How do hi-tech start-ups grow?

The fact that so many high-tech start-ups end up being acquired by large multinational corporations has bothered me for a long time. What precisely is it that makes the growth of such start-ups so difficult?

And why, despite the fact that they come up with novel inventions that change the world, do they so often fail to remain independent?

One major reason appears to be that the technological advantages of these emerging companies are not sufficient to compensate for the scarcity of distribution and marketing resources that they face. Such resources are critical for becoming global leaders.

Born global?

Yet some start-ups are able to still grow, despite these challenges, and in this regard it is worth first exploring how these companies penetrate foreign markets.

The literature seems to suggest that many hi-tech startups are ‘born global’ in the sense that they become global in their operations soon after their inception, introducing their novel innovations to the world. However my research has found that these companies do not turn global quite so quickly as one might think.

Firstly, they export to markets they consider to be not risky, while keeping all their main functions (R&D, production, marketing etc) at home. Only after a few years do they start establishing foreign marketing subsidiaries, and only after several more years do they turn to more risky foreign markets, start acquiring foreign firms, and engage in foreign R&D and production.

In parallel, I found that they also typically prefer to focus their internationalisation efforts on a specific geographic region, such as North America, Western Europe or South East Asia. They increase their foreign resource commitment to that region first and only later expand to another region, a phenomenon I have coined ‘sequencing’ in terms of their foreign market commitment.

Organising boundaries

Another important question to consider is how these companies are organised. For instance some of the literature suggests that in order to protect their specific knowledge, high-tech start-ups prefer to keep their activities in house. Yet other studies suggest that the complexity of firm-specific knowledge serves as a barrier for imitation and knowledge leakage, hence allowing firms to outsource some of their activities to third parties.

I was initially puzzled by these allegedly contradictory views, but was then able to reconcile them. In a study of Israeli start-ups I found that both very low-tech and very high-tech start-ups are more likely to outsource activities. Low-tech businesses do so because they do not have much firm specific knowledge to protect, while high-tech start-ups possess technological knowledge that is complex enough to avoid misappropriation concerns. Instead it is medium-tech start-ups that need to internalise their functions to protect their propitiatory knowledge.

Competition

A related dilemma is when high-tech start-ups should choose to collaborate with industry incumbents and when they prefer to compete with them. And here it is the structure of markets that turns out to be a key explanation for when such a choice is made.

When the markets are very competitive they prefer to cooperate with industry incumbents precisely because price competition is so fierce and margins are low. Likewise when the markets are consolidated and there are only a few large competitors they will find it hard to compete and will prefer to cooperate with them. Instead, it is in is moderately consolidated markets where high-tech start-ups will try to use their unique technological knowledge to compete head-on with industry incumbents.

Influence of founders

Finally, I reckoned that the founders of high-tech start-ups must have a significant effect on their growth. Indeed my research found that those companies that build on the prior technological knowledge of their founders are indeed those that initially grow the fastest. Yet if they do not start building on the knowledge of other firms, and of partners, customers, and suppliers, then their growth slackens after several years.

Over-reliance on the specific knowledge of founders also prevents experiential learning and initiatives that can facilitate growth, hence in this situation the growth of the company will slacken at some point.

A key lesson here is that while founders are invaluable in the early years of a company, at some point they need to let go.

So, going back to my original question, high-tech startups that internationalise gradually, those which outsource their activities according to their level of technology complexity, those that choose to compete according to their market structure, and those that know how to leverage the useful experience and knowledge of founders – but also when to stop relying on them – are more likely to succeed in becoming large successful multinational corporations.

Listen to Niron’s Original Thinking Podcast where he addresses the question of how knowledge-intensive start-ups can successfully grow to become industry leaders

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