Disease Epidemics and
Entrepreneurial Tipping Points: Models of Venture Viability from Customer and
Financier Perspectives
Patrick J. Murphy, DePaul University
Thomas E. Long, Solid Oak Consulting
ABSTRACT
Whereas discovery is
fundamental to entrepreneurship, there is low understanding of how and why some
discovered opportunities spread through market systems. We draw from epidemiological theories of how
contagious viruses spread through human populations and propose adaptations of
epidemic principles to describe venture spread patterns. We profile venture ideas via epidemiological
dimensions (contact rate, market size, adoption rate, useful life). Next, we cross-reference those dimensions to
entrepreneurial and financier orientation dimensions. Implications are relevant to the strategic decisions of
entrepreneurs and investment decisions of financiers.
BACKGROUND
Discovery
is essential to entrepreneurship (Eckhardt & Shane, 2003). It is defined by circumstances in which new
goods, services, raw materials, and organizing methods can be introduced into
an market system through formation of novel means, ends, or means-ends
relations (Casson, 1982; Shane & Venkataraman, 2000). The inherent novelty means that any given
venture offering may have never been seen before, and may never be seen
again. Neglected or fostered by such
circumstances, ventures have potential evolve, generate value, and bear upon
future decisions (Sarasvathy, 2001).
Processes driving these phenomena are a rich area of inquiry, and
research engaging the peculiarities and intricacies of entrepreneurial
discovery continues to emerge in the literature (Chandler, DeTienne, &
Lyon, 2003; Oviatt & McDougall, 2005; Murphy, Liao, & Welsch, 2006).
Opportunities
are basic to any theory of the entrepreneur (McMullan & Shepherd,
2006). Yet, why such paltry numbers of
them evolve into viable ventures is less clear. At genesis, rooted in sources of experience, relationships,
technology, and timing, an opportunity is in the purview of an individual. In early stages, new venture ideas are
frequently invisible to other market actors, who are nonetheless in similar
circumstances (Shane, 2000). Although
discovery has aspects of a science of the specific (Jacobson, 1992), the
entrepreneurship process, which transpires over time, entails system-level
post-discovery dynamics. How might
these dynamics vary based on the nature of a venture offering? Our purpose is to draw from epidemiological
theory about viral spread in human populations based on the characteristics of
viruses. We use epidemiological models
and theories (Murray, 1989) in conjunction with entrepreneurship theory
(Lumpkin & Dess, 1996) to offer some ideas instrumental to engaging the
issues.
THEORETIC RELEVANCE
Entrepreneurship
includes the discovery, evaluation, development, and exploitation of future
resources, goods, and services (Venkataraman, 1997). Discovery is necessary but not sufficient for entrepreneurship
because social processes are required for the reification eventual viability of
a business venture. Such viability
requires adoption and support from customers, employees, and financiers. Thus, factors related to transactions in the
context of a social system are important and, as such, interpersonal
interaction has been used to explain how information about new ideas is
communicated (Sterman, 2000).
The
diffusion and spread of ideas and new products feature patterns and tipping
points no less than diseases. As
susceptible human populations occupy both contexts, viral spread is can be seen
as analogous to entrepreneurial growth (Sterman, 2000: 341). As a developed field of study, epidemiology
explains the spread of diseases in populations (Anderson, 1994). Popular press (Gladwell, 2002) and viral
marketing research (Rosen, 2000) have used epidemiologically-influenced models
to explain the idea spread.
Entrepreneurship research has yet to use core principles of
epidemiological theory (Murray, 1989) describing virus characteristics to
forecast the tipping point when ventures receive begin to receive intense
attention from future customers and financiers. Our undertaking is intended to make a contribution in this
area.
Epidemiological Theory
For
a virus to spread, it must be transmitted across individuals with a contagiousness
that permeates a population via transmissions from infectives to
susceptibles. Similar to the
contraction of a virus by one who is susceptible to it, an idea can be adopted
by one who finds it idea suitable. In
both contexts, independently of the (a) virus/idea itself, diffusion and spread
involve (b) communication through various direct channels (c) in a social
structure (d) over time (Rogers, 1962: 19).
