Why incumbents struggle and lose against startups?

Albert Malagarriga
6 min readAug 10, 2020
The slingshot used by David to strike Goliath in his head before he cut his head and displayed it publicly. David was the underdog no one expected. The youngest of seven brothers, he had a lot to live up to. From having the faith to take on Goliath to trusting God throughout a tumultuous life, he exemplified faith and perseverance.

While fundraising, we get a question every once in a while which we always think has an obvious answer. Yet, even after plenty of examples of tech startups beating their incumbent counterparts at the digitalisation game, the same question keeps coming up.

What stops an incumbent (or a player in a peripheral industry) from investing €10M, cloning your technology or model and implementing it in their network of customers and erasing you out of the market? In other words, what’s the incumbent risk for your business model?

I’m sure lots, if not absolutely all startups can be challenges with this question. Not only at an early stage, but also at later stages of funding.

What stoped Wallmart from challenging Amazon in 1997? They did, eventually.

What stopped IBM from challenging Apple?

What stops some incumbent banks from challenging the N26, Monzo and Revolut of the world? Many have.

What stopped PayPal from challenging Stripe?

Well, nothing really, other than their own constraints.

Most top VC don’t ask this question. They even regard it as an amateurish investor question. It’s a completely legitimate one, and for sure the risks are different depending on the model and market.

Incumbents and waves of innovation

In 2014 I had the privilege to listen to Hermann Hauser’s speech: 6 waves of computing. I was privileged to watch it live with a small group of 100 people at Cambridge University during the Ignite program I participated in. He had a clear message which can be regarded as common business sense today: not a single time in the history of computing has the winner of the previous wave of innovation lead the following wave of innovation. He left us with an open question: will Google, Apple, Amazon, Facebook lead the next wave of computing? Has anything changed in this wave that might change his theory? I asked another question: can this model be extrapolated outside of the computing industry?

In his recent book, Loonshots, Safi Behcall provides a model to think of this question differently. In this post I shared the main points in Safi Behcall’s model. His ideas help explain if an organisation is likely to nurture innovation, which is essentially what entrepreneurs should watch out for when challenging incumbents. A definition of loonshot is probably helpful here: A loonshot refers to an idea or project that most scientific or business leaders think won’t work, or if it does, it won’t matter (it won’t make money). Loonshots challenge conventional wisdom. Moonshots are the destination or goal, loonshots are how we get there.

Are incumbents organisations well known and structured to nurture loonshots? Or can they innovate at all?

That’s of course a hard question to answer every time. The best investors can answer it. Thats one of the things that makes them the best investors.

According to Safi Behcall’s model for nurturing loonshots, organisations must enjoy phase separation and dynamic equilibrium. Artists and soldiers must be separate and must be autonomous, and information and relationships among the groups must be healthy.

Today’s tech startup investment ecosystem is ideal for nurturing innovation. Startups are the artists and VC funds are the soldiers. Startups are the makers, VC funds fund and make the most out of each iteration of innovation to take ventures to the next stage.

An innovation undergoes plenty of false failures — situations where innovation seem to have gone the wrong path, but simply needed a twitch, change or fix — . In startups, pivots are these failures in experimentation which don’t invalidate hypothesis. A promising company or innovation must pivot two or three times. Don’t trust a startup story without pivots.

Incumbent companies without a structure setup to drive loonshots won’t tolerate 3 failures in a same project. Incumbents will let the project die. The leaders of the project will be regarded as failures, and they will get patted on the back with frases like: ‘Hey, you learned a lot! Thats for you to keep.’ And in the mean time, their political rivals will have advanced in their careers and the project heroes will fall behind.

As Behcall writes:

When a script is killed at Paramount or Universal or any studio, it stays dead. When an early-stage drug project is killed inside a major global pharmaceutical company, it stays dead. In China — or in the various outposts of the Islamic empire — when supreme ruler quashed promising new ideas about astronomy, as the Chinese empire quashed Shen Kuo’s ideas, they stayed dead.

If a startup project does not deliver the expected results, they’re may be investors who take a step back and look at it with perspective, identify a false failure and continue to invest in it (it doesn’t necessarily have to be the same company, it may be another one building on the left over of the previous).

As entrepreneurs and investors our favourite preys are old fashioned incumbents.

When an incumbent is walking into unexplored territory and artists are not represented at the highest levels of decision making — soldiers must be there as well, but they usually are already -, they are less of a threat. If providers of innovation are externalised in contractors and freelancers, they are less of a threat. If builders are not incentivised — literally make them millionaires if the project works -, they are less of a threat. If leaders have incentives to invest in internal politics to climb the corporate ladder, they are less of a threat. If you find all of the above, then, my dear reader, you are in front of a great opportunity to take a piece of the pie.

The problem is not that they cannot launch innovative solutions. The issue is they aren’t ready to do so. The devotion to exploiting their current franchise businesses gives them a dis-incentive to not innovate. Extracting value from their current model stops them from attempting to change it.

Even if incumbents are ready and are well known for nurturing moonshots, recent history has plenty of examples where they still failed against new entrants:

Google beat Apple at maps.

Facebook beat Google at G+.

Amazon beat Apple with Kindle.

Apple beat Sony at digitalising the music industry.

On the other hand, if the incumbent has a tradition of innovating and releasing loonshots, a tradition of acquiring young promising startups, integrating them in their teams and keeping them focused on their project; if they treat innovation with similar incentives to an aggressive and open market such as the early stage tech industry, then beware.

Bell Labs launched the transistor while being the leader of an industry and enjoying massive network effects. Many say they kicked off the computing industry, when they originally had invented the telephone.

Pan Am launched the commercial jet engine, while operating the largest commercial airline in the world and despite competing with plenty of other nations who’s military was already exploiting the same technology in the military.

Apple successfully introduced the iPhone even years after smaller rivals had released similar versions of internet connected phones. Remember Blackberry? This is a super clear example of an incumbent cannibalising one business line (the iPod) in order to benefit from the creation of a larger business line.

It’s not incumbents that entrepreneurs and investors should fear. It’s loonshot factories and innovators you should fear; organisations well funded, structured as loonshot nurseries (not just applying startup culture street talk) and with a strong incentive to take over the next wave of innovation in an industry.

This is the reason we should give Apple, Google, Facebook and Amazon the benefit of the doubt on wether or not they will be the leaders of the next wave of computing.

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Albert Malagarriga

3x Entrepreneur turned Investor at Elixir Capital, product guy, drummer, swimmer.