How Innovation Changes During A Recession

While Winston Churchill was famously supposed to have remarked that we should never waste a crisis, the reality is that during recessions, firms often tighten their belts and reduce the amount they invest in innovation.

Of course, Churchill’s dictum rests on the way in which crises can prompt us to reassess that which we had previously taken for granted and look for new ways of doing things. Research from Kellogg explores whether that is really the case or not.

“We examine innovation following the Great Depression using data on a century’s worth of U.S. patents and a difference-in-differences design that exploits regional variation in the crisis severity,” the researchers explain.

Innovation during recessions

The study found that there was a steep decline in inventors’ patents during the depression, with this seemingly driven by reduced levels of funding due to the economic crisis. Bigger firms were generally better equipped to weather this situation, however, and the reduction in competitor’s activity may actually have benefitted them.

In short, while smaller, independent innovators reduced their activity, the activity of larger firms tended to hold steady, with the authors suggesting that perhaps the independent innovators sought more certainty at larger firms.

“It’s widely accepted that being innovative today is getting more expensive, but this is generally okay during good times as access to capital is more readily available so smaller firms can still innovate successfully,” says Anthony Durkacz, CEO of Nasdaq-listed FSD Pharma, “This generally isn’t the case during a recession, however, as investors and lenders tend to take a more safety-first approach, which usually favors bigger firms with a proven track record and income already coming in.”

A similar outcome was seen via Harvard research, which looked at whether individuals wanted to work for startups or bigger firms during the Covid pandemic.

Safer option

The researchers tracked job applicants on the AngelList Talent website, which is a leading platform for startups to hire talent. The analysis revealed a distinct shift in job searchers towards larger companies after the national state of emergency was officially declared by federal officials on the 13th of March.

This flight towards larger firms was especially pronounced among higher-quality and more experienced talent, thus leaving startups with a smaller and lower-quality pool of talent to pick from. It’s a phenomenon that the researchers believe has profound implications.

“[It] means not only that the pool of potential human capital for startup companies began declining when COVID started, but also that the quality of the pool has deteriorated,” they say. “The incumbent [companies], just by nature of having more cash or by being more established, are perceived safer during the crisis, and suddenly have a unique advantage in terms of attracting talent.”

Big company activity

The Kellogg study suggests this partly explains why independent inventors have gone from being a fairly common source of innovation to one that plays a minimal role today. Instead, the majority of innovations today emerge from large companies, where the researchers believe most previously independent innovators have ended up.

They highlight that the traditional narrative has been that innovation has shifted to become far more capital intensive during the 20th century, and this explains why more of it has been done by large organizations rather than independent innovators. While this is undoubtedly true, their findings also highlight that recessions also play a part in prompting innovators to seek the relative safety of larger firms.

While we may hope that this is a temporary shift, the data from the Great Depression showed that the innovation activity by independent inventors fell sharply in the 1930s but didn’t ever really recover again, even when economic circumstances became more benign. This contrasts with the fall in firm activity, which did bounce back again.

What’s more, this fall was noticeable across all technology areas, so the researchers believe they can discount technological trends as a key driving force behind the phenomenon. If this wasn’t the case then ebbs and flows might be expected to coincide with the emergence of different types of technology.

More than just safety

Of course, while the relative safety of big companies is undoubtedly a factor here, the researchers also highlight that things like access to finance also played a part, with independent innovators struggling to access funding during the Depression, with support often sought from wealthy local benefactors, much like angel investors support startups today. Obviously, if those individuals themselves lost money then it makes it less likely they’ll have any spare to help entrepreneurs.

“People don’t necessarily think that there is more stability with a company like ours as risks and uncertainty can never be ruled out, but people do seem to want a less risky future,” Stuart Aird, Director of Talent at regtech company Encompass Corporation told me recently. “We hope we can offer a middle ground whereby we’re not a fresh startup that comes with risk attached, but we’re also not a big firm that might make it harder to make an impact from an innovation perspective.”

This ability to get things done is something that drives many entrepreneurial and innovative people, but it’s equally important for companies to view entrepreneurial people positively. As I highlighted in a recent article, founders can often be viewed negatively as hiring managers believe that the entrepreneurial urge will never leave and they’ll soon be off creating a new business again.

Traditional bank finance also dried up, and while this was across the board, bigger firms had money in the bank to fall back on or earnings from existing products. Perhaps unsurprisingly, the decline was greatest among younger inventors and innovators.

“You have to have an open mind regarding what people can bring to an organization,” Joanna Kori, Head of People at Encompass says. “We’ve hired people from such a wide range of backgrounds over the last few years and you have to look at what people bring to the organization and what impact they can bring.”

Changing how we innovate

With a recession seemingly inevitable across the developed world in the year ahead, it will be interesting to see the impact it has not just on innovation more broadly but also what kind of entity actually does the innovation. History provides us with a useful guide as to how things might play out.

“The Great Depression provides a useful laboratory to study the role of crises in shaping innovation,” the Kellogg researchers explain. “In fact, our results highlight how crises may act as catalysts for deep changes in the way innovation is organized and conducted.”

A restriction in the flow of capital can result in a fundamental change in the way in which innovation is organized, and the researchers believe this played a major role in the shift from an entrepreneur-led innovation process in the United States to a more firm-led approach. Will the same apply today? Time will tell.