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HolidayBuyer's Guide
Tech Industry

Behind the theory of disruptive success

University of Southern California finance expert Tom Taulli explains why young companies often succeed against the odds and find ways to unseat established leaders.

Several months ago, I talked to a fast-growing, privately held search company about alternatives. My advice? Sell out--now! The company's response was very interesting. The gist was: "Based on recent mergers and acquisitions transactions, comparable companies are selling between two to three times their revenues. At our current rate, we can double revenues in at least six months and get a higher valuation."

Perhaps. But this logic may really just be smoking the proverbial crack pipe. There's no doubt that search is growing at an incredibly fast rate--and is likely to do so for the foreseeable future.

And somehow, many entrepreneurs like to harken back to Clayton Christensen's classic work on technology, "The Innovator's Dilemma." Undoubtedly, there's lots of evidence to support the thesis that megasuccessful companies get lax and fail to innovate.

Eventually, upstart companies--which do not have the shackles of legacy systems, technologies and distribution--find ways to unseat the leaders and, in turn, become the leaders.
Today's leader can become tomorrow's Wang Global or Digital Equipment. Eventually, upstart companies--which do not have the shackles of legacy systems, technologies and distribution--find ways to unseat the leaders and, in turn, become the leaders. The concept is known as "disruptive change."

However, the theory can be quite destructive for upstart companies. If anything, the entrenched legacy systems and technologies can be a prohibitively competitive advantage.

A stark example is LookSmart, a fast-growing search company that will see its business grind to a halt. Microsoft, which accounts for roughly 65 percent of LookSmart's business, has indicated that it will be nixing its relationship with the company by mid-January of next year.

There are a variety of entrenched, highly capitalized tech companies--including Oracle and IBM--that have learned the lessons of disruptive change. If these companies see a strategic technology, they quickly mobilize their resources to capture the profits.

It may take a bit of time, but it will inevitably happen. For instance, Microsoft is investing millions in the development of search technologies and will ultimately be a critical part of its next operating system. Search is too important to be left to other companies.

If anything, Microsoft has a sterling track record of quashing disruptive technologies. The history of tech is strewn with its victims: Novell, Netscape, Spyglass, Stac and so on. (An enterprising author might instead write a new book on how big companies effectively stomp on upstarts.)

If anything, Microsoft has a sterling track record of quashing disruptive technologies.
Ironically, for upstart companies, success can become disruptive. It clouds judgment. CEOs think that success will continue like a finely tuned mathematical function that keeps going up and up geometrically.

This is not to imply that selling out is the only solution. Rather, it should be looked at seriously. When mega companies are threatened, the response is often brutal and fatal. Unless the upstart has seemingly invincible barriers to entry, it is rational to believe that selling out is the right course of action.

This is what Overture did. It recognized that, while it had patents, brand and profits, it was dependent on distribution alliances with players like Microsoft. At any moment, the big players could turn the switch. Before waiting for this to happen, Overture sold out to Yahoo.

Take a look at the EDGAR filing for the deal. In it, there are Overture's reasons for the merger. Of course, there are the typical synergies--"complementary nature of the technology and products," "expanding marketing opportunities" and so on.

There is also this: "respond more quickly and effectively to technological change, increased competition and market demands in an industry experiencing rapid innovation and change."

Major companies will continue to fall into the clutches of the innovator's dilemma. Sun Microsystems, for example, seems to be experiencing this. And some upstart companies will use disruptive technology to become market leaders, which is what Amazon.com did with e-commerce. But these appear to be rare examples.

The tech titans have the cash, expertise and drive to get what they want. It's Darwinistic but true. Denying that will not help.