CUSTOMER NETWORKS, ENTREPRENEUR STRATEGY, AND FIRM GROWTH: INSIGHTS FROM THE SOFTWARE INDUSTRY

Satish Nambisan, Rensselaer Polytechnic Institute

CHAPTER MENU
 
ABSTRACT
INTRODUCTION
CUSTOMER ROLES IN NEW PRODUCT DEVELOPMENT
ONLINE CUSTOMER NETWORKS AND ENTREPRENEURIAL FIRMS
MANAGERIAL AND RESEARCH IMPLICATIONS
CONTACT
REFERENCES
TABLE 1

TABLE 2
FIGURE 1

ABSTRACT

It is well established that customers can make valuable contributions to product innovation and development, especially in the high technology sector. However, there has been limited focus in the entrepreneurship literature on how new firms can deploy their customers as partners in product development. New technologies (e.g. the Internet) now allow broad communities of interest (e.g. customers) to coalesce around specific products and services. This paper explores online customer networks or communities and their role in high technology new ventures. Specifically, we examine how new firms in the Internet software industry have leveraged online customer networks for product development and support.

INTRODUCTION

Entrepreneurial firms in high technology sectors have to compete and find success in increasingly difficult and challenging environments. The underlying knowledge base of most technology markets has become more diverse and dynamic. At the same time, rapidly shrinking product life cycles and dynamic markets indicate the need for continued product innovation. A critical success factor for young technology firms is the ability to exploit external resources for product development and support. Prior studies have established the importance of technology alliances and cooperative inter-firm networks in enabling young firms secure vital external resources for the development of new products (c.f. Stearns, 1996). Another valuable external resource is the customer; although it is well established that customers can be a critical source of innovation (von Hippel, 1988; Leonard-Barton, 1995), for a variety of reasons, entrepreneurial firms have made limited use of this resource. First, unlike older and established firms, new firms may have limited knowledge about their customers. Second, new firms often can ill-afford the expensive mechanisms that may be needed to establish relationships with their customer communities. Third, in their initial years, most firms are focused more on viewing customers as passive recipients or beneficiaries of new products rather than as co-creators or partners in product development.

The emergence of new information and communications technologies has initiated a radical transformation of customer-producer relationships in many industries. New technologies (e.g. the Internet) allow broad communities of interest (e.g. customers or users) to coalesce around specific products and services. Such online customer communities or networks enable new models of product development where firms co-create products with customers and involve them as partners in innovation (Sawhney & Prandelli, 1999; Kambil et al., 1999). While leading firms in many sectors have started deploying online customer networks to enhance their product development and support capabilities, such customer communities present unique opportunities and management challenges to entrepreneurial firms too. New technologies enable entrepreneurial firms to overcome traditional hurdles (e.g. high cost, poor geographical reach) in building and leveraging customer networks for product development and support. The software industry provides considerable evidence regarding the crucial role customer networks can play in fueling the initial growth of entrepreneurial firms. For example, in its initial years, Netscape used its online user community extensively to garner ideas for new product features as well as to test new products and thereby accelerated the introduction of new versions of its flagship browser product (Cusumano and Yoffie, 1998). Although the promise of online customer networks in entrepreneurial contexts is highly evident, there has limited theoretical focus on their potential impact and on the proactive strategies that new firms may need to adopt to facilitate them.

The present study explores the phenomenon of online customer networks or communities and their role in high technology start-up firms. Specifically, it addresses three research questions: (a) what are the characteristics of customer networks in entrepreneurial high technology contexts? (c) what is the impact of customer networks on new firms’ growth and product innovation? (b) what are the initial strategies that an entrepreneurial firm should adopt to leverage customer networks? We examine the above questions within the context of the software industry. The study is conducted in two phases. In the first phase, we conduct case studies of two entrepreneurial firms that have successfully deployed online customer networks for product development and support. Next, based on the extant literature and on the insights derived from the case studies, we devise a research model that relates the deployment of online customer networks to initial firm growth and product innovativeness. The second phase of the study involves a cross-sectional survey of software firms to provide a preliminary empirical validation of the model.

