The business case for hard tech startups
By definition, hard tech startups are hard. It’s difficult to invent new technologies, and often difficult to bring products based on those new technologies to market. Of course, there are obvious social reasons to work on hard technology problems. Solutions to hard technology problems are often world changing, paradigm shifting events that unlock tremendous opportunities and increase global welfare. Mission driven people are drawn to hard tech for this reason. Unfortunately, some business people think that hard tech companies are too difficult or too risky. This is particularly true when they are focused on short-term financial performance and near-term profitability over long term prospects. Here, I’d like to try to make a case that research and development should generally be at the core of any technology company for that company to be successful in the long term.
Let’s use a simple business school-style framework based on the following 2x2 matrix.
A technology company can either base their product offerings off of an innovative technology, or a commoditized technology. They are differentiated in the former case, and undifferentiated in the latter. In addition, customers view their products as trustworthy and capable of providing sufficient value, or as untrustworthy and potentially incapable of providing sufficient value. Clearly, the best place to be on this 2x2 matrix is in the upper right quadrant with a product based on an innovative differentiated technology that customers trust to provide substantial value. Likewise, the obviously worse place to be is in the lower left hand quadrant with a product based on a commoditized technology that customers don’t trust to provide sufficient value.
The challenge is that one usually cannot start a business in the upper right hand quadrant on day one. Therefore, startup founders and business leaders have to choose a strategy. They can either start in the lower right quadrant with an unproven product based on an innovative technology, or in the upper left quadrant with a proven product based on a commoditized technology. Which strategy should they take?
A product that starts in the lower right quadrant may be unproven for two reasons. In the first case, the technology is good enough but the company hasn’t accumulated enough evidence yet to build trust with their customer base. In the second case, the technology is not good enough yet, and the company needs to continue to develop it and improve its performance before they’ll be able to gain their customers’ trust. Tackling the first case is a standard part of the go-to-market motion and marketing of new products. And, tackling the second case falls under the general umbrella of continued research and development (R&D). Although both are risky, they are well worn paths. It is clearly possible to start in the lower right hand quadrant with an unproven technology, and then prove it out in order to move vertically into the ideal quadrant to end up with a valuable product based on a differentiated technology. This is represented by the green arrow in the figure below.
It’s also possible that a competitor could emerge and commoditize the technology before its value is proven, which would be a disaster for your business, as represented by the red arrow in the figure above. However, it is likely a disaster for their business too. There isn’t much incentive for another company to invest in R&D to develop a competing technology when the market isn’t proven yet, unless it’s anti-competitive behavior by a company willing to take a loss in this area in order to prevent the growth of a new startup.
Once a technology has been commoditized, it cannot become innovative again. It is not possible to move to the right in this 2x2 matrix without investing in substantial R&D to invent new technologies and launch entirely new product lines. Therefore, it’s generally not possible for a company to move from the upper left quadrant to the upper right quadrant. If you start by using commoditized technology in order to make sure you can provide value to customers immediately, then you will never reach the ideal state of having a valuable product based on an innovative and differentiated technology. You’re stuck. In fact, the only transition that you could make is to lose your customers’ trust (e.g., by having an error in your product) and end up in the disaster zone. By starting in the safe zone of the upper left hand quadrant, you have sacrificed the long term future of your business for short term revenue.
Well, it’s not exactly true that there’s no other path forward. If you want to start in the safe zone of the upper left hand quadrant, then you need to find some other way to differentiate that is not technology. You will have to break free of this 2-dimensional world. Other ways to differentiate include price and customer experience. Neither of these pathways are fool proof, however. You can only successfully differentiate on price if there is sufficient volume to support a low priced product and if you are able to lower your costs sufficiently to maintain reasonable margins. You can successfully differentiate on customer experience either by having exceptional product design or by providing exceptional customer service. But, product design is a type of R&D that requires specially trained (i.e., expensive) people and provides no guarantee of success, much like technology R&D. And, trying to differentiate on customer service will erode your margins such that your business cannot demand technology valuations; effectively you become a consulting firm instead of a tech company.
As a result, I believe it is much better to start in the bottom right quadrant; invest in technology R&D to create innovative and differentiated technology, and then put in the time and effort required to prove out your value proposition and earn your customers’ trust. This is a long term endeavor, but taking the safe route in the short term ultimately leads to disaster.
