14 Nov 2005  Research & Ideas

How Can Start Ups Grow?

For new ventures a lack of resources makes growth difficult to come by—just ask those nine out of ten fledgling firms that fail. Professor Mukti Khaire says the key may be in acquiring intangible resources such as legitimacy, status, and reputation.

 

The track record is well known and sobering for any entrepreneur: 90 percent of all new ventures fail. It's not hard to see why. Start-ups often lack vital resources, must compete against established companies, and have little or no track record with which to woo customers and investors. So how do those one-out-of-ten firms grow into successful, sustained enterprises?

Assistant professor Mukti Khaire believes that small companies can grow by developing intangible social resources such as legitimacy, status, and reputation. In an interesting twist, her research on this insight is that these intangible resources may be best acquired by following a road of conformity in how your company is organized and presented to the outside world. In start-ups in established industries, conventional business titles such as Marketing Director work better than novel ones like Chief Evangelist.

"These social resources are acquired by mimicking the structures and activities of established firms, and by affiliating with high-status customers respectively," she wrote in the abstract to her recent paper, Great Oaks from Little Acorns Grow: Strategies for New Venture Growth. The paper was published by the Academy of Management (August, 2005) as part of its Best Paper Proceedings.

Her research on how young firms grow is based on data looking at new advertising agencies in New York and Chicago from 1977 to 1985. In this e-mail interview, Khaire discusses her work and its implications for entrepreneurs everywhere.

Sarah Jane Gilbert: How did you first become interested in studying growth in newly founded firms and young organizations?

Mukti Khaire: Only one out of every ten newly founded firms in the United States grows to a size of more than ten employees (Aldrich, 1999). Growth is therefore a critical issue for all young firms. Most firms start out small, and small size makes them vulnerable to failure. Large firms almost always possess sufficient slack resources that buffer them from the vagaries of their environment and have political advantages due to their size. Hence, it is in the interest of entrepreneurs to grow their firms to a size that sufficiently improves their chances of survival and success. Moreover, large firms are a source of employment, and hence new venture growth is important to society as well.

It is in the interest of entrepreneurs to grow their firms to a size that sufficiently improves their chances of survival and success.

The issue of growth in young firms is also interesting from an academic perspective. There is less research on growth of young firms, compared to survival of young firms. Moreover, a majority of studies focus on issues of well-established firms rather than young ones. Since well-established firms differ from young ones in their availability of resources, adaptability, and stability in the face of changing environments, the findings from those studies are not directly relevant to young firms. Hence, I became interested in studying this relatively unexplored area.

Q: Why did you decide to focus on entrepreneurship in the advertising industry in your research?

A: Advertising more than most businesses responds to the talents and personalities of individuals, particularly founders, in the early years of the agency. Agencies then often stumble when the founder leaves.

I was interested in understanding how firms, whose chief competitive assets are their founders' talents or skills, scale their operations and grow. Heavy dependence on individuals' abilities, rather than easily expandable assets such as equipment, implies that these firms would find it especially difficult to increase the scale of their operations and grow. Hence, understanding the factors that influence growth in such firms would be a conservative test of growth in other firms. Such firms are found especially in creative industries such as advertising and design, but are also predominant in human-resource-intensive industries such as law, publishing, and consulting.

Two other aspects of the industry made advertising an interesting context for research on new venture growth. First, it is an industry with low barriers to entry and hence high levels of entrepreneurial activity, which in turn gave me a large enough sample to work with. Second, it is not an industry where venture capital activity is very high, making it a good setting to study growth in the absence of financial slack. Financial constraints are common to all new firms, and it was valuable to be able to study growth in a context where growth had to be internally rather than externally funded.

Q: Can you tell us about the concept of intangible social resources and how they contribute to a young firm's growth? How does a firm acquire non-tangible resources such as reputation and status?

A: Intangible resources are non-financial, non-material assets that a firm possesses by virtue of the social structure in which it is embedded. Although firms are economic entities, they are nevertheless affected by social variables such as legitimacy, status, and reputation because all economic transactions are embedded in a social supra-structure. Since most young firms are financially constrained, intangible assets that do not require outlays of financial resources are especially critical to new ventures.

Entrepreneurs and managers should almost never shy away from stepping out of their comfort zone.

An entity is considered to have legitimacy when its actions are considered proper, acceptable, or desirable under a widely accepted set of beliefs and norms. A new, unfamiliar activity or entity does not possess legitimacy because of its inherent novelty. A new firm, therefore, lacks legitimacy and may be looked upon with suspicion by stakeholders. In order to gain legitimacy, a new firm is required to look like existing organizations, which possess legitimacy because of their familiarity to observers. Hence, mimicry of existing organizations' structures and activities to a certain extent is essential if new ventures wish to gain legitimacy. A new venture with legitimacy acquired in this manner is more likely to succeed because it then can channel its resources and energy towards its core activity, rather than towards establishing its propriety. By doing so, it can improve performance and grow faster than an organization that does not conform to industry norms. As one founder I interviewed put it, "Customers are used to doing things in a certain way [with established organizations], and if a new agency is too far and out, it will not do well."

