Perspectives on Economic Conditions, Entrepreneurship, First-Product Development, and New Venture Success

Michael Song, Lisa Song, and Mark E. Parry

ABSTRACT

Entrepreneurial ventures have a significant impact on new job creation and economic growth, but existing evidence indicates that most entrepreneurial ventures fail.  In this article the authors report key insights from VENSURV, a new database that tracks the success and failure of ventures founded since 1998.  Based on an analysis of 539 new ventures founded during the years 1991-2001, the authors reach the following conclusions.  First, consistent with prior research, less than half of the 539 ventures survived more than two years.  Second, economic downturns lead to higher failure rates for new ventures. Third, new venture success is highly correlated with first product success. Fourth, first product success is enhanced when those products are introduced into markets with emerging market needs but with established industry standards.  Finally, first-product and venture performance are significantly higher for products based on ideas that came from the founders.  In addition, the most successful first products are based on ideas that reflect both technology development and an analysis of customer needs. 

INTRODUCTION

Entrepreneurial ventures have a significant impact on new job creation and economic growth.  In the United States, entrepreneurs found over 600,000 new firms each year (Small Business Administration Office of Advocacy, 2008) and millions of jobs have been created by these new ventures. In our own research, we have surveyed 11,259 U.S. entrepreneurs who founded new ventures from 1990 to 2001 and found that, on average, each entrepreneur was expected to create 512 jobs in his or her lifetime.  Unfortunately, existing studies reveal a high failure rate among entrepreneurial ventures.  For example, Song et al. (2008) found that the five-year survival rate for companies with more than five full-time employees was only 21.9 percent. 

While most scholars recognize the high failure rates for entrepreneurial enterprises, the impact of a recessionary economy on failure rates is debated.  A recent Kauffman Foundation report indicates that the number of entrepreneurial startups has increased during the current recession (Fairlie 2009; Tam 2009).  What is unclear, however, is whether ventures started during a recession have a higher or lower probability of failing.  While entrepreneurs may face weakened competition and enjoy lower costs during a recession, they may also encounter greater difficulties raising capital (e.g., Needleman 2009, The Economist 2009).

In this article we describe key insights from a research database for studying venture survival (VENSURV) developed by a team of scholars in the Institute for Entrepreneurship and Innovation at the University of Missouri-Kansas City.  The database combines information on venture survival and first product development.  Our data analysis yields four major insights.  First, contrary to the some recent reports, empirical findings from our database suggest that recessions have a negative impact on new venture success.  Second, new venture success is critically-dependent on the success of a new venture first product launch.  Third, both first-product and new venture performance are highest when a venture’s first product is based on radical innovations, serves emerging market needs, and is introduced into markets with an established industry technology standard.  Fourth, the most successful first-products are based on ideas that reflected both technology development and an analysis of customer needs.

VENSURV Database

VENSURV is a multi-year research program of new venture survival developed by a team of scholars in the Institute for Entrepreneurship and Innovation at University of Missouri-Kansas City, who have tracked the success or failure of the new ventures in the database since 1998.  The data reported in this article involves 539 new ventures that were launched during 1998-2001 and includes information of the first product launched by each of these ventures.  The 539 ventures include 49 new ventures in telephone and wireless communication equipment, 169 new ventures in consumer electronics, 110 new ventures in games and toys, 107 new ventures in computer and software products, and 104 new ventures in household-related products. 

EMPIRICAL FINDINGS

Does an economic downturn increase or decrease new venture failure rates?

Table 1 provides insight into the failure rates of 523 new ventures in our sample (we excluded 16 companies which were merged or were acquired by another company).  Of the 523 new ventures founded during 1998-2001, 283 (54.11%) failed during the first two years.  Importantly, an economic downturn occurred just after the midpoint of this four-year period.  From October 1998 to March 2000 the Nasdaq Composite Index tripled, only to fall 42% in the next 10 months (Browning and Ip, 1998).  The effects of this decline were exacerbated by the events of 9-11.  Given these events, Table 1 also reports the two-year failure rates for ventures started in 1998-1999 and those started in 2000-2001.  Ventures launched during the economic boom of 1998 and 1999 had a significantly lower two-year failure rate relative to ventures launched during 2000 and 2001 (41.43% versus 52.97%).  These results suggest that economic downturns lead to higher new venture failure rates.

