5 Habits of Highly Effective Revolution

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.


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
New York, the world's first "radiotelephone toll station," and a whole new business model was born-- advertiser-supported radio broadcasting.

Edison's original business model for electricity required customers to pay a flat fee for connection to the network, much like today's model for Internet access. But he soon realized that the dramatic difference in wealth between his first customer, the mighty J.P. Morgan Bank, and his subsequent, small-business customers necessitated a more flexible model, so he invented a device to measure electricity use and charged accordingly.

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."


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.


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.


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!


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 School of Information Management and Systems at University of California at Berkeley. He is also co-author of the book Information Rules.