The Ghost of Christmas Future:
The Ghost of Small Business Future
In Christmas Present we arrived at the conclusion that small = young = start ups. Start ups are important because every year that has been hordes of them; so many in fact that their brand new jobs dwarf job creation in the rest of the entire economy. We also learned that there are a relatively small number of firms, called high impact firms, which create so many jobs many have called them gazelles. Gazelles (high-impact firms) come in all sizes and ages, and if they share any characteristics, it is that they are generally more mature firms and their time in the sun (i.e. when they create jobs like crazy) is limited. Like a fire cracker they explode and most fade back from whence they came.
This all left us with the notion that small business, small in particular, confuses job creation as much as it explains it.
Size, on the whole, is not some magical condition from which innovation and jobs spring forth. Size is more a statistical manifestation, an intermediate variable, which drops out because other forces are stronger (age) and more important. We are now as confused as Scrooge was when the Ghost of Christmas Present left the scene. Not at all eagerly did Scrooge await the next, more ominous specter. Scrooge’s life, it now seemed, had been misspent adhering to the principles of the Old Truism. His wealth, acquired at unacceptable costs of his heritage and reputation. All that he would leave behind, for all his efforts, lay in tatters (just what is a tatter?). It would be the task of the final specter, the Ghost of Christmas Future, to put Scrooge’s past life into balance. The Spectre would hopefully offer a way to put Scrooge’s acquired wealth and knowledge, to work so to reverse the ill effects of his past actions. So let the Specter Speak.
In this review we shall draw from the Kauffman Institute and then from a hodge-podge of interesting but disparate sources like the Edward Lowe Foundation, the International Finance Corporation, and a follow up by our now friend, Spencer Tracy.. Settle down, after all this is a trilogy, and when you get done with this article, you’re finally finished–with this topic for awhile anyway.
To summarize: In terms of job creation, we seem to have two distinct and separate sources of new, net jobs: new start ups and high impact firms. We shall deal with each on their own terms. First, start ups.
“Where Will the Jobs Come From?” by Dane Stangler and Robert E. Litan, November, 2009; the Kauffman Foundation Series: Firm Foundation and Economic Growth
Stangler & Litan are concerned with the after effects of the Great Recession [New Normal we call it] and its impact on start ups and job creation. Before they get to that task, they put some meat on the conceptual bone we introduced in the Ghost of Christmas Present: the importance of start ups and firms under five years of age to job creation in the American economy. They first “peer under the economic hood” (p.3) of the structural distribution of American firms and “tell a more comprehensive story about job creation”.
Their initial tale relies on the reader fully appreciating the 2009 structural distribution of firms in the American economy.
Distribution of Employment by Selected Firm Size Classification
|Employer Firms||Employment in Firms||Labor Force||Firm Payroll|
|< 20 Employees||
|< 500 Employees||
|> 500 Employees||
OMG! Look at Small Firms! Curmudgeon you just said SMALL is not important! First, remember this is the structure of firm distribution, not who creates jobs. Second 89% of “employer” firms (firms with at least one employee) account for only 15% of the workforce and one can contrast that with the one-third of one per cent firms with greater than 500 employees with 42% of the workforce. This structural distribution of firms by size is not frequently appreciated by economic developers, or the general population.
There are a lot of small firms, but the employment muscle sits with the >500 employee firms. In fact, the Kauffman folk report that ” the largest share of employment is in firms with more than 10,000 employees” (p.3). So, the reality of linking workforce with the size classification of firms is that there is “an inverse relationship among firm size, number of firms, and overall employment”(p. 3) … analyzing employment in terms of firm size actually tells us very little about job creation. It would be more accurate … to discuss employment in terms of firm age” (p. 4) “The dynamics of firm age … point us away … [from the] existing distribution of employment … toward a focus on the annual changes in jobs…. companies in a given size class are not necessarily homogeneous (p.4), they can be two days old or twenty-five years old” [or more].
Substituting age for size yields an enormous increase in our understanding of American job creation. “In general, the net addition of jobs from year to year (i.e. job creation) comes from three sources: start ups; young firms, ages one to five; and the largest and oldest companies (p. 5) [a barbell effect in job creation]. But, these are GROSS jobs and one must take into account CHURN (job creation minus job destruction) which affects the youngest companies more significantly than the older firms. We shall return to this thought shortly.
Of the youngest companies, “age zero” firms, i.e. start ups, have served as “a primary sources of immediate job creation for the U.S. economy …. Indeed, without start ups, net job creation for the American economy would be negative in all but a handful of years”. These start ups (zero to one year) create, from scratch, one-third of all net new jobs annually. Remember, start ups start from a base of 0 and any hiring in their first year is a net new job.
But not every start up sticks around-roughly a third will close by the second year of existence, while only half will make it to age five. (p. 5) …. the fifty per cent that survive until age five … represents our second major source of net job creation (p. 6). In 2007, this second category of job creators (excluding start ups) “accounted for the lion’s share of job creation–roughly two-thirds, in fact”. … young companies, those aged ONE to FIVE [not including start ups] had been the most dynamic in adding new jobs to the economy …. dwarfing the other ages classes. These firms also create the highest average number of jobs” per year (four jobs) (p. 6).
