Comments for How Decoupled is The Innovation Economy From Rest of The Economy?

How Decoupled is The Innovation Economy From Rest of The Economy?

2008-09-18T19:56:17Z

What a week of market mayhem! How odd having that as the backdrop to the Web 2.0 Expo in New York. We have been sounding alerts about the economic backdrop to our world of innovation for nearly a year. Back in February we wrote that this is not our bubble. Since then, the news from the economy has gotten worse and nobody is suggesting it will get better any time soon. Reading the papers is pretty grim (unless you stick to Sports or Arts). Yet we contend that it is not grim in the 'innovation economy'. Here's why...

]]> Firstly, start-up events across the globe are crowded to breaking point. OK, perhaps they are full of entrepreneurs who were in college during the technology nuclear winter and are simply unaware that a bomb just went off.

Dot Coms 2.0? Say it Ain't So...

Maybe we are all just fooling ourselves. When the Internet bubble started to burst in March 2000, most people were saying "that's them crazy Dot Coms, not us". Gradually, it was all of us who were in any way associated with technology.

After 18 months, in the summer of 2002, everybody had capitulated. You could buy shares of Rational Corp (the leading supplier of software tools after Microsoft, bought by IBM) for a valuation of $1 billion when they had $1 billion in the bank and $1 billion in revenues (oh, yes, and a couple of bad quarters which made it obvious that nobody would buy software ever again). You could walk into a VC with a patented machine to turn mud into gold and be greeted with a sceptical "but what if gold falls in value?". You could prove that your $50k software would have $500k savings to a company within 6 months and the response was still "we will get back to you". The technology nuclear winter was very, very cold.

So maybe it is coming again in the technology business. No more funding, no more deals, no more parties. Maybe the hangover is coming.

Innovation Economy Still Thriving

But it does not look that way from what I am seeing. VCs are saying that their companies are doing well (and not all are hyping their portfolio). It also coincides with what I am seeing from companies that I know well. Companies are either growing revenues or getting more funding or doing both. I have interviewed two founders at the Web 2.0 Expo in New York that have broken into profitability. Even if VCs run for the hills they will be fine. These upstarts are taking business from higher cost alternatives.

I have also heard first hand of big deals from large companies awarded to small, young ventures. And I have seen large enterprises that are working on large social media rollouts.

This is not good for big tech companies. But it does look good for small, low cost, agile upstarts. The smart companies have worked out how to reduce risk for clients. What's the risk of implementing Basecamp or Zoho?

I call this the "innovation economy" and that is a tad worrying. It sounds like "New Economy" and we all know where that ended up. I did not want to say the "technology industry" as huge parts of the tech industry now simply follow economic cycles. The fortunes of Microsoft, Oracle, Dell, HP, IBM, Cisco tend to rise and fall in line with global GDP. Bigco is not the heart of the innovation economy.

Shift in Power to Smallcos

It is more likely to do with a fundamental secular shift in power from large business to small business. The Internet and Coase's law would be the theoretical underpinning for that. Something dramatic may have quietly happened, making the playing field not just level for start-ups vs incumbents, but tilted in their favor. It might have something to do with the tools that enable you to run a global business with all virtual operations and almost no infrastructure cost. You can simply scale faster and cheaper than your incumbents.

Conclusion

The market mayhem this week has been unprecedented, far worse than even my worst imaginings and I was thinking it was going to be bad. So this is bad. It will spill over into everything. Many parts of the Web 2.0 industry will be in trouble, specifically those with dependency on consumer advertising or financial services.

But the gritty entrepreneurs are building value and getting profitable and have better opportunities than ever before to get their case heard. VCs who keep their nerve will do enormously well, just as they did from deals done in the 2002/2003 era.

What do you think? Is it tough times for all? Or tough times for the slow and good times for the fast?

