Paul Graham: Why Y Combinator Replaces The Traditional Corporation
fastcompany.com
fastcompany.com
(As transaction costs (search costs, costs to contract, costs to outsource, etc.) go down, optimal firm size goes down. In an efficient market for contracting, like IT, tiny startups turn into long-term profitable small-headcount companies (dropbox has, what, 70 people?). In inefficient markets, you end up with huge or state-owned companies, like in natural resource exploitation or the third world.)
In all seriousness though, while the technology factors certainly enable some 'shrinkage' of the firm, human factors change less, which to me indicates that YC like agglomerations will not replace the corporation in many circumstances. In other words, it's easier to find people these days, but as contractors, are they really still going to slog it out for a company day in and day out for years? Most people out there are not like YC founders, would be my bet, and are reasonably happy with their 9/5 jobs, and with not having to hustle to find the next gig. On the positive side, these people will also retain the tacit knowledge inherent in many human activities, and provide a sense of continuity that a shifting network might have trouble fostering outside a small core. Apple, for instance, has 60,000+ employees, according to the web page - that's not what I'd consider a small core + network, even though they certainly outsource a lot. So... trend, yes, but fairly slow once the low-hanging fruit that tech can provide has been integrated.
The other big question I have in this vein is whether it will remain so cheap to create a company, or if it's an anomaly, and in the future more capital will be required for anything serious. My guess is that the long term is towards cheaper, but who knows what may happen.
BTW, Wikipedia says it's just an article, and here's the summary for those interested:
There's an argument for internal communications costs vs. external communications costs (Coase's thing) -- if it's more efficient to communicate within a trusted firm vs. between firms, you end up with huge firms. Things like tight-knit social networks outside of the firm (college alumni, things like YC, sites like hn, various ethnic diaspora in history, ...) would create some kind of hybrid, too, where a lot of interconnected small firms would work, so each firm could be smaller than otherwise. This would actually be interesting research for someone in economics or sociology -- I'd look at formal networks like YC and informal networks like casual coworking and web forums.)
To have some predictive value, what other industries besides web companies that are super cheap and easy to start, might morph towards this kind of structure? Or, here's another one: this industry has long been dominated by giants: IBM, Microsoft, Google, and so on. Will we see the end of that?
(And just to be clear, I think what pg has done is fantastic, and he/them are quite praiseworthy, etc... I'm just pushing back a bit on the idea. I can't foresee doing business with PG or YC, so I have no interest in not calling it like I see it)
I agree with Coase's reasoning and I'd like to agree with his prediction, but there are some empirical problems with it as of now.
Note that for any particular technology area, at first it makes sense to have a single integrated company which can redesign everything. But once the market knows roughly how to achieve the result and has standardized pieces, cooperation is much easier to achieve, and you naturally get a fragmentation into smaller, specialized, companies.
I've seen nice illustrations of the exact mechanics using examples from the computer industry. I think it was in Clayton Christensen's The Innovator's Solution, but I can't swear to that. (However that's a good book regardless.)
The third world has tiny average firm size, and the theory correctly predicts that in the developing world firms will get larger rather than smaller.
Consider the small proprietor in a third world who spends tons of time bargaining with vendors and customers. As people's time becomes more valuable and more products become available, the cost of bargaining increases, and larger stores replace vendors because it reduces total negotiation costs.
Third world isn't really the right term; it's more like "mostly undeveloped" vs. "developing" -- China (at least the urbanized parts) has more in common in firm size with the US, Japan, and Europe than it does with Nigeria.
The developing world has an extreme power law distribution curve. Almost all the large businesses are capital intensive. Things are probably more skewed in Brazil than in other countries due to a risk-free rate of ~11%, meaning that any business with high working capital can't rely on outside capital if it doesn't want to end up handing over all its revenue to the banks.
Firm size in Brazil is probably more related to capital costs than transaction costs. High capital costs "hollows out" the middle. Capital is often used to reduce rising transaction costs within a firm once the firm size surpasses approximately Dunbar's number. However those businesses at that are mid-sized instead of large don't have enough scale to justify the investment of capital to reduce transaction costs. Many smaller mid-sized companies will hobble along with high internal transaction costs as a result, much higher than would be tolerated in the US.
