Jan 282010
 

Last week I attended the monthly meeting of a local chapter of SIM (Society of Information Management), a professional society that I have belonged to for years. The after-dinner topic was “The 2010 Annual Report on Technology, Innovation and the Economy.” The last of the three panelists presented statistics and survey data showing that small businesses, particularly in the technology sector, were responsible for most, if not all, of the jobs created during previous recovery periods through innovation and, therefore, should be the recipient of all federal stimulus money targeted at job creation.

During the meeting I asked the speaker to explain his assertion that it was innovation by small businesses that led to their job creation ability. I offered that nothing in the numbers and analysis presented had demonstrated a linkage between the two. As is usually the case in these forums, I received an answer that skirted the question, but did not get to the heart of it. Repressing my inclination to press the apparent inconsistency further, I let the matter drop so my fellow attendees could get home in time to see the Duke/NC State basketball game that evening.

As I am sure you have experienced with similar exchanges, in the car on the way home I kept thinking, “If only I had said…”. By the time I got out of the shower the next morning, I had completed my thought process and was convinced the speaker was wrong in his contention in at least three ways. First, I was convinced that there was no clear correlation between job creation by small businesses and innovation; second, I was not sure that small business was that great a source of innovation anyway; and finally, I was not at all sure job growth by small business, though statistically verifiable, was truly meaningful.

In my experience (and everything that follows here should be prefaced with that caveat), the source of most meaningful innovation that gets translated into jobs comes from either University research (through funding by government or sometimes private sector grants) or R&D efforts by large corporations. It’s just that, in most cases, neither of these sources, because of policies or politics, is able or interested in pursuing the most promising of the innovations they try so hard to identify. Instead, it is up to an entrepreneur working in that environment to recognize the true potential of an innovation, leave the environment where it was created, and strike out on his or her own to pursue the innovation. The entrepreneur recognizes the worth of the innovation and, because of frustration with the bureaucracy, politics or getting cross-wise with management of the organization, decides to take the plunge and pursue the innovation on his/her own. Credit cards are maxed out, second mortgages taken, and sometimes, in the case of the experienced entrepreneur (more on this later), venture capital obtained. The innovation is adapted, applied, engineered and pursued. In so doing, jobs are created, revenue is generated, and, sometimes, even profits are made.

Note however, this scenario describes the application of an innovation, not its creation. A technicality? I don’t think so. Innovation is the product of universities and large corporations, not small businesses. Small businesses generate jobs based most often on the innovations they liberate from other sources.

And what of the jobs they create? Are they real, permanent and enduring or just transitional? First of all, the job of the entrepreneur and the cronies he takes with him from the source of the innovation are a job loss to the source and a job gain to small business. This on its own does not represent a net gain in jobs for the economy. Second, those people hired by the small business from the ranks of the unemployed can be tabulated as job gains to the economy, but for how long? The fate, or maybe even the purpose of most small business startups, is to prove an innovation’s merit and then, if successful, be acquired so the entrepreneur(s) become wealthy and can say, “I told you so.” (If the venture is unsuccessful, all jobs are lost.) Once the value of the innovation is proven, a feeding frenzy among large corporations ensues in an attempt to acquire the small business. The entrepreneur and most of the employees of the small business are amply rewarded for the risk they have taken, but at whose expense? Entrepreneur and employees are absorbed by the acquiring corporation who then most often proceed to squander the value of the innovation that has been acquired. Costs are cut, layoffs ensue, and often the quality of the acquired product diminished under the guise of improving efficiency. Discouraged and unable to fit into the inherited corporate culture, most of the remaining acquired employees who have not been laid off as part of the acquisition leave and appear as a net loss of jobs by the corporation.

So, what do the statistics say? Small businesses create jobs and large corporations are at best job-neutral or show a net loses in jobs. A few of the entrepreneurs, now richer, knowledgeable and more confident as a result, stay with the corporation only long enough to fulfill their contracts and identify new un- or under-appreciated innovations which they can exploit in their next small business startup. And so the cycle repeats. A bit cynical, I admit, but we have almost all seen or been a part of this innovation life-cycle process in our careers. If we are lucky, it’s from the vantage point of the successful entrepreneur.

The statistics show that jobs are created by small businesses, while large corporations appear to add little to the net national employment roles. Yet with the few exceptions of the truly successful startups that grow into giant corporations like HP, Microsoft and Cisco, I contend the vast majority of the oft-ballyhooed jobs created by small business are but transitional; vastly overrated in terms of performance, rewards, and productivity; and require the completion of the full product innovation cycle that involves acquisition to demonstrate whether they can truly be credited with having generated a net increase in jobs and, consequently, are worthy of vast investments of your and my stimulus money as their proponents advocate.

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Ken Rau

Kenneth Rau is a Senior Consultant with Cutter Consortium's Business Technology Strategies practice. He is an internationally recognized authority on IT strategic planning, governance, control, and performance measurement.

Discussion

  4 Responses to “The Myth of Job Creation by Small Businesses”

  1. avatar

    I think it is more accurate to say that a majority of new jobs are created by small businesses that are becoming big businesses.

  2. This article has a gaping logical fallacy running right through the middle of it.

    “Innovation is the product of universities and large corporations, not small businesses. Small businesses generate jobs based most often on the innovations they liberate from other sources.”

    Wait, is an “innovation” an academic idea created through millions of R&D dollars? Or is it the thing that enables business to grow and hire? You are blithely equating the two which is pure nonsense.

