established business vs. innovation

Jeff Bone jbone@jump.net
Fri, 11 Jan 2002 13:19:32 -0600


Dave Long wrote:

> >                                              ... it's important to
> > consider the resources that fat guys burn on activities other than
> > building profit, namely activities *defending* current profit.
>
> Defending from whom?

>From the potentially disruptive innovator.

> As an investor,
> I don't care if my return comes from
> the established player or the upstart,
> only how large it is overall.

Then (a) you're not a particularly smart investor, or (b) you're only looking
at this in a coarse, macroeconomic sense.  You've got to risk-adjust your
expected returns.  Once you do this, it's clear that a dollar of revenue from
the established player is preferable to a dollar of revenue from a newbie.
(Assuming you can even invest in the newbie, not a safe assumption.)

> However, that increase in risk means
> that, overall, the PQR sector as a
> whole is no longer as attractive an
> investment as it was, which should
> cause capital to flee.

This is correct for a static market.  However the fruits of innovation can
grow the total available market considerably, which might serve to balance
this effect.  The only question for an investor is "which strategy has the
optimal risk / reward balance?"  For all but the most risk-tolerant, the
answer will be to let an investment in P ride and hope P successfully defends
its revenue stream.  It's important to note that risk tolerance often
correlates with net worth, and only the wealthier / more connected folks will
have the opportunity to invest in Q / R at the earliest and most lucrative
stages anyway.  For the proles, P remains the better bet.

> Can PSFT choose projects such that
> they get a larger slice of a less
> valuable pie?  I think so, and I
> can understand why management at
> Pablosoft would think it a good
> idea, but I am not sure why most
> of their investors wouldn't prefer
> to allocate portofolios across the
> more valuable pie.

(A) I think you're underestimating the risk aversion of the run-of-the-mill
investor.  And (B) for individual investors and even funds, there are
regulatory, legal, logistical, and in the latter cases corporate / fiduciary
reasons why investing in Q and R may not be possible even if it is preferred.

POINT OF CLARIFICATION:  I am assuming for the sake of discussion here that P
is a large public company and Q / R are small private companies, as my
objection to tranparency is primarily the competitive impact it has on small
private companies.  The economics of competition between P and Q / R must
take into account two very significant factors that don't exist in a more
abstract consideration of competition:  (1) relative risk-adjusted rates of
return, and (2) the fact that investment isn't really a free market, and
there are numerous obstacles to open investment in Q / R.

> Those are the three strategies we're
> considering for the dom player after
> an innovation has been proven.  Until
> that time, you had mentioned IGNORE /
> LAUGH.

My lack of clarity.  That was just an amusing quote from Gandhi, not intended
as part of the formalism.

> If innovations, for whatever reason,
> do not pan out most of the time, then
> IGNORE/LAUGH is better initially than
> putting resources into any activity,
> even cheap ones like DISCREDIT.

Okay, let's expand the formalism:  IGNORE, DISCREDIT, COPY, BUY.

jb