Investing in Innovation to Differentiate Products
The Italian economy has suffered greatly from the Great Recession. But the country's current predicament has its roots in the historical phase preceding the crisis: for two decades, Italy has experienced little or no growth. Data show that what's missing from growth accounting is the contribution of Total Factor Productivity (TFP), which measures the ability of a system to innovate and better organize the production process, so that more output is produced for a given set of inputs.
In spite of the negative aggregate performance, there are firms who have adapted well to the new competitive environment. According to CERVED data, in the 2007-2012 period more than 3,000 medium firms have doubled sales, also thanks to high investment rates, particularly in immaterial assets. The trait common to all the firms which have managed to navigate the crisis is that these business organizations were able to reposition themselves in goods where competition occurs on product features which are not easily replicated by competition from developing economies. In order to achieve product market differentiation vis-à-vis potential competitors, firms must invest in innovation, brands, re-organization, and distribution: in a word, in immaterial capital.
Many of such activities have high fixed costs. Launching an advertising campaign, developing a new patent, building a sales network in another country, all require financial outlays that are independent from the quantity produced. From this point of view, size matters. Firms that stay too small do not reach the minimum scale capable of sustaining these kinds of costs. The Italian market structure is dominated by smallish medium firms, whose size is about half of the EU average, and well smaller than competing German firms. Having a small scale is an advantage when you compete on production costs. But now that competition is played out in different domains, being small can be a burden.
What are the factors behind the reduced size of Italian enterprises?
There is no catch-all answer. Years ago I had considered the role of Italian labor laws and in particular of Article 18 of the Labor Code ("Identifying the Effects of Firing Restrictions through Size-Contingent Differences in Regulation", with R. Torrini, Labour Economics, Vol. 15, pp. 482–511, 2008). The fact that labor legislation is more binding beyond the threshold of 15 employees has created a disincentive against company growth. And the data reflect the existence of such an effect. At the same time, its size is modest and accounts for only a small share of the difference between the average size of Italian firms and that of other advanced economies.
Another factor behind the stunted size of Italian firms is certainly their financial ownership and control structure, revolving around family companies mostly financed by banking credit. Italian entrepreneurs have keenly focused on maintaining tight control of their businesses. This can become a handicap, if the potential for business growth is considerable. Growth phases require raising additional capital and bringing in new managerial talent. Not always these assets can be found within the controlling family. Opening ownership to foreign investors, such as venture capitalists and private equity funds, could help reaping growth opportunities in the full.
Summing up: small firms have long been drivers of growth for the Italian economy. But in the near future, it is necessary that Italian companies that have growth opportunities finally seize them, even at the cost of opening up capital and management by bringing in outsiders. Next to existing small enterprises, it is imperative that the number of medium and large enterprises grows. Only with a less skewed distribution of firm size, will Italian manufacturing and service companies be successful again in the international competitive arena.