Small firms show road to future

Economic Review

It used to be fashionable, when they were a neglected species, to say that small businesses were wonderful. Then the official world caught hold of their importance and politicians began to have "initiatives" to help them.

The financial institutions, the banks in particular, spotted a new commercial opportunity and rushed in, too. Now, in the public eye at least, the wheel has almost come full circle: because everyone knows that small businesses are important the sector no longer attracts the attention it used to.

At least that would seem the best explanation for the quite muted response last week to the latest Small Firms in Britain report, published by the DTI. It is understandable, too, because as anyone who has tried to run a small business will know, Whitehall is not the most user-friendly of enterprises. So anything by a government department lauding its support for small businesses naturally gathers suspicion.

That is a pity because the information the report pulls together gives a useful snapshot of important and still-developing structural shifts within the economy. Two of these are highlighted in the graphs.

One is the steady growth of self-employment. In the 1970s we had about the lowest proportion of our work-force self-employed in the developed world. But as the graph shows, this started to grow at the end of the decade. Men in particular have increasingly chosen self-employment. We are now higher than the US, Japan, France and Germany. While the rise must to some extent be associated with the rise in unemployment during that period - people could not find jobs so they employed themselves - self-employment only fell back slightly at the beginning of the 1990s and growth may well have resumed.

The other graph shows how small firms are the main job creators. The graph shows changes in employment between 1989 and 1991. Companies with more than 500 employees shed labour, despite the fact that this was a period when overall employment rose. By contrast, firms with fewer than 500 employees on balance increased the size of their workforce, with tiny firms employing fewer than five people creating the most new jobs of all.

The report does not examine more recent trends in employment but data from Barclays and NatWest on the number of business start-ups suggest that these have picked up sharply from a low in 1992-93, implying that employment in tiny companies has continued to climb.

But if the growth of the sector is absolutely clear the reasons for it are less so. Part of the reason lies in the shift away from manufacturing to services. Manufacturing tends to require larger units than services. Within the manufacturing sector, industrial processes tend to require fewer people. Capital equipment has been substituted for labour and the unit size of many processes has declined for efficiency reasons.

But there are also managerial, rather than technical, reasons why large companies have cut their work-forces. For example the trend to "out-sourcing", getting small outside companies to provide services with would hitherto have been provided in-house, has been evident for at least a decade. Associated with that is the trend towards management buy-outs and the concentration of businesses on "core competencies".

Finally, and in a rather different vein, the development of the PC gives small companies the sort of data-processing power that previously was only available to the giants, thereby reducing big companies' relative advantage. But all this is already known. What we do not have much feel for is the dynamics of the situation: whether we are still in the early stages of a revolution, or whether change has more or less run its course. It is conjecture of course, but I'm fairly sure that we ain't seen nothing yet.

The principal reason for this is that two of the biggest forces for the down-sizing of business, the drive for out-sourcing and the advance of information technology, still have a long way to run. Out-sourcing is even taking a further twist: instead of management getting outside businesses to provide functions, the actual act of management itself is increasingly being out-sourced.

Companies find they have the management to run the business as it is, but not the skills to develop new areas. So they buy in those skills in the form of consultancy. As for technology, it is absolutely clear that the cost of information will continue to plunge and the capacity of delivery systems and processing power will boom. So even if large firms do still have some comparative advantage because of size, that won't last much longer.

Historically, the idea that people should work as employees for giant corporations is quite a recent one. The early stages of the industrial revolution were pioneered by small firms, and in the textile industry it took a while for out-working (self-employed workers operating in their own homes) to be replaced by the factory system. Now, the out-working structure is gradually reasserting itself in many of the new industries, particularly in communications.

Out-working can be combined with branding. For example, much of British (and US) TV production is carried out by small companies contracted to create programmes for the network. The network is the brand, but the work is done by small firms. Hollywood runs on a similar system, with the big studios essentially an assembly job, bringing together a series of individual firms (and individuals in the shape of the stars and key specialists) to produce a movie.

Obviously there are limits to the process. Some large companies will always be needed to assemble the goods or services and while there are considerable practical disadvantages to having a large work-force, if it can be managed effectively, there are also advantages. It is useful to have people who can do things without having to renegotiate with new firms all the while. But the trend is surely set. That little graph showing the fastest growth in jobs in firms with fewer than five staff shows the future.

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