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Examine The Role And State Of Smes

Literature Review 3 - 4

Introduction 4

Part 1: About SME’s: Role, Definition, Why they exists 5 - 6

Part 2: SME’S Markets Structure 7 - 8

Part 3: Productivity of SME’s 8

Part 4: Historical picture of SME’s from 1945 to present 9 – 14

- 1945- 1971 9 – 10

- 1971- 1994 10 – 12

- 1994 – present 13 - 14

Part 5: Government Role 15 - 17

Conclusion 17 - 18

Bibliographies 19

Appendix 20 – 26

A-1: SME criterion 20

A -2 Data showing size breakdown of UK economy 2009 21

B: 1 Porter’s theory five forces approach 22

B-2: Fragmented market characterises checklist 23

B-3: Competitive market cost curve: Long run 24

C- 1: UK industry summary 25

C-2, 3: SME productivity calculations for 2007 and 2009 26

Literature review

This is a literature review of small medium enterprises in Britain. The literature will discuss the theoretical nature of small firms; examine the structural changes that small firms have gone through from 1945 to present. I will outline reasons for supposed revival in 1970, market structure of firms and role of government. There will be use of different sources of information that relate to small and medium firms growth/decline, and provide statistical data for evidence to support my essay. They include:-

[Storey, D, 1994, pp13, P25-37] gives an overview of small firm stratum in developed economies. It demonstrates the great importance of small firms in terms of their numbers and contribution to employment. It considers the evidence for an international revival and examines the reasons for this supposed revival. This will be useful in Part 6 when I explain the revival of SME from 1971 period

[Peter Johnson, 2007, pp75-78] which will help to provide theoretical reasoning on why firms continue to survive and grow. The relationship between size and growth explain by the Gibrat’s Law (Gibrat’s 1931) on whether here is a relationship or not and the evidence to support by Dunnes and Hughes (1994) study based on period 1975-1985.This will be used in part 4. Where I will examine firm’s growth rates from period 1945 to present.

[John Stanworth, Colin Gray, 1991, pp13-15] this book will provide the SME’s economic position between 1971-1979 relating from policies and its impact on firms and also helps to explain and provides statistical data on the resurgence on small firms. It question’s why it took place? Why the change was more apparent in UK then elsewhere?. The books also mention the structural economic changes for firms, where “Ford Era” 1910 to 1975 disappeared to be replaced by “flexible firms” economy. [P200-203] That will contribute to my explaining of economic structure change in the UK economy provided by Atksion and Gregory 1986 in part 4 of the essay.

[BIS Statistics] is used to find out the changes in the SME’s sector and large firms 1994-2004. The data tables show, employment and turnover, in each category, broken down by the number of employees. Table 1 shows Private Sector, Table 2 shows Whole Economy, Table 3 shows Legal Status, and Tables 4-7 show breakdowns by the Standard Industrial Classification, with 7 being the most detailed. The reason is no data available pre 1994 because its first know by the government that has more detail on band of employment. This will be used to find the how SME’s have grown or declined over time. Which is been used in part 1 to show SME performance in 2009. And also when explaining productivity in part 3.

Introduction

The essay examines the role and importance of (SMEs) in UK economy that has been the subject of increased attention, particularly from the early 1970’s. The essay will be split into five parts.

First part of the essay will provide SME’s definition and reasons of why firms exist and role each stratum of SME’s play like sole trade, micro, small and medium play.

Second part of the essay will examine the markets of SME’s

Third examines the productivity of SME sector of economy compare to large firms

Forth part provides a historical picture of SME’s from 1945 to the present on the present. That will be spilt into three time periods:-

1945- 1971

1971- 1994

1994 – present

Fifth part looks at government role in the SME sector and their policies toward small business and their success

Part 1 About SME’s: Role, Definition, Why they exists

There is no one single definition of SME, but the EU definition refers to an SME as businesses that employs up to 250 employees. The criterion is that Micro businesses have maximum of 9 employees, small businesses maximum of 49 employees, and medium sized enterprises comprise of maximum of 249. (See Appendix A-1)

