This article originally appeared in the Harvard Business Review
As more and more companies face disruption from globalization, new technology, and startups that have more capital than the incumbents, the continuing cry from Wall Street investors is, “Why can’t companies be as innovative as startups?”
Here’s one reason why:
Startups can do anything.
Companies can only do what’s legal.
Startups can do anything
One of the unheralded advantages of a startup is what at first glance appears to be its weakness. Initially, a startup has no business model and no market share to defend. Its employees and investors don’t depend on an existing revenue stream. If they select a business model that targets industry incumbents, they don’t have to worry about upsetting existing customers, partners or distribution channels.
Yet those very weaknesses give startups an overwhelming advantage in innovation. Startups can try any idea and any business model—even those that are on the surface patently illegal.
At times laws and regulations are in place for the health and safety of consumers. But often the legal obstacles confronting startups have been put in place by companies that look to the government and regulators as their first line of defense against new market entrants. (Existing companies also use network effects of monopolies/duopolies, distribution channel kickbacks, etc., to stifle competition.)
In the past, these anti-innovation tools were sufficient to keep new entrants out. But today, investors realize that companies that depend on regulation and artificial market constraints are actually vulnerable. Once presented with an alternative to the status quo, customers who have been locked into rent-seeking companies flock to innovative startups with business models that provide better service, lower prices, etc. Enormous financial returns are available to startups taking on incumbents, regulators and the law. So, startup investors comfortable making a risk capital bet are actively encouraging startups to go after large, static industries that look prime for disruption.
Here are some of the most visible examples.
Uber – current valuation >$70 billion – knew the day they started that their ridesharing service violated the law in most jurisdictions. Carrying passengers for payment, historically considered commercial use, was regulated in most cities. In addition, some cities put an artificial limit on the number of taxi operators by requiring them to buy medallions and agree to a set of local regulations. Uber ignored all of these requirements and reinvented local transportation by offering a more convenient service. Today, New York City has 13,587 yellow-taxi medallions and more than 50,000 Uber and Lyft cars.
PayPal – acquired by eBay three years after it was founded for $1.5 billion – started as a money transfer system for buyers and sellers on eBay. Banks protested that PayPal was an unregulated bank; and of course, are regulated by the federal government and states. As PayPal grew, incumbent banks forced it to register in each state. Ironically, once PayPal complied with state regulations by registering as a “money transmitter” on a state-by-state basis, it created a barrier to entry for future new entrants.
Airbnb – current valuation $31 billion – allows people to rent out their homes, rooms or apartments to visitors. Not surprisingly Airbnb violates local housing laws and regulations in many cities. None of the renters pay hotel or tourist tax. Every Airbnb rental is a lost night of revenue for hotels that hate it. The company has more rooms available then any hotel chain.
Tesla – current valuation $50 billion – sells cars directly through its own distribution channel. To protect auto dealerships in the 1920s, direct sales by an automobile manufacturer were made illegal in most states in the U.S. Because Tesla believed that existing auto dealers would have no incentive to sell electric cars, they created an alternative option for consumers.
Companies can do anything legal
In the 20th century companies worried about increasing their market share, profit margins, return on investment and return on net assets. They tenaciously protected their existing markets from other existing companies that were using the same business model. They very rarely worried about disruption from new firms as the barriers to entry (financial, legal, regulatory) were so high.
Ironically once companies become locked in their entrenched market positions, it became difficult for them to compete by breaking the same laws or untangling their existing channel relationships. In contrast to startups, companies are constrained by local, state and federal laws and regulations. The risk of breaking laws can result in large penalties and shareholder lawsuits. The Justice Department and State Attorneys General find large companies attractive targets.
As a consequence, one of the roles of the legal department in large corporations is to protect the company from straying into any legal or regulatory danger. (For example, when Volkswagen discovered their diesel cars couldn’t pass U.S. pollution standards, it faked the tests by programming cars to pass inspections. However, in normal driving these cars put out over 40 times the allowed nitrous oxide pollutants allowed by law. After it was discovered, legal penalties cost Volkswagen $18 billion and several indicted executives.)
