The Mass Production of Startups

Many industries try to move from a "one - off" structure to a more mass produced model, usually driven by a desire of one of the players to to reduce costs and thus increase penetration and volume (the argument is of course circular - to increase penetration costs, must be reduced, and with reduced costs volume must be increased to make money). Mass production tends to work very well with commodity items, but is generally less successful when tried with more complex products, and much more difficult to do well when dealing with services - hence the reason we all love our utilities' customer service systems.

Thus it was with some interest I note there is increasing evidence that this move to mass production is being applied to technology startups - this post by Fred Wilson caught my eye:

We’ve been attending a lot of “demo days” in the past month and I am attending one more this week, TechStars in Boulder tomorrow. These startup accelerator programs, inspired by the success of Y Combinator, are launching something like 100 new web startups a year, possibly more. And the founding teams of all of these startups are young and inexperienced, mostly by design.

That youth and inexperience is an asset to many of these startups. We’ve been through why that is before. The founders have low personal burn rates so $25,000 can take them six months. They are largely developers/hackers who know how to build stuff quickly and inexpensively. They create lean, mean, capital efficient companies. They grew up with the web so they have a “native” feel for how web apps and services should work. And of course, they don’t know why they are going to fail so they “just do it”.

Once upon a time a startup was something that was initiated by an entrepreneur seeing a gap in the market, and crafting a business to address that gap, and seeking friends and funding - a "one - off" industry structure. This structure implies startup mass production. The question is whether startups are actually natural commodity goods. In other words, do we believe this process will:

(a) accelerate the formation of great new companies that bring exciting new products to market

or

(b) throw me-too sh*t at the wall to see what will stick

In the dying days of Web 1.0 (aka the dotcom era), a large number of "Incubators" sprang up. The reason too often was that there was just too much dumb money being left on the table, as there were just not enough dotcom startups to sponge it all up. Enter incubator plus stable of startups, exit money from table - and then exit the whole panjandrum when the industry collapsed. In other words, incubation was a manifestation of bubblenomics.

Having been peripherally involved with these incubators at the time, I would like to say that they followed the Type (a) scenario above - quality of the startups were high as they were carefully picked - both as people and ideas - for great potential. And I think in the early days they were. The issue was, that as more of them arose, the temptation was to build stuff that had "buzz" - ie was fundable by dumb money - rather than had intrinsic value. And - in my view - quality of teams also declined as volumes went up.

So, what makes us think that This Time Is Truly Different, that we have learned our lessons? Has anything else changed this time round. Are there any factors that will change the game?

Firstly, it is true that it is probably an order of magnitude less costly to get the technology built now, at least to a "beta" stage. This allows a startup to start to capture customers early. However, because of this low setup cost, in any sector there are typically a larger number of competitors (which incubation will only exacerbate). Thus they all have to use FreeConomic business models where the product is given away (if one does, all must) so they are not self sustaining until there has been a shakeout. Most of the "Incubators 2.0" want to sell the startup to deeper pockets long before that, of course.

Secondly, it is possibly true that this generation of young 'Net natives are sharper, cannier and more plugged in to their social media so that good ideas travel faster and poor stuff dies quicker. Possibly.

Thirdly, one could argue that funders' are more experienced this time round and are better able to predict where real niches are rather than follow the buzz and the herd. On the other hand, word on the street is that there are still shifting fashions in the funding community so there is clearly a residual of the old me-too behaviour.

Fred also makes the point that many of the teams are young and inexperienced, by design. Why by design, I hear you ask? Well, the Good Side of this is, as Fred notes, that these people are 'Net natives, and don't know they will fail. There is however - if Web 1.0 lessons are anything to go by - a Bad Side:

Firstly, many (most?) Incubators' business models had a few "interesting" characteristics around contract formation - by and large they were strongly structured in favour of the incubator, a bit like the model for signing new bands. This is a far easier sell to young, inexperienced people than those who have been around the block a bit.