Sole Propitiator provides a service to local community by selling goods and services, as a convenience. They are driven by goals of independence, money and help to promote business. Micro Firms provide formerly unemployed, part time workers employment as they can employ <10 people. They add value to country's economy by enhancing income, add business convenience and regenerate deprived areas of society. The [figure 1] indicates that sole trader had a contribution turnover of 7.9% and micro 12.2% a decrease of 4.3% and employment contribution of 11.8% for sole trader and Micro firm 2.2% which is lower of Total UK employment in 2009. ( See Appendix A -2 )

Figure 1

Small and Medium Enterprise benefits economy by bringing investment that will result in business expansion. As it expands increase competition will result in higher productivity and innovation. They provide employment and raise society wealth as they can employ up to 249 workers. The [Figure 2] indicates small business contribution turnover was 14% and medium 13.1% a decrease of 0.9%. Small business employment contributing was higher by 1.5% compare to medium business of total UK employment in 2009. ( See Appendix A-2)

Figure 2

According to Coase firms exist, as organisation cost are less then transaction cost, thus creating a net saving and that is why they exist. But Neo-classical “resource-based theory” of the firm points out that firms exist due to the fact that they can arrange wide range of resources and particular vague one, such as collective knowledge that market cannot access. Both theories hold weight, as firms require knowledge to locate resources and needs labour/capital to help reduce transaction costs through negotiations of contracts for the goods. The coordination and division of labour within the business firm reduces the cost of production.

The introduction of e-commerce has reduced the transaction costs for businesses and customers as businesses can search for products online and order it. For example Auto trader creates on-line auctions for used cars without having to ship the cars to a physical auction. This change in the process reduces transportation costs and time for both buyers and seller.

Small firms have existed along side large firms because they have been able to tap into the niche markets that are considered not profitable by large firms. Larger firms have not been able to substitute smaller firms because of internalise transaction cost for smaller projects are lower. For example to build an attic it would be expensive for larger firms because Organisation cost will be greater then transaction cost, that wont create net saving but for smaller firms organisation cost will be smaller the transaction cost thus creating net saving.

Part 2 SME’S Markets Structure

There are different sector of the economy with different competition market structures and different entry requirements. For example monopoly has high barriers of entry in terms of capital and are dominated by one or two firms. Prefect competition has low barriers of entry where many firms exist. Oligopoly dominated by few firms but has many buyers and entry barriers are high. Many Sole trade and micro firms will function under perfect market condition due to low entry barriers and capital requirements, scale of economies are not paramount.

“There are also some Small Medium Enterprises that operate as “heterogeneous oligopolists” as described by Reid. They have a significant interdependence with a marked degree of differentiation and there are not many substitutes for the particular service and goods.”[Book1], For example GP’s, solicitors or Hedge Fund will have high barriers to entry due to qualification requirements. This gives business power over price, as the rule of one price does not apply since there aren’t many doctors and costumers will have to pay given price for the treatment, as its service is inelastic.

There are some small businesses that operate under fragmented markets. They are said to have small share of the market with many competitors but have no impact on the industry. For example restaurant industry by and large, there is no demand for standardization. Many prefer the hamburgers of one fast-food establishment to those of another, and locally-owned franchises or independent restaurants can advertise as just that. The wide variety available from different types of restaurants helps add to the popularity of this fragmented industry. Essentially this type of industry competition is manageable and consumers thrive on that competition. (See Appendix B-1 )

Poter model of Structure–conduct–performance paradigm can be used to explain firm’s operation and decision-making. For example in the case of a sole trader that sells homogeneous products will operate under a perfect market conditions and will be a price maker. In terms of potential competition, it would have more competition from new entries because of low barriers to entry and exit are low that exist in the market. There will be also a threat of substitutes so sole trader will need to differentiate its products that will give him an edge over competitors. Sole trader will make normal profits or breakeven due to the competitive nature of a business. ( See Appendix B-2, 3 )

Part 3 Productivity of SME’s compare to large firms

Figure 3

[Figure 3] shows productivity of UK SME’s and large firms within different sectors in 2009 to 2007.The data indicate a negative rate of productivity. The sectors such as: Agriculture, Forestry and Fishing, manufacturing and Wholesale retail and repairs. But education sector indicate a positive rate of productivity. In comparison large firms showed strong productivity in three sectors: Agriculture, Forestry and Fishing, manufacturing, wholesale retail and repairs and transport, storage and communication. ( See Appendix C -1,2,3 )

Part 4 Historical picture of SME’s from 1945 to present

Period of 1945-1971

The end of World War 2 Britain’s economy was left in a Depression. The period of 1950 to 1971 that proceeded saw small firms facing economic difficulties. As a result small firms started to decline at a faster level then other western countries as figure 4,5 shows that small firms that accounted for 43% in 1930’s of total employment and declined to 27% by 1970 a decrease of -17%. Larger firms were dominant as there employment rose to 37% that totaled 8.5 million of workforces that peaked in 1966 because of the merger that took place in 1920.

