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Business | Into the danger zone

American tech giants are making life tough for startups

Big, rich and paranoid, they have reams of data to help them spot and
buy young firms that might challenge them

[20180602_W][20180602_W]
Jun 2nd 2018 (Updated Feb 7th 2019) | SAN FRANCISCO
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IT IS a classic startup story, but with a twist. Three 20-somethings
launched a firm out of a dorm room at the Massachusetts Institute of
Technology in 2016, with the goal of using algorithms to predict the
reply to an e-mail. In May they were fundraising for their startup,
EasyEmail, when Google held its annual conference for software
developers and announced a tool similar to EasyEmail's. Filip
Twarowski, its boss, sees Google's incursion as "incredible
confirmation" they are working on something worthwhile. But he also
admits that it came as "a little bit of a shock". The giant has
scared off at least one prospective backer of EasyEmail, because
venture capitalists try to dodge spaces where the tech giants might
step.

The behemoths' annual conferences, held to announce new tools,
features, and acquisitions, always "send shock waves of fear through
entrepreneurs", says Mike Driscoll, a partner at Data Collective, an
investment firm. "Venture capitalists attend to see which of their
companies are going to get killed next." But anxiety about the tech
giants on the part of startups and their investors goes much deeper
than such events. Venture capitalists, such as Albert Wenger of Union
Square Ventures, who was an early investor in Twitter, now talk of a
"kill-zone" around the giants. Once a young firm enters, it can be
extremely difficult to survive. Tech giants try to squash startups by
copying them, or they pay to scoop them up early to eliminate a
threat.

The idea of a kill-zone may bring to mind Microsoft's long reign in
the 1990s, as it embraced a strategy of "embrace, extend and
extinguish" and tried to intimidate startups from entering its
domain. But entrepreneurs' and venture capitalists' concerns are
striking because for a long while afterwards, startups had free rein.
In 2014 The Economist likened the proliferation of startups to the
Cambrian explosion: software made running a startup cheaper than ever
and opportunities seemed abundant.

[body_6]

Today, less so. Anything having to do with the consumer internet is
perceived as dangerous, because of the dominance of Amazon, Facebook
and Google (owned by Alphabet). Venture capitalists are wary of
backing startups in online search, social media, mobile and
e-commerce. It has become harder for startups to secure a first
financing round. According to Pitchbook, a research company, in 2017
the number of these rounds were down by around 22% from 2012 (see
chart).

The wariness comes from seeing what happens to startups when they
enter the kill-zone, either deliberately or accidentally. Snap is the
most prominent example; after Snap rebuffed Facebook's attempts to
buy the firm in 2013, for $3bn, Facebook cloned many of its
successful features and has put a damper on its growth. A less known
example is Life on Air, which launched Meerkat, a live
video-streaming app, in 2015. It was obliterated when Twitter
acquired and promoted a competing app, Periscope. Life on Air shut
Meerkat down and launched a different app, called Houseparty, which
offered group video chats. This briefly gained prominence, but was
then copied by Facebook, seizing users and attention away from the
startup.

The kill-zone operates in business software ("enterprise" in the
lingo) as well, with the shadows of Microsoft, Amazon and Alphabet
looming large. Amazon's cloud service, Amazon Web Services (AWS), has
labelled many startups as "partners", only to copy their
functionality and offer them as a cheap or free service. A giant
pushing into a startup's territory, while controlling the platform
that startup depends on for distribution, makes life tricky. For
example, Elastic, a data-management firm, lost sales after AWS
launched a competitor, Elasticsearch, in 2015.

Even if giants do not copy startups outright, they can dent their
prospects. Last year Amazon bought Whole Foods Market, a grocer, for
$13.7bn. Blue Apron, a meal-delivery startup that was preparing to go
public, was suddenly perceived as unappetising, as expectations
mounted that Amazon would push into the space. This phenomenon is not
limited to young firms: recently Facebook announced it was moving
into online dating, causing the share price of Match Group, which
went public in 2015, to plummet by 22% that day.

It has never been easy to make it as a startup. Now the army of
fearsome technology giants is larger, and operates in a wider range
of areas, including online search, social media, digital advertising,
virtual reality, messaging and communications, smartphones and home
speakers, cloud computing, smart software, e-commerce and more. This
makes it challenging for startups to find space to break through and
avoid being stamped on. Today's giants are "much more ruthless and
introspective. They will eat their own children to live another day,"
according to Matt Ocko, a venture capitalist with Data Collective.
And they are constantly scanning the horizon for incipient threats.
Startups used to be able to have several years' head start working on
something novel without the giants noticing, says Aaron Levie of Box,
a cloud and file-sharing service that has avoided the kill-zone (it
has a market value of around $3.8bn). But today startups can only get
a six- to 12-month lead before incumbents quickly catch up, he says.

