The tales of Kodak versus the iPhone, Amazon versus mainstreet retail, and Uber versus the taxi industry have captivated business leaders, boardrooms, and strategy consultants alike for years. What good old times… And while AI has become another hot buzzword for many to talk about (and yes, we will too), we decided to clear up the exciting misconceptions and how to think about more foundational concepts, before tackling the more specific ones.
The ZIRP (Zero Interest Rate Policy) years led to the high-noon of venture investing, a great engine of economic activity. And while Venturing and Venture Capital (VC) was initially linked to the disrupting force of the “traitorous eight”, kicking of the silicon and microchip gold rush, the last decade was predominantly driven by the “software-eats-the-world” plays like Cloud, Mobile and SaaS (Software-as-a-Service). Until 2022, the wave was driving aspirations to become a (lucky) investor in one of the next-generation, industry-defining startups, which were hopefully growing (quickly) into high-margin businesses and becoming long term, sector dominating platforms.
While many business and technology enthusiasts have been following the hype (don't get us wrong, there was and still is a lot of substance and real opportunity out there), often the narratives of innovation, disruption and entrepreneurship have also made it into major buzzwords and lofty hopes in corporate meetings, strategy workshops and narratives in Linkedin influencer promotions. It got much harder to separate signals from noise.
And little surprising, where the “Spice” flows, economic attention goes. While VC was a very niche industry with just a handful of Venture Capitalists or wealthy individuals funds to new business endeavors in the initial phase of the technology innovation cycle, today more than 2000 funds are competing for the (few) real entrepreneurial outlier opportunities. It got crowded in the sector of deploying capital to enable (and also participate) in technological value-creation and altering the rules of engagement and “strategies to play and win” for many. The power law is real.
Given our long experience in the realms in “the business of risk”, technology, and disruption, we decided it would be worthy to launch our series of blog articles with an initial clarification of the foundational concepts, before diving deeper in the individual topics and daily insights. Thus, we will now delve into core concepts of what innovation, entrepreneurship, and related terms truly mean from an economic and business (strategy) perspective.
On the one hand, this allows us to set the record straight and defend the outstanding intellectual honesty of the intellectual thinkers and doers of the past, while on the other hand assure that our future conversations about technology, venture funding and business-building are based on a rigid foundation and mutual understanding. Therefore, let's jump into a first, brief rehearsal of entrepreneurship, innovation and startup thinking to set the stage for the exciting journey ahead.
Entrepreneurship: Arbitrage vs. Creative Disruption
When going back to the economic foundation of innovation and entrepreneurship, the Austrian School of Economic thought, namely Joseph Schumpeter, set the stage. The Schumpeterian Theory of Entrepreneurship distinguishes between two primary types: Arbitrage and Creative Disruption.
Arbitrage in entrepreneurship involves identifying and exploiting price differentials in different markets. Entrepreneurs act as intermediaries, buying goods or services in one market at a lower price and selling them in another market at a higher price. This type of entrepreneurship doesn't fundamentally change the market or the products themselves. It relies on existing market inefficiencies and aims to capitalize on insights without real product or service innovation.
Creative Disruption, also known as "Creative Destruction" is the process through which entrepreneurs introduce innovative products, services, or processes that significantly alter or replace existing ones. This leads to substantial changes in the market structure. This type of entrepreneurship involves high levels of innovation and technological risk. It creates new industries and can render existing technologies or products obsolete, leading to economic progress and development, but also to the displacement of older industries and jobs.
Joseph Schumpeter, the economist behind these concepts, emphasized the pivotal role of entrepreneurs in economic development. He argued that creative disruption is the primary engine of economic growth, as it leads to technological advancement and productivity improvements, whereas arbitrage plays a less transformative, but still important role in the economy, as it allows for more efficient market dynamics and better distribution.
Whether we are considering the concept of Arbitrage or Creative Disruption, technology and knowledge are key resources to spot and exploit entrepreneurial opportunities. In this context often terms like “innovation” or “being innovate” have been thrown around. While “invention” and “innovation” are often unfortunately used interchangeably, they describe two very different, while important activities in the entrepreneurial process. “Invention” describes the eureka! moment that accompanies the discovery of a new technology or other outcome of research and development (R&D), resulting in specific insight or knowledge. “Innovation” on the other hand describes the process of commercializing the invention or insight by building a differentiated and sustainable business on it. The type of invention and the approach of innovation often define the impact on the market and thus the economic results and entrepreneurial outcome. Incremental innovations often allow to improve a current market offering in existing markets environments, or the way how the value is generated (supply side). Therefore it might have a completely different outcome than radical innovation, which is completely reshuffling the market forces and taking significant societal wallet share, while rendering other neighboring industries irrelevant. But as we know from financial theory, those outside opportunities of returns are always attached with the accompanying risk of failure and loss of investments.
When looking at the entrepreneurial activities of many startups, as well as corporations, we see that the underlying concepts, resource availability and risk-taking often do not align with their operational activities, time horizons and risk-profiles. Thus condemning the undertakings to fail before reaching critical traction or represent insufficient risk-return profiles to justify the risk-taking to run the experiments (by the team and/or investors) or justify the organizational distraction.
It happens quite often that the analysis of an entrepreneurial potential to drive required outsized returns are not properly assessed, or that components of the undertaking are set up and configured wrongly. Often for example a mindset of radical innovation is paired with operations that point more towards arbitrage. We also often see short-term funding plans collide with long term R&D-driven venture approaches or a mismatch of leadership aspirations (with regards to disruptive innovation) with the capabilities of the team. And this is just to name a few.
Especially in times of uncertainty and lack of visibility due to economic shakeup, the structural setup of the foundational frameworks, goals and alignment of risk-profile are paramount. While, R&D needs and early stage startup activities (read: experiments and quantified risk-taking) bring even more success-defining variables to the table. Founders and management should be very clear on their “why”to innovate and “how” to go-to-market, before allocating time and resources to the individual endeavors. And while this all can sound very technical for aspiring founders, investing their lifetime into an idea that from a probabilistic perspective will most likely fail (about 90% of all attempts fail), it is paramount to have a structural understanding why in case of a success, the venture will lead to a 10x better economic outcome for market participants.
Therefore, understanding the type of entrepreneurial undertaking and type of innovation in a specific (hopefully large) market is a good starting point to venture into the unknown and participate in the business of risk.
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