Americans are starting companies at two-thirds the rate than they did three-and-a-half decades ago, raising concerns about the country’s economic vibrancy. While there might be reasons to be worried about the decline in the new business formation rate, the fall in new company starts does not necessarily mean that the American economy is less dynamic than it used to be, or that Americans are opening up new establishments (locations at which business takes place) at a lower rate than they did in the late 1970s.
Both independent entrepreneurs and existing firms can open up new business locations, which are often demanded as the population moves and industries change. Analysis that I conducted with Mark Schweitzer of the Federal Reserve Bank of Cleveland and Ian Hathaway of Ennsyte Economics, on Census Bureau’s Business Dynamics database, reveals that new establishments are increasingly being set up by existing businesses, rather than by independent entrepreneurs, as the example of Starbucks shows.
Consider the following numbers: In 1978, Americans founded 12 new firms with employees for every existing business establishment in the country. By 2011, the latest year data are available, Americans founded only 6.2 new firms with employees for every existing business establishment. By contrast, in 1978, existing businesses created 1.7 new business locations per existing establishment, while in 2011, they created 2.6.
The growth in the formation of new establishments by existing businesses and the decline in new firm formation have changed the mix between new and existing firms as the entities creating new establishments. The new firm share of new establishment creation declined from 80 percent in 1978 to 60 percent in 2011.
Moreover, existing businesses have been creating jobs through the formation of new establishments at a more rapid pace than new businesses. Our analysis of the Census data shows that the new firm job creation rate declined 38 percent between 1978 and 2007, while the new-establishments-of-existing-companies job creation rate increased 25 percent over the same period. (Job creation by both types of businesses declined during the Great Recession and then recovered slightly in the recovery that followed.)
These patterns are consistent with prior research that has described the replacement of single-establishment businesses by multi-unit establishments in the retail sector. However, we show that this pattern reaches far beyond that one part of the economy and is present in all nine major sectors of the economy – agriculture, construction, finance, insurance and real estate, manufacturing, mining, retail, services, telecommunications and utilities, and wholesale. We also show that in seven of nine sectors, new locations of existing businesses were responsible for a larger share of new establishment job creation in 2011 than they were in 1978. (Manufacturing and mining are the two exceptions.)
While our analysis of the Business Dynamics Statistics data does not allow us to pinpoint the cause of this shift, we can offer a hypothesis: Advances in information and communication technologies have made it easier to coordinate multiple establishment businesses, offering existing businesses an advantage over new firms in meeting the need for new business locations.
Underlying the decline in new business formation and job creation by new companies over the past 30 years has been a shift from the founders of new companies to the owners of existing businesses as the source of new establishment formation and job creation. Whether that shift is good or bad depends on your view of the relative value of new and existing businesses as a source of new establishments. But data suggest that the U.S. economy isn’t necessarily less vibrant than it used to be. Rather, it suggests that the source of that vibrancy has shifted from new to existing firms.