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Written by Mike Walden
I am now a small business owner. Since leaving North Carolina State University, I have operated a private business providing speaker services, economic research, and analysis on a variety of issues.
There are no employees. This may seem strange at first glance, but it actually applies to most small businesses. In fact, the latest national data shows that 80% of small businesses have no employees.
I think there is a general feeling that small businesses are the backbone of the economy, and there are good reasons for this attitude. Using the definition that small businesses have 1,000 or fewer employees and annual gross revenues of $40 million or less, North Carolina has more than 1 million small businesses, nearly half of all employees. This means that it employs 1.8 million people. The highest concentrations of small businesses in the state are in the professional, construction, management, real estate, and retail industries.
Small businesses have their advantages, but a big one is their connection to the community. Because small businesses are small and often operate in a limited geographic area, they typically have greater knowledge of their customers. Small business owners often live in the same area as their customers. Because the owner is on-site, small businesses often have more flexibility than larger businesses. As a personal example, my local “mom and pop” hardware store has done many special orders for me that I wouldn’t be able to get at a large national chain store.
There are also broader social benefits from small and medium-sized enterprises. Typically, profits go to local owners rather than shareholders spread across the country, so a greater percentage of the money spent in small businesses stays in the local community.
There are so many small businesses, especially in North Carolina, that they are relatively easy to start, which helps the competition. Most economists agree that increased competition among substitute firms drives down prices and also incentivizes firms to continue providing what customers want. Small businesses may be able to innovate more because there is less bureaucracy and fewer decision makers have to agree on new products and services.
Although small businesses have many advantages, there are also significant challenges. The big challenge is the failure rate. According to the latest data, 50% of small businesses fail in their first five years. There are many reasons for this high rate. Many small businesses start with a new idea for a product or service that looks good on paper but may be bad in reality. Financing can also be difficult for small businesses.
Small businesses are more dependent on labor. Labor costs account for 70% of the total costs of small and medium-sized enterprises, which is much higher than the labor share of large enterprises. This means small businesses are more concerned about finding qualified workers and paying them enough wages to keep them working. Large companies can tap into deep pockets to add more technology and machinery to their operations. Technology and machines often allow us to perform tasks more efficiently. Of course, technology and machines won’t move into higher-paying jobs.
Will the future be easier or harder for small businesses? There are several parts to the answer. With birth rates declining nationwide, many futurists expect labor shortage problems to continue and perhaps even increase. This trend can be particularly harmful to small and medium-sized businesses due to their increased reliance on labor.
Our country seems to be becoming even more “homogenized.” This means that dramatic improvements in communication and travel have made us more similar and less different. When I was a young man in the 1950s and 1960s, visiting relatives in other cities and states exposed me to a wide variety of foods, restaurants, stores, and entertainment. Today, the Internet, streaming, mobile phones, and national advertising have made it easier for large companies to establish a national presence with recognizable stores and brands. This makes it difficult for small and medium-sized enterprises to break through and establish their own identity.
Increasing international competition and trade are also having a significant negative impact on many small and medium-sized enterprises. Not only do small businesses have to compete with large companies in their backyards, they now also have to compete with even larger competitors abroad.
Of course, advances in technology are happening all the time and can be harmful or helpful to small businesses. Improvements in technology that allow large companies to operate more efficiently and at lower costs can increase their cost advantage over smaller companies.
But small businesses can benefit greatly when technological advances are applied to tasks that vary little by company size, such as managing inventory, ordering supplies, and analyzing sales trends. For example, studying sales trends based on different types of buyers is very important for any business. But in the days before computers and the easy application of analytical programs like those developed by his SAS company in North Carolina, small businesses could not afford such useful work. Now it’s possible.
The big question is how AI (artificial intelligence) will be applied to the battle between small and large businesses. My guess is that the initial winners will be the big companies, but over time the profits will become more even.
I believe that small and medium-sized enterprises will continue to exist. For many people, small businesses represent hopes and dreams, but they also bring tears. Many small businesses will fail, but I would argue that overall we are winning from those who try, and certainly those who persist. But you decide.
Mike Walden is the William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.
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