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Appendix What We Know About Small Business in America Small business is an important segment of the U.S. economy, and as such it has merited substantial critical study. The purpose of this section is not to provide the definitive statement on small business In the United States, but rather to summarize some of what is known about small business and thereby put into context this report's discussion of small high-tech companies. DEFINITIONS What is a small business? There are numerous measures that could be used to capture the universe of companies defined as "small," including number of employees, business receipts, or the value of assets. However, the most common measure is number of employees. Here, the cutoff used by both the Small Business Ad- ministration and the Organization for Economic Cooperation and Development is 100 employees or fewer, although the SEA recog- n~zes that In some industries dominated by a few large players, for example, the automobile or aerospace industries, a company of up to 500 employees would still be considered small.1 1U.S. Small Business Administration, The State of Small Business: A Report of the President, (Washington, D.C.: U.S. Government Printing Office, 1992) Page 20. 77

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78 . APPENDIX Another Problem in definitions comes up in distinguishing be- tween enterprises (firms, businesses) and establishments (branches, places of business). The SEA notes that small business accounts for 99 percent of all establishments operating in the United States. Further: An establishment is defined as any single physical location where business is conducted. An enterprise is a business organization consisting of one or more establishments under the same owner- ship or control. Most small businesses consist of a single estab- lishment. However, a large firm may own many small establish- ments; these establishments should not be confused with small firms.2 These distinctions are particularly relevant when discussing fran- chises or subsidiaries. A single franchise, for example, an automo- bile dealership, owned by an individual would be considered a small business, but multiple franchises with one owner or multiple outlets owned by the parent franchiser would not. Finally, it is important to note that more than half of all busi- nesses have no employees other than the owner, and many owners work only part-time at their businesses.3 Using tax return clata, which capture all reported business activity, will give a much higher estimate of the number of small businesses than using un- employment insurance data, which exclude millions of part-time, hobby businesses (21.3 million and 5.5 million, respectively). THE JOB CREATION DEBATE Since the 1980s, conventional wisdom has held that small firms create most new jobs: a commonly cited figure is that small busi- ness creates 80 percent of the new jobs in the United States. This thesis, promoted initially by research analyst David Birch and then adopted by others who found it an excellent vehicle for promoting government programs that favor small business, has come under increasing scr~u~ny~in recent years. Researchers and economists skeptical of this claim have criticized the research methodology 2Ibid., page 20. 3Ibid., page 21.

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WHAT WE KNOW ABOUT SMALL BUSINESS IN AMERICA 79 and interpretations of data and offered alternative explanations for the growing importance of small firms in the United States.4 Charles Brown, lames Hamilton, and lames Medoff, in their book Employers Large and SmalZ5 contend that New firms, which tend to be small at birth, generate new jobs when they grow; however, those firms are not necessarily becoming more important sources of employment than large firms. Small establishments owned by large firms play an impor- tant role In generating jobs. The growth of small business industries is more impressive than the job generation of small businesses. Small business accounts disproportionately for the two most important components of employment change-the births and cleaths of businesses. Existing firms, especially small ones, are on average shrinking, but many new firms enter each year to offset that decline. Small business' share of employment has remained relatively unchanged since 1958-about 35 percent of employment is In firms with fewer than 100 employees, and about 50 percent of employ- ment is in firms with fewer than 500 employees. Small firms have higher job-Ioss rates (jobs lost as a result of contractions or closings as a proportion of all employment). INNOVATION IN SMALL COMPANIES Another area of debate has focused on whether most innova- tions originate from large corporate labs or small companies. Zoltan T. Acs and David B. Au~retsch In their work on this issue concluded that We question of big vs. small was an oversimplifica- tion that did not capture the rich configurations of research efforts 4See C. Brown, ]. Hamilton, and J. Medoff, Employers Large and Small (Cam- bridge, Mass.: Harvard University Press, 1990~. S. Davis, J. Haltiwanger, and S. Schuh, Small Business and fob Creation: Dissecting the Myth and Reassessing the Facts. Working Paper No. 4492. (Cambridge, Mass.: National Bureau of Economic Research, 1993~. B. Harrison, Lean and Mean: The Changing Landscape of Corporate Power in the Age of Flexibility (New York: Basic Books, 1994~. 5C. Brown, ]. Hamilton, and ]. Medoff, Employers Large and Small (Cambridge, Mass.: Harvard University Press, 1990 ).

