Product Innovation Isn’t Everything

starbucks

This article was originally posted on Inc.com.

How was Starbucks able to build an empire in just 35 years by charging premium prices for what is essentially a commodity? The coffee purveyor’s legions of loyal patrons seem to find significant value in what it offers, to the point that it has become one of America’s most beloved brands. Others, meanwhile, are perplexed by the fact that someone would pay $4 for a cup of coffee, standing in a long line for the opportunity to buy something that could be created at home for much less. Starbucks founder Howard Schultz has said, “If I went to a group of consumers and asked them if I should sell a $4 cup of coffee, what would they have told me?“

So how does Starbucks pull it off? Because it offers more than just coffee. It prepares premium custom beverages made to your precise order, excellent customer service, and beautiful stores with comfortable chairs and free WiFi. For many, a trip to Starbucks is as much about the experience as it is about the caffeine. For others, it is a matter of convenience-they can always find one nearby when they need to connect to the Internet. All of these things add value beyond the coffee itself, which enables Starbucks to sell one of the World’s most commoditized products, at a significant premium. For those who value these benefits, Starbucks is contributing significant value, well worth the $4 per visit.

Amazon.com is a subtler example of what’s possible when we look beyond the commodity. It is not selling a premium version of a product like Starbucks, nor does it have a physical presence on every street corner. It does, however, contribute significant incremental value beyond that of its competitors. Most of us shop at Amazon.com because we know it has the world’s largest inventory, the fastest shipping, and one of the best return policies. And, because it is now the largest retailer in the world, it also has significant pricing power and is thus able to offer some of the best pricing.

If all of these benefits seem trivial, ask yourself if you would buy from a smaller online store you don’t know much about, even if the product is the same price. Perhaps you have a bias toward supporting the small businesses or the underdog, but that aside, would you pay the same price for a product from a store that has slower shipping and an unknown return policy?

In 1979, Harvard Professor Michael Porter introduced the concept of the value chain, suggesting there are multiple layers to your business, each of which contributes to the total value to your customer. Direct activities, including sales, clearly contribute to revenue, and activities such as IT and customer service provide indirect, long-term value. The presence of all of these services form an integrated value chain that makes some brands more professional and valuable than others. The investments these companies make in their infrastructure cannot only make them more efficient and bring down cost, they have the potential to add value for their customers by improving the purchase experience, reducing risk, and addressing other needs that the customer may have but are being ignored by the market.

Starbucks and Amazon.com have both built an empire around selling commodities, but they invested heavily in the indirect benefits surrounding their offerings, thus providing more value than their rivals. Put another way, their innovation is the value chain they wrapped around the commodity products they sell, not the products themselves. After all, innovation does not always mean technical wizardry or superior craftsmanship–creating a more valuable delivery or purchase experience can be fertile ground for innovation too.

How can you take a page from Starbucks or Amazon? First, you have to appreciate the irony of selling a commodity and yet become so differentiated in the process, that you rise above the commodity trap that plagues so many businesses. Therein lies a subtle, yet crucial, distinction. Everyone in Silicon Valley seems to be “innovating” a technology product, but not many are creating meaningful differentiated value that gives them a leg up on competitors. That is unfortunate when you consider that many technology products become commodities eventually.

The bottom line? If you spend all of your resources innovating a product that is bound to become a commodity, you won’t have a defensible market position down the road. In fact, all of your resources will have been spent fighting a battle you are unlikely to win in the long term, unless your successful at being acquired during market consolidation, which is unlikely. That’s why innovating the value chain around an existing commoditized product, rather than innovating the product itself, is sometimes a better strategy. That’s especially true if you’re entering a crowded space and lack the timing or resources to become a leader when the market matures.

Adapt or Die: The New Technology Landscape

Adapt or Die

This article was originally posted on Inc.com.

A decade ago, building a website was difficult and expensive. WordPress didn’t exist, nor did the tens of thousands of free plugins and low-cost design themes that can be installed at the click of a button. Today, when someone creates a “brochureware” website or blog, there’s a good chance they’re starting with all of these resources already assembled. The job that remains is to simply integrate and customize.

