Friday, April 17, 2009

Financial Crisis Could Hinder Innovation (based on an article by Joshua Gans in MIT Sloan Management Review)

Joshua Gans, professor of management (information economics) at the Melbourne Business School, University of Melbourne expresses an important concern in his resent article titled "A Dearth of Exit Strategies" published in MIT Sloan Management Review – while governments across the globe are busy doling out stimulus packages to rescue corporate giants from the financial gutters they have fallen into, the small innovative technology start-ups are being left out in the lurch. This might have significant consequences in the longer term; say 10 to 20 years down the line. The crisis would cause slowing down of the economy, GDP plummeting a few percentage points, increase in un-employment etc but only for a couple of year or so. But if technological invention and breakthroughs, research and development slows down due to the downturn now it might wreck havoc in the foreseeable future.

Whether recession is a roadblock for innovation or not, though, is a controversial argument. According to early 20th century economist Joseph Schumpeter, who coined the term 'creative destruction', thought that the downturn will force the large inefficient companies to go to the grave opening up opportunities to the entrepreneurs to see the light of the day for their products and services. But the mechanism of toady's entrepreneurial innovations is somewhat different as explained in the next paragraph.

The start-ups might operate in one of the two ways – either they compete head-on equipped with their superior innovative knowhow with existing corporate behemoths, who resists change and cling on to proven and practiced methods or they get sold out to the large enterprises or license their technologies to them. The later method is cooperative strategy as against the competitive strategy. Where the capital investment requirement is substantial as well as the process is complex to bring the product to the market, the start-up goes with cooperative strategy, e.g. in the field of bio-technology and medical devices as against electronics start-ups.

The data shows that the US companies with venture capital funding which were acquired in 2008 decreased almost 28% from the previous years. Comparing on quarterly basis, while 70 acquisitions each took place in the first three quarters of 2008 each, the fourth quarter saw only 37 acquisitions! These restrict exit options for the would-be company founders as well as the venture capitalists and as a result discouraging them to come forward.

Hence, to preserve the creativity, that the technology start-ups bring in, and consequently to maintain the economic growth beyond the next few years the government should assist entrepreneurial technology companies in general.

Quite an interesting observation!

(Note: You can get hold of the actual article at after signing up)

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