The Clone Wars: Competitive Dynamics in the Internet Video Industry Kenny Ching1 Last updated: December 2013 <DO NOT CITE OR QUOTE WITHOUT PERMISSION> Abstract: This paper seeks to improve our understanding of the process of entrepreneurial strategy making by analyzing the competitive history of the Internet video industry in China. Leveraging a new hand-collected dataset that records activity by all entrants into the Chinese Internet video industry from 2006-2011, the paper documents how entrants that are able to adapt to a disadvantageous shift in the environment may end up outperforming those firms which chose a strategy that did not require change; and how strategic commitments to user communities can serve as a complementary asset to enhance the resilience of a start-up against disadvantageous shifts in their environment. Results are confirmed when the entrants were matched by entry and performance characteristics. The findings introduce a dynamic view to entrepreneurial strategy making by directly linking strategic choice to venture performance. 1100 Main St, E62-359, Cambridge, MA 02142, Email: [email protected], 1 Acknowledgement I thank Scott Stern, Fiona Murray, Yasheng Huang, Joshua Gans, Sarah Kaplan, Neil Thompson, Christian Catalini, Phech Colatat, Eunhee Sohn, Jae-kyung Ha, Tristan Botellho, Josh Krieger, Michael Bikard and Kenneth Huang as well as audiences at the Transatlantic Doctoral Consortium, CCC Doctoral Consortium, Academy of Management Meeting and MIT-TIES Seminar for helpful comments. The quantitative data in this paper is developed with the excellent assistance of Ziye An, You Wang and Angela Mao, and I am especially grateful to Allen Chen of iResearch for help in obtaining performance data and arranging field interviews. All errors remain mine. I acknowledge funding from the MIT Sloan Roberts E-Center Fund. Please direct comments and advice to Kenny Ching, 100 Main St, E62-359, Massachusetts Institute of Technology, Cambridge, MA 02142, U.S.A. Email: [email protected] 2 1 Introduction The early stages of a new industry are often uncertain and convoluted as firms explore potential options. As a consequence, firms that adopt the eventual dominant business model often arrive there following different paths. However the few empirical studies that examine startup performance and strategic choice either ignores the dynamic nature of strategy- making or only examine the initial strategic choices made by the startups. Although building blocks are available from prior work on firms that transit from old to the new (Anderson & Tushman 1990; Henderson & Clark 1990; Klepper & Simons 2005; Suarez & Utterback 1995), we know relatively little about the long-term implications of strategic choices made as firms navigate the decidedly uncertain startup environment. While the business world is rife with similar examples of firms that succeeded only after strategic change, a dynamic view is rarely explored in the entrepreneurial strategy literature. One of the reasons why our understanding of this critical process in entrepreneurial strategy is relatively poor is that empirically it is extremely difficult to disentangle the strategic resource from the entrepreneurial idea or opportunity. For example, Tesla’s success has been credited to a successful distribution strategy in eschewing the traditional car distributor, thereby securing higher than average margins (Gertner, 2012). However, this is also conflated by Tesla’s substantial innovation in battery technology, which allows its cars to compete effectively with traditional gasoline based automobiles – the origin of the underlying entrepreneurial opportunity. This paper undertakes a novel approach to address some of these empirical challenges. I leverage a unique entrepreneurial development in China’s emerging Internet video industry to identify a set of ventures that are exploiting the same underlying entrepreneurial opportunity. The enforced exclusion of YouTube and other foreign Internet video websites from the Chinese Internet market inspired a rush of domestic entrepreneurs who surged in to create the dominant Chinese Internet video websites. Between 2006 and 2008, more than 100 Internet video websites were spawned in China. These clones not only capitalized on the original technological idea of distributing videos over the Internet (which had spawned in the US), but also experimented in different business models to exploit the 3 entrepreneurial opportunity (Liu et al. 2011). Aided as well by Chinese Internet users’ desire for localized content (Fung 2008), these domestic entrants arose in an entirely separate and distinctive entrepreneurial context. These unique institutional features in the Chinese Internet space allowed for the simultaneous inception of multiple ventures with varied business models around the common entrepreneurial opportunity of becoming China’s dominant Internet video platform – the ideal experimental petri dish to observe entrepreneurial strategy at play. Consider the case of YouKu.com, China’s current dominant Internet video firm that is listed on the New York Stock Exchange. While it started as a pure User Generated Content (UGC) firm and sourced content from Chinese Internet users as its only content offering, it dynamically transitioned to a Mixed firm which also offers Professionally Produced Content (PPC) – content licensed from traditional media producers such as TV and movie studios – after regulatory changes in 2008 severely curtailed the UGC business model. Despite starting with a business model that would be severely challenged by regulatory changes in the future, the firm grew and adapted to be the most successful and dominant Internet video platform in the world’s largest Internet market. In this study, I introduce a new hand-collected dataset tracking all entrants into the Chinese Internet video industry from its inception in 2006 to 2011. My data allows me to follow business model strategies on a dynamic basis, including when firms change or pivot from their initial business models. I document how the most successful entrants are those which, despite starting with business models that were eventually challenged by unfriendly regulatory change, successfully adapted their business models to the dominant one. Results are confirmed when the entrants were matched by entry timing, ownership and performance characteristics prior to the regulatory change. My evidence suggests in general that in the Internet video industry, the most successful firms leveraged capabilities gained from commitment to tapping the user community, as they strategically evolved. These capabilities not only allowed them to develop new business models but also directly aided their performance. This study makes two primary contributions. First, the puzzle of the superior performance of firms switching business models serves as early evidence that firms which successfully adapt and change strategies can actually succeed in a 4 nascent industry. This perspective extends existing work on the importance of organizational flexibility in the face of commercialization uncertainty (Bayus & Agarwal 2007; Eggers 2012; Marx & Hsu 2012). In doing so, this study also adds to our understanding of competing business models in nascent industries, and demonstrates a dynamic approach to understanding the firm-level implications of strategic choice. Second, I offer a theoretical mechanism that explains the observed empirical outcome. This mechanism of leveraging the user community extends extant frameworks on user innovation (Von Hippel 2009), complementary assets (Teece 1986; Gans & Stern 2003) and platform strategies (Gawer & Cusumano 2012), by explicating the role of the user community (and their contributions) as complementary assets. I demonstrate how early investment into building a user community plays complementary roles in the websites’ eventual switch to offering professional content. This has broad implications beyond the context of this study as researchers seek to understand the strategic role of user communities (Bogers et al. 2010; Boudreau 2010; West & O’mahony 2008). To my best knowledge, this is the first study that explicitly links engagement of the user community to actual performance outcomes. More broadly, this study complements and extends the literature on entrepreneurial strategy, by introducing a dynamic view of strategy over time, and brings new identification to extant literature by delineating the underlying entrepreneurial opportunity from the strategic choice. Together with recent work on entrepreneurial strategy (Marx & Hsu 2012; Wakeman 2008), this study offers a more complete view of the dynamic processes of entrepreneurial choices in a nascent environment. By suggesting that firms which adapt and switch may be able to benefit from their failed experiences under the right set of circumstances, this paper present a detailed picture of the complex dynamics affecting strategic choices in the context of competing and uncertain options. This paper is organized as such. Section 2 outlines key theories underpinning the study and lays out the key motivating research hypothesis. Section 3 then introduces my empirical setting and approach, with an emphasis on my empirical approach in delineating the strategic resource from the underlying entrepreneurial opportunity. Section 4 presents the main empirical analysis 5 alongside key robustness checks. The paper concludes in Section 5 with further discussion on my main findings and broader strategic implications