Local & Regional Development
Formation and Function of
New (and Small) Firms
By Ania Dachowska
and Philipp Hollenstein
Lecturer: Prof. Gunther Maier
Overview
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
Small firms vs. big corporations
New and small firms as entrepreneurs
The background on starting a new business
The seed-bed hypothesis
The incubator hypothesis
Regional variations in new firm formation rates
The effects of industry structure
The effects of regional dynamism
New firms: the challenge of survival
New (and small) Firms in Local development
Small firms and regional development policy
Planning on incubators
1. Small firms vs. big corporations
• Prior: Small Firms were expected to be less economical
they are surviving only because of ...
– limited market possibilities
– or technical limitations
which constrain the possibility of generating economy of scale
• The conventional view of an ideal unit was a large firm or
large factory exploiting economy of scale
• Now: Small Firms and Entrepreneurs are considered as an
important part of the economy
– rapid growth of new businesses
– downsizing among large firms
2. New and small firms as entrepreneurs
•
Definition: An entrepreneur is a person who has possession of an
enterprise, or venture, and assumes significant accountability for
the inherent risks and the outcome. It is an ambitious leader who
combines land, labor, and capital to create and market new goods
or services (Quelle: Wikipedia)
• New fims are almost inevitably small and as a result of both
they are of an entrepreneurial nature.
• Small firms often have an entrepreneurial form business
organisation in contrast to the bureaucracy or
technostructure of large corporations
– more flexible
– rapid decision making
2. New and small firms as entrepreneurs
• Characteristics of entrepreneurial firms:
– they are highly responsive to market forces (power of the small firm is
limited)
– they operate in markets that are strongly regulated by competition
– the firm is independent
– Ownership and management is combined and personalized
– Decision-makers are risk-takers
– little or no power to change market forces
o The are small in terms of market share (no power to determine prices
or output levels)
o They have only few employees (opening and closure has no
measurable social impact)
An entrepreneurial firm does not compulsory match all these
characteristics!
And it can not be assumed that all small firms are innovative!
3. The background on starting a new
business
• Motivation to begin a new business:
– Neoclassical theory focus on … (monetary factors)
o economical rationality
o importance of cost-minimizing
o profit-maximizing
– In reality non-economic considerations do also play an important role
such as …
o To be ones own boss
o To develop own ideas (self-fulfillment)
o To balanced work and leisure
o To be rewarded appropriate
3. The background on starting a new
business
• The age of new entrepreneurs is increasing
– In Japan, until 1986, most Japanese new firm founders were in their 30s.
– Since 1986, the most founders are in their 40s.
– Reasons:
o more technological knowledge is required
o more financial capability
o need to have a strong connection with the previous workplace
o maybe nowadays older people are more forced to become self-employed
than in the past
4. The seed-bed hypothesis
• Between 68% and 90% of new firm founders located in their
local area
– The reason is that the new entrepreneurs are thoroughly familiar with
their home locales, and are well known there.
o they are aware of possible premises,
o possible workers (members of the family),
o understand the characteristics of local labour,
o contact to financial institutions (good reputation),
o are able to work at the old workplace at the same time (financing the new
firm)
o knowledge of local markets,
o get easy available equipment an suppliers
o and are able to make their first entrepreneurial steps in the rooms of their
own house (or in the garage)
4. The seed-bed hypothesis
• To locate elsewhere would involve a lot of costs and
uncertainties in collecting and understanding information on
unfamiliar places
– This stands in sharp contrast to the neoclassical view where total
information is given
• The seed-bed hypothesis is also valid for immigrants
– In Canada most immigrants who became entrepreneurs lived at least 11
years in Canade before deciding to found a new venture
– At the first glance this result support the seed-bed hypothesis but may
there can be also an other reason for it.
