Making Money During Disruption

While failure for the high-tech entrepreneur is less likely to result in death, the parallels between the Gold Rush and the current Web-based economy are many. In both cases, participants must to adapt to a new way of life, with new rules. Or rather, no pre-existing, fixed rules.

Silicon Valley’s famous tolerance of entrepreneurial failure has its roots more than 150 years ago in the Gold Rush when more than 90,000 people made their way to California in the two years following John Marshall’s discovery of gold near Sacramento in January, 1848. By 1854, more than 300,000–representing more than one percent of the total population of the United States at the time–had come west in search of fortune.

Ironically, the grueling trip west was often the best part of a 49er’s experience. The life of a 49’er was a very hard one, and mining was back-breaking work. Accidents, disease, malnutrition and mining camp violence led to a shockingly high mortality rate that within six months claimed the lives of 20 percent of the miners who came to California in 1849.

Earnings–for many–were higher in California, but the prices of staples were astronomical: a loaf of bread that cost 4 cents in New York cost 75 cents; eggs were $1 to $3 apiece; apples $1 to $5; coffee $5 a pound; a butcher knife $30, and boots $100 a pair.

“As nowhere else,” said historian J.S. Holliday, “you can fail in California. And I think the California Gold Rush taught people that failure was OK… and the result is that people accepted failure, which is the equivalent of saying they are willing to take risks. And California has been the most risk-taking society in the nation, maybe in the world.”

While mining was a rough and mostly dead-end path to riches, the Gold Rush did create a number of fortunes. Some became famous, like the New York butcher who walked to California, opened a meat shop in Placerville and made enough money to start a meat-packing plant in Milwaukee. His name was Phillip Armour.

A whole service economy sprang up to feed, clothe and entertain the miners. Levi Strauss sold blue jeans, grocers sold $5 apples, and saloon owners and prostitutes could earn a nice living, provided they didn’t extend too much credit.

Not so long ago, a canonical “dot-com” company’s business model relied on harnessing network effects by operating at a sustained net loss to build market share (or mind share). These companies expected that they could build enough brand awareness to charge profitable rates for their services later. The motto “get big fast” reflected this strategy. We heard a lot about the “first mover advantage,” the modern equivalent of mortgaging everything you have and moving to California in search of gold.

If you need help remembering the dot com bust, this classic E-Trade commercial is a good refresher. Unlike the allegorical, there were a lot of Web businesses that got a lot of people very excited about changing the world. Like the Gold Rush nearly 160 years ago, some people got rich while many more suffered huge losses. What made the difference? Seven years on from the dot-com crash, it is worth taking a look at who ended up making money from the web, and why? But first, a quick review of some of the great ideas that didn’t work out.

The Failures
Out of the dozens and dozens of well-known failures, here are a few representatives of those halcyon days.

  • Webvan. If we build it, they will come, only they didn’t. It didn’t work because, despite billions invested in automated warehouses and fleets of delivery vans, they didn’t understand how people buy groceries.
  • Business-to-Business Exchanges. The 1520 exchanges in 2001 were winnowed 90% by 2003. Just because a miner struck gold in one hill does not mean that the mere act of digging in other hills will produce returns. Electronic interchange of business information is booming, but exchanges only work when there are a critical mass of people you want to exchange data with on a single exchange. More exchanges are not necessarily better.
  • Free internet and PCs. At the peak, a couple of dozen ISPs offered free connections and FreePC was one of multiple attempts to get consumers to watch ads in return for hardware. As it turns out, free is not always better, especially when you attach lots of strings.
  • AltaVista was the best, fastest search out there. The problem is they stopped focusing on search. Their index wasn’t updated frequently. Their search slowed down. Quality dropped. They created an opportunity for someone who would focus on search (see successes list below).

The Successes
Focusing on the failures of the Internet Bubble can obscure the many valuable lessons learned from the many successful survivors who really did go on to change the world.

  • Google did not invent paid search (see, but Sergey, Larry and their gang of PhDs perfected the model and made themselves billionaires with their own 767 party jet.
  • Yahoo! figured out how to build a great Web portal by tapping into a variety of content. Unlike AOL, you could leave anytime you wanted, and most of the services were free. Where Google is fundamentally an advertising platform, Yahoo! is a media company.
  • eBay. Unlike Louis Borders and the Webvan gang, Pierre Omidyar understood how people buy and sell “stuff” and extended the fleamarket / classified model in both scale and scope.
  • Akamai took off when some big name clients decided to give the company a trial run. Paramount, ESPN, Apple, and Microsoft recognized the importance of Akamai’s Internet optimization strategy: distributing servers and routing software to the “edge” or end users, rather than centralizing services.
  • We think about as a bookseller, but in reality Amazon is a sales platform. Amazon keeps track of what you buy and look at, offers reviews from ordinary people, and even seamlessly connects with hundreds of third-party merchants.
  • Amazon Web Services. Born well after The Bust, AWS is a huge development of lasting importance. AWS commoditizes Web services like transactions, storage, etc. so that developers can buy only the services and at volumes they actually use. What Google has done for advertising–namely make it more flexible, responsive and cost effective–AWS hopes to do for Web services.

Lessons Learned
What do the survivors have in common? Like the merchants of the Gold Rush, these companies all focus on providing services to others rather than directly profiting from end users. Levi Strauss didn’t care in which hill or stream gold was found or who found it because everyone–successful miner or wannabe–needed his rugged blue jeans. Likewise, Google doesn’t care what The Next Big Thing is because whatever it is, people will come to Google to search for it.

There will always be a great business to be had in selling lottery tickets–not buying them. Building infrastructure is not as glamorous as selling the latest fad or walking into the saloon with a big, fresh gold nugget–although having your own 767 is pretty cool–but history shows infrastructure to be a resilient business model with better odds for creating lasting fortunes than the needle-in-the-haystack approach to striking it rich.

Leave a reply

Leave a Reply