Demystifying (mystifying?) small business

by on September 16, 2011 at 8:43 am in Uncategorized | Permalink

In BPEA, from Erik Hurst and Benjamin Wild Pugsley (pdf):

In this paper, we show that substantial differences exists among U.S. small businesses owners with respect to their ex-ante expectations of future performance, their ex-ante desire for future growth, and their initial motives for starting a business. Specifically, using new data that samples early stage entrepreneurs just prior to business start up, we show that few small businesses intend to bring a new idea to market. Instead, most intend to provide an existing service to an existing customer base. Further, using the same data, we find that most small businesses have little desire to grow big or to innovate in any observable way. We show that such behavior is consistent with the industry characteristics of the majority of small businesses, which are concentrated among skilled craftsmen, lawyers, real estate agents, doctors, small shopkeepers, and restaurateurs. Lastly, we show non pecuniary benefits (being one’s own boss, having flexibility of hours, etc.) play a first-order role in the business formation decision. We then discuss how our findings suggest that the importance of entrepreneurial talent, entrepreneurial luck, and financial frictions in explaining the firm size distribution may be overstated. We conclude by discussing the potential policy implications of our findings.

Michael G Heller September 16, 2011 at 9:14 am

Perhaps the authors are using a too-dramatic definition of innovation or ideas when they say that few new businesses come to the market with a new idea. Schumpeter, for example, was keen to show that entrepreneurs are often (maybe even primarily) motivated by non-pecuniary motives, and their innovation might not be intentionally earth shattering or conventionally technological. These new entrepreneurs who start up with the intention of just providing an old service to an old set of customers might nevertheless have the intention of performing that service in *new ways*. In a grumpy old market even a smile can be an innovation.

Foobarista September 16, 2011 at 1:46 pm

In other words, most small businesses are mom & pop services like pizza places, pho shops, auto repair, etc, and not tech startups. And most of them are started by people who are basically building themselves a livelihood, not trying to change the world.

Tom West September 16, 2011 at 9:30 am

Uh oh. Aren’t people who claim that altering marginal tax rates fundamentally alters the rate of small business creation going to be upset by these results?

Andrew' September 16, 2011 at 10:03 am

Why? Does the paper claim that marginal tax rates don’t alter the rate of small business creation?

dan1111 September 16, 2011 at 12:01 pm

I think the point is that “small businesses are key to innovation that drives the economy” is often used as an argument against raising taxes on the upper-income brackets.

Whatever the merits of that argument, I don’t see this paper making much of a difference. They haven’t proven that small businesses aren’t major innovators or aren’t important for the economy. All they have shown is that there are a lot more barbers, restaraunt owners, lawyers, etc. than inventors–which isn’t really that surprising.

tom September 16, 2011 at 12:47 pm

I thought it was that they create more jobs, especially in the early stages of the recovery from a recession.
Hate to have that!

Tom West September 16, 2011 at 12:22 pm

I was thinking how

Lastly, we show non pecuniary benefits (being one’s own boss, having flexibility of hours, etc.) play a first-order role in the business formation decision.

will be used. Of course, it doesn’t say that money is *not* a primary factor, but it’s easily taken from a cursory reading of the abstract (which is all that gets used in talking point debates).

anon September 16, 2011 at 10:03 am

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I own a small business, and want to keep it small. I worked in large organizations (profit, nonprofit, and academic) for more than 20 years before going out on my own. (I have no interest in working in a large organization again except possibly when I’m much older in a very low level hourly position where I could punch in, do my work, and punch out.)

For a few years after starting my business more than a decade ago, I got calls from headhunters offering me more than 4 times what I was making in my business. I turned them all down, and told the last one he could make it a million a year and I still wasn’t interested. The freedom I have running my own show is – almost – priceless. It is not merely about financial compensation.

Small business owners are not a monolithic bloc. We have different levels of education, varying backgrounds, and different motivations for starting our own business. However, among the 50 or so small biz owners I know, being one’s own boss, and having freedom and flexibility to structure their business AND the culture of their business are paramount.

All of the people I work with I like, including all of my vendors and employees, who I consider my colleagues. No small business owner does it on her own, but I now have the freedom to tell jerks and a**holes to get lost.

Bill September 16, 2011 at 10:06 am

This is WAY to general an assertion for the subject.

The first place to start is with definitions: What did you have in mind when you thought “small business”?

Here are the NAICS (or business code descriptors) of what the small businesses were in the study:

“Specifically,
these industries primarily include skilled craftsmen (e.g., plumbers, electricians, contractors,
painters), skilled professionals (e.g., lawyers, accountants, and architects), insurance and real
estate agents, doctors, dentists, mechanics, beauticians, restaurateurs, and small shop keepers
(e.g., gas station owners and grocery store owners).”

