The ultimate start-up could be, in many ways, embodied in the startup world itself.

Born at the
end of the 20th century, the startup world blossomed alongside global mass adoption of the
internet. The startups of today, or rather their progeny ‘tech giants’, make up almost half of the
Fortune 5 (Fortune 500, 2020), and to many they are the poster child for innovation. Through
this paper I will refer to this macro-organization and pseudo-institution as the “Startup World” as
I believe it extends well beyond that which the old appellation “Silicon Valley” implies. As a YC
alumni and serial-founder, I have spent the last decade quite literally growing up alongside these
ventures and have gained a unique perspective into what drives success and failure in innovation
for them. I will attempt, through the course of this essay, to provide an epistemology on the
academic view of innovation, particularly as it relates to the traditional startup world and
focalizing on the Y Combinator mentality. I will provide a classification of the types of
innovation frameworks and their application to the innovative capabilities of the modern Silicon
Valley startup, followed by the resources and processes that are especially leveraged,in the face
of constant competition. Finally, I will conclude with a comparison of the pros and cons of the
system's prioritization of different innovative ideas, it’s efficacies and ways in which they may
be improved.

Pisano classifies businesses by whether they rely on existing or invent new (1) business models,
and (2) technology (Pisano, 2015). It appears, however, that what he describes as ‘reliant on
existing business models’ is simply a substitute for innovation that results as a function of R&D
Spending. This holds true whether in discussion of leveraging existing technical competencies
(which he aptly named ‘routine innovation’) and those requiring investments into the creation of
new technical competencies (something he names ‘radical’ innovation, but I will refer to as
‘routinely-radical’). Whereas Pisano ascribes the taking on ‘new business models’ to the
traditional startup traits of an underdog (or new business) innovating either with existing
technologies, “disruptive” or by swift ‘architecture’ adoption and iteration of the new industries
born out of the routinely radical innovative investments themselves, in actual fact, industry
transformation (the ultimate result of innovation) seems to only occur when coupling both new
technology with a focus on a (new or emerging) market and vice versa (Kavadias, Ladas and
Loch, 2016).

It is important to make this distinction; for example, e-travel agencies like bookings.com do not
rely on a substantially different business models (Castillo-Manzano and López-Valpuesta, 2010;
Girotra and Netessine, 2014) and ‘routine’ innovation for many businesses come in the form of
business-model changes1 (Amit and Zott, 2012; Spieth, Schneckenberg and Ricart, 2014). By
classifying innovations instead by those that do not (or in many situations can not) develop from
R&D spend, we begin to see a trend
1 
Although maybe this is not a good thing, See: Christensen, Bartman and van Bever, 2016

whereby innovation from the Startup World (both reliant on existing and new technology)
distinguishes itself from the ‘routine’ innovation spurred by larger company spend.

If we take a look into the decision tree of how ideas are selected, we can see one potential cause
for this phenomena. Broadly speaking, there are only four types of ideas in the world: (1) Good
Ideas that sound good, (2) Good Ideas that sound bad, (3) Bad Ideas that sound good and (4) Bad
Ideas that sound bad. Most of the Good Ideas that sound good (type 1) are of course solved by
investment into R&D, thereby filling the place of routine innovation cycles (i.e. Disney Sequel)
and routine radical innovation cycles (i.e. Medical Advancements). Rational entrepreneurs of
course avoid Bad Ideas that sound bad (type 4). What is then left for the Startup World is Good
Ideas that larger organizations have overlooked (or intentionally ignored2) because they sound
bad (type 2) and Bad Ideas whose “badness” isn’t immediately apparent and therefore sound
good (type 3). The innovative ability of the Startup World (both the entrepreneur and the
Investors) is in their ability to identify the former while avoiding the latter.

