Are high-tech start-ups leaving established firms behind? Jesper
Sorenson and Toby Stuart examine the effect of aging on organizational
innovation.
IN THE HIGH-TECH ARENA, new start-ups are bursting on the scene
every day. Burgeoning with ideas, these companies are surging
ahead in the software and telecommunications industries, leaving
older, established firms behind. These days, it often seems that
the newest innovations are generated by the youngest companies,
while aging organizations are doomed to obsolescence. But is it
really so? What is the true effect of aging on organizational
innovation? Jesper B. Sørensen, assistant professor of strategy,
and Toby E. Stuart, associate professor of organizations and strategy,
tackle the topic and offer insights for established firms and
start-ups alike.
I n recent years, the business press and mainstream media have
been filled with stories of revolutionary changes associated with
Internet technologies and other new communications media. Both
investor and analyst enthusiasm have focused on the proliferation
of new ideas and technologies pioneered by high-technology start-ups,
the vast increase in the availability of venture capital devoted
to technology-based entrepreneurship, and the aggressive valuations
of e-commerce start-ups. The rash of successful high-technology
start-ups–including the 68 software and telecom companies that
have had IPOs in the first half of 1999–have led many to believe
that new ventures are at a distinct advantage when it comes to
leading technological innovation, while older, established firms
are doomed to eventual irrelevance.
This is an intriguing hypothesis. Yet, before we trumpet the virtues
of young firms, it is worth considering some caveats. Consider
patenting activity as a measure of a firm’s technical prowess.
The companies that patent most prolifically are the same companies
that are accused of being hopelessly out of touch. For example,
in 1997 the top 10 patent holders in the United States, in addition
to the U.S. government, were IBM, Canon, NEC, Motorola, Fujitsu,
Hitachi, Mitsubishi, Toshiba, and Sony. These are hardly newcomers;
on the contrary, they are large, experienced high-technology firms.
Little research has examined carefully how organizational aging
affects innovation processes within firms. Yet, in an increasingly
knowledge-based economy, pinpointing the factors that shape a
firm’s ability to produce influential ideas and innovations is
central to understanding industry dynamics and to managing high-technology
firms. In addition, knowledge of the relationship between organizational
aging and innovation will improve our understanding of the dynamics
of technological leadership. Our research helps untangle this
complex relationship.
Contradictory consequences
We believe aging has two seemingly contradictory consequences
for organizational innovation. First, we suspect that the accrual
of experience at older firms helps refine and improve established
organizational routines. The upshot of such experience-dependent
enhancements is that older firms innovate at a greater rate.
Simultaneously, however, the difficulties of keeping pace with
incessant external developments often cause older firms’ innovative
activities to become increasingly farther from the leading edge
of technology. As a result, the technological advances produced
by older firms may be less relevant, reflecting the obsolescence
of organizational know-how as firms age in rapidly evolving environments.
These seemingly contradictory outcomes reflect inherent trade-offs
in organizational learning and innovation processes. Our analyses
of patenting by firms in the biotechnology and semiconductor industries
support these arguments.
Aging and organizational innovation
We argue that innovation at the firm level is governed by established
organizational practices that are updated in response to external
feedback. A firm’s ability to generate innovations successfully
depends on two factors: how well it can refine and coordinate
its routines (we call this organizational competence) and the
extent to which those routines are well suited to the current
technological environment (we label this environmental fit). A
firm with relevant ideas (high environmental fit) may nonetheless
have difficulty generating significant technical advances if it
is hampered by ineffective coordination or excessive bureaucracy
(low competence). Conversely, a firm with a high level of internal
efficiency may nevertheless encounter difficulty if it fails to
produce what its customers demand.
Aging and innovative competence
A number of scholars have argued that aging leads to decreases
in a company’s efficiency and hence to a decline in organizational
competence. The fear is that as firms grow older and larger, decision
making becomes increasingly bureaucratic, decisions are shaped
by political coalitions, and debates are framed by outmoded, incorrect
assumptions about customer desires, competitor behavior, and industry
structure. Such factors are used to explain why so many established
companies have difficulty adapting to major changes. For example,
many experts point to these factors to account for the slow adoption
of Internet-based business strategies by established companies.
