What is the role of government to encourage small business innovation?

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Since the beginning of time, it's been entrepreneurs that drive the creation of innovation.  True breakthroughs have been the result of an individual or small team who had an idea and the determination to see it through to fruition.  In many cases, ignoring the advice of friends and the lack of what many would call standard market research/validation.   While we enjoy the fruits of the rapid pace of innovations, it is the entrepreneur, slaving away alone or within a small firm, who is inventing the future. What is the role of government to encourage this small business innovation?

small business innovation and the role of government

A set of studies by the Small Business Administration confirms this.  The  drive to invent is alive and well within the heart of the entrepreneur.  Its surprising to learn that the smaller the business, the more patents per employee are filed.   This holds true no matter the size of the business.   A company with 25 employees generate more patents per employee than a company with 50, which produces more patents than a company with 100. Even in large companies the trend holds true, with corporations of 10,000 employees filing for more patents per employee than a company with 50,000 people.  While it is true that larger corporations often become bureaucracies with layers of management being added as the organization grows, when a straight comparison of only individuals involved in research and development (innovation) is made, the trend still holds.   Small businesses invent at a rate faster than large businesses.

When it comes to breakthrough innovation, it's not about the number of patents or the number of patents per employee but about the quality and impact of the patents.

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In this case, small business lead again as a disproportionate number of patents for emerging technologies are issued to small firms  To be specific, the Small Business Administration reports that, while small firms are granted only eight percent of all patents, they receive 24 percent of all patents issued in the top 100 emerging technologies. The patents issued to small business are not just broad generic patents, but are focused toward specific innovations that have the highest impact with the highest return.


The technologies most often impacted by patents issued to small firms include:

  • Communications (telecommunications, internet)
  • Diagnosis/Surgery/Medical Instruments
  • Biotechnology
  • Pharmaceuticals
  • Power Systems

It's interesting to note that two of the top emerging technologies where large businesses have a 2x lead over small businesses are:

  • Computer hardware
  • Computer software

Whatever the underlying causes, one simple fact remains. It is the entrepreneur who blazes new ground through innovation and who raises the bar for all others. For proof, look no further than the beginnings of HP, Microsoft or Apple. In each case, two men shared a dream, and the results literally changed the world.

Its these entrepreneurs and their dreams that create economic opportunity for cities, regions and countries.  So, what is the role of government to support and encourage innovation development from entrepreneurs?

  1. Create incentives for risk capital. Establish policies (e.g. reduced capital gains taxes) and programs (e.g. matching funding with the private sector such as the SBIR from the US government) to ensure the availability of risk capital.
  2. Establish incentives for small and large businesses to co-innovate together. Create a tax and IP incentive for large businesses to invest, partner and support the innovations created by small businesses.  Small businesses need the size and scale of large businesses to bring their ideas to market while at the same time, large businesses need the breakthrough innovations coming from small businesses.
  3. Encourage entrepreneurs to invest in R&D. Eliminate the negative incentives such as the US governments AMT that wipes out any R&D tax credit for most small businesses.  (read more)
  4. Build leverage into innovation programs. Establish incentives (reduced red tape, special infrastructure investment, hiring and training incentives, etc) to invest in common areas thereby creating an ecosystem of participants (university, investors, entrepreneurs, large businesses).
  5. Commit to graduating workers prepared for the creative/innovation economy.  Embed creativity and innovation training into each subject taught in the classroom.  Make creativity/innovation just as important as the other core subjects.  What are some example of the skills that students need to learn?  (read more)
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If you had 10 minutes with a leader of your government, what would you suggest they do to encourage small business innovation?

Source:  “An Analysis of Small Business Patents by Industry and Firm Size“, Small Business Administration (SBA).  November 2008

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13 thoughts on “What is the role of government to encourage small business innovation?

  1. One challenge for small businesses is access to venture capital windows. In developing countries there is a heavy dependence on collateral- usually real estate. Most entrepreneurs have no real assets to support traditional commercial bank lending.

    Governments need to set up venture capital windows that take equity positions with innovative projects.

  2. Number 1 suggestion to government: Get out of the way.
    Government has no excuse competing against business, legislating the outcomes, or seizing the rewards of success.