    Since the title of the article is about job creation–and it certainly is a very strong title for an op-ed piece pulled off the top of your head with no data–I’m going to use job creation as a measure of innovation. Let’s call it business innovation.

    It’s true that corporate R&D has traditionally provided plenty of business innovation. However that serves the most purpose when a corporation is ascendant (as Google is now, and as Microsoft was in the 80s). Once a corporation has saturated their market, if there is no direct competition then there is a distinct disincentive to innovate, because any innovation would create a short-term cannibalization of their own profits which would be unacceptable to shareholders. This is one reason why, for example, Microsoft can not compete with Google, because doing so effectively would mean undermining their primary profit centers.

    There are still some sectors where lots of basic science is required (eg. drug companies) but in a post-industrial age capital expenditures are greatly diminished and R&D is being slashed across the board (eg. Bell Labs).

    There seems to be an underlying assumption that by default everyone works for corporations:

    “First of all, the job of the entrepreneur and the cronies he takes with him from the source of the innovation are a job loss to the source and a job gain to small business.”

    In other words, every entrepreneur comes from a corporation, and when a valued employee leaves a corporation they never hire a replacement. I’m sorry Ken, that flies in the face of all common sense, and yet you just throw it out there like it’s indisputable.

    But the absolute worst part:

    “Innovation is the product of universities and large corporations, not small businesses. Small businesses generate jobs based most often on the innovations they liberate from other sources.”

    Wait, what? Where do you even get this idea? For this to make sense you need to demonstrate that at least half of major corporations today came from an idea that was developed by another major corporation or University first. If you look at recent success stories like Microsoft and Google that just doesn’t pan out. Microsoft created the innovation of OS as product, and they did so with some seriously un-innovative software that would have been laughed out of any University CSCI Department, IBM (in fact it was) or Bell Labs. Google was not the product of extensive academic research, it was a project by a couple of grad students. Stanford can no more lay claim to that innovation than any university can lay claim to the inventions of anyone who happened to be educated there.

    Finally, focusing only on large corporations gives your argument a kind of circular logic. You completely ignore small businesses that are fundamentally size-constrained, yet in total add up to a significant portion of the economy. These range from mom-and-pop shops to seriously innovative and disruptive medium-sized businesses like NetFlix that brutally crushed the non-innovative incumbents and brought efficiency to a stagnant market.

    Ken Rau, this article is an embarassment. I suspect you have spent far too much time ensconced in the self-important world of corporate politics to get a clear view of what is happening in today’s economy. Extraordinary claims require extraordinary evidence, and you sir have provided absolutely none, not even of the anecdotal variety.

  3. […] Ken Rau argues that innovation comes from government funded research and from big business. He seems to be talking only about technological innovation, not process innovation. Peter Drucker, in his 1985 book Innovation and Entrepreneurship lists a number of different types of innovation. Process innovation is likely to come from a veteran of an industry who realizes something can be done a better way, and then strikes out on his or her own to build a company around that business. It seems to me that process innovation may or may not fit the model that Rau is describing here. In my experience (and everything that follows here should be prefaced with that caveat), the source of most meaningful innovation that gets translated into jobs comes from either University research (through funding by government or sometimes private sector grants) or R&D efforts by large corporations. It’s just that, in most cases, neither of these sources, because of policies or politics, is able or interested in pursuing the most promising of the innovations they try so hard to identify. Instead, it is up to an entrepreneur working in that environment to recognize the true potential of an innovation, leave the environment where it was created, and strike out on his or her own to pursue the innovation. The entrepreneur recognizes the worth of the innovation and, because of frustration with the bureaucracy, politics or getting cross-wise with management of the organization, decides to take the plunge and pursue the innovation on his/her own. Credit cards are maxed out, second mortgages taken, and sometimes, in the case of the experienced entrepreneur (more on this later), venture capital obtained. The innovation is adapted, applied, engineered and pursued. In so doing, jobs are created, revenue is generated, and, sometimes, even profits are made. […]

  4. “First, I was convinced that there was no clear correlation between job creation by small businesses and innovation; second, I was not sure that small business was that great a source of innovation anyway; and finally, I was not at all sure job growth by small business, though statistically verifiable, was truly meaningful.”

    Convinced based on what, exactly? Your assertions are more tenuous that those of the speaker you were questioning.

    My reading of this is that you only look at large corporates and universities and you see the trouble that have with innovation. That does not imply that innovation doesn’t happen outside those environments. In my experience in smaller companies a lot of innovation happens because individuals in those environments see problems they can solve, and they are resource constrained, which leads to better innovation.

    Look at http://ycombinator.com. They are funding startups that are innovating and creating value in exactly the way you assert is non-existent.

    As a basis for making any policy decision about how to deal with small business, this is just wrong.

    On stimulus money, however, there are other arguments for not targeting small business (or anyone). The problem with stimulus money is that it is dispensed by a large bureaucracy, which requires much effort to deal with. This means that the organisations (large or small) that get the money are those with the ability to deal with the bureaucratic issues. Large organisations have an advantage here.

    The real issue is that those organisations that actually focus on useful innovation find that their competitors have free taxpayers’ money, and are then at a competitive disadvantage. They then fail outright or have their growth stunted. Once the free money runs out, the organisation which received the donations suddenly contracts and reduces its workforce. Net result: no one wins and the taxpayer is fleeced.

    Better answer: Fire the bureaucrats, pay down debt and get on with building useful stuff.

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