The same is true of just about any Web application you may be looking to build. There is a plethora of open-source and hosted platforms that make it possible to setup well-designed, and even enterprise-grade, solutions for e-commerce, customer relationship management, and just about any software model you can describe, for a fraction of the time and cost of what was needed before. Cloud-based data and service APIs, meanwhile, are available for just about everything you can think of, often for a low monthly fee. Or in the case of Google Maps, free in many cases.

The net result of all of this inherited innovation is a better quality product for considerably less time and cost, as much as 5 to 10 percent of the prior cost, in fact. A typical e-commerce platform would have cost $100,000 to build in 2003, but it is now possible to build something comparable for $10,000 or less. And for the smaller online retailers who don’t require deep customization and don’t want the hassles of running their own technology stack, it’s possible to set up a hosted online store through Shopify, Volusion, or Magento Go for as little as $15 per month and a couple of hours of setup.

How did we get here so quickly? In one word, commoditization. In a 2003 Harvard Business Review article, Nicholas Carr boldly asserted that, “It is difficult to imagine a more perfect commodity than a byte of data. As information technology’s power and ubiquity have grown, its strategic importance has diminished.” To the ire of the IT leaders of the time, Carr argued that information technology is no different than technologies that had come before it, and it would see the same fate. Consider the jet engine, which was the “high tech” of its day and very expensive to build, employing many of the world’s best engineers at high salaries to develop. Today, that problem is solved at a commercial level, and it is just one of the many parts assembled by airline manufacturers who inherit the technology and build products around it. That is where the market is in the aerospace industry today.

As we witness the solving and inevitable commoditzation of an increasing number of software challenges, we are seeing an explosion of new Web and mobile applications in its wake. Start-ups and hobbyists alike are taking advantage of the increasingly powerful inherited technology stack in large numbers. NetCraft estimates there are approximately 15 times more active Internet host names today than a decade ago and there are now 900,000 apps in Apple’s app marketplace, a feat accomplished in the last 5 years alone.

In the midst of this explosion, we are also seeing capital reach more early-stage ventures than ever before, having a further amplifying effect. Accelerator programs like Silicon Valley-based YCombinator are providing mentorship and seed funds to scores of new start-ups every quarter in exchange for a small equity stake. They also prepare these early stage start-ups raise additional funding at the end of the program.

This approach has allowed accelerators to play the odds across a spread of big idea start-ups, without having to shoulder the risk of investing too heavily in a failed business. Because this approach has proven out so well, there has been an explosion in start-up accelerator programs across the United States since 2005, with an estimated 200 to 300 programs now operating across the country.

The implication of all of this activity for technology start-ups should give prospective founders pause. The fundamental challenge a decade ago was technical in nature. The technological and financial barriers to entry limited competition and required engineering wizardry both for the development of the platform and even to master the available online marketing channels available at the time: SEO and paid search.

Now, with many of the technical challenges behind us, the prevailing problem is competition. No matter what your idea for a website or an app, there’s a good chance you’ll find 10 other start-ups who are already in the market, and a couple of those are likely even funded and already on the ground running. Simply building another great product in this climate is not enough. It is time for technology entrepreneurs to begin developing a deeper appreciation for the art of marketing and the nuance of strategy, if they hope to compete in this maturing marketplace. The objective in this new world is to connect with customers and solve their problems through the use of technology, not innovating the technology itself.

Timing is Everything

timing

This article was originally posted on Inc.com.

Timing is everything. You’ve likely heard this said many times before, but a clear explanation of why is rarely forthcoming. And, since timing is so important, how can you identify and take advantage of good timing?

New opportunities typically arise because of new innovation that either inspires or enables others to enter a market. With the web in particular, the enabler is typically a new platform that brings people together and makes it possible for entrepreneurs to monetize those crowds. For example, Goto.com introduced Pay Per Click (PPC) advertising in 1998, which led to an explosion of e-commerce activity. In 2003 Google AdSense brought about an explosion of ad-driven content websites and blogs. In 2007, Facebook created a platform for social apps and companies like Xynga were born. And in 2008, Apple introduced the app store for the iPhone, and Google followed shortly after with the Android store.

