The Small Business

The Prevalence of Small Businesses

Industries with high concentrations of small and medium businesses generally do not require enormous capital investment up front.

Learning Objectives

Describe the characteristics of industries that are represented largely by SMBs (SMEs)

Key Takeaways

Key Points

  • If you’re going to start a business, it’s important to realize that there are specific forces acting upon each industry that affect profit.
  • Industries with high concentrations of small and medium-sized businesses (SMBs) generally do not require an enormous amount of up-front capital investment (i.e., they have lower barriers to entry ).
  • Goods producers make and sell some sort of physical product or material, while service providers don’t make tangible goods. The service industry tends to be more SMB-friendly, as it (generally) requires fewer assets.
  • Manufacturing goods competitively involves being able to do so in high volumes in order to remain cost efficient. This requires a large initial investment of capital and access. As a result, manufacturing is more commonly for larger enterprises.

Key Terms

  • service provider: An organization that operates in areas such as finance, real estate, or buying products from a wholesaler and reselling them to consumers, but does not make tangible goods.
  • goods-producers: An company that makes and sells some sort of physical product or material.

Barriers to Entry

If you’re going to start a business, it’s important to realize that there are specific forces acting upon each industry that affect profit. Industries with a high concentration of small and medium-sized businesses (SMBs) generally do not require an enormous amount of capital investment up front. The point here is that barriers to entry are central factors in determining the feasibility of the average business owner entering a given industry.

For example, it is not likely that you would start a company to build airplanes, as that would take a large investment of capital for property, plant, equipment, and labor. Many restaurants and bars, however, require simple premises and easy to find, local ingredients. This is a smaller barrier to entry, thus there are more SMBs in the restaurant industry than in the aerospace industry.

Goods or Services?

When thinking about businesses, it can be helpful to divide them into two sections: goods producers and service providers. Goods producers make and sell some sort of physical product or material, while service providers don’t make tangible goods. The service industry tends to be more SMB-friendly, as it (generally) requires fewer assets.

In the United States, roughly 20% of SMBs are concentrated in the goods-producing sector. The 80% of SMBs that reside in the service-providing sector is largely a reflection of the overall U.S. economy (services over goods), as well as the greater feasibility of service industries for small-scale entry.

The high concentration of SMBs in the service-providing sector also reflects a few realities of business. In a global economy, manufacturing goods competitively involves being able to do so in high volumes in order to remain cost efficient. This requires a large initial investment of capital and access to low-cost labor, which are both tough for SMBs to access domestically. Maintaining quality across hundreds of locations in the service-providing sector is also, as you might imagine, not an easy task.

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Small-business owner: Small businesses often begin in the services sector due to a number of factors.

Small Businesses and U.S. Jobs

Half of the U.S. private sector is populated by small businesses and the other half by large businesses.

Learning Objectives

Discuss the growth of small businesses in relation to the U.S. economy

Key Takeaways

Key Points

  • The U.S. government often defines small and medium-sized businesses (SMBs, also referred to as small and medium-sized enterprises, or SMEs) as firms with fewer than 500 employees.
  • While business has seen great consolidation in recent years, the share of employment in small firms has been relatively stable over the past few decades. Just over half of U.S. employees work for SMBs.
  • Small businesses often serve as seeds for new industries, such as Apple and Google did in their early stages. By addressing a need left unmet or innovating more rapidly than large multinational corporations, small businesses are able to carve out new niches for themselves.
  • Recent advancements in technology can reduce the amount of capital needed to start a small business and increase opportunities to scale up rapidly and cost efficiently.
  • The primary hurdle for most SMBs, particularly when they are starting out, is acquiring funding.

Key Terms

  • employment: The work or occupation for which one is used, and often paid.

The private sector consists of a wide variance in business size, grouped into small, medium, and large organizations. The U.S. government often defines small and medium-sized businesses (SMBs, also referred to as small and medium-sized enterprises, or SMEs) as firms with fewer than 500 employees. Using this definition, just over one-half of the private sector is populated by small businesses and the other half by large businesses.

Employment

While business has seen great consolidation in recent years, the share of employment in small firms has been relatively stable over the past few decades. It has fluctuated slightly in response to economic conditions, declining slightly when the economy is doing well and increasing when the economy struggles. This tracks with the slight decline in the small-business share of employment during the late 1990s and the leveling off in the 2000s.

Entrepreneurship

Small businesses often serve as seeds for new industries, such as Apple and Google did in their early stages. By addressing a need left unmet or innovating more rapidly than large multinational corporations, small businesses are able to carve out new niches for themselves. Recent advancements in technology can reduce the amount of capital needed to start a small business and increase opportunities to scale up rapidly and cost efficiently.

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Small businesses’ share of employment, 1988–2006: The small-business share of employment is relatively stable, as shown in the graph above: the bold red line representing all small businesses stays at around 50 to 55% of the total share of employment.

Funding

The problem all (or at least most) entrepreneurs face on a daily basis is funding, particularly when first starting up. While different industries display differing degrees of entry barriers, most small businesses must obtain a certain amount of capital to begin operations. This can come from a variety of places, including:

  • Self-financing by the owner through cash, equity, etc.
  • Loans from friends or relatives
  • Grants from private foundations
  • Private stock issue
  • Forming partnerships
  • Angel investors (i.e. venture capital)
  • Bank