ANALYSIS: Why Silicon Valley-style innovation is here to stay

As soon as one sector of the economy starts to boom, a procession of observers and industry experts start to queue up to label it as a bubble that will invariably burst.

Credit the originality, then, of US entrepreneur David Sacks, who recently sold his start-up Yammer to Microsoft for $1.2 billion, for suggesting that Silicon Valley will gradually deflate, rather than spectacularly explode for a second time.

On his publicly available Facebook page, Sacks posted: “I think Silicon Valley as we know it may be coming to an end.”

“In order to create a successful new company, you have to find an idea that (1) has escaped the attention of the major Internet companies, which are better run than ever before; (2) is capable of being launched and proven out for around $5 million, the typical seed plus series A investment; and (3) is protectable from the onslaught of those big companies once they figure out what you’re onto. How many ideas like that are left?”

Sacks’ argument is an interesting one. Although responders to his post quickly pointed out that human innovation is a never-ending cycle, this wasn’t quite what he was getting at.

As he puts it himself: “Human creativity has not changed, and there will always be new ideas and opportunities. But the question is, how many of those opportunities will be captured by start-ups versus incumbents?”

“It seems like a statistical fact that when you go from virtually no incumbents to multiple well-run incumbents, an increasing percentage of opportunities will be captured by the latter. That’s the point I’m making about Silicon Valley – we may not be running out of ideas, but we might be running out of big new companies.”

In Australia, start-ups have the problem of resource and scale, rather than ideas. Industry incumbents, often operating in duopolies, are ripe for the picking for innovative, nimble ventures. But the market size and limited routes to customers often put paid to these upstarts, causing them to look overseas for opportunities to grow.

In the US, Sacks seems to be arguing that the market is moving in a similar way, but with the crucial added ingredient of innovation.

While we have Coles and Woolworths turning the screw on suppliers, the US has Walmart, which is snapping up start-ups, including our very own Grabble.

In retail, US online stores such as Zappos and Amazon are streets ahead of their Australian counterparts. In the tech space, there’s no comparison – Sensis versus Google, anyone?

The US not only does large companies, it does large innovative companies. Meaning that, as Sacks’ theory goes, there isn’t much space for newcomers to squeeze into.

It’s an interesting argument. But it doesn’t quite cut it, as far as I’m concerned. This is best summed up by Silicon Valley investor Marc Andreessen, who posted in response to Sacks: “Each of those incumbents can only do so many new things before you get B and C teams screwing up.”

“Start-ups continually drain talent out of the incumbents, further impairing their ability to continue to innovate.”

And here’s the killer line: “Innovator’s Dilemma – incumbents tend not to cannibalize themselves through disruptive innovation not because they are poorly run, but precisely because they are well run.”

This is precisely the reason why, ironically, a huge firm like Microsoft spends silly money on start-ups such as Sacks’ Yammer, rather than just do it themselves. They are so wedded to the legacy of the business that it’s hard for them to shake up the market again and again because, essentially, they become the status quo that needs to be reinvented.