Arguably perhaps, no one is tested more by the vagaries of uncertainty than the high-tech entrepreneur. That is why…
Over the last decade, technology and entrepreneurship have emerged as key drivers of vigorous economic growth. The prospects of significant returns from commercializing innovative technologies and exploiting new markets encouraged would-be entrepreneurs to start up thousands of new companies. Seed capital, whether provided by venture capitalists or angel investors, was readily available. Spurred by economic liberalization and the declining cost of communication, entrepreneurs in far-flung countries such as India and Israel found that businesses were now cheaper to start and products much cheaper to advertise and distribute. When the bubble finally burst, companies started folding as fast as they had sprung up, leaving in their wake many unanswered questions. Making sense of it all more than a year and a half later, one question remains paramount: Was it actually possible to manage technology start-ups in an environment of high uncertainty?
In business, changing environments are nothing new. Moreover, change creates opportunity, which successful firms exploit by innovating and often reinventing themselves. Entrepreneurial firms, however, are in the business of inventing themselves. In what is usually a very short window of opportunity, a team of enthusiastic founders needs to turn their financial, technological and human assets into organizational resources capable of delivering results. If they are to survive, entrepreneurial start-ups have to turn their ideas into products and get those products to market. High-technology start-ups, in particular, enter industries with very short technology and product life cycles where constant innovation is a must. Thus when uncertainty hits, these entrepreneurs are already involved in a rather profound struggle, both to establish their companies and to survive.
In this article, I will look at how several high-technology start-ups around the world have responded to the sudden need to change. In the first section, I discuss the differences between risk and uncertainty, and give an example of how a British company confronted a massive shift in its business environment. In the second section, I illustrate how two U.S.-based companies caught in the grips of the market downturn adjusted theiry strategies and redefined themselves in the process. In the third section, I bring in examples from India and Israel that reveal how high-technology firms far from the epicentre of uncertainty have come to terms with its implications. In the final section, I draw some lessons from the experiences of these firms. The unequivocal, overwhelming message that the experience of these start-up firms sends is clear and simple: Surviving uncertainty requires swift action.
ENTREPRENEURSHIP, RISK AND UNCERTAINTY: LONG-TIME BEDFELLOWS
For many technology companies, the recent bursting of the internet bubble was not their first encounter with uncertainty, nor is it likely to be their last. Indeed, focusing on the end result of the last expansion obscures the persistent reality that entrepreneurship, risk and uncertainty have been long-time bedfellows. Every high-technology new venture struggles to answer the following questions: Will our technology actually work as planned? Will it deliver the desired benefits to consumers? Is the timing of its introduction too early or too late? Will the market be big enough and keep expanding? Will our competitors react in unexpected ways? Will our management team have the skills to grow the company? Will our investors stand behind the company?
Risks are the stuff of daily business in the start-up world, and entrepreneurs and investors must try to anticipate, quantify and mitigate a host of risks. What entrepreneurs fear most is the type of extended risk for which they have no reference points and which redefines overnight the bedrock of norms on which the company based its assumptions. Such risk is akin to what the economist Frank H. Knight termed “uncertainty.” It can be argued that this is what happened for many entrepreneurs when the internet bubble abruptly exploded. It is also, as the cover of the Oct. 8 issue of Business Week magazine reminded us, what happened when terrorism unsettled “the state of nature” and brought forward the type of “unquantifiable risk” that the markets loathe because “they cannot put a price on it.”
Encountering uncertainty in an already turbulent environment requires start-ups to pursue survival tactics in order to support their long-term strategies.
HOMEPRO: HIGH RISK, JUST REWARDS
To understand the impact of environmental uncertainty on an entrepreneurial start-up, consider the case of HomePro, a British company that at the height of the internet boom positioned itself as an intermediary in the home improvement market. Its founding CEO, Adam Burdess, describes how uncertainty hit home just as the company was gaining momentum. “It all happened extremely fast. In 1999, we raised money easily and based our future strategy on raising more money in successive rounds. Six months later, in May 2000, we were struggling to raise the next round. In the interim, we could see that the financial markets were collapsing, yet we were also in the midst of executing a number of international acquisitions that were all-consuming. We kept our eyes on the vision. It was hard to be paranoid about the changing environment. After all, if you are out for world domination in your space, the game plan is not helped by doubting yourself and what you are trying to achieve.”
