ENTRY AND GROWTH STRATEGIES IN THE COMPUTER INDUSTRY 1978-1980: A STUDY OF INITIAL PUBLIC OFFERINGS
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ENTRY AND GROWTH STRATEGIES
IN THE COMPUTER INDUSTRY 1978-1980:
A STUDY OF INITIAL PUBLIC OFFERINGS
Marc J. Dollinger, University of Kentucky
Kenneth E. Marino, University of Kentucky
ABSTRACT
This study, focuses on twenty-three computer companies that made an initial offering of securities
during the 1978-1980 time period. Based, on a content analysis of the prospectuses and 10-K
reports these firms filed with the SEC, their entry strategies and subsequent financial performance
have been examined. Only short term market development appears related to subsequent financial
performance. The use of other entry strategies does not explain performance variance. A variety
of research directions are suggested.
INTRODUCTION
Over the period 1978-1980, thirty-three firms in the computer industry (office equipment,
accounting and computer machines, SIC code #357) offered equities to the public for the first time.
Ten of these firms were in the development stage and had not yet produced a product for sale. These
firms are not included in this study. The dollar value of the securities offered [known as initial
public offerings (IPOs)] by the twenty-three operating firms was in excess of a quarter of a billion
dollars. These young companies, in the hands of the founding entrepreneurs had found a receptive
market for their securities. The proceeds from these IPOs go for expansion capital, working capital,
research and development, marketing and to reward the entrepreneur and other venture capital
investors for successfully bringing the firm to this stage.
The IPO can occur early in the entrepreneurial life cycle. A management team with recognized
expertise in an area can found their firm with the proceeds of the IPO. The IPO can also signal the
end of the entrepreneurial life cycle. The founder may be selling his interests, along with those of
other early investors, to reap the economic rewards of their risks and efforts. More usually, the
proceeds go to finance an expansion into a line of business or businesses. With the stakes of the
game now raised, the firm's strategy and the rigor of its planning effort take on a new importance.
The strategy is detailed in the firm's prospectus. The prospectus is a summarized account of the
longer registration statement required by the Securities and Exchange Commission for all IPOs. As
described in the prospectus, the IPO represents the confluence of entrepreneurial strategy. For it is
at the IPO that all of the elements of the business plan must come together. The nature of the
business, the dimensions of competition, the firm's entry wedges, as well as the firm's functional
strategies are included in the prospectus for the initial public offering.
The focus of this paper is to examine the efficacy of various entry wedges and grand strategies on
firm performance from data culled from IPO prospectuses.
The paper seeks to explore, clarify and refine the relationship between the entry wedges used by new
ventures and the grand strategies chosen. The entry wedge describes how the firm intends to gainits initial strategic advantage. Examples include customer sponsorship, new product development
or a license agreement. The grand strategy describes how the firm's long-range business objectives
will be achieved. Examples include a focus or concentration strategy, product and market
development strategies.
Entry Wedges and Initial Competitive Strategy
The basic underlying assumption of this research is that strategy counts and that the performance
of the firm is an outcome of the strategic choices that an entrepreneur or entrepreneurial team makes.
The vast preponderance of thinking and research on the subject of strategy has adopted this
approach.
Vesper [6] has approached strategic choice from the perspective of new ventures. He describes a
typology of entry wedges which represent the different ways in which a new venture gains a
strategic competitive advantage. Table 1, below, lists and describes Vesper's typology.
TABLE 1
ENTRY WEDGES
Wedge Description
1. New Product Invention of commercialization of
previously unavailable product,
service or product type.
2. Parallel Entry into already established
Competition industry or market based on a minor
variation of what is offered
and/or how it is provided.
3. Franchise Entry This employs a proven product or
service without variation but in a
new geographical area under license.
4. Partial Exploiting the momentum of
Momentum established enterprises by,
e.g., filling a supply shortage or
tapping under-utilized resources.
5. Customer Entering at the behest of the
Sponsorship customer, e.g., with contract in hand
or as a second source.
6. Parent Company Creation of a new firm assisted by a
Sponsorship larger firm with existing resources,
e.g., joint venture, license agreement
or spin-off.
7. Government Creation of a new firm at the behestSponsorship of the government or to meet the
government market, e.g., due to a
favored purchasing agreement or a
rule change (set aside).