Because of this, SaaS products are likely to have a transformative effect on Brazilian businesses. There is a lot of unmet demand because traditional transaction cost reducing solutions have required too much capital to implement.
I wonder why we don't see more Brazilian startups targeting international markets.
Is there a Brazilian HN, or otherwise a forum or mailing list?
My suggestion is to stick to HN and intl technology channels on IRC and Github and keep an eye out for telltale signs of a Brazilian by the name or other identifying info and reach out to them one by one. You may want to try out HackerNewsers to seed the network initially. http://hackernewsers.com/
Also, get in contact with Diego Remus of Startupi and Diego Gomes of EverWrite.
Optimal size will still depend on the industry.
Seventy guys can operate a dropbox.
You'll need a few thousand guys, minimum, to run a shipyard, assemble tractors, extract oil.
Doesn't mean they are inefficient - just that some tasks require a lot of capitol and manpower.
There is one problem with a y-combinator approach to capital intensive work: someone has to be in charge. There is 'a' party responsible for delivering the product to the customer, and that drives everything else.
Put ycombinator in charge of a shipyard and a lot of cool stuff will happen, but delivering a finished boat on time and on-cost is not one of them.
The past 100 years are a great example of how a lot of change can happen in a short amount of time.
There are some things that you can automate -- but a lot of things in the oil & gas industry cannot be automated. Specifically, the leg work required to get things started & keep them maintained. Automating those sorts of things requires a pretty advanced AI and I don't see that coming around the corner anytime soon.
Automation can get us close. Already has, but this just moves the labor out of the field and into a cube.
But (I think others have pointed out downthread by now) capital intensive projects are always going to need someone to go out and kick the tires, work a nut loose, apply some ingenuity.
If you don't have those guys hanging around to kick the tires and whack a lug nut things will stop until you send a guy out to do that.
The probes we have on Mars .. you can wait a few months for the guys at mission control to work out a problem. You can't do that with an oil well.
Comparing himself to an air-traffic controller, Graham says much of his time is spend making introductions and helping the YC community solve problems within the network
Most of the large companies I've worked with are missing somebody in the "air-traffic controller" role. It can be very difficult for individual employees to understand all the resources that are available within the company, or who they should contact with a particular question. YC might actually have an advantage in this area.
I've worked for 3 large companies, and have had the opposite experience. The problem is that everyone is trying to be an air-traffic controller. So much so, that honest work is being avoided.
I'm not excusing that behaviour but if you've spent enough time at a big company, you'll see motivations for it.
Contrast that to pg's air-traffic controller role in the YC network, providing value to all the startup people he connects.
It will be interesting to see how well pg's positive influence scales as YC continues to grow.
I can attest to this firsthand at both Microsoft and IBM.
Yahoo had at least four internal websites devoted to companywide skill-sharing. Google had a couple of these too. I don't recall them ever being useful.
They are started by naive new engineers who get frustrated because they can't get anything done. They think everyone's going to be thrilled to create a profile, say publicly what they are good at, and to answer questions from effective strangers. But it never works.
A year later they have personal relationships within the company, and know how to use those instead. And this is what motivates people to really help.
So do you think software is going to work better within the YC community? Maybe there's some communal spirit there that can overcome that tendency, due to all the dinners together or everyone knowing the YC partners. Or maybe your network is just small enough, and has higher-than-average quality people, so people would care about their reputation for helping strangers.
The only thing that worked, and people reverted back to wasn't the "sexiest" of solutions - An email list. Data gets pushed to you, you don't have to be logged into a specific application or site to view it.
Setup some tags in the subject header, and some rules to filter on those tags.
How many YC companies have ever made a real profit before being bought? How is the YC model sustainable without existing large corporations like Google or Yahoo or Linkedin waiting to buy out the startups?
YC is about grooming startups ready to be bought out in talent acquisitions after a period of rapid growth, not about creating sustainable businesses with viable products.
