Small firms

Small firms

Survival of small firms

Despite the benefits of operating on a large scale, independent and non-subsidiary small and medium sized firms (SMEs) still survive, and indeed make up the vast majority of firms.

According to the EU definitionmedium-sized firms are those which employ fewer than 250 employees, small-sized employ fewer than 50, and micro-sized fewer than 10. Most countries employ similar definitions for SMEs.

In the EU, USA, and UK, as with all economies that provide data, around 99% of all firms are ‘small’ or ‘micro’.  Some 20 million SMEs operate in the EU and 30 million in the USA. In the EU, SME’s employ around 65% of all private sector jobs, and generate around 70% of new ‘net’ jobs, as well as being a source of innovation and new products.

Why do small firms survive?

There are several reasons why small firms survive, including:

  1. In terms of the theory of market structures, despite their dominance in terms of assets, employment and turnover, only around 1% of firms are oligopolies, duopolies or monopolies. In many industries, firms are either monopolistically competitive or operate in conditions which approximate to perfect competition. The key here is that these types of markets have very low barriers to entry, meaning that, at any one time, large numbers of firms exist with each having a low market share – hence the size of each individual business is likely to be ‘small’ relative to the total market size.
  2. New technology, and the rise of the internet, has reduced start-up costs and other barriers to entry, as well as increase barriers to exit, making markets more contestable. Given so, the use of hit-and-run strategies enable some entrepreneurs to establish firms just for the purpose of making short-term (or head-start) profits. They then leave the market once profits fall as new firms enter. It is likely, therefore, that these firms remain relatively small compared with long-established firms.
  3. More generally, there may be no opportunity for firms to benefit from significant economies of scale. This tends to be true for most service sector firms, where labour is the dominant factor of production, and technology cannot be effectively employed.
  4. Small firms are often relatively easy to establish, and generally do not require complex rules and procedures to set them up.
  5. Profit maximisation may not be the driving force for all businesses, such as not-for-profit organisations. Hence, remaining small does not conflict with the profit maximisation objective.
  6. Where monopsony power dominates (as with some transnational companies), the potential for small suppliers to grow is limited given that powerful buyers can push down the prices of suppliers. This limits the revenue and profits attainable, and hence prevents organic growth. This many help explain why small suppliers to large supermarket chains and other large retailers may operate at or just below normal profit, hence scope for expansion is limited.
  7. Some markets may have limited potential for growth, including niche markets which provide specialist or customised services.
  8. Along with this is the rise of micro-marketing, where small groups of potential customers are actively targeted with advertising based on their existing or predicted buying activities.  The use of web tracking cookies makes it easier for small firms to exploit website and search engine visitors to find out about their shopping habits, and target them through their website or through emails.
  9. This has given rise to the concept of the long tail where new technology, low barriers to entry, and micro-marketing helps sustain a very large number of small firms – even in markets dominated by a few large firms.
  10. Government assistance and state aid in the form of subsidies, grants, tax incentives and relief, and guarantees also enable some small firms to survive.
  11. Diseconomies of scale may set-in early for certain types of firm, especially those in the service sector, where significant problems can be experienced as they grow, including difficulties with communication, financing, and employing and training labour.
  12. Globally, subsistence farming (which is not technically a businesses activity) and semi-subsistence farming (where farms sell up to 50% of their products) is widespread and accounts for significant employment.
  13. The rise of microfinance has also enable small firms to be established in many less developed parts of the world.