In the Sunday
New York Times, Steve Lohr touches on one of those deep mysteries that economics and business never quite solve. What kind of companies drive innovation more effectively -- small, nimble startups or big, heavily capitalized corporations? Lohr argues, backed by various experts, that we're in what he calls a "shift in thinking," from a period defined by small company innovation (more experts cited) to one in which large companies and the government dominate.
Lohr's evidence for all of this? He begins with an Obama administration intent on pouring vast sums into big projects like healthcare and energy. Given the systemic complexity of these top-down projects -- from fuel-efficient cars to digitizing healthcare records -- only big companies that employ scientists "in many disciplines typically have the skills and scale to tackle such projects," he writes. Moreover, Lohr also posits the maturation of digital technology, which suggests that progress in that key sector will evolve in smaller, slower, more expensive steps -- the kind of advances large companies, with large legacy operations, can dominate. "The pendulum of thinking does seem to be swinging toward the big guys," he says.
Now some of this is inarguable. Aspects of digital electronics have matured; Larry Ellison of Oracle Corp. (NASDAQ:ORCL) was quite candid about that trend when he launched his consolidation drive six years ago. And big government projects do naturally favor large companies. But one could as easily argue the other side. There is no guarantee that big healthcare and energy projects will produce anything more than the synfuels project of the Carter administration in the '70s, or any number of Manhattan-style initiatives launched by Japan in the '80s. And there is no guarantee either that digital electronics, in cross-fertilization with other technologies, is necessarily mature and heading on the same path as, say, the automobile. Who would have imagined Google Inc.'s (NASDAQ:GOOG) dominance in the Clinton years when Intel Corp. (NASDAQ:INTC) and Microsoft Corp. (NASDAQ:MSFT) were prosecuted for being monopolies?
All the business professors in the world doing studies can't tell us why innovation occurs in one place or the other. What we do know, however, which Lohr and his experts leave out entirely, is the influence finance plays in fueling innovation. It's no coincidence that the recognition that small companies were not driving as much change occurred around the same time as the financial crisis slammed home. In fact, funding difficulties for startups, whether it's early-stage venture capital or a dearth of initial public offerings, first appeared after the dot-com bust. With fewer dollars willing to be risked on small companies, the pace of change slows, shifting the balance of power to better-capitalized companies. Much of this is driven by perception. Experts, like those Lohr quotes, tend to ignore underlying funding problems and in a market that clearly favors large caps, declare instead that something has changed within emerging technologies themselves. Sometimes, a technology is obviously mature, like the internal combustion engine. But more often we don't really know because we can't tell the future, like technologies driven by microelectronics.
Besides, innovation often operates by stealth. The '70s were a devastating decade for venture capital funding, which almost disappeared late in the decade. But a few hugely innovative companies -- Apple Inc. (NASDAQ:AAPL), Intel -- did start up, ready to powerfully emerge in the more bountiful '80s.
This perception problem has its chicken-or-egg aspects, which is another way of saying it has feedback loops. Maturation of a key technology can slow a fast-growing economy, starve emerging companies and set the conditions for large company dominance. Or an exogenous crisis, say a mortgage meltdown and credit crunch, can create the appearance that large companies have the innovation edge as startups or midcaps wither.The
Financial Times' Lex Tuesday looks at small and midcap equities, noting their long-term overperformance, but pointing to their dramatic underperformance in the last leg of the boom. That's as close to a cyclical regulator of perceptions about size and innovation as we have. While it is true that large companies are often devalued for innovative capacity, it's also true that smaller companies in great, buzzing numbers are probably more effective at trying different approaches, and focusing obsessively on figuring out how to monetize them, thus fostering valuable creative destruction, if not always profitability.
Small companies resemble efficient free markets: They can get out of hand (or we can) as they did in the dot-com bubble. And they can seem weak and ineffectual in an age of big government and reduced financing. But for certain functions, such as out-of-the-box thinking (startups) or daily price discovery (free markets), there's no replacing either of them as engines of growth. The optimal economic system built on innovation requires both startups and free markets, and a healthy supply of both large and small companies.
- Robert TeitelmanRobert Teitelman is the editor in chief of The Deal.
Continue reading below
