A recent publication by Wharton analyzes the diversification strategies of Internet companies.
As a Wharton graduate I am biased toward agreeing with my former teachers. But it seems to me that they missed a fundamental truth about Internet companies -- they almost always get only one shot at greatness. After that one shot, they survive based largely on inertia and no amount of "adjacent" diversification will restore them to their initial state.
The key to achieving that initial greatness is coming up with a new idea that rapidly becomes very popular. During this phase of an Internet company's development, revenue -- and in some cases profit -- grows very quickly. The rapid growth creates a seemingly insatiable demand for the stock whose stunningly rapid upward rise acts as a magnet to attract Silicon Valley's top talent.
The inflow of talent demands to be expressed in the form of employee-driven innovations. But most, if not all of these innovations fail to generate sufficient new revenue to enable the company to keep growing at the same rate. (It's far harder for a $500 million company to triple its revenues every year than for a $10 million company to do so.)
As the company's growth slows, its stock plateaus and the most talented people move to a startup or to another new great company.
How does this apply to the Wharton article? In my view, Amazon.com Inc.'s (NASDAQ: AMZN) initial greatness in selling books online was not effectively duplicated in its adjacent diversification into electronics and all the other categories. Yahoo! Inc.'s (NASDAQ: YHOO) initial success as an indexer of web pages that attracted web advertising was never duplicated as it added online services and spread itself -- like peanut butter -- into every new product and service that other great companies were introducing. (These two companies trade 53% and 80%, respectively, below their all time highs.) And I sincerely doubt that Google Inc. (NASDAQ: GOOG) -- which became great by offering world-beating search advertising -- will be able to generate significant new revenues from any of the 83 diversification efforts that its employees have created.
Internet companies have an initial shot at greatness, and efforts to diversify inevitably fail. This is partially because they feel so compelled to protect their golden egg that they avoid moving into big new businesses they worry might destroy that core business. It's also because their initial talent and investors generally move on once they've made their killing.
New managers step in with the primary goal of preserving what exists rather than creating something new. Preserving the past does not excite top talent or venture investors. Thus former wunderkinds are transformed into middle-aged plodders.
Peter Cohan is President of Peter S. Cohan & Associates, a management consulting and venture capital firm, and a Professor of Management at Babson College. He has no financial interest in Amazon, Google, or Yahoo.
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