An Alternative Theory of Startups

Over the past six months or so, I have developed an alternative theory of startups, in contrast to the Paul Graham/Y Combinator theory. Please feel free to critique (so long as you have evidence). Important points: - The idea that people in small and mobile organizations, who get paid directly for their performance, can be far more productive than people in huge, bureaucratic organizations is not new; it is called "capitalism". Many people get confused on this point, because of all the politics surrounding the word, but the essence of Adam Smithian capitalism is not a few big companies with an oligopoly. It's small, individual businessmen and entrepreneurs competing amongst themselves, in an open and dynamic market where the best minds win. Capitalism allows people, through ownership of businesses that they found, to benefit when they make better and cheaper products, and that's why it's been so successful. - Capitalism came into existence (roughly) during the seventeenth century in Britain, and later on in America and Western Europe. However, in the panic after the Depression, national governments began to seize unprecedented amounts of power, and pass tax laws that favored existing large companies over new entrepreneurs. Hence, we started to see large chain stores, restaurants, etc. replacing individual and family-owned shops. In 1900, it was extremely common for people to own their own businesses; I don't have hard numbers, but I would guess that maybe 10-20% of the population did. By 1960, it was more like 2-3%. - During the 70s and 80s, the government passed numerous laws which started to favor individual entrepreneurs over large businesses again; eg., the lower capital gains tax, the breakup of state-owned monopolies like Ma Bell, deregulation, etc. Hence, we started to see a revival in capitalism, especially in the technology sector. The computer boom had already begun by that time, but what changed is that it was dominated by small companies like Apple and Microsoft, instead of large companies like IBM and Xerox, which in many cases actually did a lot of the technology development work but didn't follow up. - What made the technology boom different from, say, the textiles boom or the automobile boom, was the extremely low capital cost required to enter the market. If you want to build a factory and sell cars, or textiles, or alarm clocks, you need millions of dollars in capital. However, many startups (Apple, Microsoft, Google, Dell) were started with very little in the way of money. This allowed for extremely rapid progress in the technology sector, as competence in business became a more important factor, relative to doing good deals with investors. - In the post-Bubble era, computer technology has largely become a mature market. In any industry, shortly after the industry begins, there is a feverish wave of entrepreneurship and innovation. Shortly afterwards, the number of competing companies gets smaller and smaller through buyouts, mergers and failures, and eventually, after many decades, you have an effective oligopoly. For instance, shortly after the automobile was developed, there were a huge number of American car manufacturers, while by 1980 there were only three left. My guess is that the computer technology industry has now reached the stage where we'll see very few new big companies (Apples, Googles, Microsofts), and most startups will be smaller and will cash out by getting bought, instead of going public. There were at least a dozen billionaires created by technology companies founded from 1975-1985, and another dozen created by companies founded from 1995-2000, but only one that I know of after 2000 (Mark Zuckerberg). Most of "Web 2.0" has been absorbed into larger conglomerates, especially Google, rather than forming new conglomerates. - Computer technology, because it is such an efficient and well-run industry, will always remain a relatively small percentage of the economy. This may sound counterintuitive, but the reasoning behind it is pretty simple. The average consumer wants some basket of goods, [A, B, C, D, ... ]. As he gets more and more of A for a cheaper and cheaper price, his desire for A starts to be satisfied, and he'll respond by spending less money on A and more on B. For instance, most of us nowadays spend very little money on spices, even though in 1500 spices were an extremely prized commodity, because our desire for tasty, spicy food has effectively been satiated and we see little need to buy more. We have seen this pattern many times before. For instance, over the past two centuries, agriculture became extremely efficient, with the result that it is now a tiny percentage of the economy (2-3%), because our desire for food has been satisfied. The clothing industry also became extremely efficient, with the result that it's now a small (< 5%) percentage of the economy, because our desires have mostly been satisfied. On the other hand, health care and education, which are renowned for their inefficiency due to bloated government bureaucracies and politicization, have grown very rapidly as a percentage of the economy.