Although each of these entry wedges may produce financial success, there is no empirical evidence
to indicate whether any of the entry wedges is strategically more potent, either across industries or
within specific industries. There have been no studies indicating the frequency of use of these
wedges in either pooled or separate samples. From the theoretical perspective, the most efficacious
entry wedges, are those that provide the firm with the most defensible competitive position [5]. The
elements of competitive position and the intensity of competition are:
- the power of buyers
- the power of suppliers
- the threat of substitutes
- the threat of entrants
- the intensity of rivalry among existing firms
Each of these elements serves to squeeze profits out of an industry until, in the most intensive
competitive scenario, only normal economic profits are possible (perfect competition). Since each
of these entry wedges provides different types and intensities of defense against profit squeezes, the
choice of entry wedges will be related to the firm's financial performance.
After a firm has entered an industry as a serious competitor (as evidenced by the ability to go public,
i.e., the success of the initial public offering), the firm must develop and implement its initial grand
strategy. This grand strategy describes how the firm's entry wedge has provided a defensible
position; the grand strategy defines the configuration of the business to be defended. These grand
strategies have been summarized from the works of many authors by Pearce and Robinson [4] and
appear in Table 2.
TABLE 2
Strategy Description
1. Concentration Increasing use of present
products/services in present markets
(and increasing profitability there).
2. Market Selling present products in new
Development markets.
3. Product Developing new products for present
Development markets.
4 Innovation Ongoing commitment to develop new
products.
5. Horizontal Growth through the acquisition of
Integration firms at the same stage of production.6. Vertical Acquisition of firms who precede
Integration (supply) or succeed (purchase) the
firm in the production sequence.
7. Franchise Growth of firm through the sale of
proprietary products to others for
development and resale.
Additional grand strategies such as concentric and conglomerate diversification, as well as defensive
strategies such as retrenchment and divestiture have not been considered because of their
unlikeliness at an IPO.
As with entry wedges, there is no empirical evidence to indicate the frequency with which a grand
strategy is chosen or whether any grand strategy is more potent than any other. A contingency
theory approach has been offered in which either the environmental conditions or the stage of the
industry life cycle provide clues as to which grand strategy or strategy cluster (the choice of
combinations of strategies) should be chosen, [2]. The indications suggest that strategy evaluation
needs to be considered 'within' industries. In order to determine if a grand strategy is superior to any
other, environmental conditions and industrial (or product) life cycle conditions need to be the same
for all firms.
The firm's choice of grand strategy or strategy cluster affect the firm's potential profitability by
influencing:
- the height of the mobility barriers protecting the firm's strategic position
- bargaining power of the firm suppliers and customers
- the vulnerability of the firm to substitutes
- the exposure of the firm to competitive rivalry
The research will address the following issues: What is the frequency of use of different entry
wedges and strategies? What are the characteristics of these choices, and what is the relationship
among these choices and firm performance?
METHOD
Data Sources
The basic document for the study of IPOs is the prospectus. Documentary sources have been
underutilized for entrepreneurial studies and strategic management research. Yet, reliable
documents do exist which enable the researcher to perform large sample, longitudinal studies so
often called for. Glueck and Willis [1] discussed the use of documentary sources for business
research. They focus on the 10-K report but their analysis applies to the prospectus as well. They
note potential problems such as biased and irregular report preparation, a biased document selection
process, the incomparability of documents without identical categories and the possibility of
intentional distortion. However, historians have long used documentary evidence and many of the
problems described above are mitigated by the use of the prospectus and 10-K report. All categories
are identical for all firms, and all documents are subject to "the most comprehensive S.E.C. review
procedure to insure full disclosure and accuracy." (Personal conversation, Mr. Myberger, EconomicResearch and Statistics, Bureau Chief, SEC, 11/l/83).
The information available on each document includes a complete description of the firm's business
plan, its financial resources, its management team and the risk factors facing the firm. The
prospectus is a deliberately conservative view of the company and its plan. Table 3 summarizes this
information.
TABLE 3
INFORMATION AVAILABLE IN THE PROSPECTUS OF AN IPO
Type of
Information Explanation
1. Financial Information Complete description of the firm's
capitalization before and after offering.
2. Description of the Firm Firm's mission and basic product/market/
technology configuration.
3. Risk Factors Fully disclosed assessment of all
potential threats and uncertainties facing
the firm.
4. Dilution Effect of offering on stock value.
5. Use of Proceeds Detailed description of what the money
will be used for.
6. Business plan Detailed description of firm's entry
wedge, grand strategy and competitive
tactics. Also evaluates the competition.
7. Management Backgrounds and compensation of all
key personnel.
8. Auditors Report The C.P.A. firm's assessment of
accounting procedures.
9. Underwriting Details of the underwriting agreement.
10. Legal Proceedings Description of any lawsuits the firm has
pending.
