Figure 3.1
Key Determinants of New Firm Survival
Owner Education Owner Experience Financial Capital Human Resources Ownership Size/Scale Economies Business Cycles Minimum Efficient Scale Competitive Structure Industry Growth Entry Rates (Turbulence) Technological Intensity External Economies Human Capital Policies/Programs Institutions Local Demand Owner / Organizational Attributes Market/ Industry Attributes Regional Attributes
The survival of any new firm is contingent on three overlapping sets of attributes (see Figure 3.1). Many influential attributes are idiosyncratic to the individual business.
Characteristics of the founder or business owner such as education, prior experience and age are common predictors of business survival (Bates 1990; Brüderl et al. 1992; Headd 2003). Organizational attributes such as human capital of workers, access to start-up and expansion capital and business strategies are also critical elements of success (Hannan and Freeman
rarely available in secondary datasets used for survival analysis. Ownership status and plant employment are commonly used to proxy for the potential availability of plant and firm- specific resources.
Studies of industrial organization focus on the role of industry-level attributes in determining market concentration. Traditional microeconomic theory views entry as a response to excessive profits, which, in the long run, helps balance supply and demand and restores competitive equilibrium. But not all markets are competitive and above normal profit levels often persist without stimulating a noticeable increase in entry. To resolve this paradox, Bain (1956) introduced the concept of barriers to entry –structural characteristics of markets that prohibit free entry –to explain persistent differences in entry rates and profit levels across industries. Bain identified several types of entry barriers, most notably: the minimum efficient scale (MES) of operation necessary for competitive production in a market, deliberate actions taken by incumbents to keep out potential competitors, and growing market demand or high profit margins that may encourage entry without fear of reciprocity.
Entry barriers may provide an appealing explanation for persistent market concentration but empirical evidence of their existence is rather weak. Recent work is marked by a
noticeable shift from barriers to entry to barriers to survival to explain market concentration. Entry is widespread in most industries, even in those with presumably high entry barriers, but few firms survive their first years of existence (Geroski 1995). Roughly 50 percent of all new manufacturing plants fail within the first 5 years, and roughly than 20 percent survive beyond ten years (Dunne et al. 1989; Mata and Portugal 1994; Knaup 2005).9 Failure rates
9 Using Dun and Bradstreet records, Audretsch and Mahmood (1994) find slightly higher survival probabilities for manufacturing plants born in the mid 70’s. They estimate a four year survival rate of approximately 63
are typically higher in business and professional service establishments (Knaup 2005) and among independent entrants (Dunne et al. 1989; Audretsch 1995a; Audretsch and Mahmood 1995). Furthermore, variation in survival rates across industries is considerably higher than industry variation in entry, suggesting that survival may be more sensitive to industry- specific conditions (Audretsch 1991; Mata and Portugal 1994; Wagner 1994; Audretsch and Mata 1995; Mata et al. 1995).
The efficiency and resource of disadvantages of small firms is one possible explanation for the high mortality of entrants (Audretsch 1991; Audretsch 1995a; Audretsch and
Mahmood 1995). Size is a common indicator of internal scale economies, access to financial capital and sunk costs in non-transferable assets that dissuade exit (Caves and Porter 1976). Most start-ups are small, but those “born” larger are much more likely to survive (Evans 1987; Dunne and Samuelson 1988; Dunne et al. 1989; Audretsch 1991, 1995b; Brüderl et al. 1992; Dunne and Hughes 1994; Mata and Portugal 1994; Wagner 1994; Audretsch and Mahmood 1995; Doms et al. 1995; Mata et al. 1995). The positive size/survival relationship is particularly strong in industries characterized by a high MES of production (Audretsch 1991, 1995b; Mahmood 1992; Audretsch and Mahmood 1995). In high MES industries the efficiency advantages of large-scale production makes competition against large incumbents inherently difficult for small start-ups while larger start-ups face less of a barrier to survival. The significance of MES on survival diminishes as the firm ages (Audretsch 1995b) or grows (Mata et al. 1995).
Focus on scale as a determinant of survival implies direct market competition between entrants and incumbents. But many, if not most, new firms do not compete directly against
incumbents. Instead, they enter into niche markets where they are sheltered from the harsh rigors of direct price competition (Caves and Porter 1977, Agarwal and Audretsch, 2001; Porter 1979, 1980). The industrial aggregation in secondary data makes it difficult to distinguish niche competitors, but there is some evidence that entry rates are higher in emerging markets where a dominant design and standardized production methods have not yet been developed (Gort and Klepper 1982; Agarwal 1996, 1997). Other studies find a positive association between industry entry and innovation rates (Geroski 1989; Acs and Audretsch 1990). So while large producers make standardized goods for broad markets and compete against other large producers, entrepreneurial firms develop customized goods for specific market segments and compete through innovation, not price. In the absence of direct price competition scale deficiencies with incumbents should pose less a direct threat to survival.
An alternative perspective relates high mortality to information asymmetries, uncertainty, and evolutionary learning. New businesses are born into an environment of uncertainty, a situation exacerbated by the entrepreneur’s inexperience. A new business may lack managerial experience, knowledge of market demand and competition, or even how to successfully market a new product. Over time, less viable firms fail while those that survive gain more experience and increase their likelihood of success (Jovanovic 1982; Baldwin and Rafiquzzaman 1995; Ericson and Pakes 1995; Pakes and Ericson 1998). In support of this view, many studies find a strong positive relationship between age and survival (Evans 1987; Dunne et al. 1989; Audretsch 1991, 1995b). There is also a direct link between uncertainty, innovation and market turbulence. Firms in highly innovative, and presumably more uncertain, markets also face a higher likelihood of failure at start-up than those in mature
industries (Mahmood 1992; Audretsch 1995b; Agarwal and Gort 1996; Mata and Portugal 1999). But those firms that manage to survive past the first few years in an innovative market have a greater continued likelihood of survival than those in mature industries (Audretsch 1995b).
In addition to establishment and industry characteristics, regional attributes also influence the survival prospects of new businesses. Many of the typical elements of the entrepreneurial climate may fall into this category: such as regional variations in the costs of factor inputs, tax rates, institutions and government indirect support of government initiatives. Of
particular interest to this study is whether external economies influence the survival prospects of new firms.