Entries and exits

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technology (Nair and Ahlström 2003). Also, installed base and network effects can slow down or create excess momentum for the adoption of the new technology (Farrell and Saloner 1986).

Furthermore, switching costs that arise from the need for the reconfiguration of customer organisations can slow down the widespread adoption of a new technology (Bresnahan and Greenstein 1996). On the other hand, alliance formation can be used to speed up the transition to new technology by creating new industry standards (Rice and Galvin 2006). Alliances and technology sourcing can also help firms to keep abreast with an emerging technological regime (Nicholls-Nixon and Woo 2003). Geels (2006) argues that technological discontinuities should be seen as transitions in socio-technical systems that take place through the co-evolution of markets, user practices, regulation, culture, infrastructure and science.

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Increasing entry in the early stages of the industry life-cycle goes together with sales takeoff that is dependent on quality improvements and price reductions. However, sales takeoff is not just a matter of price decline caused by the pressures of increased entry. Agarwal and Bayus (2002) argue that sales in new markets are initially low because the first versions of the product are primitive and the willingness to pay for them is low. As new firms enter, the quality of the product improves and price may also decline which makes the product more valuable for the buyers and sales takeoff follows. Thus increased entry induces sales takeoff through the quality improvements that entrants can offer and not primarily through price reductions that they cause. Agarwal and Bayus (2002) report that a takeoff in firm numbers systematically occurs prior to takeoff in sales. Furthermore, they claim that increased entry dominates price reductions in explaining takeoff times. They interpret this to support their thesis that in the early stage of the industry life-cycle demand shifts due to non-price factors.

In addition to critical quality improvements, new industries face the challenge of legitimacy. This means that entrants to new industries face the challenges of cognitive and socio-political legitimacy to a higher degree than entrants to existing industries (e.g. Aldrich and Fiol 1994). Cognitive legitimation refers to the spread of knowledge about the new venture whereas socio-political legitimation refers to the process by which the venture is deemed appropriate and right according to existing norms and laws. Such acceptance is required from the general public, key opinion leaders and government officials. Doubts may rise from other industries because of cannibalisation effects or in society in general on whether the business in question is acceptable (ibid). Thus the success of a new industry or a new technology that replaces an older one is seldom just a matter of performance, quality, price and costs.

The stylized fact of survival rates going vastly below entry rates has opened the discussion on whether there are too many entries. Santarelli and Vivarelli (2007) argue that most new firms are doomed from the start and this type of entry is not conducive to technological progress and economic growth. On the other hand, Götz (2002) points out that from the welfare perspective there can never be too much entry as even inefficient firms provide consumers with more choices. Also, firms that exit soon after entry may have accumulated enough profit by that time to cover the sunk costs caused by entry. Thus an exit is not necessarily a disaster. Furthermore, excessive entry can be seen as a vital producer of diversity that increases the chances of success for the entire industry.

Goldfarb et al. (2007) argue that during the Dot Com era there was actually too little entry. This is because there was a general belief that it is good to get big fast and for this reason venture capital clustered and was directed at too few candidates. At the end, the Internet start-ups experienced a rate of survival similar to firms in other emerging industries (ibid.).

Young industries are characterised by turbulence that consists of high entry and exit rates, short firm life-spans and radical innovations. This pattern has been found to hold across industries and across time. The early car manufacturing industry in the early 1900s and the early PC industry in the late 1900s show similar high degrees of turbulence during their first 30 years (Mazzucato 2002).

The turbulence, or churning, due to frequent entries and exits is also apparent in the identity of the innovators. Malerba and Orsenigo (1999) found that there is a high degree of turbulence in

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innovative activities as the population of innovators changes substantially over time. De novo entrants and their exits usually generate higher turbulence than entrants through diversification and their exits. Most innovative entrants are occasional innovators and only some of them become persistent innovators. In the same vein, Audretsch (1995b) found that industries conform either to the ―revolving door‖ or the ―replacing forest‖ metaphor of industry evolution. In revolving door industries the bulk of the exiting firms are recent entrants. Thus the persistent innovators manage to survive and the occasional innovators enter and exit at a fast pace. In replacing forest industries entrants tend to replace exiting incumbents. This model thus includes only occasional innovators.

