Rough Waters Ahead
In late April, I had an interesting conversation with a gentleman for a large online marketplace about how the company that he works for had hit a build-or-buy moment for technology, and they were looking to evaluate which startups would make attractive acquisitions. Business had been reasonably good in the past couple of decades—they had been one of the pioneers of the information age, an OG-Web1.0 firm that had embraced the internet a few short months after it was opened to commercial traffic. He then went on to say something that took the wind right out of my sails:
“We’re focused on evaluating [startup] targets that could help raise our conversion efficiency.”
There’s nothing wrong with running a tight ship, particularly in his industry where Porter’s five forces would suggest some rough sailing. But something about this struck me as untenable—the company’s business model already relied on a cost-advantage strategy…how much more juice could they squeeze?
Would a fraction of a percent gain in efficiency potentially result in a few million dollars? Possibly. Would any of that matter when the suppliers found a better way to reach the end-customer? Definitively not.
Being first in a race to the bottom doesn’t make you a winner: it makes you bankrupt. This company was already dying, and this guy didn’t get that.
The Siren Song of Efficiency
So, what to make of all this chatter about digital transformation, industry 4.0, or the digital revolution? Is it all jargon and P.R. bullshit? Well, kinda—depending on who you ask, and what they’re selling. There’s a lot of money to be made in streamlining processes, cutting expenses, or risk optimization; not only because digital does these things exceedingly well, but also because it’s the easiest to wrap our collective heads around. Reach more customers at a lower cost… straight forward, right?
If your time horizon for success is a fiscal quarter or two out, you can probably call it a day – after all, you might be in a different job—or retired—in a year or two. No reason to rock the boat when you’re not expecting to be around. Make a few more bucks, spend a few less, Wall Street rejoices, and everyone wins. Rinse and repeat.
And then one day, it doesn’t work anymore.
The sea monster of macroeconomics rears its ugly head: competitors see what you’re up to and copy it. Making a killing by drop-shipping widgets online? Someone else will undercut you by a penny. In response, you crank the efficiency engine up to 11, and squeeze out two more pennies (or up distribution capabilities, or reach a wider audience, or lean harder on the suppliers.) You aspire to be the Walmart of widgets, but others are in close pursuit. This game will work for a while, but as you repeat it again and again, it gets more and more difficult.
There is a theoretical limit to the efficiency game. And before you know it, you’re left high and dry—margins are razor thin and your industry ecosystem is circling the drain—and there’s little chance of escape.
When Innovation Makes for Smooth Sailing
Before you start looking for a life raft and declare that there’s no hope for humanity, take a deep breath. There are two very good--and well supported—reasons to buy a startup: to get a forward-looking mindset, and to shake things up a bit.
If you don’t feel like pouring through James March’s research (it can be a bit heavy,) I’ll give you the short version:
But big firms naturally shift to exploitation as the business grows: after all, at some point in the past they found a winning formula, and now they want to cash in. There’s no reason to buy a startup to help them along that path…they should be doing just the opposite.
Volatility is generally regarded as a bad thing, but that's not necessarily true: making a few waves can actually make the company stronger. The introduction of new ideas, new personalities, and new mindsets can help stave off group-think and reduce the echo chamber. Want a more honest opinion? Ask an outsider.
Missed the Boat
My chat with OG-Web1.0 guy ended pretty quickly. He didn’t quite grasp that the point of buying a startup was to do new things, and I suspect the whole exercise was more of a P.R. move to revive an antiquated brand than to explore new opportunities. It’s surprisingly common: a lot of talk but not much action.
That’s okay. Someone who’s far cleverer than I am is probably working on an alternative business model right now.
OG-Web1.0 firm will continue to do their thing, squeezing more juice and upping those conversions, making a few more bucks and spending a few less. It will continue for a bit—there is a little economic slack left in the system that can still be exploited and a few pennies that can found.
But then one day, it just won’t work anymore.