Creating a company without adding jobs

In the US, the number of nonemployer businesses grew by 33.8 per cent between 2000 and 2010

When Mike Farmer started a digital search company in 2004, he had a staff of 10. Today, in his third startup, he has one employee: himself, aided by seven contractors working more or less part-time. His budget, like his head count, is smaller, and by his account the new model is much more sustainable.

“I think we’re all headed towards an agent economy, where everyone becomes an agent or a service provider instead of an employee at some big corporation,” said Farmer, whose mobile search app, Leap2, now has 10,000 users. “That’s just how the world is evolving. It’s like telecommuting, but it’s taken to the level of telecompanies.”

For more than a decade, startups have been getting leaner and meaner. In 1999, the typical new business had 7.7 employees; its counterpart in 2011 had 4.7, according to an analysis of Labour Department data by E J Reedy at the Kauffman Foundation, a research organisation focused on entrepreneurship.

The lean model bodes well for companies like Leap2 that hope to become power players with much less manpower. With a work force of contractors, Farmer said Leap2 could “dial it up and dial it down” as business demanded without having to spend money unless it was necessary, improving the company’s chances of survival. But the implications for the US work force are worrisome, and may help explain why economic output is growing much faster than employers are adding jobs. Last Friday, two days after the issue dominated the first presidential debate, the Labour Department will release the unemployment rate for September along with payroll gains, which economists predict will barely keep pace with new people joining the labor force.

For decades, new companies have produced most of the country’s job growth. Without startups, the country would have had a net increase in jobs in only seven years since 1977. The number of people employed by new businesses peaked in 1999, the height of the tech bubble, and has fallen by 46 per cent since then, to 2.5 million in 2011, creating a slow leak in job creation that has proved difficult to plug. “There’s this idea that we can somehow rely on entrepreneurship to get us out of the job crisis,” said Scott Shane, an economics professor at Case Western Reserve University. “That’s getting harder and harder, considering there are fewer and fewer of them, and they’re each employing fewer people.”

The decrease in startup size is probably driven by some combination of technology, changes in management philosophy and tighter financing. Farmer, an affable, bearded 43-year-old prone to long bouts of giddiness when talking about his company, co-founded Leap2 in 2010. He boldly declares that his app is revolutionising search on mobile phones by integrating regular search engine results with local listings, feeds from Twitter and other social sites, and breaking news.

Cheap rent

He manages this revolution from a tiny, shared office in Kansas City with a few desks and a couple of white boards. There are no Foosball tables, pinball machines or other frivolities that are common in Silicon Valley startups. Rent is cheap. Perhaps more important, the rest of the overhead is, too.

Leap2 rents server space, which means Farmer did not need to hire people to build and maintain servers, as with his earlier startups. The company has access to programming language from Bing, Twitter and other established companies, so it does not have to build a new search engine to crawl the Web and index myriad Twitter posts.

Leap2 also does not have any back-office workers to handle things like travel arrangements, human resources or accounting. That is partly because there are now Web-based resources to help with these functions, and partly because Leap2’s contracted developers pitch in on many of these tasks.

“We recruit athletes, not position players,” Farmer said, meaning he believes his contractors can fill more than one role. The desire to minimise back-office work is so common now that Leap2’s co-founder, Dan Carroll, decided to invest in a company called Rocket Fuel that helps new firms handle administrative work and other tasks – “the kind of things once upon a time you maybe had an office manager figure out,” said Carroll. Carroll brags that Leap2 has been able to spend “almost 100 per cent” of its budget on programming talent. That spending goes further because Leap2’s developers, as independent contractors, do not get benefits. Most of Leap2’s developers have staff jobs at bigger, established companies that provide health insurance. Because most of them have children, they tend to do their work for Leap2 after about 9 pm. Though the company’s developers are mostly local, they interact primarily by instant message or Skype. They meet in person once a week over dinner, and one, Michael Marley, who works on contract through the Allen Group in Norwalk, Conn., calls in via Skype. A monitor showing his face is propped up on a chair to suggest he is in the room.

“You used to hear about inventors tinkering in their garage,” said Tyler VanWinkle, the company’s product manager. “Skype is the new garage.” This focus on leanness and streamlining is not limited to high-tech startups, according to Eric Ries, the author of ‘The Lean Startup.’ He said the revolution began in Japan in the 1980s, when manufacturers learned the value of creating products in smaller batches and refining them more often, and has since spread to other industries. “Now you can rent the means of production instead of owning them,” he said.

All of these factors should make it easier to start a business, suggesting that the volume of new companies would help make up for the smaller head count at startups. That has not been the case in recent years, however.

Over the last five years, the number of new employer businesses, including new franchises for existing companies, fell by 20 per cent, to 5,36,445 in 2011 from 6,67,341 in 2006. But there was tremendous growth in businesses like Leap2 that are operated by one person, partly reflecting the fact that more Americans are going it alone as consultants and contractors. The number of nonemployer businesses grew by 33.8 per cent from 2000 to 2010, according to the Census Bureau. Some economists refer to this phenomenon as jobless entrepreneurship. Experts do not know whether or how quickly the number of startups will recover, particularly because such businesses have often been financed through home equity loans and so many homes remain underwater, according to Tim Kane, chief economist at the Hudson Institute, a conservative research organisation.

Having raised $4,70,000 in its first two years of existence, Leap2 is working on its first substantial round of venture capital, and is aiming for $1.5 million more. Farmer said he hoped to hire some of his developers eventually as full-time staff members, perhaps six by the end of the year.

But even then, Leap2 expects to keep plenty of developers on contract, on Skype and around the country, to stay lean, efficient and nimble. Carroll gave as an example one talented programmer who might help Leap2 with smaller projects while working on his own startup.