Monday, January 30, 2017

Early Indications January 2017: Where’s the innovation?

As I was discussing the pace of change with my class recently, I struggled to name a hot young startup. It turns out there was a reason for that. Looking at the Fortune list of the biggest private companies with billion-dollar valuations, filtered for US head offices only, you get these companies, all with valuations over $5 billion:

Intarcia Therapeutics

Of these, Uber and Airbnb are of course interesting, and valuable, but it’s hard to call them tech startups, based as they are on the so-called sharing economy model. (Lyft is valued at about a ninth of Uber.) Palantir is an intelligence/defense contractor, so 99% of people won’t knowingly interact with it or recognize it. SpaceX is a literal moonshot, again, not really a typical tech startup. Pinterest feels like it could have been big, but given that its valuation is higher than a projected IPO, it feels like an underwater mortgage. WeWork is more like a REIT than an Apple or Google, Theranos is discredited and won’t likely be on the 2017 list, and the biotech firm Intarcia is almost fifteen years old, focused on a diabetes drug. Stripe builds payment infrastructure, a classic B2B play. That leaves one sole unicorn in the Netscape/Google/Facebook mold: Snapchat. An IPO there could draw some attention, but I can’t see it being a seismic event on par with Google or Facebook.

It also bears noting that none of these companies is at all young. Intarcia is 22 years old, while the youngest companies date from 2010-11. Put another way, here’s a list of important tech IPOs:

Apple 1980
Compaq 1983
Lotus 1983
EMC 1986
Microsoft 1986
Oracle 1986
Sun Microsystems 1986
Dell 1988
Electronic Arts 1989
Cisco 1990
AOL 1992
Netscape 1995
Yahoo 1996
Amazon 1997
Netflix 2002
Google 2004
Facebook 2012

Note the slowdown after 2000 in “blockbuster” IPOs of companies that return value over a relatively long span; such companies as Etsy, Fitbit, GoPro, Twitter and Zynga all have flopped after hitting the public markets. Tesla stock has performed well thus far despite never turning a profit, but that can’t last forever. Netflix required a lot of patience: if you bought at the IPO, it took 8 years for the stock to stop flat-lining, but since 2010, it’s risen from $8 a share to more than $140. All in all, we seem to be in a lull as far as fast-growing tech startups are concerned (with the caveat that Uber and Airbnb are both game-changers precisely because their asset model breaks traditional assumptions).

Several forces are at work, I’m hypothesizing:

1) The App Store platform model has lowered the barrier to entry for software developers. It’s hard to find a major pure-play software company of any magnitude in the past 10 years. The enterprise market has some counter-examples, to be sure: Workday, VMware, Palantir, and Tableau each have market niches, but none dominate an entire industry or have broad public visibility.

2) The gap (in the wrong direction) between private market valuations and public market outcomes is making many companies hesitate before launching an IPO. Dropbox has (or has had) a paper valuation of $10 billion. Its public traded competitor Box has a market cap of $2.2 billion on revenues of $300 million, so Dropbox would need to be pulling in roughly 4-5 times that — in the neighborhood of $1.5 billion — to justify such a lofty pre-IPO price. Staying private prevents that gap from becoming public, but it also delays the funding entities’ exits.

3) The next frontiers in computing — big data, AI, robotics, autonomous vehicles, Internets of Things — will often be capital-intensive ventures. It’s hard to see a startup outmaneuvering GE or Caterpillar on locomotive instrumentation, or disrupting Rolls Royce or Pratt & Whitney with revolutionary jet engine monitoring systems and software. Cloud plays like Rackspace, Cloudera, and Dropbox will be similarly asset-heavy, making Facebook or Google-like multiples difficult now that the industry is both mature (in its tight margins) and operating at huge scale. Meanwhile, most IoT or autonomous vehicle operations will need deep pockets: Uber bought Otto, Google’s car business (Waymo) finally has a name to go with its budget, and the incumbents (Volkswagen/Audi, Toyota, GM, Ford, Delphi, Continental, Bosch) are busy as well. Factors like product liability can quickly discourage garage-scale operations, as they did George Hotz’s effort last October. Robotics isn’t a big factor in the unicorn list; maybe that will come later.

