Starting from the early 1990s to the end of the millennium, New York City transformed from an economically troubled city with no entrepreneurial
tradition to a burgeoning entrepreneurial center. This rapid growth was fol- lowed by an even faster decline and the eventual collapse of the newly emerged new media cluster after the stock market crash of April 2000.
Several explanations can be brought to bear on the emergence of this regional cluster. For example, population ecologists would view the case as one of the emergence of a new regional organizational population and would try to explain the growth of the cluster by recourse to the concept of population density (Aldrich, 1999; Baum and Oliver, 1996). Economic geographers would propose agglomeration economies as the primary force behind the growth of the cluster (Marshall, 1920; Storper, 1997).
Complexity theorists would say that the emergence and the growth of the cluster are due to the amplification of accidental early events in the history of the region through increasing returns and positive feedback loops (Arthur, 1994; Chiles et al., 2004). Others would propose that the emerg- ence of the cluster is associated with the presence of a financial bubble in the stock market and associated herd behavior on behalf of investors (Kait and Weiss, 2001; Mills, 2002). One or more of these processes may indeed be in place but the case discussion above points to another dimension of regional entrepreneurial change and that is institutional transformation.
The emergence of the new media cluster in New York City was accom- panied by major changes in beliefs and institutionalized practices of different types of actors. For example, governmental institutions that were previously doubtful about the potential of Internet entrepreneurship changed and provided full support to new media through various types of incentives. Real estate developers that initially did not prefer to upgrade their office buildings changed and directed their efforts to providing fully equipped office space to new media entrepreneurs. Venture capitalists who did not view Internet companies as favorable investment opportunities changed and established funds directed particularly at early stage Internet startups. The workforce in the area initially did not view employment in Internet startups as a favorable career choice but later on herds of quali- fied workers quit their traditional jobs to work for Internet companies.
Traditional media that previously ignored the Internet later on spoke about a ‘new economy’ and the new ways of doing business that the Internet created. Support service providers, such as accounting firms, law firms and consulting firms, changed their typical business practices and created a new
‘pay by equity’ system to cater to the specific needs of new media startups.
Similarly, venture capitalists and investment banks changed their criteria for screening investments and underwriting IPOs, respectively. After the NASDAQ crash, a deinstitutionalization process took place such that the newly institutionalized practices during the emergence of the cluster became unacceptable. These changes on behalf of different types of actor
each change became a trigger for other changes on behalf of interdepend- ent actors’ practices. Several lessons can be drawn from the case with respect to the institutional transformation process that is associated with these changes.
First, institutional transformation involves many different types of actors in addition to entrepreneurs. The case account above suggests that entre- preneurship does not take place in a vacuum, but rather a variety of inter- dependent actors, including local socialites, media institutions, real estate developers, financiers (including venture capitalists, angel investors and institutional investors), local workforce and government agencies, are impli- cated in the process of entrepreneurial transformation. Commercialization of a new technology requires entrepreneurs to mobilize contributions from a variety of actors (for example,financing from financiers, labor from the local workforce, coverage of positive outcomes from media institutions, facilities with appropriate infrastructure from real estate developers, incen- tives from the government and so on). However these contributions are not readily available since what the entrepreneurs would like these different actors to do are most likely in conflict with accepted norms of doing busi- ness in the region. In other words, lack of cognitive and sociopolitical legit- imacy around the new technology makes it difficult for entrepreneurs to mobilize required contributions.
An important factor in the initiation of institutional transformation is the presence of individuals from all these subgroups who are willing to take risks by engaging in actions that are not justified by the selection environ- ment associated with currently institutionalized practices. These are pio- neering individuals who see potential (that others do not yet see) associated with the emerging technology and are willing to take non-routine actions in an effort to initiate change. Accordingly, they constitute the micro foun- dations for macro transformation. These individuals are likely to have the characteristics, such as need for achievement, internal locus of control, high risk taking propensity and tolerance for ambiguity, that traits approach researchers have identified (Brockhaus and Horwitz, 1986). In the language of evolutionary economics, these individuals are the actors that introduce variation into a constantly evolving economic system and start shaping the selection environment in accordance with the needs of the newly emergent technology (Lambooy and Boschma, 2001). While the presence of such individuals is crucial for an entrepreneurial transformation, it is by no means sufficient.
