Small firms - Business Environment

There are serious problems in the analysis of the small-firm sector, including the lack of data over a long period of time and the problem of defining exactly what is a small firm. The Bolton Report,4 published in 1971, was the report of a committee set up to look into the role of small firms in the UK economy. It used various definitions for statistical purposes, depending upon the industry being considered, on the grounds that what is small in one industry might be large in another. Table shows the size distribution of firms based on their turnover for a selection of industries for 2004.

It is clear from Table that the definition of ‘big’ will vary with the industry. In the Bolton Report the definition used for small firms in manufacturing was ‘less than 200 employees’, while in construction it was ‘less than 25 employees’. In some industries turnover limits were chosen while in others a mixture of employment and turnover was used. Although this is confusing and makes comparison between industries and countries difficult, it was accepted that there could not be a single definition which would apply to all sectors. The EU in 1994 recommended to its members that they use ‘less than 250 employees’ as the definition of a small to medium-sized enterprise (SME), in order to facilitate the easy comparison of data across member states. A further refinement of the definition used by Euro stat based on numbers employed is shown in Table. Applying this definition to Table, it can be seen that 83 per cent of manufacturing firms in the UK are micro businesses, 15.5 per cent are small, 1.3 per cent are medium sized and 0.4 per cent are large. Although there are some national differences(the southern-most countries have relatively more micro businesses than the northern countries) the pattern of size structure is similar in the EU as a whole 92per cent of all enterprises are micro businesses, 7.4 per cent are small, 0.5 per centare medium sized and 0.1 per cent are large.

It is important to note that the definition of SME used within the EU changed in2005. For grant-aid purposes an SME must have no more than 25 per cent of its capital owned by a larger enterprise and must meet specific criteria with regard to numbers of employees, turnover or balance sheet totals. A ‘micro firm’ is one with0–9 employees, a maximum annual turnover of 2 million euros or a maximum balance sheet total also of 2 million euros. The equivalent figures for a ‘small firm’ are 10–49 employees, 10 million euros turnover or 10 milion euros balance sheet total; for a ‘medium-sized firm’ 50–249 employees, 50 million euros turnover or 43 million euros balance sheet total. Using these definitions it is estimated that 99 per cent of all enterprises in the EU (prior to enlargement) were SMEs and that they provided around 65 million jobs.No matter how small firms are defined, they will suffer from similar problems, which are very different from those faced by larger companies.

size of companies by turnover across different industries

Trends in the small-firm sector
Figure shows how the share of small establishments in total manufacturing employment changed between 1930 and 1990. The definition used here is fewer than 200 employees. The establishment is the reporting unit. It can be seen that the small-firm sector was in decline up to the late 1960s and early 1970s, since when its importance has increased.

Table showed that for manufacturing industries small firms are very important in terms of the numbers of companies, accounting for 99 per cent of total firms according to the Bolton Report definition. Even though they were less important in terms of employment they still accounted for 47 per cent of total employment. This tends to under state their importance because it does not include the service sector, many parts of which are heavily dominated by small firms due to the nature of the production process. Although there is a great deal of information available from official sources on the manufacturing sector, the same depth of information is not available for the service sector, so accurate information is difficult to obtain.

Share-of-small-establishment in Total manufacturing

Reasons for the growth in the small-firm sector
There has clearly been a resurgence in the importance of the small-firm sector which appears to have been more pronounced in the United Kingdom than in other countries. Why? Some causal factors are as follows:

