Economic downturns are good for innovators and bad for pretty much everyone else
The best time for new technology trends to take off is during economic downturns.
There has been a lot of talk about the current and coming future economic situation. The housing price collapse, liquidity crisis, inflation woes, and many other factors have led a lot of people much smarter than me to think a recession is coming.
My response: bring it on!
When the economy is booming, little pressure is put on expenses. In good economic times, large organizations often penalized innovators. Instead of looking for radical changes, companies are ok with spending more money on the same software, the same hardware, and the same advertising mix.
But that changes quickly in hard times. Economic downturns force companies to reevaluate how they spend money. Companies need to cut expenditures dramatically yet are expected to have the same level of service as when times were good. This forces firms to look for alternatives to what they are doing.
The last downturn in 2001-2003 was instructive. 2001 was the breakout year for Google. Companies had to look for a more effective way to advertise and they found that buying leads on search engines was measurable, easy, and highly profitable (especially back then when the cost per click was lower).
Linux also took off in 2001. Companies couldn’t afford to buy powerful Sun servers anymore yet they couldn’t afford not to do anything. So companies experimented with Linux on used Intel boxes and found that it performed quite well. And then the unexpected happened … other companies, like IBM, observed this trend and started investing in Linux to promote their own solutions.
MySQL was the same story. The free database solution was more appealing then MS SQL Server for the low-end market and Oracle for the mid-range market.
We’ll see something similar happen in the next downturn … innovations that are having trouble getting wide adoption today will take off.
This is why I’m still bullish on Internet advertising. Over the last few years, while Internet advertising has exploded, it has not even come close with keeping pace with its percentage share of media usage. If dollars were allocated as a percentage of time each form of media takes, web advertising would be much bigger than it is today. In 2006, annual U.S. online ad revenues were about $17 billion (according to IAB) which was compared to about $25 billion for publications (magazines and newspapers) and $91 billion for television. This disparity exists because it is really hard to change inertia. Media buyers like to buy TV (and there are a lot of incentives for them to continue to buy TV). And while Internet ad revenue climbed 25% to $21.1 billion for 2007 (according to IAB), the Internet still represents less than 10% of ad spending yet is far more than 10% market share of our media consumption.
In the event of an economic downturn, there will be a lot of pressure on large companies to find more cost effective (or at least more measurable) ways to advertise. So while overall ad dollars might decrease, we should expect advertising in traditional media (like magazines and TV) to drop much faster than ads in new media – and that new ratio then will become the norm when the economy rebounds.
At Rapleaf, we’re also betting that a downturn will force companies to look to their current customers for new revenue (rather than focusing on building their revenues just by getting new customers). Acquiring new customers is expensive. Get new dollars from existing customers (whether through selling them additional services or just making them happier so they stay customers longer) is much more capital efficient. Companies will switch their expenditure ratio to focus on learning more about their current customers.
Economic downturns help innovators, but they don’t necessarily help “technology” companies. The last downturn negative effected companies like Sun, Microsoft, and Cisco. While these companies do innovate, they benefit much more from the status quo. Essentially, most large “technology” companies benefit when things DON’T change. By contrast, real innovation (either from start-ups or some rare large companies like Apple) benefits from change.