How does all this square with size classification? “… the firms responsible for net job creation are not only young, but also small-and-medium sized (p.6-7) with the largest block of net new jobs coming from firms with 20-49 employees, followed by firms 1-4. Net new job creation declines with firms 50-99 and consistently declines for each size category after that. That is how size, i.e. small, shows up in statistics, but underneath size lies age. Job growth occurs in the youngest small (and medium) sized firms, not the older smaller and medium size firms [except for the high-impact thingamajig which we will talk about later].
Economic developers are sure to ask how all this job growth ties in with sectors and NAICs? You might be sorry you asked. Accommodation/Food Services, Health Care, and Retail are the three largest creators of net new jobs (and the largest sectors in terms of employment). Manufacturing and Professional/Sci/Tech lead the middle pack. Education and Information are the best sectors in lowest creators of new net jobs (p. 8) AND, when one looks at new job creation from the sectoral perspective “there is very little relationship between the amount [size] of small firm employment in a sector and its job growth. By contrast, there is an incredibly tight relationship between any particular sector’s job growth and the performance of young firms within that sector (p. 8).
But now let’s return to churn. The largest and oldest companies … still matter for job growth [they account for over 10% of net job creation each year]. We already know and understand the youngest firms exhibit exceptional levels of churn. Fifty percent of them die by age five. “When we are talking about young firms, then, we’re talking about an ever-changing assortment of dynamic firms-entering and exiting; creating and destroying jobs…. we need to foster such messy dynamism” (p.11).
In other words, in spite of the messy churn that follows a start up after year zero, these volatile creators and destroyers of jobs, overall, as a age classification (1-5 years) of firms, are our most productive net new job creators. The issue of the quality of jobs, certainly the durability of jobs created by these young firms, is very real and acknowledged aspect of young firm job creation. The economic developer should not assume he or she is assisting the creation of desirable jobs.
In any case, the Kauffman folk further “allege” that there is a symbiotic relationship between older and bigger firms and younger and smaller firms…
… we suspect that the net addition of jobs in larger companies comes from their symbiosis with younger firms. Namely, one of the only ways for big companies to add net jobs is to acquire the younger companies that are not only generating jobs, but also are responsible for a good number of innovations ….
Without more detailed data, a firm conclusion as to this dynamic eludes us; yet we suspect that such a process (among many) is at work. (p. 10)
Finally, Stangler & Litan allude to the “wave-like” of job creation. To them the entrance and subsequent erosion of start ups and young firms creates a wave-like image or effect. From this wave image we can best see the messiness of churn and consequences of innovation. The two forces result in a spasm-like expansion and contraction of individual firms, followed by flat or stagnant growth and even decline and exit. Firms move into and out of size classifications as they age. [This may be our opening into the dynamics of high-impact firms which are these older firms].
But the wave starts out big each year (we hope) with a net batch of start ups. And out of each year’s “pool” of new companies, fewer survive each year but overall create lots of jobs. The original pool of start ups diminishes each year and are succeeded over the next year or next two years by an entirely new pool of firms. The net effect of all this is to consistently add roughly two million new jobs to the economy every year, assuming demand to support their output exists. The economy generates a wave effect of new companies and new jobs each year” (p.11).
[Their analysis of the New Normal, by the way, strongly supports the perception that the Recession and post-Recession pools are noticeably smaller than the pre-Recession pools. The authors conclude with a major observation important to economic developers. The key to each wave of new job creation is to foster start ups and encourage entrepreneurs to start them. In good years, this is the source of new job growth; as our recession ebbs into the past, it is hoped that the vigor of the pool will be restored]
“Starting Smaller; Staying Smaller: America’s Slow Leak in Job Creation” by E.J. Reedy and Robert E. Litan, July, 2011; the Kauffman Foundation Series: Firm Foundation and Economic Growth
Having established the importance of start ups to annual job creation, our logical next step is to ask the obvious question: what has happened to new business formation since the onslaught of the Great Recession and the New Normal. Reedy and Litan take a stab at this question and provide some answers–and, surprise, it ain’t all that good. Using the same Census Bureau Business Dynamics Statistics Program (and BLS data as well), they arrive at two introductory findings. First, “employer” firms (those having at least one employee) actually started declining previous to the financial collapse and the Great Recession. Employer firm start ups have consistently fallen since 2006. The second finding, that new employer firms has “plummeted 27% (p. 4) since 2006 tells it all.
There is one piece of good news: the Recession has not seemed to shorten, i.e. kill off, those firms which do start up. Business survival rates (“roughly 45 percent to 50 percent of new businesses surviving five years” (p.4)) has remained stable. But this must be qualified as the data also show that new start ups during and after the launch of the Recession have been “starkly lower” and indicated that “recent cohorts of new businesses have been very hard hit by the 2007-2009 downturn (p. 6).
As to how all this has affected actual job creation, however, is a bit unclear. The uncertainty reflects noticeable and significant differences in the Census Bureau and BLS data. Why the two bureaus differ in job counts is not well understood [at least at time of writing], but in 2011 the bureaus differed with the Census being higher than BLS. Reedy and Litan present findings derived from both data sets and despite the differences, the results are either bad or less bad.
