Business startups, closures and economic churn: A review of the literature

1
Business start-ups, closures and economic churn
A review of the literature

• Brigid OLeary, Ana Rincon,
• Kate Robinson
• And Mary OMahony and Geoff Mason

2
Introduction

• What is it? Dynamic process by which firms enter
  and exit a market.
• How do we measure it? Some background and
  definitions
• What do we know? Empirical research and data
  issues
• What does it mean to us? Entrepreneurship, small
  business, start ups and closures in the UK
• Why is it important - And is there an optimal
  rate? The macro perspective and role for policy
• What do we want to know? Ideas for further
  research, evidence gaps and empirical analysis.

3
Economic churn

• Theoretical models
• Aggregate economy, Industry characteristics and
  Firm decisions
• Definitions of entry and exit
• Diversifying firms, changes in ownership,
  business start-ups
• Takeover, Bankruptcy, Change of industry
• Measurement issues
• Entry rate/ turnover rate
• entry penetration rate
• volatility measures

4
Empirical evidence on churn

• Productivity impact
• Micro panel datasets (Bartelsman and Doms 2000)
• Decomposition analysis (reallocation among
  incumbents and via entry and exit).
• Ongoing process of restructuring by incumbents is
  essential
• The net entry process also important (Bartelsman
  et al, Baily et al 1992, Olley and Pakes, Liu
  1992, Griliches and Regev 1995, Aw, Chen and
  Roberts 1997)
• Cross country evidence
• Important to help identify role of policy and
  institutions
• BUT data problems (Bartelsman et al 2005)
• More UK research needed

5
Rates of churn
6
a) Entry via diversification

• Firms diversify because they may be able to
  exploit existing resources and knowledge and have
  better
• Information about opportunities for profitable
  entry
• Access to productive resources
• Ability to respond to changes in demand
• Most entering firms are new, but diversifying
  entrants are larger, and can have a quicker
  impact on the market (Dunne et al 1988, Mata et
  al 1995).
• Are able to enter markets at a smaller scale than
  new start-ups, since resources can be transferred
  (Hariharan and Brush 1999)
• Entry through diversification more likely to
  survive, since it has cost advantages.

7
b) Changes in ownership

• Takeovers, mergers and acquisitions are form of
  reallocation of resources.
• 3 major explanations (Berkovitch Narayanan
  1993)
• Synergy Economic gains from merging resources
• Agency Pursuit of management goals
• Hubris firms incorrectly identify gains for
  synergy
• Empirical evidence on productivity impact
• US evidence - Ravenscraft and Scherer (1987) No
  productivity gain after acquisition Berkovitch
  Narayanan (1993) Positive gains in ¾ of
  takeovers
• UK Harris and Robinson (2002) Productivity
  gains from FDI changes in ownership (US), but not
  quite so clear from domestic changes.
• Explanations for ambiguity of findings
• -Adjustment costs
• -Objectives other than improving efficiency -
  gain access to a market (FDI) to acquire
  specific attributes such technology.

8
c) Business start-ups (and closures)

• Explore motivation behind business start-ups and
  closures, with emphasis in the UK case.
• Significant component of churn in the longer run
• Additional effect
• Innovative component
• Focus of policy measures
• Determinants of start-ups and closures
• Emphasis on small firms
• UK industrial policy
• Its recent focus and choices

9
Factors determining start-ups

• Profitability in an industry. This may be the
  result of the stage of the product life cycle.
• Concentration. Traditionally the more
  concentrated an industry the less likely firms
  are to enter. Geroski and Murfin (1985) point out
  that entry through niches may be appropriate in
  concentrated industries.
• Barriers to entry Product differentiation, scale
  economies and access to inputs, especially
  finance.
• Co-operation between organisations. Firms in
  early stages of development benefit from location
  within formal/informal network RD, labour
  recruitment, and facilities (Keeble et al 1998)

10
The case for entrepreneurship

• Storey (1994)
• Location endowments (population density,
  clusters, local planning regulations, transport
  communications, infrastructure, industry policy)
• Individual endowments (wealth, qualifications,
  experience).
• Qualitative research by Cosh (2006) reveals
  motivations for business start-ups (CBR Survey)
• Desire to run ones own business 70
• Unemployment 21
• Desire to implement new idea 27

