If you’ve ever witnessed two young children sitting side by side, playing by themselves and only occasionally looking up to interact or maybe take a toy, you’ve seen what psychologists term “parallel play.” It’s a normal part of social development — and, according to a new paper, a powerful analogy for how companies in emerging markets can develop successful business models.
Coauthors Rory McDonald and Kathleen M. Eisenhardt had been studying new ventures in the fintech space for several years when they began to notice a pattern among an emerging cohort of “social investing” companies: The most successful companies in the new industry weren’t worried about being different from their peers. In fact, the executives would occasionally look around and borrow a good idea or two.
“It was a eureka moment,” says Eisenhardt, the Stanford W. Ascherman, M.D. Professor in Stanford’s Department of Management Science and Engineering and the faculty co-director of the Stanford Technology Ventures Program. The way these companies interacted with other social investing startups reminded her of watching her children play when they were preschool age. At that stage of development, she says, kids “like to have a friend there, but they’re really not playing with that friend.”
The successful companies were behaving in the exact same way, she and McDonald realized. “It was parallel play,” she says.
Over time, Eisenhardt and McDonald (who earned his PhD in Management Science and Engineering at Stanford and is now a professor of business administration at Harvard Business School) developed the analogy into a paper they published in Administrative Science Quarterly, arguing that successful startups engage in the same kind of playful experimentation that preschoolers do as they play alongside one another.
It’s a powerful and instructive analogy. “I don’t think people tend to associate entrepreneurs with three-year-olds,” Eisenhardt says. “But I think what really unites the two is the idea that both of them are learning about a new world.” The contexts are different, but “the fundamental focus on learning — as opposed to competition — is the critical insight.”
Resolving the business model conundrum
The last two decades have seen a revolution in how firms make money. In the past, a company like Apple or Cisco would create a product and sell it — simple as that. Today, the nature of innovation has changed, Eisenhardt explains: “AirBnB does not, on its own, create value if there are no homeowners who want to participate. Yelp doesn’t create value unless people review. That’s really quite different from building a better product.”
In other words, business models themselves — how companies are organized and generate revenue — have become a source of innovation. Eisenhardt wanted to understand how successful companies went about developing these business models, a process few other studies have addressed.
She and McDonald decided to study the social investing market, which combines financial investment with social networking. “The general idea,” they write in the paper, “was to create an online investment community (amateur investors who would offer advice, seek advice, or both), identify its most skilled members, and monetize their investment strategies.” In 2007, when the idea of social investing emerged, many entrepreneurs thought the concept had promise, but no one knew exactly how such a company would be structured.
Five companies — about the same in size and created by entrepreneurs with similar backgrounds — entered the market at about the same time. McDonald and Eisenhardt followed these ventures from their creation in 2007, conducting real-time interviews with key players at each company, as well as industry experts. (To ensure candor, they promised anonymity to the companies and interviewees.) When the researchers finished data collection, they developed detailed case studies of each firm, relying on these interviews, archival materials such as news articles and press releases, and financial data. The aim was to understand why some of the firms thrived while others failed.
Why your peers may not be your rivals
McDonald and Eisenhardt discovered that the most successful social investing firms were surprisingly unconcerned about their peers – indifferent, in other words, to the other kids sharing the metaphorical sandbox.
In fact, the leading company, which the researchers call “Zeus”, made a deliberate decision not to focus on competing with other young firms, which they felt would lead them to “[worry] about the wrong things.” They didn’t systematically track what other social investing startups were doing. What little they knew came from media reports or conversations with other customers.
The rationale for this counterintuitive approach was simple: Why worry about another equally insignificant venture when you can go after substitute offerings from larger firms, such as Charles Schwab and Fidelity? Several Zeus executives used a golf analogy (“play the course, not the players”) to characterize this approach.
