t:iptelj, lj,eeulinf th-ts- t:hapteli-, vca s-IMuU \; Y : .:; "'": .

1 :".:;:; ,:;,
2 Describe how technological, a.t> . . ; :: . > . >:- ::
socialldemographic '' r
3
4
5
6
opportunities.
Ust the different forms that entrepreneurlat :6ppohrin!{
fies can take and explain wtly some fonils are H,er .
for new finns than others.
Explain why new finns are more :;.:
industries than in others, and the
of industry differences that infiuence the
. success of new finns.
Explain why established finns ate usually bette[ thaft
new finns at exploiting entrepreneurial
ldentify thetypes of opportunities that new firms are.
betterat exploiting, and explain why newfirms have
advantage in exploiting these.kinds of opportuoitie$.
l
38 PART 1 Entrepreneurship: Who, What, Why?
ilorer' (SifghUy paraphrased) .
"gfo/,;0\l ritimber qi is out So,caJ, and . :} ,.I
. \ .. doing a rapidly risiilgvolme ofbosinesS; ! : .: .. _.-.-:...[
on1usinessesr:-: i the al13o state they actually ..
. . ilfn io uwe g:et. to see all kinds,of stuff ... and "
'we .enjoy it" T.(ury; it doosn't get much better than
that anyone else! (see Figure 2.1).
.... . " ... _. : over
ar'"'AlL'"''"n:r '!:!hn:1 :t. it: Jhey looked iiito
Figure 2.1 Opportunities: Often the Start of the
Entrepreneurial Process
When Randy and Vera l.ewis realized that literally millions of
computers, printers, and copiers that had outlived their
usefulness were pilting up in offices and homes around the
world, they founded a new venture that spealizes in handfing
such equipment-So-Cal Computer Recyclers, lnc. This
company illustrates a basic Fact: Opportunities are often the
. : . , .. :: . , .. was.a real.
.. bu$ine$s 'pportuhity_ here.:.,a, in- which .they could
$ervice and develbp markets few, if any,
. con1panles were seriling: 's a result, they tounded
starting point of the entire entrepreneurial process.
.. Computer Recyclers:.lrrc., located in Harbor City,
.cwiforriia;,Jheir. company old equi'pment from
. . . different source8
1
oftEm. for What they
d6,wiili equiprnent depends on its First, .
they Wipe ut all daui store9 in and
. other Then, they either restore it to working
condition :aJ,d. S.erf i(to cornpanies that specialize in
hanqlihg used eqt:ripment (resellers), or they donate it to
nonproflt they dismantle the
se.lttf1e pfls. Whateverroute they take,
Why do we begin with this example of the entrepreneurial process in action?
Because it calls attention to the importance of opportunities in entrepreneur-
sltip. In fad, it is reasonable to say that oppottunitles are usually (although,
perhaps not aJways), the starting point of Lhe enlire prucess. In this chapter,
we'll consider this basic foundation of entrepreneurship in detail. To do so
effectively, we will proceed in the following way. First, we start with a
dis(.ussion of where new opportunities come from-in other words, what
factors lead to their existence? As we'll see, our hasic answer is that
opportunities generally arise from changes in the extemal world-shifts in
technology, political and regulatory policies, social and demographic trends,
and so on.
2
These and other changes form the basis for the opportunities that
bright and perceptive entrepreneurs notice and then exploit. As we'll note in
more detail in Chapter 3, the characteristics of these people-for instance, their
human capital in the form of skills, experience, and training-play a key role
in their recognition of various opportunities and decisions to pursue them
actively.
3
But in an important sense, the opportunities themselves result from
various changes in the external world.
After that, we explain why opportunities are sometimes exploited through
the development of new products or services, and sometimes in other ways,
1
. g:
&!

t
0
I
0
I
8

,0:

[
[
[
r
[
[
[
r


n
[l
n
r
r
-.!
-._
C HA PT ER 2 Entrepreneurial Opportunities: Their Origins, Foi'ms, and Suitability for New Ventures 39
such as the development of new means of production, new raw materials, or
new ways of organizing business processes. For instance, the Internet, a new
technology, did not Iead so much to new products being produced or offered
for sale as it did to a new way of organizing important business processes-
e-tailing. The kind of products sold did not change, but the ways in which they
were made available to potential customers did. In contrast, the invention of
the intemal combustion engine, once a new technology, led to the develop-
ment of a new product, the automobile. However, it did not produce changes
in the way businesses were organized: Dealers now sold and repaired
automobiles (one rnode of transportation) instead of another mode of
transportation-horse-drawn carriages!
In a third section, we focus on differences between industries that make
sorne of thern rnore attractive than others for the founding of new businesses.
We will explain the characteristics of different industries that have been found
to make thern rnore or less fertile environments for founding new firms.
Finally, we will exarnine the question of why sorne opportunities are actually
better for new firrns than for established ones. Although established firms
generally have rnajor advantages over new ventures, this situation is reversed
under spedal conditions, and those conditions are worthy of our careful
attention because they suggest when new companies can actually have an
advantage over large, existing ones.
Sources of Opportunities: The
Origins of New Ventures
In basic terrns, entrepreneurial opportunity is a situation in which a person can
exploit (i.e., develop) a new business idea that has the potential to generate a
profit As earlier, an entrepreneurial opportunity can be exploited
the of a new product or service (see Figure 2.2 for an amusing
exruhple), tfie peniilg of a new rnarket, the development of a new way of
organizing, the use of a new material, or the introduction of a new production
process. Where do these opportunities corne from? What, in short, is the basis
for their occurrence? As we'll see in Chapter 3, opportunities-and recognition
of them-involve several different factors and several aspects of human thought
(creativity, key aspects of intelligence). Here, though, we emphasize the
following basic fact Opportunities generally ariSe frorn two major sources-
the information people have that hefps them to recognize (notice) new business
opportunities, and changes in the external world that generateopportunities.
The first view, initially proposed by Kirzner,
4
emphasizes the fact that at
any given time, people vary in the kind and amount information they have
available. For instance, consider the following Situation. Two people both
Source: Creators Syndicate, October 8, 2005.
learning
.objective
1
Define an entrepre-
neurial opportunity and
explain why such
opportunities exist.
Figure 2.2
Opporutnities Ofteo Take the
Form of New Producis or
Services
1he entrepreneur hete identified
an intriguing opportunity. in fad,
one could argue that she created
this opportunity by combining a
product wtth a servlce.
40 PART 1 Entrepreneurship: Who, What, Why?
learning 2
objective
Describe how technological,
political/regulatory, and social/
demographic changes generate
entrepreneurial opporj:unities.
Figure ll.
Technological. Change: A Key
Soure of Opporutnities
Technological change often makes
it possible to do new things or do
what was done before in a more
produdive way. The invention of
the telephone, the phonograph,
and computer chips made it
possible to do things that had not
been done before-or to do them
more effedively. For instance, until
high-speed and safe elevators were
developed, it was not pradical to
build skyscrapcrs:
know about a vacant store near a large college campus. One of these two
people, an older individual who graduated from college decades in the past,
has run several restaurants, so she has information suggesting that a new
pizza parlor could do weil in that location. A a result, it is the kind of
opportunity she now pursues. The other person, in contrast, is a recent
graduate who has knowledge about what students like to do on weekends.
This suggests to him the possibility of opening a different kind of business
there-perhaps a sports bar. A a result of the different kinds of information
they possess, these two entrepreneurs start different kinds of ventures,
depending on the opportunity they each recognize and decide to pursue.
In contrast, another view-and the one we will tend to emphasize here-
suggests that truly valuable entrepreneurial opportunities come from external
changes that either make it possible to do things not done before or make it
possible to do something in a more valuable way; this view was first suggested
many years by Schumpeter.
5
For example, the invention of the Iaser made it
possible to develop a new product, the supermarket SCanner, a device that
reads the bar codes on food. In the absence of the extemal change-the
invention of the Iaser-this opportunity would not have existed. Several kinds
of change generate opportunities for entrepreneurs to pursue: technological
change, political and regulatory change, and social and demographic change.
6

Systematic research suggests that in fact, technological change is the most impor-
tant source of valuable entrepreneurial opportunities.
7
Technological changes are
a source of entrepreneurial opportunities because they make it possible
for people to do things in new and more productive ways (see Figure 2.3).
L
[
[
r
r
f
r
r
[
u
[
[
[
n
0
.
j
0
n
q
.lt-
n
CH A PT ER 2 Entrepreneurial Opportunities: Their Origins, Forms, and Suitability for New Ventures 41
For example, until development of high-speed, safe, and reliable elevators,
constructing skyscrapers was neither practical nor desirable: Buildings had tobe _
relatively short. Once such elevators were available, opportuilities relating to
skyscrapers could-and did-emerge.
P()/iticat antt
Another important source of opportunity is political and regulatory change.
These changes make it possible to develop busirtess ideas to use resources
iit new ways that are either more productive, or that redistribute wealth
from one person to another. For example, when telecommunications, irttra-
state bankirtg, truckirtg, and. railroad irtdustries were. an deregulated (the
federal government stopped trying to regulate them closely}, established
firms found it more difficult to deter the entry of new competitors, which
allowed entrepreneurs to introduce more productive business ideas into
these irtdustries.
8
.
