Innovation & Insights

Designing a New Economy

Sam Frentzel-Beyme Follow Managing Partner & Strategy Director

The Short of It

  • Creating billion dollars firms means increasing the overall number of startups.
  • More potentially successful startups means finding new pools of talent that might not traditionally choose the startup route.
  • Build ecosystems that support the overall development and nurturing of startups is critical.

With the GOP’s take over of the House, there has been a lot of talk about how to heal the divide. Not that I’m super positive of any real change, but one area that popped up on NPR was the national debt and whether or not to raise the government’s debt ceiling currently at $14.3 trillion (or a little over $46k for everyone living in the U.S.). While it may be necessary to raise the limit in the short-term, I think the bigger question is how to make sure the problem doesn’t continue to grow.

Putting the situation into more of a business context, the whole things boils down to one thing: the US of A needs a little extra credit to get things together. That may be fine. But moving forward, continued need for credit probably is a indication of systemic flaws won’t be able to continually patched over. So yes, it’s kind of a design question.

While the simplest answers for the government are to either a) reduce costs or b) increase revenue (taxes), a recent report by the Kauffman Foundation titled, Inventive Billion Dollar Firms: A Faster Way to Grow, highlighted a third option. Increase the number of billion dollar companies. In a sense what the country needs is a way to grow the entire pie and that means more entrepreneurs.

The report started with the idea of increasing economic growth by just one percent. While seemingly small, shifting growth from 3 percent to 4 percent would mean that the GDP would double six years faster (18 vs. 24). With additional compounding the extra one percent would translate over a century to a GDP three times higher than it otherwise would be. Average family income would jump from the $45,000 it is currently to $135,000. All things being equal, not a bad situation for a country to find itself.

The main premise is that truly innovative or inventive companies that produce products or services that are really new generate more overall benefits for society as a whole. They use the example of General Electric and the electric light and how that ushered in a completely new work paradigm. This in addition to the benefits gained by founders, shareholders and employees.

While they admit that the $1 billion is arbitrary, they believe that on average firms that are of this size are more likely to have been inventive (demonstrated by revenue) and are therefore able to contribute higher ratios of social to private gains.

Here’s how the numbers work. U.S. GDP is currently at $150 trillion, putting one percent growth at $150 billion. (Just to give you some scale: Google’s market cap – the number of shares outstanding multiplied by the share price – is about $196 billion, Microsoft’s is $246 billion and Apple’s is $306 billion.) No small feat.

They went on to site Yale economist William Nordhaus’ estimate that inventors (which the report interprets as entrepreneurs) only capture 4% of the value of their invention. The majority of value “leaks out” to benefit other firms and industries that use the invention.

So in order for society to get the benefit of $150 billion, inventors/entrepreneurs must collectively generate $6 billion for themselves ($150b x .04). If the average margin for a new business is 10% than that means a company needs to generate about $60 billion dollars annually to bank $6 billion. If we look at this collectively, then we need 60 one billion dollar firms.

And here is the really interesting part. According to the report, every year 500,000 startups are born. If we need only 60 of them to become billion dollar companies which represents only 0.012 percent of the total.

In the end, the big question is how to make this all happen.

The report says that traditional investment vehicles will probably not work. Investing in government-financed infrastructure like education and roads, while important, will probably not have the desired knock-on effects. Tax policy is not a good indicator as many of the biggest firms like Microsoft, Apple, Federal Express, Southwest and Intel all started with marginal and capital gains tax rates higher than they are now. And finally investment in building more research centers like Silicon Valley, San Diego, Austin, etc. has not been shown to be successful and none of the aforementioned locations were the result of government planning.

And the answer?

Just as you would suspect. If you want to increase the number of billion dollar firms, you have to increase the number of successful companies launched and that means finding individuals and teams that would not otherwise choose to be entrepreneurs and nurturing them to be founders and co-founders that build out their great ideas.

Without successful models of government policy to create these companies, the report states that we should focus on developing and growing the private sector entrepreneurial ecosystem. So if you know someone working on that next big idea, maybe take an extra minute to encourage them. It might be good for all of us.

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