Considered as perhaps the most prolific thinker and successful venture capitalist, Paul Graham
theorized that the best way to do this is to build something people actually want by solving
problems, ideally for yourself (Graham, 2010). If a problem is solved and a pain point eliminated
the problem must (a) exist and (b) not be a ‘made up’ problem like those of the ‘bad ideas that
sound good’. Therefore, it must be that all ‘good ideas’ tackled by startups must have been
overlooked (or purposefully neglected) by the larger company. This reductionist perspective
melds perfectly with The Innovation Radar (Mohanbir Sawhney, 2006) where all forms of
innovation are ultimately functions of the ability to solve a pain point (or the reasonable result of
scaling it). Platforms (and to a lesser degree networks) are either a mechanism to iterate
quickly, a system of creating network effects, or the logical conclusion of focusing on a
competitive advantage while leveraging existing technology (Thompson, 2018).
The Process, Organization and Supply Chain are but tools to unlock value through cross-
savings or expansion. Rethinking your customer or adjusting your presence are tools to resolve
specific paint points (and the Brand is the way to communicate with fewer transaction costs
(Chen, 2001)). Ultimately the offering itself is just the manifestation of the above as
an Experience to provide the key: a solution.

This results in both a competitive landscape as well as the secret to succeeding despite it.
Competitive landscapes are of course inherent in any new venture, regardless of if it
2 
Possibly due to the most disruptive innovation ideas typically going against conventional wisdom (Thomke and
Manzi, 2014) and the cost of testing these ideas are cheaper, easier for startups- an idea touched on below. And/Or
because of influences arising from incentivations arising from the way resources (capital) is allocated, “funding
authority” (Chao, Kavadias and Gaimon, 2009)

is an attempt to usurp an established incumbent, or educate when pursuing a new offering (Kim
and Mauborgne, 2004). However in recognizing that their opportunity exists and that their
solution was necessarily overlooked by their biggest competitors, startups can stay laser focused
on their customer and the problem itself. This strategy, boasted proudly by Jeff Bezos (Cheong,
2018), is part of a larger ‘Judo Strategy’ (Harvard Business Review, 1999) – a strategy which
resurfaces every few years under a new name (such as Peter Thiel's “Zero to One” or more
recently Bill Aulet’s “Disciplined Entrepreneur”). No matter what it is called, this strategy relies
on a startup’s ability to remain agile and stay hyper focused on their core audience’s problem.
Ironically, the focus on the core customer may actually be the cause of the established businesses
overlooking the solution (Bower and Christensen, 1995; Selden and MacMillan, 2006) and
ceding the opportunity to the startup in the first place.
The difference lies, perhaps, in the contrast between the ‘customers’ and the founder’s problems,
a distinction underlined in the famous quote (mis)attributed to Ford on building faster horses
(Harvard Business Review, 2011). The Startup World’s (more specifically, Paul Graham’s)
above focus on “solving one’s own problem” successfully combines these two things as one and
the same. By solving his or her own problem, the innovator ensures that they have an intimate
understanding of the underlying problem, thereby providing the ultimate litmus test to
understand if the solution is adequate enough to spur their own usage. As the innovator iterates
through this, the instant feedback loop results in less time and data ost between the analysis
(understanding the problem) and synthesis (putting into practice) steps of research which drive
innovation through learning (Owen, 1998; Beckman and Barry, 2007).

The success in employing this strategy can be witnessed in the story of the founding of Instagram
by Kevin Systrom (Geekmaster, 2019). While the other players were focused on the ‘good idea’
of a social media site for images and neglected the (seemingly) ‘bad idea’ of focusing on filters.
This feature is what Kevin focused on as this is what he and his friends wanted and used most on
social media.

From the strategies described above, the incentives to innovate, and arguably the existence of the
Startup World as a pseudo-institution, they are guided by the “Invisible Hand” of the market
(Smith, 1812). While capitalism may enable the innovation itself, Venture Capitalists and Angels
(or investors in general) operate as a system to prioritize ideas and decide in which to place their
bets. Much like a senior manager who may use his or her experience and macro-knowledge of
the business to decide which projects to allocate (human and financial) capital towards, investors
use their experience and knowledge of macro-societal and industry wide trends to identify fuel
and allocate

capital to businesses that are likely to succeed. However, unlike centrally planned systems,
ventures without backing can continue to exist provided they are not capital-intensive or if they
choose to self-fund, a process known as ‘bootstrapping’(Lam, 2010).

