"Whenever I go into a restaurant, I order both a chicken and an egg to see which comes first"

Monday, April 16, 2012

Innovation–Why Facebook Had to Pay $1b for Instagram

Most of us were amazed that Instagram, a small start-up IT company in San Francisco with 13 employees was sold to Facebook for $1b.  The one billion was pure profit, for the only capital the company had was a few computers and very little debt.  After the surprise and admiration for the 28-year old owner had worn off, I began to wonder why would Facebook have to buy this company; or why hadn’t very tech-savvy companies like Apple or Google developed this software first?  Or more appropriately, why hadn’t  Eastman Kodak develop it and staved off disaster or Nikon, Sony, or other companies in the image business?  After all Eastman was a photography company.  The answer, says the author of a fascinating article in the New York Times was corporate habit.  http://bits.blogs.nytimes.com/2012/04/15/disruptions-innovation-isnt-easy-especially-midstream/?ref=business  Once a company becomes successful, known and trusted by its clients, there is little incentive to move off that mark:

Michael Hawley, who is on Kodak’s board, said the answer could be summed up in one word: culture.

“It’s a little like asking why Hasbro didn’t do Farmville, or why McDonald’s didn’t start Whole Foods,” said Mr. Hawley, formerly of the Media Lab at the Massachusetts Institute of Technology. “Cultural patterns are pretty hard to escape once you get sucked into them. For instance, Apple and Google are diametrical opposites in so many ways, have all the skills, but neither of them did Instagram, either.”

Neither could Facebook. If it could, it wouldn’t have paid $1 billion to acquire the small team of engineers and access to the program’s 30 million users.

The articles goes on to explain ‘culture’ based on interviews at Yale and Harvard business schools: 

Clayton M. Christensen, a Harvard Business School professor, explored this problem in his 1997 book, “The Innovator’s Dilemma,” and found that “it was as if the leading firms were held captive by their customers, enabling attacking entrant firms to topple the incumbent industry leaders each time a disruptive technology emerged.”

In a 2008 talk at the Yale School of Management, Gary T. DiCamillo, a former chief executive at Polaroid said one reason that the company went out of business was that the revenue it was reaping from film sales acted like a blockade to any experimentation with new business models.

“We knew we needed to change the fan belt, but we couldn’t stop the engine,” he said. “And the reason we couldn’t stop the engine was that instant film was the core of the financial model of this company. It drove all the economics.” The same was true of Kodak and its reliance on its own cash cow: silver halide film.

It is a cyclical problem all successful companies eventually face as the technology around them changes, but  they cannot change.

What the author refers to but does not explore is the tendency in American business to focus on short-term profits.  General Motors for years ignored the Japanese small car threat because it was making huge profits on every Cadillac and Buick Roadmaster it sold.  It only changed when its market share began to fall progressively and then precipitously as Honda Civics and Toyota Corollas showed up on American docks to meet the growing consumer demand for small, energy-efficient, reliable cars.

Reliability was another innovation of the Japanese, although my former neighbor, Edward Deming, deserves much of the credit for introducing quality control to an emerging Japan.  At a time when General Motors, Ford, and Chryslers were still operating on a two-year buyer cycle, where the unreliability of everything from motors to clocks would only kick in at about the time customers were trading in their cars, Mr. Deming was helping the Japanese to build cars that would perform and last.

Why change to smaller, more efficient, and more reliable cars when gas guzzlers returned a sweet profit, retooling and reconfiguring plants required significant capital, and market share, although declining, was still high?

In more recent years this model was strengthened by high executive salaries and the bidding wars for top managers.  A Senior VP of General Motors has little to gain from a long-term investment in small, efficient cars, when his income and benefits are dependent on current sales and profits and responsibility to shareholders; and when he will soon be gone from the company.

This should be less true today, since in the software business there are not a lot of assembly lines to reconfigure, new parts to purchase, etc.  Moreover, Google and Apple are very much forward-thinking.  Microsoft recently produced its vision of the future – one where touch-mode interactivity is the norm.  http://www.pcworld.com/article/242827/microsoft_video_predicts_dazzling_technology_future.html and the company has certainly been working to realize this vision.  Google is renowned worldwide for its research labs, some highly secret, and with the vast resources the company has available, there is certainly room for short- and long-term product research.

Yet these companies did not develop the photograph-sharing software that Instagram did. One assumption (these research labs are very secret) is that they are still focused on small, incremental changes in existing products.  These changes will consolidate their customer base without causing the ‘internal disruption’ suggested in the article.  The issuance of the latest version of the I-Phone is a good example.  It was not the completely redesigned product that many had expected from such an innovative company, but an improvement – the embedding of Siri technology, extremely high-resolution graphics, etc.

Another explanation is very simple – ‘You can’t think of everything’.  Why should Apple’s engineers have come up with the Instagram model when they were focusing on something equally important for the consumer and an even greater wave of the future than picture sharing – voice recognition?  Every time Google upgrades its search engine and the software program anticipates our request almost before we type in the words, we are amazed, impressed, and thankful.  The Google options expand monthly.  They are in the information-acquisition and –sharing business, and most of their engineers, one assumes, are working on this.  Again, this is more the wave of the future than picture sharing.

A third explanation is that small, private entrepreneurs are simply more creative because the above-mentioned corporate constraints do not exist for them; and because their creativity has not yet been coopted, influenced, or corrupted by a corporate culture.  Many of these start-up geniuses have come right out of college or graduate school which is where, in the heady company of equally creative minds, their unique idea came to them and matured.

Lastly, these large companies are so wealthy that they know they can snap up any smaller company, as Apple did with Siri.  Apple is so flush with funds, that it no longer knows where to invest so it has started paying dividends!  Why disrupt a profitable enterprise when you can buy innovations?

The most perplexing part of Polaroid’s fall and Instagram’s rise can be seen with  the founding thesis of both companies. In the early days of Polaroid, Mr. Land said photography should “go beyond amusement and record-making to become a continuous partner of most human beings.” His goal was to build a business that would allow anyone to feel an emotional connection to photography. This was exactly what Instagram figured out, too. And it’s what Facebook was unable to solve on its own.

This should not be taken as a criticism of Facebook but a tribute to the small business, young entrepreneur.  This vision of an ‘emotional connection to photography’ is the same vision that Bill Gates had about the personal computer or that Steve Jobs had to the I-phone.  They both understood American culture as well as the individual consumer.  They had vision; and both were technically competent and brilliant businessmen to realize it.  In this day of apps, there was no reason for Instagram to develop its product, when Facebook appeared at their door with a $1b check.

1 comment:

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