What we’re going to talk about today

❖ Techno-economic Paradigms
❖ Google case
❖ High-growth potential startups &
uncertainty
❖ Market evolution
 Perez—Three Systems
“The space of the technologically possible is much
greater than that of the economically profitable and
socially acceptable”

Tech Econ

Institutional
 TEP

“The real reason for the decline of the English canals is,
however, to be sought in the fact that English internal
commerce had largely reconstructed itself and that the
railway transport had come to suit it far better than water
transport. English agriculturalists, for instance, had
changed from selling wheat to selling dairy produce, and
the water-ways were too slow for the transport of milk and
butter, whatever they had been for cereals. The coal
merchant was unwilling to provide large warehouses for
coal; he preferred to have it in the railway trucks and get it
as he wanted it; he could then work with smaller capital.”
Google Search
1996: Yahoo!
1999: Yahoo!
Search
 Search Engine Trajectory

❖ Who was customer?

❖ What was ‘quality’ to that customer? (ie.
what did they want more of?)
❖ How did they make money?
❖ How could they grow?
❖ What were their incentives?
 Positioning
High
Quality for Searchers

AltaVista

Ask Jeeves
Yahoo!
Excite
Low

Low High
Inventory for Advertisers
Dominant Design?
 Google
❖ March, 1996: Page launches BackRub to crawl web, feed data into an
algorithm to rate webpages by backlinks
❖ Tried to sell tech in 1996
❖ Excite didn’t want it: wanted results “80% as good as other search
engines”
❖ Yahoo! didn’t want it: “didn’t see the need to buy search engine
technology” (rumor is they asked for $1 million)
❖ Infoseek: “go pound sand” [1]
❖ Launched search engine in 1997, google.stanford.edu
❖ Raised VC in August, 1998
❖ Even as prototype, named one of top 5 search engines in December
1998

1. Sherman, Chris, “How Blunders And Myopia Helped Fuel Google’s Rise To Dominance”, Search Engine Land, 4/4/11, retrieved 1/24/14, http://
searchengineland.com/how-blunders-and-myopia-helped-fuel-googles-rise-to-dominance-71448
 1998: Business Model?

“Currently, the predominant business model for commercial search

engines is advertising. The goals of the advertising business model do
not always correspond to providing quality search to users…we expect
that advertising funded search engines will be inherently biased
towards the advertisers and away from the needs of the consumers.”

Brin, Sergey and Larry Page, “The Anatomy of a Large-Scale Hypertextual Web Search Engine”, Appendix A, retrieved 1/24/14,
http://ilpubs.stanford.edu:8090/361/1/1998-8.pdf
Why Was there an Opportunity for a New Company?
❖ Yahoo! (for example) went public in April 1996
❖ At end of 1996 (the year Google tried to sell the
tech), Yahoo! had 155 employees, $21 million in
revenue, and $94 million of cash in the bank
❖ At the end of 1998 (the year Google first raised
money), Yahoo! had $203 million in revenue, and
$482 million of cash in the bank
❖ Why didn’t Yahoo! buy the tech?
❖ How could Google compete?
 Google

❖ June, 1999: VCs invested another $25 million, but began

insisting on finding a business model
❖ By the end of 1999, Google had generated a total of $220,000
in licensing revenue, lost $6 million that year
❖ Page and Brin realized they would never generate a profit
through licensing
❖ Google launched first ad program in Q1-2000
Google v. Yahoo! Revenue, in ‘000s

Google Yahoo!
Year Revenue Revenue
1995 $1,620
1996 $0 $21,490
1997 $0 $70,450
1998 $0 $203,270
1999 $220 $591,786
2000 $19,108 $1,110,178
2001 $86,426 $717,422
 GoTo.com
❖ In 1998 was trying to figure out how to create Web search results that could
not be spammed
❖ The search company he founded, GoTo.com, used Inktomi’s search results,
but reordered them based on how much websites were willing to pay
❖ The highest payer would have their site listed at the top of the results for
specific searches
❖ Companies were not convinced this would work, so GoTo only charged
them if the viewer actually clicked on the link; This has become known as
‘pay-per-click’ (PPC) advertising
❖ Searchers (and the media) were outraged at this conflict of interest; GoTo put
the price each advertiser was paying next to each search to allay the criticism
❖ In Q1-2002, Google switched to GoTo.com’s pay-per-click model
 Questions

❖ Who are Google’s customers?