If you are an online entrepreneur, this gives you some idea of where to look, but the opportunities do not last forever. Shortly after Overture launched its paid search platform, Google launched AdWords and brought paid search to the mainstream, and the demand for this service grew quickly. Those who arrived early were able to buy traffic for pennies on the proverbial dollar and had a significant opportunity to build a new business. Competition in the AdWords auctions rose quickly however, and it wasn’t long before the costs of traffic exceeded the profit margins for many small businesses.

As for Apple’s app store, there was a clear opportunity for those who were early to provide the interactive content the market was demanding, but within only a couple years the app store had already become congested with excess content and discovery of new apps quickly became a problem for those who were not already established or who were not providing the very best and most popular content. Today, more than 700,000 apps are available in the app store and 50 percent of the revenue is generated by only 25 developers.

The Internet is unique in its ability to proliferate so many new product platforms and ecosystems so quickly, yet those opportunities are equally fleeting. Each of the platforms mentioned has gone from brand new innovation to a mature market that is difficult for new startups to enter, within just four to five years, suggesting the opportunities online move quickly and startups must be able enter the market and scale quickly, if they are to remain in the market for the long term. After all, once the market is mature, the cost of participating will be significantly higher than in the beginning, and only those who have secured the best sourcing, best talent, and distribution options, will have deep enough profit margins to participate.

To illustrate the significance of entering a market early, consider the Innovation Adoption Curve that was introduced by Everett Rogers in 1962. In this model, Rogers describes how the market slowly uptakes new innovation in the beginning but quickly accelerates towards a peak which marks maximum competition, before eventually decelerating once market consolidation sets in. If we assume the entire process of market uptake takes 10 years, that would be consistent with the observation that many of these online platforms go from new opportunity to saturated within four to five years.

In response to this challenge, a young startup might be inclined to be as early as possible in catching an opportunity. This works sometimes, but is not without it’s own risk. Sometimes the great new innovation or platform your betting on never takes off, and if you’re a young startup with limited resources, that can represent a substantial risk. It is also interesting to note that many successful companies were not the first to enter their market either – they’re often “fast followers” who were able to enter the market soon after someone else validated it, thereby avoiding R&D cost and the risk of non-adoption. This is the case for almost every major innovation in Silicon Valley: Google didn’t invent the search engine, Facebook didn’t invent the social network, and Yelp didn’t invent online reviews.

In 1991, Geoffrey Moore added to the Adoption Cure by identifying what he believed was the perfect time to enter a market, something he called the Chasm. He concluded that entering at the cusp of early adoption and early majority was ideal, because the market was sufficiently proven to reduce the risk of investment, but still provided the opportunity to scale sufficiently before consolidation set in on the back half of the curve. If applied to the online platform opportunities, that means we need to watch new emerging platforms closely and if they appear to be gaining traction, then you need to enter those markets within the next 1-2 years after its introduction.

At the end of the day, timing is merely a function of finding the right balance between supply and demand and these are merely techniques for accomplishing that goal. You need to find the sweet spot when demand exceeds supply to make your job easier and provide the runway you’ll need to take off, before a market consolidates. You can afford to get a lot of other things wrong if you get your timing right.

Are We In Another Startup Bubble?

Have you noticed how many online startups there are again recently? While it’s great for overall innovation, it can create a challenging ecosystem for budding entrepreneurs. I’ve spent more time than I care to remember, evaluating various businesses, looking at models, and seeking opportunities where I could compete. Invariably no matter what idea I find and no matter how niche or arcane it is, it’s likely there are already more than a handful of competitors already in the space.

Just a few years ago, may of the simplest online opportunities were still viable for new entrants with relatively little capital. Today, I see excessive competition everywhere I look, and nearly every niche seems to have at least 1 or 2 well-funded competitors. The other day I was joking with my wife about the issue, and we came up with a business idea (as a joke) that we thought would be a good litmus test — a dating CRM. Afterall, a busy dating pro needs to keep track of all their dates right?. So we looked online, and to our horror, there were several, one of which appeared to be a serious product.

