Apr 102012
happy guy with lots of money

Monday’s announcement that Facebook would buy photo sharing website Instagram shows the power of Silicon Valley investor networks and how they operate, we should be careful about trying to emulate that model too closely.

Intagram has been operating for 18 months, has 13 employees, has no prospects of making a profit and is worth a billion dollars to the social media giant. Pretty impressive.

A look at the employees and investors in Instagram shows the pedigree of the founders and their connections; all the regular Silicon Valley names appear – people connected with Google, Sequoia Capital, Twitter, Andreessen Horowitz.

The network is the key to the sale, just as groups of entrepreneurs, investors, workers and innovators came together to build manufacturing hubs like the English Midlands in the 18th Century, the US midwest in the 19th Century and the Pearl River Delta at the end of the 20th Century, so too have they come together in Silicon Valley for the internet economy.

It’s tempting for governments to try to ape the perceived successes of Silicon Valley through subsidies and industry support programs but real success is to build networks around the strengths of the local economy, this is what drove those manufacturing hubs and today’s successful technology centres.

What’s dangerous in the current dot com mania in Silicon Valley is the rest of the world is learning the wrong lessons; we’re glamourising a specific, narrow business model that’s built around a small group of insiders.

The Greater Fool business model is only applicable to a tiny sub set of well connected entrepreneurs in a very narrow ecosystem.

For most businesses the Greater Fool business model isn’t valid.

Even in Silicon Valley the great, successful business like Apple, Google and Facebook – and those not in Silicon Valley like Microsoft and Amazon – built real revenues and profits and didn’t grow by selling out to the dominant corporations of the day.

The Instagrams and other high profile startup buy outs are the exception, not the rule.

If we define “success” by finding someone willing to spend shareholders’ equity on a business without profits then these businesses are insanely successful.

Should we define business success by creating profits, jobs or shareholder value then the Silicon Valley VC model isn’t the one we want to follow.

We need to also keep in mind that Silicon Valley is a historical accident that owes as much to government spending on military technology as it does to entrepreneurs and well connected venture capital funds.

It’s unlikely any country – even the United States – could today replicate the Cold War defense spending that drove Silicon Valley’s development and much of California’s post World War II growth.

One thing the United States government has done is pump the world economy full of money to avoid a global depression after the crisis of 2008.

Some of that money has bubbled up in Silicon Valley and that’s where the money comes to buy companies like Instagram.

Rather than try to replicate the historical good fortune of others, we need to make our own luck by building the structures that work for our strengths and advantages.

  3 Responses to “Hyping start ups for pleasure and profit”

  1. Hi Paul,

    It’s hard to believe that Instagram is worth $1B using any accounting metric. Even their most recent funding round had valued the company at $500M. Instagram was however, becoming a social connection app which was growing on a mobile platform, something that Facebook was struggling with. They bought out a fast growing potential competitor. The consideration for the acquisition of Instagram is a combination of cash and Facebook shares. I haven’t seen how much cash changed hands, but given that there is no real market valuation of Facebook ($100B pre IPO valuation), the value of the Facebook shares that were handed over are most likely to be over inflated.

  2. This reminds me of the YouTube acquisition, Google already had a video platform but purchased YouTube for the community. YouTube clearly wasn’t profitable (at least at the time) but I don’t think anyone now can really say it was a bad acquisition.

    Facebook has a strong community now.. but I think the move is to capture external branches and bring them closer/back in.

    • Graeme,

      There’s no doubt there are underlying strategic reasons for most of these acquisitions by large companies although more often than not the execution leaves somewhat to be desired and we could question how much is paid; that’s a topic for another post.

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