CUSTOMER ROLES IN NEW PRODUCT DEVELOPMENT

In the strategic management and quality management literatures, studies have identified five roles for customers in value creation: as resource, as co-producer, as buyer, as user, and as product (Kaulio, 1998; Lengnick-Hall, 1996). The first two customer roles are at the input or upstream side of organizational activity, while the other three roles cluster at the downstream or output side of the system. The above framework is used here to examine customer involvement in new product development (NPD). Specifically, we focus on three roles: customer as resource, customer as co-creator, and customer as user.

The first role, customer as resource, relates to the customer as a source of innovation. Customers’ role in idea generation or product conceptualization has been well explored in marketing and NPD literatures (c.f. Leonard-Barton, 1995; Winsted, 1990). Customers have traditionally played a passive role in product conceptualization, with firms eliciting new product ideas from customers through a wide range of mechanisms including market surveys and focus groups. In certain industries (especially technology industries), lead users have assumed a more active role as they, in the process of finding “solutions” to specific internal problems, generate new product ideas for vendors (von Hippel, 1988). It is now relatively well established that customers are an excellent source of continuous (or incremental) product innovation rather than of discontinuous (or radical) innovation (Christensen, 1997; Leonard-Barton, 1995). For entrepreneurial firms in particular, customers represent a highly relevant and valuable resource since much of the product innovation in the initial years of a new firm tends to be incremental.

Customers also play a valuable role as co-creator of new products in which their participation ranges from product design activities to product development activities. The role of customer as co-creator is perhaps more evident in industrial products than consumer products (Garvin, 1988), although in certain technology industries, even non-business customers have played the role of co-creator (e.g. electronics, automobile) (Kambil et al., 1999). For example, automobile giant Fiat recently invited its customer community to participate in the selection of new design concepts for its Punto model. Schneider and Bowen (1995) identify several possible incentives for customer co-creation including increased self-esteem because of increased control, more discretion and opportunities to make choices, and greater customization. Entrepreneurial firms can gain valuable benefits by deploying customers as co-creators especially in product design. For example, i2 Technologies, a supply-chain management software firm, in its early years included several of its business customers as members of the product development team with their involvement ranging from deciding the product architecture to providing domain expertise for product integration.

As users, customers can create two valuable outcomes for entrepreneurial firms. The first relates to their role in product testing (c.f. Dolan and Mathews, 1993). New firms can derive significant benefits from employing customers in product testing. For example, the initial success of Netscape was largely due to the effective exploitation of its user community for beta product testing (Cusumano and Yoffie, 1998). The second contribution of customers in the role of a product user relates to end-user product support. Customers are uniquely qualified to provide support to other product users as they acquire valuable product expertise from continued usage. Expert users possess product troubleshooting skills that are often superior to that of the firm’s own product support specialists (Kay, 1999). However, few new firms have exploited their customers in such a capacity due to the lack of cost-effective communication forums to support customer interactions.

For entrepreneurial firms, deploying customers in the above roles in product development and support may deliver several important benefits. First, customer involvement in product development can lead to significant reduction in the time taken for developing new versions of a product. For new firms, especially those in high technology industries, the ability to rapidly introduce new versions of a product is a critical determinant of the initial growth and success (Cusumano and Yoffie, 1998; Zahra and Bogner, 1999). Further, customer involvement may also lead to stronger customer-product ties and higher market visibility—critical success factors for new firms in the initial years.

ONLINE CUSTOMER NETWORKS AND ENTREPRENEURIAL FIRMS

Organizations ranging from Shell Oil and Anheuser-Busch to Cisco, Hallmark, and Microsoft have started deploying online communities (of customer, suppliers, and organization members) to facilitate knowledge sharing and collaboration within and across organizational boundaries (McWilliam, 2000; Prahalad and Ramaswamy, 2000; Kambil et al., 1999; Wenger and Snyder, 2000). Here, our focus is on understanding how entrepreneurial firms can deploy online customer networks to facilitate different types of customer-NPD roles described earlier. Given that new ventures in the software industry have taken the lead in this regard, we first examine the experiences of two software firms.

