I was having breakfast recently with a friend who argued that Nest, the hardware company, only existed because it chose to do something that wasn’t important enough for a company like Apple to do because the market wasn’t big enough to move the needle for it.
It reminded me of an old Mark Zuckerberg trope that he has repeated many times in public, namely that he always expected social networking to be won by one of the big technology companies with tons of resources and patience—not a startup.
People like to talk about how the most impactful projects need time and space to grow, with space meaning projects that few others are trying. My view is that while those ingredients are nice to have, the real thing startups need is shade. They need to pursue something that most people—and in particular leaders of big and successful companies—have passed over either because they believe it to be actively wrong or simply not worth the effort in the context of their business and culture.
It is usually a mistake to believe that big companies have not already thought of or considered a new idea. They are usually full of very smart people who have been thinking about their problem space for a very long time. After all, these companies most likely got big in the first place because they were run by smart people and did something very right.
Big companies do, however, discard what turn out to be very good ideas all the time for a whole series of reasons; that in turn, generates tons of shade for startups to work in.
Discarded Ideas
The first reason companies discard ideas is market size. The bigger technology companies get, the harder it is for any given new product—even if it is successful—to move the needle for the company overall. For many of the top technology companies, even billion dollar new lines of business become uninteresting. I would imagine that if a company like Apple doesn’t think it can generate tens of billions of dollars on a new product line after a few years of growth, it almost has to discard the idea and focus instead on something that can. This leaves huge swaths of markets in the discard pile for the best technology companies.
The second reason big companies discard ideas is margins. Technology is a very high margin business. Software and advertising are some of the highest margin parts of technology. There are many great businesses in the world that just don’t generate the margins technology companies (and their investors) are used to. It is easy for companies to discard businesses that have lower margins than they are used to, in part because investors will penalize them if they don’t.
The third reason ideas are discarded is relative effort. This is related to but distinct from margins. All big companies face internal pressures around resource allocation. Companies are almost always constrained by either capital or labor or both. Good companies usually have a very efficient and well-measured way of turning capital and labor into revenue and profit—after all, that is how they got big in the first place.
Any new business idea that a company wants to pursue comes at the direct expense of its existing economic engine, which means that a big business pays doubly for doing something new. It pays the cost of the work on the new project, and it pays the foregone return (and market-multiple) on the opportunity cost of having chosen not to put those same resources to work in its primary business.
The irony of this third reason is that, the more successful a company is, the more that success fundamentally limits what it can do. The most profitable companies that best understand their metrics and how to drive them become the companies that pay the highest taxes on doing something new.
Finally, big companies discard ideas because of their mission and culture. Big companies generally carry with them strong cultures and opinions about how the world works and what their mission is.
Missions are extremely empowering and can generate a great return on work. But they also frequently get in the way of companies doing things which don’t match. People generally don’t want to work on things which are actively at odds with their co-workers and the mission of their company. For example, Facebook is so fundamentally dogmatic about connecting the whole world that it is hard for it to work on projects that don’t further that prime principle.
The leaders of these companies know these pitfalls well and work hard not to fall into them.
Facebook has everything from Internet.org to Oculus. Mark made bold bets acquiring and internally funding things like Instagram and WhatsApp, both of which had effectively zero revenue, in an attempt to avoid normal pitfalls.
Traps of Scale
Google, in some ways, is even more energetic in its efforts to not fall into the traps of scale. The market is granting it room to work on a whole host of un-economic activities in the hopes of finding a brighter future after the inevitable decline of search ads, and Larry Page is clearly taking advantage of the leniency.
Google is also clearly willing to engage on businesses with dramatically worse margins (like its shopping service Google Express) to avoid the margin pitfall. Apple invests in music, which is clearly a worse business than hardware—but likely with a justification that someday it will help Apple sell more hardware.
But projects that meet the four pitfalls above still represent the greatest opportunity for startups because they can count on shade.
I get excited about startups doing something culturally at odds with what the big players espouse. I get even more excited when I believe that an idea isn’t just culturally at odds with larger competitors but also presents resource allocation and margin issues for a bigger company.
Small market sizes are never good. But sometimes a CEO who sees a small market is miscalculating—as was famously the case when IBM CEO Thomas Watson predicted that there would be a “world market for maybe five computers,” albeit in 1943.
The idea that startups need space and time to grow is certainly true. But I think time and space are insufficient. Venture capital may be free-flowing and patient, but bigger companies can be patient as well if they believe the investment is worth it in the long run.
It is far better for entrepreneurs to find a place that is currently shady—a place everyone plainly sees, but where no one else wants to play.