A case for developing regional strategies for innovation led economic development.
By H. Randall Goldsmith
In 1979 David Birch coined the term Gazelle to describe companies whose employment growth rate exceeded 20 percent per year. Birch was one of the first economists to recognize these fast growing startup companies created the vast majority of jobs in the United States. While Gazelles are found in all industry sectors, a large percentage exist in the retail and wholesale industry sectors. For no other reason than to establish a stronger association between high performance, innovation intensive enterprises (HPIIEs) and the growing awareness of the importance of innovation led economic development, I prefer the term "Hippie" companies. While many Gazelles are in all probability also Hippies, the term Hippie is more descriptive to my satisfaction.
First, the term "high performance" better captures the value and importance of human capital to the enterprise. The "high performance" aspect can be quantified in a variety of financial metrics per employee ranging from value added, sales, and wages. In other words, if a company's performance generates a value added per employee that is 25% or greater than the national average for its industry sector, we consider it a high performance enterprise
Likewise, if sales or wages per employee within their industry sector are 25% above the national average, they meet the definition. Granted the 25% level is an arbitrary bench mark and could be set lower or higher. From my view point, setting the bench mark is a decision based on the mission and target market of the entrepreneurial support organization. If an organization's mission is to assist in the development of a large target market of life style companies, the bench mark can be established closer to the national average. However, if the mission targets a more selective market of enterprises with potential to change an economy, the bar must be higher.
Second, the term "innovation intensive" brings to focus the importance of innovation to achieving market differentiation and competitive advantages in a global economy. While much emphasis has been placed on "technology-based economic development," there is a growing trend to characterize the current new economy as "innovation-based economic development." This subtle change does not minimize the importance and value of technology which by nature is innovation, but expands the concept to address the innovative marketing, financing, venture structure and relationships resulting from global economic conditions.
Given the diversified demographics of industry sectors, geography and age of HIIPE companies, the idea of developing entrepreneurial service organizations to support the development and growth of high performance innovation intensive enterprises is, in my opinion, not only an appealing one but an achievable one. The intent of this article is to characterize the opportunity and suggest programs and tools to establish regional infrastructure to advance innovation led economic development.
Hippie companies come in a variety of flavors. Some are young early stage companies in emerging technology sectors that are redefining global markets. Having these innovation driven entrepreneurial enterprises within our communities is a major objective in virtually every state's strategic growth plan. Over the last decade, these plans have been characterized as "Technology Based" and "Innovation Led" economic development. A variety of research results justify these initiatives by presenting empirical evidence that the strongest determinant of real state growth results from local economies that support the creation of innovation intensive enterprises. Other reports indicate that 5 percent of the 500,000 to 700,000 new enterprises created each year eventually account for two-thirds of all new jobs and radical innovations. These findings clearly validate state and local investment in entrepreneurial service organizations, business accelerators, investment capital initiatives and other programs to support entrepreneurship and innovation.
Another type of Hippie firm is referred to as a "second stage" enterprise. While "first stage" refers to startup and early-stage companies, second stage companies are those who have sales in excess of $1,000,000 per year. The SBA Office of Advocacy recently released a report, "High-Impact Firms: Gazelles Revisited," that offers surprising insights into these second stage companies. Their study defines high performance companies as those that doubled sales and employment in the last 4 years. The findings indicate that the average age of second stage Hippie firms is 25 years old, and include 375,000 U.S. companies spread across all industry sectors of which 94% have fewer than 20 employees. Larger Hippie firms up to 500 employees represent only 6% of the companies but 24 percent of job growth. Another surprising finding debunks the myth that "high tech regions" account for all the Hippie companies. The study shows that the number of Hippie firms as a percentage of all firms within nine geographic regions of the country range from a low of 2.1 percent to a high of 2.3 percent. Moreover, 23 percent of these companies are found in rural areas. Hippie enterprises can succeed anywhere.
A fair question is "what makes Hippies so important?" It is a simple question with a simple answer, but one that is often overlooked by those who fail to understand growth beyond job creation. The answer is "productivity." Worker value, enterprise profitability, economic health, and corporate and individual wealth can be explained in a word – productivity. Within the last 50 years, the global economy transitioned from an industrial economy to a service economy and a service sector that moved through an "information age" to a "knowledge age." The simple observation is that Hippie firms, in contrast to low performance companies, are driven by innovative products, processes, materials, designs, know-how and business strategies requiring knowledge-based workers. The SBA study reports that average revenues per employee from small, medium and large Hippie companies is $100,000, $225,000, and $285,000 compared to low performance revenues of $85,000, $115,000, and $203,000 respectively. Companies that can increase productivity in the face of competition will survive and thrive.
It is widely recognized and accepted that innovation is the primary differentiator between low performance and high performance companies. Companies who are successful at innovation can maintain or improve their market position as long as the innovations remain relevant and provide competitive advantages. Innovations generally fall into two categories, "incremental" and "radical" and can apply to products, processes and/or business strategies.
