Jun 11, 2013

Market vs. Technological Risk

We've observed the proliferation of social, mobile and gaming start-ups in the last few years, and how some of them managed to hit the 'lottery ticket' and make large exits, while most others crash and burn. It is my opinion that most start-ups in those spaces are doomed to failure due to the intense competitiveness of those markets. Or at the very least unable to build a long term business model by focusing purely on user growth.

A better way of understanding the current problem in the start-up ecosystem is to think about market risk vs. technological risk. The risk involved in creating a new company is inevitably a mixture of those two, and it is interesting to think about where on the spectrum a given start-up will fall.

Many of the over-valued and 'pump and dump' start-ups in the social, e-commerce and mobile space are faced with the challenge of extreme market risk. Although they are not necessarily tackling a difficult problem from a technological standpoint, the intense competition with other similar start-ups and uncertainty when it comes to user adoption and monetization make them highly volatile. And their outcome is less in the hands of the founders, thus the label of 'lottery ticket'.
The only ones that succeed are those that manage to create their own specific market (ex: Twitter) or brand themselves exceptionally (ex: Zappos). 
For that reason, many start-up will often try to label themselves as unique or different, and narrow their market, despite that not being the case. They will tell intersection stories: LinkedIn ∩ Artists ∩ Online Gallery. Peter Thiel has a good example of this type of start-up:
"Starting a new South Indian food restaurant on Castro Street ... is, a hard way to make money. It’s a big, competitive market. But when you focus on your one or two differentiating factors, it’s easy to convince yourself that it’s not."
There is a rush to get into the 'trendy' markets and get a product off the ground quickly, pivot as many times as necessary and get accelerated ad nauseum, losing sight of any real long term goal. Even though the initial execution might be easier, at the end of the day the same amount of sweat and tears is involved than with an ambitious, long-term focused idea.

Contrast that with major tech companies like Google or Apple. During their inception, most of the risk involved coming up with the right technology to address the market needs, and pulling it off. They were not worried about how unique their market is, how many users they need to get in order to get to the next stage of funding, or how they will monetize, because their product was fundamentally novel, useful and difficult to pull off. They are shielding themselves from a hyper-competitive market with a high barrier to entry.
An extreme example of technological risk is SpaceX. The market risk is virtually nonexistent - they will find clients if they can create a relatively cheap and reliable rocket - but getting there involves considerable effort and risk.
Tackling difficult and concrete problems reduces the importance of market risk (albeit not completely, since product/market fit is always paramount) and puts more emphasis on the type of risk that founders have control over: addressing specific customer needs, improving the quality of the product.
As Paul Grahams says:
"That scariness makes ambitious ideas doubly valuable. In addition to their intrinsic value, they're like undervalued stocks in the sense that there's less demand for them among founders. If you pick an ambitious idea, you'll have less competition, because everyone else will have been frightened off by the challenges involved."

I believe that if more start-ups where tackling difficult problems, rather than going for what is 'trendy' and easily executable, we would not be in a climate of market risk and facing the Series A crunch that we are facing today.

1 comment:

  1. Great points. So hard to predict what new thing will take off - I still don't get the appeal of Twitter - or what conditions foster the kind of new-market-creating-activity you refer to. Some argue that industry clusters are useful becuase the need for differenetiation drives creativity of new ideas. Who knows. And so many internal barriers as well to new ideas - the belief that if you think of it it must not be new -my favorite joke about the efficient markets theory: one economist says to the other "look, there's 20 dollars on the street," and the other replies "no there's not -if there were, someone would have picked it up."