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The Wonderland Economy

A close-up look at the vital role small business plays in America's economy that debunks many myths about this sector.

Small companies are critical to the health of America's new economy. But we're only beginning to pierce the shroud of myth, half-truth, and outright ignorance that surrounds this dynamic sector of the marketplace

I'm a big fan of the financial writer Andrew Tobias. He writes about money more engagingly and more clearly than anybody else. But when he blows it, he blows it big. I'm thinking of a little piece Tobias did in the mid-1970s. It was called "The Day They Couldn't Fill the Fortune 500."

The tongue-in-cheek concept was indisputably clever. Large companies were getting so big and were combining into so many conglomerates, argued Tobias, that by 1998 there would be only 479 giant corporations left. They would utterly dominate the economy. All the other companies -- the mom-and-pop tradespeople, the Main Street merchants, and the rest of the left-behinds -- would be so small that to put them on the magazine's famous list would be ludicrous. How could you rank even a $250-million company number 480, when number 479 was up around $7 billion?

I bring up this misguided missile not to taunt Tobias. I mention it only to show just how recently most of us took for granted three seemingly obvious truths about the U.S. economy. Bigness was inevitable. Ever-larger corporations would inexorably rule the marketplace. And small business, to put it bluntly, simply didn't matter. The "giant corporate sector" would balloon, predicted Tobias. The "independent entrepreneurial sector" would shrink to the vanishing point.

At the time the facts were on his side. As a group the Fortune 500 had been growing steadily ever since the list was created in 1954. By 1979 their total sales amounted to 58% of America's gross national product, up from 37% 25 years earlier. They employed more than three-quarters of the manufacturing work force, up from half. Every so often a frenzy of conglomeratization would seize them, and the giants would snap each other up -- thereby growing bigger still.

Received wisdom was on Tobias's side, too: for decades, scholars and policy makers had been worrying about the health, even the survival, of small business. Senator William Proxmire wrote a book in 1964 called Can Small Business Survive? John Kenneth Galbraith (and nearly every other economist) advised us that small companies would forever be consigned to the fringes of the modern economy. George S. Odiorne, then a professor at the University of Michigan, may now seem to be a contender (with Tobias!) for the Clouded Crystal Ball Award. But back then he was only repeating for Harper's magazine what people thought they knew. "As in the prize ring," wrote Odiorne, " . . . the good big man invariably beats the good little man." No small company "has much prospect of outsmarting Sears or Macy's or IBM."

Ah, well. Times change. Today almost any upstart seems able to outsmart Sears or Macy's or IBM.

And today, small business matters -- a lot.

We know now, for example, that small companies are one of the U.S. economy's most powerful job-generating engines. Researchers disagree over exactly what share of new jobs small business is responsible for. (See "Small Is Beautiful! Big Is Best!" [Article link].) But some trends are beyond dispute. After growing steadily since the 1950s, the nation's 500 biggest manufacturers began cutting their payrolls. From 16.2 million workers in 1979 they shrank to 11.5 million in 1993. The 500 biggest service companies increased their employment, but only a little. So most of the 20 million new jobs created during the past 15 years came not from established giants, the companies that had led America's growth up till then. The jobs came from companies that were smaller, newer -- or both. They came from that "independent entrepreneurial sector" that Tobias (and a lot of other people) thought would disappear.

We also know that small suddenly became more beautiful in the marketplace.

The self-employment rate had been heading downward for decades, as old-line shopkeepers and tradespeople struggled to compete in the modern economy. Then, unexpectedly, it turned upward. The number of small businesses with employees rose sharply as well, thanks mostly to an explosion in the number of start-ups. When the number of businesses increases, so does the number of small businesses, since more than 99% of all companies are small.

Trends toward smallness turned up throughout the economy. For decades, small manufacturers had lost ground to their larger competitors. Now they began gaining, not just in the United States but all over the industrialized world. Small companies proliferated in the service sector, notably in fast-growing fields such as business services. Small shopkeepers were buffeted by big chains in some retailing categories -- but held their own, according to the latest research, in many others.

The trends are visible not just in the numbers but in the everyday economic landscape:

* Go to the store for a six-pack of beer, and you'll find scores of brands on the shelf: Samuel Adams and Sierra Nevada and Pete's Wicked Ale alongside Bud and Miller Lite and Coors. From beer and coffee and snack foods to industrial chemicals and railroads and electric-power production, the story is much the same. Giant corporations still dominate, but it's the small specialty producers that are enjoying all the growth.

* Order long-distance phone service for your company, and you can choose not only from the offerings of the big three but from a variety of aggregators, resellers, and special-services providers. Here is an industry that for most of the 20th century was one big company. Now -- in long distance, in cellular, in specialized hardware and software -- it's a hotbed of entrepreneurial upstarts.

