23, May 2023

The Mythical SME

A mythical creature is one that exists in our imagination but not in real life.  Examples are mermaids, dragons, unicorns and fairies. Myths are widely used to tell stories about complicated or taboo situations.  However myths can also be dangerous if they lead people to take wrongheaded action. Remember ”weapons of mass destruction”  in Iraq or “vaccines cause autism”?

So what about SME’s – small and medium sized enterprises?  Most governments in Canada have policies to target SME’s in order to assist them in growing.  They are an essential part of the economy and employ millions of people. According to Statistics Canada a Small business has 1-99 paid employees and a medium sized business has 100-499 paid employees.

How are small businesses different from medium sized businesses?

  1. Their numbers. According to ISED, there are 1,187,658 small businesses and 22,700 medium sized businesses in Canada. So small businesses outnumber medium sized businesses by a factor of about 52. In other words, small businesses represent 98% of SMEs.
  2. Access to finance. Obtaining financing is one of the major problems for small businesses and startups. However, medium sized businesses generally have no problem getting financing. We interviewed the CEOs of more than 20 medium sized companies, and they all told us that getting bank financing was not a problem.  They have a track record of financial performance, repeat customers, good credit ratings, and a proven business model, all of which make them ideal customers for the banks.
  3. Contribution to GDP (Gross Domestic Product). Small businesses contribute 38.0% of GDP, and medium sized businesses contribute 14.3%, so SMEs contribute 52.3% of Canada’s GDP. The 2% of SMEs who are medium sized contribute more than 27% of the GDP attributed to SMEs.
  4. Small businesses employ 8,204,700 people, 67.7% of the total private labour force, and medium sized businesses employ 2,476,600 people or 20.4% of the private labour force. The 2% of SMEs who are medium sized employ 23% of all SME employees.

The myth of the SME.

Looking at the information about numbers, access to finance, contribution to GDP and employment it is obvious that there really isn’t much in common between small and medium sized businesses.  So there is no such thing as a “typical”: SME. It’s either a small company or a medium sized company. That is why the SME is a myth. It exists only in our imagination.

Why is this a problem?
It is clear from the list of differences above that small and medium sized businesses have completely different needs. For example, providing financial assistance is key for small businesses but much less important for medium sized businesses that can usually raise bank financing without too much trouble. Combining the small and medium businesses together means in practice that the medium sized businesses often get neglected because of the sheer number of small businesses. One size fits all doesn’t work.

Key role of the medium sized businesses.

This is important because the medium sized businesses are often the backbone of the economy and provide stability during the business cycle. When we interviewed the CEOs of medium sized companies in Alberta we were impressed by how similar they were to the German Mittelstand companies, who are often held up as an example of Germany’s economic success.

What’s the alternative?
According to a 2017 study, high-growth firms contributed to 41% of the total net employment change in Canada between 2009 and 2012.    High growth firms are a small proportion of all firms. Based on revenue growth they are 6.2% of all firms, and based on employment growth they are 3.4%. According to the Organisation for Economic Co-operation and Development, high-growth firms are firms with 10 or more employees that have experienced average annual growth greater than 20%, in terms of employment or revenue, over three consecutive years.

So, rather then combing firms into a single category (SMEs) it would make a lot more sense to separate them into three groups: 1. Small businesses; 2. Medium sized businesses  and 3. High growth businesses. Because their needs are so different, they would need supports tailored to their needs.

How to spot high growth firms?

There is no sure fire way of identifying high growth firms in advance, but there are a number of approaches to narrow the field:

1. Ask the CEO or owner. When we interviewed the CEOs of medium sized firms we found   that most of them didn’t want to grow. They had an established business they were happy with and growth represented risk – new markets, new customers and new competitors. If the CEO doesn’t want to grow, the business is very unlikely to become a high growth firm

2. Look at the business sector. Many small businesses are in sectors that don’t grow much – flower shops, hairdressers, snow cleaning services, restaurants, etc. Although there are a few exceptions (e.g. Starbucks) these are very unlikely to become high growth firms. Other sectors are much more likely to produce high growth firms (e.g. mining, quarrying and oil and gas extraction).

3. Look at their competitive advantages. If there is a firm with a strong patent position a plan to export and a CEO with ambition to grow that is much more likely to become  a high growth firm that another firm with a me-too business plan.

The SME is a mythical creature. It exists in our imagination but not in real life. A better way to support small businesses would be to segment them into three categories and provide specialized support appropriate to each category. The categories are:

Small businesses.  These are about 95% of all firms.
Medium sized businesses.  These are about 2% of all firms.
High growth businesses.  These are about 3% of all firms (for employee growth).

Peter Josty