23 Feb 2009  Research & Ideas

Creative Entrepreneurship in a Downturn

Entrepreneurs, take heart. True, the global economic malaise removes opportunities and precious resources—but also adds them in new and interesting ways, argues HBS senior lecturer Bhaskar Chakravorti. In this Q&A he identifies reasons for optimism, and shows how entrepreneurs can think differently about bad news. Key concepts include:

  • There are three fundamental decisions facing any business in good times and bad: where to play, how to deliver, and how to win.
  • Entrepreneurs should systematically identify "downturn needs," including necessities and affordable luxuries, substitutions for previous products and services, and products that deliver value for money.
  • To serve these needs, look for downtime resources that might be available at relatively low cost.
  • Think business model, says Chakravorti. Consider the unintended consequences of cost cutting, and instead focus holistically on the interconnected parts of your entire business model.

 

Whatever the headlines predict these days, there may still be good news for entrepreneurs. Many successful products, services, and pivotal ideas have been launched during an economic lull, according to Bhaskar Chakravorti, a senior lecturer of business administration at Harvard Business School, citing the examples of Motorola, Southwest Airlines, Revlon cosmetics, Hewlett-Packard, and MTV.

Good ideas are not hard to come by. The more complicated part is to harness the diminishing supply of capital. But capital can still find its way to a credible idea, he argues.

"I have high hopes tempered with great caution," says Chakravorti. "The entrepreneurs who can capture the limited resources have the potential to do well. Shortage and adversity are powerful stimuli for focusing the mind."

At HBS, Chakravorti teaches and writes on entrepreneurship management, new venture formation, and innovation. He is also a partner of the international management consulting firm McKinsey & Company, where he is a leader of its Innovation practice. Chakravorti has advised over 30 Fortune 500 companies on innovation, growth, and new business-building in industries such as technology, health and consumer care, and renewable energy. His scope of work to date encompasses the United States, the European Union, Brazil, India, Malaysia, South Korea, Philippines, Canada, and multiple African countries.

In our e-mail interview, Chakravorti explains how entrepreneurs can systematically identify opportunities all around them.

Martha Lagace: Your work highlights many opportunities for innovation and success despite the serious market conditions facing entrepreneurs. What about past experience and the current downturn gives you hope and confidence that entrepreneurship can still thrive?

Bhaskar Chakravorti: Let me start with a replay of a conversation I had recently with Frederick, the person who runs the auto repair shop where I regularly take my 1998 and 2002 vintage cars. I asked him if he was experiencing a big uptick in his business in the last few months. He said indeed he was, and wondered why I had asked.

Well, I told him of some rules of thumb I have been working on to isolate entrepreneurial opportunities in a recession, and this question was meant as a test for one of the rules. I knew of several new car dealerships that were scaling back or closing down. Clearly, though, people were still driving cars, so the only way the math could clear was if more people were going to Frederick's shop or to other auto repair shops to get their old cars to go a few extra miles. The rule of thumb here is simple: In an economic downturn, consumers consume less of many products. Invariably, this creates the need for substitutes (in the example with Frederick, repaired older cars are a substitute for new car purchases)—at least for some of the most essential products.

"In an economic downturn, consumers consume less of many products. Invariably, this creates the need for substitutes."

Another outcome of a drop-off in consumption and employment is a need for products that become more valuable during such periods when consumers have more time on their hands. An astounding number of media companies and brands—Fortune magazine, MTV, CNN, USA Today, and so on—started during economic downturns. When people are laid off from jobs, they need re-training. Employers need confidential data to remain protected despite large numbers of their workers being let go. All of these broad trends create the need for new products and services: adult re-education, corporate data security, etc. And indeed, we see companies that have stepped into the breach, such as the very large University of Phoenix from an earlier downturn or a tiny firm like Fidelis Security Systems during the current recession.

With firms scaling back and with the scarcity of capital for launching new ventures, this creates huge possibilities for an entrepreneur to identify the opportunities, get creative about assembling resources, and go after them with the knowledge that the potential for competitive advantage will be greater than in a boom period. I have a lot of hope for the entrepreneurial momentum that builds during a downturn.

If history is any guide, we can expect some significant industry shapers to emerge from the current crisis. During the 1930s alone—the period to which we often compare our situation today—there were entrepreneurial start-ups that went on to become household names: Motorola, Hewlett-Packard, Texas Instruments, and many others.

All that said, it is simply irresponsible for us to tell students, managers, investors, or inventors to just go out and be entrepreneurial. As we are well aware, capital is in short supply. Big companies are scaling back on higher risk projects and new ventures. This has a domino effect on the venture capital providers and subsequently on the angel investor community. Each group is concerned that there will not be an investor willing to fund or buy into a venture down the road. The net result: Investment in start-ups fell 33 percent in the fourth quarter of last year compared with that of the previous year. Only six venture-backed companies were able to go public last year in the United States. According to a report in the Wall Street Journal, 260 venture-backed businesses were acquired by big companies last year. This is the first time in five years that the number has gone below 300. Together with the credit crunch, we are witnessing a plethora of potentially great opportunities but with a measly amount of capital to fund them.