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80 APPENDIX and sources of innovation in the United States.6 Although Bennett Harrison, in his book Lean and Mean: The Changing Landscape of Corporate Power in the Age of Flexibility criticizes their methodology, it is worthwhile to note one of their conclusions, namely that in- dustries dominated by large companies, for example, aircraft and automobiles, tend to be more innovative, but it is the small compa- nies in those industries that were likely to produce the innova- tions.7 John Case, an editor at Inc. magazine, has pointed out several reasons why this may be so. First, innovative entrepreneurs often have spent some time at big companies before leaving to launch their own firms. Small companies often commercialize technolo- gies developed in corporate R&D labs. Finally, big companies of- ten help small companies bring their products to market, through investing in the companies, providing a distribution system, or assisting In marketing.8 A 1992 study fundec! by the SBA looked at R&D within small firms in four industry groups: office and computing machines, electronic components and accessories, machine tools, and aircraft and parts.9 It found that small firms in those industries with uni- versity research relationships earned more per R&D clollar than large firms. The estimated rates of return on R&D dollars spent were 30 percent for large firms and 44 percent for small firms. OTHER AREAS OF COMPARISON BETWEEN LARGE AND SMALL FIRMS A useful comparison of large and small companies is the book noted above by Brown, Hamilton, and Medoff, Employers Large and Small (1990~. The authors compare small and large firms in such 6Zoltan I. Acs and David B. Audretsch, Innovation in Large and Small Firms: An Empirical Analysis (Vol. 78, No. 4. September 1988. Pp. 678-690~. 7B. Harrison, Lean and Mean. The Changing Landscape of Corporate Power in the Age of Flexibility (New York: Basic Books, 1994) Cohn Case, "Sources of Innovation," Inc. June (1989~: 29. 9Albert N. Link and John Rees, Firm Size and External Research Relationships, Research Summary Number 129 (U.S. Small Business Administration, Office of Advocacy, December 1992~.

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WHAT WE KNOW ABOUT SMALL BUSINESS IN Al\/lERICA 81 areas as wages, benefits, job security, training, unionization, politi- cal resources, influence, and intangibles (e.g., proximity to owner- founder). Wages Workers in big companies or locations earn more over 30 per- cent more than their counterparts in small firms. Even when other factors such as differences in worker education and experi- ence, differences between manufacturing and service industries, differences in working conditions or union rates, or union avoid- ance strategies are taken into account, the size-wage premium re- mains at 10-15 percent. Benefits Small firms do not offer many of the fringe benefits, or equiva- lent benefits in the fringes that are offered, which are available from larger firms. For example, 100 percent of the large firms surveyed for a 1986 SBA study offered health insurance whereas only 55 percent of the firms with fewer than 500 employees offered health insurance. A 1984 Harris survey found that workers' satis- faction with benefits grows with firm size. Differences in fringe benefit offerings can be explained by larger firms' attempts to se- cure and retain needed labor, the desire to forestall unionization, and lower costs for large firms to set up and run a benefit program. lob Security Although much has been written about job loss due to the re- structuring of big business, employees In large organizations are actually less likely to be laid off than employees in small compa- nies. Data collected on the U.S. manufacturing sector for the pe- riod 1950-1971-showed that a smaller proportion of the workforce was likely to be laid off each month in large establishments than in small establishments. Another study conducted in 1980 and 1981 found that even though large employers are more likely to be in high-layoff industries, within an industry, large employers offer more job security.

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82 APPENDIX ~ ~ 1 raining It is commonly thought that because many workers start out in small firms, they are acquiring their training in those firms as well. However, results of studies on training and firm size are mixed. One study found that new employees received far more hours of both formal and informal training in establishments with more than 500 workers than in smaller workplaces. This can be attrib- uted to the fact that large firms can train more people in one class with a single instructor and there is more extensive informal train- ing by coworkers. A later study showed the smallest and largest establishments providing the most training. Unionization Eighteen percent of the U.S. workforce is unionized, and work- ers in large companies are much more likely than those in small ones to be unionized. Even though the data on unionization rates and firm size imply that union representation must be more desir- able to workers in large firms than small ones, a Harris survey for the AFL-C]:O found that workers of small employers were much more likely to vote for unionization than were the workers of large employers. The discrepancy may reflect the fact that unions gain more from organizing larger units and that larger (and by implica- tion longer-lived) employers have been exposed longer to the pos- sibility of being unionized. Political Resources Small business is viewed by the public as having little influence in politics. This can be attributed in part to its association in the public's mind with mom-ancI-pop stores or the lone entrepreneur. Also, there is no single lobbying organization for small business to project a unified message for that sector of the economy. However, it is important to note the political clout of trade groups and pro- fessional associations representing the interests of individual in- dustries that are composed primarily of small businesses. Of the top 10 contributors to political action committees (PACs) in 1986, five represented small business constituencies: realtors, home builders, physicians, trial lawyers, and insurers. A Federal Elec