“As measured in the BLS series (employment at new establishments) has moved steadily downward since about 2000” (p. 7). 1997-2000 new job creation was about 4.65 million annually, but in 2010 there were only 2.5 million. Census data declined since 2006 (7 million jobs) but by 2009 it was 4.5 million. In any case, “The big trend is unambiguous across all data series. New business births have been contributing fewer jobs to the economy in recent years” (pp. 8-9). “The aggregate and per-business numbers paint two similar narratives of why new businesses have been contributing fewer jobs… (it) reflects both a drop in the number of new establishments and shrinking employment levels at these establishments…. (p. 10).
Possibly in an effort to make lemonade out of the above lemon, some people (unknown as to who) advanced the notion that shrinking employment and new firm creation actually might mean that the firms that survive can grow “more rapidly over time” (p.10). To evaluate this hypothesis, Reedy and Litan note that “those businesses that remain in operation tend to get bigger, not smaller …” (pp. 10-11) and with this in mind they review the data to assesses whether new firms are indeed growing bigger, faster.
Their conclusion [which they described as “mixed”] that “new businesses that survive continue to be significant contributors to employment as they age and grow, the rate … of their employment additions has been trending downward for business cohorts since 1994 (pp. 11-12). Then to cheer up their readers still further [Christmas spirit and all that, the Curmudgeon supposes] they add that despite whichever data series one uses that “Businesses that survive their early years of existence have been adding jobs at a slower pace than the historic norm in recent years” (p.12). Once again, coal in the stocking!
The reader, no doubt now remembers how the Ghost of Christmas Future appears as a terrible and frightening specter, and probably wonders if having only recently discovered a New Truism are we about to put it in the grave? Well, to complete our metaphor: you betcha! Posing one last question and hoping for a positive answer, the authors ask whether “aggregate employment of new business cohorts (expands) over time? So looking at both data sets they conclude: No.
“Both the BLS and Census data show a similar pattern. The business cohorts continue to shed more jobs in the aggregate than they add in total over the years”. Say it another way, expanding businesses did not compensate by adding employees at fast enough pace for the business cohort to hold onto the total employment it started with … (p.12). Or, say it still another way. “The employment that a new business cohort is born with in the United States is likely the maximum employment that business cohort will experience in its lifetime” (p. 13-p.15)
So Merry Christmas and Happy New Year to all–and to all a good night.
Having discovered that start ups and young firms create the most jobs in the US economy, we are now pleased to hear they are doing so at rates in noticeable decline. We are leaking jobs. Why? The authors are very clear in acknowledging that both Census and BLS data need additional research and clarification before we can penetrate into the dynamics underlying this problem in new business creation. And the authors do remind us that despite the job leakage of new business cohorts, job growth in our community’s “will be driven more by the collective decisions of the millions of young and small businesses whose changing employment patterns are not easy to see or influence” (p.15) than by any new firms economic developers are able to attract and relocate into their community.
They conclude with the important observation that “it is easy to be deluded into thinking that the jobs problem will be solved by growth in the number of the self-employed” (p. 16) Because of dynamics such as outsourcing and temporary contract professional service organizations [i.e. Accenture, et al], “individuals … ‘entrepreneurs’, are not likely to employ others or to reach significant scale… No matter how laudable their individual efforts, these sole proprietors … are not likely ever to be major employers”. “The clear challenge for the U.S. economy instead is to start more employer businesses, ensure that they are starting larger, and nuture their growth” (p. 16).
High Growth Firms. Is Rudolph a Gazelle, not a Reindeer?
Be of good cheer. Tiny Tim does survive and while the body in the grave is Scrooge’s, he is allowed a “do over” and prospers for many a future Christmas. In our case, the “do over” is to focus on a second source of job creation: the high growth firms or gazelles– or what the Edward Lowe Foundation label “second stage” firms.
We have already introduced the concept of high growth and gazelles in both the Ghosts of Christmas Past and Present. We will not, as in Good King Wenceslas, tread in the footsteps of these two articles so the reader unfamiliar with these concepts will no doubt be a bit chilly as we go forward into the snow storm [does the Curmudgeon stretch the Christmas metaphor as far as it can go … and then some. The future reader if reading this in July, will not realize this is our Christmas-New Year edition and wonder what the heck is going on with the Christmas obsession]. Anyway….
Dane Stangler from the Kauffman Foundation in “High-Growth Firms and the Future of the American Economy”, March 2010, updates us and carries us forward. For Stangler, “high-growth firms–the so-called ‘gazelles’ that, despite their relatively small numbers, nonetheless account for a disproportionate share of job creation. Stangler observes that “in any given year, the top-performing 1 percent of firms generate roughly 40% of new job creation” and that that “fast-growing young firms [a subset of the start ups discussed in the sections previous to this article], comprising less than 1 percent of all companies, generate roughly 10 % of new jobs in any given year” (p. 2)
Stangler starts out by reviewing the dastardly goings on in the post 2008 American economy–the New Normal. For those living deep under a rock for the last few years, this New Normal has not played very well with most people and all sorts of bad things have gone, and still are going, badly.[Remember the cheerful message in the section preceeding this one] On top of all this, the author reviews the outline and conclusions of the article we just finished reviewing and dwells on its message that while young new start ups are the largest source of new job creation, these very same firms, then proceed to destroy almost, if not, all in the following years (pp. 2-5). But fear not, we promised good news and great cheer and here it comes.
