Shooting for Start-up Success? Take a Detour
Every
start-up dreams of having the billion-dollar troughs of Uber,
industry-disrupting business model of Airbnb or brand recognition of Snapchat.
Reality check: The vast majority of tech start-ups are far from achieving the
status or financial backing of these high-profile companies. Instead, these
firms have to work harder to make sure their product or service makes it to
market, whether they go solo or with a corporate partner. But successfully
shifting from a beta version to the marketplace needs thoughtful planning and —
surprisingly — perhaps a strategic detour as well.
“We
have these ‘unicorns’ and ‘decacorns’ [start-ups valued at billions of dollars]
that everyone recognizes as being disruptive and whose valuations are
incredible. But for most new ventures, there’s going to be a healthy amount of
skepticism” about their business models, says Wharton management
professor David Hsu. “A lot of times, entrepreneurs believe they
could just jump into a particular way of commercializing or making money from
their innovations. There are two dominant ways — one is entering into the
product market directly and competing with others, and the other is a
partnership type of strategy. The problem is, each of these strategies might
not initially be feasible.”
That
means a start-up might want to sell directly to customers, but lack the
necessary supporting infrastructure such as those in marketing, distribution
and services. The business does not have these “complementary assets” because
it cannot afford or does not know how to build them by itself. Conversely, a
start-up might prefer to license its technology to a big corporate partner, but
cannot land a strategic alliance because its product is unproven. These are two
scenarios that can beset many start-ups.
Hsu
says start-ups should consider taking a strategic detour if a direct path seems
unattainable at first. While people might see victory as a straight ascension,
sometimes the road to success goes sideways before going straight up. Hsu
details these findings in a new paper scheduled for publication in the
journal Research Policy, “Strategic Switchbacks: Dynamic Commercialization
Strategies for Technology Entrepreneurs,” which he wrote with MIT professor Matt
Marx.
They
advocate a “switchback” strategy, a technique used by mountain trains such as
the Darjeeling Express. These trains navigate steep inclines by going sideways
while still continuing to ascend. “The analogy that we use in the paper is the
idea of scaling a mountain,” Hsu says. “The most efficient way of doing that is
to bolt straight up to the top. But a lot of times, while that may be the most
efficient way, it’s not very feasible.” Instead, start-ups can use a switchback
just like the mountain trains. “If you could zig and zag your way up to the
mountaintop, you’re going to take some detours that may feel a little bit less
efficient. But the payoff there is you could easily get up to the top.”
Hsu
and Marx point out that a switchback strategy is not the same as a pivot, in
which a business changes course only after its initial strategy failed. In a switchback,
start-ups deliberately plan on changing course later after their initial
strategy succeeds. The authors examine two kinds of switchbacks in their paper:
temporary cooperation and temporary competition.
The Case of Genentech
:
Start-ups
that want to sell directly to their customers but do not have the supporting
infrastructure such as marketing and distribution can adopt the temporary
cooperation switchback strategy. That means leadership would seek to
temporarily cooperate with a corporate partner that has the resources and
infrastructure to take the start-up’s product to market. In the partnership,
the start-up learns from the corporation how to market its product. Eventually,
the goal is to break free and go directly to customers.
Take
the example of biotech firm Genentech, now a unit of Roche Holding AG. In its early years, the
company knew it wanted to make and market drugs by itself to better control
distribution and maximize profits that can be channeled into research and
development. But it did not have enough skills or the market power to do so at
first. Thus, Genentech decided to license its first products to others until it
developed enough experience navigating clinical trials and garnered adequate
skills in marketing and sales, the paper said.
This
rationale led Genentech to license human insulin to drugmaker Eli Lilly, which
held 80% of this market and sold through pharmacies. It would have been tough
to market the product alone, given Eli Lilly’s dominance. Meanwhile, another
product by Genentech — growth hormone — was being distributed by a
quasi-government agency and had no entrenched competitors. This drug was easier
for the company to take to market itself; Genentech also said its version was
safer. Here, the biotech firm is “cooperating initially while learning from
partners and developing complementary assets, then later switching to a
competitive strategy,” Hsu and Marx write.
It
worked. In 1980, 80% of Genentech’s products were sold through its partners.
Four years later, the figure had dropped to 38% of new products. And the
company is not unique in using this strategy. In an analysis of 169 U.S.
biotech firms that went public, Hsu and Marx determined that once these
companies went past the median age of seven years, they were only half as
likely to enter into alliances or joint ventures and also 20% more likely to
end existing partnerships. These findings support the idea that many biotech
firms initially license their innovation but later go to market themselves, the
researchers write.
