IS INCUBATION A WINNING STRATEGY?
PART TWO - FACTORS IN SUCCESS
Part One of this article provided a review of scholarly studies on business incubation, as well as the observations of incubator managers and tenants from facilities throughout the Untied States and Canada. It is only recently that there have been unbiased and statistically valid analyses of business incubator performance. These studies have uniformly found that business incubation, as a practice, has had no significant impact on the rates of business formation or the success of incubated businesses relative to their peers.
Based on these findings it might be easy to dismiss incubation as an entrepreneurial development strategy, but some deeper digging is required. There are individual examples of highly effective incubators that have produced multiple successful companies. So why do they succeed while others fail? Ultimately, it comes down to the fact that while organizations that establish the incubator may have had good intentions, they often lacked the capacity for the project or made critical mistakes that have been difficult to overcome. From our own research and experience, and particularly from the insight of many incubator managers who shared their observations, we have attempted to identify some of the most critical factors in the success or failure of business incubators.
Successful incubators are preceded by good market research
Economic developers would not advise any person to launch a business without first gaining a very clear understanding of the market opportunity and prospective consumers. Yet when it comes to business incubation, many incubator projects are preceded by no market research, or an analysis that falls short of what is needed. Too often the decision to proceed with an incubator is made based on little more than a hunch, for political purposes, or to jump on the bandwagon of the latest trend.
In our consulting practice we are often contacted to conduct a feasibility study only to learn that the organization has already decided (formally or informally) that it wants an incubator. A good market analysis or feasibility study should always precede a decision. This is important, as in addition to determining if there is a market, selecting appropriate targets, and defining the needs of the market, the analysis may point to alternative entrepreneurial strategies or economic development needs. Some of the critical information to be gleaned from the market analysis will include the following.
How many organizations really know what businesses are being started in their territory? Most do not, including many that think they do. Part of the problem is that most have little more than anecdotal evidence. The Census Bureau or other government agencies are the chief source of industry data for most organizations and consultants, but local data is almost always suppressed to maintain confidentiality. This leads to conclusions for a local market being drawn from data for a metropolitan or larger region hardly reflective of local circumstances. This may still be aggregated at so high a level of industry classification as to provide little detail about the businesses being started.
Private sources can provide more detailed data at a substantial cost. Put it in perspective. Is several thousand dollars spent on data too much to determine the merit of committing to a project that will cost several million? If the answer is “yes” the organization may question if it will be able to come up with the funding necessary to hire good management, provide quality facilities and services, and otherwise sustain an incubator.
The data should provide information on business starts by year, detailed industry sector, and employment, as well as survival rates. It should also provide information on the general economy including existing small businesses that may be part of the incubator market. Data from private sources is often geocoded or addressed to allow an analysis of activity at the neighborhood level, and can help in facility site selection.
The importance of this analysis should not be discounted. Some consultants do not give quantitative analysis as much credence as qualitative techniques like surveys or interviews. Both are important, though, and play different roles. In the worst cases, market research amounts to little more than the analyst sitting in a room with a dozen or so people and ask, “Do you think this will work?” Crunching number gives you hard evidence to define the market opportunity and make decisions about whether it is worth pursuing, as well as how an incubator should be designed. The interviews should be used to fill in gaps or understand nuances of the local market, and not to replace quantitative research.
How far are people willing to commute to be tenants at an incubator facility? Aside from a few exceptions, the answer is “not far”. Most incubator managers will define their market area as about 20 minutes or 20 miles. Political boundaries also come into play. Incubators in border regions seldom pick up tenants from the neighboring state. As one manager put it, “If I am starting a business, why am I going to want to add the extra challenge of learning the taxes and regulations of two states?”
It is rare for an incubator to attract tenants from beyond the immediate area. When this does happen it is almost always for some exceptional reason. As an example, one incubator manager told of a business owner who was a faculty member of a college, commuting 100 miles once or twice a week to an incubator affiliated with another branch of the college, because the lab fees were substantially less. This is not uncommon, and unlikely to lead to a graduate business locating in the vicinity of the incubator. In general, specialized incubators such as those providing shared commercial kitchens seem to attract more of the small number of distance commuters.
