Finding Fertile Ground - getAbstract

Finding Fertile Ground Identifying Extraordinary Opportunities for New Ventures

by Scott A. Shane Wharton School Publishing © 2004 256 pages

Focus Leadership & Mgt. Strategy Sales & Marketing Corporate Finance Human Resources Technology & Production Small Business Economics & Politics Industries & Regions Career Development Personal Finance Concepts & Trends

Take-Aways • Entrepreneurs should select industry sectors that provide the best odds for successful start-ups. • Ten rules can greatly improve your chances of success as an entrepreneur. • The first rule is to join the right industry. Start-ups have a much better chance in certain innovative industrial sectors. • Gaining traction is easier in a young industry. • Industries that require basic research or complex production methods are much harder to enter. • Do not try to break into an established industry with already dominant corporations and product designs – you'll probably fail. • Understanding adoption curves enables you to select an advantageous entry point. • Plan to raise barriers to prevent or delay others from imitating your innovations. • Don't try to own everything you need to build your company. Other methods, such as licensing and franchising, are often more practical. • Minimize risk at every opportunity.

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Relevance What You Will Learn In this Abstract, you will learn: 1) How to apply the 10 rules for creating a start-up company; 2) Why selecting the most fertile industrial sector is your most important entrepreneurial decision; and 3) What business opportunities you should view with extreme skepticism. Recommendation Scott A. Shane’s excellent book focuses on technology entrepreneurs – no discussions of starting your own hair salon or sushi restaurant here. In fact, he notes that the original title specified “technology entrepreneurship” rather than entrepreneurship in general, though this is a valuable contribution to entrepreneurship literature. Most works on entrepreneurialism emphasize the personality characteristics of successful entrepreneurs. Entrepreneurs, common wisdom says, are hard driving, charismatic and visionary. Shane turns sharply away from this “entrepreneurial cult of personality,” and presents a strong case that what really counts is picking the right industry to enter in the first place, and then proceeding correctly. getAbstract.com strongly recommends this to entrepreneurs because it guides them to the industries, strategies and perspectives that are likeliest to work. It indeed plows fertile ground.

Abstract “No book discussed high technology entrepreneurship in a way that showed people how to identify a business opportunity to exploit a new technology successfully.”

Choosing Wisely The next time you walk through a crowd, consider this: four out of every 100 people you pass are starting their own companies. In fact, business owners are 13% of the nonagricultural work force in the U.S. Being an entrepreneur, it seems, is as American as apple pie.

“This book identifies the key difference between the successes and the masses – the selection of the right business concept to exploit a valuable opportunity.”

Ten Commandments of Entrepreneurial Entry Entrepreneurs considering a start-up in a high tech field should heed these 10 rules:

The good news is that more new organizations are being formed in the U.S. than ever before. The bad news is that most of them will fail, four out of 10 in their first year. Only one in four will survive eight years, and most of the owners will make less than they would working for someone else. If you hope to be a long-term entrepreneur, perhaps the most important decision you will make is what industry to enter. Restaurants and retail businesses experience a very high incidence of failure, but companies that specialize in technology-related fields have a much greater chance of success.

Rule No. 1: “Select the Right Industry” The first rule of success for starting a new business is choosing the right industry. New firms do far better in some industries than others. Industries have four traits that determine how well a new company is likely to perform once inside the fold. They are: 1. “Knowledge conditions” – Several knowledge factors determine an industry’s receptivity to new entrepreneurs. If a production process is highly complex – the manufacture of aerospace products, for example – conditions are less favorable Finding Fertile Ground

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“So, where do these opportunities come from? What form do they take? How do successful entrepreneurs match opportunities to innovation? How do successful entrepreneurs identify these opportunities?”

“The central goal of this book is to provide you, as a potential or actual technology entrepreneur, with the tools necessary to identify the right business concept.”

“While it wouldn’t hurt to be a good entrepreneur no matter what business you start, what really matters is picking the right business for a start-up.”

