Small business isn’t just important to the economy it IS the economy

The small to medium enterprise (SME) sector is frequently acknowledged by government as an important engine room for the creation of jobs and enhancement of economic growth. However, despite such rhetoric the small business sector is often ignored or overlooked by politicians and the media, who’s attention is more readily captured by large firms. This relative lack of attention on the small firm is disappointing given the sheer size of the SME sector.

Any objective assessment of the total size and impact of the nano, micro, small and medium enterprise (NMSME) sector is significant and is arguably more than just an important part of the national economy, it virtually is the economy! While this may sound unreasonable to some, the sheer number of SMEs as a proportion of the total business sector cannot be easily ignored.

According to the World Bank there are around 125 million formally registered micro, small and medium sized enterprises (MSMEs) operating across 132 countries. Such firms represent more than 90% of all businesses in these countries. Many more firms operate in the informal economy, comprising businesses that are not formally registered with their government taxation authorities.

In many developing economies, these informal businesses make up a significant proportion of all firms. For example, it has been estimated by the World Bank that in India such enterprises comprise about 94.2% of all MSMES.

The small business economy

The sheer size of the SME community can be found by looking at the relative number of small firms as compared to large ones. Definitions of what an “SME” is vary from country to country, but the most commonly accepted definition is a business with fewer than 250 employees. This is the definition used by the European Union (EU) and the OECD. In Australia, the cut off is 200 employees. In both the EU and Australia SMEs comprise 99.8% of all firms.

As shown in Figure 1, only 3,717 firms out of the total 2.12 million registered businesses in Australia have more than 200 employees. If the EU definition were to be used the proportion of large firms would shrink significantly. It should also be recognised that these figures do not include the “nano” businesses that are not registered for the Goods and Services Tax (GST), due to their annual turnover being less than $75,000.

In considering the SME sector it is also worth noting that in Australia only 140,834 firms, or 7% of all Australian businesses have an annual turnover of more than $2 million (see Figure 2). Once again, these figures do not include the “nano” businesses that are not registered for GST.

The contribution by small firms to jobs and growth

While SMEs are the most numerous of all businesses, the more important question is what is their overall contribution to the national economy? In particular their ability to contribute to the creation of jobs and economic growth.

In terms of creating and sustaining jobs, the SME sector in Australia is very important. As illustrated in Figure 3, the small business sector has consistently provided the majority of employment for the Australian workforce.

In terms of value adding, the SME sector also provides more than half the total value added within Australia and as illustrated in Figure 4, this has been a consistent pattern over many years.

This is a pattern found throughout the world. For example, across the EU, SMEs employ around 67% of the workforce while contributing about 58% of all industry gross value added. This is a similar pattern found across the OECD group of countries, where 99% of all firms are SMEs. These small firms provide around two-thirds of all employment and more than half of the gross value added.

In the United States, where the definition of a “small” firm is one with less than 500 employees, SMEs account for 99% of all companies and nearly half of all private sector jobs. Small firms are therefore the overwhelming type of enterprise within the economy. Yet government policy remains fixated on large companies and the high-tech start-up sector.

The allure of the “Gazelle” and the “Unicorn”

Government policy focuses on small business because it offers the allure of job generation and the potential for high growth “Gazelle” or more recently “Unicorn”, businesses. Such firms are rare and their high growth – particularly from start-up – makes them inherently risky and unpredictable.

Analysis of such high growth firms suggests that they comprise only a very small percent of all firms, typically around 3%, and can be found in low-tech as well as high-tech sectors. While many “Gazelles” are relatively young, and therefore growing, they are not start-ups and are often more than 10 years old.

Of course, the definitions that are used for such firms can determine the results of any analysis. It is sufficient to say that most net new employment growth is found within a relatively few, relatively young, SMEs. Such firms can be found in any industry and are not necessarily high-tech.

Government policy needs to pay attention to these growth oriented firms and help them to scale-up. Such support is surprisingly less about handing out grants or setting up venture capital pools, and much more about developing their managerial skills, and boosting their access to skilled workers, global supply chains, and high-quality knowledge sources.

However, it should also be recognised that while the hunt for “Gazelles” or the even more elusive “Unicorn” business remains attractive, government policy must not ignore the majority of “ordinary” SMEs. The strengthening of a small firm’s management skills, operating systems and product or service quality, or the speeding up of its cash flow through faster payment of accounts receivable, can have a transformative effect.

Unlocking the potential and profitability of the 99.8% of SMEs that dominate our economies will significantly boost the overall rate of job creation and economic growth. It requires a holistic approach to small business policy and a greater recognition of the importance of the SME sector to the economic and social well-being of the nation.