Start-ups play a fundamental role in the creative destruction popularized by Joseph Schumpeter. Whilst this typically sees them creating new companies that disrupt the status quo, a new paper finds that they also play a disruptive role by selling their inventions without ever actually taking them to market.
Indeed, the paper argues that such behavior may actually be more potent in disrupting the market than taking the new invention to market themselves because a bidding war for their invention can encourage inventors to double their efforts in ways that building an uncertain start-up can struggle to.
Central to this thesis is what’s known as preemptive acquisitions, whereby inventions and technologies are acquired pre-market or not. Of course, this isn’t the only option available to bigger players, as they can also attempt to defer the entry into the market of the new technology.
This exit strategy is increasingly common, with the latest Startop Outlook report from the Silicon Valley Bank revealing that acquisition is more preferable to the modern startup than an IPO.
Which path the startup takes is likely to come down to the quality of the invention on one hand, and the market competition on the other. Whilst it may seem sensible to assume this is a fair fight off, it is actually the quality of the invention that dominates.
The rationale for this comes from a discussion around how incumbents might respond. They already have a product in the market, so their rationale is how the invention will affect the income from that product if they own the new invention versus a competitor owning it.
So acquiring the new invention is likely to both increase their own profits whilst also reducing the profits of their rival (who didn’t acquire it), thus increasing the likelihood of them bidding a high amount for the invention. In other words, the better the invention, the higher the premium that can be charged for it.
This high price is then likely to encourage the entrepreneur to sell out rather than take the risky path of a flotation of their product in the hope that it will gain market share on its own.
Interestingly, whilst this might appear to be disrupting the very creative destruction process itself, the paper argues that the end consumer actually benefits more when the inventor sells out pre-market than they do if they try and take the product to market themselves.
Again, this all goes back to the quality of the invention, with the sale route believed to provide greater incentives for producing a great product than the going to market route.
Another angle of course is that if inventors try and take their product to market themselves, it can spark retaliatory R&D from the incumbents who try and block the new product. This has the impact of reducing the incentives for the inventor.
So, if policy makers wish to encourage innovation in their economy, the best approach might be to make the merger and acquisition market as fluid as possible.