However,
start-ups have to be smart in the way they execute a temporary cooperation
switchback strategy. It is important to ensure that the agreement with the
partner is structured in a way that the start-up can learn from the experience
— such as retaining the right to co-market the product and participate in
clinical trials. What gives start-ups leverage in contract negotiations is if
they own valuable innovation or are backed by influential venture capitalists.
If these do not apply, start-ups should consider taking smaller fees in
exchange for participation rights, Hsu and Marx suggest.
Also,
start-ups will find it easier to execute a temporary cooperation strategy if
they have a pipeline of products instead of just one. Genentech was able to
license earlier drugs, but kept the development and marketing of later drugs to
itself. In contrast, speech-recognition software developer Nuance
Communications had a tougher time because it had a single product, the
researchers note. It started out with a partner, but when Nuance decided to so
solo, the partner suddenly became a rival, creating tensions.
From
the incumbent’s point of view, partnering with a start-up that might eventually
become a competitor presents a challenge. One way to protect against enabling a
future rival is to insist on long-term exclusivity in licensing rights or of
wide industry scope. Another could be inclusion of “grant-back” clauses for
technology advancements — in which any improvements have to be disclosed — to
avoid enabling a direct competitor, Hsu and Marx write. Also, the firm could
disagree to any co-marketing or similar arrangements.
When Partners Are Skeptical
Start-ups
that are having a tough time finding a bigger partner to license their
technology or through whom they could sell their products might wish to
consider going to market themselves — at first. This is what Hsu and Marx call
the temporary competition switchback: Compete in the market to prove the worth
and usefulness of the product or technology as a way to get a future licensing
deal or strategic alliance. This strategy would work for start-ups facing
skepticism from potential partners, which arise because the most valuable
applications for the technology are not clear, could not be measured or because
an industry standard has not yet emerged.
Take
the case of Qualcomm. Back in the 1980s, mobile phone calls were handled using
the time-division multiple access, or TDMA, protocol where one frequency was
used per conversation. Qualcomm introduced the code-division multiple access,
or CDMA, protocol that enabled multiple calls to be handled on one frequency.
While it was more efficient, makers of mobile phones and base stations were
reluctant to adopt it because they did not believe the technology would work.
Qualcomm then decided to build its own CDMA-enabled devices and years later,
sold the hardware business to focus on licensing.
The
experience of Qualcomm is especially common to other companies with
“disruptive” technologies, according to the paper. The incumbent companies
might see them as being “too radical” as well as “serving unattractive
customers and having little value.” A start-up that decides to go to market
itself benefits in several ways: It gets an opportunity to get market
validation and it also receives market feedback that can be used to improve its
products. Moreover, sometimes just the threat of going to market can bring a
potential partner to the negotiating table.
To be
sure, there are risks to the temporary competition switchback strategy even if
the start-up successfully secures a partner later on. These include the
possibility that it might not be able to recoup its initial investment in
complementary assets; it gets further removed from the customer; and early
public exposure could dilute the value of licensing the technology because
rivals could reverse-engineer the device.
Look
at the case of the Pebble smartwatch, for instance. Pebble Technologies raised
$10.2 million in a five-week period in 2012 from nearly 69,000 backers through
crowdsourcing platform Kickstarter, the paper said. “However, some analysts
believe that the highly visible oversubscription provided valuable market information
to possible competitors, and may raise barriers to a subsequent cooperative
strategy,” Hsu and Marx write. But the dilemma is that without proving the
Pebble’s public popularity through crowdsourcing, it might not have been
possible for the company to raise $15 million in venture capital later on.
So
when is it not feasible to adopt a switchback strategy? One answer is when
there are many providers of similar strategies and the start-up’s innovation
struggles to gain acceptance, the researchers say. But too few rivals also
signal that the demand for a product or service might be limited, clouding the
pipeline of future licensing revenues. Another reason that a start-up would not
need a switchback is when it has enough funding to pursue s desired strategy
without needing backing from a big corporate partner.
Looking
ahead, Hsu says the next step for their research is to document the performance
of start-ups that deploy switchback strategies. “Our hypothesis is that companies that
undertake these switchbacks are more likely to perform better Twitter ,” he says. “We have some
anecdotal evidence of that, but what we hope to show is that companies and
entrepreneurs and ventures that undertake these switchbacks in an appropriate
manner are much more likely to succeed.”
http://knowledge.wharton.upenn.edu/article/how-a-detour-can-help-start-up-success/?utm_source=kw_newsletter&utm_medium=email&utm_campaign=2015-08-12
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