Here is where qualitative information can make a difference. While there are some entrepreneurial education and service needs that are very consistent across industries and locations, interviews with local economic developers, small business owners, and potential entrepreneurs can refine this information. Importantly, it can also help to determine the willingness to pay for these services.
The analysis should take into account complimentary and competing facilities and service providers in the region. It is important to understand the geographic and sectorial markets they serve, the type of space and services they provide, and historical utilization of their programs and resources. Given this competition, is there enough demand to support a new incubator, or an advantage to the proposed incubator that will allow it to secure the number and quality of tenants it needs? Are there niches that can be served, or even opportunities to collaborate with other incubators?
The asking rent for traditional office or industrial space in the area must also be considered. Inexpensive rent should not be the primary advantage of an incubator space. Especially outside of suburban locations, it may not be difficult for a business to find cheap space. Meanwhile, offering a low rent at a newly constructed or decently remodeled incubator will almost always require a subsidy.
A feasibility study takes market research a step further. In addition to examining the market, a feasibility study will assess other dimensions of the incubator, including political will, likely financial performance, and technical capabilities of the organization and its service providers.
Hopefully anyone reading this article will already understand the value of market research and would not proceed without it. But too often, economic development organizations are all too willing to skip this step, move forward with a weak analysis, or even ignore the data because they want to pursue a high profile industry or proceed on little more than perceptions of the market.
Successful incubators are designed to respond to the unique conditions within their market
What worked somewhere else may not work in your community. It is a great idea to look at case studies and to learn from the successes or failures of others. It is not a good idea to simply try to copy what somebody else did in another place and time. The factors that go into the success of any venture are highly dependent upon unique circumstances of place, market, prevailing economic conditions, management and service providers, financial support, and a myriad of other factors.
It can seem comforting or easy to try to replicate a successful program in its entirety. Economic developers need to sell the idea of incubation to stakeholders and clients. A “franchise” may look to have better odds than a new model built from the ground up. In reality, though, the opposite is usually true.
The questions to ask, in the right order, are:
This approach usually leads to an aggregation of ideas from many sources. It may also help to identify outside resources or opportunities for collaboration.
Successful incubators have a clear mission statement and well-defined measures for success
Simply put, what is the purpose of the incubator? This is a clear statement of who the program serves and the outcomes that are expected, and how they will be achieved. Having a well defined mission statement can serve many purposes.
In order to establish itself and gain continued support, the incubator will need to have a mission that is broad enough to appeal to key individuals and groups whose support it will need to thrive. At the same time, it must resist the temptation to include everything in an attempt to appeal to everyone. A narrow focus is more likely to produce visible results.
Lastly, the incubator must assess whether its potential mission (as well as programming) may be at odds with the needs of its targeted clients. Common examples may include goals like job creation and business formation. Often, the business will be best served by not creating jobs, or simply licensing technology rather than commercializing it through its own efforts. Conflicts such as these may be cause to reconsider the organization’s mission.
Successful incubators begin with a program, then look for a location
Choosing the wrong location can lead to a failed incubator. The most common reason why incubators choose the wrong location is that they do not put the needs of the client first. They are instead motivated by reasons that should be seen as secondary. The following are some examples.
Incubators are businesses. They need to think like a business and put the needs of their customers first, selecting their location based on the desires of their targeted businesses.
Taking the topic a step further, some prospective incubators may need to consider whether they should have a physical location. Perhaps affordable space is easily obtained, entrepreneurs are already congregating on their own, or new businesses do not care to have a conventional office. Virtual incubation, providing all of the services of an incubator without providing a physical space, may be the answer.
