Wednesday, May 21, 2014

Why America Is Losing Its Entrepreneurial Edge

The U.S. is one of the few nations on earth where private, for-profit business formation is seen as a quasi-heroic act. The resulting entrepreneurial culture has captured the world’s imagination and driven the nation to great prosperity. Yet now it is clearly faltering.

In a new paper that’s already generated much discussion, economists Ian Hathaway of Ennsyte Economics and Robert Litan of the Brookings Institution document four decades of “Declining Business Dynamism in the United States.” Looking at data from all fifty states and all metropolitan areas, Hathaway and Litan conclude there’s been a secular decline in business formation throughout the country, with a concurrent increase in business dissolution. The rate of business formation in 2011 was almost half of what it was in 1978, with the rate of dissolution somewhat higher than the past couple decades. When they restate this another way, the implications are clearer: “Whatever the reason, older and larger businesses are doing better relative to younger and smaller ones.” Deep, disruptive economic change is all around us, but the data indicates that the national response has not been, contrary to our myths and history, one of increased entrepreneurship.

Hathaway and Litan stay close to the data in this work and stop short of speculating about causes of this trend. So allow me. While there are numerous factors in such a massive shift away from business formation, one of the most powerful has to be the consolidation of multiple economic sectors toward a handful of firms with hegemonic power over their industry. Much of this is driven by the needs of the financial sector, which itself has consolidated massively. This paper by the Richmond Fed shows how from 1960 to 2005, the U.S. financial services sector went from 13,000 of independent banks to half that number, while the top ten banks grew from 20% market share to 60%. As of 2013, the top ten banks had 70% of the market.

Consolidation of the financial sector has led to similar dynamics in other industries. In pharmaceuticals, the largest company, Pfizer, is the result of decades of mergers. The current corporate entity is comprised of firms that used to be called: King Pharmaceuticals, Wyeth, American Cyanamid, Lederle, Pharmacia, Upjohn, Searle, SUGEN, Warner-Lambert, Parke-Davis and others. In chemicals, energy, technology, beer and more, you can see a multi-decade trend toward the consolidation of behemoths. In the guitar business, too.

How does this consolidation impact entrepreneurs? Giant firms seek the services of similarly large vendors. New, small entrants into the market will be at pains to form relationships with such firms, and the power imbalance is effectively a monopsony — sell to us at our price, on our invoice terms, or get lost. Trying to sell into a world of enormous corporate cartels is considerably more difficult than it was forty years ago, when every sector in America was smaller, more diverse and more dynamic.

Also, consider the need for new products and services in a country full of concentrated industries. When a company had dozens of potential competitors in various geographic regions, there was an incentive to innovate before the other guy does. In a concentrated market, competitors are few, and growth may come more from mergers and government lobbying than new product lines. For entrepreneurs, why start something new in such an environment? The current tech boom might serve as a counterexample, but consider that for most venture-backed companies, the ultimate exit plan is for sale of the firm to an existing behemoth, not continued independent operations.

The American entrepreneurial mythos arose in an environment that was perfect for supporting new businesses: rapid growth, technological change, constant competition, limited government intervention. We need to find ways to bring that environment back.

Written by Eric Garland
Source: Harvard Business Review

No comments: