Can you invest in a copycat and still look at yourself in the mirror?

by Om L. Lala

In our most recent LTV class, Fred Wilson noted that he could never bring himself to invest in a “copycat” venture that simply borrows an idea or business model that has already succeeded. Baidu, Mercado Libre and other tech companies in emerging markets were referenced as examples. He argued that such copying was morally questionable and that from a personal perspective, investing in such a company would make it “difficult to look at [him]self in the mirror.” (To clarify, Fred was not referring to stealing specific intellectual property, which is simply illegal, but using an overarching idea or business model already developed by another entrepreneur).

At first, Fred’s argument resonates with most people. To the extent that an entrepreneur is able to serve society by creating value and meeting an unmet need, he or she is entitled to profit from the value created. And viscerally, it feels right to say that an entrepreneur who borrows an idea is far less entitled to profit than the entrepreneur who first conceived it. The original entrepreneur does the hard work of testing hypotheses and takes numerous risks to succeed. But upon deeper analysis, this initial feeling we all have (including myself), incorrectly overemphasizes the importance of the idea itself in creating value, and undervalues the importance of execution quality and speed, level of consumer choice, and the additional innovation generated from increased competition. Also, it is often incorrectly assumed that copycats cannot offer anything new and creative or meet needs not currently being met by the original firm.

If an original venture were already meeting all of its customer demands completely, then a copycat would not be able to enter a market or compete. In fact, it is only because the copycat can meet a demand not currently being met by the original venture that it is able to succeed. For example, one may argue that Baidu was simply a copycat of Google in China. But, Google was not meeting all the demands of the Chinese market and was perhaps too slow to make faster penetration a top priority. So, Baidu offered a means to meeting demand, not only by scaling faster but by offering an interface that is tailored to Chinese consumer preferences e.g. a more crowded web layout, which is popular in China.

A company that is the first to conceive and execute an idea is many times not the company that ultimately offers the best version of the product they create. For example, Friendster and MySpace existed before Facebook, and one could argue that Facebook in many ways was just copying a pre-existing idea. But Facebook executed the idea in a different way and offered a different interface that ultimately appealed to consumers more. Similarly, Apple invented the PC and envisioned a world with a PC in every home, but it was Microsoft that became the winner in the PC market, yes partly because of unfair monopoly practices that were reprehensible, but also because they were able to offer productivity and business software tools that Apple did not.

Furthermore, so much of innovation and originality is driven by competition, and if no one invested in copycats, first movers would not have as much incentive to move quickly or improve their products to better satisfy consumer preferences. Thus, I feel that the reluctance many VC’s may have to invest in copycats is based more on a desire to be original, create something new, and perhaps most of all not see themselves or be perceived by others as profiting from investing in a business idea that has already been proven by others who worked harder and were willing to take greater risks earlier. But while an individual may feel uncomfortable with investing in copycats or may fear the reputational risk of doing so, there is no unequivocal moral reasoning that it is wrong. The very existence of a viable opportunity to enter a market as a copycat means that the original firm is clearly not yet meeting all demand and that there is room for you to add value. And if you are able to better execute an idea that is not your own, or make improvements to an idea that is not your own, it in fact only increases competition and the chances that maximum value, innovation and consumer choice will be created as swiftly as possible.