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Thursday, April 9, 2009

Illegitimate startups

In grading business plans this week, I was struck by a common blind spot: my undergraduates were overly optimistic about their chances of gaining sales (or distribution) from day one.

They didn’t realize that they would be handicapped by the inherent lack of legitimacy that a brand-new firm has. This is something I lived as a software entrepreneur, but also a well-known problem to strategy researchers.

Just as innovation and entrepreneurship scholars often trace back their core theory to Schumpeter’s “gales of creative destruction,” those worried about the disadvantages faced by young firms go back to sociologist Arthur Stinchcombe and his 1965 book chapter which coined the phrase “liability of newness”.

Subsequent research (such a 1986 ASQ article by Singh et al) has shown that the liability stems in large part to the lack of external legitimacy held by the new organizations. (The test was with nonprofits, but the principle is the same).

I had trouble finding something suitable for undergraduates to read; perhaps this is a publishing opportunity. However, I but did find a closely related 2008 article in Entrepreneur entitled “Credibility is King.”

In class, I tried to tease out the difference between legitimacy and credibility, but given the impromptu nature of the discussion I have to admit I was mostly winging it. In my mind, legitimacy is whether or not you’re in the consideration set. Credibility (as in the political context) is whether or not customers believe what you say.

We brainstormed the reasons or conditions for a lack of legitimacy, and I noticed that they all boiled down to two issues. One is the lack of information (e.g. about the unmeasurable quality of your good). The other is for cases of high risk: making a bad decision on a bicycle helmet is different than doing so for buying an ice cream cone. Again, this is something I hope to elaborate in a future article.

In terms of solutions, most of our options boiled down to two. One is to borrow legitimacy, such as from suppliers (“Intel inside”), dealers, or testimonials by buyers or celebrities. The other is to reduce the risk faced by buyers, such as by providing a free trial.

Again, this is something I’d like to write up sometime, but at least I have a starting point to sensitize future students to this challenge they will face as entrepreneurs.

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