Basing market-entry decisions on objective predictors

For every successful market entry, about four fail. Some of these failures are inexperienced start-ups, but many are sophisticated corporations and experienced entrepreneurs.

by The McKinseyQuarterly 2005, No 4
Last Updated: 23 Jul 2013

Often the problem can be attributed to cognitive biases - systematic errors in the way executives process information. When confronted with a difficult decision, most executives rely on an inside view, focusing excessively on the specific issue of the time. This tendency prevents them from developing an outside perspective based on previous market entries and even from assessing opportunities on the basis of common predictors of success.

In addition, cognitive biases often lead executives to believe that their company's skills are more relevant than they really are, that the potential market is bigger than it really is or that rivals will not respond to the move. Business history is littered with examples illustrating how serious such miscalculations can be.

However, some practical steps can help executives control these biases and so improve their odds of success. First, objective predictors of success can be used to create a reference class, a group of similar decisions that other companies have made in the past.

This class typically yields comparative data that are a valuable reality check on the analysis carried out within the organisation. Above all, having such a class should counteract the tendency of decision-makers to fall into the "confirmation trap", where they seek information that confirms their hypotheses.

Statistical research shows that six factors - size of entry relative to minimum efficient scale, relatedness of the market entered, complementary assets, order of entry, industry life-cycle stage and degree of technological innovation - are particularly important predictors of success.

The first step for a would-be market entrant is to assess which of these is most relevant and construct a reference class accordingly. It is important that the reference class includes failed market entries as well as successful ones, so that it more accurately reflects what really happens.

Besides developing a more objective view of their plans, companies should also remove biases from their analysis of entry decisions. This involves targeting five core issues - the value proposition and capabilities, the size of the market, the competition, market share, and revenue and costs. Depending on the circumstances, other issues such as regulatory concerns, will be important. Then, the reference class is used to test each issue.

Companies that do this should then be in a much better position to decide whether to go ahead with their original plan, adapt it in some way or to abandon the idea altogether.

Source: Beating the odds in market entry: how to avoid the cognitive biases that undermine market entry decisions
John T Horn, Dan P Lovallo and S Patrick Viguerie
The McKinsey Quarterly 2005, No 4

Review by Roger Trapp

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