Instead of reindeer on the roof bringing toys for the stocking, Stangler sees gazelles. The average high-growth firm, gazelle, “contributes eighty-eight jobs per year … and end up with somewhere between twenty and 249 employees (compared to the average firm in the economy which adds two or three jobs per year). Their growth has a ceiling, however. On average, they maintain that pace for one or two, maybe three years…. high-growth firms are clearly concentrated in time” (pp. 5-6). But a small subset of these high-growth firms become “super high-growth firms”.These relatively few thousand firms will be “the next generation of iconic companies.One element, a sub-set of the high-growth firms are those high-growth firms which are between three and five years old. These firms are included within a new five year business cohort which we have just finished understanding are the source of the absolute, raw numbers behind annual new job creation.
This young, fast-growing subset of firms (about 42,000 nationally, or about .8% of all firms) creates about 10% of new jobs in any given year (about twenty-seven jobs per firm per year and grow to a ceiling of about twenty to ninety-nine employees (p. 6).Another element or sub-set of the high-growth firms are the old buzzards, the Curmudgeons of the business community who are older than six years. These old buzzards are about 25% of the high-growth firms (about 13,000 firms in total) but they display the highest propensity for growing to “extraordinary size” [i.e. really big, or “like totally awesome” size for you whippersnappers]. Some grow to above 10,000 employees.
High-growth firms do not have to be young and/or small. “… in any given year, the cohort of young, high-growth companies is joined by older firms that either grew continuously from a young age or suddenly began growing rapidly at an older age” (p. 8). The author refers to this as a “rolling dynamism” [earlier we alluded to a “wave-like effect] which constantly, year after year, reoccurs, like deja vu, all over again. But the growth of these firms is a bit complicated in that a key component of the growth of high-impact firms involves the acquisition of other existing firms. Gazelles “do not always embody clear cut cases of organic growth” (p. 8) [Gazelles apparently eat somebody’s else’s young firms]
[Depending on how one wants to look at it, acquisition is a form of creative destruction in that the firm being acquired dies, and at best becomes an “establishment” within another firm. Acquisitions create what the British charmingly call “redundancies” (i.e. layoffs). All this gets lost in the annual aggregate data on which these numbers and these concepts are derived. But creative destructive can, usually does, have differential consequences for the various geographies affected– i.e. your community. This is one concrete example of a topic we will later discuss: the Think Tank policy perspective versus the economic developer’s perspective.]
[Speaking of the economic developer’s perspective versus the policy perspective, any actually breathing economic developer in the field, i.e. working in a community, is probably wondering how she can find and locate these high-growth gazelles. Simple, look up gazelle in your yellow pages (that’s the hard copy phone book). For you whippersnapper economic developers, its in Craigslist. Ha Ha! Sorry! These gazelles, as far as I can see, are known only through computer-assisted data analysis and only then, in hindsight. This might be a problem for those who sign your paycheck or attend your public hearings. So at this juncture, we are going to go on a meaningful tangent. We, in the middle (actually two-thirds into the article) of Stangler’s article, will temporarily move away, and will return to it shortly, to another article which may help address this hindsight issue which real economic developers actually face–so patience and flexibility please!]
“The Significance of Second Stage”, the Edward Lowe Foundation (www.edwardlowe.org) provides the economic developer with more practical suggestions on how to cope with these high-growth firms, be they young or old. The Edward Lowe Foundation, among other activities, focus on the concept of entrepreneurship. Too often they suggest, entrepreneurship is linked to young start ups and small business specifically. This is, in their mind, not correct. They focus on “growth-oriented entrepreneurs”.
Many small business entrepreneurs, like the Curmudgeon for instance, are “lifestyle entrepreneurs” “who are self-employed because they like being their own boss (actually the Curmudgeon has a boss but technically it is a dotted line). Creating jobs isn’t a priority for life-style entrepreneurs. Also there are quite a few small businesses that while they provide jobs in a community, they are very low growth. The local trading area they serve often restricts their growth. In contrast, the Edward Lowe Foundation seeks to uncover the “growth entrepreneurs” who are significant job creators because of their appetite-and aptitude- for expansion. And because they often have national or global markets, they bring outside dollars into the community”. The best opportunity for these growth entrepreneurs lies with “second-stage companies”.
Second-stage growth entrepreneurs are defined as having 10-99 employees and annual revenue ranging between $1 million and $50 million [these can be picked up on business retention surveys, or visits]. Second stage companies are nearly 11% of establishments but represent 36% of jobs and 39% of sales (figures derived from YourEconomy.org, the Foundation’s online research tool). Second state companies can be a gazelle, i.e already growing, or they can be companies with the “potential” for high growth (not yet growing), and still other second stage firms can be “steady growers”, not gazelles. [This does seem a bit open-ended and may not be specific enough for an economic developer in the field (what is an economic developer doing out in a field anyway? Industrial Park?]
The concept of second stage is drawn from Doug Tatum’s, No Man’s Land, which appears out of print, but can be picked up on Amazon. Tatum’s observation is that the business plan, leadership, and even organizational structure of a young firm can grow that firm to a certain point, or ceiling, but then inhibit further growth. This is called the “adolescent phase”. Companies for a wide variety of reasons can languish or even grow slowly, but usually more or less stagnate in this adolescent state. “They are too big to be small, but too small to be big”. They need to be yanked from this phase [it is not completely clear to the Curmudgeon, how this is to be done, but new leadership or crisis certainly play a role]. At this point, economic developers can enter the picture.
