Startup Wars: The Incumbents Strike Back

A short time ago in a place that we’re all familiar with…

One of the major areas of interest for us at High Alpha is the disruption potential in markets with big incumbents. There are a ton of industries that have had a large market player for years with their products becoming increasingly out-of-date and difficult to use in today’s times. These products aren’t necessarily bad or worse than the competition, but they aren’t exactly fitting the bill in terms of the evolving demands of the consumer.

It’s usually here that some entrepreneur sees a great opportunity to follow in the industry and pick off some of the less happy customers of the incumbent to make a business. Usually, the smaller companies rely on an innate flexibility and ability to move quickly and efficiently compared to the larger players. This often manifests itself in technology adoption and product evolution, but could also be due to better customer success solutions.

Direct vs. Indirect Differentiation

There is a significant difference in methods of competition. I’ll define them into two separate buckets in order to clarify what’s happening right now.

The first is Direct Differentiation. Direct Differentiation refers to a meaningful difference between two products, such as the technology stack or the product features. A lot of these features are innate differences that are incredibly difficult to bridge the gap between. As an example, the taxi industry and Uber have a direct competitive difference, which is the main mechanism of interaction. For taxis, you either have to physically hail the ride or call a taxi company. Uber uses a mobile application. For the taxi industry to compete with Uber, they would have to completely modify the way they operate currently.

The second is Indirect Differentiation. Indirect differences can be material in the sense of change, but aren’t usually meaningful differences in the actual mechanics of the product. A lot of these have to do with non-R&D functions. As an example, if two CRM companies have different pricing structures and customer success methods, but have similar products, they would be indirectly differentiated. It would be easier for a customer to shift between the two products if they wanted to or had to.

How the World Used To Be

If you look back to 15 years ago, the gap between a startup and large corporation was massive. The large incumbents were often fairly slow to innovation and would be very reluctant to spend their capital in new and interesting ways.

Young startups could easily find deficiencies and solutions that incumbents were unwilling to take on and use. They could eat a large chunk of the incumbents’ business over a period of time. In fact, some businesses have even taken over the incumbent in this time. The automotive industry is a great example. GM, Ford, and other large incumbents sat at the top for a very long time, and then Tesla came with a completely new concept (software-oriented electric cars) and was able to run all the way to the top. Earlier this year Tesla, become the most valuable U.S. car manufacturer by market capitalization. Ford and GM saw Tesla, but assumed that it wouldn’t be able to shift consumer preferences to electric vehicles and largely ignored them. Some automakers experimented with the technology like the Nissan Leaf and the Chevy Volt, but once Tesla came out and started gaining a big following, attempts to truly compete fizzled out. Even for startups similar to Tesla, it was difficult (see Fisker and Faraday Future).

The big incumbents in this case wouldn’t innovate or adopt new standards quickly enough to fend off the young startups until it was too late.

How the World Is Now

Today, it’s a very different game. The big incumbents are much more flexible and are willing to move around more when it comes to their strategy. A great example of this is in financial technology. Many banks have started up corporate venture arms and incubators, while also increasing R&D spend to a point where they can compete with smaller firms. For fintech, blockchain and cryptocurrencies are a new, emerging area of interest, and companies like JP Morgan Chase are spending significant resources to acquire talent in these areas and starting to build practices and solutions around them. The chance they get disrupted by a new technology is significantly reduced because they are deploying their biggest advantage to level the playing field: capital.

The big incumbents have more flexibility and options than ever to go and be on the cutting edge and innovate more efficiently. It’s a growing trend with corporate venture capital at an all time high and more corporations working with startups to find unique solutions to problems. Incumbents aren’t 100% there yet, so the opportunities are still existent, but the game is changing and the big guys are more competitive than ever. The smaller startups now have fewer chances to find those meaningfully-direct differentiation opportunities and now must compete on the indirect opportunities. Things like customer experience are much more difficult to use to supplant the big guys as even they are becoming better in these spaces with the increases in technology.

So, Now What?

We’ve arrived at an interesting point where supplanting industries is becoming harder and harder. The big players are more flexible, move quicker than ever, and are faster to adopt and alter plans to close the gaps. The real key is to find what the big incumbents can’t or won’t do. The “can’t do” is becoming increasingly rare, but the “won’t do” is still a big deal.

These may be things like pricing mechanisms, customer engagement, special processes (like Southwest’s ‘Pick Your Own Seat’), and others.

With these tools, it’s still possible to provide meaningful distinction and separation from the incumbents and build good businesses, but the bar is higher than it ever has been before. This forces entrepreneurs and startups to do more with less. So in the next few years, we may see “The Return of the Disruptors.”

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