Most companies see competition as a threat. If someone’s products could substitute for mine, they’re a competitor; and if a potential customer chooses another product instead of mine, that’s a bad thing.

Lightweight startups take this even further. If you see a need, but another startup has already started addressing the need, then you came at it too late. You’re lightweight, and so your only real advantage is speed. But someone beat you to market. Makes sense, right?

Except it doesn’t work that way.

Going it alone

The typical, but wrong, paradigm goes like this:

• Competition is bad

• Competitors are enemies

• Fewer competitors are better than more competitors

• An opportunity addressed by a few people already is “taken”

• An opportunity with zero competitors looks attractive

There is some truth to these things. Growing in the web search market today is pretty difficult. So is the operating system industry. So are dozens of other industries, and in these spaces, competitors may be be enemies.

But these are mature, settled industries. If you want to create a new search engine, or a new operating system, more power to you – but Google and Microsoft ARE going to be threats. Of course, most startups don’t try to dislodge Microsoft. If you’re working in an emerging market, on a disruptive or innovative technology, you might want to consider a different approach to competition.

Running in packs

This alternative model was described by Andrew Van de Ven of the University of Minnesota in an article called Running in Packs Versus Going It Alone. Andrew and his team found that in emerging, information-based technologies, competition often does not occur between individual startups, but between groups of startups. So as an alternative to trying to go it alone, startups may be better off running in packs: coordinating their efforts by simultaneously cooperating and competing.

This means that when a disruptive technology appears on the scene, its success is dependent upon the whole field of companies working on the technology, not on a single company.

So startups who run in packs should seek the growth of the entire market, in addition to trying to grow their own market share. Better to have a good slice of a growing market, than total domination of a dead market.

Actors seek both to maximize their total surplus and their respective shares in the surplus. ... This draws actors together and drives them to cooperate because no one actor has sufficient resources, competence, or legitimacy to do it alone.

Running in packs works for at least two reasons. First, competitors may help speed adoption of the emerging technology. Second, strong competition may improve and sharpen the quality of the technology.

This also means that politics is important when running in packs, as startups both compete and coordinate.

Actors with political savvy – an ability to recognize the interests of key actors and enroll them to one’s viewpoint – will be more successful in effecting institutional change and realizing their goals than actors without political savvy.

Van de Ven also found that the (disputed) first-mover advantage only really materializes with technologies with strong IP protection, and which can’t easily be reverse engineered, imitated, or substituted. Most web startups these days fall squarely in the “easily imitated” category – including giants like Facebook, Digg, Flickr, and Twitter. And even with a head start and strong patents, first movers may be better off seeking a pack to run with rather than going alone.

Of course, the advantage of running in packs probably only works up to a point. Settled, mature, and (worse) shrinking industries are far more competitive than emerging industries. This means that they’ll have a harder time working together to grow the whole industry, that adoption is less of a problem, and that technological improvement is slower.

This perhaps is why population ecology studies have found that having more competitors in a new organizational niche increases the survival probability of its members until a threshold level is reached where resource scarcity limits the growth of all members of a population.

A retail example

For a low-tech example of running in packs, look at clothing retailers. If going it alone worked in the retail industry, stores wouldn’t pay huge sums for space at the Mall of America – they would avoid it like the plague. After all, clothing stores are highly competitive – one can be substituted for another quite easily, and innovation happens slowly, with the basics (pants, shirts, socks) having been around for quite some time. So you would think that these stores would want to destroy their nearby competitors and be the only place to buy clothes for miles.

But in reality, the opposite is true. Retailers like to locate near other retailers, because going it alone as a retailer apparently doesn’t work very well. When someone needs a new pair of pants, their first thought is to go to a place where lots of people are selling pants. A shopping mall acts as a center of gravity to pull in buyers, and a lone clothing store without competition gets forgotten. So the stores simultaneously coordinate (bringing in lots of buyers to a single area) and compete with each other (for individual buyers). And as a pack, they compete with other packs of stores.