The needs of a second stage company are different. They need to focus more on a new core strategy, adapt to new industry changes, expand their markets, build a new management team and embrace new leadership roles. (p. 1) They need to strengthen the firm’s footprint in their market and acquire new customers. Marketing can be critical. Second stage firms need to understand their competitive advantage and their need to upgrade key software and revamp their organizational structure. These are all critical micro-economic, intra firm evolutions. How can the economic developer do her thing and help trigger these changes inside a firm?
The Foundation encourages formation of “entrepreneur support organizations” (ESOs) or CEO round table-like entities. The Economic Gardening strategy (National Center for Economic Gardening (www.nationalcentereg.org), a subsidiary of the Foundation, offers specific ideas and actions for the economic developer.
Tangent Over! Return to Stangler article, Kauffman Foundation. Sorry for the interruption.
The policy perspective offers some ideas on how to facilitate high-growth firms as well. They are: (1) focus on creating more new firms which by simple arithmetic will increase the number of high-growth firms over time; (2) remove barriers (access to financing) that block the emergence of high-growth firms (including capital gains taxes, r&d tax credits and regulations); (3) target immigrants (core of new American entrepreneurship) (EB-5 programs) and link entrepreneurs to universities (p. 9) and finally, (4) the development of “high-growth entrepreneurship”[God only knows what that is? Presumably only universities can teach that!].
All of these, sort of business climate activities, are pretty general, and most are really beyond the capacity of a local economic developer, and quite possibly even a state-EDO. They make considerable sense to a policy wonk in Washington DC but they justify, at least to the Curmudgeon, the injection of the Edward Lowe Foundation approach in the middle of this review.
“Accelerating Job Creation in America: The Promise of High-Impact Companies”, Spencer L. Tracy Jr. Corporate Research Board, LLC under contract with Small Business Administration, July 2011.
He’s back. We reviewed in Ghost of Christmas Past, a 2008 article by Spencer Tracy which reintroduced the concept of high-impact firms. The 2011 article is both an update and delving deeper into the description and understanding of who these gazelles are. Tracy recognizes the concern which we have introduced in the last few paragraphs of this issue: that there is a wide gap between the policy perspective and the “in the field” economic development perspective. Knowing conceptually there are such “creatures” as high-impact firms and that these firms produce a gigantically huge disproportionate share of annual new jobs, is one thing. But knowing who and where they are, and why they grow (almost out of the blue), why they stop growing, and what is it we can do to assist them or prompt their growth still eludes us.
But while Tracy acknowledges the validity of these concerns, he admits his assessment continues down the quantitative road–a road which yields few answers to the above questions. As such he continues with the same methodology and definitions that his 2008 article are based upon. In this study he updates the data by adding a new five year period (2004-2008) which allows him to view a firm through two business cycles. He also expands his focus of observation to include gender, firm financial condition and location.
- There are about 350,000 high-impact firms in each five year period (6.3% of all firms)
- The number of women-owned high impact companies is proportionate (11.7%) to the number of woman-owned non high-impact companies (12.8%). Women high-impact ownership is most found in 1-19 employee firms (12%) and decreases to only 4$ in 500+ segment.
- The greatest share of high-impact firms is in the 1-19 employee size (94%); 5.5% in 20-499 and .5% 500+
- On average, high impact firms created about 10.7mm jobs in each of the periods. High impact companies appear to create the most jobs in periods of economic contraction (p. 4).
- The average age of a high impact firm is seventeen years; for 500+ employee high impact firms the average age is about thirty-five years old, and twenty-five for the 20-499 segment. Average age is relatively constant through the four five year periods. The reader is advised that the definition of a high-impact firm requires four years of existence at least and accordingly, no high impact firm can be a start up.
- Seventy-five per cent of high impacts firms and jobs are found in FIVE of the TEN SBA regions. “Paradoxically, the Northeast Region … contained the least number of high impact companies …, yet it produced the most high-impact jobs of all regions. (p. 4)
- There are many high-impact firms in rural areas (58,000, 16%) but only 7% of high impact jobs.
- On average high impact companies grow in size between 115 and 400% (compared to one to six percent for non-high impact).
- High impact firms are “relatively evenly distributed across all sectors of the economy. No industry dominates … (p. 5). There are even high impact companies in declining industries.
- High impact firms are the most productive as they generate more revenue with the same share of human capital inputs than all other companies. (p. 5)
- There were over seven thousand “back to back” high impact firms (i.e. high impact in two consecutive five year periods). Overwhelming they were 1-19 employee firms (we now know why size enters the picture–the residues of the start up cohorts). The Professional Services industry “contains the largest share” of back to back high impact firms and the Construction industry, “the second largest share” (pp.52-53). FIRE contained the second largest share of companies with 500+.