11. Financial Audited financial statements.
This information is free from researcher and executive bias, it is unobtrusively available and, due
to S.E.C. scrutiny, is accurate. The content outline and content instrument for both the prospectus
and 10-K reports are available from the authors upon request. The development of these instruments
is detailed in "Research and Methodological Issues in the Study of IPOs" [3].The Companies
The companies chosen for inclusion in this exploratory research are from the Office Equipment,
Accounting and Computing Machines S.I.C. code (#357). These firms represent all companies that
went public over the period 1978-1980. Thirty-three firms were identified from Securities and
Exchange Commission computer tapes as meeting the criteria set forth above. Ten firms in the
development stage were deleted because they had yet to sell a product commercially. The reason
for choosing SIC 357 for the research is that it contained the most firms for the period in question.
The period 1978-1980 was chosen because it represents the beginnings of the boom in IPOs due to
the change in capital gains tax laws (1978 and 1980) and the "bull" market of 1980.
RESULTS
The results of the study are presented in three parts. These three sections detail the descriptive
information concerning a) the condition of the firm at the time of the IPO, b) the subsequent
performance of the firms, and c) the wedges and strategies used by the firm at the time of the public
offering.
IPO Conditions
Table 4 presents summary statistics for the twenty-three firms at the time of the initial public
offering.
The summary statistics indicate that while all the firms were relatively young (between 3 and 12
years old), the firms vary a great deal by size and profitability. For example, Denelcor went public
in 1978 with sales of 1.4 million and net loss of $18,000. Paradyne went public with annual sales
of 15.3 million and a net after tax income of 1.554 million. Both firms' basic strategies included new
product development with government sponsored research and sales. This underlines the difficulty
of developing a homogeneous set of firms for testing hypotheses concerning strategy and
performance. Even though all the firms in the study experienced the same organizational event
(going public) at about the same time (1978-1980) in the same industry classification (SIC 357), the
firms display great variation in sales and profitability.
TABLE 4
SUMMARY STATISTICS FOR FIRMS AT IPO
Range
Variable Mean S.D. Low High
Offering Information
Age of Firm (yrs) 7.35 2.9 3.0 12.0
Offering Price ($) 14.17 7.8 0.00 32.0
Shares sold by Firm (mil.) .794 1.02 .100 4.6
Shares sold by Others (mil.) .185 .2240 .000 .70
Proceeds net to firm (mil.$) 9.559 16.84 .000 82.14Table 4 Cont.
Income Statement Information
Sales ($ mil.) 18.484 24.55 1.40 117.90
Net income ($ mil.) 1.575 2.78 -2.52 11.70
Earnings Per Share .359 .678 -1.57 1.06
R&D Expense ($ mil.) 1.438 1.763 .038 7.30
S,G&A Expense ($ mil.) 3.511 4.820 .027 18.92
Balance Sheet information ($million)
Working Capital 4.864 5.22 - .157 23.3
Current Assets 9.569 11.13 .500 54.1
Prop. Plant, and Equip. 1.731 1.80 .115 6.9
Long Term Debt .965 1.10 .000 3.2
Net Worth (before offering) 5.030 5.72 -2.750 25.9
Uses of Proceeds ($ million)
Working Capital 6.312 13.56 .000 63.3
Fixed Assets 1.357 2.61 .000 11.0
Retirement of debt 1.658 2.50 .000 7.85
Marketing Expenses .252 1.07 .000 5.0
R&D Expenses .274 .70 .000 3.0
Financial Performance - 1981
Table 5 shows summary performance statistics for the firms. The financial figures used were from
fiscal year 1981 and taken from 10-K reports. The reasons for using 1981 were: a) it was the first
year following the last IPO, b) using the same year controls for fluctuations in economic conditions,
and c) 1981 provides for the maximum number of firms. However, it is recognized that by using
the same year for all firms, the time lag effect of going public and performance is missed. For
example, a firm that went public in 1978 is measured 3 years after the event while a firm that went
public in 1980 is measured 1 year later. While data were available to control for time lag, this
analysis will be left for another study.