Figure 4 Figure 5

Ian Worthington & Chris Britton, 2006 Francesca Carnevali,2005, P85 (Book 3) ,P247 (Book 2)

The reasons behind the decline was under development of capital market that made it harder for small firms to raise finance for growth, and government weren’t lending to small firms that hampered their growth. Large firms were given more importance under the assumption that:-

Large firms bring economies of scale

Large firms stimulate more innovation through R&D

Large firms increase competitiveness in world markets

UK government policy was designed to stimulate growth of large firms. For example, in 1966 announced the formation of industrial reorganization corporation, which emphasized the need for concentration in British industry, so firms could benefit from economies of scale in production and increase expenditure on R&D. These are some of the reasons why large firms dominated British economy and were a major contributor to UK employment and GDP as noted in Bolton report in this period.

As Schumpeter 1943 writes “that large firm has come to be the most engine [economic] progress and in particular of the long run expansion of the total output (Bannock 1981)”(Book 4)

Period 1971-1994

The UK economy went through recession caused by oil shock in the 1970’s. That resulted in the economy going through a period of stagflation and higher inflation rates of from period 1970 to 1981. As the table below shows:-

Year

1973

1974

1975

1976

1977

1978

1979

1980

1981

U. K Inflation

9.1

16

24.2

16.5

15.8

8.30

13.4

18

11.9

Web 1

As a result manufacturing production costs increased and the inefficiencies were exposed within the sector. The consequence was 2/3 of workers losing their jobs due cost cutting by large firms and by the 1980 the UK GDP fell to -2.4%. To deal with crises government concentrated on the financial services sector ignoring the major manufacturing sector hence the growth of SME’S and demise of large firms. As the [figure 6] below shows a turnaround in the early 1970’s in the share in small establishments and new small enterprises rose to steadily back to 1935 level when they accounted for nearly 43%.

Figure 6

John StanWorth & Colin Gray,1991, P3 Book 5

The UK economy sector shifted heavily towards services sector as the government and financial sector dominance increase. The [Figure 7] shows that in 1969 tertiary and secondary employment share evenly spilt. That increased in 1984 to 70% but secondary sector declined to 30% and share change of employment of negative 20% in secondary sector and positive increase of 20% in services sector.[Figure 7].

Figure 7

Ian Worthington & Chris Britton,2006, P273, Book 2

The advancement in technology has been a major contributing factor to the rise of SME’s from 1969. For example Computer Aided Design has reduced firms costs of production. Furthermore computer technology altered the structure of demand and the balance of economies of scales towards small firms. The emergence of global economy has restructured the economy. That help to increase proportion of the workforce classified as self-employed from by 1985’s as [Figure 8] indicates in UK. The Self- employed sharply raised to 3,500,000 in 1990 from 2,700,000 an increase of nearly 30%.

Figure 8

Craig Lindsay and Claire Macaulay, Web 2

As core-periphery thesis offered by Atksion and Greogory 1986 argued that large mass production firms of Fordism Era 1910-1975 were disappearing and replaced by “flexible firms” economy.[Book 5].

This is also the reason for the U shaped trend in small firms described by Segenberger et al. hypothesis to be U shaped which is supported by Storey where he finds UK total economy has had data with same U shape pattern. [Book 6]

The rise has been due to de-regulation in 1980 and government policy to support business start-ups as a way of reducing unemployment, policies aimed at improving competitiveness by growing existing SMEs . “According to Storey 1987 the relative increase in the importance of small enterprises reflects the poor performance of large firm then good performance of small firms, which is supported by Johnson 1989 evidence that shows the creation of small establishment arisen due to contraction of large firm”[Book 6]. The formations of these small businesses have been positively related to unemployment rates [Bannock and Doran 1984] [Book 5].

Period 1994 to present

The period between 1995 and 2009 the number of people in SMEs has shown some inconsistency from year to year. Especially in terms of births and dead rates for SME’s.