Start-ups have management that is often stretched to the limit. The timing and impact of the uncertainty is affected as much by when management is able to process the change as when the actual event occurs. While managers know that something fundamental is changing, they cannot immediately understand its direct impact.
In the middle of 2000, the socially accepted norms changed abruptly for HomePro. Burdess continues: “One day, we realized that the goalposts had been moved. While we were working to execute a strategy based on one set of agreed upon premises, the world changed and so did the premises. Our investors were not wrapped up in running the business, but they were involved in the value creation exercise with us. Their ability to process the change depended very much on when they entered the company and why they had invested. Those who entered most recently, and for strategic rather than financial reasons, were willing to go along a bit further, to see if things might eventually work out. Our financial investors, however, harboured few illusions.”
Most technology start-ups raise equity capital from a variety of outside sources that include venture capitalists, angels and corporations. In some cases, technology start-ups receive debt financing from banks or grants from government agencies. In research I recently conducted, “Money and Knowledge: Sources of Seed Capital and the Performance of High-Technology Start-ups,” I showed that the control investors have over the firm has significant implications for its performance. Thus, when confronted with uncertainty, managing a diverse set of stakeholders proves to be a challenge. How quickly and willingly investors grasp the need for change depends on how long they have been with the company, why they had originally invested, and how close they are to the source of the uncertainty.
Just as risk is a daily reality, so is uncertainty part and parcel of major technological upheavals. More than sixty years ago, Joseph A. Schumpeter characterized entrepreneurs as the agents of creative destruction that drive the economy from equilibrium to disequilibrium. In the process, they generate renewal where new firms, new technologies, or modes of commerce displace the old established order. The process is messy, and the uncertainty it creates allows entrepreneurs to pull off spectacular deals. In the case of HomePro, Burdess reflects: “If I had my chance again, I would not do anything differently. If we were more conservative, we might not have had the opportunities we did. We were aware that it couldn’t last forever, so we decided that we might as well go all out rather than tiptoe along. You sense that it will turn on you, but you cannot anticipate it in every way.” To combat the pressures of the changing environment, HomePro scaled down and refocused its operations; it hit break-even earlier this year.
Far from driving the economy from equilibrium to disequilibrium, as Schumpeter proposed, entrepreneurs may actually do the reverse. Perhaps as the American economist, Israel Kirzner, suggested, entrepreneurs are the equilibrating force in the economy. Kirzner, whose work is shaping our understanding of entrepreneurship, has suggested that entrepreneurs find the economy in disequilibrium, out of joint and inefficient, and drive it back into a state of equilibrium through innovation. Either way entrepreneurs instigate change. In the long term, they can only do so by surviving the uncertainty such change creates.
MANAGING RISKS WHEN UNCERTAINTY HITS
Entrepreneurs need to confront ambiguity and change on a daily basis. Successful entrepreneurs are continually alert to changes in the environment and carefully analyze it in search of opportunities. Peter Drucker has pointed out that entrepreneurs are not “risk-focused, but opportunity-focused.” In fact, Drucker reminds us that, “Innovation is risky,” but “all economic activity is by definition high-risk. Defending yesterday, that is, not innovating, is far more risky than making it to tomorrow.” Successful entrepreneurs take calculated risks and try to turn the odds in their favour. Successful entrepreneurial firms have to be fluid and adaptive. When uncertainty hits, implementing change; and doing so quickly, is critical.
GRADUAL CHANGE, SUDDEN SHIFT: BUSINESS LAYERS AND DIGITAL FUELS
On Sept. 10, 2001, Business Layers, a three-year old New York-based e-provisioning company, announced that it had closed its latest round of financing. Timing is, unfortunately, everything,” says its CEO Izhar Shay.
Shortly before the recent uncertainty that has gripped the market, Business Layers had begun to notice a change in its customers’ needs. Originally set up as an e-provisioning company, Business Layers soon found itself in the de-provisioning business. (E-provisioning allocates digital resources to employees and business partners according to the needs of the business. For example, a new employee needs access to various applications, email and network accounts, while a new partner needs access to a company’s price list product information and marketing literature. De-provisioning disconnects employees and partners form those privileges). Says Izhar Shay. “In the heady days of the internet, e-business and e-everything was the rage. Companies were recruiting and moving people around at fever pitch. They had a desperate need to make sure that employees were immediately productive.”
