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INNOVATION
& DESIGN Home Page Architecture Brand Equity Auto Design Game Room SMALLBIZ Smart Answers Success Stories Today's Tip INVESTING Investing: Europe Annual Reports BW 50 S&P Picks & Pans Stock Screeners Free S&P Stock Report SCOREBOARDS Hot Growth 100 Mutual Funds Info Tech 100 S&P 500 B-SCHOOLS Undergrad Programs MBA Blogs MBA Profiles MBA Rankings Who's Hiring Grads | | NOVEMBER 24, 1999 IN BOX Nonprofit Business Incubators: Development Panacea or Pork? Readers debate frontier Online's recent article
 Reporter Jeremy Quittner's recent article examining the economics behind nonprofit, publicly funded business incubators (see frontier Online, 10/25/99, "Can Business Incubators Justify Their Existence? provoked a flood of letters — mainly from those associated with incubators. Below is a sample. Mr. Quittner's response follows. (Letters are edited for style, length, and clarity.)
To the Editor: Jeremy Quittner's attack on business incubators utilizes specious arguments and misreads research conducted by the University of Michigan and other respected institutions. He says: "Keeping businesses alive for a few years isn't an exceptional feat." I don't disagree. The companies in this study, however, survived a great deal longer. Also, he fails to explain that most incubators improve survival rates and accelerate the growth of companies in distressed inner cities, small towns, and rural areas or that they support high-tech spinouts from universities and federallabs, which pose special challenges. These entrepreneur-support and training programs assist companies that are creating jobs, opportunities, and new technologies in your hometown and mine, not only in boom towns like Silicon Valley. And they assist all types of worthy entrepreneurs, not just ones with old-boy connections. Quittner misquotes the Michigan study: "The study's claim that incubators produce $5 in taxes for every dollar of public subsidy is...puzzling," he says. If he had read on, he would have seen that a random sample of the client firms from the study returned $5 in local tax dollars for every $1 in subsidy from all sources received by their incubator programs! The study notes: "The calculation of return on investment may considerably underestimate the total return...because it does not include the contribution to the tax base of the other 157 client and graduate companies that were served by these incubators [from 1990 to 1996 time period for which data was collected], nor does it include state or federal taxes [paid by the companies]." The analysis also did not include taxes paid by companies served prior to 1990 nor those paid by the incubator and its staff. Quittner ignores the track records of many highly successful programs, although these were identified in interviews. He also ignores successful incubator graduate firms such as Mindspring, Centocor, MapInfo, and many others. "It would seem likely that in the last 20 years, at least one [incubator] would have produced a large, profitable company," he writes, then he chooses Peapod, the market-leader online grocery order-delivery company based near Chicago as characteristic of successful incubator graduates. Peapod, which went public in June 1997, posted $60 million in revenues in 1998, but has yet to post an annual profit, though it employs 1,400 people nationally. True, Peapod isn't representative of all successful incubator startups, but the company started in Chicagoland, rather than Silicon Valley, and we bet tax authorities and Peapod's employees are pleased that it was incubated there. The average annual operating subsidy for incubators in our study was $86,000, but much of this money comes from corporate sponsors and gifts, not just tax revenues. Meanwhile, it's no time at all before the graduates pay the "loan" off. What next, Mr. Quittner? Libraries? There are countless examples of wasted public funds. Sorry, this isn't one. Sincerely, Dinah Adkins Executive Director National Business Incubation Association Athens, Ohio To the Editor: I read with interest your article on small business incubators. I am pleased to see you raise questions about the efficacy of investments in incubators. In the mid-1980s, when communities were grasping for ways to cope with massive industrial restructuring, small-business incubators developed a "magic bullet" aura about them, which fit nicely with the popular view that small businesses create most new jobs. If we are losing large firms, but small firms are the key to our new future, we need an incubator, communities reasoned. So many hoped -- and continue to hope -- that building an incubator would lead to economic renewal. Of course, no incubator can carry such a burden. Many have been failures. But the notion of a new incubator continues to be an unrealistic symbol of hope for communities without one. However, I do feel comfortable saying that even if expectations of incubators are overblown in some circumstances, that doesn't mean that they're not appropriate, with the right expectations and right management in other situations. Incubators can be one valuable tool among many in an economic-development strategy. Thus, I think your article goes a bit too far in questioning the notion of incubators per se. It would be more appropriate to question how the tool has been applied. Communities and funding organizations considering small-business incubators need to understand the circumstances where an incubator is appropriate, the best management practices, and realistic outcomes. To what extent does such an understanding exist or is being applied? As a major funder of incubators, is EDA using appropriate criteria in choosing grantees? Does it see that they have appropriate technical assistance? These are the questions I would like to see answered if you pursue the value of incubators further. Incidentally, EDA funded a 1989 analysis of one element of its incubator-funding program led by David Allen, then at Penn State University, now at Ohio University in Athens, Ohio. I was an active participant as a