How to shift the economy by 1% – Schramm’s Law and African Lions

How to shift the economy by 1% – Schramm’s Law and African Lions

carl schrammIn the search for much needed growth in South Africa a different approach prescribed by Schramm’s Law would shift our attention to fostering the formation and acceleration of billion rand companies, so called African lions.  We would only need 10 of these African lions a year to fundamentally change the long term growth rate of South Africa.

As the South African economy growth rate dropped to a level of 1.3% in 2015 Quarter One, it moved further and further away from the requirements of the National Development plan that we grow the economy by at least 5.4% over the next 15 years – a minimum requirement if we are to have any hope of addressing the unacceptable levels of unemployment and poverty in this country.

It raises the question for which we are all seeking an answer.  How do we grow the economy? In fact let’s simplify and quantify this question.  How do we grow the economy by 1%? Over the years we have been subjected to a number of different economic theories as to how this might be possible.  Yet in recent times it has become clearer that there is an actor in this economic landscape that deserves more attention.  Fundamentally new research suggests that the formation and growth of firms is the most important variable in the growth question.  In fact, the past president of the Kauffman Foundation, Carl Schramm, described once by the Economist as the “Evangelist of Entrepreneurship”, formulated what has become known as Schramm’s law which states that:

“The single most important contributor to a nation’s economic growth is the number of start-ups that grow to a billion dollars in revenue within 20 years.”

Now if true, this is a staggering and powerful claim.  It suggests that rather than the usual suspects such as fixed investment, levels of innovation, exchange rates and inflation, the single most important variable is the number of new firms that reach significant scale over time.

In order to demonstrate how big an impact just a few of these firms might have on an economy, let’s rephrase our initial question to ask: “How many billion dollar companies do we require to grow the economy by 1%?”

In order to answer this question we need to rely on the work of Yale economist William Nordhaus, who estimated that inventors, which we will assume here to be proxies for innovative entrepreneurs, capture only 4 percent of the total social gains from their innovations. This is why it is important for Schramm’s law to talk about billion dollar companies. The cut off number (a billion) is slightly arbitrary, but the purpose behind it is that companies of this sort of scale must have been in some way innovative, and by virtue of them being innovative the 4% Nordhaus relationship holds. Essentially these innovative companies generate far more value to society than they are able to capture for themselves.  The majority of the gains leak out to benefit many other firms and industries that use the innovation in other ways.  The immediate example would be smart phones which have added far more value to society than that captured by the individual firms producing the devices.

Armed with this ratio we can now do the calculation of how many billion dollar firms it would take to grow the South African economy by 1%:

Size of SA Economy: $370bn
1% of SA Economy $3.7bn
Required Firm Value Capture: $148m (4%)
Required Total Firm Revenue $1bn (Assuming 15% return on revenue in SA)
Required number of firms: 1

If these firms were to increase the economy by 1% ($3.7bn), which is the total value added to society, they would themselves have captured $148m of that value (4% of the total value they had added to society). If they had captured $148m of value/profit and we assume a return on revenue of 15%, then the total revenue (sales) of these firms to shift the economy by 1% would be $1bn – simply we would require one billion dollar company a year to shift the long term growth rate in South Africa by 1%. Only one!

Even if we made it more contextually relevant and changed the requirement to billion Rand companies, it would still only be 10 a year.  Only 10 out of the many thousands of companies that are started every year. Let’s identify these companies. Let’s celebrate them.  To assist us in doing this we need to give them a name. The entrepreneurial world has fallen into a pattern of naming special companies after animals. Fast growing companies are called gazelles, companies that reach a valuation of $1b are called unicorns.  So our own name for these billion Rand companies should be African Lions.

How many of these African lion companies do we currently produce?  As a rough starting point we can look at companies listed on the Johannesburg Stock Exchange.  Based on the Financial Mail 2014 Top Companies Report there are 189 companies that have reached the billion rand revenue mark.  Our exchange has been in existence for over a 100 years.  So the rough average number of these companies produced per annum over time is about two.  It is likely that this rate has increased in recent years and so a conservative baseline would be that South Africa produces 3 of these billion dollar companies a year.

Our challenge is therefore simple – we need to increase this rate three fold and move it into double figures. Now there is a goal to mobilise around! It’s time for us to find some Africa lions.

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