Note, however, that regulatory or political change does not necessarily
enhance productivity. Often, these changes generate entrepreneurial oppor-
tunities by simply allowing people who respond appropriately to the change
to gain at the expense of others. For example, suppose the town in which
you lived passed a law requiring all historic homes to be repainted using
the same type of paint that was used 100 years ago. An alert entrepreneur
could profit from this regulatory change by obtaining exclusive rights to
all paint formulas from 100 years ago. This entrepreneur' s profit would
. nothing to do with productivity. Itwould simply come fromthe higher
that people in the town would have to pay for paint that met the
'"%istandards of the new Iaw instead of the less expensive paint that they would
otherwise use.
Research shows that certain types of regulatory and political change are
.;; particularly valuable sources of entrepreneurial opportunities. First, as we
,'<meQ.ti,onedeqrlier, deregulation is a valuable source of opportunity by making
it easier for people to enter industries with their new ideas. For instance,
deregulation of the airline industry made it possible for companies such as
Southwest Airlines-perhaps the most successful large carrier in the United
States-to compete on the basis of price (see Figure 2.4).
Second, regulations that support particular types of business activity
encourage entrepreneurs to undertake those activities.
9
For example, pro-
cartel policies encouraged the formation of Massachusetts railroads in the
nineteenth century, while antitrust legislation in other states discouraged the
formation of railroad companies.
10
Third, regulations provide a source of
opportunity by providing resources that either increase demand for particular
activities or subsidize firms that undertake them.U For instance, in recent
years, the federal government in the United States restricted the amount of
sulfur that electric-generating plants can release into the air. This restriction
greatly increased the demand for low-sulfur coal and created opportunities for
companies that can meet this need.
5()ciat tWt
Social and demographic changes . are also an important source of entrepre-
neurial opportunities. Think about the clothes that you wear and the music
you play. They are probably different from the clothes and music that your
parents favored when they were your age. Changes in people's preferences
make it possible for alert entrepreneurs to provide products and services that
meet changing tastes and styles.
Suppose you discovered that next year, fashion among college students
would change significantly. Instead of jeans, tee shirts, and basehall caps,
Figure 2.4
Political and Regulatory Changas
are Often Sources of
Entrepreneurial Opportunities
When the Federaf government in
the United 5tates deregulated the
airline industry, this created a
valuable opportunity for airlines
such as 5outhwest Airlines, which
chose the strategy of competing on
the basis of price. The successful
development of this opportunity
made 5outhwest and similar
airlines the mostprofitable ones in
their industry in recent years.
42 PART 1 Entrepreneurship: Who, What, Why?
Figure 2.5 Social and Demographie Changes are Sources of Entrepreneurial Opportunities
Entrepreneurs in the Fashion business have often profited greatly from noticing-and responding to-changes in taste and style. For
these entrepreneurs, such changes are an important source of business opportunity.
they would start dressing up for dass because suddenly, this style would
be considered "cool./' You could take advantage of this social change to
begin a company to manufacture and sell "dress up
11
clothing to students.
Does this scenario sound ridiculous? Maybe it is. But, in fact, exactly the
opposite sliift occurred in the 1970s. In the 1950s and even 1960s, college
students dressed up for dass. By 1970, however, the casual Iook that
dominates today had totally taken over. The result? Entrepreneurs who
started making jeans and tee shirts took advantage of this trend and reaped
large profits (see Figure 2.5).
In addition to sodal trends, demographic changes-changes in the size,
growth, distribution, and age of human populations-are also an important
source of entrepreneurial opportunities. The demographics of many countries
change all the time. Over the past 20 years, the aging of the population in
many countries is generating opportunities for entrepreneurs to make
products that meet the spedal needs and preferences of older individuals,
such as assisted living fadlities. Populations also spread out from large eitles,
creating opportunities for entrepreneurs to build malls further from the center
of cities, and to provide products that meet ernerging markets. For example, as
the Spanish-speaking population of the United States increases, opportunities
for supennarkels Utal sell Laliu foods urc growing, as are Spanish
language radio stl'lfions.
Why are sodal and demographk rh:mees <l source of entrepreneurial
opportunity? Two reasons seem most imporlant. First, social and demographic
changes alter demand for products and services. Because entrepreneurs
generate profits by selling products and services that customers want, changes
in demand create opportunities to produce and sell different things. Second,
social and demographic changes make it possible to generate solutions to
customer needs that are more produclive than those currently available. For
instance, as noted earlier, the nurober of people above the age of 65 continues
to increase rapidly in many countries. Many of these people are retired and
have lots of spare time; and in addition, many don't like to drive their own
automobiles over long distances. The result? Emergence of a tremendous
opportunity for entrepreneurs who can meet these needs by providing
vacations that include guided tours by bus specifically designed for older
(_
l
[
f
r
r
r
r
r
r
r
r
r
n
u
n
n
1
C HA PT ER 2 Entrepreneurial Opportunities: Their Origins, Forms, and Suitability for New Ventures 43
customers. This solution is much "neater" for the special needs of these
customers than other existing alternatives-and many companies specializing
in particular kinds of tours of geographic areas have been started to meet it
(see Figure 2.6).
Forms of Opportunity: Beyond New
Products and Services
When they think about opportunities, most people imagine that once they are
tecognized, they are developed through new products or services. However,
opportunities can also be developed in other ways-in other words, they can
take other forms than new services and products. As we explained in Chapter
1, entrepreneurs can actually develop business ideas to take advantage of
ernerging opportunWes in five different ways: (1) they can develop new
products and services; (2) they can develop or tap new markets; (3) formulate
new methods of production; (4) identify new raw materials; and (5) develop
new ways of organizing business processesY Note that these modes of
development are independent of the source of the opportunity, which, as we
Figure 2.6
New Markets-and
Opporutnities-are Often Created
by Demographie Trends and
Changes
The nurober of older people is
increasing in many countries. Many
of these people do not like to drive
. their own automobiles on long
road trips. Together, these
demographic trends create a
tremendous opportunity for
entrepreneurs who can provide.
guided vacations by.bus for such
.customers. You now see these tour
buses near every vacation spot oll
over the world.
learning 3
objective
List the different forms
that entrepreneurial
apportunilies can take
and explain why some.
forms are beHer for new
firms than others.
44 PART Entrepreneurs hip: Who, What, Why?
noted earlier, can involve changes in technology, government policies and
regulalions, demographic or social trends, or markets. So regardless of the
source of an opport:Unity, it can then.be developed in several different ways.
Piease keep this point in mind because it is an important and basic one about
apportunilies and how they are developed.
New products are, the most common means through which
entrepreneurs develop opportunities, but they often the basis for new services,
too. For example, Expedia.com and other online represent this
approach. They provide services that simply did not exist in the past.
Entrepreneurs also develop apportunilies by tapping into new markets.
Consider a new chain of restaurailts founded recently that serves Indian
cuisine in a casual atrnosphere, callea Cafe Spiee. This chain was started by
Sushil Malhorta and Rajesh Bahardwaj, who realized that Indian cuisine has
grown increasingly popular in the United States. However, until recently, it
has been available mainly in regular sit-down restaurants that serve entire
meals. They came up with the idea of serving Indian cuisine in casual, low-cost
cafes, and have already enjoyed tremendous success opening such businesses
near college campuses.
In contrast, consider Amazon.com: lt provides an example of a business
idea (selling books without using physical bookstores) that one entrepreneur,
Jeff Bezos, developed through a new way of organizing business processes.
Amazon.Com was one of the first, but the idea it developed has now been
exploited by many other entrepreneurs in other markets. As an example of a
new raw material, consider a start-up venture named Cycletech, which
attempted to make used tires its raw material. The basic idea was to freeze the
tires to very low temperatures and then to separate the valuable materials
. remaining in them-steel, nylon, rubber; The company did not succeed for
reasons we'll describe in Chapter 4, but it provides a clear example of
developing an opportunity based onnew technology (the freezing process)
through the use of a new kind of raw material. Finally, biotechnology start-ups
. often provide good. examples of apportunilies that involve the use of new
modes of production. Such companies sometimes use bacteria to synthesize
substances that can be used in valuable drugs. Thus, they develop
opportunities that emerge from technological advances through new means
of production.
Even though opportunities can be developed in all of these ways, the
most common route taken by entrepreneurs is that of introducing new
products or services. Tapping into totally new markets, developing new raw
materials, coming up with new ways of organizing or new methods of
production, are less commonY In fact, research findings clearly indicate
that entrepreneurs founding new firms usually do so through the intro-
duction of new products or services, while existing companies are more
likely to follow the other routes (e.g., new production processes, new raw
materials, etc).
14
The fact that most new ventures are started to develop opportunities
through new products or services does not mean that this is always the best
route, howevcr. In fact, founding a new business in lhe musl "typical" way
may not be the most profitable. As we will see in more detail in Chapter 10,
success in founding new ventures requires that entrepreneurs develop a
business idea that can be readily defended against competition, which is
usmilly quick to develop if it does not already exist. Research findings indicate
that entering a new market is a parlicularly risky way to develop opportunities
because it is virtually impossible for entrepreneurs to defend this form of
development against competition. New products or services provided to a
new market are usually easy to duplicate, and unless they are. protected in
some way (patents, trademarks, and other factors we'll discuss in Chapter 8),
15
l
[
[
r
f
r
r
[
r
[
[
[
r
u
[
i
!
l
D
u
n
C HA PT ER 2. Entrepreneurial Opportunities: Their Origins, Forms, and Suitability for New Ventures 45'
Table 2.1 Examples of Different Fonns of Entrepreneurlai Opportunities that Result trom Technological Change
This table illustrates the foct thot ony given opportunity-in this case, one deriving from technological chonge-con be developed in any
one of several different ways: through development of a new product or service, topping into o new market, a new of
production, new raw materials, ond so on.