  1. The changing pattern of industry. In it is shown that there has been a change in the industrial structure of the United Kingdom away from manufacturing and towards services. Since many services are dominated by small firms, there will be a corresponding change in average firm size. However, this does not provide the full explanation as there has been a growth in the share of small firms even in the manufacturing sector. And it does not explain the international differences since there have been similar changes in industrial structure in other countries too.
  2. Changes in consumer spending habits. A move from mass-produced goods to more specialized products puts small firms at an advantage as they can react more quickly to changes in demand and shorter product life cycles.
  3. Flexible specialization and the growth of subcontracting. A debate which started in the late 1980s centers round the idea of the ‘flexible firm’. As a result of the recession of the early 1980s there was a drive by firms to reduce their costs in order to remain competitive. One way of reducing overhead costs was to move to a flexible firm structure whereby the firm’s activities are divided into core and peripheral activities. The core activities, which are central to the activities of the firm, would be kept ‘in-house’ and carried out by full-time permanent workers. The peripheral activities would be carried out by temporary workers or would be subcontracted. The firm has then reduced its overheads and can react to peaks in demand by increasing the amount of temporary labour it uses or increasing the amount of subcontracting. This might also have had the effect of increasing the relative importance of the small-firm sector.
  4. Reorganization and job reduction. There has been an increase in the phenomenon of downsizing by organisations in an attempt to reduce costs. Ninety per cent of large companies have reorganized and cut jobs since 1985.
  5. Government policy. After the Bolton Report there was a much greater interest in the role of the small firm in the regeneration of the economy and in the provision of jobs. But most of the initiatives designed to help the small firm came after the start of the resurgence of the small-firm sector in the early 1970s.
  6. The growth in self-employment. A part of the growth in the small-firm sector has been due to the growth in the number of self-employed. The self-employed accounted for 9.8 per cent of the workforce in 1984 and 11.7 per cent in 2004. This represents a 19 per cent increase in the number of those self employed over this period. The level of self-employment is likely to be related to the level of unemployment, so that as unemployment rose during the 1970s and 1980s there was an increase in the level of self-employment. This goes a long way to explaining the international differences as the growth in self-employment in the United Kingdom has far outstripped that in other countries. Again, however, it does not provide the full explanation as business births were growing in the late 1960s when unemployment was falling.
  7. Technological change. Changes in technology, particularly information technology and the miniaturization of components, has made it possible for small firms to benefit to a similar extent to large firms. This has had the effect of reducing the importance of economies of scale and enabling small firms to compete more effectively with large ones.
  8. Competitive forces. As far as the international differences are concerned, the

Percentage-of-workforce self employed

Bolton Report found that industry in the United Kingdom was biased towards large size in comparison with other countries. So what may have happened as a result of competitive forces is that the balance of industry in the United Kingdom has moved towards the norm of other countries.

The role of the small-firm sector
The growing importance of the small-firm sector implies that small firms do have a valuable role in the economy apart from being a mere provider of employment.
The areas in which the small firm has advantages over large firms are those where there are:

  1. Clearly defined small markets. It is not worthwhile for large firms to enter such
  2. markets since there are no economies of scale and no scope for mass production.
  3. Specialist, quality, non-standardized products. Again it would not be worth a large firm entering such a market as the benefits of large-scale production cannot be reaped.
  4. Geographically localized markets. For example, the small corner shop.
  5. Development of new ideas. It is often argued that the small firm is the ‘seedbed’ of ideas and that, because of greater motivation and commitment on the part of the owner of the small firm, it is very conducive to invention and innovation.

Aid to the small-firm sector
The thinking on small firms has changed over time. Initially they were viewed favourably, but after the Second World War the dominant thinking was that large scale production could take advantage of large economies of scale and that costs would be lower and production more efficient. It was not until more recently that the interest in the small-firm sector has increased again. The main reasons for the renewed interest are seen in the results of empirical studies which have shown that the role of the small firm is greater than previously thought in areas such as innovation, the balance of payments and employment.