Phase I: Case Study

We chose for our study two Internet software firms. The first firm, InSoft, is a developer of a PC-based multimedia tool that is offered as a stand-alone product to both business and non-business users. The second firm, BusSoft, offers small businesses an Internet-based customer relationship management (CRM) software product. Both firms have been in existence for less than three years, and both established their online customer community during their initial year of operation. Interviews were conducted with the senior managers of the two firms. The interviewees, who included the CEO, the CTO, and the product managers of the two firms, were asked about the objectives behind establishing online customer networks, the nature of customer-NPD roles enabled by their online forums, the organizational strategies adopted to facilitate them, and the benefits realized. A total of nine unstructured interviews were conducted (five in the first firm and four in the second firm) with each interview lasting approximately an hour or so. While we collected a diverse set of data from the interviews (Table 1 provides a snapshot of the data), here, we limit the discussion to three key issues: building online customer networks, organizational support strategies, and potential impact on firms.

While both Insoft and BusSoft adopted an incremental approach to building their online customer networks, they differed in the timing and the techniques employed. InSoft created a Web-based forum for its potential customers even before its first product was launched. As its CTO noted, InSoft’s primary objective from the outset was to use the online customer community as a source of incremental innovation. Since the firm had poor initial market visibility, it adopted a program to give gradual exposure to the online customer forum by allowing potential customers to download test versions of the product from there (although the final product was sold primarily through stores). BusSoft, on the other hand, viewed its online customer network primarily as an end-user product support forum. It encouraged its customers to register their product through the customer community web site. The firm channeled all customer queries to the online forum and created a growing searchable knowledge base. The knowledge base incorporated product usage tips from the internal product development team, FAQs, and information about upcoming versions. Although initially, the online customer network set up by BusSoft was open to anyone on the Internet, it later created a “gated community” to which only registered customers were allowed entry. This was done to encourage more focused discussion groups for its valued business customers. The design of online customer networks should be guided by several factors including the dominant customer-NPD role, product characteristics (e.g. knowledge intensity, usage pattern), and customer characteristics (e.g. customer technical skill). For example, the primary focus of InSoft was on supporting customer-firm interactions (through email, voting tools, etc.), whereas that of BusSoft was on supporting customer-customer interactions (through groupware, discussion boards, etc.).

The second issue relates to the measures that must be adopted to facilitate online customer networks. Both firms realized much early on that achieving customer participation in the online community was a significant challenge. Apart from ensuring that the technologies deployed were easy to use, the two firms also adopted several strategies to facilitate their operation. For example, given its key objective of utilizing customers as a source of incremental innovation, InSoft created a new organizational role to tie its internal NPD team to the online customer network. The new manager was primarily responsible for categorizing and channeling all customer ideas and suggestions for the upcoming versions to the internal product team and posting the response of the internal team to the customer community web site. The firm believed that a response from the NPD team on each customer suggestion would increase the transparency of the process (to the customer) and encourage them to contribute more aggressively. Similarly, BusSoft wanted to encourage its customer to provide product support to peer users. To this end, it created a customer recognition program where expert customers are awarded a status based on their quality of contribution (similar to Microsoft’s MVP program). Given that most of its customers are small businesses, BusSoft also gives other incentives including product discounts and special implementation services. Table 1 lists some of the other strategies adopted by the two firms

The third issue relates to the potential outcomes of online customer networks. The most important impact, perhaps, is on a new firm’s product innovativeness. It can not only enhance the quality of incremental innovation, but also accelerate the process. As Insoft’s NPD manager noted, “the online customer community played a key role in accelerating the development of the second and third versions of our product.” During the development of the third product version (approximately one and half years after the launch of the product), InSoft involved its community members extensively in defining and prioritizing new product features. The CEO of InSoft noted that, while the key objective of getting customers to contribute to the development of new versions was gradually getting realized, another positive outcome was the high visibility the young firm gained among potential customers. Such firm visibility is invaluable for new firms in most high technology markets. BusSoft managers also expressed similar outcomes. While their initial focus had been on involving customers in end-user support, the firm soon realized that an indirect benefit was the generation of ideas for new versions. They also discovered that their network had gradually become a forum for their customers to discuss general issues related to small businesses and this gave the young firm several innovative ideas for new related products. Managers of both firms also noted that since their customer networks have grown more or less along with them, the two entities (the firm and the customer network) have influenced each other in several beneficial ways.

