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Entrepreneurship, Innovation and Ethics In the Turbulent Internet Age Philip Rosson* School of Business Administration Dalhousie University 6152 Coburg Road Halifax, Nova Scotia Canada B3H 3J5 (902) 494–3161 (T) (902) 494–1107 (F) [email protected] & Jeremy Hall Haskayne School of Business University of Calgary 2500 University Drive N.W. Calgary, Alberta Canada T2N 1N4 (403) 220–2694 (T) (403) 282–0095 (F) [email protected] *Address all correspondence to Philip Rosson This paper contains original work that has not been presented at a conference or submitted to a journal Abstract We investigate the entrepreneurial opportunities and ethical dilemmas presented by technological turbulence. More specifically we investigate the line between productive and unproductive (i.e. illegal or unethical) entrepreneurship (Baumol 1990) through three examples of Internet innovation—spam, music file sharing, and Internet pharmacies. The emergence of accessible Internet technologies has, under present norms, generated the potential for unproductive entrepreneurial activities. Because of the propensities for self-serving biases (Baron 1998), the need for creativity in overcoming obstacles, bending or breaking the rules (Bhide & Stevenson 1990), and overall “liabilities of newness” (Stinchcombe 1965), entrepreneurs are likely to challenge established industrial morals and laws (Raiborn & Payne 1990). Unlike new entrants, incumbents must abide by the currently accepted norms, and thus suffer from “liabilities of oldness” (Dobbin & Dowd 2000). The challenge for new entrants is to change sociopolitical legitimacy (Aldrich & Fiol 1994), whereas incumbents need to defend the established norms. We discuss competitive and other issues that result from technological turbulence and innovation.


Entrepreneurship, Innovation and Ethics In the Turbulent Internet Age Introduction Technological turbulence creates entrepreneurial opportunities, a challenge to incumbents and established norms, and in some cases ethical dilemmas. Indeed, technological innovation has long been recognized as the main driver of industrial growth as well as a major cause of social disruption. For example, Schumpeter (1934) argued that an economy is healthy when it is in a state of dynamic disequilibrium, resulting from the activities of enterprises and entrepreneurs that bring forward new combinations (of products, processes, markets etc). Such dynamics create discontinuities and the obsolescence of existing technologies, businesses and economic systems, or what Schumpeter referred to as “creative destruction.” From the firm’s perspective, innovation is a difficult and expensive activity, yet often a key to survival and a main source of sustained growth (Penrose 1959; Schumpeter 1934, 1942). It is also a primary source of competitive advantage, as well as a significant source of uncertainty, competitive disruption and failure (c.f. Teece et al. 1997; Eisenhart & Martin 2001). R&D projects, for instance, can be unpredictable, and even when they are successful, unforeseen or uncontrollable external factors often determine whether an innovation will gain widespread acceptance (c.f. Arthur 1988; Nelson & Winter 1982; Rogers 1983). Innovative activities thus create both winners and losers. Whether in the form of corporate venturing or new entrepreneurial activities1, innovative activities have become the focus of both management and policy makers. Baumol (1990) frames the contrasting impacts of entrepreneurial activity as being either “productive entrepreneurship” (i.e. socially beneficial activities derived from new, improved technologies or ways of doing business) or “unproductive entrepreneurship” (i.e. entrepreneurial activities that do not create socially beneficial improvements, but instead seek rents through for example the exploitation of legal loopholes or criminal activity). He thus recognizes the importance of innovation and entrepreneurial activities in economic growth as well as ethically unfair—and thus socially undesirable—behaviour. Baumol (1990) further notes that society’s rules and norms create incentives that influence entrepreneurial activities. Similarly Aldrich and Fiol (1994) argue that emerging entrepreneurial activity is in part dependent upon its level of legitimacy, or what Stinchcombe (1965) calls “liabilities of newness.“ Aldrich and Fiol (1994) identify two dimensions of an industry’s legitimacy: (1) cognitive, or knowledge about the new activity and 1

For the purpose of this discussion, we use the term ”entrepreneurship” to mean what Sharma and Chrisman (1999) more precisely refer to as “independent entrepreneurship“ where an individual or group create a new organization independently of any existing organization.


what is needed to succeed in an industry; and (2) sociopolitical, or the value placed on an activity by cultural norms and political authorities. Sociopolitical legitimization is thus the process by which key stakeholders accept a new venture, given existing norms. Such non-economic criteria are emphasized by Schumpeter (1934): “a fact is never exclusively or purely economic; other—and often more important—aspects always exist” (p. 3). In other words, firms always face an external environment that can affect their success (Katz & Shapiro 1985; Rogers 1983). Such external forces have been analyzed with stakeholder theory. For example, Freeman (1984) proposed a framework that considers the variables of external change, such as the emergence of new stakeholders. In addition to value chain members, communities, governments, the media, NGOs, etc can be considered stakeholders as far as these new actors either affect or are affected by the firm’s activities. We argue that they can also play a role in enforcing or thwarting the legitimacy of an incumbent or new technology or venture. In this paper we investigate technological turbulence and Internet innovations. More specifically we investigate the fine line between productive and unproductive (i.e. illegal or unethical) entrepreneurship through three examples of Internet innovation—spam, music file sharing, and Internet pharmacies. We argue that the emergence of easily accessible Internet technologies has, under the present rules and norms, created a predicament regarding both the strict legality of the technology versus the degree to which it is socially productive or unproductive. The challenge for incumbent firms (i.e. the potential losers) is to defend against a potential change in sociopolitical legitimacy that favors the new entrants. In the process, incumbent firms must abide by the currently accepted rules and norms, and thus suffer from what could be termed “liabilities of oldness“ (Dobbin & Dowd 2000). Conversely, new entrants must focus their efforts on legitimizing their activities. We thus bridge the innovation literature (which focuses on technological effectiveness) with institutional theory (which also considers sociopolitical legitimacy). A key challenge facing new Internet companies, incumbent firms and other stakeholders is to understand the interconnected relationships between technological innovation and sociopolitical legitimacy, yet this is insufficiently recognized or understood. Entrepreneurial Opportunities and Incumbent Hazards Opportunity identification is generally regarded as the first stage of the entrepreneurial process Timmons (1990) . An opportunity is a “favorable set of circumstances creating a need or an opening for a new business concept” (Morris 1998). The opportunity can originate in different ways: from demographic, industry or technology changes, as a result of unforeseen events, or because of incongruities (Drucker 1985). In any case, there remains the ability to identify the


