"The fundamental problem with Silicon Valley’s favorite growth strategy"

The writer, Tim O'Reilly, is one of the poobahs of tech.
He gets it.
From Quartz, Feb. 5:

The pursuit of monopoly has led Silicon Valley astray.

Look no further than the race between Lyft and Uber to dominate the online ride-hailing market. Both companies are gearing up for their IPOs in the next few months. Street talk has Lyft shooting for a valuation between $15 and $30 billion dollars, and Uber valued at an astonishing $120 billion dollars. Neither company is profitable; their enormous valuations are based on the premise that if a company grows big enough and fast enough, profits will eventually follow.

Most monopolies or duopolies develop over time, and have been considered dangerous to competitive markets; now they are sought after from the start and are the holy grail for investors. If LinkedIn co-founder Reid Hoffman and entrepreneur Chris Yeh’s new book Blitzscaling is to be believed, the Uber-style race to the top (or the bottom, depending on your point of view) is the secret of success for today’s technology businesses.

Blitzscaling promises to teach techniques that are “the lightning fast path to building massively valuable companies.” Hoffman and Yeh argue that in today’s world, it’s essential to “achieve massive scale at incredible speed” in order to seize the ground before competitors do. By their definition, blitzscaling (derived from the blitzkrieg or “lightning war” strategy of Nazi general Heinz Guderian) “prioritizes speed over efficiency,” and risks “potentially disastrous defeat in order to maximize speed and surprise.”

Many of these businesses depend on network effects, which means that the company that gets to scale first is likely to stay on top. So, for startups, this strategy typically involves raising lots of capital and moving quickly to dominate a new market, even when the company’s leaders may not know how they are going to make money in the long term.

This premise has become doctrine in Silicon Valley. But is it correct? And is it good for society? I have my doubts.

Imagine, for a moment, a world in which Uber and Lyft hadn’t been able to raise billions of dollars in a winner-takes-all race to dominate the online ride-hailing market. How might that market have developed differently?

Blitzscaling isn’t really a recipe for success but rather 

survivorship bias masquerading as a strategy.

Uber and Lyft have developed powerful services that delight their users and are transforming urban transportation. But if they hadn’t been given virtually unlimited capital to offer rides at subsidized prices taxicabs couldn’t match in order to grow their user base at blitzscaling speed, would they be offering their service for less than it actually costs to deliver? Would each company be spending 55% of net revenue on driver incentives, passenger discounts, sales, and marketing to acquire passengers and drivers faster than the other? Would these companies now be profitable instead of hemorrhaging billions of dollars a year? Would incumbent transportation companies have had more time to catch up, leading to a more competitive market? Might drivers have gotten a bigger share of the pie? Would a market that grew more organically—like the web, e-commerce, smartphones, or mobile mapping services—have created more value over the long term?

We’ll never know, because investors, awash in cheap capital, anointed the winners rather than letting the market decide who should succeed and who should fail. This created a de-facto duopoly long before either company had proven that it has a sustainable business model. And because these two giants are now locked in a capital-fueled deathmatch, the market is largely closed off to new ideas except from within the existing, well-funded companies.

The case for blitzscaling

There are plenty of reasons to believe that blitzscaling makes sense. The internet is awash in billionaires who made their fortune by following a strategy summed up in Mark Zuckerberg’s advice to “move fast and break things.” Hoffman and Yeh invoke the storied successes of Apple, Microsoft, Amazon, Google, and Facebook, all of whom have dominated their respective markets and made their founders rich in the process, and suggest that it is blitzscaling that got them there. And the book tells compelling tales of current entrepreneurs who have outmaneuvered competitors by pouring on the gas and moving more quickly.Hoffman recalls his own success with the blitzscaling philosophy during the early days of Paypal. Back in 2000, the company was growing 5% per day, letting people settle their charges using credit cards while using the service for free. This left the company to absorb, ruinously, the 3% credit card charge on each transaction. He writes:

“I remember telling my old college friend and Paypal co-founder/CEO Peter Thiel, ‘Peter, if you and I were standing on the roof of our office and throwing stacks of hundred-dollar bills off the edge as fast as our arms could go, we still wouldn’t be losing money as quickly as we are right now.’”

But it worked out. Paypal built an enormous user base quickly, giving the company enough market power to charge businesses to accept Paypal payments. They also persuaded most customers to make those payments via direct bank transfers, which have much lower fees than credit cards. If they’d waited to figure out the business model, someone else might have beat them to the customer that made them a success: eBay, which went on to buy Paypal for $1.5 billion (which everyone thought was a lot of money in those days), launching Thiel and Hoffman on their storied careers as serial entrepreneurs and investors....

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