Entrepreneurial models and the software sector

Abstract

Young, radically innovative, growth-orientated and publicly listed high-tech companies in Silicon Valley, together with venture capital financiers, gave birth to the concept of the ‘Entrepreneurial Business Model’ (EBM). This concept has become central to the debate about the innovative capacity of nations in information technology and its promotion became an important policy objective in Germany during the 1990s. This paper addresses the question of whether German software companies on the former ‘Neuer Markt’ of the Frankfurt stock exchange were able to successfully implement business models similar to that of the typical entrepreneurial company in the USA. The paper focuses on the performance of software companies and venture capital investments on the ‘Neuer Markt’. A number of findings emerge from this effort. First, successful German software companies implement traditional business models. The most successful German companies specialize in IT – and software services. Such firms do not specialize in standardized software products which require little service and customization. Secondly, German venture capital for the most part was not able to establish successful entrepreneurial companies on the Silicon Valley model. Nor were they able to create a successful German variant of venture capital involvement in more traditional companies.

Keywords:

• Venture capital
• Software
• Stock markets
• Germany
• Entrepreneurial Business Models

Acknowledgements

The author would like to thank Pablo Beramendi, Tom Cusock and Sigurt Vitols for their detailed comments. The usual disclaimer applies. Partial support of the European Commission Key Action ‘Improving the socio-economic knowledge base’ through contract No. HPSE-CT-2002-00146 is acknowledged.

Notes

Frequently used synonymous terms are ‘Silicon Valley’ company, high-tech startup, new technology-based firm (NTBF) or entrepreneurial company.

An initial public offering (IPO) is a company's first offer to sell stock to the public.

This does not imply that a product has to be marketable without any customization and further human interaction. If a software product with high implementation and customization complexity is distributed and implemented by a third party this will not negatively influence the cost structure of the software producer itself.

The seed and start-up stages are the stages in which VC investment would support the R&D phase of a new product. Expansion financing in essence prepares a company for the stock market by scaling up operations. Bridge financing is mainly a financial investment which increases a company's equity to a level adequate for the stock market, and which covers the expenses of the IPO.

This so-called ‘pull’-thesis about the cyclical nature of VC activity is not unchallenged (Becker & Hellmann 2002). Competing explanations include long-term social change and the emergence of a powerful transformational technology (‘push’-thesis) (Fiedler & Hellmann 2001).

Profitability, growth and age are measures easily calculated with the information provided by annual reports. Entrepreneurial financing patterns and corporate governance structures are indicated through the presence of early-stage VC as shareholder and board member as publicized in the IPO prospectus of a company.

The difference in product standardization between the first two groups as a whole and the latter two groups as a whole is the most pronounced. The differences between group 1 and group 2 and between group 3 and group 4 are not as large.

This average excludes three outliers with compound annual average growth rates much larger than 100 percent.

This figure excludes companies that have been acquired or which have filed for bankruptcy.

Table 6 provides the same measurements as Table 5, ‘normalizing’ the data for the respective company's year of IPO. This gives an impression of the companies' economic development, taking into account their different positions in the capital market cycle. Here, this rearrangement does not lead to major differences in the group characteristics.

Enterprise Resource Planning Software. The most famous ERP Company in Germany is SAP, which was never listed on the Neuer Markt.

Here technical productivity is used: sales/number of employees.

For more detailed information and references on age, size and sector membership as predictors for sales growth and about size and sector membership as predictors for productivity growth, see Whittington (1980), Dunne and Hughes (1994), Geroski et al. (1997) and Söderbom and Teal (2001).

The picture did not change when narrowing down the definition of VC in the regression model to early-stage and expansion financing.

Age is normally not used as predictor of company productivity (Söderbom & Teal XX01). Therefore, it was not included as a control in the second regression.