Sunday, November 20, 2005

Massachusetts Brain Trust

The Massachusetts’s brain trust (MBT) is the source of thousands of high tech companies and millions of jobs. What is the MBT? What has been its performance? What challenges must it address to maintain its track record? What are the implications for government leaders?

The MBT is a collection of capabilities that has helped propel the state to the forefront of technical innovation – creating shareholder wealth and employment in the process. The capabilities include:

  • Universities and research laboratories. Harvard, MIT, Massachusetts General Hospital, the Dana Farber Cancer Institute and many others exemplify the notion of Massachusetts as a global talent magnet;
  • Venture financing. On a per capita basis, Massachusetts invests the most venture capital in the US. American Research & Development, founded in 1946 by George Doriot, a professor of industrial administration at Harvard Business School, was one of the first venture capital firms – made famous by its investment – which grew from $70,000 in 1957 to $355 million in 1971 -- in MIT-graduate, Ken Olson’s, Digital Equipment Corporation;
  • Entrepreneurs. Many of the students who come to Massachusetts for school decide to start businesses including Analog Devices, Analogic Technologies, EMC, Lycos, Staples and Teradyne. Furthermore, university faculty members have founded major local firms such as Akamai Technologies, Bose, and Biogen;
  • “Yankee Ingenuity.” Massachusetts has a culture of frugal experimentation which leads venture capitalists to make smaller, more-focused investments leading to higher investment success rates; and
  • Government support. For example, Massachusetts defense contractors get funding from the Navy and Air Force as well as the Small Business Innovation Research (SBIR), a US Department of Defense program that provides $500 million in early-stage R&D funding for small technology companies.

While it’s not clear exactly how this collection of capabilities emerged; it appears that intellectual capital came first and the supporting capabilities followed. According to Alain Hanover, managing director of Navigator Technology Ventures, the core of the MBT is Massachusetts’s schools, such as MIT and Harvard, and its research laboratories. Students come to the schools from around the world, they like the area, they get jobs after graduation, and when they see that the potential rewards of entrepreneurship exceed the risks, they start companies.

The MBT has demonstrated a remarkable resiliency in the face of economic cycles. According to Mike Goodman, Director of Economic & Public Policy Research at the University of Massachusetts Donahue Institute, the Massachusetts economy has always been cyclical – driven by waves of innovation. This has been true from the industrial revolution to the minicomputer to the dot-com era.

The state economy must reinvent itself – it must come up with new ideas and create new companies and new industries around them. Massachusetts is good at product development and prototyping but not so good at mass production. So when a technology market begins to commoditize, Massachusetts moves on.

Massachusetts is not a low cost producer. It can’t rely on masses of land. The weather is bad. But it does have an innovative and entrepreneurial spirit. One thing that has changed is that the pace of reinvention has picked up. In the past, Massachusetts could ride a technological innovation for a generation. Now, innovation comes in much shorter -- five or 10 year -- cycles.

Through these economic ups and downs, the MBT’s creative contribution has been impressive. Evidence of this economic creativity comes from MIT which has produced 4,000 MIT-related companies employing 1.1 million people which have annual sales of $232 billion. In determining where to locate, a survey of 1,300 MIT corporate founders ranked the following factors as critical:

  • Quality of life in their community;
  • Proximity to key markets;
  • Access to skilled professionals;
  • Low business cost; and
  • Access to MIT and other universities.

MIT gives back to Massachusetts. While California workers (162,000) benefited the most from the creation of the MIT-related companies, Massachusetts (125,000) came in a strong second. The 1,065 MIT-related firms headquartered in Massachusetts employ 353,000 people worldwide and 125,000 people in the state. They generate worldwide sales of $53 billion.

These companies represent 5% of total state employment and 10 of the state’s economic base. MIT-related firms account for about 25% of sales of all manufacturing firms in the state and 33% of all software sales. While only 9% of MIT undergraduates are from Massachusetts, more than 42% of the software, biotech and electronics companies founded by MIT graduates are located in Massachusetts.

MIT’s companies are also at the forefront of knowledge-based industries. They are highly dependent on a workforce of skilled professionals. They rank product quality and reliability, customer service and innovation as the most important ingredients to their success and build a corporate culture which stresses innovation, cooperation and individual attention.