- [The Curmudgeon wonders how all this fared after 2008 since these were all sectors that were crushed by the recession and haven’t really come back in real strength since. This leaves open the possibility that different sectors respond differently in each business cycle and, may well also open a can of worms that even high-impact firms shift unevenly during a business cycle. There is a lot we do not know about these firms–which the authors are quick to agree]
[Certainly Tracy provides a measure of description–but again its description is drawn from the rear view mirror. The report offers some ideas about how to facilitate these firms. In a lead paragraph, Tracy wonders if we should include performance benchmarks in government loan guarantee program (sort of a measurement tool more than anything else because it would not seem to provide much incentivization). But then in a critical point which the Curmudgeon does thinks make sense, Tracy urges a more “shotgun” versus rifled approach (develop less targeted programs or new programs that are not targeted at all). This is almost heresy to an economic developer for whom “picking winners” seem a part of their professional definition.
Tracy concludes with a rather ominous, yet absolutely on the mark observation. “This report … bears limitations. It is almost entirely quantitative and therefore answers questions related to the ‘what’, ‘where’ and ‘how many’ of research. (But) as Birch suggests, our next phase of research should focus on the ‘why’. (p. 57) The sad reality is that Birch said that in 1994.]
So Where Does the Ghost of Christmas Future Lead Us?
Well, Scrooge’s first act was to con a little boy into buying a turkey which had been hanging in the butcher’s window for several days. No wonder he gave the turkey to the Cratchett’s anonymously. A word to the wise, the Curmudgeon’s blather is on the move!
We need help in this future endeavor business and so we turn to a research note by Tom Gibson and Hugh Stevenson, “High-Impact Gazelles: Should they be a major focus of SME development?”, International Finance Corporation, World Bank Group, October 2011. Gibson and Stevenson hover around the Edward Lowe Foundation second-stage concept in that they observe that “SME’s are not homogeneous. Thirty years of research shows that a small percentage of them, the gazelles, create the vast majority of net new jobs and GDP growth in U.S. and Europe. These gazelles are not life-style businesses and they usually fall outside the pale of venture capital involvement.” The author’s primary interest in this article, which is far from our primary interest, is to extend the concept of gazelles into the developing world (they are from the World Bank). They cite the all pervasive Michael Porter who apparently in 2011 was in the process of identifying gazelles within transition and developing economies (the AllWorld Network, based on Inc 500 fastest growing U.S. companies). Porter has found gazelles in developing nations and this actually creates a problem for Gibson and Stevenson.
Gibson & Stevenson’s initial issue is how to provide financing for the gazelles; the problem is gazelles do not fall within the conventional playground of venture capitalists. Gazelles need long term, non-asset-based risk capital [what the Curmudgeon labels mezzanine financing, deeply subordinated debt, or my personal favorite, “near-equity”. Most banks don’t do this and neither do the Bank Sourced-SBA programs [7a and ‘Low-Doc’ for instance].]. Venture capitalists are a much publicized, but a rather slender reed, on which to grow companies on any large scale. Venture capitalists usually employ a capital gains-based strategy with a couple of takeout/exit programs (i.e. a plan on how to convert their ownership positions to cash/profits through some form owner buyout (e.g. an IPO like our recent Facebook episode). This is not especially helpful to an established or even young gazelle. What gazelles need most of all is second stage financing (p. 5).
[At the very least, this finance-based conversation is helpful in the sense that an economic developer can move beyond the university-based entrepreneur mentoring/CEO Round Tables, or the sexy, but dubious solutions like having tenured academics teach business executives about risk-taking, team building and the like (can you picture Steve Jobs in one of these classes?). Instead, we turn to finance which is more commonly understood within the profession and around which a cadre of economic developers can be found. Many EDOs do have finance-based tools, such as RLFs and taxable and tax-exempt bond issuance.
[But public sector financed subordinated debt, stripped of dysfunctional social agendas like living wage, prevailing wage , specific hiring requirements, and claw backs, are few and far between these politically-correct days . The real need in the gazelle world is for BDC (business development corporations) and Private Equity (can you say Bain Capital). Those vehicles seem more appropriate to the world of gazelles. Economic developers can perform a very useful function in identifying potential gazelles and facilitating linkage and involvement with these entities. That, however, requires some level of financial sophistication, and some measure of creativity, if the economic developer is to be taken seriously.
[In the Curmudgeon’s misshapen mind, the more realistic direction in providing long-term financing to gazelles lies in combining the Lowe Foundation, second stage revamp of an older firm, with a brilliant understanding of specific industry demand and technology trends. Remaking an older firms into gazelles makes sense only for those firms which can address the PERCEIVED demand for a product and service at a very early, or even previous to, the start of the demand cycle. The key element in this linkage is the CEO, and the important traits are a natural risk-taking propensity combined with technical/industry/sector based knowledge and experience.]
[The Lowe Foundation approach essentially focuses on “execution” of the firm’s revamping, the leadership skills and the operations management necessary to develop a potential gazelle. But gazelles need, first and foremost, to anticipate demand for the products and services before such demand is evident to the bigger players. This is what Steve Jobs and Apple, (and yes Gates and Zuckerman) are all about. (Gibson and Stevenson also agree and they write “gazelles are not typically found in sectors with small market potential” (p .7). How an economic developer gets his or her hands around this demand phenomena is far from evident to the Curmudgeon. And embracing a strategy which invades the internal and proprietary essence of a private firm is also terribly difficult task for an economic developer with a planning degree and a “blue-state ideology”.]
