Catching the Second or Third Train

When a startup gets traction, there will be imitators.  The other thing to realize is that there is no monopoly on good ideas.  Just because one startup has an idea and starts to execute it, it doesn’t preclude or mean that another startup won’t do the same thing.  It might be in the same town or it might be in another part of the world.

One example of this is Uber and Lyft.  Another might be Groupon and all of its lookalike competitors or GrubHub and its look-alike competitors.

As an investor, it is hard to decide whether to invest or not.

• Is it a winner take all market?  If so, there often can be a first-mover advantage if the first mover gets good traction.
• Is the market so big and fragmented you can build a huge company despite a look-alike competitor? Consumer products companies can do this, and segment markets.  B2B is different and often winner take most.
• Is the market highly specialized, with a few customers and great margins? In consumer-focused companies, often the market isn’t specialized.  They have to figure out a different way to get stickiness.
• Are there large switching costs to switch from one platform to another?  In the case of the examples above, there are basically no switching costs.
• If it is a relatively easy technology to replicate, can competitors emerge from existing industry or adjacent industries?  Once the taxicab companies saw Uber and Lyft, they could have easily rolled out their own app but didn’t.  The advantage technological incumbents have over entrenched industry is often the entrenched industry is local and not scaled across several markets.  Sure, there were taxicab companies in every major city but they weren’t owned by the same company.  Why didn’t rental car agencies enter the market with their own app?  They could have easily dominated and had the advantage of being able to provide cars to drivers with a lot of added-on fees like insurance they could make money on?

Sometimes, investors hear a pitch one or two times from similar companies. They don’t invest.  Those companies get traction.  Another company comes in with the same pitch.  The investor might have fear of missing out.  They invest.  Most of the time, those companies don’t make it.  Of course, there are exceptions but they are few and far between.  The train already left the station and they are throwing good money into failure.  The best they can hope for is an acquisition.  Usually, these are done at low multiples and often don’t have cash associated with them.

When I was trading, I saw this a lot. One trader would put something on.  As soon as it looked good, other traders would plow into the trade driving the price even more.  The first trader had all the advantage since price movement would mean less volume at each price.  Until one point, there would be a lot of volume as the entire market figured it out.  The first trader would start to unload their position as the rest of the market plowed in. Momentum would dry up, and guess who was holding the bag?

I was thinking about that this morning after I was served an ad on social media for a company.  I had passed on a similar company years ago.  The train has left the station and the game is already over for this particular market segment.

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