TABLE 5
Summary Statistics for Financial Performance 1981 (all in
millions of dollars except per share information)
Range
Variable Mean S.D. Low High
Income Statement information:Table 5 Cont. Sales 52.5 76.3 1.32 334.70 Net Income 3.87 7.5 -36.60 39.40 EPS($) .267 .515 7.19 1.75 R&D Expense 4.19 4.99 .00 20.90 SGA Expense 12.30 15.67 1.01 67.30 Balance Sheet Information: Working Capital 24.79 34.7 -22.2 156.9 Current Assets 36.79 48.3 .729 227.1 Property, Plant & Equip. 8.28 10.0 .143 37.3 Long Term Debt 1.97 4.3 .000 17.8 Net Worth 30.15 42.1 -9.890 177.4 Profitability Ratios Return on Sales -.21 .89 -3.64 .20 Return on Net Worth .08 .34 -1.09 .31 Return on Total Cap. .08 .30 -1.05 .31 Return on Assets .06 .42 -1.23 .19 Table 5 can be compared to Table 4 to demonstrate the change in firm profile over the three years. On an average, firms are approximately three times larger based on income statement data but slightly less profitable. From balance sheet data, firms are about 4-5 times larger than they were when they first went public and this also indicates that proportionately, more assets are required to produce addition gains to net income. In addition to the size and growth indicators shown in Table 5, profitability measures were calculated for the firms' 1981 financial performance. Even though cumulative profits for the firms were positive (Table 5, mean net income = 3.87 million), average return on sales and assets were negative. This seeming contradiction is explained by noting that the low performers (those with losses) were generally the smaller firms and those losses were therefore a larger percentage of sales and assets than the gains of the larger firms. For example, Systems Industries, which is classified as a high performer, had a net income of 5.94 million on sales of 62.9 million for 1981. This produces a handsome after tax return on sales of 9.44%. Denelcor, on sales of $1,319 million had a loss of 4.80 million. This works out to a negative return on sales of 364%. When weighted equally the return on sales figure is clearly negative but the combination of the firms (5.94-4.80) is still profitable. Wedges and Strategies Tables 6 and 7 present the frequency of use of entry wedges and strategies broken down by performance. High performers were those firms above the median for the performance measures and low performers were below the median. A chi-square test was conducted to indicate if any strategy or wedge was over or under represented among high and low performers. Strictly speaking,
because these firms are the complete population of IPOs 1978-1980 and not a sample, sampling
distribution tests are inappropriate. Any difference is 'real'. However, if the firms under
consideration here are considered a sample of all firms at the time of initial public offering, then the
use of inferential statistics can be justified. Only in the case of short term market development does
it appear that there is a statistically significant difference (p=.01). More high performers, when
performance was measured by-sales, had strategies for short term market development at the time
of IPO than did subsequent low performers. This indicates that attention to selling is important right
from the start for even 'high tech' firms.
The most prevalent wedge was parallel competition (21 firms) with new product introduction a far
second (7 firms). This indicates that small modifications of existing products or technologies is still
the dominant form of entry, even in a fast-changing dynamic industrial environment. In addition,
the most prevalent strategy was short term product development (22 of 23 surviving firms. One
firm, Randal Data Systems, declared bankruptcy before 1981). Although this result is not surprising
in a high-tech industry, it adds evidence to the notion that strategic choice may not be as difficult
as strategy implementation.
TABLE 6
Wedges and Strategies by Firm Performance
(SALES) ... Crosstabulation
High Perf. Low Perf. x(2) Significance
(N=11) (N=11)
Wedges
New Products 3 4 .00 1.00
Franchise 2 3 .00 1.00
Geographic Expansion 3 0 1.54 .21
Customer Contact 1 1 1.00
Joint Venture 2 0 .55 .45
Spinoff 0 2 .55 .45
Government Sponsorship 2 3 .00 1.00
Strategies High Perf. Low Perf Significance
(N=18) (N=9)
Concentration 4 5 .00 1.00
Mkt. Devel. 9 2 6.55 .01
Innovation 2 0 .55 .46
Licensing 2 2 .00 1.00TABLE 7
Wedges and Strategies by Firm Performance
(Return on Assets) ... Crosstabulation
High Perf. Low Perf. x (2) Significance
(N=12) (N=10)
Wedges
New Products 3 4 .08 .77
Franchise 2 3 .05 .81
Geographic Expansion 1 2 .03 .86
Customer Contact 1 1 .00 1.00
Joint Venture 2 0 .37 .54
Spinoff 0 2 .77 .38
Government Sponsorship 1 4 1.57 .20
Strategies
Concentration 6 3 .26 .61
Market Development 7 4 .18 .66
Innovation 1 1 .00 1.00
Licensing 3 1 .12 .72
Discussion
Rather than attempt to draw conclusions from an exploratory study such as this, it is perhaps more
appropriate to examine what still needs to be done.
