How golden is the golden age of small business?

Small businesses are the backbone of Britain or the lifeblood of the economy. Whatever the metaphor, it’s rare to hear politicians do anything other than heap praise on them. Last month, Lord Young proclaimed a “golden age of small business” when commenting on the rapid increase in the number of small firms over the last five years. Earlier this year, David Cameron said that the future of the economy depends on small firms. Not to be outdone, Labour promised to “unleash the full potential of small businesses”.

High hopes and expectations, then, but a number of recent reports suggest that the last few years have been anything but a golden age for British small business. 

SMEs suffer from low productivity

Last week’s report from the All Party Parliamentary Small Business Group found that small business productivity has fallen over the last five years. Although it has started rising again recently, it is still well short of where it was at the last election.

Screen Shot 2015-03-06 at 09.59.56

Turnover per worker in SMEs is generally lower than that of larger firms. For firms employing fewer than 250 people, productivity has been on the slide since the recession. For all but the largest firms, turnover per worker is lower in real terms than it was in 2002.

Screen Shot 2015-02-05 at 08.59.51

Chart via New Policy Institute.

Startups are not boosting productivity

New firms are supposed to innovate, disrupt markets, kill off tired old competitors and thereby increase overall productivity. There’s not much sign of that happening in the UK though.

The All Party Parliamentary Small Business Group notes that the rash of new businesses hasn’t done much for productivity.

Furthermore, the rate of start-ups in the UK does not appear to have a tangible impact on productivity levels. The rate of start-ups has remained steady since the downturn averaging just over 400,000 per year at a time when productivity growth has fallen.

Startups didn’t do much to boost the UK’s productivity before the recession either.

Research by NESTA found that, in the decade before the crash, 90 percent of the productivity gain came from existing firms doing things better and that there was little net productivity gain from new firms. Furthermore, a lot of high productivity firms left the market and were replaced by low productivity ones.

As the chart shows, the productivity of some new firms was more than offset by the low productivity of other new entrants. At the same time, high productivity firms were leaving the market, partly offsetting the productivity gains made from the exit of low productivity firms. This left older established firms to account for most of Britain’s productivity improvement before the recession.

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The paper concludes

This is a troubling finding given the emphasis being placed on entrepreneurship as a means of tackling Britain’s current economic predicament. The experience of 1998-2007 suggests that promoting new business formation in a general way will not do much on its own to increase productivity.

[T]his research is a useful reminder of a known but yet often forgotten fact. Quality matters more than quantity when looking at entrepreneurship. Therefore, policy makers should focus on supporting high-impact entrepreneurship rather than on increasing the overall number of entrepreneurs, which are often low productivity businesses.

Sussex University’s Paul Nightingale and Alex Coad found that most British business startups create churn rather than adding value. The typical startup, if it is still in business after 2 years, just puts another one out of business.

It certainly is the case that a small number of start-ups has a positive impact on the economy, but most of the time, for most of the firms, and for most of the performance metrics, the economic impact of entrepreneurial firms is poor.

The firms are marginal because they lack the ambition or capability to grow or innovate, have high death rates, and are poorly captured in statistics or academic studies. They are undersized because they lack the minimum efficient scale needed to perform on par with incumbents in their sectors and industries. As a result, they are poor performance: they have low productivity and low levels of innovation, and generate churn rather than economic growth.

As NESTA says, most startups are not particularly special from an economic point of view. Whatever else is going on in our economy, it’s not Schumpterian creative destruction.

More isn’t necessarily better

Although the UK has had a relatively high number of business startups in recent years, we are not producing high value entrepreneurs. Research by the Social Market Foundation found that this country has relatively few of the type of entrepreneur that has “a larger effect on the country’s economic strength”.

Screen Shot 2015-03-07 at 18.16.57A report by the Centre for Policy Studies showed similar results, even suggesting there might be a negative relationship between the number of self employed and the number of business builders in a country.

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Many small businesses are not well-managed

On the whole, British small businesses aren’t that good at managing people. The UKCES Growth Through People report published at the end of last month found that, while some SMEs are managing and developing people very effectively, a lot of them are not.

The study grouped firms with 5-99 employees into categories based on 4 dimensions of high performance working:

  • access (recruitment and resourcing)
  • „ability (workforce skills and training)
  • attitude (engagement and motivation) „
  • application (deploying skills)

It came up with 7 categories of employer. (The details of the study are here.)

