delanceyplace.com 11/24/09 - more innovation

In today's excerpt - small firms have an
advantage over larger firms in innovation,
and venture capital plays a
disproportionately large role economic
growth:

"Initially, economists generally overlooked
the creative power of new
firms: they suspected that the bulk of
innovations would stem from
large industrialized concerns. For instance,
Joseph Schumpeter (1883-1950), one
of the pioneers of the serious study of
entrepreneurship, posited that
large firms had an inherent advantage in
innovation relative to smaller
enterprises. ...

"In today's world, Schumpeter's hypothesis of
large-firm superiority
does not accord with casual observation. In
numerous industries, such
as medical devices, communication
technologies, semiconductors,
and software, leadership is in the hands of
relatively young firms whose
growth was largely financed by venture
capitalists and public equity
markets. ...

"A
study by Zoltan Acs and David Audretsch
examined which firms developed some of the
most important innovations of the twentieth
century. They documented the central
contribution of new and small
firms: these firms contributed almost half
the innovations they examined. ...

"What explains the apparent advantage of
smaller firms? Much of it
stems from the difficulty of large firms in
fomenting innovation. For
instance, one of Schumpeter's more perceptive
contemporaries, John
Jewkes, presciently argued:

" 'It is erroneous to suppose that those
techniques of large-scale operation and
administration which have produced such
remarkable results in some branches of
industrial manufacture can be
applied with equal success to efforts to
foster new ideas. The two
kinds of organization are subject to quite
different laws. In the one
case the aim is to achieve smooth, routine,
and faultless repetition, in the other to
break through the bonds of routine and of
accepted ideas. So that large research
organizations can perhaps
more easily become self-stultifying than any
other type of large
organization, since in a measure they are
trying to organize what
is least organizable.'

"But this observation still begs a question:
what explains the difficulties of larger
firms in creating true innovations? In
particular, there are at least three reasons
why entrepreneurial ventures are more innovative:

"The first has to do with incentives.
Normally, firms provide incentives to their
employees in many roles, from salespeople to
waiters.
Yet large firms are notorious for offering
employees little more than
a gold watch for major discoveries. ...
Whatever the reason, there is a striking
contrast between the very limited incentives
at large corporate labs
and the stock-option-heavy compensation
packages at start-ups.

"Second, large firms may simply become
ineffective at innovating.
A whole series of authors have argued that
incumbent firms frequently have blind spots,
which stem from their single-minded
focus on existing customers. As a result, new
entrants can identify
and exploit market opportunities that the
established leaders don't
see.

"Finally, new firms may choose riskier
projects. Economic theorists suggest that new
firms are likely to pursue high-risk strategies,
while established firms rationally choose
more traditional approaches. Hence, while
small firms may fail more frequently,
they are also likely to introduce more
innovative products. ...

"On average a dollar of venture capital
appears to be three to four times more potent
in stimulating patenting than a dollar
of traditional corporate R&D."

Josh Lerner, Boulevard of Broken
Dreams, Princeton, Copyright 2009 by
Princeton University Press, pp. 45-49, 62.