TECHNOLOGY, BUSINESS AND THE MARKET

LECTURE 3: INNOVATORS, ENTREPRENEURS AND VENTURE CAPITALISTS

LECTURE OBJECTIVES

(i) To examine the nature of entrepreneurship an innovation and

(ii) To briefly examine the role of venture capitalists

1. Introduction

‘The fundamental impulse that sets and keeps the capitalist engine in motion
comes from the new consumers’ goods, the new methods of production or
transportation, the new markets, the new forms of industrial organization that
capitalist enterprise creates (which) incessantly revolutionises the economic
structure from within, incessantly destroying the old one, incessantly creating a new
one. This process of Creative Destruction is the essential fact about capitalism. It is
what capitalism consists in and what every capitalist concern has got to live in’ –
Joseph Schumpeter
Henry Kressel, following the views of Schumpeter, offers the following definition,
‘innovation is an historic and irreversible change in the way of doing things…This
covers not only techniques, but also the introduction of new commodities new forms
of organization, and the opening of new markets’ (Kressel, 2007,p.2). Finally, the
management thinker Peter Drucker offered the following definition, again following
Schumpeter, and linking innovation with entrepreneurship:-
‘Innovation is the specific tool of entrepreneurs, the means by which they exploit
change as an opportunity for a different business or a different
service….Entrepreneurs need to search purposefully for the sources of innovation,
the changes and their symptoms that indicate opportunities for successful
innovation. And they need to know and to apply the principles of successful
innovation’ (Drucker, 1985/2005, p. 18).
An appreciation of the influence of the Austrian economist Joseph Schumpeter is
essential to a proper understanding of innovation and entrepreneurship. In a series
of books, culminating in his Capitalism, Socialism and Democracy first published in
1942, Schumpeter sought to discover or elucidate the underlying dynamics of
capitalism and its future trajectory. In his view capitalism is characterised by constant
evolutionary change – intrinsically dynamic in nature, ever shifting and ‘churning’ as
old processes and enterprises decline and newcomers take their place. This is the
process of creative destruction alluded to in the opening quote and has a certain
Darwinian flavour. In his book The Theory of Economic Development, first published
in German in 1911 and in English in revised form in 1934, Schumpeter sought to
identify the source of profit in the capitalist enterprise, allocating this role not, for
example, to the exploitation of labour or the earnings of capital invested, but to the
activities of entrepreneurs. In the words of Heilbroner:-

‘An innovation implies an innovator – someone who is responsible for combining

the factors of production in a new way. This is obviously not a ‘normal’
businessman, following established routines. The person who introduces change

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into economic life is a representative of another class – or more accurately, another
group, because innovators do not necessarily come from any social class.
Schumpeter took an old word from the economic lexicon and used it to describe
these revolutionists of production. He called them entrepreneurs. Entrepreneurs
and their innovating activity were thus the source of profit in the capitalist system.’
(Heilbroner,1995, p. 295).
Schumpeter saw entrepreneurs as a sort of elite struggling against ever increasing
intervention by the state and other agencies, all serving to inhibit the entrepreneurial
impulse and thereby slowing the pace of innovation. Eventually, innovation becomes
institutionalised and reduced to mere routine; bureaucratic structures are erected
which make innovation ever less likely; and entrenched, vested interests inhibit the
pace of change. This problem was highlighted in Rosabeth Moss Kanter’s 1983
book The Change Masters and more recently by Tyler Cowan in his book The Great
Stagnation.
2. The role of Innovation management