Then the market crashed, and the same companies started to lay off people. Their needs flipped. Companies became obsessed with cost-cutting and security. They needed to make sure that assets were under lock and key. Izhar Shay says that, “While our technology could support e-provisioning as well as de-provisioning, we had to reposition the company to communicate that we had that capability and realign the organization from within. We had to position ourselves as a life-cycle company capable of supporting e-provisioning and de-provisioning.” As a further hedge against the worsening economic situation in the U.S., Business Layers branched out into Europe and set up offices in the U.K., France and Germany. “The needs were broadly similar and we were ahead of the game in these markets.” For Business Layers, making the change represented an evolution rather than a revolution. But, at a certain point, it was obvious what the company needed to do.
Unlike Business Layers, Digital Fuel had to change its strategy before it even opened for business. Headquartered in Brisbane, California Digital Fuel received its seed financing in April 2000. “We were the last ones to get money before the doors were shut,” says the company’s CEO, Benny Lehmann. Digital Fuel’s founders were veterans of the computer industry, and they raised their initial financing from a seed venture capital fund and a number of technology-savvy serial entrepreneurs. The business plan called for the company to create a service-level management solution for ASPs and others who needed to outsource. However, before the money reached the bank, Digital Fuel had to change its value proposition. Companies were now in a cost-cutting mode, and Digital Fuel had to change its software tools accordingly. Such a sharp switch was made possible by the fact that Digital Fuel was a nimble company whose leaders emphasized and used forward planning. The company’s founders realized that they “simply could not predict the future.” They had built a modular product from the ground up that made it easy to plug new pieces into the platform as well as get rid of the parts they did not need. When the market changed, says Benny Lehmann, “We had no choice but to make the switch and, being a very young company, we could do it while our competitors were locked in.”
THE TSUNAMI HITS INDIA AND ISRAEL
In India and Israel, the number and size of technology start-ups expanded greatly during the boom years. In July 2000, Wired magazine named Israel as one of the world’s top high-technology countries. The country’s entrepreneurial culture and first-rate technical human capital attracted $4.5 billion (U.S.) in venture capital (second only to the U.S. in per capita terms) and fuelled the establishment of several thousand entrepreneurial ventures.
In Bangalore, India, software was king, and entrepreneurs were building organizations to meet the growing needs of their U.S. and European customers. But once the Nasdaq crashed, the contraction travelled swiftly and forced major changes in how Indian and Israeli CEOs coped with future prospects.
In 1999, Siri Technologies, a Bangalore-based provider of software solutions, had one main U.S. customer that accounted for 90 per cent of its revenue. Srikanth Manchikanti, the CEO of Siri Technologies, had worked as a consultant in the U.S. in the 1980s. In the 1990s, he returned to India to start Siri Technologies. The company grew by securing small projects and building on earlier success.
Manchikanti describes the situation in which the company found itself after the U.S. economy turned. “We built the company on great personal relationships with our major client. We grew from 10 to 25 to 70 employees at the height of the expansion. Every time I hired 10 new engineers, the client would give us more work. The problem was that we simply had no time to grow the business in any other direction. We made some half-hearted attempts to establish inroads in Europe and Asia, but with business coming in we had little incentive. Then suddenly, the project flow ground down. We were incurring losses month after month. We had to do something. We hired the best and most well-groomed sales and marketing person to get us contracts. This turned out to be a terrible strategy. He did what he knew how to do. Unfortunately he had learned everything he knew while the boom was on. Such methods no longer worked and they cost us one year and $100 million.”
To deal with a worsening situation, Siri Technologies had to return to its roots. Management looked at itself, decided to take control of the situation and changed the customer strategy. It went out and began to offer potential customers discounted pilot projects through which Siri Technologies could again prove and position itself for further business. Manchikanti now says that, “We have secured contracts in Europe and the United States. Our original major client now gives us only 30 per cent of the revenue, but we have made up the rest through new business. We run the show from India and travel on demand to meet clients. It looks promising, but we are not out of the woods yet.”
