In Silicon Valley, it's good to be king

By Christopher Lochhead , written on April 8, 2013

From The News Desk

Silicon Valley is a mythic place, and the San Francisco Bay Area’s allure is well earned. We have a healthy startup ecosystem with a proven track record of nurturing big entrepreneurial winners. It seems you can’t go a week without reading about how some other part of the world is trying to be “the next Silicon Valley.”

But there’s a reason they call it a “myth.” That’s because the Valley has always produced many more failures than successes. Which should come as no surprise, but often does. I regularly find myself in a meeting where someone says something like, “This is going to be a massive space and there will be room for a lot of winners.” Well, it turns out that is just not true. Silicon Valley produces a small number of legendary successes, handfuls of also-rans, and buckets of road kill. The proof of this shows up clearly in two places: venture capital returns and technology company economics.

Last week Sarah wrote about an exchange she had with Mike Maples, Jr., co-founder of Floodgate (where I’m an investor/advisor) about the “stats in the venture industry.” The two assert that most of the returns in venture capital come from less than 5 percent of the deals, busting the myth that lots of venture firms are successful.

“The only companies that matter in the Valley are the handful of ‘Thunder Lizards,’ that can become huge,” Maples says. There’s a straight line between venture returns and the way technology markets work. We have invested much in analyzing how technology categories get created, disrupted, and developed. We’ve learned that the technology business is generally a winner take all game. Market leaders or “Category Kings” often achieve 50 percent market share and 70 percent of the available market capitalization of a given category. And they always have much higher growth rates, margins, and market caps (valuations) than competitors.

Today, Google has 67 percent market share in search. Oracle has 48 percent market share in relational databases. Twitter is now rumored to be closing in on $1 billion in revenue. Can you name the number two player in the micro blogging space? Evernote dominates the cloud note-taking category with more than 35 million users and has no direct competitor. Microsoft killed Lotus, WordPerfect and Ashton Tate (look it up, kiddies) about 20 years ago. Today, Microsoft Office is a $20+ billion dollar product line that enjoys approximately a 95 percent market share.

Recently Netscape co-founder turned venture capitalist Marc Andreessen said, “The big companies in technology tend to have 90 percent market share. We think that generally these are winner-take-all markets. No. 1 is going to get 90 percent of the profits. No. 2 is going to get like 10 percent of the profits, and Nos. 3 - 10 are going to get nothing.”

He’s right. With few exceptions success is binary in Silicon Valley; you’re either a zero or a one. Category Kings get most of the economics from the entire space they play in. Being No. 2 generally sucks. That’s why the companies that matter are the ones that can create or disrupt large market categories, establish a defendable leadership position, and execute over-time to become number one. Reaping massive rewards. Often for decades.

Mike and Marc know what they’re talking about.

[Image courtesy Waiting For The Word]