    “Incentivizing” suggests that lawmakers know better than the markets what society wants. Let the markets kill off the losers and reward the winners. Let government protect and defend. Let trial lawyers go do something else.

  3. Great points about US entrepreneurial innovation. Unfortunately, since 2000 we have passed a number of laws and regulations that are killing innovation in the US. The incredible innovation of the 90s was based on technology start-up companies built on intellectual capital, financial capital, and human capital. All three of the pillars have been under attack since 2000. Our patent laws have been weakened reducing the value of intellectual capital. Sarbanes Oxley has made it impossible to go public reducing financial capital for start-ups and the FASB rules on stock options have made it harder to attract human capital to start-ups. The Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulations are Killing Innovation http://www.amazon.com/Decline-Fall-American-Entrepreneur-Regulations/dp/1439261369/ref=sr_1_1?ie=UTF8&s=books&qid=1262124667&sr=8-1, explains these problems in more detail.

  4. Hi Phil,

    “what would you suggest they do to encourage small business innovation?”

    I’d suggest they read two or three current book offerings, and contemplate the role of intra-organizational innovation, the initiative question generally, and not “make bets” on the next new thing.

    1. Josh Lerner’s “Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed–and What to Do About It. Just published by Stanford Press, claims to be the “first” look at this vexed area.

    2. The HP Phenomenon book, which you recently reviewed and also published an interview with one of the authors. By far the best account of what intra-organisational innovation involves. More on this later, as I’m preparing a review of the two books above, #1 and #2.

    3. Again, I suggest Judy Estrin’s “Closing the Innovation Gap” for its clearsightedness about the relation between “good thinking”, “good education” and “good innovation”. Covers your point #5 above, namely “Commit to graduating workers prepared for the creative/innovation economy”. Except start in Reception Or K, depending on your nation’s nomenclature for early childhood education.

    As for the “get out of the way” crowd, governments have assisted industry and commerce since modern capital formation began in the 17th century – as House and Price’s book shows for the 20th century, for example, vis a vis HP’s development in the late 30s. As for the entrepreneurs whinging about the lack of venture capital (whether here in Adelaide, Australia, or your local Silicon Valley whinging) get over it – the idea will be good and fundable, good and not funded, or as with much of the “search engine VC world”, copycat-like and funded and counter-innovative.

    These are some of the big questions, for which “just do it” is often the correct answer, whether it brings a successful outcome or not.

    Michael Zerman
    Adelaide, AUSTRALIA

  5. Thank You Michael Zerman for providing some needed counterpoint. I was in a graduate school of business in the 1980’s and saw from that time the incipient spread of what I believe to be one of the more malicious notions extant: That what matters most is gaining access to and accumulating boatloads of capital with which to do “Big Things”- not having good ideas, developing the skills required to plan their step-by-step accomplishment, finding like-minded (and yes, even contrarian) partners who can bring different perspectives and resources together creatively.
    Persuading oters to invest and demonstrating value instead of launching IPO’s to nowhere. The notion that governments are a decelerant to needed business innovation is relentlessy flogged in some quarters, but the truth is that government is adaptive and responsible over a much longer time horizon than the typical firm or product. To date we have globalized mostly the zippier information driven aspects of finance, trading, investment and currency and created some aspects of a global econosphere – but we haven’t begun to integrate the greater human, engineering time and resource limited realities of what this means in a coherent way. Perhaps we never will, but unless or until some of these restless entrepeneurial minds are equally keen to grapple with the equally daunting issues of scarce resources, equity, distribution and the environment – then I would respond that not every innovative idea ought to be treated as being equally deserving.

  6. I agree with you to a degree, i wouldn’t encourage big business intervention, i would suggest rather that the big businesses offer assistance at a directorship level, and not necessarily obtaining control. I believe for quality business to be continued, competition should be upheld, thus small businesses need to be supported to a level where they can compete with big companies, this is especially important in smaller developing countries, i believe the trend of big businesses taking over should be countered by promoting innovation and providing support for small business. government intervention would be preferred in forms of funding small start entities.

    awesome article

  7. What role does society have in the advancement of small business development and access to finance, is there even much that society can do, and what role are we ought to be seeing from the banking sector and private sector in the advancement of small business development.

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