MIKE WALDEN COLUMN: What’s the future of small business?

I am now a small business owner. Since retiring from North Carolina State University, I have operated a one-person business offering speaker services as well as economic studies and analysis on a variety of issues.

Mike Walden

I have no employees. While at first glance that may appear odd, it’s actually the case for most small businesses. Indeed, the latest national data show 80% of small businesses have no employees.

I think there’s a general feeling that small businesses are the backbone of the economy, and there’s good reason for this attitude. Using the definition that a small business has no more than 1,000 employees and $40 million of annual gross receipts, there are over 1 million small businesses in North Carolina employing 1.8 million people — close to half of all workers. The highest concentration of small businesses in the state are in the professional, construction, administrative, real estate and retail trade sectors.

There are advantages to small businesses, and a big one is their ties to the community. Because they are small and often operate in a limited geographic area, small businesses usually have good knowledge of their customers. Often, owners of small businesses live in the same neighborhoods as their customers. Because the owners are on site, small businesses can often be more flexible than larger ones. As a personal example, a local “Mom and Pop” hardware store I use has done numerous special orders for me that a large national chain store wouldn’t do.

There are also broader societal benefits from small businesses. Because earnings usually go to a local owner rather than to shareholders spread across the nation, a larger percentage of funds spent at a small business stays in the community.

Because small businesses are so numerous and can be started relatively easily — especially in North Carolina — they contribute to competition. Most economists agree that more competition between alternative firms helps keep prices lower and also motivates businesses to continuously provide what their customers want. Small businesses may be better able to innovate because they have less bureaucracy and fewer decision-makers who must agree to new products or services.

Although there are numerous advantages from small businesses, there are also large challenges. A big challenge is the failure rate. The latest data show 50% of small businesses fail in their first five years. There are many reasons for this high rate. Numerous small businesses begin with a new idea for a product or service, which, although it looks good on paper, may not be good in reality. Financing can also be harder for small businesses.

Small businesses have a greater reliance on labor. Labor costs account for 70% of small business total costs, much higher than the labor share for larger businesses. This means small businesses worry more about finding qualified workers and paying enough so they stay. Larger businesses are able to use their deeper financial pockets to add more technology and machinery to their operations. Technology and machinery can often perform tasks more efficiently, and, of course, technology and machinery will never leave for a better paying job.

Will the future be easier or harder for small businesses?

There are several parts to the answer. With the drop in the national birth rate, many futurists expect the issue of labor shortages to continue and perhaps increase. With their greater reliance on labor, this trend may be particularly harmful for small businesses.

Our country appears to have become more “homogenized.” By this I mean the dramatic improvements in communication and travel have made us more alike and less different. When I was a youngster in the 1950s and 1960s, visits to relatives in other cities or states exposed me to different types of foods, restaurants, stores and entertainment. Today with the internet, streaming, cell phones and national advertising, it can be easier for big businesses to establish a national presence with stores and brands everyone knows. This makes it difficult for small businesses to breakthrough and create a unique identity.
The increase in international competition and trade has also had a large adverse impact on many small businesses. Not only do small businesses have to compete with big firms in their backyard, but now they must compete against even larger competitors from foreign countries.

Of course, advances in technology are constantly occurring, and they can be harmful or helpful to small businesses. Technological improvements that allow larger businesses to run more efficiently and less costly can increase their cost advantage over small businesses.

But for technological advances applied to tasks that vary little between the size of a business, such as keeping inventories, ordering supplies or analyzing sales trends, then the benefits can be significant for small businesses. For example, examining trends in sales based on different types of buyers is very important for any business. But in the days before computers and easily applied analytical programs such as those developed by the firm SAS in North Carolina, small businesses couldn’t afford to do this kind of helpful work. Now they can.

A big question is how AI — artificial intelligence — will be applied in the battle between small and large businesses. My guess is the initial winner will be larger firms, but over time, the benefits will be more even.

I think we’ll always have small businesses. For many, a small business represents hopes and dreams, but also some tears. While many small businesses will fail, it can be argued we collectively still win from those that try and certainly those that persevere. But, you decide.

Mike Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.