Like any system, this process is far from perfect. Broadly speaking the problems with this system
fall into two categories: Entrepreneurs and Externalities.

Entrepreneurs

With the competitive landscape inherent in startups and the personality traits required to succeed,
recalcitrancy is a relatively common trait in startup ventures. Take for example Uber, which was
considered by the city of San Francisco to be operating an illegal taxi service (MG Siegler,
2010), or the numerous studies that suggest rebelliousness is an indicator of entrepreneurial
success (Grant and Sandberg, 2017). In fact, it has been theorized that the productive
contribution of entrepreneurs to society is, at least in part, controllable by policies in place that
encourage (or discourage) the allocation of these same skills to unproductive activities such as
crime or rent seeking (Baumol, 1996). While these traits may help spur innovation, they run the
risk of causing trouble not just for society but for the success of the idea itself. For example,
Startup founders may find it difficult to relinquish control of their venture at the right time
leading to more authority at the cost of performance and/or capital (Wasserman, 2008).
Malfeasance is not the only flaw of a system of innovation driven by entrepreneurs. It is difficult
to create or maintain company cultures that properly incentivize and encourage innovation
(O’Reilly, 1989), an increasingly important element as innovation (may) rely more and more on
larger groups than just single’ individuals (Rickards, Runco and Moger, 2008) and the complex
trade-off needed to manage increased diversity and size in innovative teams (Kavadias and
Sommer, 2009). Other issues such as letting go of incompetent staff (when the incompetency is
not their fault), balancing psychological safety with honesty and holding close friends and
associates accountable can present tough situations that well-intending entrepreneurs may
struggle with (Pisano, 2019).

Externalities

Aside from the well-documented problems arising from negative externalities in a capitalist
society, innovation is particularly susceptible to historical influences that limit innovative
success. For example, it is unclear as to whether gasoline is a better fuel than steam (in fact there
is a case to be made that steam is more cost efficient), however the years of focus on gasoline as
a fuel prove it is not cost effective to rework history. The same idea rings true for several historic
decisions such as nuclear energy being based in light-water substances (which was selected by
the US during the arms race against Russia, allowing them to license GM as a manufacturer
despite being more

costly and less efficient than heavy water) (Dixit and Nalebuff, 2010). Another ‘flaw’ of this
system is the growing shift to ecosystems as a business model (Brandenburger and Nalebuff,
1997) and open innovation moving from strictly being “outside in”(leveraging other products
and services into your business) to also being “inside out” (allowing others to utilize your
data/information) (Chesbrough, 2017). The latter source of innovation is becoming more and
more commonplace, especially as we see an increase in the number of platform businesses
(Cusumano, Yoffie and Gawer, 2020). Scale holds a huge advantage for platforms (Cusumano,
2020) due to their network affect and makes it even more difficult for newcomers to
compete3 (Eisenmann, Parker and Van Alstyne, 2011).

In summary, we are alive during one of the most exciting times in modern history, where we are
beginning to innovate the ways in which we view innovation itself. The Startup World, grouped
as a quasi-institution, provides a unique insight into the type of ‘disruptive’ innovation that has
defined the past two decades. While the mechanisms for innovation may not have changed much,
an emphasis on problems over customers gives small businesses an advantage. As we look to the
future, this trend may not persist as we move towards the establishment of platform ecosystems
or it may reset the course and characterize the future of all innovation.
3 
Time will tell if this holds true. Possibly this is additionally affected by how many of Kavadias’s “six key features”
this holds. ( Kavadias, Ladas and Loch, 2016)

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