The Small Business Dream

Benjamin Franklin famously said, “In this world nothing can be said to be certain, except death and taxes.” In Washington, DC these days, there is one more certainty to add to the list—government gridlock. In 2011, as the world watched, the U.S. government took the global stage in a spectacular display of dysfunctional stalemate, as Democrats and Republicans publicly squabbled about the right way forward to increase the country's debt limit and prevent the superpower from defaulting on its loans. Not surprisingly, citizen confidence in and approval for government politicians seemed to be in a freefall. According to a USA TODAY/Gallup Poll, approval for Republican congressional members had sunk to 28 percent; Democratic congressional approval wasn't much better at 33 percent; and Obama himself was not immune to the damage, with just 45 percent of Americans approving of the President's performance at the time. As one self-described Republican voter from Utah so eloquently put it, “They're [the Government] screwing up right and left.... All they're doing is arguing among themselves and not getting anything done.”²

Alas, although political impasses have consumed politicians in unending discord, there is one economic objective it seems both Democrats and Republicans can rally behind—that of preserving the growth of small businesses in the United States. According to President Obama, “Small businesses create two out of every three jobs in this economy, so our recovery depends on them.” Republican Presidential candidate Mitt Romney couldn't agree more, stating on the stump, “My job, if I'm President, among other things, is to make sure that we are the best country in the world for small business.”³ Indeed, even big businesses are joining the crusade. In announcing a program that would offer $10 million in credits to small business advertisers on Facebook, Chief Operating Officer Sheryl Sandberg said, “Small businesses are the backbone of the American economy.”⁴

Small businesses are about as American as motherhood and apple pie. Aside from owning a home, starting a small business is the epitome of the American dream. Politicians, eager to reflect the ideals of the constituency that elected them, idolize small businesses as the engine behind economic growth and, in particular, job creation. The phrase “small business” appeared in the Congressional Record more than 10,000 times in the past two years, outranking references made to the very public debt limit debacle by comparison. It appears that Congress's fascination with the topic is warranted, at least insofar as the phrase “small business” is sufficient on its own to evoke emotion. According to Frank Luntz, GOP pollster and language specialist,

Indeed, small businesses are known for their sweat equity, with a majority of Americans (59%) believing it difficult for people like them to start a company, compared with only 36 percent who thought otherwise.⁶

If starting a business is difficult, staying in business is even more so, according to data from the Small Business Administration (SBA). Half of startups fail within the first five years. Less than one in five make it 10 years. Indeed, in the 2012 Alcatel-Lucent study of more than 2,500 enterprise respondents, small businesses (five to 99 employees) made up nearly half of the failing companies, as self-reported through a battery of financial metrics covering revenue, profitability, and employee growth. In contrast, they represented less than one in five of the top-performing companies by way of financial success. Proving that these top performers are the exception and not the rule, two in five business “exits” in 2009 were the result of bankruptcies, rather than successful acquisitions or initial public offerings, according to a report by the Center for Venture Research at the University of New Hampshire's Whittemore School of Business and Economics. The trend is even more sobering, because just 27 percent of exits suffered the same misfortune in 2007.⁷

Still, some 600,000 new businesses are founded each year,⁸ despite the challenging odds. According to research by Yahoo! and Ipsos, entrepreneurs shoulder significant risk to pursue a personal passion. Twice as many small business owners than nonbusiness owners say they are doing their dream job. Nearly 80 percent say the best thing about owning their own business is a flexible work schedule. Even among those who have not yet started a business, 61 percent say they want to do so such that they can earn a living while fueling personal passions.⁹ In addition, government lauds these indomitable risk takers for being the economic engine behind job creation—that is, until new data surfaces that challenges the veracity of this claim and, accordingly, the government's love affair with small businesses.

It's not that small businesses don't create two out of three jobs as President Obama claimed; it's what's behind those numbers that reveals a different story. According to Kelly Edmiston, a senior economist at the Federal Reserve Bank of Kansas City, the claim “masks a huge amount of people being hired and let go.” He asserts that small-business jobs are far less stable than those within large enterprises precisely because of those high failure rates facing startups in their initial years.¹⁰ According to Edmiston, 22 percent of staff in companies with fewer than 100 employees quit or are fired, compared with only 8 percent of those with 2,000 or more workers. Hourly wages are also more lucrative in larger enterprises, earning employees $27 per hour, on average, compared with $16 per hour for employees in companies of less than 100 employees. Companies with more than 100 employees are also more likely to offer superior benefits to their workforce when compared with smaller enterprises.¹¹