Our interviews with the managers of the two firms raised several other issues. One issue relates to the potential legal implications of accepting ideas and other types of resources from customers. Traditionally, business organizations (especially US-based) have been reluctant to involve customers in product development due to the potential problem related to intellectual property rights (Winsted, 1990). Another issue relates to project uncertainty. Incorporation of online customer communities in product development projects may enhance the level of project uncertainty and call for the deployment of new organizational mechanisms to monitor and control the development process. As such, the participation of customer communities in product development must be carefully governed for the benefits of customer contributions to outweigh the costs of increased uncertainty in the system. Finally, while new firms have a lot to gain from online customer communities in their initial years, investments in this area should be made after taking into consideration the specific customer-NPD roles most appropriate for the firm.

Phase II: Research Model & Validation

Next, we describe a research model that relates the deployment of online customer networks to initial firm growth and product innovativeness (Figure 1). Following that, we present the results of a survey-based study recently conducted to provide a preliminary validation of the model. The context for the study is the Internet software industry.

Impact of Online Customer Networks

In the software industry (as well as in most other high technology industries), the primary challenge for new firms is to keep their products alive through the rapid development of new versions. As newer technologies and standards emerge, firms have to constantly update their products. Indeed, the higher the intensity (or, frequency) of product upgrades, the greater the probability of initial success (Cusumano and Yoffie, 1998; Zahra and Bogner, 1999). As prior studies have indicated, customers are a valuable source of such incremental innovation. Customer contributions can not only reduce the time taken for detecting the defects or flaws of the current version but also accelerate the identification and design of the features of new versions (Leonard-Barton, 1995; Thomas, 1995). Moreover, the greater the diversity of the customers participating in the process, the greater the benefits to the firm. Online customer network provides a rich, direct, and cost-effective communication channel for a wide range of customers to participate and contribute to the product development process (Kambil et al., 1999). Thus, by establishing online customer networks new firms can accelerate the development and introduction of new product versions. Further, by directly involving customers in product development and support, new firms can strengthen customer-product ties (or customer loyalty) in a cost-effective manner and thereby enhance the initial firm growth. Thus, the following two hypotheses.

Hypothesis H1: The deployment of online customer network by a new venture is positively related to product innovativeness.

Hypothesis H2: The deployment of online customer network by a new venture is positively related to initial firm growth.

Organizational Support Strategies

New firms can enhance the effectiveness of their online customer networks by adopting suitable organizational strategies. Here, we focus on three specific strategies. The first strategy involves creating new organizational roles to tie the online customer community to the internal NPD team. Specifically, a firm may assign one or more organization members the responsibility to channel the creative contributions of customers and to provide feedback to the customer community on the actions taken on their input. Prior studies have shown that the utilization of external resources in product development calls for the implementation of formal roles to ensure effective communication and to sustain coherent development objectives (c.f. Jassawalla and Shashittal, 1998). The second strategy relates to enhancing the customers’ ability to contribute to NPD by providing access to online product/technology knowledge base. Such online databases enable customers to complement the experiential knowledge that they have gained from continued product usage with related knowledge about the underlying technologies and markets. Further, online knowledge base may also serve as a vehicle to share product usage knowledge, gained from expert product users, with other product users (Kay, 1999). For example, Specialized Bicycle Components Inc., a popular bicycle manufacturer, provides customers access to an online searchable database that contains all customer product queries and responses provided by expert users as well as internal NPD teams. The third strategy relates to customer motivation. Customers’ disposition to participate in value creation can be enhanced through appropriate reward and recognition programs (Larsson and Bowen, 1989). Firms may give customers special status within the community based on their contribution to product development and support. For example, Microsoft has established the MVP program to recognize the contributions of its customer community to product support. Participating customers earn their status by being nominated by peers and Microsoft engineers who see their consistent and accurate technical answers posted on electronic customer forums in response to customer queries. Firms may also adopt other strategies including product discounts, admission to restricted areas of the customer community forum, and early product notices to motivate customers to participate in product development and support. We posit that the above three strategies enhance the impact of online customer networks and facilitate value creation by customers. Thus:

Hypothesis H3a: New ventures can enhance the impact of their online customer networks by creating new roles that link the online customer community with internal NPD teams.

Hypothesis H3b: New ventures can enhance the impact of their online customer networks by providing customers with access to online product/technology knowledge base.

Hypothesis H3c: New ventures can enhance the impact of their online customer networks by establishing explicit customer reward and recognition programs.