Table 1
Percentages of New Ventures Failing During Their First Two Years

Venture Establish Year

Number Of ventures

Failed First 2 Years

Survived More Than 2 Years

1998-1999

321

41.43%

58.57%

2000-2001

202

52.97%

47.03%

Total

523

54.11%

45.89%

Note: Chi-square test for differences in success-failure rates was significant at p < 0.01.

What is the relationship between first product performance and new venture performance?

The first product of a new venture is critical to the venture’s reputation and its ability to  attract needed resources. In VENSURV, a first product was classified as successful if the performance of the product had exceeded the new venture’s predefined goals and objectives (such as profitability, sales, etc.) as stated in the business plan after two years of product commercialization.  A successful new venture was defined to be a venture that had (1) provided acceptable returns on investment to the founders and investors and (2) met predefined goals and objectives (such as profitability, sales, etc.) as stated in the business plan. Table 2 presents the results of the data analysis. Of the 539 new ventures in the VENSURV database, 176 (32.65%) were successful.

Table 2
First-Product and New Venture Success Rates and Performance

 

First-Product Succeeded

First Product Failed

New Venture Was Successful (N=176)

132 (77.19%)

44 (11.96%)

New Venture Was Unsuccessful (N=363)

39 (22.81%)

324 (88.04%)

First Product Performance

8.33

1.17

Venture Performance

6.53

1.55

Note: Performance was measured on an 11-point scale from 1 to 10.

What propels new venture success?  Our results in Table 2 demonstrate a high correlation between the success of the first product and the success of the new venture.  Among the new ventures that had an unsuccessful first product, only 11.96% of them succeeded, in sharp contrast to the 77.19% success rate among new ventures that had a successful first product.

Our data also include ratings on the performance level of the new ventures and their first products relative to predefined goals and objectives. The ratings ranged from 0 to 10, where a 10 indicated that that the venture’s or first-product’s performance far exceeded the minimum acceptable performance standard (MAPS) stated in the business plan, while a response of 5 indicated that the venture or first product had barely met its MAPS and a response of 0 signified that the venture’s or first-product’s performance fell far below its minimum MAPS.  Among new ventures that reported their first-product was successful, the average venture performance was 6.53, while the average venture performance level among new ventures that classified their first product as unsuccessful was 1.55. 

What explains the performance of the successful first products in VENSURV?

To explore the factors that impact first-product performance we analyzed the following three characteristics of the first products: (1) The product was either a radical or an incremental innovation; (2) The product served an emerging or established market; and (3) The product was introduced into a market that had an emerging or established industry technology standard. 

Table 3 contains the results of this data analysis. First products that incorporated radical innovations had a significantly higher average performance level than those built on incremental innovations (4.44 versus 2.81).  Furthermore, first products that served emerging markets had a significantly higher average performance than those that served established markets (3.68 versus 3.18).  In addition, first products introduced into markets with an established industry technology standard had a significantly higher average performance level than those introduced into markets with emerging industry technology standard (4.57 versus 2.06). The same findings were obtained for new venture performance. 

Table 3
Differences in First-Product and New Venture Performance:
 Product Type, Market Characteristics, and Technology Standard

 

First-Product Performance

Venture Performance

Product Innovation

 

 

Radical Innovation

             4.44*

               3.86*

Incremental Innovation

             2.81

               2.67

Market

 

 

Emerging Market

             3.68*

               3.38*

Established Market

             3.18

               2.86

Industry Technology Standard

 

 

Emerging Technology Standard

             2.06*

               2.22*

Established technology Standard

             4.57

               3.87

Note: a * indicates means are significantly different at the 90% confidence level.
Performance was measured on an 11-point scale from 1 to 10.


