The Value of the Micro-Business Sector

She enjoys her jobSmall business is often touted as the engine of growth. But what of the smaller segment of this sector, the micro-business sector?

A recent publication of the RSA caught my eye. Entitled ‘The Second Age of Small’ this report by Benedict Dellot (June 2015) considers the economic impact of micro businesses in the UK. There are now around five million firms in the UK with nine or less employees. Fifteen years ago, there were only 3.5 million. This increase is significantly higher than other firm size categories. Today, micro-businesses represent 33 per cent of private sector employment and 19 per cent of total output. The RSA has described this trend as the ‘second age of small’, referring to Britain’s first age of pre-industrial cottage industries.

In Australia, the statistics bureau (ABS) classifies a Micro Businesses as a sub-set of the Small Business category with 0–4 employees. Small Businesses have 0-19 employees. As of June 2011, ABS counted 2.13 million businesses of all sizes trading in Australia. Of these, 96 per cent were Small Businesses. Within this category, 85 per cent were Micro Businesses. The majority of the Small Business population, 61 per cent, were one-person businesses that did not employ any additional staff.

There are mixed views on the value and importance of these figures. Many economists have argued that a large micro business sector is symptomatic of a poor economy –– just look at developing economies where micro businesses and the informal economy dominate. The large size of the micro business sector in these countries is often driven by survival. The lack of employment opportunities and a failing or absent welfare state forces unemployed people to do what ever they can to generate money. Some have described these businesswomen and men as “necessity-based” or “survivalist” entrepreneurs –– people who are essentially forced into business by the lack of any other alternative.

Proponents of innovation and entrepreneurship will often distinguish between necessity-based and “opportunity-based” entrepreneurs (see the Global Entrepreneurship Monitor 2014). Opportunity-based entrepreneurs are considered to have a choice; they choose to start their business in order to pursue the opportunities they identify. The Global Entrepreneurship Monitor argues that “motivation matters” –– it is more desirable for entrepreneurship to be opportunity-driven in terms of the benefits this leads to in terms of innovation and, ultimately, employment. The GEM 2014 report finds, unsurprisingly, that the lowest Motivational Index is observed in non-EU countries and in GEM African economies (e.g., South Africa 1.3, Botswana 1.8). The highest motivational index is presented in North America (i.e., USA 5.0, Canada 4.0). Australia’s GEM motivational index score was 3.6; UK 4.1.

The RSA report is valuable because it draws us into more detail around the key figures concerning micro-business. For example, the figures on employment in micro-businesses often reflect poorly: most micro-businesses don’t employ and, when they do, workers tend to be paid less, engage in training less frequently and have fewer protections such as extra maternity pay and extended pension coverage. However, Dellot’s report cites the latest results from the UK Workplace Employment Relations Study, which finds that micro business employees are the most satisfied group of workers in the labour market, scoring highest on several indicators such as job control, influence in decision-making, loyalty to the business and even satisfaction with pay. Moreover, micro businesses are more likely to employ individuals on the economic margins, including migrants, disabled people and the recently unemployed.

Similarly, when productivity is considered, the general view is that micro-businesses perform poorly: the productivity of very large firms (as measured by revenue per worker) is on average more than twice as great as that of micro businesses. However, when employing micro-businesses are considered, productivity is highest in nine of the 19 fastest growing industries, scoring particularly well in sectors where relationships are important, such as education, health and social work.

Innovation, too, presents mixed results. While the general view is tat micro-businesses typically struggle to innovate (e.g., with low levels of investment into R&D), there is evidence that these firms are more efficient at innovation, meaning they create more innovations for every unit of R&D expenditure as well as extract more financial value from these developments. The report also highlights that the changing nature of innovation means that micro-businesses are better placed to engage in innovations that have lower resource requirement. This includes, for example, the generation of new concepts, designs and experiences.

From a policy and programme perspective it is important to not get caught up in generalities and stereotypes. Not all businesses are run by “entrepreneurs” and not all micro-businesses are the same. There are many determinants to business success and few of these can be controlled. Paul Nightingale and Alex Coad from the University of Sussex provide some valuable insights into this topic in their paper, entitled: ‘Muppets and gazelles: political and methodological biases in entrepreneurship research’. In their review of the literature, they find that the median entrepreneurial start-up is likely to be “closer to a muppet than a gazelle”, which helps explain a number of stylized facts in industrial dynamics: market entry is common, particularly for smaller firms, despite low survival rates and the high positive correlation between entry and exit, suggesting it drives churn rather than growth; growth is difficult and it can take a long time for entrants to compete on par with incumbents (10 years); growth is rarely persistent and is approximately as persistent as a random coin toss; adjustment costs are high; and as firms get both older and larger their survival improves.

I have written before about the problem policy makers face when only targeting gazelles. While targeting might be difficult, the diversity of the business sector should be understood and the factors affecting start-up, growth and innovation require careful diagnosis. What should not be forgotten is how these factors can vary across locations.