It's common for entrepreneurs--especially tech entrepreneurs--to rush to enter markets that are in the midst of a boom, usually presaged by a spectacular event such as a billion-dollar IPO. Entrepreneurs reasonably assume the risk of failure is lower when entering then, and that's why high-profile successes can trigger an explosion of interest in a particular area.
Of course it works both ways. If a market has a large negative event--like a high-profile bankruptcy--entrepreneurs are far less likely to enter that market, because it is seen as too risky. Big splashy events--both negative and positive--can lead to an exaggerated view of the underlying market and that causes entrepreneurs, as well as venture capitalists, to flock or flee en masse.
It would seem counterintuitive then, to make the case that entrepreneurs who enter a market at its low point actually stand a better chance at succeeding than those who enter when a market is hot. Yet that's the argument Stanford Graduate School of Business Professor William P. Barnett and University of Chicago Booth School of Business Professor Elizabeth G. Pontikes make in their new working paper: "When to Be a Nonconformist Entrepreneur? Organizational Responses to Vital Events."
"People and the press tend to magnify the importance of failures and successes," says Barnett. But entrepreneurs, like everyone else, make sense of an uncertain world by referring to popular sentiment and by watching what their peers are doing. That tends to magnify a particular belief in the market, and then helps it spread.
But nonconformist entrepreneurs go against popular wisdom. They choose to enter an unpopular market at a time when consensus is against them, and face far more rigorous scrutiny by investors and potential partners because of that, says Barnett. "But they are much more likely to survive as a result."
Take Google, he says. In the late-1990s, many of the firms specializing in search, like Lycos, Alta Vista, and FAST Search, failed, and market watchers questioned if search was a viable business. Yet a few years later Google’s success handily reversed that skepticism. Barnett says Google's founders, like other nonconformist entrepreneurs, were scrutinized harder than they would have been if the search market had been booming.
"That scrutiny makes it more difficult for a company to get into the market, but we hypothesized that if they do get in, there is a better chance they will do well and stick around for a while."
To test that theory, Barnett and Pontikes used data about software companies they gathered from 268,963 industry press releases written between 1990 and 2001. Those releases each contained at least three mentions of the word “software.” The data covered 400 segments within the software industry. The researchers also used financial services firm Thomson Financial to plot the timing of events, like venture capital investment and software company bankruptcies, during that period. As expected, positive events drew a host of entrants into a market, including companies that weren’t a great fit.
Looking at 15 years of this data, Barnett and Pontikes found that, on average, businesses created in the wake of a start-up frenzy were unlikely to survive and, even if they did, were unlikely to go public. "On average, our findings showed that businesses entering a frenzied market were less likely to succeed," says Barnett.
On the flipside, starting a business on the heels of a big failure in the market--or a spate of them--is extremely difficult. In fact the scrutiny is so intense, those startups that do make it into the market "are often great," says Barnett. "The conventional wisdom today is ‘let’s make it easier to start a business.’ But what makes Silicon Valley great is not that it’s easy to start a business. It’s that it’s possible to start another one after you fail," he says. "That’s why the ones which succeed are so good."
Entrepreneurs often face the dilemma of whether or not to stick with their idea, especially when that idea is unpopular. In his blog, Barnett cites the example of Irwin Jacobs, the founder of telecom giant Qualcomm, who believed strongly his CDMA technology--a method for transmitting digital signals that is widely used today in cell phones--would become a wireless standard. He and his engineering team claimed to have made it work, but doubts about that claim mounted, even among highly regarded experts. Despite that, Jacobs continued to believe it would work. "The team at Qualcomm might have been wrong, but they felt they understood it," says Barnett. "And Qualcomm, of course, was successful, and Jacobs is often described as a genius. His success was greater because of all those early doubts."
Nonconformist entrepreneurs--like Irwin Jacobs and the founders of Google--were willing to buck the trend and that is a risky strategy, says Barnett. His research has shown that the highest return ideas are often the least supported. The lower-risk strategy--entering a market that’s popular--is also a low-payoff strategy, says Barnett.
In other words, when the market is hot and entrepreneurs are rushing to enter, they may skimp on the due diligence required to succeed long-term because it’s easier to get funded and get started.
The non-conformist entrepreneur, on the other hand, is taking a bigger risk initially by entering a market that others are staying away from. Because the likelihood of failure is higher, their plan faces greater scrutiny and that makes them more likely to succeed in the long run if they make it through to the market.
"It’s much riskier to do what's unpopular and very likely fail. But if you don’t fail," he says, "you’ll probably be considered a genius and become a big success."
This piece was originally published by Stanford Business and is republished with permission. Follow them @StanfordBiz