The second important factor in the initiation of institutional transfor- mation is the presence or creation of a medium where these pioneering indi- viduals can come together and create an early community around the new
technology. In the absence of such a community, pioneering individuals remain as lonely, delinquent actors or dreamers who favor actions that are not in line with institutionally accepted practices. The establishment of an early community provides pioneers with a distinct identity which in turn isolates them from traditional industries and initiates the process of legit- imization of their non-routine actions (Garud and Rappa, 1994). Of par- ticular importance for the creation of an early community are networking events and the presence of actors who organize them. These actors are typ- ically highly connected individuals or institutions who use their connec- tions to establish ties between pioneering actors so that they can mobilize each other’s support. In this regard the presence of an active social scene and venues, such as bars, restaurants and so on, in the region where pio- neers can meet each other, exchange ideas and establish ties is crucial for institutional transformation. The case discussion illustrates how the early networking activities of actors such as Jamie Levy, Mark Stahlman, Jason McCabe Calacanis and Courtney Pulitzer, and the vibrant social scene in Downtown Manhattan proved to be influential for the creation of an early new media community in SA.
The third important factor in the initiation of institutional transforma- tion is the creation of media outlets that will distribute information about the emerging community, their activities or outcomes and the opportunities associated with nascent entrepreneurship to the world outside the early community. Traditional media may ignore the early community or other- wise present a negative picture of the actions of its members. Therefore cre- ation of new outlets by pioneers may be required. Media portrayals of key actors, businesses and their behaviors and outcomes affect the meaning making process by which the public constructs the social image or identity of an emerging community. A favorable social image created by the media generates support for participation in the activities of the early community members and helps establish cognitive legitimacy. Furthermore distribu- tion of information through media outlets facilitates others’ adoption of the non-routine actions of pioneers through social learning and hence extends the early community by the addition of new members. The more actors adopt the non-routine actions of pioneers, the bigger the early com- munity becomes and the more likely the non-routine actions of its members are to become institutionalized.
The very early adoption of non-routine practices may be facilitated purely by an interest in the new technology or even by people having nothing better to do, as illustrated by Rufus Griscom’s quote earlier.
However large scale adoption requires the presence of largely publicized, idiosyncratic success stories. For example, news about SA had been cir- culating through the new media community in New York but everybody
IPOs of a few SA companies, such as DoubleClick, Earthweb and TheGlobe.com. Idiosyncratic success stories provide proof that the non- routine actions of pioneers who were acting against institutionalized norms were indeed justified. In other words, the early community’s beliefs about the potential of the new technology were more than just a roman- tic pursuit of a non-realizable dream but rather the pursuit of a vision that will lead to profitable business establishments. Furthermore these types of success stories are likely to generate wide coverage by traditional media which helps dissemination of information to wider audiences beyond the region. Consequently, idiosyncratic success stories con- tribute in a major way to the establishment of cognitive and sociopoliti- cal legitimacy.
At this juncture it would be in order to discuss the role of financial markets on the emergence (and decline) of SA in particular and regional entrepreneurial transformation in general. The explosive growth of SA coincides with what is referred to as the dot-com bubble (Ljungqvist and Wilhelm, 2003). Whether SA would have grown so big (and as fast) in the absence of a strong stock market is a question whose answer will not be known. Perhaps the growth of the cluster would have been much slower and the cluster more sustainable. Regardless, the role of the stock market bubble on the area’s entrepreneurial transformation (particularly with respect to the decline and eventual collapse of the cluster) cannot be ignored. The positive investor sentiment associated with the strong stock (and IPO) market of the late 1990s influenced the institutional transfor- mation around the growth of SA in major ways.
First, it increased the availability of risk capital to the newly emerging entrepreneurial ventures and provided successful exit opportunities for risk capital providers. Investors commit money to venture capital funds only if VCFs can provide returns that are higher than the opportunity cost of capital (Gompers and Lerner, 1999). Given that VCFs’ returns materialize when they exit their investments, the status of exit markets is central to the operation of the venture capital industry. VCFs typically exit their invest- ments through IPOs, acquisitions, buybacks, liquidations or write-offs.
Amongst these options, IPOs provide the highest return (Soja and Reyes, 1990). The higher returns that IPOs generate make them the desired exit mode for VCFs. In fact VCFs consider alternative exit modes only when they judge that the company will not be able to do an IPO (Gompers and Lerner, 1999). Given that the most profitable exit mode for VCFs is IPOs, hot IPO markets – periods during which IPOs generate extremely high returns (Ritter and Welch, 2002) – are associated with high levels of new commitments to venture capital funds. In addition to the large amounts of
new commitments to venture capital funds, hot IPO markets create an environment in which VCFs can exit lesser quality investments through a successful IPO due to positive investor sentiment (Lowry, 2003) and the associated increased receptivity of the stock market to lower quality firms (Ritter and Welch, 2002).
