-- By Eilene Zimmerman | Stanford Business contributor
Sometimes it's hard to tell what a company does. That's why market categories exist, to help consumers understand what products or services a business offers.
Some categories, however, are a bit fuzzy, like social entrepreneurship, nanotechnology, and enterprise software. "Lots of businesses call themselves enterprise software companies, but they all do different things," says William Barnett, a professor at Stanford Graduate School of Business. "The only thing you have to do to be an enterprise software company is sell your product to big businesses." And that, he says, doesn't give a consumer much information about what, exactly, the company does.
Loosely defined categories like these are known as "lenient," and Barnett says they have historically been considered confusing to consumers because the categories lack a commonly accepted set of expectations. Lenient categories make it difficult for customers to identify a business -- and also for a business to identify its customers.
Yet research from Barnett and his colleague Elizabeth Pontikes at the University of Chicago finds that despite the confusion that lenient categories cause, they have not only persisted but are flourishing. And they attract a lot of companies, especially those with money. "Executives making strategic decisions about their company are strongly influenced by their VC backers, who tend to prefer lenient categories," says Barnett. These broader categories allow for more flexibility than clearly defined ones. "Venture capitalists are interested in organizations that can change the market," he says. "You can't do that in a constrained market category."
This research differs from most of the recent studies into market categories, which have focused more on the consumer's perspective.
In examining the producer's viewpoint, Barnett and Pontikes looked at all the market categories used by software companies in press releases from 1990 to 2002. They found 456 categories and more than 4,000 organizations.
Because of their flexibility, these categories attract a wide variety of businesses; they also have high rates of entry and exit. Companies may leave a category when managers realize they aren't able to shape it in the way they had hoped, or find they are having difficulty attracting interested customers. They leave, looking for a better market category fit.
The researchers also found that companies that exit lenient categories are more likely to enter another lenient category than companies that choose to start in a more specific category. That's because a company has to do many things to conform to the requirements of a more constrained category, so once that company gets there, it is far less likely to leave. "If you're doing applications security, for instance, you're developing capabilities that are specific to the space, and that makes it unlikely you will just leave the category," says Barnett.
Venture capitalists like lenient categories because they allow fledging companies to be more nimble as they search for novel products and services."Those categories let the company fit customer expectations even though they are still experimenting with their product," says Barnett. "And the industry we looked at -- software -- is a very innovative one, with lots of experimenting. These entrepreneurs can alter their products and services while continuing to call themselves by the same category name. It allows them to frame the activities of their business in ways that potentially satisfy a much bigger market."
With so much freedom, companies in lenient categories also do a lot of pivoting, says Barnett, something common among startups. "A company might have a technology or product and is trying to figure out how the world understands it," he says. "If things aren't working out with a particular audience, they can try it with a different one, changing the way it's deployed, used, and presented."
This challenges previous research that assumed lenient categories were less useful than constraining ones and therefore temporary, showing that these fuzzier categories have staying power. For companies that don't fit easily into well-defined markets, joining a lenient market category may make sense. Barnett cautions entrepreneurs, however, against thinking that simply switching from one category to another will reinvent their business. "Experimenting is fine, and companies can jump from one category to another as part of that process," he says. "But they shouldn't expect a new category will be a complete game-changer for a them. That takes a lot more work."