opportunity. Kirzner (1979) defines such entrepreneurial knowledge as “a rarified, abstract type of knowledge—the knowledge of where to obtain information (or other resources) and of how to deploy it.” Entrepreneurial cognition, specifically the ability to use heuristics to extrapolate from previous experience in order to deal with new situations, is also critically important (Alvarez & Busenitz 2001). Entrepreneurs thus require both a basis of knowledge and the understanding of how to use that knowledge to interpret and theorize under conditions of partial ignorance (Hayek 1945). Yet because their heuristics and previous experience have not been shaped by industrial norms, they may be more willing to challenge existing norms (Baumol 1990) and are open to opportunistic behavior that would otherwise be unacceptable by incumbents. Naturally, a critical first step is for the entrepreneur to assess the size and scope of the opportunity, using criteria similar to those proposed by Timmons (1990). When attractive opportunities are identified, the timing of any response is crucial, since there is always the risk of being too early or too late with a market launch, i.e. a narrow strategic window of opportunity (Abell 1978). Such pressures may increase the necessity to act sooner rather than later, which in turn may push ethical boundaries. Empirical research also shows that new firms tend to be more successful with radical innovations, whereas established firms are more likely to do better with incremental innovations (c.f. Christensen 1997; Utterback 1994). Anderson and Tushman (1990) for example argue that established firms are reluctant to engage in competency destroying activities as these could be detrimental to their established competency base. Initially inferior technologies may be applied in niche markets and later disrupt mainstream incumbent technologies as technological improvements emerge and selection criteria change (Hart & Christensen 2002). Afuah (1998) notes that entrepreneurs are not constrained by present technologies, products and market positions. He further argues that an innovation is more likely to succeed if it does not disrupt the competencies of other innovation-value chain members. Entrepreneurs are drawn to opportunities marked by uncertainty (Ronen 1983), or perhaps are ghettoized into these areas because they cannot compete in established competitive environments, as radical innovation is by its very nature difficult and risky, whereas incremental innovation is alluring for incumbents (Christensen 1997). Table 1 summarizes these concepts. Incumbent firms generally possess cognitive legitimacy, the technical and commercial knowledge and capabilities needed to compete, whereas new entrants must face the difficult challenge of accumulating it. Radical (competency destroying) innovation changes the rules of the game, thus offering opportunities for new entrants. Incumbents also possess sociopolitical legitimacy, which can be both a benefit and a curse; the latter because it dictates norms and guidelines that outsiders may not have to follow, i.e.


“liabilities of oldness”. Of relevance here is that ethical and legal constraints may be vulnerable to de-legitimization, thus opening up opportunities (albeit questionable) for new entrants or the use of business practices that may be unproductive or destructive, as suggested by Baumol (1999). Table 1: Innovation, Legitimacy and Liabilities of Newness/Oldness Cognitive legitimacy (Technical/commercial criteria)

Sociopolitical legitimacy (Non-technical norms and values)

Incremental innovation

Reinforces Incumbents’ positions

Reinforces barriers to entry Incumbent advantage

Radical innovation

Obsolesces incumbent’s knowledge base; window of opportunity for new entrants

Restrains incumbents from testing norms and ethical boundaries: window of opportunity for new entrants

Entrepreneurship and Ethics According to Ferrell et al. (2002) business ethics “comprises principles and standards that guide behavior in the world of business”, and are thus within the realm of sociopolitical legitimacy. At issue here are actions that might be considered good and right versus bad and wrong (Henderson 1982), and thus involves the relationship between law and ethics. Although these fields are clearly related, they are not synonymous. Scholars point out that (1) laws tend to lag the moral standards of society, (2) laws may not necessarily be ethically sound, and (3) unethical acts should not necessarily be made illegal (Hosmer 1991). This situation leads the philosopher Hospers to conclude that “for most ethical systems there is much more involved in figuring out what is morally right than considering what is legal” (1988). By considering both moral aspects (spirit of the law) and legal aspects (letter of the law), Raiborn and Payne (1990) formulate a hierarchy of ethical behavior founded on the types of standards used in cost accounting. It begins with the most moral behavior and ends with behavior that is legally acceptable. There are four levels in the hierarchy: theoretical, practical, currently attainable, and basic. The highest level of behavior is the ideal theoretical level, which is impossible to reach and represents the highest potential towards which society should continuously strive. The practical level represents behavior, which can be achieved the majority of the time through diligent effort. The currently attainable level represents the behavior normally exhibited by individuals. In the final level, the basic standard, behavior is acceptable since it is within the letter of the law; however, this level does not reflect any attempt to comply with the spirit of the law. Decision-making also requires