A favorable response from financial markets in return signals opportu- nities and provides financial incentives to potential entrepreneurs.
Consequently, an entrepreneurial boom may start during hot IPO markets.
A caveat is that firms founded during such booms are not necessarily high quality firms. For example, Florida and Kenney (1990) argue that entre- preneurial booms are associated with a ‘startup mania’ in which entrepre- neurs with low quality ideas rush to the marketplace with copycat product designs to cash in on the latest technology fad. Similarly, Barnett et al.
(2003) provide evidence that entrepreneurial booms are associated with a more lenient entry selection environment and thus the entry of lower quality firms. Their evidence suggests that firms that enter during entre- preneurial booms experience higher death rates.
The hot IPO market during the Internet boom helped SA generate the idiosyncratic success stories that helped legitimize the emerging cluster;
on the other hand, it may be argued that it caused the institutionalization of unproductive practices. Venture capitalists and investment bankers abandoning the traditional criteria to screen investments and underwrit- ing IPOs are examples. These changes in financial markets in return facil- itated the institutionalization of a business model whereby SA firms would aim to raise large sums of money from public and private equity markets and then spend it on costly growth strategies that did not create performance outcomes, such as a steady stream of revenues, development of a proprietary technology or profits that markets traditionally favored.
The newly institutionalized business model for new media startups was characterized by rapid, excessive growth fueled by external capital towards fast IPOs. Accordingly, when the hot IPO market came to an end with the stock market crash and the newly institutionalized practices were no more acceptable,firms founded based on these practices started to fail.
The SA example thus demonstrates the extent to which macro financial markets can be influential in terms of determining a region’s path of entrepreneurial transformation. A strong stock market may speed up the process of regional growth to a great extent by channeling much needed investment money to entrepreneurial startups. On the other hand, tem- porary speculative bubbles, especially if they last a long time, may sys- tematically legitimize unproductive business practices in a self-reinforcing manner which may result in regional growth that is superficial and non-sustainable.
the importance of the creation of buzz and an early community around emerging technologies. The generation of new technologies in a region is a major policy problem in itself and several solutions, such as providing training to create a qualified local workforce and establishing local univer- sities and research institutions, have been previously proposed (McQuaid, 2002). In the case of SA the technology (that is, the Internet) was not created locally but its commercialization took place at a regional level due to the successful transformation of the institutional environment in the city.
New York was privileged as a metropolis and enjoyed urbanization economies due to the presence of many established industries, such as finance, entertainment and media. Accordingly, it housed many individu- als that had the potential to be pioneers during the commercialization of an emergent technology. The fact that the economic recession prior to the emergence of the Internet left most such individuals unemployed also helped. For regions that do not enjoy urbanization economies a major pri- ority should be generating diversity in the region so that pioneers who are willing to go against institutional norms would emerge. This could be achieved by making the region an attractive place to live for a diverse popu- lation. A nice physical environment, high quality education and medical facilities, entertainment venues where a social life can flourish and superior means of transport and communication are prerequisites. Beyond these infrastructural requirements, local governments need to keep a close watch on emerging technologies and facilitate the emergence of early communi- ties around promising new technologies. This may be achieved primarily through establishment of mentoring programs, organization of networking events and creation of outlets where outcomes of pioneers can be publi- cized. In addition government incentives should not be directed solely at entrepreneurs but also other actors whose contributions are needed for suc- cessful entrepreneurship. For example, government incentives were key in the establishment of the NYITC and the Plug ‘n’ go Program which facili- tated the transformation of the technology infrastructure in New York City office buildings.
More generally, developmental policies should be custom designed to meet a region’s particular needs and path dependent historical development (Lambooy and Boschma, 2001). This contrasts with the currently predom- inant approach of trying to find optimizing policies that have universal applicability. Local policies should co-evolve within the specific context of the regional system as policy makers improve their understanding of the self-organizing mechanisms at work in the region through a trial and error process, and implement incremental policies along the way that are aimed at short-term changes rather than long-term, pre-defined targets.
NOTES
1. http://www.ite.poly.edu/55case/begin.htm.
2. ADNY is a commercial organization that collaborates with the local government and other organizations in the area to provide Manhattan’s historic financial district with a premier physical and economic environment.
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