Consulting and Rails

Running in packs works for some location-based businesses, and it often works in emerging industries (the internet, mobile devices, etc.). But it also works with non-commercial technologies, like programming languages.

I’m a co-founder of Slantwise Design, a Ruby on Rails consulting shop. We mostly build web applications for startups. And while there are lots of companies trying to build web applications for startups, a majority of the time, our clients didn’t solicit bids from other competing shops. And as far as I’m aware, after 30+ projects and twice as many proposals, we’ve only competed directly with other Ruby on Rails shops twice.

(There are a few reasons for this, and I won’t go into them in much detail. The most important one is that by the time we give a proposal to a client, they’ve already made up their minds. They don’t want to decide between 10 consulting firms; they’re trying to confirm that we’ll do a good job.)

Ruby on Rails is still a growing technology, and adoption is still increasing. If you want to provide Rails consulting services, there is far more room to grow by taking business from Java or PHP shops than by taking business from other Rails shops. And the technology is still improving, so the growth of the Rails industry is fueled by knowledge sharing between Rails shops. Hence, not only is competition rare between Rails shops, but competitors should be seen as friends, not enemies.

So running in packs works for both Rails consulting firms, and for the proliferation of the Ruby on Rails technology itself.

What about you?

Every startup is different. But a lot of us need to start running in packs. Which model is best for your startup: running in packs or going it alone?

	Run in packs	Go it alone
Market size	Lots of growth potential	Level or shrinking
Degree of innovation	High – you spend time educating your customers	Low – everyone already understands
IP protection	Low – your startup could be imitated or substituted	High – given time and money, someone could do what you’re doing
Industry concentration	There is room for lots of companies to profit	The industry will only support 1-2 companies

And of course, this leads into a second question: which sort of industry would you like to be a part of?

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Further reading

This post is based on “Running in packs to develop knowledge-intensive technologies,” by Andrew Van de Ven. MIS Quarterly, June 1, 2005. You can buy this article at Amazon as a downloadable PDF for $3.95

For other thoughts on startups in emerging markets, check out Steve Blank’s Four Steps to the Epiphany.

This is the third of three articles discussing Startup School 2008, a free conference that happened at Stanford on April 19. The first article covered Paul Graham and David Heinemeier Hansson, who talked about building the right product and how to make money from it. The second article talked about VC funding. This one covers five remaining presenters.

Listen to your users – but not too much

Paul Buchheit, creator of Gmail and FriendFeed, talked about the process of listening to users. User feedback is important, of course, but when it comes to this feedback, listen != obey. Often, users’ feedback needs to be decoded and interpreted; a user may ask for one thing but really need/want something else. At Gmail, for example, a lot of users asked for the ability to reply to a message right from the inbox. After listening to users, though, Paul learned that what they meant was that it took too long to view a message and reply from there, which means that the real problem was that Gmail was too slow. So they sped up the system, and users stopped asking for this feature.

Similarly, users sometimes ask for conflicting things. 5% of your users may ask for Feature X, but what if Feature X makes the system less useful or more cumbersome for the other 95%?

The long and short is to care about user feedback, but don’t be a slave to it. Users don’t always know what’s good for them, and what’s good for one user may not be good for another.

EC2 is interesting

Jeff Bezos of Amazon pushed AWS. Hosting is basically “undifferentiated heavy lifting” – it needs to be done, but it doesn’t matter who does it. In other words, your site will be worse if it is hosted poorly, but once you reach a baseline of quality, your site won’t be any better or worse based on who does your hosting. Jeff compared this to electricity: 100 years ago, a factory may have its own generator for creating electricity. But with modern electrical grids, most businesses would be crazy to create their own electricity.

I’m not sure if EC2 is quite ready (though persistent storage and elastic IPs help), but it definitely has promise. Indefinite auto-scaling of the application layer sounds great. Unfortunately, EC2 doesn’t offer much to help database scaling, which is a harder problem anyway; so capacity for thousands of web/application servers might not mean anything if your database is the bottleneck. And you almost certainly want your database and your application servers in the same network.

