In a new book from Wharton School Publishing, alumnus Scott Shane, G’92, identifies key factors for success for high-tech startups.
If you’re starting a business, your best odds of success are in high technology industries — not just computing and telecom, but also biotech, aerospace, electronics, manufacturing and materials, medical devices, pharmaceuticals, robotics, and other knowledge-intensive fields.
In a new release from Wharton School Publishing entitled Finding Fertile Ground: Identifying Extraordinary Opportunities for New Ventures, Scott Shane, G’92, identifies the drivers behind the world’s successful knowledge-intensive startups and offers readers strategies for aligning those drivers behind their own businesses. Along the way, he shows how to account for critical issues such as network externalities, and the emergence of dominant designs and technical standards. In short, Shane’s book offers entrepreneurs the tools they need to beat the odds; in fact, David Courtney, Executive Vice President and Board Member of TiVo, Inc., has called the book “a ‘must read’ for anyone considering starting a new venture.”
Shane, who is a professor of economics and entrepreneurship at the Weatherhead School of Management at Case Western Reserve University, has authored over 50 scholarly articles on entrepreneurship. His other books include A General Theory of Entrepreneurship, Foundations of Entrepreneurship, Academic Entrepreneurship, and Wealth Creation and Entrepreneurship. He also edits the Innovation and Entrepreneurship Division of the leading scholarly journal, Management Science. He has taught at MIT’s Sloan School of Management, Georgia Tech’s DuPree School of Management, and the University of Maryland’s Robert H. Smith School of Business.
In the following Q&A, excerpted from Soundview Executive Book Summaries, Shane answers questions about his new book and navigating the high-tech startup field. (The complete interview with Soundview editor-in-chief Chris Murray is available on an audio CD included in Shane’s book.)
Q: What is a high-technology venture?
A: These days, when you turn on CNBC or read the Wall Street Journal, and you hear or see the word “technology” to describe something, it is usually in reference to IT companies. This book uses the word “technology” in a broader, more traditional sense. Technology is the embodiment of knowledge in ways that make it possible to create new products, exploit new markets, use new ways of organizing, incorporate new raw materials, or use new processes to meet customer needs. Certainly, information technology — the use of zeros and ones in digital form on computers — is an important technology, but there are many other important technologies as well. Biologically based technologies, such as those used to create new drugs or to clean up pollution, are also important. Similarly, mechanically based technologies, such as those that make pumps or valves, matter. New materials, such as those in new ceramic composites, are valuable.
Q: You say that high-technology ventures have a greater chance of success than low-technology ventures. Why is a high-technology business more likely to be successful than a low-technology business?
A: High-technology businesses are based on advances in technology— developments in materials, drugs, software, equipment— that make it possible to develop new products, design new production processes, create new ways of organizing, and target new markets to meet customer needs that could not previously be satisfied, or satisfy those needs in a way better than the competition. They also provide ways to capture the returns to entrepreneurship so the profits go to the entrepreneur, not imitators. This can be done much more easily in high technology than in low technology. And the numbers reflect that.
Q: Also, doesn’t the mass of dot-com busts indicate that online ventures are just as risky or riskier than off-line ventures?
A: Even at the height of the dot-com bust, a smaller percentage of dot-com start-ups went under than the percentage of new restaurants or retail stores. So, no, dot-com ventures are less risky than typical retail businesses.
Q: You say that “if you start a biotechnology firm, your chances of success are much greater than if you start a restaurant.” That seems absolutist. Aren’t there situations that change that equation? For example, I live in a rural community that is booming with new home construction, bringing in hundreds of middle- to high-income families to the area. There are great opportunities for entrepreneurs in that area, because there is a huge demand that is not being met — including for restaurants.
A: To be successful, an entrepreneur needs to identify a need, find a way to satisfy that need and come up with a way to keep others from imitating the solution. The problem with restaurant businesses is twofold — first you might benefit from some local demand, but there are going to be limits to how large your business can be. If you develop a drug that cures heart disease, you have worldwide unmet demand that is very large. There is no world-wide unmet demand for your restaurant. Second, you can patent your drug, making it difficult for others to imitate you. But your restaurant can be imitated. If you see excess demand in your area, so will others. They, too, will start restaurants. The number of restaurants founded in your area will be proportional to this excess demand and, unless you have something that makes you better than the competition (perhaps your mother’s secret recipes), you will not capture the profits.
These forces are what show up in the data. The average new restaurant’s rate of becoming an INC 500 or IPO firm is about 1/265 that of the average biotech firm.
Q: In your book, you discount the so-called entrepreneurial skills and attributes. Others have argued that there are personal keys to success an entrepreneurship, including risk-taking, hard work, vision and so forth. Do you believe that anyone can be an entrepreneur no matter what their personal characteristics, or is your point that anyone can fail as an entrepreneur, no matter what their personal characteristics?
A: Having done a great deal of research on entrepreneurship, two patterns are undeniably clear. First, there is no robust evidence that entrepreneurs are more risk taking, harder working, have better vision, etc., than other people. Most people want to believe that entrepreneurs are special because of a concept psychologists call the fundamental attribution error. That is, people have a tendency to attribute success to human factors even when structural factors explain performance. So we want to attribute the disproportionate success of software entrepreneurs over the past 30 years to the people founding those companies. However, in reality, it is the fact that these people identified valuable opportunities in software that explains their performance.
Second, even if someone has great personal characteristics, that won’t stop them from failing as an entrepreneur if they select a lousy opportunity for a new business. Swimming against the tide is exhausting and often futile. Entrepreneurs are much better off picking valuable opportunities and going with them.