  • Organisers score well for planning, but especially for their commitment to organisa- tion , while also being more likely to train and more likely to reward employees for their performance.
  • Developers are better than average in planning. Where they excel is in developing employees , and then giving them autonomy and rewarding their performance.
  • Recruiters are significantly better than average in planning, but they focus on reward- ing employees and giving them autonomy, but they are less likely to train.
  • Trainers are focused on training, while being above average in planning and below average in organisation. While they reward employees for performance, they give them limited autonomy.
  • Freeriders are above average at planning, but they avoid training and development and while they do tend to reward for performance, they give them limited autonomy.
  • Plodders are below average at planning and in most other respects – where they stand out is in their avoidance of performance-based rewards for employees.
  • Survivors are poor at planning and organisation, train little and give little reward for performance, and are average for autonomy.

The report finds that less than a quarter of small firms, accounting for less than a third of their employees, fall into the two high performing categories.

Screen Shot 2015-03-04 at 17.07.10

Those working for the Freeriders, Plodders and Survivors get very little in the way of development and make up more than a third of those employed by small businesses.

Drawing on data on small firms from the World Management Survey, UKCES found that, relative to other richer economies, management in small businesses is not particularly good. The UK’s score is brought down by a long-tail of poorly performing businesses.

Screen Shot 2015-03-04 at 18.05.14

UKCES comments:

[T]oo many businesses seem in a ‘low skill equilibrium’, limiting their ambitions by organising work around a low level of skill. These businesses use the minimum necessary skill from their employees, rather than seeking to fully utilise their talents, or develop them further, to drive the business forward.

These findings are borne out by a Department for Business, Innovation and Skills report on leadership and management practices published last week. Its study of firms with 5 to 250 employees also found a long-tail of poor performing businesses:

The data shows that for most skills and practices, there are ‘long tails’ of businesses that have relatively under-developed skills and which fail to implement best practices.

The increase in small business is mostly from very low turnover firms

Over the last 15 years, the number of businesses in the UK has risen steadily. Most of that increase has come from small businesses that only employ the owner. Of those, the majority have turnover below the VAT threshold of £81,000 per year.

The number of employing and VAT registered businesses has increased roughly in line with the size of the workforce. The share of employment among firms with between 1 and 500 employees is slightly lower than it was 15 years ago. The reason for the increase in small business employment is purely due to the rise in the number of owner only businesses.

Private sector businesses 2014

Source: BIS Business Population Estimates 2014

The UK is less of a small business country than it was in 2002

The increase in employment share for small business is entirely due to the rise in self employment. Take out the no-employee businesses and the share of employment in companies with fewer than 250 employees has fallen slightly since 2002.

Looked at in terms of money rather than people, the last decade or so has seen the rise of big business, not SMEs.

Screen Shot 2015-02-05 at 08.55.16

Chart via New Policy Institute.

Firms with fewer than 250 employees have seen their share of turnover fall from 58 percent in 2002 to 48 percent in 2014. Businesses of over 250 workers now have a greater share of the market.

All things considered, then, talk of a golden age of small business sounds a bit premature. Sure, many of our small businesses are doing well but a lot aren’t. The recession seems to have hit them especially hard. In most of the political discussion around small businesses, it’s taken as read that they are a Good Thing and that having more of them must therefore be a Good Thing too. But many of Britain’s small firms are poorly managed SMEs or marginal microbusinesses. On current evidence, most are unlikely to do much to improve the country’s productivity.

All this is a bit un-PC at a time when it seems to be obligatory for politicians to talk up small business. A couple of years ago, the Economist commented:

It is shrewd politics to champion the little guy. But the popular fetish for small business is at odds with economic reality.

When you look a little more closely, the golden age of small business loses a lot of its shine.

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9 Responses to How golden is the golden age of small business?

  1. I think its pretty clear that most small businesses are self employed people who are unlikely to employ others, and often with low value skills. Many will not even be working full time (either by choice or from lack of work). Wwhat happens to the other numbers if you strip out “marginal micro-businesses”.

    Another problem is that direct comparisons of turnover per employee between big businesses and SMEs are highly distorted. Turnover per employee is higher in capital intensive businesses, and the proportion of capital intensive businesses is different. It would be more useful to compare productivity between big businesses and SMEs in the same line of business (not just in the same indsutry, but providing similar products or services).

  2. sdbast says:

    Reblogged this on sdbast.

  3. rogerh says:

    “High impact entrepreneurship” is just the sort of buzzword the useless classes adore. A new Apple or Intel or Mercedes Benz? So inconvenient – all that building roads etc. What we get instead is a few apps or estate agencies – nice clean activities. So do we have the right environment for entrepreneurship – or would a potential entrepreneur do better in property development or privatising public services?