In a different part of the globe, two Israeli companies, both launched in early 2000, each with products for the mobile market, and each with successful fundraising in hard times, are now struggling to find the right launching pad in the telecom doldrums. One company, Mobile Economy, raised seed financing to launch a series of flexible billing agents that allow the cost of mobile calls to be transferred between parties. The company has signed commercial agreements in Scandinavia and opened a sales office in the United Kingdom. But its CEO, Ofer Bengal, says that getting orders has become as difficult as getting money out of venture capitalists. “The basic need for our product has not changed; it is still there. However, the way we need to approach the mobile operators has changed. We can no longer approach them directly. We now have to position ourselves to form alliances with strong strategic players. We are working parallel to them on many fronts not to overlook anything.”
Another Israeli company, Celltick, has developed interactive broadcast technology for mobile phones. But “today, telecom companies are buying painkillers and not vitamins. We have to sell them what they need. We have to offer them solutions to their immediate problems,” remarked Yossi Wellingstein, the company’s CEO. Having raised an additional large round of financing, Celltick is branching out to Europe and focusing on building its delivery channels.
EMBRACING UNCERTAINTY: RYANAIR
More recently, we have seen another source of uncertainty. The attack on the World Trade Center left people scared of flying and many airline carriers flying empty. Overnight, customers disappeared. Most airline companies retrenched, but RyanAir, a low-cost European carrier, reacted immediately. The company’s CEO took out ads in all the major papers and offered RyanAir’s customers an opportunity to fly for as little as £10 (approximately $15 U.S.) throughout its network. Unable to resist the offer, customers came back. While chance may favour the prepared mind, few could have called the overnight disappearance of customers anything but a massive dose of environmental uncertainty. RyanAir’s action was a classic example of an entrepreneurial vision quickly executed.
UNCERTAINTY CAN BE MANAGED
The experience of firms discussed in this article suggests that high-technology entrepreneurs should do three things to manage uncertainty.
1. STAY ALERT TO THE CHANGING ENVIRONMENT. Entrepreneurs take opportunities and manage risks. To identify those opportunities worth taking, entrepreneurs continuously scan the environment. However, once in a start-up mode, the demands of running a business usually leave mean less time for scanning. In the case of HomePro, major international acquisitions took up all of management’s bandwidth.
Entrepreneurs may also feel that they know the environment, since they are already in the midst of it. For example, Siri Technologies’ management ate and slept the software business, scanning the environment only infrequently.
The message, then, is loud and clear: When uncertainty hits, reacting quickly depends on having clear, up-to-date knowledge of the environment. Investing time in getting to know the environment can mean the difference between survival and extinction.
2. ADAPT STRATEGIES AND TACTICS TO IMPLEMENT CHANGE. Most experienced entrepreneurs and investors know that entrepreneurial strategies and tactics must remain flexible. As soon as the ink on the business plan is dry, the need for sudden change occurs. In times of great uncertainty, adaptability serves as a buffer for the core technologies and competencies of the organizations. In the cases of Digital Fuel and Business Layers, the adaptability of their strategies and tactics allowed the firms to retain the value of their core technologies. Each firm first defined its competencies and then redefined its strategies. In other words, a strategy of sticking to your knitting can spell a quick demise when uncertainty prevails.
3. FORM ALLIANCES AND LOOK FOR INTERNATIONAL OPPORTUNITIES. Both strategies can be important hedges against uncertainty. However, they are not without their dark side, nor are they for every start-up firm. Nevertheless, entrepreneurs have long considered strategic alliances as launching pads for their new ventures or as extensions of their organizational capability. Forming alliances and other types of collaborations could offer stability in what is an otherwise turbulent environment.
As for international expansion, it clearly represents opportunities for exploiting knowledge already accumulated. In many global industries, both alliances and international expansion are the norm, and both have been shown to mitigate uncertainty.
While the firms described above have survived for now, many others have not. Environmental uncertainty is a powerful force that can sweep away thousands of start-ups, even those with the best of plans. However, as very recent history shows, swift, decisive action in the face of uncertainty can indeed enable the firm to survive.
