The New Builders: Face to Face With the True Future of Business by Seth Levine & Elizabeth MacBride

The New Builders: Face to Face With the True Future of Business

Seth Levine & Elizabeth MacBride

304 pages, Wiley, 2021

America has always had a love affair with size. In the business world, we call it “scale” and celebrate it. The concept dominated the last generation of company builders, who have built modern-day tech empires.

But our history has always been a story of balance. Innovation requires that the empires are challenged by New Builders. The challenges today are fewer and further between: Entrepreneurship is on a 40-year decline in the United States.

In The New Builders, we explore the question of why, tell the stories of New Builders that are succeeding despite the obstacles, and offer some solutions. Two of the keys are refocusing on the important role small businesses play and investigating how our love affair with size came to dominate the conversation. In the following chapter, we take a look at these entwined conversations. And yes, Milton Friedman and next-gen capitalism are part of the story.—Seth Levine and Elizabeth MacBride

* * *

In our collective search for convenience and lower prices, and in our embrace of size, we hardly see small businesses as the economic and community powerhouses they actually are. They are an irreplaceable part of the American experience, often finding creative solutions to everyday problems and bringing energy and focus to critical causes. Small business owners are the people whose passion for something is so crazy that they’ll build a livelihood around it. And while they certainly don’t have a lock on ethical business practices, you will often find them melding compassion and good business, doing good while doing well, and in many cases employing people on the margins of our society.

These are the reasons supporting “New Builders” is so important. We risk losing so much more than just economic output if we abandon these businesses. We lose a key part of what is in effect the soul of America.

Main Street USA

According to the statistics site FiveThirtyEight, “Main” is the most common street name in America, with 10,902 streets carrying this moniker. Strangely, the second most common street name in America is 2nd Street, followed by 1st Street—which seems counterintuitive but is backed by the data.

The name Main Street has expansive connotations. It evokes nostalgia for smaller towns and simpler living. But, importantly, the idea of Main Street USA isn’t just a part of our history and days gone by. It turns out that thriving Main Streets and the robust set of local entrepreneurs who line them, or who operate out of office parks, strip malls, and other clusters, are critical to our economy’s future.

The high-tech entrepreneurs who garner so much of our collective attention are a tiny sliver of the small businesses that drive the US economy. Fewer than 1 percent of entrepreneurs are backed by venture capital. Less than 250,000 businesses are “high-tech.”

America’s army of entrepreneurs includes many Main Street entrepreneurs—people whom we like to think of as grassroots entrepreneurs. Many New Builders come from their ranks and create much of the entrepreneurial activity across our nation. In the United States, small business is big business. Small businesses employ nearly half of the US workforce, over 60 million people. Smaller firms created over 1.6 million jobs in 2019. Importantly, firms that drove the most job growth were those that employed fewer than 20 people—a trend that matches that of prior years.

In a widely cited 2010 report, The Kauffman Foundation’s Tim Kane argued that startups—companies less than a year into their existence—were responsible for essentially all of the job creation in the US economy. In other words, without entrepreneurs, our economy would not add new jobs. The report further notes, “Gross job creation at startups in the United States averaged more than three million jobs per year during 1992-2005, four times higher than any other yearly age group.”

There already was a cloud over the US small business economic engine. Even before the Covid-19 pandemic, that same 2018 SBA report that described small businesses as the “driving force behind US innovation and competitiveness” showed that the percentage of overall economic output produced by smaller firms was declining relative to that of larger companies. In the 16 years from 1998 to 2014, the small business share of GDP fell to 43.5 percent from 48.0 percent, according to the report.

This shift away from recognizing the value of small business and the entrepreneurs who build them has occurred over the last 40 years. The Silicon Valley/high-tech narrative is part of the reason. But there have been other changes in our economy that are important to understand as well.

How Big Became Beautiful

On September 13, 1970, economist Milton Friedman published one of the most influential essays in the history of business, “The Social Responsibility of Business Is to Increase Its Profits,” in the New York Times Magazine. It was, as the New York Times’ DealBook staff noted in a retrospective published in 2020, “a call to arms for free-market capitalism that influenced a generation of executives and political leaders, most notably Ronald Reagan and Margaret Thatcher.”

DealBook’s retrospective included reflections from Nobel Prize winners, corporate executives, and entrepreneurs who had grown large companies, but not a single small businessperson. This is the nature of reporting about business today. Serious opinions are the purview of those who have size on their side. That in itself is but one influence of Friedman’s essay.

