Networking as the most potential driver of growth in innovative entrepreneurship

Networking as the most potential driver of growth in innovative entrepreneurship

Firms need networks of experts and institutions around them to get feedback on their products and services. Digitalization has lowered transaction costs (Williamson, 1991) of control allowing a dispersed organization of the firm, e.g. outsourcing of back-office operations. The cross-border trade of digitized products, such as music videos, via the Internet and the Web has been scaled up in service industries (Cross, 2000). Networking in its modern forms could be the competitive edge for small firm (Peters, 1990). However, multinationals are building networks in production, sales and service all around the world. Multinationals are able to renew continuously their core competences (Hamel & Prahalad, 1994). They take advantage of their legal superiority in even business secrets which in principle should be an advantage of small firms (Lahti et al., 2006). Multinationals collaborate with the best universities and research labs to get access to the latest technology and knowledge. In sum, multinationals can take advantage of their: (1) global geographical reach (Dicken, 2003), (2) dominance in standard technologies (Durbin, 1998) (2) skills to manage globally complex legal operations like the global outsourcing contracts and so on (Buckley and Ghauri, 2004).

Networking seems not to become the “super highway” of small firms to global markets as neo-Schumpeterian writers (e.g. Peters, 1990) have claimed. Networking is highly profitable for multinationals (Lahti, 2007). The main reason is that global business operations are risky (Poole-Robb & Bailey, 2003), because of their complexity in cultures and markets. For small firms, the pattern of going abroad is often an accident like an unsolicited order, resulting from advertising in trade journals, through exhibitions, and by other means (Albaum et al., 1998). Promotion of small firms’ exporting capacity is in the political agenda of e.g. the EU. The paradox is that importing is often more prospective that exporting (Korhonen, 1999). A solution to this paradox is disruptive business models and technologies (Christensen, 1997). The key issue is economies of speed (Chandler, 1990). Globalization though a gradual involvement in foreign markets advocating by the stage-theory (Luostarinen & Welch, 1990) is too slow. A born-global model (e.g. Knight & Cavusgil, 2004) is a promising option. Investments in globalization, to get access to relevant tacit knowledge, and agency costs related to risk finance, are tempted to marginalize small firms (Lahti, 2008). Most of multinationals are public-listed or have otherwise “deep” pockets by wealthy owner families. Multinationals can speed up their operations through foreign direct investment (FDI) and they have for their good optimal geographical reach worldwide. In sum, we will conclude that networking as such is an edge of small firms if it is organized as professionally as multinationals’ hybrid (Williamson, 1991) operations.

Subcontracting Excellence Club S.E.C ry, SEC[1] is a cooperation network consisting of small firms which have their special field of expertise in metal based industry, mechanical engineering, technical planning and industrial design. SEC is the basis which the cooperation is built on and where the versatile skills of the members speed up the development of new ideas. SEC was established in 1993 in the situation when Finland’s economy was in a severe crisis. SEC has succeeded well through networking[2]. SEC has as a whole plenty of expertise and capacity to deliver larger and more complete products and systems. SEC is a source of new ideas that can be provided to big firms through subcontracting so that customers can concentrate in their core businesses. The ultimate goal of SEC is to create added value for clients by means of networking and achieve competitive advantage for the members. The characteristic features of SEC are open communication and exchange of information between the members. The utilization of advanced technology and virtual networks among SEC make it possible to cooperate around activities of mutual benefits, such as training, marketing, management, research, etc (compare Piore & Sabel, 1984).

In order to create networks, we need to distinguish between the degree of knowledge embedded in e.g. physical, human and social capital (Chandler et al., 1998). We assume that there are three basically different kinds of capital:

1. Social capital refers to norms, trust, networks, etc. that facilitate co-operation among the group for the mutual benefit of the group. It allows the exchange of information, otherwise considered sensitive. For the transfer of tacit knowledge face-to-face contacts are vital. Putnam et al., (1993) studied the Third Italy[3] and could indentify many various social and institutional innovations that have been used in the region to create institutional and business networks with low transaction costs, common language and trust. SEC in Finland facilitates business networks. In SEC the boundaries of social capital are much more specific than in the Third Italy. It is much easier for entrepreneurs to cooperate when entrepreneurs know their partners, and when their partners are representing the same values and ethical principles as their principals.

2. Knowledge capital is different from the traditional factors of production, since useful tacit knowledge is not possible to exchange without major transaction costs (Nonaka and Takeuchi, 1995). The rise of internet is credited with lowering the transaction costs for general codified knowledge. Intelligent networks are developing rapidly. Networking is closely related to lateral and holistic thinking when the management theories are focusing adaptive and linear thinking (Lahti, 2000). In the Third Italy, there are both creative designers and rational businessmen. Networks of innovative firms are led by marketing organizations in Milan and Florence. The most talented businessmen appreciate design industries and top positions in the leading design firms. The production of the Italian design is organized by family firms often without skills in foreign languages. These firms are extremely elastic of their structure. They succeed through co-development with marketing organizations[4]. The SEC in Finland follows the same model. The famous Italian networking model is very competitive in its nature. This is the story that the Silicon Valley verifies. A balance between competition and cooperation (compare Arrow, 1962) is a good standpoint for the evolution of institutions (trust, social capital) and for business prospects (customer contacts, product innovations).

