TCS Daily

Small Is the New Big

By Dominic Basulto - November 3, 2003 12:00 AM

The myth of the Next Big Thing has a special place in the hearts and minds of Silicon Valley insiders. It is almost impossible to attend a technology conference or read an article on the future of the Valley without hearing about the Next Big Thing. Venture capitalists, marketing executives and start-up entrepreneurs are all too willing accomplices in creating the notion that a new, revolutionary technology is being cooked up in an R&D lab somewhere on the West Coast.


IT research firms also get into the act, hyping the appearance of the next billion-dollar market opportunity -- or, in the case of nanotechnology, the next trillion-dollar market opportunity.


Yet, as Michael Lewis warned in The New New Thing several years ago, there is a very real risk that "businessmen" in the technology sector are becoming nothing more than "conceptual artists." Pitch a cool concept, get funding, hire an all-star team, and then hope for a market to materialize.


If the economic slump continues in Silicon Valley, this strategy of pumping tens of millions of venture capital dollars into new start-ups in the hopes of creating the next billion-dollar behemoth may go the way of junk bond financed takeovers. Of course, mega-deals will still exist, just like junk bonds still exist. If nothing else, though, VC firms will stop raising billion-dollar funds, since quite simply, it is impossible to put all that money to work while still achieving 30% annual returns. Borrowing an analogy from Hollywood, VC firms will once again start viewing themselves as 'independent movie studios' pumping out quality films on shoestring budgets, not as big Hollywood giants looking for marketable concepts and big-name actors (entrepreneurs) to exploit billion-dollar market opportunities.


Interestingly, Inc. magazine recently published its "Inc. 500" -- a list of the fastest-growing companies in America over the past five years. The Top 10 companies in the list averaged over 10,000% growth over the period 1998-2002, yet it is likely that only a handful of them would even merit the attention of VC investors. Only one company, in fact, is even based in California. Most importantly, only one of the top 10 companies has even reached the $100 million annual revenue mark. The top company -- American Biophysics of Rhode Island -- is basically a glorified "pest control" company that makes highly effective mosquito traps. When the company approached an outside financier for the first time, the response was not unexpected: why invest in a business model full of bugs (literally)?


Yet, it is exactly these types of small, fast-growth companies that should attract outside investors. With the exception of one company in the luxury nursing home business, each of the Top 10 companies is putting world-class technology to work to solve real problems. Under Armour Performance Apparel has developed high-performance synthetic materials for athletes. Rent Rite uses the Internet to create an online marketplace for office furniture. Cross Match Technologies has developed a unique fingerprint ID technology that has immediate applications for homeland security. Blackboard is a successful online learning company. ProFlowers has become a successful B2C purveyor of, you guessed it, flowers.


Small, well-run companies either bootstrapped by their founders or backed by modest amounts of VC financing that are using technology to solve real problems are the real hope of Silicon Valley. These companies tend to create their own market opportunities -- they are not "concepts" in search of a market. Think of Google, which was founded with a mission to build the best search algorithm possible. At the time, search was basically viewed as a "commodity" service. Now, however, Google is front-and-center in one of the hottest markets going -- paid search -- and already commands a multi-billion dollar valuation.


More than one experienced technology observer has noted -- usually after attending yet another whiz-bang Silicon Valley confab -- that "these things just happen." It's futile to hunt for the Next Big Thing -- it just happens. Even if a new technology appears ready to attain Next Big Thing status, a perverse form of the Efficient Market Hypothesis ensures that nobody makes money. If one VC firm invests in a certain technology sector, ten other VC firms will invest in that sector. As more money goes to work in that sector, more information is "uncovered," and it is no longer possible to buy low and sell high. In fact, in overheated sectors, investors are suddenly buying high and selling low. At some point, investors abandon the sector and move on to the Next Big Thing. Over time, it is impossible to beat the market.


So what comes first -- the billion-dollar market opportunity or the start-up with the billion-dollar market valuation? Most would argue that the billion-dollar market opportunity comes first. Why start a company if there is no possibility to make real money? Yet, as shown above, it is often the case that billion-dollar market opportunities only materialize when nobody expects them to appear. If this is true, maybe Silicon Valley insiders should hope for the appearance of a bunch of smaller things, and not just the Next Big Thing. Maybe small is the new big.


Dominic Basulto writes frequently for TCS about technology development and business.

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