How to Spot and Avoid Tech Bubbles
In finance, a bubble is too much money chasing assets, greater asset production, and a herd mentality. In startup business plans, a bubble is too many entrepreneurs and too many investors chasing the latest “next big thing,” like Google, Facebook, or Amazon. In all these cases, a bust is inevitable and everyone loses.
The big question is how to spot these bubbles and jump to a better alternative, rather than get sucked into the vortex. I read a book recently by Vikram Mansharamani, “Boombustology: Spotting Financial Bubbles Before They Burst,” which gives some insight on the financial side, but I believe it can be equally applied to bubbles for startup ideas as follows:
- Avoid the herd mentality. In theory, this is called the “emergence of group order” or swarm mentality, where everyone rushes in without regard to whether there is enough food to go around. For startups, investors usually toss business plans with ten or more real competitors, especially if several have the penetration of a Facebook or Google.
- Overconfidence. In finance, “this time is different” is the beginning of a new bubble. In startups, it is the idea that “this solution is different,” without sufficient analysis of base anchoring features, differentiation features, or no new early adopters. Change is always hard, so people already on Amazon are not easily converted to another e-commerce site.
- Supply and demand ignored. We all believe that supply and demand meet to create stable prices (reflexive). But sometimes higher prices create higher demand, causing a boom. Busts result when lower prices stimulate more supply. In startups, a great success like Google causes busts by stimulating more supply, without regard to demand.
- Cheap money. The Austrian school of economics asserts that “cheap money is the root of all evil” as an explanation for all boom and bust cycles. This also works for startups, where cheap money occurs when too many investors jump on a bandwagon. Experts argue that a higher percentage of startups fail with too much money, rather than too little.
- Policy-driven distortions. Government actions sometimes meddle with normal supply and demand equilibriums, or money allocations. In startups these days, governments are incenting green and alternative energy solutions, to intentionally create a bubble. All too often, that leads to a bust for startups who have not adequately prepared or executed.
- High valuation, low profit. A sure sign of a bubble is when assets are artificially valued high, without a corresponding intrinsic value or cash flow. Social media darling Twitter is the most fragile of these bubbles. In my opinion, now is not the time to bet your startup on a Twitter clone.
Every startup wants to be the one to start the next bubble, but these are impossible to predict. It’s much easier to spot current bubbles and resist the urge to build a “me too” product. The focus should always be on execution, revenue, and profits. Vision, growth over profit, and eyeballs won’t do it this time. Startups that master iteration, momentum, and the ability to pivot will win.
I’m personally looking to Gen-Y as the source of the “next big thing,” that will become the next bubble. To the rest of us, new great things often start out looking like toys, and Gen-Y knows their toys. In addition, they have less baggage, more creativity, and already understand the market segments with the most buying power.
I also believe we are beginning a new wave of startup investing. Angels are becoming more liquid as their stock market and real estate assets recover, and institutions again have earnings to put into venture capital funds. It’s a good time to start some new bubbles and win. Don’t let the fragile old ones burst your bubble as well.