Successful incubators align partners and secure long- term commitments necessary for the incubator to generate results
Nearly all business incubators will need a large initial capital outlay and annual subsidies to remain viable. These are simple facts that must be accepted by the organization before it commits to the project. Having accepted this, it is then necessary to line up the funding and secure commitments for ongoing financial support.
Funding may include cash (from grants or contributions) or donations of in-kind services or assets. A word of caution is warranted with in-kind contributions. These can have value or can become liabilities, such as when a poor location comes at little or no cost, or when in-kind services like technical assistance and programs are of an inferior quality or not well matched to the needs of clients.
Organizations should also give a great deal of thought to long-term funding commitments. If it is unable to secure these it may be forced to spend an inordinate amount of time on fundraising for its annual operations, with adverse impacts on the quantity and quality of programming. In the worst scenario, it may be unable to sustain even the minimal level of funding needed to continue the program. Organizations that are dependent upon governmental funding sources are especially at risk due to constantly changing administrations and political priorities.
An element of creativity can be helpful. One strategy that we have advocated involves establishing the incubator as a freestanding nonprofit organization. With access to grants, tax increment financing, and other financial tools, the local government is used to construct, and continue to own the building. That government enters into a long term lease of the building to the nonprofit at a nominal rate, allowing the nonprofit to apply nearly all of the client rental income into programming, maintenance, and other operational costs. Because of the lease agreement, the nonprofit gets an annual cash infusion without needing to make an annual request, sheltering it from changes in the local political landscape. Meanwhile, the local government is protected by having ownership of the building, which can be sold or used for other purposes if the incubator ceases operation.
Successful incubators receive a majority of their funding from rents and fees paid by their client companies
Do not expect a business incubator to be a profitable venture. This is a goal attained by only about 20 percent of incubators, and those tend to be profitable both by picking only the best prospects and taking an equity stake in the business.
At the same time, rent, fees for services, class or program registrations, and other fees should be sufficient to fund a significant part of the business incubator’s operational costs. There is a good deal of truth to the statement that if a business is unwilling to pay for services, there is either a problem with the services offered (poor quality or poorly matched to business needs) or the business is at risk (insufficient funding or unwilling to seek required expertise).
Successful incubators have, and stick to sound policies for tenant selection, continuation, and graduation or exit
It is a simple concept. If an incubator can find and recruit the tenants best fitted to its goals, it is more likely to produce successful graduates. The problem is that many incubators do not determine what basic requirements must be met for an applicant to be selected, or if they do, they may feel pressured to lower those standards in an effort to lease vacant space. Before long the incubator can stagnate, with its valuable space filled by businesses without solid prospects for growth, unable to benefit from the assistance available, and simply taking advantage of space at a subsidized price.
The following are some of the considerations that may be used to determine eligibility for admission into incubator programs, based on the needs and desires of the particular program.
As a part of the application process it is a standard requirement for the prospective tenant to submit a well developed business plan along with financial documentation that may include company financial statements, projections, and personal financial information. Applicants should be reviewed by a team that may include incubator staff, board members, and individuals with industry expertise.
Good incubators enter into more than simply a lease with the business. An agreement between company and incubator should identify specific requirements (such as training or technical assistance) based on an appraisal of the company’s needs, and establish timelines for meeting critical milestones in the company’s growth. Examples might include milestones related to applying and securing intellectual property rights, developing prototypes, launching campaigns, reaching sales goals, etc. As a condition of continuing in the incubator, the company should agree to, and comply with requirements such as:
It is vitally important that incubators have a plan to push businesses out of the incubator once they can no longer benefit from it or are making no progress. Companies that can be successfully launched are said to graduate, while others that do not perform are “exits”. The criteria for leaving may be general, or specific to the client. Some common approaches include:
A good incubator will work with its tenants to prepare a plan for leaving the incubator. This is a significant transition that, in addition to needing to find suitable space, is likely to trigger demands for purchased equipment and services that had been provided by the incubator. It may also create a need for additional marketing, and the establishment of policies and procedures for the new site. In some cases, the move may be complicated by technical requirements and compliance with local or state regulations.