that a balance be struck between the interests of important stakeholders (e.g. shareholders, employees, customers, and community), without violating the rights of any single group (c.f. Freeman 1984; Phillips et al. 2003; Mitchell et al. 1997). Questions about ethical behaviour are particularly problematic for entrepreneurs. Several authors (e.g. Vyakarnam et. al. 1997; Teal & Carroll 1999; Humphreys et al. 1993) have presented evidence that entrepreneurs or small business owners/managers differ from other individuals in the moral issues they face and how they deal with them (Kohlberg 1973) Timmons & Spinelli (2004) write “numerous ethical dilemmas challenge entrepreneurs at the most crucial moments of survival, like a precarious walk on a tightrope.” The necessity of making decisions in high–pressure situations might lead to expedient rather than appropriate choices. The entrepreneur’s strong commitment to his/her ideas and business can produce a self-serving bias and self-justification, and lead to unethical decisions (Baron 1998). A more general challenge for entrepreneurs is pointed to by Bhide and Stevenson (1990), who see the reconciliation of “entrepreneurial” and “ethical” behaviour as difficult, given that the former often involves creatively overcoming obstacles, bending or breaking the rules, exaggerating a position etc. Studies that focus on venture development stages also provide useful insights. Vyakarnam et al. (1997) identified four areas in which the ethical issues confronting small business may differ from those confronting agent managers in larger firms: nature of entrepreneurial activity itself, prioritizing stakeholders, conflicts of interest (separating self from business), and personality issues. A review of ethical decision-making at start-up, transition and maturity stages, reveals a number of countervailing forces among start-up companies. “Pragmatic operational demands, limited management controls and lack of public visibility in early stages may reduce pressure to act ethically. At the same time, the entrepreneur’s pride and personal identification with the venture may encourage a higher ethical standard” (Morris et al. 2002). Although these descriptions are straightforward, commentators make the point that ideas about acceptable corporate behavior are complicated by the changing nature of society and the various interest groups with whom companies must deal (Kuratko & Welsch 2004). Thus sociopolitical legitimacy is dynamic; what are considered appropriate principles and standards will vary over time, reflecting changed social mores and values. These changes, coupled with technological turbulence (i.e. competency destroying innovation) can lead to the opening of opportunities for both cognitive and sociopolitical legitimization for new entrants.


Evaluating Innovations Although there is a vast literature on the evaluation of innovations (e.g. see Afuah 1998), the majority focuses on mostly technical/commercial viability, or primarily cognitive legitimization issues. The inclusion of non-technical, subjective issues has for the most part been ignored within the technology management literature. However, one view proposed by Martin (1994) and later

Harper (1996 sees an innovation or new entrepreneurial activity as an experiment, that is a Popperian conjecture that must be tested first by the entrepreneur, then the market. Kaplan and Norton (2001) similarly argue that a firm’s strategy can be conceptualized as a series of linked hypotheses that should be constantly tested. Martin (1994) argues that the following tests, or hurdles, must be overcome if an innovation is to be commercially successful: (1) it must be demonstrably feasible technologically; (2) it must be demonstrably feasible commercially; (3) any health, safety, and environmental impacts must be socially acceptable; (4) relevant government policies should be supportive; and (5) it should be congruent with corporate objectives and goals. More recently Hall and Martin (2003, 2004) have argued that four general areas of innovative uncertainty, as suggested by Freeman and Soete (1997), must be overcome: technological uncertainty (i.e. the innovation or venture must be demonstrably feasible based upon corporate scientific and technological competencies); commercial uncertainty (i.e. it must be commercially feasible); organizational uncertainty (i.e. it should be appropriable and congruent with the overall strategy and capabilities of the firm); and societal uncertainty (i.e. any side effects, externalities or societal concerns must be overcome). Drawing on Simon’s (1969) concerns over imperfect information, Hall and Martin (2004) suggest that the more complex (i.e. more interacting variables) and ambiguous (i.e. inability to identify key variables) the uncertainty, the more difficult it is to determine the viability of the innovation. This is often the case for social uncertainty, which parallels sociopolitical legitimization, as there are many stakeholders with varying demands, perspectives and norms. They further suggest that managers are ill-prepared to deal social uncertainties because the vast majority of management training is based on the Popperian approach and focused on reducing uncertainties through for example actuarial sciences, market studies, simulations, etc. Such techniques are only applicable if key variables can be identified and probabilities can be reasonably estimated. As discussed above, corporate ethics and norms do not fit within this managerial decisionmaking framework because they are often subjective, complicated and continuously changing. Within an ethical context, the challenge for incumbents and new entrants alike are thus to manage not only the somewhat pedestrian challenges of technological and commercial viability, but also the more subjective and often ambiguous social uncertainties. Technological developments, such as those driving the Internet, may present not only disruptions in cognitive,