The main argument for giving support to the small-firm sector is that it has a valuable role to play in the economy. In the 1980s and 1990s, for example, small firms were seen as a mechanism for reducing the very high levels of unemployment. Between 1983 and 1993 the small-firm sector created 2.5 million jobs. The basic premise for support is that small firms are at a disadvantage with respect to large businesses in areas such as raising capital, research and development and risk bearing. Two particular problems faced by small firms were highlighted in 1996: cash flow problems which stem from the late or non-payment of bills; and dealing with government red tape. These problems have been addressed by a number of recent developments. All public limited companies are now required by law to state in their annual reports the average length of time it takes them to pay their bills. The Federation of Small Businesses published a ‘name and shame’ list for the first time in April 1999 which is expected to apply peer pressure and there by encourage firms to pay bills on time. It also provides information to help small firms decide who to trade with. The Federation of Small Businesses has estimated that 44 per cent of bill sare paid more than 15 days after the normal 30-day credit period. The comparable figure is 35 per cent in the EU. It is also estimated that about £20 million is tied up in late payment, with a half of this owed by large firms to small firms. The government also publishes ‘league tables’ of government departments which are slow in paying their bills, with the pledge that this will be improved. To reduce the amount of red tape faced by firms, the government has, over the years, relaxed many of the rules and regulations involved in running a business. For example, from 1996 there has only been a single form for registration for income tax, national insurance and VAT, from April 1999 small employers have been able to move from monthly to quarterly payment of PAYE and National Insurance contributions.

Government policy
Within the UK national policy for small firms has increasingly become a vital component of governmental attempts to create a competitive economy capable of achieving sustainable economic growth. To this end policy initiatives in recent years have become more focused and have tended to adopt a multi-agency approach, aimed at improving the environment in which small businesses emerge and grow, and at fostering enterprise and innovation. Key developments over the last decade or so have included:

  • Business Link a national network of ‘one-stop shops’ to provide information and support to small firms.
  • Direct Access Government a ‘one-stop shop’ on the Internet that provides businesses with access to regulatory guidance and forms.
  • The Enterprise Zone another Internet-based initiative to help firms with finding information on issues such as finance, exporting, technology, innovation and management.
  • The Teaching Company Scheme (TCS) the government’s premier technology transfer mechanisms for linking UK higher education establishments and businesses.
  • The SMART Awards designed to promote technological development and innovation.

There have also been a number of legislative and fiscal changes aimed at reducing the burdens on small businesses (e.g. levels of corporation tax). Some of the most recent developments have included the launch of the University for Industry (UfI the Enterprise Fund, the University Challenge Fund, the Small Business Service(SBS) and the EU SME Initiative. The latter introduced in December 1997 was designed to assist SMEs in rural areas or areas of industrial decline to become more competitive in overseas markets. There have also been attempts to reduce the flow and improve the quality of regulation affecting smaller businesses and an action plan to make the UK the number one location for starting and growing a business.

Networking between firms
A more recent trend in industry which is well documented is towards co-operation rather than competition. This co-operation can take many forms: for example, subcontracting, networking (both formal and informal) and joint ventures. Such co-operation can be (and is) used by large as well as small and medium-sized enterprises. For large companies it is a way to grow and diversify without risk. For smaller firms it allows them to stay small but at the same time to benefit from some of the advantages of large-scale production like specialization.
There has been an increase in the amount of subcontracting, where firms do not carry out the whole of the production process themselves but subcontract some of their activities to other firms. This represents a rejection of vertical integration and it is related to the notion of the flexible firm mentioned earlier. Subcontracting goes some way to explaining the phenomenal growth rate in ‘business services’ that occurred in the 1980s. It is increasingly common for businesses to subcontract specialist work in areas such as human resource management to outside consultancies. ‘Partnering’ between companies and consultancies is becoming more common where the consultancy is retained on a semi-permanent basis to give advice on a whole range of human resource matters from recruitment to planning for succession. This will obviously boost the small-firm sector. There has also been an increase in ‘partnership sourcing’ as large firms are developing long-term relationships between themselves and their suppliers. This phenomenon brings benefits to the large firms in the form of reducing stock levels and associated costs and facilitating just-in-time production methods. It also brings benefits to small firms, many of which are the suppliers, in the form of greater security.