Internet New way of organizing . Online book sales
Refrigeration New market Refrigerated ship
Computer New method of production Computer-aided design
Oil New raw material Producing gasoline
they don't stay "new" or "unique" very long. In contrast, business ideas
2
-:> involving. new methods of production often provide better opportunities for
, ,.._::; entrepre!leurs because they can be kept secret and therefore are more difficult
-.. to copy.,;ecause entrepreneurs sell their new products to customers, all of the
___:, attributes:,of their new products are available for others to see. Competitors can
buy apart, and see how it works. Then the competitor can copy the
product. In contrast, an entrepreneur does not have to show anyone eise the
productio,l1,,;process that he or she uses. Therefore, it takes much longer, is
much more difficult, and costs much more for competitors to imitate business
ideas that are developed through new production processes than ones that are
developed through products and services.
16
Table 2.1 shows examples of the different ways in which opportunities
arising from technological change can be developed. Piease read this table
carefully because doing so will clarify an important point: The source of
an opportunity and the way in which it is developed are relatively
independent. (Now that we have examined various sources of opportunities
and ways in which they can be developed, we'll pause briefly to consider the
widespread belief that small companies often have a big advantage over
large ones. This issue is discussed in the Qualifying Common Sense section on
the next page.)
The combusfi!Jn
to JlOWE!I
The Iotemet li!II<Jws people to sell
products without retail outlets
The refrigerated. ship allows ranchers
in one to sell their meat in
another
The computerallows designers to
make products without building
ptiysical prototypes
Oil is refined into gasoline to power
vehicles
46 PART 1
" " .
.
Entrepreneurship: Who, What, Why?
.CZuatftplhff' CtJ trl/liitJ h " mttt tre rve
'Knt>uJ tt6()ut f'lt -Mut mttt 'fVe l)o 'KIMu/
. iisig are ploddifig
" : $Qurs," atrd new ven"tiites can (Jften
"nin cirdes araund them." "
Have you ever" heard this idea? We think you
have becal!se there is a widespread
" belief thatlarge, existing corripanies are con"
Thls" that large
.. " "companie$ Crui;trespohdto or new
always have im edge in doing so. This
is an issue we will in detail in the next
section of this chapter. Here, we simply want to
alert you. to the" generar overall conclusion:
Yes sornetimes new ventures do have an
I . . .
advaritage"':"their small size allows them to move
strciin"ed by their own large size and entr(mched .
buteaucrciciel3 so tbat they simply cannot
quickly or weil to changing coriditions.
This, it is further reasoned; often gives an
important edge to new ventures that are small
and can quickly and weil to shifting
or events. What do you this
assumption correct? Recent examples in which,
for instance, giant U.S. automakers such as GM
and Ford stumbled badly seem to suggest that
this idea is accurate. These companies had put
most, if not all of their new product "eggs" into
a single basket-producing ever,larger and more
fuel-guzi:ling SUVs and trucks. They were
. caught total!}' off balance when oil prices
skyrocketed during 2005 and 2006 and con"
sumers suddenly woke up to discover that they
simply could not afford to fill the tanks of these
large, inefficient vehicles. The result was disas"
ter for the automakers ahd for anyone who held
their stock. Of course, this did not Iead to the
founding of new ventures to produce smaller
and more fuel-efficient vehicles-entering this
partlcular industry would require many millians
or even billions of dollars. But the lesson in such
events seems clear: Large companies are often
constrained by their own large size and
trenched bureaucracies.
quickly to develop prodt.icts or services that are .
"" reaiiy new. Mreover, because they can be so
flexible; they often attract precisely the kind of
creative, innovative people they both want and
need-people who question everything and can,
uliimately, shake up even
industries. lt's important to note, though,
such instances are the exception rather than the
rule. Large existing companies have many
important advantages that weigh in their favor-
and which"they"often use to full advantage. They
have the financial resources, the established
reputations, the large customer bases, the
experienced salespeople, and the distribution
networks thatnew ventures can only dream of
deveioping. So overall, and contrary to what
common sense suggests, it is generally large
companies, notnew, small ones, that hold the
competitive advantage. Y es, innovative entre"
preneurs can develop excellent opportunities
they have identified and can sometimes
accomplish this very rapidly. But a theme of the
remainder of this chapter will be that they can
only do so under speCial circumstances. So
please read on t find out what these conditions
are and when, in fact, new companies actually
can "rtin circles" araund large ones.
lndustries That Favor New Firms:
Fertile Grounds for New Ventures
Explaln new firms are more
succe5sfut irvsdine industries
in clrid idehtify the
major f.ypes of differences .
tha:tinfienee the success
of new firms.
One of the most interesting findings to emerge fr()m recent research ?n
entrepreneurship is that the extent to whlch new ventures are successful van:es
dramatically across indu:stries. For instance, if you take two entrepreneurs
with exactly the same 'skills an:d abilities and you place one in an industry
favrable to new firm fonmition and you place another in an industry
unfavorable to new firm formation, the probability that the new firm
will survive, the likelihood that the new firm will go public, the amount of
l
r
[
f
f
f
r
D
'
n

j !
_;
n
ll
r
'i
C HA PT ER 2 Entrepreneurial Opportunities: Their Origins, Forms, and Suitability for New Ventures 47
sales growth it will have, and the Ievel of profits it will eam have been shown
to be as much as 10 times higher in the favorable industry than in the
unfavorable one.
17
.
One of the most important things that a budding entrepreneur can: leam,
therefore, is to identify industries that are favorable to new firms, where the
likelihood of success is high or at least higher than is true in other indtistries. But
what is it about specific industries that make them relatively good or relatively
bad environments for new ventures? Careful research on this important question
indicates that four industry dimensions are most important.. knowledge
conditions, demand conditions, industry lifecycles, and industiy structure. ~
W e'll now describe each of these dimensions so that you can know what industry
characteristics to Iook for as you think about starting your own company.
1\Jww* CtJIUiitionJ;: ~ w $ f?w fdu;w*
.. ~ and 5haMd?
. Knowledge conditions is a term used by economists to refer to the type of
information that underlies the creation of products and services in an industry.
It includes such things as the degree of complexity of the production process,
the Ievel of new knowledge creation in the industry, the size of the innovating
entities, and the degree of uncertainty. Take, for example, a comparison of the
pharmaceutical industry and the retail clothing industry. The production of
drugs is much more complex, requires much greater investment to produce
new knowledge, requires !arger entities to undertake innovation, and is much
more uncertain than the production of clothing.
So what does this comparison have to do with starting new firms? You have
probably guessed already. Certain knowledge conditions make it easier to found.
new ventures .. In this respect, three dimensions of an industry' s knowledge
conditions are most important-and create conditions favorable to new firms.
FirSt, inclustrieathat have greater R&D intensity aremorefavorable to new firms
than industries that have lesser R&D intensity.
18
R&D intensity is a measure of
how much research and dev.elopment expense firms incur for every dollar of sales.
This measure captures how heavily firms invest in the creation of new knowledge.
Researchers have found that R&D intensive industries have more new firms
because the invention of new technologies is a source of opportunity for new
business ideas. The more R&D, the more new technology is invented. The more
new technology that is invented, the more opportunities arise for new businesses.
This relationship raises an intriguing question: If companies spend a lot of
money on research and development in an industry, why aren't they the ones
that capture and develop these opportunities? Part of the answer involves what
is known as knowledge spillovers-instances in which information about new
technology and how to develop it "leaks" to other people not in the company
that generated this knowledge. Forhmately for entrepreneurs, these spillovers
are far from rare. For instance, such "leakaP" occurn in social Situations.
Imagine that a young engineer from a !arge company who goes out on a date
with a man who just graduated from San Jose St<ltf' l Jniversity. After a few
beers, the young engineer, hoping to impress her date, tells him about her
iinportant work on developing a new generation computer chip. Unknown to
the young engineer, her date has been thinking of starting a business to produce
. a new generation of computer chip." However, his undergraduate thesis showed
that he was missing a key piece of the puzzle about how to do it. The engineer
now unintentionally provides the missing piece. Over a couple of beers, this
knowledge spilled over from the engineer to her date, who can then use it to
start a new business. Similar leakage also occurs at parties, in social gatherings,
conventions, trade shows, and many other settings. People have a strong
tendency to talk about their work and what interests thern, and this can often
/
48 PART 1 Entrepreneurship: Who, What, Why?
l
Figure 2.7
New Knowledge: ls lt Made
Public or Guarded Closely?
Organizations such as universities
or research laboratories have a
clear gool regarding new know
ledge: Put it into public domain as
quickly as possible. This goal makes
it relatively easy to develop new
. ventures in industries where most
new knowledge is provided by such
organizations. ln contrast, in
industries where most new
knowledge is provided by private
corporations, it is carefully
guarded and not made pub/ic. For
this reason it is often more difficult
to start new ventures in such
industries.
provide valuable information to others who may not,
in fact, have been actively or intentionally seeking it.
Another aspect of knowledge conditions that
enhance new firm formation is the locus of innovation.