“New firms tend to perform better when industries are first born, or are young and growing, than when they are mature or are dying out.”

for a new firm. Similarly, if an industry requires a great deal of groundbreaking knowledge – say, pharmaceuticals – your odds of success aren’t very great because basic research is costly. Codification of knowledge is also important. In industries such as computer programming, a great deal of information is publicly available. Industries that rely on closely held “tacit knowledge” require a much longer learning curve. Pursue an industry where much of the innovation comes from outside the industry itself. In the semi-conductor business, for example, many innovations come from universities, so your company might find an opportunity to be a middleman. This greatly improves your odds. Finally, avoid industries that heavily depend on manufacturing and marketing. You’re probably not going to have the initial capital to set up an elaborate assembly line or to buy extensive advertising. 2. “Demand conditions” – What do consumers seek? How do their wishes translate into their demands of your business? Demand conditions influence an entrepreneur’s success in any industry. Choose an industry with substantial consumer demand. A large market gives you a better chance, because greater demand leads to faster earnings. Rapidly growing markets offer more fertile ground than markets that are expanding gradually – competition is vicious in slowly growing markets. Look for industries with niches and segments that you can reach. 3. “Stage of the industry life cycle” – Young industries are more open to entrepreneurial upstarts, while industries that have been around for a while tend to be set in their ways. By getting into a young market, new companies can ride the growth of the market as more customers adopt their new products. 4. “Market structure” – Study the characteristics of your new market. You have a better chance if you enter an industry that is labor-intensive, not capital-intensive. Avoid industries that rely heavily on advertising, because you’ll be at a disadvantage. Watch out for industries that are highly concentrated between just a few major players; entry will be very difficult. Also, look for industries where the participating companies, on average size, are relatively small. This suggests that the economic forces are conducive to small firms, obviously an advantage for start-ups.

Rule No. 2: “Identify Valuable Opportunities” Being an entrepreneur calls for taking advantage of opportunities when they arise. Be mindful of the types of opportunities likely to come your way. Technological change is perhaps the most obvious opportunity, but there are others. Changes in society generally, including demographic changes, present many opportunities. Some opportunities stem from new regulations and political shifts, or from industries that evolve constantly. Shrewd entrepreneurs exploit those shifts to their advantage – think of how Jeff Bezos and Amazon.com took advantage of the Internet to reinvigorate book selling. Once you perceive an opportunity, match it to the type of innovation you will use. Certain industries are much more receptive to some types of innovation, such as enhancing the scale of production, increasing production process automation, improving yields or boosting performance. Some opportunities transcend new products, including innovative forms of organization or new production processes. To improve your likelihood of finding new entrepreneurial opportunities gather and process as much information as possible about your targeted industry and the changes affecting it.

Rule No. 3: “Manage Technological Evolution” Technological evolution doesn’t happen randomly. To succeed, study its patterns. They may open entrepreneurial doors at specific points in the process. Finding Fertile Ground


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“Much like the typical lottery ticket buyer who dreams of being the jackpot winner, but ends up holding a handful of losing tickets, the typical entrepreneurial effort ends in a business closure.”

Perhaps the most important pattern to understand is the “shifting technology S-curve.” Richard Foster, a McKinsey & Company consultant, developed the S-curve to depict the rate of adoption of any given technology. Graphically, at the bottom of the S, you have a very low adoption rate. At some point, adoption takes off and climbs. As the industry matures at the top of the “S,” the adoption begins to plateau. This curve tells the entrepreneur several important things. First, initial acceptance will be low as you compete against established alternatives. Don’t expect your product to be in high demand right away. Often the best time to enter an industry with a new product is when established companies’ products are at the upper end of the plateau and leveling off. At that point, customers are getting restless for a better mousetrap just as larger competitors are focused on squeezing diminishing returns out of their current technology, where they have investments they cannot abandon. Study product designs in your industry, and observe how they influence the structure of markets. Technical standards, such as the establishment of a CDMA standard for cellular telephones, can be very influential. Entrepreneurial entry will be more favorable before any one design starts to dominate the market.

“The process of developing a new technology company involves the management of significant uncertainty.”

“When a new product is introduced, a small number of customers, called innovators, adopt it immediately.”

“Established companies need to reward people for doing their existing jobs, and this constrains them from rewarding people for undertaking innovation.”

