Understanding Job Creation: Part 3 Firms

How firms form, grow, decline and exit are all critical factors in job creation and economic growth. Economists have been studying which firms are the highest job creators in order to target policies to support the most effective businesses to create jobs.

Mature Firms

The term mature firm refers to the growth phase of a business that is “well-established in its industry, with a well-known product and loyal customer following” (Kenton, 2019). Mature firms generally have slow and steady rates of growth and face constant competition.

Mature medium and large firms that account for most employment (about 45 percent) and most job creation and destruction (Haltiwanger et al, 2010). Most people believe that firms with the “most jobs create the most jobs;” however, these large businesses typically grow at around about 1-2 percent per annum (Arslan, 2011). Goswami, Mevedev & Olafsen (2018) explain that large ‘incumbent’ firms can lack the ability to adapt and innovate from a too greater focus on existing products and services; and therefore they are not job creators once established.

Conversely, small businesses make up (over nine in ten) of Australian businesses. They generate “33 percent of Australia’s GDP, employs over 40 percent of Australia’s workforce, and pay around 12 percent of total company tax revenue” (Commonwealth of Australia, 2016).  However, they typically pay the least of all sectors small businesses are often associated with negative net job creation and are the least likely source of job growth. This is because small businesses may have low productivity, operate in declining markets or they may not be inclined to grow (Haltiwanger et al, 2010).

This is not to say that mature firms of all sizes are not important, as they certainly play a role in the traded economy, underpin existing competitive advantages and clusters, support innovation and stable employment. It’s just that from a job creation perspective, they have limited capacity.

Start-ups

A start-up is often misunderstood for simply a small new business; however, there is a difference between the two. A start-up is a saleable new firm that is working to solve a problem and capitalize on developing a product or service which they believe there is demand for (Grant & Kenton, 2019).  While a new small business may be operating on a traditional businesses model, has limited scalability and are producing goods and services that are already available in the market.

Start-ups typically exist in high-tech or financial sectors but not exclusively, and therefore often in the tradable sector. Start-ups are also more innovative than any other business due to reasons such as:

  1. Fewer barriers to entry (i.e. they aim to commercialise new ideas);
  2. Start-ups choose higher risk strategies and can ‘pivot’ more easily to adapt to markets demands or gaps; and
  3. large rewards for successfully starting a business and commercialising an innovation (Acs & Audretsch, 1988; Koutroumpis, Leiponen & Thomas, 2017; Lerner, 2012).

By nature, all start-up firms operate in a volatile environment as they test their products and services on the market, build an appropriate business model to scale. Start-ups face what is known as the valley of death, an ‘up or out’ dynamic, which forces a young business to manage a negative cash flow before their new product or service generates revenue from real customers (Forbes, 2013). As a result, start-ups are more likely to exit and therefore they also disproportionally contribute to job destruction. In fact, it is estimated that 90 percent of start-ups fail and that after five years, many of these young start-ups destroy nearly half of the jobs they created (Patel, 2015; Haltiwanger et al, 2010). Nevertheless, the surviving firms continue to ramp up, growing faster than more mature firms, and continue to create a disproportionate share of jobs relative to their size.

High Growth Firms

Recently, words such as gazelles and unicorns have been used to describe young and small firms that have continued to grow strongly beyond the start-up phase. Referred to by academics as high growth firms (HGF), they have drawn a lot of attention because of their ability to stimulate growth and job creation. In addition to this, they also generate significant spillovers such as knowledge, innovation and inspire entrepreneurship that benefit other businesses and support start-ups (Goswami, Mevedev & Olafsen, 2018).

High Growth Firms: There is no single definition of a HGF and what constitutes an extraordinary growth rate. However, most agree that a firm that is able to increases its revenues by at least 20 per cent annually for three years or more is considered high growth (Financial Times, N.D.; Kenton, 2018b; OECD, 2012).

HGF makeup on average between 5 percent and 10 percent of all firms and create around 50 percent of all new jobs (Financial Times, ND). Economists found that HGF generated revenue nearly twice as fast as GDP (Evans, 2017). These figures are relatively consistent across developed nations (e.g. UK, US, Australia); however, in developing nations HGF can make up to 20 percent of firms and “generate as much as 80 percent of all new sales and jobs” (Goswami, Mevedev & Olafsen, 2018).

Goswami, Mevedev & Olafsen (2018) advise that while HGFs are typically young, they do not have to be and they are not necessarily small. Research from the UK found that the majority of these HGFs have less than 50 employees but were relatively established in the market and just over five years old. The high growth episode typically starts post start-up stage and most HGF are not able to sustain this growth past five years. Therefore, HGF do not remain strong job creators in the long term. HGF were also found to operate in all industry sectors (e.g. food, health), not just the technology sector and pop up in all sorts of diverse geographical areas, responding to local challenges and opportunities (Fetsch, 2016; Goswami, Mevedev & Olafsen, 2018, OECD, 2012). Thus, policy must take into consideration the creative destruction dynamic and as a result, policies targeting HGF policies targeting can be misguided (Duranton, 2012; Goswami, Mevedev & Olafsen, 2018).

Support

Governments around the world now widely recognise the powerful link between HGF firms and innovation, job creation and international competitiveness. Most are now actively reviewing policies, laws and taxes to support new firms to start and achieve this growth episode (European Commission, 2012; Goswami, Mevedev & Olafsen, 2018). However, both government and professional investors such as venture capitalists, are “notoriously bad” at picking these businesses and a HGF can typically only be identified once it is in a growth run (Goswami, Mevedev & Olafsen, 2018).  Nevertheless, it is important for governments to understand how these firms are established, what drives them and ways to encourage more business growth in order to design effective interventions.

Academics and institutions (Goswami, Mevedev & Olafsen, 2018; Lerner 2012; Marrugo-Salas, 2018) agree that instead of working with individual firms, efforts should be directed towards building the entrepreneurial environment. There is broad agreement that there are a number of determining factors that support HGF and job creation more broadly. These include:

  • the proximity to suppliers and customers;
  • contact and exchange with research and development (R&D) institutions;
  • access to financial resources;
  • economics of scale (industrial agglomeration);
  • managerial capabilities and worker skills;
  • global linkages; and
  • entrepreneurial and creative culture.

Finally, to help policymakers’ structure policies that support firm’s innovation and economic development, Goswami, Mevedev & Olafsen (2018) call for policymakers to focus on stimulating factors such as “innovation, agglomeration and network economies, managerial capabilities and worker skills, global linkages, and financial development, which contribute significantly to increasing the probability of a high-growth episode”. To do this, they propose an “ABC framework”:

  1. improving Allocative efficiency e.g. productivity improvements, labour flexibility, start-up regulations, logistic networks, land use allocations;
  2. encouraging Business-to-business spillovers e.g. industry clusters, smart specialisation, technology parks and export markets development; and
  3. Strengthening firm Capabilities training, R&D, financial incentives, advisory services, incentives, promotion and awards, incubators and accelerators.

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