Dale and Morgan, 2001, SBS/TBR job creation study, Web 3, [Figure 9]

The [Figure 9] shows that from 1995 to 1999 there were 2.3 million new businesses created that accounted for 85% in small business. These new business created 3.5 million jobs as shown in [Figure 10]. Small business might not expand due to immense number of small firms in comparison to large business. But they accounted for 66% of new jobs created [Figure 10]. SME’s accounted for 66% of jobs created much higher then the initial shares of employment, more then their share on employment of 56% but there was also 66% of job losses in this period for small business [Figure 11]. There was a net gain of 800 thousand jobs in this period, and small businesses accounted for around 70 per cent of this as [Figure 9] indicates

Figure 10 Figure 11

Ian Dale (Small Business Service),Anna Morgan (Trends Business Research)

Web 4

But if we look at period 2001 to 2009 there has been a reversal of trend where business and start-ups are seeing more deaths and low birth rates as (ONS) indicates that 279,000 businesses closed in 2009, the highest number since the current series began in 2000.Furthermore ONS statistician Andrew Allen said: “Not only is it the highest number of businesses closing in a single year, it is also the first time that business deaths have outnumbered business births since the series began.” The [Figure 11] shows that have decline to 10% and death rates have risen to nearly 12%. The reasons for the decline line is because of 2008 recession that resulted in a credit freeze. That meant small business couldn’t get loans to pay off creditors that resulted in insolvencies and due to shortage of financing available new businesses couldn’t start.

Figure 12

ONS, Business demography 2009:Enterprise births, deaths and survival, Web 5

Part 5 Government Role

Government can play by improved regulatory system, providing support to small businesses to improve business environment. The UK government has three underlying policy objectives for SME’s. They include:-

Building an enterprise culture

Improving access to finance for small businesses

Developing better regulation and policy

To encouraging enterprise cultures government is introducing polices such as:-

Lifetime limit for entrepreneurs’ relief from £5 million to £10 million has been doubled; mean fewer entrepreneurs face capital gains tax, allowing for reinvestment in the economy.

New Enterprise Allowance (NEA) will provide financial and expert information support to businesses, with its 40,000-experienced new advisors.

The figure below shows “UK’s “Global Entrepreneurship Monitor” (TEA) rate has varied little during the period 2002 to 2008 and has tracked the G7 average very closely” [Web 6] but has performed better then France and Germany.

Jonathan Levie, Mark Hart, Monitoring Report, UK, 2008 Web 6

2:- Government has scrapped the regional development agencies (RDA) whose purpose was to support local businesses. The policy seems conflicting, as it would take the support away form small firms, who relied upon them for advice. The £1 billion growth fund introduced instead is below the current £1.5billion current (RDA) budget.

Government has launched in 2011 “Merlin project” that aims to force banks to lend about £190bn to small businesses in 2011 - including £76bn to small which is up 15% but VAT and inflation amount is not been accounted for. Which when included the amount would be unchanged.

3:- To cut regulation government has proposed one-in, one-out’ rule whereby no new regulation is brought in without other regulation being cut by a greater amount and ending “tick box culture”. This is in response to BCC “ burden barometer” that tells regulation will cost businesses in and excess of £88 billion by 2010.[Figure 13].

Figure 13

British Chambers of Commerce, Burden Barometer, 2008,Web 7

These policies seem to indicate that government intervention will obstruct small businesses because there hasn’t been real change in favour of small business but the conditions have been made worse. Even though “government want to support small business and enterprise” but there action seem to indicate otherwise for example scrapping RDA and replacing with growth fund with 0.5 billion less then RDA budget. Government Project merlin that will make banks lend £76 billion to small business, but the amount is nominal and not real because VAT of 20% and inflation hasn’t been taken into account, means the amount will be considerably less. FSB report “Voice of Small Business Index, which looks at the general health of the small business sector, has found in the fourth quarter of 2010 that business confidence fell for the third successive quarter to a net score of -13.2%, the deepest decline since the survey began in March 2010”. [Web 8] Even though small businesses are facing tough economic challenges and polices mixed. Britain according to taxpayer alliance still ranked in the top 10 countries for doing business in the world for year 2009 as [figure 14] shows.

