Last week, when I wrote a post about differences in failure rates across industries, Joe commented, “Good point about selecting an industry with high survival rates for a startup . . . but does not an entrepreneur have to stick to the industry he or she knows? Perhaps the information is valuable for angel investors but I think entrepreneurs cannot change their spots, stick with your strengths.”
To my way of thinking Joe is half right. Entrepreneurs won’t be successful if they try to start businesses in industries they don’t know. We have a lot of data that show that various dimensions of start-up performance – survival, sales growth, employment growth, and profitability all increase with the number of years of experience that an entrepreneur has in the industry in which he or she is starting a business.
But Joe and many other people are missing an important part of the success story, operating in a favorable industry. I can tell from the comments on my posts about picking a good industry that people are frustrated by this point because it creates a problem for many people. The dilemma is that if your experience lies in an industry – like autos or steel or retail – that isn’t favorable to start-ups, you’re disadvantaged relative to your friends in computer software. Their fifteen years of experience in software positions them well to start a business; your fifteen years of experience in autos or steel or retail does not. The frustrating part is that you can’t change your history.
But this dilemma doesn’t change the facts. Success as an entrepreneur is enhanced by being experienced in a favorable industry; being inexperienced or operating in an unfavorable industry puts you at a disadvantage. Even if you want to fight the odds, it’s an uphill battle because investors, customers, and suppliers understand the situation.
To illustrate my point about where the best chances for entrepreneurs lie, I drew the two-by-two matrix below (I’m a business school professor after all).
Your chances of success are best in a favorable industry that you know well and worst in an unfavorable industry that you don’t know at all. Your odds are in between if you are in an unfavorable industry you know well or a favorable industry you don”t know well.
I don’t know which of the two off diagonal choices is better. What I do know is that you will maximize your chances by being in the upper left hand cell.
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About the Author: Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of eight books, including Illusions of Entrepreneurship: The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By; Finding Fertile Ground: Identifying Extraordinary Opportunities for New Ventures; Technology Strategy for Managers and Entrepreneurs; and From Ice Cream to the Internet: Using Franchising to Drive the Growth and Profits of Your Company.
Hi Scott, this is an excellent continuation of your last article. I love the chart, too! Deceptively simple, but very useful.
A specific industry must be able to change its status due to external factors, e.g. changes in regulations and tariffs in the steel industry. Have you seen changes of favorable industries during a time period, say from the IT boom in end of the 90’s and now?
My husband I are going to open our small business in London and we found a great system to save money in telecommunications. We have been saving so much money.
Can you continue this theme and give us some more concrete examples of favorable industries? I’m beginning to feel frustrated with my start-up and wondering if I am in the wrong box. My expertise is in Grant Writing & Research. I have a very inexpensive price for my research service for college bound (we’ll do the work for parents and students) but after a lot of work and investment … getting very little takers? How do you know if it is an industry problem or a marketing problem, or something else?
>>But Joe and many other people are missing an important part of the success story, operating in a favorable industry.<<
Thanks for the followup Scott. You prior article missed the important point–an entrepreneur must operate within an industry well known to him or her, period. This article corrects the omission. Booyah to you professor.
Makes perfect sense to me. Knowing your industry well just increases your odds of success all the way around and operating in a favorable one lends even to your endeavor.
Great matrix – simple and useful.
It’s safer and logically true that, although unfavourable, sticking to the industry I know well should do me better.
However, I currently in the phase of entering favourable industry that I don’t know well – despite the disadvantage, I love the challenge…
To answer your question of which of the two off diagonals is more advantageous than the other, I would give a slight advantage to the top-right cell (knowing the unfavorable industry). As examples, look at the bevy of businesses that have been born out of the after-market for automobile parts. The automobile industry itself is difficult to break in to, but these entrepreneurs managed to become successful in, I would say, the shadow of the big players. What I don’t know, admittedly, is what level of industry experience any of those entrepreneurs had in the industry when starting. Because some of the after-market parts are rather specialized (think of the weekend gear-heads trying to squeeze as much power out of their cars), I feel comfortable assuming they have industry experience.
I hope you are enjoying your summer. Perhaps I will see you in the fall.
It is always better starting the business in the area you know well and you have a lot of contacts to grow the business quickly.
But there is always a risk of being in a tough competition from your friends as you have them in your own network right now.
I agree with Anita, this is a great discussion and the matrix is very useful. Both posts are valuable. However, I can’t resist jumping in on this one on the side of Alex and Joe. I particularly like Alex’ specific recommendation, I second the advantage to the upper right over the lower left. I might go even further, and eliminate the lower half of the matrix entirely. My assumption would be that starting a business where you don’t know the industry is a completely different animal, so much more prone to failure that it shouldn’t be considered. So the auto and steel and retail people don’t switch to software, that isn’t an option. They just focus better and define narrower target markets and narrower business offerings. BTW, you should see the trackback on this one, I posted on one of my blogs …
@Tim, thank you for the hat-tip
One reason I find the bottom-left cell in the matrix valuable is that it leaves room for for describing the general odd of success for entrepreneurs that are building a company in an emerging market, one in which no one has a lot of experience, but one that has been determined to have enough good signs that it can be sustainable in the long run. Think about the market for iPhone apps (like Steve Jobs’ keynote address today): Apple is showing strong support for the iPhone by backing it in a number of different ways: lower price, extra internal features, a wide selection of complimentary services, etc. These are good signs for third party companies whose core business is not in make iPhone applications but something else: making video games (Sega), aggregating news sources (The Associated Press), social networking (Loopt), and so on.
However, I will leave it up to Professor Shane (or another commenter perhaps) to perhaps talk about whether his matrix holds true even in niche markets like the one for iPhone applications or after-market performance parts for automobiles.
I agree, you must love the business that you start. I loved doing weddings on the beach in Florida, so i started my own company