❖ What do its customers want? (What is “quality” to that customer?)
❖ Who were Google search’s competitors?
❖ Why didn’t Yahoo! et al respond at the time?
❖ Why didn’t Yahoo! et al respond later?
❖ Was there a tech discontinuity?
❖ Could this market have evolved a different way?
 Market Creation

Maturity

Dominant Dominant Growth

Category Design
Technical
Discontinuity
Take-off

Market Formation
Innovation
Co-evolution
Market Creation
 Black box model of a company
Inputs
Labor Outputs
Raw material Goods
Rent Services
Capital

• Profit = Value of output - Cost of Inputs

• All costs factored into inputs, including
• Entrepreneur paid market salary for their position
• Capital gets paid a risk-adjusted rate of return
 Theory
Inputs
Labor Outputs
Raw material Goods
Rent Services
Capital

• In a competitive market, the inputs and their costs and the outputs and their prices
are the same whether a startup or an established business
• Competition erodes the “profit” to zero
• That is, the entrepreneur receives the same amount for both their labor/capital as
they would if they were an employee/third-party investor
The data shows most startups are normal
Employee v Entrepreneur Income Employee v Entrepreneur Wealth

Most entrepreneurs create their own job, and that’s it

-from Shane, Scott. op cit. pp. 107-108. Data from Quadrini, V. “The Importance of Entrepreneurship for Wealth Concentration and Mobility,”
Review of Income and Wealth 45, no. 1 (1999): 1-19.
 What about that top decile?

Efficiency Value
Normal
Innovation Innovation

Ø
Inputs Outputs Profit Inputs Outputs Profit Inputs Outputs Profit

- Schumpeter, J.A., The Theory of Economic Development, 1934, transl. Redvers Opie, New York: OUP, 1961.
 What about that top decile?

Efficiency Value
Normal
Innovation Innovation

“Entrepreneurial
Profit”

Ø
Inputs Outputs Profit Inputs Outputs Profit Inputs Outputs Profit
 Entrepreneurial Profit is Usually Fleeting

Exclusivity
Excess profit

Innovation
Competition

Time

Successful startups need time and space to establish themselves before competition from
other firms, especially firms already established in their industries (incumbents)
 How can high-growth startups keep
competitors—especially better-resourced
incumbents—from competing in the near-term?
 Big companies are Innovators

Once a large company realizes an opportunity, they can create great

products to seize it
And what they don’t invent, they steal

“...most of PepsiCo’s major strategic successes are ideas

we borrowed from the marketplace--often from small
regional or local competitors.”
- Andrall E. Pearson (former president of PepsiCo), Tough-Minded Ways to Get Innovative, Harvard Business
Review, May-June 1988

Innovation, even protected by IP, is not in itself a sustainable

competitive advantage
What do high-growth startups have
that incumbents don’t?
 Startups have more…
Innovation?
Technology?
IP?
Risk-taking?
Smarter?
Harder-working?
More motivated?
Move fast?
Break things?
Startups need space and time
Innovation?
Technology?
IP?
Risk-taking? Incumbents have all these,
Smarter?
plus a lot more resources.
Harder-working?
More motivated?
Move fast?
Break things?
 What does experience tell us?
Apple New technology
Google New customer need, tech driven
Tesla New customer need, societal change driven
Spotify Complementary assets needed
Uber, AirBnB Regulatory change needed
Sam Adams Market segmentation
Genentech IP ownership
Others Competed head-to-head and won
 What does experience tell us?
Apple New technology
Google New customer need, tech driven
Tesla New customer need, societal change driven
Unpredictability
leads to new
Spotify Complementary assets needed
market creation
Uber, AirBnB Regulatory change needed
Sam Adams Market segmentation
Genentech IP ownership
Others Competed head-to-head and won
 New markets

❖ Clayton Christensen in his Innovator’s Dilemma studied entry and

exit in the disk drive industry, 1975-1994
❖ Categorized companies by new/existing technology and
emerging/established market
❖ Counted success and failure

The book is Christensen, C. The Innovator’s Dilemma. Boston, MA: Harvard Business School Press, 1997.
 Emerging Markets are the Best Strategy
Proven New

Technology Technology

8%
0%

Established

Chance of
Chance of

Market
Success Success

Proven New

Technology Technology
38%
38%

Emerging

Chance of
Chance of
Established
Entrants: 36
Entrants: 15

Market Market Successes: 3 Successes: 0

Success Success

Emerging
Entrants: 24
Entrants: 8

Market Successes: 9 Successes: 3

 Where Startups Succeed
Proven New

Technology
Technology

riskier

Established

Market Incumbent
riskier

Emerging
Startup
Market
What is different about new markets v existing?

Markets that don’t exist can’t be analyzed.

- Christensen, op cit, pp. xxi.

What is different about new markets v existing?

Markets that don’t exist can’t be analyzed.

- Christensen, op cit, pp. xxi.

