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Australia's high-growth firms: worth the hype?

December 2017

With its focus on so called High-Growth Firms (HGFs), the 2017 installment of the Australian Innovation Systems Report series provides a timely warning for policy makers not to get ahead of themselves by focussing government policies and support only on a small number of presumed drivers of employment and economic performance.

In 2015, a landmark report in the UK brought to popular attention that just 6% of the fastest growing firms in the UK accounted for more than half of national jobs growth. Across other developed economies between 2% and 4% of firms generate a disproportionately large share of net employment growth.

However, the broader social and economic benefits resulting from HGFs are actually not yet understood.

For example, in a feature article included in the report Paul D. Reynolds, a Visiting Research Scholar at the Queensland University of Technology, points out that there is the assumption that the creation of jobs within a cohort of HGFs reflects overall job creation in the economic system.

But this is not necessarily the case. An individual firm growing in an established market potentially could absorb the competition or drive them out of business, with little or no net benefit to employment (the growth of WalMart in the US set an example for this).

A large proportion of the jobs created in HGFs may also be short-term.

In any case, the growth potential of new ventures is difficult to predict and 'no regrets' policy approaches that improve the general business environment, and remove barriers to business growth, may the best way forward to provide fertile ground for HGFs.

Or as put by two international experts of innovation policy, Professor Alex Coad from the Peruan Pontificia Universidad Católica del Perú, and Jose Manuel Leceta, the director of Spanish public corporate Red.es: "...policy should focus on the broader ecosystem, rather than chasing in vain after elusive unicorns".

This also, as HGFs need to interact with many partners and stakeholders within the innovation system, such as providers of finance, a skilled workforce, an entrepreneurial culture, and suppliers, clients, and collaboration partners.

The report's findings also suggests a general relationship between the number of HGFs in the business sector and the economic growth cycle, as reflected in a decline in the proportion of HGFs in Australia over recent years alongside a slowing in GDP growth rates (by international standards, Australia still ranks well above average in the proportion of firms with high employment growth).

It discerned two types of firms which in a given year grew either in employment or turnover by over 20% (only firms with 5 and more employees were considered due to the volatility of very small micro-businesses).

According to the report, between 2004-05 and 2011-12 around 9% of Australian firms reported high-growth in employment, and around 15% were turnover HGFs. On average they respectively contributed 46% to full-time employment growth and 69% of the value added growth in the Australian economy.

Rapid growth is a characteristic often associated with high-tech firms that are young and small.

But the report shows that Australian HGFs are very diverse and present in all industries.

On average they tend to be younger than other businesses, but they can be of all ages.

And their average size was found to not differ much from that of the general business population.

But instead of describing a particular type of firm, an HGF often refers to a phase some firms go through during their life cycle. According to the report, the majority end their growth episode within 4 years, with some first experiencing rapid increases in turnover to then transition into a phase of high employment growth in later years.

Most HGFs are of medium size, employing between 20 and 199 employees, but the small percentage (around 0.5%) of large HGFs with more than 200 employees showed the greatest impact:

Between 2004-05 and 2011-12 they contributed 25% of total employment growth and 40% of value added in the Australian economy.

For example, are these firms more innovative than others, given that innovation has previously been shown to have a direct positive influence on firm growth?

According to the report's analysis, around three in five Australian firms were actively innovating between 2004-05 and 2011-12, whether they were HGFs or not.

However, while being innovative is generally beneficial to businesses, the impacts across performance indicators vary greatly depending on the kind of innovation activity and the level of business growth.

For example, across all firms, producing new or improved goods and services appears to boost turnover growth, on average by 3.3 percentage points. But the effect was found magnified in HGFs, where it spurs growth by around 7.5 percentage points.

Marketing innovation, however, improves growth across the general business population, on average by 4 percentage points, but has not benefit to high-growth firms, which also did not appear to benefit much from any other type of innovation.

Also interesting is the impact of a strategic approach to innovation. All businesses benefit from such a focus, with turnover growth increased on average by 4 percentage points, but again the effect was found much more pronounced in HGFs, where turnover was increased on average by 9.7%.

And the report indeed found that on the whole this is the case, but these benefits are not set in stone. In fact, there are large variations, with slower growint firms experiencing even negative impacts. By contrast, businesses that engaged frequently in R&D and were in a phase of high growth appear to much better capitalise on their R&D.

It highlights the complexity of the various circumstances a business may be in. For example, a firm spending on R&D may still fail in a competitive environment, and then be worse off. Rival firms may also imitate products capitalising on the R&D it took to create them.

And because business circumstances vary so much, there is no optimal amount of R&D that guarantees a firm's growth or survival, the report concludes.

In other words, investing in R&D involves risk, but most firms will benefit, and for those that succeed the pay-offs can be great.

But Australian business expenditure on R&D (BERD) has been lagging.

During the mining boom expenditure on R&D grew strongly between 2000-01 and 2008-09, with the BERD to GDP ratio doubling to 1.4%, and the share of BERD as share of Australia's gross expenditure on R&D (GERD) rising to 61%. But then it dropped again sharply with end of the mining boom, and the decline of Manufacturing in Australia.

In 2015-16, BERD to GDP was down to 1%, and it's share in GERD dropped to just 53%. [This compares to an OECD average of 69% [OECD Science, Technology and Industry Scoreboard 2017].

There are flow on effects, such as that by international standards, Australian businesses employ few researchers. With only 4.7 researchers per 1,000 employees in industry Australia ranked 21st out of 36 OECD countries in 2013-14.

And this may be behind the low level of collaboration of businesses with the research sector (Australian SMEs ranked last of 29 OECD countries on this indicator).

In fact, as the report's findings indicate, many businesses may simply not understand the potential value of engaging with research organisations.

R&D is understood to be a main driver in the development of new-to-the-market products, and it is therefore not surprising that few Australian businesses create them, despite their high economic value.

Instead, innovation in Australian firms often means adopting innovations developed by others [The Australian Innovation System Report 2014 reported only 5.7% of all Australian businesses introduced new-to-market innovations in 2012–13.]

Inducing change in the innovative capacity of the Australian business sector has been a challenging for policy makers.

The current Government's National Innovation and Science Agenda (NISA) is now in full swing, and it is also about to release the Innovation and Science Australia strategic Plan for the Innovation, Science and Research System out to 2030.

The impace of NISA, announced in 2016, is still too early to assess although it was recently labeled as poorly designed in an Auditor-General's report: "A number of the proposals that involved significant expenditure aimed at transforming parts of the innovation system [and] relied on assertions rather than evidence."

The problem may be that the issues are complex and there is a relatively thin evidence base available to operate with.

Still, over the past decade policy may have triggered notable changes. For example, the proportion of SMEs that show high-growth and undertake R&D increased from 69% in 2005 to 85% in 2015.

The Australian Innovation Systems Report attributes this at least in parts to the introduction of the R&D Tax Incentive program in 2011.

It replaced the previous R&D Tax Concession with increased incentives for SMEs to perform R&D (through an after-tax benefit of at least 13.5 cents in the dollar).

(It should be noted, though, that over the same period the share of high-growth firms in BERD has dropped significantly from 33% down to 15%.)

And policy makers need to be careful in their approach toward the HGF phenomenon.

On the positive side, though, there are major structural changes in the economy, and while R&D performed by HGFs in both Mining and Manufacturing declined over recent years, it rose in other sectors (including Professional, Scientific and Technical Services; Information, and Media and Telecommunications; and Financial and Insurance Services).

It's a welcome sign that the economy is (finally) diversifying.