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How fast is too fast?

Speed in building a business is sometimes advisable, even necessary. But more often than not, it kills.

    Just a few years ago, the notion of how to create a New Economy business was turned on its head. Suddenly, you were supposed to enter a market before you had finished surveying the competitive landscape, confidently identified the right opportunity, and crafted a compelling strategy; all of that would have to occur once your business was up and running.

    "You have to act; you can't afford to think about it," proponents claimed. Even after the collapse of hundreds of start-ups and the meltdown of the Nasdaq index, we would hear colleagues and clients alike affirm their belief in speed--albeit with less vehemence.

    Is such advice always sound? Are there times when moving with extreme speed amounts to dangerous risk taking? If so, how does an entrepreneur balance the benefits and risks of moving fast? While these are questions for all strategists and business builders, the Internet's sheer volume of start-ups, embodying every conceivable business model, makes that medium a logical place to seek answers.

    We studied 80 Internet companies, including business-to-consumer companies, business-to-business companies and infrastructure providers. We sought to determine the speed with which each of them built its business--and the outcome. Many other factors affect the growth of a new company, so it is hard to pinpoint the effect of speed. Nonetheless, it quickly became clear that moving fast at the expense of developing a solid business plan and gathering the right resources rarely paid off. Speed gave an advantage to 10 percent of the companies studied, and only if certain conditions were present. When they were not, moving fast provided no discernible advantage or turned out to be costly.

    The perils of moving too fast
    Generally, the faster you build a business, the less time you have to study the market, test assumptions, understand competitors, and optimize resources. Some entrepreneurs today have actually made getting to market as fast as possible an end in itself, even though it often involves doing so with incomplete information and plans as well as inadequate resources. Usually, this approach is what passes for moving at extreme speed, or "e-speed."

    Faster execution carries the risk of burning through resources, both financial and human. Admittedly, speed can provide important benefits. A company that is first to market can shape industry standards and erect entry barriers against competitors. For example, eBay wouldn't dominate online auctions if it hadn't moved extremely fast. But faster execution carries the risk of burning through resources, both financial and human, before the business becomes self-sustaining and of overlooking or misunderstanding the economics of the business model or the realities of the market.

    The challenge, therefore, is to know how fast to move. One start-up we studied--Altra, in the field of wholesale energy trading--figured that out; another, called HoustonStreet, appears not to have done so.

    Altra: Slow and thoughtful evolution
    Created in 1995, Altra has evolved into one of the leading energy-trading exchanges through a series of carefully planned steps. Founder E. Russell Braziel sensibly cautions that the energy market has been based on relationships and that it won't be possible to create an Internet-based transaction business instantaneously. The company started out designing software for managing natural-gas transactions. By 1998, it had a solid customer base, for which it then created an online trading platform and transaction-processing services. Once it had established itself as a leading player in natural gas, Altra expanded into other fuels, such as natural-gas liquids (NGL) and crude oil.

    By closely partnering with, rather than attacking, huge industry incumbents, Altra removes them as a competitive threat and protects itself from future attackers. For example, Altra recently launched Market Solutions, which provides energy companies with the technology to develop their own Web-based strategies and services. Altra's software and trading systems now serve more than 7,000 energy professionals who work for 500 companies, and trading volume is exploding.

    HoustonStreet: Strategy by rapid-fire experimentation
    In contrast to Altra's methodical development, HoustonStreet has followed a "try it, learn from it, and improve it" strategy. Chief Executive Frank W. Getman Jr. explains, "In 2000, it was being first-to-market that mattered." Within months of launching an online electric-power trading exchange in the northeastern United States in 1999, HoustonStreet went national. At the same time, it transformed its Web site into an energy portal. Within a year, HoustonStreet had expanded into the trading of oil, even though the two commodities had very different customers, which traded in very different ways. Just months later, the company expanded into natural gas. Then, at the end of the first year, HoustonStreet founded a Web-based, Pan-European trading platform, placing it at odds with several regional European exchanges.

    Incurring the cost of rushing to market is pointless if competitors can quickly steal your customers by copying what you do. Throughout the course of these rapid market entries, HoustonStreet introduced products that were not fully developed, requiring subsequent revisions. In one instance, it had to go back and make its customers' trades binding. More worrisome, it did little to differentiate itself from other online trading exchanges and failed to establish a strong presence in any market.

