What determines a firm's choice of new markets?

If your company is thinking about entering a new market, you should challenge your traditional business mindset. Entering new markets is inherently risky, but there are proven ways to reduce your risk of failure.

This article is based on research by Alex Makarevich

Esade Assistant Professor Alex Makarevich and his research collaborator Young-Choon Kim at the Ulsan National Institute of Science and Technology have discovered a mechanism that helps companies reduce uncertainty when entering new markets.

When firms choose a new market to enter, they are concerned with reducing the uncertainty associated with new markets. As a result, they often choose markets that are closely related to the markets they are familiar with and have experience in. But this approach may not always be optimal and has drawbacks.

"Firms that only choose familiar markets fall into competency traps. They don't evolve but just keep doing what they know. Instead of developing core competences, firms develop 'core rigidities'. Over time, they become obsolete and other firms outcompete them," warns Makarevich.

Firms that only choose familiar markets fall into competency traps

Another key way in which companies choose new markets is imitation — that is, entering the markets that competitors or market leaders are choosing. Imitation also happens when deciding what markets to exit, especially in industries where the levels of uncertainty are high and companies rely more strongly on what others are doing.

"If firms in your industry are exiting certain markets, you are more likely to exit the same ones based on the assumption that they know something you don't know. You believe that their calculations are better than yours," says Makarevich. 

Yet this second option also has its downsides: "The problem with imitating your competitors is that what's good for them may not necessarily be good for you."

Another uncertainty-reduction mechanism

In their study, Makarevich and his co-author reveal that there is another way for firms to reduce the uncertainty associated with new markets. The researchers analysed thousands of venture capital firms in the United States during a 23-year period and discovered a mechanism that firms use to enter new markets: partnerships with other firms.

"We analysed whether the choice to enter a new market was affected by the degree to which a firm's partners are present in a particular industry," says Makarevich. "We found that, accounting for other relevant factors, firms are more likely to enter new market segments in which their partners are already operating."

When a firm chooses which markets to enter based on its partners' choices, it has an added advantage. The findings suggest that having partnership ties to a new market segment reduces a firm's uncertainty in that market segment.

"We argue that firms' uncertainty is reduced through learning about new markets via their partnership ties," explain the authors. Why? "Partnerships allow you to receive a lot of valuable information from your partners because of your close relationship. They may convey market-specific information that can be very helpful for you in deciding whether or not you want to enter and whether or not you can succeed. You can also learn from your partners in a new market vicariously, gaining insight into what they do in a market, how they do it, what challenges they face, how they tackle them..."

Firms are more likely to enter new market segments in which their partners are already operating

The structure of connections to a new market matters

The researchers found that partners have less influence on firms' choice of new markets when the firms are connected to potential new markets by multiple indirect linkages. "In such cases, you benefit not only from your direct connection to your partners in a new market but also from information flows that reach you through indirect ties in your network. As a result, you become less dependent on the direct connection to your partners and their effect on your market choice diminishes," explains Makarevich.

Firm experience

In their findings, the researchers observed that when deciding what new markets to enter a firm's prior experience can decrease the external influence of partners. "Firms that have extensive experience and have solved many problems in the past have demonstrated that they are capable of doing things correctly and making the right decisions," says Makarevich.

For these firms, the presence of partners in a new market becomes less important. "If you already have a lot of experience that is relevant to the market segment that you're thinking of entering, then you might rely less on your partnership ties because you already have competences that can help you determine whether or not to enter a particular market."

This article is based on research published in the Journal of Management Studies.

All written content is licensed under a Creative Commons Attribution 4.0 International license.