Big Companies Need Startups – and Vice Versa

The leaders of big companies are getting a lot of criticism nowadays, especially as supposed “superstar” firms are laying off people and preparing for recession.  A recent article in CEO World told them flatly, “You suck at innovation.”  It’s true that large organizations struggle to develop new products and services as well as startups do.  But big companies bring many assets to the economy that leaders can use to sustain their competitive advantages.  And while they may not like to admit it, startups often make big companies more successful.

I just co-authored a book about the many ways that American politics and economics have favored entrepreneurial ventures.  We focused on startups and other entrepreneurs before their successes led them to build large organizations.  We also acknowledged the familiar challenges that big business faces in pursuing breakthrough innovation.  But we insisted that a vibrant economy needs both – “gorillas” as well as “guerillas.”

It’s easy to see why we need startups.  I can speak from direct experience here.  Back in the 1970s, my father turned a startup motor club (similar to AAA) into what has become the largest roadside assistance firm in the country.  He did this by decoupling the offering and tailoring services to meet the needs of automotive manufacturers and insurance companies – entirely new channels for the product offering.  Over time, we created a new segment that now covers over 120 million motorists, in contrast to AAA’s roughly 50 million.  Yet even as we challenged the industry leader, new technology firms nipped at our heels, primarily using new technologies to do so.  That forced us to innovate by recruiting teams in new areas and by acquiring a San Francisco-based startup, largely for its team and culture.

So why do we need big companies?  Let’s start with the basic but overlooked point that big companies often provide crucial infrastructure in which startups can thrive.  In the book, we wrote about how the big railroad companies spawned mighty entrepreneurs in steelmaking, meatpacking, and mail-order retail.  In recent times, startups have benefitted from the logistical benefits of Amazon (e-commerce and cloud), EBay and Etsy (e-commerce), Paypal (payments), and Apple (app store) – not to mention the non-electronic but often essential offerings of providers such as UPS and FedEx (logistics).  It’s no surprise that many consumer product companies have set up operations near Walmart’s headquarters in the otherwise obscure town of Bentonville, Arkansas.

Big companies also define the markets in which startups can easily operate.  By providing a baseline service, they educate the mass of consumers in a certain product or service that startups can readily improve.  Some startups aim directly at disrupting market categories, but that’s much harder than working within the parameters already demonstrated by the big guys.

Big business as a whole provides crucial financial advantages.  That’s most obvious when a large firm acquires a startup, giving the founders and their backers a ready payout.  But it also demonstrates that payouts can come over time with well-functioning capital markets anchored by large organizations.  Most startups fail to generate the lucrative IPOs envisioned by founders, but enough of them have succeeded in doing so to entice investors.  And in the United States, unlike many other countries, entrepreneurs who succeed mightily with startups can be confident that governments won’t confiscate their wealth.

Finally, big companies are essential to achieving our affluent society of reliable products and services at affordable prices.  The very structures that hinder them from breakthrough innovation – their extensive bureaucracy and hierarchy – enable them to churn out offerings at high volume and quality.  Startups are great at innovation – but often lousy at expanding new offerings at scale.  Often the only way they can get there is by licensing their goods to a big company, or becoming large themselves.

The inherent advantage of the American economic system is that by freeing upstarts to challenge incumbents, it allows innovation to reach the market while forcing established companies to stay on their toes.  While this might make the job of CEO less cozy, it does drive productivity and the economy further than in less open countries.  It is one of the pillars of our global competitiveness.

Written by Howard L. Wolk.
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