(or should it be “opportunities that can’t be

analyzed must create new markets”?)
 What do We Mean by Uncertainty
❖ The difference between unpredictable and inherently unpredictable
is more than semantics, it is a qualitative difference
❖ Measurable uncertainty is risk, and is tractable
❖ Unmeasurable uncertainty (called Knightian Uncertainty after
Frank Knight, or often now, “ambiguity”) is something else

“It's hard to make predictions, especially about the future.”

(attributed to Niels Bohr)
 Knightian Uncertainty
By "uncertain" knowledge, let me explain, I do not mean merely to distinguish
what is known for certain from what is only probable. The game of roulette is not
subject, in this sense, to uncertainty; nor is the prospect of a Victory bond being
drawn. Or, again, the expectation of life is only slightly uncertain. Even the
weather is only moderately uncertain. The sense in which I am using the term is
that in which the prospect of a European war is uncertain, or the price of copper
and the rate of interest twenty years hence, or the obsolescence of a new
invention, or the position of private wealth-owners in the social system in 1970.
About these matters there is no scientific basis on which to form any calculable
probability whatever. We simply do not know.
- Keynes, J.M. "The General Theory of Employment". The Quarterly Journal of Economics (1937) 51 (2): 209-223 doi:10.2307/1882087

Risk is actuarial, uncertainty is not.

 People avoid uncertainty
❖ “Better the devil you know than the devil you don’t.”
❖ Ambiguity aversion (the Ellsberg Paradox)
Urn 1 Urn 2

Total balls: 100 Total balls: 100

Red balls: 50 Red balls: ?
Black balls: 50 Black balls: ?
Pick a ball from an urn. If red: win $100, if black: nothing.
Which urn would you rather choose from?
-Ellsberg, Daniel. “Risk, Ambiguity, and the Savage Axioms.” The Quarterly Journal of Economics, Vol. 75, No. 4 (Nov. 1961), pp. 643-669.
Already-successful companies avoid uncertainty

Companies whose investment processes demand quantification of

market sizes and financial returns before they can enter a market get
paralyzed or make serious mistakes when faced with disruptive
technologies. They demand market data when none exists and make
judgments based upon financial projections when neither revenues or
costs can, in fact, be known. Using planning and marketing techniques
that were developed to manage sustaining technologies in the very
different context of disruptive ones is an exercise in flapping wings.

- Christensen, op cit, pp. xxi-xxii.

 Big ideas often face uncertainty
❖ Change the world through innovation?
❖ ‘Special causes’ (as opposed to ‘common causes’) means not
having enough information for induction
❖ Market/industry participants will prefer to wait until there is less
uncertainty
❖ Known/unknown/unknowable
❖ But unknowable can only be reduced by creating information
through action
❖ Action creates information creates more action, in a feedback
cycle
So markets are not so much like this

Innovation

Time
As like this
 Three Spheres of Change
Economic Institutional
Production Socio-political
Capital ideas & behaviors

Financial Socio-institutional
Capital frameworks

Technological
Technological
Revolutions

Techno-economic
Paradigms

Progress in each is rate-limited by the uncertainty of its participants

 Four Spheres of Uncertainty
Customer adoption
Will it solve my problem?
Will it continue to be supported?
Will it be immediately superseded by continued technological advances?

Technological
Will it work?
How long will it take to get it to work well?
Would it be a better investment to continue searching for a better way?
What will it be used for?

Institutional
Does it fit society’s value systems?
How will entrenched interests fight back?
Will change have unintended consequences?
Will this make society better off?

Economic
Will other companies help build system of tech to make this tech work?
Is there a viable business model?
Is there a viable financing path?
 Uncertainty Causes

❖ Slow customer adoption

❖ Lower investment in technology improvement
❖ Slower creation of complementary assets
❖ Difficulty gathering resources
❖ Difficulty standardizing
 Some thoughts on dealing with uncertainty

❖ Classifying uncertainty: the known, the unknown, and the unknowable

(KuU)
❖ When you look at a market:
❖ Known: state of the market as it is today
❖ Knowable: immediate reaction of market to your entry
❖ Unknowable: long-term reaction of market to your entry
❖ Sources of uncertainty include the epistemic, the aleatory, and the systemic
❖ Each can be alleviated, or at least mitigated, differently
❖ Once the uncertainty is alleviated, your strategy must change!
 When to Enter a Market

Maturity

Dominant Dominant Growth

Category Design
Technical
Discontinuity
Take-off

Market Formation
Innovation
Co-evolution
Market Inception
 Evolution?
❖ From 30,000 feet the ‘ferment’ of products looks like
random generation and survival of the fittest
❖ But a dominant design is not necessarily the fittest, it’s
just the design that becomes dominant
❖ Fitness is defined by the TEP
❖ The TEP is the result of the market creation process
❖ There is no exogenous best: the market (YOU) create the
conditions under which best is defined