Flickr photo via Justin D. Miller

Guest Commentary: We’re very clearly in a new tech bubble now.  Valuations, funding rounds, recruitment incentives are already remarkably similar to what we saw 10 to 12 years ago.

But the first bubble, the days of Pets.com, HomeStore, Kozmo.com and shooting gerbils out of cannons on Super Bowl Sunday, that was different.  The primary objective then was to build a real business, the next Amazon.com.  Take the business public and keep growing.  The idea was to go it alone.

That’s not the case now.

If what we’ve seen over the past few months continues, this bubble is about R&D. Startups are less concerned about making money, and more interested in selling to a larger company that no longer needs to invest to develop that innovation for themselves.

It’s not a bad thing.  Far from it.  Startups, founders and their backers want a happy ending.  Those dollars either come from paying customers, the market (via a public offering) or an acquisition.  Money is money.

But if you think about this from the buyer’s point of view, it makes even more sense.  Companies like Microsoft, Google, HP and Salesforce.com invest billions of dollars in hard and soft costs to develop new technologies, new innovations, new opportunities to engage and monetize current and future customers.

Matt Heinz

Those who have worked in R&D, or have taken multiple ideas or products to market, know that the success rate of innovation is quite low.  Big companies will, effectively, waste tens if not hundreds of millions of dollars on ideas and prototypes and concepts that never see the light of day or make a dollar in revenue (let alone margin).

If I’m that big company, today’s startup community is my new R&D, my new incubator.

One thousand garages working for me.  And I don’t spend a dime until I see something I like.  Will I pay a multiple on what it would have cost to build that innovation myself?  Absolutely.  But this cost is still a small fraction of what it would have taken to fund the myriad projects to come up with that innovation ourselves.

I look at local companies such as Picnik and Gist, acquired by Google and Research In Motion respectively.  Those buyers could have developed these services themselves, but at what cost?  In how much time?  With what kind of distraction to their core, currently-revenue-producing priorities?

The money flowing from VCs to these start-ups recently looks breathless without this context.  But smart VCs have figured out this dynamic as well.

This is not a universal driver of all new businesses, of course.  Plenty are and will become successful, stand-alone businesses.  The next Amazon, the next Salesforce.com.  But if this premise is true, there’s little mystery as to why we’re back in a bubble.

Where do I sign up?

Matt Heinz is president of Heinz Marketing, a Redmond-based marketing firm. Follow him on Twitter @heinzmarketing.

Comments

  • http://twitter.com/Keithmetz Keith Metzger

    Matt – I understand the differences you’re drawing between the last bubble and the current one. But what’s similar – and is reflected by the valuations – is irrational behavior. Something I do not believe is justified now, simply because of the R&D value to a company.

    While it makes sense for large companies to look to the startup market for R&D, and makes sense for startups to understand this and formulate strategy accordingly – it is not impossible for this to occur in a market with reasonable valuations. That will lead to sustainability, instead of the bubble burst that will most certainly bring all bubbles – including the current one – to a close. Something that would be more beneficial to more people than the relative few that get in and out at exactly the right time to scoop up large rewards from a bubble.

    You say that the costs reflected in these valuations are “a small fraction of what it would have taken to fund the myriad projects to come up with that innovation ourselves.” What deals are you referring to? Sure – that’s not impossible. But given the current state of things, I don’t see very many deals that would model out that way. Else, we wouldn’t be seeing this as what it is: a bubble. (I think of a recent news item about a company that doesn’t have “much of a business model yet” being valued at $200 million by investors. Imagine the R&D that can be funded with just one deal @$200 million…)

  • http://blog.CascadeSoft.net @CascadeRam

    >>Startups are less concerned about making money, and more interested in selling to a larger company

    yes, this seems to be true (for venture/angel funded companies).
    However, very few startups publicly say that their goal is being acquired :)

  • Dara Albright

    Interesting perspective, Matt. Please also check out mine at http://nextstreetjournal.com/2011/04/14/bubble-what-bubble-2/

  • Brian Hansford

    Nice content Matt, as usual! Bubble 2.0 has so many of the same irrational and greedy behaviors from the Dot-Not Bust it leaves me shaking my head – “did we learn anything from 1999 and 2000?” I’m slightly skeptical and cynical on some of the social media hysteria and so-called “innovations.” (Sorry Gen Y, business is business.)

    While I applaud any entrepreneur who has their small enterprise acquired by a larger fish, I am skeptical how the innovations will actually be integrated with a solid go to market strategy that actually works. Integration is so incredibly challenging after M&A. The SM players with (currently) sexy companies don’t have the boardroom chops to make things work once the contracts are signed. Even more difficult – INTEGRATION. Ouch. Integration. That word sucks after the hangover of a nice big check and the yachts are bought. The founders will find ways to get through their retention bonus periods. The parent company CxO’s will typically fail to motivate their execs to “buy into” the vision while boardrooms will be eager with self-congratulation yet fail to push on execution.

    I am cautious about current innovations that help companies better reach their customers. I don’t see any major industry emerging. It’s all a new way to “sell.” In my opinion the Dot-Not hype of a lottery style M&A win will prevent many true innovations from actually succeeding.

    Cheers,
    Brian Hansford
    CMO
    Zephyr 47
    http:://www.Zephyr47.com

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