The Death of Disruption
Moneyball is a fortnightly newsletter from Koble exploring the limitations of human decision-making and their implications for startup investing.
We’ve spent two years developing our groundbreaking algorithms, which discover early-stage startups that outperform the market and predict their probability of success.
This week
🧠 Mental Model #24 – Disruptive Innovation – The Death of Disruption
📖 Investor reading – “The reason Silicon Valley has been so successful is because it's so f***ing far away from Washington DC” – VCs are traders, they are not investors – Venture firms hang “For Sale” signs on portfolios
💬 Some tweets – Empiricism is the key to progress – Another downside of being constantly busy – Choosing a romantic partner
The Death of Disruption
Of all the words that have come to encapsulate Venture Capital, “disruption” has to be the most ubiquitous.
The entire startup ecosystem has bought into the concept. But what if that was a mistake? What if disruption was nowhere near as significant as people think it is?
In the 1990s, researchers became obsessed with business failure. Why were so many large companies being overthrown by startups? Clayton Christensen developed a succinct solution to this problem, and the concept of “Disruptive Innovation” was born.
From humble beginnings as the offspring of Christensen’s research into the relationship between incumbents and startups, the concept of “Disruption” has proliferated like a virus. The D-word is everywhere – screaming at us from the pages of cut-and-paste pitch decks, conference agendas, and VC websites.
But the rhetoric has lost touch with reality. Turns out that since the turn of the century, disruption has become less prevalent in the US economy. That might sound unbelievable (and hard to prove), but according to this paper from Boston University’s James Bessen, it’s true.
In studying disruption, Bessen calculated the chance that one of the top 4 firms in an industry would fall out of the top 4 the following year. And his findings were stark; the “displacement” rate increased in the 1990s when the concept of “disruption” entered popular consciousness, but it has declined since 2000. For two decades, disruption has been on the retreat.
Indeed, there is a growing body of evidence charting the decline in competition in the US (an economy inextricably linked with technology, innovation, and disruption).
To understand the underlying cause of this, it’s worth consulting the abstract from Bessen’s paper:
“Displacement hazards rose for several decades since 1970 but have declined sharply since 2000. Using a production function-based model to explore the role of investments, acquisitions, and lobbying, we find that investments by dominant firms in intangibles, especially software, are distinctly associated with greater persistence and reduced leapfrogging. Software investments by top firms soared around 2000, contributing substantially to the decline. Also, higher markups are associated with greater displacement hazards, linking rents positively with industry dynamism. While technology is often seen as disrupting industry leaders, it now appears to help suppress disruption.”
The final line is particularly interesting and warrants a closer reading:
“Technology [...] appears to help suppress disruption.”
This insight blows a hole in the concept of “Disruptive Innovation”, undermining the entire premise of startups disrupting incumbents with technology.
Perhaps software isn’t eating the world after all? Perhaps it’s eating startups?
Bessen has linked the decline in disruption to large firms’ use of custom software (he refers to Walmart and Amazon creating logistics and inventory systems that are proprietary in nature, so the technological benefits don’t spread to other firms, creating a gap in capabilities between companies in the same industries).
He expands on that dynamic by emphasising the importance of intangible assets in perpetuating market dominance (this includes access to people who know how to deploy technology in the right ways). The title of that article – “How Software Is Helping Big Companies Dominate” – says it all.
Ultimately it boils down to scale. The biggest companies can use their size to digest disruption and turn it outward. There will always be exceptions to the rule, but large industries have done a fantastic job of mitigating disruption, even weaponising it to their own advantage.
The financial services playbook has involved incubating and acquiring innovative fintechs in order to improve the customer experience, increase market penetration and grow revenue, and cut costs. Fintech startups have avoided using the word “disruption” for years, finding it at best, counter-productive, and at worst, downright dangerous.
Bill Gurley’s recent talk on the dangers of regulatory capture and its negative impact on the human experience resonate here. The higher the regulation, the lower the competition, the higher the prices, the lower the innovation. Big companies love regulation because it protects them from disruption and competition, and we all lose because of that. The EU’s heavy-handed approach to regulating AI is a case in point.
Implications for investors
Of course, the death of disruption doesn't change anything for investors.
Successful founders – the kind that genuinely disrupt incumbents and change conventional ways of doing things – are outliers. VCs are making educated guesses on which startups from the dealflow firehose will capture value from inefficient industries. And some processes simply can’t be disrupted (as anyone who has tried to find a reliable nanny via a cutting-edge childcare platform will testify).
Disruption is still happening, but on a much smaller and unevenly distributed scale than everyone thinks. It’s an exception to the dystopian rule, not some kind of broad-based utopian movement.
Perhaps we should use the word “disruption” less when it comes to technology? It’s certainly hard to escape the vernacular of startup investing. But the relationship between the two is far more nuanced than most people think.
Work with Koble
At Koble, we’ve spent two years developing our groundbreaking algorithms, which discover early-stage startups that outperform the market and predict their probability of success.
We’re working with forward-thinking angels, VCs, family offices, and hedge funds to re-engineer startup investing with AI. If that resonates, get in touch.
Investor reading
🤖 “The reason Silicon Valley has been so successful is because it’s so f***ing far away from Washington DC” – Bill Gurley warns against regulatory capture in AI, hails open-source efforts, and calls for “massive transparency” in government.
📈 VCs are traders, they are not investors – The “Dean of Valuation” debunks how price is different from value, and why most venture capital firms are incapable of valuing companies.
🛒 Venture firms hang the “For Sale” signs on portfolios – Some of the most active startup investors have been hanging a “for sale” sign on their portfolios at a time when VCs are finding it increasingly difficult to raise new funds.
Some tweets
Parting shot
“Everyone thinks of changing the world, but no one thinks of changing himself.”
– Leo Tolstoy
Regards from your [disruptive] startup investing AI,
About Koble
Koble is re-engineering startup investing with AI, applying quantitative strategies that have disrupted public markets to early-stage startup investing.