    Industry watcher AMR Research, which has reported that HoustonStreet was less willing to release data on its trading volume, believes that it lags behind Altra. In January 2001, HoustonStreet was forced to lay off no less than 20 percent of its work force and to cancel several expansion projects. As HoustonStreet continues to fight for success in the market, it does not appear that a rapid pace of development has given the company a source of competitive advantage.

    When speed makes sense
    While HoustonStreet may view speed as an imperative, it is in fact a strategic choice, with its own peculiar benefits and risks. The proper ratio between them will differ for each industry and, often, for each competitor. Yet the Internet companies in our sample that realized benefits from moving fast had certain common characteristics: They were the first movers in large markets, they managed to erect entry barriers against competitors, and they directly controlled the critical business elements needed to manage the hazards of starting a company. When these conditions are in place, an intense focus on moving fast is probably worth the risk.

    Lasting barriers to entry
    Incurring the cost of rushing to market is pointless if competitors can quickly steal your customers by copying what you do. Moving at extreme speed makes sense only if you can lock in customers and keep out competitors. A strong brand, satisfied customers, and a talented work force do not, by themselves, qualify as barriers to entry or to switching: Employees are fickle, brands time-consuming to build, and even relatively satisfied customers susceptible to the marketing ploys of competitors. Not even Amazon.com's one-click shopping and personalization functions have proved to be very "sticky."

    Customers do resist switching when it involves large setup costs or a complex implementation process. B2B application providers, for example, lock in their customers when they install costly proprietary software systems. Self-reinforcing networks of customers or suppliers have the same effect; eBay's trading community and America Online's instant-messaging system are prime examples.

    But to lock in customers securely, a business also has to keep potential competitors away. Individual staffers may come and go, but an organization that, by virtue of the knowledge embedded in it, continually improves its coordination, facilitates information flows, and accelerates process innovation, is very difficult for competitors to imitate. Organizations that are not permeated by this kind of knowledge cannot manage inventory as efficiently as Wal-Mart does or develop a range of software comparable to Microsoft's.

    Companies can also build high entry barriers by locking up a key resource or forging a privileged relationship with a key resource owner. Qwest Communications International, for example, hampered competitors by obtaining the exclusive right to lay fiber-optic cable along railroad lines as it built its long-haul communications network. Wireless-communications companies can create an entry barrier when they buy broadcast spectrum, provided they don't then turn around and sell it.

    A large market potential
    Even when there is a possibility of creating entry barriers, the risk of moving at e-speed is worth taking only if the potential market is very large--several billion dollars or more. Large markets offer revenue far in excess of the cost of entering them. Revenue on this scale is needed to recover the large investment that moving at e-speed usually entails and to compensate companies for the risk that moving at e-speed usually represents. For example, eBay could afford to make aggressive investments during its rapid entry into the consumer-to-consumer online auction business because the B2B auction market, which it was able to enter successfully as a result of what it had learned, offered revenue large enough to justify those earlier risks.

    To cite another example, AOL added Internet service before it had the server capacity to handle all of the subscribers it had signed up. It became so difficult to get online that AOL was confronted with mass protests and defections. But before too long, it added to its server capacity and smoothed the waters. Today few people remember the episode. The size of the market that had been won justified the scale and risks of the marketing effort.

    Unfortunately, many entrepreneurs fail to understand the true market potential of their businesses. Overestimate your near- or long-term markets and you burn resources and take risks for which there can be no payoff; underestimate your markets and you may not move quickly enough to capture all the available rewards. Many consumer-focused start-up companies (such as Pets.com and Stamps.com) moved rapidly to capture markets that, in the end, were too small to defray the cost of extreme speed. Others allowed the size of the potential revenue to obscure the narrowness of the margins they could reasonably expect to capture.

    Manageable hazards
    Finally, moving at extreme speed is inadvisable if the survival of a business depends on factors that lie outside its control, including technological uncertainties, a rapidly changing regulatory landscape, a large incumbent competitor that is poised for defense, or key resources that are controlled by others. Moving extremely fast is also incompatible with difficult negotiations or partnerships, since the side with the tight deadlines usually is forced to yield before winning its point. Businesses that are so challenged must proceed at a pace that permits thoughtful navigation of the hazards.

    Moving at extreme speed is inadvisable if the survival of a business depends on factors that lie outside its control. Enron, for example, moved at e-speed to develop a marketplace for trading broadband bandwidth. But a key factor--healthy demand for broadband--has not yet materialized, because of forces outside Enron's control: the slow development of applications and the steady rate at which DSL (digital subscriber line) and cable providers are installing "last mile" lines.

