How Do You Create a Successful Startup Hub?

A professor says policymakers should better understand early-stage companies in their own area, rather than try to create another Silicon Valley.

June 1, 2011|by Stanford GSB Staff

• For just one example of entrepreneurship around the world, take a look at Argentina-based MercadoLibre Inc. It's a top Latin American e-commerce technology company and provides online systems to consumers and merchants doing business over the internet. Its CEO is Marcos Galperin, MBA '99. Operating in 12 Latin American countries plus Portugal, MercadoLibre went public in 2007, listing on the NASDAQ. The icing on the cake: getting on the Credit Suisse Research Institute's list of 27 "Great Brands of Tomorrow."

Governments worldwide should encourage more entrepreneurial ventures, such as MercadoLibre, as they build foundations for economic growth, says a report released by the World Economic Forum in collaboration with Stanford GSB and Endeavor Global, a New York not-for-profit that supports entrepreneurs. Against the backdrop of ongoing turmoil in global finance, successful early-stage companies are forming around the globe and creating jobs and wealth.

Policy makers need to understand how early-stage companies work, what makes them successful, and what kind of local environment - political, regulatory, or otherwise - allows the small companies in their own backyards to thrive. Learning more about entrepreneurship, policy makers can act accordingly to create an entrepreneur friendly setting, or a "hot spot," in their home territory.

"Understanding the elite few in their own ecosystem may prove a far more effective strategy than trying to replicate the success factors of other entrepreneurial hubs such as Silicon Valley," said George Foster, the report's lead academic researcher and the Konosuke Matsushita Professor of Management at Stanford GSB. Antonio Davila, a former GSB professor currently at IESE in Barcelona, also was part of the academic research team for the report, "Global Entrepreneurship and Successful Growth Strategies of Early-Stage Companies." The other researchers include Martin Haemmig, a professor at the Center for Technology and Innovation Management in Germany; Xiaobin He, PhD '10, assistant professor at Huazhong University of Science and Technology, Wuhan, China; and Ning Jia, PhD '07, associate professor at Tsinghua University, Beijing.

Early-stage companies drive economic growth effectively and efficiently, the report says. Researchers found that the top 1% of 380,000 companies studied in 10 countries contribute 44% of total revenue and 40% of total jobs created by early-stage companies in those countries. At the same time, 5% of those companies contribute 72% of total revenue and 67% of total jobs.

The impressive statistics on net revenue and net job creation by startups mask a sizable amount of individual revenue drops and job losses by previously high-growth startups.

A major new finding in the report was the extensive amount of revenue and job destruction that some early high-growth companies experience. The report shows, for instance, the typical annual revenue trends of young companies and finds that "down" years are to be expected. Indeed, 42% of companies between 2 and 5 years old experience 2 "up" years and 1 "down" year, while 31% have 3 "up" years. Analyzing lists of high-growth companies published in 13 different countries, the report found that 75% of the fledgling firms appeared on the list once. A major reason for the company not continuing to appear on such lists is a sizable slowing of their growth rates.

Subsequent research is needed to examine whether these setbacks are due to larger established companies entering the new space, other startups capturing the revenues and jobs, or the new product area becoming less important. Interviews with some entrepreneurs stressed the role that self-inflicted wounds, such as very lax recruitment policies, play in the setback situations.

The report aims to aid government policy makers by detailing and illustrating how entrepreneurs around the world think and tackle difficult business problems. It lays out some main paths entrepreneurs tend to pursue. Some, for instance, try to create an entirely new consumer trend or invent a new product. Or, an entrepreneur might form a company to commercialize a basic scientific discovery or to adapt a business idea that's already thriving in another country. The study details some of the many issues that can throw even the savviest entrepreneur for a loop, such as measuring market size, seeking funding, hiring managers, and understanding government regulations and taxation policies.

