The two faces of entrepreneurship, part one: Replicative entrepreneurs serve growing population

July 19, 2006

In October 2005, Entrepreneur magazine ranked Arizona as the top hot spot for entrepreneurs. The Phoenix-Mesa metropolitan area also grabbed first place among all large cities. The listing ranks locations based on two factors: the number of companies that started 4 to 14 years ago and have at least five employees; and overall employment growth.


Arizona and the Phoenix metropolitan area have also consistently ranked among the fastest growing areas in the nation. Percentage-growth data from the U.S. Census Bureau shows that Arizona was the second-fastest growing state between 2004 and 2005; the Phoenix metropolitan area was the 13th-fastest between 2003 and 2004.


Does Phoenix's top hot spot ranking and rapid population growth mean that we're the next Silicon Valley? Experts at the W. P. Carey School of Business say: "Not necessarily."


To explain, W. P. Carey Deputy Dean Phil Regier describes two types of entrepreneurs: those who are replicative and those who are innovative. "The Phoenix metropolitan area ranks relatively high in terms of measures of replicative entrepreneurship, but relatively low on measures of innovative entrepreneurship," Regier said. In contrast, Silicon Valley would rank very high on measures of innovative entrepreneurship.


According to "University as Entrepreneur: Ideas that Fly" -- ASU's recently released proposal for the Kauffman Campuses Initiative -- it is replicative, not innovative, entrepreneurs who are flourishing in Arizona. The proposal states that "… even with increased employment rates, Arizona's per capita income as a percent of national average has actually decreased, and many of Arizona's jobs are in industries that attract and service new residents, rather than those that serve as part of Arizona's base for innovation."


Innovative v. replicative entrepreneurs


Regier -- who provided input into the "University as Entrepreneur" proposal -- takes the distinction between businesses that service new residents and those that serve as innovators from two economists: William Baumol and Joseph Schumpeter.


According to Regier, Schumpeter wrote extensively about innovative entrepreneurs who "act as destabilizing influences triggering 'creative destruction' -- the simultaneous creation of new industries through innovation and elimination of sectors of prior economies."


Replicative entrepreneurs, on the other hand, "function as efficient coordinators of resource usage, starting small businesses that mimic predecessors," Regier said.


"As the population grows, an economy has to provide more goods and services for the growing population," Regier said. "The businesses to do so are most often replicative -- dry cleaners, movie rental shops, and grocery stores." Replicative businesses are focused on serving a growing population; they most often stay small and don't export their products or services outside the boundaries of the area they serve.


Regier contrasts those entrepreneurs with innovators, who "don't focus on serving population growth, but are interested in selling to customers both inside and outside the population center. For that reason, we call them export entrepreneurs." These entrepreneurs, according to Regier, are the ones who create wealth -- increasing standards of living.


Associate Dean for Research Dennis Hoffman explains the wealth-creating distinction: "Replicative entrepreneurs are associated with overall aggregate growth. Population growth leads to growth in the number of replicative entrepreneurs, who produce more goods and services, which necessitates more jobs. Output (goods and services produced) increases, but so does the labor force, so productivity remains the same (productivity is output divided by labor force). If new businesses generate 20 percent more output (and, therefore, 20 percent more sales revenue), but have to hire and pay workers 20 percent more, then the rate of return remains the same as it was with fewer businesses, less output, and fewer employees."


"Replicative entrepreneurs provide needed products and services while driving managerial efficiencies that result from competitive market dynamics," Hoffman said. "But they are challenged to create new wealth -- per worker or per capita -- in the economy because they don't tend to have much impact on overall productivity."


"In contrast," said Hoffman, "innovation allows for increases in output without equal increases in workers, which increases productivity. If a business can increase output by 20 percent (therefore increasing sales revenues by 20 percent) by only hiring 10 percent more workers, then the company generates more in profits even after paying workers higher salaries. Overall, that means wealth creation in the economy that generally translates to higher standards of living."


Replicative entrepreneurs flourish wherever there is economic growth. Innovative entrepreneurship, on the other hand, is much harder to develop and sustain. It tends to flourish in places near major research universities and in places where there is a critical mass of innovative businesses at all levels of development. The reasons are complex, but simple economic growth won’t lead to increases in innovative entrepreneurship.



The face of the replicative entrepreneur


Lee McPheters, senior associate dean and director of the Bank One Economic Outlook Center, explains that being growth-driven, replicative firms open new businesses using tried-and-true business models in new areas. For example, when housing prices in the Phoenix metropolitan area first began their dramatic increase, people believed that population growth would slow. But builders kept selling houses -- by offering less expensive options in the metro area's outskirts, notably in the western and eastern parts of the Valley.


