Econ Dev Tour 2007!

I apologize for the skipped week(s), but June was hectic in kicking off the economic development conferences that accompany the summertime. I spent the last few weeks in Europe, namely the UK and Portugal, in various cities meeting with folks in economic development and university technology transfer. Let me recap some of the highlights and my reactions from the start of my trip, a few days in central-western England, the UK’s Black County, for a conference on entrepreneurship and economic development. I had the opportunity to speak with a number of great folks from the area, who were quite gracious hosts, I should add. I strongly recommend a visit, especially the Great Western Pub.

The conference embodied many of the themes I have encountered across the U.S., particularly at conferences on entrepreneurship and economic development. Here’s the most prominent 4 themes I found:

1. Real Estate = Economic Development. Much of the conference was targeted at real estate development, which was largely used synonymously with entrepreneurship and economic development. This is not unique to this conference, and many cities have mixed supporting start-ups with building renovation and land reuse. The interesting aspect of this mix is that rarely is the question asked: are new malls, train stations turned loft offices, and the like what our start-ups most principally need?

2. Where’s the Entrepreneurs? I was one of two people whom I could find at the conference who had previously started a technology company. It was interesting to sit through a large conference about encouraging entrepreneurship when there are virtually no entrepreneurs in attendance. This is how one gets back to point 1 above.

3. What makes you different? The question I like to ask first to everyone I meet at such a venue is “What’s your strengths as a city?” The answer is generally “livability, an educated work force, and technology.” But ever city says that. A regional development strategy has to account for uniquely valuable assets in the region. Its that simple.

4. Profit driven economic development. Growing up in the 70’s and 80’s, I embodied Alex P. Keaton’s ideals. As I went off to college, I knew my eventual studies had to be a mix of economics and business. I joined the College Republicans. As you might imagine, I’m as much a free-market capitalist as the next guy.

All that said… it is tricky to mix profit motives with economic development. Specifically, throughout Europe (and the U.S.) I ran into a number of incubators and support organizations who charge high rent or take sizeable portions of their companies. Not all such organizations did, but many. Advocates of such an approach rightly argue that there needs to be some cost or any person will start a company to take advantage of the free space. I generally agree with the idea, but not the implementation. First, isn’t encouraging anyone to start a company the idea? Second, there’s other ways to screen that don’t take ownership and money out of the company.

Lastly, and most importantly, the debate is in the outcomes. Throughout my travels, I have observed that the more you charge in rent (or the costlier you make it), the more incubator spaces you have that house local R&D branches of big companies and small, stable (often service-oriented) companies. These are the two types of companies that can actually pay rent but don’t need to have their own large space.

Entrepreneurial Arbitrage

We have all heard the arbitrage business strategy: “Our goal is to develop a working product and be acquired by Company X.” In the current climate of lucrative acquisitions by Google and their competitors, it is tempting to be enticed by the fast sell.

Let’s define Entrepreneurial Arbitrage as the explicit strategy of creating firm built on replicable technology or business models whose sole essential asset is lead time. This is arbitrage to the extent that many firms create businesses around the goal of simply arriving slightly ahead of competitors in a market or while a worthy suitor, a major established company in the market, is considering entry. Development then simply becomes a make-buy decision for the acquirer. This is also a dangerous strategy for the other 99.9% of firms that aren’t going to be the subject of an intense public bidding war.

The perceived low barriers to entry and promise of network effects encourages many to enter software space with an Entrepreneurial Arbitrage approach. Web apps, portals, social networking and the like have attracted many, but this approach is starting to spread to other markets with higher entry costs and for which the network effects are less clear, such as what I call Social Acceptance Network Effects or SANE (more on that in a future blog).

In my experience, there’s two types of technology start-ups out there. Those that focus on being purchased by the Googles and Microsofts of the world and those that are focused on building products protected from the Googles and Microsofts of the world. I always advice companies to adopt the latter approach for three reasons:

1. Putting many eggs in one basket: its tempting to customize “just a little more” to cater to the suitor’s needs—if the suitor doesn’t come through, the start-up is stuck with extras that are merely distractions from a real business model.
   
2. The perceived success (likelihood of success times net cash received) is much lower than folks think: for every MySpace, there are 10 unknown failures out there.
3. Acquisitions take a long time. It is easy to think that an interested acquirer is a once-in-a-lifetime chance. You can still build your core product around sound, protected business principles, and when the time is right you can still sell your company.

