The Big Business Contradiction

I’m a big fan of Clayton Christensen’s seminal work The Innovators Dilemma. One of the central themes of this work is that established companies often focus on sustaining innovations rather than disruptive innovations. This means incumbents often focus on improvements to existing products but miss new technologies and business models. This is because incumbent businesses undervalue new innovations which initially only serve niche markets and generate a tiny proportion of revenue (if any at all) compared to main revenue streams. These same incumbent businesses are constrained by existing customers and profitability targets. They don’t disrupt themselves. 

The Innovators Dilemma was published in 1997, right at the point where the internet started to launch disruptive haymaker after disruptive haymaker on incumbents across various industries. Bookstores focused on their physical stores, while Amazon disrupted them with ecommerce. A few years later, Apple would disrupt the music industry with the launch of the iPod, an invention that, by all accounts, was Sony’s to create. Even the earliest internet companies were not safe: Yahoo!, an absolute darling of early internet folklore was disrupted by search, and Google in particular.

However, it’s now not 1997, it’s 2024, and far more people know the long term benefits and value of disruptive innovations. Whilst once Steve Jobs stood out for saying you had to disrupt yourself, now its common business sense. Though apparently that didn’t get through to Google who rested on their laurels as search’s dominance came under threat from generate AI powered products such as Perplexity.

Clayton Christensen explained how startups focusing on a niche market can lead to incumbent firms missing up and coming innovations. But Peter Thiel explains why startups should focus on niche markets: “The thing that’s always a big mistake is going after a giant market on day one…it normally means there’s going to be too much competition.” He lists massive companies that started with small markets and then expanded: Amazon started with bookstores, then expanded; eBay started with Pez dispensers and Beanie Babies, then expanded; PayPal started with power sellers on eBay, then expanded; Facebook started with Harvard, then expanded.

This isn’t a new phenomenon, but just needs remembering. The internet era led people to think this phenomenon had changed, when in reality, it hadn’t, it had just sped up.

In the UK, Tesco was founded in Hackney in the East End of London in 1919. Morrisons was founded in Bradford in 1899 as an egg and butter merchant. Sainsbury’s was founded in 1869 in Covent Garden, selling fresh foods. Asda originated in 1949 through a merger between a butcher and dairy farmers in Yorkshire. The origins were niche, both in location and industry. Then they relentlessly expanded year after year.

Peter Thiel then goes onto take aim at the business school approach to market targeting, and it’s a critique I agree with. The business school approach (and many strategy departments worldwide) look at potential markets and go after the biggest. They ignore small markets because they don’t appear to have any value. But this is a myopic, static analysis. Each of the markets the companies above started in were a launchpad to grow into other markets. Whilst “it’s a £100 billion market, if we can take 1% we get a billion” is a neat mental model, it’s generally a very bad strategic model. As Peter Thiel says, if it’s a £100 billion market, then others would almost certainly have noticed and would be competing in that space. By entering, you are competing against others, and you really want to avoid competition. 

In exactly the same vein, Warren Buffett once said that even if he had billions, he couldn’t dispose the Coca-Cola Company's leadership in the beverage industry. The soft drinks market is huge (something around $500 billion depending on how you define the market), but it’s going to be mightily tricky to get even a small sip of that.

A more nuanced way to look at this is how big the market is now relative to where it could be in the future. It’s a prediction wrought with uncertainty, but take this example: in the mid-noughties Facebook, YouTube and Twitter were in their infancy, and Instagram arrived at the turn of the decade. Each found it’s own particular niche and grew. In 2009 the combined revenue of these companies was just under £1 billion. In 2023 it was about $170 billion. In many ways, what sets these companies out as different is that they created a whole new market.

There’s never a shortage of industries to choose from, and interestingly, the value added by industry, as a percentage of GDP, in the USA, is reasonably static over time. 

We can see how stable each industry has been using data from the Bureau of Economic Analysis. By this measure, since 1997, the finance, insurance, real estate, rental, and leasing industry sector has been the leading industry, with a percentage share rising from 18.8% in 1997 to 20.7% in 2023. There have been some declines; the manufacturing industry’s contribution has declined relatively from 16.1% in 1997 to 10.3% in 2023. Professional and business services (consultants) has grown from 9.8% in 1997 to 13% in 2023. This high level industry view obscures some underlying trends, however.

The data processing, internet publishing, and other information services industry has seen its share increase from 0.4% in 1997 to 1.7% in 2023, a fourfold increase. But none of the tech behemoths set out to impact GDP by this amount, just like none of the founders of the four UK supermarkets set out to turn the market into an oligopoly.

It’s the big business contradiction: to get big you need to start small. You have to focus on the small market niche first. That can be either an industry niche or a country niche, or both. Sometimes, the best niches exist at the intersection of industries and it’s been a hallmark of software eating the world. Back in the 1990s and the 2000s, software began to intersected with different industry’s and provided opportunities for disruptive innovation.