web 2.0 skeptics are having their I-told-you-so moments.
I believe the wave is real; it's just the profits that aren't. Here's why.
Software is eating the world
As Netscape co-founder cum super-investor Marc Andreessen wrote in the Wall Street Journal, software is eating the world, meaning that a wide spectrum of formerly physical goods and services are being turned into software problems.
An example: First music went digital, then teenagers and college students pirated it rather than pay for CDs, then they acquiesced to paying 99c a song for convenience and insurance against lawsuits. In the process, music fans migrated from portable CD players to another physical player, the iPod. It sold like mad for a few years before it too was replaced by digital files, this time software running on phones.
Andreessen marches through other examples: Amazon and e-books, Netflix and streaming video, mobile and desktop games from Rovio and Zynga, animated movies and Pixar, photography websites and apps, advertising and Google, phone calls and Skype, recruiting and LinkedIn, logistics and Walmart, financial services and Square and PayPal.
Software is bringing huge change to every industry that can benefit from data-driven decision making and automation.
But is software making the pie bigger, or shrinking it by eating it, one slice at a time?
Or eating the world's profits
Capitalism is creative destruction, and software is destroying existing industries. Newspapers, print advertising, book stores, neighborhood shops and video rental stores are among the recent casualties. In all cases, software has been a major killer -- of profits for incumbent businesses.
And software companies destroy each other as well. Google killed AltaVista. Facebook killed MySpace.
Software has lowered the barrier to starting a business. There's a long list of things you don't need in a startup now, largely due to software.
That's why the price to earning multiples for technology companies are so low. Just as Linux disrupted Sun Microsystems and IBM's hardware business, so investors fear that new companies will creatively destroy the Groupon's and Facebook's of today.
Stock in a high-tech company is not like a perpetuity that you can buy and hold for your entire lifetime. The company is unlikely to be here five years from now. Patient long-term investors like Warren Buffett steer clear of technology companies, because change comes too quickly.
Basic microeconomics predicts that businesses will purchase software that reduces their costs or increases their revenues. If software substitutes for something that costs more -- like typists, travel agents, wired phones, reference books -- software will eat the paychecks of those employed in the old industries, and eat the profits of the companies.
At the consumer level, people like you and me will try out software if it costs us less than the alternatives -- like Skype vs. landline phone services, or digital photos vs. printed albums and slideshows. We'll happily pay if software brings us more convenience or pleasure, as with smart phones and games, at a price we can afford. Truly, we've never had access to so much free and inexpensive diversions, some educational like Wikipedia, others distracting like mobile games.
But even as we choose to shop on Amazon instead of go to the stores downtown, or stream movies from iTunes rather than go to the theater, we are helping software to eat paychecks and profits too.
Software is eating the world's profits, and we're contributing, in our personal and professional lives. But that's not all.
Moving from disruptive to revolutionary
In my experience talking with the founders of high tech startups, as well as alumni of successful young companies, it's obvious that their goal in launching a new company is not to destroy. Nor is it to "disrupt", though that's an obligatory cliche in any business plan. To suck the life out of incumbent companies bogged down in bureaucracy is not the goal.
No, the goal is not to destroy or disrupt. It's to create. What motivates the entrepreneurs I've met is the creative side of creative destruction. They want to revolutionize an industry.
Whereas disruptive technology may appeal to a different market segment, then mature and take over the entire entrenched space like the classic examples in The Innovator's Dilemma, revolutionary technology, by contrast, creates new value. Revolutionary innovations change the whole game.
And that's what the Web 2.0 companies need. They need to find new business models, not only eyeballs and advertising.
That's why Steve Blank, a veteran entrepreneur and professor at Columbia Business School, advises startups to rapidly iterate until they find a scalable business model. Whereas titans like Google can invest in revolutionary long-term visions like self-driving cars, startups with less lavish funding need to prototype and figure out what works as quickly as possible.
As a venture capitalist told me while I was getting one of my own companies off the ground, "Your first startup, you learn your lessons. Your second, you make your connections. Your third, you make your money." Indeed, the data show that repeated efforts increase the odds of success.
To capitalize on that insight, the lean startup approach of Steve Blank and his pupil Eric Ries advises cycling through as many ideas as you need even within your first startup, functioning like the first, second and third company all in one, until you achieve success.
Software is eating the world's profits, but only some of them. It's simultaneously destroying industries and creating new ones -- primarily the software industry itself.
Though internet companies may earn pennies on the dollar for their virtual products compared to the physical ones they've replaced, there are enough pennies to add up to real money. Moreover, the costs are low enough that successful software businesses enjoy enviable profit margins. Even at a $10 billion market value, Facebook would count as a phenomenal success.
Disruptive companies change the guard and gradually transform industries, maintaining the same basic dynamics. By contrast, the revolutionary startups are striving to create new industries and a better world. They're eating the world's profits, but generating new profits and business models too.
Disruptive vs. Revolutionary Innovation
Things You Don't Need in a Startup
What's the Recipe for Innovation?