There’s diet cola version of Entrepreneurial Arbitrage: building to a potential partner’s specifications. It is a fine line between being a good partner and being distracted from building that initial prototype or beta version, in the case of software.

Bottom line(s): focusing on building the first product is always first priority, and Entrepreneurial Arbitrage threatens that needed focus. Building to be bought is exciting, but its also like playing the lottery. If the company isn’t acquired, there’s little future left since little effort was put in to a sustainable business model.

The Need to Pollinate

When I began looking at entrepreneurship as an academic, I would be commonly asked by seasoned captains of industry, “How can you study entrepreneurship if you haven’t done it yourself?” My immediate response was always a dire analogy: if you had cancer, would you rather receive advice and prescriptions from a studied oncologist or a cancer-survivor?

Most people opted for the doctor, though some people stuck with the patient. I’m not sure the latter answer is often genuine. Regardless, the point was made.

My answer is “both.”

I realize that wasn’t presented as a choice. And, that’s my real point. To date, it hasn’t been offered. The vast majority of universities have supported research faculty; economic development organizations have supported Executives-in-Residence. The policy failure has been to not coordinate these two valuable groups in any truly meaningful way.

I’d like more professors armed with rigorous research methods and thinking and the experience, even if a short-lived failure, of starting a company. Entrepreneurship, like many social phenomenon, requires both the tacit knowledge and skills garnered through first hand experience, and a rigorous review of past entrepreneurial events which comes with a broad analysis… not just opinion papers based on anecdotal evidence derived from an individual’s personal experience, which often passes as research among experienced entrepreneurs. Admittedly, this leaves a small list of eligible mentors today, and we have to work harder as a society to bring these groups together.

To date, policy, business, and academia have largely failed to converge on how to encourage and train in entrepreneurship. I argue it is in large part because the marriage of research and experience has been wholly dismissed by both sides. Seasoned entrepreneurs have not sought, or even found it helpful, to conduct rigorous empirical research, and university research faculty, at least in my experience, have not deigned to get actively involved in start-ups.

Why not? Two words: incentives and gate-keeping.

Incentives: Entrepreneurs typically lack the research skills and incentives to be involved in rigorous research projects. I mean rigorous, not just simple marketing reports and white papers. And, there’s no apparatus to provide seasoned entrepreneurs such experience. A few people, like Hank Chesbrough of University of California Berkeley (full disclosure: Berkeley is my alma mater), represent a rare exception.

Gate-keeping: The tenure system rewards focused effort on publications, grant dollars, and teaching ratings. Experience and impact on the community are simply not considered. No rational faculty would engage actively while simultaneously maintaining a research agenda full-time and expect to remain clearly on the tenure track.

Bottom line: more cross-pollination is needed. We cannot expect effective entrepreneurial mentoring, training, and teaching until we take seriously the experiences and criteria necessary to train someone in this area. Effective mentoring, training, and teaching requires letting faculty both gain experience firsthand and pursue research agendas in this area, while simultaneously encouraging experienced entrepreneurs to develop research skills and be a participant in empirical research projects on entrepreneurship.

Philanthropic organizations, government agencies, and policy makers can make a difference by encouraging such joint programs. But, this burden largely falls on universities to adopt more flexible positions within their graduate schools and faculty rosters.

Deming on Regional Development

Applying statistical thinking to thinking about economic development: today, I offer a simple list that takes a page from Deming’s approach to business. This list provides a follow-on to the previous post on regional metrics. Based on a few emails I received, I realize I should have been to be clearer: Something needs to be measured, but my main point is that its worth thinking carefully about how statistics can lie to us if we don’t first recognize the truths behind numbers. So, in today’s blog, I offer three examples of metrics pitfalls.

1. Absolute success does not necessarily translate to competitive advantage.
Regional metrics commonly examine growth trends in a variety of industries and technology areas, then focus investment recommendations on the largest (by absolute numbers) or fastest growing economies. Even if a region or company in a region measures well on an activity, industry, or business model, that does not make it the platform for growth. Here’s a straw man: we have all seen consulting reports noting (paraphrased) “Region X has a rapid growth in green chemistry patents and employees, among the top 10% in MSA’s. Thus, green chemistry is a central investment opportunity.”

