5
Habits of Highly Effective Revolution
02.21.00
Mark Twain is reputed to have said, "The
past may not repeat itself, but it sure does rhyme." The feeding frenzy
surrounding the Internet looks new, and it is, at least in our lifetime. But
the same patterns of behavior occurred in the development of earlier
technologies, including steam engines, telegraphy, automobiles, airplanes, and
radio. Investors who know something of the history of these eras can extract
valuable lessons to help them understand how the Internet economy is likely to
evolve.
Typically, a technological innovation passes through
five main stages as it undergoes industrial development: experimentation,
capitalization, management, hypercompetition, and consolidation. Let's look at
these stages in turn to see how they might manifest themselves in the Internet
age.
Experimentation
Entrepreneurs are the first to recognize the potential
of new technology. Initially, entry costs are low--which is why many industries
are born in garages and basements. Rarely is there a single inventor of any
fundamental technology: Who invented the railroad, the automobile, or the
Internet? Even when textbooks name specific inventors, such as Morse, Marconi,
or the Wright brothers, closer examination reveals parallel inventive activity,
so that we almost certainly would have had telegraph machines, wireless
communications, and airplanes even if these great inventors had never lived.
Once the building blocks of new technology are present,
hordes of inventors and entrepreneurs frantically experiment with different
ways of recombining those components to create new value--hence
"experimentation."
The modern telegraph rapidly developed once there were
reliable ways to send electric pulses down wires, which required a whole host
of supporting technologies. The Wright brothers retooled mechanical components
from their bicycle shop and combined them with wings and wind to create an
airplane. By the same token, today's entrepreneurs are taking the building
blocks of chips, software, and Internet protocols, and combining them in
countless ways to create new value.
Sometimes the major innovation is a new business model.
This happened with the radio industry. Initially, people viewed radio as a
substitute for the telephone. That others could overhear a conversation was
regarded as a nuisance. Then, in 1923, AT&T started WEAF in
Today, much of the experimentation on the Net involves
this same kind of groping for the right business model: Revenue-making ideas
such as subscriptions, advertisements, banners, links, bundling, licensing, and
auctions are run up the flagpole, and investors wait to see who--if
anyone--salutes.
Some, perhaps most, of these experimenters are bound to
be disappointed. As with past technologies, there is a lot of money to be lost
on the Internet.
Between 1904 and 1908, more than 240 companies entered the
automotive business, all attempting to find the best user interface for their
"horseless carriages." Karl Benz's first car in 1885 was a
three-wheeled, horseshoe-shaped vehicle. We look at these cars in museums today
and say, "Isn't that funny--they thought automobiles should look like
carriages." Fifty years from now our grandchildren will look at early
microcomputers and say, "Isn't that funny, they thought computers should
look like typewriters."
Capitalization
Entrepreneurs may be the driving force behind technological
experimentation, but they need money to pay for it. This quest for capital
brings in financiers. Financial institutions obviously have evolved from the
days when the town bank was the primary source of loans. But venture
capitalists, or their equivalent, have always been around to place the first
bets, and then cash out with a public offering. IPOs
and burn rates aren't new concepts. Many innovations, such as railroads,
required huge up-front investments before returning any cash flow. Great
fortunes always have been made by placing the right bets, and they have been
lost the same way. Early investors in railroads won big; those who arrived late
to the scene never fully recouped their investment.
Management
Financiers provide capital that enables entrepreneurs to
leap from garage to mass market. But to reach the scale necessary for mass
marketing, operation of an industry has to become dominant over its innovation.
Innovators have to know when to step aside and let the adults take charge.
This is tough to do, especially when your name is over the
door. Many great innovators of the past were terrible businessmen. Thomas
Edison, for example, was a scientific genius but no financial wizard. He spent
or gave away money faster than he could earn it.
One of the most difficult decisions an entrepreneur has to
make is when to hand off the business to the professional managers. Bob
Metcalfe, inventor of Ethernet, has said, "In 1982 my board of directors
started calling me a visionary, and I ate it up. Next thing I knew, I wasn't
CEO anymore."
Many fledgling Internet businesses are still in the
experimentation phase, struggling to define their business model and their
market. Few have moved into the operations phase, where the keys are building a
bulletproof operation, establishing the brand, and developing a loyal customer
base. Operations, marketing, execution, and alliances are all critical. If you
falter, the competition is only a step behind.
Hypercompetition
Inevitably, some do falter. Financiers get worried, pull the
plug, and yet another business drops out of the race--or, more likely, gets
gobbled up by an industry leader. The hypercompetitive phase has begun.
Economies of scale now become the defining
competitive activity. It takes multiple forms. On the one hand are the
traditional supply-side economies of scale--the larger you are, the lower your
unit costs of production. But in many of the most important new industries,
there are also demand-side economies of scale--the more customers you have, the
more valuable your product becomes. This latter effect is strong in
telecommunications (telegraph, telephone, Internet) and in industries where
interoperation and standards are critical. In some cases, a combination of
demand-side and supply-side economies of scale can generate huge, positive
feedback loops, so that companies that get ahead acquire both cost and a
revenue advantage--a powerful pairing.
But there's a dark side to all this.
Companies that fall behind almost inevitably fall farther behind. In the end,
only a few winners emerge. Why those companies succeed and not the others is
often a matter of luck as much as cunning. The Stanley Steamer was one of the
fastest automobiles of its time. But its inventors refused to mass-produce it.
Even if they had, eventually "steamers" would have likely lost out to
the competition's gasoline-powered cars--how different the history of the world
might have been!
Consolidation
As the hypercompetitive stage fades, the winners settle down
into a routine. Products become standardized, brands and marketing are
fine-tuned, and costs are wrung out of the system. Competition for the market
becomes competition in the market. Market shares become well defined,
and corporate strategy turns to chipping away at the competition rather than
engaging in all-out war. Management can sleep at night...or at least some
nights.
The danger at this stage lies in being too competitive.
Dominant players have to learn how to avoid price wars and costly standards
battles. Companies that have withstood a prolonged war of attrition may find it
hard to believe they've won, and find it difficult to make the transition to a
less frenetic environment. Worries about survival are replaced with worries
about antitrust suits. Company executives now have a lot more interests to
consider: Workers, unions, lawyers, activists, foundations, journalists,
shareholders, and politicians all expect to have a voice in how the industry is
managed.
As the Internet business starts to mature, it will likely
consolidate into a market structure with a few big winners (companies like AOL,
Yahoo, Cisco), a few big losers (fill in your candidates here), and lots of
perpetually small players focusing on niche markets. The Internet's strength
lies in selling highly differentiated content and services. The infrastructure
providers of basic services may dominate the headlines, but the bulk of the
business opportunity lies in customized services and targeted media.
Today it is hard to think of the Internet as "settling
down" into a mature industry, but it will happen. It will become something
we take for granted. By then new frontiers will be found, perhaps in biotech,
nanotech, and some other, as yet unknown, tech, in an endless cycle of
innovation. The hot technology of 2050 doesn't even have a name yet.
Hal Varian is the dean of the