The golden age of startups: Technology is lowering barriers to entry, but increasing barriers to exit

The Los Angeles banking scene is in for a shock. A young British bank, Monzo, founded in just 2015, is set to make its move in the US, initially by making a few thousand of it bank cards available in Los Angeles. Technology is lowering barriers to entry, how else can you explain why a bank, which half a decade ago was just an idea lurking in the head of the young tech entrepreneur, Tom Blomfield, who had never worked in banking, is rattling the cages of established banking behemoths. That is why we could be approaching the golden age of startups, a time when tech entrepreneurs can reign supreme. But it won’t always be plain sailing, the barriers to exit are high too.

A recent report from Credit Suisse came up with an interesting metaphor to explain what’s happening. It compared companies to ant colonies. There is a source of food nearby, some ants find this source and via chemical signals communicate its existence to other ants. And the ant colony sets to work, exploiting this food source, like a mining company that has found gold. But the ant colony also has ants that wander aimlessly, these are like explorers which may occasionally stumble on new sources of food. “But it gets even better” states the Credit Suisse report, “the rate of exploration is roughly correlated with the rate of change in the environment.”

It suggests that company failures may often occur because they put too much emphasis on exploring the opportunities of the core business and not enough on exploration. “Exploration requires a different structure than exploitation, causing companies to stumble,” it said. The locality, by contrast, may not suffer from the same weakness. So Silicon Valley, or the tech hubs of London, remain intact, the food sources remain, but different companies emerge to exploit them.

Suppose, though, technology is creating new opportunities thick and fast — analogous to new sources of food for our ants. This will surely mean that technology is lowering barriers to entry, creating new opportunities for foraging startups that may stumble, like our exploring ant, on new opportunities. But for the region itself; Silicon Valley or London, for example, the barriers to exit remain. The golden age for startups may be approaching, but the eco systems, the tech hubs scattered around the world, not just in the Valley or the UK capital but in Boston (focused on MIT), Manchester, Berlin…the list goes on, is supporting this.

Maybe that is why companies are not hanging around for so long. In 1964, the average tenure of a company on the S&P 500 was 33 years. By 2016, this had fallen to 24 years, and is predicted to fall to 12 years by 2027.

So why?

The Credit Suisse report suggests that these things come in waves and that “short corporate lives are associated with rapid innovation.”

There are two theories to explain this: there’s Joseph Schumpeter’s idea for great gales of creative destruction — monopolies emerge, seemingly invincible, customers remain loyal — barriers to exit are low — but then things change, the way that the company had operated, a focus that had served it so well, counts against it, and the businesses failed.

The Harvard professor, Clayton Christensen, developed a complementary theory — innovators dilemma. How dominant firms can lose their position of power because they failed to spot the change — the new technology or even fashion. They put too much emphasis on exploring their established business model and not enough on exploring new ideas.

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In the early days of the 20th Century, the famed economist Alfred Marshall drew up a list of the world’s largest companies. He said that these firms were so powerful that while they would not last forever, they would enjoy something approaching immortality. He likened these companies to Californian Redwoods, which can live for thousands of years, seemingly immortal to short lived humans.

In 1995, however, the economist Leslie Hannah revisited the list of the world’s 100 largest companies in 1912, and found that 19 were still in the top 100, 28 had survived and were larger (relative to inflation), 29 had experienced bankruptcy or similar and 48 had disappeared.

But it seems this creative destruction has sped-up, maybe temporarily, as Credit Suisse seems to suggest, maybe for good.

It is not just about technology creating new opportunities that established firms missed, technology is lowering barriers to entry in another way, too.

Take the cloud — all of a sudden, the IT setup costs have plummeted — instead of having to pay upfront for software, hardware and various tools that are essential to build a business, it is possible to pay as you go — software as a service, for example, or ramping up storage and processor capacity when you need it, ramping down when you don’t.

“For building websites, creating brands, supply chain solutions, creating products, even building quite simple SAS type platforms; barriers to entry have definitely lowered,” said Louis Warner, COO at the Founders Factory, an accelerator that supports startups. “So with pay as you go services you can quite quickly stitch together a technology stack that is totally plausible and acceptable.”

Daniel Domberger, Partner at Livingstone and expert on technology platforms agreed. He said: “The barriers to entry in tech have plunged with the ready availability of compute and storage in the cloud. The barriers to scalability in tech have shifted as a result of the same factor — the ability to scale is no longer constrained by hardware or capital cost, but is now a function of architecture more than anything else.

Tech has lowered the barriers to entry in a wide range of other sectors – it’s increasingly easy to be a tech-led or tech-enabled disruptor – but market entry is only the start.”

Now tech firms are seeking to use technology to support smaller companies even by applying techniques that were hitherto enormously expensive. Take AI, now Californian tech Node is offering an AI as a service product.

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Companies like DataRobot or Snaplogic are even making the role of data scientists available to companies who may not have the resource to employ these specialists.

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The internet is lowering barriers to entry in another way — it is making it more viable to market your product to a wider audience.

When banks operated solely via their branch network, breaking into the market was nigh on impossible — the likes of Monzo or Sterling wouldn’t have stood a chance.

There is also the issue of the long tail. The internet had opened up a global audience, creating opportunities for niche products that might have been impossible to market in a different era.

Finally, Amazon has made it possible for companies to sell products to a global audience without the need to setup merchandising facilities — Amazon provides a method of global distribution.

Ya-Heng Judy Chen is a professional flautist who studied at Royal Academy of Music. When she struggled to find easy to book, affordable rehearsal space, she recognised a gap in the market and has set up an online business mushRoom to link musicians to homeowners who have space that they’d like to rent out — an Airbnb of rehearsal space. Her business, which launches this year, recently won an entrepreneurial award. She feels it would have been impossible without technology lowering the barriers to entry for her business. “The rapid growth of the sharing economy and the development of two-sided platform technology has helped mushRoom to launch its service a lot easier than it would have been only a few years ago,” she said. “Marketplace platforms used to have to be built from scratch, now open source platforms like Sharetribe provide a complete back-end service with a customisable template that enables non-tech entrepreneurs like me to easily launch my business with 5–10% of the time and money it would take to build a platform from scratch.”

But there is another side — the golden age of startups, maybe, but with a caveat

“Marketing spend and routes to market can be quite expensive, said Louis Warner. Startups need “to leverage partnerships,” he suggested, adding: “These days getting people to use your product let alone pay for it is hard enough.”

“The barriers to scale remain, and can often be harder to overcome,” said Daniel Domberger. “The actual barriers to scale, particularly in enterprise tech, remain the prosaic business factors — distribution, sales force and sales cycles, channel partners, working capital, and so on.”


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Michael Baxter

.Michael Baxter is a tech, economic and investment journalist. He has written four books, including iDisrupted and Living in the age of the jerk. He is the editor of and the host of the ESG...

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