Where startups have a right to innovate
By Francis Ho, Partner
We all know that in fields that rely on scientific innovation such as AI, biotech, and sustainable technologies, startups are one of the main sources of innovation and business transformation.
Of course, in order for a new startup’s business plan to succeed, a large number of factors must align. Many of those factors have to do with how effectively the startup can execute, such as the founding team’s experience and expertise, their ability to raise capital, the size of their target market, etc.
However, from the thousands of startup business plans I’ve seen, I think there is one factor that many startups need to consider more carefully: Why is this an area where a startup has a right to innovate?
Some examples of why a startup may not have that right to innovate:
The industry and pain point addressed are too mature. Although it may be attractive to attack a large existing market with high growth, if the basic economic factors driving the market have been steady for a while, that means the incumbents have been working on the problem for a long time, and also many other startups have already tried to tackle this in the past.
The regulatory hurdles are too high. Regulatory hurdles translate to more time and capital required for new entrants. So a startup’s business plan has a chance to succeed only if the market size and potential returns on investment are large enough to compensate for that.
The customers and/or value chain are too risk averse. This may be due to the regulatory environment, or the large capital expenditures required to undertake a new direction (this can show up both as economic concerns about ROI, and psychological concerns about sunk costs), or the mindset of the incumbents/partners/customers. In all cases, this translates again to more time and capital required for a successful startup.
What are some signals that a market may not present startups with the right to innovate? Here are some (by no means exhaustive) examples:
The incumbent products are in the Nth generation.
As of mid 2023, the iPhone is at iPhone 14; the Dexcom continuous glucose monitor is at G7 (not sure if that’s actually the 7th generation, but for sure there were G4, G5, and G6 CGM products from Dexcom in the past).
The value chain and ecosystem of stakeholders is complex.
The canonical example is the U.S. healthcare industry, where there are many powerful stakeholders (payors, providers, pharma, medical device, …) that need to align for any new innovation to scale. This is an extremely complex equation to solve, which again translates to much more time and capital required for any new entrant to succeed.
The target product for the startup is at the tail end of a long value chain.
For example, electrical receptacles are essential components for any new construction, but they are part of a long tail of supplies, and there is a big chain of businesses that stand between the buyer of the receptacle and the end customer (such as a home buyer). So even if a startup invents an electrical receptacle that costs nothing and saves electricity, it would be difficult to scale such a business from a startup perspective.