Interlude – Extinction Events As Drivers Of Step Changes In Business Evolution

The news is full of doom and gloom about the Credit Crunch. Jason Calacanis has today written to his list suggesting that 4 out of 5 startups will go out of business and that we are in for 3 to 4 bad years where investment is almost impossible to find, and consumer spending falls dramatically. The Financial Times published a piece on the collapse of the shadow banking system (The writer, chairman of Roubini Global Economics, is
professor of economics at the Stern School of Business, New York University and apparently knows a thing or two) which has direct consequences for the flow of money into VCs and investment bodies. (Yes, VC's are leveraged and borrow as well as invest the savings of the wealthy.)

Many blogs and learned pieces are covering the impact on the sanity and mental health of investors and entrepreneurs. It all seems rather bleak, doesn't it?

Local pundits are telling me that we face a 50% collapse in the value of real assets, a collapse of VC interest in second stage investment, the default of major investors in existing companies and the fatal decline of consumer discretionary spending in the face of inflation, raw material price inflation, job losses, and rental rises. (Cambridge, UK has the Judge Business School, several business courses integrated into other subjects, and a thriving VC sector and two Angel communities – Cambridge Angels and Cambridge Capital. Cambridge is also full of very bright business students, professors and research bodies.)

All doom and gloom? Flee to the hills? Grab a life boat? Canned food and shotguns?

I'm not so sure. I'm going to go out on a limb here and suggest that the issues for business have strong ecological parallels and that we can find answers in nature.

What we are facing in the current credit crunch is an extinction event. (I wish I was clever enough to have given a new name to sudden, non-cyclical business event like that coined by Nassim Nicholas Taleb in his 2007 book
The Black
Swan.). What ever we call it, the real questions for each business are:

1 – can we tell what business species are going to go extinct; and
2 – can we tell how many buinesses will go extinct; and
3 – what are the best strategies for business survival?

As to which business are most at risk; the overall sentiment is that any business which is about to require large capital injections, large working capital needs, or debt refinancing is in the direct firing line for extinction right now. Similarly any business which relies on discretionary consumer spending or which has a foundation in property, financial instruments, or debt arbitrage is in for a very rough time. But if that is not you, why is it an issue? Because of the “shotgun” nature of the collapse of the business ecology, and because of the interconnectedness of businesses. Outside the immediate areas of risk, there will be a percentage of casualties.

As to how many casualties, I'd say that the 50% to 90% range from ecological catastrophe is an over estimate for business purposes. I'd put a small bet on the 25% to 50% range. Care is needed here, as I mean “25% to 50% of current businesses will collapse if they continue to follow their current business plans”. The critical factor here is that businesses can change their models, and business per se can continue even if it no longer looks like it used to. What is critical is that the business DNA – the core idea of the business – carries on.

Finally, what are the best survival models for your business idea? Let me pick three for discussion: death, aestivation, or adaptation.

First up: give up and die. Many suggest this as a valid response to the current financial circumstances. Any good business manager should spend at least one day this month going through this as an option.

Second up: aestivation. In zoology, a state of inactivity and reduced metabolic activity, similar to hibernation, that occurs during the dry season in
species such as lungfish and snails. In botany, the term is used to describe the
way in which flower petals and sepals are folded in the buds. That is what bears do. You might call it “hibernate”, but it is not quite the same: aestivation is a biological mechanism for avoiding the worse environmental conditions. That is pretty well what most business pundits propse right now. Close the doors, go home, close the shutters and wait out the storm sitting on a pile of cash (&/or gold).

The third option: adapt.

This is the one I would suggest business should follow. Rapid, radical change and ferocious selection of ideas in order to better fit the business to the existing business climate. These options are not available to all businesess: for some the costs of change are high, their entrenched business decision making processes are so slow and so risk averse that they are doomed. Like dinosaurs.  Can you guess where this is going? Yes. Small tech media businesses are the mammals scurrying about the feet of the large business dinosaurs.

Silicon Valley tech businesses have a very simple business model: grab $25 to $50m of investment, race for 1m users and hope someone buys you. Reid Hoffman is the leading exponent of this approach. But it simply does not work in a credit crunch. You need a new approach. Even if your business idea, your DNA, is fine and fit, you can't realistically expect instant mega funding in the new business world. (Some will still get it, and they are the lucky and / or very connected ones, I'm just saying that if you are planning right now, plan to win).

Aestivation is not an answer – you will miss the critical evolutionary changes, and emerge from your cocoon to find the ferns have gone and the mammals have eaten your eggs. The very last thing that any business should do right now is hide from reality. Quite the contrary – business leaders should be head up like a mongoose watching for all the signs of potential food sources as the big dinosaurs crash down and die all around.

What new approach? Carrion eating is a fine strategy for survival, so are egg theft, parasitism, displacement and niche invasion. Start looking at ways of carrying your business idea on a new business model, through the credit crunch, but designed in such a manner to expand rapidly once the worst is over.

The local and global advice is, therefore, that small firms should
hunker down close to the ground, while keeping an eye out for revenue
opportunities. We should, apparently, plan to stretch available capital
as long as possible, strive to make break-even despite clashes with
expansion plans, cut costs to the minimum maintenance level, and ensure
that alternate revenue sources (consulting, asset sales, etc) are
bumped up the Board agenda even if that diverts management attention
from 'sacred' product development.

There are huge opportunities during mass extinctions. Not only do old niches come free as the incumbent species die off, but new niches become available. Asteroids smashing into the planet change the mineral balance of the oceans, the flooding of volcanic traps changes the atmosphere, ocean heating can release methane and perhaps bacteria can flood the atmosphere with toxic gas
yet each time, new niches were created into which life evolved and flourished.

It may take a while, but business will flourish in the post Credit Crunch world. (BTW: when did Credit Crunch first get capitalised?) The critical difference is that some business leaders will still be here. Baring self-extinction, businesses and business leaders can watch, adapt, learn and survive. Which is why I said above that it is business models that will go extinct, not necessarily businesses. You can change you model, survive, replan and then thrive in ways that were simply not possible before the “Crunch”.

Which business segments have a good chance? Hard to tell. Whatever business you are in, if you have a year of cash on hand, and / or have a reasonable revenue stream, things are looking better for you. Some specific segments have proven remarkably counter cyclical: computer games, gold mining, cheap food, cheap alcoholic drinks, and going to the cinema. It is a reasonable bet that the same sorts of things will command consumer spending even in the bad times of an economic extinction event. Why cinema and computer games? Because they make you feel good when everything else is bad, because you can control the time and the cost of them, and because they are a relatively small part of anyone's budget.

But whatever you are doing as a tech entrepreneur, now is not the time to roll over and die. Pick up the pace, look harder, look in the niches as they open up. See what the extinction event offers you and your small business. I'd rather be an entrepreneur right now than anything else. It is easier to expand into a business vacuum than struggle up through the tangle of established companies that shade out your space. (I was blessed with having lectures from Sir Richard Southwood, and his passionate description of the struggle of forest trees to reach the light has stuck with me for life)

Whether you are a believer in punctuated equilibrium or pure Darwinian evolution, the evidence is that after a mass extinction event, new forms of life emerge and rapidly dominate the ecosystem, but that the forerunners of those new forms were already present before the extinction event, just in small numbers, dominated by the historic incumbents. Why should business be any different?

So, go out there, small entertainment tech media entrepreneurs, and take over from the dinosaurs. The credit crunch will drive huge business changes, and my money is on the SME sector providing all the winners in the next age of business. If I was an investor, I'd be looking there for the next step change in business evolution, and feeding it well. The rewards for survival are massive expansion after the dust settles on the extinction event.