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Entrepreneurs must learn to understand incumbents

April 5, 2011, 7:17 PM UTC

How to make your startup an attractive target for acquisition.

Chris Dixon is co-founder of Hunch, and is an active angel investor. Visit his blog.

By “incumbents” I mean the big companies that are loosely competitive to your startup.

– The first thing to do is try to understand the incumbent’s strategy. For example, see my analysis of Google’s strategy.

– Being on an incumbent’s strategic roadmap is a double-edged sword. On the one hand, they might copy what you build or acquire a competitor. On the other hand, if you build a valuable asset you could sell your company to the acquirer at a “strategic premium.”

– Incumbents that don’t yet have a successful business model (e.g. Twitter) might think they have a strategy, but expect it to change as they figure out their business model. An incumbent without a successful business model is like a drunk person firing an Uzi around the room.

– Understand the incumbent’s acquisition philosophy. More mature companies like Cisco barely try to do R&D and are happy to acquire startups at high prices. Incumbents that are immature like Facebook only do “talent acquisitions,” which generally lead to bad outcomes for VC-backed startups (but good for bootstrapped or lightly funded startups). Google is semi-mature, and does a combination of talent and strategic acquisitions.

– Understand the incumbent’s partnership philosophy. Yahoo and Microsoft are very open to partnerships with startups. Google and Facebook like to either acquire or build internally. If you don’t intend to sell your company, don’t talk seriously about partnerships to incumbents that don’t seriously consider them.

– Every incumbent has M&A people who spend a lot of their time collecting market intelligence. Just because they call you and hint at acquisition doesn’t mean they want to buy you — they are likely just fishing for info. If they really want to buy you, they will aggressively pursue you and make an offer. As VCs like to say, startups are bought, not sold.

– Try to focus on features or technologies that the incumbents aren’t good at. Facebook is good at social and social-related (hard-core) technology. Thus far they’ve kept their features at the “utility level” and haven’t built non-utility features (e.g. games, virtual goods, game mechanics). Google thus far has been weak at social and Apple has been weak at web services.

– Try to focus on business arrangements that the incumbents aren’t good at. Facebook and Google only do outbound deals with large companies. With small companies (e.g. local venues, small publishers) they try to generate business via inbound/self service. Building business relationships that the incumbents don’t have can be a very valuable asset.

– Be careful building on platforms where the incumbent has demonstrated an inconsistent attitude toward developers. Apple rejects apps somewhat arbitrarily and takes a healthy share of revenues, but is generally consistent with app developers. You can pretty safely predict what they will allow to flourish. Twitter has been wildly inconsistent and shouldn’t be trusted as a platform. Facebook has been mostly consistent although recently changed the rules on companies like Zynga with their new payment platform (that said, they generally seem to understand the importance of partners thriving and seem to encourage it).

– Take advantage of incumbents’ entrenched marketing positioning. The masses think of Twitter as a place to share trivial things like what you had for lunch (even if most power users don’t use it this way) and Facebook as a place to talk to friends. They are probably stuck with this positioning. Normals generally think of each website as having one primary use case, so if you can carve out a new use case you can distinguish yourself.

– Consider the judo strategy. When pushed, don’t push back. When Facebook adds features like check-ins, groups, or likes, consider interoperating with those features and building layers on top of them.