5. The incubator hypothesis
• There are many different types of incubators
– local ethnic groups that help to nurture immigrant entrepreneurs
– business organizations or educational institutions which spin-off
entrepreneurial ventures through the initiatives of former employers are
incubators
– The original expression refers to long established industrial cores within
metropolitan areas as incubators
o The rate of new firm formation is positively influenced by the supply of
agglomeration economies
o New firms will be attracted to areas offering services essential to their
operation that they, because of their small size and limited resources,
would be unable to provide internally
e.g. access to cheap suppliers, markets, transportation, consulting,
advertising; create external economies of scale
5. The incubator hypothesis
– But there are also diseconomies of scale in such metropolitan centers
o problems of crime
o obsolescent physical and social infrastructure
o long-standing trends of suburbanization and non-metropolitan
industrialization (reduce attraction
– This lead to some other incubators outside the metropolitan area
o Silicon Valley
o Boston 128
– One of the big advantages of an incubator area is the access to venture
capital
o Venture capital is connected with a lot of risks for the lender – therefore
many venture capitalists tend to invest into local ventures where they are
able to monitor, supervise and assist their partners
6. Regional variations in new firm
formation rates
– he difference in the birth rates of manufacturing firms varies
among regions
– sub-regional variations are greater than those revealed at the
interregional scale Silicon Valley
6. Regional variations in new firm
formation rates
UK
- the rich and fast growing regions of the south and east and weaker in the more
peripheral regions
- the regions with the longest traditions of government assistance for industry
perform the worst in terms of new firm formation
-birth rates of firms are increasing although, as of the late 1980s, small firms were
still relatively less important in the UK economy, for example, compared to Germany
Europa
- the regions with the highest birth rates generate from 2.7 (Germany) to 6.5
(Sweden) as many new firms (per 10, 000 population or 10, 000 employees) as the
regions with the lowest rates
- Sweden - the highest rates to be located in regions that are small in terms of
population, while the populous centres of administration and education tend to have
lower rates
USA
- the natoional variation is even many times larger than in Europa
6. Regional variations in new firm
formation rates
• Indicators representing various regional characteristics such
as population, demand and employment conditions and
urban industrial structure:
–
–
–
–
–
–
–
the percentage of small firms
the percentage of the population that are managers
the percentage of the population with degrees
savings per head of population
the percentage of owner occupied houses
the percentage of the workforce in low entry barrier industries
the regional income distribution
6. Regional variations in new firm
formation rates
• Association of birth rates among manufacturing firms with
indicators of regional characteristics
– The main determinants of new firm formation at the regional level (not
always statistically proved):
o the proportion of small firms in the area
o growth in local industrial demand
o the proportion of professional and managerial occupations in the
population
o the impact of government policy
– However
o new firm formation rates vary internationally – factors operating at the
international scale might be ignored as countries are implicitly treated as
closed systems
6. Regional variations in new firm
formation rates
o isolated regions with small populations (north Scotland and north
Sweden) have high rates of new firm formation, but in absolute terms the
number of new firms in such regions is likely to be quite small
o there may be intangible considerations which are hard to quantify that
bear on new firm formation rates
• The positive association between the existing proportion of
small firms in a region and rates of new firm formation.
7. The effects of industry structure
– Small firms cause to exist small firms while large plants replace them –
reasons:
o differences in employee experience and labour relations
large plants
- employee experience is more likely to be strictly specialized
- greater employment security
- more attractive non-wage benefits in the form of pension schemes,
vacation rights and pay, medical insurance related benefits
small firms
- employees are more likely to perform a wide variety of tasks
- greater opportunity for them to become familiar with firm’s total business watching and learning
- job security is likely be less than in large plants and employees are likely
be less inhibited from leaving because of accumulated benefits - pension
benefits, union seniority
7. The effects of industry structure
o the demand is satisfied by large firms
- they are likely to rely on the head-office for various services and on
affiliated plants for various parts and processes
- for small firms it’s hard to be competitive - workers are relatively unskilled
and management functions relatively limited to labour supervision and
machine maintenance
But the relationships between plant size, ownership and new firm formation need to be
explored in particular contexts, because…
– The size distribution of firms varies internationally
o Example: the stronger role played by small and medium size firms in the
Japanese and German economies than the American or British
economies reflects the stronger tradition of large firms and plants in the
former economies to create and cooperate with new and small firms
7. The effects of industry structure
– Changes occur over time
o In the contemporary period of restructuring there is re-thinking about the
relative roles of large and small firms in favour of the latter - a tendency
for firms to increase subcontracting
o the permanent lay-off of managers as well as workers thus creating a
potential pool of entrepreneurs
8. The effects of regional dynamism
– Regions which sustain growth over a long period of time are more likely
to generate higher rates of new firm formation than slow growth or
stagnating regions.
Sustained growth encourages entrepreneurship because:
o implies that threshold levels for an increasing number of economic
activities are passed
o more diversified economies in terms of skills and occupations provide
more opportunities for new firms
o bigger populations in turn increase the chances for innovative behaviour
o growth is likely to fuel its own spirit of speculation and optimism
o implies net in-migration and interregional migration
o emphasizes better educated, higher skilled and higher income individuals
8. The effects of regional dynamism
– The most important influence on new firm formation is:
local economic diversity and that population growth and greater personal
wealth revealed 'strong' positive associations.
