My Rival, My Friend

It's hard to see competitors, especially new ones, as good for your business. New entrants typically lead to higher costs, as businesses suddenly have to fight to retain or hire skilled workers and compete for other resources. But new research by Lawrence Plummer, a visiting economist at the Small Business Administration, says competition hurts performance only in the short run. If a business can survive, the competition appears eventually to make all players better off.

Plummer looked at the return on assets (ROA) between 1990 and 2004 of 377 companies that went public in the early 1990s. He then used U.S. Census Bureau data to track new companies opening in counties within 75 miles of the established one. When new competitors popped up, ROA at the established company fell in the next year. (Plummer also found that more spending on research and development could help cushion against this.) But after two to three years, the performance of both the new companies and the existing ones had improved.

One reason for the turnaround is that "the established company and the new entrants end up forming an industry cluster," says Plummer. The proximity of several companies within the same industry can lead to knowledge-sharing, either through collaboration or when workers move between businesses. The clusters can also give rise to complementary businesses, such as suppliers. Both factors tend to improve worker productivity and company performance.

The results also provide some insights for local and state governments. First, because new entrants can pose a real threat to existing firms, economic development agencies should carefully consider plans to lure relocating businesses and cultivate startups. And both government and community development agencies should be patient, giving new and existing businesses the time they need to take off—and ultimately jumpstart the local economy.

By James Mehring

    Before it's here, it's on the Bloomberg Terminal.