* Page through a copy of PC World or any of the other computer magazines, and scope out an industry that didn't exist 20 years ago. It has its share of giants: Intel, Microsoft, IBM, and so on. It also has a startling abundance of small and scrappy suppliers. Does anyone really think the personal-computer business in all its facets will "consolidate," as economists say, anytime soon?

Why should the long-term drift toward ever-bigger companies have reversed itself? Economists aren't sure, but they often point to three key factors, none of which seems likely to disappear. One is stiffer competition. In a fast-changing global marketplace, even the largest companies can no longer dominate their industries. They must cut costs (often by outsourcing) and focus their resources (often by selling off extraneous operations). That's why their payrolls have been shrinking.

A second factor: technology. The rapidly dropping price of computing power has created not only whole new industries but whole new methods of producing goods and delivering services. Unlike technological revolutions of the past, this one is accessible to companies of all sizes.

Then there's a third factor, a kind of entrepreneurial snowball effect, at work. Say a few enterprising souls take advantage of new technology or new market niches and start up some companies. Some are wildly successful. Now big established companies find themselves faced with even more competition. The giants have to cut costs, so they slash their payrolls, throwing seasoned, savvy businesspeople out of work. A few of the newly unemployed start companies of their own. Every new company needs office supplies and furniture, computers and programming services, advertising and marketing, accounting and payroll, janitorial and temporary help, and so on -- and it wants to get these services from independent suppliers. A 1,000-employee corporation has its own cafeteria and legal department. Ten 100-employee companies support a lot of lunchrooms and law offices. Result: an entrepreneurial explosion.

So one astonishing thing about this economic transformation is simply that it occurred. No one expected it. A second astonishing thing is how little, as yet, we know about it.

Back in the corporate era, it was pretty easy for anyone to get a handle on what was happening in the marketplace. What counted, in economic terms, was a relative handful of companies. Nearly all were publicly traded and therefore easy to track. And now? Those big corporations still "count" -- but so do tens of thousands of growth companies (at all stages of development) and millions of smaller enterprises, most of them privately held.

Who knows what all those businesses are up to? Who knows what their revenues are, how many people they employ, or even exactly what they sell? The Internal Revenue Service knows their financials -- maybe -- but the IRS doesn't release much of its data. Dun & Bradstreet and other credit bureaus collect some information, but a D&B data set is only a first approximation of a complete and accurate census. The Census Bureau gathers business data every five years. But the bureau doesn't release its statistics for another three or four years, half a lifetime in today's fast-changing economy. Then, too, as David Friedman argues elsewhere in this issue, many of the new companies are invisible -- and can be hard to classify even if they do turn up on a statistician's radar screen. (See "Job Detection," [Article link].)

Without definitive data, claims about small business and the economy often degenerate into disputes about details and squabbles over statistics. The truth gets mired in a welter of myths and confusion. What is a small business, anyway? If a company starts small and quickly grows big, do we count it in the statistics as small or large? How many small companies really do grow (and, yes, how many jobs do they really create)? Attempting to answer those questions raises a host of policy issues. Should government help small companies? Why? How?

Today all of us -- businesspeople, policy makers, researchers, journalists -- are explorers in this new and poorly charted territory. The pages that follow lay out the basic data -- the state of small business and its role in the economy -- as best we understand it. But we don't have all the information we need. Nor can we see over the horizon. As Zoltan Acs, visiting professor of business and public policy at the University of Maryland in College Park, points out, we can't yet know whether the upheavals of the past 20 years are just a momentary blip in the long-term trend toward bigness. Andrew Tobias may turn out to be right after all -- but a little later than he imagined.

But if the upheavals are not a blip, if the future is a continuation of what we're seeing right now, then we're in a truly new economy -- a world in which small business, far from being a backwater, is a roiling, swollen, turbulent tributary to the main stream. In that world, the state of small business is an issue that no one who cares about America's economic future can ignore.

* * *

The (Small) Business Landscape
If businesses were buildings, you could walk around the economic landscape and count them. You could see how big they were and what condition they were in. You could note how many new ones were under construction and how many were waiting for the wrecker's ball.

If you could do the same for businesses -- if you could gather regular, accurate, up-to-the-minute data on all those variables -- you could compile a rock-solid assessment of how your industry or region or country was faring economically. You could see where the jobs were coming from and where the hot new markets were developing. You could measure which policies helped, and which hindered, business creation and growth.

Maybe some day. Right now what we've got are estimates of those data, not always accurate and not always up-to-date. When you start to count businesses, you quickly realize that you have entered a kind of Wonderland, where things aren't always what they seem. Consider some of the data -- and some of the complications:

* * *

Counting companies. In 1992 more than 21 million "businesses" filed tax returns. That doesn't mean we have 21 million companies in the United States. I filed one of those returns because I made a little extra money that year as a freelance writer. My wife filed one, too -- she works for a health-maintenance organization, but she has a small psychotherapy practice on the side. Our returns and 15 million others were from proprietorships -- from shop owners, plumbers, part-time accountants, craftspeople, and everyone else who works mostly alone. (Three-fifths of those sole proprietors run their business on a full-time basis.) The other 6 million tax returns were from corporations and partnerships. Only 4% of the 21 million income-generating enterprises reported revenues of more than $1 million.