The model assumes some individuals know about the new idea (or carry the
virus) whereas, at the same time, others do not. Social interaction is required.
Thus, diffusion entails social dynamics, and multiple models have been
offered to explain these phenomena.
Rogers
(1962) described the classic model of diffusion in terms of adoption
mechanisms. Adoption entails contact
with venture offering and subsequent decisions of whether or not to utilize
it. Spread rates of extreme
acceleration exhibit the classic epidemic model and curve, as exhibited in
Figures 1 and 2. Although the model describes
viral spread in terms of contact rate, population, infectivity, and duration,
it does not explain the genesis of the virus.
A zero point is an assumed equilibrium condition; in an entrepreneurship
context, therefore, initial startup processes are out of bounds. Early development, as it were, is driven by
indirect effects from outside the model.
In an entrepreneurial context, such effects include advertising, media reports,
and other indirect social channels (Sterman, 2000: 332). Although such elements become important when
populations become large, they are unable to describe boom and bust cycles,
dynamic pricing levels, variation in quality, competition, and other market
factors that require feedback mechanisms and feature fluctuation patterns.
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As
diffusion in a population is dynamic and chronological by nature, it is useful
to determine the recovery rate of carriers.
In epidemiological models, the rate corresponds to average recovery time
of infected parties. In an entrepreneurial
context, discontinuation rate is the average point at which current adopters
become former adopters. Past adopters
are not prone to readopt the idea after discontinuation. Similarly to the varying contagiousness
levels of infected parties in an epidemiology context, only current adopters in
an entrepreneurship context communicate information about the venture idea
actively to others in the market system in meaningful ways.
The
addition of discontinuation events led to models with population segments of
susceptible, infective, and removed (SIR) classes . SIR models describe these classes, who catch the disease (S),
carry it (I), and are recovered, immune, or removed (R). Murray (1989: 611) depicts the process
programmatically via the schematic,
Sà I à R
The
Bass diffusion model (Bass, 1969) describes diffusion via adoption mechanisms
and external awareness. It overcomes
the startup problem faced by simpler models because it admits that susceptibles
in a large population contact a virus or venture idea via indirect and external
sources. Whereas the Bass model
describes contraction from direct sources identically to earlier models, it
also assumes a probability of adoption based on exposure to external and
indirect sources. Such influences
account for a constant percentage of infectives in a given time interval. In idea diffusion contexts, the Bass model
figures an adoption rate (AR),
AR = aP + ciPA/N
In which a = advertising effectiveness, aP
= adoption from advertising per time period, and ciPA/N = adoption from word of mouth. As Sterman (2000: 333) explains, the model overcomes the startup
problem because external sources are the only source of adoption when adopter
population is zero. External sources
decrease as the pool of susceptibles is depleted. Figure 3 shows both s-shaped curves in the Bass diffusion model.
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Bass
models treat total population as a constant.
When used to explain viral spread in an environment that can change in
size, therefore, some assumptions are liable to be violated. In entrepreneurial contexts entailing
innovations or new products with short life cycles, its assumptions are
reasonable. However, diffusion over long
time frames strains the model because new dynamics emerge (e.g., demographic
shifts). As well, mutations to the
virus can occur.
Virus
mutations can change the quality and robustness of a virus. As this kind of variance is liable to shift
contagiousness, it also has an effect on the percentage of the population
susceptible to it. The spread dynamics
incurred by viruses mutating over time are different from fleeting ones. In entrepreneurial contexts, innovations
serve a function similar to viral mutation.
Such phenomena are not described by the Bass model. Yet, they occur in entrepreneurial contexts,
for example, in the form of discontinuous changes in fashion or
technology. Additionally, the Bass
model does not explain immunity effects.
In an entrepreneurship context, an immunity effect is reflected by
experience with an innovation over its useful life lowering susceptibility to
continue using the offering. Despite
such shortcomings, these models are useful tools for considering venture
diffusion.
Proposition 1: Epidemiological models are useful for
explaining venture viability and spread in a market population.
