Dr. John Psarouthakis, Executive Editor
The Business Thinker. LLC Internet magazine and Founder and Managing Director of JP-Management Center, LLC.
A Lecture Given at Hillsdale College
some long time ago that I believe is relevant today
The subject was
Small Business Growth
I am pleased to be at Hillsdale College for many reasons not the least of which is that the subject of this talk seems particularly appropriate. I am concerned about the factors that lead to employment growth, something that should be of vital interest to every student. So often discussion about employment or business focuses on the largest companies. Yet I think that we have not looked at the relationship of company size to employment growth and value to the society as a whole. I’m sure you were all pleased to see that Money magazine ranked Hillsdale College among U.S. colleges and universities as a best value. One can raise the question of whether Hillsdale College is a best value for its size or does its size make it a best value. This relationship of size to value is an important one that is often distorted by mythology and misperceptions.
“Small business is the economic backbone of the nation.” “Small businesses are the only ones that are creating jobs in our economy,” “The future belongs to the person working at home connected to the outside world with a modem, computer, fax machine and a cellular telephone.” If all this has a familiar sound to it, it should. The last few years have produced endless streams of prose about small business and the new economy. Most of it glorifying the role of small business. Yet, for all the discussion, the concept of small business is more of an ideological construct than an economic or analytic one. One could argue that the ideological pull of small business is not a new phenomenon but a cultural mainstay of American life.
Throughout much of American history, the term “big” has often had pejorative connotations. There is a strong pastoral ethos in this country which glorifies the values of country life as opposed to city life, and small towns as opposed to big cities. The westward expansion of the country was fueled by the desire of many to seek a better life and to get away from the crowded east and be able to own some land. The agricultural sector of the economy has always had a privileged position in American life and while the nature of agriculture has changed extensively to big agri-business the stereotype strongly remains one of the small family farm and the positive values associated with that type of life.
Owning land was the pre-eminent symbol of independence for many because it also meant owning one’s own business and therefore implied a degree of freedom and control over one’s life. While the desire to own land and develop the family farm may be a diminishing one within the country, the desire for a degree of economic freedom and control is as strong as ever. It often takes the form of owning one’s own business. The urban and small town analog of the farm was the small family business, often retail stores. Many of the waves of different immigrants moved into the economic mainstream of the country via the route of the mom and pop business. Starting a small business has been the traditional outlet for many who faced barriers to entering the work force. It still is. Over one third of new businesses are now started by women, many seeking to break out of the confines they feel characterize the broader business environment.
Entrepreneurship and risk-taking are a significant part of our culture and for many, a symbol of independence. Small business and ownership continue to be important and a vibrant fact of economic life.
What is significant, however, is that while small business is a powerful symbol and is a term that is widely used, it is not an analytic term because, despite reams of prose, it remains undefined. It covers such a huge amount of territory that its analytic power is limited. For example, the Small Business Administration defines small businesses as ones with fewer than 500 employees. Just how broad this definition is can be seen if we look at 1992 figures which showed that of 5.7 million companies with at least one employee, only 14,000 had more than 500 employees. Using this definition we are left with this category called small business comprising more than 99% of all the businesses in the country. Even if we relax the employee requirement it does little to improve this amorphous category.
Over 90% of all businesses employ fewer than 20 people.
In this category of small business we find a significant number of businesses which, even if they continue for a long period of time, will not grow and are not necessarily intended to grow. We will also find those businesses which may become new giants that will offer significant employment opportunities for many individuals. In the latter category are companies such as Gateway 2000 which in 1987 had 11 employees and $1,5 million in revenues and by 1994 had 5000 employees and $2.7 billion in revenues. It is this subset of small business that is important to analyze and to differentiate from the others.
Our concern is to look at economic growth as it relates to employment. Ultimately a nation’s economic well-being is strongly dependent upon an internal market for its goods and services. The old economic theories of mercantilism recognized that but sought to promote that goal through protectionism. This was a short sighted strategy two hundred years ago and makes even less economic sense today. In a world where boundaries are permeable and communication is instantaneous, such strategies simply will not work. We face a world in which it is impossible to insulate yourself from international competition.
