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A good reason why we are not in a technology bubble: Competition

There is a lot of debate in the venture capital circles around whether we are seeing the first signs of another internet or technology bubble. When the last internet bubble burst I was in high school and not even living in the United States but I clearly remember starting computer science school reading the horror stories of companies going out of business and the entire world complaining about the lack of sustainability of Internet startups. Ten years after, we are, yet again, experiencing an explosion in technology markets that are bringing back dark memories from the last collapse.

Certainly, the excitement in areas like cloud computing, mobility or green computing are pushing valuations to levels that, sometimes, are not a true reflection of the real value of a company. You even have companies like Pandora being able to pull a $1B IPO without even being profitable. On the other side, we have many indicators that contradict the hypothesis that we are entering a technology bubble. Arguably, the clearest of those indicators is the fact that the hottest technology companies like Apple or Google are trading below average levels.

I’ve spent a lot of time watching the market and thinking about this topic and I firmly believe that we are NOT experiencing a technology bubble. I will go as far as to say that there are some very specific conditions that will prevent the technology market from experiencing another massive collapse. If you do some research online, you will find a lot of macroeconomic reasons that will sustain this argument and I certainly don’t plan to expand on those aspects in this post. Instead, I would like to focus on a basic and almost trivial argument that, in my opinion, will prevent another technology bubble: Competition.

My thesis here is very simple, I believe that the fierce competition we are experiencing in the technology market will guarantee that only great companies will prevail at the end of this cycle. If you look at any of the hot internet trends these days like location, social or recommendations, you will find a small number of companies raising the level of innovation at an unprecedented pace which, at the same time, is raising the level of maturity of the current market. This almost contradicts the characteristics of a technology bubble.

How Is That Different From The Dotcom Days?

Well, if you think about it, despite the number of internet companies started during those days, there was not enough level of competition to increase the maturity level of the market. Interestingly enough, the few areas that did experience tough competition like search or ecommerce ended up producing companies like Google, Amazon and EBay which are some of the pillars of the modern internet.

What Competition Can Do…

Here is a quick anecdote of how the rivalry between two of the greatest masters of the Italian renaissance helped to influence a beautiful piece of art.

Italian Renaissance artists Michelangelo. Buonarroti, and Raphael Sanzio were unspoken rivals. The irascible Michelangelo, forced by Pope Julius II into painting his own private chapel, the Sistine as we know it, complained that he was not a painter, but a sculptor. This complaint fell on deaf ears as the pope had a war to fight and little time or patience for soothing the artistic temperament.

Raphael, on the other hand, blessed with a much more affable personality, never seemed to lack for funds or friends. Both artists were occupied simultaneously with the pope’s own private artistic visions in the Vatican.

Raphael’s work in the Vatican Stanze was open to the curious; while Michelangelo left strict orders that no visitors were to be allowed in the Sistine Chapel. Michelangelo, busy as a bee himself, consumed with a daunting task, apparently had little interest in Raphael’s work. But Raphael had an interest in his. Raphael paid a secret visit aided by the pope to view Michelangelo’s ceiling in progress.  So profoundly did it affect him that he returned to his work in the Stanza della Segnatura (the pope’s private library), where he proceeded to pay tribute to Michelangelo by incorporating a seated figure of Michelangelo in the foreground of his masterpiece fresco, The School of Athens.

Competitive Market For Investors

The level of competition we are currently experiencing in technology expands beyond companies and  touches the investors behind these companies. Even though it’s true that there are a lot of funding options available to companies these days, competition is putting investors under constant pressure to make sure they back and grow the right companies and is forcing founders to make sure they select the right investors. With a little bit of luck, such a competitive market will play a role on preventing investors from focusing heavily on irrelevant companies.

Forcing To Innovate Fast

Competition is forcing companies to innovate really fast. If you think about it, only great companies have the ability to continuously innovate at a fast pace and, at the same time, stay very competitive. The companies that are not able to do keep up with this level of innovation, will see their value proposition diminished and, therefore, will have little chances to influence a potential technology bubble.

Forcing To Pivot Fast

When you are operating in a highly competitive environment, your target market and users are likely to evolve relatively fast. In that fast changing market you will, inevitably, realize that some of the your product features or even complete ideas are not relevant anymore. At that time, is when great companies have the ability to pivot onto a different direction that allows them to stay competitive or to expand onto new market areas.

Pivoting a business is extremely hard and a large majority of companies simply don’t have the skillset or support to do it. The fierce competition between internet startups will force a lot of founders and investors to pivot their businesses multiple times which will cause a lot of those businesses to either fail or stagger which will leave little chances to influence a technology bubble.

Alternatives To IPO

Technology bubbles are mostly influenced by disproportional company valuations which is a phenomenon ultimately reflected when companies start trading their stocks publicly (IPO). In recent years, the level of competition and innovation in the internet space have, almost organically, created various alternatives to IPOs which allow founders and investors to stay involved in a company for longer times.

Acquisitions, secondary markets or secondary funds are some of the most obvious alternatives to traditional IPOs. This competitive market is obviously forcing a lot of the big technology vendors to expand onto new areas by acquiring new technologies, which, at the same token, influence their competitors to acquire similar technologies.

Secondary Funds like Russia’s Digital Sky Technologies (DST) are offering investors and founders the opportunity to obtain some liquidity without the pressures of going public. Finally, secondary marketplaces like SecondMarket offer shareholders the opportunity of trading some of their stock options while the company stays private.

There Will Be Exceptions

Like any other big macroeconomic phenomenon, we will see exceptions that make us believe we are in a technology bubble. Unreal valuations, companies going public without creating a sustainable business are going to be a normal element in the near future of the technology market. However, we should trust that the level of competition in today’s technology market will be one of the factors that will organically help to prevent another technology bubble.

 
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Posted by on August 2, 2011 in entrepreneurship, startups

 

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