This kind of crowding isn’t what you want to see if you’re about to take a major career gamble.

So why has the market become so congested? Consider what has happened with venture capital investments in Internet startups. Only a decade ago, the expense of getting a startup off the ground was very high. With the cost of servers, and having to write all the low-level code from scratch, it was entirely likely to require millions of dollars to get a company off the ground. As hardware commoditized and foundational software became open source, the cost and time to get off the ground has reduced substantially. Investor Mark Suster wrote an interesting piece on this topic, suggesting that the capital cost of launching a new startup has gone from a million dollars to only $50,000.

I’ve heard it said anecdotally that only 1 in 1,000 Silicon Valley startups would be considered a “success” five years later. A little more promising, I also heard Founder Institute CEO Adeo Ressi indicate that startup success was closer to 3%. I don’t know what the actual number is, but this serves to illustrate just how high the risk is and why the lower cost of investment for VCs is such a good thing. Rather than spending a million dollars on a single business, you can spread that same million dollars across many young startups and significantly increase your odds of reaching positive ROI. That’s why we saw Y-Combinator launch a few years ago to provide early-stage mentorship and $20,000 of investment for college students who want to take a chance on a startup.

The Y­‐Combinator model has proven so successful that it has attracted much more money into the ecosystem and there has been an absolute explosion of startup accelerators across the country, all proliferating the same mentorship + seed capital model. The net result is that you have often multiple tech entrepreneurship factories churning 20-50 out cohorts of new startups every quarter.

With geek now being chic and success stories such as Facebook and Google inspiring movies and careers around the world, the allure of becoming a startup millionaire is today’s equivalent of becoming a rock star. And the Internet has torn down many physical barriers that once precluded other nations from competing. Now you see merchants selling directly from China on eBay, and SaaS companies providing compelling online software solutions directly from India and Eastern Europe. No wonder it feels so crowded!

But let’s focus back on the maturing of capital markets and their contribution to this phenomenon. In the traditional investing cycle, initially, a few investors would reluctantly invest a little money in a company that already had a proven model and track record. With a nearly guaranteed return on investment, they saw healthy returns and confidence built. In the next cycle, more investors observed this success and tried to step ahead of the conservative late-stage investors to get in on the easy money. They accepted more risk and lower returns. This process continued until we had a very mature market in which too much money was chasing too few ideas, all trying to step ahead of one another. And eventually we got to where we are today — money being thrown at every college kid with an idea and no track record. Now imagine what happens with the newly passed JOBS Act, that will make it easier for small businesses to attract angel funding from non-accredited investors, particularly through crowd-funding.

But everything goes in cycles, and I can’t help but wonder if this wave is already cresting. While there’s been opportunity for venture capital firms to spread their risk across numerous startups and increase their odds, doesn’t the proliferation of incubated startups actually challenge the success potential of each one of them? And how long does it take for the aggregate return-on-investment to once again find its historic equilibrium?

It was less than a decade ago that Wall Street was touting financial innovation and Congress was touting easy lending that would make it possible for more Americans to become homebuyers. This, of course, opened up capital to home buyers and investors that created the housing boom and eventual bust. But all it really did was bring more people into the market place and temporarily distort opportunities; a distortion resolved a few years later.

So how long will it take for this bubble to correct? As aggregate returns begin to marginalize and the over-supply of startups begin to cannibalize one another, other investment opportunities such as real estate may become more attractive again and provide healthier alternatives for the early ‘smart money’. The ultimate consequence is going to be a downward leg for a number of years for startups. It won’t be the end of the world, but it will mark the end of an easy-money cycle and a period of exaggerated perceived opportunity.

For would-be entrepreneurs looking to invest in a startup today, it may be worth taking a hard look at whether this is the best time to take the plunge. Isn’t it after all the height of a market cycle when the opportunity looks the best and when everyone is convinced that ‘things are different this time’?

Originally published at  VentureBeat.com:

Are We In a Startup Bubble?