Wednesday, September 14, 2011

Business incubation and high growth firms

NESTA and the Institute for Manufacturing at Cambridge University Engineering Department have just published a review of current knowledge on the role of business incubation in supporting high-growth ventures. A summary of the key findings are given below (as this topic has strong resonance with open innovation) and the full report can be downloaded from the NESTA publication website.

Incubation for Growth: A review of the impact of business incubation on new ventures with high growth potential
Nicola J. Dee, Finbarr Livesey, David Gill and Tim Minshall

Business incubators have proliferated since their emergence over 50 years ago. Over this time business incubation has evolved to include a range of incubation practices. Nonetheless business incubation can deliver critical value to tenants. Contrasting early definitions of incubation where survival of tenants was emphasised, we define incubation as “...a shared office-space facility that seeks to provide its incubatees with a strategic, valueadding intervention system of monitoring and business assistance.” (Hackett, S. M. and Dilts, D.M. (2004b) A Systematic Review of Business Incubation Research. ‘Journal of Technology Transfer.’ 29: 55-82). Our key findings follow the structure of the report.

The proliferation of business incubation over the last 50 years has resulted in diversification of terminology used and types of incubation offered. To help overcome this problem we compared business incubation with two activities sometimes confused with incubation – equity financing and professional services firms. For example, though not as intensive for venture capitalists, incubators implement an entry selection process for tenants. Perhaps more importantly incubators often have a very mixed revenue stream and incentives as a result, strongly encourage peer-to-peer networking, address multiple needs of new ventures without prioritising just one, and offer continual exposure to the incubation environment and services.

Absolute measures of incubation are impractical, but performance indicators are useful. Given the relatively small number of studies and the lack of comparability between them, any conclusions should be treated as indicative at best.

The UK has approximately 300 business incubators supporting around 12,000 businesses (UKBI). Estimates of the direct impact of business incubation by industry associations 2 include between 25-40 supported businesses and between 44-91 jobs per incubator. Many incubators (~60 per cent) also have outreach programmes to support businesses not resident in the incubator.

Indirect incubator effects, e.g. additional jobs and wealth generation from providing products/services to incubator and incubatees, globally range between 0.48-1.5 times the direct impacts of incubation.

Few studies capture the full impact of business incubation, for example taking a measure of incubation impact over the incubation period rather than longer term, and ignoring entrepreneurial learning and subsequent venturesome activity as a result of business failure. Job creation, while a popular metric used to evaluate incubation, is not generally considered a useful measure of incubator value. An emphasis on job creation also contradicts the advice of many investors who are acutely aware of the need to control spending by investee firms, which often means delaying recruitment. Further work is needed to develop appropriate performance indicators for incubation.

In practice, incubation can lead to several outcomes for new ventures. Incubation can impact new ventures through modifying or accelerating the entrepreneurial process of business development. But while incubators have been associated with business acceleration of incubatees, this same process can lead to ‘life support’ which extends the time to business failure. A period of high risk can confront incubatees when leaving the support of an incubator.

Selecting firms with potential for high growth is an uncertain process. A portfolio approach mitigates the risk associated with relying on the performance of a single firm. Across a portfolio of incubator tenants around 23 per cent identify the incubator as important to business performance. ( CSES (2002) ‘Benchmarking of Business Incubators.’ Sevenoaks: Centre for Strategy and Evaluation Services) Over 60 per cent identify the incubator as critical, while just under 17 per cent regard the incubator as unimportant to performance.

Incubators influence new firms by:

Lending credibility through association, and through shared (and therefore affordable) access to professional facilities and an identifiable and flexible incubation space.

Offering business support and coaching which are often subsidised e.g. strategic insights, market research etc.

Providing access to additional resources and talent e.g. finance, legal help.

The incubator draws on its own staff, external consultants, and its existing entrepreneurial support network to provide business support. Peer-to-peer networking is also encouraged.

Matching incubator services to the needs of firms is important. New venture activity and business support needs vary between regions, industries, prior entrepreneurial experience and so on.

Incubators with links to universities are associated with technology firms with higher growth potential, but not all universities have an entrepreneurial culture or are surrounded by a supportive business environment. In addition to technology and facilities, people are a main contribution of universities to entrepreneurial activity.

Rather than cater to all firms, most business incubators have a selection/screening process to target a particular group of firms. This screening process is imperfect, but can be improved through the use of multiple screening dimensions. ( Aerts, K., Matthyssens, P. et al. (2007) Critical role and screening practices of European business incubators. ‘Technovation.’ 27: 254- 267) Nonetheless a selection process can only be imposed if the incubator can afford to turn away potential tenants.

Tenants seem to become dissatisfied with incubator support when the incubation programme is predetermined rather than re-evaluated depending on the changing needs of tenants. The entrepreneurial support mechanisms also fluctuate, with incubators able to offer some continuity.

As incubators become more embedded in a region they tend to become more specialised. A word of caution – while many try and emulate incubation strategies from Boston, Southern California (US) or Cambridge (UK), these regions are also considered atypical and likened to ‘regional incubators’ owing to the amount and maturity of entrepreneurial activity and infrastructure.

Even incubators with similar objectives can have different business models. Business models have changed over time. Since 2005 there has been a reported increase in the cost per job created each year in business incubation in Europe. Some incubators now offer equity finance, and some equity investors offer incubation, with an unclear distinction between both. The challenge for incubators and their funding bodies is to capture some of the value created for incubatees. Generating revenue from services when clients are resource constrained is often not possible without subsidies from public bodies. Corporate funded incubators typically require a strong strategic fit of incubatees with the corporation, which is not appropriate for all ventures. Incubators with mixed funding may encounter principal-agent problems as they attempt to meet multiple objectives.

Capturing value through taking equity in clients introduces delays in revenue and can cause the incubator to behave more like an equity investor by prioritising short-term financial returns rather than longer-term performance. The literature offers little insight on whether incubators could generate better returns for early-stage investments than pure equity investors. Already early-stage investments are associated with poor returns in Europe, especially compared to the US. Further research is needed to understand the strengths and weaknesses of business models for different contexts.

In summary, the evidence we have reviewed indicates business incubation is a valuable tool as part of an entrepreneurial support infrastructure. Incubators deliver the most value when able to respond and adapt to the needs of new ventures. We realise some of our conclusions regarding how business incubation should be monitored challenge some existing norms in this domain. However, the lack of comparability between studies demonstrates how important it is to improve the quality of metrics. Even so any measure of incubation is likely to be incomplete. The impact of incubation on incubatees should extend beyond the incubation period and incubator environment, though measuring this impact could become onerous and time consuming.

While we recognise the variety of business models used and the continuing evolution of the industry, we nevertheless conclude that further research is required for the fundamentals of incubation models – a topic largely neglected in the extant literature – to be properly understood.

The full report can be downloaded by clicking here.