I have high hopes tempered with great caution. The entrepreneurs who can capture the limited resources have the potential to do well. Shortage and adversity are powerful stimuli for focusing the mind. All of this, by the way, is "private stimulus" and is in addition to any new opportunities likely to be created by the "public stimulus" being orchestrated by the Obama administration.

Q: Elsewhere you have described three fundamental decisions facing any business: where to play, how to deliver, and how to win. Taking the first fundamental, how can an entrepreneur think creatively about making the best of a downturn in terms of where to look for demand? Are there lessons from the past that could be used for guidance?

A: Clearly there will be areas such as infrastructure, health care, education, clean technologies, etc., that will get a boost because of investments and demand from the public sector. Let us put these areas aside—because they will be readily identifiable. I am more interested in isolating the opportunities that arise organically and will be developed through private initiatives.

Here, I think it is critical to systematically identify what I would call "downturn needs." There are many different kinds of such needs. First, there are needs that are created by the substitution effects I spoke of earlier. Second, there are needs that emerge because of the availability of excessive time or the unavailability of productive employment. These are by way of necessities. In addition, there is also a need for affordable luxuries. After all, just because consumers are cutting back doesn't mean that they do not still enjoy products that give them pleasure and entertainment—or even distraction from the difficult times around them. The third category of needs is a more obvious one: products that deliver value for the money spent on them. When consumer budgets are tight, such products will have plenty of appeal.

"If history is any guide, we can expect some significant industry shapers to emerge from the current crisis."

In terms of lessons from the past, there are many examples that we can turn to. Taking the last of the needs first, in the airline industry alone, Southwest Airlines, Ryanair, and JetBlue were founded during downturns on the principles of delivering value. In terms of affordable luxuries, consider the emergence of cosmetics, such as Revlon, and media, such as CNN, during downturns. I already offered some examples of opportunities that come out of the substitution effect or of products that complement the surplus time that consumers may have on their hands. You could go even further and brainstorm a fairly long list of ideas: for example, think along the lines of meals at home, budgeting tools, job matching, etc.

Q: As for the second fundamental, how to deliver, what creative opportunities in this downturn do you see for delivering products or services more cheaply and effectively?

A: The opportunity here is in all the surplus resources that you can tap into and harness. For instance, the downtime created by the collapse of the Internet bubble gave rise to a host of new applications that we now collectively know as Web 2.0. Technologies and materials left unused due to the collapse of one industry can be creatively re-directed towards others that can take advantage of the low input costs. Silicon and wafer cutting technologies that were rendered surplus after the semiconductor industry slowed down during the last recession were picked up by a fast-growing solar energy industry.

Q: What advice would you give would-be entrepreneurs and investors for following the third fundamental, how to win?

A: My advice here is simple: Think business model.

Most managers tend to focus on cost management and operational efficiencies when they strategize during a downturn. While there is nothing wrong with that, I do think such measures often miss the unintended consequences of the actions.

Cost cutting can severely impair your ability to be competitive or could cause you to lose customers. This creates an opening for entrepreneurs who think holistically. They consider mutually reinforcing changes in the entire business model that encompasses many interconnected elements: customer acquisition and retention, costs and productivity, firm scope, pricing, growth platforms, etc. Some of the finest examples of business model innovations, whether it is IBM's outsourcing of key elements of the IBM PC or Salesforce.com's offering of software as a subscription service, evolved during downturns.

Q: What particular entrepreneurial activities seem to be making the best of the bad economic situation and seemed poised for future success?

A: I can think of several. But you don't have to look very far; just read the newspapers (which are in difficult circumstances themselves) a bit more closely and talk to people (like Frederick, the auto shop owner) in your neighborhood.

On the very day that the Wall Street Journal had a story on how venture financing is down—February 11, 2009—the New York Times had a story about a few individuals who are ideal illustrations of what I am talking about. Craig Brandman has a company called Medilinq that provides medical discounts for people with low incomes or who are unemployed; he predicts that participation will grow six-fold by year-end. Peter George founded Fidelis Security Systems to provide protection against potential data breaches such as those by recently laid-off employees; he said his sales rose by 55 percent in 2008. Charles Burckmyer and Scott Noll have created a fund to buy companies that are now available for a song and can be turned around at a relatively low cost.

The examples go on and on. But there is a method to finding the sweet spots. A systematic application of such a method also helps create a credible signal to the other side of the market that provides entrepreneurial capital. Such signals are essential for the capital to find its way to a good idea. That is the key message.

Q: What are you working on next?

A: I am working on several articles—one is called "Letting No Serious Crisis Go to Waste: Is a Downturn Really a Good Time to Turn towards Entrepreneurship?"—that develop the framework for choosing entrepreneurial opportunities in economic downturns and credibly signaling the attractiveness of the opportunities to capital providers.

Also, I am interested in mapping different categories of opportunities to different classes of capital providers: corporate, public sector, venture, and angel. I am collecting data to help inform this mapping process. With this I hope I will be able to provide a system for idea developers and capital providers to find the appropriate matches and enable entrepreneurship to flourish even in these constrained times.

About the author

Martha Lagace is the senior editor of HBS Working Knowledge.