Part of the challenge facing small companies is their lack of productivity efficiencies—more common in larger firms able to acquire economies of scale. In fact, most small businesses occupy the services sector, such as restaurants, skilled craftsmen, independent retailers, and personal service providers—areas where economies of scale are typically not realized as the size of the firm grows. According to an analysis of Census data by Erik Hurst and Ben Pugsley of the University of Chicago, in the United States there were roughly 6 million companies with workers on the payroll in 2007—90 percent of which employed fewer than 20 people. Collectively, this lion's share of companies accounted for just 20 percent of all jobs. And, according to Hurst and Pugsley, these firms had no intention of growing their payroll in the first place. Eight in 10 small businesses that remained in business from 2000 to 2003—the most recent data for Hurst and Pugsley's analysis—did not add a single employee.¹² Their data is corroborated by economist Scott Shane at Case Western Reserve University, who found that, among small businesses in their second year of business, more jobs were lost to bankruptcy than were added by those still operating. The same held true in years three, four, and five.¹³

But, perhaps the most damning evidence to cast doubt on small business as an employment engine comes from the agency that purported the two-in-three job creation claim in the first place—the Bureau of Labor Statistics. In February of 2012, the agency released figures that challenged its original and longstanding assertion. “The most growth in employment has been in large firms,” said Nathan Clausen, the Bureau's economist in charge of the development of new statistics. In looking at data spanning April 1990 through March 2011, large company employment (at those companies with at least 500 employees) rose 29 percent, while employment at smaller companies increased by less than half as much. The data was released by a separate unit of the Bureau of Labor Statistics than the one founding the original two-in-three job creation claim, a discrepancy the agency attributes to the way businesses are classified by each division. Even for the incongruities of the claims, both groups agree that the proportion of private sector employees working for large companies has been steadily rising in recent decades—at a much faster growth than that experienced by small companies—tarnishing, in part, the lustrous image of small businesses as the backbone of employment growth.¹⁴

Before casting aspersions on these entrepreneurs for failing to create as many jobs as once thought, consider the risks they incur for doing so. Nearly 80 percent of small companies (those with annual incomes between $10,000 and $10 million) have no payroll at all.¹⁵ They represent sole proprietorships of committed individuals resolute in following their passion or destined to pursue an entrepreneurial path for lack of any other viable employment option in a tough economy. To this latter point, a 2011 survey among 1,700 small business owners by the company Webs found nearly two in five respondents to be unwitting entrepreneurs forced to start their own business because of a layoff or inability to find full-time employment.¹⁶ Whatever accidental or deliberate causes behind these ventures, many small business owners have no intention or desire to hire employees. Even among those who do have such aspirations for growth, a soured economy is forcing other plans. Although the same Webs study revealed nearly half of respondents believing the economy would bounce back in the next few quarters, virtually the same number admitted delaying hiring someone because of the recession.¹⁷

Perhaps there is no single function more complicated to a small business owner than that of IT. If the vast majority of small business owners will not or cannot hire staff, they are certainly not keen to inflate their payroll with IT professionals who may prove indispensable one moment and extraneous the next. Kevin Kay, owner of a South Carolina healthcare company with 53 employees, expresses the sentiment shared by his entrepreneurial ilk: “I don't have an IT department. It's not a luxury I can afford.”¹⁸ Yet, these same small businesses also can't afford to ignore the significant disadvantage they carry against their larger competitors when it comes to employee productivity. According to a study by economists Rafael La Porta of Dartmouth College and Harvard University's Andrei Schleifer, in developing countries, large companies are far more productive—with value added per worker an average of 59 percent higher.¹⁹

Luckily for small enterprises, technology offers advantages to help narrow La Porta and Schleifer's productivity gap. Beyond the technology, a vibrant IT services market consisting of some 300,000 independent IT consultants and another 114,000 small IT companies²⁰ stands ready to support entrepreneurs who would rather save their payroll dollars for other needs. IT outsourcing is a trend that is creeping into midsized businesses as well. According to the research firm IDC, U.S. businesses with fewer than 500 employees spent roughly $23.5 billion on IT services in 2011, a figure that is expected to grow to $27.2 billion by 2015. As proof that outsourcing is more than just a passing trend or one simply relegated to small and medium companies, spending on IT services by U.S. companies of all sizes now exceeds $300 billion, has been growing an average of more than 3 percent in the past five years, and is 55 percent more than these companies spend on computer hardware and software combined, according to Gartner.²¹ Whereas this is an impressive market for companies of all sizes, the pressure among very small enterprises to compete on a level playing field with their larger counterparts is readily ameliorated in a booming IT services market. The 2012 Alcatel-Lucent study finds very small companies with a payroll (those between five and 19 employees) having the highest incidence of IT outsourcing. Specifically, nearly three in 10 of these very small companies admit to currently outsourcing their entire IT function, compared with just 11 percent of companies composed of more than 100 employees reporting the same. And, the complexity of selecting and managing these outsourced IT providers is outweighed by the benefits, according to the majority of subjects in the 2012 Alcatel-Lucent study. When asked to choose which statement came closer to their view:

