It is well accepted that the information technology (IT) industry is highly volatile, where incumbent firms are often disrupted by startups entering their product or service markets. This creative destruction is driven by large-scale movements within the entrepreneurial ecosystem, consisting of startups, venture capitalists, and innovators. These collectively represent the threat of new entry for incumbents, leading to turbulence in the future and necessitating a strategic response. Quantifying these risks of new entry threats (NETs) has always been problematic given their probabilistic and forward-looking nature. Taking advantage of text analytics, we develop a text-based measure of NET based on the extent to which a firm’s description of its product markets overlaps with business descriptions of entrepreneurial firms backed by venture capitalists. This measure is then used to investigate how IT firms respond to NET through preemptive investments in research and development (R&D). We show that incumbents actually reduce R&D spending, on average, when facing high NET, consistent with risk aversion and financial conservatism. However, firms operating in contexts where high NET is unlikely to change market structure are likely to be more aggressive with their R&D spending—these contexts include markets with winner-takes-all dynamics because of strong network effects and those where the success of R&D effort hinges on the relevant continuities with prior innovative activities.
The threats of new entry by startups in the fast-moving information technology (IT) industry have important implications for firm decision making. Although analytical work on the strategic responses to new entry threats (NETs) through preemptive research and development (R&D) has produced contradictory predictions, empirical analysis of this relationship is limited, largely because of 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 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 preemptive R&D investments as a response to NET in the IT industry.
The online appendices are available at
https://doi.org/10.1287/isre.2018.0816
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Storm Clouds on the Horizon? New Entry Threats and R&D Investments in the U.S. IT Industry

10.1287/isre.2018.0816