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Entrepreneurial Ecosystems around the World

By Zoltan Acs

Over the past dozen years we have witnessed a new approach to improving the world’s economy.The story goes something like this. If we could get more cooperation and integration between economies then the economy might improve. The answer seems to be found in something called an entrepreneurial ecosystem. The ecosystem shows how well we integrate the institutions and people in an economy. Of course this is not new. We have had such focuses in the past but never has the focus been so clearly on the role of entrepreneurs in the ecosystem.   If we could get better cooperation betweenuniversities, governments, venture capital foundations and other relevant institutions we could improve the economy of all countries.

This new focus on ecosystems has bought a new and concerted effort to create entrepreneurial ecosystems and tools to measure existing systems.One such tool is the Global Entrepreneurship Index (GEI).  The GEI measures how institutions and individuals interact across four sub-indices and fourteen pillars. The GEI then ranks economies across the globe on their ecosystem performance.  Thus, we have a way to measure the ecosystem that is more or less useful for the task at hand. However how will improving the entrepreneurial ecosystem in a country lead to better economic performance? And if so, how will better performance manifest itself? Before we can answer this question we need to lay a little ground work.

Over the years we have moved from a focus on more startups, to more high growth startups and finally to more high tech startups. What we know is that more startups are negatively correlated with growth and not positively. In other words what we need is fewer startups and fewer small firms to grow an economy.  However, the question of the ecosystem is less clear. We do not know if improving the ecosystem will improve the economy or by how much.

Perhaps the first point that should be made is that economic growth does not equal productivity. Economic growth basically refers to the capacity of countries to produce more goods and services, irrespective of how higher production is achieved. The positive variations in GDP or employment over time are the usual suspects among those interested in studying economic growth figures, mostly because they represent the desired objective of most policy makers, as a measure of economic prosperity.

Productivityis a more complex concept. At the country level, total factor productivity(TFP) deals with two highly interconnected economic aspects. First, TFP has to do with the capacity of countries to allocate and exploit available resources efficiently (P = productivity effect). The notion that markets are good at directing resources is a good catch-all explanation concept; but for many businesses it is hard to find all that is required to perform in the market and to keep pace with industrial and digital revolutions that not only equip businesses with new resources, but also change the ways to exploit them.

The second component of TFP deals with the capacity of organizations to channel innovations to the economy (I = innovation effect) that, consequently,  translate into higher levels of output per input unit (in the case of countries, GDP per worker). Maybe we all are too used to link innovation to technological inventions that are successfully commercialized. However, our definition of innovation is not restricted to engineering (such as the driverless car) or to medical advances (such as nerve stimulation or non-invasive procedures), and is open to other, equally valuable, types ofnon-technological innovations related to product and processes.

In plain words, the combined effects of productivity and innovation shape total factor productivity (TFP = P * I). However, the capacity of countries to produce GDP is bounded by their available resources and their transformative capabilities. This way, total factor productivity defines the countries’production frontier and captures productivity variations that originate in differences in both production factors (P) and technology linked to innovation activities (I).  

What we would like to do is to measure the relationship between the quality of the entrepreneurial ecosystem in a country and TFP and its components. However, first we want to clarify two more ideas. A country can either be on the technological frontier or trying to get to it. For example a country like Switzerland is almost certainly on the technological frontier and a countrylike Egypt is certainly not on the frontier but is trying to get there. Broadly, countries that try and push the frontier are trying to be more innovative, and countries that are not on the frontier are trying to be more productive or more efficient with existing resources.

  We can argue that the entrepreneurial ecosystem impacts total factor productivity (TFP) via two differentiating effects (TFP =P * I): productivity (P) and innovation (I). This suggests that a superior entrepreneurial ecosystem does not necessarily make a country richer but,  rather, shapes economic and market structures as well as cultural aspects of societies, all important factors of the entrepreneurial ecosystem that improve total factor productivity.

We first explored the relationship between the GEI index and total factor productivity (TFP), paying special attention to the productivity (P) and innovation (I) effects. To do this we used data made available by the International Monetary Fund (IMF) to compute, for each country, the total factor productivity values (TFP = P * I)—defined as the capacity to produce GDP(output) using the capital stock and the labor force as inputs—as well as the productivity (P = use resources more efficiently) and the innovation (I = do new things to shift the production frontier) effects.

We found a significant, relatively strong positive correlation between entrepreneurship and total factor productivity (0.35). We also noted that entrepreneurship correlates weakly positively with the productivity effect(0.09).

Variables Correlation
GEI vs. total factor productivity 0.35
GEI vs. productivity effect 0.09
GEI vs. innovation effect 0.39

The strongest positive correlation was found between entrepreneurship and the innovation effect (0.39). This is not surprising. Just like we cannot imagine progress in the 19th century without the creation and development of steam engines, it is hard to imagine entrepreneurship in the 21st century without the power of technology-driven inventions. With the new millennium industries and markets from around the globe are witnessing drastic transformations that are the result of a digital revolution in which entrepreneurs are taking an active role by creating new businesses that are responsible for this revolution. The result is a good sign that reinforces our argument that the creation of ‘new things or new ways to do things’ definitely constitutes the vital force driving economic development. 

