Actually, small companies are better at innovation than large companies

Grant McCracken summarizes an Economist post that argues that big companies are better at innovation than small ones (well, he discusses both sides).

But theory says that small companies are actually the winners.

Economists have long wrestled with this, the “diseconomies,” problem: why do smaller organizations outperform large ones?  (Todd Zenger’s 1992 Management Sci piece summarizes this work nicely.)  Schumpeter indeed went both ways on this (Dick Langlois discusses the “two Schumpeters”-thesis a bit here).  But yes, large organizations seemingly have the resources, complementary assets, access to talent etc to outperform small organizations.  But small organizations still outperform large ones.

Large organizations have lots of problems (I’ll spare the references, for now).  They

  • mis-specify incentives,
  • suffer from problems of social loafing (free-rider problem),
  • engage in unnecessary  intervention, etc.

And, if large organizations had such an advantage, why not take this argument to the extreme and simply organize everything under one large firm?  That, of course, was one of Coase’s central questions.  Obviously the organization-market boundary matters and there are costs associated with hierarchy.

Sure – there are lots of contingencies, caveats and exceptions [insert example from Apple or 3M].  And, definitions matter [what exactly is “small” versus “large”].  But on the whole, the theory says small companies win in the innovation game.

3 Comments on “Actually, small companies are better at innovation than large companies”

  1. I also read many of the advantages of big organizations, in the Economist piece, as advantages in capturing value from innovation more than advantages in creating innovation. It made a better argument for why the big guy might win, rather than for why the big guy will create the most value for society.

  2. This question needs to be specified more precisely. It also needs to be set in a dynamic context. Large firms were once small firms — they grew through some combination of above-average ability and luck. Most entrants fail, and many small firms are unproductive. A minority of entrants turn out to be very productive and eventually evolve into large firms.

    Akcigit and Kerr have a great working paper with a simple model of innovation. In their paper, small firms take more draws from the “exploration” distribution than large firms (this is essentially by assumption in the model). The ones that get good draws grow (and look more innovative) and the ones that get bad draws exit.

    Here is a link to an early version of the paper:

  3. srp says:

    The old lit on this, focusing on R&D intensity, such as Kamien and Schwartz, used to generate an inverted-U distribution. Lots of empirical work purported to find this greater R&D intensity of medium-sized firms.

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