The dynamics of innovation

A lot has been written over the past few days about Judy Estrin's concern about declining innovation in the USA and Silicon Valley.

While I agree with some of the quoted issues underlying the declined such as the quality of our education system and how the Federal research budget is administered, I (like others it seems) believe that innovation is alive and thriving in the US.

But as the NY Times article quoted Vint Cerf (one of the true fathers of the Internet and now Chief Internet Evangelist at Google):

"There is a remarkable telescoping of vision and an unwillingness to make long term bets."

I think Vint has nailed the true issue on the head – it's not innovation that is declining, it's the way companies are now being built that is the real issue.

Let's step back for a moment and look at the dynamics of the late 90's – the run up to the Internet bubble…

• The vision of the Internet was being embraced by everyone – the "new frontier" effect with lots of opportunity and "real estate" for expansion.
• The threat of Y2K was top of mind for every IT executive – "we need this for Y2K" was almost a blank check for IT spending.
• The impact of PCs, software and communications on productivity was becoming clear.  Some pundits even used "ever increasing" productivity as a counter to Alan Greenspan's "irrational exuberance" concerns about the rapid growth of the stock market.
• Corporate demands to address Y2K and productivity were poorly met by incumbent vendors making it much easier for startups to sell into the Enterprise.
• The stock market was on fire – there was tremendous appetite for new stock offerings (IPOs) that tapped into the opportunities of the "new worlds" of the Internet and productivity improvements.
• VC's has plenty of capital, the cycle time for investments to exit had seldom (never?) been shorter (2 years!) and as a result, VC returns were off the charts.

In short, times were great and growth was fueled by a confluence of drivers (Internet, Y2K and productivity improvements).

Back to today – we're faced with almost the polar opposites of most of these factors…

• The Internet has been widely adopted by the enterprise.
• Y2K was a non-event.
• The low hanging opportunities for productivity improvements are gone.
• The Enterprise buyer is back to being very conservative and a startup now has a very hard time selling into the Enterprise.  This has driven up the cost of sales and the time to complete a sales process – all consuming more capital for the startup.
• The current economic mess has further dampened the appetite (and budgets!) for buying new products and essentially shut the IPO market.  M&A exists are down in number and exit value.
• VC's still have plenty of capital but the time from initial investment to exit continues to climb and is now averaging about 7 years. 

Most VCs will tell you that times of economic turmoil set the ground work for the next wave of dominant players to emerge – this means being optimistic about the future and making investments in early stage companies despite the likely 7+ years it will take to grown them to a decent exit.

Meanwhile, the pressure to generate returns has driven a larger percentage of dollars and focus to later stage (more mature companies already well into revenue) investments or to companies with accelerating growth in a belief that this will lead to a high priced (nearer term) M&A.

For these latter investments, accelerating growth doesn't have to show as revenue – in many ways we are back to counting eyeballs, page views and the number of concurrent users.  The investment is made on the thesis that the path to monetization will be found along the way – perhaps through advertising or by carving out a big enough piece of real estate that an existing player will pay up so that they can use their own monetization process.  This works some of the time…

As a result, it's much harder for a raw startup to raise capital from the VCs or angel investors when they are proposing to build a new product that will take a couple of years to reach the market and then even more years to build up meaningful revenue.

Mindful of these dynamics, the entrepreneur adapts… and turns their focus to leveraging cloud computing, Google AppEngine, Amazon Web Services etc. to build a much simpler and focused software company.  Less capital is required so the entrepreneur can finance the company themselves or through friends and family.  If the entrepreneur picks the right problem to solve and leverages the Internet for everything (distributed development, open source, marketing, buzz…), it's possible to generate rapid growth.

So innovation isn't declining, its dynamics have simply adapted to the current environment.

Time to be a contrarian – when everyone turns their attention to the short term there are indeed opportunities for a big long term play.  The trick is to focus on the magnitude and prevalence of the problem you set out to solve – then apply innovation to build the solution.  Leverage the dynamics of innovation in your favor!

So please, it's TIME TO THINK BIG!!!