Rule No. 4: “Identify and Satisfy Real Market Needs” It sounds obvious, but to succeed you need to address real customer needs. Focus groups and surveys can help you determine what consumers really want, but they usually aren’t the whole answer. Your innovations must focus on solving real problems, preferably economic ones. Rule No. 5: “Understand Customer Adoption” Consumers adopt new ideas and products based on a curve that moves slowly at first, and then with increasing rapidity. While you ultimately want to satisfy your industry’s mainstream customer base, you may find that you can enter the industry more smoothly by creating products and services that appeal to a targeted piece of the market. This provides a base for making the transition to serving the broader market. When estimating the potential size of your market, consider its dynamics rather than relying on a static snapshot. Study evolving “technology diffusion and substitution.” Diffusion measures how quickly consumers adopt a given technology-based product or service. An accurate diffusion estimate will tell you how big the market will be. Substitution occurs when consumers replace one product or technology with another. Classic examples include the substitution of Internet telephone service for standard telephone service, and the substitution of digital cameras for film-based technology. Substitution tends to negate the “scale economies” of larger competitors. It provides fertile ground for the entrepreneur.

Rule No. 6: “Exploit Established Company Weaknesses” When battling Goliath, it’s better to strike at his weakness rather than his strength. Exploit the weaknesses of the established companies in your market; don’t go up against the things they do best. Established firms, for example, often fixate on the efficiency of their existing operations. You may beat them on innovation, but if you try to out muscle their distribution network, they may crush you. Established companies are weighed down by the need to keep their existing customer base happy. As an entrepreneur, you’re free to invest in any product you want to offer. Finding Fertile Ground


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“While entrepreneurs like to think of themselves as being able to overcome all of the obstacles that life puts in front of them, being a successful technology entrepreneur is really more about playing the odds successfully.”

“Being a successful entrepreneur is much like being a good professional gambler. If you know the games where the odds are least stacked in favor of the house, and you understand the rules of the game you are playing, you can greatly improve your chances of winning.”

Rule No. 7: “Manage Intellectual Property” Large companies sometimes let others innovate, then come in and imitate their successes. You can thwart or, at least, delay this process two ways. The first is to maintain the confidentiality of your innovations and processes for as long as possible. For example, limit the number of individuals who have access to proprietary information, and preserve the information in a form that is tacit rather than written. The second technique is patenting, a critical tool for preserving your firm’s intellectual property. Patents give you the time to assemble a system of vendors and distributors to bring your product to market. Yet, patents carry some serious disadvantages. Defending a patent can be very expensive, especially if you’re up against a phalanx of opposing corporate attorneys. When you obtain a patent, you must explain how your new technology works; this itself can diminish the value of the patent. And patents don’t work well in industries where competitors can attain the same objective easily with alternative technical means.

Rule No. 8: “Appropriating the Returns” for Innovation Proactively creating barriers to copycat firms is always a good idea. Companies that are prepared to do so have a much better chance of thriving. Traditional methods of creating barriers, such as building a brand-name reputation, may not be available to entrepreneurs, but some other tactics are, though not all of them work in every circumstance. To raise the barrier to imitation, perhaps you can gain control over the talent or resources needed to make your product. Or, maybe you can establish a unique, strong reputation and brand, since innovators often gain a first-mover advantage. Another aggressive tactic is to secure assets that complement your innovation, such as distribution outlets. Rule No. 9: “Choosing the Right Organizational Form” Entrepreneurs usually err when they try to own and manage all aspects of their value chain. Instead, you can advance your interests through contractual vehicles that harness other people’s efforts. These include licensing technology, franchising and corporate partnerships. Sometimes it is to your benefit to control rather than to own. Consider alternatives to outright ownership, for example, if you need to move quickly, but aren’t in a position to do so, or if a process requires capital you don’t have readily available. Rule No. 10: “Managing Risk and Uncertainty” Managing risk, or exporting it to other parties who can manage it better, is practically an art form. Certainly, some risk is unavoidable. However, you can manage and minimize the risks you face by taking these steps. First, gather as much information as possible before you make decisions that might raise your new firm’s risk profile. Try to minimize your investment in assets, especially if you won’t be able to recoup your investment if your venture fails. Don’t maintain a death grip on an approach that isn’t working – be willing to change your company’s direction quickly if new opportunities arise.

About The Author Scott A. Shane, Ph.D., has written more than 50 articles on innovation management and entrepreneurship, as well as several books on entrepreneurship. He is a professor of economics and entrepreneurship at the Weatherhead School of Management at Case Western Reserve University and previously taught at MIT’s Sloan School of Management. Finding Fertile Ground


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