But Gibson and Stevenson then move onto the heart of this gazelle dialogue. “The promising data on gazelles raises the question of how to identify a latent gazelle which has not yet achieved four years of sustained high growth. … It is important to remember here that we are NOT talking about start-ups (p. 6). The key concept they quickly gravitate to is “that the attributes which drive growth at the gazelle pace are overlapping with, YET NOT SIMPLY IDENTICAL TO, those commonly associated with successful entrepreneurs or highly profitably companies. (p. 6) They arrive, essentially, at the same place the Curmudgeon did in the previous paragraph. Entrepreneurism and the making of gazelles involves a mix of skills which arguably cannot really be “taught”, but which relate to, and tap the character and personality of the entrepreneur herself. Public sector intervention literature seldom recognizes this complexity, or simply dismiss it by asserting that university professors can create Carnegie and Ford and Gates etc. That is a very arrogant assertion.
Perhaps the reason the Curmudgeon likes Gibson and Stevenson so much is that they agree with him (or vice versa). ” (G)azelles should have founders and owners with personal attributes such as a strong entrepreneurial spirit, drive, confidence and a tolerance for uncertainty) as well as relevant professional experience and strong network” (p. 7). [If the economic developer has a “good nose” for identifying such an individual than his job is simplified–but that also sounds like a very arrogant assertion as well].
Then the authors spoil this great insight by adding that the “psychometric testing approach … by the Entrepreneurial Finance Lab of Harvard University (which) assess personal characteristics of SME owners applying for credit may prove a useful tool” (p. 7). [to which the Curmudgeon replies, Good Grief–we are back to the long-discredited notion that we can test for, and measure, personality attributes. Conventional theory today asserts one can’t measure personality, but one can measure personality traits. The distinction eludes the Curmudgeon who has never moved beyond Socrates and his “Symposium on Love”. To be sure, the Curmudgeon taught this stuff in his Public Administration leadership classes, but even at its best, measuring traits is light years beyond “teaching” or “creating” traits. Warren Bennis still has a web site and the reader might check him out for how to approach this psychometric testing idea (www.warrenbennis.com).
But Gibson and Stevenson, after this horrible digression, return to Curmudgeon-friendly territory. Citing Acs et al (reviewed in the Ghost of Christmas Present), “The data suggest that economic development officials would benefit from recognizing the value of cultivating high-growth firms versus trying to increase entrepreneurship overall or trying to attract relocating companies” (Acs, Parson and Tracy). Instead G&S urge economic developers to take a close look at “economic gardening” which they correctly assert is “a form of local or regional capacity building” which is the polar opposite of “economic hunting” built around “providing inducements for firms elsewhere to pack up and move to one’s own locale” (p. 8).
Economic gardening can provide support and assistance for two critical needs of potential gazelles in transition. First, economic developers can provide support to assist CEO’s in building a new team and locate and help train a skilled labor force (p. 7). Specifically, economic gardening has, for G&S, two distinguishing elements:
(1) economic gardening assumes that entrepreneurs grossly under utilize information resources in the public domain and,
(2) as opposed to typical business development services, economic gardening programs establish a high profile locally in order to draw out and capitalize on all available public and private resources with the potential to support local entrepreneurs. This includes lobbying for more entrepreneur-friendly policies and greater expenditures on physical infrastructure…. The harder elements of economic gardening programs … include assistance in: (p.9)
- recruitment of labor and management of personnel
- market intelligence and industry sector research and analysis
- international trade issues and linkages
- site selection
- understanding regulations and obtaining licenses and certifications
- obtaining government procurement contracts
- networking and mentoring schemes
[G&S conclude with the call for economic developers “to identify latent gazelles at the right point in their life cycle and provide appropriate capacity-building and finance to allow them to shift into a high-growth trajectory” (p. 12). The Curmudgeon would call this the RIFLE approach and while he has no disagreement with it in theory, the practicality of an economic developer finding such a firm at its critical point and being permitted to access and participate in the huge and proprietary transition led by a true entrepreneur, who is probably a control freak and psychologically warped, strikes the Curmudgeon as the definition of a hopeless romantic idealist–or a political, blue-state Progressive (same thing actually).]
[Instead, the Curmudgeon senses that a SHOTGUN approach may make more sense. Unless the economic developer has Diogenes (who searched the streets of Athens for an honest man, but found only ‘rascals and scoundrels’–a Curmudgeon role model) as a role model, it is probably better to forego the search and the dream and instead to establish the capacity or access to programs and expertise and make them available to all–i.e. fairly loose eligibility (except for the financing programs, of course–subordinated financing is not for everybody). Combined with a strong public relations and economic developer networking, the hope would be that the potential gazelle would herself appear at the economic developer’s doorstep. Self-selection of entrepreneurs, still a low percentage process, is infinitely more likely to yield real entrepreneurs who check almost anything out to see if it can help. In the meantime, a strong business retention initiative could be built around the economic gardening strategy. At the very least the economic developer is out in the field (there’s that proverbial field again) and not in his office]Startups, gazelles and entrepreneur economic development programs are a dime a dozen today. No we don’t know why these efforts should work or not work–we really still do not know enough real life, versus theoretical/quantitative about high-growth firms to do much good. But are there any “half-way reasonable” ways to deal with these targets. The Kauffman Foundation’s Phillip Delves Broughton offers some thoughts on how to “Jump-Start Entrepreneurism”, Wall Street Journal (fittingly, Dec 25, 2012). Kauffman and the Case Foundation and their Start-up America Partnership confront many of the issues we have outlined in this review. Acknowledging that “entrepreneurhips is a amorphous and fast-moving target and entrepreneurs are hard to classify … (and the technology so fast moving that) An industrial wizard of 1912 might flounder in the Silicon Valley of 2012″, they offer a couple of ideas.