A second method of counting companies is to tally only those with employees. In 1992 the United States had 5.7 million companies with at least one employee, up from 4.7 million a decade earlier. Big companies are rare even in that crowd. More than 50% of the 5.7 million employ fewer than 5 people. Ninety percent employ fewer than 20. Only 70,000 companies have more than 100 people on the payroll, and only 14,000 have more than 500.

Researchers often try to distinguish between "real" businesses -- the ones with employees -- and "casual" businesses, meaning me and all those other Schedule C filers who run some kind of moneymaking operation on the side. That's a valid distinction in principle, but in this electronically networked age it's hard to separate the two categories. The reason: people who seem to be sole proprietors may in fact be at the node of a virtual company -- and may be responsible for as much wealth creation (and as many tax dollars) as any old-style small business.

Consider Paul Farrow, founder of Walden Paddlers, a kayak manufacturer. Farrow works out of a home office in suburban Boston, alone except for a few leased employees. His kayaks are made by a nearby plastics fabricator. His 250 dealers in the United States, Canada, and Japan distribute $1 million worth of the boats to some 40 customers ranging from Eastern Mountain Sports and Recreational Equipment Inc., which operate more than 100 stores combined, to the single water-ski shop. Walden Paddlers is a "real" business, just one with an exceptionally small payroll. Today many such companies dot the economic landscape.

* * *

What's "small"? Even among companies with employees, figuring out what a small business is can be tricky. Does "small" mean fewer than 500 employees (the Small Business Administration's definition)? Fewer than 100? In fact, when politicians and their constituents think "small business," they're usually envisioning struggling shops with a payroll of 5 or 10, not well-?established (and often thriving) companies with 495 workers.

Like Farrow and his virtual peers, some companies seem small at first glance and considerably bigger at second. Consider Novellus Systems, a Silicon Valley manufacturer of chip-fabrication equipment. Novellus designs the products, farms out manufacture of subassemblies, and then does final assembly and marketing. In 1993 it did this with 371 employees, who generated $113.5 million in sales. Just 12 months later it had 531 employees generating nearly $225 million in sales.

Unlike buildings, businesses don't stay the same size for long. Some small companies grow at a seemingly impossible rate. In 1987 computer maker Gateway 2000 had 11 employees and $1.5 million in revenues, small by any standard. In 1994 it had 5,000 employees -- and $2.7 billion in revenues. Gateway is unusual, sure. But there are many such anomalies, and they generate both confusion and acrimony. In the months leading up to the June 1995 White House Conference on Small Business, heads of many fast-growing companies argued that their concerns were being swamped by those of tiny, slow-growth businesses. "Big business and small business are well represented in Washington," the CEO of a growth-oriented software company told the Wall Street Journal. "But companies like [ours] don't have a voice."

* * *

Hybrids and networks. Not far from where I live is a Mail Boxes Etc. franchise, owned by a guy named Steve Ochi. Ochi is the quintessential small-scale entrepreneur: he has one store and four employees. Most of the time he's behind the counter himself. But Mail Boxes Etc. isn't exactly a small company. Worldwide it has more than 2,600 stores and more than $1 billion in revenues. Other franchise companies are as big or bigger, right up to giant McDonald's. Individual franchisees may be small operators, but their livelihood depends as much on the decisions of a big company as on their own business acumen.

Franchising is growing. (See chart, "The Growing Number of Franchised Establishments," page 8.) In 1990 franchised units accounted for 34% of retail trade, up from 26% in 1975. Franchising's share is expected to jump another six percentage points by 2000. Franchising is also growing in complexity. "Conversion" franchises, for example -- acquisition or affiliation of existing businesses by a national chain -- turn the conventional franchise relationship on its ear. Nor is "franchisee" synonymous with "small business." In 1990, reports the SBA, about 40% of franchise owners owned more than one unit. That group includes the likes of Marriott, which owns 78 franchises.

Other hybrid business forms are also proliferating, such as strategic alliances between large companies and not-so-large ones. (See chart, "Nature of Small-Firm Alliances," page 8.) Mail Boxes Etc. is 16% owned by United Parcel Service, which means that Ochi, and every other franchisee, is linked to one of the biggest transportation companies in the business. Redhook Ale Brewery, a microbrewery headquartered in Seattle, recently sold one-quarter of its equity to Anheuser-Busch. Redhook CEO Paul Shipman, a classic start-up entrepreneur whose 12-year-old company has 110 employees, has provided himself not only with capital from the giant's deep pockets but with immediate access to beer distributors in every corner of the nation.

