Pinchpoints in non-linear growth businesses

Non-linear growth business is best explained via examples. Twitter is a non-linear growth business because the number of users doubles every few months. Cellular service is a non-linear growth business because the number of cellular phone subscribers worldwide has doubled every year. Computer hardware is a non-linear growth business because the number of computers has doubled every few years and Moore's law has doubled the number of gates in a microprocessor every 2 years.

Naturally, such non-linear growth in a business attracts competition. For example, there are plenty of social networks vying for user attention and competing with Twitter. There is healthy competition in cellular service providers in most countries. Similarly, IBM has been supplanted in the PC hardware business by HP, Lenovo, Dell, etc. So the profit in a non-linear business can quickly evaporate due to competition. The pie is divided up. Capitalism and market forces 101.

But there are companies that build effective moats around their products and keep the whole pie. The moat is usually a combination of two components. One component is a standards and IPR protection for products. By creating a standardized and widely adopted product (e.g. MS Windows) companies can effectively keep others out. The second component is the high entry bar. A modern CISCO router ruitinely runs a 15-20m line operating system, making it incredibly hard for a start-up to join the fray.

CISCO operates on a pinchpoint, at the bottom of an inverted pyramid. At the top are all Web 2.0, Internet applications, and data centers. All the growth and innovation at the top makes money for CISCO. Intel is another pinchpoint and all PC manufactures compete at the top of the inverted pyramid. Truly smart are the business models that perch companies on the pinchpoints... the pie just keeps getting bigger!

If there is a Microsoft Yahoo deal then startups will feel the pinch

Figure 1: Representative acquisitions of Yahoo, Google, and Microsoft (from this blog)

A Microsoft takeover of all or some of Yahoo will be a good thing for Microsoft in it's battle to unseat Google from the Internet's helm. Perhaps a later Microsoft-Facebook arrangement will finally present a credible challenge to Google. I doubt if the Yahoo board will now agree to anything less than the 72% premium over the original share price Microsoft had offered earlier, so Yahoo shareholders will also come out wealthier from the deal. End users are likely to benefit from a stronger alternative to Google as well.

But one quarter will suffer quietly in the short to medium term: startup companies. Yahoo and Microsoft are some of the most prolific startup acquirers (see Figure 1, from this blog). Yahoo merging with Microsoft removes a big buyer for many startup companies. Moreover, Microsoft will have that much less cash (approximately $44B less based on the first MS offer) to throw at startup acquisitions. With the credit supply tightening up and the economy slowing down, you can be sure of a capital drought ahead for many Internet and software startups.