For Broughton, ‘Everyone has a view on how best to help entrepreneurs, ranging from educating them to offering them money to getting obstacles out of their way”. But citing another Kauffman piece, “The Ascent of America’s High-Growth Companies” by Yasuyuki Motoyama and Brian Danley (September, 2012) which is based on research/data (ah yes, still another database) on the INC Five Hundred, Broughton alerts his readers that the geography of fast-growing (our gazelles for the most part–the Curmudgeon assumes) is not quite what most would expect. Washington DC is number one and Salt Lake City, second–and only then came Austin, San Francisco and Boston. “Only a quarter of Inc’s listed firms are in conventional high-tech sector”. Instead, high-growth firms are as likely to be in manufacturing and other less sexy sectors, as well as locations.
No matter where they are these high-growth firms can become “disconnected” from the different pieces they need to complete their growth puzzle. Whether its money, talent, or customers, high growth firms don’t always connect with the answers to their needs. Kauffman’s Start-up America Partnership has stressed as the counter to this “strong state organizations run by and for entrepreneurs. Their job is to connect ….” “What America’s entrepreneurs don’t need is more people flapping their arms and shouting at them from the sidelines. It turns out that what they need more than anything is each other”. With all respect to state economic developers, the focus on the state as the natural spot for entrepreneurs to seek help seems a bit … optimistic. This solution, in any case, offers little to a sub-state economic developer.
Instead, Kansas City, Kansas has launched a more locally-based approach. Drawing from a November 14th Wall Street Journal article by Jack Nicas, a “handful of players from the local technology scene have come together to turn the old antique district of Kansas City (about six blocks) into Kansas City’s ‘start up village'”. Installing fiber and a superfast high speed internet connection, they have in only a few months attracted a small number (dozen) of start ups into the district. The “Organizers believe that the tech startups’ density will, in turn, attract more entrepreneurs and help them flourish”. At this point, it appeared that a wealthy private foundation located a mere two miles away teamed up with them to finance the Kansas City “start up village”—that ironically was the Kauffman Foundation.
This same density thesis underlies another start up initiative entitled “the Siliicon Prairie” and composed of Omaha (Mastercraft), Des Moine (Silicon Sixth Avenue) and Kansas City (both Missouri and Kansas). Other such initiatives can be found in New York City’s Union Square, Boston’s “start up trail–subway line from Harvard to MIT, and Chicago’s Merchandise Mart. Google was attracted to this and two week’s ago picked Kansas City, Missouri and Kansas as the first cities in which they will install their new fiber-optic network capable of reaching speeds far greater than average cable-modem connections. Stir up some dust and some of the big boys might take notice of you?
Each of these initiatives involve real estate, fast internet, and density to solve the issues of disconnectedness. Initiatives such as this avoid the Curmugeon’s fears of “teaching and creating entrepreneurs”, and instead let real estate and infrastructure “connect” the elements and resources needed for start ups with self-selected entrepreneurs who take the risk by relocating into the district composed of other self-selected entrepreneurs. This almost looks like entrepreneurial capitalism–let the best entrepreneur win. And it something that can be done in every size urban and even rural area.
And the Ghost of Christmas Future Disappears
So the Ghost of Christmas Future has left, but in leaving has provided Scrooge with insight and direction. We started out with small in size business being the generator of most, if not all the American economy’s new job creation (the Old Truism). Upon finishing our trilogy, we are left with start ups and gazelles, entrepreneurs and economic gardening. This may well be the New Small Business Truism–but the New Truism will be known only by a few. Why? Because in no way have we dented, or will it ever be dented, the Old Truism of small business. The Old Truism has permeated our media, politics and collective economic psychology. It has acquired a life of its own–but don’t you the reader believe in it any longer.
But the Old Truism is, and never was, true. The New Truism is more realistic and probably accurate but how an economic developer can take advantage of their new-found knowledge is very unclear. Can an economic developer meaningfully increase the number of start ups in her community? Can an economic developer really identify gazelles without using their rear-view mirror? Can you (should you?) really “teach” risk-taking and create entrepreneurs?
Maybe? Maybe not? But an economic developer can’t stand and intellectualize all this stuff and dither in Curmudgeon blather. Economic developers are paid to act now and produce results tomorrow at the latest. Scrooge apparently did save Tiny Tim’s life, thanks to the Three Ghosts (and Marley, of course), and the tasks of increasing start ups, finding (and helping) gazelles, and facilitating entrepreneurism are very tough, but necessary, approaches, vital to community revitalization. And while economic gardening may not be your sole and exclusive economic development strategy, it does offer a fundamental insight: the seeds of future community growth are already planted in your community Support and nourish them.
And as for the Curmudgeon, there’s more gravy than grave in the message of the Three Ghosts.
See you about February 20th: Business Climate Rankings: Should an Economic Developer Ignore Them? Can an Economic Developer Ignore Them?