Drivers to Entrepreneurship

People like crystal balls that predict the future. They publicly lament and place blame on potential causes when the crystal balls offer fictitious predictions of negative outcomes. The crystal balls, accusations, and lamentations flourish in conversations about creating environments that foster new ventures. False thought-leaders blame the lack of entrepreneurial activity on the dearth of VC money, the absence of good ideas, or cultural factors that discourage entrepreneurship. These ideas are fodder for fun conversations, but it is time to inject some facts into the mix. As can be expected, the often-discussed factors have much less effect than hard cold economics.

Published research available from the Global Entrepreneurship Monitor (GEM) produced by the Kaufman Foundation has uncovered a few simple rules for predicting the creation of new ventures . The largest factors that determine the rate of new venture creation, according to the GEM research, are economic growth (GDP Growth) and levels of unemployment. Growing economies encourage individuals to establish new ventures. Contrawise, unemployment coupled with low unemployment benefits coerces individuals to establish new ventures. Combined, these facts may indicate that good individuals experiencing a loosing situation in a winning economy are most likely to start a new venture.

True, research from the University of Chicago does indicate that venture capitalists have a higher tendency to fund businesses near their offices, but it does not tell us why a venture capitalist will select to establish operations in one region versus another. Discussions regarding ideas and markets have also been inconclusive with regards to identifying the location of new venture creation. These factors may affect the type of business activity that is initiated, but their effect on the level of new venture creation is questionable.

Opportunity or Necessity Motivated

Entrepreneurs can be categorized as either opportunity or necessity motivated. Opportunity motivated entrepreneurs establish new ventures out of the desire to pursue a promising business opportunity. Necessity motivated entrepreneurs establish new businesses out of the requirement to find suitable work. Statistics indicate that two-thirds of entrepreneurs self classify as opportunity motivated while one-third self classify as necessity motivated. It is noteworthy that the survival rate of new businesses is independent of the motivating factor. Necessity and opportunity motivated entrepreneurs are equally likely to succeed. A possible bias of these motivation statistics is their use of self-classification. Given the opportunity, many individuals that are truly “necessity” motivated would rather state that they are “opportunity” motivated.

While the GEM studies strongly indicate that new venture creation is mostly determined by high unemployment levels in an otherwise growing economy, these statistics do not indicate the type of new ventures that are created. The GEM study includes restaurants, convenience stores, and landscaping in the same count of new business creation with technology companies, biological companies, manufacturers, and management consultants. Clearly, these company types are very different.

Opportunity motivated and necessity motivated entrepreneurs were found to establish very different kinds of business. Opportunity motivated entrepreneurs are most likely to anticipate the creation of an organization and the hiring of numerous employees. On the other hand, necessity motivated entrepreneurs were more likely to establish smaller businesses. It can be inferred then that opportunity motivated entrepreneurs would require larger capital investments than necessity based entrepreneurs.

When speakers address the issue of new venture creation, they are usually thinking of technology, biological, or other scientifically based new ventures that require significant capital investment. In trying to understand the factors that cause these types of businesses to be founded, we should combine the GEM statistics with the question of the type of people that are being displaced from their jobs and their motivation. Statistics indicate that people initiating new businesses are most likely to initiate activities in a business similar to that which they left. Thus, displaced military industrial workers on the West Coast, displaced electrical engineers in the Southwest, and displaced steelworkers and manufacturers in the Midwest are likely to create different types of businesses.

Silicon Valley

Anecdotal evidence supports these claims. In the late 60’s, Fairchild Semiconductor in Silicon Valley responded to a decline in the military demand for electronic components with entering new markets in the commercial sector for its transistors and integrated circuits. Surrounding Fairchild’s shift in market focus was the creation of several ancillary companies that could either incorporate Fairchild’s chips or aid in their construction. Again, in 1989 the US began to downsize the defense industry in California in response to the end of the cold war. Soon after, Silicon Valley became the center for new venture activity for hardware and software.

There are three key aspects to the Silicon Valley case studies. First, in both cases, displaced workers sought greener markets. Either through redirecting the focus of existing corporations or the creation of entirely new businesses, individuals that were otherwise unneeded by the market created new customers for their services. Second, in both cases, the US economy as a whole was growing. And third, the displaced individuals were highly educated and skilled workers that operated in the knowledge economy.

Telecom Corridor

Texas too offers an example of the negative correlation between the strength of technology driven large corporations and the creation of entrepreneurial firms. We can see this by examining the number of new firms operating in Texas and contrasting it with the employment levels of large firms.

