Chapter 9: Formation and Function of New (And Small)

Firms

Chapter 9: Formation and Function of New (And Small)

Firms

By Nirveen Basra and Connie GuoBy Nirveen Basra and Connie Guo

New (and Small) Firms as EntrepreneursNew (and Small) Firms as EntrepreneursNeoclassical Landscape of Perfect

Competition new/small firms: Have no market power or social powerIndependent, decision-making/risk-taking

are personalized, and pursue self interest based on perfect information/rationality

Are limited to the effectiveness of these responses

Neoclassical Landscape of Perfect Competition new/small firms: Have no market power or social powerIndependent, decision-making/risk-taking

are personalized, and pursue self interest based on perfect information/rationality

Are limited to the effectiveness of these responses

Entrepreneurial FeaturesEntrepreneurial FeaturesHave little/no power to change market forces

Little market share therefore price-takersFew employees and sales

Independent: input and output transactions are done at “arms-length” and closely regulated by external market forces

Ownership and management is combined and personalized: “hands-on” decision makingRisk-takers motivated by self-interests

Have little/no power to change market forcesLittle market share therefore price-takersFew employees and sales

Independent: input and output transactions are done at “arms-length” and closely regulated by external market forces

Ownership and management is combined and personalized: “hands-on” decision makingRisk-takers motivated by self-interests

Defining small FirmsDefining small FirmsRequires judgments concerning market share

vs. judgments about geographic size of markets and barriers to entry for new firms

When is a firm independent? How should owner-management be defined?Level of risk involved in creation of firm: not

all firms are innovative

Requires judgments concerning market share vs. judgments about geographic size of markets and barriers to entry for new firms

When is a firm independent? How should owner-management be defined?Level of risk involved in creation of firm: not

all firms are innovative

Defining Small FirmsDefining Small FirmsCharacteristics of a new/small firm are along a

continuum and hold some but not all characteristics and at different levelsEx 1) Loyal Opposition Firms: have established

own customer base in competition with large corporations

Ex 2) Satellite Subcontractors: service large firms

Ex 3) Satellite FranchiseEx 4) Small Firm Laggards vs. Leaders (in the

PLC)

Characteristics of a new/small firm are along a continuum and hold some but not all characteristics and at different levelsEx 1) Loyal Opposition Firms: have established

own customer base in competition with large corporations

Ex 2) Satellite Subcontractors: service large firms

Ex 3) Satellite FranchiseEx 4) Small Firm Laggards vs. Leaders (in the

PLC)

Case StudiesCase StudiesThe Formation of new firms, or supply

of entrepreneurship provides a vital measure of local economy

Two Case Studies:Pacific Emergency Inc.Madge Networks

The Formation of new firms, or supply of entrepreneurship provides a vital measure of local economy

Two Case Studies:Pacific Emergency Inc.Madge Networks

Pacific Emergency IncPacific Emergency Inc Founder: Bradley Field was on the ski patrol at Crystal

Mountain, BC Need arose in carrying medical supplies on the

mountain Created his own adjustable elastic system Demand for products was there and started an in-house

manufacturing company Small Operation: 30 employees No Significant Market Share Low Barriers to Entry for new entrants Don’t effect local economies of city Owner-Managed Defined as “leader” firm

Founder: Bradley Field was on the ski patrol at Crystal Mountain, BC

Need arose in carrying medical supplies on the mountain

Created his own adjustable elastic system Demand for products was there and started an in-house

manufacturing company Small Operation: 30 employees No Significant Market Share Low Barriers to Entry for new entrants Don’t effect local economies of city Owner-Managed Defined as “leader” firm

Madge NetworksMadge NetworksComputer company: started with 4

employeesCreated in 1988Major Competitor: IBMBy mid 90’s sales were $213 million

and 200 employeesCaptured 15% of market shareFormed alliance with Cisco Systems

Computer company: started with 4 employees

Created in 1988Major Competitor: IBMBy mid 90’s sales were $213 million

and 200 employeesCaptured 15% of market shareFormed alliance with Cisco Systems

Learning From CasesLearning From CasesGeneral Patterns:

Husband-wife team that did virtually everything including manufacturing, designing, financing, purchasing and marketing