* * *

The future. Cast an eye on the chart on page 8 showing the growth in the number of businesses compared with the growth in U.S. population. That change in the companies-to-people ratio -- another measure of the explosion in entrepreneurship -- has at least three sources. One is the set of economic and technological factors mentioned earlier. A second is the long-term shift from a manufacturing to a service-based economy. A third is the aging of the baby boom: when you have more people in prime company-starting age, you have more companies.

That last factor won't go on forever, and as the boomer generation grows older we may see a drop-off in the rate of company formation. (A recent article in The Economist argues that it is already slowing.) Or will we? The shift to services continues unabated. "Major growth [is] expected in health services, business services, professional services, and educational and social services," notes the SBA in a study forecasting the state of small business in 2005. Neither globalization nor the technological revolution has come close to running its course. So the entrepreneurial explosion is not yet quieting.

And if the past 20 years have shown anything, it's the difficulty of predicting the shape of enterprise in a time of rapid change. Maybe, as William Bridges proposes, more and more of us will be working at home, as independent contractors, and will simply sign up for "projects" rather than full-time employment. (See "A Nation of Owners," [Article link].) Our ideas about jobs are shifting, which means that our ideas about what a "company" is must shift as well.

Which, of course, will only make it harder to take an accurate census of the landscape in which we Americans earn our living.

* * *

Nothing is as important to the state of small business -- or to the health of the U.S. economy -- as the rate at which entrepreneurs are creating new companies.

Partly this is a matter of logic. Start-ups take the place of companies that shut down. They replenish the business population and sow the seeds of growth. They provide jobs, income, and hope for the future. Often, they create new markets, just by nosing their way into niches no one knew were there.

It's also a matter of experience and evidence. When a new industry takes off, it's invariably populated by a host of start-ups. When a region booms, part of the reason is always the creation of new companies. Nationally, job growth mirrors almost perfectly the rate of new-business formation one year earlier.

So what do we know about the start-up rate and the people -- the entrepreneurs -- who are responsible for it? Inevitably, not enough.

One widely cited figure is the number of new incorporations, toted up each year by Dun & Bradstreet from state-government figures. That number has exceeded 600,000 every year since 1983 (up from only 326,000 in 1975). But some of the "new incorps" aren't new (they're reorganizations of existing businesses), and some aren't even companies (maybe they're neighborhood associations). Also, plenty of new companies get under way each year without incorporating.

That said, the new-incorp trend has been mainly upward for the past two decades, with only a slight falloff since its mid-1980s peak. It may not be a perfect measure, but there's no doubt as to its general direction.

Every year more than 700,000 new companies begin paying payroll taxes to their state governments and so show up as new businesses in Labor Department statistics. Their ranks are supplemented by another 150,000 or so "successor" companies, meaning new firms that take over existing businesses. The bottom line: between 800,000 and 900,000 new companies with employees come into being every year. (See chart, "Change in the Number of U.S. Businesses with Employees," page 9.) On average, about 75,000 more companies are created in a year than go out of business.

But what about people who are in the early stages of company creation -- people who aren't close to incorporating or hiring an employee and indeed may never do so? Thanks to Paul Reynolds and other researchers, we know at least a little about those fledgling entrepreneurs.

Reynolds, a sociologist, is Coleman Foundation chair holder of entrepreneurial studies at Marquette University, in Milwaukee. (See "Who's Who in Small-Business Research," [Article link].) For the past few years he has been surveying samples of the general population to find the entrepreneurs among them. The findings are astonishing even to Reynolds: 4% of the population -- one in every 25 adult Americans -- say that they're in the process of starting a company. As a group they have taken an average of seven steps toward realizing their goal. If the findings hold true throughout the country, they put the number of incipient entrepreneurs at more than 7 million. Since many are working together, the number of new companies in formation may be well over 3 million.

One-third of those would-be business creators, says Reynolds, are women. That squares with tax data -- 32.2% of all proprietorships in 1990 were owned by women. (See chart, "The Growing Number of Self-Employed," page 7.) The number of female entrepreneurs is considerably higher today than it was in the past. Between 1979 and 1990, the number of proprietorships owned by women rose twice as fast as the number owned by men. According to estimates compiled by the National Women's Business Council, women owned 6.5 million companies in 1992, up from only 2.6 million 10 years earlier.

* * *

The myth persists. The "fact" that "four out of five start-ups fail" continues to turn up in any number of pronouncements about the precarious state of small business. Advocates say it shows that small business needs government help. Critics retort it shows that small business can't be depended on for stable economic growth.

Unfortunately -- or maybe fortunately -- the "fact" is wrong, as researchers have discovered only in the past few years.