Epidemiology and Tipping
Points
Once individuals no longer carry a virus, they are not
likely to be infectious to others and are not prone to reinfection. A disease will not spread in a population if
the rate at which individuals become immune is faster than the rate at which
carriers infect susceptibles. In the
same way, new venture ideas will not spread if users discontinue use before
influencing others to do so. As such,
if a disease is “too fatal” or adoption “too fleeting,” epidemic spread is not
likely. On the other hand, imbalance
between contagiousness and susceptibility can open the way to tipping
points. If the infection / influence
rate maintains a much faster rate than recovery, a tipping point event is
likely to ensue. When infection rate
greatly outruns recovery, the resulting spread pattern may approximate an
s-shaped curve.
In
the popular business press, the tipping point concept derives from
contagiousness, large-scale ramifications, and dynamic idea spread patterns
(Gladwell, 2002). Epidemiological
models define a tipping point mathematically (Murray, 1989). The reproduction rate associated with the diffusion
of an effect is defined by the number of new cases produced by a given (I)
before recovery (R) status and the probability of transacting with a
susceptible (S) case. In terms of an
entrepreneurial venture offering in a market system, reproduction rate is
described by
cid(P/N) > 1
in which c is contact rate, i is
percentage of adopters, and d is
average active usage period. P is population of potential adopters
and N is the total population. This model shows a tipping point occurs when
reproduction rate equals one. Sterman
(2000: 341) explains that if reproduction rate is greater than one, the spread
dynamic approximates a fad or fleeting trend instead of the s-shaped curve in
Figure 6. (Figure 1 depicted a curve
describing such an effect.) When P is low enough to bring the rate
sufficiently below one, the effect is precluded from spreading.
Proposition 2: Epidemiological models are useful for explaining the nature
and occurrence of “tipping points” in the spread of a venture idea.
THE ENTREPRENEURIAL CONTEXT
The
spread of venture ideas reflects epidemiological models. Potential customers come into contact with
new venture ideas directly (e.g., meeting a current customer) or indirectly
(e.g., advertising). Through the
richness of direct contact, uncertainty is mitigated. Questions can be answered, for example, making an adoption
decision more simple. For example,
financial services professionals provide incentives for word of mouth
advertising among current and potential customers to generate new business. Advertising is effective for spreading the
word about a venture idea more widely and quickly than word of mouth, but such
indirect contact makes for slower adoption decisions.
Epidemic
modeling uses virus characteristics such as (1) communicability, (2) longevity
of incubation period, (3) terminality, (4) carrier period duration, and (5)
immunity characteristics to explain the speed, duration, spread, and intensity
of viral spread. Like susceptibles and
infectives in epidemiological theory, potential customers and financiers are
also susceptible and more or less liable to be “infected” by a venture
idea. Therefore, epidemic modeling is
applicable in those contexts.
Characteristics of Venture
Offerings
The
characteristics of a venture idea affect how quickly it may be adopted by
customers. Epidemiologic models,
similarly, refer to the infectivity and other characteristics of a virus. For example, in an entrepreneurial context,
the most well known venture idea for buying and selling books online (i.e.,
Amazon.com) took years for many customers to adopt because online purchasing
was utterly novel. Uncertainty was high
because customers did not want to enter credit card information online, keeping
initial adoption rates low. For venture
ideas with more precedent, as in the improvement of an existing product, adoption
rates may be faster because uncertainty around purpose and value is lower. For example, Starbuck’s offered an
improvement in the quality of coffee in terms of coffee taste and the
experience of visiting a coffee shop.
Although the offering was more expensive than the average cup of coffee,
initial adoption rate was faster than Amazon’s because customers were more
immediately certain about what they were getting (i.e., coffee).
Epidemiology
describes viral spread via recovery rates and immunity. In an entrepreneurial context, the useful
life of venture ideas also varies.
Sometimes venture offerings approximate fads or fashions. Other times they are ubiquitous and
indelible, based on length of time adopters will continue to use them and how
long before interest wanes. Useful life
varies based on the nature of a venture idea.
