Monday, March 14, 2011

Can We Ever Have Too Many Startups?


My recent post on the diatom bloom in the startup ecosystem prompted calls for me to dig deeper and provide more data. Far be it from me to disappoint!

Chris Tacy asked, are we seeing too many startups? It's a loaded question, but a good one.

My instinctive reaction is that it's always good to have more startups. When I was younger, and people asked me about the value of startups, I would ask them, "Who do you think will produce more innovation and value? Microsoft and its 40,000 employees, or 10,000 four-person startups?" (this was back when Microsoft had only 40,000 employees...and was still a widely admired company).

The answer, of course, is 10,000 startups. (I hope I'm not giving Dave McClure any ideas for his next fund....)

Yet the incredible recent explosion in startup numbers does give me pause--and not just because AngelList solicitations threaten to outpace Viagra ads in my inbox.

10,000 startups working on 10,000 different ideas is wonderful for innovation. 10,000 startups working on the same idea--not so much.

The reason that a diatom bloom is dangerous is that it's a monoculture that crowds out the rest of the ecosystem.

The danger we face with today's startup explosion is that we could end up in a situation where there are too many startups pursuing the same ends.

For example, just how many local deal sites do we really need?

And don't forget that even startups are still subject to the laws of supply and demand. If there is an excess of supply, the price drops accordingly. Too many startups pursuing the same market tend to compete away all the value in the market. It's hard to charge a fair price for your product or service if there are 10 other people trying to penetrate the market, and are willing to discount to get an advantage.

Startups are a force for good because they have proven over time to be the best vehicle for pursuing innovation. But not all startups are innovative.

We can never have enough startups that are pursuing unique solutions to important problems. But a profusion of "me-too" startups can actually damage the startup ecosystem by consuming the sunlight (funding, engineers) that would otherwise go to more unique and innovative startups.

14 comments:

Chris said...

Like this post? Upvote it on Hacker News:
http://news.ycombinator.com/item?id=2324920

David Shen said...

Your last paragraph is the most important one. Think about what people could accomplish if they just banded together a little more and worked on one thing versus being independent and all working on different little things?

acgourley said...

David - that same thought has been on my mind lately. Several of the hackreprenuers I respect most are all working on their own thing, as am I. I feel like together we'd be unstoppable, but instead we have 5 smaller companies which each have a smaller chance of success.

Still, my overall conclusion is that the expected value of those 5 companies is higher than the hypothetical where we bind together. After all, we're better able to leverage our own passions (idea and tech wise).

Later, if any of the ideas prove not to work, there is a good chance that founder will bind onto one of our startups as early employees. In the end, as a community of 5 entrepreneurs, we end up exploring a lot of idea space while spending very little capital. Seems like a win.

Hong said...

Upvoted and left a comment on HN post. Unoriginal ideas that get backed by investors is part of the problem.

jas225 said...

Would be curious to know, other than local deal sites, what you see pitched a lot these days? Hyper-local recommendations?

David Shen said...

acgourley,

you are correct that exploring more ideas in general than exploring less. The issue is more from the side of the investor. Since you have less resources, the probability of failure of any one of your teams' ideas is much, much higher. Unless we have enough resources to place bets on all of you (assuming we liked all the teams' ideas), it is much more risky for investors to play unless we can afford to play with a large bucket of money.

I believe that in today's market, it is fast moving to a place that is too hard and risky for angels to make money and that those of us who invest to make money (vs. other reasons for investing) will not play any more. On the other hand, in all cases, startup founders always benefit regardless of whether the startup dies or lives, even in the case of a talent acquisition. In the case of a outright failure, you can definitely find a new job anywhere. But for us investors, that money is gone forever.

Patrick Moore said...

A bit one sided. You have some flawed assumptions:

1) in existing crowded space there is complete overlap. A local deal site could be a direct competitor to Groupon or it could be niche enough that Groupon will never be a competitor.

2) existing entrants in a space contain the eventual winners

3) multiple companies can not all be successful

4) new investors in a space are happy to let the earlier investors in a space get the return

5) "too many" is subject to interpretation

6) observer understands all entrants direction. 2 companies may start with same features or product and head in divergent directions.

7) only return is measured in dollars. An engineer may want to start a company for the sales, marketing, management experience.

8) return expectation: The engineer may not care about making a return a VC/Angel would be happy with. "Life-style" businesses can be worth millions.

zeruch said...

I agree with the root point about having a monoculture (of opportunism), but at the same time, there is the counterforce of consolidation that always follows the initial bloom.

Nivi said...

"We can never have enough startups that are pursuing unique solutions to important problems."

Yes!

Foudres said...

Google is a me too.
Facebook is a me too.
Twetter is basically glorified SMS or mailing lists.
Apple just provided a mobile phone with a better browser and better MP3 player with it's iphone.
Samsung as now a huge success with it's Samsung Galaxy mobile series and is really a copy of Iphone.
Many of the most successfull app on Iphone are somewhat "stupid and simple" games.

What is important is that you manage to find enough money to stay in the game. Being innovative is way. Solving pain points is maybe another way.

The concept of groupon is really simple. Now to be able to do it well is another thing.

Chris said...

