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Small Business Economics

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19-12-2017

Too big to succeed or too big to fail?

Authors: Arthur Fishman, Hadas Don-Yehiya, Amnon Schreiber

Published in: Small Business Economics | Issue 4/2018

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Abstract

It is often argued that smaller/younger firms are more innovative than older/larger firms—the latter may be “too big to succeed.” We show in the context of a simple industry model with consumer search frictions why evidence suggesting that smaller or younger firms are more successful at innovation may be subject to sample selection bias. Specifically, smaller more recent entrants may appear to innovate more successfully simply because unsuccessful larger incumbent firms’ size advantage enables them to survive when unsuccessful smaller ones cannot—they may be “too big to fail.”

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¹Lieberman and Montgomery (1988) identify three mechanisms which may lead to first mover advantage: (i) technological leadership, (ii) preemption of scarce resources, and (iii) switching costs. The first mover advantage in this paper, due the fact that it is costly for consumers to switch firms, falls under the third category.

²Bound et al. (1982) argue that sample selection bias may arise for a different reason, namely that small firms might appear in the data set only if they have successful R&D programs and hence some patent applications. This may be because a small firm is included in the sample only if it “commands sufficient investor interest”, and one likely cause of interest is a successful R&D program and patent applications. In that case only successful small firms are observed whereas almost all large firms are publicly traded, and will thus appear in the sample whether or not they have been particularly successful in research or innovation.

In Section 3 we expand the analysis to the case in which successful adoption depends on investment in R&D.

As shown below, the profit of a period 1 entrant at period 1 is \(-F+\frac {W_{1}}{N_{1}}\) which is positive for sufficiently small and positive N ₁.

The feature that consumers exit when their first firm exits greatly simplifies the analysis but is inessential. In our working paper we show that the main features of the analysis extend to a richer but more complicated setting in which consumers switch to new firms when their ‘old’ firm exits.

This is implied by the first order condition in Eq. 25 in the appendix.

⁷Arrow (1962) defined an innovation as drastic if the old technology is no longer a viable substitute.

To get a solution for (54) one can use regular methods of function analysis. However, since it is easy to see that the derivativewith F of the right-hand side of (56) is positive, there is a simpler way to show it for any value of F lower than 8.267. We start theproof at F = 1. WhenF = 1the left-hand sideof (56) equals 1 and the right-hand side equals 0.134, so (56) is not satisfied. Since the right hand-side of the inequality increases withF, and since at F = 2it is still lower than 1 (it equals 0.908) we can conclude that for F between 1 to 2, the inequality is not satisfied. Thismethod can be used step by step to get the desired result.

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Title: Too big to succeed or too big to fail?
Authors: Arthur Fishman
Hadas Don-Yehiya
Amnon Schreiber
Publication date: 19-12-2017
Publisher: Springer US
Published in: Small Business Economics / Issue 4/2018
Print ISSN: 0921-898X
Electronic ISSN: 1573-0913
DOI: https://doi.org/10.1007/s11187-017-9968-1

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