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Y Combinator
Watch out for Facebook.
TOUGH BREAK

Competing with Facebook and Google is hard. Y Combinator president Sam Altman says it’s only going to get harder

By Michael J. Coren

Silicon Valley’s giants are only going to get more powerful, and more ruthless about snuffing out—or snapping up—potential challengers. What does that mean for startups? Advises Y Combinator president Sam Altman: Watch your back. 

In his annual letter to entrepreneurs on Feb. 16, Altman says that startups cannot count on big companies to be plodding, inept, and vulnerable when it came to the internet. Those days are largely over. New incumbents like Amazon, Facebook, Google, Apple, and Microsoft wield advantages most founders and investors still do not yet fully grasp.

“I expect that they will continue to do a lot of things well, have significant data and computation advantages, be able to attract a large percentage of the most talented engineers, and aggressively buy companies that get off to promising starts,” noted Altman, whose accelerator-turned-seed fund has backed about 1,500 companies including Dropbox, AirBnB, and Stripe. ”This trend is unlikely to reverse without antitrust action, and I suggest people carefully consider its implications for startups.”

Sam Altman, president of Y Combinator

Tech companies also have an edge because of a phenomenon known as network effects: when products or services increase in value as more users adopt them, driving an exponential advantage for incumbents. In his note, Altman argues that we are entering the age of “hyperscale technology companies,” which are “now far more powerful than ever before, simply because the number of people connected to the internet keeps getting bigger, and n^2 [the squared value] gets big really fast.”

How big is that competitive advantage? In a world of at least 2 billion connected mobile devices (expected to hit 6.1 billion by 2020), startups’ markets can be global from the day of their founding. The real advantage, says Alex Taussig at venture firm Lightspeed, is all the data those customers confer on companies. 

What makes that data even more valuable now than 20 years ago are developments in machine learning. Algorithms capable of sifting through petabytes of data to better serve that next product or recommendation are now commonplace. That’s a formidable lead against would-be competitors that want to steal your customers. “The more data you have, the better your models get, and the more value you can deliver to your customer,” says Taussig. “At some point, it’s hard for startups to compete.”

Take Google and Facebook, companies that suck up 85% of new digital advertising dollars. Their value is not derived solely from the number of users, searches, or shares, but also from owning data that permits them to fine-tune products and services, an advantage Taussig compares to the new economies of scale. In network-driven markets such as search and social media, we’re unlikely to see new entrants meaningfully challenge incumbents as they did in the early decades of the internet.  

That has massive implications for which companies will thrive in the future, says Roy Bahat, head of the venture capital firm  Bloomberg Beta. Startups will need to hunt out weak spots in markets rather than directly confront tech giants in some cases. Bahat suspects the falling costs of digital communication will reward two types of firms: enormous, global behemoths such as Amazon, and small but scrappy startups that can quickly fill a new market niche with only a handful of employees. ”Things are getting much bigger and smaller same time,” he says. “What’s really likely is that all the [companies in the] middle die.” 

As technology drives down costs for people to coordinate tasks, small companies can take advantage of global markets with small upfront investments. A few dozen people built WhatsApp, which had 600 million monthly active users when it sold to Facebook for $19 billion in 2014. DistroKid, a side project launched by software engineer Philip Kaplan in 2013, is now among the largest music distributors in the world. DistroKid has three employees, only one engineer (Kaplan), and no outside investors.

But those cost reductions also benefit large companies, which can now expand to unprecedented sizes in their industries. Walmart, for example, already one of the world’s largest companies in 2000, had doubled in size to about 2.2 million employees by 2012. Today, the majority of Americans work for companies with more than 500 people, a big shift since 2000. Bahat believe these trends, which squeeze the middle in favor of large and small firms, are spilling over from technology to the rest of the economy. Startups and investors may take advantage of this by adjusting their strategies to get big fast, or spread like a weed with just a few employees.

To be sure, Y Combinator is not arguing that the glory days of startups are over. The fund continues to invest millions of dollars in startups every year. Would-be entrepreneurs just need to face a different reality: Easy wins may be fewer, but there will be no lack of opportunities as long as startups still have access to data and customers on the internet, says Naval Ravikant, the founder of AngelList, a startup financing platform. 

“As long as we have open platforms and open data, there will always be room for startups,” he wrote by email. “The most talented engineers will want to work on small teams or on their own things, but they need at least a somewhat level playing field to do so.”

Correction: A previous version of this post stated the incorrect number of users when WhatsApp was purchased in 2014.