Patrick:

Good comments, that deserve a detailed response:

1) in existing crowded space there is complete overlap. A local deal site could be a direct competitor to Groupon or it could be niche enough that Groupon will never be a competitor.

It's true that things don't overlap 100%. But there are usually only a few winners. In social networking, Facebook and LinkedIn are the winners. MySpace, Bebo, Tagged, Hi5, and 10 million other players are the losers.

Same holds true for search, etc.

2) existing entrants in a space contain the eventual winners

Not always true, but a decent first order assumption. If someone is already at a billion dollars in revenue, it's a bit late to start from scratch.

3) multiple companies can not all be successful

In the startup world, the top player (Gorilla) accounts for 70-80% of the value, the second banana (Chimp) accounts for 10-20%, and everyone else fights for the meaningless scraps.

4) new investors in a space are happy to let the earlier investors in a space get the return

New investors want to make money. There's no rule saying that they have to invest in an existing space. In fact, we try to avoid me too companies.

5) "too many" is subject to interpretation

Inarguably true. But I believe you can have too many, based on the criteria of what brings the greatest good to the greatest number.

6) observer understands all entrants direction. 2 companies may start with same features or product and head in divergent directions.

Yes, but that's always true of all startups.

7) only return is measured in dollars. An engineer may want to start a company for the sales, marketing, management experience.

That's fine, but the return for investors is measured in dollars. If you ever want to raise money (and most founders do), the dollar return is what matters to the investors.

8) return expectation: The engineer may not care about making a return a VC/Angel would be happy with. "Life-style" businesses can be worth millions.

True, in which case they shouldn't raise money. I have no objection to millions of people starting overlapping lifestyle businesses. I just wouldn't expect them to be very successful, or for investors to invest in them.

Chris said...

Foudres:

You make a good point that the first mover isn't always the winner. Otherwise, we would all still be using WebCrawler, and connecting with each other on Ryze.

But the fact that the first mover advantage isn't all-powerful doesn't negate the fact that in most high tech markets, there are 1-2 real winners at most.

I strongly agree that entrepreneurs should seek to innovate or solve problems (or preferably both!). Wantrepreneurs who build pitches based on what's hot (I'm looking at you, MBA johnny-come-latelys) do neither.

Pat said...

@Chris --

Thanks for the reply.

Our disagreement comes from our different perspectives.

You are considering startups from an institutional perspective with LPs to satisfy. I am considering it from an entrepreneurial perspective.

investor v. engineer

As an investor you are looking to MAXIMIZE your return. You have a finite amount of time to spend with companies and LPs to satisfy.

I would guess that an LP is unhappy if a fund returns 30% ROI when competing funds returned 40% ROI.

You however have many baskets for your eggs.

A engineer/entrepreneur has only a single basket at a time. As such, their FIRST focus is to minimize the downside. A engineer /entrepreneur can consider their startup a success if it does no WORSE than a W-2 job.

wrt, "millions of people starting overlapping lifestyle businesses. I just wouldn't expect them to be very successful"

From the engineer's perspective the startup can be a raging success if he makes a reasonable percentage above base salary expectations. Consider an engineer making $125K starts a business that results in him making $250K/year. He just doubled his salary. Excellent choice!

"That's fine, but the return for investors is measured in dollars. If you ever want to raise money (and most founders do), the dollar return is what matters to the investors."

Hmm. Most founders that I know do everything they can to avoid VC money. You see this with the lean startup model.

"But there are usually only a few winners"

Certainly, that is true in cases where there are real network advantages. But there is lots of software that has minimal network advantages.

For example, web email: hotmail, Yahoo, gmail, others are all still fighting it out.

How about CMS's ? Sure there is wordpress but there is also drupal, joomla, etc. And each one of these has a community of developers and companies making a living off of those ecosystems.

So why not consider those companies as startups?

I think your definition of "Startup" includes only companies that follow a certain financial path results in IPO or M&A

The well-defined "Seed, Series A, Series B, Exit" strategy.

A company isn't a startup if it is a "life-style" business where "life-style" business is defined as anything not following the above path.

By this definition, Walmart was a "life-style" business. Sam Walton never had an exit strategy planned when he started the first Waltons in 1950. (Walmart was an outgrowth of the Waltons 5-and-Dime.) Walmart went public in 1969 about 19 years after Sam started creating his chain stores. ( reference )

Currently, 10% of all retail sales in the US are by Walmart. Not bad for a life-style business!

There are many investors outside SV that are looking for a rate of return not a homerun liquid exit.

In fact, the concept of IPO or M&A is really a new one when it comes to how an investor was to get their return. It traditionally was in the form of a dividend stream!

Unfortunately the VC model precludes a steady return and discourages anything less than swinging for the fences.

But that doesn't mean that businesses that are not going for the A,B,C and then Exit! route are not startups.

However, you are right of course that they are not a good match for the VC model of doing things.

Chris said...

Pat,

I think you're dead on in distinguishing between the investor perspective and the engineer perspective. The two are truly different.

I will also mention that there is a movement towards revenue financing, which is an investment model that is far more friendly to lifestyle businesses. In revenue financing, startups commit to pay a certain % of revenues to investors until the investment is paid back and a certain return is reached.

This arrangement can work for both parties.