By analyzing information provided by the CEOs and the CFOs of 110 companies from 17 different countries, the report found that firms with higher growth in headcount and revenues were those that were the earliest to adopt management systems. This finding supported prior research Davila, Foster, and Jia had reported in their study of 78 California early-stage companies. That paper, "Building Sustainable High-Growth Startup Companies: Management Systems as an Accelerator," was published in theCalifornia Management Review, Spring 2010, issue. In May, it was named as co-winner of the 2011 Accenture Award as a paper that made an important contribution to the practice of management.

As a highlight, the World Economic Forum study includes lengthy excerpts from interviews with many startup founders and executives, giving readers valuable insight into the challenges of entrepreneurship. Niklas Zennström, cofounder of Skype, a Luxemburg company the emerged eight years ago, talks about what prompted him to pursue the internet communication firm.

"My cofounder and I have a drive to change the status quo. One of the painful points all around the world is the size of monthly telephone bills. Having people around the world communicate with each other in a clear way for free is a very basic idea. It is also a status quo-changing idea. Hundreds of millions of people around the globe would be interested in this idea. My belief was that, if you could successfully address this basic idea, you probably could create a good business out of it."

Zhengrong Shi, founder of China-based Suntech Power Holding, a solar-energy firm started in 2002, discusses a major challenge he faced in high-growth years.

"A major challenge was navigating through government incentive programs as they come on and off for political reasons. This is a very typical situation for green-tech companies. I always say we are swimming in the ocean and often encountering waves. Our main strategic response to such government incentive risk is trying to reduce manufacturing costs. This is achieved by the development of a supply chain, improvement of manufacturing technology, and achievement of scalability. With all these, we can reduce manufacturing costs significantly so that more people can afford solar energy. ? Lower manufacturing costs will enable the market for solar energy to expand quickly. More governments are now willing to subsidize solar energy. All governments tend to agree on the notion of green economy, which is now a new sector of economic growth."

And Carlos Munoz, cofounder of Spanish airline Vueling, speaks of "dark moments" at the carrier founded in 2004.

"The moment was a very heavy snow storm in February 2005. It was impressive but also brought up the dark side of how Spain works. The snowfall was much larger than ever experienced before. The airport needed snow removal machines, and there were only three at the airport - two of which did not work, while one worked only partially because of bad maintenance. For Vueling it was the biggest operational disaster. The problem was our inexperience. We had promised our clients that there would be no cancellations, and we had always fulfilled that promise. The day of the great storm, we discovered that trying to keep our promise was worse than canceling would have been. We found that it would have been better to tell customers immediately that there was a cancellation instead of having them wait to leave and then telling them that the flight was cancelled. We cancelled 14 flights. Trying to stick to our promise beyond reasonableness ended up being worse for our customers."

The 380-page report had its foundations in research started at Stanford in the early 2000s by Davila and Foster, who works with both the school's Center for Entrepreneurial Studies and the Center for Global Business and the Economy. Foster also is affiliated with two other Stanford campus initiatives on entrepreneurship - the Stanford Technology Ventures Program and the Stanford Program on Regions of Innovation and Entrepreneurship.

"The World Economic Forum has been delighted to partner with George Foster and Stanford on this important work, which highlights how global entrepreneurship and, in particular, rapidly growing early-stage companies are such a critical catalyst for economic growth," said Kevin Steinberg, MBA '96, and COO of the World Economic Forum USA. "Last year when the project was first being explored, as an active GSB alum I was struck by the clear overlap between the World Economic Forum's longstanding motto of entrepreneurship in the global public interest, and the GSB's aspirations to Change Lives, Change Organizations, Change the World. The close collaboration that ensued has led to insightful results, and it has been a pleasure to champion the project within the Forum, work with George and the team, and see its impact. I certainly hope the partnership between our organizations will continue and deepen in the coming years." Each year in Davos, Switzerland, Kevin and his wife, Michelle Barmazel (MBA '95), host a reception for Stanford alumni and their partners attending the conference.

For the report, the research team benefited greatly by working with the Stanford global network and multiple coauthors with Stanford connections. Subsequent to release of the Report at the 2011 meeting in Davos, Foster was appointed chair of the Global Agenda Council of the World Economic Forum on Promoting Entrepreneurship.