This term refers to those who produce the technology
that is a s6urce of opportunity . .In some industries, like
automobile manufacturing, private sector firms pro-
duce most of this knowledge, while in other industries,
such as pharmaceuticals, public organizations, indud-
ing universities and government research Iabs, are the
source of much new knowledge. Research findings
indicate that industries in whieh public sector organ-
izations produce most of the new technology are ones
with a high rate of new venture formation.
19
The
reason seems straightforward. In contrast to large
private companies that often take great pains to
protect new knowledge gained by their employees, universities and rei>earch
Iabs have a very different mission. Their goal is to add to knowledge and put it
into the public domain so that society can benefit from it. So, for example, if
engineering professors and their stu:dents invent a new kind of computer chip,
they tend to publish their research. This legitimate desire of people working in
the public sector to make new knowledge they acquire public makes it easier for
entrepreneurs to found new firms in industries where most of the new knowledge
comes from public sector organizations such as universities (see Figure 2.7).
A third dimension of knowledge conditions that create a positive
environment for new firm creation is the nature of the innovation process
itself. In some industries, such as automobile manufacturing, innovation and
new technology development require a large scale of operations and lots of
capital, leading most of the innovation to be done by large, established
companies, such as General Motors and Ford. In other industries, such as
computer software, Innovation and technology development requires flexible
and nirnble organizations, leading most of the Innovation to be undertaken by
new and small firms. Because new firms tend to start small, they do better at
coming up with new products and services in industries in which small firms
are the better innovators. Therefore, industries in which innovation demands
can be met by small organizations tend to have more new firm formation than
industries in which Innovation demands larger organizations.
20
f
f
r
r
r
r
r
[
[
[
r
[
[t
lJelnal1d
tJf lna!tkea 'FtwtYb 71ew 7/eniuJley U
Demand conditions ts a term that researchers use to explain the attributes of
customer preferences for products and services in an industry. Customcrs can U
express light demand or heavy demand for products. Demand can also be
growing or it can be shrinking. lt can be stable or it can be changing. It can be
homogenaus or it can be heterogeneous.
Three attributes of demarid conditions make an industry favorable for new U
firm foundation: market size, market growth, and market segmentation.
have found that new firms perform better in larger markets than Jl,
in smaller ones becau8e !arger markets are moreprofitable for new firms.
21
_
Entrepreneurs face a fixed cost to found new firms. This fixed cost can be
amortized, or spread out, over more sales in a larger market than in a smaller f:.:.:
market As a result, the expected retums to founding a firm are greater in a I !
Iarger market than in a smaller market.
New firms also perform better in more rapidly growing markets than in f;...
less rapidly growing or shrinking markets because new firms can enter rapidly
growing markets to serve customers that established firms are unable to
C HA PT ER 2 Entrepreneurial Opportunities: Their Origins, Forms, and Suitability Ventures 49
serve.
22
Not only does this allow new firms to gain customers who
are relatively easy to persuade-they have excess demand
(customers want the product or service very much)--:but it also
allows new finrts to avoid trying to take customers away from
existing firms as a way to make sales. lnstead, they are acquiring
customers the large companies don't or can't serve.
Lastly, new firm foimation is more common in markets that are
more heavily segmented. Industries differ in their degree of market
segmentation. For example, many more different types of cars are tar-
geted at different types of buyers than types of frozen com
are targeted at different types of buyers. The reason is that people
have more varied preferences for automobiles than they do for frozen
corn. Some need-or simply want-cars that are sleek and
11
Sexy,"
others want ones that give them lots of cargo room, and still others want highly
fuel-efficient cars. Not so many different segments exist for frozen corn. A high
degree of market segmentation makes it easier to start new ventures
23
because
niche markets-relatively small, specialized markets-favor organizations that can
exploit them even without high volumes of production. New firms are better than
the average established firm at small-scale production. In addition, the exploi-
tation of niches requires quick and agile firms that can take advantage of market
segments that other firms have left unsatisfied. New companies tend to be
quicker and more nimble than large, existing ones. For example, consider Javette,
a new start-up company that produces coffee concentrate in single-serving pack-
ages; this company was started in 1999 by Candy Palmer-Steele (see Figure 2.8).
}<Vhen mixed:with hot water, it produces excellent gourmet-style coffee, which is
::;}Ust whafiinany business travelers want to have in their hotel rooms or other
)t 'is a relatively small niche market, but one that was not being
--:exploitecLby existing, large companies, so Javette moved in quickly and is now
.reaping success: Sales doubled every year, and now the company
seems po!sed. to really take off. Market segmentation also allows a new firm to
enter a mar!<et and obtain a foothold without going after the mainstream
customers of' an established firm. As a result, new firms can enter segmented
markets without the Ievel of retaliation that they face in entering unsegmented
markets where they must try to take customers away from established companies.
t.tte ?Iew Orfren lJtJ
13at&v in SnduJitties- 7han lnttiuM Ones-
Like people, industries are born, mature, age, and-in some cases-ultimately
die. Probably, you are aware of the birth of electronic commerce as an
industry. But you are probably less aware of death of the Pony Express unlcss
you walch a Iot of late night Westerns un televiluu. The uirlh, maluraUon, and
death of industries, what researchers call the industry life cycle, is important
to entrepreneurs because the life cycle has a powerful impact on the ability of
entrepreneurs to found successful new firms.
First, research shows that new firms do much better when industries are
young than when they are older.Z
4
As you may have leamed in market courses,
the adoption of new products is normally distributed. A small number of people
adopt them as soon as they appear (these individuals are known as Iead users),
a moderately large number (early adopters) adopt them somewhat later but still
ahead of most others. Most people, however, adopt products in the middle of
the curve-after the products have been available for some time. A relatively
small number of people are Iate adopters, and a smaller number adopt new
products only after most others are already using them. The form of this
function is a normal distribution (height is another factor that is distributed
normally)
1
and this distribution yields an S-shaped curve of market growth-
one in which sales rise rapidly as more and more people adopt the new product
Figure 2.8
Market Segmentalion Often, lt
Favors StartUp Ventures
When markets are highly
segmented, or involve many
different niches, they often provide
good environments for new
ventures; New ventures can move
quickly to ft/1 sma/1 market niches.
One example is )avette, a start-up
venture that produces single-
serving packages of coffee
concentrate, perfect for business
travelers who miss their gourmet
coffee while on the road;
50 PART Entrepreneurship: Who, What, Why?

New f'itm Foimatin ls Easiei:.in .
Than lri:Oiaet
Market Growth ls
RaprEI. lnitially
A nq"/r,atdfitrfbUtion o(adopiei$
generatf!Sc<tin 5-sh.aped pattein of
f'JQrket wh(c.h ,
easier.for nt?w tbmpaniestci entei
young m"drkets than,.oldi?r ones.
wher.e growtl{ is slower. . .
Soles rise rapidly
at 6rst, because
many customers ore
adopting the new
product, creating
a favorable
environment for
new venlures.
loler, demand
Rattens out, a
less favorable
siluolion for
new venlures.
Source: Based on infonnation in Rogers, E.1983. Diffusion of Innovations. New Y ork: Free Press. p. 243.
but then, ultimately, begin to decrease (see Figure 2.9). As a result, if the
adoption of most new products follows the normal curve, then demand for new
products will first aceeierate and then decelerate. Because it is easier for new firms
to enter markets during periods of rapid demand growth, this is one reason why
they do befter in younger markets than in older ones. Moreover, when industries.
are new, no existing firms are available to meet changes in demand. Without
existing firms present with which they must compete, new firms do better than
when they have to compete with existing firms to serve customers.
Furthermore, firms get better at meeting the needs of customers through
experience. Because firms have to operate in an industry to gain experience,
new firms are at a disadvantage when compared to established firms. Early in
the life of an industry, this disadvantage is small because even the oldest firms
have little experience. However, when the industry becomes mature, the older
firtns' Ievel of experience makes itmuch harder for new firmstoperform weil.
Second, when industries mature, they tend to converge on a dominant
design. A dominant design is a common approach or standard used to make a
product. For example, the intemal combustion engine is a dominant design.
Early in the life of the auto industry, many firms useq engines based on steam and
electrical power rather than the internal combustion engine. None of the major
auto use engines based on steam or electrical power anymore.
The concept of a dominant design is important to entrepreneurship because
new firms tend to do much better before a dominant design emerges in an industry
than after it has been established. Before a dominant design is established, an
entrepreneur can adopt any design that she or he wants for the new venture' s
product or service. However, the establishment of a dominant design Iimits the
approaches that entrepreneurs can take to those designs that fit the standards that
established firms are a1ready using. Not only does the new firm have to use the
dominant design for itfi products, the established finns possess a big advantage:
They already have greater experience with this design. So once a dominant design
emerges, competition in an industry changes. Instead of competing to see who has
the design that fits the preferences of customers the best, firms compete on
who can make a standard design most efficiently. Because established firms
are larger and have more experience, they can produce more efficiently, and so
have distinct advantages once a dominant design has emerged in an industry.
Take VHS tapes for example. Once the video recording industry
converged on the VHS standard as the dominant design, it became almost
impossible for new companies to introduce other tape formats. The major
Japanese companies that produced VHS tapes, such as Matsushita, were able
. to produce the tapes more efficiently than anyone eise, and were able to gain a
major competitive advantage.