Owners had little or no prior knowledge, skills developed on the job

Kept full-time jobs while developing skillsHad no money for investments: relied on personal

credit/relatives/income from jobsLocation wasn’t explicitly decided but changes

according to demandFace significant uncertainty: unknown market potential

Unfamiliar with key activities in running firmHard to determine when exactly firm is formed

General Patterns:Husband-wife team that did virtually everything

including manufacturing, designing, financing, purchasing and marketing

Owners had little or no prior knowledge, skills developed on the job

Kept full-time jobs while developing skillsHad no money for investments: relied on personal

credit/relatives/income from jobsLocation wasn’t explicitly decided but changes

according to demandFace significant uncertainty: unknown market potential

Unfamiliar with key activities in running firmHard to determine when exactly firm is formed

Motivation to Begin a new BusinessMotivation to Begin a new Business3 general reasons:

IncomeWork SatisfactionLifestyle Gratification

Important to be able to have control over work, to develop ideas fully, work-life balance and to be financially rewarded in a way that reflects true worth

Ex// In the US self-employment satisfies personal values

3 general reasons:IncomeWork SatisfactionLifestyle Gratification

Important to be able to have control over work, to develop ideas fully, work-life balance and to be financially rewarded in a way that reflects true worth

Ex// In the US self-employment satisfies personal values

PICTURE!!!PICTURE!!!

Entrepreneur’s Age at Formation of BusinessEntrepreneur’s Age at Formation of BusinessJapan:

before 1986 founders mostly in their 30’sAfter 1986 trend to be in their 40’sSimilar to British Studies

More new firms are requiring more technological knowledge, greater financial capability, and a greater need to have strong connections with the previous workplace before start-up

Japan: before 1986 founders mostly in their 30’sAfter 1986 trend to be in their 40’sSimilar to British Studies

More new firms are requiring more technological knowledge, greater financial capability, and a greater need to have strong connections with the previous workplace before start-up

Seed-Bed HypothesisSeed-Bed HypothesisThe rationale for the tendency of new

firm founders to locate in their local or home regionsEx// UK Report: 68-90% of new firm

founders located in local areaHave existing knowledge, capital outlay

smaller, labour demands easier to satisfy, raw materials available at fixed prices-firm is relatively immobile

The rationale for the tendency of new firm founders to locate in their local or home regionsEx// UK Report: 68-90% of new firm

founders located in local areaHave existing knowledge, capital outlay

smaller, labour demands easier to satisfy, raw materials available at fixed prices-firm is relatively immobile

Seed-Bed HypothesisSeed-Bed HypothesisNew entrepreneurs are thoroughly familiar with

their home locales and within these locales are most likely known

Entrepreneurs aware of possible location decisions, possible workers or labour could be provided by families, understand characteristics of local labour

Have contacts with local financial institutions, knowledge of markets, knowledge of available equipment and suppliers

Homes provide an automatic locationLocating elsewhere require high degree of

uncertainty!

New entrepreneurs are thoroughly familiar with their home locales and within these locales are most likely known

Entrepreneurs aware of possible location decisions, possible workers or labour could be provided by families, understand characteristics of local labour

Have contacts with local financial institutions, knowledge of markets, knowledge of available equipment and suppliers

Homes provide an automatic locationLocating elsewhere require high degree of

uncertainty!

Seed-Bed HypothesisSeed-Bed HypothesisCountries with high levels of

immigration (Canada, Australia):Immigrant entrepreneurs tend to live in

new country to acquire decent level of local geographical know-how before creating firm.

Some policies favour early investment by immigrants: HIGH RISKPossible Solution: join established, closely

linked cultural groups that will nurture their new firms in unfamiliar surroundings

Countries with high levels of immigration (Canada, Australia):Immigrant entrepreneurs tend to live in

new country to acquire decent level of local geographical know-how before creating firm.

