Is Consolidation Killing Innovation?
The shrinking of the tech sector threatens creativity and new thinking
By Christopher Lochhead, strategy advisor and former chief marketing officer, Mercury Interactive
Is Silicon Valley at risk of becoming Detroit 2.0 — a company town dominated by a handful of big, uninspired conglomerates?
Lochhead advocates a mix of innovation and consolidation
Consolidation is replacing innovation as the hot strategy. During his company's battle for PeopleSoft, Oracle CEO Larry Ellison declared that the software industry has entered a "period of contraction and consolidation."
Talk about a self-fulfilling prophesy: Oracle has gobbled up at least a dozen more companies since it closed the PeopleSoft deal in 2005, and a big purchase of Sun Microsystems is pending. And other companies widely are expected to follow Oracle's acquisitive ways.
Is consolidation good for the kind of technological creativity that traditionally has come out of Silicon Valley? More on that in a moment. First, a rundown on what's driving the urge to merge:
Slowing growth
In late 2008 research firm Gartner pegged the industry growth at an anemic 2.3%. As overall growth rates crater, the game for tech giants changes. The thinking in the C-suite goes from: “How do we capture market-share when business is growing?" To: “How do we gain wallet-share as the industry is shrinking?”
Big portfolios trump hot products
Many mega tech companies today favor quantity over quality. Instead of marketing a single product or service as best-in-breed, these giants push their customers to save money by buying "bundles." This strategy can be good for a particular vendor, but it drives down overall tech spending.
M&A equals outsourced innovation
Why take the risk of pioneering new technologies and business models when you can leave that up to entrepreneurs and venture capitalists? Let someone else take the arrows in the back. Bigger companies tend to behave more conservatively: Risk-adverse boards of directors want predictable earnings and no surprises. Innovation is risky. Innovation is unpredictable. So the titans let the startups innovate. Then, when smaller companies get to an interesting size and prove their metal, the big boys buy ’em. In this way a consolidation strategy is de-risked innovation.
The IPO window is nailed shut
Despite the recent success of SolarWinds and OpenTable, the IPO window for most startups remains closed. As a result, the most viable exit for smaller companies is to sell. (VCs need to generate returns and entrepreneurs want to get paid.)
Zombies are attractive acquisitions
There seems to be a never ending lineup of troubled technology companies to buy. These zombies tend to have bloated costs that can be cut quickly. Once purchased, the big tech buyer can fire a lot of people, gut sales, marketing, and r&d costs, then milk the maintenance revenue cow. This makes these acquisitions profitable fast. Oracle, by now a master at absorbing its purchases, has said it expects the purchase of Sun to add at least 15 cents (non-GAAP) to earnings in the first full year after closing.
So is the shift to consolidation good news? It depends on your perspective. The ability to successfully execute acquisitions is a meaningful competitive advantage. When done well, acquisitions are a savvy way to gain market share and drive earnings. Just look at how effectively Cisco and Oracle have used their M&A muscle to force competitors to tap out.
But focusing principally on consolidation leaves the big guys vulnerable to attacks from innovators. Apple has been crushing Microsoft, Motorola, and Nokia with their innovative product, marketing, and retailing strategies.
And when consolidation comes as the expense of innovation, the results can be toxic. Consider all those start-ups that are getting acquired rather than getting a chance to flourish as independent companies: Could one of them been the next Apple or Google, companies that have continued to innovate in spite of their size?
Bottom line: Growth comes from innovation. And without innovation, the tech industry could end up with a few big companies playing a game of musical chairs on the titanic. This will be bad for the industry and bad for the country. Historically tech has been a key growth driver of the U.S. economy. Tech needs to be a growth industry again; that will only come from a healthy mix of innovation and consolidation.
Lochhead is a retired marketing executive turned strategy advisor and ski bum.
To DamaskinosWasRight:
I am one of those H1B's you speak of and I can tell you that you are 100% wrong. I have been here long enough to know many, many qualified engineers and scientists who cannot find employment simply because they are too old.
It has nothing to do with whether they are qualifed or not, It has everything to with Companies wanting cheap (meaning young) labor.
Yes, older labor can be out of touch technically. But that is because companies no longer take on the responsibility of enabling their experienced labor in touch. In stead they are driven to work unpaid hours beyond 40/week and told they need to be apart of the new global economy Clinton helped to usher in with Limbaugh's help.
The real problem is that Americans are so stupid that they cannot fill the available jobs even with training.
We need another three million H1Bs to fill the tech jobs and we should also cut taxes.
Bill Clinton would know what to do, he was the best Republican President since Gerald Ford.
It worked before !
so you are saying those that copied the innovations actually did a better job getting something out of the ideas than the original inventors?
The original inventors run out of R&D funds because??? They failed to capitalized on their own inventions perhaps because they are too complacent and not very competitive. And we are talking about Ford …
The US is a nation of idiots. Only in that country it is allowed that a foreign competitor swallows an American promising tech start up. No country would ever have allowed Roche (a racist Swiss conglomerate) to swallow Genentech, no country would allow Samsung or Toshiba to swallow Sandisk, no country would allow Hynix to swallow Micron Tech.
