High Growth Firms – The Vital 6%

High-growth businesses have become big economic news. Stian Westlake describes the findings from work done by NESTA examining the characteristics of such companies and how they continue to thrive in difficult economic conditions. This has important implications for government policy.  

The uncertain recovery has put economic growth at the top of the political agenda. However, some companies continue to grow and there are important implications for government policy to help promote these kinds of companies. NESTA’s 2009 research summary The Vital 6 Per Cent highlighted the importance of the small number of fast-growing businesses that between 2002 and 2008 generated most of the employment growth in the UK.

These businesses can be found across all sectors, and include established firms and start-ups, small businesses and large ones. This finding has attracted the attention of policymakers and commentators, and has become an important part of the debate on economic growth in the UK.

High-growth businesses remain vital to the economy, despite the recession, and the government’s policy for fostering economic growth needs to have high-growth businesses and their particular needs at its heart.

Analysis of newly available business records shows that growth businesses still matter: a very similar number of businesses experienced high levels of growth in the period 2007–2010 as over the rest of the past decade. And these businesses continue to account for a disproportionate amount of job growth. Businesses that had demonstrated high growth before the recession were less likely than other firms to become insolvent when the recession took hold. This suggests that some of the characteristics of businesses that achieve high growth may also be responsible for their resilience in tough times.

However, a new analysis (Research Summary: Vital Growth, March 2011) highlights the challenges these businesses face. It suggests that high-growth firms both have a greater need for capital than lower-growth firms and may be assessed as having a lower credit rating by the kind of systems banks use to make commercial lending decisions. This is especially concerning given the sharp decline in risk capital funding seen in the UK since 2008. So, we asked what an economic policy geared to the needs of high-growth businesses should look like, based both on interviews with high-growth companies and economic research. In particular, the answer focuses on what policy can do to support one important factor that many growth companies have in common: their innovativeness.

PRIORITIES FOR GOVERNMENT POLICY MAKERS

The summary identifies several conditions associated with innovation and growth that should be priorities for economic policymakers. These include:

● Removing the obstacles to growth, such as excessive regulation of highly skilled immigrants and land use in dynamic clusters.

● Ensuring access to finance for growing businesses, especially venture capital and expansion capital, which are particularly important for growing businesses.

● Investing in a skilled and creative workforce.

● Using research and university funding, and planning policy, to encourage strong and wide-ranging networks between researchers and businesses that encourage the flow of knowledge and information.

 ● Harnessing government procurement to provide a market for innovative offerings from business. Over the coming months, NESTA will be working with growth businesses, researchers, investors and policymakers to investigate these areas in more detail.

THE IMPORTANCE OF HIGH-GROWTH BUSINESSES TO RECOVERY

The Chancellor of the Exchequer, in an article co-written with Google’s Eric Schmidt in November 2010, highlighted the importance of the small minority of  fast-growing companies. This was echoed by the Prime Minister in his speech on economic growth in January 2011, in which he argued that these businesses – the ‘giants of the future’ – were central to economic growth.

These comments are supported by a long tradition of academic research into high-growth businesses and a recent surge of interest in policies for how they can be encouraged from a range of developed countries, and international organisations such as the OECD.

This should come as no surprise: the economic contribution of high-growth firms has been nothing short of remarkable. NESTA’s 2009 research summary The Vital 6 Per Cent analysed the records of all UK companies between 2002 and 2008 and showed that the 11,000 businesses that generated 20% or higher average annual employment growth over a three-year period were responsible for creating 54% of new jobs.

Surviving the recession

Analysis of newly released UK business records shows the continued importance of growth businesses. Despite the deepest recession in 80 years, many companies still experienced high growth. In the period 2007 to 2010, the number and share of UK businesses growing at over 20% per year remained broadly similar to that in the periods 2002–2005 and 2005–2008.

High-growth firms still account for a disproportionate share of job creation, generating half of new jobs created by firms of ten or more employees between 2007 and 2010. This suggests there is a robust relationship that holds through good times and bad.

Companies continue to find routes to high growth, even during the recession. The research also looked at the high-growth businesses after their period of high growth, during the recession. How did a track-record of growth affect their performance in bad times? The analysis suggested that higher-growth firms were subsequently more resilient: they had markedly lower insolvency rates than their slower-growing counterparts during the recession. There is also some limited evidence that these firms are more likely to grow in sales in the two years after the growth period than non-high-growth firms, consolidating their growth by improving productivity.

Not only do high-growth businesses appear to require more capital, there is some evidence that they may have difficulty obtaining it. When grouped with non-high-growth businesses that have similar credit scores, high-growth businesses have lower insolvency rates than their non-high-growth counterparts. This is true in particular for the lower grades, where credit is more likely to be refused or highly priced.

These findings suggest that a small number of fast-growing businesses represent the most important source of growth in recessionary times. But the analysis also suggests that these firms may have specific difficulties in accessing finance, particularly during the recession. Policies for high-growth firms should create an environment where more companies aspire to and are able to achieve growth.

WHAT GROWTH COMPANIES ARE, AND AREN’T  

Given the importance of high-growth businesses, it is unsurprising that policymakers are interested in doing what they can to encourage more of them and to help those that exist to grow further. However, this is easier said than done. Developed countries have put in place many programmes to support the corporate success stories of the future, but few have delivered results.