According to Peter Drucker:-

‘Successful innovation aims at leadership. It does not aim necessarily at becoming
a ‘big business’; in fact, no one can foretell whether a given innovation will end up as
big business or a modest achievement. But if an innovation does not aim at
leadership from the beginning, it is unlikely to be innovative enough, and therefore
unlikely to be capable of establishing itself. Strategies vary greatly, from those that
aim at dominance in an industry or a market to those that aim at finding and
occupying a small ‘ecological niche’ in a process or market. But all entrepreneurial
strategies, that is, all strategies aimed at exploring an innovation must achieve
leadership within a given environment. Otherwise they will simply create an
opportunity for the competition.’ (Drucker, 1985/2005. p. 124)
Opinion is divided on whether large companies can remain sufficiently ‘nimble’ to
nurture continuous innovation. Certainly, large companies can deploy greater
resources if they ‘stay hungry’ and resist the process of innovation inhibiting
bureaucratisation described in the previous section. In this sense an organization
needs to be constantly re-defining itself; asking itself questions about which market/s
it is in and treading a fine line between diversification and sticking to what it does
best. In the long run most business organizations fail as the competition catches up
or new innovations become dominant, eclipsing the demand for an existing product
or service. Equally, it is contentious whether a monopoly position supports and
stimulates innovation or stifles it by giving undue shelter from competition. Further,
the role of the state in nurturing innovation is a matter of debate – whether the state
has a positive effect or a negative one – whether the state should let entrepreneurs
make the running or become involved in trying to ‘pick winners’.
Basically, the process of innovation needs to be managed in such a way as to
nurture individual initiative whilst meeting corporate product requirements, whether
the ‘corporation’ be a tiny start-up or a massive transnational. Henry Kressel, for
many years a researcher and manager at the RCA Labs where he was responsible
among other things for the commercialisation of products, took the view that the
innovators should be as closely involved as possible in the management of

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innovations into viable products, including the process of ensuring manufacturability.
As he put it:-
‘My experience convinced me that technology transfer into products is best done
when innovators can participate in the process as much as possible. A ‘hands-off-
approach is not efficient, because an innovator who knows the product from the
ground up can solve performance and production problems far more rapidly than
someone uninvolved with its creation. That’s why the Laboratories encouraged
researchers to participate in moving their innovations into products. As part of this
culture, PhDs willingly worked with engineers in the product division to launch
products. Researchers commonly took up residence in RCA factories in the course
of the new product introduction. When the product launch was completed, they went
back to the Laboratories and started other projects, applying the valuable practical
experience they had gained, plus an appreciation of what it takes to deliver a
product’ (Kressel, 2007, pp. 112-3).
This is good advice and illustrates the obvious value of team working and the
development of mutual understanding across professional boundaries. Of course,
innovations occur in certain places at certain times and spread to other areas either
gradually or more rapidly depending on circumstances. This process is termed
diffusion. In his book Diffusion of Innovations Everett Rogers identifies four main
elements in the diffusion of innovation as follows:-

• Innovation — the nature of the innovation itself will influence the pace
of diffusion. Innovations that have an apparent relative advantage over
what is currently on offer; are compatible with existing values, past
experiences and needs; are simple to understand; can be tried with
minimal risk; and are readily visible to others have an advantage in terms
of diffusion.

• Communication Channels — communication is the process by which

participants create and share information with one another in order to
reach a mutual understanding. A communication channel is the means by
which messages get from one individual to another. Communication
channels can be through mass media or interpersonal channels. In any
case shared language will facilitate diffusion

• Time — refers to the rate of adoption of any innovation in any particular

set of social circumstances. This incorporates the innovation-decision
process which runs from initial knowledge of the innovation; being
persuaded to try it; deciding after a trial period to adopt or reject it;
implementing it for trial period; and confirming its use over time.

• A Social System — may be made up of just a few individuals, groups or

entire societies. One aspect of a social system is the development of
norms of behaviour which can promote or inhibit the diffusion of
innovation.