The revolving door model reigns in industries with high scale economies and under routinised regime whereas the replacing forest is more applicable to industries under the entrepreneurial regime (ibid.).

The transition from the era of ferment to the era of incremental innovation, or from entrepreneurial to routinised regime, is marked by the emergence of the dominant design and followed by a shakeout. Klepper and Miller (1995) define shakeout as a lengthy period of time after the sharp increase in firm numbers during which there is a persistent fall in the number of firms while there is continued growth in output. Shakeouts have been shown to be common across various industries (e.g. Gort and Klepper 1982). Klepper and Graddy (1990) as well as Klepper and Miller (1995) have reported 20 to 30-year periods between the entry of the first firm and the beginning of the shakeout and around 10-year shakeout periods in various industries. The typical shakeout included a drop of roughly 50% in firm numbers whereas in some industries, such as cars and tyres, the numbers declined by 80%. Even though the industry life-cycle theory predicts the shakeout to take place after the dominant design has emerged and thus relatively early in industry history, shakeouts have also been detected in mature industries (Bergek et al. 2008). On the other hand, Day et al. (2003) argue that in the ‗new economy‘ shakeouts will come increasingly fast. For example, in the PC hard disk drive market it took only 10 years from the entry of the first firm to the onset of the shakeout and in online business-to-business exchanges the boom and bust appears to take only five years (ibid.).

The causal explanations for shakeout can be divided into roughly two approaches. The first class assumes that mass-exit follows mass-entry and thus shakeout is caused by excessive entry. Horvath et al. (2001) argue that as most firms die young it is only natural that industry shakeouts follow periods of mass-entry. For Carree and Thurik (1999) entries take place when there are profit opportunities and exits when there is a lack of such opportunities. As the number of firms exceeds the carrying capacity of the market some of them are forced to exit. Aaker and Day (1986) argue that shakeout is the product of excessive entry relative to market size. Such excessive entry takes place because growth industries attract numerous competitors who believe in easy market share gains and profits and are eventually disappointed by the intensity of competition. Day et al. (2003) term these entrants as an ―unsustainable glut of competitors‖ who may be naïve about entry barriers and unaware of the volume of hopefuls preparing to enter at the same time.

Klepper and Miller (1995) discredit the overshooting theory in their study of nine products that had undergone a shakeout and seven products that had not. Shakeout products included adding and

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calculating machines, freezers, guided missiles, paints, radars, radio transmitters, televisions, pneumatic tyres and windshield wipers. Non-shakeout products included lasers, pens, shampoo, cryogenic tanks, tapes, transistors and zippers. The shakeout products showed a longer duration of exit than predicted by the overshooting model and the non-shakeout products showed persistence in entry and exit inconsistent with the overshooting model. Alternative explanations are thus needed.

The second class of explanations assumes that shakeout is caused by technological developments and thus excessive entry and shakeout do not have a causal link but rather they correlate. Utterback and Suárez (1993) explain shakeout based on the dominant design and the transition that it brings about in innovative activities. Firms that are unable to move towards greater product standardisation and process innovation will not succeed in competition against those who make the transition and they will eventually die. In the Jovanovic and MacDonald (1994) model shakeout is the result of a single major refinement innovation that substantially increases the optimum firm size. As many firms ramp up production to exploit such scale economies the market is overflowed and price drops.

This causes many firms to exit. Klepper‘s (2002a) theory, on the other hand, is based on dynamic increasing returns to R&D. As large firms benefit most from R&D due to their large output they also tend to perform the most R&D. This gives the incumbents an ever increasing advantage over entrants as they tend to have grown larger and have had more time to perform R&D. The later entrants find it hard to catch up in size and as the price continues to fall the smallest firms and least able innovators exit.

As the shakeout has taken its course the industry reaches ―ultimate structure‖ that is determined by the sequence of events traversed (Gort and Klepper 1982). Utterback and Suárez (1993) call it a point of stability where few large firms have standardised products and stable market shares. For them this is not in any way an ultimate structure but a situation that is waiting for the next technological discontinuity.