One Theory on Why We’re Not in a Tech Bubble: The Corporation-Startup Innovation Shift
Every week I seem to read a few articles centered around why we are or are not in a tech / VC bubble. Most of these focus on key metrics then vs. now, graphs comparing investment dollars in private/public markets, and other compelling insights. In this post, I will highlight why I believe there has been a fundamental shift in where innovation occurs which has rationally triggered an increase in private venture capital investing.
What is involved for innovation to take place in a company?
CEOs spend millions on their vast R&D departments in order to accomplish their 10-year growth plans. This is a reasonable step for CEOs because they will be the CEO for 10–20 years, they’ve spent most of their professional life working for this company and they have the confidence of a board that believes in the CEO’s long-term plans. It is very expensive to come up with new technologies, so they direct much of their company’s vast resources to bring a viable new product to market. The engineers and scientists in R&D love their well-paying, steady jobs that provide well for their families.
Obviously that’s not how innovation happens anymore. 30 years ago — yes, that’s how it happened. But the times, they are a changin’.
Now here’s how innovation happens today:
Every year, thousands of entrepreneurs launch high-potential tech-enabled startups with only their own skills, some great ideas and little capital. Family, friends, angels and ultimately VCs invest in some of them. Some of these startups — after countless pivots, near-death experiences and an occasional brush with the law — have created something so innovative and well-executed that they have produced millions in revenue and can sell at aggressive multiples to large corporations desiring exactly what they’ve done. The CEOs that buy these startups are thrilled to acquire the new product, team and user base as it provides an instant increase to their key metrics, gives them a place to grow and makes them look like a (temporary?) genius.
Here are some of the key trends behind this shift (many of which are further discussed in this great article in The Economist):
- Behaviorally, corporations have become more risk averse. Executives can’t take on the high risks of new product development, and R&D spending has stalled. The workers in corporations have grown older and self-selected to become those least willing to bet on something new.
- Much of the talent in the latest generation of workers does not value the security of a lifelong career at a large corporation, likely because they are starting their families later, the suburban-lifestyle does not appeal to them and/or because of the positive feedback loop of an increasingly traditional and stagnate corporate environment
- Corporations have grown and become more bureaucratic, partly due to their market expansion binge in the past decades. This diffuses responsibility, creates indifference/apathy and bogs innovators and risk-takers down.
- Ubiquitous technologies (internet, smartphones, cloud computing, etc.) have drastically reduced the cost of developing new technology and proving it in the marketplace
- CEOs are more short-sighted and dependent on quarterly earnings reports for their jobs rather than long-term investments, in part because of their decreasing average tenure. And yes, it often doesn’t help that their income is largely dependent on massaging the stock price.
- M&A used to be primarily for the purpose of consolidating market share and expanding into untapped markets. Now, M&A is often for talent, new product and/or patent acquisition.
Bottom line: All of these trends compound to form our current, quickly-expanding VC investing environment. Rather than invest in high-risk new technologies in-house, CEOs are forced instead to pay a premium for a proven product with a large user base by acquiring successful startups. In a sense, large corporations have contracted out their R&D departments.
This gets to my original point — if these are long-term trends we are observing (which I don’t think many would argue with), then is the growth in venture capital investments really a “bubble”, or just the market rationally responding to the increase in demand for private, de-risked innovation? If technology development has been outsourced to smaller, private companies, then as an investor seeking high-returns it makes complete sense to put my capital there instead of slower-growth public markets.
So why are people talking about a tech bubble then? Well, that may be because people are always talking about a tech bubble- and according to this Google trends chart on “tech bubble”, it appears we are just as concerned about this hypothetical bubble as we have been for … the last 8 years. I guess, seeing as you read this post, it makes for good clickbait too…
About the Author
Victor Gutwein is the managing director of M25 Group, a micro-VC firm he started with his family in 2015. M25 Group’s focus is on seed and Series A rounds for Midwestern startups. He has worked in corporate retail in both the fashion and ecommerce industries in a wide variety of cross-functional experiences, from marketing to merchandising, international to omnichannel retailing. Victor has a passionate history with startups, including a vending machine business and kick scooter company, along with being on the board of the University of Chicago’s first student-run venture fund.
Victor lives with his wife on the South Side of Chicago and loves staying active with backpacking, water polo, rugby, ultramarathons, and triathlons. If he can’t convince you to workout with him though, he’ll usually succeed in getting you to try out a Euro-style board game (like Settlers of Catan) with his friends.