3. Money capital is needed in commercialization of products. It is useful to benchmark venture capitalists (VCs) that have a similar mission as network builders. VCs have also a long-term contract. When net workers seem to rely on trust as the basics of long-term contracting, VCs prefer formal legal contracting. Most VC funds have a fixed life of 10 years and a 3-5 years investing cycle. This is about the same kind of contractual model that most of multinationals have with their subcontractors. VCs usually have several funds at the same time to avoid the lack of capital prior to the end of fund’s life cycle. Multinationals systematically utilize the portfolio theory of Harry Markowitz (1959), a Nobel prize-winner. Multinationals have a global sourcing strategy to search for new subcontractors. Both VCs and multinationals have specialists engaged in the implementation of existing contracts with small firms. VCs are selective in dealing with firms, so are multinationals. Both know that the major source of value added is the intellectual property. Both appreciate solid business plans, good management teams, and a passion for excellence among their partners. VCs and multinationals follow the model of rational investor behavior, the “economic man” behavior propagated by economists.

The problem of small firms in their internationalization is how to compensate the small scale in competition against multinationals. Instead of scale, small firms have to rely on scope (Lahti, 1983, 1989, 1991, 2000). Networking is the best vehicle for that. The handicap in practice is that only a few entrepreneurs know how to tackle and even economize their extended scope of resources through networking at international scope. This is certainly related to the fact that the research and practice in entrepreneurship has not succeeded to integrate three forms of assets (social, knowledge/ technology and money) in the way that could be applicable to entrepreneurs and their small and medium-sized firms. For instance, the well-known Swedish network school of internationalization (e.g. Axelsson and Easton, 1992) has developed behavioral models of decision-making and attempted to identify the actors, contexts and interaction modes in business interactions. Unfortunately, these models are relatively complex to be used by entrepreneurs and small firms. In my model these three different kinds of capitals (social, knowledge and money) integrated over time. Why this model useful for entrepreneurs? The fact is that the model has been successfully utilized in multiple efforts in building networking between entrepreneurs[5].

The most important of these three for entrepreneurs and small firms is social capital since it can be developed by zero or marginal costs compared with the value of social capital. The network program by Denmark’s government in the late 1980s was successful and the country later on just because of the strong emphasis given to social capital (Lahti and, Eräheimo, 1993). The famous cases of the Third Italy and the Silicon Valley provide evidence on the value of social capital. Therefore, in any kind of innovative effort, entrepreneurs should focus on social capital in the first place. Knowledge and especially tacit knowledge is more specific and related to social networks. Therefore, it is reasonable for the network members to delay their common knowledge and technology projects and to concentrate on get-together activities. Referring to my own experiences of tens of networking projects, I would like to stress that entrepreneurs are men of women of acting. They have difficulties to perceive why they should use time to socialize, “not doing anything”. In order to understand this vital point, entrepreneurs need to allocate their time for discussion with specialists of human behavior. Money is always mobile and can be allocated without time-lags. In order to avoid market failures in networking operations, entrepreneurs should try to postpone money investments following the brilliant idea of option theory (Grenadier and Weiss, 1997; Huchzermeier, A. and Loch, C., 2001).

[1] Source: My own experiences of creating SEC network for SMEs.
[2] Today, there are 17 top quality, entrepreneur driven companies in SEC, located mainly in the southern part of Finland. The cumulative turnover of the members in 2004 is about EUR 140 million, and they employ some 1.300 individuals. http://www.secry.fi/english.htm
[3]The "Third Italy" around the province of Emilia-Romagna with 3.9 million residents. The success of the "Third Italy" is evident since during past two decades the "Third Italy" have advanced from Italy’s poorest province to the fastest growing economic powerhouse of the country. Today, the region is famous of fashion firms such as Benetton.
[4]Source: My own field research travels in the Third Italy in the end of 1980s and in the beginning of 1990s, when I analyzed some thirty firms and collaborated with the leading entrepreneurs in the region.
[5]Subcontracting Excellence Club S.E.C ry, SEC (metal based industry, mechanical engineering, technical planning and industrial design) is an example (secry.fi).
Furniture Excellence Club, FEC (starting in 1989 as a project by The Nordic Council of Ministers and having about 10-20 furniture firms from Denmark, Finland, Norway and Sweden as members)
Three-Finland-Programs (starting in 1990 as a project by about 100 specialists and being later organized as the activity program of Finland’s Ministry of Employment and the Economy)