This is not a picture of what you might be thinking of as small business when you read this post, or, if it is, fine, because if you have this picture in your mind, then the conclusions of the paper follow and accord with your understanding: but, it was not mine, which is small manufacturing, processing, etc. This actual set of small business is basically independent contractors. (By the way, with that definition of small business to include a lawyer, you had better listen to me because I am a small businessman).

We are all small businessmen.

BTW, US small business (by which I mean small manufacturing and processing) gets screwed with differential tax treatment between themselves and multinationals and the MNCs of transfer pricing and other techniques in the international market to basically avoid or greatly diminish their tax load relative to small business. But, you will never see the Business Roundtable work to lower MNC advantages so they could lower small business tax rates.

byomtov September 16, 2011 at 10:16 am

Those seem like small businesses to me.

By coincidence, I had a guy come clean my carpets yesterday. He told me he works alone, and has for thirty years. He said he doesn’t want the hassle of employees, and makes a nice living this way.

Does a good job, too.

Andrew' September 16, 2011 at 10:52 am

One of the Robert Kiyosaki books makdes the distinction between being a small business versus self-employed. Vague distinctions are very valuable to politician types. As I recall, his definition was that if you leave the place where the work happens and work stops happening, you are self-employed and not a small businessman.

Bill September 16, 2011 at 1:28 pm

byomtov,

When these small businessman are so similar to workers I question whether we should be treating them better than workers, both under the tax laws and with respect to government policy, any more than we should be treating farmers better than workers.

As anyone who has ever been in the small business category, by this definition, you can find an amazing number of tax deductions (seminars, travel, and client entertainment expenses) that are unavailable to average workers, which most of these small business categories looked like to me.

Urso September 16, 2011 at 1:37 pm

That’s what I think of. I can’t imagine there are really that many manufacturing concerns that are truly small businesses. There are just too many economies of scale there. Whereas if you’re a plumber or a lawyer your economies of scale are low (unless you’re reviewing 3,000,000 pages of documents).

Anthony September 16, 2011 at 4:30 pm

Any specialist manufacturer is likely to be a “small” business, since “small” is usually defined by number of employees. These days, it doesn’t take many employees to run a moderate-size production line, though it will take a lot of capital to get started. For example, right across the parking lot from my company is small manufacturing operation with somewhere around 10 to 15 employees. They’ve expanded somewhat over the past 7 years, taking over more of the building they’re in. They’ve changed their production process somewhat over the years, though I suspect it’s fundamentally pretty similar. They’ve changed their products over time, though mostly in stylistic ways.

prior_approval September 16, 2011 at 10:10 am

Wait, a study says U.S. small businesses owners may not really form their businesses for the money?

Well, that goes well with the idea that the unemployed in Georgia should work for free for a corporation’s profit.

And even seems to have tangential connection to the reason that the U.S. car industry is seemingly falling apart is because unionized German and Japanese and Korean and French and Spanish and Italian car workers are paid less than $14 dollars an hour, and thus cleaning up in global automotive markets?

Seriously, this is the best satire site concerning the U.S. on the web at this point.

(For fun, a bit of information about those Korean workers. from July 16, 2011 –
‘The South Korean division of General Motors has agreed to a record bonus payment for its employees following a partial strike last week. This was the first organized union strike to hit GM Korea in three years and it led to a production loss of 9,700 units.

The agreement between GM Korea and the union includes a raise of basic salaries by 4.7% and, more importantly, a $6,140 (6.5 million won) bonus to each worker.

The local division of GM was originally formed out of the remains of Daewoo, and is the American firm’s biggest manufacturer of Chevrolet models outside of North America, exporting more than 80% of its production and accounts for one in every four cars of the brand sold globally.

However, the good news for GM’s South Korean workers might not be so good for domestic manufacturers, like Hyundai and Kia, who are also facing demands for significant hikes in wages and bonuses.

According to analysts, GM’s move may have a negative effect on the countries competitiveness. Currently, South Korea is the world’s fifth largest car industry just below Germany, with 4.1 million vehicles and a 6% market share in 2010.

http://carscoop.blogspot.com/2011/07/gm-agrees-to-pay-korean-workers-record.html

Shhhh … don’t let anyone in the U.S. find out how the Koreans are destroying their auto industry.

As for the Germans, well there’s this from Feb. 8, 2011 –
‘Setting a key benchmark for the country as its economy booms, Volkswagen said on Feb. 8 that it has agreed to a 3.2% wage hike with Germany’s top trade union IG Metall.

VW and IG Metall also agreed on a one-off bonus equal to one percent of a worker’s annual pay, with a minimum payment of 500 euros ($680).

The pay increase is to take effect on May 1, effectively bringing it forward by eight months, VW added.

“The company and IG Metall have found a fair solution that offers a very decent rise in pay while preserving competitiveness,” said VW personnel director Horst Neumann.

