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UI Researcher Studies Businesses That Create Their Own Competition

Businesses are always on the lookout for new competition from outside companies. But research by a University of Iowa economics professor shows that some businesses should be just as concerned about competition that comes from within their own walls.

April Franco, a professor of economics in the Henry B. Tippie College of Business, studies "spin-outs"—businesses started by employees who leave a company and compete in the same industry. She found that especially in knowledge-based industries, it's not unusual for these spin-outs to take customers and market share away from the parent company.

"Spin-outs tend to be entrepreneurial in nature and are often more flexible and attuned to their markets," said Franco. "It's especially true in technology intensive industries, where the spin-out founders benefit from the knowledge they gained while working for their former employer, so they're not really starting a business from scratch."

Franco provides examples from the highly competitive and rapidly changing computer hard drive industry, the context of one of her recent research projects that examined spin-outs. In several instances, she said, the spin-out outperformed its parent over time. Shugart Associates, for example, was an IBM spin-out, which in time surpassed IBM, the one-time dominant player in the industry. In turn, Shugart itself spawned Seagate Technology, which proceeded to become one of the leading players in the industry while Shugart eventually disappeared.

Franco's work in the area has already received critical acclaim; a research paper she co-wrote titled "Knowledge transfer through inheritance: Spin-out generation, development, and survival," received the prestigious Best Paper Award for articles published in 2004 in the Academy of Management Journal, the leading journal in the discipline.

Franco said companies can avoid spawning their own formidable competitors by creating new markets, and by encouraging employees to develop new products to sell in those markets. Ultimately, she said, one key to keeping talent in-house is to create an "intrapreneurial" atmosphere that encourages employees to develop their ideas and take ownership of their creativity.

"In many cases, employees take a great new idea to management and get little support in return. Then they become frustrated, often leaving to start a new company," said Franco. "Human capital is an important resource in these industries, and businesses have to think about what kind of competition they are creating in-house by not allowing their employees to feel fulfilled."

Encouraging innovation by employees is also important, since companies cannot afford to become complacent when operating in volatile knowledge-based technology industries. The computer industry, for instance, shifted to smaller and smaller machines, necessitating smaller and smaller hard disk drives. The obituaries of many disk drive companies show their failure to adapt to these new and changing markets.

"Many companies became too wedded to their current customers' needs, and perceived the emerging market as either too small or not interesting enough," said Franco. "That left them unprepared when the market evolved to the smaller drives. It shows that businesses may occupy a niche, but not become so embedded in it that niche they cannot get out of it and move into new markets when necessary."

Interestingly, her research found that companies that create their own competition through spin-outs do not suffer as much from a lack of technological knowledge as from a failure to understand how to use that knowledge effectively. The incidence of spin-outs is highest, Franco found, when companies create new knowledge but fail to put it to good use.

Franco's paper "Knowledge transfer through inheritance: Spin-out generation, development, and survival" was co-authored with Rajshree Agarwal of the University of Illinois and Raj Echambadi and M.B. Sarkar of the University of Central Florida. The Academy of Management Journal is published by the Lubin School of Business at Pace University in New York City.


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