Letters To The Editor: More On Cycles

Letters To The Editor: More On Cycles

An old friend, Darryl Carlton, has been corresponding with us from Australia, to let us know that the problems of innovation, venture capital investing (or the lack of it), and the notion of Waves of Technology are not restricted to North America.

I’ve done some editing and commenting here; if you’re into this subject, Darryl is adding lots of great references and insights.

You need to keep in mind that Darryl was burned in the Internet bubble. He had a terrific idea for offering a sophisticated accounting software application as an on-line service, but got caught in the downward drafts and the loss of investor interest that drowned many interesting new ideas.

Amy,

The Theory of Predictable Waves of Advancement is neither new nor radical: The internet bubble was not unique in either its rate of success or its rate of failure. Perhaps the only unique aspect was the degree to which the internet companies received public recognition, and the speed at which they attained their Initial Public Offerings.

John Nesheim wrote his book High Tech Start Up that the chances are 6 in 1 million that an idea for a high-tech business will eventually go public; less than 1 in 5 that a funded start-up goes public. On average, a VC funds 6 out of 1,000 business plans received each year; 60% of venture funded companies will end in bankruptcy. It takes 5 years on average, and up to 9 years for a startup to get to IPO stage.

(Editors Note: I think Darryl has been cribbing a look at my course notes for Why New Technologies Succeed or Fail – I taught this lecture yesterday. Of course, I’d add that most startups never get to an IPO.)

So the question then is why the internet bubble? Why did it feel like so many companies went super-nova with such staggering speed and force.

What was it all about? What can we learn from this period of development?

Darryl depends heavily on Geoffrey Moore’s Chasm Theory. I guess I’d say that I believe it sometimes, but not all the time. On balance, Darryl seems to like it more than I do. If you want to know more about it, read the book.

Darryl continues, Geoffrey Moore has explained in detail in several books that the bell shaped curve view of technology adoption is simply not reality. In fact a great yawning chasm exists between the Visionaries and the Pragmatists who make up the early majority. According to Geoffrey Moore, the Early Market buyers, the Visionaries, buy for totally different reasons than the Early Majority or Main Street buyers. Even scarier is the fact that Main Street buyers do not even consider the Visionaries as viable or substantive references against which they can judge buying decisions in their own organizations.

(Editor’s Note: Startups beware. This means that you can’t trust the views of your early buyers to prove the marketability of your concept to the main volume marketplace.)

There is a predictable and well documented set of stages that a company must go through in order to build its business and there can be no shortcut to this. Even though many internet companies through their rapid ascension to IPOs appeared to short-cut of the normal values of business.

One of the theories that is gathering pace is that the Technology Adoption Cycle moves in much the same manner as the so-called Kondratieff Wave (developed by the Polish economist Kondratieff.). This theory postulates that economies grow in a cyclic fashion, with a predictable and measurable periodicity. Kondratieff holds that the time between the peaks and troughs is roughly 50 years. This cycle is shown most clearly by the behavior of prices and interest rates, rising and falling over time.

Darryl believes that this cycle intersects with other major developmental shifts; in fact that you can plot the relationship between three major theories; Geoffrey Moore’s Technology Adoption Cycle, Clayton Christensen’s Innovators Dilemma, and John Nesheim’s Technology Startup Process.

In my view what happens when a truly disruptive technology is introduced into the market, is that the period during which that disruptive technology enters the Chasm, on its way to greatness, the old technology companies also enter the Chasm on their way to oblivion. A titanic struggle then ensues for the hearts and minds of the main-street buyers!

What is needed now is to completely re-engineer existing client-server architectures in order for new applications to emerge for the internet. Current technology cannot migrate to the internet as it is. IBM refers to the cycle that we are currently in as a “crisis of complexity” as we focus on technologies (and services) needed to integrate all of the “stuff” that has come before – instead of re-inventing how and why we use technology.

The new technology that, in the words of Clayton Christensen “causes great firms to fail” is a completely new distributed architecture for the internet, for services. Software will cease to be product, and it will become a service. ERP will become bookkeeping services. This is not just a new label. Consider if you will, when a company subscribes to a payroll service provider, the customer is not licensing software, he is buying a service... So it will be for all software applications in the very near future.

(Editor’s Note: Sounds good, but I suspect that such sweeping change may be much slower and less all encompassing than that. We are moving in this direction, but it won’t happen so quickly or without many intermediate and unpredictable steps.)

“The Innovators Dilemma” will come to pass. Great firms, leading firms will fail to make the transition from client-server to the internet and will cease to exist. New firms will become leaders. Not all the new firms will necessarily be “new” – they may just be new players in this space. Microsoft may finally figure out enterprise applications with their acquisition of Great Plains and may become a serious competitor to SAP and Oracle in the applications space. Hewlett-Packard may become a leader in Software as a Service as other hardware companies continue to focus on “professional services” (consulting) when they consider services. But many brand new companies will come into existence and to some dominance if they follow Clayton Christensen’s simple model.

