Why Incumbents Struggle To Out-Compete Great Startups – Hangover and Incentive Paralysis

There is a clear market friction to be solved which a startup has identified, and is on the mission to make it happen, and create better demand-supply equilibrium. The Problem is obvious [square]. The Incentives are evident [pentagon and hexagon]. The startup is going to business to solve the problem with these clear incentives.

Then an incumbent firm sees the startup, and quickly creates a unit or division to attack the same problem. Unfortunately, there is a hangover effect (legacy), despite its apparent advantages on capital, experience and other systems for production. Due to the hangover, the incumbent will develop new incentives on the original problem.

Magically, the incentives become triangle and circle over the startup’s pentagon and hexagon. As a result of these incentives, the incumbent will go and modify the problem to fit into the evolved incentives. By the time it is done, the problem is no more a square but a star. Simply, it is now solving a different problem, and will likely fail.

This is why most incumbents never catch-up with startups on great missions. Google+ could not stop Facebook because Google+ had different incentives – connect people to support other Google’s properties which differed from Facebook’s original incentives. Due to those evolved incentives, Google+ was solving a different problem when compared with what Facebook was solving.

Of course this does not mean the incumbent cannot arrive at a better problem to solve by changing the incentives. My point is simple: if a startup is doing great in the market, it means its original problem was a friction that has existed in market unsolved. Changing that may not help the incumbents over time.

Sure – the startup must continue to execute to ensure it wins.

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