Avoiding Asymmetric Competitors in Technology Investing
In a recent conversation with a leading technology-focused sponsor, I was asked an interesting question: if [insert hyperscale technology company name] is getting into everything, then how do I know what’s safe? In this case, we were talking about Amazon, but the same could have applied to Microsoft, Google, Apple, Salesforce, Adobe, and more.
First, I will admit that answering this question requires predicting the future, and I am aware of the dangers of even writing this piece. If you had asked whether I thought Amazon was likely to “enter” the healthcare management market, or whether they would buy their way into the pharmacy space, I would have said no. (Note that these two moves are not obviously connected today, though they could be in the future, which has to be a bit terrifying for multiple companies.) Anyway, with that caveat made, I’ll give my best answer on predicting the level of threat a technology company faces.
If you want to know whether you are on safe ground investing in a technology company, there are a few activities that can help determine the risk level:
- Assess the solution space: what’s the problem being solved, for which functions and which verticals?
- Assess the target company’s unique selling proposition from the customer’s view: what is driving customer interest in this company today? Why do customers choose this company vs. peers?
- Assess the solution space and “hyperscale” competitors: is the target’s product in the productivity space (Microsoft, Google, Amazon)? Is this in the sales and marketing space (Salesforce, Microsoft, Adobe)?
- Assess the business models that hyperscale competitors are taking in the space, by asking a few questions:
- Why does the hyperscale player care about this space?
- What is their business model?
- Where do they plan on monetizing?
- Does the company really care about our market niche or is it part of a broader platform style approach?
Some might ask, why care so much about the hyperscale competitors? The reason is that they compete asymmetrically, which means they can be overwhelming competition not just with their deep pockets but often with a radically different business model. This radical difference is usually a source of both strength and weakness. For instance, Google’s massive advantage in monetizing user information means that it can offer services at far lower prices (often free) than nearly any other company. On the other hand, they may provide only the level of service, product feature completeness, and quality, that the data is worth. This can leave relatively unscathed the premium segment of the market, if there are customers willing to pay more for the service than their data would be worth to Google’s monetization machine. On the other hand, if your target’s unique selling proposition is “be lowest price” in a segment that fits Google’s ambitions, then run like hell.
An alternative viewpoint to this entire argument is that investors shouldn’t see hyperscale players as a concern, instead they should view them as a great exit strategy. I think this is mostly outdated thinking.
In the past, hyperscale players were frequent acquirers because they sought talent and users. Today, they have an overwhelming amount of both; and they’re instead looking for stack integration and to leverage a common graph(s) across their portfolio. This allows them to drive differentiated insight from aggregated data and to create compelling user simplicity through offering common data objects across all their services. In this new world, acquisitions can be more of an integration burden than they were in the past. If the target company has a data moat, then it might still prove attractive. But if what sets it apart is feature differentiation, then that’s just altogether too replicable. Look at Microsoft Teams, Hire by Google, Amazon Chime, Microsoft Bookings…these are all recent organic entries into spaces where attractive, actionable acquisition candidates existed.
Trying to decipher the business model of the large tech players in and around your space? A good way to do so is to spend time poking around the (often publicly available or otherwise easily ascertained) product feature roadmaps. Where is the company building toward? What does the feature prioritization say about engineering resource investments? Of course, this is true for incremental moves; heavy R&D projects (e.g., “Google X” or Microsoft Research), or transformative acquisitions are harder to predict. However, their relative infrequency of occurrence (let alone success) should put them lower on the list of risks. If you want the opinion of a seasoned observer, though, you can always head over to Ben Thompson’s excellent stratechery.com and see if he’s done an analysis of the hyperscale competitor’s strategy yet.
Large technology companies are like Ohio-class nuclear submarines: they’re well-armed, pop up in the middle of nowhere, and typically outlast their adversaries. They are also driven by a predictable mission…you don’t outgun them, you just make sure you never end up needing to try.
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