The Economics and Management of Small Business

An International Perspective

Graham Bannock

• Publisher: Routledge
• Year: 2004
• ISBN:
  9781134305797
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Despite the seemingly relentless march of the multinationals, small businesses continue to thrive across the globe and form a vital part of all successful economies. The Economics and Management of Small Business provides an international perspective on this important topic, and includes many useful pedagogical features such as questions for discussion, international case-studies and empirical research.

Graham Bannock's accessible writing style is key to the reader gaining a good understanding of this important area, and students of small business and entrepreneurship courses will find this book extremely useful.

1 Defining and counting small firms

Definition

How you define ‘small business’ is not an issue of great importance in the economics of the subject, although it raises interesting questions, and at least one book has been entirely devoted to the subject (HERTZ 1982). The essential point is that ‘small’ is a relative, not an absolute concept and where the line is drawn in the continuum of businesses from ‘momma and poppa’ shops to General Motors is inevitably arbitrary.

The reasons why people are interested in small business have to do with the juxtaposition of its perceived desirability and vulnerability. Small and medium-sized enterprises (SMEs) are desirable because they promote competition and employment and because a few innovate and grow into large firms that potentially generate even more of these things. There is more: starting a small business can be a means for an individual to achieve independence and self-expression and even wealth; and small firms serve wider, and perhaps less well understood social purposes – for example, by recycling local expenditure and savings into communities in ways that large firms may not, or by keeping streets alive at night and thus helping to reduce crime (see JACOBS 1961). The presence of SMEs also helps to avoid an overconcentration of political and economic power, a role traditionally greatly valued in the United States (BRUCHEY 1980; BUNZEL 1962).

The vulnerability of small firms arises virtually by definition from the small scale of their human and financial resources. Hundreds of thousands of firms open and close each year in the major countries, the vast majority of them very small. Businesses close for a variety of reasons and, as we explain in Chapter 2, starting a small firm can be a fairly risky thing to do. Certainly, the smaller and younger the firm, the more likely it is to close: about two-thirds of closures take place within three years of start-up. Evidence of failure is evident enough on city streets, where hopeful entrepreneurs spend money on fitting out new small shops and restaurants only to close again, perhaps their capital exhausted, when the firm cannot make money. These, however, are only the more visible signs of the vast ‘churning’ that goes on all the time in the business population. This churning comprises a large variety of experience, from people dropping out from employment, perhaps to do bed and breakfast from a new and cheaper home in the country, to new well-planned and funded manufacturing businesses and the kind of person that closes or sells out a firm to retire after thirty years of ups and downs, but nonetheless triumphant survival. One approach to defining the small firm is to focus specifically on the features which distinguish the small firm from the (obviously) big firm. The Committee of Inquiry on Small Firms, chaired by the late John Bolton (BOLTON 1971) identified three characteristics in its economic definition of a small firm:¹

• A small market share, that is not large enough to influence national prices or quantities. (Even though a village shop may be the only one, its prices cannot get too far out of line from those of major national retailers in the nearest town, even though people will pay something for local convenience.)
• Managed in a personalised way: the owners actively participate in all aspects of the business, unlike in a large firm where the shareholders and management are usually almost entirely separate.²
• Independence or the exercise of ultimate management responsibility.
  A small subsidiary of a large firm which has a head office to report to does not share this characteristic.

These three characteristics are to be found in the vast majority of all businesses (and, therefore, most businesses are small) but the economic definition is of no use for statistical purposes since business statistics are not classified in terms of market share, owner-management and independence. For this and other reasons, small firms are usually defined in terms of numbers employed. There is a difficulty here, in that in the employment dimension, a threshold that seems appropriate to define a ‘small firm’ in one activity may not be appropriate for another. For example, a manufacturing enterprise employing fewer than 250 people could be considered ‘small’, while a retail organisation with 250 employees and perhaps 10 or 15 branches is clearly quite a large firm, relatively speaking. However, employment numbers are generally superior to other measures of firm size as the data are easily collected (every SME owner knows how many people are employed); they are not ‘sensitive’ like turnover, nor are they affected by inflation.