but also sociopolitical legitimization. An entrepreneurial opportunity—or incumbent hazard—is presented because it is not always clear where to draw the line regarding socially acceptable behavior (Raiborn & Payne 1990), while acceptable business behavior is influenced by environmental circumstances and subject to change (Baumol 1990; Kuratko & Welsch 2004). The specific challenge for new entrants is thus to change ethical norms and the legal infrastructure by arguing that such changes will lead to socially productive entrepreneurship; conversely incumbents must demonstrate the opposite. In the next section we describe three cases of Internet-based of innovation. These illustrate entrepreneurial opportunities that have been identified and exploited, as well as challenges laid down to incumbent firms. Further, the cases permit more detailed examination of the concept of productive versus unproductive entrepreneurship. Three Case Examples For each of the three Internet innovations, we define the innovation in question, gauge its impact, sketch in the five-Ws (who, what, why, when, and where), and then outline relevant issues and actions. The innovations appear in chronological order. Spam Spam2 is the word commonly used to describe unsolicited bulk e-mail or unsolicited commercial e-mail (UBE/UCE). Spam has become so large an issue for the Internet that some observers talk about it bringing about the end of e-mail, the Internet’s most successful application. A few statistics suggest the scale of the problem. It is reported that spam makes up 15% to 20% of the inbound e-mail at typical corporations in the US and 30% of inbound e-mail at Internet service providers (ISPs). Apparently, spam could cost US corporations $10 billion in 2003, due to lost productivity and increased staff and operating costs (Andrews 2003). Because it is the biggest ISP, AOL

is targeted by many spammers; on average it blocks 780 million UBEs daily ("Business:

stopping spam" 2003). Although spamming can be traced back to the late 1980s, it is generally agreed that the first large-scale use of spam for commercial purposes occurred in 1994, when two lawyers in Phoenix, Arizona, attempted to solicit new clients. They hired a computer programmer to write a script that would post an advertisement to all of the 6,000 or more newsgroups (or message boards) on 2

Why the term “spam”? The most frequent explanation dates back to a restaurant skit on the 1970s television program Monty Python’s Flying Circus. The Viking customers are told that every dish includes the canned luncheon meat Spam, prompting them to sing about “spam, lovely spam, wonderful spam.” It is rumoured that the word spam was repeated over 100 times in a two and a half minute skit. Thus, spam is “something that keeps repeating and repeating to great annoyance” (Templeton 2003) An alternative explanation is that spam stands for “simultaneously posted advertising message” (Mitrovic 2002).



the largest online conferencing system (Templeton 2003). The ad was then delivered to

individual members of all of the newsgroups, announcing legal services to help immigrants participate in the federal government’s “green card lottery,” a program that awards people permits to live and work in the US. The ploy was successful, bringing in $100,000 of business for Canter and Siegel (C&S), the husband-and-wife lawyers involved. Although successful for C&S, many people were outraged by this use of the Internet; so much so that the law firm received 36,000 angry e-mail messages over two days. The main objections focused on the widespread and nondiscriminating nature of messages transmitted and newsgroups targeted (Sandberg 1994). This breached “netiquette” (Donaldson & Dunfee 1999) at the time leading one analyst to write “users not borne of the Internet culture are less inclined to conform to that culture” and “the opportunity for financial gain is a powerful incentive for flaunting voluntary ethical guidelines” (Bashkin 1994). C&S saw the situation differently, arguing that the dominant users of the Internet (largely the academic community) were opposed to the commercialization of the Internet by newcomers like themselves (Lawrence 1994). C&S were unrepentant about their actions. They soon abandoned immigration law, penned a book How to Make a Fortune on the Information Superhighway, and established a cyberspace consulting practice (Higgens 1994). C&S opened the Internet world to spam but faded into obscurity within a year or so. Continuing public attacks on the lawyers were a contributing factor in the company’s demise. In the 10 years since 1994, an ideal environment for spamming operations has evolved. Spamming has grown because (1) e-mail use is a growing and almost universal activity among those online, (2) spamming costs are very low, (3) consumers and businesses increasingly carry out commercial transactions on the Internet, and (4) governments and others have been slow to respond to a mounting problem. E-mail is the most popular activity for people online, as reflected by the number of accounts and usage levels. There were 505 million e-mail mailboxes in use in 2000 and this is expected to climb to 1.2 billion by 2005 (Pastore 2001), and the number of emails sent is forecast to double to 60 billion a day between 2002 and 2006 (Saunders 2002). With these levels of existing activity and projected growth rates, it is small wonder that e-mail users have attracted the attention of spammers, whose entry into the business is made even more attractive by the cost structure of the business. With low operating costs, messages that receive a tiny response rate (e.g. as low as one in 100,000) will potentially yield a profit.3 The growing interest and participation of consumers and businesses in e-commerce has also benefited 3

Spamming software is available online free or for a few hundred dollars. CD-ROMs of mailing addresses cost about $5 per million ("Business: stopping spam" 2003), and transmission costs are essentially zero for the sender, although there is a cost to the ISP, who passes this on to Internet users. This is in marked contrast to physical junk mail where the sender bears the cost of the mailing.


spammers. As buyers become more open to purchasing a variety of products and services online, and as confidence develops as a result of successful prior transactions, the potential for business via UBE/UCE increases. A final reason for the growth of spamming is that governments and other bodies have been uncertain about what actions should be taken to regulate these activities (see below). What issues are raised by spamming and why does it create more negative feelings than physical junk mail? The Coalition Against Unsolicited Commercial E-mail (CAUCE) is one of many organizations opposed to spam, which it criticizes as follows (Kennedy 2002): •

Cost shifting—spammers steal time and bandwidth from users and their ISPs.

Fraud—spammers disguise their messages because they are not welcome.

Resource waste—spam clogs the Internet and corporate servers.

Displacement—spam reduces the efficiency and value of regular e-mail.

Annoyance—spammers co-opt e-mail addresses and identities.

