Elizabeth G. Pontikes -Booth School of Business, University of Chicago
William P. Barnett – Graduate School of Business, Stanford University
Valentina A. Assenova – School of Management, Yale University
Daniel B Davis – Department of Sociology, UC San Diego
Article link: http://asq.sagepub.com/content/early/2016/07/16/0001839216661150.abstract
Question 1. What was your inspiration for examining how vital events affect competitive dynamics within market categories?
We were struck by the faddish nature of the technology sector, where market categories briefly become “hot” only to crash and burn. There are anecdotal stories around this, and many within the industry lament the tendency to herd into hot markets. But there have been no systematic studies of it. The academic literature on diffusion shows that producers imitate each other, but we suspected that vital events would be even more important. Moreover, there is little research about the consequences of such behavior. We wondered what happened to companies that followed the consensus. Perhaps it was sound strategy, such that companies could successfully repackage themselves according to current market trends. But many studies suggest otherwise: change is hazardous, and it is important to maintain a consistent identity. We noticed that firms that chased hot market categories often did so at the expense of product-market fit. We modeled this as entry selection, where consensus beliefs about the potential of a market effectively lower the barrier to entry. From this simple model, it follows that consensus behavior will result in long-term hazards. We have unique data on the many market categories in software, which enabled a systematic study of the process.
Question 2. Your study was done on software startups. To what degree do you think the vital events herding mechanism might be different across other industries?
These effects should occur in any environment where there are exaggerated reactions to vital events – that is, where vital events result in assessments of market categories as more promising or more perilous than warranted based on the underlying fundamentals of the market. Which is, basically, everywhere. But of course in some domains these tendencies will be stronger than others. The software industry is especially fertile ground for this behavior, perhaps because technologies are often platform based, so that one technological platform can be applied to multiple market categories. In addition, there is a lot of VC investment in early stage companies, where bets are placed on future potential rather than an established track record. Another industry where consensus behavior is widespread is in film, where a successful new genre is met with a flood of “me too” compositions – for example the spate of superhero films that have recently been released. Effects would be smaller where there are high structural barriers to entry into market categories, such as if it was necessary to build a new plant or invest in expensive technologies in order to enter.
Question 3. In the paper, you propose that consensus entrepreneurs are more prone to enter a “hot” category despite being poorly suited to it, which ultimately increases the probability of market exit. How do you differentiate between new entrants into a category (e.g. Zimride) and experienced entrepreneurs who are migrants to a new category (e.g. Lyft)? How might the exit rates and IPO success of ventures differ for category migrants versus new entrants?
We do not find differences between whether an entrepreneur is founded into a “hot” market category or whether they migrate into that category. Our model suggests that both types of entry should result in adverse long-term effects, because the effective entry barrier is reduced in both cases. There are some theoretical reasons to predict that migrants might have more problems if they already have built structures that are poorly suited to the target market, which are difficult to change. At the same time, it is possible that companies with some experience have a better sense for how well they can fit into a new market, as the Zimride/Lyft example illustrates. This question would be an interesting topic for future research.
Question 4. You had a quote in the article that the key is to be “non-consensus and right,” but assuming market-fit falls on more of a continuum than a dichotomy (right vs wrong), would you say it is better to be “consensus and only somewhat right” or “non-consensus but partially wrong?”
This can be mapped in a two dimensional space, where both “consensus” and “right” are on a continuum. The higher a company is along both dimensions, the more likely they will be successful. Comparing dimensions – whether “somewhat right” outweighs “somewhat consensus” will depend on the context. In general, a company has no chance for success if they bet on the wrong market–if there turns out to be no demand for the product in question. For example, investors thought the Segway would be as transformative as the Internet, but they were wrong. Segways turned out to be a niche market, used for city tours and by some police departments. Companies can’t succeed in a bad market, which is one reason why entrepreneurs default to consensus strategies: they feel safer. But, as we show, consensus behavior is also not a safe strategy. It leads entrepreneurs to systematically overlook product-market fit, which results in even higher long-term hazards. The upshot is that entrepreneurship is inherently risky. There are no safe bets, and more importantly, no substitutes for entrepreneurs thinking for themselves. It is critical to draw on intuition and experience to carefully examine not only whether a market has long-term potential, but also whether their company is positioned to uniquely serve that market.
Question 5. How does this paper fit into your larger research agenda?
Our paper lies at the intersection of entrepreneurship, innovation, and market categorization, three areas that are central to my research interests. It shows that entrepreneurs strategically use market categories to position their products and companies, searching for a market they can dominate. Entrepreneurial search is important for innovative companies that do not squarely fit into an existing market category, or even for companies that are not innovative, but are trying to position themselves as having a unique offering. Our findings highlight the constraints and long-term perils of using market categories strategically. Entrepreneurial search often leads to consensus behavior, where entrepreneurs attempt to fit their product into a hot market category, in a strategic attempt to attract investors, as an entrepreneur quoted in our paper directly states. But in doing so they overlook that market categories have social meaning. Positioning in a market category elicits expectations from customers and investors about the type of product the firm will produce. Consensus moves sacrifice product-market fit, making companies ill suited to the market they are in. Being in a hot market does not override concerns of fit. As a result, entrepreneurs that follow the consensus in entering market categories suffer in the long run.