The conclusion for countries and public policy is that improving the entrepreneurial ecosystem helps countries push out the technological frontier that are already on the frontier! If your country is not on the technological frontier then improving the entrepreneurial ecosystem will help very little to improve your economy.

Blogs

Save Your New Business – Avoid The Chasm by Nick Hixson

iefblogthefutureeffect

There is an issue with any new product launch. It’s commonly described in Figure 1: Innovation Adoption Life Cycle

Chasm

Figure 1: Innovation Adoption Life Cycle

The first people to buy your new product or service will be innovators and early adopters (I+EA) – people who like new things. But then you have to start selling to the rest of the market – The Early Majority because you have sold to all the innovators and early adopters that you can find. And that’s when you hit a problem. It’s described by the chasm. A place where suddenly sales dry up. And losses mount.

Product marketing strategies

Your sales can dry up because your marketing to I+EA does not work with The Early Majority. And you don’t know exactly where that change occurs. So, you still use the same marketing strategy for the I+EA group but you are running out of them. You need to use a different marketing strategy for the rest of the market.

Innovators and early adopters like new things but the rest of the market – the Early and Late Majority – wants proof. Proof your solution will work for them, which typically comes in the form of other people having bought it and used it already, liking it and reviewing it. Then you’re into a market which is full of competitors. And your marketing needs to address this.

It’s difficult to know when this change occurs so you tend to use the wrong strategy for too long. Because your idea is new, there’s no data to tell you when you’re running out of I+EA customers. You may feel that it is getting more difficult – speed of sales starts to fall off, the time to convert a lead starts to increase, but it won’t be enough to tell you definitively you are at The Chasm. However, it is enough to tell you to start marketing for the Early Majority as well as continuing your marketing for the remaining I+EA.

Now, for ‘product’ read ‘business’

What is less well understood among small business owners is this concept works for a new business as well as for a new product or service. With any new business, its first customers are taking a chance as they have no track record to rely on, no-one they can ask – and there are no reviews for something which hasn’t existed before. But they will take a chance and often offer the new business far better terms especially in paying its invoices, than any existing business can get. Your first customers (I+EA) are invested in your success and will change the normal rules to help that happen. Recognising this, the business will treat those first customers incredibly well as they are providing some feedback that the business has got an idea with some merit that somebody will pay for.

As the new business starts to run out of I+EA customers it needs to switch its marketing in the same way as if it were selling a new product. It needs to market to the Early Majority. The business needs to provide proof which it has from the testimonials and case studies based on the I+EA customers.  Service levels to the I+EA group still need to be high though, and it’s very easy for service levels to drop as the business changes its target markets. This needs careful management otherwise I+EA customers will not provide the proof needed for the Early Majority.

Planning for The Chasm

Figure2: The Product Life Cycle chart shows the sales and profits (and for profits read cash flow) of a new product or service.

Product Lifecycle

Figure 2. Product Life Cycle: Sales vs Profits

Usually a loss is expected in the early period from investment in product development, acquisition of assets and structure to enable sales to take place, which naturally starts later. This is the dip in profit shown underneath the horizontal axis at the beginning. Again, the analogy is accurate for a new business as well as a new product or service. The new business needs to invest time and resources, which create a loss before it can sell anything. The business generally accounts for this in its business plan, but what it doesn’t often do is plan for The Chasm.

Realisation of the risks

The general rationale of most businesses is that customers are all much the same so that more marketing effort will simply result in more customers in a linear way. Wrong! Business plans may have built-in some sensitivity and SWOT analyses but they tend not to produce anything which recognises the necessary change in marketing method to address the change in market when the new business or the new product changes from I+EA to Early Majority.

The first realisation is that all customers are not the same. Failing to recognise the differences between I+EA customers and the rest of the market will slow sales and impact cashflow negatively, possibly fatally.

The second realisation is that overlap marketing may well be necessary to bridge The Chasm quickly.

Double dip losses

If the new business has insufficient cash resources, either through trading or through funding to invest in the necessary overlap marketing to soak up the remaining I+EA with the initial marketing strategy, whilst simultaneously spending on the new marketing strategy for the Early Majority, there is the real risk of a double dip of losses just at the time when that Chasm appears. So, it is quite possible that the double dip together with a lack of sales can cause the business to fail. This is illustrated in Figure3: The Double Dip

Chasm +P+L

Figure 3 : The Double Dip

Avoid The Chasm for survival

To avoid this double dip the new business needs to retain enough resources to fund the double marketing effort so that the chasm is reduced or eliminated. You need to review your planning and check you have enough marketing budget.  Bridging the chasm quickly by reducing its timespan and impact is critical to business survival and enables you to scale the business faster.