Ethics—spammers mostly offer products and services of dubious legality.4

The unsolicited and unwanted nature of spam has led large numbers of Internet users to install spam-blocking software so as to reduce the volume of messages reaching mailboxes. About 75% of US companies employ such software in 2003, and this will rise to 98% by 2007 ("Spam: filters and further protection" 2003). Technical advances, however, make this a “cat and mouse” game, with advances on one side being neutralized by the other. Governments are now taking a stronger stand against spammers. At present spamming is not illegal in the US, although this may change. Senate passed the anti-spam bill S. 877 in October 2003, which will now go to the House of Representatives before becoming law. CAUCE and others do not support the bill, arguing it does not go far enough.5 Individual states have taken stronger action: more than 20 states had anti-spam laws in 2003 (Nelson 2003). Europe has taken the approach that many others would like to see, permitting bulk e-mails only to individuals who have opted to receive them. Thus, the European Union has essentially banned spamming and member states have until October 2003 to implement the 4

A leading supplier of filtering software reports that “adult” offerings and “scams” account for 12% and 10% of all spam, respectively. Adult offerings include pornography and relationship advice, while scams include such items as Nigerian investments and pyramid schemes (Brightmail 2003). 5 The proposed legislation does not require that individuals opt to receive the e-mail messages (“opt-in”) nor does it provide for the possibility of private action against e-mail offenders.


necessary legislation ("Business: stopping spam" 2003). Canada has been slow to respond to the problem of spam (Geist 2002). Despite the development of new blocking software and increased legal action, spammers are very difficult to neutralize. Some are too small to be worth suing (Mangalindan 2002) whereas others that have a great deal at stake are elusive. These companies move their operations from one ISP

to another, and from country to country, seeking out businesses and nations with the laxest

standards and laws (Stone and Lin 2002; Schwartz 2003). These latter companies are closely monitored and tracked. It is claimed that 90% of the traffic in North America and Europe emanates from 200 spammers and their “spam gangs” (Spamhaus 2003). The present situation leads some analysts to conclude that the only way to halt spamming is through a different economic model. At present, almost all of the delivery costs of e-mail are borne by the receiver, i.e. ISPs, companies that maintain servers, and individuals. Implementing a small charge for sending each e-mail would dramatically change the profit equation for spammers that send out hundreds of millions of e-mails on a daily basis (Hammonds 2003). Music File Sharing This innovation made it possible for Internet users to download music files from other users’ computer hard drives at no cost. Shawn Fanning, a teenage college student, wrote the software that made this possible. Millions of users saw the value of Fanning’s software and, for a two-year period, Napster—the name of the software and company—was one of the Internet’s biggest brands. However, its success was short-lived. In mid-2001, Napster ceased operations as a result of legal action taken by the music industry. Despite closing down Napster, record labels are still fighting file sharing. Other firms have taken Napster’s place and are less easy to take action against. Largely because of file sharing activity, sales of recorded music fell by 7% in 2002, and 11% in the first half of 2003 (Evans & Thompson 2003). Developments in file sharing technology are also of concern to other digital content providers, including movie companies. Two technical breakthroughs were instrumental in the development of Napster: (1) MP3 technology6 that permitted the compression, storage, and retrieval of music files from a computer without much loss of quality, and (2) the development of Internet Relay Chat (IRC) that enabled users to communicate with each other online through such services as ICQ and AOL Instant Messenger. The idea of sharing music files arose naturally; people chatted online about music (and MP3s) and agreed to swap songs (Cyriac et al. 2003). Swapping with friends was one thing, but Fanning discovered that finding MP3s on the Internet was problematic; many file links were 6

MP3 is a standard that was developed by the Fraunhofer Institute in Germany in 1992. It significantly compressed audio files while retaining sound that was almost the quality of a compact disc.


broken, file indexes were out-of-date, etc. Fanning decided to tackle these problems and started writing the code that would become Napster in 1998, while he was a student at Northeastern University in Boston. His goal was to develop software that would help users to share personal music collections, find MP3s on line, and chat about music. Fanning found that he was unable to study and make sufficient progress with programming. He therefore decided to leave school in January 1999 to devote all of his time to the project. Following initial testing of the software, and at uncle John Fanning’s insistence, Napster (Fanning’s nickname) was incorporated in May 1999.7 Napster was an immediate hit. Fanning gave the beta version of Napster to 30 friends in a chat room to test. Within three days the number of testers grew to 4,000. News of the software spread rapidly by word-of-mouth and usage grew to the point where students at some universities were tying up significant computing resources as they exchanged music files (Cyriac et al. 2003). With some initial financing in place, Napster moved to California, appointed a CEO, and began the task of building an organization to handle rapid growth. Fanning gained such notoriety that he appeared on the cover of leading magazines such as Time, Business Week, FORTUNE, and the Industry Standard. This provided wonderful exposure for the company as well as fueling discussion about the ability of the Internet to empower users. Fanning advocated empowerment and change, “I believe the Napster technology can help everyone involved in music—including artists, consumers, and the industry. New technologies can be a win-win situation if we work together on building new models, and we at Napster are eager to do so” (Biren 2003). Industry did not agree. In December 1999, the Recording Industry Association of America (RIAA) sued Napster for (1) copyright infringement, arguing that the software allowed users to access music at no charge, and (2) harm, claiming that Napster materially damaged the industry by depressing CD sales. After months of meetings with venture capitalists who rejected Napster’s approach as unethical and/or immoral, in May 2000, a $15 million investment was secured from Hummer Winbald of San Francisco. This funding was critical to sustaining operations since Napster had never tried to generate income from its software or web site.8 The company’s legal woes continued. A decision to close Napster pending a civil trial on the copyright issue was handed down in July, only to be stayed at the eleventhhour. October 2000 was a significant month for the company. On October 2, a three-judge panel heard arguments from the RIAA and Napster on the validity of the earlier ruling. Then, on October 31, it was announced that Napster had struck a deal with the e-commerce group of Bertlesmann,


