Your firm has been asked to invest in a new, early stage firm.  The firm is in a brand new industry and, although the firm is still in its early stages, it believes it has a very promising new...

Your firm has been asked to invest in a new, early stage firm.  The firm is in a brand new industry and, although the firm is still in its early stages, it believes it has a very promising new product. Other new firms are also in this industry and also have their own new products.  At this stage, long term demand for products in this industry are expected to be strong. You have been asked to evaluate this situation for your firm – before they make any investment. What are your recommendations and why?   

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kipling2448 | (Level 3) Educator Emeritus

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All of the information provided in the student's question regarding a hypothetical decision to invest in a new company with a promising product and, presumably, an identified and substantial market, suggests that the employee or consultant's recommendation would be to pursue the acquisition of the new company. It is the rare corporation that is not regularly and vigorously researching ways to expand and become more profitable. The scenario described also indicates that the new firm's product is similar to products being offered by competing businesses. The corporation's managing officials, then, would be wise to consider the investment. If this "new firm" has already developed the product in question -- in other words, the "new firm" has already covered the research and development costs associated with a new product -- than the attractiveness to the larger corporation of investing in the new firm increases even more. Research and develop costs can be substantial, and recouping those costs through sales is always the challenge. If those costs have already been paid, then the potential down-side to the acquisition shrinks considerably.

An alternative perspective to the above argument can involve a careful analysis of the market for the product, or category of products, in question. As the student's question notes, other firms are already in this market with similar products of their own. A decision to invest in the new firm, then, has to be at least partly predicated upon an assessment of whether the market can absorb one more competitor. At some point, the market becomes saturated, and the winners and losers will start to emerge. The established firm looking at the new firm may not want to accept the risks associated with such an investment if it believes other companies have already secured market-share. Now, if the new firm's product appears qualitatively better than that of the competitors and represents a newer generation of the technology involved, and even if it doesn't, then a decision could hinge on calculations of whether a clever marketing strategy can prove the difference between being a winner and a loser. Marketing, after all, exists to give the impression that one company's product is better, and a better buy, than the others. A successful marketing strategy can overcome qualitative, and even cost disadvantages, so the established firm's analysis would have to factor into its equation the prospects that its marketing division (or outside advertising agency) could overcome hurdles with respect to public perceptions of the company.

Given the limited information provided in the question, one could easily arrive at the conclusion that the established, older firm's decision would be to move forward in merging with or acquiring the new firm, or just investing in the new firm's product. The risk of missing out on "the next big thing" is often too much to ignore. There are only so many seats at the table, and no firm wants to be the one left out of the market. To ignore that market could result in the established firm being increasingly marginalized if perceptions emerge that it has grown old and stale and too reluctant to take a risk on the future.

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