    Anyway, do we really expect productivity ( rate of output per unit of input) to be uppermost in the mind of an entrepreneur? Don’t think so, the idea is to get something going and selling, details like efficiency and productivity come later. Model T anyone?

  4. Bernie Samson says:

    Whatever the meaning of high-value entrepreneurship, it is interesting that Sweden seems to be doing so well. It certainly always seems to punch above its weight in the engineering and life sciences fields that I am familiar with. I see a far more vibrant community of entrepreneurial businesses in those sectors in Sweden than I do here.

    A part of it might be related to what they call the “teaching exception” in Swedish patent law. If a teaching academic makes an invention in his research, he has the first right to apply for a patent to it and thus build a business around it. In the UK (and in fairness, most of the world) the university would own the invention, though most would be entitled to a small cut of any commercialisation value.

    The UK way encourages academics to pass inventions to their technology transfer office and let them get on with any commercialisation. The Swedish way encourages the academic to take ownership of the technology and to drive the commercialisation personally. Clusters of investors sit around the universities in a way that we don’t see in the UK and I would imagine that the attraction of starting a career in academia is viewed differently in Sweden to how it is here.

  5. Dave Timoney says:

    The sub-optimality of SMEs in the wider economy is hardly news. If we increased the number of SMEs we would, ceteris paribus, depress productivity, average wages and profit margins. We’d also adversely affect the balance of payments, reduce R&D and lower national “human capital”. SMEs are parasitical, in the sense that they provide services and parts to larger businesses, or to employees of those larger businesses. It is the big firms that drive GDP growth, productivity (and thus wages), and human capital formation. Given all this, the question to ask is: what ideological role do SMEs play?

    One role is provide a pro-capital excuse for nationalism. If we valorised large business rather than small, there would be no desire for an EU referendum, we’d be encouraging immigration, and we’d probably have fully-subsidised childcare. Another role is to convince us that ceaseless struggle (the reality for most small business owners) is our rightful lot and that we should cherish our independence and “liberty” (in reality, most SMEs could do with external input and often benefit from the constraints of legislation – the “troubleshooter” TV documentary is the dramatic clash of small vs big capital).

    Perhaps the most pernicious ideological role is as an ideal of property – the small business as inheritance. In this regard, the rise of the exemplary small business has paralleled the rise in the value of house prices. Far from being a sign of a “golden age”, the increase in SMEs is a sign of the increasing dominance of unproductive capital and the growth of the rentier class.

    • P Hearn says:

      “SMEs are parasitical, in the sense that they provide services and parts to larger businesses…”

      ‘Parasitic’ is a bit harsh. ‘Symbiotic’ is perhaps a better word: many large businesses rely heavily on small companies, often to do really quite tricky things they struggle with themselves.

      There’s not doubt a firm is more productive than a man in a shed, and God forbid we descend into a nation of such tiny enterprises, but a mix of big and small is healthy and provides some dynamism to the system.

    • NeilW says:

      Large firms do not drive productivity. What they do is use their oligopolistic position to extract value out of the rest of the chain without paying for it – using working capital tricks and other monopoly tools like not paying their staff fairly for the hours they work.

      It’s an illusion that just makes people miserable and the categorisation of these sort of studies promote that viewpoint.

      Large businesses are invariably entropy ridden inefficient political melting pots that stay around because of scale economies and tax backhanders.

      What you have in effect is a set of Feudal Lords and a load of Serfs concentrating exclusively on GDP as a measure rather than the happiness and wellbeing of the population.

      The smaller companies don’t die quickly because as soon as they cry ‘skill shortage’ another batch of visas is immediately issued. There is no ‘skill shortage’ anywhere until wages are somewhere near the 90th percentile. What there is is a load of people who want God on a Stick for 10p.

      And that will continue until labour has an alternative provided to them where they can choose not to work for private capital until they improve their offer. At which point things will start to equalise – as they would if there were effective Unions of the same size and structure as the firms their members work for.

      • Graeme says:

        I agree with Neil insofar that large businesses in many sectors are rentiers or ejoy some monopoly pricing power.

        However, turning to large unions as a solution just creates another group of monopolists, hardly a route to efficiency or competition. Visa restrictions are almost as bad as they drive up prices and provide an incentive to relocate – if the labour cannot come to you, you can go to the labour.

        I have blogged bout related issues at some length, so I will not repeat myself, but the solution is to look at regulations and other problems that keep smaller businesses from enjoying a level playing field. Looking at how to encourage high value start-ups would be good as well.

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