However, there also are strong reasons why a firm’s competence
might improve with age. We believe that gains from experience
with the innovation process will outweigh any negative consequences
of bureaucratization. Regardless of the quality and significance
of their output, we argue that organizations become more adept
at producing innovations as they age. Research has shown that
the accumulation of knowledge in a domain enhances a firm’s ability
to recognize and assimilate new advances and to convert this knowledge
into further innovations. Thus, if the accumulation of knowledge
is driven by research experience in a particular area, organizational
competence will increase with age. We expect that organizational
age will be positively associated with the rate of innovation;
in particular, we believe that the patenting rates of firms will
increase with age.
Aging and environmental fit
How does aging affect the fit between an organization’s internal
competence and the current demands of its environment? If organizational
age gauges not just the length of a firm’s operational experience
but also the duration of its exposure to technological change,
then the effect of aging on organization-environment fit depends
on the capacity of an organization to adjust its internal routines
at the pace of environmental (in this case, technological) change.
Unfortunately, many firms have not been very successful in this
regard. We argue that aging will be associated with a decline
in organization-environment fit, particularly in industries where
frequent developments in technology can require radically different
knowledge and skills than those needed to succeed in the recent
past.
Several studies support this claim. A substantial body of evidence
suggests that the principles and practices implemented when an
organization is young are likely to persist over its lifetime.
This idea, known as path dependence, has been observed in decisions
ranging from target markets to human resource practices. Path
dependence in research and development activities of high-technology
firms implies that organizations tend to search for new ideas
and practices locally, meaning they look for improvements to techniques
and products similar to their current ones. Most importantly,
individual decision makers in the firm use their past experiences
as a basis for evaluating alternative courses of action.
Also, the hiring patterns and technical skills of the organization
stabilize as formal structures and routines become institutionalized.
In order to preserve their privileged positions, dominant political
coalitions inside the organization often ensure that it continues
to focus on activities and market niches that require their expertise.
Incumbent personnel also have career interests at stake if they
have developed expertise specific to an organization’s previous
focus, particularly if that expertise is of little value to other
organizations. Similarly, the need to service existing customers
often hampers an organization’s ability to perceive and pursue
emerging market opportunities.
Adding to these conservative tendencies, firms also are less likely
to change their basic routines as they age because their performance
in a specific area improves as they gain more experience. The
better a company executes its strategy, the more appealing it
is to stick with the proven returns of an existing course of action,
and the less appealing it is to choose the unproven route.
Finally, as organizations age they may fall victim to technological
lockout.When firms lack detailed knowledge of a rapidly evolving
technological area, they are poorly equipped to assimilate and
exploit new information and opportunities in that domain. Even
if such opportunities are recognized, insufficient background
knowledge impedes the firm’s ability to capitalize on new developments.
It is very difficult for a newcomer to play catch-up in an established
area of technology. This means that new areas of technol-ogy are
often dominated by the firms that enter those areas when or shortly
after they are pioneered.
It is important to note that inertial tendencies and path dependencies
can be observed even in some of the most admired high-technology
companies. One example is Intel and their production of DRAM (dynamic
random access memory) chips. Even though the company had lost
all but a minuscule share of the market by the early 1980s, executives
were reluctant to walk away from large investments in fabrication
facilities, a self-perception of the com-pany as a memory company,
and a desire not to abandon some of its existing customers. The
company also had to contend with the resistance of a number of
executives and technologists who worked in memories. All these
path dependencies prevented the company from implementing the
exit decision for several years after it should have been made.
Several hypotheses can be drawn on how age affects the quality
and nature of firms’ innovations. First, we anticipate that older
firms are more likely to exploit their established innovative
domains rather than move into new fields. Second, because of inertial
forces, older firms are likely to build on their previous innovations.
They also are less likely to incorporate the technological advances
of other firms into their activity, effectively ceding the development
of newer and potentially more influential areas of technology
to upstart organizations. The cumulative effects of these three
outcomes lead to a final consequence: In the broader industrial
community, the innovations of older firms will be less influential
on subsequent technology development than those of their younger
counterparts.
Analysis supports predictions
We tested our ideas using large samples of firms from two different
high technology areas: semiconductors and biotechnology. There
are many differences in the underlying technologies in these two
businesses, in the types of firms that populate them, in their
market dynamics, and in the maturity levels of the technology.
Rather than focus on a single industry, we collected data on these
two diverse contexts on the premise that consistent findings across
the two domains will provide strong support for the theory.