Another straw man example we’re all familiar with: regions are chasing biotechnology in all its forms. In conversations with policy makers, elected officials and foundations in cities across the U.S., I consistently hear something along the lines of “We’re creating a biotech corridor built on our (large medical school/local drug companies/excellent reputation for health care/etc.,.).” A major medical school with a specialty area is insufficient if (a) other regions have similar levels of expertise (thus competitors for your resources) and (b) the particular technology area does not create agglomeration economies.

These observations tells us very little. Rather, to be a competitive advantage and a platform for growth, a region must exceed other organizations in other regions, AND the regional activity or asset cannot be competed away in the medium-term (3-10years). Metrics on which industries are driving a region today have to categorically respect which industries and opportunities are easily competed away and should qualitatively capture likelihood of outsourced jobs, codified (rather than tacit) knowledge base, and specialized complementary assets all create situations where industries can be competed away.

2. A misunderstanding of “the direction of causality”.
We use this term in economics frequently to describe research proposing a conclusion about an outcome being caused by a specific activity, when in fact it is the activity that is being caused by the outcome. Richard Florida’s “Creative Class” argument has been criticized on these grounds: Do creative innovators move to regions and thus cause economic prosperity, or do creative types move to regions where there is prosperity because prosperity means more resources for artistic, scientific, and other creative endeavors to be creative? Just correlation alone does not prove a good econ dev strategy. Good metrics have to respect that one can plausibly assume away or control for “reverse causality”.

3. You can be fooled by the success of a start-up
A success start-up or two does not guarantee regional growth. Regional growth requires new firms generate positive externalities (wealth, jobs created that are not internalized by the company) for the region. Has Ann Arbor, Michigan (Headquarters of Domino’s Pizza) turned into the economic center of pizza making? Why not? Because while efficient delivery was valuable business innovation, pizza franchising does not generate the externalities necessary for agglomeration. In fact, there has been recent academic debate over whether such common drivers of externalities (knowledge spillovers) truly exist, and what determines them.

Pizza is a trite example to prove a point, but the same type of thinking holds true for semiconductors, agile robotics, biotechnology, tissue engineering, and so on. Simply establishing metrics based on counts, trends, etc., which I most commonly see regions engaging in these days--without implicating any one in particular, fails to recognize the competitive characteristics needed. We would rather have a moderately growing industry with promise of agglomeration than a rapidly growing, but unprotectable (easily moved) industry.

With these ideas laid out, future blogs will address the apparent elements of agglomeration economies (if such a thing truly exists).

OK, I skipped a week. But, I had an excuse...

A number of folks emailed me last week. Some to prod along another blog entry; some to tell me they told me so. When I restarted an effort for a weekly blog on economic development in April, there were naysayers: "You won't keep up with regular blog entries".

Then, my lack of attention to my recently refounded blogging effort became public:
http://www.post-gazette.com/pg/07146/789186-96.stm

So, now fueled by prodding emails and Ms. Shropshire's article, I hereby pledge to pick up where I left off-- with Tuesday blog entries on entrepreneurship and tech-based economic development. Keep your eyes peeled tomorrow!

The Unintended Consequences of Metrics

Among economic development circles, we have heard the phrase “unintended consequences” a lot over that past few years. My favorite recent topic that is subject to unintended consequences is metrics. Matt Hamilton, Anne Swift and I, all of Carnegie Mellon, are researching the impact of technology-based economic development programs on the regional economy. So far, this project reveled to us the seemingly endless number of cities and regions asking the inevitable question “what should we track to know if we’re on track?”

The answer is complicated beyond imagination because for benchmarking, trend analysis, and the like, no two regions face the same supply, demand, and political economy conditions. Even with a sophisticated multivariate regression, we currently lack the economic understanding (theory and evidence) to make meaningful comparisons.

But the grander issue, the “big picture” if you will, is: what happens when we start tracking data… and publishing it? On a regular basis? That’s where unintended consequences come in.

We all recall the famed Frederick Taylor studies, the grandfather of efficiency and operations management. Taylor, it is recounted, would time workers with a stopwatch as they performed various tasks, only to later realize that workers changed their practices when they knew they were being timed.

This happens everyday in economic development. For example, everyone’s favorite yardstick, patent counts, is an oft used metric for regional innovation output… or capacity, depending on the consulting report. And, I’ve seen several consulting reports by the same company that – at least pick one for consistency, but, it can’t be equally both. Anyway, if you start measuring patents, then the investment strategy of a region quickly turns to favor patent-intensive industries, like pharma, biotech, and chem. Twenty years of economic research by Wes Cohen, Dick Nelson, John Walsh, Sid Winter and others has shown that these industries focus on patents far more than semiconductors, software, and other areas. As a result, measuring patents only measures the mix of biotech and chem industries in a region and rarely represents actual performance, thereby veiling deeper economic trends.

