has to change its business model to become less profitable, which is nearly impossible in a modern corporation.

Christensen’s main recommendation to defend against this tendency is to create a sort of think tank internal to the company that actively tries to disrupt the company’s own product lines. In other words, Google X. Furthermore, Silicon Valley’s major tech companies have also concentrated decision-making power in a very tight number of individuals, mainly company founders. Indeed, one of the benefits of having multiple types of voting shares is that executives can make self-disrupting decisions more easily than if they have to get permission from Wall Street.

Given that incumbent players seem quite adept at weathering any disruption, one would hope that startups in new industries would have a chance to succeed. Yet, the news over the past few months has shown that the behemoths are not going to allow that strategy to succeed, either. Facebook’s acquisitions of WhatsApp and Oculus means that the leading companies in two up-and-coming industries – messaging and virtual reality – have already sold out, albeit at very nice price premiums. We should expect similar news to emerge in industries like drones, bitcoin, and 3D printing.

We are witnessing a world that is quickly ossifying around a handful of juggernauts. There seem to be few solutions to the situation, but there is one irony here: The biggest challenger to this status quo may actually be yesterday’s famous behemoth. Microsoft used to be the most powerful software company in the world, and while its revenues have certainly remained high, it has lost its cachet in a mobile world where the company lacks a serious contender in the market.

Microsoft’s new CEO, Satya Nadella, has said: “Simply put, our vision is to deliver the best cloud-connected experience on every device.” Given the company’s position, it very well could act to force open Silicon Valley if it chose a more open approach to its business.

The other option, which happens to be Microsoft-related, is whether there needs to be increasing attention paid to antitrust enforcement in Silicon Valley. Particularly given the recent revelations of wage fixing, it is clear that there should be more attention paid to the collusion inherent in the tech industry today. While it’s certainly a question that has received its share of air time in the past, I think it is worth looking more closely at whether monopolies or dominant businesses are healthy for innovation.

Building a disruptive technology company is not impossible. But competing against the incumbent Silicon Valley companies is increasingly becoming long odds. There are no panaceas here, but some basic rules continue to hold true. Focus on building great products in niches not covered by Big Tech. And if you are serious about joining the elite club, be ready to turn down insane acquisition offers and handle the resulting press glare. If you can decline billions of dollars, then maybe Google can be beat.

Image by Flickr user Christian Rondeau under under a CC BY 2.0 license