According to Christensen, disruptive enterprises share six (6) qualities:

all were enabled by infrastructural innovations

they reshaped the prevailing business model to earn profits in a new way

they served customers as the “portal” of their day

they enabled customers to do things that only specialists could do before

they tended to migrate upmarket

branding opportunities shifted from the product to the channel

The cycle that we are currently in is not a failure of technology companies; rather it is a failure of the investment community to fund real change. The new business that the internet introduced was a fundamentally new and different way to invest in companies. Companies were thrust forward faster than they could cope, and faster than the market could cope with unproven products, management and ideas. The outcome was a predictable failure – the reaction to that failure has been to “throw the baby out with the bath water”. New technologies would come into existence if the engine of innovation was readily accessible – money, and the freedom to create.

Unfortunately the investment community became accustomed to unreasonable returns in unreasonably short time frames, with little or no commitment to the companies that produced products – in fact the interest was not in what the companies did, but was solely focused on whether or not these companies could make it to an IPO in double quick time. The focus of attention must return to the original Silicon Valley model of “Patient Capital”.

Darryl Carlton

Carlton Training Organization

http://www.carlton.to

email: darryl@carlton.to

Darryl,

I agree with some of what you say, but not with all of it. Most of us have read Crossing the Chasm and The Innovator's Dilemma (which I use as one of the textbooks for my course in Why New Technologies Succeed or Fail). I don't think every company follows any of these models -- but they are a good place to start thinking about a complicated problem.

I agree with you that when investors started investing in "how soon can we create a liquidity event -- IPO or whatever" rather than in building valuable assets they went astray. I'm not sure that had a lot to do with any particular time table. We had companies before the Internet that went liquid in three years (usually being sold to another, bigger, company) and we've always had companies that were never going anywhere. The Internet didn't change that.

What the Internet bubble did was convince a lot of people who should have known better that the need to create value and build companies with reasonable business models had somehow been suspended. Instead, they had been issued hunting licenses that guaranteed them a fast fortune. No one seemed to understand that their fortune was based on their ability (or their colleagues' abilities) to conduct what amounts to a financial hustle, knowingly or not.

The venture capitalists are still recovering from the morning after the Internet bust. But I suspect their hangover will be finished soon. Investors are never patient, Darryl. It's their money, after all, and they keep thinking maybe they would have been better off investing it elsewhere (or keeping it in their mattress).

Amy

Amy;

The Chasm and the Innovators Dilemma as models are interesting - what I am suggesting is that their import perhaps lies in their intersection with Kondratieff.

That said however - and I agree with you on this point - the investors were not considering the stage in "the" cycle that the companies were currently in; but perhaps, if they did have some way of objectively measuring where companies were at in the various cycles - then their investment decisions would be "smarter" and more likely to make a return.

Most debt capital investors - direct investors - equity investors - venture capitalists; are not in fact investing their own money, but are investing on behalf of someone else, and they have an obligation to obtain a return on that money. The only way that they can make that return is by investing wisely. The investment habits during the Internet bubble were far from wise.

Investors NEED to invest - companies need money to innovate; during the bubble the wrong investments were made in the wrong technologies (and in that statement is a big clue to the problem).

(Editor’s Note: I’m not sure what a “right investment” is, Darryl, except one that after the fact proves to have made money. We’ve already agreed that’s a very small per cent of the total.)

The waves that Mark Stahlman refers to do in fact occur - but there are different sets of waves following different trends. And as one wave starts to wane and another to surge then both the existing companies and the new entrants simultaneously enter The Chasm (on Everest it is called the death zone - above 24,000 feet). IBM managed to cross the chasm and reinvent itself under Lou Gerstner. Microsoft managed to cross the chasm.

For investors the question becomes: where in the cycle is the company in whom I am interested in investing, what is needed to move them from where they are, what is happening to the rest of the industry with respect to this cycle. We need to know the answers to these questions - because the future successful companies are still in their infancy and cannot be easily recognized - and these can be the wise investment decisions.

Yesterday, at the AVCAL Conference in Queensland, Joe Schoendorf of ACCELL Partners affirmed many of the observations that Mark, you and I have been making with respect to "waves" He believes the root cause of the current malaise is that "it still takes 5 to 7 years to grow a company from dollar one to IPO; during the bubble companies were hustled through in 2 years; the 'bread wasn't baked' and it was being let loose on the public with no supervision".

Schoendorf refers to four stages of the wave:

(1) freefall
(2) bottoming
(3) building
(4) accelerating

He argues that truly great companies are nurtured during the bottoming phase, and then built from that point. A company (according to Schoendorf) cannot build during the accelerating phase - the Internet bubble.

There are predictable economic waves, there are predictable stages of company evolution, and these intersect to the point where there is a right time and a wrong time to start a venture, irrespective of how good the idea is. The old adage "there is nothing more powerful than an idea whose time has come" holds dramatically true - if we can pinpoint when that time is. 2002 may turn out to be, in the USA at least, the bottom of the bottoming cycle, and 2004 may become the first of the building years of this next wave.
Darryl
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