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CRIC Project - The Innovation Performance of Small Firms (Project completed)

The Problems Addressed
Empirical Work and Data Sources
Key Results and Outcomes
Significance of Results and Outcomes
Key Publications
Other References

The Problems Addressed

For twenty years or more, there has been an abiding perception, with considerable currency amongst politicians and policy makers in London, Brussels and elsewhere, that new and small firms are an important source - perhaps even the source - of innovation, new technology and employment creation. These are three of the crucial dynamics of economic development, but areas in which the UK and Europe have struggled against world-wide competition. Despite this, relatively little evidence is available on the contribution of new and small firms to these economic phenomena.

These issues clearly relate to the 'systems of innovation' stream of CRIC's work, as well as to our work on the measurement of innovation. The 'US system of innovation' for example, is based to a significant degree on entrepreneurship, and in the US some start-up companies have been able to grow into industrial giants in the space of only a few years. But there is very little evidence of similar growth in the UK or in continental Europe. This raises two questions: Is the US system of innovation superior? And should Europe seek to adapt its (more corporatist) system of innovation to emulate that of the US by encouraging entrepreneurship? Clearly there are differences across Europe. In the 1980s, the UK has sought to encourage entrepreneurship much more than most of continental Europe, although more recently expectations with respect to entrepreneurship seem to have declined, whilst the rest of Europe is increasingly looking to entrepreneurs to provide innovation and create jobs.

Empirical Work and Data Sources

Despite the significance attached to entrepreneurship and innovation, very few empirical studies exist that demonstrate the contributions of new and small firms to innovation or employment creation over a substantial period of time, such as a decade or more. For our studies we draw on a database of the new and small firms which won the Queen's Awards for Technological Achievement, or the British Design Award, between 1980 and 1990. The performance of these firms with respect to sales from their innovations has been estimated (Tether, 1998) and their employment creation performance has been compared with studies of other firms from the general population (Tether and Massini, 1998).

Key Results and Outcomes

As mentioned above, despite the attention paid to innovative ventures by politicians and policy makers over the last twenty years, there is very little evidence on the extent of growth of such firms in the UK (or indeed in continental Europe). Below, we set out a number of pertinent findings from recent research, including our own, which provides a summary of the state of knowledge on innovative and technology based new and small firms. We consider this under the headings of: on contributions to innovation; on survival; on employment creation; and on networking, before ending with a discussion of the implications for policy making.

On Contributions to Innovation

In the late 1980s and early 1990s several studies were published which argued that small firms, particularly in manufacturing, were responsible for more innovations than their share of employment would suggest. This finding arose in studies using US, UK and European evidence and was widely interpreted as showing that small firms were more efficient innovators than their larger counterparts.

This interpretation, however, depends on the important assumption that the economic value of the innovations introduced did not vary with the size of the firms responsible for their introduction. In one of our research papers (Tether, 1998), this assumption was tested and found to be invalid. In fact, the value of innovations tends to increase with the size of the firms responsible for their introduction. More specifically, it was found that the sales value of over 100 award winning innovations introduced by small firms was less than the value of just seven award winning innovations introduced by large established firms. Thus, although new and small firms do innovate, they tend to introduce relatively lower value innovations. This research was based on UK evidence (and specifically the Awards database mentioned above), but there is good reason to believe that the pattern discovered is also true of Europe, and possibly even the United States. However, it must be appreciated that small firms provide other important inputs to innovation elsewhere in the economy, and we discuss this later in relation to innovation and technology networks.

On Survival

Although innovative or technology based ventures might be expected to be higher risk than other start-ups operating with more conventional ideas or technologies, the evidence from the UK suggests that, overall, innovative and technology based ventures tend to be more likely to survive than new firms generally. Put more cautiously, it is possible to conclude that innovative and technology based new and small firms are no more likely to fail than other small firms. This may be because innovative and technology based new firms tend to be established by founders with higher levels of 'human capital' than the average new firm. Cressy (1999) has found that the founders' level of 'human capital' is the most important determinant of survival amongst new firms. Like the general population of small firms, however, the death rate amongst innovative and technology based small firms tends to be particularly high in the period immediately after start-up.

On Employment Creation

The recent studies (Tether and Massini, 1998) on innovative and technology based new and small firms have reported various rates of average employment creation. But from these four key facts appear to emerge:

Innovative or technology based new and small firms are more likely to create employment than similar firms in the general population. This is understandable, and we would be worried if this were not the case.
More interestingly though, the average rate of employment creation within an individual innovative or technology based new or small firm tends to be modest. In general, the average rate of employment creation amongst such firms has been much less than ten new jobs per firm per year (Storey and Tether, 1998). Not only has this been a recurrent finding for the UK, but also for continental Europe. For example, in France and Sweden studies have found modest growth to be the norm amongst firms established by scientists, and modest growth has also been the norm amongst technology based small firms with 'growth potential' in Finland. This means that a very large number of these firms is required to provide substantial amounts of employment, equivalent - in employment terms - to the establishment of a substantial plant through inward foreign direct investment. In this sense then, support for innovative or technology based start-ups and small firms should not be seen as an alternative to supporting established large firms if the primary aim is employment generation in the short term.
The third recurrent finding is that growth amongst innovative and technology based new and small firms tends to be concentrated in a few firms (Tether and Massini, 1998). Amongst a cohort of firms, only a handful will be responsible for most of the new jobs created by the whole group of firms over a period of a decade or so. For example, our study found 10% of the firms studied were responsible for half the new jobs created by a group of 149 firms over a decade (Tether and Massini, 1998). It is worth noting that this pattern of growth concentrated in a few firms is also true of studies of more conventional firms. Indeed, the concentration of employment creation may be even greater amongst conventional start-ups.
The fourth finding is that even amongst the fastest growing innovative and technology based new and small firms the absolute number of jobs created over a decade tends to be modest. Our UK based study (Tether and Massini, 1998) found the fastest growing innovative or technology based new or small firms in the sample created hundreds rather than thousands of new jobs over the 1980s. Similar findings have arisen from studies of European new and small firms. From a policymaker's perspective, this is probably the most disappointing finding, and may be hard to believe. There are of course some such firms - such as the German software company SAP which was established in 1972 and which now has over 7,000 employees, and Dyson Appliances Ltd, the company established by James Dyson to manufacture his novel bag-less vacuum cleaners - but we submit that they are few in number.