How many teams within traditional corporations are profitable? How many new products that traditional corporations launch are profitable?
If people who think we're in the business of grooming startups for HR acquisitions stopped to do the math, they'd realize we'd be acting against our own interests if we focused on that. Essentially all the returns in startup investing (for us as for any investor) come from the big successes. Whereas we often make zero from early acquisitions.
I'm not sure what you mean by "sustainable businesses," but if you mean profitable businesses, big successes necessarily are that.
I scanned this list, and don't see many public companies... http://yclist.com/
Microsoft Research alone outspends Y Combinator by a factor of 50,000,000. And they're thinking 10+ years out. Money aside, their internal expertise and contact network far exceeds "the guy who made Django."
Kudos for what you've done, but when you start talking this way I feel obligated to point out that you're a grain of sand on the beach compared to the Fortune 50--or even CMU/Berkeley/MIT.
You're doing something totally different. Own it. Say what you're for, not what you're against. Say what you're building, not what you're killing.
The fact that people who interview you keep painting you into these corners means that the general public still doesn't understand what's going on with YC. Less hyperbole, more concise vision. Your essays often achieve this, your PR should too.
Mostly from the same place Microsoft's R&D budget comes from: the companies' own revenues.
An example would be someone like Simon Peyton-Jones at Microsoft:
http://research.microsoft.com/en-us/people/simonpj/
Much of what he does may eventually filter down to the rest of the company, but there's a real risk that some of it won't, or that it'll be picked up by someone outside of Microsoft, etc...
How does that sort of thing work out with a number of small companies networked together?
https://github.com/nathanmarz/storm
They did some other stuff to accommodate their needs.
Maybe the YC model will reach that "how will we be computing in 10 years" phase at some point. But (perhaps with good reason?) it does not seem to be there yet.
Really? So those YC acquisitions deals are all-cash?
Maybe you can't build a fusion reactor on a YC-style seed investment, but Etherpad, AirBnB, and Reddit have done more for my life than fusion research has, so far.
You, personally, were able to innovate and productize immediately, but that's not the norm. For most people the choice comes down to: Do you want a nice car or you want to change the world?
1. http://en.wikipedia.org/wiki/Microsoft_Research 2. http://en.wikipedia.org/wiki/Microsoft
Investors aren't investing in technology companies in the hopes they get acquired for $10m in Google or Facebook stock -- they are looking for large sustainable companies that generate revenue (and profits). The difference between YC and traditional investors is that YC doesn't block founders from taking talent acquisitions, which may be one reason it seems like there are more of them.
For example, traditional corporations I've worked for have had large HR departments. Now where I work (with 40 employees) we use another company to handle most of the HR functions. This allows us to focus on our core business model.
That's because of antiquated management structures. Look at Gore and Associates (makers of Goretex) for a modern corporate structure. Elements of a corporation should be almost completely independent and the only reason they are part of one entity is because of synergies and cooperation.
To give a toy example, McDonalds might grow and slaughter their own cows because they can better place them near their distribution facilities. Buying from a third party might create unnecessary overhead.
I'm sorta oversimplifying things, but I'd recommend reading
"Re-Creating the Corporation" by the late Russell Ackoff to appreciate why corporations exist (and why sometimes they shouldn't)
http://www.amazon.com/Re-Creating-Corporation-Design-Organiz...
I do believe there are things that large corporations can do well and they do have their place. I hope that with technology advancements smaller companies can compete is some spaces traditionally well suited to these larger organizations.
Maybe I'm not understanding this right, but the phrase "in exchange for", seems like it should have read "in addition to". Can someone please clarify?
Could be better organized as: "... Y Combinator, the investment firm that plugs seed money (~$18,800) into early stage startups and offers mentorship and access to its ever-growing network of alumni, in exchange for a modest equity (~7%) of the startup."
In addition to trying to use each others' services, YC companies will probably often give each other feedback about what could be improved about each other's services.
Compare this to the alternative of trying to launch a new service, gain customers, and get feedback on your own.