[
[
f
r
r
r
[
[
[
[
r
[
r
C HA PT ER 2 Entrepreneurial Opportunities: Their Origins, Forms, and Suitability for New Ventures 51
C()tnfNdititJn lil1d 5qe
()t C't>tnpdittJ't-Y
Industries also differ in their structure, making some of them more hospitable to
new ventures than others. Researchers have identified four aspects of the
structure of an industry that make it easier for a person to found a successful
new firm in it First, some industries are more capital intensive than others.
Capital intensity refers to the degree to which the production process in an
industry relies on capital rather than on Iabor. New firms perform relatively
poorly in capital-intensive industries.
25
When new ventures are initially created,
entrepreneurs must spend capital to obtain equipment, establish production
facilities, set up distribution, and otherwise get organized. This expenditure of
capital occurs before the new business can sell its products or services and so
generate revenue. Because new firms do not generate cash from their existing
operations, they must obtain this capital from investors. For reasons we will
describe in more detail in Chapter 6, investors charge entrepreneurs more for
capital than it costs for them to use internally generated capital. For now, we'll
simply note that entrepreneurs know much more about their business ideas and
venture opportunities than the investors who back them, .and_so _ _the investors
demand a risk premium to compensate for those entrepreneurs who might try
to take advantage of their (the investors') relative ignorance. Because existing
firms can use capital from their current operations to finance new business
ideas, this puts new firms at a disadvantage. This disadvantage grows as the
capital intensity of the business increases.
Second,new firms perform worse in advertising-intensive industries, such
:!'ii':' as consumer products, than they do in industries that do not rely heavily on
advertising,'like industrial chemicals. Brand reputations are developed over
.. '. time through repeated advertising efforts. As a result, it takes considerable
time for new firms to develop the same Ievel of brand name recognition as
established fums. Moreover, advertising is subject to economies of scale.
.- Economies {)f scale is a term that economists use to explain that the cost of each
unit of a product goes down as the volume of production increases. Scale
economies exist any time the cost to produce the first unit of something is
greater than the cost to produce additional units. Because the cost of
developing a television or radio advertisement is the same regardless of the
number of units of the product that you sell, the cost per unit of advertising is
significantly lower, the more units of your product that you produce and sell.
Therefore, the small size of new ventures makes it hard for them to keep their
per-unit advertising costs as low as those facing established firms.
26
Third, new firms perform worse in industries than they do in
fragmented industries.
27
Concentration refers to how much market share lies
in the hands of the largest firms in the industry. When industries are
concentrated, new firms have to challenge the customcr base of established
firms with the power and resources to drive them uut of busirwss. Jn contmsl,
when inchJRhiP.s fragmented, new firms can enter by challenging small and
weak established firms whose customers are more vulnerable.
Fourth, new firms perform better in industries that are composed of
companies that are relatively small in average size.
28
Most new ventures are
relatively small because starting small allows entrepreneurs to minimize the
cost and risk of establishing theU: new ventures. Because entrepreneurs are
often wrong about their business opportunities, they would like to minimize
the cost of being wrong, which they accomplish by starting on a small scale
and testing whether their business ideas work.
In industries composed mostly of small firms, starting small does not put a
new venture at much of a disadvantage relative to established competitors.
However, in industries composed mostly of large firms, starting smaH greatly
52 PART l Entrepreneurship: Who, What, Why?
Figure 2.10
Aspects of lndustry Structure that
lnfluence New Venture Success
As shown here, several aspects of
industry structure make a
particulor industry one in which it
is relatively easy or relatively
difficult to start new ventures.
disadvantages new firms whose established and much !arger competitors can
purchase in greater volume, produce at a lower average manufacturing
and spread their costs of advertising and distribution over more umts.
Therefore, new firms tend to do more poorly in industries made up of
relatively large firms. Figure 2.10 summarizes the aspects of industry structure
that have been found to strongly affect the success of new ventures. (What
happens when entrepreneurs ignore these factors? For an example, please see
the Danger I Pitfall Ahead! section.). .
i.tatute lndustries at Your Own Doe& ij requir6 large amount to enter?
Perlt Ak markets growing mpidly qrare: they" ...
. stagnnt? And is ihe iodustty 'young_or
a new. a riskfpropo : to tq
g6d:the6pportunfty .: ...
e rlfre. P :teil. ide. n_ m_ aoy. b$taeles '' ,: ......... .. '.. ,... .... .. :.
" . . . . .. . .. , ....
. . . tM Way qf-'i:etlGhirig this . . , ln. the ilate. bierltistin . . .
. .. .
la;uncihed. JheleSes; whictf th_e seien- .
f19W: iif:Ef.bey6n,d: tbEtfr: : be adjij$fecl (tl. the


ttuBr& . . _.: . : . _ . , sf . " , > ,
.... , f!or clea_r
neors' ma of- a new' bu_Sinl'!'ss . :jif.
.. .. '.

... ..
"
t
[
r
[
r
r
r
[
[
[
[
[
r
[]
0
n
n
u
n
r
r.

J
r
C HA PT ER 2 Entrepreneurlai Opportunities: Their Origins, Forms, and Suitability for New Ventures 53
~ -
: ....'
. . . .
. ' ..
.. .. : '
54 PART 1 Entrepreneurship: Who, What, Why?
learning s
objective
Explain why established firms
are usually better than new
firms at exploiting entrepre-
neurial opportunities.
Opportunities That Favor
New Firms
One of the difficulties that people face in founding successful new businesses
is that they confront strong competition. The individuals who run established
firms are often talented, experienced, and highly motivated: They, too, want to
profit from the exploitation of opportunities. So, not only does an entrepreneur
have to identify and exploit a valuable opportunity to start a successful new
company; the entrepreneur also has to do so despite strong competition from
established companies. How do new ventures sometimes manage to overcome
these odds, which are heavily against them? Research Eindings indicate that
entrepreneurs and the new ventures they start sometimes are able to succeed
in the face of these obstacles because some apportunilies are especially
favorable for new businesses. By focusing on opportunities in this category, an
entrepreneur can increase his or her likelihood of succe5s. In this discussion,
we will carefully consider both kinds of opportunities: ones that favor
established firms and ones that favor new firms.
. tntJ>t FtWtJ4 FWny
Most of the time, established companies do a better job than a new company at
exploiting an opportunity for several important reasons, all of which have to
do with the following basic fact: When companies have been in business for a
while they develop several advantages over new competitors. First, they move
up what is . known as the learning curve. This simply means that their
.performance improves as a function of how much experience they have had
with the product or Service they provide. This performance improvement
occurs both for companies and for individuals. For example, think about
learning to ride a bicycle. Probably, at first, you feil off repeatedly. Gradually,
though, your performance improved and soon, you were able to do much
better-and feil off only rarely. In other words, the more practice you had, the
better your performance. The same basic function applies to companies.
Initially, they find it difficult to manufacture products efficiently because they
have not worked out the ''bugs" in their production processes. Moreover, they
haven't yet figured out the best way to sell products to customers. However;
just like you and your bicyde, as companies produce more of something,
... get betterat doing it (see Figure 2.11). Because new companies have.not.yet .
moved up along the learning curve, they are generally worse at manufacturing
and marketing products than established companies: They just don't have the
experience. (practice) to be as good.
Second, business depends a great deal on reputation. Research findings
indicate that peoiJle are much more likely to buy products from suppliers they
know and trust
29
than from new and unfamiliar ones. Experience in
h\Leracli.ng w ilh a particular supplier gives a customer confidence in the
products and services that this suppler provides. Think about gomg out to
dinner. If you've eaten at arestauraut before, you know you like it.
Although you might have a better meal at a new restaurant, you don't know
whether the rneal. will be any good. The reputation that the established
restauraut has developed with you (and other customers, too) keeps you
coming back and makesit harder for the new restauraut to get you in the door.
This advantage is also important for established companies. fu addition, and
closely related to these points, Iarge existing companies also have established
customers, marketing departments, and experienced salespeople-all these
make it truly difficult for a new company to capture their markets.
Third; if businesses are successful, they develop positive cash fiow. That
is, they bring in more cash than they spend to produce and distribute their
L
[
[
r
r
r
f
r
[
[
[
[
[
[
r
C HA PT ER 2 Entrepreneurial Opportunities: Their Origins, Forms, and Suitability for NeW Ventures 55
I
I
I
I
I
I
Experienced, existing companies
are for along the leoming curve,
'-
_so_lh_e_y_a_re ..... ___J ____ - ----Ii"
/
I
I
I
,
,
/
/
,.""'
... -
,.,.
... -
""_ ...........
New venlures are furlher back
on the leoming curve, so
lhey are-less efficient.
Experience in Manufocturing a Product
products and services. This cash flow is useful for developing new products
and services .. If an established business has positive cash flow, it can use that
cash to invest in producing new products and services that meet the needs of
customers. ,'For example, Dell invested the cash it earned from selling
computers ,irtto making and selling printers. Because new companies haven't
yet sold anrproducts to customers, they do not have positive cash flow, and
,-, have to borrow money or issue stock to raise capital. These options cost more
... than using;.Jnternal cash, and so puts new companies at a disadvantage
, relative to established companies where producing new products is
concerned.
