1.2.25 Entrepreneurial Strategy

Hi, everyone, David Hsu from the Wharton School covering a session on entrepreneurial strategy. An opening question that motivates this session is, why does strategy even matter for entrepreneurs? If you pick up the Wall Street Journal, or any other leading business press, you often hear the headlines, as to successful entrepreneurship as, we out hustled, we out executed the competitors. And at the end of the day, we just made it happen. And so that would be one extreme view. The other polar extreme view would be, you’ve got extremely limited resources as an entrepreneur, and so it’s even more important for you to strategize, to think through how competitors are going to react to your entry. And to the extent that you’re able to get some of those theories out there, or hypotheses, as to why you’re going to be able to succeed, that’s going to complement your execution, your implementation, all those other things that are necessary for you to really outmaneuver and successfully compete against more established rivals and incumbents. And at the end of the day, having a strategy will allow you as the entrepreneur to prioritize. What are the things that really have to go right at the beginning of your venture initiation, in order for you to successfully enter into the market? And that’s what really what is motivating today’s session. Let me give you a real life example. So back in 1999, there was a very interesting company called Webvan. It was a very highly touted company that was going to enable online delivery of groceries. You would be able to open up your Internet websites, browser, click on the groceries that you want and all of a sudden those groceries would show up in your back door. That company actually consumes a great amount of venture capital, but ultimately failed. It took a strategy of really trying to disrupt the industry incumbents. On the other hand, there is another company that was really founded around around the same time, Peapod. And here, instead of being a substitute to the industry incumbents, they thought that they would be a complement to the incumbent grocery chain. And here what they allowed the customer to do was if the customer wanted they would be able to open up a website, and be able to order their groceries online and have them delivered. And the marketing was not so much, we’re going to replace the grocery chain Peapod. Instead, we’re going to be the online arm, so if you prefer your groceries to show up online and to order them online, that channel is available as well. And here, it’s a company that actually end up doing quite well. And the lesson here is that these are two entrepreneurial companies really seeking to exploit the same entrepreneurial opportunity that was afforded by the rise of the Internet, but had dramatically different results probably because they had very different strategies. I’m going to contend three different strategies we can think of for entrepreneurs. The first is a value chain strategy, working with industry incumbents to reinforce the value that they’ve already established. Yet, you’re innovating along one part of the value chain. Take the example Foxconn. This is a company that is manufacturing iPods, iPhones, Kindles, and the like, in cooperation with industry incumbents, Amazon and Apple. Yet, being at the leading edge of manufacturing and production, and therefore reinforcing the existing value chain of incumbent. That would be an entrepreneurial value chain strategy. A second strategy that is quite different is more along the lines of the Webvan strategy, which is to try to disrupt or to undermine the existing value chain of the industry incumbents by bringing a different platform, a different value chain on to the scene. So, in addition to the Webvan example, we might think about Netflix, as it tries to enter in, and disrupt, as a distribution channel, media, and movies, compared to the industry incumbent at the time, Blockbuster. A third strategy would be to really deflect your competition all together, and to try to think about ways in which you can enter a market space that is green field, completely new, that’s not being offered by anyone in the industry. And here, this is a notion that’s popularized by these NCI professors, really creating new market spaces. The leading example here, Airbnb, creating a new market category that, in some sense, is an alternative but wasn’t thought about before in the space of providing housing for individuals seeking housing. We’ll come back to these examples and drill down a little bit more in depth.
Now one question you might ask is which is the best strategy? To address that, some of you many know about these unicorns. Unicorns is a term, that term that really suggests private value, at least at the level of $1 billion. And just let me just tell you about the methodology here. I hired a team of researchers at Wharton to categorize the 140 companies that have been labeled as unicorns, and we’re trying to analyze, what are the strategies that they’re using in coming into market? And perhaps surprisingly to some of you, by and large, the value chain strategy is much more important than the disruption strategy in terms of just what strategies are these uniform unicorn companies using? Now, that’s a very particular data point but at least gives you a notion that value chain strategies could be quite important, not just disruptive strategies has been made kind of popularized in the press as to what is the basis of valuable type of companies.