There are some exceptions. Airbnb, Uber, Slack and other "unicorns"
have faced down competition from incumbents. But they are few in
number and many startups have learned to set their sights on more
achievable aims. Entrepreneurs are "thinking much earlier about which
consolidator is going to buy them", says Larry Chu of Goodwin
Procter, a law firm. The tech giants have been avid acquirers:
Alphabet, Amazon, Apple, Facebook and Microsoft spent a combined
$31.6bn on acquisitions in 2017. This has led some startups to be
less ambitious. "Ninety per cent of the startups I see are built for
sale, not for scale," says Ajay Royan of Mithril Capital, which
invests in tech.

This can be enriching to founders, who can go on to start another
firm or provide financing to peers with smart ideas. To the extent
that such exits provide more capital to spur innovation, this is no
bad thing. The tech giants can help the firms they acquire grow more
than they might have been able to do on their own. For example,
Facebook's acquisition of Instagram took out a would-be competitor,
but it has thrived under the social-networking giant's sway by
adopting the technical infrastructure, staff and know-how that
Facebook had in place.

Friend or foe?

But plenty of people in the Valley reckon the bad outweighs the good
and that early, "shoot-out" acquisitions have sapped innovation. "The
dominance of the big platforms has had a meaningful effect on the
entrepreneurial culture of Silicon Valley," says Roger McNamee of
Elevation Partners, a private-equity firm, who was an early investor
in Facebook. "It's shifted the incentives from trying to create a
large platform to creating a small morsel that's tasty to be acquired
by one of the giants."

And when startups are bullied into selling, as some are, it is even
more worrying. Big tech firms have been known to intimidate startups
into agreeing to a sale, saying that they will launch a competing
service and put the startup out of business unless they agree to a
deal, says one person who was in charge of these negotiations at a
big software firm (which uses such tactics).

There are three reasons to think that the kill-zone is likely to
stay. First, the giants have tons of data to identify emerging rivals
faster than ever before. Google collects signals about how internet
users are spending time and money through its Chrome browser, e-mail
service, Android operating system, app store, cloud service and more.
Facebook can see which apps people use and where they travel online.
It acquired the app Onavo, which helped it recognise that Instagram
was gaining steam. It bought the young firm for $1bn before it could
mature into a real threat, and last year it purchased a nascent
social-polling firm, tbh, in a similar manner. Amazon can glean reams
of data from its e-commerce platform and cloud business.

Another source of market information comes from investing in
startups, which helps tech firms gain insights into new markets and
possible disrupters. Of all American tech firms, Alphabet has been
the most active. Since 2013 it has spent $12.6bn investing in 308
startups. Startups generally feel excited about gaining expertise
from such a successful firm, but some may rue the day they accepted
funding, because of conflicts. Uber, for example, took money from one
of Alphabet's venture-capital funds, but soon found itself competing
against the giant's self-driving car unit, Waymo. Thumbtack, a
marketplace for skilled workers, also accepted money from Alphabet,
but then watched as the parent company rolled out a competing
service, Google Home Services. Amazon and Apple invest less in
startups, but they too have clashed with them. Amazon invested in a
home intercom system, called Nucleus, and then rolled out a very
similar product of its own last year.

Recruiting is a second tool the giants will use to enforce their kill
zones. Big tech firms are able to shell out huge sums to keep top
performers and even average employees in their fold and make it
uneconomical for their workers to consider joining startups. In 2017
Alphabet, Amazon, Apple, Facebook and Microsoft allocated a whopping
$23.7bn combined to stock-based compensation. Big companies' hoarding
of talent stops startups scaling quickly. According to Mike Volpi of
Index Ventures, a venture-capital firm, startups in the firm's
portfolio are currently 10-20% behind in their hiring goals for the
year.

A third reason that startups may struggle to break through is that
there is no sign of a new platform emerging which could disrupt the
incumbents, even more than a decade after the rise of mobile. For
example, the rise of mobile wounded Microsoft, which was dominant on
personal computers, and gave power to both Facebook and Google,
enabling them to capture more online ad dollars and attention. But
there is no big new platform today. And the giants make it extremely
expensive to get attention: Facebook, Google and Amazon all charge a
hefty toll for new apps and services to get in front of consumers.

Seeing little opportunity to compete with the tech giants on their
own turf, investors and startups are going where they can spot an
opening. The lack of an incumbent giant is one reason why there is so
much investor enthusiasm for crypto-currencies and for synthetic
biology today. But the giants are starting to pay more attention.
There are rumours Facebook wants to buy Coinbase, a cryptocurrency
firm.

Regulators will be watching what the giants try next. Criticism that
they have been too lax in approving deals where tech firms buy tiny
competitors that could one day challenge them has been mounting.
Facebook's acquisition of Instagram and Google's purchase of YouTube,
before it was obvious how the pair might have taken on the giants,
might well have been blocked today. To fight back against the
kill-zone, regulators must closely consider what weapons to wield
themselves.

This article appeared in the Business section of the print edition
under the headline "Into the danger zone"

Business June 2nd 2018

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The surveillance state: Perfected in China, a threat in the WestThe
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