Fourth, many established businesses enjoy the advantage of economies
of scale. For example, think about the cost of producing a computer
game. Writing the software code for the first copy. of the game is quite
expensive. A computer programmer will have to spend several hundred
hours writing this code. But once the game has been written, a person can burn
CDs of the game for only pennies. Economies of scale benefit established
companies over new companies because the established companies are
already producing products and services. So if they are buying raw materials
or advertising or doing anything eise that requires economies of scale, the
established company faces lower costs than the new company because it
produces more units.
Fifth, new companies often find it difficult to compete with established
companies because they Iack complementary assets. Complementary assets
are things that are used along with the entrepreneur's new product to make or
distribute that product. For example, suppose you have developed a new type
of fuel that will deliver more than 200 miles per gallon in existing automobiles
and is also less polluting than existing fuels such as gasoline. Could you bring
it to market and sell it? Perhaps. But consider this: would the existing oil
companies allow y6u to sell your new fuel at their service stations? And would
they allow you to make it in their existing oil refineries or other plants?
Probably not! They control the complementary assets-the ones needed to
produceJmge quantities of this fuet and to actualiy deliver it to consumers.
Unless you could make some arrangement with them, you would not be able
to deliver your new fuel to drivers. Your competitors-existing, large
companies.........control the complementary assets needed to do so and would
be unlikely to give you access to these assets.
Figure 2.11
The Leaming Curve: A Big
Advantage for Existing
Compnies
Because new companies have more
experience 11t manufcii:Wriilg
produds' than' new. compaiiies,
they ore fqrther afong the fearning
curve and can .
products with which theyhave
past experience much more .
effidently than new componies.
56 PART 1 Entrepreneurship: Who, What, Why?
rearning . 6. . ...
objective _
ldentify the lypes of opportl!
nities that new firms are better
at exploiting, and explain wby
new firms have an advantage in
exploiting these'l<inds-of
opporh.lnities.
7ld '11w
Admittedly, all these factors sound discouraging: The "business deck" is
indeed stacked strongly against new ventures. So how, in the face of these
major disadvantages, do they succeed? The answer involves the
fact that entrepreneurs have several important "aces" up their sleeve. In other
words, they actually have several advantages over existing companies. Let's
now take a closer look at these advantages.
One major advantage new companies have is that they are better at
exploiting competence-destroying change. Earlier in the chapter, we noted
that one of the major sources of opportunity is technological change.
Technological change makes it possible to introduce a new product or service,
open up a new market, use a new raw material, develop a new way of
organizing, or introduce a new production process. Such change, however, can
be competence-enhancing or competence-destroying. Competence-enhancing
technological change is a change that makes people or companies better at
what they are already doing; in contrast, competence-destroying technological
change is a change that makes people or companies worse at what they are
doing.
30
Most technological change is competence-enhancing. For instance,
companies that have been exploiting a technology for a while are better at
doing things that make use of further advances in this technology because of
the learning curve that we described earlier: They are experienced with it, and
so can quickly take advantage of further advances. As Iong as the effort to
produce a new product, develop a new production process, exploit a new
market, use a new raw material, or organize in a new way takes advantage of
something that had been learned before, the established firm, which has
moved further up along the learning curve, has an advantage. But sometimes,
change is competence-destroying. In .those instances, having done something
before doesn;t make you any better at exploiting a business idea than someone
who hasn't done that thing before--in fad, it makes you worse. Why? Because
having done something in one way for quite a while, individuals or companies
find it difficult to do things in a new way-more difficult than individuals or
companies with no prior experience, and who, in a sense, haven't failen into
what might be termed "the ruts of habit."
For example, when the Internet was introduced, experience with bricks-
and-mortar retailing didn't help established clothing companies as e-tailers. In
fact, it made the established companies worse. Their managers kept trying to
use the experience that they had gained from retail stores in their online sites
without realizing that online shoppers cannot try on or touch dothes in the
same way as shoppers in a retail store. In this case, the managers' previous
experience got in the way of selling dothing online in a new way-a way that
new companies with no experience in running actual stores were quickly able
to adopt. In this sense, the Internet was a competence-destroying technological
change.
The disadvantages of technological changes such as the Internet go well
beyond simply undermining the advantages existing companies gain from
the_ learning curve. In addition, established companies face several other dis-
advantages in exploiting competence-destroying changes. First, to invest in a
competence-destroying technological change, an existing company has to
cannibalize its existing business. Cannibalization occurs whenever a company
Iaunches a new produd or service that replaces its existing products or services:
For example, unlike Amazon.com, book sales on the Web by Barnes & Noble
cannibalized its existing business, which was based on actual bookstores. When
it introduced barnesandnoble.com, Barnes & Noble found itself in the Situation
of serving many customers who would have bought books in its stores. So it
was serving its previous customers, but at an additional cost of setting up the
l
r
f
[
r
[
[
[
[
[
[
[
r
[
r
f
r
C HA PT ER 2 Entrepreneurial Opportunities: Their Origins, Forins, and Suitabil.ity ,for New Ventures 57
online business. In such Situations, new companies have an advantage over
existing companies because the existing companies must make investments that
don't pay off in new customersj rather, the mvestments merely allow them to
serve their existing customers in a new way.
31
The same thing is true for many.
!arge retailers that invested heavily to develop Web-based sales-JCPenney,
Sears, and dozens of others (see Figure 2.12).
Moreover, consider the fact that companies that have existed for years or
decades generally develop routines for doing business efficiently. These
routines allow them to do things without having to evaluate whether those
activities are worthwhile every time they do them. For example, existing
companies might have procedures for manufacturing a CD player by means of
a specilic. kind of technology. Even though these production routines are
useful for manufacturing the CD player efficiently, they may obstruct efforts to
explore new technologies, such as those behind MP3 players. The result? New
companies often have an advantage in doing things that are really new, such
as investigating the MP3 technology, because they are not constrained by
existing routines that direct them into doing something eise. In fact,
entrepreneurs may be better able to exploit new information about changing
markets and other factors than individuals who work for large, established
firms, and this, too, can give them an important edge.S
2
Established companies also seek to satisfy their existing customers. As you
perhaps learned in marketing courses, satisfying customers is important if a
company is going to sell its products, but keeping customers happy has a
downside ... When companies develop new products, they often ask their
customers what they think of those products. Much of the time, customers
reject new either because those products aren't useful to them,
because they simply cannot envision changing to something new, or because
changing requires effort. Because established companies run the risk of losing
their existing customers by pursuing products that these people do not want,
they often avoid the new products. After all, wh:X go to the trouble of making
existing customers don't want? Here's one example: When
IDM developed the Iaser, its lawyers weren't sure that the company should
patent it because IDM's customers couldn't find any use for the technology.
But as we now know, a huge. market can be found for lasers in everything from
supermarket scanners to making CDs. The lesson in this discussion is dear:
New companies are often better than established companies at developing
new products or services because established companies are constrained by
their existing customers. If their existing customers teil them that they don't
like a new product, the company may Iisten and decide not to develop it.
Because new companies have no existing customers, they often feel no such
constraints against developing new products.
New companies arealso more successful when they develop products and
services that are discrete. An example of a discrete product is a new drug. Any
company that produces a drug can sell that drug without combining il wilh
other products or devices. In contrast, a windshield wiper is not discrete:-it is
. part of a system. Separated from the rest of a car, bus, or other vehicle, a
windshield wiper is pretty useless. In essence, discrete products are better for
new companies because these products are "stand-alone" itelllS and can be
developed without the cost and difficulty of trying to replicate existing
companies' entire systems-for instance, a new company can make and sell a
drug without combining it with other products.
34
New companies are also more successful when their business ideas are
embedded in human capital rather than physical capital. Human capital is
value invested in people, while physical capital refers to things such as
machines and equipment. New businesses do better with ideas that are
founded in human capital rather than physical capital for several reasons.
First, human beings can move relatively easily from an existing organization to
Figure 2.12
T echnological Change ls
Sometimes a Major Advantage for
New Companies
When e-tailing on the Internet
took off in terms of volume,
retailers such as JCPenney, Sears,
and Barnes & Noble, who
previous(y sold products in actual
stores, had to spend large amounts
of capital to estabfish effective
Web sites. This move didn't bring
them many new customers,
however. lnstead, they were simply
cannibafizing their existing
business. ln contrast, new
companies such as Amazon.com
obtained only new customers from
the Internet. Thus, this
technological change, like many
others, gave new ventures an
important advantage over existing
companies.
58 PART 1 Entrepreileurship: Who, What, Why?
a new one to pursue an entrepreneurial opportunity. For example, if you have
an idea for a new product or service while working at a full-time job-an idea
that is not related to your job in any way-you can leave and start a company
to develop this idea (But be careful: if you have signed a noncompete
agreement this may be illegal; see Chapter 8). Altematively, suppose that
sorneone you meet has an idea you think is simply. great; it is her idea, but
since she can take it with her, you might try to persuadeher to start a company
with you so that you can both benefit frorn this idea. Consistent with this
reasoning, recent findings indicate that new ventures that focus on human
capftal development strategies-recruiting knowledgeable employees, training
existing ones, developing diverse teams for work on various projects-are
especially likely to develop truly new and path-breaking new products.
35
In contrast, if business ideas are ernbedded in physical capital, they can't
be moved as readily. For instance, expensive and highly specialized equip-
ment required to make a product or offer some service means that only
companies that possess or can afford such equipment can develop the product
or service. Because few new companies have large resources at their disposal,
existing companies have an advantage in this respect.