A lot of attention has been paid to Friedman lately, but too little has been paid to the effect of his thinking on the small business economy. In 1970, Friedman posited that shareholders were the most important stakeholders in the business world and, in his view, distributing profits to them was the most efficient economic system. At the time, Americans were becoming owners of public companies’ stocks in increasing numbers, a trend that peaked in 2007 with about 65 percent of Americans owning public stock according to the polling firm Gallup. Lately this trend has reversed, with just over half of Americans—55 percent—owning these securities.ⁱⁱ

Friedman’s thinking changed the way corporations acted. It was common up until the 1970s for firms to reinvest their profits back into their businesses—into R&D and employee salaries and benefits. In his Harvard Business Review paper, “Profits without Prosperity,” Professor William Lazonick argues, “From the end of World War II until the late 1970s, a retain-and-reinvest approach to resource allocation pre- vailed at major US corporations. They retained earnings and reinvested them in increasing their capabilities, first and foremost, in the employees who helped make firms more competitive. They provided workers with higher incomes and greater job security.”

After Friedman’s seminal paper, the mantra quickly changed to become one that favored reducing costs and distributing the cash gains from those cost reductions to shareholders. Lazonick termed this new management imperative downsize-and-distribute.

The new approach favored value extraction over value creation (literally, taking cash out of businesses and putting it into shareholders’ pockets). Along with the weakening of the power of labor, the rise of technology, and the increasing use of stock-based compensation, this approach has contributed to increased income inequality and overall employment instability.

As Friedman famously put it, the only “social responsibility of business is to increase its profits.” Exacerbating this was the increasing use of stock-based compensation for executives, which, while in theory aligning their interests with those of shareholders more broadly, in practical application served to drive short-term profit-seeking behavior. Not surprisingly, the largest component of the income of top earners (the top 0.1 percent) since the 1980s has been driven by stock-based pay. This has also led to some unwanted market perversions. For example, from 2003 to 2012, the 449 companies of the S&P 500 listed through that entire period of time used the majority—54 percent—of their earnings (a total of $2.4 trillion) to buy back their own stock. If you include dividends paid out during that period, 91 percent of earnings went to shareholders, leaving little left for reinvestment into these businesses.

This profit-seeking behavior also had an effect on small business and the overall dynamism of the economy.

Why a Dynamic Economy Is Important

Milton Friedman’s theories reshaped corporate practices, resulting in companies that were huge, not in terms of employees but in terms of resources, power, and access to capital. In 1964, the nation’s most valuable company, AT&T, was worth $267 billion in today’s dollars and employed 758,611 people. Today, Apple is worth more than $2 trillion but has only about 147,000 employees—less than a fifth the size of AT&T’s workforce in its heyday.

Simply put, today’s entrepreneurs face a nearly impossible uphill climb because large businesses are increasingly unchecked in their market power and profitability. At the same time, rising income inequality means fewer and fewer people have the savings to start businesses, a process that often means forgoing income for several years.

Almost like a living organism or a healthy forest, economies stay healthy by constantly building and changing. New firms are created, established firms grow, and outdated firms fail and close down. It’s a balancing act between growth and consolidating market power and new businesses and new ideas nipping at the heels of incumbents. As just one example of this process in action, consider that the half-life of companies on the Fortune 500 list of America’s largest corporations is just 20 years, meaning that 20 years from now we can expect 250 from today’s list to no longer be among the top 500 companies in the country. This is dynamism at work, and it’s a powerful force in our economy.

But there are signs that dynamism in the United States is waning. A 2019 recent study by Ufuk Akcigit, a professor of economics at the University of Chicago, and Sina T. Ates, a senior economist at the Federal Reserve Board, developed a theory as to why dynamism is slowing. They noted 10 factors:

Market concentration has risen.
Average markups have increased.
Average profits have increased.
The labor share of output has gone down.
The rise in market concentration and the fall in labor share are positively associated.
The labor productivity gap between frontier and laggard firms has widened.
Firm entry rate has declined.
The share of young firms in economic activity has declined.
Job reallocation has slowed down.
The dispersion of firm growth has decreased.

All of these factors are important, but several have direct implications for New Builders. Specifically, increasing market concentration, increasing profits, the correlation between the rise in market concentration and the fall in labor share, new firm entry rate, and the declining share of economic activity from newer firms all describe how larger firms are making up a greater share of the market and wielding more market power.