High-status organizations tend to be buffered from environmental shocks and more likely to survive adverse circumstances and perform better than low-status organizations. Organizational status is usually a function of size and good past performance. However, young firms possess neither large size nor a track record of good performance. Although the benefits of status are crucial to their performance, they are unable to avail of them. An alternate way of acquiring status is through high-status affiliations. When a young, unknown firm has affiliations with high-status entities, stakeholders tend to impute the status of the latter onto the former, thus granting higher status to the young firm. I found that young agencies with high-status clients performed better and grew faster than agencies without high-status clients (controlling for the revenues brought in by each client). Thus, status acquired through affiliations provided young firms with the buffering advantage that larger, well-established firms enjoyed due to their status, and enabled them to compete in the same arena as much larger firms.

Q: How important is the location of a business? How much does this impact its success?

A: To answer that, I shall use the words of a founder I interviewed: "Clients want to work with New York agencies, just like you would want to make a movie in Hollywood, not in Toledo."

Thus, some locations have symbolic benefits for firms that establish there. Researchers have shown that benefits from knowledge spillovers explain why firms in an industry cluster in specific geographical areas—think Silicon Valley. In the advertising industry, however, knowledge spillovers within the industry are not as important as spillovers between agencies and customers, so agencies need not cluster as they do, for instance, on and around Madison Avenue. I reasoned that they do so because the pioneer agencies in the nineteenth century set up offices there, lending legitimacy to the location. Advertising agencies became associated in people's minds with Madison Avenue. (For example, a recent Wall Street Journal headline said, "Google Weighs on Madison Avenue," not "Google Weighs on Advertising Agencies.") New entrants to the industry need to be associated with legitimate locations in order to gain credibility and benefit from the cachet associated with that location. A new fashion designer in France aspires to set up shop in Paris rather than Lyons because of the cachet associated with being a fashion designer in Paris.

So in some cases the location of a new venture is a critical facilitator of success not just because of the tangible benefits that clustering offers, but also because of the symbolic benefits offered by an office address that is legitimate in the minds of stakeholders.

Q: Were there any findings in your results that surprised you?

A: One revelation was the strong positive effect that mimicking older organizations had on new venture growth.

While I expected this based on theoretical frameworks, we have come to associate entrepreneurship with novelty so strongly that I was nevertheless surprised to see that mimicry was beneficial even to young firms that typically do not possess historical institutional baggage. It did appear, as one of the founders I interviewed pointed out, that "it pays to be on the bandwagon."

The other thing that surprised me was that while legitimacy became less important to firms as they grew older, status, acquired through affiliations with high status, remained important to even older firms. This indicates to me that firms have to work at maintaining their status in the hierarchy, while legitimacy is a critical issue only in the early stages of firms' lives. Once a firm has become familiar to observers, it assumes a taken-for-granted position that enhances its legitimacy. After a point, actively acquiring legitimacy becomes less critical for firms. Not so for status: Firms have to keep up their efforts at maintaining their status.

Q: What are the implications for entrepreneurs and managers?

A: Mimicry is important. Many entrepreneurs strike off on their own because they get tired of the way things work in their previous organizations and are determined to do things very differently. My findings suggest that for new firms in established industries, there is value to doing some non-technical, symbolic things in the manner that is widely accepted, and to adhering to industry norms and culture. For instance, entrepreneurs often promote flat, non-hierarchical structures in the firms they start. However, if customers are used to dealing with titular "Vice Presidents" in other firms, they may be wary of meeting just "Joe." The presence of job titles, a workplace with a professional appearance, even a receptionist, increases the legitimacy of a young firm with an unproven track record and improves its credibility.

Another implication is that you can bite off more than you think you can chew. While having a large prestigious client may seem like a double-edged sword because of the power such a client has over a young, struggling firm, the signal that the prestige of the client sends out is more valuable than any potential negative impact. Hence, entrepreneurs and managers should almost never shy away from stepping out of their comfort zone and taking on large jobs, since the payoff does arrive.

In general, then, I found that entrepreneurs need to weigh the costs of short-run discomfort against the benefits of long-run viability and success. While the financial constraints they face early on may make having a nice office, or being a member of industry associations, seem like an extravagance, the intangible benefits of doing so can have a very tangible impact on their business.

Q: What research are you working on now?

A: There are three streams of research that I want to pursue:

1. The growth of founder-centric young firms: At present I am working on understanding how the career trajectories of founders affect the performance of their firms.

2. Entrepreneurship in creative industries: While this area is related to the first, I am particularly interested in creating accounts of entrepreneurship in these industries in developing economies where they are a novel phenomenon. Such entrepreneurs face more uncertainty than other entrepreneurs—they are embarking upon a new venture, in a new industry in economies that are emerging. The creative and founder-dependent nature of their products naturally adds another dimension of difficulty to their struggle to grow and succeed.

3. The impact of intangible assets on economic transactions: I plan to study commercial transactions in which finances are not the sole currency of exchange, and intangibles like status and reputation of the actors in the transaction play a pivotal role. An example of such transactions is real estate deals where the status of the buyer rather than the price is the most important aspect of the deal.

About the author

Sarah Jane Gilbert is a content developer at Baker Library.