Now one thing that underlies the value chain strategy is this notion of cooperating with others. In contrast to the disruption strategies, which is much more of a competition type of strategy. And so just to review some of the benefits to cooperating with industry incumbents. One is very clear, here’s this division of labor so the startups are doing what they do best, that is upstream innovation. Yet, they get the best of both worlds by doing a deal or cooperating with partners, industry incumbents that have assets that are downstream. That is, typically, these incumbents are quite good at bringing products to market, they have superior manufacturing, distribution, marketing, sales type of channels. Those downstream assets are often associated with industry incumbents, and if you could marry these two entities together, that could be a winning strategy. And at the societal level, governments for example might care that we don’t want to recreate things, avoid duplicative investments if you get out of this division of labor in society. So, those would be the benefits of cooperating with others. Now that begs the question, why doesn’t cooperation always occur? There’s a couple of frictions that are associated with cooperation. One is simple transaction cost. Could be difficult to find the appropriate partner, and even if you could find the appropriate partner, think about all that in depth contracting that you have to do. You have to specify, who is responsible for what? Under bad states of the world, who gets rights? All of these different elements of codifying The different cash flow, control rights that are associated with the contracting type of process. Those were all various transaction costs associated with corporation. There could also be a divergence in beliefs, right? One party may really have a different view as to whether a certain innovation is important, right? And so as a consequence, one party may not be interested in doing a deal with the other. The difference in perception may be different that the value proposition of the startup is not very verified and so these things could lead to differences in beliefs and therefore break down cooperation. Finally, from the startup’s perspective, there could be this disclosure dilemma. Doing any deal with an industry incumbent
involves disclosing in some detail what you’ve done. And without proper protection, disclosing that information may undermine the very value that you have as a startup entrepreneur. And so just to give one concrete example. There was a movie that was made based on the situation in which an entrepreneur comes up with a better windshield wiper, gets very excited. Goes to the industry incumbent auto manufacturer and says look, I’ve invented a very important windshield wiper and wouldn’t you like to do a deal with me?
The auto industry incumbent says thanks for coming in, but we’ve already been working on that. And so some of you may know this film, Flash of Genius, that really goes through all the headaches and heartaches associated with that particular episode. And so it really underscores this notion of negotiating with incumbent in a contracting process or cooperation process has its own pitfalls. Now what I want to do is to depart to kind of leave you with a few other considerations in using a value chain strategy. Even if you have an aspiration, especially if you have an aspiration to learn production skills because one day you hope to grow up and graduate from being a startup entrepreneur to being an industry incumbent. It may be better for you to get in the game by producing and not just leave things to arm’s length contracting. Because you have to make the mistakes, you have to go up a learning curve in order for you to have a long-term prospect of integrating into production. All those downstream aspects that you need to do well as a fully fledged type of company. And if you only do a deal in a arm’s length manner with an incumbent, that may not work out so well for you in the long term. The next strategy I want to cover is the disruption strategy. Now remember in contrast to the cooperation strategy, this is the compete strategy. To illustrate this notion, let me give you one concrete example taken from Professor Clay Christensen of Harvard Business School in his 1997 book. And what he is showing is that across generations of hard disk drives as you moved from the 8-inch generation to the 5.25-inch generation. Take a look at these attributes that are the key performance indicators associated with this particular industry. As you go from the 8-inch generation to the 5.25-inch generation, the capacity of the hard disk drives gets worse, the access time gets worse, the cost per megabyte all gets worse. So if you ask the customers, do you prefer these worse performance indicators as you move to this new generation of hard disk drive? Most customer’s will say no. And that is the signature of a disruptive technology. That is, if you ask the customers what they prefer, they never tell you that they prefer the new generation that’s only getting better on one attribute, the size, the miniaturization of the size, but largely gets worse on every other attribute.