It is not unusual for a business leaving the incubator to have a continuing relationship with the program. This is particularly true where the incubator may have specialized assets that the company needs to access in order to grown, but may not yet be able to provide on its own.
Successful incubators have strong management and well-qualified service providers
Finding qualified service providers may be one of the most difficult challenges for any entrepreneurial development program. Concerns might include whether the region has the level of qualified expertise needed by clients, whether the potential service providers understand and are a good fit for clients, and how much the services being provided may cost.
Examples of the kinds of service providers typically sought by entrepreneurs include accountants, attorneys, designers, human resources professionals, marketing specialists, and technology experts. The incubator will often want to establish relationships with financial providers as well, including conventional lenders along with angel investors, venture capitalists, and others. Additionally, it may identify mentors to provide general advice, such as prior successful entrepreneurs or subject experts like academic researchers.
All too many incubators take the easy approach of simply using Small Business Development Centers (SBDCs), SCORE, and similar organizations as their service providers. This tends to produce poor results. These kinds of organizations are often inconsistent in quality and may do a poor job of supplying the tailored and one-on-one expertise needed by startups and companies in an incubator. In many cases they are staffed by academics or others without prior startup business experience, and may be too inclined to direct clients into standardized programs and classes that may be easy for the organization to deliver, but fail to provide individualized assistance. Though these organizations may seem to be good partners, careful consideration is needed and the program should not try to fit existing providers into an incubator if they are not valued by that incubator’s target market.
Businesses in the community may seek to become service providers, perhaps at discounted rates, in the hope of securing future clients as startups grow. As with organizations, the quality of these potential service providers varies, and each should be carefully vetted to ensure that they will be able to recognize client needs, deliver effective assistance, and serve as strong advocates for the program. Above all, they should be monitored to ensure that they continue to place the needs of the client and incubator above their interests in marketing their own business.
Successful incubators embrace an element of risk-taking, as do the entrepreneurs they serve
Entrepreneurs often have the ability to see opportunities or approaches that others will miss. They are inherently risk takers. Economic developers, and especially their boards, seldom share that trait. They are more prone to having a “play it safe” mentality that can even spill over into the service providers used by the organization. When this happens it impacts the program in two ways. The first is that it may inhibit the ability of the organization to identify promising startup opportunities. The second is that a conservative approach may actually work to discourage clients and provide them advice that can hamper their ability to make significant breakthroughs. There is nothing wrong with a good dose of reality, but not at the cost of an open mind.
Successful incubators seek objective feedback from clients, sponsors, service providers, and the community
Good measurement goes beyond simply counting the number of people attending a training session, recording an occupancy rate, or other simple statistics. Incubators need to understand how they are perceived by their various stakeholders. They need to understand how their programs, and the incubator itself are valued.
This constant feedback, obtained through evaluations, surveys, and candid discussions, will give the organization the insight it needs to modify programs and respond to market demands. Organizations that do this often face unflattering results at times, but rather than failures, these should be seen as priceless opportunities to learn and to improve service offerings. Incubators that do not seek candid feedback run the risk of alienating potential clients, offering irrelevant or ineffective programs and services, losing supporters, and ultimately failing as an economic development strategy.
Successful incubators know that it can take years to see results
Economic developers are often pressured by boards, politicians, and the public to produce rapid results. Incubation is not a strategy designed to score quick successes. It is not uncommon for the development process to take a year or longer, followed by another year in which the program implements programs and leases space. The first successful graduates may not appear until several years after the decision is made to create an incubator. People need to understand this up front, and this is why long term commitments are essential.
Successful incubators adapt to changes in their economy, technology, and the needs of their market
Any program established today may become irrelevant in a very short period of time. Industries shift. Breakthrough technologies change how we work and live. Economies go through cycles of growth and contraction. The needs of the area’s entrepreneurial community change. Staff can change. New resources may be available. And with these or other changes, the incubator program must be able to adapt, reposition itself, and remain relevant to the marketplace.