Secondly, young people are both idealistic and cheap - an ideal combination for exploitation. You can make them work ludicrous hours, sleep in a garret, and pay a pittance on the promise of an eventual (and extremely unlikely, statistically) Liquidity Event. And they know nothing of the Founders Discount

In other words it may be more a funders' economics thing than anything else. The other thing I must note about the "youth" thing is this - Fred writes that:

When do the advantages of youth and inexperience give way to the advantages of maturity and experience? And what are the tell tale signs that the young founders are maxing out on what they can give the company? And what does it take to get them to willingly hand over the keys to the car to someone else? Does it happen without VC investors forcing the issue?

A wry smile at this point and a bit of disclosure here - we too are a tech startup, but we are not in the first flush of youth. It would appear that many of these programs are actually closed to people like us, despite (a) knowing our stuff technically and (b) having actually been senior managers, walked the talk etc. (Update - an (old codger) friend has noted that this youth focus is rational, as given the high attrition rate at this stage, throwing lots of cheap bodies at the wall is optimal for an incubation model)

We did go on a startup program last year, but one that was funded by the LDA, NESTA etc - we beat 700 applicants to get to the last 10 - but it was one of the few programs that did not actively discriminate on founder's age. Most of the other entrepreneurs on that program were also experienced. By the way, one of the elements of that experience is a deep interest in funding terms and contractual obligations to funders

Now it would be interesting to see how much better or worse the dotcom incubators' success rates were than the overall funded startup population. Sadly I don't have that data, but my hypothesis would be the fared no better, in fact my empirical observation was worse overall as by and large they were more prone to being in late, with me too stuff, and below average calibre teams. I do recall a McKinsey study soon after the crash showing that pretty much every VC in the dotcom game after 1998 lost money.

So I would make a few predictions here on the Next Generation of Incubators 2.0 (I'll call them hothouses as its more part of the zeitgeist):

(i) There will be little difference in average outcome between hothoused startups and organic ones, but later hothouses will underperform on average, as.....

(ii) There will be a higher propensity for the hothouses to follow fashion, as following the crowd is an easier sell to funders. This will make them more costly than organic plays which will by and large be earlier in.

(iii) There will be little advantage gained from using youth and inexperience early up, apart from low cost of the initial "throw at wall" phase - if anything sticks, age and guile will be required, and as it has less stake, it will e at premium pricing - or the founders have to give up a large slug of equity.

(iv) The "Next Web" will not be built in the hothouses, as innovation is not really their business model - fast following is.

Fundamentally, this is not a type of industry that lends itself to mass production as it stands, and treating it as such is probably the wrong approach. But I'm sure everybody told Henry Ford that too.....

Funnily enough, I think the Boy-band model alluded to above is closer to optimum - if the infrastructure can be standardised (knowing where to find funders, advisers, facilities etc) and contracts standardised then there would be no need to aggregate in hothouses. Perhaps this is what Silicon Valley is closest to in reality ?

(Update II - good note from Nic Brisbourne re differences between Incubation 1.0 and 2.0 in the comments section)

Update III - saw this on Forbes - pertinent somehow as to the Incubation Endgame I predict:

It's just the sort of improbable success that Silicon Valley adores. Two young entrepreneurs have, in a mere five years, turned an obscure Chicago venture capital firm into a presence visible from Sand Hill Road. This year Keith Daubenspeck and Dwight Badger's Advanced Equities Financial is on track to raise $1 billion for startups previously backed by industry Brahmins like Kleiner Perkins Caufield & Byers, Benchmark Capital, New Enterprise Associates and Vinod Khosla.

In the process, closely held AE earned operating income (Ebitda) of $26 million last year on $300 million in revenue. Daubenspeck is ranked 72nd on the 2008 FORBES Midas 100 list of top tech dealmakers. He hopes to take AE public within 18 months.

The problem with this picture is that in vaulting AE to its high perch in the VC world, Daubenspeck and Badger have left a wake of aggrieved customers, furious former employees, lawsuits and more than their share of busted startups. At least 18 former clients have filed arbitration complaints accusing the firm of wrongdoing. Separately, six brokers have alleged that AE stiffed them for millions of dollars.

Its an interesting read......