Friends or Foes:

The Spatial Dynamic between 

Established Firms and Entrants

An Office of Advocacy Working Paper

By Lawrence Plummer, University of Colorado, [35] pages. Under contract SBAHQ-06-Q-0015

Purpose

State and municipal economic development agencies are increasingly designing policies to nurture 

and support home-grown businesses to achieve their 

growth objectives. 

This research explores the impact on established 

firms of new local entrants. It evaluates the competing views that new firms increase competition and 

thus hurt existing firms and, on the other hand, that 

new entrants provide positive spillover effects that 

benefit everyone, including existing firms.

Overall Findings

In the first year of a new firm’s existence, before the 

entrant has time to contribute to positive local effects, 

its entry is more likely to hurt the financial performance of existing firms. By the third year after entry, 

however, the effect on the financial performance of 

existing firms is positive. In the short term, entrants 

are foes and in the long term, entrants are friends.

Highlights

• The average return on assets for the sampled 

377 focal firms was negative during the 1990 to 

2004 period. This is consistent with the belief that 

newly public firms often take a few years to show a 

positive financial return.

• In the year of local business entry, the effect on 

existing firms’ financial performance (return on assets) 

was negative. One and two years following entry, the 

impact subsided (was not statistically significant).

• The three-year lag effect of entrants on existing 

firms was positive (and statistically significant). This 

is consistent with the belief that in the first two years 

or so of a firm, they produce limited positive spillover effects as they are struggling for survival, but 

eventually positive spillover effects occur.

• Technology-oriented existing firms are less 

affected by entry than are nontechnology-oriented 

existing firms.

• Smaller first-year local entrants cause less damage to existing firms. Existing firms’ financial performance in the entrant’s first year decreased as the 

average size of the entrant increased.

• The research points out that existing firms may 

want to conduct activities that nurture new entrants 

to improve their own future financial performance. 

Results suggest they would do well to befriend other 

firms in the immediate area. 

• The control variables showed little statistical 

significance throughout the econometric models (this 

was understandable because the lag of the independent variable was used as a dependent variable to 

ward off spurious results).

Scope and Methodology

The research uses 377 firms that filed initial public 

offerings from 1990 to 1993 as the basis for existing 

firms and follows their financial performance from 

1990 to 2004. Employer establishments entering a 75-

mile radius of the 377 existing firms were considered 

entrants.

Econometric models were used to test the impact 

of various lag intervals of entrants on the return of 

assets for 377 firms. Control variables included a 

technology component (R&D expenditure), firm 

advertising expenditures, and the area’s business 

environment (business size and density). 

February 2007 No. 293

This report was developed under a contract with the Small Business Administration, Office of Advocacy, and contains information

and analysis that was reviewed and edited by officials of the Office of Advocacy. However, the final conclusions of the report do not 

necessarily reflect the views of the Office of Advocacy.
Two side projects were also evaluated The technology component was tested to see if the technology intensity of the existing firm had an effect on its 

financial performance impact from entrants, and the 

impact of the average entrant’s size on existing firms 

was studied.

The researcher procured special tabulations from 

the U.S. Census Bureau on establishment births and 

utilized Compustat data for financial information as 

the basis for data in the models.

This report was peer-reviewed consistent with 

Advocacy’s data quality guidelines. More information on this process can be obtained by contacting 

the Director of Economic Research via email at 

advocacy@sba.gov or (202) 205-6533.

Ordering Information

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Small Business Administration's Office of Advocacy 

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