Four years ago, David Birch showed that small companies create most of the country's jobs. Now he has found that failure is just as important as success in keeping the new jobs coming.
If Arp Instruments Inc. hadn't gone bankrupt in 1981, David Friend probably wouldn't have helped start Computer Pictures Corp., which, in its second year, generated profits on sales of around $6.5 million. If they hadn't started Computer Pictures, Friend and his co-founders couldn't have sold it to Cullinet Software for $14 million last fall. And without the sale to Cullinet, Friend wouldn't be the well-heeled venture capitalist he is today, with two more start-ups under way.
David Birch would make the unsettling argument that the more Arp-like failures an economy experiences, the healthier that economy is likely to be. If that sounds farfetched, consider the Arp case more closely.
Arp was founded in 1969 by Alan R. Pearlman, an engineer with one successful start-up to his credit already. With $100,000 of his own money and $100,000 more tapped from friends and family, he developed the company's first electronic music synthesizer. Soon he was joined by Friend, a 21-year-old graduate student with a background in engineering and music but not in business. The third principal was Lewis G. Pollock, a Boston attorney
This unlikely threesome rapidly built Arp's sales to $7 million and its work force to nearly 200. The company turned in several profitable years. Its products advanced the state of the art in electronic music synthesis. The country's biggest rock stars made music on Arp's high-tech instruments, while the company itself became a star in its own right.
Yet, by 1981, Arp was bankrupt.
Whose fault the bankruptcy was is still an issue of contention (See INC. November 1982 page 38). But it is unarguable that Arp failed ultimately because it could not compete: The particular combination of human and tangible assets that constituated Arp Instruments was not efficient enough to permit the company to remain in business. However, freed by bankruptcy and liquidation, Arp's assets -- some of them, anyway -- have found more valuable employment.
So, in the end, Arp's failure was healthy for David Friend. It was also healthy for the economies of Massachusetts -- where Arp and Computer Pictures were based -- and of the country. In place of one ailing business, several thriving or promising companies now exist. Which is precisely David Birch's point.
Birch, who heads Massachusetts Institute of Technology's Program on Neighborhood and Regional Change, achieved stardom of a sort himself four years ago when he made what was at the time a startling pronouncement Small companies, not corporate giants, create most of the country's jobs Small companies, those with fewer than 100 workers, employ 30% to 40% of the U.S. work force. But, Birch found (through computer analysis of data collected by Dun & Bradstreet on nearly 6 million companies), these small companies generated 82% of the jobs created from 1969 through 1976.
At first it seemed like a paradox: From year to year, decade to decade, the small business share of employment remained about the same, 40% or less. How could small companies generate all those jobs and yet not become a bigger and bigger portion of the economy? That is the wrong way to look at it, Birch says, citing another example to explain why. Divide the population into two groups, he says, children and adults. As individuals, children gain more weight than adults. But, the weight of the children's group remains about the same in proportion to the weight of the adult group. That is obviously because full-grown children enter the adult group. Likewise, small companies that have already completed most of their job generation move into thc big-business category.
If Birch's findings no longer seem especially remarkable, it is because they have been so quickly assimilated into the conventional wisdom. Organizations and individuals who promote the political and economic cause of small business in Washington and in state capitals couldn't quote Birch often enough Credible, academic, and ideologically neutral evidence that small companies generate more jobs than large companies, in proportion to their share of the work force, was valuable ammunition for small business lobbyists competing with other interest groups for attention and favors from Congress and local legislatures.So frequently were they cited that Birch's findings led to thc coining of what Candee Harris of The Brookings Institution in Washington, D.C., calls the Eleventh Commandment: "Thou shalt aid and protect small business because it creates jobs." Birch found himself a much-sought-after luncheon speaker.
Birch's sparkling credentials got a bit tarnished last year when Harris and other members of a research team at Brookings released new, apparently conflicting, statistics about job creation, based on their own analysis of Dun & Bradstreet data. Their work produced numbers not nearly as impressive as Birch's. Small companies, they said, really create only about 40% of the new jobs in the United States, not much more than you would expect from their proportion of the work force.
National Journal's Robert J. Samuelson, an economic journalist widely read and respected by Washington politicians and power brokers, publicized the Brookings study and took potshots at Birch's work. The damage was apparent almost immediately to small business advocates who had been leaning heavily on the Birch revelations to support their political cases. For example, the campaign staffs of two Democratic Presidential candidates, Ohio senator John Glenn and former Florida governor Reubin Askew, got nervous. "After the Brookings study came out," says Jere Glover, a Washington attorney and active Democratic advocate for small business, "we started having problems with them. Askew's staff had been talking to us about a strong small business plank in their campaign, but the next time we called, his policy guy said, 'Hey, these numbers you gave us are in dispute now. They're not clean.' Before, they were hot to trot. Suddenly, they weren't." It took some explaining, Glover says, but most candidates are back in the fold now.
