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April 03, 2012

Small Business: Good or Bad?

Last November I discussed two diverse views about big business in a post entitled Big Business: Good or Bad? Venture capitalist Luke Johnson took a rather dim view of big business. He wrote, "I used to believe that the great divide was between the public and the private sector: between state and commercial interests. But in truth the real difference is between giant and small organisations, whether they are for profit or not; between huge bureaucracies and owner-run outfits." ["Why big businesses are bad for business," Financial Times, 18 October 2011] As I wrote in that post, "Clearly Johnson believes that size matters and, from the headline of his column, he apparently thinks that big is bad. What seems to bother him most about big companies is their lack of humanity – their disconnectedness from community." On the other end of the spectrum was Charles Kenny, a fellow at the Center for Global Development and the New America Foundation, who has a very different view of big businesses than Johnson; especially when it comes to job creation. He claims, "Big companies are … the key to growth." ["Rethinking the Boosterism About Small Business," Bloomberg BusinessWeek, 28 September 2011]

Frankly, Kenny's arguments are pretty strong and even Johnson ended up admitting that "certain sectors require huge amounts of capital, such as car manufacturing or mining. Others, like water supply, have to be monopolies. And global enterprises can achieve economies of size that they pass on to the consumer. So I readily accept that big business can be beneficial to society – and is a fact of life. But I still hope that one day the relentless tide of consolidation is reversed, and both government and industry revert to a more human scale." A recent article in The Economist takes another look at the big business versus small business debate and concludes that "small firms are less wonderful than you think." ["Small is not beautiful," 3 March 2012] Before getting into the discussion, let me clarify the title of this post. There really isn't an inherent moral dimension (i.e., goodness or badness) associated with most businesses regardless of their size. The title was selected as a foil to my previous post and to Johnson's headline that declared that big business is bad for business.

The primary focuses of The Economist article are productivity and growth. It begins by acknowledging there exists a prejudice against big business (like the one expressed by Johnson). It states:

"People find it hard to like businesses once they grow beyond a certain size. Banks that were 'too big to fail' sparked a global economic crisis and burned bundles of taxpayers' cash. Big retailers such as Walmart and Tesco squeeze suppliers and crush small rivals. Some big British firms minimise their tax bills so aggressively that they provoke outrage. Films nearly always depict big business as malign. Tex Richman, the oil baron in the latest Muppets movie, is so bad he reads The Economist. Small wonder that whenever politicians want to laud business they praise cuddly small firms, not giants. It is shrewd politics to champion the little guy. But the popular fetish for small business is at odds with economic reality. Big firms are generally more productive, offer higher wages and pay more taxes than small ones. Economies dominated by small firms are often sluggish."

It almost sounds like The Economist is agreeing with Mitt Romney's statement that "corporations are people too." The claims it makes about big business echo the facts presented by Kenny and discussed in my previous post. To drive home its point, the article looks at southern Europe. It reports:

"Consider the southern periphery of the euro area. Countries such as Greece, Italy and Portugal have lots of small firms which, thanks to cumbersome regulations, have failed lamentably to grow. Firms with at least 250 workers account for less than half the share of manufacturing jobs in these countries than they do in Germany, the euro zone's strongest economy. A shortfall of big firms is linked to the sluggish productivity and loss of competitiveness that is the deeper cause of the euro-zone crisis. For all the boosterism around small business, it is economies with lots of biggish companies that have been able to sustain the highest living standards."

In other words, small businesses aren't bad, but they don't promote growth. Kenny stressed this point when he wrote, "The majority of small business owners say that's precisely their intent—they didn't start a business for the money but for the flexibility and freedom. Most have no plans to grow." Since economic growth is the key to prosperity, you can understand why The Economist appears to be on the side of big business. The article continues:

"Big firms can reap economies of scale. A big factory uses far less cash and labour to make each car or steel pipe than a small workshop. Big supermarkets such as the villainous Walmart offer a wider range of high-quality goods at lower prices than any corner store. Size allows specialisation, which fosters innovation. An engineer at Google or Toyota can focus all his energy on a specific problem; he will not be asked to fix the boss's laptop as well. Manufacturers in Europe with 250 or more workers are 30-40% more productive than 'micro' firms with fewer than ten employees. It is telling that micro enterprises are common in Greece, but rare in Germany. Big firms have their flaws, of course. They can be slow to respond to customers' needs, changing tastes or disruptive technology. If they grew big thanks to state backing, they are often bureaucratic and inefficient. To idolise big firms would be as unwise as to idolise small ones."