In contrast to Zeus, the leaders at the low-performing “Icarus” dismissed traditional asset-management firms as “irrelevant and stodgy.” It never occurred to them that they could persuade the customers of legacy firms to invest some of their money with Icarus instead. They focused on Zeus, which one Icarus leader deemed their “chief competitor.” So did fellow low-performer Phaeton, much to their later regret. “I think we were paranoid about the wrong people too early,” one executive lamented.
Borrowing your way to a business model
Not only were the most successful companies noncompetitive with peers, they — just like the preschooler who borrows a toy or mimics a playmate’s game — occasionally echoed them. Zeus, for instance, noticed that a peer had a good user interface, so they copied it, rather than devoting time and money to creating something new. Another successful company, “Hercules,” took the same approach, also borrowing the basics of its user interface from a peer.
In contrast, Icarus built a user interface from scratch — even though another peer had already developed one that they found impressive — and wrote proprietary algorithms to scrape data from brokerage accounts, rather than using a financial analytics firm like Zeus and other peers did. They felt novelty was key to their survival. Regrettably, the result was that Icarus spent most of its initial funding on these technical elements, and so took longer than Zeus to launch a prototype. The company’s push for uniqueness came at a cost.
The importance of occasional borrowing was surprising to Eisenhardt. “Most of business is about competing and being different. It’s not about ignoring whether or not you’re the same,” she says. But in nascent markets, when no one is sure which sorts of novelty and differentiation really matter to customers, borrowing nonproprietary elements from other companies doesn’t hurt. In fact, clever copycatting allowed companies such as Zeus to conserve their resources and energy for more critical aspects of their businesses.
By engaging in parallel play and borrowing from peers, Zeus bought themselves the time and freedom to learn more about their customers and product. When the company released a “good-enough-for-now” version of their platform, the team sat back and waited.
During this pause, instead of running many trial-and-error tests on their users and playing with new features, Zeus mostly observed who was naturally attracted to their rather generic social investing platform. They learned that it had many more customers among professional investors and aspiring money managers than they had initially realized. When they resumed work on their platform, they spun that insight into a fully-fledged business model: Connect professional investors and aspiring money managers to clients who were eager for professional money management but also desired the low fees and transparency that their social investing business model afforded. By the end of that year, even an executive at a peer company had to admit that they “Nailed the deal…. Their business model is strong.”
Like the decision not to compete with peers, pausing before elaborating on a business model goes against conventional wisdom about how startups thrive. Yet it was clear to McDonald and Eisenhardt why a brief break was so helpful to a company like Zeus. Some say companies should move as fast as they can, but “to go as fast as you can, you have to know where you’re going. If the world is ambiguous”— like the social investing market was at the beginning — “you can’t really see the path forward very well. So there is often value in waiting for the world to clarify,” she explains. Zeus succeeded partly because it conserved its fuel, and only accelerated when a clear business model revealed itself.
Parallel play vs. lean startup
On its face, the popular “lean startup” methodology, which emphasizes customer discovery via open-ended prototyping, has a lot in common with the idea of parallel play. Yet Eisenhardt thinks the concept of parallel play can help entrepreneurs solve business challenges that aren’t addressed by lean startup. “Parallel play is not inconsistent with lean startup,” Eisenhardt says, “but it’s missing some insights.”
For instance, while lean startup emphasizes a company’s relationship with customers, it doesn’t tell entrepreneurs how to identify which firms are their most important competitors, or – crucially – how to interact with the players – large and small – that inevitably flock to a new market.
The success of Zeus suggests that new ventures in emerging markets shouldn’t spend much time worrying about competing with other startups, and may at times even benefit from copying them. Rather, it’s better to focus on Goliath — the big, legacy firm you hope to supplant — than to sling stones at other Davids.
Ultimately, what the “parallel play” concept offers is a roadmap for how entrepreneurs can learn about a business space whose rules and horizons aren’t yet clear. In these situations, McDonald and Eisenhardt find, the best thing you can do is get in touch with your inner preschooler: Focus mostly on the tower in front of you, borrow a block from your playmate if it’s better than the one you have, and watch out for the older kid who wants to knock the whole thing over.