1. Y Combinator's success criteria for its startups involves a liquidity event - there's no mention of a company staying privately owned and profitable as being a successful outcome (http://ycombinator.com/about.html). This is unsurpising given that pg himself exited to Yahoo
2. To date, YC liquidity events have all been sales to medium-to-large companies (http://yclist.com/). There may be a couple of big IPOs on the horizon, which is great, but the general trend is for Y Combinator-funded startups to be acquired by big corporations, which boosts those large companies' competitiveness and innovation capability
So I would certainly say that Y Combinator's structure is unusual and admirable - but de facto it acts much more like a pilot fish for traditional corporations (creating some kind of new, syncretic innovation model for them), rather than as a replacement for them.
Do I think a r/evolution of the Y Combinator model could replace the traditional corporation? Certainly, but this will be done by "slowcubators" rather than by traditional incubators. A slowcubator looks like this:
1. No expectation of a liquidity event in the child companies. It's expected instead for the child companies to become self-sustaining, profitable businesses a la GitHub or Plenty of Fish
2. Significant shared tech IP - this is something a Y Combinator can't do, because shared tech IP makes it impossible to acquire a startup. But it makes huge sense for a slowcubator, because a) acquisitions are the exception, not the norm, and b) there are huge cost savings to be made by sharing tech IP across properties (think private PAAS, Chef recipes, AdWords automation tools etc). Joltid is the posterchild of shared tech IP driving multiple successful startups
3. Staff incentives which are not structured around focusing 100% on one product until it exits or dies, but instead encourage staff to rotate within the slowcubator's companies to where they are currently needed most. It's great that the Django creator can answer a YCfounder's questions over some beer and pizza, but in a slowcubator he would be hands-on helping multiple products to be as good as they can be (as DHH does at 37signals)
In the same way that the startup acquisitions of the past decade shaped the incubator model that we see today (and is exemplified by YC), I fully expect the bootstrapped successes that we are seeing today to give rise to a wave of slowcubators - the best of which will indeed rival (if not replace) the big corporation.
This is the mistake. It's the general trend only by number of companies, not by valuation or number of people. Measured by valuation, the majority of our portfolio is not interested in being acquired.
Can you share the % splits? Would be a really interesting (and yet still anonymous) snapshot of the portfolio companies' intents in the aggregate...
The moment the golden handcuffs are off, there will be flight back to creating a startup in most instances. This means that the big companies can only remain competitive by throwing money at the problem.
Some areas/departments areas are great and keep innovating and others lose people once the golden handcuffs are off.
I believe KPCB were referred to as a Keiretsu for encouraging their portfolio to buy from each other -- eg, getting Netscape to buy servers from Sun etc.
There was a time when it was fashionable to imitate Japanese business, so VCs actively pursued this type of PR. So it's more likely that KPCB issued PR about itself calling itself a Keiretsu, having the added benefit of seeming much larger than they are. (The Keiretsu were large conglomerations.)
Now, not so much of that PR is being created.
EDIT: I thought I remembered them self-referencing keiretsu. This is from 2001, look at the bottom:
http://web.archive.org/web/200012122131/http://www.kpcb.com/?
Arrogance was a strong suit. Last I knew, IRRs from funds in that timeframe were negative and that included Google!.
What's more, the SF network extends to people who are not just in startups, but also established companies, universities, and even unrelated things (like the Because We Can people, who are making a business out of custom CNC products.)
Or do YC people collaborate more closely than that? Give up their time more freely to a fellow YC'er?
If someone cold-emails me, or has a mutual acquantance do an introduction, I usually don't feel as obliged.
When I walk down the street in SOMA or the Mission, I too am likely to run into a developer that I know. And I'm not even a very social person. But I've been around the Valley & SF for almost six years now.
Maybe YC gets you off the ground faster, maybe you get that in year one. Still, I hope you are also reaching out to make connections with non-YCers.
I'd like to see more places like Incubation Station come about - http://www.theincubationstation.com - or hear about similar incubators for consumer products if anyone knows any.