New companies often benefit frorn other factors that might be described as
"intangible" in nature, but are still very important: the enthusiasm and
persuasiveness of their founders. People who work for large, existing
companies often feel strong cornmitment to these companies, but this loyalty
generally pales in comparison with the commitment entrepreneurs feel for
their own ideas.
36
When they translate this enthusiasm into effective
communication, they can gain an important advantage over large existing
companies. Necessity, it is often said, is the foundation for eloquence, and
Table 2.2 Some OpfXirtunities Are Setter for New Ventures Th.an Others
As shown here, some opportunities. favor established 6rms while other.s favor new ventures.
Relies heavily on reputation Established firms People are more likely to buy from those whom Restaurant; Retail
know and lrust stores
Has a strong learning curve Established firms Estabfished firms are further up the leaming Automobiles
curve and are better at producing and
distributing products
Requires a Iot of capital Established firms Established firms have existing cash flow that Jet
they can use to produce a new product or
service
Demands economies of scale Established firms The average cost of producing a product or
service goes down with the volume produced
Computer chip plant
when economies of scale exist
complementruy assets Established firms The ability to meet customer needs otten Television sets
and distribution requires access to retail distribution
Relies on an incremental Established firms The established firm can add the incremental DVD player
product improvemenf improvement to its products more easily and
cheaply than the new firm oon i m i t o . ~ o their
product or service
Employs a compelence-destroying New ventures Established company experience, assets, and Traditional travel
innovation routines get in the way of innovation
Does not satisfy the needs of New- ventures Established firms focus on serving their Computer disk drives
existing firms' mainstream mainstream customers and will not pursue
customers products or services !hat do not meet the
needs of those customers
ls based on a discrete New ventures New firms can exploit discrete innovations Drugs
innovation without replicating the entire system belonging
to established firms
Based on human capital New ventures who has the knowledge can produce a Food recipes
or service that meets customer needs
L
f
[
[
[
[
[
r
f
[
[
r
r
r
[
[
[
r
r
C HA PT ER 2 Entrepreneurial Opportunities: Their Origins, Forms, and Suitability for New Ventures S7
since entrepreneurs need customers very badly---:-much more than existing
companies-they can, and often do, translate their own commitment and
passion into important advantages for their new ventures.
By now, we hope, the main point is clear: Even though most opportunities
favor existing companies, which have greater resources, established reputa-
tions, and many other advantages, some opportunities do actually favor new
ventures. Entrepreneurs should consider this fact carefully before proceeding,
because in essence, it only makes sense to pursue opportunities that offer new
ventures if not a totally Ievel playing field, at least one that is not tilted heavily
in favor of large, existing companies. Table 2.2 summarizes basic dimensions
of opportunities and indicates which kinds favor existing companies and
which kinds favor new ventures.
An entrepreneuril;opportunity. is a sifua'.
tion in which a person can exploit new
business idea that has the potential to
generate a profit.
Entrepreneurial opportunities exist
because people differ in the information
they pqssess, . . .
i!l Entreprene!Jrial opportunities also eieist
because f sources Qf change,
. particillarly technologicalchange, regula::
tory and political cnange, and soci?l ahd .
ohange.
Technological . chail.ges are irnportant .
SOUrCeS of entrepn;ine(JdaJ Opportunity:
because they make it possible for people
to do tliings in new arid more productive
ways.
Political and . changes are .. .
sources ot . because tney
make it possible to develop business .
ideas to use in new ways that
are either more prc:fudive or that .
tribute wealth from one persoh . to ..
another.
. ' . . . .
Social and. demograph!c .. changes. are .
sources of . opportu.nity beqause the}< . .
alter demand fr products aild . service$, ..
as weil as make. it possible to generate .
solutions ta ct.istomer needs tt1at :
more .. productiV.e . those curreritly
availabte.
!it Entrepreneuiiaf opportunities.do not nly:
take the .. form of new products arid
services. They can also take the frrrt of
60 P.ART 1 Entrepreneurship: Who, What, Why?
. new methods of production, new raw new
ways of organiZing, and new markets.
"!} Entrepreneurs' business ideas often involve the
introduction of new products and services or entry
into new markets.
:'f: The most common form of opportunity exploitatioll by
entrepreneurs is not necessarily the best. Research
findings indicate that new businesses tend to do
worse at entering new markets and introducing riew
products and services than at developing new
production processes.
New firms perform better in R&Dintensive industries
because the invention of new technologies is a
source of opportunity for new business ideas.
lndustries. in which public sector otganizations are
the locus of innovation have morenew firm forrriation
because public sector orgimizations do. not try as
hard as private sector fitms .to minimize knoWiedge
.spillovers.
New firms peiform better in in which most
of the innovation is providedby small fimis.because
innovation in these industries requires agile and
flexible organizations, and new firms are agile and
use this design,.'and if. is one with which established
companie& have greater
1Il! lndustries that are capital-infensive, advertising-
intensive; and concentrated are more hostile to new
firms because they the resources to compete
and must try to win customers from large established
firms.
!l'i Established tkms are better than new firms at
exploiting most opportimities. Established firms
have the advantage of the leaming curve, which
improves their ability to introduce a new product or
service, tap a new market, use a new material, take
advantage of a new production process, or organize
in a new way.
Established fir:ms have reputations, which encourage
. customers and suppliers to do business with them;
lli: . Established firms have cash flow from existing
. Operations; which they. can invest in the exploitation
. of new opportuhities at a lower cost than new firms
ean tap extemal capitat
Establlsh firms have . access to compiEm'lentary
. assets in nianufacturing, mar.keting, and distribution,
which are necessary to exploit opportunities.
m. To finns, entrepreneurs must
New.fmns.,pen:fomi'betteri.in-.15lrger in, >, ,exploitopporttinities-tf:iatfavon:iewfirms, Competence-
. smaller Ohes. and. ln rapidly grWing,matkl3tS. than. ;Cfestroyjng .fa\lon{new firms because
flexible.
.. ones .that:a:re growing.slowJY. . . competencede.stroying pharige undermines the
it Market, enharices neVJ firm

. of exist_ing fitills forces established
becausemiche organizationsthat ean . Jirms to cannibalize-:theit e}dstlng assets.
.explitoppGrtuoities. Gm a .. ,. that. are . are. good for new
markef: segrnentation allows a: new firm to .. enter a firms be.6a:use ehtreprenel,lrs cn exploit them with-..
market and obtain a foothord without going affer. the- . . . out having to ,repficate established firms' entire
. customers of an establislied firm. systein of assets ..
Young industries are more supportive of new firms Opportunities embedded in human capital offer
because demand grows more rapidly in young advantages to new firms, because entrepreneurs
industries than in mature ones and because no can leave their employers to found firms that exploit
existing firms are available to meet demand in young the knowledge. they possess and because such
industries. opportunities permit them to translate their enti:msi-
''<i Development of a dominant design in an industry asm and commitment into tangible outcomes such as
works against new ventures because they . have to increasing sales.
Amor1:ized: A method of distributing the cost of an
investment over the number of units produced or
sold.
Cannibalize: An effort to produce and sell a product m;
service that replaces a product or service that one
already produces and sells.
Capital Intensive: The degree to which the production
process in a firm or industry relies on capital rather
than on labor.
Cash Flow: The intemally generated funds available to
a firm after costs and depreciation are subtracted
from revenues.
Competence-Destroylng: A form of change that under-
mines the skills and capabilities of people who are
already doing something. It is contrasted with
competence-enhancing change, which enhances the
skills and capabilities of people who are already
doing something.
[
[
[
r
r
[
[
[
[
r
r
[
[
0
[
[
[
f
r
C HA PT ER 2 Entrepreneurial Opportunities: Their Origins, Forms, and Suitability for New Ventures 61
Complementary Assets: Assets that mtist be used along
with an innovation to provide a new product or
service to customers, typically including manufc-
turing equipment as weil as markefing and distri-
bution facilities.
Con.centratlon: The proportion of market share that
lies. in the hands of the largest firrns in an industry.
This concept is commonly measured by the four-
firm concentration ratio, a government measure of .
the market share that lies in the hands of the four
largest firms in an industry.
Discrete: A characteristic of a new product or service
that makes it independent of a system of. other
assets necessary to use the product or service.
Dominant Design: A common approach or standard to
making a product on which firms in an industry
have converged.
Economies of Scale: A reduction in the cost of each unit
produced as the volume of production increases.
Entrepreneurial Opportunity: A situation in which aper-
son can exploit a new business idea that has the
potential to generate a profit.
1. you discovered a eure for some serious
.. ,Would that discovery be an entrepreneu-
rial pportunity? What about a new kind of .
canqy t4:;tt did not cause people to gain weight or
experience tooth decay?
2. What do you think will be the major sources
of apportunifies over the next five years? Why are
they sources of entrepreneurial opporhmities?
3. Think of five opportunities. What forms do they
take? Are some of these forms better for entre-
preneurs from the point of view of founding new
ventures?
The Hunt for Opportunities:
Building Your Skins
We defined an opportunity as the potential to create q
l?Omething new and desirable (new products or services,
new markets, new production processes, new raw
materials, riew ways of organizing existing technologies,
etc.) that emerges from a complex pattem of changing
conditions. You'll need to identify an entrepreneurial
opportunity to start your bttsiness. We believe that you
can use some of the things that we discussed in this
chapter to identify an entrepreneurial opportunity. To
do so, please follow the steps described here.
