Some tech startups are more high-tech than others

In the business press, academic teaching and research, there’s often a discussion of the unique characteristics of “tech startups”, “technology entrepreneurship” and “technology-based firms.” Such startups are the focus of this blog.

Often the distinction between high- and low-tech startups is measured by the proportion of technical employees — such as fraction of R&D employees or fraction of R&D spending (i.e. R&D intensity).

Still, tech startups are not homogeneous. Some of the distinctions that have been draw are science- vs. engineering-based startups, or industry-specific startups like IT, cleantech, or biotech.

This week I attended two business plan competitions here in Claremont: Wednesday’s business plan competition at the Keck Graduate Institute (which I organized) and today’s Kravis Competition across all the Claremont Colleges.

Judges at KGI 2013 Business Plan Competition: George Golumbeski, Stephen Eck, Bob Curry. Not shown: Liam Ratcliffe, Paul Grand

Our KGI business plans (from my ALS 458 class) were all about commercializing patented (or patent-pending) biomedical technologies (therapies, diagnostics, devices) developed by top research institutions such as Caltech, City of Hope, and USC. The Kravis competition included several IT concepts, some low tech businesses, and AccuMab, a cancer diagnostic company from my KGI class.

In comparing the KGI plans to the other Claremont projects — or those in our textbook — it seems to me that — at least from a financial standpoint — there are three types of companies: high tech, medium tech and no tech.

What is dramatically different about our students projects was that (with one exception) is that they’re highly capital intensive, requiring $5 to $50 million in outside funding. For example, the winning team — using technology from Children’s Hospital Los Angeles to repair Shortened Bowel Syndrome — estimated it needs $20 million in equity and $5 million in government grants to get to market. This project — like many others — is building on millions of dollars of NIH/NSF/foundation grants already received to develop the basic science. There is a certain minimum scale required to get FDA approval and thus generate first revenues.

2013 winning KGI team — Hadi Mirmalek-Sani, Porus Shah, Shrina Shah, Rajesh Pareta —
with Bob Curry, chair, KGI Board of Trustees

Think about the story of Mark Zuckerberg, who launched The Facebook in early 2004 and took its first outside investment (of $500k) later that year. (Yes, they didn’t monetize initially, but still they created a compelling product and reached a million subscribers using the founders’ money). The iPhone app startups were launched for tens of thousands of dollars: Rovio had 40 million Angry Birds users before they took their 2011 Series A investment.

Over the years, entrepreneurship researchers (and practitioners) have demonstrated that any new company or product has highest uncertainty and risk up until first customer sale. So from a practical standpoint, I suggest a new metric: how much R&D spending do you need before launching a product? How big a bet — with what scale of outside investment — does it take until the entrepreneur finds out whether (s)he has a viable business?

By this measure, the difference is not the % of the money that goes to R&D but the size of the R&D bet that’s needed to test the marketing hypothesis.

A company that takes 5+ years and $50+ million is fundamentally different from one that can ship a 1.0 (or revenue-generating beta) for less than $1 million. By that standard, after biotech the biggest bets required are for renewable energy. You can start dozens (or hundreds) of software companies for one fully mature biotech, biofuels or solar company.

When (and whether) to scale?

My friend Tom Eisenmann (@teisenmann) has blogged for his entrepreneurship students on the important question of when (and why) entrepreneurs should ramp up to achieve scale economies. This is an issue that I usually address early when I teach entrepreneurship and also technology strategy.

Of course Tom is a leading scholar of network effects and technological innovation: he knows the material cold. Thus it’s not surprising that his advice is solid — the pros and cons of trying to be a first mover, the benefits of scale, and the obstacles that startups typically face in getting there.

In some ways it’s a more complete explanation than mine would beHe makes the point in a more quantitative way than I have, suggesting that his students are in a program that expects financial analysis throughout the program, not just in a few select classes.

There is only one thing I would add if I were using it in my own course. The posting assumes that the entrepreneur will (or must) scale, and I think it’s a choice that every entrepreneur should consider.

Perhaps it’s Tom’s audience. I can see a scenario where people who plunk down $170K for a Harvard MBA aren’t going to mess around with a mere “lifestyle business” — they’ll take someone else’s money and (ala Babe Ruth) swing for the bleachers rather go for the sure single.

However, in my class I talk to students about what causes scale economies, and how some businesses have them while some don’t — or, more realistically, can achieve minimum efficient scale with fairly modest staff and/or revenues.

Yes, I wanted to create the next HP or Apple, but I didn’t blow my brains out when that didn’t happen — nor did I pull the plug on my business and my customers. (I did cut back to part-time status and get a Ph.D., but that’s another story.)

So what I teach my students is that scale is a choice and a matter of fit to both aspirations and pragmatic realism. If you want to make a rapidly growing business that has a huge exit, 9 times out of 10 you need to attract sizable venture investments and generate the explosive growth those investors demand.

However, if you don’t want to take their money — or don’t have an idea that will generate the growth they expect — you can still start a business. The trick is to find a concept that doesn’t require such scale to create a sustainable competitive advantage.

As with any other aspect of strategy, success is a matter of aligning the goals with the reality, and then executing like hell.