Back in my economics classes, I was always fascinated on how theories from books could be related to real life events. I read about Kondratieff’s cycles, Smith’s invisible hand, Keynes’s supply and demand. But my favorite was Schumpeter’s creative destruction, and now after six years in the world of startups, it’s fascinating to see it play out in the real world.
At a fundamental level, the economics of a startup are pretty simple. Most startups bootstrap their way to their first customer, and probably their first hundred customers. They bet everything on scaling those first hundred customers into the first two hundred customers, spend money they don’t really have on achieving that scale, and pitch investors on their ideas and potential. And the founders work damn hard to get those investors to write checks to sustain the startup until the moment it becomes a little more mature, and a lot more profitable.
These economic realities are the same for startups in France or those in Silicon Valley. Every startup goes through periods where their finances are teetering on the edge of failure and where a few bad months – maybe even just a few bad weeks – can see the company destroyed.
And almost every founder dreams of an economic miracle when the stars align and the perfect investor asks for a meeting to decide whether to invest six figures or seven figures.
But there are economic principles at play in the startup world besides simple profit and loss, and investment and one of them that we at DOZ have become increasingly familiar with is actually called creative destruction.
On Your Marx, Get Set, Go!
Startups are the ultimate exercise in capitalism.
Founders ask investors to risk their hard earned dollars on an idea that may or may not pay off. Investors hope the hoof beats they hear are from unicorns instead of a run-of-the-mill horse, and the market ultimately decides who wins and who loses. Stakes are gambled and returns are only ever promised, never guaranteed. But when it comes to the notion of creative destruction it is not an arch capitalist we turn to, but rather the father of communism, Karl Marx.
In his book The Communist Manifesto Marx wrote about how capitalist economies regularly entered periods of crisis. In these crises, he argued, “a great part not only of existing production, but also of previously created productive forces, are periodically destroyed.”
In more simple terms, the German philosopher was saying that, from time to time, entire sections of an economy that is otherwise productive will be destroyed and replaced by new systems and structures.
In other words, the creation of something new will require the destruction of something that exists – that’s creative destruction.
Schumpeter Says…
If Marx described the idea of creative destruction it was Austrian-American economist Joseph Schumpeter who truly gave the notion its name.
More than 70 years ago in Capitalism, Socialism, and Democracy Schumpeter extended Marx’s idea and described the forces in a market economy that disrupted and transformed entire economies.
He would write that creative destruction is “the essential fact about capitalism”, and that the “fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization” that
For Schumpeter, creative destruction was a process of incessant revolution where economies were changed from within. The old way of doing things was destroyed entirely, and replaced by a new, better, more efficient, and more productive way of achieving the same ends.
Creative destruction, he concluded, is the reality that every capitalist business must exist, survive, and seek to And had he lived to the twenty-first century he might have looked to the current startup scene to illustrate this conclusion with examples galore.
Startups Creatively Destroying the World
Take a look at any list of the leading startups in an ecosystem and you’ll see they have one thing in common: they are all attempting – sometimes without even being aware of it – to creatively destroy existing economic architectures and replace them with newer, better, architectures of their own.
Take Uber.
So successful has Uber been at destroying the previously dominant taxi and metered car industry that this ‘old’ economic model has only been retained in cities where massive government intervention and legislative restrictions have been introduced.
In New York City there are now more Uber cars on the road than there are the famous yellow taxi cabs. In just four years Uber has changed how New Yorkers get around while also changing the lives of the drivers who work for them.
Reports one driver, “You can just turn on your phone and start working at any time.” He earns $85,000 a year driving for Uber – and that’s double what the typical yellow cab driver takes home.
Left to the market and the consumer to decide, Uber and its ride-sharing model has emerged victorious every time, and the existing economic model left to rot, a victim of its inability to evolve.
Or take Airbnb.
The San Francisco-based startup has revolutionized the short-term accommodation market across the world. The old model for finding a room to rent has been destroyed entirely, replaced now by a more efficient model that the consumer has embraced.
In 2012 airbnb had just 7000 listings in the whole of France. Today there are more than 50,000 in Paris alone, a number that continues to climb towards the existing 80,000 traditional hotel rooms in the city. Those 50,000 listings have created income streams for owners, opportunities for renters, and helped airbnb creatively destroy a lodging industry that had changed little in hundreds of years.
Companies like Zenefits are good examples of creative destroyers, too.
This American startup helps manage the human resources needs of more than 10,000 small and large businesses across the United States. In the same way that IT consultancies replaced IT staff and outsourced manufacturing replaced the American factory job, Zenefits proved it could revolutionize the administration processes of businesses across entire industries by applying a SaaS solution to a human and enterprise problem.
Its competitors charge fees and retainers for things that Zenefits gives away for free. Is it any surprise that a recent news report out of Portland warned that Zenefits had business and HR consultants “running scared”? Zenefits is revolutionizing the administrative landscape, offering a creative solution to a consistent problem, and is reaping all the benefits of their disruptive and creatively destructive approach: just two years after their launch they are now valued at $4.5 billion.
Or even consider my own company, DOZ.
Our entire business model has been developed around creatively destroying the existing marketing agency model. No longer do companies need to keep an agency on retainer, purchase project management and marketing management software, attempt to coordinate their local and remote teams through another communications software, or work only with the handful of professional marketers they can afford to keep on staff. Businesses are additionally saddled with the costs of expensive marketing consultants who don’t always deliver on the broad promises they make.
Instead, our SaaS marketing management software comes with a marketplace of thousands of marketers baked in. DOZ means that every business can manage their own digital marketing projects with a team of +5,500 marketers available on-demand in 30 countries.
Goodbye tiny teams and agencies on expensive retainers.
Hello DOZ, and creative destruction.
Schumpeter’s Startups
I believe that all startups, whether they are aware of it or not, embrace the notion of creative destruction.
Startups at their heart are offering people a different way of doing something. It doesn’t matter if it is an app, a product, a service, or a full SaaS platform complete with its own marketplace. The underlying assumption of every startup is that the old way isn’t working, that a new way exists, and that the startup holds the key to opening the door to that new way of running things.
Startups align with Schumpeter, embracing the creative destruction of existing business models, even entire industries, and re-write the rules of the global economy. Startups respond intelligently to gaps in the market, they create opportunities where older, so-called wiser eyes see none, and they embrace the wild ride experienced on the edge of chaos, on that thin line between defeat and triumph that every startup must negotiate on the way to creatively destroying the way of doing things that came before.
Some will fail – that’s inevitable.
But the best startups deliver better, less expensive products and services. They deliver greater efficiencies, greater productivity, they save energy, are more environmentally friendly, and better connect the billions of individuals living in today’s single, global economy.
The startup ecosystem represents one of the most perfect examples of Schumpeter’s creative destruction in action. Recognizing this, embracing this, and building upon this not only leads to success, but it might even make my old economics professor smile.
Yes, I really was listening in class.