Table 4 examines the two-way interactions among these variables.  Radical innovations performed significantly better when they served emerging markets than when they served established markets (5.02 versus 3.98), and they also performed significantly better when they were introduced into markets with an established  industry technology standard  rather than an emerging technology standard (5.42 versus 2.86). Incremental innovations performed significantly better when they were introduced into markets with an established industry technology standard rather than an emerging industry technology standard (3.92 versus 1.66), but it made no difference whether they were introduced into emerging or established markets. Again, the findings were the same for venture performance.

In addition, first products that served emerging markets with an established industry technology standard had the highest average performance relative to alternative combinations of these variables (5.20 versus (1) 4.02 in established markets with established technology standards, (2) 2.22 in emerging markets with emerging technology standards, and (3) 1.81 in established markets with emerging technology standards). First products that served emerging markets outperformed first products that served established markets when industry standards were established (5.20 versus 4.02).  In contrast, when technology standards were emerging, performance was not significantly affected by the decision to target markets in which customer needs were established or emerging. 

Similar results were found for new venture performance.

Table 4
Differences in First-Product and New Venture Performance:
Two-Way Interactions among Product Type,
Market Characteristics and Technology Standards

Product Type by Market Characteristics Cross-Tabulation

 

First-Product Performance

Venture Performance

 

Emerging Market

Established Market

Emerging Market

Established Market

Radical Innovations

5.02 (A)a

3.98 (B)

      4.52 (A)

3.33 (B)

Incremental Innovations

3.02 (C)

2.52 (C)

     2.81 (B,C)

2.46 (C)

Product Type by Technology Standard Cross-Tabulation

 

First-Product Performance

Venture Performance

 

Emerging Technology Standard

Established Technology Standard

Emerging Technology Standard

Established Technology Standard

Radical Innovations

2.86 (C)

5.42 (A)

      2.80 (C)

4.52 (A)

Incremental Innovations

1.66 (D)

3.92 (B)

      1.94 (D)

3.37 (B)

Technology Standard by Market Characteristics Cross-Tabulation

 

First-Product Performance

Venture Performance

 

Emerging Market

Established Market

Emerging Market

Established Market

Emerging Technology Standard

2.22 (C)

1.82 (C)

      2.42 (C)

1.94 (C)

Established Technology Standard

5.20 (A)

4.02 (B)

      4.38 (A)

3.42 (B)

a Within each 2x2 cross-tabulation, different letters indicate that the corresponding means are significantly different at the 90% confidence level.


Do new ventures founded by an individual have higher performance than new ventures founded by a team?

In their review of entrepreneurial teams, Kamm et al. (1990) concluded that ventures founded by teams outperformed ventures founded by a single entrepreneur.  In contrast, we found no significant difference between new ventures founded by a single entrepreneur and ventures founded by multiple-member teams in terms of either venture or first-product performance. The average performance level for ventures founded by a single entrepreneur was 3.42, and the average performance level for team-founded ventures was 3.05.  Similarly, the average first-product performance level was 3.83 for single-entrepreneur-founded ventures and 3.33 for team-founded ventures.

Do sources of new product ideas matter for new ventures?

Based on discussions of market-pull and technology-push innovation (e.g., Utterback 1971; Parry and Song, 2010), we examined the market performance of product ideas that were based on (1) an analysis of customer needs (n = 123), (2) the development of new technology (n = 142), (3) both the analysis of customer needs and the development of new technology (n=179), or (4) other idea sources.  Table 5 presents the results of this analysis.  On average, both first-product and venture performance was highest when the first products were based on ideas that came from both technology development and the analysis of customer needs.  Specifically, the average performance level for first products based on both technology development and customer needs was 4.42, which was significantly higher than the performance levels for first-products based on technology development alone (3.23), customer needs alone (3.25), or other ideas (2.18).  Average venture performance levels by idea source exhibited a similar pattern, declining from 3.87 for ventures with first products based on ideas from both technology development and customer needs to 2.21 for products based neither on technology development nor on customer needs. In addition, relative to ventures with first products based on customer needs, ventures with first products based on technology development were associated with significantly higher performance (3.24 versus 2.65), but this did not hold for first-product performance.  Finally, relative to products based on other idea sources, products based on customer needs had higher first-product performance (3.25 versus 2.18), but this did not hold for venture performance.

