Why some big firms struggle to compete with startups

Founders and investors in their startups have to choose which markets to attack and by extension which companies to compete with. Most often that’s done by looking for industries where there has been little innovation and/or the founder has a plan that leads to a sustainable competitive advantage. As an example from our portfolio, Thread.com has built a personalisation algorithm which allows men to “dress better without trying”. They are competing with offline and online fashion brands that haven’t changed the buying experience much beyond putting their inventory online.

It’s interesting to ask why it takes a startup like Thread.com to exploit this ‘personalisation’ opportunity. Selfridges, Mr Porter or any other established fashion brand could have gone after it at the same time or earlier and with more resources.

A big part of it is that change happens very fast these days and big companies inevitably gravitate to a manageably small number of opportunities that are most likely to move the needle in the short term, taking them towards the obvious and away from ideas that are higher risk/higher return.

However, another part of it is that many big companies aren’t organised to innovate well. Drucker foundation strategist Steve Denning says that focusing on short term share price movements is a big part of the problem:

Why are firms failing to be entrepreneurial and invest in long-term growth? The answer isn’t hard to find. Once a firm embraces maximizing shareholder value and the current stock price as its goal, and lavishly compensates top management to that end, management naturally focuses on exploiting the existing business and bolstering the stock price by increasing dividends and share buybacks, at the expense of innovation and investing in the future.

And focusing on shareholder value requires a culture that’s incompatible with innovation:

Even worse, shareholder value theory has joined forces with hierarchical bureaucracy. Once a firm embraces shareholder value theory, the C-suite has little choice but to deploy command-and-control management. That’s because making money for shareholders and the C-suite is inherently uninspiring to employees. The C-suite must compel employees to obey. With only one in five employees fully engaged in his or her work, and even fewer passionate, innovation and entrepreneurship are even less likely.

Not all big companies are like this of course, but most are. Interestingly, many of the world’s biggest companies today have eschewed shareholder value theory and remain entrepreneurial to the core – Apple, Amazon, Google and Facebook are four good examples.

When assessing whether industries are ripe for disruption looking at the DNA of leading players is informative even before the disruptive idea is formed. Companies focused on shareholder value (including many PE backed businesses) and, more obviously, those which are hierarchical and bureaucratic, make good targets. Those that are entrepreneurial to the core, not so much. Returning to Thread, the large entrepreneurial companies in fashion are mono-brand plays innovating through supply chain management, and the multi-brand retail focused companies that might be competitors are more stuck in the bind that Denning describes.