Big Vs. Small

By Janice Castro

The U.S. economy's undisputed hero in the 1980s has been that footloose, creative pathfinder the entrepreneur. At a time when corporate America often seemed incapable of daring innovation, the likes of Apple Computer's Steve Jobs and Microsoft's Bill Gates forged breakthroughs in semiconductors, software and personal computers. Even in lower-tech fields, such risk takers as Domino's Pizza Founder Tom Monaghan demonstrated an impressive ability to create new products and services that no dominant corporation could match. "This has been a great age to be living in if you're an entrepreneur," exclaims Alfred Rappaport, a Northwestern University business professor who started his own consulting group in Chicago.

But many scholars and business leaders, from the Bay Area to Boston, are beginning to voice concern about what Harvard Economist Robert Reich has dubbed "chronic entrepreneurialism." These contrarians contend that America's obsession with start-up companies is undermining U.S. competitive strength. They blame the proliferation of small companies for an alarming loss of U.S. market share in strategic high-tech businesses, ranging from semiconductors to fiber optics. The constant sprouting of new ventures, they explain, may be weakening the U.S. industrial structure by splintering American manufacturing power into too many small pieces.

At the same time, as Trade Expert Clyde Prestowitz argues in his recent book Trading Places, the flight of budding entrepreneurs from large heavily capitalized corporations is wounding the very U.S. companies that are most capable of competing with the sprawling industrial giants of Japan. Even some leading entrepreneurs, mostly those whose brainchildren are now billion-dollar companies, say the start-up craze has gone too far. Gordon Moore, chairman and co-founder of Intel, the chipmaker based in Santa Clara, Calif. (1987 revenues: $1.9 billion), says "vulture capitalists" have lured away some of his best technicians with offers of seed money to start their own firms.

The entrepreneurs know that if they succeed they can reap far greater financial rewards than can the most generously salaried worker. An estimated 2 million U.S. men and women are millionaires, and nearly 90% of them earned their fortune by starting their own firm. The small-business boom shows no signs of slowing. Even last October's stock-market crash discouraged start-ups only briefly. Jane Morris, editor of the Venture Capital Journal, reckons that venture funding for new enterprises this year may surpass last year's record of $3.9 billion.

To proponents of the entrepreneurial boom, the complaints are sour grapes and nonsense. They point to the starring role that small firms have played in recent U.S. economic growth. Since 1980, as the biggest U.S. industrial corporations have restructured, cutting their payrolls by some 3.1 million workers, small companies have created more than 17 million new jobs. The Reagan Administration estimates that firms with fewer than 500 employees accounted for 63.5% of all new employment between 1980 and 1986. Small firms have also contributed to the resurgence of U.S. manufacturing exports. In a study of more than 400 small high-tech concerns, the Bank of Boston reported in August that most such companies began to export their products almost as soon as they started operations.

Small enterprises serve as incubators of U.S. innovation. The National Science Foundation estimates that 98% of "radical" product developments spring from the research labs of small firms. "Why did the large employers allow the entrepreneurs to escape?" asks Frederic Scherer, an economics professor at Swarthmore College. "There is one story after another where superior ideas were rejected by the larger companies and disgruntled staff went out to found their own enterprises."

Perhaps one reason the 1980s fostered entrepreneurship is that during the decade Big Business tended to grow even bigger as companies merged and improved already dominant positions. In industries as diverse as banking, airlines and brewing, the major companies increased their market share. That in turn presented the opportunity for upstarts to begin filling the niches too small to be noticed by the behemoths.

In the debate over entrepreneurship, everyone agrees that the U.S. needs a balance of large companies and small ones. But critics of the entrepreneurial era believe Government policies and America's business culture have provided too many incentives for innovators to strike out on their own, especially in manufacturing and high-tech industries, ranging from steel to supercomputers. Says William Weisz, vice chairman of Motorola (1987 revenues: $6.7 billion): "Entrepreneurs create a lot of energy, but big businesses are the only ones that are going to maintain an industrial base for this country."

While upstart ventures may run circles around stodgy companies when it comes to rolling out fresh products, they often cannot protect their new markets against giant foreign conglomerates that can knock off their merchandise and mass-produce it at a much lower cost. American companies invented many of the basic technologies behind such products as videocassette recorders and robotics, but Japanese firms have captured the lion's share of the sales in those fields.

