Neutralizing Speedy New Entry Threats

Information technology firms can never rest. Speedy startups constantly emerge from the entrepreneurial ecosystem with novel products and services. One strategic response could be preemptive investment in research and development. But a new study from the University of Maryland’s Robert H. Smith School of Business shows the opposite usually occurs.

“Incumbent IT firms on average reduce their R&D spending when they face high new entry threats,” authors Yang Pan, Peng Huang and Anandasivam Gopal write Information Systems Research. Pan, a professor at Louisiana State University, is a Maryland Smith PhD alumna, while her co-authors are professors at Maryland Smith.

Prior research has produced contradictory predictions about the response to new entry threats in the IT space, where fast clock-speed drives economic growth.

“Some may choose to increase their investments in R&D, in the hope of establishing advantage in technological and process capabilities,” the authors write.

On the other hand, incumbents may hold off on R&D spending, where the payoffs are uncertain.

“They may choose, instead, to either conserve their cash in anticipation of acquiring technology licensing later from pioneers, or invest in complementary capabilities like marketing, distribution and manufacturing that can help the incumbent compete more effectively should the anticipated threats materialize,” the authors write.

To draw their conclusions, the authors first had to develop a valid instrument for measuring threats from new entrants. Such an instrument has remained elusive, largely because the central question involves speculation about future activity.

Researchers must quantify threats that don’t yet exist, but may materialize later. “Notwithstanding the importance of new entry threats in theoretical work, the absence of an established measure represents a significant gap in the literature,” Pan, Huang and Gopal write.

The authors tackled the challenge using text mining. They started with product descriptions filed by incumbent firms with the Securities and Exchange Commission from 1997 to 2013, and then looked for overlapping words and phrases in business descriptions of entrepreneurial ventures that received first-round funding from venture capitalists during the same period.

“The presence of VC funding makes them credible threats, while also signaling quality,” the authors write.

Many startups at the first-round stage are still years away from selling products or services. But several tests confirm the validity of the instrument developed by the authors.

Related insights also emerged. “We show that firms facing high new entry threats are likely to experience greater turbulence in the forms of layoffs and bankruptcies in the future, dynamics consistent with prior theory,” the authors write.

Read more: Storm Clouds on the Horizon? New Entry Threats and R&D Investments in the U.S. IT Industry, by Yang Pan, Peng Huang and Anandasivam Gopal, Information Systems Research.