[Figure 14] Wold Rank of doing business indicators, UK 2008 and 2009

Ibid; UK Statistics, Web 9

Conclusion

To sum up, SMEs have grown in numbers and in their importance to the UK economy significantly in recent decades. Most significantly from 1975 where SME increased and large business share of establishments declined. This growth was

Linked to the increased flexibility of the economy because of the shift from Fordism era (1910-1975) to flexible firm economy in the 1980’s. This helped to increase proportion of people self-employed by 1985. As Technology lowered market entry costs, reduced the advantages of bigger units associated with economics of scale, and made small firms more competitive due to their flexibility.

By 2000 SME’s accounted for the 99.8% of all businesses and 54.1% employment in UK where SME’s played a vital role in the economy compare to 1940 period where large firms dominated and SME’s ignored.

Startup firms seem to be the greatest source of new jobs created. At a sector level, the contribution of new firms was determined by net employment change the contraction or expansion as evident in 1995-1999 where net gain was 800 thousand in this period, and small businesses accounted for around 70 per cent

But this trend has shifted, as there are more deaths and lower birth rate of firms from 2008 to 2009. Indicating that Small businesses are facing difficulties due to recession of 2008. That has reduced credit and loan availability for firms making it difficult to start up business or expand existing business. In addition the austerity measure has dampened economic growth. This has put SME in difficult state due to uncertainty, low growth and finance availability. As small business confidence has fallen to -13.2% all time all. The productivity seems to indicate that recession affected small and medium business as they had negative productivity in 2009 compare to 2007.

Government polices are mixed because on one had they have increased VAT to 20% and on the other they have extended Lifetime limit for entrepreneurs’ relief to £5million that will increase reinvest from the capital gains for small businesses

Bibliographies

Books

1- Small business Enterprise: An Economic Analysis,Gavin.C. Reid, Pages 327,1993,New York: The Typical Small business enterprise, page 55

2- The Business Environment, Ian Worthington & Chris Britton, Pages 560, 2006: Size structure of the firms, pages 247, 273

3- Europe's Advantage: Banks and Small Firms in Britain, France, Germany, and Italy since 1918, Francesca Carnevali, Pages 228, New York: Small Banks and firms after 1945, 2005, Page 85

4- Applied Economics, Alan Griffiths, Stuart Wall,Pages 652,2007,Essex,11th edition: The Small firm, page 63

5- Bolton 20 years on:The Small firm in 1990s, John Stanworth and Colin Gray,Pages 292,1991,London: pages 3,14,200

6- Understanding The Small Business Sector, DJ Storey,355 pages,1994, London, pages 31,32,38,

Websites:-

1 - www.whatsthecost.com/historic.cpi.aspx

2 - www.statistics.gov.uk/articles/labour_market.../Growth_article.pdf

3 - www.berr.gov.uk/files/file39768.pdf

4 - www.tbreconomics.com/downloads/pdf/jobcreation.pdf

5 - economy.swo.org.uk/EasySiteWeb/GatewayLink.aspx?alId=45947

6 - www.gemconsortium.org/download.asp?fid=898

7 - www.britishchambers.org.uk/.../Burdens_Barometer_2008.pdf

8 - www.fsb.org.uk/News.aspx?loc=pressroom&rec=6873

9 - www.taxpayersalliance.com/BERR.pdf

Appendix’s

Appendix A

A- 1

A - 2

UK employment/Turnover of different in 2009

Appendix B

B- 1

Porter’s theory has become quite famous and according to his “five forces approach” competition within an industry can be described in terms of five major “force fields” operating upon individual firms. This is a crucial part of their business environment. These forces are:

Table showing influences that effect the company using porter analysis.

B – 2

Table showing the characterises of fragmented markets

Reid looks at various industries with a strong small firm composition in Scotland. These were: Business Services, Plastic Injection Moulding, Window Cleaning, Industrial Microfilming, PCB manufacture, Phototypesetting, Cardboard Packaging. Examining these industries for characteristics of fragmented markets he characterised them as follows.

B – 3

Showing perfectly competitive cost curve

Appendix C

C - 1

Data

Employment and turnover of industry sector 2009 from BIS

C-2

Productivity formula = Turnover

Employment

Productivity of SME in 2007 and 2009 for different for different sector of economy in UK

C-3

Table showing productivity of Different sector of SME and large firms using the formula above for productivity

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