However, we must still recognize that the generation of wealth is dependent upon consumers for the goods and services that are produced. Employment multiplies the money in the economy. International competition has forced many companies to reduce employment and improve productivity as a way of staying price competitive. The Big Three automakers have reduced and will, over the coming years, continue reducing employment. There are literally hundreds of thousands of individuals who have been or will be removed from the automotive work force. For many of these displaced individuals, this has meant a drop in their standard of living as their new jobs often pay lower wages or salaries than the jobs that were cut. During this process, the cost of automobiles has not decreased and for the domestic market we find that the average price of a new automobile represents a growing percentage of the average worker’s annual income.
As pressures on many established companies grow, the response is to grow earnings by reducing employment in order to enhance productivity. In the case of the auto industry, these pressures have not only resulted in downsizing but in greater use of out-sourcing. Vendors became the targets for price cutting as the Big Three use their purchasing clout to force suppliers to meet their conditions. Such competitive pressures may result in improved earnings and profits for corporations, but long term problems are being created in terms of squeezing the potential consumer out of the market as a result of employment losses. Established companies in competitive industries often can only grow revenues and profits by increasing productivity which usually means cutting employment. The best we can hope for from these companies is that their employment levels will stabilize. This does not mean that such companies and industries are not important. They still employ large numbers of individuals and contribute enormously to the wealth of the society. Such companies will often remain large and the remaining work force will be well compensated but these companies have passed the point in their development where they will be major generators of new employment. Without the growth of replacement industries which are characterized by significant employment growth, our standard of living will slowly but inevitably decline.
It is imperative that we be attuned to where and under what conditions we can Keep employment levels high and ensure a standard of living that allows for economic growth that is widely shared. It is for that reason that we want to look at this subset of emerging businesses. For all the reasons I have indicated earlier, I am reluctant to call these small businesses. The term is too vague. Emerging businesses are those companies that are experiencing exponential or geometric growth. They are moving from the infancy of their start up phase into the awkward adolescence of growth and maturation. As such they often bear little resemblance to the more established
industrial giants with which we are more familiar.
These companies are the potential engines of new economic growth because they are the job creators in the society. Such companies are characterized either by the fact that (1) they create and define new industries or new products; (2) they exist within mature industries but have defined a new niche market; or (3) they are synergistic or additive enterprises who string together previously existing companies that singly are static or even declining but together offer a synergism that allows for high growth and employment opportunities.
What characterizes these companies during their major growth periods is lack of competition. It is that absence of significant competition which allows for employment and revenue growth to assume geometric dimensions. We need to examine in more depth these three categories of developmental companies.
New Industries and New Products
Companies that are creating new industries and new products are often technologically or research driven. Recent examples are numerous and easy to list. In some cases these industries are spin-offs of other activities. While it is often overlooked, our space program has led to an amazing growth of new industries and technologies which have become major sources of employment. The miniaturization of circuitry which the space program required led to the development of the personal computer industry with the concomitant growth of software companies and information or entertainment related companies to service this new market. Such giants as Intel or Microsoft or Compaq or Apple are the direct result of this technology driving the creation of new markets.
Even more obvious is the satellite communication revolution. Prior to placing synchronous satellites in orbit for communications, the cable television industry was merely a way to bring standard broadcast signals to weak or fringe reception areas. The ability to provide alternatives to standard broadcasting is dependent upon satellite technology. This has allowed cable giants such as TCI and Comcast to grow. It has created any number of new programming services to come into being, services such as CNN which we now take for granted. The whole area of wireless communication is growing at exponential rates and companies such as McCaw, which is now part of AT&T experienced enormous rates of growth in terms of both revenues and employment.
One industry which is in the process of growth and where there has been some movement to profitability is the bio-engineering sector. While still in its infancy, this is a new industry with enormous implications for health care and agriculture. It is an industry based on technology and research.
Historically, we can note similar patterns. The state of Michigan’s economy was transformed by mass production of the automobile as well as the ancillary activities associated with the industry. Michigan’s population growth was linked to the expansion of the auto industry and what seemed to be its almost insatiable demand for employees. A very large portion of Michigan’s population can trace their lineage to the large scale migration of white and black southerners to the state because of employment opportunities.