To fix this idea, there is this generalized notion of this theory that disruptive technology initially performs worse compared to the existing technology. But look at the trajectory of improvement. It’s much steeper as compared to the established technology and at the point at which the established, the disruptive technology eclipses the needs of the average, mainstream consumer. That’s precisely the moment in time in which the industry incumbent gets disrupted. Now, go back to the example of Netflix or Airbnb. Now, Airbnb I covered under blue ocean strategy, but it’s not necessarily mutually exclusive with the disruptive technology. At the beginning, the performance is much, much worse. You’re sleeping on the couch, in the case of Airbnb and the industry incumbents, Hilton and the Sheraton, they don’t think that this Airbnb is a credible threat to their business. But the performance trajectory of AirBNB is much, much steeper compared to the incremental advances that Hilton and Sheraton are employing. And all of a sudden as you fast forward in the industry, there’s this performance trajectory that’s much, much better. And the hope of these companies like Netflix, AirBnb, Uber is one in which, by the time the industry incumbent recognizes the destructive nature, it’s much, much too late. Because they’ve overtaken and eclipsed the market value in terms of performance to the customers. To conclude this section, what I want to do is to give you a comparison. Both from the startups from the incumbent behavior standpoint as well as the startup behavior in terms of the challenges. This is the material I’ve already covered, but encapsulated in this handy slide or chart that really gives the central managerial or entrepreneurial challenges that are associated with each of these strategies. For the value chain strategy, why does the partner, the incumbent, want to work with you? For the disruptive strategy, at what point will the incumbent wake up and really respond? And for blue ocean, why is there this missed opportunity? In terms of new market space that is, in some sense, left on the table that the incumbent hasn’t uncovered. From the perspective of the startup, in terms of the challenges and the key questions, we could also summarize these things from the perspective of each of these strategies. For value chain, how could you mitigate your expropriation threat or convince the partner that this is really something that they should be interested in in cooperating with you as a startup entrepreneur? And for the disruptive and blue ocean strategies, the main challenge is how are you going to out execute? Suppose the incumbent wakes up. Do you have some way of protecting your idea? Or out executing the incumbent, should they decide to come in and aggressively compete against you. So that’s a summary of these three startup entry strategies in the context of this particular module. Here I want to introduce a new idea to you. Before we talked about this notion of value chain strategy in which you’re cooperating with industry incumbents or a disruption or blue ocean strategy session in which you are instead competing against industry incumbents. A lot of times as a start up entrepreneur, those options may not be immediately available to you. And so, similarly to the analogy of scaling up a mountain, the most efficient way of getting up to the top would just be to go straight up the mountain. But a lot of times for startup entrepreneurs Even if your goal is to eventually cooperate or eventually compete, that may be difficult for reasons I’ll shortly discuss. As a feasible strategy, what you want to do is zig and zag. Take one strategy first that may then enable a different strategy. What we’ve termed this is an entrepreneurial switchback strategy and it’s based on some of my own research. Let me introduce the ideas to you. There are two types of entrepreneurial switchbacks. The first, is what we’re labeling temporary competition switchback. Here, the idea is that your eventual goal it’s to cooperate with industry incumbents. But the problem that you may face as a start up entrepreneur is that maybe the industry incumbent doesn’t believe that you are going to deliver the promise type of innovations that are claiming that there’s a substantial amount of uncertainty both at the level of you as the entrepreneur with respect to no established track record, or the product or service that you’re trying to bring to market. And so what you may want to do under these circumstances, that your eventual goal is to compete, is to eventually cooperate, is to instead enter the market in a competition strategy first. And validate or show the world in the incumbent that you’re not just talking about vaporware, that you have actually come up with an innovation that you’ve purported to come up with. And then it may be more efficient to cooperate or do a deal with the industry incumbent. And so essentially what you want to do in this switchback is to demonstrate to the cooperation partner that you have what it takes and that your innovation is for real. Now the opposite strategy of this is a temporary cooperation switchback. Here, as a startup entrepreneur, your eventual goal is to compete in the product market. But the dilemma here is that you don’t have all those other organizational assets. Those complementary assets that you need in order to bring an end to end solution to the marketplace. So instead what you might do, is in the first phase of your history as a startup entrepreneur, do a cooperative deal with the incumbent. That is, try to do some joint marketing, some joint manufacturing with an industry incumbent, so that you’re learning along the way. And then in the second phase you are able to then end those cooperative relationships ,so that you can ultimately enter the product market with a brand of your own.