For example, Apple’s iPod, once adopted, tends to be used regularly and
continuously. Although the idea of a
portable music player is not novel (e.g., the Walkman), high storage capacity
distinguishes it as an improvement over previous offerings, making for a fast
adoption rate. Ability of users to
listen to wide ranges of music or podcasts appropriate to changing interests
lowers the recovery rate. Taken
together, these aspects extend useful life - immunity takes longer to
develop. By comparison, the “pet rock”
enjoyed a fast adoption rate when introduced.
However, unlike the iPod, the pet rock does not offer rich variety of
experiences and is not dynamic. As
such, the recovery rate of adopters was high, as immunity developed quickly,
and the useful life was short. The
result was a fleeting trend instead of a venture idea that had staying power in
the marketplace.
Given
that venture spread reflects viral spread, entrepreneurial firms can take on
specific strategies to promote spread based on the nature of their
offerings. Drawing from the
characteristics of a venture idea and its expected spread dynamics in
epidemiological sense, entrepreneurs and financiers can make better decisions
with respect to firm performance and investments.
Proposition 3: Epidemiological models are useful for
formulating venture strategy and orientation with respect to procuring
resources via customer and financier channels.
SPREAD DYNAMICS
We use four elements from epidemiological theory that
affect the spread dynamics of a virus in a population (contagiousness,
population size, infectivity, carrier period) and adapt them to the
entrepreneurial context. These basic
elements are (1) contact rate, (2) market size, (3) adoption rate, and (4)
useful life. These dimensions are
liable to affect the spread dynamics of a venture idea similarly to how they
affect the spread of a virus.
Therefore, there are more or less appropriate entrepreneur and financier
orientations based on varying profiles of them.
Contact rate
refers to the levels of speed and ease by which individuals are exposed to the
venture idea through direct or indirect channels. Contact rate is generally higher for simple product offerings
that are easy to perceive immediately and understand (e.g., new clothing
accessories). For more complex product
offerings, such as an engineered product that requires training to use (e.g., a
buzz saw designed for precision cuts), the contact rate is lower.
Market size
refers to the number of customers who will potentially adopt the venture’s
product offering. Highly specialized
product offerings (e.g., precision scales for weighing small objects) usually
have a smaller market size because there are less individuals with the specific
need that such offerings are intended to address. More general product offerings (e.g., bath towels) with wider
appeal have a larger potential market size because there are more individuals
with the appropriate needs.
Adoption rate
refers to the rate of speed at which potential customers choose to adopt the
product offering after coming into contact with it. Some venture ideas and product offerings have the quality of fads
and fashions and are adopted very quickly by customers (e.g., certain toys for
children). Other product offerings are
adopted quickly because they are novel as well as clearly useful (e.g.,
microwave ovens). Some venture ideas
and product offerings take a relatively longer time to be adopted, perhaps
because their value is not immediately apparent or because they are quite
different than established norms (e.g., selling books on the internet).
Useful life
refers to the length of time a customer who adopted a venture idea will continue
to use it. Useful life can vary
dramatically and independently vis-à-vis other venture idea dimensions. For example, venture ideas that are adopted
quickly may tend to have a short useful life (e.g., the pet rock). Venture ideas that are adopted quickly can
also have a long useful life (e.g., portable MP3 music players). Some new product offerings that are adopted
after a somewhat long period of time can have long useful lives (e.g., the
electric guitar).
Entrepreneurial Orientation
The
strategic orientation and decision-making of entrepreneurial firms can be more
or less appropriate based on the spread dynamics of its venture ideas and
product offerings. Here we draw from
one model (Lumpkin & Dess, 1996) to describe how entrepreneurial firm orientation
may vary based on the spread dynamic profile of a venture idea.
An
innovative entrepreneurial orientation works well when contact rate is fast or
slow. In the former case, an innovative
orientation allows the venture to keep pace with the market expansion. In the latter case, it can help enable the
venture to continuously seek new ways to reach customers more quickly. The innovative orientation may not work as well
in a large market as in a small one.
