Pittsburgh: The Entrepreneurial City (Part 2)

Rob May recently moved his startup, Backupify, to Boston. We’ve heard this story in Pittsburgh before, only this time the startup left Louisville, not Pittsburgh. We often get caught up in the “one that got away” — the idea of big city investors poaching our startups because they don’t like to travel, or small town entrepreneurs lured to the bright lights of big city opportunity.

This is not just another story of the small town losing a hard-earned startup to the big City. Actually, that is the story, but the lesson of Backupify and the insights from May are more important for the future of entrepreneurship in so-called second- and third- tier cities.

The Backupify story goes to the heart of whether you can launch a successful startup outside a major urban center. May says you can, but it’s not as easy and it sometimes depends on the type of startup. What really matters is the type of startup, how it gets financed, and what markets you play in. If you are playing in markets where your customer is the average American, and you need little capital, or can grow slowly, or can use customer capital, then you can build a company anywhere you want to be. But building companies that need a lot of capital, grow extremely quickly (and thus need a lot of employees), or are very high-tech is extremely difficult outside of major or minor startup hubs. (To see full story: Why I Moved Backupify To Boston.)

It’s difficult to track this startup-relocation theory. A few data sources track companies moving but not what happens in that preliminary space before a firm is legally incorporated. It’s clear, however, that trying to stop the churn (entry, exit, birth, and death) is a losing strategy. Dynamic, growing regions have lots of churn in terms of people and firms moving in and moving out. Bob Gradeck’s research on migration demonstrated that Pittsburgh’s population loss is attributable to our inability to attract new residents to replace those who left.

Careful studies of firm relocations in the region are few and far between, but a few comparisons can help to show whether our region is suffering from a startup drain. In percentage terms, Pittsburgh trails cities like Austin, Boston, and even Cleveland on the relocation balance sheet, but mighty startup capital San Jose is suffering from an even more severe startup drain. While the latest data show Pittsburgh is losing jobs from companies leaving the area, this amounts to only 13 out of every 10,000 jobs. Pittsburgh lost 13,910 jobs from firms moving out and added 12,128 jobs from firms moving into the region, resulting in a net loss of only 1,782 jobs from these relocations. See graph below.

One might conclude that smaller regions can only be startup hubs for small-market players and lifestyle firms that provide a comfortable living for the founders but never grow significantly. Startup guru Andy Grove, former CEO of Intel, says too much emphasis is put on startups when what we really need are companies that can transition from prototype to mass production. The scaling process is broken, in part, because the U.S. offshores so much production.

Consequently, smaller regions face a double-barreled threat. Even if you manage to keep the startup, you may lose the production jobs that provide employment for more people. This reality is another classic chicken and egg problem, except that it is a little easier to figure out. If we don’t keep the startups, we have little chance of winning the production jobs. Relocation is not the major culprit for direct job losses, but it could play a big role in foregone supply chains jobs.

Is there little hope for smaller regions, forever doomed to fall farther and farther behind? Not exactly. Look at once small cow-town like Austin or swampy backwater Raleigh-Durham, now major players. In fact, regions have always been able to leapfrog established competitors, whenever those competitors are too inwardly focused or too tightly bound by aging technology and outdated structures. These aren’t easy, of course and they take time.

The Pittsburgh region is becoming more innovative and more entrepreneurial. Entrepreneurs will say we don’t have enough risk capital, while investors complain we don’t have enough good deals to fund. Both agree on this: we need a deeper pool of talented entrepreneurs and executives.

In the 1990s, venture investment in the Pittsburgh region didn’t top $100 million until 1998-1999, approaching $900 million in 2000 before falling back to Earth. Excluding the single boom year of 2000, venture investment has averaged nearly $200 million annually over the past decade.

During the 1990s there were 379 new firms for every dollar of annual venture investment; now there are only 27 firms competing for each dollar. Excluding the boom years of 1999 and 2000, we average slightly fewer startups today than we did in the early 1990s and the average annual investment today is twice the level it was in the 1990s. By these measures, access to capital has improved dramatically but the complaints about the lack of capital haven’t abated. See graph below.

Does size really matter?

Research on cities, growth, and innovation have shown that larger cities have distinct advantages. Researchers at the Santa Fe Institute reveal a direct correlation between city size and innovation; larger cities are more innovative, even on a per capita basis. Part of the advantage larger cities have is more creative and innovative people. If this advantage were based on size alone, large organizations would always be more innovative, but that is not the case. More is not always better except that you have a greater chance of having more smart people from which to choose, who get smarter because they are networked with other smart people with whom they can share their ideas and make better.

What might appear to be an advantage associated with size is really an advantage associated with connectivity. Steven Johnson describes how the combination of different people and ideas is important not just for individual products and companies, but for cities and regions as well. An environment that fosters connecting people and ideas expands the potential for increasingly powerful combinations. An innovation that may have been a failure or only mildly successful in one application can be transformative when applied differently. Johnson uses the analogy of spare parts — the more spare parts (ideas) you can gather, the greater the ability to create useful ideas and products.

Even if a region is small it can increase its capacity for growth if the environment is conducive to new combinations. It’s also important to have a diversity of spare parts and ideas. Richard Florida had it right when he talked about tolerance and creativity but was sidetracked by the proxies he used to measure tolerance, diversity, and openness. Openness to experiments and new possibilities is essential. Environments that block new combinations will stifle innovation. If we put our economy in a box, it will surely suffocate.

The next installment will explore the ecosystem for innovation and entrepreneurship in the region. Tim Hindes is helping develop a visualization of the variety of spare parts we have in the region and how they fit together.

View Part 1 in this series.

This article originally appeared in PopCity on 01.26.11.