Entrepreneurship May Work Like A Clock, But It Still Needs Winding: Exploring the Kauffman Study on New Firm Formation

1/15/10Follow @wroush

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a permanent reduction in new firm starts, or maybe a permanent increase as people decide not to go back to big firms,” says Stangler. “That’s a question that won’t be answered for a long time.”

And here’s an even bigger caveat: The fact that new firm formation is so consistent may be irrelevant to the nation’s overall economic health. If other research going on at the Kauffman Foundation is correct, then what really matters for economic growth is how many of the firms spawned each year mature into “high-growth” companies that hire lots of people and change their industries. In any given year, just 5 percent of companies account for two-thirds of the new jobs created, Stangler and Bob Litan, the Kauffman Foundation’s vice president of research and policy, found in a 2009 paper. For an example of this kind of stratification, you need look no further than the search-engine business: Silicon Valley entrepreneurs started scores of search-related startups back in the 1990s, but today only one, Google, really counts. In other words, it could be that “the process rather than the input is what matters,” as Kedrosky and Stangler write.

If all this is true, and if the number of new firms competing to become high-growth firms stays constant no matter what, then how should we answer my original question? (Which was, roughly, whether we really need to sweat the details—things like quarterly swings in venture activity, or the resources going toward the promotion of entrepreneurship on college campuses or through incubator programs like TechStars.) If you want my opinion—and Stangler’s—the answer is yes.

Look at it this way: the United States is doing something right, even though we’re not exactly sure what it is. Year in and year out, in good times and bad, Americans start 700,000 new companies, which, if you think about it, is sort of amazing. It may testify to a certain level of resilience and drive in the American character, or it may have more to do with social policies and cultural factors that encourage and reward risk-taking. Whatever the answer, this is one tendency we don’t want to mess with.

As Stangler puts it, “It’s difficult to prospectively tell which companies will succeed/survive or which ones will be high-growth, so it’s highly important that we have thousands of people trying to do it each year.” So until we understand entrepreneurship better, we can’t afford to stop obsessing over it.

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Wade Roush is a contributing editor at Xconomy. Follow @wroush

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  • http://www.cictr.com Tim Rowe

    You can’t draw conclusions about lions by counting cats.

    What is clear is that this country’s lions are not fairly distributed. They like to cluster in the places that feed them best. Think about where the Googles, Akamais, Microsofts, and Genzymes spring up. So lets not let up on our efforts to feed the lions!

    The Kauffman Foundation has done research recently looking at the differences between US states’ ability to support startups. They analyzed many factors, and found huge variation. And these differences indeed seem to play out in the flow of venture capital. For instance, they found that Massachusetts was the best state for entrepreneurship in US, looking at factors like the presence of leading tech institutes, like MIT, social acceptance of entrepreneurship, etc. And MA also has the highest venture capital investment per capita of any region in the world. The conclusion: supporting entrepreneurship does make a difference.

    Restaurants, laundromats, landscape services companies and their like provide the majority of employment in the US, and we are blessed to be an entrepreneurial nation that keeps these sectors vibrant. We need those businesses. And we ALSO need the new lions who help us remain globally competitive, by becoming the next generation of global corporations. And by and large, it is our lions who make inroads into improving the quality of human life around the globe, be that through energy efficiency, better healthcare, or better productivity.

    So, I’ll say it again: lets keep feeding the lions!

  • Wade Roush

    @Tim: Well said. I don’t think the Kauffman researchers are suggesting that we should stop feeding the lions (although Paul Kedrosky has argued, in other writings, that the venture industry needs to shrink drastically). I think the work they’re doing is important because it makes us question our long held assumptions — such as the belief, so widely held that it’s almost unspoken, that more venture investment automatically equals more innovation.

    What strikes me when I read Kauffman studies is how little we really know about how entrepreneurship works. If anybody is going to make “entrepreneurship studies” into more of a science, it’s them.

  • http://www.venturemechanics.com Ron Wiener

    Agree with you both. Perhaps stated a little differently, what matters the most is not quantity but qualities of these startups. The very nature of today’s startups, so many of them built on low-cost platforms (VoIP, smartphones, etc.) not generally available five years ago, is dramatically different from the average profile of prior generations of startups. CapEx requirements, time to market, “virtuality” if you will, all different; as are market potential, jobs creation potential, shareholder returns potential, fundability. Any study that is looking strictly at the number of new startups is not gathering the relevant underlying trends.

    Let’s assume all things remaining equal (e.g. population) there is a set % of society that is entrepreneurially minded. Unemployment may encourage a few more people to think about taking a hiatus from the corporate world but without an entrepreneurial mindset and skill set, and a good business idea, how many will actually launch a startup? Not that many. What matters most are the characteristics of the companies being started now versus in years past, not the number. And as Tim pointed out, national statistics are not as revealing as regional comparisons; they are simply too blended to show what’s really going on.

  • http://www.forleapsake.com/blog Dino Herbert

    Those who conducted the Global Entrepreneurship Monitor 2009 Global report stated that the number of new U.S. businesses declined by 24% in 2009. It will be interesting to see what the researchers at Kauffman find for the period from 2006-2009.
    It’s also understandable that the “big boys” will always account for the “lion share” of job creation. This is to be expected. However we cannot discount the effect that the 95% of “normal” firms are having on the economy. Having 33% fewer new jobs annually would definitely be newsworthy.

  • qed

    To Dino Herbet: the 2009 publicity of GEM is not necessarily reliable. PR reports decline, although, on average, there was actually an increase across countries. There is good evidence to suggest that during recessions, the number of attempted start-ups actually increases, when displaced employees attempt self-employment. GEM measures start-up attempts, not actual start-ups.

  • http://www.forexbase.com Pavel Rorecek

    The big question is what percentage of these companies are incorporated in the US just for tax reasons (domestic or abroad) and are actually not founded by real entrepreneurs.

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