Cross-posted from Harvard Business Review Online, February 3, 2014, https://hbr.org/2014/02/for-a-booming-economy-bet-on-high-growth-firms-not-small-businesses/
“Small business is the backbone of our economy.” President Barack Obama, August 17, 2010
“New businesses are the lifeblood of a healthy… economy.” PM David Cameron, November 20, 2013
These two statements have something in common: they are wrong — or at best, misleading. This may surprise you given the prevalence of our leaders’ public declarations that small, new businesses are the key to economic health. (And one could add “knowledge-based” businesses to this list of exhortation.) Indeed, for over a generation stimulating growth via “SMEs” or “small business” has been at the heart of economic and industrial policy throughout the world, only recently being upstaged by “startups.”
In our decades of experience in all aspects of entrepreneurship, it is rare to hear an entrepreneur, hell-bent to scale his or her venture, call themselves a “small” business or “SME” — because those designations actually connote sluggish, slow and static. More and more voices, frustrated with the lack of effectiveness of the startup or SME policies, have started calling for a new, more balanced approach one that emphasizes fostering conditions for existing ventures of all ages, sizes and sectors to be able to kick start rapid growth. There are good reasons for this redirection:
High growth firms generate jobs. The literature consistently shows that a very small number, from 1%-6% or so of all ventures in a region, account for the lion’s share of net job creation and other spillovers from entrepreneurship. However, increasing the number of startups has not increased the number of high growth ventures. In fact, numbers of newly formed ventures and high growth firms seem to be negatively correlated. To quote one of our colleagues from a study of business ventures in the US: “High-impact firms …represent between 2 and 3 percent of all firms [in the US], and they account for almost all of the private sector employment and revenue growth in the economy.”
High growth firms are older than we think. Furthermore, high growth firms are neither what we normally think of as startups or small businesses — the average age of high growth ventures averages from 15-30 years. To quote our colleagues again: “High-impact firms are relatively old, rare and contribute to the majority of overall economic growth. On average, they are 25 years old.”
High growth is highly unpredictable and chaotic. Schumpeter wrote it in 1932: Economic growth occurs in “jerks, cracks and leaps,” and is impossible to break into small incremental steps. So it is with high growth firms: studies of these firms show that their growth occurs in sudden, largely unforeseeable spurts for reasons ranging from market shifts, buyouts, recapitalizations, new management and sometimes luck. High growth entrepreneurship is in reality closer to a “random walk” than to the linear idea-startup-scale fairy tale often told. Thus we need to shift our efforts to creating conditions conducive to high growth.
High growth ventures are more prevalent in basic industries than they are in the stereotypical technology sectors. High growth firms are more likely to be in food services, real estate, construction, commerce, logistics and manufacturing than in ICT and life sciences. This is not to say that ICT and life sciences ventures cannot achieve rapid growth, only that they are not a panacea for slow growth. Furthermore, studies have shown that the stereotype of university-based ventures is more myth than reality, and the very large majority stay small or fail.
Small is not always beautiful. The true enemy of growth for firms is stagnation, and the reality is that most small businesses are stagnant, regardless of how old they are. What do Italy, Greece, Mexico, Portugal and Spain have in common? According to a recent OECD report, over 40% of these businesses have fewer than 10 employees. What do Germany, Switzerland, New Zealand and the UK have in common? Fewer than 20% of the companies are small businesses. Indeed, Germany’s post-war economic success is often attributed to the so-called “Mittelstand,” a large cohort of globally competitive, steadily growing medium- (some would say “largish-“) sized firms. We also know that owners and workers in small businesses work longer hours, make lower wages, and have fewer benefits.
Over-focus on startups is bad policy. As researcher Scott Shane told us, ”We have no evidence that firm formation causes economic growth.” On the contrary, he argues, economic growth causes firm formation, and “investing a dollar or an hour of time in the creation of an additional average new business is a worse use of resources than investing a dollar or an hour of time in the expansion of an average existing business.” It is no coincidence that Startup America closed shop last year and that, around the world, startup movements by themselves show few concrete benefits. Despite the language used to support them — such as “seed investment” and “incubator” — growing a venture is not like a growing baby or tree. The vast majority of small businesses do not naturally evolve into larger businesses. If anything policy makers need to let markets play a much stronger role in choosing and nurturing early stage winners while letting losers fail, even in risky entrepreneurial ventures.
Fostering high growth firms is not a “numbers game.” In order to reap the significant economic and social benefits that entrepreneurship can deliver (under the right circumstances), private and public sector leaders need to get their facts right. To use a transportation metaphor: it is futile to jam the on-ramp of our economies with startup traffic without well-paved fast lanes, high powered cars, skilled drivers, good police, and lots of exit opportunities.
In short, we need to foster, through policy and practice, complex entrepreneurship ecosystems in which high growth firms can take root and thrive.
This post was written together with Dr. Ross Brown, who is a Lecturer at the School of Management, University of St. Andrews, United Kingdom. He is a researcher and expert on high-growth entrepreneurship and public policy.