Why Do Entrepreneurs Keep Entering Highly Unprofitable Industries?

Source: New York Times

During the early days of my strategy courses, we often learn about Porter's five forces as a tool for evaluating industry structure.  We often examine industriest at the extreme - either highly profitable (such as pharma) or highly unprofitable (such as airlines or fitness centers).  We use the framework to try to explain the level of profitability in these markets.  Of course, one examine barriers to entry quite closely.  Low barriers to entry tend to depress profits in an industry, because new players can easily come in and compete on a relatively even playing field with incumbent firms.  

Students often ask me a question:  "Why do entrepreneurs keep entering these industries with consistently low profits? Don't they understand how hard it is to make money in these markets?"   What a terrific question!  As I read a New York Times story this morning about two new upstart airlines, the question really hit home again.  Why enter the airline business when it has been so unprofitable for decades?  After all, Richard Branson has told a great joke about the business.  He says that people always ask him how to become a millionaire.  He says it's quite easy.  You just start as a billionaire and then open an airline.  

What is happening in these industries?  For me, three factors explain the continued entry into unprofitable markets. 

1.  The low barriers to entry make it quite enticing for entrepreneurs.  They don't see the major obstacles that often obstruct entry into other industries.   They would love to be an entrepreneur, and they are looking for "easy targets" - i.e. markets that they can access more readily than some others.  

2.  They enter because, to them, it's a lifestyle business. They aren't think simply in terms of profit maximization. Fitness centers is a good example.  People open gyms because they have a passion for fitness and wellness.  They also would love to be their own boss.  A similar phenomenon has emerged in the wine industry. Many people enter the business because of their passion for the art and craft of making wine.  It's also a status symbol to enter the industry. Witness the celebrities who enter, including athletes, movie producers, and actors and actresses.  

3.  Entrepreneurs think to themselves, "I'm different. I'll be the exception to the rule."  In fact, some of the most compelling business stories are those of firms that have made strong profits in very unattractive industries. People know the remarkable story of Southwest Airlines, or Ryanair in Europe.  Or, they have observed the success of Planet Fitness and Trader Joe's (both companies about which I have written case studies - Planet Fitness case and Trader Joe's case).   Therefore, entrepreneurs think to themselves, "I can do that!"  Or, they look at the many failures in the industry and think, "That won't be me. I'm smarter than that!"  Unfortunately, they often don't understand quite what that it takes to position a firm to survive and thrive in a very challenging industry.   Hubris clouds their judgement as well.   

Solo Founders or Teams: Who Has More Success?

None of us is as smart as all of us. Right?  Teams are smarter and more effective than individuals at challenging tasks, right?  Not so fast.  New research by Jason Greenberg and Ethan Mollick examines new ventures.  They found that solo founders tend to achieve better results, at least in terms of certain metrics, than entrepreneurial ventures founded by a team of people.  Here's an excerpt from an NYU summary of the research:  

Common wisdom has assumed that the value of having a team is additive or even synergistic, based primarily on the theory that starting a business requires a portfolio of skills and resources that few individuals possess. However, in “Sole Survivors: Solo Ventures versus Founding Teams,” Professor Greenberg and his co-author, Wharton’s Ethan Mollick, showed that companies started by solo founders survive longer and generate more revenue than those started by teams, while not performing significantly differently across various operating categories.

The authors’ unique dataset was comprised of companies that were crowdfunded via the Kickstarter site between 2009 and 2015, were eventually established formally, and whose performance could be followed for several years. For-profit and nonprofit companies were analyzed separately, and collectively they raised $151 million in crowdfunding and generated approximately $358 million in revenue.

Of course, these results do not suggest that teamwork is not essential for a new venture.  It speaks to the possible frictions and dysfunctional conflict that can occur when you have multiple founders though.  Moreover, it may speak to the speed of decisions in situations where multiple founders must come to an agreement on key strategic choices.  Still, one should not conclude that a solo founder does not need  a strong team around them.   Collaboration is essential in many aspects of a startup, regardless of the structure at the very top.  

Busting Myths about Successful Tech Entrepreneurs

The typical successful startup founder in Silicon Valley is in his or her twenties, right? Millennials have the creativity and fresh thinking required to disrupt entrenched incumbents in industry after industry, right? A comprehensive new study debunks this popular myth.  Kellogg Insight describes new research by strategy professor Benjamin Jones and his co-authors.   Here's a quick summary of their findings:

In a new study, Jones, along with Javier Miranda of the U.S. Census Bureau and MIT's Pierre Azoulay and J. Daniel Kim, use an expansive dataset to tackle that question. The researchers find that, contrary to popular thinking, the best entrepreneurs tend to be middle-aged. Among the very fastest-growing new tech companies, the average founder was 45 at the time of founding. Furthermore, a given 50-year-old entrepreneur is nearly twice as likely to have a runaway success as a 30-year-old.

Here are a couple more intriguing statistics from their research:

• The average age of the founder of one of the fastest-growing tech companies in their massive sample was 45 years old.
• The average age of the founder of firms that achieved successful exits either through IPO or acquisition was 46.7 years old.  

Why is it important to debunk the popular myth about millennials and successful tech startups?  First, we have to consider the biases that might shape investor decisions.  Might some be inclined to think that the best ideas come from founders in their 20's and perhaps find themselves biased against older entrepreneurs?  Second, we have to consider how the myth might discourage older individuals from taking the risk to launch a startup.  I applaud the authors for such an extensive study that shines a light on the actual experience of successful tech startups and their founders.  

The Advantages & Disadvantages Incumbents Have Relative to Startups

In this brief video, Stanford Professor Jesper Sorensen explores the advantages and disadvantages that incumbents have as they compete against startups.  It's a good recap for any entrepreneur.

Entrepreneurs: Are They Truly Different Than Others?

Conventional wisdom about entrepreneurs tends to focus on their mental make-up.  They are risk-seekers.  They are creative.  They are daring.  They are ambitious.   They are not afraid to make mistakes or to fail.   Perhaps we should take a step back and question this conventional wisdom..   Laura Huang and Peter Cappelli of Wharton have a terrific article in the Wall Street Journal today that challenges these prevailing view about entrepreneurs.  They write, "There’s only one problem with the conventional wisdom: There is no direct evidence to support it and some solid research to suggest it isn’t true."  I suggest reading their article for more details about their review of the academic literature. 

Why has this conventional wisdom dominated our thinking about entrepreneurs for so long?  Why do we believe that entrepreneurs have a different make-up than the rest of us?   Huang and Cappelli explain that the fundamental attribution error plays a key role:

"Why are we so inclined to believe that entrepreneurs are different and better people than the average? The answer is something known in social psychology as the fundamental attribution error: We tend to assume that behaviors are caused by someone’s disposition, even when circumstances are the real factor, such as assuming that the driver of the speeding car must be an irresponsible person rather than thinking he might be going to an emergency."