There is one thing that EC2 is perfect for, though: asynchronous processing. If you need to do a lot of processing in the background (see Zencoder, NY Times, Animoto), then you have an easy choice between EC2 and purchasing thousands of servers to meet a short term need.

Tell TechCrunch a Story

If you want to get on Techcrunch, you’re in good company – just about every startup would like a positive writeup from Michael Arrington, and the traffic that follows. But TechCrunch has grown to the point where it can’t write about every startup, so it is picky. Michael talked about how to stand out from the crowd. The solution is what any good PR firm knows: tell a story. “Please write about GoodReads” is not a story. “GoodReads Launches” is a story, but not a very interesting one. “GoodReads gets 1,000,000 users” is a bit more interesting. “GoodReads to publish Harry Potter 8 online” will be picked up by TechCrunch, Mashable, CNN, NY Times, and everything else.

Michael also cautioned that sometimes the stories that are most interesting to the media (TechCrunch included) are the ones that you don’t want written. Leaks, rumors, and scandals play well in the press. So you might want to think about how you can make the most out of gossip and “negative” stories if they arise. And if TechCrunch bashes you, says Michael, engage them – don’t ignore or throw stones.

Finally, Michael recommends that startups not pay for PR, but rather engage the community through blogs, Twitter, discussions, etc. Personally, I don’t see what’s wrong with combining traditional PR help with social/community relations, but talk to me in another year or two and I’ll have a better perspective on the matter.

Be so good that they can’t ignore you

Marc Andressen has several big successes under his belt and is currently working on Ning. He did a Q&A session with Jessica Livingston, asking questions voted on by Startup School attendees. The discussion was good, though as Q&A it didn’t really have a single theme. One thing that stood out was Steve Martin’s advice to young comedians wondering how to break out: “Be so good that they can’t ignore you.” This is great advice to startups, who sometimes get caught up in issues of funding, pricing, staffing, marketing, networking, etc. All of these things are important, but if your product is good enough, the others will fall into place.

Data provides the best feedback

Peter Norvig closed the day and talked about learning algorithms, not surprisingly. But of course, he connected them to startups. A good formula for a startup goes something like this:

1. Start small
2. Go fast
3. Gather feedback *
4. Iterate

Learning algorithms can help with #3. The right dataset plus 20 lines of code can tell you important things about your users, your market, etc.

Conclusions

• Build something worthwhile, and build it really well.

• Build something you care about.

• If you need funding, go in with your eyes open and with the right advisors. And don’t let the quest for funding kill you before you even get out the door.

• Build something that people want and need.

• Iterate quickly and frequently, based on user feedback; but dig into the feedback rather than following it blindly.

• Engage the community.

A few days ago, I wrote about Paul Graham and David Heinemeier Hansson at Startup School 2008. This article discusses three more talks, all of which deal with funding and legal issues. I’ll write more tomorrow about five remaining talks, which talk about building and marketing the right product.

I’m not going to spend as much time on the these 8 presenters. If you want to read more about the event, check out the videos themselves online, or other summaries of the event (Phil Crissman, Matt Maroon, Foodliker, etc.).

Raising money is an evil – make sure it’s necessary

Sam Altmann of Loopt discussed his experience raising venture money from Sequoia. VCs, in his experience, look for three things: the right market, the right team, and the right product. Each firm has a different emphasis, but all three really need to be in place. Sam introduced a great concept: demand by proxy. For example, if the most common text message is “where are you?” – which it is, apparently – then there may be demand for a mobile solution for locating people.

He also talked a bit about the process of raising money. Raising money is no fun, and it ultimately isn’t productive. Every week spent courting investors is a week that you aren’t working on your product, your marketing, etc. Of course, it is sometimes necessary. But if your company is going to raise funds, this should be the responsibility of only one of the founders, and (ideally) this should not be his or her only responsibility. This sounds obvious, but Sam has seen startups where multiple founders focus all of their energy on raising money for several months, which is tough on a company.

