Launching the Novel Product: Patience is A Virtue for Start Ups

Published on: 02/07/2014
Posted on: 02/07/2014
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In new research, ITOM Professor Sreekumar Bhaskaran of SMU Cox School of Business and co-authors analyze the operational tradeoffs for entrepreneurial, start-up firms launching a first product that lays the foundation for success or failure. Biotech firms, for example, face tradeoffs about when to launch a first breakthrough product or when to wait for the best available version. The threat of bankruptcy often puts pressure about the decision to launch or not. "The conventional wisdom of 'failing forward' is not the best strategy for start ups," says Bhaskaran.

For a start-up firm, the decision about when to launch a novel, breakthrough product can be complicated, in comparison to a product rollout of an established, larger firm.  Solar power and biotechnology firms that have made it through the start-up storm likely have stories to tell — and lessons learned. In new research, ITOM Professor Sreekumar Bhaskaran of SMU Cox and co-authors analyze the operational tradeoffs for entrepreneurial, start-up firms launching a first product that lays the foundation for success or failure.

Companies, especially those offering breakthrough technologies, often launch a new product, only to deliver a better version later. "This is a classic sequential product introduction story," says Bhaskaran. "We were intrigued, however, about firms that were not large, well established ones, but smaller, entrepreneurial start-ups.” Start-up firms face several challenges. Not only are they working on novel, breakthrough technologies that tend to have significant uncertainty surrounding their potential market, they are also severely cash-constrained. "Their primary challenge then becomes launching the revolutionary product they have in mind without upsetting the delicate cash constraints," he offers.

Conventional wisdom suggests that any firm that engages in sequential innovation must remain patient with an eye on long-run profits. But for a start-up firm, too much patience in pursuing its initial product can often be risky and could result in bankruptcy; indeed, launching an early though, imperfect version of the product would provide a valuable infusion of liquidity and knowledge, which can extend the product development process and potentially reduce the risk of bankruptcy. Some practitioners urge start-ups to launch a current or existing version of their product as early as possible rather than waiting for the more desirable breakthrough version. However, launching an imperfect first product may have dire consequences for a start-up without prior brand equity, say the authors.

Cash-constrained start-up firms often consider launching an immediately available product to generate funds, with an eye toward developing more advanced products. An established firm can offer a 'just-good-enough' product and launch an advanced, better version later without necessarily harming its balance sheet or reputation. But a start up that launches a novel medical device, for example, that could have glitches, in hopes of launching the best version later, cannot afford the consequences. The reputational penalty could be large and near impossible to overcome on a re-launch. Additionally, sales may be dampened and cannibalize the profitability of the upcoming next-generation version.

Real options
An often-cited example of the product introduction challenges of start ups, Biopure Corporation faced this similar product introduction dilemma. In the late 1990s, Biopure's goal was to launch a human blood substitute, Hemopure. Biopure gradually spent its entire cash cushion during the unexpectedly long wait for Hemopure's approval by the FDA. Biopure executives deliberated over whether an approved product, Oxyglobin, a veterinary equivalent of Hemopure, should be launched first to generate cash flows.

The dilemma faced by the start up involved the tradeoffs of firm survival and future profitability. The immediate release of Oxyglobin could create an unrealistically low price expectation for Hemopure in the more lucrative human blood market. The firm chose to wait and launch the human blood substitute Hemopure. Ultimately, Hemopure, initially used in warfare circumstances where blood was needed urgently and frequently, was not a reliable substitute for human blood transfusions. The firm went bankrupt in 2009. "Biopure may have launched the revolutionary product too soon —one that was not ready for prime time — because of cash constraints or investor pressure," notes Bhaskaran.

In the research, the authors cite another case involving the novel product launch of an orthopedic implant device. The firm decided to launch an early version after lobbying doctors about the benefits of their custom devices, only to discover complications in patients later. When the firm launched the better version, with cash flow to sustain operations until the next iteration, they were confronted with reputational issues. The doctors had spent their own goodwill with patients and were reluctant to offer a second chance to the start up, even though the new product was considerably better with no potential for complications. The mea culpa ultimately worked, but not without severe stress for the firm. In this case, launching early may have constrained future revenues, and likely cannibalized future product sales.

Given capital constraints and technological and regulatory uncertainty that is germane to many entrepreneurial initiatives, a start up needs to consider numerous variables while determining its path forward, Bhaskaran explains. "For example, an immediate launch of the existing product helps extend the development cycle because the cash burn rate slows down.” When the firm is able to extend their development cycle time, they can then continue working toward their new technologies —they have bought themselves time.

An optimal policy
From the modeling of these tradeoffs, the authors derived a policy that could guide the start up's new product launch decision. "The optimal policy depends upon the cash position of the firm," says Bhaskaran. "There is a cash threshold below which you would launch the immediately available, although imperfect product, and above which you would not launch the existing product. If think your cash will become constrained, then at that point you launch the existing product." A standard response to launching a new product is to launch as soon as possible, and established firms can take the chance that quality may not be superior. In general, the authors found that delaying the existing product in favor of launching the best version later is the better path for start ups.

The conventional wisdom of launching a good quality product as soon as possible may not always be the right one. In general, the authors found that delaying the existing product in favor of launching the best version later is the better path for start ups. This surprising result is primarily driven by the ability of the revenues from the a good quality product launch to reduce cash burn rate and extend the product development cycle for the ultimate prize -- the best quality product.

The challenges faced by the start up require more scenario planning. "What may seem to be immediately profit maximizing, may lead you to bankruptcy sooner," says Bhaskaran. "Delaying a launch could lead to a lack of funding. The conventional wisdom of 'failing forward' is not the best strategy for start ups. " Bhaskaran suggests that start ups need to push the right buttons all of the time, while larger firms have latitude and can hedge their product introductions against other product or business lines.

Importantly, the goal is firm survival and creating a profitable firm. "Many start ups create knowledge but are not very operationally savvy," offers Bhaskaran. "Often they are reacting to events rather than planning what to do at different stages and decision points. These involve decisions about cash flow; when to look at additional funding sources; when to tap existing products; and what to communicate to angel investors." This is a real options decision, suggests Bhaskaran, where being enamored about the technological breakthrough and its implications should not trump business decisions.

The paper "Sequential Innovation by Start-ups: Balancing Survival and Profitability" by Sreekumar Bhaskaran of SMU Cox School of Business, Sinan Erzurumlu of Babson College, and Karthik Ramachandran of Georgia Institute of Technology is under review.

Written by Jennifer Warren.

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