It appears that Fanning’s motivations in developing Napster were not commercial, whereas his uncle’s very much were. See Menn (2003) for an account of their relationship. 8 Eighteen months after releasing its software to the public, Napster had 50 million users.


the world’s third-largest media company and owner of the BMG record label. Bertelsmann would loan Napster $50 million to develop a legal file-sharing service, with the option of taking a majority holding in the company. BMG would pull out of the RIAA lawsuit should Napster be able to develop the legal service. This arrangement helped Napster but also put pressure on other record labels because BMG obviously saw the future of music sales at least partly being via the Internet. On February 12, 2001, the court issued its opinion that Napster did indeed violate copyright laws. It therefore ordered that Napster stop facilitating music file exchanges through its website. Napster responded by installing a series of filters and blocks to prevent transfers of music files, but these proved not to be effective.9 Rather than risk further legal action, Napster closed the service in July 2001, with the intention of launching a subscription-based service at a subsequent date. This did not materialize, however, and in July 2002 Napster filed for bankruptcy protection. Bertlesmann now faces a $17 billion lawsuit brought about by songwriters and music publishers who claim that Bertelsmann kept Napster operational longer than was appropriate given the court ruling. Lawsuits from other parties are expected (Parloff 2003).10 Although the RIAA was able to close down Napster, others have come along to fill the void. Successor companies include KaZaA, Morpheus, Gnutella and Limeware (Cox 2002), and are creating difficulties for music labels. KaZaA, for example, uses peer-to-peer (P2P) technology developed by FastTrack in the Netherlands that operates through distributed and self-organizing networks, with so-called “super nodes” (or search hubs) appearing and disappearing according to demand. Unlike Napster, there is no one file-sharing index or log where records are kept that provide the basis for legal action. Further, KaZaA has located its servers in Denmark, software in Estonia, domain name registration in Australia, and corporate offices in Vanuatu (Woody 2003). P2P networks present challenges to other digital content businesses. Download activities now encompass much more than music files, including video, games and software packages ("Tipping Hollywood the black spot" 2003). Recent research reports a 300% increase in the number of P2P file sharing web pages in 2002.11


Downloads of music files via Napster servers reached a peak in March 2001, at 165 million files a day (Parloff 2003). 10 In October 2003, Napster resurfaced in the music business. Roxio, a digital media company acquired rights to the Napster name and logo for $5 million and used it to re-brand Press Play, a licensed online music service that it purchased from Vivendi Universal and Sony ("New-look Napster steps out to a different tune" 2003). 11 A disturbing statistic is that 42% of all file searches are for pornographic movies or images (Greenspan 2003)


Internet Pharmacies An Internet pharmacy can be described as one that uses the Internet to (1) promote the drugs it stocks, (2) list prices, and (3) generally facilitate the prompt and safe filling of prescriptions and other orders. Usually, Internet pharmacies were stand-alone entities, but in a few cases bricksand-mortar companies had established virtual operations to exploit an emerging opportunity. By mid-2003, there were about 40 Internet-based pharmacies in Manitoba, Canada, that had been established primarily to service US customers. This new “industry” did over $400 million annually in drug sales and employed 1,500 people, including 150 pharmacists ("Southern Manitoba labour market review" 2003; "Industry facts" 2003; Baglole 2003). It is not clear who originated the idea of Internet pharmacies but Andrew Strempler appears to have been one of the key innovators. In 2000, one year after graduating from pharmacy school, Strempler and his wife established a traditional pharmacy in a small town in Manitoba. This did not go well and with failure imminent, he wondered if the Internet might provide a solution. Recognizing that drug prices were higher in the US than Canada, Strempler experimented by offering Nicorette gum (a non-prescription remedy that helps people stop smoking) at what he believed would be attractive prices via eBay. The response was overwhelming and Strempler quickly developed a web site to sell the gum and a limited number of medical supplies. Customers in the US then asked if he could supply prescription drugs at similar low prices. “Andrew found that he could fill prescriptions as long as they were written by a Canadian doctor, and he figured out how it could be done” (Wolfe 2003). This led to the formation of a new company—Mediplan Health Consulting Inc.—to sell a wide range of prescription drugs into the US market at low prices, using the Internet (Redekop 2002). The business process that Strempler developed was relatively straightforward. Visitors to Mediplan’s online store RxNorth.com were able to search for drugs by category, product name or keyword. Search results are listed showing drug strength, quantity, and price (in US dollars). For prescription drugs,12 the order process is as follows. After finding the relevant drug online, the visitor was required to mail or fax a completed order form, liability waiver and prescription to RxNorth. The information was sent to a physician (licensed in Canada and paid by Mediplan) to review the information and write a Canadian prescription. This is a legal requirement. The prescription then went to a pharmacist to be dispensed. Shipping costs were $15 for a complete order and the delivery time was two to three weeks from receipt of required paperwork. Refills took one to two weeks. Various payment forms