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WHAT WE KNOW ABOUT SMALL BUSINESS IN AMERICA 83 lion Commission study found that small-business PACs contrib- uted nearly two-thirds as much as big-business PACs to Senate and House candidates and roughly the same amount as PACs as- sociated with labor. In a survey of trade associations, small-busi- ness associations had approximately 20,000 staff, compared with 15,000 for big-business associations and 4,000 for labor unions. Small business also represents a sizable voting block in every con- gressional district. The positive public image of small business is also an asset; the public is much more likely to support programs endorsed by small-business advocates than programs enclorsed by labor or big-business groups. Journalists also rate the credibility of small business much higher than that of big business or labor. Influence A number of studies of roll-call votes have pointed out that small-business PAC money does indeed sway votes. Actual influ- ence may be greater, however, considering the fact that small-busi- ness PAC contributions may affect the outcome of elections so that canclidates that favor their positions are more likely to end up in Congress. Another measure of small-business influence is that small and large firms are not subject to the same regulatory com- pliance and reporting requirements. Studies have shown that when subject to health and safety regulations, enforcement tends to be more lax in small firms so that the workers are less protected than their counterparts in larger firms. Intangibles Small companies are said to offer "intangibles" that large firms do not. These include proximity to, and guidance of, an owner- founder, potential to move up quickly if the firm grows quickly, opportunities for an equity interest, and the opportunity to get involved in more aspects of a company's business. However, us- ing quit rates among workers with the same wages as a gauge of employee satisfaction, it has been found that workers in large firms have a much lower quit rate than their counterparts in small ones. Although there is more internal job movement among workers of large employers, even for workers for whom internal job move- ment was not an issue, those working for large employers were

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84 APPENDIX less likely to change their employer. Large firms also appear to have longer queues of qualified job applicants for the positions they offer. THE DATA ON SMALL HIGH-TECH COMPANIES The Office of Science and Technology Policy estimates that there are 75,000 small high-tech firms in the United States with approximately 1.75 million to 2 million direct employees engaged in key high-technology areas. SEA studies note that small high- tech firms create twice their proportional share of new jobs, that they produce two to four times the number of products and pat- ents per R&D dollar, and generate half of all major technical inno- vations leading to commercial patented products.l The National Science Board's 1993 Science and Engineering Indi- cators notes that, "many of the new technologies and industries seen as critical to the Nation's future economic growth are closely identifiecl with small business." These technology fields include automation, biotechnology, computer hardware, advanced materi- als, photonics and optics, software, electronic components, and tele- communications. Even though the late 1980s saw a sharp decline in company formation from the earlier part of the decade, almost half of all U.S. high-tech companies operating in 1993 were formed since 19So.12 Sixty percent of companies in computer-related and bio-technol- ogy fields were formed since 1980. Software companies account for the greatest number of small business start-ups among all tech- nology fields; 34 percent of the 10,000 new high-tech companies formed since 1980 and In existence In 1993 were software develop- ment or servicing businesses (See Figure ~ and Table 2~. 1OThe State of Small Business: A Report of the President (U.S. Small Business Ad- ministration, 1990, and Cognetics Consultants, Inc. 1991~. See also William K. Scheirer, Small Firms and Federal R&D (Office of Management and Budget, 1977) and Innovation in Small Firms, Issue Alert Number 8 (U.S. Small Business Admin- istration, July 1986~. 1lScience and Engineering Indicators 1993 (U.S. National Science Board, 1994, p. 185~. 12Ibid.

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WHAT WE KNOW ABOUT SMALL BUSINESS IN AMERICA Automation Biotechnology Computer hardware Advanced materials Photonics and optics Software Electronic components Telecommunications 1 1 1 1 1 1 1 _ Total number of companies ~ ~ ~l formed in each period ~1980-8457659 _1 ~1985-894~660 ~. ~ . . ~ ~.~. _ , _ = 1990-93638 _ _ . __ _ ..... i ... , . ~ ~ ~ . ~ ~ it. . ~ - ~ ~ 1 _ I".: ~ _ _ .,,, i, i, ~ ~ i, ~ ~ i, ~ ~ ~ ~ ~ i, i, ~. i, i, ~ ~ . . . ~. . ~. - ~ 4 ~. .... _ .~.~.~ ~] 1 1 1 1 1 1 1 0 10 20 30 40 Percentage of all high-tech companies formed during each period 85 FIGURE 1 High-tech business formation, by technology. Note: Data reflect information collected through July 1993. Reprinted from Science & Engineering Indicators 1993 (National Science Board, 1994~.

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