Some policies favour early investment by immigrants: HIGH RISKPossible Solution: join established, closely

linked cultural groups that will nurture their new firms in unfamiliar surroundings

Incubator HypothesisIncubator HypothesisStresses the importance of long-established

industrial cores within metropolitan areas are incubators

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”Ex// external economies of scale in metropolitan

areas- transportation and storage facilities would be closer therefore, less costs

Stresses the importance of long-established industrial cores within metropolitan areas are incubators

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”Ex// external economies of scale in metropolitan

areas- transportation and storage facilities would be closer therefore, less costs

Incubator HypothesisIncubator HypothesisOld Industrial Cores of Metropolitan Centers

are being replaced with other uses of land such as retail, transportation, and residentialEx// False Creek in Vancouver:

Industrial Core----Residential ComplexEx// US Cities-problems with crime and

obsolescence physical and social structuresUK: Constrained Location Hypothesis

Shift in manufacturing activity from urban to rural areas from the lack of physical space within cities

Commercial and re-industrialization in old cores is growing

Old Industrial Cores of Metropolitan Centers are being replaced with other uses of land such as retail, transportation, and residentialEx// False Creek in Vancouver:

Industrial Core----Residential ComplexEx// US Cities-problems with crime and

obsolescence physical and social structuresUK: Constrained Location Hypothesis

Shift in manufacturing activity from urban to rural areas from the lack of physical space within cities

Commercial and re-industrialization in old cores is growing

Incubator Functions of Technology-Oriented ComplexesIncubator Functions of Technology-Oriented ComplexesTechnology-oriented complexes (TOC’s)

Ex// Silicon Valley and Boston 128Simultaneous Development with R&D initiatives

and small firm creationAttraction: access to large-scale research

activities, employment pool, support services to venture capital

Technology related venture capitalists have an uneven distribution where most are located near Silicon Valley and Boston 128

Less “capital stress”

Technology-oriented complexes (TOC’s)Ex// Silicon Valley and Boston 128Simultaneous Development with R&D initiatives

and small firm creationAttraction: access to large-scale research

activities, employment pool, support services to venture capital

Technology related venture capitalists have an uneven distribution where most are located near Silicon Valley and Boston 128

Less “capital stress”

Regional Variations-FormationRegional Variations-Formation Supply Conditions and Industrial Structure-various

effects on entrepreneurship Encourage start ups? What is industry dominated by? NY vs. Pittsburg example: leader vs. Laggard

Formation rates NF rates 3 times more in highest region (UK in 1970s) Highest in growing regions Birthrates related to NF formation (manufacturing) Some rural areas still traditionalized- not good for NF + Related to areas of administration and education

Supply Conditions and Industrial Structure-various effects on entrepreneurship Encourage start ups? What is industry dominated by? NY vs. Pittsburg example: leader vs. Laggard

Formation rates NF rates 3 times more in highest region (UK in 1970s) Highest in growing regions Birthrates related to NF formation (manufacturing) Some rural areas still traditionalized- not good for NF + Related to areas of administration and education

Strategic ExpansionsStrategic Expansions Population, demand, employment conditions, urban

industry structure 6 Major Factors:

% of existing Small Firms % population of Managers % of people with degrees Savings per person % of Owner Occupied Homes % workforce in Low Entry Barrier Industries

Proportion of SF & professionals, growth, demand and policy Important!

Population, demand, employment conditions, urban industry structure

6 Major Factors: % of existing Small Firms % population of Managers % of people with degrees Savings per person % of Owner Occupied Homes % workforce in Low Entry Barrier Industries

Proportion of SF & professionals, growth, demand and policy Important!

Effects of Industry StructureEffects of Industry Structure Plant size distribution: avoid regions with large plants Externally controlled branches Large Plants reply on specialized/uniform experience,

Small Firms rely on variety in talent Big Firms

Security and comfort

Small Firms More relevant experience, variety of tasks, close

relationships, more complete knowledge of business

International Differences UK& US vs. Japan & Germany

Changes take time…

Plant size distribution: avoid regions with large plants Externally controlled branches Large Plants reply on specialized/uniform experience,

Small Firms rely on variety in talent Big Firms

Security and comfort

Small Firms More relevant experience, variety of tasks, close

relationships, more complete knowledge of business

International Differences UK& US vs. Japan & Germany

Changes take time…

Regional DynamismRegional Dynamism More SF in regions able to sustain growth Growth encourages entrepreneurship

Bigger proportion to motivate behavior Fuel speculation and optimism Better education, higher skills and income

Migration Share and pool ideas, skills, contacts and investments

Business Cycle Fluctuations and uncertainty Perverse effects of UE- take off and invest in New Firm Rapid cycles: higher wages and prices from LF, SF unable to

compete and is crowded out

More SF in regions able to sustain growth Growth encourages entrepreneurship

Bigger proportion to motivate behavior Fuel speculation and optimism Better education, higher skills and income

