Why catching the third wave is sometimes the best strategy

July 10, 2024

“Why now?” This is a key question we always ask ourselves when considering an investment.

The race to be first to market is often seen as the ultimate measure of success. However, in the world of deep-tech, where developing science and engineering-based solutions to address complex problems is filled with significant challenges, the reality is far more nuanced.

Why? Because:

  • The objective of venture capital is to drive businesses to achieve scale – but scaling can only happen when a market and product successfully ‘cross a chasm’ and are embraced by the majority.
  • The level of technology risk associated with deep tech is inherently high which means market risk needs to be lower.

Before exploring our thinking into why investing in third movers can be the best strategy, it’s important to highlight that deep-tech and SaaS represent fundamentally different asset classes with distinct journeys to achieving scale.

Deep-tech involves longer development cycles and higher technical risks, while SaaS typically focuses on quick development, rapid market penetration and customer acquisition. Given these differences, each demands specialised investment strategies to support their unique hurdles and capitalise on their respective growth opportunities. Consequently, the approach deep-tech venture capital investors take differs significantly from those focusing on SaaS.

Introducing the concept of the third wave:

If, as venture investors, our goal is to support deep tech opportunities with the potential to capture large markets, then timing is everything.

In the same way that Henry Ford transformed the automotive industry by innovating production methods to make cars affordable for the average consumer, we seek to back companies that can answer the critical question, 'Why now?'.

Rather than focusing solely on first or even second movers, we look at invest in enabling innovation - companies that have matured to the point where they can offer their product at a competitive price. We find these are generally third movers which have the potential to broaden their target market and position to achieve scalable growth.

First movers are typically at a stage where they don’t know what the customer wants and so they often try and fail. Importantly, investors also don’t know what the market wants and so there is a risk of investing into a bubble or even worse, a non-existent market. Fora SaaS venture, once the customer is fully understood, a company can easily pivot and update its product to address a market. However, with deep-tech’s high capital costs and long R&D cycles, pivoting is much more difficult.

Second movers on the other hand, have the capability to observe real customers to form a view on likes and dislikes, to enable the launch of an improved product that addresses a customer need. However, second movers often have not simplified an innovation to deliver it at a price that enables scale. Even if they have secured a significant proportion of the market, they risk being disrupted by eventual commoditisation of a third mover.

The advantage of catching the third wave:

The journey from concept to commercialisation in deep-tech is highly risk, requires patient capital and the timeframes are long. Aside from highly niche medical markets and chemical compositions and methodologies with robust IP protection, following the establishment of a dominant design, most products will eventually commoditise, and therefore scale – the Gartner Hype Cycle (below) illustrates this journey.

Third movers have a strategic advantage.

By entering a more mature market where the initial groundwork has been laid and the technology has been further refined, third movers benefit from greater market clarity and acceptance, and can avoid the volatility and inflated expectations that often accompany the initial hype cycle bubbles of first and second movers.

In simple terms, third movers have the benefit of sitting back and observing the market to clearly understand what the customer wants. With this clear focus, they can develop a product that can be delivered at a price that can address the widest possible market. This reduces market risk, which is crucial in deep tech as investors often find it challenging to tolerate both high technological risk and market risk.

There are many notable examples of third movers winning from our daily lives: social media(Facebook), search engines (Google), desktop chips (Intel), GPU's (Nvidia). These third movers displaced the companies that launched prior to them.  

 Illustrating the advantage using the Gartner Hype Curve:

Third movers are more likely to be taking on a market well after the ‘trough of disillusionment’ phase, when growth expectations are more likely to be real and where a more balanced and informed market landscape can be leveraged.

For investors, the phase after the trough of disillusionment presents a strategic opportunity as its generally the period when overstated expectations are being/have been moderated, and more realistic and sustainable growth prospects are emerging, particularly in industries that are not merely disruptive but transformative, creating entirely new product categories and markets.

Even though third movers are in a race against their competitors, because they are more likely to deliver a product that can reach the masses and be competitive in the long-term, and so are more likely to be able to generate a long term sustainable business. This can facilitate a potential ~20 – 50x investment return given sufficient time in the market.

The Gartner Hype Cycle

How Bovonic caught the third wave:

Our portfolio company, Bovonic has executed on this strategy.  

Bovonic has observed the first generation of mastitis screening technology, which is manually collecting milk in cups and sending it to a lab, which was too labour intensive, slow and expensive. Second generation tools solved the labour and time problem through automated systems, but were close to $2000 per bail, which resulted in a 1:1 benefit to cost ratio. Unsurprisingly only 5-10% of NZ dairy farmers adopted these products.

Benefiting from observing the market, Bovonic realised that if an automated detection system could be delivered for $500 per bail, then a 4:1 benefit to cost ratio could be achieved which would enable scale. Bovonic has now secured $400,000 in pre-orders in a short period of time.

In this graph, which illustrates the key trends that are shaping the future of our food, Bovonic is classified as a food robotic a.k.a a rising star that has the potential to have a transformative impact.

Source: Digital Food Lab

So, what about first & second movers?

First and second movers can be successful, but they need to operate in spaces where IP protection is strong or can move very fast and be acquired quickly before limitations manifest and their competitive landscape further develops.

For investors, first and second movers could provide a quick 3 – 10x investment return but are at significant risk of failure if not acquired at the right time.