Yet trying to stay within the legal lines companies paint themselves into a corner by creating their own internal barriers to innovation. Instead of innovating, most industries being disrupted turn to litigation.
To compete with Tesla’s direct sales to consumers, GM, Ford, and the rest of the auto industry either have to shut Tesla out of selling directly to consumers or they have to abandon their own dealer networks and sell directly as well. It’s an untenable and unsustainable position as consumers find car salesmen to be one of the least trusted groups. To defend their dealer network, car makers decided to litigate instead of innovating.
Taxi companies needed to start copying Uber’s business model but instead they turned to lobbyists and legislation to convince cities that deregulated ridesharing was a bad idea.
Hotel chains burdened with even a greater capital investment in their physical buildings are doing the same thing.
Corporations using existing business models have people, processes and revenue goals that can’t be changed overnight. These incumbents tend to have short-term goals and incentives (stock price, quarterly earnings, year-end bonuses) and often fail to recognize that more money can be made on new platforms and new distribution channels. In each case litigation versus innovation is seems obvious choice.
What can a company do?
The introduction of new technology has always been disruptive to existing markets, particularly to those who sell through well-established distribution channels and have extensive capital equipment and fixed investments. But today, as disruption happens faster, and is funded at enterprise scale, companies need to figure how to create a portfolio of innovation. They can do so by first identifying technology trends with innovation outposts located in technology centers; second, by investing in early-stage disruptors; third – buying disruptors and keeping their innovation culture and people; while fourth, creating an innovation culture internally that disrupts their own business model before others do.
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Filed under: Corporate/Gov't Innovation |
The term illegal is a bit hard, imo. There is a difference challenging the status quo based on regulation and outright illegal activities.
Sometimes, I do have the impression that some founders do regard ANY law as disposable and deniable, only bc it fits their story.
Some do behave like zealots here, and do attack and ignore laws and regulations only bc they exist.
This becomes a huge problem, if the health of the customer or a neutral observer can be impaired. This happened in the case of Tesla.
Fun ends with death and health problems. In the case of Tesla’s reckless promoted AutoPilot I even would say that destroying or killing the driver would be an act of self-defense, and would be ethical acceptable.
I don’t think that I do have to accept personal risks just because somebody is too lazy to drive his Tesla on his own.
And I’m not alone, after an accident with a self-driving car, some people said exactly the same.
I don’t think that it helps any startup is their product is seen as a personal threat.
In that sense venturing into the markets shouldn’t happen without considering hazardous risks.
Turning the business model of incumbent up sight down, Ok. Destroying an industry, Ok. Unbundling monopolies, Ok.
Destroying the environment, not Ok. Risking the life and health of people, not Ok.
And especially Uber and Tesla, was and are reckless here, and exactly for this reason the CEO of Uber had to go, and it’s only a question of time until Musk has to go.
This recklessness also didn’t SV very well, the founder bro culture spiraled out of control in some cases, with unpleasant side-effects. That’s bad for the long term prospects.
In Tesla’s case, it was the driver who was reckless ignoring all the signaling of the car telling him to put the hand on the steering wheel, or using the system outside motorways when the car very clearly signals you with noises not to do it.
Automatic driving is already safer than manually driving. With automatic driving this will improve and will be 10 times, then 100 times safer than manual, just like it happened with airplanes.
I met a veteran pilot with 95% of his youth partners dead in accidents. Now it is the safest medium of transportation because of automation and learning by mistakes, improving the machines, not the humans.
Right now you have to accept personal risks on the road because there is drugged and drunk people driving. There is old people with health problems(and senses deficiencies) that believe they drive like they did 50 years ago. There is young people working too much and getting sleep on the wheel.
