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The Observer

Sunday December 19, 1999

Small's no great thing

Plucky little entrepreneurs, battling for Britain? A myth, says Simon Caulkin

It is one of the more notable millennial cults: that of the small company. Gordon Brown in his pre-Budget statement proudly presented share-option tax breaks for start-ups as a central business initiative. This promise was made to a background of weekly announcements of a new business-school course in entrepreneurship here, a fresh incubator scheme for start-ups there, or another venture-capital fund.

Behind these devotions is the assumption that small companies offer a path to economic salvation that large ones cannot. This notion has been greatly boosted by the Internet, where a few dozen wildly successful start-ups and flotations appear to offer the promise of a whole new economic paradigm.

Alas, the Chancellor's 'fat kitten' largesse is a waste of money. Although no field in business is hotter than entrepreneurship, the 'supply of systematic knowledge about new business has not matched demand', points out Amar Bhidé at the beginning of his timely new book, The Origin and Evolution of New Businesses (Oxford University Press).

The truth about small business is both more complicated and a lot less euphoric than the rhetoric would suggest. Small businesses have always comprised more than 50 per cent of developed economies. But only a small minority - say 5 per cent - make any contribution to growth or jobs - or indeed make much money for their owners.

About the same proportion play a part in developing new technologies, but only to the point where they are bought out or handed on to bigger ones that have the clout to commercialise them.

The majority are 'marginal microenterprises' in mature businesses such as hairdressing, cleaning and odd jobs, providing a wage for the proprietor and maybe one family member. They are set up on a shoestring and almost by definition destined for an early demise. Nor does this matter much: since such small amounts of money are involved the companies have little economic significance.

Small firms, Bhidé shows, are not large firms in miniature; there is no 'natural' development path that takes them from 'small' to 'large' or from 'struggling' (as almost all do) to 'successful'. Very few manage to jump the gap, even if they survive. The bigger fledgling firms grow, the more irrelevant - or even counterproductive - become the qualities that first won them their success. Only exceptional entrepreneurs, says Bhidé, have the will and the capacity to adjust.

Contrary to popular conception, very few successful start-ups are based on significant innovation or brilliant individuals. Most are based on copycat ideas by medium-qualified individuals. Venture capital-supported firms are a tiny minority, but although this élite are fast-tracked through their early development, even they have no guarantee of success.

So what does single out winners from losers? Some 88 per cent of winners attributed success to exceptional execution of ordinary ideas. Turbulent markets helped, improving companies' (very small) chances of striking it rich, usually by nothing more complicated than arbitrage - buying cheap and selling dear to customers lacking the complete information they would have in more stable market conditions.

Market upheavals also favour those who can duck and weave, changing products and tactics at the drop of a hat without losing self-confidence or panicking - a crucial quality Bhidé terms 'tolerance of ambiguity'.

Attracting customers and other resources means entrepreneurs must also have iron self-control, be able to live with rejection and be highly perceptive. Contrary to accepted wisdom, the qualities usually thought of as entrepreneurial - risk-taking, breakthrough creativity, foresight, grand ambition, power and administrative abilities - are all secondary.

Indeed, over-boldness may be a handicap. Rather than fly in the face of risk, good entrepreneurs accurately assess it and adjust their plans accordingly. Fully 40 per cent of successful start-ups had the benefit of neither unstable markets nor a unique product. All they had, in effect, was 'hustle' - drive, energy and ingenuity in meeting customer demand.

Clearly, these facts make a nonsense of much of the usual rhetoric about small companies and entrepreneurship. Most of them are bootstrapped on tiny amounts of sweat capital scrounged from credit cards, family and friends. For them the idea of share options, let alone tax breaks on them, is just laughable, while the rarities that get venture-capital backing are by definition highly incentivised already.

More fundamentally, as Andrew Dilnot at the Institute of Fiscal Studies has pointed out, smallness is not a good proxy for things that governments want to encourage, such as research and development and innovation. Most small firms are undercapitalised and operate in mature markets where they survive (if they do) only because their competitors are equally poorly endowed. Targeting them with incentives is not a compelling option.

Even the so-called capital shortage for small companies may be a fallacy. Most promising start-ups don't need much capital. Indeed, as Bhidé points out, the whole point of entrepreneurship is substituting brains and hustle for capital, so it's not even clear that beyond a certain point better access to capital is an advantage.

In fact, the glut of funding available for Internet start-ups may be too much of a good thing, encouraging the break-up of existing teams and firms and the abandonment of promising follow-up projects in favour of new ones - a wasteful and inefficient process for the economy as a whole.

Small firms exist in symbiosis with large ones and other economic actors, including banks, local communities and stock markets, to name a few. Managing the interactions between them is an impossible task which governments probably shouldn't even try.

Improving the climate for enterprise as a whole, suggests Bhidé, is a better bet than focusing on any particular brand of entrepreneurship.
Large and the small of it
Typical start-up companies: Established companies:
Have little capital, few intellectual or other assets, novel ideas or experience. 
Pursue opportunities in niche markets requiring little investment, but where the likely pay-off is small and uncertainty high. 
Depend on the energy and opportunism of individuals; improvisation; tolerance of ambiguity; sketchy planning and little research. 
Focus on short-term cashflow. 
Have ample capital, many tangible and intangible assets (patents, know-how, brands), extensive co-ordinating mechanisms. 
Pursue opportunities in mass markets requiring high investment but where thepay-off is high and uncertainty low. 
Depend on planning, wide-ranging co-ordination, long-term programmes to develop assets and markets. 
Focus on long-term profits. 

Source: Amar Bhidé

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