In 1989 Bruce Phillips (of the Small Business Administration) and Bruce Kirchhoff (of the New Jersey Institute of Technology) analyzed business records from the government's Small Business Data Base (SBDB). Their first finding: nearly 40% of new companies in the file survived six years. That was already twice as many survivors as the myth predicted. Even after eight years, the survival rate was close to 30%. (See "Who's Who in Small-Business Research," [Article link].) Rates varied by industry -- manufacturing companies, for example, typically had a higher survival rate than retailers. Size made a difference, too. The tiniest companies, and those that never added even one employee, were more likely to fail than others.

Kirchhoff scrutinized the data still further. Companies are terminated for all kinds of reasons. The owner sells out or decides to get a regular job. He or she closes one company to start another, maybe in a different industry or location. Those discontinuances are different from what we usually think of as business failures, meaning a closing in which creditors lose their money. Kirchhoff found that discontinuances where creditors don't lose money account for the vast majority of all terminations. Only about 18% of all new businesses, he discovered, end in real failure. The rest survive or are closed voluntarily.

So is that the whole story? Not yet; the research is still new. But most investigations bear out Kirchhoff's conclusions.

* Studies of Census Bureau data by several economists suggest numbers in much the same ballpark as the Phillips-Kirchhoff estimates. One research team found 40% of new manufacturing companies still alive after five years. A second team looked at a representative sample of industries and found half the companies surviving.

* Just last year Joseph W. Duncan and Douglas P. Handler of Dun & Bradstreet discovered a much higher rate of survival among companies tracked by D&B. Nearly 70% of companies formed in 1985 were still alive nine years later, reported the two economists. What's more, the smallest companies in D&B's listings had a higher survival rate than the larger ones.

* What no one knows as yet are the failure rates of the very smallest companies, the ones that never make it into D&B's listings. Sketchy evidence indicates that business mortality even in this high-risk population may be lower than expected. Paul Reynolds and Brenda Miller studied a representative sample of 550 companies started in 1984 and found that nearly four-fifths of them were still alive four years later. A survey of new companies by the National Federation of Independent Business came up with nearly identical results.

Those surveys, explains Kirchhoff, don't necessarily contradict the broad-based statistical studies. The surveys didn't ascertain whether respondents were in the same business in the same location, just whether they were still "in business." Maybe they had closed one company and started another, or maybe they had moved. Those events would have shown up in the statistics as a discontinuance.

In fact, Kirchhoff adds, that very disparity points to the essential truth contained in the new research. According to the old myth, small business was an enterprise fraught with financial peril -- didn't four out of every five fail? We know now that only a small fraction come to real grief, complete with losses to creditors. Many more survive and thrive.

* * *

Job Generation
Give David Birch the credit. And at least some of the blame.

Back in the late 1970s, the hot economic issue had nothing to do with small business; it was whether "runaway" shops were causing job losses in the northern states and corresponding job gains in the southern states. Birch, who was affiliated with the Massachusetts Institute of Technology, figured he could answer the question with a database that tracked individual business histories. So he arranged to acquire Dun & Bradstreet's files for the years 1969 through 1976. He was the first researcher to do so. (See "Who's Who in Small-Business Research," [Article link].)

Plowing through the records, Birch found that runaways weren't really very important. But when he began analyzing which companies were adding jobs, he found a surprising correlation. Eighty percent of new jobs were coming from small companies, those with fewer than 100 employees.

It was a startling statistic, and when Birch publicized it he got a lot of attention. He testified before Congress. He wrote articles. The Small Business Administration named him Researcher of the Year -- just in time for the first White House Conference on Small Business, held in 1980.

Ever since, people have been arguing about the numbers.

A 1982 study by two Brookings Institution researchers, for example, seemed to contradict Birch. That study was still being cited years later -- even though one of its authors had since done a subsequent study with conclusions that turned out to be closer to Birch's. Other scholars joined the fray. At one point Birch became so exasperated with the debate that he told the Wall Street Journal that 80% was a "silly number" that meant "almost nothing." His critics pounced on that to claim that he really didn't know what he was talking about.

But he did.

To be sure, the debate continues today -- you can tune it in by turning to Article link. But what's interesting by now isn't just the points of difference among the disputants, it's the points of agreement. Three key ones:

* The share of new jobs accounted for by small companies varies substantially, depending on the time period you're looking at. During an economic downturn, for example, small companies are typically the only ones doing any hiring. When the economy picks up, big corporations often add to their payrolls.

It's this variation that was behind Birch's "silly number" statement; as he went on to explain, you can say that small companies account for whatever fraction of new jobs you want them to, simply by choosing the right start date. The Brookings study that apparently contradicted his findings scrutinized a different time period and therefore found different numbers.

* That said, the share of new jobs accounted for by small companies is nevertheless higher than you might expect. Half of private-sector employees work in small companies, a number that has remained stable over time. So you'd expect half of the new jobs, over time, to come from that sector of the business world.