Image credit: Thomas Hawk

Comment from Tony Trupp on 2008-09-18

2008-09-18T21:55:22Z

Anyone who thinks this is just a real-estate bubble is a shortsighted. This is a credit bubble that's been growing for 40 years. Here's a tally of where we're at:

The average american has $10,000-30,000 worth of debt, and the country has about $10,000 trillion.
9% of homes are facing foreclosure. 1/3 of home owners owe more than what their home is worth.
3 of the 5 top investment banks in the country have gone under, as have the top 2 mortgage companies (owning half of all mortgages in the U.S.), and the top insurance company.
The stock market just hit a 10 year low, and unemployment has hit a 6 or 7 year low.

Essentially all these companies that are failing were investing money that was backed by too much debt, not by their own equity, and this is what the whole country has been doing... living on borrowed money. The question is will this trickle into the rest of the economy? Will the banking system as a whole collapse as it did in the great depression? This is a whole lot more severe than the dot-com burst. Sorry.

Alan Greenspan: "This is a once in a half century, probably once in a century type of event"..."There's no question that this is in the process of outstripping anything I've seen, and it is still not resolved".
http://www.bloomberg.com/apps/news?pid=20601068&sid=amVkrOCQNBQs&

Comment from Tony on 2008-09-18

2008-09-18T23:16:48Z

Bernard, I've been wondering about your "Shift in Power to Smallcos". I think you're right that this will probably happen with regards to the internet if the economy, and investment, continues to contract. Since it's inception, most VC's have been trying to extract more money out of the web that what each of their business model's could ever possibly hope to extract. All of these companies with millions in investment have flooded the market with services, but with the internet still being young, it can't possibly float so many companies of that size. The competition has driving the price down to zero for most services! At the same time it makes it a lot harder for small businesses and micro ISVs to make a living compete against the big boys. If the web 2.0 venture money dries up, I wonder if we'll see a much higher ratio of "profitable" web service companies in the mold of 37signals. Thoughts?

Comment from Amir Helzer on 2008-09-18

2008-09-19T00:08:13Z

I agree that VC money is distorting reality for too many businesses. It makes building hype all too easy. Then, when it fails, it's easy to justify.

Good businesses grew strong after the .com burst. I think that after the current round of companies who are cannibalizing every possible service dies off, it would be much easier for businesses that intend to profit.

Comment from Jon on 2008-09-18

2008-09-19T01:44:01Z

meh, the question we all use to gauge the severity of an economic problem:

how does it affect me, personally? as for me, alot! the number of service calls for pc repairs has gone up in my shop and people are now willing to spend more to FIX the pc rather than just replace it. for the past 4 years it's been rare to have a repair job come to more than 200 bucks, but lately customers are paying for replacement parts instead of just trashing the old pc.

not that i am happy with the economy. but folks like me who make a living doing repairs might see a slight uptick.

Comment from Gaith on 2008-09-18

2008-09-19T02:00:31Z

Regarding the dotcom bubble. When it burst VCs went extreme and forget that there are startups with the basics of Business: added-value and a real plan for profitability.

Then we saw Alan Greenspan lowering interest rates, which created the real estate bubble. And he saw it happening for years, but did not do anything about it!

As Tony Said the real estate bubble is part of a credit bubble.

Now we r living in Dangerous economic times specially of for USA.

Laurence J. Kotlikoff a professor of economics, Boston University said on a Forbes post
"The real liability facing our government is $70 trillion this represents the present value difference between all the government's projected future spending obligations and all its projected future tax receipts.