Governments, for simplicity, tend to use one definition for statistical purposes and other, sectoral or asset- or turnover-based definitions for specific policy purposes. The European Commission and many member states, including the UK, define SMEs as those with fewer than 250 employees.³ Other countries use other thresholds for statistical purposes: the United States uses 499 employees as the overall threshold for large firms. Japan uses different thresholds for manufacturing (299 employees), wholesale distribution (99 employees) and retail distribution and other services (49 employees).

For policy implementation, as distinct from statistical purposes (for example, in determining eligibility for subsidised loans), official definitions are usually different and try to take into account the fact that the concept of what is ‘small’ must vary between different activities. The Bolton Committee, for the purposes of its Inquiry, came up with small firm definitions for nine different activities. The Small Business Administration (SBA) in the United States, using the wide discretion under the Small Business Act,⁴ went further and individually determined thresholds in terms of employment or sales for each of the four-digit standard industrial classifications (SICs). This led to some anomalies – including, famously, in 1966, the classification of American Motors, then one of the 200 largest US corporations, as a ‘small’ firm for SBA procurement assistance programmes (PARRIS 1968). (American Motors was small relative to the Big 3 – General Motors, Ford and Chrysler – and had a share of less than 5 per cent of the market for passenger cars. Its vulnerability was proven by its later absorption into Chrysler which, later still, merged with Daimler–Benz.)

Statistics

There are as yet no universally agreed and observed standards for international small firm statistics. In their official figures, most countries exclude agriculture (the UK is an exception) and many do not include the self-employed without employees (‘O’ employee firms) in their overall totals of business enterprises. Another difficulty, among many, in making international comparisons is that some figures do not exclude establishments that are owned by large firms and which are not therefore properly interpreted as ‘small independent enterprises’. Problems of statistical coverage are greatest in developing countries, where most small firms are in the informal sector and may not be registered or appear in official statistics at all. However, even among the advanced countries there are sometimes major differences in statistical coverage which offer pitfalls for the unwary. For example, it is not generally appreciated in Europe that the official enterprise statistics for the United States and Japan do not include enterprises without employees – which can mean a difference of 50 per cent or more in the enterprise total!

The inevitable conclusion is that SME statistics must everywhere be interpreted with caution. While statistics are generally improving – people are much more interested in SMEs than they were 50 years ago – it takes very many years for significant improvements to be made, and often requires changes in the laws governing statistical inquiries and the exchange of information between arms of government. The European Union (EU) has issued a directive which requires the adoption of unique enterprise identifiers and the compilation of enterprise registers in all member states, but results are not expected before 2006. The Appendix at the end of this book (p. 206) provides a fuller discussion of the coverage and sources of SME statistics and makes some detailed international comparisons.

Meanwhile, some general conclusions can be drawn. The first conclusion is that, however defined, the vast majority of all business enterprises are very small. In the United Kingdom, for example, 99.1 per cent of the 3.7 million business enterprises employ fewer than 50 people – there are only 3,500 with 500 or more employees. In employment terms, SMEs with fewer than 250 employees, the EU definition, are less dominant: they account for 55.4 per cent of all private sector employees. In the rest of Europe, SMEs are in fact even more predominant than in the United Kingdom.

The second conclusion is that there do appear to be differences in the total number of enterprises (and therefore of SMEs) in relation to the population between countries. Table 1.1, for example, suggests that southern European countries have relatively more small firms than those further North. This table also indicates that Zambia, a country typical in this respect of sub- Saharan Africa, and perhaps surprisingly, has a comparable number of SMEs to some European countries.

Finally, and contrary to common opinion, Japan has fewer SMEs than the United States, which in turn has roughly the same number as the United Kingdom. Although the figures used in Table 1.1 have been adjusted for comparability for Europe by the Statistical Office of the European Communities, and those for the United States and Japan by the author, we still cannot be certain that like is being compared with like. All the adjustments made have tended to reduce the differences in the importance of SMEs between countries, and the suspicion lingers that, with the possible exception of the EU Mediterranean states, differences in SME density, particularly for countries at similar stages of economic development, owe more to differences in coverage rather than real differences, though some undoubtedly remain. We shall find some support for these suspicions elsewhere in the book, for example in comparisons of business mortality (Chapter 2).