In fact, the proportion is greater. "It is reasonable to estimate," says a study in a July 1994 article in Business Economics, "that over the past twenty-five years two-thirds of the net new jobs in the private sector originated among small firms." Most serious students of the subject would now agree.

* But "small business" in this context is a misnomer. The typical small company stays roughly the same size the rest of its life. In their D&B study, Joseph W. Duncan and Douglas P. Handler found that 65% of the companies started in 1985 and surviving in 1994 reported exactly the same number of employees as when they started. Only 24% reported any increase in employment, and only 6% had added more than 10 employees.

Some small companies, by contrast, grow rapidly. Birch calls them "gazelles" and argues that they account for a large fraction of new jobs. In a recent study, he and his coauthor write: "During the 1988Ñ1992 time period . . . 4 percent of all firms (about 350,000) . . . accounted for about 60 percent of all the new jobs in the economy." Significantly, Birch's coauthor is James Medoff, a Harvard economist and a former Birch critic. Thus has a rough consensus about job generation been hammered out.

At the same time many issues about jobs and small business remain unresolved. One is whether the jobs being created by small companies are "good" jobs. Historically, small business has paid lower wages and provided fewer benefits than big business. That remains true today, even though job security in large corporations isn't what it once was. Whether new jobs fall into any recognizable pattern that varies with company size is, however, a matter of debate. David Birch's data show that "small firms are raising the wage scale . . . not lowering it." Others aren't so sure.

A second issue: whether the noisy debate over job generation simply misses the point. "Small" versus "big" isn't really the issue, argue critics such as the University of Michigan's John E. Jackson. What we really want to know are the "dynamic properties" of the gazelles, the companies that are creating jobs, however big or small they may be. By that reckoning, it makes more sense for a researcher to lump Microsoft together with an innovative machine shop and a fast-growing travel agency than with a tottering (but equally large) company like Digital Equipment Corp.

A recent column by Henry Kressel and Bruce Guile made just that point. (See "The Wrong Question," Inc., March 1995, [Article link]). Look at the video rental business, they wrote. You don't learn much by counting all the jobs created by the mom-and-pop enterprises that once populated the industry, nor by counting the jobs those same small companies have since lost to giants like Blockbuster.

What's important about video rentals is that small entrepreneurs took a risk and helped create a market full of customers accustomed to renting videotapes. "Without that business there would be no data on which to base projections of demand for services such as videos-on-demand." And there would be a smaller group of companies (large and small!) interested in the exploding new field of digitized home-entertainment products.

* * *

Small Business in the New Economy
"Small business" used to be the shops along Main Street and the offices one flight up. It was two-story brick factories and warehouses along the tracks. It was plumbers and landscape contractors and machinists working out of a garage.

Small business today is all those things. But it's something more as well. Go looking for a typical small company, and you're likely to bump into some highly atypical enterprises.

Maybe, for example, you'll visit Concepts, Ink, a one-woman marketing consulting firm in Menlo Park, Calif., headed by an ex-Apple Computer executive named Ellen Leanse. Working out of a fully computerized home office, Leanse has built a network of high-tech clients (including Apple) and a web of colleagues and suppliers who provide her with specialized expertise when needed.

Or maybe you'll stop in at OTR Express Inc., a 420-driver trucking company in Olathe, Kans., a suburb of Kansas City. OTRX, as it's known, operates in the nationwide "spot" market for truckload shipments -- and uses complex computer analyses to deploy and redeploy its trucks for maximum profitability every day. (See "Riding the High-Tech Highway," Inc., March 1993, [Article link].) In an industry once dominated by giants, OTRX has grown from start-up to more than $40 million in only a decade.

Then again, you might find yourself at Reflexite Corp., a 325-employee company with headquarters near Hartford, Conn., and sales in more than 30 countries around the globe. Once a struggling plastics company, Reflexite now manufactures and sells the reflective material used on everything from highway signs to life preservers -- and does so in direct competition with giant 3M Co. (See "Collective Effort," Inc., January 1992, [Article link].) Export sales account for nearly half of Reflexite's revenues.

The world has changed, in short, and small business along with it. Where once it was a sleepy appendage to the corporate sector, it now stands alongside it -- and in some cases well out in front of it. Small companies themselves rarely look the way they once did, even if they're in traditional industries (See "There Are No Simple Businesses Anymore," [Article link].) They use state-of-the-art technology to deliver sophisticated goods and services. They push aggressively into niches that would once have been dominated by the Fortune 500. They don't shrink from international, even worldwide, markets.

The diversity in this landscape makes it difficult to assess the state of any given group of small businesses. Companies that fail to adapt to the new realities continue to be squeezed out of the marketplace, even as savvier enterprises find (or create) new avenues for growth. Granted, we don't know as much as we could about the landscape. The statistics are incomplete, out-of-date, or unavailable. But even if we had good ones, we would see only the outlines of our new economy. Statistics can portray what has happened. They can't tell us why one small company fails and another succeeds.

