By Anton Gravets
Everybody knows this story – Xerox, a massive company, builds the first personal computer that sits in a room collecting dust while Steve Jobs briskly walks past, yanks the idea and takes it to market. I really can’t speak to the accuracy of it, especially my oversimplified version of the story. However, it often serves as the example presenters use to explain the inability of big corporations to innovate. They also draw on the stories of Blockbuster, Kodak, Motorola, and Yahoo to make their case. This prompts a discussion on why big companies, with their abundant resources and expertise, are unable to bring disruptive technologies to market. Many list bureaucratic corporate cultures, leaders’ complacency, and a hesitance to cannibalize their own products with new offerings as the key causes.
But I’d like to add another little discussed disadvantage – probability. I believe that along with all the other reasons, a big company is less likely to disrupt the market because, in aggregate, startups have the probability advantage.
Picture that there is a market with a need – they need a way to send text based communication over the Internet. There are 50 companies that identify this as a need and take action.
Company 1, also known as “Goliath Co.“, is a big company, so they immediately assemble a team to address this need by developing a product. This team is very capable; they’ve got marketers, developers and a veteran project manager. They come up with product specifications of what the final result should look like and get going. Along the way, they deviate from the product specification but basically deliver what they initially promised. Unfortunately, their particular offering doesn’t quite address the needs of the complex market and they fail to create value for the consumer. All members of the team are fired and the project manager is forced to watch his Gantt charts burn on a pyre.
Companies 2-49 are small. However, they will go through basically the same process (minus the Gantt charts) and, sadly, produce similar results. They will each come up with a way to solve the problem, only to have the market reject it. They run out of cash and take jobs at Goliath Co. so they can pay back the loans they took out to pay for the startup costs.
Company 50 (aka “David Co.”) is also small and goes through the same process as Companies 1-49, but happens to get it right. Their final product is just what the consumer wanted. They immediately file for an IPO.
What are the stories that we’re reading in the news soon after these events?
“David tops our 50 most innovative companies list.”
“Goliath’s co-presidents step-down. New CEO promises to revitalize company with excellent marketing and PR campaign.”
It’s obvious what the conclusion is – startups are better at innovating. David defeated Goliath, but at what cost? David did it at the cost of the other David hopefuls. The startups, in aggregate, had 50 tries at it while Goliath had one. They stood on each other’s shoulders and had 5 feet on the other guy. What could Goliath have done differently then?
Perhaps Goliath should have assembled five different teams to take different approaches to solving the problem? It’s highly unlikely that this will happen. First there’s the matter of ego, as in, “We’re massive and should be able to figure out the solution from the first try.” If there are no ego problems and they decide to try the diverse approach, then that firm would have to bear the cost of the other 49 failures. I’m assuming Goliath is also developing a few programs besides this one, which makes it a very heavy failure burden.
But what about the advantage of having more productive resources? Here’s where I want to again bring up the idea that Goliath Co. has many projects going on at the same time. This particular project may seem pretty interesting, but their finance people projected an NPV of 5 million for it. They put some good developers on it, but the best guys are working on the digital toilet project with an NPV of 10 million. Their lack of focus distributes the resources based on projections of gains. While this could marginally improve the probability of success for a particular project or two, as a whole, I believe the big company loses its productivity advantage when they put all their best bets on the “big winners.”
I don’t think I can provide a definitive answer to the question of why start-ups can disrupt markets, leaving Large Co.’s in the dust, but I would like to contribute a small piece of the puzzle by suggesting that the probability of a new product succeeding plays a significant role. It’s highly probable that novel ventures will fail, but start-ups distribute the costs of failing across many independent founders. A single firm has to absorb the cost itself. Therein lays the aggregate advantage for startups to out-innovate the likes of Large Co.
Note from the Editor: You could easily replace “startup” in this article with “university research lab.” Microsoft Research is one of the biggest corporate R&D groups on the planet with ~100 PhD level researchers. That sounds like a big deal until you realize that the computer science department at McGill University has roughly the same number of PhD level researchers (professors, post-docs, adjunct/associate professors, etc.). And that’s one of around 20 similarly sized universities in Canada, over 100 in North America, and more than 1000 globally. That’s not even counting smaller universities, or those PhD students doing nothing but research for those professors. The university world has the biggest computer science R&D entity beat by 1000x. Now if someone were just to figure out how to leverage all those academics efficiently… 
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