Are small businesses still leading the pack, or have they lost their edge?

By Mark Hendricks

Innovation is the water Stefane Barbeau swims in. Without a constant stream of new ideas for consumer products, Vessel Inc., the Boston design company he co-founded, would quickly cease to exist. “It’s really important,” the 34-year-old entrepreneur says of the company’s ability to innovate. “It’s what sets us apart from other companies.”

Thanks to a series of well-received original designs such as Candela rechargeable lights and Time Tag clip-on watches, Vessel has grown to four employees and $3.5 million in projected annual sales in only three years. Barbeau doesn’t expect to run out of ideas soon. But he’s a little concerned about other small businesses.

Vessel has to deal with a regular lineup of knockoffs and, contrary to popular belief, they are coming from U.S.-based companies as well as some in China and elsewhere. “There seem to be a lot of me-too entrepreneurs,” Barbeau says. “It doesn’t mean they’re not valid, but it’s a little weird that there are so many out there.

So is there reason to be concerned about the innovativeness of American small businesses? The answer is complicated. For one thing, innovation resists easy measurement. Furthermore, whatever American businesses do with regard to innovation, they have to compete with entrepreneurs from other economies, and global innovation is clearly on the rise. Finally, most studies of innovation focus on large companies—despite the significance of small-company innovation.

Some evidence suggests that innovation may pose a challenge to American business in general. In 2004, according to the Organization for Economic Cooperation and Development, China surpassed the U.S. to become the world’s leading IT exporter. In 2005, the U.S. Patent and Trademark Office listed six foreign-based corporations among the top 10 recipients of U.S. patents.

“Whether U.S. innovation is going up or down, everyone else is catching up,” says David Attis, senior director of policy studies at the Council on Competitiveness, a Washington, DC, public policy action group. “Whatever we’re doing now, it might not be good enough in the near future as everyone catches up to us.”

Nevertheless, other evidence shows that the U.S. still has a good lead on the rest of the world in many areas. The U.S. has more scientists and engineers than any other country, Attis notes. Although China and India are catching up, this still gives U.S. companies an advantage in cutting edge areas such as nanotechnology, chemistry and materials science.

What’s more, the U.S. is better equipped to finance business innovations than other individual countries. At the end of 2004, according to the National Venture Capital Association, U.S. venture capitalists managed an all-time high of $261 billion. By comparison, all European Union nations combined had the equiva has more scientists and engineers than any other country, Attis notes. Although China and India are catching up, this still gives U.S. companies an advantage in cutting edge areas such as nanotechnology, chemistry and materials science.

What’s more, the U.S. is better equipped to finance business innovations than other individual countries. At the end of 2004, according to the National Venture Capital Association, U.S. venture capitalists managed an all-time high of $261 billion. By comparison, all European Union nations combined had the equivalent of approximately $323 billion in private equity under management.

That financial system helps the U.S. spend more than 2 percent of its gross domestic product on R&D, handily beating other industrialized Western nations such as the United Kingdom and Germany, and putting the U.S. well ahead of the European Union’s average of 1.2 percent, according to the UK’s Department of Trade and Industry. While some U.S. companies are offshoring R&D to take advantage of lower costs, there are more Asian companies coming here to do research than U.S. companies going to Asia, Attis says.

U.S. environmental regulations are often cited as barriers to innovation. But Americans’ concerns about health and the environment have also encouraged companies to become leaders in electrical power storage, organic products and clean-air technology.

And it may be that the most important sources of innovation aren’t caught by these and other conventional metrics. Since large firms spend the most money on product R&D and other innovation related activities, studies tend to focus on them. However, SBA studies show a small firm’s patent is more likely to be among the top 1 percent of frequently cited patents than one granted to a large firm.

Not all innovation is measured by counting patents and employees with Ph.D.s, however. Much of the innovation taking place in U.S. small companies is in service industries, where patents are of little use. Furthermore, R&D spending isn’t always an indicator of innovation. Attis points out that Apple Computer is an icon of innovation, yet it spends less than its industry average on R&D.

To observers such as Attis, small companies seem to come up with better ideas and are also better at making something out of them. “When people talk about innovation, they talk about Apple and Intel and IBM,” he says. “But beneath all that is a continuous curve of innovation coming from small firms.”

Being Innovative
Small businesses can’t keep generating innovations unless their leaders make a priority of sustaining innovation, Attis says. “It’s hard to stay focused on innovation when you’re trying to make payroll,” he adds. Small companies are also usually underrepresented at hearings on government policies likely to impact innovation, he notes. “The CEO of a small firm can’t take time off to come to Washington and testify, whereas Microsoft has a team of people who work on this full time.”

Even small companies that make the effort to focus on innovation may find it heavy sledding. Manufacturers, for example, have to overcome the effects of a couple of decades of strident emphasis on cutting costs and increasing quality. “Now, when you have global low-cost competitors, you have to think about what you can do that your Chinese counterpart can’t,” Attis says. “That’s about innovation, and it’s difficult for a lot of manufacturers. They’re not used to thinking about new products and markets.”

The shortcut to innovation runs outside the company. Bringing in an outside perspective is the quickest way to inject some innovation into an enterprise, says Anand Chhatpar, founder and CEO of BrainReactions LLC, a Madison, Wisconsin, innovation consulting and training firm. Chhatpar sells innovation-seeking companies ideas generated by a brainstorming pool of creative college students. He says many companies should first look to their customers. “Your most creative customers can be your biggest assets and resources to find new innovations,” says the 24-year-old entrepreneur, who has grown his company to seven people and seven-figure projected sales in two years.

Harness your employees’ innovative spirit by sharing information and decision decision making powers with them, suggests Lisa Gundry, management professor and director of the Leo V. Ryan Center for Creativity and Innovation at Chicago’s DePaul University. It’s a mistake to rely too much on your own innovativeness, she warns. “The myth of the lone genius or idea that the founder or CEO is solely responsible for innovation is a real obstacle.”

Send employees to meet with customers, and seek ideas from experienced veterans in your company. “The experts in a firm can really put their finger on the pulse,” Gundry says. “And innovation is often driven by the market, so you need to get employees in touch with that market.”

None of this will work if you don’t stay open to all kinds of ideas. The most innovative companies celebrate and reward any ideas, including those that may result in only small improvements. According to Gundry, “They encourage employees to experiment, [creating] a culture where you’re rewarded for nice tries and not just home runs.”

A Sense of Urgency
Although small business as a whole retains its innovative capacity, individual entrepreneurs must not fall into complacency. “This isn’t just about growth,” cautions Gundry. “Years ago, we thought innovation was something nice to do when you [had] the time. Today, it’s about survival.”

If a one-size-fits-all approach to surviving through innovation exists, Barbeau says it consists of strenuous effort and market focus. “The feedback loop of product development and product selling is really important,” he says. “You can learn a lot from listening to your customers about how they are using your product.”

Hard work aside, Barbeau has a final word to entrepreneurs who think innovation requires deep understanding of cutting-edge technology. Many noted innovations, such as Apple’s paradigm-busting iPod, combine existing technology in useful and easy-to-grasp ways. “Innovation and simplicity need to work off each other,” Barbeau says. “Because if you’re being innovative, that innovation needs to be communicated to markets clearly and efficiently.”

Mark Henricks writes on business and technology for leading publications and is author of Not Just a Living.