Human Capital: Inves"tment or value in human resources
rather than physkal assets.
lndustry Life Cycfe: Refers to the birth, maturation, and .
death of indu.Stries.
KnowJedge Spillovers: the accidental transfer of infor-
mation about how to create new products, produc-
tion processes, ways of marketing, or ways of
organizing, from one firm to another.
Learning Curve: A relationship that measures the per-
unit performance at production as a function of the
cumulative number of units produced.
LociJs of Innovation: The location, both within the value
chain and between the public and private sector, in
which efforts to apply new knowledge to the crea-
tion of new products, production processes, and.
ways of organizing, occurs.
R&D lntensity: The proportion of a firm' s sales that are
devoted to creating new scientific knowledge and
applying that knowledge to the creation of new
products and production processes.
4. Pick three industries you know weil. What
dimensions of these industries make them favor,-
able or unfavorable to new venture formation?
5. Go back to the five opportunities you thought of
. in response to question 3. Would established
firms have an advantage over new ones in
exploiting these opportunities? Why? Why not?
6. Describe an opportunity that, in your view, would
be an excellent one for an entrepreneur to pursue-
one that would give new ventures important
advantages. Why does this opportunity offer a
good foundation for starfing a new venture?
Step 1:
Construct a list of recent changes in (1) technology,
(2} demographics (changes in the make-up of the
population), (3) life style and other social changes,
(4) markets, and (5) government policies. List these
changes on the following form.
Changes You Observe
Technology:
1.
2.
3.
64 PART 1 Entrepreneurship: Who, What, Why?
dates to. illessages (hence the riame) to. ensure that
. .
information wouldn't "gtow legs" and travel beyond its
intended recipients. "We got going back in 1998
because we believed e-mail privacy was unattainable
for legal reasons, i.e. that the threat wasn't the man in the
middle, it was a lawyer with a subpoena, and that the
technical problems were related to the multiplicity of
copies, and their stubbom persistence over time."
But, says Ubois, "lt turned out to be very difficult to
sell privacy to either companies or individuals. At the
corporate Ievei, privacy has been an afterthought.
Concems, if they exist at all, tend to revolve araund
potential liability, loss of intellectual property, and com-
pliance with GLB, SOX, HIPM, and other similar rules. ln
the absence of some clear legal requirement, companies
don't spend on money it."
He says that the Canadian company ZeroKnowledge
Systems was "probably the best of the companies
selling privacy to individuals. One of the problems with
that is that no one had lots of friends using secure e-mail,
i.e., there is a type of social proof required to make people
think it's worth the hassle." He also cited the technicaJ
burden as a problem: "Most e-mail security technologies
were and are pretty difficult to use." Being hard to use still
seems to be the ca.Se-do you send or receive encrypted
e-mail yourself?
has gotten out of that business,
shuttering its services for individuals and shifting to
providing system management services to Internet
1 Hofer, E. (1973). Reflections on the Hui1Uln Condition.
New Yorlc HarperCollius.
2 McMullen, J.S., & Shepherd, D.A (2006). Entrepreneurial
action and the role of uncertainty in the theory of the
entrepreneurs. Academy of Ma11ilgement Review,31, 132-152
3 Lee, J.H., & Venkataraman, S. (2006). Aspirations,
market offerings, and the pursuit of entrepreneurial
opportunities.Journal of Business Venturing, 21, 107-123.
4 Kirzner, I. (1997). Entrepreneurlai discovery and the
competitive market process: An Austrian approach. The
Journal of &:onomic Literature 35, 60-85.
5 Schumpteter, J.A. (1934). The Theory of Economic Devel-
opment: An Inquiry into Profits, Capital Credit, Interest, and
the Business Cycle. Harvard University Press Cambridge,
MA.
6 Bhide, A. (2000). The Origin and Evolution of New
Businesses. New York: Oxford Univeciity Press.
service providers, a more lucrative blisiness than seUing
that everyone says that they mightcare about,
but that few will pay for, even if it's just the time and
attention needed to click on a button to encrypt e-mail.
Disappearing, lnc., has itself, in fact, disappeared. lt
was acquired in 2004 by Uquid Machines, after changing
its name to the decidedly lessinteresting Omniva. Policy
Systems. Ubois's experience was that of a good many
entrepreneurs, where the venture ends more in a
whimper than a bang: "As a faunder ... I watched the
national value of my stock rise quickly, plateau, and
collapse. Though I did sell some shares before the
company was acquired, the acquisition by Liquid
Machines didn't return anything to the founders of the
company, nor cover the investment made by the VCs."
Questions
1. How can a small, entrepreneurial company anticipate
regulatory changes that might provide a window of
opportunity to introduce new services?
2. Askeptical view on.entrepreneuring in the marketfor
secure massaging is that, ."lf it turns out to be
valuable; Microsoft- willjust add it into the Windows
operafing system and all the companies affering it
will go out of business." Oo you agree?
3. What legal and regulatory changes might we see in
the near futute that will provide apportunifies for
entrepreneurs?
7 Shane, S. (1996). Explaining variation in rates of
entrepreneurship in the United States: 1899-1988.fournal
of Ma11ilgement,22 (5), 747-781.
8 Holmes, T., & Schmitz, J. (2001). A gain from trade: From
unproductive to produclive entrepreneurship. Journal of
Monetary Economics, 47,417-446.
9 Baum, J., & Oliver, C. (1992). Institutional embeddedness
and the dynamics of organizational populations. American
Sociofogical Review, 57, 540-559.
10 Dobbin, F., & Dowd, T. (1997). How policy shapes
competition: Early railroad foundings in Massachusetts.
Administrative Science Quarterly, 42, 501-529.
11 Feldman, M. (2001). The entrepreneurial event revisited:
Firm formation in a regional context. Industrial and
Corporate Change, 10 (4), 861-891.
12 See note 5.
![
[
[
[
I[
I[
f[
![
\[
l[
f[ . . '
l
[.[
' ;
l.
C HA PT ER 2 Entrepreneurial Opportunities: Their Origins, Forms, and Suitability for New Ventures
65
13 Ruef, M.. (2002). Strong ties, weak ties, and islands:
Structural and Cultural predictors of organizational
innovatioit. Industrial and Corporate Change, 11 (3), 427-
4So. .
14 Utterback; J. (1994). Mastering the Dynamics of Innovation.
Boston, MA: Harvard Business School Press.
15 Parker, S.C. (2006). Leaming about the unknown: How
fast do entrepreneurs adjust their beliefs? Journal of
Business Venturing, 21, l-26. . .
16 Mansfield, E. (1985). How rapidly does technology leak
out? Journal of Industrial Economics, 34 (2), 217-223.
17 Shane, S. (2003). The Individual-Opporlunity Nexus
Approach to Entrepreneurship.
18 Dean, T., Brown, R, & Bamford
1
C. (1998). Differences in
!arge and small firm responses to environmental context:
Strategie implications from a comparative analysis of
business formations. Strategie Management Journal, 19,
709-728.
19 Audretsch, D., & Acs
1
Z. (1994). New firm start-ups,
technology, and macroeconomic fluctuations. Small
Business Economics, 6, 439-449.
20 Acs, z., & Audretsch, D. (1989). Small firm entry in U.S.
manufacturing. Economica, 255-266.
21 Eisenhardt, K., & Schoonhoven, K. (1990). Organiza-
tional grow$: Linking founding team, strategy, envir-
onment, and growth among U.S. semiconductor
ventures,. 1978-1988. Administrative Science Quarterly,
35,
22 Portugal, P. (1994). Life duration of new firms.
The of Industrial Economics, 42 (3), 227-243.
23 S. (2001). Technology regimes and new firm
formation.!vfanagement Science, 47 (9), 1173-1181.
24 Barnett, W. (1997). the dynamici of competitive inten-
sity. Administrative Science Quarterly, 42, 128-160.
25 Audretsch D. (1991). New firm survival and the
regime. Review of Economics and Statistics,
441-450.
26 See note. 17.
27 See note 21.
28 Audretsch, D., & Malunood, T. (1991). The hazard rate of
new establishments. Economic Letters, 36,409-412.
29 Aldrich, H. (1999). Organizations Evolving. London: Sage.
30 Tushman, M. & Anderson, P. (1986). Technological
discontinuities and organizational environments. Ad-
ministrative Science Quarterly, 31, 439-465.
31 Arrow, K. (1962). Economic welfare and the allocation of
resources for inventions. In R Nelson (ed.), The Rate and
Direction of Inventive Activity. Princeton, NJ: Princeton
University Press.
32 Parker, S.C. (2006). Learning about the unknown: How
fast do entrepreneurs adjust their beliefs? Journal of
Business Venturing, 21, 1-26.
33 Christiansen, C. & Bower, J. (1996). Customer power,
strategic investment, and the failure of leading firms.
Strategie Miznagement Journal, 17, 197-218.
34 Winter, S. (1984). Schumpeterian competition in alter-
native technological regimes. Journal of Economic Behavior
and Organization, 287-320.
35 Branzei, 0., & Vertinsky, I. (2006). Strategie pathways to
product innovation capahililies in SMEs. Journal of
Business Venturing, 21, 75-105.
36 Meyer, J.P., & Herscovitch, L. (2001). Commitment in the
workplace: Toward a general modeL Human Resource
Miznagement Review, 11, 299-326.
L
[
r
. r
r
r
r
r
[
[
r
r
r
r
c