Mediplan sells over-the-counter (non-prescription) drugs as well. Since no prescription is required, this process is quick and simple.


were available. Narcotics and sedatives were not sold and, since returns of drugs were not permitted, all sales were final. Mediplan made its first prescription drug sale in March 2001 and, by early 2003, had grown to the point where it was filling over 2,000 prescriptions a day, doing C$80 in sales annually, and employing 230 workers. Management believed it needed to establish a facility in a second location to handle the anticipated business growth. Like other Internet pharmacies, Mediplan enjoyed immediate success because it was able to combine low prices, the reach of the Internet, and simple and secure business processes, to provide a winning value proposition for many customers in the US. Many Canadian prescription drug prices were lower than those in the US because of quite different regimes. In the US, pharmaceutical companies were essentially free to set their prices without interference from government. In contrast, federal and provincial governments regulated drug prices in Canada with the result that in 2001, it was reported that drug prices were on average 69% higher south of the border (Gross 2003). The advent of Internet pharmacies made it possible for more US consumers to buy their drugs in Canada. Over the years, many US consumers had made trips to Canada to buy prescription drugs, but the actions of Mediplan and others created much higher levels of awareness and involvement. This was particularly relevant for older, poorer and uninsured Americans, who often struggled to pay for needed drug treatment. Several stakeholder groups took issue with the methods employed by Internet pharmacies. The regulatory bodies for physicians and pharmacists were opposed to certain aspects of Internet pharmacies. Colleges of Physicians, for example, made the point that patients must be examined before a doctor could write a prescription. The Canadian Pharmacists Association was concerned about the legality of drug exports and associated consumer safety questions. However, statements from national organizations were compromised by the fact that physician and pharmacist practices varied across the country. This meant that physicians and pharmacists took a stronger line in some provinces than others; Ontario and Quebec were most opposed to Internet pharmacies, whereas Alberta, British Columbia and Manitoba had the “softest” regulations. Under the US Food Drug and Cosmetic Act it is illegal to move prescription drugs across the US border. However, this legislation has not been enforced with regard to individuals. Whether dealing with US consumers crossing the border, or with packages destined for American addresses, the Food and Drug Administration seldom takes action when small amounts of drugs for personal use (i.e., no more than a three month supply) are involved. Initially, the cross-border sale of drugs was viewed as a minor disruption of normal business patterns by governments and politicians. Later, the trade became much more political. The fact that US citizens bought drugs


from Canadian sources was proof for many that there were fundamental problems in the US health care system. Health-care reform was expected to be a major focus in the 2004 presidential election but, for the moment, it was unclear what form this would take. For, while no elected official could ignore the plight of vulnerable groups (such as seniors and those without private health insurance), yet other groups (local pharmacies and the drug manufacturers) also had loud voices. For the time being, the importation of drugs from Canadian Internet pharmacies was illegal ("Canada, ho!" 2003). The very success of Internet pharmacies provoked a strong response from pharmaceutical companies. GlaxoSmithKline plc (Glaxo) was the first to take action. In February 2003, citing the “illegal, potentially unsafe importation of prescription drugs” into the US, Glaxo cut off supplies to Internet pharmacies it suspected were exporting to US customers (Zehr 2003). Other global pharmaceutical companies supported Glaxo’s stance; by August 2003, AstraZeneca, Wyeth and Pfizer had initiated their own actions against Internet pharmacies and the wholesalers that supplied them.13 Noting that half of the pharmaceutical industry’s sales and most of its profits were generated in the US, cynics saw the actions taken by these pharmaceutical companies as simply protection of a critical market by a powerful industry (Harris 2003). It is estimated that Canadian Internet pharmacies now serve a million or more customers in the US. Clearly, these businesses fill a need. At the same time, questions can be raised about their operations and, hence, their long-term viability. These businesses technically break the law each time a package is shipped across the US border. An important ethical question concerns the practice whereby physicians co-sign prescriptions for patients they have not seen. On the latter issue, Andrew Strempler said, “How many doctors have prescribed a drug based on another doctor’s opinion? That’s the reality out there. The issue isn’t whether the patients are receiving proper care. The issue is we are doing something new, and when you do something new, people are going to question it” (Cohen 2002). Discussion A common feature of the three Internet-enabled innovations described above is that they have produced many business start-ups and created significant revenues, although the future of these innovations is not assured. As a result, it is too early to determine whether the new entrants or incumbents will eventually triumph. We argue that the success of these technologies will be dependent in part on whether or not they can gain sociopolitical legitimacy. The new entrants 13

It was reported that these companies’ drugs made up 40% to 45% of the Internet pharmacy exports to the US (Kuxhaus 2003).