Patent counts are perhaps the most obvious, but represent just one of many metrics that fall into this trap. Recognizing this problem, econ dev gurus propose a “multi-tiered” or “multi-layered” measurement approach drawing from a basket of measures. Now we take one bad measure, and multiply it by ten. We’re only increasing our “measurement error” in statistical terms.

The bottom line: focusing on econ dev metrics without nuanced understanding of what popular measures are really capturing dangerously misguides policy and business leaders. Dangerous is a heavy-handed word to use, but I mean it. And, this concern is compounded when one considers the temptation to report metrics on a short-term (annual or quarterly) basis when we all know economic development is a long-term investment.

The Ivory Tower’s Children

Industrial cities are increasingly turning to universities as the source of economic expansion. Chicago, Cleveland, Columbus, Pittsburgh, and others have established formalized programs to support university-based start-ups. Often these programs are paid for by a combination of public and philanthropic (quasi-public) dollars. Thus, the policy question: are these good investments for the taxpayer?

The answer to this simple question includes numerous complexities beyond just one or two studies, but some data are worth point out.

Our first pass shows us that university start-ups turn out to have a higher rate of success than we all thought. In a recent study by myself and Arvids Ziedonis of the University of Michigan (Management Science, 2006 v 52: 173-186), we examined a novel data set of almost two decades of licensing activity at the University of California System. We compare the relative performance of start-ups and established firms in commercializing inventions discovered in the same university departments. We find little difference between start-ups and established firms in the time it takes to develop and introduce to the market a product based on a licensed invention. We also find that start-ups generate greater levels of licensing revenues for similar technologies than do established firms.

Moreover, >80% of the start-ups founded between 1986-1995 (all pre-dot com, “real companies”) were still operating companies by 2004.

The good news is that parallel examinations of Carnegie Mellon and Georgia Tech data yielded similar results. In personal discussions a few years ago with Ed Roberts at MIT, he told me he found the same for his university. Thus, of the few universities we know data from, we observe a really good success rate, certainly better that we all might expect.

This observation doesn’t definitively prove that university start-ups are the best use of public funds, but the data to date certainly support that they’re good investments. The larger policy question is what/how-should programs support this investment, and do university-based firms have a real pay-off for the regional economy.

Destructive Entrepreneurship

Pennsylvania, Ohio, and other former industrial states have spent a lot of money to promote entrepreneurship over the past decade. But, can there be too much of a good thing? Sure. I've had my fair share of Chicago-style pizza and Old Style, and there's definitely a limit to how much one can tolerate in one sitting. The same is true of entrepreneurship, or should I say promoting entrepreneurship. That's where the term Destructive Entrepreneurship comes in.

Noted economist William Baumol penned a brilliantly simple, important, and regrettably obscure article on destructive entrepreneurship. Baumol points out that e-ship comes in various flavors: productive, unproductive, and destructive. The gist of his article is that entrepreneurship can be expressed in a variety of forms, some which are quite bad for a society. Society and the famed invisible hand can provide resources and incentives to promote entrepreneurial endeavors, but if the wrong conditions are in effect, "entrepreneurs" will utilize these resources for personal gain at the cost of economic growth for society.

What are the wrong conditions? Without close monitoring of public resources, stable and predictable courts, and infrastructure support for business growth, entrepreneurship takes the form of graft, theft, and the style of business dealings most common in The Sopranos. These are extreme cases, but Baumol impressively has examples. (If I whet your appetite, you can find his article in the Journal of Political Economy, 1990 v98: pp 893-921.)

There is a softer but more prevalent threat when providing public and philanthropic funds to support entrepreneurship. Nepotism, favortism, vanity investments, and the like all creep into the scene. Public investments to support entrepreneurship are susceptible to each of these unproductive (at best) and destructive (at worst) activities. Unchecked by monitoring or market forces, and you have leaders of entrepreneurial efforts in jail or raking in salaries in the many hundreds of thousands... yes, that's U.S. dollars.

Entrepreneurial support is critical, but it is equally important to make sure that someone is guarding the guardians of the regional economy.