Additional analyses of the VENSURV data also suggest that first products built on ideas generated by the founders outperformed other first products. In particular, both first-product performance (4.08 versus 3.17) and venture performance (3.53 versus 2.96) were significantly higher for first products based on ideas that came from the founders.

Table 5
Effects of Sources of First-Product Ideas on First-Product and New Venture Performance:

Source of Product Ideas

Number of Observations

First-Product Performance

Venture Performance

Both Technology Development & Analysis of Customer Needs

179

4.42 (A) a

3.87 (A) a

Technology Development

142

3.23 (B)

3.24 (B)

Analysis of Customer Needs

123

3.25 (B)

2.65 (C)

Other Idea Sources

95

2.18 (C)

2.21 (C)

a Within the last two columns, different letters within the same column indicate that the corresponding means are significantly different at the 90% confidence level.

 

Conclusions

In this article we have described several important insights arising from the analysis of a new database on new venture failure, first-product performance, and new venture performance.  From our analysis of 539 new ventures in the VENSURV database, we draw the following conclusions.  First, consistent with prior research, most new ventures fail.  Only 45.89% of the new ventures in our data survived more than two years. 

Second, some observers have pointed to evidence of increased entrepreneurial activity during recessions as a sign that downturns in economic activity enhance entrepreneurial opportunity.  While the number of businesses started during a recession provides one perspective on entrepreneurial opportunity, another important perspective involves the success rates of ventures launched during an economic downturn.  Our data suggest that the economic downturns lead to higher failure rates for new ventures.

Third, our data demonstrate that new venture success is highly correlated with first product success. Fourth, first product success is enhanced when those products are introduced into markets with emerging market needs but with established industry standards.  This is especially true when the product is based on radical innovation. In our sample, first products based on radical innovations performed significantly better than those based on incremental innovations.

Finally, our data indicate that first-product and venture performance were significantly higher for products based on ideas that came from the founders.  In addition, the most successful first products were based on ideas that reflected both technology development and an analysis of customer needs.  Products based on either an analysis of customer needs or technology development (but not both) had statistically indistinguishable performance levels, but the venture performance of products based on technology development was higher than the venture performance of products based on customer needs. 

One important managerial implication of our results involves the importance to new venture success of a successful first product launch.  A second important implication involves the types of entrepreneurial ideas and products that enhance the probability of new venture success.  In screening venture opportunities, entrepreneurs should focus on ideas that are based on both technology development and an analysis of customer needs.  In addition, entrepreneurs should look for opportunities to develop a first product that incorporates radical innovation, builds on an established industry standard, and targets emerging customer needs.  These findings are consistent with previous research emphasizing the importance of differentiation and cost control to entrepreneurial success. 

The results presented in this article suggest several directions for future entrepreneurship research.  First, economists like Joseph Schumpeter have argued that recessions create opportunities for entrepreneurs by causing inefficient established firms to fail (Gans 2009).  However, the empirical results reported in this article suggests that ventures success is positively-related to the health of the economy, a finding that may reflect the difficulties entrepreneurs encounter raising capital during a recession.  The validity of this explanation, as well as the existence of other possible interpretations, should be explored in future research. 

Second, our findings suggest that both first product and venture success is enhanced by targeting markets with an established industry technology standard.  This result may reflect the favorable impact of an established industry standard on new venture risks and product development costs (Jaworski and Kohli 1993; Song, Di Benedetto, and Parry 2009).  However, by entering a market in which technology standards are still emerging, new ventures have the opportunity to shape those standards and thus enjoy a leadership position once industry standards become established.  For this reason, new ventures that enter markets with an emerging industry standard may have lower survival rates, but survivors may enjoy relatively higher long-term performance.  Thus possibility should also be explored in future research. 

Finally, contrary to conventional wisdom and the findings of Kamm et al. (1990), we found no difference between the venture performance or first-product performance of new ventures found by a single entrepreneur and those founded by a team of entrepreneurs.  Future research should explore the degree to which these contradictory results can be explained by variations in the variables used to measure performance and variations in the time frame over which performance is measured. 

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