Storm Clouds on the Horizon? New Entry Threats and R&D Investments in the U.S. IT Industry

Abstract

The threats of new entry by startups in the fast-moving information technology (IT) industry have important implications for firm decision making. While analytical work on the strategic responses to new entry threats (NET) through pre-emptive R&D has produced contradictory predictions, empirical analysis of this relationship is limited, largely due to the absence of a reasonable measure. In this work, we make two contributions. First, we develop and validate a measure of these threats through text mining, using product descriptions provided by incumbent firm 10-K filings and business descriptions provided by startups. This novel measure of NET differs significantly from observed entry and competition. Second, we study the R&D investment strategies of IT firms facing new entry threats. Using a sample of U.S. IT firms over the period 1997-2013, we show that incumbents on average reduce R&D spending when there are greater threats from the startup space. More importantly, we show that the effect is not uniform – firms that operate in industries with strong network effects or with high levels of technological cumulativeness invest relatively more in R&D when they face greater NET. Our work adds to the literature on the relationship between product market threats and firm decision making by expanding the scope of this line of work to include the role of threats of new entry – a central construct in the field of strategy and industrial organization – and by highlighting conditions that influence the effectiveness of pre-emptive R&D investments as a response to NET in the IT industry.

Keywords: new entry threats, text mining, R&D investment, uncertainty, real options, innovation, disruptive technology