    Markets that are new or lie on the fringes of established ones often contain fewer of these hazards. Such markets are likely to be free of giant incumbents, or the start-up businesses may fail to show up on the incumbents' radar screens. They are also less likely to have established owners of key resources or to present regulatory obstacles. Yahoo had no competitors until it started to catch the attention of traditional media companies, for example, but by then it was too late. Innovative new markets are often so different from current markets that traditional players don't see or acknowledge the threat to their business.

    All three conditions rarely hold
    New business opportunities that meet all three conditions for extreme speed are rare. Only 10 percent of the companies in our sample entered large markets offering relatively few major roadblocks and the opportunity to erect strong barriers. Nonetheless, nearly 80 percent of the remaining 90 percent of companies that didn't qualify appear to be moving at e-speed.

    In 1996, for example, a major U.S. discount retailer forayed into e-tailing. After failing to attract much business to its Web site, the company decided to revamp and vigorously promote it in late 1999. A quest for speed was apparent: The company?s "decision to outsource order fulfillment for its Web site is a short-term move to...fulfill a need for speed," noted one market observer.

    The result was predictable: The many problems with fulfillment and with the design and functionality of the site were responsible for its being ranked near the bottom of 50 e-tailers in September 2000. Hurrying clearly provided no benefit--especially since this retailer had re-entered the game late. The company has since adopted a more measured approach to building the e-tailing business, whose new manager--the former CEO of another major online retailing effort--describes it as "a marathon and not a sprint."

    Harnessing the power of speed
    The conditions that justify extreme speed do not banish risk, which must be thoughtfully minimized. Ariba knew how. In 1996, it was among the first entrants into the new and potentially large market for e-procurement and B2B applications--a market that was projected by IDC to be worth nearly $10 billion by 2004.

    Gripped by a misunderstanding of competitive dynamics, dot-coms squandered their ample but not limitless resources. Installing Ariba software and helping customers make the transition to it created high customer-switching costs and thus barriers to competition. Neither the resource owners nor the regulators posed any serious roadblocks, and incumbent service providers, such as SAP and other enterprise resource planning (ERP) software houses, paid little attention to the emerging Internet market. Noting this, Ariba moved quickly and went after the biggest customers first.

    Moving at e-speed didn't come naturally to CEO Keith Krach, a veteran manager. But as he soon came to realize, "This market changes a lot, so you have to move really quick." Ariba therefore introduced the first version of its e-procurement software in early 1997, landing several major customers, including Cisco Systems and Advanced Micro Devices. Over the next three years, Ariba introduced a total of five upgrades, each with increased functionality. Every year it won important new customers, including Chevron, DuPont, Enron, Hewlett-Packard and Visa International. By 2000, Ariba was the leader in the e-procurement application market and had begun expanding further into the market for business applications.

    Although Ariba moved with extreme speed, it reduced technological uncertainty, and therefore delay, by purchasing key technologies (which it then controlled) rather than developing them in-house. On Nov. 15, 1999, Ariba acquired TradingDynamics, a company that had few sales but owned solid technology for online business auctions. Krach started negotiations with Tradex Technologies, a maker of software for building online communities of buyers and sellers, later that same afternoon and went on to buy the company within a month. Other acquisitions were completed at a similarly blistering pace.

    To accelerate the acquisition of customers, Ariba entered into alliances. One of them set out to exploit IBM's significant sales and distribution capabilities and i2 Technologies' expertise in supply-chain automation. Ariba also partnered with the system integrator EDS to create and manage online auctions and e-marketplaces. In doing so, Ariba gained access to companies such as Clorox, Entergy and Kellogg. In just four years, Ariba became the largest operator of e-marketplaces, numbering 286, and the clear leader in e-procurement.

    Dot-coms have failed for many reasons, but their unrelenting focus on speed should not be overlooked. Gripped by a misunderstanding of competitive dynamics, these companies squandered their ample but not limitless resources. While methodical business building will never become obsolete, it should also not be forgotten that speed does have its uses, despite the general discrediting of the speed-centered dot-com phenomenon. Unfortunately for those dot-coms, the situations in which speed does confer an advantage are rare.

    For more insight, go to the McKinsey Quarterly Web site.

    Copyright © 1992-2001 McKinsey & Company, Inc.