Nowhere is this process more sharply defined than in the $32.5 billion global semiconductor industry. Since 1980, more than 200 new U.S. semiconductor companies have been formed as the development of microchip technology has surged forward. Yet the U.S. share of world semiconductor production has slipped from 57.2% to 39.4% during this period, while Japanese companies have expanded their market share from 27.4% to 48%.

Once dominant mainly in manufacturing, Japan's giant electronics companies are sharpening their edge in product development as well. Reason: manufacturing profits have bankrolled research and development. Japan now leads the U.S. in twelve of 25 strategic chip technologies, has pulled abreast in eight others, and is catching up in the remaining five.

Who let down the U.S. -- big firms or small? Two scholars came to sharply different conclusions in essays published earlier this year by the Harvard Business Review. Supply-Sider George Gilder, author of the book The Spirit of Enterprise, cites the roaring success of several of the newest Silicon Valley semiconductor firms -- including Chips & Technologies and Cypress Semiconductor -- as proof that such start-ups are the best hope for continued U.S. economic growth. In what Gilder calls the "law of the microcosm," he contends that the use of computers has given individuals more opportunity to innovate. Says he: "As circuitry is compressed onto single chips, it enhances enormously the power of individual designers and entrepreneurial creators."

But Charles Ferguson, a former IBM analyst who is now a research associate at M.I.T.'s Center for Technology, Policy and Industrial Development, argues that the U.S. semiconductor industry is collapsing because start-ups have siphoned off talented engineers from larger firms. Example: in 1981 a group of Intel executives started Seeq Technology (1987 revenues: $44.6 million) to develop sophisticated memory chips. Four years later, three Seeq employees specializing in such chips quit to form their own company, Atmel.

Ferguson contends that America's most consistently successful and advanced industries, notably aerospace and chemicals, have been dominated by a few giant companies. (Gilder might cite as a counter-example RCA, which squandered its technological heritage by investing in such diversions as carpetmaking and rental cars.) High-tech corporations, says Ferguson, need a heavy capital base to pay for research, computer networks, manufacturing systems and worldwide organizations for sales and customer support. Upstart U.S. firms, too small to bankroll their own factories, often turn to Japanese companies for manufacturing help or sell their key technologies to raise capital for expansion and product development. A common result: the erosion of overall U.S. market share.

What can be done to help U.S. companies gain global clout? Many business leaders and economists contend that major companies must be permitted to work together, in some cases to plot joint international strategies. According to economists like Lester Thurow, dean of M.I.T.'s Sloan School of Management, U.S. antitrust laws may be out of date in an era when it is virtually impossible for one company to monopolize the world market. In Japan major companies work together and with government planners to a much greater degree. Says Motorola's Weisz: "We can't continue as a house divided against the rest of the world."

Persuaded that the critical U.S. semiconductor and computer industries need special help, the Reagan Administration has permitted the formation of two experimental consortiums, Sematech and the Microelectronics and Computer Technology Corp. (MCC), both based in Austin. Since 1983, 19 major computer manufacturers, including Control Data, Digital Equipment and Honeywell, have pooled advanced research efforts through MCC. More than 70 new advances developed by MCC are now being refined by member firms.

At Sematech a group of 14 semiconductor manufacturers has been working since last year on joint research, bolstered by a $100 million federal grant. Says Sanford Kane, an IBM official who serves as chairman of Sematech's executive committee: "We've discovered a formula where normally fierce industry competitors can work together with the Government. Fear ((of foreign rivals)) can be a very persuasive motivator." Democratic Presidential Candidate Michael Dukakis apparently thinks the idea could serve older industries as well. On a tour of a specialty-steel plant in Pittsburgh last week, he promised that as President he would create a national steel-technology research center.

Some tinkering with tax policy could encourage more long-term research and development. The elimination of the investment credit in the 1986 tax reform discouraged many large manufacturers from investing in new plant and equipment. Capital spending in the U.S. stagnated in both 1986 and '87, though the Commerce Department expects it to increase nearly 11% this year.

Large corporations can do a lot on their own to become more nimble. One way is to stimulate employee innovation by providing entrepreneurial incentives. Under the IDEA program at Texas Instruments, workers who propose promising ideas are given the time and resources to test them. One result: the development of gallium arsenide, a material with the properties of silicon but able to withstand higher temperatures. Big companies just might find that the more opportunities they offer for employees to live out their entrepreneurial dreams while still on the payroll, the more rewards both will share.

With reporting by Jeanne McDowell/San Francisco and William McWhirter/Chicago