But those new developments, as much as fifty miles from downtown Phoenix in the midst of miles upon miles of farmland, had no commercial development -- no dry cleaners, grocery stores, or retailers; no restaurants, gas stations, or video stores.


The new residents didn't want to drive for thirty minutes to pick up a carton of milk or a movie; they demanded those services closer to home. That created the opportunity for entrepreneurs to do something they'd always wanted to do -- open up a video rental store, coffee shop, or fast-food restaurant -- because the population growth created the need.



The role of the replicative entrepreneur in Arizona's economy


McPheters says that there's an ongoing confusion about why we keep building Wal-Marts, dry cleaners, video stores, fast-food restaurants, and the like. "What's wrong with our economy?" people wonder. McPheters says the answer is: nothing.


According to McPheters, Phoenix is on par with other cities in the numbers of those businesses per capita. Based on the national average of businesses per capita, the Phoenix metropolitan area should have 216 video rental stores, and 2,731 fast-food restaurants. In reality, Phoenix has 196 video rental stores (91 percent of the national average), and 2,673 fast-food restaurants (98 percent of the national average).


It does seem that there's a general consensus that replicative ventures -- the grocery stores, gas stations, fast-food restaurants, dry cleaners, and video stores -- are inferior to sexier, more publicized innovative ventures. But McPheters cautions against such a narrow line of thinking.


"There is a strong argument for cultivating innovative entrepreneurship. But, while the growth of replicative entrepreneurship is a more natural process that happens with population growth, it's certainly not an inferior one," McPheters said.


Regier agrees. "Just because replicative entrepreneurs aren't wealth generators doesn't mean that they're not important," he said. "Replicative entrepreneurs play an incredibly important role in creating efficiencies in our economy."


Albert Cannella, professor of management at the W. P. Carey School, says that replicative businesses are important because they provide goods and services that people value. "Because replicative entrepreneurs follow population growth, they're providing goods and services in places that needed them; if people in Phoenix's suburbs have to drive thirty minutes to the dry cleaners or to rent a movie, a replicative entrepreneur that opens up a new shop within the community is absolutely adding value," Cannella said.


For McPheters, the value that replicative businesses provide is in creating a competitive economy. "If we didn't have replicative entrepreneurs to support population growth, not only would people have to drive farther to find the goods and services they want, but we'd all probably have to wait in longer lines and pay higher prices," McPheters said.



The future for replicative entrepreneurs in Arizona


Arizona State University's "University as Entrepreneur: Ideas that Fly" initiative is designed to cultivate innovative entrepreneurs in the Phoenix Valley and help the area "transform into a global economic presence."


Will replicative entrepreneurs need help, too?


Hoffman doesn't think so. "The Valley won't be challenged by a lack of replicative entrepreneurs as long as it remains an attractive place for people to move to," Hoffman said. Because he sees the success of replicative entrepreneurs in Arizona as "almost a given," Hoffman doesn't think a strategy needs to be developed to promote their growth here.


In fact, Hoffman suggests, the development of innovative entrepreneurship in Arizona will drive growth in replicative ventures. "As innovative entrepreneurs raise the standard of living in Arizona, people will demand more luxury-type services -- the kind that replicative ventures like spas, shopping malls, and restaurants provide," Hoffman said.


Where replicative entrepreneurs languish, according to Hoffman, is in regions that are experiencing population declines. "Entrepreneurs aren't rushing to open video stores, dry cleaners, and fast-food restaurants in Flint, Michigan," Hoffman said, "because the city's population is not growing."


For cities in Flint's situation, the key to boosting replicative entrepreneurship is boosting attractiveness to drive population growth.



The importance of the distinction between replicative and innovative


But the assertion that replicative entrepreneurs in Arizona won't need help to succeed doesn't mean that it's not important to understand what makes those businesses tick. At the least, it's important to understand the value that replicative entrepreneurs bring to our economy and the reality of what life would be like without them.




Bottom line


  • Innovative entrepreneurs either have a unique product or service that is not easily duplicated locally or are export-oriented, focused on developing new and different goods and services to sell both inside and outside the population center.
  • Innovative entrepreneurs create wealth and increase a region's standard of living relative to peer regions.
  • Replicative entrepreneurs are not export-oriented, do not create wealth or increase standards of living. Instead, they serve growing populations by mimicking tried-and-true business models.
  • Replicative entrepreneurs are important in creating efficiencies and maintaining economic competitiveness.
  • Replicative entrepreneurs will flourish wherever populations are growing.