Why Startups Are More Successful than Ever at Unbundling Incumbents

September 10, 2015
min read

Scale isn’t what it used to be. It’s never been easier to start a company, and as a result new entrants are unbundling incumbents’ businesses and chipping away at their advantage. Upstarts like The Honest Company, Warby Parker, and Airbnb are able to quickly win market share from leading businesses like Procter and Gamble, Luxotica, and Starwood Hotels by decomposing markets into highly customized niches so that the incumbents can’t compete on scale alone. And by now it’s clear that these companies are well positioned to achieve greater success than originally envisioned, and may displace many of the Fortune 500 brands over the next decade or two.

It’s also clear that this is an economy-wide phenomenon. The playing field is being leveled across a variety of industries: Tesla is a leading high-end automaker, SolarCity is taking share from electric utilities, Uber is reorganizing the taxi industry on its platform, and companies like Blue Apron and Casper are chipping away at various retail segments. There are companies attempting to redefine customer experiences in almost every industry including education, healthcare, and financial services.

There are two core drivers of this economy-wide unbundling.

First, these companies are essentially product design teams that are focused on iterating fast to find product-market fit. They are able to offer fundamentally better products and services than the incumbents because of the product-centric DNA of the management teams. They usually focus their product development on a sub-segment of the millennial demographic because millennial customers don’t have much loyalty to existing brands. Whether it’s consumer packaged goods or financial services, these customers are willing to try new brands and share their experiences openly with each other through rankings and reviews. As a result, momentum builds fast behind companies whose products and services are truly better in the consumers’ minds.

Second, these companies rent all aspects of operational scale from partners and eliminate any capital expenditures or operational inertia from their execution plans. They are therefore designed for growth, especially given their lean organizational structures. For manufacturing, logistics, customer acquisition, and commerce, there are third party services and APIs available to scale with customer demand as quickly as necessary. Once these companies have built a relationship with their customers, they quickly go on to re-bundle products and services to increase their share of the customer’s wallet.

As an example, The Honest Company has emerged in recent years as a new type of consumer goods company, focused on quality and sustainability. (Disclosure: my firm is an investor.) The company started by selling diapers that replaced petroleum-based ingredients with organic materials. Once it had built a relationship with the “millennial moms” as a safe and high-quality brand, it went on to bundle other household products in its offering. Today, the company looks like a fast-growing, early version of the next Procter and Gamble.

Lending Club is another example of a company that is taking share from incumbents in a massive category. It started in 2008 as one of the first applications on Facebook’s platform and allowed consumers to lend to other consumers. It offered a new type of investment opportunity, rather than the traditional option of investing money through banks. It can cost-effectively market to consumers on social platforms like Facebook, and it leverages cloud services to enable the lending workflow, movement of money, and management of risk. The company had originated over $7.5 billion in loans by 2014 and has become one of the largest financial institutions in just a few years.

This is a structural change. Today’s innovative companies also run the risk of being disrupted by a new generation of nimble upstarts that will use the very same unbundled business model to their advantage. Businesses will need to persistently focus on product and customer success, because for most firms scale isn’t a moat any more. (The monopolistic advantages of scale are shifting to platform companies like Amazon, Facebook, Apple Pay and YouTube. These platform companies are becoming essential to how the economy functions, as power companies and internet service providers have been for decades.)

The implications of this structural shift are quite profound.

For example, until now, policies designed to protect labor, consumers, and trade practices were set by law. Now these platforms make many of those decisions based on machine learning algorithms with the objective of maximizing profits. These platforms need to embrace a new level of algorithmic accountability as they become the utilities of the new economy.

These same platforms have also started to enable workers to make the profound shift from a being an “employee” to managing a “personal enterprise” which extends its services to various sharing economy platforms. All the labor protections that have been in place for decades need to be reimagined. (I will explore these topics in later posts.)

Still, the lessons for businesses are relatively simple. For incumbents: you can’t count on scale like you used to. For entrepreneurs: rent scale where you can, and focus on product design above all else.

Originally published at hbr.org on June 18, 2015.