The sub-title of this article could well have been “The Myth of Vertical Integration”, because it is really about why the idea of building vertically integrated space companies is both widespread and mostly misunderstood. I think this myth is a lovely example of something called the “Dunning-Kruger Effect” come to life.
To understand that we need to back up and talk about that effect and then talk about why it matters so much (or should matter so much) to both founders and investors in the space sector.
So, who are Dunning and Kruger and why is there an effect named after them? Well, David Dunning and Justin Kruger are psychologists. In 1999, they introduced the concept that there is a common cognitive bias where individuals with limited knowledge or competence in a particular area tend to consistently overestimate not only their abilities, but also their performance. This has become known as the “Dunning-Kruger Effect”, and it has attracted more research since it was first identified.
It’s a fascinating phenomenon because it highlights how a little bit of knowledge can be a dangerous thing. When people have just enough information to be dangerous, they often don’t realize how much they don’t know. This is known as a state of “Unconscious Incompetence”. This leads not only to an inflated sense of confidence, but also to an inability to objectively evaluate their own performance. Since they don’t know what success looks like, they are unqualified to judge whether or not they are succeeding.
Further research has shown that there is an interesting mirror effect where those who are truly knowledgeable tend to have lost sight of the complexities and nuances which they have mastered on their way to becoming experts. This is known as “Unconscious Competence”. This has the effect that they genuinely don’t understand why those that are not competent don’t see the obvious flaws in their performance.
For completeness – there are two intermediate states between these two. The first is “Conscious Incompetence” which is when you actually begin to understand how much you don’t know. This hopefully is followed by a state of “Conscious Competence” in which you become aware of how much you DO know, but you are still in the process of actively and explicitly improving your knowledge and your performance.
With that out of the way – I would assert that we are currently experiencing a bit of an outbreak of the Dunning-Kruger effect in the space business these days.
When talking to founders of new space businesses – and their investors – I think this outbreak expresses itself in two words: “vertical integration”. This is the feeling that new founders and new investors believe that the right way to “get their product to market” is to control all aspects of its development, deployment, and operation.
The result is that many founders are convinced, and encouraged to believe, that in order to bring their particular niche technology to market they should not just focus on that which they know well, but that they should effectively create their own market by planning to build a satellite, or even a whole constellation of satellites to host a payload that features their particular innovation.
But in this they are fooling themselves. Being subject to the Dunning-Kruger effect they not only fail to realize the level of expertise required to complete all of the tasks necessary to design, build, assemble, integrate, test, launch, commission and operate a complete constellation of satellites. They fail to realize how much of this expertise they do not have. They also do not understand how long (or expensive) it will be to acquire it.
Eventually, though, they will discover the depth of their “incompetence”, as Dunning and Kruger would say. Once they become conscious of this incompetence, they will begin to be able to evaluate the gap between their abilities and what is required to succeed -and compete – in this business.
At that point, they and their investors will have to confront the fact they really cannot expect to successfully complete their vertically integrated project with the team they assembled to build their innovative technology. They will discover that, in effect, they need to procure the ability to successfully complete those parts of the project that exceed the original founding team’s competencies.
Now, they can procure what they need by buying it at market prices from suppliers, or they can attempt to acquire the ability to produce it by hiring existing expertise. In both cases, though, this will be a “procurement” – meaning it will be expensive, and it will not add any more value than it costs to acquire it. In other words, it will not provide any meaningful return on the capital used to buy it.
This cost will almost certainly be substantial. In fact, for something like a satellite constellation, funding the parts of the project that exceed the founder’s competence will likely cost several times what it cost to fund those parts which are within it.
This then backs both the founder and their original investors into a corner. Because they need to use funds to procure “assets” to which they are adding no value, they will have difficult time claiming that their value is actually increasing. This means that they will struggle to raise more capital because their valuation is not increasing – AND – the capital they are planning to raise will not add measurably to their own value – instead it will be destined to fund other ventures – namely their suppliers – or maybe their key employee’s retirement funds.
In short, attempting to vertically integrate will almost certainly be unsustainable for any venture without an inexhaustible supply of either capital, or the “incompetent” investors who are willing to supply it.
I do not think that it is a stretch to claim that where vertical integration has been successful it has been because one or both of these factors have been at play.
This is dangerous because at the current moment in time the space sector is experiencing significant interest from people who are smart, passionate and thoughtful. But they are also incompetent to judge their own abilities or the ingredients in the success of others in this business. They are unable to appreciate why a vertical integration model has requirements that simply cannot be met by most ventures. This becomes and even more dangerous combination as the increasing “velocity” of investment of this type accelerates the problem as the level of Incompetence rises and the level of Consciousness of this fact declines.
The Dunning-Kruger effect is real. It is documented. You cannot avoid it by being smart, or well educated or experienced. You cannot avoid it because you are already successful. You can only avoid it by admitting there are things you might not know – and then working hard to find out what they are. In other words – be curious but be slow to understand.