To measure innovative activities, we gathered data on all U.S.
biotechnology and semiconductor patents assigned to the firms
in each of our industry samples as well as all patents that were
cited by or subsequently cited those patents. To determine if
older organizations produce more innovations, we modeled the rate
of patenting as a function of firm age and other organizational
characteristics, including firm size. Consistent with our predictions,
the results of our statistical analyses show that older firms
innovate at a higher rate. This supports the claim that as firms
age, they gradually refine the organizational routines and competencies
that underlie the production of innovations. In the semiconductor
industry, a one-year increase in firm age leads to a 3 percent
increase in the patent rate; in biotechnology, the corresponding
increase is 2 percent.
Our remaining analyses show that the fit between an organization’s
innovations and environmental demands appears to decline as firms
age; thus, our second prediction holds that age increases the
likelihood that firms will innovate in familiar technological
areas. For this analysis, we determined if the new patents issued
to a firm are in the same technical areas as its previous patents.
The results show that as semiconductor firms age, they are more
likely to build upon prior areas of activity than to branch into
new technological domains. The pattern is most striking in the
biotechnology sample–as the age of biotechnology firms increases,
their propensity to generate patents based on their own prior
innovations increases dramatically.
We further hypothesized that because of increasing obsolescence
due to aging, firms would not capitalize on the most current technological
developments. The extent to which firms have incorporated recent
technological developments into their innovations can be measured
by looking at the vintages of the technologies they have employed.
In both the semiconductor and biotechnology industries, older
firms proved more likely to be working in older market niches.
This further reinforces the claim that as firms grow older, their
innovation-related activities run the risk of becoming increasingly
dated.
Finally, we argued that older firms are likely to produce innovations
that have a lesser impact on their technological communities than
those of young firms. This would manifest itself in a lower likelihood
that the innovations produced by older firms will be adopted by
the other enterprises working in the same area as those organizations.
Our empirical analysis offered only partial support for this prediction:
It held true for semiconductor firms but was not supported in
the biotechnology sample.
Our study produced strong evidence that the competence to produce
new innovations–or at least patents–appears to improve with age.
However, these gains in organizational competence come at a price:
an increasing divergence between organizational competence and
current environmental demands. The data analysis provided compelling
support for our argument that age negatively affects the fit between
organizational competence and environmental demands. Considered
together, the evidence suggests the existence of an obsolescence
process in which the innovative activity of firms lags increasingly
behind the current state-of-the-art as they age.
Uncovering basic truths
The idea that organizations improve their routines just as they
lose touch with environmental demands may seem paradoxical. Yet,
this idea reflects some basic truths about the ways in which organizations
learn, from their own experience and from the world around them.
Firms are concerned with improving the efficiency of their internal
processes, yet gains in efficiency are achieved by making simplifying
assumptions about how the world works. Typically, such assumptions
are formulated early in a firm’s lifetime and reflect the prevailing
conditions at the time of the firm’s founding.
As the technological environment changes, a firm must update its
understandings and develop more appropriate routines. Yet there
are many reasons for organizations to be biased toward incremental
improvements in existing routines, rather than abrupt, radical
changes in organizational processes. A growing number of empirical
studies have shown that introducing significant changes in organizational
routines is risky, as change upsets existing balances of power
and patterns of interaction between the units of the firm and
can degrade performance. Without compelling evidence of the inferiority
of existing routines, firms are unlikely to substantially modify
seemingly successful procedures. Rather, changes in the blueprints
for behavior will tend to be incremental.
Our results, therefore, point to one reason why periods of rapid
technological change are often associated with the emergence of
new organizations and the failure of many established firms. In
these times, the increasing gap between older organizations’ innovative
capabilities and the technological frontier creates opportunities
for new firms whose internal routines are better aligned with
the current state of technology. In fact, we believe that the
inability of established firms to adopt and incorporate major
technological changes is one of the most important factors giving
rise to bursts of high-technology entrepreneurship.
The inertial forces operating on existing firms is one of the
reasons why start-ups–which, relatively speaking, lack operating
experience, capital, reputations, brand names, customers, and
economies of scale–are nevertheless able to create new market
niches and compete against older and larger firms. We are quick
to point out, however, that the demise of older firms in the face
of competition from young start-ups is far from guaranteed, in
large part because older firms often occupy stronger competitive
positions and benefit from many competitive advantages compared
to new entrants.
Details of this research can be found in Jesper B. Sørensen and
Toby E. Stuart’s paper, “Aging, Obsolescence, and Organizational
Innovation,” which can be downloaded from Stuart’s Web site at
www.gsb.uchicago. edu/fac/toby.stuart/research/.