The employment of professionals is positively correlated with new firm
formation and such individuals are often important components of
economically motivated migration streams - in-migration potentially diversifies
the range of skills, ideas, contacts and investment opportunities in a region.
8. The effects of regional dynamism
– How the bussiness cycle influences birth rates of new firms?
UK - the 'desperation' hypothesis:
new firm formation rates increase during recessions as people who are laidoff are encouraged to invest in their own businesses
US - unemployment during business downturns across a wide spectrum of
industries is strongly negatively correlated with new firm formation
The most important variables during recession and recovery:
 economic diversity
 wealth and population growth
 the nature of labour relations
8. The effects of regional dynamism
However…
– If lay-offs are temporary or perceived to be temporary and a social assistance
programme is in effect, then this relationship may not be important.
– During an unusually rapid growth cycle, the leading firms and sectors may be
in a position to pay high wages, salaries and prices and thus ‘crowd out’
smaller firms and pre-empt new firm formation, at least for a time.
But in-migration might be expected to help off-set this effects.
– Smaller firms may be more stable than large firms during recessions as they
were willing to accept lower labour productivity during periods of declining
demand.
9. New firms: the challenge of survival
New firms experience the highest death rates among firms of all ages and that death
rates are high.
The problems facing new firms can be reviewed within the context of a life cycle
model:
1. Introduction
New products are introduced at which time the firm experience consumer ignorance and possibly
resistance. Sales are typically low, growth slow for a while and profitability hard to achieve.
2. Take-off
The product becomes accepted and sales grow and profitability is achieved.
Although the higher the profits the greater the possibility of competition.
3. Diminishing growth
Growth typically slows down due to saturation of demand, competition and attainment of a size that
the owner is ‘comfortable’ with (comfort level). Profits might slip.
4. Maturity
Sales are static and may simply be replacement sales. There is a need for product differentiation.
5. Old age
In the absence of product innovation decline may set in and firm may die.
9. New firms: the challenge of survival
– Problems of strategy formulation and organizational adjustment in a
short period of time.
Introduction Stage
 the marketing problem - accesse a sufficient number of customers and develope a market
niche,
 the accounting problem - establish a cash flow
 the financial problem - typically overcome by use of personal funds and borrowed money
from friends, relatives and perhaps banks
9. New firms: the challenge of survival
Take-off Stage
The nature of the management, marketing, accounting and financial problems continue to evolve.
The firm has to develop proper procedures for control and planning and solve the problems
necessary for rapid expansion.
 Marketing
- a more systematic approach to marketing is needed (administration, files, cost allocation, hiring of
sales people)
- the firm has to access more consumers on a more permanent basis
- expansion requires a strategy to reach new customers (advertising, identification of customers,
personal contact with new markets, innovation of new products)
 Employment practices and relations (not in the model)
- an expansion involves decisions to hire, train, supervise, establish pay scales, hours of work, and
non-wage benefits
- the owners have to handle a variety of personnel matters
- an increasing amount of paper work and record keeping is required (tax and business laws,
medical and insurance requirements)
- increasing delegation of supervisory responsibilities
- the work force may wish to unionize which would require an entirely different system of labour
relations for the firm
9. New firms: the challenge of survival
The life cycle model is an ‘idealization’. In practice the life cycle characteristics of real firms vary
considerably.
 In real world some stages can be omitted, some can be quickly reach.
 The nature of the business challenges facing new firms are difficult and they can evolve rapidly.
 New firms have to face these problems with little prior experience.
 New firms face considerable uncertainty.
All that helps explain the high death rates among such firms.
relations for the firm
10. New (and small) Firms in Local
development
– Contributions of new (and small) firms play in local development
1.
Job creation.
This contribution varied by time period and country.
However, even in countries such as the US and UK, where large firms have dominated, new
and small firms have increased in importance as job creators.
2.
Utilizing the internal human and capital resources available to them. Influencing external
organizations.
- Large firms are particularly effective in influencing rivals, consumers, suppliers and
governments.
- Entrepreneurially run firms have high potentials for fully utilizing their own resources in terms
of their ability to effectively use available labour, space, management and equipment. The
ability to make decisions quickly is another example of such potential.
3.
Increasing capital/output ratio to the extent that new firms utilize the existing stock of 'old'
machinery and buildings.