• Access to IT through outsourced companies has increased the opportunities for my company by allowing us to more effectively compete against large enterprises without requiring us to maintain significant IT staff or technology; or
• Access to IT through outsourced companies has introduced new complexities for my company since we must closely manage a third party and don't have as much control over our IT resources or support,

roughly 60 percent of very small firms (five to 19 employees) selected the first statement. Not surprisingly, these companies recognize that technology, once a “luxury” reserved for the most highly efficient and scalable large enterprises, is increasingly being democratized with a glut of IT options available for outsourcing—the very outcome that Carr predicted and that led to his assertion that IT would soon be irrelevant because it alone is incapable of yielding sustainable competitive advantage. Yet, if the technology on its own cannot provide sustainable advantage, it can at least be leveraged to neutralize a disadvantage faced by smaller enterprises. For too long, these companies have been unable to influence the market price or quantity of IT services. They have been unable to lock in suppliers and could not overcome the barriers to entry set by their larger counterparts. All the while, they have been saddled with significant odds against their favor in seeing their five-year anniversary, complicated by scarce human and financial resources and a productivity deficit that would seem insurmountable at best. Of course, the complexion is radically different once technology and the resources needed to support it become democratized in the market. Among the most significant trends that level the playing field are the following:

• Cloud services inoculate the weakness—Among other outsourced areas, these small companies are turning to cloud services to afford them the elasticity they desperately crave in both resources and capital costs. Even if a startup were able to invest in the necessary human resources to staff its own IT department, maintaining a sophisticated team of professionals is in itself too much for many to bear. According to Rich Rodgers, cofounder of Tesaro Inc., a two-year-old biopharmaceutical company based in Massachusetts, “The minute you bring them [IT professionals] in, unless you spend a tremendous amount on training and keeping them up-to-date, their skills deteriorate.” Instead, Rodgers turned to Mindshift Technologies Inc., a Massachusetts-based provider of IT services to more than 5,400 small and mid-sized businesses nation-wide and a recent acquisition target of national big-box retailer Best Buy. Best Buy led the trend of full-service IT for the consumer market with its Geek Squad-branded suite of in-home technical support services. It is now hoping to be an early front runner for small and mid-sized businesses with Mindshift. However, Best Buy does not plan on allocating retail space for Mindshift as it has with its Geek Squad line. It's apparently not worried that foregoing a retail presence for Mindshift will harm its ability to compete against those hundreds of thousands of consultants and smaller IT providers eager to amplify their highly localized capabilities. That's, in part, due to the lower provisioning and support costs associated with the cloud-based model. “We can do 99 percent of the work remotely,” says Paul Chisholm, Mindshift CEO. “More and more customers want to go to the cloud, and the independents and small regional providers don't have the financial capital and expertise to develop scalable cloud offerings.” Scalability matters to small businesses unable to sink the same resources to match the economies set by their larger counterparts. In Rodgers' case, he was able to pay Mindshift about $40,000 for all of Tesaro's 2011 IT needs.²² The same budget could hardly have afforded even one dedicated and competent IT professional on staff.

  Although the cloud is not without its challenges, including the most often mentioned security issues likely to capture headlines and cause many a sleepless night, in a paradoxical twist, small businesses are sometimes finding it more secure to turn to a cloud provider rather than attempt a do-it-yourself alternative. When San Antonio Food Bank's Eric Cooper wanted to secure the nonprofit's donor list and supplier network, he needed a solution that went “well above our technological and intellectual capacity.” He outsourced Food Bank's IT needs to a cloud provider, stating, “It was a no-brainer. I can't be worried about whether there's someone hacking our system.”²³

  It appears that more small and mid-sized businesses are coming around to Cooper's point of view. In 2008, when research group IDC asked what factors were most likely to dissuade company usage of cloud services, 72 percent of small businesses (those with less than 100 employees) and 63 percent of mid-sized companies (100–999 employees) cited security as their chief worry. However, the trend shows that cloud security solutions, if not the way small and mid-sized businesses think of them, are evolving. By mid 2011, the numbers had dropped to 50 percent of small and 47 percent of mid-sized companies indicating security as their top concern. At the beginning of 2010, roughly 7 percent of small companies and 17 percent of mid-sized businesses had some cloud activity. In just 18 months, the numbers had doubled to 13 percent and 36 percent, respectively.²⁴ In the 2012 Alcatel-Lucent study, more than one in three small enterprises (those between five and 99 employees) were very likely to use a cloud service that dynamically offered network, storage, or compute resources on demand. Nearly two in five mid-sized companies (100–999 employees) indicated the same. When combining a cloud-based service with a mobile application through a virtualized desktop solution (one that gives employees access to enterprise files and programs from any device), the appetite soared to more than 40 percent of small enterprises and nearly 50 percent of mid-sized companies being very likely to use such a capability.

