2019 is the first year in a long time when IPOs are generating lower returns than existing stocks. Has the era of disruption come to an end?
Not for a minute, if you ask me. Finding ways to disrupt a market to deliver more value to a group of customers will always be at the heart of strategic, market, and economic success. The renowned economist Schumpeter taught us this fact decades ago. The generation of wealth since WWII in free markets versus planned markets was proof of his thesis.
So, of course, the market loves disruption and awards start-ups, some with “Unicorn” (i.e., > one billion dollars) valuations. But some disruptions are duds. WeWork, the shared office space company, is one example. WeWork recently withdrew its IPO as potential investors raised questions about its underlying financials. Others are not all they are hyped up to be. Uber’s stock has lost a third of its value since its peak as losses mount. It turns out that the market will no longer pay for significant losses if investors cannot see a way to profit. Profits, according to the New York Times, finally matter in the start-up world.
If you are considering a move into market disruption, here are some questions to ask.
Is the promised disruption doable?
The health technology company Theranos is a case in point for failure. All blood tests from a drop? The disruption sounded tremendous, and high valuations followed. But more people should have called “foul” after a look at the company’s Board of Directors – with no outside scientific talent – and lack of published papers. Another health tech company, Exact Sciences, is the poster child for the alternative. It is disrupting colon cancer testing by providing a non-invasive alternative to colonoscopies. The science is there; so are the clinical papers. The valuation has followed.
Is it a first-to-market concept or first with the best offering?
If scale economies will underlie success, which they did for Uber, Google, and Airbnb, then first-to-market will matter. Facebook was not first; MySpace was. But Facebook created the winning application and captured the public. As Facebook got more members, it was hard for users to switch platforms. Advertisers quickly followed allowing Facebook to quickly monetize its platform.
Is there or could there be a competitive advantage?
The lack of an enduing advantage was WeWork’s downfall as there are local companies that offer shared working spaces. And an existing competitor, IWG, had a robust business model, raising the question if WeWork was a disruption at all. WeWork offered the advantage of “culture” and “vibe,” both of which turned out were not differentiating to the point of financial return.
Netflix had the advantage of convenience (relative to Blockbusters’ DVD rental business) with its home delivery and then streaming services. When competitors entered streaming, Netflix wisely pivoted to creating original content and thereby sustained the company’s growth. Disney and Apple are now trying to copy Netflix as producer/streamer, but Netflix’s talent as a producer remains, at least as measured by Oscar nominations and subscribers.
Can it be copied?
Uber knew local taxi companies could not afford to build a ride-hailing platform. To generate a return on developing the ridesharing platform, you needed a large national market. Uber targeted that market. Similarly, hotels were unlikely to respond to Airbnb. Both companies took off.
As communication shifted from words to images and from email to texts and chats, Facebook made sure it maintained its advantage with the new communication methods. It has eliminated other potential strong competitors from the marketplace by acquiring them. (US anti-trust forces will decide if these acquisitions pass the anti-trust standard.)
Are there growth opportunities beyond taking market share from the disrupted businesses?
At first, a disruption disrupts the alternatives, then the new business scales—and then what’s next? Disrupters will be successful in the long term only if they have a pathway to new markets. This growth is critical to maintaining and building shareholder value.
Uber/Lyft’s ability to contribute to self-driving cars is a primary driver behind their value. Food delivery also helps. Airbnb is trying to expand from rooms to experiences. Fodors and TripAdvisor have moved from advice to selling hotel rooms and travel tour experiences. And Zillow, an on-line platform for house hunting, now buys and sells homes and arranges for an agent. Exact Sciences is moving into testing for other cancers from blood samples.
Taken together the answers to the five questions shape the answer to the ultimate question: Will the new business be profitable?
Amazon lost money for years, but the inherent strength of its platform and its scale promised to transform retail beyond books, thus keeping investors smitten. And its services platform, AWS, was profitable soon out of the gate.
Uber, on the other hand, faces a profit challenge: Is the cost of opening new markets worth it when you lose money in the newly entered geography for a long time? Uber appropriately left territories where growth was not affordable. Its lack of profitability has become an investor concern.
In sum, disruption is a great innovation strategy. Just be sure the concept is secure.