In 1956, Texas Instruments (TI) located its corporate campus off Central Expressway just north of Dallas. Since its origins in DRAM and subsequently Linear Circuits, it has become the dominant competitor in the DSP market. DSPs are the core processors of cell phones and wireless technologies. As the telecom boom came, numerous telecom firms located offices near TI to take advantage of tight integration between TI’s technology and their products as well as the number of highly skilled electrical engineers in the area. These firms include MCI Network Services, Rockwell International, Nortel Networks, Fujitsu, and Ericson. Subsequently, the real estate north of Texas Instruments was named the Telecom Corridor.

TI and the Telecom Corridor have had many ups and downs. For instance, in 1995, TI had revenue of $13.1 billion but declined to only $9.9 billion in 1996. Again, in 2000, TI’s revenue was at $11.9 billion but following a restructuring their revenue fell to $8.2 billion in 2001. TI is not alone. Currently many of the businesses in the Telecom Corridor are experiencing very low revenues. I personally know of many people who left TI during an economic downturn to start their own businesses. However, anecdotal evidence needs to be supported by statistical analysis in order to form a strong argument.

To construct a statistical analysis, data was collected on the employment level in Texas and the revenue of TI. Robert Crawley from The Texas Workforce Commission’s Labor Market Information Department provided the Wiglaf Journal data of employment levels according to the size of firms. Financial data on TI revenue was collected from past annual reports. Although Texas has other employers than TI, and TI has operations outside of Texas, data analysis reveals relevant and strong negative correlation between the TI revenues and Texas entrepreneurism.

The analysis reveals that for every $10 million decline in revenue that TI experienced, an average of 9 people would entrepreneurially join the workforce of the single person companies in that year. In the next year, an average of 5 more people would join the workforce of the single person companies. A possible explanation is that as revenues of TI decrease, TI sheds some of its workforce. These people may have left TI, but they didn’t cease to seek productive means of contributing to society. Many of the unemployed ex-TIers rationally responded to the situation by starting their own firm.

(The multivariate regression analysis examined the number of individuals operating within single person companies against the revenues of Texas Instruments for that year and the year prior. In a separate regression analysis, negative correlations were also found between the number of people employed within large firms and the number of people employed within small firms at a significant level. The validity of the analysis of TI Revenues versus Single Person Company employment level is perhaps comparable to the Economist’s Big Mac Index for purchasing power parity between companies. Like the Economist’s Big Mac Index, the analysis is done to make other research more approachable to general audiences.)

Midwest

The Midwest has undergone terrific periods of unemployment during a growth economy. Steel mills and auto manufacturers have shed thousands of employees over the past three decades. Yet, where are the new ventures? They exist, but not only in the technology industries. The Midwest entrepreneurs established other types of businesses, many that required less VC money and were more closely aligned to their skill sets.

Recently, Crain’s Chicago Business ran a story on a number of entrepreneurs in the Chicago area who have run their own company for a decade or longer. Most of them are sons and daughters of wealthy corporate titans, like Patrick Ryan Jr., son of the founder of Aon Corp. The Chicago story that wealth breeds entrepreneurism is supported by the GEM research which indicates that family contributions to entrepreneurs is a significant form of early company investment.

Consider also the last three years since the stock market began to drop. Nationwide unemployment is high, perhaps higher in Chicago than any other single city in the US. Arthur Andersen, Divine, and Montgomery Wards are gone. Motorola has shed workers from a high near 140,000 employees to a current level near 90,000 employees. These are exactly the right kind of displaced workers for the initiation of high growth new companies. Yet, where are the new ventures? Unfortunately, because the overall GDP growth is dismal, these two factors may be negating each other in the current Chicago area economy.

Economics Drive Entrepreneurship

Entrepreneurism is very much alive in today’s economy. While many necessity motivated entrepreneurs have responded to the economic climate with self-employment, others are seeking capital to create larger organizations. Our crystal ball can’t predict which industrial sector will undergo a downturn while the economy is improving or which new industry will be created. But, at least we can understand the true factors that drive entrepreneurism: unemployment and economic growth. In today’s economy, unemployment is driving entrepreneurism and the necessity motivated entrepreneurs are primarily seeking to establish cash flow, not large organizations.

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References

1. P. Reynolds, W. Bygrave, E. Autio, L. Cox, and M. Hay, Global Entrepreneurship Monitor 2002 Executive Report, Ewing Marion Kauffman Foundation, 2002.
2. A. Zacharakis, P. Reynolds, W. Bygrave, Global Entrepreneurship Monitor National Assessment: United States of America 1999 Executive Report, Babson College 1999.
3. O. Sorenson, T. Stuart, Syndication Networks and the Spatial Distribution of Venture Capital Investments, Selected Paper 83, The University of Chicago Graduate School of Business, 2001.
4. The regression analysis had an R-squared of 52.6% and yielded the following equation: Number of Single Person Companies in Current Year = 28181 – 0.889 * TI Revenue in Current Year – 0.505 * TI Revenue in Prior Year. All coefficients are statically significant. Data from TI Annual Reports and the Texas Workforce Commission.