Summary Slides – Innovation &

Entrepreneurship
LECTURE 1:
Goals of the lecture:

 Understand the nexus between innovation and entrepreneurship

 Distinguish between startup innovation vs incumbent innovation
 Discuss the advantages and prevalence of each mode of innovation

Creative Destruction

 Innovation causes most markets to evolve in a characteristic pattern.

 Markets have periods of comparative quiet when firms that have developed superior products
and technologies earn positive profits.
 Fundamental shocks destroy old sources of advantages and replace them with new ones.
 Entrepreneurs who exploit the opportunities created by the shocks enjoy economic profits during
the next period of quiet.
 Startup: New entrants are associated with the creation of disruptive technologies.
 Incumbent: Incumbent firms often are associated with incremental innovations.

Entrepreneurship as an Opportunity-Based Framework (Shane and Venkataraman, 2000)

 Entrepreneurship (innovation): the discovery and exploitation of a lucrative opportunity.

 Opportunities: situations in which new goods, services, raw materials, and organizing methods
can be introduced and sold at a greater value than their cost of production.

Who discovers opportunities?

 Entrepreneurship requires that people hold different beliefs and capabilities about the value of
resources.
o Heterogeneity generates a comparative advantage that allows some individuals and not
others to act on certain opportunities. Two factors:
 Possession of prior information necessary to identify an opportunity.
 The cognitive properties necessary to value it  Specific capabilities to identify
means-end relationships.

Four types of Innovation (Startups vs Incumbent Firms) & (Discovery and Exploitation)

1. Incumbent innovation – All in-house (Apple iPhone)

 The incumbent firm both discover and exploits the opportunity  All in-house.
 Arrow Replacement Effect: the incumbent firms discover the invention, but prefer not to
commercialize the innovation  New inventions can disrupt current products of the firm.
2. Incumbent innovation – External Invention (Safety Pin)
 The startup discovers the innovation, but the incumbent firm exploits the innovation
 o Startup-Discovery: Walter Hunt (Startup) was granted a patent for the safety pint, but
sold his patent to W.R. Grace and Company (Incumbent firm)
o Incumbent-Exploitation: W.R. Grace and Company mass-produced the safety pin.
3. Startup Innovation – Spinout
 The incumbent discovers an invention, but the startup exploits the invention.
o Separation of a division of an established firm to form a new firm
o An inventor creating a separate startup.
4. Startup innovation – Entrepreneurial Inventor (Facebook)
 The startup both discovers and exploits the invention. This is done when:
o Markets for technology are not available.
o Knowledge is tacit.
o The entrepreneur has information about the viability of the invention that cannot be
easily transferred to third parties.
o The invention is so novel that incumbents do not have complementary manufacturing
capabilities.

The optimal choice of mode (Incumbent vs Startup)

Some relevant findings from different papers

 Asterbo (2003)  Internal Rate of Return

o Startup: the return on independent inventive efforts is 11,4%
o Incumbent firms: the median return on innovative activities in established firms is 25%
o Based on the above, we can conclude that incumbent firms generally have a higher
Internal Rate of Return (IRR), which means that the returns in these firms tend to be
higher compared to startups.
  Garcia-Macia et al. (2019)  How destructive is Innovation
o Creative destruction is not as important as thought.
o Most innovations are incremental innovations by incumbents.
o Incumbent firms are able to preserve their competitive advantage from their resources
and capabilities.
 Bloom et al., (2020), Jones (2010)
o Ideas are getting harder to find.
o Research productivity is declining.
o Burden of knowledge; age at first invention is increasing and increasing dominance of
teams in scientific publications and inventions.
 Azoulay et al. (2020)
o Successful entrepreneurs are middle-aged, not young.
o The mean age at founding for the 1-in-1000 fastest-growing new ventures is 45.

LECTURE 2:
Goals of the lecture:

 Understand the entrepreneurial process.

 Review the main difficulties that entrepreneurs experience in raising resources needed to bring
an entrepreneurial opportunity to fruition.
 Review strategies for gaining the legitimacy required to attract resources

Entrepreneurship takes resources

 Both discovery and exploitation of a lucrative opportunity take resources:

o “For entrepreneurs, it can be virtually impossible to know whether a particular
technology or product or business model will be successful until one has actually
invested in it” (Kerr, Nanda, and Rhodes-Kropf, 2014).
 But this is highly uncertain, two challenges with the commercialization of new ideas:
o The actual distribution of returns has a low median value but very high variance  Most
new ventures fail badly, but some turn out to be widely successful.
o It is impossible to know in advance which ideas will work, even for professional
investors.
 Allocating resources correctly is important!
o “How entrepreneurs and investors respond to these challenges has important
implications for their own success and also for the broader economy in terms of the
“best ideas” being commercialized” (Kerr, Nanda, and Rhodes-Kropf, 2014).

The Entrepreneurial Process

Knightian Uncertainty

 No information to know the alternative outcomes associated with decisions and the probability
of those outcomes (Knight, 1921).
o Knowledge used in the process that has the potential to result in innovative
combinations of resources may often also have unanticipated flaws (Taylor & Greve,
2006).
 Trial-and-error decision-making process through bricolage.
o "Trial-and-error" suggests that decisions are made by trying different options and
learning from the outcomes.
o "Bricolage" refers to a process of resourceful improvisation, where individuals or
organizations make use of whatever materials or knowledge they have at hand to solve
problems or create innovations.
 Calibration of judgment: This refers to the process of adjusting one's judgment or decision-
making based on industry or market experience, specific technical or market knowledge, and
past experiences in exploiting entrepreneurial opportunities. Done through:
o Risk-based data collection techniques  Customer focus groups, customer surveys,
archival data.
o Risk-based decision-making tools  Real options analysis, scenario analysis.

From idea generation to resources

Resources
  Barney (1991): “Firm
resources include all assets,
capabilities, organizational
processes, firm attributes,
information, knowledge, etc.
controlled by a firm that
enable it to implement
strategies to improve its
efficiency and effectiveness”.
 Different classifications of resources  Barney (1991), Grant (1991), Morris et al. (2001)

The Valley of Death (Auerswald & Branscomb, 2003)

 There are five distinct technological stages, and each of these stages requires funding from
different sources (frequently/occasionally).

To get resources you need legitimacy

 What is legitimacy?
o Suchman (1995): “A generalized perception or assumption that the actions of an entity
are desirable, proper, or appropriate within some socially constructed system of norms,
values, beliefs, and definitions”.
 Getting legitimacy is often difficult because there is uncertainty surrounding the entrepreneurial
project:
o Difficult to pledge assets as collateral – Few assets and often intangible.
o Difficult to evaluate the project beforehand due to technical complexity.
o Difficult to monitor entrepreneurs – Moral hazard and adverse selection.
 So you need a strategy!

Strategy for gaining legitimacy: Signaling strategy

  Signals such as personal wealth, social capital, complementary assets (manufacturing
capabilities), human capital, alliance, and IP rights (patents).
 Bapna (2017): Four main dimensions that capture venture uncertainty from the perspective of an
equity investor
o Product/service characteristics: functioning prototype/product, protected, unique.
o Market characteristics: market acceptance, market need, entry barriers, competitive
threat, market size
o Management team characteristics: skills and experiences, completeness, reputation.
o Investment characteristics: exit potential, valuation, return potential.
 Strong complementarities  A signal about product characteristics is the key to unlocking the
value of signals of market or investment characteristics:
o Product certification (signal of product) + prominent customer (signal of market).
o Product certification (signal of product) + social proof (signal of investment
characteristic).
 How to send a signal through business plans  Hsu (2007)
o Founding experience (especially when financially successful)
o Founders’ ability to recruit executives via their own social network.
o Founding teams with a doctoral degree holder.

Strategy for gaining legitimacy: Experimentation (Kerr, Nanda & Rhodes-Kropf, 2014)

 Resource provider (investor):  Learns project viability

o Assessment of intermediate results
o Real option value: possibility to quit/continue before committing full capital
o Exploration of a project that would be out of reach otherwise.
 What can the entrepreneur do?
o Improve the prototype before looking for investors.
o Reduce costs and constraints to experimentation.
 Experiment-based strategy Calculating Net Present Value (NPV)  Example!
A) No experiment  All or nothing bet
o Calculation: NPV = probability of success * return of success – Investment

B) Experiment  Stage Financing  Stage 1: Experiment, Stage 2: Investment

o Stage 1 – Calculation: NPV = probability experiment success * expected value project
(See calculation A) – X (Cost of Experiment) >= 0
 o Stage 2 – Calculation: NPV = probability of investment success * expected value project –
experiment costs