Migration Share and pool ideas, skills, contacts and investments

Business Cycle Fluctuations and uncertainty Perverse effects of UE- take off and invest in New Firm Rapid cycles: higher wages and prices from LF, SF unable to

compete and is crowded out

Product Growth CycleProduct Growth Cycle Intro Stage Take Off Stage Slow Down Stage Maturity Declining Stage

Simply “ideal” model, real world variations in face of changing business challenges

Intro Stage Take Off Stage Slow Down Stage Maturity Declining Stage

Simply “ideal” model, real world variations in face of changing business challenges

Organizational ChangeOrganizational Change Problems facing New Firms

Intro Stage: survival! Owners do everything Suppliers, employees, marketing, seek customers Often faced with cash problems and need to borrow

Second Stage: from Survival to Consolidation More admin: marketing, accounting, financial Need to develop procedures and plans of control Marketing: more customers, niche market, research to reach

new customer groups Employment practices INNOVATION!!

Little experience in dealing with everything!

Problems facing New Firms Intro Stage: survival! Owners do everything

Suppliers, employees, marketing, seek customers Often faced with cash problems and need to borrow

Second Stage: from Survival to Consolidation More admin: marketing, accounting, financial Need to develop procedures and plans of control Marketing: more customers, niche market, research to reach

new customer groups Employment practices INNOVATION!!

Little experience in dealing with everything!

New and Small FirmsNew and Small Firms Local Development

Job Creation Full utilization of Capital Resources Output ratio Innovation! 3% R&D to 1/3 increase! Local Multiplier Processes Self-Sufficiency Local Control-enhance potential

Spirit: Good and Bad Hyper competition, exploitation of HC and environment

Local Development Job Creation Full utilization of Capital Resources Output ratio Innovation! 3% R&D to 1/3 increase! Local Multiplier Processes Self-Sufficiency Local Control-enhance potential

Spirit: Good and Bad Hyper competition, exploitation of HC and environment

SF & Development PolicySF & Development Policy Local Development Policies (US, UK, Canada)

Encourage creation of New Firms and expansion of Small Firms (Manufacturing and Non-Manufacturing)

Financing, information, services, access to foreign markets Offers Small Business Networks of support

High Tech Industry: incubate New Firms

Problem with Financial Gap Start ups and Growing firms Bank support? Skeptical investors with High Risk! Government/Bank programs- VC and Loan Options Policies to support SF, link to market

Local Development Policies (US, UK, Canada) Encourage creation of New Firms and expansion of Small

Firms (Manufacturing and Non-Manufacturing) Financing, information, services, access to foreign markets

Offers Small Business Networks of support High Tech Industry: incubate New Firms

Problem with Financial Gap Start ups and Growing firms Bank support? Skeptical investors with High Risk! Government/Bank programs- VC and Loan Options Policies to support SF, link to market

Incubators and EducationIncubators and Education Industrial Parks

Physical infrastructure-attractive to high tech firms Offers factory space, services, admin support, equipment,

advice centres, venture capital TOC: Innovation Centres (285 in US)

Education Promote in universities Job security and potential in high tech firms Growth in various sectors

Industrial Parks Physical infrastructure-attractive to high tech firms Offers factory space, services, admin support, equipment,

advice centres, venture capital TOC: Innovation Centres (285 in US)

Education Promote in universities Job security and potential in high tech firms Growth in various sectors

Small Business BCSmall Business BC•Created in 1993•Resource for Business Info and Services•Government sponsored entrepreneurial advice and support•Various Branches

  

Vision: drive and motivate and inspire entrepreneurial growth and success in BCMission: business development resource of individuals to explore opportunities and launch new ventures!

Services include: info, registration, library, coaching, tax services, market research…etc.

Education and CompetitionEducation and Competition• New Program Options at Universities

• Entrepreneurship concentrations• Related courses and seminars

• Competitions and financial options• BDC funding and encouragement• Venture Capital Financing and Bank programs

• Conferences run by Students at a national level• Enterprize Conference at UBC• Concentration in technology and bio-health ventures

• New Program Options at Universities• Entrepreneurship concentrations• Related courses and seminars

• Competitions and financial options• BDC funding and encouragement• Venture Capital Financing and Bank programs

• Conferences run by Students at a national level• Enterprize Conference at UBC• Concentration in technology and bio-health ventures

Questions and Comments?Questions and Comments?