In the end, the article concludes that it is not size that matters but growth. It continues:

"Rather than focusing on size, policymakers should look at growth. One of the reasons why everyone loves small firms is that they create more jobs than big ones. But many small businesses stay small indefinitely. The link between small firms and jobs growth relies entirely on new start-ups, which are usually small, and which by definition create new jobs (as they did not previously exist). A recent study of American businesses found that the link between company size and jobs growth disappears once the age of firms is controlled for. Rather than spooning out subsidies and regulatory favours to small firms, governments should concentrate on removing barriers to expansion. In parts of Europe, for example, small firms are exempted from the most burdensome social regulations. This gives them an incentive to stay small. Far better to repeal burdensome rules for all firms. The same goes for differential tax rates, such as Britain’s, and the separate bureaucracy America maintains to deal with small businesses. In a healthy economy, entrepreneurs with ideas can easily start companies, the best of which grow fast and the worst of which are quickly swept aside. Size doesn't matter. Growth does."

When it comes to growth and job creation, the sector in which a business operates matters more than size. For example, Kenny reports:

"Most small employers are restaurateurs, skilled professionals or craftsmen (doctors, plumbers), professional and general service providers (clergy, travel agents, beauticians), and independent retailers. These aren't sectors of the economy where product costs drop a lot as the firm grows, so most of these companies are going to remain small."

On the other hand, Emily Maltby reports, "Small businesses that heavily use technology, from back-end software to social-media websites, are highly successful job creators, according to a research report released ... from the Technology CEO Council. The findings, culled from a variety of third-party studies on entrepreneurship, point to robust job growth at small tech-savvy enterprises." ["Are Small, Tech-Savvy Firms Top U.S. Job Creators?" Wall Street Journal, 6 March 2012] Maltby continues:

"Amid the political debate on how to spur hiring, the TCC report was released to legislators and the general public from the nation's capital. The report suggests that a series of policy changes, including removing immigration barriers for skilled workers and reforming the U.S. corporate tax system, could help U.S. entrepreneurs build their businesses and expand them more rapidly. 'There is a certain type of company that is creating an enormous number of jobs,' [Michael Dell, founder of Dell Inc. and chairman of TCC], says. One type: Web-knowledgeable small and midsize firms in industries ranging from retail to manufacturing. They create twice as many jobs as companies that have limited Internet use, according to a McKinsey Global Institute study mentioned in the TCC report."

Maltby reports that McKinsey study is supported by another study conducted "by researchers at Brandeis University [that] shows that technology-intensive service firms added jobs at a rate of 5.1% from 2001 to 2009, while employment overall shrank by .5%." The rub, of course, is that the jobs are not the blue collar jobs that have been lost in huge numbers over the past decades. A worker can't step off of production line and into a technology-intensive service firm without some retraining. Maltby points out that even though tech-savvy firms create jobs, they don't create them in the same quantity as new firms did in the past. She writes:

"Technology makes young companies more competitive, TCC states in the report. For example, online crowdfunding channels like Kickstarter.com and IndieGoGo.com can help start-ups land financing to grow. And daily deal companies like Groupon Inc. and LivingSocial Inc. can help small businesses connect with new customers. But other studies recently have shown that adopting technology keeps firms leaner because entrepreneurs can do more with less. Importantly, there's evidence that new businesses getting off the ground are doing so with nearly half as many workers as they did a decade ago. [A recent story] by The Wall Street Journal's Angus Loten noted that startup-ups are now being launched with an average of 4.9 employees, down from 7.5 in the 1990s, according to the Ewing Marion Kauffman Foundation, a Kansas City, Mo. research group."

The Economist and Kenny would probably take some umbrage with the study since Catherine L. Mann, a professor of global finance at Brandeis, whose research appeared in the TCC report, notes that her work "focuses on net job creation, rather than growth of individual companies." Growth appears to the most important differentiator for companies that are going to have the greatest impact on the economy in the long run. Nevertheless Mann defends her work claiming "even if technology-driven service firms are staying leaner, ... there may be more of them today because barriers to entry are lower than ever. Technology has allowed companies to launch on a shoestring budget and grow more efficiently." Maltby's article points out that even though tech-intensive firms are creating jobs technology is also eliminating some jobs. She writes:

"Among the technology-intensive manufacturing firms in [Mann's] study, ... jobs contracted 34.3% in the 2001 to 2009 period. Mr. Dell acknowledges that technology can eliminate the need for some jobs. He points to the transformation of the agriculture industry in the U.S., which was once labor-intensive and is now much more efficient despite having fewer employees. 'Every time a certain machine is created, there is job displacement,' he says. 'There's no question jobs have to evolve. We have to march forward and advance skills.'"

In the end, I find the arguments presented by Kenny and The Economist to be the most convincing. Although my company is a relatively small, if growing firm, it works and partners with big companies. It is the work with the big businesses that is allowing my business to grow -- and in the end growth matters.

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