This the sixth and final installment of the this series on the New Space Revolution. If you have not read the previous articles you may want to do that as they will provide useful context for this one. Over the course of this series I have talked about how the advent of new space companies based on a new business model that was made possible by a combination of dramatically falling launch costs combined with dramatically increasing ability to produce more and more capable satellites in smaller and smaller packages.
We also talked about how the those businesses have evolved and how the response of large legacy space companies and government have also shaped the evolution of the industry. In the last article I made the argument that the most aggressive innovation in the space sector is now largely concentrated amongst smaller companies and that this drive for innovation is being fueled by private risk-capital. The net effect has been, over the past few years, increasing fragmentation at the small end of the market and that this fragmentation has also led to the opportunities for and the development of small companies with key enabling technologies.
And while it is true that this fragmentation is generating significant opportunities, it also presents some significant challenges and that is what I want to examine in this article.
In a nutshell, I would say that the challenges arise from the interaction of two factors. The first of these is what I referred to in an earlier article as the “Cheap-Space” effect or maybe more appropriately the “Cheap-Space” myth. The second of these factors is external to the space sector and it has to do with the shift in the investment climate over the past two years.
The effect of the “Cheap-Space” myth is that, to put it bluntly, getting a business that is based on space assets up and running is just more expensive and time consuming than it may appear to be. This is especially true for those who are new to the space sector. As I discussed in part four of this series (Size Matters) there are aspects of designing, building, and successfully deploying spacecraft whose complexity and cost have not been entirely alleviated by the dramatic decrease in launch costs.
In some cases, these costs may not even necessarily be associated with building a single first version of a working spacecraft – but rather they are costs associated with being able to replicate the initial success in a reliable and robust way in order to satisfy the on-going demands of the market. As a result, founders and their investors may find that while they have some early success, achieving the critical mass of technical proficiency and operational experience necessary to run a viable business may take more time and more funding than they initially believed. Sometimes a lot more.
And this is where the reality of the Cheap Space Myth collides with the reality of the current investment climate. Because we haven’t discussed the investment climate in any detail, I think it’s important to say just a few words about investment and the role it plays in the life of new space companies. I suppose it would probably be more accurate to say that I’ll say a few words about my impressions of how it works. I hasten to point out, that this analysis is purely my own, and based purely on my personal observations from working with founders and their investors and advisors.
The thing that I have realized from this interaction is how important investor “sentiment” really is. In other words, while each investment decision is judged on its own merits to some degree, the larger investment climate is more critical than one might assume. This is because investing is not just about how much you pay for something. Investing is actually mostly about how much you think you will sell that thing for.
In other words, when investor sentiment is running high, investors are not only more willing to invest, they are willing to support more aggressive valuations for companies because they are much more willing to believe that valuations will continue to grow in the future.
In such an environment requiring more cash and more time than expected to achieve your business goals are not insurmountable issues. If investment sentiment is positive and valuations are generally rising, then raising more cash may mean giving up some value due to having your investment diluted. But, even if the terms on which that dilution occurs are not very palatable, they will be possible.
But, if, on the other hand, investor sentiment is trending negative, it will be much harder to raise future rounds of funding at all because it will be harder to convince new investors to accept higher valuations. Further, knowing that valuations are not rising quickly investors will be less likely to invest as much in the first place and will do so at terms that founders find less attractive.
All of which is to say that the sharply negative trend in investor sentiment over the past two years has had a dramatic effect on the amount of cash available to new founders. There is a lot less cash available in the deals they are able to secure, and there is much less likelihood that they will be able to engage in multiple rounds of funding.
You can see, therefore, that when this sudden dramatic contraction in the amount of cash is combined with the Cheap Space myth the effect can pose a significant challenge. Compared to three years ago, there is much less margin for error on how much time and cash will be required to get to space and operate reliably from there. Business plans that were made on the assumption that subsequent rounds of funding might be required to complete them are suddenly very much at risk.
Companies who expected that the principal value in their idea would be their innovation and that the means of delivering that innovation would be a small part of their overall cost structure are finding that this is not so. They are finding that while they might have sufficient resources to develop and even perfect their proprietary technology they are struggling to find the financial means to get it to orbit and provide the necessary infrastructure to operate it reliably. They are finding that integrating their innovation into a satellite and deploying the means to operate that satellite and deliver products and services to customers is much more difficult and expensive than they had planned for it to be.
In the worst case, these companies may fail before ever getting to market. Or, in the best case may have some initial success, but will find that is difficult to maintain and build on because their solution is not robust enough. While this may not necessarily be fatal and the venture may survive, it will probably find that more capital is needed (possibly much more) before it is able to achieve the scale expected by both the founders and the original investors.
But what about the enabling firms that we talked about in the last article. Well, for these companies the current situation may also pose significant challenges. This is because the combination of the expectations set by the Cheap Space Myth and cash constraints imposed by the contracted investment environment mean that many enabling companies may find that their services are not deemed to be affordable.