The specialization required to reach a small market implies high levels
of innovation and development. Of
course, an innovation orientation can be instrumental to staying competitive in
large markets too, but intense innovation is more likely critical in a small
market. If the adoption rate of a
spread dynamic is high, innovation may drive changes when no such changes are
needed (i.e., too much technology push).
At the same time, a lower innovation orientation may allow a venture to
keep pace with the market when it takes considerable time getting to understand
a venture offering before becoming a customer.
An
entrepreneurial orientation of risk-taking is usually integral to venturing
because it facilitates the discovery of unforeseen options. If the contact rate of a venture offering is
low, however, high risk-taking can disrupt adoption with operational or product
changes before potential customers have a chance to decide whether or not to
adopt. If contact rate is high,
risk-taking can meet the uncertainty of the market with new strategies and
ideas through attempts to maximize contact.
A risk-taking orientation can drive firm behavior that better meets the
needs of a market that is large and diverse.
Risk-taking may also inadvertently cost a firm significant resources.
Proactivity
in an entrepreneurial venture’s orientation varies in relevance based on the
nature of the venture offering. When
the contact rate of the venture offering is high, low proactivity can help
forecast contingencies as information about the venture idea itself travels
quickly through the marketplace. On the
other hand, when the nature of the venture idea is such that information about
it does not spread quickly through a marketplace, a venture orientation of high
proactivity, and the action following from it, can be instrumental to achieving
venture success. A proactive
orientation can also be instrumental for reaching niches in a large market, but
may not be as necessary if the market is small. Smaller markets with less turbulence do not call for as much proactivity
to act in relation to future environmental change. A proactive orientation can be instrumental to taking steps to
increase the adoption rate of a venture offering by customers. For example, disseminating information about
a venture offering in advance of rollout can manage market expectations. However, some venture offerings do not lend
themselves to a proactive orientation meant to promote adoption rate. Some venture ideas are well-suited to slower
adoption rates (e.g., innovative novel products requiring significant training
before use by customers).
Competitive
aggressiveness can be more or less appropriate depending on the nature of the
venture offering. It is part and parcel
of offerings with a high contact rate.
As buzz about an idea spreads fast, an aggressive orientation keeps the
firm responsive to competition. The
orientation can be either offensive or defensive. Just as an offensive stance supports a high contact rate, a
defensive stance can maintain status vis-à-vis competitors when contact rate is
low. Competitive aggressiveness can
help create a strong position if a market is large, whereas it may lead to
market dominance in smaller markets.
Thus, competitive aggressiveness can help maintain a fast adoption rate,
but may be redundant if adoption rate is slow.
If the venture offering lends itself to slow adoption (e.g., early
television), a competitive aggressive orientation may drive behaviors that are
redundant. When the useful life of a
venture offering is long, competitive aggressiveness can be instrumental to
defending venture position during the product offering’s life cycle. With a short useful life, such an
orientation can help prevent competitors from stealing market share between
product life cycles.
As
an entrepreneurial orientation, autonomy offers a variety of ways to respond to
a firm’s environment based on the nature of the venture offering. When contact rate is high, autonomy for
making decisions enables venture team members to respond to contingencies as they
emerge. Such responses are only helpful
to the degree they create opportunities to boost contact rate, which implicates
risk-taking. However, depending on the
environment, autonomy may not boost the contact rate of the venture
offering. In large markets, autonomy is
a strategic enabler for responding to discontinuous change. In small markets, though not as critical, it
can serve a similar function, particularly with regard to competition. As consumers in a marketplace quickly adopt
a venture offering, an autonomy orientation facilitates responses to market
dynamics. Such facilitation is
attenuated if the potential market is small.
If the venture offering has a long useful life, autonomy can lead to
managing various relations with users during the period of the useful
life. As well, autonomy is important if
the product offering has a short useful life.
It can promote innovation to extend usefulness or develop new product
offerings for quick replacement of the offering when its short useful life expires. Table 1 summarizes relations between
entrepreneurial orientation dimensions and venture idea diffusion
characteristics.
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Financier Orientation
Appropriate
strategic orientations and decision-making by financiers, angel investors, and
venture capital investors can also be delineated based on the characteristics
of venture ideas and product offerings.
