Cities have always been the crucibles of innovation. They import food, energy and people, and export progress in the form of ideas, technology and art. Urban density provides the matrix in which innovators find market niches, while urban diversity brings new intellectual ingredients into collision; half of Silicon Valley’s startups have had at least one immigrant on the founding team. Cities are also the factories that produce new consumers. Worldwide, the increasing size of cities will produce a billion new consumers by 2025, according to a McKinsey study, and urban incomes are already rising faster than the number of new households. McKinsey estimates that by 2025, urban consumers will add US$20 trillion in new annual spending to the world’s economy.

That urban wealth grows faster than population is an example of what physicists call “superlinear scaling,” and it applies to everything that happens in a city. The only way to keep these ever-greater outputs ahead of finite resource inputs is to continuously reengineer how almost everything is done. The cycle of innovation accelerates with the city’s size, which may be why people really do walk faster in large cities.

Urbanization is the true mother of invention because it creates the necessity for invention. Cities invent the future in order to survive.

You might think that the prospect of a billion new consumers spending US$20 trillion a year would have corporate CEOs re-engineering their companies around urban centers, but most of the world’s largest companies are resolutely uninterested in the world’s largest cities. A McKinsey survey of nearly 3,000 top executives around the world found that “fewer than 20% make location and revenue decisions at the city level.”  Three out of five described cities as “irrelevant” to their companies’ strategic plans.

While corporations are ignoring the rise of cities, most banks are missing a tectonic shift from tangible assets to intangible assets. It’s easier to value things like buildings and machinery than processes and software, never mind that intangibles are now by far the larger side of the ledger and 80% of the US economy is services.

Big cities get smarter. Big companies don’t. There is evidence that the typical large corporation can’t keep up with the innovation cycle that urban growth demands. Where large cities create wealth at superlinear scale, becoming more productive as they grow, large companies become less productive with size. When physicists Geoffrey West and Luis Bettencourt analyzed data from 23,000 publicly traded companies they found that as companies grow, profit per worker attenuates.

For CEOs riveted on share price, transactions have more allure than investment; and more cash often goes to repurchase stock than to sowing new seeds of growth. This puts many corporate chiefs on the wrong side of the Innovator’s Dilemma, doing more business with established institutional partners – because that’s where the easy money’s always been – and willfully blind to change coming from the margins.

It’s a sure bet that the trillion needs of the new urban consuming classes will be met, but maybe not by the big names we expect. The legacy institutions of the 20th Century are still organized for a mass market that no longer exists. Marketing departments are flummoxed by the heterogeneity of urban society with its myriad market segments, income pyramids, non-standard distribution channels and behaviors.

Laboratories for wealth creation. Cities are Petri dishes for small companies that begin by filling unique local needs. As urbanization accelerates, niche markets gain critical mass, allowing the most successful small companies to outflank traditional competitors on every side.

Similarly, new kinds of financial institutions like our company, Next Street, are springing up to serve urban enterprise. These companies are willing to do the hard work to value intangibles like ideas and potential. Many operate more like technology firms than traditional financial institutions.

Mindset over mass. Great corporations looking to grow at the pace of the world’s great cities need to look beyond their own manifest advantages in capital, systems, and scale. They need to think differently. What distinguishes the most successful urban companies is not their assets, it’s their outlook:
 

• Social purpose. The needs of the surrounding community are obvious to the urban enterprise in a way that they are not to a global corporation. Urban CEOs invest proportionately more in pay, training and benefits than do their Fortune 500 counterparts.
   
• Collaborative relationships. Working inside clients’ businesses helps firms like Next Street learn to recognize value in new forms. (It’s worth noting that most tech startups don’t get money from banks; they get it from specialized venture firms that usually include successful tech entrepreneurs who know the value of code.)
   
• Continuous experiment.  In the mass-market era, long planning cycles helped corporations squeeze risk out of mass market-scale investments. In the age of cities, a long planning cycle becomes the risk. Rapid prototyping, in-market testing and continuous iteration help urban innovators learn what works and scale up good ideas quickly.
   
• Connection. The future belongs to the best networkers – far beyond traditional supply chain partners. Cities contain worlds of for-profit and non-profit organizations, government and quasi-governmental agencies, as well as a host of non-official actors that fly below the radar of big business.  Even favelas are organized, in ways that are invisible to outsiders.

Large institutions understandably shy away from the unruly street-level scuffle where the needs are greatest and new business models are being created. With more to protect than to gain, some find the familiarity and security they require by trading with their peers. A few, more far-sighted, are testing the urban ground through partnerships and, like cities themselves, innovating to survive in a new era.

(c)TLQmedia 2013