 Explanation in-text of the above example: “Even though the original investment of $11 million
was not a good idea, a first-stage investment of up to $8.9 million followed by a second-stage
investment of $11 million, if the experiment is successful, is a good idea […]. Spending an
additional $8.9 million to learn about the viability of the project is more valuable than simply
directly spending $11 million. This is the power of experimentation.” (Kerr, Nanda & Rhodes-
Kropf, 2014)
 Importance of experiment costs:
o Experimentation costs in the Internet sector have declined
o Experimentation costs in other industries are higher and have remained stable or
increased (Pharmaceutical sector)
o Burden of Knowledge dynamics suggests that the costs of research are increasing over
time.
 Determinants of experimentation
LECTURE 3:
How to measure innovation success (Hultink & Robben, 1995)

 Innovative success: sustained growth through continuous invention and adaption – Ability to
contribute consistently to growth
 Three levels to measure the innovation success
o Product level measures: launched on time, speed to market, development costs, quality
guidelines met
o Customer acceptance measures: revenue goals met, market share goals met, % of sales
by a new product, customer satisfaction & acceptance.
o Financial performance measures: profit goals met, margin goals met, return on
investment goals met.

5 dimensions of important success factors of product innovation ( Hultink & Robben, 1995)

 Product characteristics: product advantage, customer needs met, technical sophistication,

innovativeness.
 Strategy characteristics: market synergy, dedicated R&D resources, dedicated HR, strategic
orientation.
 Process characteristics: marketing tasks proficiency, technological proficiency, launch proficiency,
market orientation.
 Marketplace characteristics: the likelihood of competitive response, competitive response
intensity, and market potential.
 Organizational characteristics: organizational design, degree of centralization, degree of
formalization.

The Innovation Value Chain (Hansen & Birkinshaw, 2007)

 The innovation value chain offers a comprehensive framework for firms to:
o Get a view of their innovation efforts
o Pinpoint their particular weaknesses
o Tailor innovation best practices
1. Idea generation:
a. Inhouse: creation within a unit.
- Do people in our unit create good ideas on their own?
- Number of high-quality ideas generated within a unit
b. Cross-Pollination: collaboration across units.
- Do we create good ideas by working across the company?
- Number of high-quality ideas generated across the units
c. External: collaboration with parties outside the firm.
- Do we source enough good ideas from outside the organization?
- Number of high-quality ideas generated from outside the firm.
2. Conversion:
a. Selection: screening and initial funding
- Are we good at screening and funding new ideas?
- Percentage of all ideas generated that end up being selected and funded?
 b. Development: movement from idea to the first result
- Are good at turning ideas into viable products, businesses, and best practices?
- Percentage of funded ideas that lead to revenues.
3. Diffusion:
a. Spread: dissemination across the organization and the market.
- Are good at diffusing developed ideas across the company?
- Percentage of penetration in desired markets, channels, and customer groups.

LECTURE 4:
Two types of legitimacy (Aldrich & Fiol, 1994)

 Cognitive legitimacy: “How much knowledge is there about the new activity?”
 Sociopolitical legitimacy: “Do key stakeholders, the general public, key opinion leads, or
government officials accept an activity as appropriate and right?”

What needs to be legitimated?

 Product innovations: new products and services  Car, phone, airbag

 Process innovations: new processes, forms of organizations, and operations  KANBAN,
digitalization/AI
 Organizational innovations: new organizational forms, rules, and social institutions  Reduction
of hierarchy, employee evaluations.
 Business model innovations: New ways to generate value  Netflix.

Who grants legitimacy?

 Stakeholders:” Any group or individual that can affect or is

affected by the achievement of the firm‘s objective" (Freeman
1984).
o Nevertheless, although legitimacy can be viewed as
an asset “owned” by a certain actor—an individual,
organization, or category of organizations—it still
remains a social evaluation made by others.  See
the bike example on the right.

Why is legitimacy important

 Attracting customers
 Attracting other stakeholders (and their resources!)
 Governmental approval or ‘protection’, e.g. by legislation or subsidies.

How to create legitimacy? – Internal & External means (Rao et al. 2008)

 Legitimacy through external means increases reward for product innovation.

 Internal means of legitimacy (all but location) are especially needed when external means are
low substitution.
How to create legitimacy? – Entrepreneurial strategies (Aldrich & Fiol, 1994)

How to create legitimacy? – Entrepreneurs’ symbols

 Traditional symbols: entrepreneur’s/founding team’s prior education, use of business planning

techniques, certificates, and endorsements.
 Visual symbols: setting (office space, the area), props (prototypes, pictures), dress
(formal/informal), expressiveness (body or facial movements)

Important decisions entrepreneurs have to make when founding a company (Wasserman, 2012)

 Number of founders

 Split of shares
  Joint CEO position / Decision-making approach

 Founders on the board

Organization of innovation transactions (Powell, 1990)