On the Role of Small Firms in Innovation and Technology Networks

Until now, we have essentially considered the contributions of new and small innovative and technology based firms in isolation. We have examined their relative likelihood of survival and the extent to which they have grown and created employment. Research within this 'atomistic' tradition has provided some valuable findings, but there is a danger that the contributions of new and small innovative and technology based firms will be too narrowly interpreted from this perspective, such that a failure to grow will be interpreted as a failure to perform, due to market failures or widespread barriers to growth. Whilst not denying the existence of market failure and barriers to growth, it is important that the wider, systemic, contributions of new and small innovative and technology based firms are appreciated.

Although it is very difficult to measure such contributions, it has long been recognised that one of the most important contributions of small firms to innovation is through the provision of specialised equipment and services which enhance the production and innovation performance of larger firms. Other authors, notably Autio (1997a&b), have argued that the obsession with atomistic growth of the dominant tradition of research into innovative small firms is framed in the linear model of innovation and diffusion. Instead, Autio emphasises the importance of innovation networks, or milieux, within which technology based new and small firms play an important role. We have a great deal of sympathy for this perspective, although unfortunately, systemic contributions are very hard to measure.

From a systemic perspective, however, it is important to understand the diversity of innovative and technology based new and small firms (Tether, 1997). By appreciating this diversity it will be easier to recognise that, for most companies, the failure to achieve rapid growth is not related to a business failure, market failure or barriers to growth - for most firms new and small innovative or technology based firms do not even aspire to grow rapidly into large firms (Autio, 1997a&b,). Barriers to growth (and 'market failures') are not generic, and particular barriers, such as the absence of risk capital, are acute for some firms but are unimportant for others. Of course, it may be that the absence of risk capital is particularly important for the relatively small group of firms which are seeking to develop 'generic technologies' with wide potential applications (Tether, 1997) - just the sort of firms that might grow organically into large firms on the basis of the linear model of innovation and diffusion.

Significance of Results and Outcomes

This research clearly relates to the CRIC's agenda and our understanding of the processes of innovation and competition.

Firstly, in relation to the measurement of innovation the work presented in Tether (1998) makes a significant step forward by weighting the significance of innovations by their commercial value - something no previous wide scale analysis of a database of innovations had done. The implication of this reweighting was non-trivial, as it effectively overturns the existing and established result that small firms are a disproportionally important source of innovation. We find that most small firms introduce relatively low value innovations, so the number of innovations they introduce effectively over-represents their contribution to innovation.

Secondly, in relation to the 'systems of innovation' literature, it is clear that at a broad level the different (direct and indirect) contributions of entrepreneurship to innovation and employment growth in the United States and Europe (including Britain) should not simply be reduced to 'barriers to growth' and 'market failure' explanations, but reflect wider differences between broad 'systems of innovation'. Also within this tradition, our analysis emphasises the diversity amongst the innovative new and small firms: only a few are seeking rapid growth and only a few have introduced innovations intended for wide generic markets which, if they are successful, would provide a route to rapid growth.

In relation to policy making it is important to get the balance right. We know that new and small firms, particularly those that are technology based, play an important economic role through innovation and employment creation, but it is important not to get the actual or expected economic contribution of these firms out of proportion - particularly if employment and sales are the measures used to assess their contribution. It must be understood that large firms are also important, probably more so, for innovation, and that small and large firms interact and inter-depend in innovation. Small and large firms should not, therefore, be seen as alternatives. Both deserve support, but in the case of new and small technology based firms this should be provided whilst also holding realistic expectations as to what they can, and cannot, contribute to the UK (or European) economy.

Key Publications

Tether, B. S. (1997) 'Growth Diversity amongst Innovative and Technology Based New and Small Firms: An Interpretation', New Technology Work and Employment, 12(2), pp. 91-109.

Tether, B. S. (1998) 'Small and Large Firms, Sources of Unequal Innovations?', Research Policy, 27, pp. 725-745. (An earlier version is available as CRIC Discussion Paper No. 11)

Tether, B. S. and Massini, S. (1998) 'Employment Creation in Small Technological and Design Innovators in the UK during the 1980s', Small Business Economics, 11, pp.353-370. (An earlier version is available as CRIC Discussion Paper No. 10)

Tether, B. S. (2000) 'Small firms, innovation and employment creation in Britain and Europe: A question of expectations …' Technovation, 20, 109-113. (An earlier version is available as CRIC Briefing Paper No. 2)

Other References

Autio Erriko, (1997) 'Automistic' and 'Systemic Approaches to Research on New Technology Based Firms: A Literature Study, Small Business Economics 9, 195-209

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