Instead of the entrepreneurial orientation model, we use a model based
on key investment decision factors. The
model we present here includes five critical factors used by entrepreneurial
venture financiers, including the second author, to evaluate proposed ventures. The dimensions of the model include market
maturity, return rate, investment size, faith in the management team, and
product uniqueness.
When
a market is mature, investments are generally less likely because consumer
taste for new things is lower. With
fast contact, however, market maturity is not so important, as faster contact
rates are favorable. Generally a larger
market is better. However, size
covaries with maturity: financiers understand there is better chance for viral
spread if the market is young. As well,
offerings with fast adoption rates have a greater chance of creating a “tipping
point” in a large market. If the useful
life of an offering is long, it increases the chance for viral effects. There is more chance for a higher return
rates due to inherent switching costs, resulting in a better investment
opportunity. If the useful life of an
offering is short, it may be a fad. As
such, unless the margins are large, expected return rates may not merit the
investment.
Higher
return rates are more likely with fast contact because there is a better chance
of succeeding before competition develops.
With a slower contact rates success is possible but there is an increased
chance of competition before success is achieved, which lowers the probability
of high return rates and makes financiers more cautious. There is better chance of achieving a high
rate of return in a large market, increasing the attractiveness of large
investments. With a smaller market, the
best chance for a high rate of return is to “own” the market. Otherwise, there is more caution on the part
of investors. As useful life
facilitates larger investment flow, it also increases the chance of a high rate
of return.
Larger
investments are more feasible when contact rate is high since success or
failure can be tracked more quickly, thus allowing financiers to be more
confident in their investment. Market
size is generally better when large from a financier’s perspective. With slow adoption rates, there is still
chance for success over longer time cycles.
In such cases, the risk is such that the venture may deplete the
investment before generating enough revenue to be viable. Financiers know that slow adoption rates
also make for lower rates initially and thus warrant more caution.
Faith
in the management team is important to financiers, who believe lack of
management skill and poor strategizing are important reasons for failure. Financiers look for evidence entrepreneurs
will make effective business growth decisions quickly when contact rate is
high, and commit to smart strategic decisions when contact rate is low. Financiers value complex decisions in large
heterogeneous markets, and the ability to handle the stress of rivalry in small
markets. Similar to varying contact
rates, financiers rely on a management team to make appropriate decisions based
on varying adoption rates. When useful
life is long, a customer service strategy may be important, whereas continuous
innovation strategies are important if offerings are outdated quickly.
A
unique offering adds a multiplier effect to fast contact because it increases
the chance of exponential growth. For
really unique products, a larger market allows for more rapid success. For financiers, there is not much investment
value in products without uniqueness.
Financiers understand that even though a very unique product may be a
fad, such products can be profitable if contact and adoption rates are high and
the venture is the first to market.
Unique offerings with a long useful life are generally favorable
investment opportunities, whereas short useful life offerings are perceived as
somewhat less favorable. Table 2
presents a summary of the relation between the financier orientation dimensions
venture idea diffusion characteristics.
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Conclusion
Using
epidemiological models in conjunction with entrepreneurship theory to
facilitate forecasting venture offering spread patterns is a novel
application. Although such models are
clearly relevant, existing entrepreneurship theory has not drawn deeply enough
from core principles describing viral spread and applied them to idea
diffusion. Our paper is one initial
attempt, and it stands to be developed much further in future research
efforts. Such research, relating
venture idea characteristics to dimensions of entrepreneurial and financier
orientation, will add value to post-discovery
dynamics in the entrepreneurship process.
Such research will complement and enhance existing models of
entrepreneurial discovery as well as further enhance entrepreneurship theory’s
applicability to practice.
CONTACT: Patrick J. Murphy;
Kellstadt Graduate School of Business, One East Jackson Boulevard, Suite 7000,
Chicago IL, 60604.
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FIGURES AND TABLES
Figure 1. Classic epidemic model.
Figure 2. Classic epidemic model curve.
Figure 3. Bass model curves.