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 3. Case studies

 Ray Kroc fast food and franchising - ‘In 1954, a fifty-two-year-old milk-shake-
machine salesman saw a hamburger stand in San Bernadino, California, and
envisioned a massive new industry: fast food…Kroc, the founder and builder
of McDonald’s Corporation, proved himself an industrial pioneer no less
capable than Henry Ford….Throughout the company’s spectacular growth,
Kroc maintained a delicate balancing act, imposing rigorous system-wide
standards while encouraging an entrepreneurial spirit that welcomed ideas
from all levels…By putting the humble hamburger on the assembly line, Kroc
showed the world how to apply sophisticated process management to the
most prosaic of endeavours. To succeed the McDonald’s way, companies
must define the basic premise of the service they offer, break the labour into
constituent parts, and then continually reassemble and fine tune the many
steps without a hitch’. (Gross, 1996, pp. 177-8)
From very small beginnings, Kroc built a major international brand, using a system of
franchising. Franchising enables the franchisees to buy into the major corporation’s
business model – taking their products from the lead company and operating under
the lead company’s brand; enjoying the benefits of economies of scale and
benefiting from the advertising campaigns funded and sustained by the lead
company. McDonalds currently operates approximately 33,000 restaurants globally
in 119 countries, employing 1.7 million staff, claiming 68 million customers daily and
having annual sales estimated at around $30 billion – 80% of the restaurants are
operated as franchises and the current cost of buying a franchise is around one
million dollars.
The initial vehicle for Croc’s success was not the restaurants themselves but a
subsidiary, the Franchise Realty Corporation, which enabled him to buy likely sites
for future restaurants and then lease the sites to franchisees. This not only provided
an alternative source of revenue, but also enabled Kroc to impose a standardised
corporate image – ensuring that the design of the restaurants, the menu and the
service were identical same throughout the ‘network’. As Gross puts it:
‘Kroc set about expanding and professionalizing the growing industrial empire.
Knowing that the hallmark of any sophisticated industrial complex is professional
management, Kroc in 1961 launched a training programme – later called Hamburger
University at Elk Grove, Illinois. There, the faculty trained franchisees in scientific
methods of running a successful McDonald’s and drilled them in the Kroc gospel of
Quality, Service, Cleanliness, and Value….Hamburger U also contained a research
and development laboratory to develop new cooking, freezing, storing, and serving
mechanisms’. (Gross,1996, p.185-6).
Although by the time Kroc died in 1984, he had built McDonald’s to become the
largest restaurant company in the world, he did not of course achieve this alone.
Specifically he was assisted by perhaps the ultimate company man – Fred L. Turner
(1933-2013) sometimes called ‘the man who made McDonald’s’. Kroc believed in
promoting men from the shop floor and Turner began his career with the company
on leaving the US Army in 1956 operating the grill in Kroc’s original restaurant in Des
Plaines. He rose rapidly through the ranks, becoming operations manager in 1958,
president and chief administrative officer in 1968, taking over from Kroc as the

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company’s chief executive in 1974 and remaining active at the top of the
organisation until his final retirement in 2004. Turner presided over the rapid
expansion of the company, introducing new products and moving into overseas
markets including the UK in October 1974. Turner was particularly active in the
establishment of the first McDonald’s Hamburger University mentioned above which
was renamed the Fred L. Turner Training Centre in 2004. The McDonald’s model
has been adapted over the years to incorporate greater regional variations in the
contents of the menu and the design of the actual restaurants. In recent times
McDonald’s have lost ground in mature markets such as the USA and UK and is
struggling in emerging markets too as changing eating habits and ‘nimbler’
competitors literally eat into the market for fast food. Nevertheless, numerous
examples of the franchising approach exist including Subway (1,500 stores in the UK
and Ireland and 38,000 worldwide) and the Tesco owned chain of local shops, One
Stop, with 750 stores in England and Wales.

 Intel’s microprocessor and the computer revolution – ‘In 1968, when Gordon
Moore and Robert Noyce left the security of a large established firm to start their
own company, their plan was to manufacture a product they had yet to invent: a
tiny semiconductor chip with the same capacity to store computer memory as the
large magnetic cores used in mainframe computers…Intel’s engineers set out to
put more and more computing power into ever smaller chips. In 1971 they made
a chip that could be active in the operation of a computer….By compacting the
power of a 3,000-cubic-foot computer into a chip smaller than a fingernail, Intel’s
microprocessor made possible the personal computer….Even after establishing
its microprocessors, which are produced in state-of-the-art factories around the
world, as the industry standard, Intel continues to operate as if it were a research
institution. In recent years its annual budget for research and development has
topped $1 billion.’ (Gross, 1996, p. 247-8)
Gordon Moore, who gained a PhD in chemistry from the California Institute of
Technology in 1954, joined Shockley Semiconductor in 1956 where he met Robert
Noyce who held a PhD in engineering from MIT. Shockley Semiconductor was a
research group run by William Shockley, who won the Nobel Prize in 1956 for his
part in inventing the transistor. The transistor replaced vacuum tubes in radios,
leading to the production of smaller radios and paving the way for the personal
computer. Shockley was a genius but also something of a tyrant and Moore and
Noyce, together with several other researchers, decide to break away. They
eventually made contact with the New York based Fairchild Camera and Instrument
Company which agreed to fund a new division devoted to semiconductor research.
Fairchild Semiconductor opened in Mountain View, California in 1957 – in the area
later know as Silicon Valley - with Moore as the manager of engineering and Noyce
as division manager. In 1963, Moore and Noyce were joined by Andrew Grove, a
Hungarian refugee with a PhD in chemical engineering from the University of
California at Berkeley. Gove became the leading organizational force in Fairchild
Semiconductor which, by 1967, had annual sales of $130 and a staff of 15,000.
In spite of commercial success, Moore and Noyce became frustrated with being part
of the Fairchild ‘empire’ and in 1968 they broke away, taking Andrew Grove with
them, and founded Intel. Intel’s function was to investigate and then commercially
develop the possibilities of semiconductor memory by continually cutting production
costs while cramming ever more transistors on a single chip. In 1970 the company

