Areas such as Silicon Valley and Boston are often held up as examples of innovative regions to be emulated, but what makes them this way? By analysing patent data on computers and communication technology, Ajay K. Agrawal, Iain Cockburn, Alberto Galasso, and Alexander Oettl, argue that the mix of large and small firms in a region is very important to regional innovation. He writes that regions where a number of small and large lists coexist are more productive in terms of innovation, when compared to those that have only a small number of large firms or a large number of small ones

Agrawal, Ajay K.

Cockburn, Iain

Galasso, Alberto

Oettl, Alexander

LSE Research Online

blogs.lse.ac.ukhttp://blogs.lse.ac.uk/usappblog/2014/06/05/a-mix-of-small-and-large-firms-can-be-key-to-regional-innovation/#AuthorA mix of small and large firms can be key to regional innovationAreas such as Silicon Valley and Boston are often held up as examples of innovativeregions to be emulated, but what makes them this way? By analysing patent data oncomputers and communication technology, Ajay K. Agrawal, Iain Cockburn,Alberto Galassod, and Alexander Oettl,  argue that the mix of large and smallfirms in a region is very important to regional innovation. He writes that regionswhere a number of small and large lists coexist are more productive in terms ofinnovation, when compared to those that have only a small number of large firms ora large number of small ones.A striking feature of economic geography is the large variation in productivity acrossregions. Moretti (2011) documents that after adjusting for skill composition, averagewages in the highest and lowest paying U.S. metropolitan areas diﬀer byapproximately a factor of three. Such dispersion is also evident when one comparesinnovation outcomes across regions. Silicon Valley and Boston are popularexamples of outlier regions, significantly more productive than others in terms of innovation.In Figure 1, we illustrate such variation using US patent data on computers and communications technologies in1995. Even Metropolitan Statistical Areas (MSAs) of similar size in terms of the number of local inventors oftendiffer substantially in terms of their innovation productivity (number of citation-weighted patented inventions perinventor). For example, Rochester, New York and Portland, Oregon had a similar number of innovators working inthe computer and communications industry in 1995, but Portland inventors generated almost double the numberof citation-weighted patents.Figure 1 – Variation in Regional Innovation Computers and Communication patenting in 1995Regional productivity disparities have led to a variety of policies focused on enhancing local innovation. In citieslike San Diego, California or St. Louis, Missouri such initiatives have mainly focused on encouragingentrepreneurship. Conversely cities like Flint, Michigan or Greenville, South Carolina have invested heavily inattracting large corporations.In recent research, we study how local innovation is affected by the organization of R&D manpower. In otherwords, for a region with a given number of inventors, does the manner in which those inventors are organized(e.g., all in one large firm, spread out across many small firms, distributed across a mix of large and small firms)influence their productivity? We argue that innovation productivity is greater in “diverse” regions, i.e. those wherelarge and small labs coexist.Large and small labs can be beneficial to one anotherThe presence of large labs is beneficial because they have an advantage in idea production due to within-firmknowledge spillovers as well as spreading the fixed costs of research over more projects (Schumpeter, 1942). Atthe same time large labs only commercialize innovations that “fit” with their established research activities. Forexample, in 2001 only 5 out of more than 2,000 new product proposals by General Electric employees wereaccepted for product development.Spin-outs (when a division of a company becomes a new business) may commercialize “misfit” inventions thatare not consistent with the assets, capabilities, or strategy of the parent firm. We expect the cost of spin-outformation to be reduced when a large number of small labs are present in the region. Intuitively, the presence ofmany small labs generates a thick local market for ancillary services, and may also spur a culture ofentrepreneurship that lowers the risk and cognitive cost for employees of large labs to leave their employer andstart their own firm or join another entrepreneurial venture. The complementary externality effects of co-locatedlarge and small labs imply that innovation is maximized in regions which have a diversity of firm sizes.We test the empirical validity of our theory using U.S. regional innovation data for 1975-2000. First, we report twocase studies from 1995 that are consistent with our theory to illustrate our main point: 1) Portland, Oregoncompared to Rochester, New York (lack of small firms), and 2) Atlanta, Georgia compared to Seattle, Washington(lack of a large firm).For Portland and Rochester, the number of inventors patenting in the computers and communications technologyclass is very similar in the two cities (roughly 1,000 inventors). However, Portland significantly outperformsRochester, obtaining about twice the number of quality-adjusted patents than Rochester. While both cities registera similar presence of large labs, the number of small labs is substantially different: Portland has more than fivetimes the number of small labs as Rochester.On the other hand, in the chemicals technology class, Seattle and Atlanta have a similar number of small labs (38and 36, respectively) and also a similar number of overall inventors (457 and 484, respectively), but only Atlantahas a large lab (Kimberly Clark). Atlanta also has 37 percent more quality-adjusted patents.We also find that in periods where at least one large lab and numerous small labs co-exist, regions experience a17 percent increase in innovation. Furthermore, consistent with the proposed mechanism, we find that diversity isassociated with a 28 percent increase in the probability of spin-out formation. Moreover, we present additionalanalyses indicating that the data are consistent with our causal interpretation but not the main competinghypotheses.Our findings suggest important policy implications. Regional productivity disparities have led to a variety ofpolicies focused on enhancing local innovation. Such initiatives often focus on either promoting entrepreneurshipor attracting large corporate labs. Our results indicate that policies focused exclusively on attracting “anchortenants” or cultivating new ventures may not be as effective as promoting firm size diversity, leading to anappropriate mix of large and small firms. In other words, our results suggest that there is no universal “best”policy, but rather the optimal policy depends on the organizational structure of R&D labor in a region at a givenpoint in time. In simplistic terms, a region with large firms but few young entrepreneurial firms may benefit morefrom policies designed to cultivate new ventures rather than to attract more large firms, whereas regions withoutlocal large firms may benefit most from attracting those. This article is based on the paper “Why are some regions more innovative than others? The role of small firms inthe presence of large labs” in the Journal of Urban Economics. Featured image credit: Ryan Holst (Creative Commons BY)Please read our comments policy before commenting .Note:  This article gives the views of the author, and not the position of USApp– American Politics and Policy, norof the London School of Economics.Shortened URL for this post: http://bit.ly/1meLVqj_________________________________________About the authors Ajay K. Agrawal – University of TorontoAjay Agrawal is the Peter Munk Professor of Entrepreneurship at the Rotman School ofManagement at the University of Toronto, Research Associate at the National Bureau ofEconomic Research in Cambridge, MA, and co-founder of The Next 36. His research is focusedon the economics of innovation, creativity, and entrepreneurship. Iain M. Cockburn – Boston UniversityIain M. Cockburn is the Richard C. Shipley Professor of Management at the Strategy andInnovation Department in the School of Management at Boston University. His research interestsinclude the economics of innovation, intellectual property, productivity measurement, industrialorganization, and applied econometrics. _Alberto Galasso – University of TorontoAlberto Galasso is an Associate Professor of Strategic Management in the Department ofManagement at the University of Toronto Mississauga, with a cross-appointment to the StrategicManagement area at Rotman.  His research is focused on the determinants of innovative activity,the management of innovation and the functioning of markets for technology._Alexander Oettl – Georgia Institute of TechnologyAlexander Oettl is an Assistant Professor in the Scheller College of Business at the GeorgiaInstitute of Technology. His research interests include the economics of innovation, knowledgespillovers, labor mobility, and economic geography.  His current work focuses on the productionand diffusion of ideas at the individual, firm, and regional level.CC BY-NC-ND 3.0 2014 LSE USAPP

A mix of small and large firms can be key to regional innovation

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