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INTRODUCTION

Venture capitalists are conspicuously successful at predicting new venture success and numerous studies have investigated their decision making (Sandberg & Hofer, 1987; Hall & Hofer, 1993). The majority of research on venture capitalists’ decision making has produced empirically derived lists of venture capitalists’ “espoused” criteria which are the criteria venture capitalists report they use when evaluating new venture proposals (see, for example, Gorman & Sahlman, 1986).

Social judgment theorists suggest that “espoused” decision processes may be a less than accurate reflection of “in use” decision processes (Zacharakis & Meyer, forthcoming). For example, studies have found that ”espoused” processes typically employ a larger number of criteria than actually used. It has also been shown that decision makers overstate the least important and understate the more important criteria when compared to the models derived from statistical analyses (Riquelme & Rickards, 1992). Prior research on venture capitalists’ decision making is therefore possibly biased.

As a result of insufficient theoretical discussion and methodological limitations in previous research, Sandberg and Hofer (1987) believes there to be no thorough integrated explanation of new venture performance. Hall and Hofer (1993) propose that much remains to be understood about venture capitalists’ decision making. This study aims to increase understanding of venture capitalists through the use of new venture strategy literature as a theoretical basis for the investigation of venture capitalists’ decision making in assessments of likely new venture profitability.

LITERATURE REVIEW: NEW VENTURE STRATEGY

The new venture strategy literature proposes timing of entry and a number of other entry strategy variables affect performance. These entry strategy variables include key success factor stability, educational capability, pioneer’s lead time, competitive rivalry, scope of entry, mechanisms of entry and industry related competence, and for the most part, have been investigated individually. Hofer (1975) proposes that strategy research must investigate contingency relationships. DeCastro and Chrisman (1995) believe this also to be the case with entry strategy research.

The majority of new venture strategy research relates to timing of entry into a market or industry (Lieberman & Montgomery, 1988; Mitchell, 1991). In general, it appears that early entrants have higher returns if they are successful (Schumpeter, 1975; MacMillan, Siegal & SubbaNarisimha, 1985; DeCastro & Chrisman, 1995), but bear a higher risk of failure. However, the relationship between timing and performance appears more complex than the above statement depicts. It is proposed that the following new venture entry strategy theory will provide explanatory and predictive ability for venture capitalists’ assessment of new venture proposals in terms of likely profitability.

Stability of Key Success Factors

Requirements for success in a market may change radically with market evolution (Abell, 1978). Superior performance arises from a fit between the competencies of a venture and key success requirements (Andrews, 1987). Pioneers commit to a number of key factors they believe will lead to success within the competitive environment (Slater, 1993). If the competitive environment changes, so too may the key success factors rendering the venture at a competitive disadvantage (Abell, 1978; Aaker & Day, 1986). Later followers are better able to recognize the attractiveness of a market, key success factors necessary for entry, and are able to minimize the costs of entry through cutting R&D corners and/or leapfrogging the pioneering technology (Yip, 1982). However, if key success factors within an industry remain stable, it is proposed that pioneers' early commitment to a new technology is likely to provide superior new venture performance.

Hypothesis 1a: Key success factor stability moderates the relationship between timing and venture capitalists' assessment of profitability.

Hypothesis 1b: For high levels of key success factor stability, venture capitalists' assessment of profitability decreases with later timing, whereas for low levels of key success factor stability venture capitalists' assessment of profitability increases with later timing.

Educational Capability

There is often considerable uncertainty about the rate at which customers will substitute new for old technology (Porter, 1980). Pioneers' potential customers often lack a frame of reference for understanding a new product concept (Slater, 1993) and the benefits of a venture's offerings. A frame of reference needs to be constructed in order to encourage substitution into the industry. Customers then need to be persuaded that the benefits of purchase are greater than the risks (Slater, 1993; Rogers, 1983). Customers' frame of reference can be difficult and costly to construct, in terms of time as well as financial and human resources. If a venture already possesses these resources, it has educational capability that can be directed towards performing original market research and necessary market development (Stinchcombe, 1965). Educational capability refers to skills, knowledge and resources that venturers may effectively apply to both market research and market development. Venturers with high educational capability can hasten customer substitution into the industry (Slater, 1993; Rogers, 1983), thereby increasing industry and firm profitability (Porter, 1980).

Hypothesis 2a: Educational capability moderates the relationship between timing and venture capitalists' assessment of profitability.

Hypothesis 2b: For ventures with high educational capability, venture capitalists' assessment of profitability decreases with later entry; for ventures with low educational capability, venture capitalists' assessment of profitability increases with later entry. However, venture capitalists' assessment of profitability is significantly higher for ventures with high educational capability than ventures with low educational capability.

Lead time

Barriers to entry initially provide pioneers a period of monopoly, that is, a lead time, and thereafter minimize competitive rivalry within the industry. Together, lead time and competitive rivalry provide greater understanding of new venture performance by identifying how an advantage is obtained and the means by which it slowly reduces over time. Lead time is the period between the pioneer's entry into the market and the appearance of the first follower. A longer lead time may increase pioneering advantages through helping the pioneer establish an even stronger brand name (Schmalensee, 1982) and moving customers' ideal points closer to the pioneer's attribute mix (Carpenter & Nakamoto, 1989). Increasing lead time helps pioneers further broaden their product line (Robinson & Fornell, 1985), provide superior profits and prepare for new battle grounds (Porter, 1980). Along with higher market share as a result of longer lead times (Spital, 1983) and an opportunity to charge premium prices, the pioneer may also achieve cost advantages through experience effects (Abell & Hammond, 1979). These cost advantages put later entrants at a competitive disadvantage. Pioneers may be able to erect barriers that lock out followers (Porter, 1980), further lengthening lead time. Therefore the market momentum supported by lead time helps pioneers maintain their advantage. If lead time is short however, little time is available to develop pioneering advantages, decreasing the advantages of early entry.

Hypothesis 3a: Lead time moderates the relationship between timing and venture capitalists' assessment of profitability.

Hypothesis 3b: Venture capitalists' assessment of profitability decreases with later entry at different rates for different lead times. For pioneers, venture capitalists' assessment of profitability is higher for a long lead time. For late entrants, venture capitalists' assessment of profitability is higher for a short lead time.

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