He was a ‘transportation geek’ and a serial entrepreneur.
Of course, he would try to uproot the creaky transportation world order.
He seized on the large market opportunity in ‘peer-to-peer ride-sharing’.
His idea was to turn everyday car owners into part-time drivers.
The roads are packed with underutilised vehicles. So why not monetise this underused capacity?
He wasn’t Travis Kalanick, the co-founder of Uber.
He was Sunil Paul, the founder of the peer-to-peer ride-sharing app Sidecar.
Paul may have been first to the thought, but other entrepreneurs were circling. Something was in the air — transportation was set for a revolution.
While Paul was developing Sidecar, Zimride — a carpooling startup co-founded in San Francisco — decided to pivot and rebrand.
Zimride ditched its carpooling model and turned to casual ride-sharing. Zimride also changed its name to Lyft.
Of course, neither Sidecar nor Lyft became as global or dominant as another transportation app that began as a luxury black car service.
Uber.
As Mike Isaac wrote in his acclaimed Uber biography Super Pumped: The Battle for Uber:
‘Paul was first to the thought, and more prescient than he could have known at the time. But in Silicon Valley, being first doesn’t matter — being the best does.’
Silicon Valley often operates under the Ricky Bobby principle: if you’re not first, you’re last.
Being first in a winner-takes-all field is lucrative…but difficult and improbable.
Winners, success, and ambition
W3Catalog, Yahoo!, WebCrawler, AltaVista, RankDex, Ask Jeeves, MSN, Bing…Google.
The dominance of Google’s search engine sometimes makes it seem like we used nothing else.
But many search engines came before, and all have wilted under the growing shadow of Google.
In search, there is no bigger winner. Google has taken it all.
The dominance of Google, Apple, Amazon, Facebook, and Uber highlights the stupendous success a business and its investors can find when coming out on top in an emerging sector.
Such success begets ambition.
Entrepreneurs see in past glory the template and scope for their own.
Success also stirs daydreaming in investors.
‘Imagine if I invested in Apple at the ground floor?’
‘What if I invested in Amazon and held on till now?’
This entrepreneurial ambition and investor hunger have been codified in one of the most influential Harvard Business Review (HBR) articles ever.
Tech’s gospel: the theory of increasing returns
In 1996, economist W Brian Arthur published an article in the HBR titled ‘Increasing Returns and the New World of Business’.
Arthur argued that the shift from ‘processing of resources to processing of information, from application of raw energy to application of ideas’ led economic behaviour to be defined more by increasing rather than diminishing returns.
On the 20th anniversary of its publication, Fast Company dubbed Arthur’s theory as ‘the most important economic theory in tech’.
To get a clearer sense of Arthur’s ideas, here’s a snippet from his article (emphasis added):
‘Increasing returns are the tendency for that which is ahead to get further ahead, for that which loses advantage to lose further advantage. They are mechanisms of positive feedback that operate—within markets, businesses, and industries—to reinforce that which gains success or aggravate that which suffers loss. Increasing returns generate not equilibrium but instability: If a product or a company or a technology—one of many competing in a market—gets ahead by chance or clever strategy, increasing returns can magnify this advantage, and the product or company or technology can go on to lock in the market. More than causing products to become standards, increasing returns cause businesses to work differently, and they stand many of our notions of how business operates on their head.’
(Trivia for the Cormac McCarthy fans: the acclaimed novelist helped edit Arthur’s article line by line over four days prior to publication.)
A key takeaway for me is the point that if a company gets ahead, increasing returns accruing to it work to extend its lead.
As a result, the company captures the market.
Think of increasing returns accruing to Uber.
The more customers join the platform, the more drivers find Uber an attractive option. The more drivers on the platform, the smoother the service for customers and even more customers join.
This snowball effect led Arthur to playfully coin Arthur’s Law: ‘high-tech markets are dominated 70-80% by a single player—product, company, or country.’
Let’s work through some implications.
Assessing a tech stock’s potential
If Arthur’s findings stand firm, we can use them as analytical tools.
If you are considering a tech stock, you should take account of its competitive landscape.
What’s the lay of the land?
Is your tech stock operating in a market already dominated by one player? In your scoping of the landscape, ask who the market leader is and how far ahead they are.
Has one player captured so much of the market that it shortens your tech stock’s growth potential?
In other words, will your stock idea be fighting for scraps, with future cash flows crimped?
And if you think your stock can overtake or disrupt the incumbent, why?
Now, what if your stock is launching into a wholly new field, sector, or market where no clear winner has emerged yet?
First, you’ll have to confirm the market is new, with large upside potential, and that it lacks any dominant player so far.
Then you can ask if your tech stock can be the one to capture >50% of the market via increasing returns.
Why is your tech stock idea more likely to capture the market than a rival? Does it possess a clever strategy, a superior product, or a lucky advantage it can use to entrench its position?
Remember Sidecar.
It was first to the idea of peer-to-peer ride-sharing. But it was Uber who came out on top.
Downside of winner takes all: losers take nothing
If increasing returns compound to a firm capturing the market, that firm and its investors will enjoy great success.
But success entails failure for rivals.
If the winner takes all, losers take nothing.
Ricky Bobby’s rule really does hold here — if a business isn’t first, it may as well be last.
Commenting on his article years later, Arthur rued the article’s reception (emphasis added):
‘The only thing I would change about that article is the way the whole thing was viewed. In 1999, 2000, and 2001, we had a tech bubble. People were talking about network effects and waving that article around a lot. Startups were going in front of venture capitalists and saying, “All we need to do is fan the flames a bit and everything will take off. It’s winner-take-all, so we’re going to get a huge amount of the market.”
‘But if they’d understood the idea a bit better, they’d have realized that out of the 20 startups rushing into one field, 18 or 19 were likely to fail. The chances of being that winner-take-all would have been 1 in 20, which isn’t a very good bet for a startup.’
For every Uber, there are many more Sidecars. For every Google, there are many more Bings.
For every dominant winner, there are countless losers.
Until next week,
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Kiryll Prakapenka,
For Money Morning