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introduced its first successful product, the 1103 chip which contained 1K, or a
thousand bytes, of dynamic random memory (DRAM). By 1971 the company’s sales
had reached almost $9.5 dollars and the company was able to raise almost $7
million from an initial public offering of its shares. All of this, however, was merely a
prelude to the technical breakthrough that would propel the company’s growth – the
invention and introduction of the INTEL 4004 microprocessor. As Gross has
commented, ‘no bigger than a caterpillar with metal legs, it was packed with 2,300
transistors and held as much computing power as the 1946 ENIAC, the electronic
computer, which had occupied 3,000 cubic feet. The $200 chip, introduced in 1971,
could complete an astonishing 60,000 operations in one second’ (Gross, 1996, p.
254). The invention of the microprocessor generated the proliferation of personal
computers as well as all manner of ‘appliances’ from digital watches to calculators.
Intel grew to be a massive organization, continuing to spend massively on R&D and
improved production techniques and facilities and becoming familiar to consumers
through the presence of its logo and the tag line ‘Intel Inside’.
Intel were late arrivals on the brand building and advertising scene, seeing
themselves as somewhat above such things. It was only in the late 1980s that the
company began to give serious thought to marketing its products beyond the tech
savvy world of design engineers working for personal computer companies, to the
general public. This shift in strategy, stemming from the ideas of a single individual,
provides a perfect example of innovation within a large, established corporation.
Originally an engineer, Dennis Carter joined Intel in 1981 from the Harvard Business
School where he had completed an MBA. Working as technical assistant to the
company’s chief executive officer Andrew Grove, Carter became aware that Intel
faced major challenges in the rapidly maturing microprocessor market. The impact of
‘Moore’s Law’ was to ensure constant technological obsolescence. For example
Intel’s 16-bit microprocessor (the 286) was overtaken in three years by the
company’s 32-bit microprocessor (the 386). However, demand for the new product
was sticky, and the 386 was slow to be adopted even as a superior product - the 486
– was becoming feasible. Basically, technological improvement was running ahead
of end-user awareness. Denis Carter’s proposed remedy for this was to develop and
launch a marketing campaign aimed at raising awareness of Intel’s microprocessors
among the general public. In 1988 he persuaded Andrew Grove to fund a pilot
campaign aimed at establishing the Intel brand in the minds of consumers –
essentially giving the company’s product an identity. The success of this initial
campaign, which among other things succeeded in eclipsing the 286 and
establishing the 386, led to a major marketing campaign calculated to coincide with
the launch of the 486. Interestingly, a 1991 court ruling determined that Intel were
unable to trademark mere numbers like 286, 386 or 486. This led the company to
search for an umbrella brand and prompted Carter to approach the PC
manufacturers with the offer of a co-operative marketing scheme, whereby Intel
would pay three per cent of its revenues from microprocessor sales into a fund that
would pay half of a PC manufacturer’s advertising costs – as long as the ad
concerned promoted Intel-based PCs carrying Intel’s logo. Dell signed on
immediately for the scheme and, by the end of 1991, three hundred manufacturers
had agreed to join – perhaps most famously IBM. IBM’s advertisement in The Wall
Street Journal was the first to give equal billing to the ‘Intel Inside’ tag line and logo.
By the end of 1992, Intel’s worldwide sales had increased by 63% and by 1995
brand awareness of Intel among European consumers had risen from 24% to 94%.