And so the idea is that you’re able to address and build up your organizational capabilities, so that you’re well-positioned to compete in the product later on. Let me go into detail and to each of these strategies. The temporary competition switchback. Let me give you one concrete example from Qualcomm’s. This is a company that really came up with this important innovation called CDMA, Code Division Multiple Access. It allows communication patterns, essentially enables the cellular phone industry. At the beginning of entry of Qualcomm into the industry, they came up with an innovation of this new standard that competed against the prior standard. Which in various parts of the world were known as GSM or TDMA, Time Division Multiple Access. And when we talked to the founder, one of the founders of Qualcomm, the challenge that he really articulated is that no one really believed that this could be for real. CDMA seemed too good to be true. So what Qualcomm had to do is, they had to enter into the market even though that was very expensive. And efficient for them to build the cell towers and to build the handsets because none of the carriers believed that what they had come up with was really real, and so when Qualcomm did enter and demonstrated to the world that this was a workable standard, they then divested those parts of the business, no longer efficient for them to put up cell towers around the world. And so they ultimately ended up divesting those cell towers to Kyocera and Ericsson on the handset side. And they’ve become what we know Qualcomm to be today, that is just generating intellectual property. That moves forward the CMA and other types of standards and so, this very well illustrates this conundrum that for some sort of. They would like to eventually corporate or take a value change strategy was very difficult because of skepticism and lack of reputation. With regard to the industry incumbents. Let me now cover in a little bit more detail the other switchback strategy that we’ve discussed which is the temporary cooperative switchback. Here is you recall the ultimate strategy is to compete against industry incumbents. Maybe taking a blue ocean or disruptive strategy but the problem is initially you as a startup entrepreneur don’t have any of those downstream complementary assets, you don’t know how to market, you don’t know how to manufacture, all those complementary assets that are necessary to successfully compete. Think about the example of a company like Acer. Here, you may think about Acer, we know them now as the makers of branded electronics equipment but early on they had to be a white-label maybe even a original equipment manufacturer for the likes of Dell.
Dell essentially said make these computer boxes to our specification, we going to put our label on them. Then a company like Acer graduates to being not just manufacturing to someone else’s design but then, becoming out original design manufacturer ODM in which they’re responsible for designing
the equipment Dell still gets it’s name on the ultimate box but at least Acer is able to improve their design capabilities. So then, the final phase of graduation to fully fledged branded player in which they are designing and branding their own equipment, that’s what we know Acer to be today, but in the interim they had to cooperate with some of the best brands out there in order to develop some of those organizational assets. And so in essence allows you to learn together with some of the best out there, in terms of the partners, but then once you’ve learned those capabilities, you’re able to shed those partnerships. And essentially go out there and compete.
And so we could cover other examples in this quote, I won’t read verbatim, but you can see the same set of patterns associated with Genetech. A very different sector but the founder here is recounting how they brought their first product insulin in the market in the form of a partnership, but then they had become the Genentech of what we know today, which is essentially a company that is standalone, branding their own products. In recap, the entrepreneurial switchback strategies could be relevant if your are stymied or blocked form taking your preferred strategy initially, but offers a migratory or evolutionary path to get to your preferred strategy down the road.

Jim Rohn Sứ mệnh khởi nghiệp