This fiscal gap takes into account Uncle Sam's need to service official debt--outstanding U.S. government bonds. But it also recognizes all our government's unofficial debts, including its obligation to the soon-to-be-retired baby boomers to pay their Social Security and Medicare benefits."
http://www.forbes.com/business/forbes/2008/0929/034.html

Moreover it seems more financial companies in USA are in trouble, so if they default I think the only way to save them is for the Fed to bail them out, like AIG. (btw a socialist move :P)

But if that happens from where the Fed is gona get the money from. Print more dollars! if foreign investors see that they will simply lose trust in US gov.'s bonds, the dollar and investment in USA in general , which will lead to more shocks. For example: collapse of the dollar which lead to hyper inflation.

lowering taxes to stimulate the economy also a dilemma since there is another factor like 10% of us household are/or will be bankrupt and with the rising inflation. -even though it dropped last month- so this won’t increase spending allot since tax benefits will be offset with inflation, on the other hand the US gov. needs taxes to pay for its debts.

This crisis is similar to 1929, back then Keynes came with his theory: The general theory.. and described the situation as liquidity trap –now is it not a liquidity trap-, where the solution he called for is fiscal policy: increased government spending ( inside America).

Today US government spending is on the rise, but it is leaked to wars with a deficit of 700 $ billion a year.

So the only way to fix this is to end the deficit to bring trust back to the financial system, and expand government spending inside USA in new projects not just bailing out companies. To create demand that will move the economy again.

As with regard with web 2.0 it is not a bubble like the dot com one. True some companies are hyped but I see most having a plan for profitability if they are not now already. So VCs should not panic as they did with the .com, the real danger is in the whole economy collapsing, may god forbid.

This will affect the world, but some analysts said that China has 2 trillion $ in reserve which they can use to create domestic demand which will offset any loses from exports to USA, in this case the world has to speak Chinese!

The coming days, weeks, and months will be critical to see how things unfold whether America faces depression and shatter my and others startup dreams. And it all depends on the US government!

Comment from Robert on 2008-09-19

2008-09-19T09:58:35Z

Yes, I really think it is tough times for all, as the credit crunch affects all areas of the economy. However, even in bad times there will always be opportunities, and good people and good business will still be able to survive, and set themselves up to prosper. It will force people to re-focus on real revenues and real profits. Plus, as the saying goes - necessity is the mother of invention - so hard times can still be a ripe environment for good tech innovation.

Comment from John Welsh on 2008-09-19

2008-09-19T10:21:00Z

We must not rush to lump the entire digital economy into one corner. The economy and well-being of Web 2.0 start-ups will be very different from established digital companies such as Google and Dell.

The most robust revenue in all of this will be digital revenues in traditional media companies. Their once traditional advertisers will not allow their newly emerging digital businesses/marketing to suffer.

So, comparatively, any downturn in the general economy will hasten disintermediation within traditional media companies as digital revenues grow more quickly as a percentage of total revenues.

Comment from Engago Team on 2008-09-19

2008-09-19T11:15:04Z

After the CreditCrunch a TechCrunch?
Instead of getting money from a VC, now start-ups and grown ups need to get paying customers (paying for service or advertisers).
Companies need sales and therefor need leads at a low cost.
The Internet is the lowest in most cases.
Comparing to bank transactions:
- face to face transaction at the counter: $10-$15
- ATM transaction: $1
- Online transaction: $0.10 - $0.15
Online is where companies will need to get their leads and nurture their prospects/customers.

Comment from jbur1 on 2008-09-19

2008-09-19T16:37:23Z

There used to be a saying, "Whats good for GM is good for the country." GM's stock is at a 50 year low yet if you walk into an Apple store on a weekend it looks like the place is being looted only everyone is paying before they leave. Which America will win out?

Comment from Tony on 2008-09-19

2008-09-19T18:13:23Z

Gaith, really good points!

I can't believe how strongly this administration's fiscal policy is tilted towards the rich. They've tightened bankruptcy laws to make it so much harder for people to declare bankruptcy, but when these huge businesses start to go under they pump in billions of dollars of tax payer's money in bail outs: http://news.bbc.co.uk/2/hi/business/7624961.stm

I understand they're in panic mode and are trying to avert a crisis, but they could have done the same thing by giving financial assistance to the poor who can't pay for their homes. Classic republican top-down economics.

So much for "Fiscal conservatives".