How to Know if Innovation is Revolutionary
Tech's big promises are often fundamentally constrained
NOTE: Sorry I’m posting later than usual. The original column I was writing is an interesting idea and hopefully will be for next week but it still needs some serious editing. Also, I won’t be doing much taking on current events so hopefully this is a brief escape to help think about other things.
The internet has clearly transformed our lives in so many ways. Instant communication means I can talk to friends and family across oceans without worrying about where I am in the world. Search means I can find more knowledge than I could ever hope to be useful with in my pocket. Being able to buy online gives me more than I ever could have hoped to buy in an instant without ever putting on real pants.
We all know how all these have massively changed our lives. But there seems to be some sort of idea that all sorts of innovations in our experience is fundamentally disruptive to how things work.
So there’s a standard framework for how to think about innovation but I think there can be a better way to look at it, specifically as it relates to technological innovation.
Basically many of these seem to relate to the experience of using some service rather than anything fundamental about the business itself. All positive innovations work because they allow more productivity, but exactly how is hugely important. So I’ll make 3 main categories of tech innovation, and most of these come to exactly what is scaled.
Large audience leads to more specialized products being viable.
This is quite simple and basically just an extension of the Adam Smith observation that “the division of labour is limited by the extent of the market.” Basically by being able to have a much larger market, a very specialized product or service may be available. If you always wanted to sell artisanal pinned insects or something equally esoteric, it is now much easier now that you can use our global communication, you can find all the entophiles that might want to buy what you’re selling. Making all kinds of products and services available that otherwise wouldn’t have been.
Network effects mean larger user base means lower costs and increases value
This is a more traditional tech story and social media is the best example. Basically the more users a network has, the more possible connections there are and the more value there is to be on the network. Another good example is something like Google Maps traffic data. The more people who use it, the more data they have and the more accurate and useful the data is.
Reaching many more people without massively increasing workers needed
This is simply that you are able to reach many more people at a very low marginal cost. Take Netflix as an example. Prior to them the options for watching a movie or TV show at home were to buy/rent a DVD, or wait for it to be on TV. Both of those have high distribution costs, either direct in the case of a DVD or opportunity costs in the case of TV as there is only a limited amount that can be shown. Netflix essentially eliminated those costs.
So Where Does That Leave Us?
To begin, this isn’t an exclusive list and products and services may fill multiple categories. So let’s look at a few examples of successes and companies that have failed or I see as doomed to fail.
Amazon
I’d start with Amazon. Now, they clearly have various parts of their business, but I’m just going to look at the consumer side of things and ignore Amazon Web Services, even though that is probably the core of their business.
In the case of Amazon, they really have a market advantage in network effects and to a lesser extent via a large audience.
It seems obvious, but the retail side of Amazon is a logistics company much more than a store. Their big deal is getting things where they need to be and when. The reason they can do this so much better than other logistics players is the sheer amount of data they have to be predictive about how to move things around. UPS can’t figure out where to send things until an order is placed. Amazon can tell that there’s increased interest in a product even without purchasing, exactly where that is geographically and can get things on the move instantly.
Of course all the centralized warehouses also help to lower the cost per item. Amazon retail has sort of been a revolution of a thousand cuts where small, incremental things add up to something much larger than the sum of the parts.
Additionally, because of the massive reach and audience, their marketplace is able to sustain businesses that would not have been viable otherwise. I can’t imagine there’s be much of a yodeling pickle market in any single area, but Amazon’s large reach and their logistics are able to get that brined alpine wailing to….whomever might actually want that.
Uber
Now we’ll get into the negatives. Uber was sold as a way to have revolutionized taxi services. But here’s the issue, their idea doesn’t scale. Every ride still requires a car and a driver and you just can’t scale those costs. Uber found a few places that were able to innovate.
The first non-tech way was regulatory capture where they were often able to break up the taxi cartels and a classic example of concentrated benefits for medallion owners and diffuse costs of just a few more dollars per ride. They also managed to incrementally lower the capital costs of the cars themselves by having people use cars they would have bought otherwise, meaning the idea was to minimize loss rather than cover the complete cost.
The second, and their big tech innovation, was innovating taxi dispatch. That is what massively improved the user experience of hailing a car. They can send millions of cars out with just a few employees. Now the problem is dispatch was a tiny part of the cost of a ride so while it was certainly a good thing, there’s just not that much room to actually lower costs to users.
So now you have a company that has massive debt, and fundamental cost constraints. A new player can enter without all of that debt and be able to undercut them. I expect this to happen in the next couple of years as interest rates rising are quickly going to call the bluff of unsustainable businesses and Uber has yet to make money.
AirBNB
AirBNB is a company that I can’t quite figure out what their tech innovation is at all. It’s basically wholly premised on the idea of there being slack in the number of beds available. I do see a couple of limited use cases of someone renting out their guest room while continuing to live there or renting out a house they only use part of the year. But the rest just seems to be purely getting around regulations. Travel search is a space that’s pretty developed in general so there’s little tech that’s new.
But the problem to me with that seems to be in markets where there could be the most value for that, there is an overall shortage of housing units writ large. That’s also generally caused by regulatory issues (primarily local zoning laws) but means that if someone has a dedicated space to rent, the primary cost becomes the capital cost of the real estate itself rather than all the other services associated. Indeed, the fact that the “cleaning fees” associated mean those costs are passed on to the renter and AirBNB is often more expensive than just booking a hotel anymore.
I just don’t see it as a service that adds that much value compared to the alternatives. I think a version of it could survive as a niche operation, but again, the business took on a ton of debt so I don’t see it surviving.
So What To Make of This?
In the end that what we think of as innovation often amounts to the experience of using a product or service and if it feels like something is different. But the fact is boring old cost structures are far more important to how to evaluate the world. The costs determine if something is worth it at all, and often times it seems the answer is “no” even if it feels like it shouldn’t be.
It’s also important to think this way when people talk about the future of automation. If someone says a certain job sector will be automated away, but then just assumes everything else stays the same, you can be certain they aren’t thinking things all the way through. Our society is organized how it is economically because of cost structures. So if you fundamentally change those, then the way the economy is organized will also fundamentally change and find new ways to add value.
Now, when it comes to being an early investor, nothing would have been better than to be on the ground floor of Uber or AirBNB, but by the time these companies go public, it’s a lot more of a gamble about how things will go and VC firms aren’t generally thinking about how things will be in 15-20 years, as they need their returns sooner.
Personal Update
In canine news, the dog took a trip with us to León, Spain and I have to say he enjoys new places more than anything. So much so that it’s a problem as he wants nothing more to pull you, and he has quite a lot of power, to go see everything new. Of course seeing so much energy, size and power frightens half the people going by.
On the personal side, my workload for my job is growing quickly as we plan our US launch. I may have to scale back the writing here pretty significantly in a couple of weeks. I will try to go weekly but I may have to keep it to 500 words or so.