• Mobile services accentuate the strength—It's no surprise that a solution leveraging both mobility and the cloud scored so well among small companies in the 2012 Alcatel-Lucent study. Small businesses were on the mobility bandwagon even before consumers caught on to the trend. In late 2010, when only 17 percent of Americans had smartphones, Forrester found a whopping 49 percent of small business owners using the gadgets for work.²⁵ For these early adopters, mobility has proven an indispensable resource in helping narrow the productivity advantages of the large enterprise. A study by the Small Business and Entrepreneur Council found that small businesses that use mobile applications to help manage their business are saving more than 370 million of their own hours and more than 725 million employee hours annually. The study showed nearly one in three very small firms (fewer than 20 employees) to be using mobile applications, with owners estimating saving an average of 5.6 hours per week. By reducing the amount of nonproductive time associated with onerous administrative tasks and processes, nearly half of these very small businesses are able to spend more time increasing sales and chasing new revenue streams²⁶ (important, because nearly 40 percent of small business owners in the Webs survey were most concerned with generating new leads and acquiring new customers²⁷). These benefits add up to an indispensable technology for these small enterprises. A 2011 AT&T study among businesses with two to 50 employees found nearly three-fourths using mobile applications in their business, with roughly four in 10 reporting they could not survive—or it would be a major challenge to survive—without the applications.²⁸ Indeed, it seems that very small enterprises are jumping headlong into the newest flavor of wireless technology, 4G LTE, as evidenced by the 2012 Alcatel-Lucent study, which found nearly one in five respondents from very small businesses (five to 19 employees) currently using the technology for work and home purposes, compared with less than 15 percent of respondents from very large enterprises (more than 1,000 employees) stating the same.

  Catalyzing the continued adoption for advanced mobility services are the productivity benefits that small businesses seek to attain. However, there is perhaps an even more powerful reason one will find an advanced mobile device on the hips of so many small business owners and their employees—mobility plays to a small business's customer service advantage. A 2011 American Express survey reported that more than eight in 10 consumers believed small businesses deliver better service than their large competitors. What's more interesting, the same study found seven in 10 Americans willing to pay an average of 13 percent more with companies they believe provide excellent customer service. In comparison, in 2010, just six in 10 Americans indicated that they would be willing to spend an average of 9 percent more with such exemplary companies.²⁹ Perhaps it's a function of more nimble capabilities, a more localized touch, or the halo effect of consumers rewarding the Americana of the entrepreneurial spirit, but, whatever the case, small businesses consistently outmatch larger behemoths when it comes to servicing customers. And, given that many small businesses are inherently service-oriented by their very nature, mobility allows these companies to forage for their customers in the field, rather than be tethered to an office or desk. One such service company, C&C Landscaping in Salt Lake City, was able to use mobile technology to connect the owner with five of his top employees to share multimedia messages of clients' sites before determining how best to serve them. For just $720 per year, the company's use of the mobile application has resulted in it being able to reduce mistakes in the field by 75 percent, cut driving time in half, shed overhead by about 6 percent, and maintain annual sales despite the economic downturn.³⁰ Of course, none of this would have been possible even five years ago if not for the burgeoning mobile application market and the ever robust mobile broadband networks and devices accompanying it.

• Big data evens the score—Although small businesses are known for delivering superior customer service, larger companies are known for having a wealth of data about their existing customers. Incumbents that are able to mine the history of customer purchases and contact transactions can leverage this resource to build propensity models that help attract or retain clients—in a way, using this data as a means to improve customer service and defend against smaller challengers that tend to fare better in caring for customers. Small companies (or any new challenger, for that matter) are at a significant disadvantage when attempting to steal market share from established incumbents that have amassed a wealth of information about their customers. Historically, these small challengers have been forced to rely on guerrilla marketing tactics and word-of-mouth referrals to lure customers away. But statisticians offer a new approach using readily available data that can yield interesting propensity models to rival the proprietary knowledge earned by incumbents over time. Big data has altered the landscape and democratized market knowledge once reserved for large enterprises.

