Storm Clouds on the Horizon? New Entry Threats and R&D Investments in the U.S. IT Industry

Abstract

It is well accepted that the information technology (IT) industry is highly volatile, where incumbent firms are often disrupted by startups entering their product or service markets. This creative destruction is driven by large-scale movements within the entrepreneurial ecosystem, consisting of startups, venture capitalists, and innovators. These collectively represent the threat of new entry for incumbents, leading to turbulence in the future and necessitating a strategic response. Quantifying these risks of new entry threats (NETs) has always been problematic given their probabilistic and forward-looking nature. Taking advantage of text analytics, we develop a text-based measure of NET based on the extent to which a firm’s description of its product markets overlaps with business descriptions of entrepreneurial firms backed by venture capitalists. This measure is then used to investigate how IT firms respond to NET through preemptive investments in research and development (R&D). We show that incumbents actually reduce R&D spending, on average, when facing high NET, consistent with risk aversion and financial conservatism. However, firms operating in contexts where high NET is unlikely to change market structure are likely to be more aggressive with their R&D spending—these contexts include markets with winner-takes-all dynamics because of strong network effects and those where the success of R&D effort hinges on the relevant continuities with prior innovative activities.