In Praise of Bad Times: What we can learn from the last downturn

The following is a guest post by Nigel Eccles, co-founder and CEO of Hubdub, the prediction trading game.

If Silicon Valley checked into hospital, it would be diagnosed with severe bi-polar disorder. In mid-September, with the bad economic evidence mounting and the markets in freefall, its mood swung from vaunted optimism to extreme despair. Sequoia summed up the change in mood, titling their recent presentation “RIP Good Times”.

So, as we officially head into Bad Times, the first question is, will we see a period of mass extinction similar to the one that occurred after the dotcom bubble? Unlikely. Firstly, the dotcom bubble gave rise to thousands of companies with heroic growth assumptions and high cost bases, serving markets that didn’t yet exist. In contrast, while many web 2.0 companies are still propositions looking for a business model, they often run at less than 10% of the cost of an equivalent dotcom business. Secondly, in retrospect we see the market peak in early 2000 and then the gradual slide as if it were inevitable. However, right up until 9/11 there was a feeling that the market might pick up again and the good times return. This resulted in many companies failing to adjust quickly enough to the new reality which caused many to enter, what Sequoia described as, a ‘death spiral’. Given the speed at which start-ups have cut costs this time around it looks like that mistake is not being repeated.

In fact, Bad Times can be very good for start-ups. In the last tech downturn we saw the birth of Last.fm (founded in 2002), Skype (2003) and MySpace (2004), along with a plethora of other successful web 2.0 start-ups. Tighter times mean less competition, not only for staff but also for users. This is highly significant as pay-roll and cost of user acquisition are the two biggest costs for any start-up. More importantly, a tougher environment forces start-ups to ruthlessly focus on only those opportunities where they can bring value.

On entering a downturn it is often hard to see if the economy will ever recover. I remember in 2002 wondering if there was any future in the web economy (and at least one of my developer friends retrained as a cocktail waiter!). However while expectations of growth got wildly inflated by 2000, the underlying trends continued. People continued to migrate to the internet and also massively increased the amount of time they spent on it. In a downturn, the allure of the web as both cheap entertainment and as a utility gets stronger. And while it may be hard today to picture the wider economy coming out of recession, the most likely scenario is that it will, and indeed within the next two or possibly three years. What will the world look like for start-ups when it does?

Very. Well. Positioned. To understand why, consider Start-up Economics 101. Big companies struggle with innovation, even at the best of times. During the past 10 years in the technology and media industries the smart money has been on start-ups out-innovating more established companies. Whether it is Google besting AltaVista in search, Flickr out-performing Yahoo in Photos or YouTube whipping Google in Video, it was the start-up that came out top.

However in downturns, innovation in big companies is pretty much closed down as the focus moves to cutting costs and eliminating any product lines that arenít showing immediate profits. Last week we saw AOL shutter XDrive, AOL Pictures, MyMobile, BlueString and AOL Video Uploads. Innovation at AOL, like most big companies, isn’t seeing much love these days. However the media sector, like the technology and mobile sectors, is seeing deep structural changes. Consumers are moving rapidly from print and broadcast to digital media. And consumers are being swiftly followed by advertisers. Over the next 2-3 years innovation within the media sector will happen in start-ups, not big media companies. That means when the market returns, media companies will have to acquire if they wish to remain relevant and grow.

Of course many things will stay tough over the next couple of years, with finance in particular remaining tight. However start-ups that can work through that constraint and focus on opportunities where they can create value will be excellently positioned when the economy picks up again. Now is a great time to be an entrepreneur.