A remarkable group of entrepreneurs deserves credit for transforming America's toughest neighborhoods, writes Michael E. Porter. But there is still much that cities can and must do to support these crucial growth companies.
In 1998, my colleagues and I created the Inner City 100, a list of companies that were growing rapidly despite (that is how most people would see it) being located in inner city neighborhoods. My hypothesis was that certain characteristics of inner city communities -- centrality and proximity to transportation nodes, availability of labor, and unmet local market demand -- suggested that companies based in inner cities could actually enjoy a distinct competitive advantage over rivals in the suburbs and elsewhere.
In the years that have followed, the team at the Initiative for a Competitive Inner City, working with Inc. magazine, has identified hundreds of fast-growing inner city companies that do in fact derive competitive advantage from the factors I had identified. We also learned that the advantages were even greater than we had imagined -- centrality meant access to broadband, for example. There was also unmet local demand for business services, not just consumer goods. What we have, then, is a vibrant entrepreneurial economy emerging in neighborhoods that were ravaged a generation ago by violent crime, the drug trade, riots, poverty, and neglect. The aggregate revenue of the 413 firms that have appeared on the seven Inner City 100 lists stands at $7 billion (counting the highest revenue attained by a ranked firm, and subtracting the handful that have gone out of business), and they are growing on average at a compounded 54% per year. But the influence of these companies is not merely economic. They are also powerful engines for social change. They transform neighborhoods and the lives of residents, more so than most any social program.
Of equal importance, they offer us a window onto the future. Significant economic and social forces -- both the positive and the negative -- have historically appeared first in inner city settings. It stands to reason that the businesses that operate in these neighborhoods will face important changes before most others, and that the best companies -- the smartest entrepreneurs -- will master these changes before the rest of us. And yet the good news is tempered by the fact that even the most successful inner city businesses still face daunting obstacles to their continued success -- obstacles that are entirely man-made, as avoidable as they are costly.
In the past seven years, the Inner City 100 companies have created 40,000 new jobs, half of which are held by inner city residents. Inner City 100 companies also enhance their communities in a number of other ways, from boosting home ownership to refurbishing buildings. Sometimes they directly address pressing neighborhood concerns, by running charter schools, for example, or providing affordable health care or child care.
This is the economic model for urban revitalization, and it is a virtuous cycle: The more inner city businesses form and grow, the more jobs they create and the more transformation they catalyze in their communities. The economic model offers a powerful alternative to the social model of the past, which favors subsidies, public real estate projects, income assistance, and other programs to support individuals in need. For the economic model to take hold, however, it is imperative that inner city growth companies remain in the city and expand operations locally. And according to our research, 75% of these companies are planning to expand, and all of them would prefer to remain in the inner city. Yet we also find that the single most important reason companies leave the inner city is that they are unable to find a site or otherwise expand in a timely fashion.
City bureaucracy is often to blame. Shortsighted community activists also often drive growing companies out of the very neighborhoods that need them the most. This is tragic. As we have all observed, most inner cities have no dearth of vacant buildings and plots. The problem lies in the fact that available property often consists of small noncontiguous parcels with multiple owners. Assembling the land to create a usable site for a business is a complicated and lengthy process. Municipal governments, though they are starved for tax revenue, nevertheless make life miserable for companies in terms of construction codes and permits. And city, state, and federal agencies often engage in protracted territorial battles over land rather than expediting development.
Meanwhile, community organizations routinely raise objections to business expansion projects. For example, when Cleveland-based real estate developer Rysar Properties (No. 92 on this year's list) tried to expand its headquarters onto a neighboring plot that was vacant, it encountered fierce opposition from a local community group lobbying to build a homeless shelter on the same site. After months of negotiation, the land still lies vacant. The $20 million expansion project, which would have created 50 new jobs by Rysar's estimate, never got off the ground.
Other regulatory and bureaucratic delays drive up costs. Brownfield sites are not uncommon in inner cities. To build on one of them often requires the demolition of existing structures and environmental cleanup, which makes the reclamation of the land expensive. Rather than supporting businesses that seek to reclaim brownfield land, however, many cities have in place archaic laws full of clauses and subclauses that add further time and cost to a project. Instead, cities should see that businesses are their best allies in reclaiming brownfield sites.
Still other easily remedied circumstances stunt the ability of inner city businesses to grow. An innocuous issue like the lack of adequate parking or inadequate access to highway ramps is often enough to hobble business development. In some cities, roads and bridges built over viaducts are too old and narrow to accommodate modern-day vehicles. Take the case of Kim & Scott's Gourmet Pretzels (No. 48). The company's manufacturing facility in Chicago is located in an industrial corridor between housing developments. There is no holding zone for trucks in the area and Kim & Scott's loading zone is inadequate, so the company must pay between $50 and $100 per hour per truck in waiting charges on delivery days. The costs add up: The company receives eight to 10 truck deliveries per week. For now, Kim & Scott's plans to stay in Chicago, preserving 100 jobs. Cities need to be aware of such issues and play a role in helping companies address them. Otherwise, cities stand to lose their winners, as fast-growth companies will be forced to leave the city when they expand.
