Second-order effects: What can exist?

I started reading Paul Allen's memoir, Idea Man, and in setting the stage for the founding of Microsoft, Allen talks about monitoring the release of Intel's 4004 chip in November 1971 and then the much more powerful Intel 8008 four months later. 

My really big ideas have all begun with a stage-setting development—in this case, the evolution of Intel's early microprocessor chips. Then I ask a few basic questions: Where is the leading edge of discovery headed? What should existing but doesn't yet? How can I help create something to meet the need, and who might be enlisted to join the cause?

This is clearly an effective approach...

Consider Reed Hastings and Netflix. The below is from A16Z podcast "Tech and Entertainment in the 'Era of Mass Customization.'" Marc Andreessen recalls how Reed Hastings had invited him to discuss streaming video in 2003-2004, and Andreessen told him, "Eh, it'll never work...there are too many technical impediments." Andreessen asked Hastings to walk through how he had thought about it, and here's what Hastings said:

On bandwidth trend. If you looked at median residential bandwidth from 1980 forward, it's completely smooth. We've gone through multiple technologies: dial-up, DSL, cable, fiber. Interestingly, the speeds at which streaming was going to become practical (1-2 Mbps) was completely knowable. Now, we weren't that smart. We knew it was sometime in the future. But—right from the beginning in 1997 we envisioned it. When I was at Stanford you take the classic Tannenbaum computer networking class, and it makes you think about networks differently. You have to calculate the bandwidth of a station wagon filled with backup tapes driving across the country. So you start to think about networks differently. So in 1997 when a friend told me about DVD, I thought, "Oh my god, that's the station wagon." That's this 5 GB packet that you could mail. (High throughput, high latency—24 hour latency but good throughput.) It's that cross-fertilization of metaphor. So we always viewed DVD by mail as a digital distribution network, and we knew that eventually [we would be delivering over the internet]. And that's why we called the company Netflix and not something like "DVD by mail." So we had a slight advantage that we didn't fall in love with our first business. We knew it was a path to something else.

On timing. We knew it was an issue. We went public in 2002, and we said eventually internet delivery would come. We didn't do much with it until 2005, when we saw YouTube. That's when we realized: it's beginning. And that's when we started that effort and launched in 2007. As Clay described, the key thing is not getting into the new business. Lots of companies do that. We knew the key was focusing on it—how this is going to grow into it's own business. But it was too young to do that. It didn't have enough content so we couldn't sell a streaming content service on its own. So we "hybridized" it with DVD. As usage and content grew, we knew we could split them apart. That went until 2010. We did our first test of the streaming-only service in Canada—a new country that wasn't used to our DVD service. We wanted to understand: with the content we had, could we build a service that had word-of-mouth and could grow. It was a rocket ship. In our first three days, we got as many subscribers as we thought we'd have in three months. It was clear you could position Netflix as streaming-only.

On "Innovator's Dilemma" dynamics (old business v new). One of the most painful moments on that journey was that DVD business was all the revenue and profit. We were hybridizing it with streaming, and we were getting more streaming attention (and executives). But DVD was getting more attention. So we realized we had to kick out DVD executives from the main management meeting. They weren't adding value in streaming discussion. We always compared ourselves to a "streaming pure play"—what would we do? [Key is to separate them: Apple did the same thing, just in reverse.]

Consider Marc Andreessen and A16Z. In the podcast, "Software programs the world," Andreessen talks about the falling costs of chips: 

Let me go to the foundations. Moore's Law has flipped. This has happened over the last 7-8 years. For many years, Moore's Law was a process of the chip industry bringing out a new chip every 1.5 years that was twice as fast as the previous chip at the same price. That continued for 40-50 years. That resulted in everything from mainframes to PCs to smartphones. About 7-8 years ago, that process topped out at 3 GHz. Some people said progress was going to stall. I think what has happened is that Moore's Law has flipped. The dynamic now is instead of increased performance is reduced cost. You now have this dynamic where every 1 to 1.5 years, the chip companies release a chip that is the same speed but half the cost. This is a massive deflationary force in the technology force, and I suspect in the economy in general. Basically, computing is becoming free. What we do in this business is we chart out the graphs and assume that we get to the end point. So what we assume is that chips are going to be free. Which means chips will be embedded in everything. And we've never lived in that sort of world. 

Consider Roelof Botha. In Venture Capitalists at Work, Roelof Botha talks about the investment process for YouTube:

On enabling technologies: bandwidth, browsers, and devices. Video had come and gone—for example, with RealPlayer—but never became a huge hit. So what changed that made YouTube possible? At Sequoia, we'd investigated related ideas back in 2004 and 2005. We were keeping an eye on broadband penetration in the US—where was the topping point at which a large enough percentage of US consumers had decent home internet connections? And what new services would that unlock? ... We also kept tabs on the state of browser technology. ... We were listening to semiconductor companies that made the components for handheld devices—devices that made it easy for consumers to capture pictures and videos. 

On consumer behavior. There was the emergence of blogging, photo-sharings services like Flickr, and review sites. People wanted to express themselves through text and pictures; the next natural step was video. 

On the value proposition and product. When I first encountered the website, I uploaded a few videos. In just a few minutes I'd posted them and e-mailed them out. People were watching videos that had been sitting on my hard drive for years. Other video sites at the time had clients that you had to download. Even with the browser-based ones, their products just weren't as good. 

On founder quality. I was lucky enough to know the founders from PayPal. I knew how good they were. And they were fantastic talent magnets. When Google acquired YouTube there were only fifty-five employees. 

And also... We have a predisposition toward the long view. If you were to hold onto the shares of every IPO company we invested in until today, you would have made significantly more money than if you were to invest with us at the venture stage alone. ... People overestimate the impact of technological shifts in the short run and underestimate them in the long run. But the long-run effects are just so spectacular. 

In each of the cases, there were fundamental underlying shifts, or clear trends indicating a tipping point. The second-order effect of a key (or in some cases, many) underlying shifts—chip speeds, chip costs, bandwidth, browser technology, handheld capabilities, consumer behavior, etc.—enabled something new and valuable.