  As an example, consider a specialty retailer that provides goods to expecting mothers. Among notable large-scale retailers also capable of serving this demographic is Target. As discussed in an earlier chapter, Target has quite advanced statistical models capable of using past purchase history for its customers to predict future needs. Its accuracy in using these models is uncanny, because, by comparing the combination of purchases in a particular household, the retailer was able to inform an unsuspecting father of his teenage daughter's pregnancy before he was even made aware of the fact. For any independent retailer attempting to grab a slice of the expecting mother market, facing giants like Target that are capable of sending premeditated and targeted offers to buyers before the prospects in question even realize they have such a need is daunting, to say the least. Yet, here is where big data from publicly available sources evens the score. According to Kurt Jetta, CEO of the TABS Group, a consumer analytics company in Connecticut, there's no shortage of data available that can be used to create propensity models for small and large enterprises alike. In addition, because the data in question is readily available, there are also fewer opt-in concerns associated with using what already exists in the public domain. For the independent retailer specializing in maternity goods interested in combating a statistical powerhouse like Target, consider Jetta's solution that offers its own propensity model:

  If I took the voter roles and census data for a neighborhood, I could go to Google Earth and look at how many houses have jungle gyms and overlay census income data and identify the average square footage of the houses, and I could identify which houses have kids. I could identify when they were born and understand the probability that within the next three years another one's going to be born. The combinations are infinite. Those are publicly available sources of information that you can't shut down, and there will always be a statistician like me to figure it out.³¹

  For small enterprises willing to dedicate a portion of their marketing budget to hire a statistician like Jetta on an as-needed basis, the return on investment will more than likely justify the expense. Of course, whereas small enterprises are fighting fire with fire to know more about the prospects they want to woo, large enterprises are using big data to even the score in their own way. That is, in addition to combating small business's superior customer service capabilities with more intimate customer knowledge, large businesses are using big data combined with collaboration tools to accelerate decision making within their enterprises. Indeed, one advantage of small companies is the velocity with which they are able to maneuver dynamically and respond to changing market conditions. Consider that small-company employment seems to be more stable in good times and bad, growing and receding more predictably. When large companies shed employees during the recession of 2001, the number of people working for small companies actually rose. At economic turning points, these smaller businesses are better able to respond to headwinds and tailwinds. In June 2007, at the first signs of economic recession, small companies began to reduce employment, seven months before larger ones did. At the first inkling of economic stability, small companies began to add workers in November 2009, four months before larger ones responded.³² Whether because of a lack of bureaucracy, scarcer resources, a more sensitive tuning to market dynamics, or a combination of all factors, small businesses are faster than their larger counterparts. However, the more successful companies among the latter are increasingly using data-driven decision making to recognize harbingers sooner and accelerate their response to market turbulence.

Although small businesses may not actually create the wealth of jobs ascribed to them by politicians, it is difficult to impugn a category of entrepreneurs for an objective most never had in the first place. However, some are calling for government's love affair with small businesses to come to an end, or at least be tempered. As economist Scott Shane concludes, after studying the economic data, “Because the average existing firm is more productive than the average new firm, we would be better off economically if we got rid of policies that encouraged a lot of people to start businesses instead of taking jobs working for others.”³³ Yet, before doing so, politicians may want to reevaluate the real economic value provided by entrepreneurs. That is, although job creation may be a bit spurious, based on how it is measured and defined, the economic development offered by small businesses cannot be denied by the communities they support. According to Edmiston, although one might think that a large firm would spur economic growth by yielding significant gains in employment and personal income, the indirect effects carry greater weight when evaluating net economic impact. He cites evidence of new-firm locations and expansions in Georgia that suggests that the location of a new large firm (greater than 300 employees) often retards the growth of the existing enterprises or discourages the establishment of enterprises that would otherwise have located to the area. He advises communities to forego aggressive attempts at recruiting large enterprises to their area and instead invest those same resources in creating a more conducive business environment for existing firms—both large and small.³⁴

America's fascination with the unwavering spirit of today's entrepreneur will not falter any time soon. As Dieter Ibielski, international small business counselor and senior advisor at large of the World Association for Small and Medium Enterprises, poetically offered in 1997:

Small business owners are the consummate risk takers, fighting for a piece of the American dream, and increasingly relying on technology solutions to level a historically uneven playing field. And, as entrepreneurial contributions to economic growth continue to evolve with the latest numbers, the love affair shared by Americans and politicians is sure to remain timeless. Perhaps this is yet one more certainty to add to Franklin's list.