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Meanwhile, a three-second jingle had been added and the Intel Inside slogan
supplemented by the Pentium brand. By the time Carter retired in 2000 Intel had
become one of the most valuable brands in the world.
Intel continues to invest heavily in R&D in the face of sustained competition, not least
from Samsung. In a recent article in the Financial Times the company’s chief
executive, Brian Krzanich, was quoted as claiming that Moore’s Law is ‘slowing
down’. Gordon Moore originally estimated that the number of transistors able to fit
on an integrated circuit, and thus processing power, would double every eighteen
months. He later modified this two every two years. Moore’s Law has underpinned
Silicon Valley’s rapid technological advancement and consumers have seen the
benefits in ever smaller and more capable devices. The chip inside Apple’s iPhone 6,
for example, has two billion transistors. However, achieving biennial breakthroughs
has required ever more sophisticated and expensive materials, science and
engineering to shrink transistors to a few billionths of a metre. Intel’s strategy to shift
from its current 14 nanometre generation to 10 nm has been delayed by six months
to the second half of 2017. According to Krzanich, ‘our cadence today is closer to
two and a half years than two’.
4. Post-script - venture capital

Capital is an essential ingredient in entrepreneurial activity and the development of

innovation. An obvious source of capital is the entrepreneur’s personal assets. In
the case of Intel, for example, Moore and Noyce made their original contact with
Fairchild Camera and Instrument Company through a San Francisco-based
investment banker called Arthur Rock. Fairchild Semiconductor was funded using
Rockefeller money invested by what would later become the venture capital vehicle,
Venrock Associates. When Moore and Noyce wanted to break with Fairchild they
consulted Rock again and he succeeded in raising $2.5 million dollars to invest
alongside their own contribution of $500,000. In the case of Thomas Edison, the
commercialisation of his inventions was funded by ad hoc or specific arrangements
with bankers such as J.P. Morgan. This is so-called ‘angel’ or seed funding of the
kind that might support the staging of a Broadway show or the initial sponsoring of a
band. The investor is looking for returns of the sum invested but the relationship is
‘personal’ rather than ’corporate’. Venture capital is a sub-set of private equity (see
MBE Lecture 10) and seeks to match institutional investors with potentially, highly
profitable ventures.
The accepted founder of the venture capital model was George Doriot, a former
Dean of the Harvard Business School and founder of INSEAD. Doriot was
instrumental in establishing the American Research and Development Corporation
(ARDC) in 1946. In 1957 ARDC invested $70,000 of its client’s money in a company
called Digital Equipment Corporation which was valued at $355 million following the
company’s initial public offering (IPO) in 1968 – an annualised rate of return of
101%. Venture capital was prominent in the funding of enterprises in Silicon Valley
and is still associated with the so-called ‘high tech’ industries – industries which often
carry a very substantial level of risk. As Kressel (who successfully made the
transition from the technical world at RCA Labs to the world of venture capital) has
commented:-

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 ‘Venture capital funding enabled the launch of major new markets. Giant
companies such as Intel, Oracle, Cisco Systems, Apple Computer, eBay and
Google, all initially venture-backed start-ups, continue to play leading roles in those
markets….(However), while many ventures succeeded, many others fell by the way-
side. Funding of early-stage technology ventures is very risky…and for this reason
venture capital investors expect high rates of return on the funds committed.’
(Kressel, 2010, p. 13)
In recent times a further variation has been provided by ‘crowdfunding’ facilitated by
the Internet.
Sample examination question

Identify Roger’s four main elements in the diffusion of innovation.

Assess the role of venture capital in stimulating innovation.

References and background literature

Drucker, P. Innovation and Entrepreneurship, Routledge, 1985/2005

FT Weekend 18/19 July 2015

Gross, D. Forbes Greatest Business Stories of All Time, Wiley, 1996

Heilbroner, R. The Worldly Philosophers, 7th edition, Penguin Books, 1995

Kressel, H and Lento, T. Investing in Dynamic Markets: Venture Capital in the Digital
Age, Cambridge University Press, 2010

Rogers, E. Diffusion of Innovation 5th edition, Free Press, 2003

Schumpeter, J. The Theory of Economic Development, 1934