This is partly because of the vexed nature of government-provided business support in general. But it is also because of a deeper mistake: high-growth businesses are hard to characterise and identify, so it is easier to target companies based on some other characteristic, hoping it is a good proxy for growth potential. This may have led policymakers to direct their energies to unproductive areas, and miss the real opportunities.

THEY ARE NOT JUST TECH COMPANIES

Some of the most startling high-growth businesses of the past decade have been technology companies, specifically internet companies. The allure of these businesses, and the goal of creating a British Google or Facebook, is an admirable one. But the Silicon Valley tech company is not representative of the majority of high-growth businesses. NESTA’s analysis of growth companies from 2002 to 2010 shows that they are distributed across the economy, from mining to banking.

A cursory look at any listing of growth businesses – such as the Sunday Times Fast Track 100 – confirms this. Alongside the odd company clearly identifiable as high tech, you will find logistics providers, facilities managers, professional services firms and traditional-looking manufacturers.

Although high-tech businesses are not the only ones with potential for high growth, research by NESTA has demonstrated the importance of healthy high-tech businesses to a sustainable recovery. The UK has many strong high-tech firms, which are occasionally overlooked in an excess of British self-deprecation. But they are only part of an overall growth picture that depends just as heavily on businesses that innovate in other ways: new services, new business models, and new processes are often as important to growth businesses as new technology. Even within these high-tech companies, innovation in business models, services and processes may be just as important as the technology behind the products.

The implication of this is that encouraging high-growth companies is not a matter of picking high-tech sectors and using public money to back them. Indeed, these sectors on their own are generally responsible for relatively small numbers of jobs. High growth can come from anywhere, so the entire system needs to be responsive to the demands of innovative companies with the potential for growth.

THEY ARE NOT JUST START-UPS

 It is also important to appreciate that new companies are not the only ones that grow rapidly. For every burgeoning start-up, there are many growth companies that built the foundations of their growth over many years. For example, folding-bicycle manufacturer Brompton is 30 years old (see case-study box, left).

Some of the world’s most dynamic and disruptive high-growth companies have grown quickly, right from the start. It is important that the UK does what it can to ensure that it provides a supportive climate for these businesses. But most start-ups are not like this. Most start-ups start small and either stay small or die. They are not based on disruptive business plans and have little ambition to grow. Even those that do have ambition to grow often take a long time to build up the technology and support to finance that growth.

Analysis of the progress of all businesses founded in the UK in a single year bears this out. Of the 221,731 businesses founded in 1998, for instance, two-thirds had vanished by 2008, and of those that remained, only 10% had more than ten employees, and 7% had seen at least one year of high growth.

The 150,000-odd start-ups of 1998 that failed over the next ten years, and the 70,000-odd that did not grow beyond 20 people, were generally not unlucky Googles. New work examining small businesses that fail to grow, or fail entirely, observes that the majority of these businesses lack the competitive positioning and underlying competencies to achieve it.

This means that the government needs to think very carefully about any policy that involves spending money to encourage new businesses indiscriminately. Such policies may have beneficial social and cultural effects (for example by encouraging people to start small businesses rather than being unemployed or take low-value jobs). But even if such a policy works, generating more businesses that do not have the potential or ambition to expand is unlikely to lead to economic growth.

DEFYING PREDICTIONS

 If high-growth companies were easy to identify before they grew, the role of government (and for that matter, of venture capitalists and other private investors) would be simple. Unfortunately, this is not the case. We have already seen that the idea of betting on growth sectors is problematic.

Past performance is also an unreliable indicator: today’s high-growth firms are unlikely to be tomorrow’s high-growth firms. Looking again at the 1998 cohort of start-ups, less than 40% of all the start-ups that achieved growth above 20% in a single year had another episode of high growth in that decade.

This is a salutary reminder that high growth is not an intrinsic characteristic of some businesses, but a stage that some companies will go through, and others will not, either because they do not aspire to it, as is the case for the majority of single-person enterprises, or because they can’t achieve it.

This means that government’s job is not to identify high-growth firms and then channel support to them, but to create the conditions where businesses that have the potential to grow can do so.

COMMON FACTOR: INNOVATION

If past performance and sector are not good predictors of high growth, what is? Researchers have made a number of attempts to analyse this and have identified a few factors that may be associated with higher growth. These include the age of the firm, the human capital of the entrepreneur or their gender, the firm’s exporting activity and its networks, or the degree of competition in the industry. But frequently these effects are small or questionable and even when they are clear, do not offer a clear guide for policy.

An exception is innovation. Earlier work by NESTA and the National Institute of Economic and Social Research has shown that for UK firms, being innovative is strongly associated with high growth, with innovative businesses growing twice as fast as non-innovative ones.

The implication of this is that by improving the way policy supports innovation, we can help support high-growth firms, even if we know that the government struggles to identify them. The finding is consistent with the specific policies recommended by many of the growth firms that NESTA works with and that we have interviewed in creating this summary.

This feature is based on a summary of the NESTA report. The full report, Vital Growth, including all references is available at www.nesta.org.uk/publications Stian Westlake is executive director of policy and research at NESTA. [email protected] Additional contributors were Albert Bravo Biosca and Louise Marston of NESTA.