I can say from experience that raising money is a hard process, and that it really needs to be kept in check. If you need investment, you’re better off spending some time on your product as well; after all, if you can build a good product and get early signs of traction in the market, investors are going to be much more interested than if you just have an idea. And if you don’t get the funding you need and need to bootstrap, then you’re better off spending more time on the product as well.

Actually, there is one sense in which pitching to investors is productive (apart from the potential investment). Pitching helps you to nail your plan. Most angel and venture investors are careful with their money; they don’t want to throw it away. And most get pitched frequently – several times a week even. So they will typically be happy to point out what’s wrong with your business and why it won’t work. As an entrepreneur (who can easily get buried in a project and lose perspective), it is great to be challenged. Even if you get rejected, talking to a few smart investors will help your vision.

Hire good attorneys

Jack Sheridan, an attorney with Wilson Sonsini etc. (the law firm for Silicon Valley startups, according to Jessica Livingston), talked about legal issues for startups as they are founded, raise money, etc. The biggest take away was to have good lawyers. More specifically, Jack warned founders against participating preferred stock, where on liquidation an investor first gets paid back their original investment (the “preferred”) part, and then receives a full share of the remaining funds (“participating”; and cumulative dividends, where the company is obligated to pay a continual dividend to preferred shareholders, and where the obligation accumulates over time if it can’t be paid. In other words, if you take VC money under the wrong terms, your company could be a moderate success (e.g. sell for $20M), and the investors could walk away with just about everything.

The second main point was to be careful with vesting. Even founders’ stock should be vested, according to Jack. Let’s say three people start a company and divide ownership evenly. One quits after two months, while the other two work hard for years for low pay. The company is then acquired after 5 years. With no vesting, the founder who left still owns a significant portion of the company. Vesting takes care of this by issuing shares progressively over time. Brad Feld has a good article on vesting with details of typical terms, etc.

Find and ride the right wave

Greg McAdoo is a partner at Sequoia Capital, one of the top VC firms in the world. Greg gave a good overview of what VCs look for. Some of this was redundant with Sam’s earlier talk, though it was interesting to hear about VC funding from both sides (the investor and the entrepreneur). Greg emphasized the importance of finding the right market, using a surfer analogy. A surfer (entrepreneur) needs to wait for the right wave (market), and needs to hit it at the right time. The surfer can’t change the wave and can’t create the wave – they can just ride it, successfully or unsuccessfully. Similarly, a great product isn’t worth much if it hits too early or too late, or if there is no market for it.

Greg also suggested that startups build products for people whose hair is on fire. If you come across someone who is on fire, and offer them a solution, they’re likely to take it and unlikely to haggle with you on price.

Finally, try to find an unfair advantage – something that keeps other people from competing successfully with you. And try to increase this advantage over time, rather than just worrying about it early on.

Watch for the final post tomorrow, which will cover Paul Buchheit, Jeff Bezos, Michael Arrington, Marc Andressen, and Peter Norvig, along with a conclusion.

I attended Startup School at Stanford this weekend and thought it was really well done. There were 11 (count ‘em) talks of about 20-30 minutes, which was a pretty good format: lots of information, and not much fluff.

Paul Graham’s Mid-Morning Keynote

Sure, it was 10:30am, but Paul Graham’s talk had the feel of a (short) keynote. He spelled out the YCombinator approach to startups: Make Something People Want, and don’t worry too much about making money early on. But this approach makes for a strange equation:

Make Something People Want + Don’t Worry About Making Money = Non-Profit

Of course, as an investor and libertarian, Paul Graham is all about making money. But if you really do make something that people want, you can often find a way to get their money. Think of Craigslist. It’s 99.9% free, and doesn’t seem especially concerned about money, but it is also extremely successful. They basically just made something that people wanted, and the rest fell into place.

So instead of nailing down a business model early on, Paul suggests that you work your way “upwind” of profit. If you’re fighting a sea battle in a frigate, your ultimate goal is to sink your opponent’s ship. But the way to do this is to work yourself into position where you can win, by being upwind of the enemy. In a sense, being in the right position is more important than firing your canons early on. (By the way, I’m a little inexperienced with naval warfare, so if you find yourself in a sea battle, I don’t recommend you rely on this advice.)