Unfortunately, all this economic productivity cannot obscure the challenges that Massachusetts has faced in the last five years. It had 3.5% to 4% unemployment before the dot-com crash in 2000 which resulted in unemployment peaking between 6% and 7% in 2002. While state data show Massachusetts has posted job gains in 11 of the past 12 months, it has regained only 25% of the 207,000 jobs lost since employment peaked in 2001.

Nevertheless, Massachusetts’s 2005 unemployment rate has fallen back to 4%. But this decline has more to do with a drop in the number of workers than to an increase in the number of jobs. According to Hanover, What happened in the last few years is that people who were in Massachusetts left the area and fewer students who came to Massachusetts for school ended up staying here. So the workforce size declined between 2002 and 2005. Now it is becoming more difficult for companies to find people skilled in software, biotechnology, and telecommunications.

What is the next big thing? Goodman believes that the answer lies in biotechnology, life sciences, health care technology and nanotechnology – particularly as it might be applied in electronics or computers. According to the Massachusetts Biotechnology Council, 8% to 10% of all drugs in development are being researched by Massachusetts firms.

The strongest recent job growth has come in health services, reflecting Massachusetts’ reputation as a hub for medical research and hospitals. Health services accounted for 11.7% of Massachusetts’ jobs in the first half of 2005, compared with 9.2% nationally. Health care is a “normal good” meaning that as a region’s wealth increases, its spending on health care will increase as well. This feature, coupled with the growth of demand for health care as 77 million baby boomers age, is likely to propel demand in the future.

The challenge for Massachusetts is that a lot of the wealth created by biotechnology and nanotechnology will not be labor intensive. Therefore, the jobs lost due to the dot-com crash in IT and telecommunications are not in the same industries where Goodman sees future jobs. Workers cannot go from jobs in telecommunications manufacturing to those in health care. The IT skills are not transferable for displaced workers.

Over the last several years, Massachusetts corporations have rebuilt their profits; however, they are not creating enough jobs to pick up all the slack in the work force. Nevertheless, IT firms with large Boston outposts, such as Cisco Systems, Hewlett Packard, Sun Microsystems, and Oracle, have picked up some of the slack.

So until the next big technology wave swells; the MBT is down but not out.

The MBT story suggests some thoughts and raises some questions for government leaders, including the following:

  • Academic excellence. The starting point for a successful knowledge economy is universities which attract the world’s best students. Since university reputations seem to follow those of its faculty, recruiting world class faculty and creating an environment which supports their work is critical. If government leaders seek to create a knowledge economy, such recruiting initiatives could be an excellent first step;
  • Risk culture. Entrepreneurship is inherently risky. The typical track record of a venture capital firm is to have one big “win” for every 10 investments. The reason that US venture capitalists are willing to take these risks is a culture – helped by its capital markets; legal and tax systems -- that help manage the risks. Furthermore, US capital markets create opportunities to realize the gains from creating successful new businesses. Without such a risk culture, students will not see entrepreneurship as an attractive career option; nor will investors seek returns in new venture creation. Could government leaders do more to create a risk culture?
  • Entrepreneurs. Massachusetts has a long history of successful entrepreneurship. Other regions and countries had histories of entrepreneurship which may have lapsed. For example, Portugal showed its entrepreneurial mettle way before Massachusetts did. 500 years ago, Portugal had a small home market but tremendous skills at building ships and sailing them to rich overseas markets. Can Portugal apply new skills to rekindle this spirit of entrepreneurship in the 21st century?
  • Capital. A high tech economy depends heavily on the availability of capital willing to make the risky bets on such entrepreneurs. Venture capitalists depend on large pools of pension fund and endowment money to put a portion of their capital into the hands of the venture’s general partners. The pension funds and endowments in the US have the freedom to place a portion of their funds at substantial risk because the track record of venture capital has been better than virtually any other asset class. And a key source of these superior returns is a vital market for initial public offerings and acquisitions of the companies these venture capitalists help create. Are the conditions for a booming venture capital industry present in other regions?
  • Government support. Government certainly plays a substantial role in the Massachusetts high-tech economy. It provides significant funding -- through defense contracts and medical research grants – that have formed the basis for many of the great technical innovations driving the many companies cited above. Yet in other ways – such as making specific investment decisions or selecting entrepreneurs – the government leaves the driving to the venture capitalists. Could government leaders play a similar role to support a high tech economy?

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