Skip to main content
india_goods001
Up Front

Do multinational corporations play a role in entrepreneurship in developing countries?

For many, the first rule of policymaking is to avoid administering medicine that could be worse than the disease itself. When it comes to spurring entrepreneurship in developing countries, a key symptom of the “disease”—or market failure—that impedes the emergence of new firms is a lack of finance when excessive risk is involved. A dearth of entrepreneurs means there are few investors (because they cannot hedge their risk), and in the absence of investors there are few entrepreneurs. Thus, a natural course of treatment to remedy the problem is to have the government share risks with investors, or to assume the risks by investing in firms, generating a big enough mass of startups and investors. This, in turn, would allow for more complete risk capital markets.

However, this policy is also risky. Even if investors get public subsidies, the (likely) failure of the pioneers is enough to alienate potential followers to follow suit and invest in that market.

So what approach might prove to be a more effective “medicine”? Is there a role for private sector actors, besides investors? Well, in multinational corporations (MNCs), there may be.

MNCs are typically larger and more productive than domestic firms, and are usually willing to invest in local markets. MNCs in many countries are playing an important role in not only buying new technologies, but also in hosting new firms through incubator programs. But they can do more: they can invest on a bigger scale in technology start-ups related to their line of business. In this setting, startups in developing countries can benefit hugely, not only from the availability of new sources of funding, but also from working within the fold of a larger and more productive firm with a record of investing heavily in research and development (R&D) and innovation. Simultaneously, MNCs can now outsource some of their corporate research and development efforts by investing in local startups.

This approach might also solve the problem of coordination failure. Unlike many investment firms, MNCs are already there, and will remain there. These larger international companies have already shouldered large fixed costs to set up a foreign subsidiary, and given exiting would incur further fixed costs, they’re unlikely to leave with any haste. Given their larger scale, MNCs can hedge their risk capital portfolios by investing in startups across a wide spectrum of locations where they operate, using their local subsidiaries to monitor their investments. Thus, negative returns in a risky investment portfolio at the local level wont jeopardize their stay in the market. This will eventually increase the mass of startups, and potentially attract risk capital investors to that market.

Potential entrepreneurs might worry this approach could exclude their new firms from future rounds of investment, or deny them the opportunity to sell their technology to an actor other than the multinational (such as a competitor, for instance). Nevertheless, incorporating a healthy dose of legal frameworks could reduce these concerns. For instance, contracts may be written to incorporate some form of “right of first refusal” clause, in which the MNCs can prevent the early selling of an incubated startup to a competitor only if the former matches the offer the latter is making.

So why haven’t MNCs engage in these strategic bets, so far? In fact, they have. According to CBInsights.com, corporate venture capital has grown dramatically in the last few years, from investing $5.5 billion in 2011 to $12.3 billion in 2014 in the United States alone. Furthermore, multinational firms such as Google, Microsoft, and Citi have also created corporate incubators to host new firms in several locations across the globe. Scaling up this approach in developing countries can potentially be a key factor to spur entrepreneurship and innovation , perhaps, with some public support to provide proper institutional frameworks and to share some risks with these MNCs, particularly in places where markets are smaller.

MNCs are believed to be highly beneficial for developing countries in terms of bringing employment opportunities and new technologies that spillover to domestic firms. Furthermore, MNCs often benefit from government subsidies, which could in future be linked to investment in local firms. Through their involvement in investing in local startups, MNCs can play an important role in building an entrepreneurial ecosystem in developing countries and, if done correctly, might solve the typical coordination failure that most governments struggle or are unable to cure.

This blog post benefited from conversations with Oran Kochavi, VP TerraLab Ventures (Israel).

More

Get daily updates from Brookings