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.
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.
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.
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”.
A 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.
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.
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.
[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.
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.
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.