The best cities and the most effective mayors are addressing these problems head on. Once they do, inner city business development can thrive. For example, in my hometown of Boston, we have an unusual situation. Economic growth in the inner city is outpacing growth in the rest of the city (for our working definition of an inner city, see "What Is an Inner City Company?" on page 94). Mayor Thomas Menino deserves a good deal of credit for this feat. Recognizing that inefficient government departments and processes were stifling entrepreneurship, Menino streamlined city licensing procedures and created the BackStreets program as a one-stop shop to serve the needs of the city's more than 4,000 business owners. Mayors nationwide should follow his lead.
Despite the Inner City 100 and other evidence on inner city economic potential, business development in inner cities is also limited by persistent negative perceptions. One myth that persists: Inner city residents make bad employees. Fortune 1000 representatives, asked in a survey what they considered the biggest obstacle to increasing business development in inner city areas, responded that they perceived the main barrier to be an undereducated or unskilled work force. Yet Inner City 100 entrepreneurs who actually operate there consistently tell us that local residents make loyal and diligent employees and directly contribute to business success. In fact, many of the 2005 Inner City 100 winners ranked the availability of a diverse work force as the top advantage of their location. The average employee turnover of these businesses is 15%, compared with the national average of 25%.
Misperceptions also endure about the extent of crime in inner city areas. Of course, crime remains a concern. But public safety officials across the country have made substantial progress in the past decade in reducing urban crime. Moreover, the impact of crime on businesses is often overstated. In 2005, only 11% of Inner City 100 companies cited actual crime as a serious problem. Yet some 27% said the perception of crime caused them grief. In other words, it was a barrier in recruiting employees or it made a potential customer reluctant to do business with them. Many inner city businesses are a force for change in improving public safety. Perhaps the most dramatic illustration of this is Sneaker Villa (No. 54), a retail chain with locations in cities such as Philadelphia and Pittsburgh that participates with local police in a "Turn Your Guns In" program that swaps guns for Sneaker Villa coupons.
A third misperception is that the inner city is not a viable market because residents are poor. Yet the retail market in the inner city is worth $90 billion a year, and the national inner city population is equal to that of the state of Texas. Because of the high population density of inner city areas, average resident retail spending is $36 million per square mile, compared with $3 million per square mile for the rest of the metropolitan area. Yet many retailers and financial services providers have not addressed this obviously underserved market, though there are emerging signs of progress.
Business services companies have largely overlooked the inner city market too. They are missing the fact that, according to our latest research, more than 814,000 businesses make their homes in inner cities -- 80,000 of them with annual sales of more than $1 million. Both debt and equity providers have been slow to seize the opportunity to provide start-up and growth capital to these businesses, despite the fact that the average bankruptcy rate among inner city businesses is only one-tenth of a percent higher than it is in the rest of metropolitan areas.
A good example is Miami-based military housing contractor Kira (No. 95). It took Kira three years to get its first line of credit. As many as 24 banks in Florida rejected the company, until finally a bank in Washington, D.C., agreed to extend it a modest $100,000 credit line. Today Kira's credit line is $10 million, and its annual sales top $20 million.
In many ways, inner cities represent a microcosm of the emerging American economy, and that is why the health of the growth companies that take root in these neighborhoods is a matter of national, rather than local, concern.
The diverse, multilingual, multiracial, immigrant-friendly nature of inner city communities means that they are a window onto the future. Every minute an entrepreneur spends worrying about parking or a building permit, he or she is not figuring out how to expand the business and, with it, the well-paying jobs that transform urban neighborhoods.
If negotiating with community groups over land usage drags on, then there is less time to learn how to best serve local consumers.
The strategic location of inner cities aligns with the demands of a high-service, just-in-time, integrated, global business environment. And yet if a city's transportation infrastructure bypasses urban neighborhoods, or if trucks are not able to get to warehouses, then companies cannot derive the benefits of a central location.
If we can shed old perceptions and focus on the economic opportunity in America's disadvantaged communities, the stubborn challenge of reducing economic inequality can be met. Changing minds is never easy or immediate. But if this can be done it will unleash the nation's most effective jobs program, and its strongest safety net. We need to build on the greatest American strengths -- entrepreneurship and the market system -- and extend the fruits to every citizen.
Harvard Business School professor Michael E. Porter founded the Initiative for a Competitive Inner City in 1994. For more information about the work of ICIC, visit www.icic.org.