Method and Data

Data for empirically validating the above hypotheses were collected through a survey. The survey instrument was sent to 243 US-based software new ventures. The survey questionnaires were addressed to the firms’ CTO. The data collection procedure consisted of two mailings of the questionnaire and the return envelope. A total of 79 usable responses were received. Of the 79 firms who responded to the survey, 42 firms indicated that they had established online customer networks to facilitate customer participation in product development and support activities.

The research variables were operationalized as follows. The primary independent variable, the deployment of online customer network, was measured using a nine-item instrument that considered the nature of connectivity and the type of communication services offered by the network. Initial firm growth rate was operationalized as the annualized rate of increase in sales of the firm’s primary product in the first two years. Product innovativeness was operationalized as the rate of introduction of new versions of the firm’s primary product. Multi-item scales were constructed to measure the three support strategy variables. The survey instrument also collected descriptive data on the management and the characteristics of the online customer networks. The survey instrument was validated using a test sample of ten software firms, before being administered to the study sample. Statistical regression analysis was employed to test the various hypotheses. Three control variables were used in the analysis. The first control variable was the time duration for which the online customer network had been in existence. The other two control variables were product size and firm size.

Results

Preliminary analysis of the data provides support to the two primary study hypotheses H1 and H2 (see Table 2). Firms that deployed online customer networks to facilitate customer involvement in product development exhibited greater product innovativeness (i.e. introduced a greater number of product upgrades in unit time) (p < .001) and attained higher initial growth (in terms of product sales) (p < .01). Given the rapid pace of the software industry, the initial success of a new venture is highly dependent on how rapidly it adapts its product to the dynamic market. By leveraging online customer networks new firms can enhance their product innovativeness as well as initial growth. Also, in the case of both the dependent variables, hypotheses H3a (p < .01) and H3c (p < .01) were supported, while H3b was not. Creating new organizational roles to link NPD team to the online customer community was found to enhance the positive impact of the online network. Similarly, the implementation of customer recognition programs was also found to positively moderate the relationship between online customer network and the dependent variables. A possible explanation for the weak support for hypothesis H3c may relate to the specific content of the online knowledge base. The development of such knowledge base may be a gradual process since firms have to carefully identify the type of content that would be most beneficial to customers based on particular customer-NPD roles. Further, although our variable operationalization included items that reflect the type of knowledge, other dimensions that capture the richness, relevancy, and depth of the content may provide a better measure for future studies.

Limitations

We acknowledge that the current empirical study is only a starting point in the theoretical examination of online customer networks in an entrepreneurial context, and has certain limitations. First, we did not differentiate among the different customer-NPD roles that are supported by online customer networks. Better insights on the impact of online customer networks could be gained if we also consider the particular customer-NPD roles that are enabled by these networks. Second, in the survey-based study, we limited our focus to three support strategies. However, the case studies as well as prior literature indicate that firms need to deploy a portfolio of organizational mechanisms to facilitate the varied customer-NPD roles in an online environment. Third, the generalizability of the study results may be limited by the unique characteristics of the software industry. Software products are highly knowledge intensive and hence, highly suitable for implementing such Internet-based distributed innovation models. While virtual reality tools and other new technologies promise the applicability of such online forums to other industries too (Dahan and Srinivasan, 2000), further investigations are required to validate the research model in the context of other high technology industries.

MANAGERIAL AND RESEARCH IMPLICATIONS

The study has several important implications for both research and practice. First, it provides a theoretical framework to examine the benefits of online customer networks for entrepreneurial firms. Here, we adopted a new product development perspective and examined how such online networks can facilitate value creation by customers. Several interesting research questions arise in this context. What are the different ways in which new firms can utilize their online customer networks? What is the relative importance of the various customer-NPD roles in the context of new firms? What are the important features or characteristics that new firms should focus on while designing and building their online customer networks? What are the potential drawbacks of online customer networks for a new firm? Future studies may also focus on identifying and categorizing the benefits that new firms could derive from online customer networks (e.g. innovation-oriented benefits, market-oriented benefits). Finally, the deployment of online customer networks may have implications not only on product development, but also on other parts of the firm’s value chain, and hence, new venture managers need to adopt a holistic approach while building online customer environments.

CONTACT: Satish Nambisan, Lally School of Management & Technology, Rensselaer Polytechnic Institute, Troy, NY 12180; (T) 518-276-2230; (F) 518-276-8661; nambis@rpi.edu

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