Nooks, Crannies, and Dot-Com "Get Big Fast" Bubbles

During the dot-com bubble, did investors overlook profitable "niche markets" in favor of "Get Big Fast" strategies in an attempt to exploit potential first mover advantages (though see Netscape on the potential disadvantages of moving first)? Did this mistake lead to the dot-com crash?:

The Dot-Com Bubble Is Reconsidered -- And Maybe Relived, by Lee Gomes, Commentary, WSJ: The traditional history of the dot-com bubble has been told many times: Too many companies rushed into the market in defiance of all known business fundamentals, and when the crash came, all but a tiny fraction of them just as quickly imploded and went away.

That received wisdom, though, is now getting a going-over by economists, business historians and others, some of whom are coming to new conclusions about what precisely went wrong during the bubble years ... dated from the Netscape IPO in August 1995 to March 2000, when Nasdaq peaked at above 5100.

A recent paper suggests that rather than having too many entrants, the period of the Web bubble may have had to few; at least, too few of the right kind. And while most people recall the colossal flops of the period (Webvan, pets.com, etoys and the rest) the survival rates of the era's companies turns out to be on a par, if not slightly higher, than those in several other major industries in their formative years...

David A. Kirsch, a professor of management at the university's business school and one of the authors of the study, said it relied on a thorough examination of one particular treasure trove...: every business plan, roughly 1,100 in all, submitted during the period to an East Coast venture firm... Prof. Kirsch said ... the ... firms he studied were representative...

Looking through those business plans, and contemporary press accounts, the study identifies a defining business strategy of the bubble era: Get Big Fast. A business was supposed to grow as quickly as possible because the first successful entrant in a category could keep out challengers. If a company was able to successfully get big, it could use that position to later finesse other questions, such as how it might one day actually make money.

Belief in this "first mover advantage" is today tempered by a new awareness of the risks of being the first out of the chute. Back then, though, VCs used Get Big Fast as their basic investing strategy, despite the absence of any evidence that it worked. By the spring of 2000, however, the world was beginning to wake up to the fact that it didn't work. The crash followed soon thereafter.

The study suggests, though, that the dimensions of that crash might be misunderstood. Nearly half of the companies they studied were still in business in 2004. Prof. Kirsch says that most people believe just a few percent made it through.

The study found that the attrition rate for dot-com companies was roughly 20% a year, which is no different from what occurred during many other industries, such as automobiles, during their early boom periods.

Most of these survivors, though, aren't the titans like Amazon or eBay, but much smaller efforts such as wrestlinggear.com, which sells equipment to high-school and college wrestlers, what Prof. Kirsch called precisely the sort of demanding niche market for which Web shopping was invented.

The fact that so many dot-com companies survived suggests that even more could have started. But that didn't happen, says the study. Investors following conventional wisdom of the day were interested only in companies that could dominate an entire industry. In looking for these, they ignored smaller niche opportunities that had the potential to become modest but profitable enterprises.

"It turns out there were lots of nooks and crannies for entrepreneurial action," says Prof. Kirsch. "But those nooks and crannies might have been $5 million or $10 million businesses -- well worth doing, though not necessarily for VCs." ...

[I]t's clear that a variation on Get Big Fast is alive and well today... Companies like Interactive, eBay and Google are spending hundred of millions, often billions, on start-ups such as MySpace, Skype and YouTube, which have developed a commanding market presence but without actually making money...

It will take awhile to know whether things will turn out differently this time. But bubbles always have happy endings, don't they?

The article argues that the survival rate for these firms is "on a par, if not slightly higher, than those in several other major industries in their formative years." At the same time, it argues that there were "lots of nooks and crannies for entrepreneurial action" that were overlooked leading to a misallocation of resources toward the "Get Big Fast" strategy. The article implies that if this had been recognized at the time so that more investment was devoted to filling the nooks and crannies rather to following the "conventional wisdom," perhaps the dot-com crash could have been avoided or made less severe.

But if the survival rate is already a little higher than the typical benchmark industry, then it is hard to make the case that investors should have made even better choices. There very well may have been too much investment in the "Get Big Fast" type of strategy, but it seems a stretch to suggest it was because there was too little investment in niche markets. Even if there was too little overall investment in the niche markets, if the source of the over investment in the "Get Big Fast" schemes was due, say, to a misperception of their profitability, then more investment in niche markets would not have reduced the amount devoted to "Get Big Fast" schemes and hence would not have reduced the risk of a crash.

Comments

[cactus]

I guess his argument works if you assume that the world has changed in a way that allows for increased survival rates of companies relative to the past.

[Mark]

Statistics Alert

Survival rate isn't an appropriate or even particularly meaningful statistic here because the data is so heavily skewed (the rate is high precisely because the typical survivor is so small). You can't use this number to make comparisons to industries where the distributions are radically different (and often skewed the other way).

I don't want to whine too much here but this really is the sort of mistake that makes statisticians pound their heads on their desks.

Analytic flaws aside, I don't doubt the conclusion that small, niche models make more sense on the internet. I do however wonder how well large investors will be able to capitalize on that.

[Lafayette]

Let us presume for a moment that the "Get Big Fast" (GBF) factor was the predominant reason for the dot.com bust, because insufficient numbers were behaving in such a manner. The fact that the drop-out rate was similar to "ordinary" business ventures discredits this theory. But that is not the point.

The point is this: Why should "fast" have anything to do with it? What is it about VC's in the US that getting filthy rich quick was important or even desirable?

Because GBF had happened to a select few, by simple comparison, it was assumed that GBF should happen to all.

If you look at the typical venture capitalist at the very beginning, they were often people who were leaving the computer business, which had become staid. Remember Digital Equipment Corporation, the number 2 computer company in the world? Whatever became of DEC ... ? Well, a good many of the people who worked for such companies became VCs, and these were people who did not earn a fast million. Their millions had taken decades to earn.

So, what happened? The simple word for it is "feeding frenzy". That is, an animalistic behaviour that occurs when the component of time takes an exaggerated and entirely unsubstantiated predominant importance. Does this mean that the "human animal" is capable of behaving like a frenzied shark in a pool with other sharks all trying to get the same bit of protein?

In a word, yes. Because the basic instinct of competition that the brain dominates and relegates to secondary importance - given the right circumstance - will see through and control altogether our judgement.

A good idea is a good idea is a good idea. Getting Big Fast does not necessarily lead to market dominance. Get Big Slow depends upon good organizational execution towards a common goal and can lead to market dominance.

So does Getting Big Fast. But, if it is thought that time is the ONLY dependent variable worth considering, then one is likely to judge that a project is not viable because it is not growing sufficiently quickly. It is therefore not worth pursuing. In fact, all it is doing is taking time to gestate.

But, in a feeding frenzy time is of capital importance.