Cult of the Innovator

Real innovators don’t earn profits.

Call this the “law of the pioneer.” For all the talk of the riches to be gained by those who dominate new high-tech businesses, the stubborn truth is that trailblazers rarely get rich. Think of the first car-makers in the early 1900s. Or the first movie studios around the same time. Or the initial wave of airline companies after World War II. Or the postwar mainframe makers. Or the first PC suppliers in the 1970s. Or makers of database software in the 1980s. All these companies were in the right industry at the right time, yet precious few earned money.

This lesson is worth remembering in our time of turmoil in tech stocks. In the hoopla over the New Economy, many forget that pioneers pay a price, just as they did in the Old Economy. Successful innovators are like Moses, who led his people through the wilderness but never reached the Promised Land.Many innovators never get to the Promised Land either, which in the terms of the market means their low profits ultimately translate into low stock values.

People once knew that no earnings meant no riches. For four decades, ending in the mid-1990s, the stocks of hightech companies traded at a lower price-to-profit ratio than stocks of conventional companies. This reflected the heightened risk of picking winners and losers in high-tech businesses.Many people think that the rise of the Net and e-commerce, with its dazzling potential, changed this. Not so. Rather the great success in the 1990s of the twin towers of the “pre-Net” economy,Microsoft and Intel, induced a collective amnesia in which innovation became synonymous with controlling a standard and achieving the power to exact exorbitant “rents” over essential goods. Under the sway of the Microsoft-Intel axis, the endgame of innovation came to be seen as market power rather than destabilizing markets by creating novel ways of meeting human needs.

While this sounds bad, it turns out that control over markets is the secret to earning steady profits. But such control need not flow automatically from innovation. In the case of Microsoft and Intel, market control was given to them by IBM, which effectively set all computing standards 20 years ago. Indeed, the greatest bursts of innovation for Intel and Microsoft came after they gained control of the chip and operating-system standards, not in their early days.

Innovators, then, have drawn the wrong conclusion from recent high-tech history. They seek to earn profits by winning control of markets through new products and services, when in fact innovators almost never gain market power because they are,well, too busy innovating. The experience of Netscape offers a classic example. The company pioneered the first commercial Net browser. It even won control of the standard. Yet its control was based on continued innovations, and when Netscape failed to keep that momentum, Microsoft’s superior market power took precedence. Netscape never earned any money and ultimately ended up as a ward of America Online.

Or consider the dilemma of Amazon, the first truly successful electronic retailer.When Amazon realized it couldn’t earn more than slim profits from selling books, it moved into other areas. But the cost of becoming the Wal-Mart of cyberspace is so great that Amazon won’t earn profits for a long time, if ever. And since the bricks-and-mortar Wal-Mart wants to dominate the Net too, it is only a matter of time before Amazon sells out to the discount retailer-or to one of Wal-Mart’s competitors.

Now you might say that this merely shows that Amazon, like Netscape, isn’t innovative enough. But the predicament of these companies doesn’t stem from lack of innovation but from the mistaken belief that they could earn profits in the first place. It’s a business truism, or ought to be one, that an innovation must create a sustained competitive advantage or else it merely paves the way for rivals. This truism, by the way, explains the success of the Linux operating system. It became attractive as a standard precisely because no one was trying to use it as the basis for a profitable business. Because the Linux standard is free, the problem of wringing profits from this innovation never arises, which is one way of resolving the pioneer’s dilemma.

The realization that innovators don’t earn profits will cause some suffering on Wall Street. This isn’t all bad.America has made a cult out of the entrepreneur and the innovator -so much so that even within the engineering community people feel they are somehow less if they can’t blaze an original trail. This is unfortunate.Not everyone can, or should be, an innovator.As the computer pioneer Vannevar Bush pointed out in a short essay he wrote for this magazine, titled “The Builders,” there are many important roles in the community of research and engineering. The role of innovator is only one, and it is rarer than most realize. This is good, since most innovators lose lots of money and, in the end, leave for others the hard work of turning a path into a highway. Those who come after and turn the innovation into a practical alternative are no less essential than the innovator-and a good deal better at posting profits.