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Selecting the Right Industry

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This chapter is from the book

While entrepreneurs like to think of themselves as being able to overcome all of the obstacles that life puts in front of them, being a successful technology entrepreneur is really more about playing the odds successfully. While you certainly need to temper playing the odds with playing to your strength, and make sure that you do not pursue a venture in an industry that you know nothing about, you need to keep in mind that your success depends a great deal on selecting the right industry in which to launch a new firm. Some industries operate through dynamics of creative destruction, and, as a result, entrepreneurs tend to perform very well. In these industries, entrepreneurs enter with new firms, challenge established firms on the basis of new ideas, disrupt the old ways of production, organization, and distribution and replace the old firms. Examples of industries in which this process of creative destruction appears to operate and entrepreneurs tend to do very well are chemical processes, computer disk drives, machine tools and lighting.(1)

Other industries operate through dynamics of creative accumulation and entrepreneurs tend to perform very poorly. In these industries, entrepreneurs enter and challenge established firms on the basis of their new ideas. However, established firms defend their old ways of production, organization, and distribution, and the new firms tend to fail. Examples of industries in which this process of creative accumulation tends to be found are organic chemicals, telecommunications, and electronics.(2)

This chapter focuses on identifying the attributes that make an industry favorable to new firms. The first section provides empirical evidence of the differences in the favorability of different industries to new firms. The subsequent sections each review different dimensions of industry differences that influence the performance of new firms: knowledge conditions, demand conditions, industry life cycles, and industry structure.

Looking at the Evidence

If you are thinking of starting a new technology company, you can and should examine how favorable different industries are to new firms. A former PhD student of mine, Jon Eckhardt, who is now on the faculty at the University of Wisconsin, compared the proportion of start-ups in different industries that made the Inc 500, the magazine's list of the fastest growing young private companies. Looking from 1982 to 2000, Jon found very high levels of variation in this measure (see Table 1.1).(3) For instance, Jon's data show that the odds of starting a biotechnology company that made the Inc 500 were 265 times higher than the odds of starting a restaurant that made the Inc 500 and that the odds of starting a computer software company that made the list was 823 times higher than the odds of starting a hotel that made the list. In short, an average entrepreneur starting an average new firm will be more likely to create a high-growth private company or a newly public company in some industries than in others.

Percent of New Firms in Selected Industries That Have Become Inc 500 Firms.

Industry

Percent of Start-ups

Pulp mills

18.2

Computer and office equipment

4.2

Guided missiles, space vehicles, parts

3.3

Nonferrous rolling and drawing

2.4

Railroad car rental

2.2

Measuring and controlling devices

2.0

Paper mills

2.0

Search and navigation equipment

1.9

Communications equipment

1.9

Drugs

1.8

Medical instruments and supplies

1.8

Luggage

1.7

Footwear, except rubber

1.5

Security and commodity exchanges

1.4

Steam and air-conditioning supply

1.2

General industrial machinery

1.2

Photographic equipment and supplies

1.1

Manifold business forms

1.1

Household appliances

1.0

Electrical industrial apparatus

1.0

Legal services

0.008

Eating and drinking places

0.007

Carpentry and floor work contractors

0.006

Real estate operators

0.006

Hotels and motels

0.005

Painting and paper hanging contractors

0.005

Retail bakeries

0.005

Grocery stores

0.005

Used merchandise stores

0.004

Automotive repair shops

0.004

Beauty shops

0.004

Residential care

0.004

Video tape rental

0.004

Stop! Don't Do It!

  1. Don't start a business without investigating how favorable the industry is to new firms.

  2. Don't fight the odds. Don't start a business in an industry that is unfavorable to start-ups.

So how do we explain these data patterns? Unless most of the talented entrepreneurs are drawn to some industries (e.g., biotechnology) and not others (e.g., hotels), some industries are just better for starting new firms than others. This, of course, means that you need to understand the characteristics of industries that make some of them better for starting firms than others if you want to increase your chances of success. Research has shown that four different dimensions matter: knowledge conditions, demand conditions, industry life cycles, and industry structure.

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