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Published: February 28, 2007

 
 

Lessons of the Last Bubble

First-Mover Fallacy
A key contributor to the land-rush mentality was the first-mover fallacy: a belief that the winners would be the ones who got there first and got big fast. Conventional wisdom argues that the first company to stake out a position will dominate its industry — especially during a rapid growth period like the early days of the Internet. But history has proven that the opposite is often true: Commodore, Osborne, and Kaypro pioneered the personal computer industry in the early 1980s but did not establish dominant positions. Rigorous academic research has shown that early movers may achieve a market share advantage, but they do not systematically achieve greater profits or a higher survival rate.

A look at Internet retailing substantiates the idea that you don’t have to be a first mover to succeed. Founded in 1994, Amazon is the clear leader in Internet sales, but it did not achieve full-year profitability until 2003. Although it remains marginally profitable today (4.2 percent net income for 2005), Amazon still has cumulative net income of negative $2 billion. Another early “e-tailer,” eToys, fared even worse. Founded in 1996, eToys went public in 1999 and declared bankruptcy in 2001. By contrast, Newegg, which sells new and used computer and electronic equipment, didn’t launch until 2001 and is now the second-largest pure-play Internet retailer, with 2005 sales of $1.3 billion.

First movers do not necessarily find the most fertile ground. Those who wait to explore later, or more patiently, benefit from the experiences of earlier settlers. They can bypass the hulking shells of unsustainable structures built by the first-generation pioneers and salvage the best ideas buried in the wreckage. Consider FreshDirect, the online grocer, which offers a direct delivery model much like that of Webvan. FreshDirect serves 250,000 customers in the greater New York City area from a central distribution center in Queens, just outside midtown Manhattan. A privately held company with an estimated $150 million in annual sales, FreshDirect ranked 68th among American Internet retailers in 2005, and (according to Forbes magazine’s September 18, 2006, issue) became profitable within the past year.

Unlike Webvan, which viewed the “last mile” as a golden opportunity and sought to be the first mover, FreshDirect took inspiration from Internet pioneer Dell. The founders sought to redesign the grocery supply chain, using a rapid-assembly “build-to-order” approach to provide fresher products at lower costs. They recognized that developing this capability would take time and focused experimentation. The company continues to patiently refine and expand its business from its Queens location rather than pursue rapid, unprofitable growth. When the model matures and the timing is right, FreshDirect is expected to expand beyond New York. But in the meantime, it happily pursues its niche in one of the largest grocery markets in the world. (See “Was There Too Little Entry During the Dot Com Era?” by Brent D. Goldfarb, David Kirsch, and David A. Miller, Robert H. Smith School of Business research paper no. RHS-06-029, April 24, 2006.)

Overhyped Networks
During the early days of the New Economy, previous models of success were easily dismissed. Dot-com businesses were not supposed to operate by the same rules as traditional firms. The new calculus posited that the Internet generated “network effects,” which made the first-mover strategy critical. The fate of early personal computer hardware companies was irrelevant; the example of Microsoft setting the industry standard for PC operating systems offered a more relevant example. The pundits proclaimed that “network effects” would rule the new “network economy.” Unfortunately, many investors learned that just because the Internet is a network doesn’t mean it offers significant network effects to every business.

 
 
 
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