10. New (and small) Firms in Local
development
4. The innovative process.
Small firms of less than 200 employees, in part because of the expense involved, have been poor
adopters of new technology. However, some studies suggest that the innovativeness of small firms
is better than of large firms.
The scavenging activities of some firms are consistent with this view.
At the same time, it’s needed to underline their ability to integrate new systems with old equipment
in a manner which would not be contemplated by most large firms.
Incremental innovations occur as more or less continuous improvements by engineers and others
in productivity, products and services and at least important segments of small firm populations do
implement incremental change.
Although not dramatic, cumulative impacts of incremental technological change can result in
impressive productivity improvements over periods of time. Indeed, by virtue of their specialization
and narrow focus, small firms are a particularly important source of incremental innovations, the
benefits of which, can be passed on to large firms through subcontracting linkages.
10. New (and small) Firms in Local
development
5. Enhancement of local multiplier processes
by their willingness to purchase local supplies of inputs of goods and services.
The direct implication of the seed bed hypothesis:
new firms will rely on highly localized suppliers.
6. Improving levels of self sufficiency in a local economy, reducing reliance on imports or at least
acting as a relatively cheap form of learning as to whether or not the particular good they are
manufacturing is actually viable within a local economy.
In this regard, high death rates among new and small firms is not simply a waste of resources as
the entrepreneur and locality can learn from such disappointing experiences.
10. New (and small) Firms in Local
development
7. Implying local control which enhances a region's potential determine its own future
and realize its own development potential. Local control of an economy may also have
implications for the cultural, social and educational vitality of a region.
But the opportunism of entrepreneurs may generate socially undesirable outcomes in the
form of hyper-competition, labour exploitation wyzysk and environmental degradation.
Any implications of new firms for local development does of course depend on their establishment
and survival.
11. Small firms and regional
development policy
New firm formation and the small firm sector in general has acquired a higher profile in regional
and local development polices in many countries.
Stimulation programmes in support of small firms.
At the beginning industrial stimulation programmes favoured the attraction of large scale branch
plant operations. However, it was noticed that small firms are needed.
The goals of small firm stimulation programmes:
to encourage the creation of new firms
to encourage the consolidation and expansion of small firms
The policies in different forms and mixes provide:
financing
information and advice
services
access to foreign markets
infrastructure
In recent years there has been growing concern for promoting networks of small firms, especially
high tech firms - sience parks.
11. Small firms and regional
development policy
Financial support:
Banks are highly conservative in giving loans to new firms, they consider a new/small firm a
potential customer if its accounts reveal high profitability, high liquidity and a low gearing ratio.
New firms have distinctive financial problems, notably a lack of capitalization at start-up, and then a
lack of capital to finance growth.
Support is justifiable to overcome a financial gap which is temporary.
Controversis:
 financial markets are there and any financial gap reflects a lack of knowledge and/or financial
competence
 financial help is limited to new firm owners and does not extend to employees who are also tax
payers
 the efficacy of large public sector bureaucracies - the emphasis of bureaucracies on procedure,
qualifications causes that in many new firms die
12. Planning on incubators
Industrial parks and estates of course have been a long established feature of regional
development policy
From the 1950s to the 1970s, however, the main purpose of industrial parks/estates
was to provide the physical infrastructure to attract large scale branch plants .
With the shift in regional and local development policy towards small firms, however,
efforts have been
made to design industrial parks which hopefully will act as incubators to new high tech
firms.
Industrial parks provide:
factory space
incubator buildings which offer services such as typing, faxing, computing, seminar
rooms, video equipment
business advice centres
such social services as restaurants
These services may be provided free or at low cost, at least for a particular time
period to help firms overcome the difficult period of start-up.
12. Planning on incubators
Innovation centres and science parks
- they provide the impetus for new firm formation in high tech activities
- offer some form of incubator help, in some cases including venture capital help
Difficulties in meeting their expectations:
 The importance of new firm formation varies among science parks.
Cases are known where:
30% of Science Park tenants are new firms
10% are new branches of existing firms
the majority of facilities are relocation decisions by small and large firms
 The effectiveness of science parks in promoting university-entrepreneurial links and
linkages among park tenants.
 Doubts about the job potentials of new high tech firms.
12. Planning on incubators
In practice, available evidence suggests that planning for incubation, whether with
respect to manufacturing firms as a whole or high tech firms in particular, is
problematical.
At the local level, there are successes and failures, and perhaps in a high tech
context, attempts to clone Silicon Valley have been predominantly frustrating
exercises.
Thank You For Your
Attention