11
Competition and innovation

• 2 theories
• a) Competition may discourage innovation and
  inhibits productivity growth by reducing expected
  rents from innovation (Aghion and Howitt 1992)
• b) Competition encourage innovation in since
  incumbents are forced to innovate to compete with
  entrants (Nickell 1996, Blundell, Griffith and
  Van Reenen 1999).
• Possible explanation of both theories
  Competition and innovation u inverted
  relationship (Aghion et al 2005 a) dominates
  for low levels of competition and b) at higher
  levels.
• Entry has positive effects on incumbent
  innovation incentives but only in industries
  initially close to technological frontier (Aghion
  et al 2006) and in advanced countries, rather
  than in less developed countries that rely on
  imitation and adaptation of technologies (
  Acemoglu, Aghion and Zilibotti 2003)

12
Innovation and small firms

• Which firm size is most conducive to innovation?
• General empirical support of a u shaped
  relationship between firm size and innovation
  output (Hoffman et alia 1998)
• Large firms have a relative innovative advantage
  under some circumstances and small firms have
  relative innovative advantage under other
  circumstances (Acs and Audretsch 1987)
• Large firms In industries capital-intensive,
  concentrated, highly unionised, and with
  differentiated goods.
• Small firms In industries in early stages of
  the life-cycle, innovative, with high skilled
  labour.
• Characteristics of SME innovators
• Located in niche markets, product innovators,
  external linkages.
• Important role by means of imitation and
  diffusion (Cosh et al 2006)
• Innovative capabilities in UK SME determined by
  (Romin and Albaladejo 2000)
• Internal factors owner technical education,
  technical skills of workforce, RD, training.
• External factors Public RD support, interaction
  with RD and training institutions, Interaction
  with suppliers, customers and similar firms not
  found important.

13
The UK experience

• Churn
• Evidence from Bartelsman et al (2005) suggests
  that churn in UK manufacturing is almost 24 per
  cent greater than the cross country average they
  find (19 per cent)
• Half of entry and exit employment due to
  entry/exit from new establishment by existing
  enterprises. (Disney, Haskel and Heden 2003)
• Single plant closures are 50 less likely exit
  is a last resort, but closure of young
  US-acquired plants 165 more likely (Harris and
  Hassaszadeh, 2002)
• Harris and Robinson (2001) looked at entry and
  exit in relation to firms in receipt of
  government assistance and found that assisted
  plants were less likely to exit.
• Entry and exit and productivity
• In the UK, contribution of entry and exit to
  labour productivity and TFP growth is 50 for
  1980-1992 (Disney, Haskel and Heden 2003).

14
Is there an optimal rate of churn?

• Churning also turbulent process for firms and
  employees Business closures are disruptive to
  supply chains and networks and labour market.
• Trade-off between bad socioeconomic
  consequences and good competitive effect
  (Boltho 1996).
• Caballero and Hammour (1998) consider welfare
  effects
• Unemployment
• Net productivity effect is a relationship between
  level of creation and level of destruction
• Passive destruction Exogenous reasons for
  failure
• Privately efficient destruction Schumpeterian
• Privately inefficient destruction Due to
  financial constraints.
• Van Stel (2005) considers the optimal rate of
  churn using a volatility measure
• Finds no evidence of an optimal rate

15
UK industrial policy to foster start-ups

• Governments action plan for small businesses
  (DTI) to make UK the best place in the world to
  start and grow a business
• 7 POLICY AREAS
• 1. Knowledge and enterprise culture
• 2. Dynamic start-up
• 3. Improving management capabilities
• 4. Financial constraints
• 5. Addressing social inequalities
• 6. Providing better access to services
• 7. Reducing impact of regulation.
• Subsidies Interfere with churn process if
  indiscriminate
• But targeted financial support can be very
  important useful for small businesses, especially
  for innovative ideas.
• Policy should ensure market environment is
  conducive to business, not distortionary ( e.g.
  tax or regulations should not act as barrier of
  entry)

16
The business environment Determinants for success
(Atherton 2006)
17
Proposal for future analysis in UK

• So far focus on manufacturing sector.
• Increase availability of services microdata at
  ONS.
• Consider more aggregate data in combination with
  micro data to identify effects on growth,
  employment.
• E.g. construct measures of churn by industry
  using microdata
• Include these measures as explanatory variables
  in industry production function/employment
  equations
• Can use datasets in Bartelsman et al.
  international study combined with country and
  industry panel data for EUKLEMS