Recessions promote breakthrough innovations

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.

9 thoughts on “Recessions promote breakthrough innovations

  1. David Binetti

    True — and some other benefits to consider:
    1) Increased availability of talent and better rates.
    In the first bubble, I remember paying more than 60K to a *high-school student* to take care of our IT because talent was so difficult to recruit. This also is true for office space, infrastructure, etc. The general availability of resources increases in downturns.
    2) Increased access to (early-stage) capital.
    In downturns, returns on investments shrink, and investors seek higher returns through risker investments. This capital can be expensive, but there is actually more of it available for early-stage investments.

  2. Philip Kaplan

    Great post. And don’t forget that Jonathan Abrams pretty much invented modern social networking when he launched Friendster during the low tide of 2002.

  3. Gadi BenMark

    True. One distinction to keep in mind:
    * Innovations that cut cost (such as the examples given, MySQL, and Linux) can do well during a downturn
    * Innovations that increase revenue for large companies can find it real hard when there is overall belt tightening going on, for a number of reasons:
    1. Many top line growth related innovations require some investment, and this investment is hard to come by
    2. In many companies people and units that focus on growth (such as business development or corporate development) are among the first to get downsized
    3. Corporate culture overall becomes more risk averse and less willing to experiment, even when technologies are offered free of charge during an introductory period

  4. christian

    hey Auren, I have to disagree with part of your big company comment: yes, there can be general complacency in big companies while times are good, and impact to cash cows when the markets turn south, but even companies such as Microsoft and IBM experience tremendous innovation during these downtimes. When cuts are being made, many groups scramble to prove relevance, fighting to keep their jobs/orgs alive, and their own careers moving forward. There is often a constant parade of efficiency and cost-cutting efforts, and bootstrapping teams get creative — the same as their startup counterparts.
    I’ve seen the dark side of the complacent startup — well-financed companies blowing wads of cash on nice digs overlooking the bay and $1500 swivel chairs (I had both at a previous startup). Innovation struggled because people became lazy, too reliant on deep VC pockets. A strong argument can be made for having a (somewhat) penny-pinching and “hungry” attitude through up and down market trends. The trick for big companies is to apply this wisdom consistently across the org, replacing complacent indulgence with innovative hunger.

  5. hunter walk

    downturns are great times to start projects with longer timeframes too because they can hit their stride when the next cycle picks up. This assumes you plan for a long build and have money to support a small team for several years. Second Life started late 2000 in the nuclear winter of consumer internet.

  6. James Ransdall

    With tough times looming, smart companies, ones that have successfully been innovating, resist the resort to “turtledom” and instead move into “yellow light” mode. That is, they don’t stop funding innovation, rather they focus on tightening up the process: portfolio and gate reviews get a little tougher, defensive innovations get more consideration, as might those focused on customer retention. At a higher level, breakthrough ideas often find a more open market in tough times, with less competitive clutter, as the turtles retreat.

  7. tris metcalfe

    We would like to believe this down turn could inspire backing for a breakthrough project but,,, we have found that what we have may suffer from being too far beyond normal imagination and intuition to attract enough support even in a down turn.
    It was moving along very well until funds began to run low as we wasted time seeking private support that ultimately has been less than sufficient while the up was turning down.
    In hindsight we foolishly sidestepped a NASA grant that was advised to us by the chief of their department closest to our new field of research. He and his technologist gave it a positive review but we assumed private funding would be better, ha;-(.
    So the question is whether private funding always will suffer from ignorant reactions when it appears too good to be true. Research grants do look beyond ignorance of solid proof, but in our case we will loose well over a year before NASA backing will be available to get us going again. This down turn will just make it all the harder to maintain our progress being self funded by a professional practice as we wait for the real support that actually seeks out breakthroughs.
    I accept the thesis of this article, but it applies to the more proven technologies which only have an unsure market. We have the opposite situation: a solidly proven world wide market demand but an as yet unproven technology.


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