How, then, do you put yourself in position to make money? First, Make Something People Want. Second, consider benevolence. After all, if you build something people want, and treat them well, you’re well positioned to capture their money.

Beyond this, Paul gives three reasons why benevolence makes business sense.

1. It improves morale: your employees will be happier, and people will be more interested in working for you.
2. Being benevolent makes others want to help you.
3. It also helps you be decisive. If you’re deciding on a course of action, and you choose whatever is best for your users, you’ve probably made a pretty good decision. Whereas if you’re out to screw people over, your life is a little more complicated. (Think of lying: if you lie a lot, you have to keep track of all the lies you’ve told; but if you tell the truth, you don’t need to worry about that.)

I’ve been thinking a lot about startups and ethics lately – not in the “business ethics” sense of “should I play dirty to win?”, but in the sense of “life isn’t really about making money.” This talk was an interesting call to build something worthwhile first, and to profit later.

Notice that this all depends on funding. If you have no funding or no day job, it probably isn’t a good idea to build something without worrying about the business model. But that’s YCombinator: YC provides the seed round, and often paves the way to Angel or VC money.

David Heinemeier Hansson provides a good counterpoint to this approach.

The secret to successful startups

David Heinemeier Hansson gave a great talk soon after Paul Graham, in which he proposed a different approach to successful startups. The secret, according to David, is the middle term in this common formula.

1. Build a great application
2. ???
3. Profit!

Paul Graham suggests that you overlook #2 early on, and instead worry about #1. While David agrees that #1 is important (and is completely in line with the YCombinator “Make Something People Want” mantra), he suggests that #2 is actually pretty easy:

1. Build a great application
2. Price
3. Profit!

In other words, if you want a successful startup, charge money! Don’t worry about VCs, complicated business models, or winning the $1.6B lottery. Instead, just build something people like and charge for it.

He goes into a little more detail, suggesting that you’re better off selling to businesses than to consumers. Consumers want things for free, but businesses are generally willing to pay for good services. He also provides some helpful math, like: $40/month * 2000 users = $1,000,000/year. In other words, you don’t need a ton of users in order to make good money.

There has been some discussion (blog post and news.yc thread), suggesting that it isn’t that simple. After all, 37signals is a PR machine, as much (or even more) than a software company. When they launched Basecamp, they already had a huge following, which gives them a huge advantage over the rest of us.

This is all true, and it’s true that David oversimplified things. But his point wasn’t that it’s easy to win – in fact, he suggested that you might only have a 1 in 10 chance of winning. His point was that you’re better off taking a 1 in 10 bet at a Basecamp-size success than a 1 in 10,000 success at a YouTube-size success. Even though the next YouTube may make 1,000 times the money of the next Basecamp, the marginal value of the first $1M is much higher than the last $1M. So if you only have one life to live, you’re probably better off aiming for a small success than a take-over-the-world success.

As a corollary – and I thought this was a great point – you’re better off enjoying yourself at a somewhat successful company than spending your life in meetings at a hugely successful company. Would you rather be a modest success and work 4 days a week or be a workaholic and hope that you win the M&A lottery?

Again, it’s not quite that simple. It is hard to build even a modestly successful company, and it doesn’t hurt to aim big. But in principle, I’m down with David. After your basic necessities are met, having more money doesn’t really make you happier. And I’d much rather build software 30 hours a week than sit in meetings 60 hours a week, even if the latter paid better. And though it isn’t easy to build a successful “lifestyle” business (which a terrible term, by the way) if you’re smart and apply yourself, you’ll probably figure it out eventually.

I’ll write about the other talks tomorrow. And if you didn’t attend, the videos are posted at Omnisio.

During the dot-com era, a new set of heros were discovered: startups. Rejecting the suit-and-tie of their former lives, brave men and women wore jeans and baseball caps to work and demanded comfortable chairs. They shed the shackles of their soul-stifling 9-5 jobs in Corporate America and worked long hours for smaller companies. Fortunes were made and lost in a matter of weeks. Porsche Boxters littered the California highway, the People’s Car of this revolution.