Last week a neighbor of mine died as a cyclist hit by a car, piloted by a drugged and drunk person. It is illegal but people do it anyway.
My uncle had a vision problem because of age, he believed he could continue driving(because he didn’t want to lose the freedom driving gave him), even when everybody in the family opposed it. In two months he had two small accidents(with dents in the car) because in his own words “cars appeared out of nowhere”, in his mind, not his fault of course. When his license expired, he was not able to pass the tests. But on those two months he was a danger for lots of people.
If you made numbers with real statistics you will realize your worries are out of proportion with reality. When there are 70.000 teslas out there on the entire planet and 1.000.000.000 not teslas, non autopilot cars.
With autopilot cars at least when someone is drugged or sleep or does not see well and it is going to have an accident, the autopilot today will avoid the accident most of the time taking control when a collision is detected.
I agree in Uber being reckless, Musk is not.
I would also add that if the automated driving software has a feedback loop where a company can do analysis on driving in general, after an accident or near miss, they can improve the software and improve thousands of “drivers” with an software update. Can’t do that very well with human drivers.
Interestingly, the same logic can be applied to the campaign of Donald Trump. Untethered to donors, the Beltway insiders, and unloved by the mainstream media he could say and do anything and wound up destroying incumbents who were constrained to the point of being crippled. BTW, this is not an endorsement of Trump at all, just an observation.
It doesn’t seem fair though, does it? It shouldn’t be the norm or acceptable to ignore the law by the startups IMHO and they should at least consider who is being hurt or affected by it. The modern culture seems to encourage such risk taking as long as it promises big upside.
I think there is a big ethical difference between what Tesla was doing (fighting old industry-protecting regulation) and what Uber or Airbnb were doing – skirting taxes and fees that local governments relied on to offer better prices and not acknowledging their responsibility to those involved in the transactions they were facilitating with fairly wide control.
Should it be left to Uber, AirBnB and future leaders of industry to continue to support local governments or is that a model that needs to evolve too, in keeping with the theme of Steve’s article?
It’s a good point of course, but the reality is that governments don’t evolve as fast and loss of revenue can have quite unpleasant consequences for their clients – you and I.
This is another example of Steve’s great skill of bringing clarity to something that has been in front of us all for a while — but needed an oracle to make it clear. And in it making it clear, and bringing into the daylight of discourse, makes it a learning experience for all of us. Thanks Steve.
There are laws of different weight and significance. Start-ups should by all means go against any law that is intended to protect incumbents, they are one of the most powerful forces that can change status quo, and they do it at their own risk. Napster paid dearly and went out of business, yet others are able to bring about great positive change to society and the legal system.
Interesting article with good food for thought. In my view, the larger explanation for companies not being more like startups is the combination of risk aversion, lack of entrepreneurial capacity and incentives for incrementalism. There are a great many business model innovation opportunities for most large companies that aren’t legislated against, yet they largely remain unaddressed.
Excellent point well made Steve. I wonder whether we will still be having this debate in 25+ years, when these so called “disruptive” organisations are no longer startups but are the incumbents. Will Amazon, for example, be able to maintain their culture of challenging the status quo (and infringing a few laws here and there) or will they revert to abusing their position to stifle new entrants too?
Interesting points. To note, all the companies you’ve listed are consumer-facing. It may be that only consumer-facing companies are able to get away with actually breaking the law and or ignoring regulations. If you look at how Uber stared down Mayor DeBlasio in NYC, you can see why: politicians are accountable to their constituents and his constituents became dependent upon Uber and so they pressured DeBlasio to back off. The same goes with regulators, but with an additional degree of separation (and perhaps some dissipation of the effect). While companies may provide money to political campaigns, they don’t get to vote, whereas people do. It would seem, therefore, that only companies whose customers are also voters would be able to ignore rules with relative impunity. To test this, you’d want to look at rule-breaking enterprise-facing companies or companies that sell to consumers who can’t vote, i.e. children.