Lookout2b_30U30_panoramic_17564Someone asked me this question on Quora recently, asking specifically about how mobile security startup Lookout was able to beat all of the established incumbents in the security space, especially McAfee and Symantec.

It is a very interesting question since it speaks to why startups exist in the first place – after all, if new billion dollar businesses are created every year, why wouldn’t the large companies win those markets vs. losing to startups year after year? They have people, money, expertise, brand, sales channels, loyal customers, and a long list of advantages.

I spent two years as an executive at Symantec after we sold Vontu to them for $350M in 2007. Post-acquisition I worked on many strategy and M&A projects. I also know a lot of the investors, board, and employees of Lookout – many Vontu folks moved on to Lookout, and I’m in touch with them regularly.

Does that mean I am going to give a down and dirty, behind-the-scenes account of how a startup thoroughly spanked a big bad public company? Should you pop up some popcorn and settle in for a good long read?

Nope, put down the butter salt. This is nothing of the sort.

The story is thoroughly unremarkable and requires no proprietary knowledge of the situation. It is a story that plays out time after time. The walloping of a large incumbent by a startup is so unremarkable that it is worthy of a case study when it doesn’t happen. This is, to a large degree, why the startup “industry” exists in the first place.

Let’s break it down. Successful startups like Lookout have these key ingredients:

  • A prodigious concentration of talent
  • With a laser focus on a new opportunity
  • And a high tolerance for risk

I’ll compare Lookout to a hypothetical Some Big Tech company on each of these dimensions. I won’t pick on Symantec or McAfee specifically since the point here is that the problems are structural and not directly tied to specific companies – they are common across most large public companies.

A prodigious concentration of talent

Lookout was founded by John HeringKevin Mahaffey, and James Burgess in 2005. Not only was the team very talented, but they lived and breathed Lookout for years and years, living on ramen, couch-surfing, and working on little else.

Once they gained traction and moved to Silicon Valley, they were able to pull in an incredible assemblage of talent.

  • Joseph Ansanelli as an investor and Chairman of the Board. Formerly Vontu, now a GP at Greylock.
  • Khosla Ventures, Accel, and Index, with new board members Ping Li andMike Volpi.
  • Angels Chris Sacca and Kevin Hartz (also on the board).
  • Strong executives like Chris Jones (VP Product, from Vontu), Julie Herendeen(VP Marketing, from Apple), Margie Mader-Clark (VP HR, from Vontu, formerly Netscape).
  • A very deep bench of marketing, tech, and business development talent.

This is a collection of talent that rivals what any large public company has available, except all laser focused on one new market opportunity instead of scattered across the dozens of legacy businesses that a SomeBigTech company has.

SomeBigTech companies have plenty of talent, but they will almost never be able to concentrate that talent on a new market opportunity:

  • The best talent at SomeBigTech is going to be already committed to the mostprofitable legacy products which have the most political capital and, since they drive the numbers, can take the least risk.
  • Managers at SomeBigTech have no incentive to give up their best people – they are bonused on making revenue targets around existing businesses.
  • There is little career upside to working on new businesses – most of them fail or are cancelled, and often the people put on the projects are layed off. I’ve had to do this myself. The conversation, “thanks for taking a risk for the company, now you’re fired” is not a pleasant one.
  • No financial upside - your startup succeeds and you are a millionaire. A project in a SomeBigTech succeeds? Maybe you’ll get a slightly better bonus, but still probably less than the team working on the billion dollar revenue teams.
  • Organizational - startups have great engineers working alongside great marketers, operations folks, business development teams, etc. Big companies are organized by functional silos – innovation projects often just turn into engineers working in isolation with no interaction with the people who will market and sell their product if it ever went to market.

New businesses can become ghettos inside of these companies – employees who didn’t make it elsewhere, are expendable, or who were naive enough to sign up for this duty. For a company to innovate, it needs to put its best people into these groups, shield them from internal politics, be willing to fail, then reward, not punish, the failures.
With a laser focus on a new opportunity

Lookout - when Lookout started, their market was precisely $0. The team took the risk that smartphone adoption and a concurrent security market would grow to 10′s and then 100′s of millions of dollars and that they would win a large enough share of this market to become a large company.

Even ahead of that market, they had to build a marketing team, an engineering team, a sales and business development team, a PR effort, operations, and raise enough venture capital to go 100 mph against an opportunity where no one knew how large it could ultimately be.

SomeBigTech has little capacity to go after new $0 markets. They hit several barriers:

  • They have quarterly earnings targets that cannot be missed, and often just a few hundred thousand dollars can be the difference between making and missing earnings by a penny – dumping money into projects that aren’t generating revenue rarely lasts long.
  • They don’t have the R&D skillset - for example McAfee and Symantec didn’t have several dozen great mobile engineers to put on this problem, nor can they recruit them when competing against startups like Lookout.
  • They don’t understand the business models - selling consumer antivirus via PC manufacturers or enterprise security products to IT have very little to do with app stores, freemium, and carriers.
  • They don’t have the partners - different market, different partners. Being tight with Dell and HP is little help when the opportunities are with Samsung, HTC, and the carriers.
  • They can’t experiment - a company like Lookout can constantly test different feature sets, landing pages, offers, and pricing schemes and promote the best one. At SomeBigTech it can take months to simply get a page onto the corporate website or get access to some servers. The accounting systems may be decades old and might not even be able to handle freemium and subscription billing, much less testing different offers continually.
  • They don’t have the infrastructure - a startup can spin up a dozen AWS instances at 3am in the morning by pushing a button. At SomeBigTech it can take many months and 10′s of thousands of dollars to get a single server installed by the company you outsourced your IT to. Good people don’t work under those conditions.
  • They will usually lose anyway - even if they could rally the resources, they would struggle to beat companies like Lookout that have all of the advantages discussed here.

And a high tolerance for risk

Lookout - Lookout has a startup culture. They knew the business could fail, pivoted and iterated until they found the right model, doubled down on it, then brought new employees and investors along for the ride, all of whom knew they were signing up for something that could possibly fail.

SomeBigTech - most have very little tolerance for failure. It can ruin careers, damages earnings, hurts the stock price, and perturbs the CFO.

But even if SomeBigTech could absorb the occasional failure, they would need to literally launch dozens of innovation projects in order to yield a single Lookout. Lookout is an outlier – for each Lookout that succeeds several dozen startups you never heard about fail.

Venture Capitalists will put over a hundred million dollars into the sector where Lookout competes – SomeBigTech simply doesn’t have the ability to spend that kind of money on something that may never pan out.

So what is the answer?

There seem to only be a few formulas for successful internal innovation into new markets:

  • Be willing to tell Wall Street to pound sand - Amazon has been especially good at setting investor expectations that it will sacrifice earnings for future growth. However many companies don’t have this luxury. Some (like Dell) go private just to obtain it.
  • Be so wildly profitable that you can invest in lots of projects and cancel the losers - Google has always been good at this, although their biggest winners financially have typically been acquired businesses (Adsense, Adwords, Android) or have been better implementations of existing categories (GMail, Maps).
  • Be Apple – this works well for Apple. But even in their case they are usually innovating in existing markets, not brand new ones (the iPad is, arguably, the main exception).

Most other companies (Cisco, HP, IBM) typically wait until the winners emerge in a market and pay a premium to acquire them. Smart companies put together good M&A teams to identify, acquire, and integrate acquired startups. The acquisitions are often the second-tier competitors in the market given that the leaders are priced at a premium.

But this is very difficult and has risks of its own: Startup Acquisitions: Why do large companies acquire startups and just let them die? Is there value in acquisitions to eliminate competition?