The story ended in tragedy, but we were all taken on a wild ride, and we enjoyed it. We are chastened now; investment money is harder to come by, and companies are often forced to figure out their product before they figure out their IPO. And yet the idol of the startup founder remains with us, working long hours in jeans and sneakers, drinking too much coffee, negotiating eight-figure venture funding deals. Dreaming of a 12-month concept-to-funding-to-sale cycle (or is it funding-to-concept-to-sale)?

This idol is back, in an upgraded 2.0 form. The names have changed (Digg instead of Lycos); they are often smaller and more frugal; and many of them will succeed.

But the idol needs to be dispelled.

Meebo is a startup in Silicon Valley that provides an in-browser, cross-protocol IM program. Think iChat or Trillian in a browser.

Business Week recently published an article on Meebo. It’s a typical dot-com profile. Meebo has 10 engineers, 7 business types, and is hiring. Their product is fairly complex and cool, with an Ajax front-end, a C++ backend, and a made-up name. Its developers work 14- to 16-hour days to keep the site running and to add new features like Meebo Rooms (kind of like chat rooms, but with 100% more Meebo). The environment is fun and informal, with ethnic take-out, games, toys, inside jokes, and Simpsons posters. Meebo also has serious VC funding from Sequoia Capital and Draper Fisher Jurvetson.

This makes for an exciting Business Week article: our eHeros are back! But two things give me pause.

First, 15 hour days are not a good thing. Long days at a startup sound sexy, like Aeron chairs and razor scooters. There are plenty of people out there that those kind of hours are ubiquitous for tech startups, like a company can’t succeed on 40-hour weeks. But death marches typically end with, um, death. Those hours can ruin a company and its employees. And more importantly, working long hours isn’t good for software. Software development is hard, and 40 good hours are better than 80 tired hours. I know developers who have burned out, gotten physically sick, and divorced because of this kind of thing. It isn’t healthy, sustainable, or profitable.

Second, Meebo won’t be a success unless it sells for $500 million, according to Business Week, and that just isn’t a good business plan. Paul Graham explains this well:

Venture investors like companies that could go public. That’s where the big returns are. They know the odds of any individual startup going public are small, but they want to invest in those that at least have a chance of going public.

Currently the way VCs seem to operate is to invest in a bunch of companies, most of which fail, and one of which is Google. Those few big wins compensate for losses on their other investments. What this means is that most VCs will only invest in you if you’re a potential Google. They don’t care about companies that are a safe bet to be acquired for $20 million. There needs to be a chance, however small, of the company becoming really big.

In other words, if VCs put $10m into Meebo in exchange for 40% of the company, then they’ve valued the company at $25m ($10m / .4 = $25m). So if they want a 20x return, then Meebo isn’t worth selling for less than $500m ($25m * 20 = $500m). In practice, they might be interested in cashing out at $100m if things look “bad” (for a 4x return), but they certainly wouldn’t want to sell for $20m, since that would actually represent a loss.

Maybe Business Week is exaggerating – I hope they are. I have no inside information on Meebo, and so maybe Business Week (or I) have the details wrong. But really, how many web startups sell for half a billion dollars? Maybe one a year? Off the top of my head, we’ve got MySpace, YouTube, and Skype (if Skype counts) over the last few years. Does Meebo provide anything as wide-reaching or revolutionary as these?

Venture capital may be great for biotech, aerospace, semiconductors, &c. But $10m isn’t needed for most web startups. There is another approach to startups, which understands the inefficiencies of large teams and the value of constraints. Throwing $200,000 at a programming problem often produces better results than throwing $2,000,000 at it. Not always, but often. If you have enough money to bootstrap a small team (3-5 developers) for a year, and if you (ahem) have a revenue model, you’ve got what it takes to build a business. You probably don’t need venture money.

And really, who wants to start a web business that isn’t a success at $30m?