Q: You spend some time in your book looking at the issue of customer adoption patterns. What are adoption patterns and why are they important to entrepreneurs?
A: Adoption is the rate at which new products or services are chosen by potential customers. Adoption is important to entrepreneurs because the pace at which new products and services are adopted by customers is not linear — it takes the form of an S-curve. Most markets are made up of a normal distribution of customers. Take DVDs as an example. A small number of people adopt early and late, but most adopt in the middle. This pattern means that markets grow slowly at first, accelerate and then slow down their growth. Entrepreneurs need to understand these patterns because they influence how to project demand, how to develop products that satisfy customers, and how to compete with other firms.
Q: What are some of the specific questions that entrepreneurs should ask themselves about market adoption before deciding to launch a new product?
A: You want to ask yourself the following questions: What adoption pattern do I expect my product or service to follow? Why will innovators buy my product? Why will the majority of the market buy my product or service? Why do customers have a compelling reason to buy? How large is the market that I am planning to enter going to be? What will influence how fast my product or service will diffuse? What products and services will my new product or service substitute for?
Q: You emphasize that this book explains how to identify a business concept that can support the development of a successful technology-based business, which is important because the performance of technology-based businesses depend on a variety of factors that are not present in businesses not based on technology. Can you explain some of those factors, and why they don’t apply to non-technology ventures?
A: Technology-based businesses differ because many of them are based on increasing rather than decreasing returns. Agriculture is an example of something based on decreasing returns. The more land you farm, the worse ground that you have to exploit. A web auction site is an example of something based on increasing returns. The more customers you have for it, the higher the returns because the more attractive your site becomes for selling products. Many things are different in increasing returns businesses — how you price products, market entry strategies, ways to work with other companies. So you need to know that to be successful in a high-tech new venture. But low-tech businesses, which are often based on decreasing returns, demand different approaches.
Another factor is intellectual property protection. Patents matter a great deal in technology businesses. For example, in biotechnology they are a crucial competitive advantage. However, they don’t matter very much in retail. So a technology entrepreneur needs to understand intellectual property laws much more than does a non-technology entrepreneur.
Q: One of the subjects you cover in your book is the evaluation of customer needs for new products. How can you tell if a customer is going to need your product? And, is need even the right term? It seems that in today’s affluent society, luxury items that are not needed, per se, are very successful. Plasma screens for example are hardly needed. Everyone has TVs. Yet they are upgrading to this luxury item.
A: Need is subjective. You don’t want to think in terms of what customers have as their absolute physical needs. If that were the case, all we would need for shelter is a roof over our heads. Customers need something if they have something that they want and that want is unsatisfied by existing solutions, or if your solution is superior to that offered by others already satisfying a particular want.
Q: The ideal for an entrepreneur is to enter a field in which there are no competitors. But sometimes, entrepreneurs will be going against established businesses. However, you say that this may be an advantage for the new firm. What are some of the disadvantages that established businesses may have against new businesses?
A: Even the best established companies have Achilles heels by virtue of being established entities. Such things as seeking efficiency, exploiting existing capabilities, listening to customers, exploiting an existing organizational structure, and rewarding people for doing their jobs, provide advantages to established companies in many settings, but make it difficult for established companies to compete with entrepreneurs to exploit many opportunities. Successful entrepreneurs exploit these points of weakness by focusing on opportunities in which these things offset the advantages that established firms have over new firms.
Q: One of your rules of success is to successfully manage technological transitions — understanding how technology evolves so you can be at the forefront of technology, where starting a new business is easier. What is the single most important issue that entrepreneurs need to be aware of concerning technological evolution?
A: Timing the point of entry is crucial. If you start too early, before the technology takes off, you will run out of cash and not capture the transition. If you start too late and the new technology has taken off, you run the risk of not having the first mover advantage or being behind on the learning curve.
Q: One thing that fueled the dot-com boom followed by bust is hubris — people overestimated how important the Internet was or how much it changed everything. Do you have any cautionary words in your book about this, what I’d call, e-hubris?
A: People have always engaged in hubris with new technologies. If you look back at the telegraph ventures in the mid-19th century, the new automobile industry, the new electricity industry, people always say that the new technology will change everything. Waves of people start companies, only some are successful and there is a huge shakeout. The problem is that the Internet entrepreneurs of the 1990s weren’t around for the electricity or auto revolutions that had “changed everything” for previous generations. So they made the same mistakes that those entrepreneurs made.
This book is helpful because it provides a way to learn the lessons of history and what they mean for starting new technology companies. By reading the book and seeing the standard patterns, entrepreneurs can see that what they are doing is less unique than they might otherwise think and can apply the lessons from those earlier days.
Q: Why do you think this book is necessary?
A: This book is necessary for three reasons. First, technology businesses are different than non-technology businesses. Things like intellectual property and increasing returns that we just discussed make the knowledge that technology entrepreneurs need to have different from the knowledge that non-technology entrepreneurs need to have. And there aren’t any books focused on technology entrepreneurship. Second, to be successful, entrepreneurs need to understand answers to “why” questions, not “how” questions. Most entrepreneurship books answer “how” questions. How do I incorporate? How do I hire employees? However, the answers to “how” do not influence success. What successful entrepreneurs need — and this book provides — is answers to why questions: Why should I price low in increasing returns businesses? Why should I protect my intellectual property through a patent rather than trade secrecy? Third, much of the success of new technology businesses lies in finding the fertile ground — identifying the right opportunity for the new business. Most entrepreneurship books focus on the characteristics of entrepreneurs. Unfortunately, this attention is misplaced. The data show that the effect of having the right opportunity and pursuing it correctly matters more than having the right personality traits.