The state of small business as a whole, however, is much less puzzling. Yes, it's tumultuous. But that very tumult has created a bustling, creative, and resourceful sector of the U.S. economy -- a sector, we now know, that is in no danger of disappearing.

* * *


The Growing Number of Self-Employed

Nonfarm Self-Employed Workers (millions) % of Nonfarm Self-Employed Women
1990 8.8 32.2%
1985 7.8 28.1%
1975 5.7 26.1%

Sources: Statistical Abstract of the United States, U.S. Department of Commerce, Washington, D.C.,1994; A Compendium of Statistics on Women-Owned Businesses in the U.S., National Women's Business Council, Washington, D.C., 1994.

Small Business's Share of U.S. Sales
Small businesses in the United States -- more than 20 million strong -- create two out of every three new jobs and are twice as innovative as large companies. Small businesses also account for more than half of the sales of all goods and services.

Change in the Small-Business Sales Share 1982 and 1987 (in trillions of dollars)

1982 1987
Total U.S. company sales $5.27 $7.09
Small U.S. company sales (< 500 employees) $2.72 $3.79
Share of sales 52% 53%

Source: The State of Small Business, A Report of the President, Small Business Administration, Washington, D.C., 1993.

Fortune 500 Companies' Percentage Share In U.S. Economic Activity, 1975Ñ1992
The graph below shows the effect Fortune 500 companies have on the U.S. economy. The numbers in the manufacturing shipments and civilian employment categories represent Fortune 500 companies' percentage share in those categories. The GDP category represents Fortune 500 companies' revenues measured as a percentage of gross domestic product.

Manufacturing Shipments GDP Civilian Employment
1975 84% 55% 17%
1980 88% 61% 16%
1985 78% 45% 14%
1990 80% 43% 12%
1992 80% 40% 10%

Source: "Small Business, Flexible Technology, and Industrial Dynamics," by Bo Carlsson, Case Western Reserve University, Cleveland.

How Many Small Businesses Are There? It Depends on How You Define Small Business

Number of Employees 1Ñ19 20Ñ99 100Ñ499 500+
1980 88.7% 9.3% 1.7% .3% Total Companies: 3.97 million
1988 83.3% 14.1% 2.3% .3% Total Companies: 5.3 million

Source: U.S. Small Business Administration, Office of Advocacy, Small Business Data Base, Washington, D.C.

Nature of Small-Firm Alliances
(sales < $50 million)

Marketing 26%
Joint Venture 21%
R&D 21%
Manufacturing 15%
Licensing 13%
Equity Stake 3%
Funding 1%
Total Alliances: 2,800

Source: The Alliance Analyst, Philadelphia, 1995.

The Growing Number of Franchised Establishments

Number Sales
(in thousands) (in billions)
1992 558 $803
1990 533 $716
1980 442 $336
1970 396 $120

Sources: Franchising in the Economy , U.S. Department of Commerce, various years; International Franchise Association, Washington, D.C.,1992.

The Riskiest and Safest Businesses
Every month, according to Dun & Bradstreet's records, several thousand companies fail under circumstances in which creditors lose money. Small companies fail more frequently than larger companies do, which means that entrepreneurship can still be hazardous to your financial health. But the aggregate numbers camouflage some remarkable differences among industries, argues Bruce Phillips, the Small Business Administration's Director of the Office of Economic Research at the Office of Advocacy, in Washington, D.C. Phillips studied what the SBA calls small-business-dominated industries for the year 1990 and found that failure rates varied from a whopping 578 per 10,000 companies all the way down to a piddling 13 per 10,000. Here are the businesses that Phillips's study revealed to be the five riskiest and the five safest, based on failure rates:

Failure Rate per
Industry 10,000 (1990)
Amusement and recreation services 578
Oil and gas extraction 166
Lumber and wood manufacturing 106
General building contractors 101
Furniture and home-furnishings stores 99
Personal services 39
Insurance agents and brokers 28
Legal services 25
Health services 21
Educational services (private education) 13

Growth in Businesses and Population
In 1992 more than 21 million businesses filed tax returns in the United States. And only 14,000 of those businesses employ more than 500 people and are considered by the SBA to be "large" businesses. At the end of 1992, there were 5.7 million businesses with employees in the United States. The net number of companies increases at a rate of between 2% and 3% annually, which is slightly higher than the rate of growth of the general population and of the work force.

Company Counts: Nonfarm Business Tax Returns

U.S. Companies-
Total % Prop- Population to-People
(in millions) rietorships (in millions) Ratio
1992 21.3 71% 255.5 (est.) 1:12.0
1990 20.4 70% 250.5 1:12.3
1985 17.0 69% 238.5 1:14.0
1982 14.3 69% 232.2 1:16.2

Sources: The State of Small Business, Small Business Administration, Washington, D.C., 1993; Statistical Abstract of the United States, U.S. Department of Commerce, Washington, D.C., 1994.

