The unfair advantage of Net start-ups

When Draper Fisher Jurvetson funds a start-up today, we rarely worry about a large corporation posing a competitive threat to our investment.

4 min read
On the Internet battlefield, it's Goliath 0, David 15.

Most of the economic wealth on the Internet has been generated by start-ups as opposed to large, established companies. The vast majority of today's major Internet brands and companies did not exist five years ago.

When Draper Fisher Jurvetson, an early-stage venture firm, funds a start-up today, we rarely worry about a large corporation posing a competitive threat to our investment. Companies like Microsoft, IBM, Hewlett-Packard and Sun Microsystems are not the biggest problems for the Internet entrepreneur. Much more worrisome are other start-ups.

For every good idea, an ecology of small competitors springs up contemporaneously. It's amazing how different this is from five years ago. Incumbents used to be credible threats. We used to worry about the giants. But today, an existing business franchise is more often an albatross than an asset. It is as if the start-up has several unfair competitive advantages, from flexibility to partnership dynamics.

Be nimble, be quick
Start-ups have a dramatic ability to act and react to the marketplace; they can change business plans in a matter of days. The Internet is a disruptive technological dislocation that time and again has favored new entrants. In the Internet era, a company's competitiveness seems to depend on its velocity of thought and action.

When DFJ funded Beyond News, it was a corporate "push" technology developer. That business turned out to be a dead end, so the company transformed itself into a developer of consumer shopping bots and changed its name to C2B Technologies. Inktomi acquired it soon thereafter in a stock deal worth $2 billion today.

The Internet is a substrate for intellectual property growth. It allows good ideas to spread more quickly than ever before. In the physical world, companies have to build factories and inventory; customers can only buy products as quickly as they learn they exist, by going into a store. The pace of the physical world is slow, allowing incumbents time to respond to new entrants.

But with the rapid proliferation of Internet companies, the rules have changed, and a good idea can take off like wildfire. Ideas do not require physical assets or a huge capital base to gain adoption. Historical advantages to corporate scale are dissolving.

That leads us to "Internet time compression." From first product launch, it took Hewlett-Packard 47 years to gain a billion dollars' worth of market capitalization; it took Microsoft about 15 years, Yahoo about two years, and NetZero about nine months. When time is the competitive weapon, a small, nimble company can outmaneuver a large company every time.

A start-up also doesn't have any sacred cows. It can come into a new business with a remarkably open mind. And with the Internet, it can ask questions and propose business models unlike any we have seen in the physical world. In contrast, many incumbent businesses seem wed to their channels of distribution, their partners, their payment mechanisms, and their internal politics and budget processes. As a result, they are not the first movers on a new business model and have more to lose by making abrupt changes.

Channel to the new
The Internet is a new direct distribution channel, and new distribution channels tend to benefit new companies. Incumbents have channel conflicts and business relationships that keep them from selling directly to consumers.

In the PC industry, the direct mail approach was a boon for Dell Computer and Gateway as new entrants, but Compaq Computer and the other incumbent PC companies failed to benefit. It was too painful for Compaq to embitter its sales force and anger its distributors by competing in a new channel; it was as if Compaq was destined to watch helplessly as Dell took the business.

Proliferating partnerships
A start-up also can partner in a highly focused way. When a large company like Microsoft seeks a partnership, the partner never knows for sure who it is they are dealing with, which of Redmond's product groups will learn about the proposal, or which parts of Microsoft may come around to hurt them.

In contrast, a start-up tends to do one thing, so it is able to easily partner broadly outside its core. A web of partnerships can help a young company succeed in terms of market entry timing, awareness building and ecological leverage. The Internet has collapsed the cost and latency of communication, making it much easier to focus on a core value-added product or service and to partner for the rest. A business model can be much narrower than before and still be viable.

Advantage: start-up
Internet business is like a game of 3D chess--competitive and rich with strategy--but with the added twist that at any moment, a new company may redefine the plane of play. Suddenly, an incumbent business may find that it has few pieces on the new playing field.

We are in the first inning of the Internet revolution, and there are many exciting changes yet to come. Don't look to the giants of the 1900s. Start-ups will continue to be the engines of innovation and value in the Internet economy.

They are our inspiration.