Innovative products and people who build them make my work in venture capital enjoyable . In my mind, VC investing means feeling innovation’s pulse. Over the years, I have started to classify creative ideas into two broad categories: : process innovations and product innovations. You need some combination of the two or no deal. Here’s how I classify innovation.
If you came up with a novel way to do something unchanged for years, but have not created a new technology enabling that improvement, you are a process innovator. Process innovators focus on changing how something is done, and not on what is done. There is absolutely nothing wrong with that. Some examples of fantastic companies that changed existing processes:
- Groupon has taken two simple desires: the consumer’s want of a good deal and the vendor’s need to get new customers, joined them in a clever way, and became a big business commanding a huge valuation. Most people look for bargains and Groupon’s value proposition makes sense. There are arguments on whether Groupon’s innovation will turn out to be sustainable, but one can not argue that Groupon has pioneered and scaled the “offer space” like few others. Because of Groupon, how merchants attract business and how people buy has changed.
- Redfin changed the way people buy and sell houses by mixing internet technologies with a novel way of running a real estate agency. Redfin’s CEO happens is one of my best friends (and former co-founder) Glenn Kelman. When Glenn originally described the company he was joining, I remember shaking my head and asking “so, what’s new about that?” I was thinking as a software engineer. But, as I saw and read more about Redfin, I understood that the company is not about creating new software but rather about creating new approach to an old marketplace, about changing how real estate is sold. The technology enables the new process. Redfin is a process innovator in my book.
- FreshDirect simplified the way I shop for groceries in Manhattan. Since FreshDirect first appeared on my radar in 2003, I have shopped at traditional Manhattan supermarkets only about a dozen times. I can not imagine my life without this service. Shopping for food is not a new idea, nor is delivery. But FreshDirect, combining technology, supply chain management, and service has changed how I stock my refrigerator.
Note the similarities: take a process that could use improvement (clearing out old inventory, dealing with obscure real estate listing services and questionably motivated realtors, or hauling grocery bags), use technology, change the routine, and you have a new company. All companies I mentioned are useful, profitable, and growing. Competitive barriers these companies create appear due to the size to which their operations have grown. Sure, I can start a company that lets you order groceries on-line (as others have tried), but, to match FreshDirect, I will have to build a warehouse, stock it with perishable food, buy a fleet of trucks, and hire an army of delivery people… hard to do, expensive, and time-consuming. Groupon clones are the rage these days, but, what most don’t understand, is that to compete with Groupon they will need a sales staff to match (4,000 of Groupon’s 8,000 employees work in sales).
Indicators of process innovators’ potential: traction. That’s about it. The market should be big, obvious, and already exist (bricks and mortar retailers, real-estate agencies, grocery stores) and waiting for disruption. Companies needs to have some semblance of a product built, the product should be in the public’s hands, and the adoption curve should start showing exponential growth. Their products’ adoption often is “viral.” I don’t think it makes sense to place a bet on a process innovation without real evidence of this exponential adoption. Investments in process innovators are expensive because the goal is to grow the customer base faster than the competition — to outgrow them, usually by outspending them.
My technologist’s heart tends to favor this group. Product innovators make you exclaim “wow, that’s really a clever idea!” The company still needs the right market and a great team (see earlier post), but I tend to want to invest more time in these companies and, instinctively, like to invest in them. Real product innovations are few. Real product innovators in a market that’s right are even more rare.
Some examples of product innovations:
- Nintendo Wii has integrated an innovative controller technology into a prevalent gaming platform and changed the way we enjoy console games at home. There have been hardware extensions to video games (GuitarHero guitars, racing wheels, and Twister boards), but the idea that we will make a hand-held device that translates kinetics into visual screen feedback, and its simple implementation are new. The original “Pong” was a tennis match. Tennis on the Wii is radically different from any video game I have ever played. The Wii had changed what we mean by playing a video game.
- Square. I stood in a taxi line at JFK sometime in 2009 next to a young man also waiting for a cab. He asked me what I did. I told him I was a software entrepreneur. “Me too,” the young man said and pulled from his pocket a little white square that he plugged into his iPhone. That young man turned out to be Jack Dorsey. He showed me what the product did in about 2 minutes. “Whoa,” I said, “this is really cool.” I thought using the audio port was clever, that the form factor of the little square was great, and that capturing my signature on-screen was nifty. I thought this product will go far. It did, and I couldn’t be happier for Square and its founder. Mobility + simplicity + plastic economy = a product innovation that will keep on growing. I am sure that Jack has something figured out for the NFC wave coming next. Square changes what accepting credit card payments means.
Indicators or product innovator’s potential: the idea. Here, “why didn’t I think of that?” is the reaction you should expect. From an investment point of view, the goal is to make sure the market for the idea is correct, make sure the company has a roadmap for what to do when the idea is no longer new, and that it gets enough money to move quickly and confirm the invention’s market applicability. Money is important because talent acquisition is paramount. But these usually don’t take as much cash as process companies.
This is how I look at innovation. And I feel that there are great opportunities to invest in both types of innovators: process and product. However, personally, I am much more of a “product guy” than a “process guy.” Venture capital firms, or partners in each firm have preferences and comfort zones with one type of innovation or the other. When considering whom to approach with your idea, also consider the personal preferences of the individual listening to the presentation. Will it be building a better mousetrap or figuring out a way to get more mice to run into existing ones? I welcome the new mousetraps.