Note: 1992 numbers are projected.

Change in the Number of U.S. Businesses with Employees 1982Ñ1992 (in thousands)

Successor New
Companies Companies* Companies Terminations
1992 5,711 137 734 819
1990 5,626 148 785 835
1988 5,480 154 731 751
1986 5,187 176 720 809
1984 4,966 164 687 677
1982 4,718 189 587 717

Source: The State of Small Business, A Report to the President, Small Business Administration, Washington, D.C., 1993. * New firms that are taken over by existing businesses

Staying Alive

Percentage of Companies Started in 1985 That Were Still Operating in 1994, by Original Employee Head Counts

Number of employees Survival rate
1Ñ4 74%
5Ñ9 65%
10Ñ14 59%
15Ñ19 57%
20Ñ49 53%
50Ñ99 52%
100+ 42%
All 70%

Source: The Dun & Bradstreet Corporation, New York City.

U.S. Small Business as a World Economic Power

Total Output of U.S. Small Business Compared with the World's Largest Economies, 1988, in trillions of dollars

United States $4.9
Japan $2.9
Small Business $1.9
Germany $1.4
France $.9
United Kingdom $.8
Italy $.8
China $.5
Canada $.5
Brazil $.4

Source: A Small Business Primer, by William J. Dennis Jr., National Federation of Independent Business Foundation, Washington D.C., 1993.


How easy it would be if you could count small companies' contribution to job generation with the economic equivalent of a couple of snapshots. Take a picture of small-business employment in 1992, say. Take another picture in 1994 and compare the two.

Alas, the world doesn't work that way, simply because companies don't stay put in the same size categories.

Take a simplified example. Suppose in 1992 you have two companies with 10 employees and two with 1,000 employees. Between 1992 and 1994, one of the small businesses adds 500 employees. That gives it a total of 510 and puts it over into the "large" category.

If the others all stay the same, the snapshot in 1994 will show that big business has gained a

lot of jobs -- 510, to be exact. Small business, meanwhile, will have lost 10 (half its jobs!) -- even though it was a small company that created all those new jobs.

To get around that problem, researchers have learned to conduct what they call longitudinal studies. They identify a universe of companies in 1992, or whenever, and then follow each and every company over time. The jobs added or lost by companies that were small in 1992 are counted as jobs added or lost by "small business." Small business's share of new jobs is simply that number divided by the total number of new jobs.

In practice, of course, the calculations are never simple. Company records in any database may be incomplete or missing. Available databases (like Dun & Bradstreet's) may not capture important subsectors of the economy. It's often hard for researchers to keep track of ownership -- so that a company-owned Budweiser distributorship, for example, is counted as part of a big company, while an independently owned distributor is counted as a small business.

Job Generation Among Small and Large Companies, from 1981 to 1990
Share of total number ot jobs created

Small Companies Large Companies
1981Ñ82 92% 8%
1985Ñ86 44% 56%
1989Ñ90 100% 0%

Source: Entrepreneurship and Dynamic Capitalism, by Bruce A. Kirchhoff, Praeger, Westport, Conn.,1994.


The new economy is a global marketplace. How many small companies are players?

The short answer: no one knows -- but the number is probably growing. In 1993 the Commerce Department released a study of U.S. exporters that provided the first solid data on the size of companies engaged in exporting. Some 96% of manufacturers that sold goods abroad, said the study, were small or midsize. (Three-quarters of that group had fewer than 100 employees.) Nearly all the wholesalers and other intermediaries engaged in exporting were small as well. However, large com-

panies still accounted for the vast bulk of export shipments. The 100 leading exporters alone -- companies like Caterpillar and General Electric -- accounted for half of the total.

Despite this study, it's hard to know the facts. Look at those "intermediaries," for instance. Manufacturers of all sizes often deal through intermediaries, and the statistics have no way of identifying the original suppliers of the goods being exported. Service exports, moreover, are notoriously hard to track. Then, too, the Commerce Department study was based on the 1987 Economic Census, and data from the 1992 tabulation won't be available until 1996 at the earliest. So how many small companies are actually selling to export markets right now is anybody's guess.

What makes us think the number is growing is a survey of small companies conducted every year for the past three years by Arthur Andersen & Co. and National Small Business United. In 1992 only 11% of the respondents said that they exported goods or services. In 1993 that number was up to 16%; in 1994, 20%. The most common markets? Canada, Western Europe, Mexico, and Asia/Pacific, in that order.

U.S. Exporters by number of employees

Percentage of Total
Fewer than 20 63%
20Ñ99 24%
100Ñ499 9%
More than 500 4%

Total Exporters: 105,000

Source: A Profile of United States Exporters, International Trade Administration, Washington, D.C

Last updated: May 15, 1995

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