must therefore demonstrate that they are creating productive entrepreneurial activities. We compare and contrast the three innovations next and then return to the issues raised in the beginning of the paper. In contrast to music file sharing and Internet pharmacies, which are innovations that have been eagerly embraced by many, spam is barely tolerated by consumers. Spam is the “dark side” of technology—showing what is possible as opposed to what is desirable. Companies employing spam essentially use the resources of others to bombard e-mail accounts with unsolicited messages and offers, which are fraudulent or at best involve questionable business practices. The main complaint of consumers is that spam invades their privacy. Although governments have been slow to pass laws, spammers have come under close scrutiny by affected businesses and indignant consumer groups. As a result, they regularly move their operations and change their tactics so as to stave off action. In the past decade, spam has spawned many new business ventures and impacted numerous existing companies. Arguably, the incumbents that have been affected most are those that employ legitimate direct marketing techniques, particularly Internetbased permission marketers. These businesses have been harmed because spam has generated considerable suspicion and skepticism among consumers. However, spam has intruded in the lives of many consumers and the operations of countless organizations, Yet, because of its wide application, spam appears more difficult to counter than music file sharing and Internet pharmacies, where the focus is more industry-specific. Music file sharing over the Internet achieved rapid acceptance, predominantly among many young people. Fanning thought that Napster’s success would demonstrate that it was time for a new business model in the recorded music industry. Such an idea was anathema to the dominant music labels and the Recording Industry Association of America (RIAA), who successfully sued Napster for copyright infringement. This led to the closure of Napster, but not before attracting the support of Bertlesmann, a key player in the music industry. Although the music labels were successful in terminating Napster, the file sharing technology was taken up and improved by others. Consequently, music and other digital content providers continue to be threatened by file sharing services such as KaZaA, that are more elusive than Napster. Internet pharmacies also enjoy support from many consumers, as well as other stakeholders in the health-care system. Through the development of Internet-based processes that supplement mail-order operations, Internet pharmacies have expanded prescription drug buying and selling beyond local markets. The key factor in the success of this innovation, however, is that the pharmacies are able to offer drugs at lower Canadian prices. Pharmaceutical companies, physician and pharmacist groups, as well as some politicians and government officials have


attacked Internet pharmacies. The key arguments are that the importation of drugs is illegal, and that it is unethical for drug prescriptions to be filled by doctors who have not seen the patient in question. Because they face formidable opposition from the pharmaceutical industry, some professional bodies, and many lawmakers, the outlook for Internet pharmacies is far from clear. At the same time, the one million senior citizens who are the main users of Internet pharmacies are strong supporters, and this group has political leverage, particularly in a presidential election year. The interest of some states and cities in using Internet pharmacies as a way to control drug costs also lends support to the entrepreneurs that have developed a profitable Internet-based business model. Of the three Internet innovations examined, spam appears to be the most unproductive entrepreneurial endeavour. Those that make their living from spam have made no attempt to gain sociopolitical legitimacy for this innovation. On the contrary, these firms seem to put considerable effort into staying one step ahead of those that are opposed to their practices. The diffused effect of spam across many fronts means that opposition is general rather than focused. Accordingly, governments and consumer groups have led the charge against spammers, rather than narrower interest groups that have been negatively impacted by the innovation. While not illegal per se in many jurisdictions, because it violates privacy, many consider spamming to be unethical. Ultimately, spam has no sociopolitical legitimacy, yet because it is difficult to counter it is likely to persist as an unproductive entrepreneurial activity. In contrast, there is a groundswell of support among certain communities for music file sharing and Internet pharmacies, and efforts have been made by the entrepreneurs in question to achieve greater support. Although these innovations contravene intellectual property rights (music) or are presently illegal and go against professional ethical norms (pharmacies), these are conventions that could change. Clearly, a sizeable segment of the population believes that these innovations deliver legitimate value and are deserving of support. In both cases, lower prices are part of the attraction for consumers. In the minds of many, the dominant position of music labels and drug companies were accompanied by unreasonably high prices. Naturally enough, incumbents oppose this view. The RIAA and the pharmaceutical industry have used a full range of actions in an attempt to nip these entrepreneurial efforts in the bud. Mixed success has been achieved: Napster was closed but a wave of newer file sharing services has emerged to threaten the music labels (and movie studios). Drug companies have restricted shipments to pharmacies suspected of exporting their drugs to the US, but business continues because other sources of supply have been found. While it might be argued that file sharing services and Internet pharmacies are in a somewhat precarious


position given present legal and ethical challenges, the passage of time has solidified their positions. Music file sharing and Internet pharmacies grew their businesses rapidly to the point that today neither can be consider upstart or fledgling businesses. This very strong beachhead makes it harder now for incumbents to turn back the tide of innovation. Music labels in particular contributed to their own problem: their slowness and complacency in responding to criticisms about the delivery and cost of music in the traditional industry system, helped to create Napster. Concluding Remarks Technological change often disrupts traditional consumption patterns and industry structures and consequently is a driver of entrepreneurial opportunities and social benefits. New technologies can also create ethical dilemmas, yet the innovation literature offers scant advice on how to deal with this issue, which is often subjective, complex and ambiguous. Managers must attend to such questions and typically do so through mostly reactive and ad hoc responses. In an attempt to contribute to further analysis, we have presented a framework that synthesizes various concepts from innovation management and institutional theories. Incumbent firms generally possess cognitive legitimacy, scale economies and technical and commercial capabilities that contribute towards competitive advantage, whereas new entrants must accumulate such attributes. The emergence of new technologies often changes the rules of the game, creating opportunities for new entrants. The battleground however is not limited to technical and commercial viability; sociopolitical legitimacy is also critical for both incumbents and new entrants, and perhaps the most critical challenge in the cases presented here, given the ease with which the technology/business concept can be copied. Such battles can be won depending on whether or not stakeholders perceive the technology to be productive or unproductive entrepreneurial activities. In some cases (e.g. spam) it is clear that it is unproductive, and such activities are likely to be relegated to black markets. In other cases (e.g. music file sharing and Internet pharmacies) it is much less clear; the success or failure of these industries will be dependent on their abilities to demonstrate overall social benefits. The challenge for management – and question for future research, is whether our current managerial approaches are capable of dealing with this increasingly important dynamic.



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