subcontractor. While my memory of the final report is dim, I believe our case studies found both failures and successes. Sincerely, Andrew Reamer Andrew Reamer & Associates, [Mr. Reamer heads an economic-development consulting firm.] Belmont, Mass. To the Editor: Your focus on not-for-profit/public incubators didn't take into consideration the considerable success of for-profit incubators. Certainly, companies like IdeaLab have a strong track record in producing companies that create jobs, tax base, high public market valuations, etc. They may have succeeded where not-for-profits may have failed because of the level and quality of support and infrastructure provided to nascent companies (as well as the nature of the business, most focused on dot.coms). We are launching an incubator that offers a full suite of services, including seed capital, infrastructure, on-premise professional services (legal, engineering, finance), and mentoring from seasoned executives. We believe this model will increase the batting average for startups and speed strong ideas and concepts to market. Neil S. Cohen Net2Future San Francisco, Calif. neil@net2future.com Mr. Quittner's response: Many of the letters I received appear to miss the point of the story. First, the story didn't attack business incubators. Instead, I examined the economics of publicly subsidized incubators -- not the for-profit models, as I made clear in the first sentence of my story -- and their role in this era of incredible prosperity. As I pointed out, an enormous number of small businesses have come into being and thrived without help during this expansion. My point -- which a number of letters reinforced -- was that the incubator community appears to rely heavily on anecdotal evidence to support its view of the special role of incubators. I spoke to researchers, incubator managers, and the NBIA in dozens of interviews over two months. Yet no one could point me to clear, detailed data demonstrating that publicly subsidized incubators are as effective as so many in the industry say. As I wrote, there's no question that reduced overhead is a boon to entrepreneurs in incubators. Yet, it's unknown whether the money invested in their companies ultimately creates businesses that survive longer than they would have without it. The 1997 study that NBIA Executive Director Dinah Adkins cites ("Business Incubation Works" by the University of Michigan, the NBIA, Ohio University, and the Southern Technology Council) concedes as much: "It is impossible to know after the fact what a firm would have done without the assistance of its business incubator program. Consequently here, as in most research on the impact of business assistance programs, analysis focuses upon gross, as opposed to net, impact." Contrary to some readers' perceptions, I never said that keeping a startup alive for the first few years is not an achievement. But the success rates the NBIA claims for incubated businesses don't appear to be any better than those that the Small Business Administration and various private studies report for businesses in general. Ms. Adkins says that I failed "to explain that most incubators improve survival rates and accelerate growth." Despite numerous attempts at my request, the NBIA was unable to turn up data that demonstrates incubators actually do this. It referred me repeatedly to the 1997 report, which says on average 87% of the graduates of the programs were still operating in 1996. Ms. Adkins contends I misquoted the report on the $5-to-$1 return on public investment from tax revenues from incubated companies because I didn't note that the $5 figure refers to local tax receipts. The problem with the ratio is more basic. As the 1997 report acknowledges, it wasn't based on real numbers: "The team could not calculate the average tax revenue per incubator because of the large variation in local tax rates and economic conditions," so it "estimated local tax revenue generated by a sample of 23 incubator firms in four communities." The report adds: "Note that these results cannot simply be used as a measure of the rate of return of all incubation programs because they were based upon a very small sample of firms and incubator programs and the calculation did not include capital subsidies." The report is also unclear on the source of the tax revenues it cites. Few early-stage companies are profitable, so they don't pay corporate income tax. Furthermore, by the NBIA's own statistics, 90% of incubators are nonprofit, which are generally exempt from taxes (except possibly on property or earnings from for-profit subsidiaries.) Ms. Adkins writes: "The average annual operating subsidy for incubators in our study was $86,000, but much of this money comes from corporate sponsors and gifts..." That's at odds with what the 1997 report says: It uses the $86,000 figure to help calculate what's specifically labelled as the public subsidy cost of jobs created by incubators. As for the track records of successful programs, my story did highlight the efforts of several incubators that were trying to wean themselves off public subsidies. Nor did I arbitrarily choose Peapod as an example of a successful public-incubator graduate. In numerous interviews, I asked people in the field to name a prominent, incubated company, and Peapod was the only one they could actually identify. Finally, I chose not to focus on private-sector incubators because they are based on a venture-capital approach, often taking an equity stake in a fledgling company with active involvement in its management. Furthermore, private incubators are mainly in business to make high returns for their investors -- not to assist businesses in disadvantaged areas. Moreover, as they don't rely on taxpayer support and are typically closely held, their shareholders, not the general public, bear the burden of failure. Publicly supported incubators may well provide an invaluable service. If so, their advocates should be better prepared to demonstrate their benefits.  By Jeremy Quittner  | | |
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