Local & Regional Development Formation and Function of New (and Small) Firms Lecturer: Prof. Gunther...

Local & Regional Development

Formation and Function of New (and Small) Firms

Lecturer: Prof. Gunther Maier

By Ania Dachowska

and Philipp Hollenstein

1. Small firms vs. big corporations

2. New and small firms as entrepreneurs

3. The background on starting a new business

4. The seed-bed hypothesis

5. The incubator hypothesis

6. Regional variations in new firm formation rates

7. The effects of industry structure

8. The effects of regional dynamism

9. New firms: the challenge of survival

10. New (and small) Firms in Local development

11. Small firms and regional development policy

12. Planning on incubators

Overview

1. Small firms vs. big corporations

• Prior: Small Firms were expected to be less economicalthey 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


• 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


• 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!


• Motivation to begin a new business:– Neoclassical theory focus on … (monetary factors)

o economical rationality o importance of cost-minimizingo profit-maximizing

– In reality non-economic considerations do also play an important role such as …o To be ones own bosso To develop own ideas (self-fulfillment)o To balanced work and leisureo To be rewarded appropriate

• 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 capabilityo need to have a strong connection with the previous workplaceo maybe nowadays older people are more forced to become self-employed

than in the past



• 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)

• 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.



• 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 incubatorso The rate of new firm formation is positively influenced by the supply of

agglomeration economieso 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

– But there are also diseconomies of scale in such metropolitan centerso problems of crimeo obsolescent physical and social infrastructureo long-standing trends of suburbanization and non-metropolitan

industrialization (reduce attraction

– This lead to some other incubators outside the metropolitan areao Silicon Valleyo Boston 128

– One of the big advantages of an incubator area is the access to venture capitalo 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


– 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



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

• 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


• 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 areao growth in local industrial demand o the proportion of professional and managerial occupations in the

populationo the impact of government policy

– Howevero new firm formation rates vary internationally – factors operating at the

international scale might be ignored as countries are implicitly treated as closed systems


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.



– 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


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 internationallyo 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


– Changes occur over timeo 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


– 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 passedo more diversified economies in terms of skills and occupations provide

more opportunities for new firmso bigger populations in turn increase the chances for innovative behaviouro growth is likely to fuel its own spirit of speculation and optimismo implies net in-migration and interregional migrationo emphasizes better educated, higher skilled and higher income individuals


– 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.


– 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 laid-off 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


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.


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. IntroductionNew 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-offThe product becomes accepted and sales grow and profitability is achieved. Although the higher the profits the greater the possibility of competition.

3. Diminishing growthGrowth 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. MaturitySales are static and may simply be replacement sales. There is a need for product differentiation.

5. Old ageIn the absence of product innovation decline may set in and firm may die.


– 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


Take-off StageThe 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


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


– 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.


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.


5. Enhancement of local multiplier processesby 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.


7. Implying local control which enhances a region's potential determine its own futureand realize its own development potential. Local control of an economy may also haveimplications for the cultural, social and educational vitality of a region.

But the opportunism of entrepreneurs may generate socially undesirable outcomes in theform 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.


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.


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


Industrial parks and estates of course have been a long established feature of regional development policyFrom 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 beenmade 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 equipmentbusiness advice centressuch 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.


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 firms10% are new branches of existing firmsthe 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.


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.

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Local & Regional Development Formation and Function of New (and Small) Firms Lecturer: Prof. Gunther...

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