IG Metall official Hartmut Meine said “the conclusion of this agreement takes into consideration the solid economic situation of major European car makers and compensates personnel for their performance.”
http://www.industryweek.com/articles/volkswagen_ig_metall_union_agree_on_3-2_pay_hike_23841.aspx?cid=NLQMN

Another competitor about to blow up – after all, what do Germans know about building quality cars using expensive labor? Well, thinking about it, they actually know a hell of lot more about how to do it than anyone in the U.S. at this point.)

JimC September 16, 2011 at 10:14 am

I have been self-employed in small manufacturing for nearly 30yrs. There has not been one second that I ever considered ‘The Tax Consequences’ of a new idea. That’s such B.S. Maybe Exxon has a building full of people who are concerned, but no little guys I know.

New ideas are compulsive for me, I am not overly concerned if a new item makes money. I have developed a line of primary, profitable products and simply look to scratch that ‘new item’ itch .. and with luck, add to the pile. I only sell what I make, and use $100k as Zero in my bank balance. I would never expose my self or people to default. I started in the basement, then lived ‘above the store’ ..12yrs before I bought property on a creek. These days it seems people expect to hang a sign and buy on the water in the same week.

Jim

Hasdrubal September 16, 2011 at 11:35 am

A course on entrepreneurship I took really made sure to draw a distinction between “small business” and “entrepreneurial business.” Small businesses being things that didn’t really have aspirations beyond making a good living, like the local dry cleaner or halal meat market. Entrepreneurship, however, was more about thinking big, creating something new, doing what nobody else had done before type things. And entrepreneurial business might or might not grow large, but a small business wouldn’t even try. So the person who runs a restaurant because that’s what they enjoy and it pays well enough to get the kids through college is a small businessman, the person who tries to create a Michelin 5 star restaurant, or who wants to grow the family restaurant into a franchise is an entrepreneur.

I always substitute “entrepreneurial business” for “small business” when I hear talk of small businesses being the engine that creates jobs. It’s the businesses that start small (or ideas in large firms that start small) and then grow big that create jobs. Not so much the accounting practice or law partnership or doctor’s office that’s pretty much only ever going to support a family or three.

E. Barandiaran September 16, 2011 at 11:48 am

Tyler, hope you like the extension of the paper’s analysis to Ph.Ds:

In this paper, we show that substantial differences exists among U.S. Ph.Ds with respect to their ex-ante expectations of future performance, their ex-ante desire for future growth, and their initial motives for starting an academic career. Specifically, using new data that samples early stage professors just prior to career start up, we show that few Ph.Ds intend to bring a new idea to society. Instead, most intend to add value to an existing research program and by extension to its funding sources. Further, using the same data, we find that most Ph.Ds have little desire to grow big or to innovate in any observable way. We show that such behavior is consistent with the academy characteristics of the majority of Ph.Ds, which are concentrated among skilled scientists and intellectuals. Lastly, we show non pecuniary benefits (being without a boss, having flexibility of hours, attaining tenure, etc.) play a first-order role in the academic career decision. We then discuss how our findings suggest that the importance of scientific and intellectual talent and organizational luck in explaining the income distribution may be overstated. We conclude by discussing the potential policy implications of our findings.

Mike September 16, 2011 at 4:07 pm

In a related story, a paper from a Nobel Prize winning physicist determined that water is wet. The central contribution of the paper was defining what we mean by “wet”, taking a large sample of diverse water specimens, and accurately measuring the degree of wetness. The study determined that wetness is relative, in such a way as to distinguish low wetness liquids from high wetness solids. The research will proceed with an analysis of Jello.

Robert September 17, 2011 at 3:40 am

We have a small 5 person consulting business; we are in a specialized niche of entertainment technology.

We have no desire to expand, despite the opportunity. Mostly because of regulations that kick in for more than 5 employees

infopractical September 18, 2011 at 7:47 pm

I think it’s more correct to think of many small businesses as being modular arms of innovative businesses. Somebody at a larger company invents something, then produces that something. Then entrepreneurs who recognize the value of that something business businesses that help connect that something with a market.

This is the way many small businesses, such as medical supply companies, operate. They are, in effect, independent arms of large companies. And to try to define them as lacking innovation is really unfair — the existence of a modular class of entrepreneurs is itself one of the great innovations of the practical modern economy. Not giving credit where credit is due seems dehumanizing.

Silvia Plank September 19, 2011 at 6:28 am

Hi! Small businesses most times offer services within the parameters of demand. People are working to fulfill the needs of their customers. Big Businesses often change the demand, offering new technologies. Economizing production, administration, communication and other areas of life, they cut down the need of workforce, leaving more and more people unneeded without inventing new challenges for them. Furthermore, big businesses often have lobbyists that improve their legal position and downgrade the legal position of small businesses. Thus big businesses only work out well with a diminishing population. Still big businesses need growing population for increase. This discrepancy must lead to crisis.

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