Table 1.1 Non-primary enterprises per 10,000 of the population, selected countries, number c. 2000

The final conclusion to be drawn from the review of SME statistics in the Appendix is that the numerical importance of small firms changes in character as countries move through different stages in economic development. There is evidence that across large numbers of countries the share of SMEs in output and employment tends to decline with economic development, and the average size of SMEs tends to increase. There is also evidence that small firms are important drivers of economic development (a full discussion of this is deferred until Chapter 9). Next, in Chapter 2 we look at some of the characteristics of small firms, and the people who own them, in advanced countries.

Notes

1 The Bolton definition echoes that of the US Small Business Act (1953), which says that ‘a small business concern shall be deemed to be one which is independently owned and operated and which is not dominant in its field of operations’.

2 This separation of ownership and control, first analysed by BERLE & MEANS (1932), lies at the root of the endless debates about the governance of large corporations. It is interesting to note that the owners of these large businesses are generally separated from management at one remove, since between management and beneficial shareholders are the large pension funds and insurance companies that control the majority of equity shares. Even where private individuals own shares directly, since the late 1960s these shares have generally been held electronically through nominee companies registered with (in the UK) CREST and, unless special arrangements are made, shareholders are invisible to their companies and do not receive communications from them.

3 The European Commission further defines an SME as having fewer than 250 employees, not more than 25 per cent owned by enterprises not satisfying that criteria, and with either a turnover or balance sheet total of less than €40 million and €27 million, respectively.

4 The US 1953 Small Business Act says: ‘Where the number of employees is used as one of the criteria [sic] in making such definition for any of the purposes of this Act, the maximum number of employees which a small-business concern may have under the definition shall vary from industry to industry to the extent necessary to reflect differing characteristics of such industries and to take proper account of other relevant factors.’

2 Some characteristics of small firms and their owners

Heterogeneity and rationality

It is best to begin this chapter with recognition of the variety which exists in the small business population. Obviously SMEs differ greatly in size, in their activity sector, their growth rates and in other dimensions. In fact, it is well established that there is far greater variability in some SME characteristics than among large firms: profitability is a good example. In a non-economic sense, the ‘personality’ of a small firm, reflecting as it does the ideas and idiosyncrasies of its owner(s) is also bound to vary, as individuals obviously differ from one another. It is no exaggeration to say that each small firm is unique. This contrasts with large firms, where the separation of ownership from control and the group pressures for conformity among its numerous managers erode (but do not entirely eliminate) idiosyncrasy. Common observation suggests, for example, that large firm management frequently falls into the grip of the latest management fads and fashions from which most SME owners, less interested in the art of management as an abstraction, are largely free.

Some researchers have been so overwhelmed by the variety exhibited in small business as to deny that meaningful generalisations about the subject can be made at all. This is not the view taken in this book, though it is acknowledged that caution is necessary in making generalisations. What gives the small business population some coherence are the characteristics discussed in the Definition section of Chapter 1: personal ownership, independence and lack of market power. These characteristics produce the constraints on management and financial resources that are an inevitable consequence of small scale. While SMEs may be all different from one another, they do share many characteristics that differentiate them from large firms as a group. Failure to appreciate the nature of these differences is at the root of many of the contrasts drawn later between received opinion about the nature of small firms and small business policy and what is advocated in this book.

All businesses, large and small, have to be – or must try to be – rational in their pursuit of profit and survival. In small business the need for rationality, the objective weighing up of the pros and cons of alternative courses of action, is heightened by their vulnerability: they cannot afford too many mistakes. Mistakes can exhaust their limited resources and lead, in the face of competition, to the demise of the firm and possibly the ruin of its owner(s). Most of the puzzles about SMEs compared with large firms and which bemuse policymakers – for example, their reluctance to make business plans, take external equity or use more external training – simply reflect a rational response to their situation rather than, as is often supposed, ignorance and lack of sophistication.

A topical illustration of SME rationality, for example, is their generally more hostile view, compared with large firms, to the adoption of the euro by the United Kingdom. This is, of course, a p...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Preface
• Abbreviations and Acronyms
• 1. Defining and Counting Small Firms
• 2. Some Characteristics of Small Firms and Their Owners
• 3. Do Small Firms Matter?
• 4. The Constraints On Small Firms
• 5. Business Owners and Government
• 6. Entrepreneurs and Managers
• 7. Government Policies On Small Firms
• 8. Training and Support
• 9. Small Firms In Developing Countries
• 10. The Big Picture
• Appendix: Coverage, Sources and Comparisons of Small Business Statistics
• Bibliography