Many of these factors reinforce one another. Economic activity from newer businesses is going down (factor 8), which is related to the fact that fewer newer firms are being formed and entering the market (factor 7). This leads to a greater concentration (factor 1) and the consolidation of power of incumbent firms (which is causing profits to be increasing—factor 3—at the same time these firms are relying less and less on labor—factor 4). It’s a virtuous cycle. Or perhaps more aptly put, a vicious cycle.

Harvard economist Larry Katz described the increasing concentration of American business as one of the leading factors in the decline of dynamism as well, describing to us that “there has been really big growth in economies of scale … many traditional businesses can’t compete with the large firms.”

Of course, businesses create and shed jobs all the time. Critics of the idea that small businesses are an irreplaceable piece of the dynamic American economy have argued that studies that profess the power of small business job growth gloss over job losses incurred by those same startup firms after their first year of operations. The net job numbers for startups include only companies adding jobs; after year one, they include companies that are adding new jobs and companies that go out of business or shrink, in each case, shedding jobs.

Robert Atkinson and Michael Lind argued the case in their book, Big Is Beautiful. It’s a provocative work that argues that small businesses are in fact not responsible for most of the country’s job creation and innovation. In Atkinson and Lind’s worldview, the only kind of small firm that contributes to innovation are technology startups—who, they point out, ubiquitously have the goal of becoming big businesses. They believe that the idea that small businesses are the foundation of our economy is a relic of past times and nostalgic thinking. They argue that both consumers and workers are better off buying from, and working for, large businesses. In their view, new small businesses create new jobs; however, they argue that these jobs are lost over time as those businesses eventually close.

While important to acknowledge differing views—especially ones that are well formulated and argued—for us, these arguments fall short and ring hollow. It is absolutely true that businesses fail at a relatively high rate. To us, that is not a limitation of small businesses but, in some regards, a feature to them. Of course, new businesses create a large share of jobs. But to argue that if they simply didn’t exist, larger companies would create those same opportunities defies logic and sense. If that were true, larger businesses would be creating new jobs irrespective of what is currently taking place at small companies. Big businesses would be setting up shop on Main Streets, financing the first chocolatier in Arkansas, or starting a guiding company in the Bob Marshall wilderness. They are not.

Small businesses have a larger appetite for risk, and by virtue of their owners’ passions, are sometimes willing to live with lower profits. An economy devoid of small businesses is a flat, uninspired landscape of sameness. To continue to thrive, America needs both big and small business and grassroots entrepreneurs of all backgrounds to create a living, vibrant entrepreneurial economy.

To be clear, large companies are important to our economy as well, and nothing in our experience meeting New Builders or in our work as a venture capitalist and journalist suggests that they’re not. But by abandoning our startup economy, by failing to support New Builders, we risk a critical part of America’s economic engine. Importantly, the struggle we’re describing is not one of big business in conflict with small business. In fact, many of today’s biggest businesses sell products and services to small businesses, which makes the danger even greater. Our economy is not a zero-sum game and we don’t need to choose sides. In fact, our economy should be viewed as positive-sum. The American economy has thrived with both big and small businesses in balance. That balance ebbs and flows over time, but we need to recognize that we’re in danger of letting that balance get dangerously, perhaps irreconcilably, out of whack. Stories of well-loved small businesses closing their doors because they cannot compete with larger, and larger-than-life, businesses have become all too common.

Over the past 50 years, the US regulatory and political landscape has changed significantly. Those changes have generally helped larger businesses and hurt smaller ones. As much as politicians love to talk about their love of Main Street and the importance of small businesses, their actions largely have shown otherwise. So while we don’t subscribe to the blanket “‘big is bad” mantra that some in the media like, even as they celebrate “scale” and high returns, we recognize through our research and reporting that our systems have become skewed too much in favor of large businesses. And in the places we’ve tended to support smaller enterprises, we’ve been overly focused on that tiny portion of new companies that have both the goal and the potential to become large businesses. In doing so, we’ve destroyed the level playing field that fits the entrepreneurial mythology of the American Dream and created one that stacks the odds against grassroots entrepreneurs.

There is another cost to our love affair with big. Over the past decades, we’ve narrowed our focus as to where innovation happens, and in doing so, we miss seeing where creativity occurs. Especially if it’s on a smaller scale.