What is critical to note is that new technologies breed new industries and products that have significant implications for employment. The reason is clear. The major growth pattern of these companies takes place during an essentially non-competitive period. New industries and products create demand which far outstrips supply. The problem for such companies is generating sufficient product to meet that demand and that means that employment grows. If the demand is strong enough, price sensitivity is not that great and inefficiencies are tolerated by the business in order to meet the demand for product. Inefficiencies can be tolerated because of the ability to pass along the cost of those inefficiencies. Over time new entrants come into the market, particularly where the cost of entry is minimal. Those who took advantage of the developing PC market did very well. Large companies, such as IBM, which ignored the development of this new market and continued to place its reliance on large mainframes suffered and over time has had to trim its work force by 45,000 jobs.
If we look at the PC market today, competition is a fact of life. The market has matured and demand is stimulated only by new product and by pricing* Productivity demands accelerate and employment is declining.
New Niche Markets
Within developed industries, we often see new companies able to grow themselves or older companies reinvent themselves by carving out niche markets. Spartan Motors in Charlotte, Michigan did this when it began concentrating on building chassis for fire engines. It was an arena that had been all but abandoned by other companies and became a profitable niche. The result was the company significantly added to its employment rolls. It was essentially the absence of competition that allowed for this niche and made it profitable.
Within the auto industry, Chrysler was able to stabilize its decline and grow again as a result of its pioneering of the mini-van. While the overall employment at Chrysler was going down, employment on the minivan lines increased. It was the existence of that new product and the time lag it took for the other automobile manufacturers to move into that segment that allowed Chrysler to return to health. In the midst of all the auto companies engaging in rebates, Chrysler did not have to use that technique on its minivan line until Ford and General Motors began offering similar products. Until the reintroduction of competition, price was not a major factor affecting demand.
As in the case of new industries, niche markets stimulate employment growth in the absence of competition. It is the demand for product that stimulates employment. Demand generates further entrants until supply and demand reach an equilibrium, at which point the period of rapid employment growth for a company declines.
The Synergistic Enterprise
Mergers and Acquisitions are often another example of growth but we need to make distinctions within this category. In the seventies and eighties when mergers, acquisitions and leveraged buyouts were an almost everyday occurrence, these activities increased the size and earnings of individual companies but they did not often generate employment. In many cases companies acquired other companies that had little relationship to their core business. ITT went from a telephone company to an awkward agglomeration of totally distinct enterprises such as insurance companies, automotive suppliers, and a hotel chain.
The types of mergers and acquisitions that have the potential for generating employment are what we call synergistic acquisitions. This is something that I have great familiarity with as it was the guiding principle of JP Industries and is the policy of JP Enterprises. In both cases we looked for companies that fit with our previous acquisitions and gave us expanded market opportunities. The synergy that resulted allowed for growth and reinvestment that these acquired companies could not have achieved on their own. As a result of those efforts jobs were generated at headquarters to manage what became a $500 million a dollar a year company and employment grew. Even with reductions in redundant activities, we were a source of continued and new employment. The synergistic energy that was created made the company greater than the sum of its parts, and generated market demand for our products. That synergy allowed us to open up new markets and establish relationships with Japanese manufacturers that had not existed before.
In looking at these three categories of emerging companies, it is clear that the greatest employment growth will come in new industries and from new technologies. Niche markets in established industries and synergistic acquisitions will generate some employment and stabilize employment levels but it cannot generate the same level of employment opportunities that are possible as a result of new technology such as bioengineering.
What I am suggesting is that there is nothing inherently bad or good about particular size companies. However, there is a direct linkage between emerging companies and the ability of a society to generate employment. Generating wealth without maintaining and increasing employment opportunities has dangerous consequences for a society. It often means an increasing polarization between economic classes in the society and it means a slowing down or relatively static level of economic growth. This often leads to demands for schemes to redistribute wealth. By focusing on creating employment growth what we are really doing is distributing a growing amount of wealth among larger and larger parts of the population. And we do this without removing the incentives and rewards for risk capital and entrepreneurship.
It is clear that individual emerging companies experience the most explosive employment growth in the absence of significant competition. As markets develop, newly created industries increase employment but the original companies find their employment leveling off. What is needed and the challenge we face is finding the conditions that help facilitate the formation of emerging companies and industries and doing away with the restrictions that impede such formation.