Formation and Function of New and Small Firms

Chapter 9Michael Brady McMahon

Kyle Shepherd

Summary of Topics

• Background• New and Small Firms as Entrepreneurs• Features of Entrepreneurial Firms• Case Studies• Motivation for Firm Start up• Characteristics• Hypotheses (Seed-bed and Incubator)• Regional Variations in New Firms• Regional Dynamism• Small Firm Life Cycle• Contributions of Small Firms• Policies

Background

• Past 15 Years – Surge of interest in New Firms• Downsizing among large firms• Rapid Growth of new business formation• Ideological shift celebrating the role of

initiative and entrepreneurialism

New and Small Firms as Entrepreneurs

• Business organization stands in sharp contrast to bureaucracies and technostructures that administer large corporations

• Entrepreneurial firms operate in market strongly regulated by competition– Neoclassical approach– Firms as black boxes

Features of Entrepreneurial Firm

• As indicated by Neo-classical model:– Firms have little power to change market forces– Input and Output transactions are at arms length

and closely regulated by external market forces– Combined and personalized decision making

leading to personal incentives to improve efficiency

New Firm Case Studies

• Pacific Emergency Inc. (and Pacific Body Armour)– Backpacks for Medical Equipment– Niche market– Husband-wife team with no prior knowledge of activities– Both owners kept previous full-time jobs (little money, minimal startup capital)– Location not explicit part of the story (simply started working in their home)– Significant uncertainty and “knowledge gaps” in creating Pacific Armour

• Madge Networks– High tech manufacturer which developed a sophisticated computer component– Entering as direct competitor to IBM (IBM 70% market share in token rings)– Location near home of founder– Hands on management– Financing problems (mortgaging his farm)– Uncertainties associated with firms start-up and development

Motivations For Firm Startup

• Control over work• Develop ideas to their fullest potential• Autonomy over work-life balance• Financial reward reflecting true worth• Western ideal: “being one’s own boss”

Characteristics

• Entrepreneur’s age at formation of business

• Founders Previous occupation

• Relationship with previous workplace

The Seed-Bed Hypothesis

• Majority of new firms locate in their local area– Rationale:• Local contacts (equipment, suppliers & markets)• Inheritance of knowledge of location• Provision of labour by family• Elimination of costs associated with collection of

information on unfamiliar locations

The Incubator Hypothesis

• Firms attracted to areas offering services essential to their operations

• Examples:– Ethnic group supporting immigrant entrepreneurs– Institutions that spin off entrepreneurial ventures through the

initiatives of former employers – Geographical planning stressed importance of long-established

industrial cores within metropolitan areas (natural incubator functions)

Incubator Hypothesis

• Incubator functions of technology-oriented complexes – Silicon Valley & Boston 128• Result of spontaneous development • Establishment of R&D facilities by major corporation

and small specialized operations• Access to large scale research institutes• Importance of Venture Capitalists

Regional Variations in New Firm Formation Rates

• Variation is an implication of traditional geographical incubator hypothesis– New York vs Pittsburgh example

• Pittsburgh dominated by heavy industry and a few large corporations• New York enjoys a more diversified composition comprised of a large

population of small firms

– Government assistance for industry hinders new firm formation

Regional Variations in New Firm Formation Rates

• Key Variables– Percentage of small firms– Percentage of population that are managers– Percentage of population with degrees– Savings per head of population– Percentage of owner occupied houses– Percentage of workforce and low entry barrier industries– Regional income distribution

The “Best” Irish Case

• Main determinants of new firms formation (Hart and Gudgin, 1994)– Proportion of small firms in the area – Growth in local industrial demand– Proportion of professional/managerial occupation – Impact of government policy

• Variables used do not adequately capture regional characteristics

Regional Dynamism

• Refers to absolute increases in levels of economic activity and regional income

• Sustained growth encourages entrepreneurship• Local economic diversity stimulates new firm

formation• Population growth• Greater personal wealth

Small Firm Lifecycle Model

• Stage 1 – Introduction– New Products– Encounter consumer ignorance or resistance – Sales low – Growth slow

• Stage 2 – Take-off– Product accepted– Sales grow– Profitability achieved

Small Firm Lifecycle Model

• Stage 3 – Slow Down– Growth slackens• Saturation of demand • Competition• Attainment of size

• Stage 4 – Maturity– Sales Static– Need for product differentiation

Small Firm Lifecycle Model

• Stage 5 – Decline – Lack of product innovation– Firm could die

Contributions of Small Firms

• Job Creation• Efficient utilization of resources• Effective use of old machinery• Innovation• Positive effect on local suppliers• Local marketing linkages• Local control of economy

Small Firms and Regional Development Policies

• Policies are highly varied and come in different forms and mixes

• Include:– Financing– Information and advice– Services– Access to foreign markets– Infrastructure– Promotion of networks of small firms (esp. High-tech)

• Science Parks – seek to help incubate hi-tech firms

Takeaways

• Surge of Interest in new firms• Variety of motivations for firm start up• Seed-bed Hypothesis and Incubator Hypothesis• Reasons for regional and spatial variation in small

and new firms• Small firm life cycle• Contributions of small firms• Regional development policies