This is because, to some extent, their essential value proposition are based on achieving a minimum scale where they are rapidly accruing experience by working for many customers. Thus the slower they are to achieve scale, the harder it will be to justify their prices – which in turn will make it harder to attract customers. Thus, the inability to find customers who can afford their offerings is a very real threat to their business models.
So, the combination of the contraction in available capital and the unrealized expectation of how “Cheap” space is actually proving to be in practice is a significant challenge for the entrepreneurial end of the space market today.
The challenges faced by small companies in this fragmented and uncertain investment market will likely come in two forms: diversification, and scale.
Scale, as already mentioned is kind of obvious. There is a minimum critical mass that has to be achieved to benefit from, literally, economies of scale where there is enough work and enough staff to spread across that work to be efficient, but also to have enough work to provide the opportunity to refine products, services and processes, and to allow staff to gain experience and expertise which in turn lowers costs and increases reliability.
The effect of diversification, is similar. Or rather, maybe it is more correct to say that diversification is the enabler of scale. By diversifying products and services a company is not limited by growth in one market segment. This presence across segments allows companies to find more potential customers. But, critically, it also affords the opportunity to provide more products or services to each customer. So, in effect, cross-segment capability can enable exponential rather than linear growth.
But, scaling up by diversifying internally is a challenge. A significant challenge, in point of fact. Each new product or service is, effectively, a new venture that, initially places a strain on resources both human and financial. Each new product represents a technical risk as the company has to perfect new technology, develop new products and assimilate the skills to build and deploy them. These kind of resource commitments are, frankly, beyond the means of most startups – particularly in this investment constrained environment.
So, one answer to the need to diversify and scale is to consolidate rather than to grow organically. Combining separate entities, even ones with quite disparate offerings, provides the opportunity for immediate diversification and scale without the need to “bootstrap” based on the resources that can be generated from the operating business.
Further, when done well, such consolidation, provides each of the combined component entities with the benefit of scale because commonly used skills can be spread across all of the component thus achieving the much sought after economy of scale. Also, when done right such consolidation also provides the opportunity for each of the component businesses to reinforce the others by cross referrals of customers and sales channels – thus accelerating scaling.
Again, this sounds obvious, and attractive. But there is a catch. That issue, of course, is that such consolidation requires capital. Often a significant amount of capital.
It also requires founders of the component businesses which can be convinced to join forces ( for which, see need for capital above).
Finally, it also requires a fairly unique set of business skills. Make no mistake that combining disparate skills, business models, and cultures requires a fairly rare combination of business acumen leadership and vision.
On the other hand, it is exactly the significance of these challenges and the rarity of these skill sets which will make effective consolidation extremely lucrative. Because, of course, in a market where there is significant sensitivity to price, companies that can achieve critical mass and make use of economies of scale will have a significant competitive advantage over their competition.
It is this effect, which to some extent always drives the consolidation phase of the Innovation-Disruption-Fragmentation-Consolidation cycle. When disruptive innovation first occurs, the value of the innovation is high. This because the innovation is unique or rare. As these disruptive effects become obvious there are more entrants into the market – resulting in fragmentation.
But as the innovation becomes less rare – customers can compare competing solutions – and invariably this comparison begins to involve price. Eventually, the companies that survive are those that can innovate efficiently. In other words, companies that can offer the benefits of innovation less expensively then their competition. And, as we just discussed, diversifying and scaling up is an excellent way to achieve this efficiency.
So, at last, we arrive at the end point of this six part argument. And that is, that the new space sector is, or soon will, enter a phase of consolidation.
In summary, the argument is this. The New Space disruption of the last decade was really about innovative business models that took advantage of significant shifts in the costs of getting to and operating from space. The established space market responded to this disruption by adapting their own practices to allow them to take advantage of these new business models. But the established players did not revolutionize their business practices.
The effect of this initial reshuffling was to leave a portion of the New Space market open for innovative new players. This portion of the market, though, generally consisted of smaller scale opportunities which were more suitable to start-up scale companies. This caused a significant growth both in companies pursuing novel applications of space technologies but also in companies that were founded in order to enable the development and deployment of these innovative solutions.
Thus we have had innovation which caused disruption and market reaction that, in turn, generated an expanding but fragmented new market. If the investment climate had continued to be as positive as it was in 2020, this expansion and fragmentation might have continued for some time. However, the sudden collapse of investor sentiment in 2021 suddenly brought sharp limits to the availability of capital to start new projects and to complete those already under way. This, in turn, has meant that this part of the market much more cost sensitive which means that companies are increasingly finding that they cannot depend solely on innovation, they must also pay attention to efficient operations.
And that drive for efficiency sets the stage for consolidation. We may not be there yet and it is not clear what form the consolidation will take – or who the main players will be. But, consolidation is coming.