Dynamism

https://aashay.substack.com/p/dynamism?token=eyJ1c2VyX2lkIjoxMTAyNzI2LCJwb3N0X2lkIjoxODM2Nzg4LCJfIjoiWE4vWmkiLCJpYXQiOjE2MDAwOTQ5MzAsImV4cCI6MTYwMDA5ODUzMCwiaXNzIjoicHViLTE0ODc5Iiwic3ViIjoicG9zdC1yZWFjdGlvbiJ9.XE09sKkL4_yjX6EgTXlxV-m5x9zA3rPd4w9Jga14dzQ

“Only slight knowledge and simple machinery went into the manufacture of the first Ford. No trained engineers were used. The frame of the car was moved manually; it helped that it could be lifted by two men. The modern auto factory, hi contrast, is itself a complex and closely articulated machine. Nothing is done by muscular effort. Computers control the flow of parts and components. Only the hideousness of the product, on occasion, reminds us that human beings are involved. We see here one reason for the increase in capitalization of Ford from £30,000 to £2,200,000,000.” - JK Galbraith, Reith Lectures 1966: The New Industrial State

The maturation of the automobile, both as a technology and an industry, introduced increased complexity, planning, and organizational bureaucracy into the production of individual cars. As it became a more legible technology, layers were added in, and the process of development and assembly became highly mechanical. Any sense of craftsmanship and dynamism was all but lost.

In a piece from the beginning of this year, Ben Thompson points to the full bloom of the software paradigm, writing, “In other words, today’s cloud and mobile companies — Amazon, Microsoft, Apple, and Google — may very well be the GM, Ford, and Chrysler of the 21st century.” (The whole post is worth reading). While we are far from seeing the totality of impact of software on our lives, I have been thinking quite a bit about the state of software business models recently. While my lens does not stretch back many years, there are a few things worth noting that could support this claim:

  1. Beyond Equity-Based Funding Models -- In Public to Private Equity in the United States, Michael Maboussin and his team note, “buyouts of software firms, a sector with above-average multiples, rose from 6 to 17 percent of all deals over the past decade.” Buyout arrangements are reserved for industries with hard assets, and financing software with debt demonstrates a sophisticated understanding of the recurring nature of enterprise software.
  2. Coalescence of Capital - Venture investors seem to have collectively agreed on funding a few categories -- collaborative (and horizontal) applications, infrastructure software and developer tools, fintech rails, and vertical SaaS + marketplaces. I kid slightly, but the level of pre-emptive investment in these categories signals to me that there many assumptions baked in about market size, runway, and margin structure at steady state.
  3. The “Markets Driven” Investor - This hypothesis is far from fleshed out, but I tend to see more specialist investors winning competitive deals (again, not a translatable signal to eventual return) vs. generalist investors. One can point to the prevalence of platform funds (which host a cadre of specialist GPs), founder sensitivity to the cap table (picking an investor who shares POV and understands the space), and network effects stemming from being in a portfolio cluster. In some eyes, the prevalence of top-down thinking signals the “end of cycle.”

The last argument needs a bit more development, and I’m not exactly sure I’m right yet, but it’s something I’m watching. Another discussion worth having is if venture is “less risky” than previously anticipated and returns are compressed due to capital in the asset class, how should large allocators treat it given their portfolio models?

I highlight all these points to say that it feels as if startups have become more mechanical in the past few years. Some categories even seem formulaic i.e. “Building an OSS business? Here are steps 1, 2, and 3 to world domination.” I’m guilty of propagating this myself. There’s certainly merit to guiding heuristics and frameworks, as founders should not have to make easily avoidable mistakes. But when the steps for idea generation, reaching product-market fit, and company building become too concrete and almost algorithmic, its worth questioning.

The beauty of startups is in their dynamism. They benefit from uncertainty, while big companies falter from it. A startup benefits and captures values from small dislocations and changes that lead to massive overhauls in adoption and behavior. The inspiration for this post came from a re-reading of Elad Gil’s “10X Your Business.” He writes, “ Do x, then y, then z, each of which has a linear increase in the value of the product or company. I think it is good to periodically get out of that way of thinking and ask what sorts of deals, adoptions, or customers would completely change the game for the company. These things should be at least borderline realistic.”

Our mental model fantasies have relegated us to the fact that Google’s structural, product-driven network effects always contributed to its dominance with limited to no hiccups. History gets re-written. We rarely talk about some of the initial distribution deals that jump started the engine. While software continues to mature and that force feels insurmountable, I would love to see more of this thinking Elad pointed to in our ecosystem now. One recent example was Kustomer willing to buy out its competitor Zendesk’s contracts as a means of customer acquisition. It was brash, bold, counterintuitive, and unexpected. It’s too early to tell how that exact chess move will pan out, but I applaud the strategy.