Less Experience Equals More Profit?

Written by Eric Butterman

It seems intuitive that the startups most likely to deliver big returns are led by founders with deep experience in the industry. But new research suggests the opposite: the biggest breakthroughs often come from outsiders. 

The paper Flying High or Crashing Down: Pre-Entry Knowledge, Post-Entry Learning and the Distribution of Startup Performance finds that when people with little related experience create a start-up, it’s more likely that they have the huge profitable idea.

“Many spend years acquiring knowledge capabilities, networks and build in it,” says co-author Rajshree Agarwal, the Rudolph Lamone Chair of Strategy and Entrepreneurship at the Robert H. Smith School of Business. “So when you think about starting your own firm and the capabilities of operating in an industry, you want to leverage to your benefit and on average stay in the industry where you have a tendency to do better. Research shows that. But it doesn’t explain the fact you have unicorn organizations that come from outside industry and have big success. We see a lower average performance overall from them, yes, but why do we see them multiplying high? This has always been a puzzle both in scholarly research and in practice—and this is what we set off to find out.”

Using data from the Longitudinal Employer-Household Dynamics project for employer firms in 30 covered states for the years 1990 to 2008, the founding teams’ previous industry experience, the earnings of startup founders and ensuing growth and survival of their firms were assessed.

“Many outsiders know going in that the odds are very much against them,” she says. “They can see the advantage that those with insider know-how possess. So why take the financial risk, along with the frustration? I have said it many times, but people aren’t stupid. The research says they are compelled because their idea on average is just that good, not that they just think it is. A great idea can overcome a lack of knowledge with a huge result.”

Agarwal adds that she actually believes the upside of the outsiders is even higher because of the equity but they weren’t privy to actual acquisition deal value.

Another conclusion, according to the paper, is that outsiders “entering high-tech industries may wish to focus their resources on post-entry learning mechanisms and adaptive experimentation in business model elements to mitigate adjustment costs.”

The paper points out that it doesn’t have to be that outsider start-ups simply take a chance with a lack of knowledge. Large corporations looking for the big score profit-wise may also want to consider taking a greater look at these start-ups. “It is a situation where everyone can win, because these larger corporations can bring their industry knowledge, helping with the burden that is on the start-up,” she says. “By pooling the innovation with those who know the ropes, it can make for a major success in acquisition for everyone involved.”

Hitting the Mark for the Market

One of Agarwal’s hopes is that the research inspires people to understand the dynamic revolution of entrepreneurialism of individuals and helps investors to think outside-the-box so great ideas are encouraged instead of squelched. Another is that it will encourage outsiders to consider putting an even greater focus on showcasing the value of the start-up to have a better chance at acquisition before they run out of money to stay afloat.

“There is a great market for innovation and investment,” she says. “It can be even greater through open minds.”