IS BUSINESS INCUBATION THE RIGHT STRATEGY FOR YOUR ORGANIZATION?
Incubation can be an effective entrepreneurial development strategy, pushing intensive resources to companies targeted for growth. Unfortunately, many of the organizations that attempt to develop incubators misread the market, lack long term committed support, or do not have the technical or financial capabilities necessary to be effective. For these and others, the greater question may still be whether incubation is the right approach to achieve the organization’s goals. A number of collaborative models have appeared in recent years that may be better suited to their needs and capabilities, including coworking, hackerspaces, and makerspaces. Introduced by innovators in the private sector, these environments may serve as platforms for more wide-reaching and manageable approach to entrepreneurial development.
Coworking and related spaces are fluid environments where entrepreneurs, established solo and micro businesses, freelancers, contractors, and even employees of larger firms come together to work in a common space. Growth and learning are realized informally through the interaction and collaboration of members, and that membership is regularly evolving as new people join and existing ones fall out. In addition to space, many of these spaces are developed around occupational clusters, and share access to assets like oversized or 3D printers, recording studios, software packages, machinery, or other unique resources that may be difficult for an individual or a small business to afford.
It is not hard to image how an economic development organization might add a layer to the model, supplementing the peer-based education, mentoring, and networking of a coworking platform with the more intensive and individualized services normally delivered in an incubator. Advantages might include cost – the vast majority of coworking spaces are self-funded, the ability to reach a far greater number of businesses than might an incubator, and a lower draw on the technical resources of the organization.
Ultimately, the best approach can only be determined by understanding the organization’s goals, its financial and technical capabilities, and the market. It is important, though, to understand that there are now good alternatives to traditional business incubation.
BRINGING IT ALL TOGETHER
Our goal in this two-part series was to examine the practice of business incubation, providing some objective assessment of its effectiveness, and suggesting a few practices that can help exiting or potential incubators to be successful. Business incubation is touted as a highly effective entrepreneurial development strategy, and there are examples of incubators that show consistent results. In reality, however, the majority of incubators do not live up to the hopes of their organizers. Some do not have a market producing the candidate businesses that can benefit from incubation. More often, the organization itself does not have the considerable financial, technical, and managerial capacity required to execute an effective business incubation program.
Too often, the decision to pursue a business incubator is made before there is really a good understanding of the local entrepreneurial and small business community. As in any business venture, the planning should begin with good market research to understand potential targets and their needs. These can be matched to the goals and capacity of the economic development organization to choose the best model, whether that may be an incubator, coworking space, or any other option. The resulting program then needs to earn stakeholder support and adopt well defined policies designed to produce results for its specific targets.
This article was entitled “Is business incubation a winning strategy?”, and in the final analysis, there is no clear answer. Economic developers and community decision-makers should not be persuaded by stories of high-performing programs spinning off a steady stream of graduates. There are a relative handful of these. But neither should they be dissuaded by the more typical example of facilities that have devolved into little more than low rent office or industrial buildings. It really comes down to individual circumstances, a well-informed assessment of the alternatives, and effective execution.
About the Author
Michael Stumpf has had a lengthy career in economic development, during which he inherited and closed a failed incubator and assisted in starting a new one. As the economic development director for the City of Boulder, Colorado in the early 2000’s, he saw first-hand how a vibrant entrepreneurial ecosystem could generate new ideas and new business ventures. Interacting with these businesses, he came to understand the needs of startup businesses through a personal, rather than simply academic perspective. He was ultimately inspired to launch Place Dynamics in 2005. Consulting with individuals, organizations, and governments, he has prepared several entrepreneurial development strategies as well as feasibility studies and planning for incubators. In recent years he has been a strong advocate for coworking and similar collaborative approaches as an incubation platform, seeing them as an approach more closely matched to the constrained resources of most organizations, while also reaching a greater number of businesses in the community.