Every, every US tech startup is a possible snap up for a foreign predator.
The lower the dollar, the more foreign "investments" (what a word).
Innovation is still thriving, it is just harder to get traditional support. I run http://www.MyOnlineToolbox.com that just won a DELL TOP 10 INNOVATOR AWARD for mobile computing that targets the small to mid-sized contractor in home repair, service and remodeling. There are a few million independant plumbers, painters, electricians, roofers and others that are quickly gravitating to the Internet to run their business. The vast majority of this market needs a business tool to help them manage estimates, schedules, invoices and collections. The challenge is that the owner needs a way to have a solution that can be used whether at the office, home, a customer or even while stopping for a coffee at Dunkin Doughnuts. MyOnlineToolbox was created to address the evolving tech savvy contractor market. We raised money from numerous angel investors to solicit a large beta community, created the product and have attracted hundreds of customers. The challenge lies within the investment community who have closed their doors to supporting the entreprenurial spirit of America. We are MyOnlineToolbox are a proven concept that is Made in America For American labor and now just need to find the American financial spirit.
It has been stated that recent bubbles in the economy was growth fueled by consumption with no innovation. The point being that such growth cannot be maintained. This is why we can expect a jobless recovery.
Furthermore, large companies know that they cannot innovate which is why they buy small companies that have innovated. Once bought, innovative skills quickly dissipate.
The bad news is that this corporate behaviour has developed at an increasing pace over the past 30 years. Once upon a time, large companies could be depended upon to innovate and even help small companies along too. Today, innovation has been displaced by the demand for larger profit.
I believe the responsibility for this change rests firmly with the Government – both parties are responsible starting (in my experience) with President Reagan. Real stimulus would involve Government support for R&D. Sadly, those of us still in this business are having to go abroad for such funds.
Perhaps a starting point would be to catch up with China's and India's Space programs. We need to re-inspire the next generation.
The article is a good overview of what's driving the consolidations.
The "Detroit 2.0 analogy" seems a bit over the top, especially for software companies.
Detroit has large capital infrastructure costs. A company making cars would have to spend significant money to convert to manufacturing for trucks, and significantly more for airplane or bridge trusses. In software people drive the manufacturing costs. A team of software engineers can more easily switch from financial services software to travel engines or facial recognition software than a heavy manufacturing plant could retool and restaff for an equivalent change.
Additionally, software companies can and do start out with a handful of people and grow. Automotive companies these days cannot easily start in someone's garage and grow because the capital costs are too high.
These two differences in industry economics allow the software industry to be much more flexible and versatile than Detroit.
Viewed from 30,000 feet, thiss innovation crater goes back to the 80's when many innovations were copied by Asia. The Japanese stealing patents, not allowing the Honeywell's. Perkin Elmers, even Ford, capitilize on their inventions. Do it enough times, those companies run out of R&D funds.
The web is distortion in that it was already 'invented'. the bubble/bust/bubble of pets.com to google hang off a platform that existed.
There has been very little innovation for quite some time. We've been raked clean, yet no other country or region has stepped up to the plate. iphone isn't innovation… it is evolution. As is blu-ray, netbooks, etc.
The first color Laserjet was innovation (1991?), as was Motorolas first 2lb cell phone, and Ford's automatic overdrive transmission (1983, copied by Honda 1985).
Let's have less 'smart water' and more revolutionary ideas.
One of the subtle shifts that has contributed to this trend has been on the customer (purchaser) side of the equation. In the late 90's, CIO's and IT management were provided significant latitude within their discretionary budget to experiment with emerging technologies. This allowed emerging technology companies focused on business applications to find visionary CIOs to bankroll their initial cash flow.
With the tech downturn in 2001/2002, many organizations migrated ultimate decision making for IT budgets out of the CIO office into the CFO or COO office. These organizational units have approached technology investment less as a strategic innovation driver and more as a cost / efficiency level.
Hence, corporate buyers in the market have led the technology industry to the path of product bundling, etc, as described in the article.
Great article! I would like to add that when you have consolidation you also have less people making more money as well as less jobs all together. Seeing as the population is growing and we always have more people that need work, this is not good for the long run. It seems this country is loosing its sense for innovation more and more. Instead it's becoming all about the money, everybody is joining in on the bandwagon trying to get rich because it's just the thing to be because nothing's free.
Great observation. You might want to add the negative effect of employees not wanting to rock the boat (=innovation) in an environment where everybody is afraid of losing their job at one of these IT dinosaurs.
IT's time for the elephants to get back on the dancefloor…
I wonder if you slightly miss the point by not factoring that the "big companies" were small-er companies not all that long ago. They just are the ones that bubbled up to the top. The free market system is pretty good at sorting out companies size's across any particular time period and most of them get big, not through innovation but through consolidation. So my position would be that unless you can change free market capitalism in its very function and eliminate pubic companies altogether there will always be that sorted stack we call the "Fortune" companies. We don't have to like it but that is the way it works.
Hi Jonathan,
Thank you very much for the insight. It is greatly appreciated