Networking refers to the relationships that exist between organisations and the people within those organisations. These relationships can be of different types, both formal and informal, and there is increasing recognition of the importance of these relationships, especially to small firms (e.g. they may be based on the exchange of goods and services, like the relationship between a firm and its supplier or client). Subcontracting is an example of this kind of network but there are other links not based on exchange, like the relationship between a firm and the bank manager or other advisers. There are also informal links between the entrepreneur and family and friends, and between entrepreneurs in different organisations. There might also be co-operative links between firms. This can be seen in the market for executive recruitment where there has been a growth in the links between consultancies, particularly for international work. The creation of the
Single European Market and the increased internationalization of business left the smaller consultancies in a weak position relative to the large international recruitment firms like Korn Ferry International, which have branches in most European countries. The smaller consultancies have reacted by forming networks. There are basically two types of network:

  1. Where firms are members of a network but where the network has a different name from the individual firms and the firms operate under their own name (i.e. the network has an identity of its own). The members are independent firms that co-operate in carrying out their business. There are 16 such groups in Europe including EMA Partners International and AMROP Heuer Group.
  2. Where firms are part of a network of independent firms but where the network does not have a separate identity and the firms operate under their own names.

There are ten such groups in Europe.The firm is seen as existing within a spider’s web of relationships, as Figure shows. It is possible for two firms to be linked in a variety of ways; in one market they may be competitors, in the next co-operators, customers in another and suppliers in another.

Networking has taken on greater significance because of changes that are taking place in the economy, which include the reversal of the trend towards higher industrial concentration, the adoption of Japanese methods of production, the decline of ‘mass markets’ and technological change that requires greater specialization than previously. All of these changes favour the formation of networks.The role of strategic alliances between firms has been recognized, especially in the small-firm sector where expansion through other means is often impossible and in the process of internationalization.

The virtual organisation
The virtual organisationis a network-based structure built on partnerships where a small core operating company outsources most of its processes. It is a network of small companies which specialize in various aspects of production. The organisation can be very big in trading terms but very small in the numbers of permanent staff. The process is typically mediated by information technology.

The main benefit of the virtual structure is that it helps organisations to deal with uncertainty. When virtual organisations are managed properly they can simultaneously increase efficiency, flexibility and responsiveness to changes in market conditions. The organisation is reaping the benefits of specialization without having to develop those specialisms itself. Therefore overhead costs are minimized, as too are training costs and support costs. Information technology assumes many of the co-ordinating and managing roles that managers and committees carry out in large organisations. Information technology enables communication and the sharing of information across geographical boundaries. It is often the case, however, that the creation of a virtual organisation is driven solely by cost considerations rather than strategic considerations, in which case the benefits might not be realized. There will be a loss of control over outsourced activities and it may actually cost more to manage such activities. The organisation can become locked into contracts and specific relationships so that flexibility is reduced. There may be a lack of commitment of key resources (i.e. contractors) to the company and the loss of a contractor will be very serious.

There is some evidence that the incidence of virtual organisations is on the increase, facilitated by developments in information technology. It is a matter of ‘wait and see’ if this will become the dominant organisational structure in the future.
Joint ventures
As indicated earlier in this chapter, joint ventures are a good way for firms to diversify and enter other countries’ markets. Joint ventures benefit both parties as each can diversify with the benefit of the experience of the other, and the level of risk is minimized. Again, there are examples in the area of executive recruitment. The International Search Group, for instance, was set up as a joint venture between five companies in France, the UK, Austria, Germany and Italy in order to offer a European service to its customers.
In some industries co-operative behaviour has come about for particular reasons. In process plant contracting, for example, the projects are often too large for single firms and so they form consortia in order to bid for the contract. The consortium will include contractors, suppliers and bankers who together will have the expertise and the resources to carry out the project.

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