Before hypotheses can be drawn from a preliminary study, some assurance of validity and reliability
is necessary. One possible source of validation is the triangulation of evidence. The present study
categorizes firms according to their self-proclaimed and documented entry wedges, strategy, and
sub-strategy. Based upon these descriptions of firm intentions, firms were ascribed certain
characteristics. Validating these descriptions requires seeing if the firm actually performed or
enacted their plan. Thus, differentiating between intended and actual strategy aids the validation
process. One method of ascertaining whether or not the strategy was indeed carried out is to
examine the pattern of expenses and investments made by the firm. Another is to interview the
principals. A third is to examine subsequent documents filed by the firm to the S.E.C.
Another validity issue concerns the categorization of the wedges and strategies. This study assumes
a simplistic additive model for performance = a + b (strategy). However the operationalization of
strategy can easily be viewed not as a single choice, but as a set of choices. This set of choices, or
strategic configuration, would conceptualize strategy and wedges in a multiplicative and perhaps
exponential manner. Since this study assumes only the most simplistic model, evidence of validity
may be obtained by testing more complex schemes.The reliability of this exploratory study also needs confirmation. A single rater was used in this study and by all accounts, content analysis of this type requires multiple raters. This is especially true where judgments are used to scale items. But it is also necessary for simple classification schemes. Until multiple raters and classifiers have developed the data, they are subject to many forms of bias and rater error. A final caution before looking directly at the results concerns the number of firms and the number of industries. This has been a small sample, single industry study. Even at that the firms probably exhibit too much heterogeneity. Still additional industries and larger populations of firms need to be investigated before anything but the most qualified conclusions can be drawn. Now on to the qualified conclusions. The single most striking finding in this study has been the failure to reject the null hypothesis; i.e., that strategy, entry wedges and sub-strategies do not affect performance at the time of IPO. The results tend to indicate that only the size of the firm at the IPO is a good predictor of subsequent success. Further since size is highly correlated with profitability at the IPO, it can be concluded, albeit tentatively, that profitable firms stay profitable and unprofitable firms remain unprofitable. Since strategy per se doesn't explain these initial and subsequent conditions, what does? One possibility is that the implementation of the strategy is more important than the strategy chosen. Two hypotheses follow. One is that it doesn't matter what strategy a firm chooses, as long as it implements it correctly. This is not suggested by the research because there is little real variability in strategic choice. The second hypothesis is that given some set of objective conditions, most or all firms will choose the same strategies and initial endowments and implementation are the most important factors. This hypothesis is suggested by the results of this preliminary study. A second possibility is that neither implementation nor choice makes any difference. It may be hypothesized that economic conditions, technology and social forces produce an environment in which a population of firms may exist. If conditions are favorable, the population thrives. If conditions are hostile the population succumbs. The behavior of any individual firm within the population may be adaptive or not and subsequent performance may be high or low but neither behavior nor performance at the firm level is predictable. Within a population, firm survival and prosperity is random chance, the error term. Only at the population level can hypothesis about environment, industry structure and industry performance be drawn. While this may exaggerate a bit, this is the contention of the school of population ecologists'. The intent of this study has been to explore the relationship between entry wedges, strategy and performance for firms at the time they became public companies. From this preliminary investigation, three conflicting paradigms have emerged, each with its own set of hypotheses, each paradigm offering a valuable contribution to the understanding of the strategy-performance relationship. The first of these paradigms is the 'strategy causes performance' model. This was the initial premise of the research and the inability to confirm this premise here certainly does not invalidate it. There are too many problems of validity and reliability to suggest otherwise. The second model is the 'implementation' model. Since the research found few differences in strategic choice, this suggests that how a strategy is executed may be more important. Variables such as leadership, structure, organization, timing and resource endowment may be better predictors than choice.
The last model, the population ecology model suggests that the level of analysis should be the
population of firms within an ecological niche. Individual firm performance is highly unpredictable
but the performance of the population can be predicted based upon environmental consideration.
REFERENCES
[1] Glueck, W.F. and Willis, R. "Documentary Sources and Strategic Management Research",
Academy of Management Review. 1979, 4, pp. 95-102.
[2] Hofer, C.W. "Toward a Contingency Theory of Business Strategy," Academy of
Management Journal, December 1975, p. 784-810.
[3] Marino, K.E. "Research and Methodological Issues in the study of IPOs", presented at
Academy of Management Meetings, Boston, 1984.
[4] Pearce, J.A. and Robinson, R.B. Strategic Management, Homewood, Ill: Richard Irwin,
1982.
[5] Porter, M.E. Competitive Strategy, New York: Free Press, 1980.
[6] Vesper, K.H., New Venture Strategies, Englewood Cliffs, N.J.: Prentice-Hall, 1980.You can also read