4) Starting with Netscape, web-based software businesses have had a difficult time getting money from retail customers, compared with Lotus, for example. Netflix is the rare content play that turns a profit from direct payments; AOL, news media, standalone music services, and even investment advice sites are struggling. Some have tried the enterprise route, but the big successes have been ad-funded. Given the enormous power (speaking here of the U.S. market) of Google and Facebook, it’s hard to see how Snapchat, Vine, Twitter, Tumblr, or some new startup can break into that select club. Even Quora, with its vast knowledge base, seems content to run low-key ads that likely don’t pay the rent. On the demand side meanwhile, people are accustomed to getting good stuff for free (“consumer surplus,” in economists’ terms), making the ad model viable and in many sectors essential. There are only so many hours of human attention in a day, though, and getting new share means dislodging some well-entrenched incumbents.

5) Maybe, in line with what the economist Tyler Cowen has argued, a broader innovation slowdown is hitting the tech sector. When you look at our grandparents or great-grandparents, some of whom lived through both the Wright Brothers’ first flight and the 1969 moon landing, mass electrification and the atom bomb, penicillin’s introduction and the MRI, open-heart surgery and test-tube babies, the Internet’s origination and the first cell phone, 1900-1980 was a period of innovations that reshaped everyday life. Since 1980, what else is in that league besides the smartphone and World Wide Web, obviously? Fracking transformed oil and gas, the mini-mill reinvented the steel industry, and minimally invasive surgery is the norm for many procedures (as are stents rather than open-heart surgery). Cloud computing is reshaping the server and now storage markets, Skype was revolutionary (but non-revenue-producing) before Microsoft tamed it, and Google search solved a very hard technical problem. GPS reinvents our sense of space and location. But will we really look back on Facebook, YouTube, and LinkedIn on the same plane as the automobile, television, or the transistor?

6) Speaking of the smartphone, the final factor affecting our perception of innovation is the globalization of tech. Whether it’s the Japanese messaging app Line raising $1 billion last summer, Alibaba’s record-setting $25 billion offering in 2014, or privately held Xiaomi’s status as a pre-IPO hardware company worth $45 billion, the biggest stories are all global plays (Uber and Airbnb among them). More and more are headquartered closer to the fastest growing markets and/or talent bases outside Silicon Valley: India’s Flipkart (an online retailer), Sweden’s Spotify, Coupon (a South Korea e-commerce business), or Global Fashion Group (an e-business focused on apparel serving 24 countries based in London). Innovators can be literally anywhere, building apps and businesses North Americans never see or even hear of.

So is innovation slowing own? I think it makes sense to set a baseline: a huge percentage of human codified knowledge is now online, often for free. Many, soon most, adults on the planet have a networked supercomputer close at hand, often in a pocket or purse. Everyone with these devices knows exactly where he or she is at any time; can reach millions or billions with a tweet, a post, or a blog; and can capture and watch high-definition video and still images. That’s our baseline of “interesting,” which has to count for something. At the same time, we still burn coal and petroleum for most of our mobility and much of our illumination, train service is pathetic in much of the world, and human life expectancy extension may be slowing down or even reversing. In the narrow realm of content, E-book sales are slowing, vinyl LP sales are expanding rapidly off a very small base, and even cassette tapes are in favor among some hip populations. 

Do we measure innovation by the magnitude of problems we have solved, or by the frontiers left relatively unconquered? Is the IPO success of an online merchant important for quality of life, relative to the possibilities for telemedicine or Kenya’s mobile banking success? As usual, “it depends” sounds like a copout, and maybe it is, but I do long for the days when hardware, software, and services for the “average” North American were new, exciting, and a bit rough around the edges as compared to the tech landscape of the media and entertainment period we currently inhabit.