When considering incremental and radical innovations applied to products, two distinct business models come to mind. Some companies employ a competitiveness business strategy through continuous adoption and deployment of incremental product innovations to sustain or improve their market position. This strategy is generally characteristic of mature, second stage, companies with an established customer base. The competitiveness strategy of other companies is through the commercialization of radical innovations. This strategy is typically characteristic of new, first stage, enterprises bringing new products to market.
It is not surprising that mature companies are more likely to adopt an incremental innovation strategy versus a radical innovation strategy characteristic of new enterprises. Mature companies are typically more risk adverse and have a bias againstadopting strategies that could potentially disrupt, disappoint, or confuse their existing customer base. Thus, growth strategies for mature companies can, to a great degree, be tied to the market capacity to adopt incremental change.
A less frequent but effective accelerated growth strategy is achieved through the acquisition of other companies. The typical model for this strategy is a larger company acquiring an innovation intensive startup or early stage company with high performance potential developing a radical product with a growing customer base. This strategy allows the larger company to minimize the risk associated with the uncertainty of the research, development and market introduction phase of product development.
When considering a regional strategy for innovation led economic development, two key questions beg to be asked and answered. The first question is "what do Hippie's need to be successful," followed by a logical second question of "what can we do as entrepreneur service organizations to meet their needs?" While each company is unique, there appears to be a portfolio of service offerings that have value for this unique market sector.
A variety of services fall into the category of what I refer to as "soft" services. These relate to consulting with entrepreneurs and CEO's on qualitative topics such as time management, leadership, team building, peer networking and other personal development offerings. I classify "hard" services as more quantitative assistance more directly related to productivity such as innovation ideation, customized workforce training, strategic planning, and marketing research.
The most prevalent need for first or second stage companies is development capital for new product development, expanding market share, and operating capital. The type and sources of capital needed to support Hippie growth are typically different from the capital opportunities of low performance enterprises. Low performance firms eventually find themselves competing on the economics of "faster, better, cheaper" and devolving into obsolescence and diminishing returns in the absence of innovation, and therefore have more limited access to capital.
In the era of open innovation, the opportunities for creative financing strategies offered by strategic partnerships, licensing strategies, spinouts, and angel and venture capital have greatly expanded the potential for Hippies to explore and exploit their market opportunities. As common as this need is across all industry sectors and geographies, it is, in my view, the least understood, least available, and most challenging for the Hippies and the service organizations who serve them. In my twenty years of working in the innovation arena driven by research, technology, entrepreneurs, investors and a global economy, I've observed that individuals and organizations that have the programs, tools and competencies to successfully connect Hippies with capital have a unique market value.
Success for entrepreneurial service organizations that chose to operate in the innovation financing environment depends on customer satisfaction. Customer satisfaction, in turn, depends on whether the customer achieves their financing objectives. Consequently, it is imperative to the existence of the entrepreneur service organization to have a reputation for positive outcomes. At the same time, the service organization typically does not have the luxury of picking and choosing winners and losers without diluting its market value. To manage this challenge, my position has always been to never, or at least rarely, tell a company what can't be achieved, rather to tell them what they must accomplish to achieve their objectives – regardless of how realistically achievable they may be. In this way the challenge and burden of responsibility rests with the company to perform. If they find the challenge too great, they eventually self-elect to abandon the effort, whereas successful performance most often results in positive outcomes.
Most Hippie financing will be in the form of private equity. Thus, another essential criterion for success is that individuals in the service organization have a solid understanding of investor mentality, criteria, and process. Moreover, it is equally important that they have the ability to immediately raise the Hippie's knowledge level about the private equity investment environment. I find that there are two fundamental concepts to share with entrepreneurs and companies to propel them into this learning process. One is the investment risk concept. All investors distill their criteria, knowingly or not, into five risk categories, each of which must be acceptable to their risk threshold.
The second concept is understanding investor motivation. To assist Hippies to understand the investor, I pose 5 questions for them to answer 1) exactly how much money do you need, 2) what exactly is the intended use, 3) what is the expected return on investment, 4) when will the pay off occur, and 5) what will be the source of pay off?
To quantitatively and qualitatively address these concepts, I've developed a commercialization tool kit consisting of 7 surveys to assess the Hippies readiness at any given time to commercialize their product or venture opportunity. The questionnaires provide a quantitative score from an investor's perspective to assess the status of the venture/product development progress, the risk inherent in the venture, the quality of the business plan, the commercial potential of the product, the innovation profile of the Hippie, the valuation for investment percentage, and capitalization table. These surveys are available as web applications at www.venturcapitaltools.com.
Finally, having knowledge of and access to as many sources of capital possible is as fundamental to the success of the entrepreneur service organization as is the ability to serve the Hippies. Without access to capital sources that have developed trust in the service organization's ability to qualify the Hippies for funding, the whole process breaks down and becomes meaningless.
In summary, my perception is that this new economy consists of innovations with exceptional market value, creative capital, and high performance innovation intensive enterprises. Communities and states who establish core infrastructure composed of competent entrepreneurial service organizations, with the ability to programmatically assist Hippie's in becoming financing candidates, and identify and mobilize investment capital, will have a distinct competitive advantage in accelerating innovation led economic development.