Small but mighty: Why SMEs will power the next phase of economic growth

They number in the hundreds of millions. They employ over half the planet’s workforce, and they represent around 40% of global GDP. Small and medium-sized enterprises (SMEs) are, to put it mildly, very important, and there are reasons to think they are about to become even more so.

The hidden giant

On 27 June the United Nations celebrates MSME Day, standing for micro, small and medium-sized enterprises. It’s an attempt to bring the world’s attention to a part of the economy that is very often overlooked, due to its sheer complexity. Not only are the numbers of SMEs very large, but they work in every part of the economy, from light engineering to fried-chicken vendors to dance schools and, yes, even editorial consultancies.

In China, SMEs represent 80% of non-government employment. Vice-Premier Liu He describes them as the mainstay of the domestic economy. In the US, the number of SMEs has surged, with business applications doubling in 2020 compared to previous years. The US Chamber of Commerce attributed this to an entrepreneurial wave caused by the pandemic. The growth rate in the UK was even higher.

However, SMEs are generally less efficient than large companies. Productivity - output per unit of input - tends to be lower. McKinsey notes that within the same sector, the productivity gap between large companies and SMEs can vary by a factor of two or more. Its data also suggests this gap varies wildly between countries, from as high as 80% in Greece to as low as 26% in France. The variability of these numbers suggests that closing the productivity gap is possible – and indeed, that it could have a dramatic impact. McKinsey in fact estimates that halving the productivity gap between SMEs and large companies could add US$15 trillion to global GDP.

Governments around the world are waking up to the fact that if they are to deliver growth, they need to help SMEs bridge this productivity divide. In 2021, the Chinese government launched a five-year plan intended to make SMEs more innovative, more specialised, and less vulnerable to monopoly behaviour by bigger companies as the country seeks to boost SME productivity by 18% by 2025.

Scale e-tricks

One disadvantage SMEs face is lack of scale. They rarely advertise or recruit at a national level. Most are embedded into a specific local economy and they may see little advantage in expanding beyond that locality. This is especially true in the services sector, which can be difficult to scale, given that growth often depends on hiring more personnel while maintaining the same level of skill and service.

A majority of SMEs are micro-businesses with fewer than 10 people, who between them have to fulfil functions that in large companies are the remit of highly skilled specialists. IT, tax and regulatory compliance, sales and marketing, project management and administrative support are just some of the functions that can divert SME staff from their core business activities.

However, new technology is beginning to offer smaller businesses a way to overcome some of these scale disadvantages. For example, SME manufacturers are often reluctant to invest in dedicated machine tools that may only be of use for a single contract, for fear that the investment will not pay off once that contract ends. But the emergence of more flexible ways to access such resources are now reducing that risk, allowing SMEs to compete for a wider range of work.

A shortage of spare parts triggered by supply-chain disruption during the pandemic was in some cases bridged by SMEs with industrial 3D printers that could produce substitutes using high-strength composites. The flexibility offered by 3D printing – otherwise known as additive manufacturing (AM) – is now viewed by many governments as a way of closing the productivity gap between SMEs and the giants. In the US, the Biden Administration’s AM Forward initiative is targeted at strengthening the AM capabilities of SMEs, which account for 99% of US manufacturing enterprises.

E-commerce is another recent innovation that is allowing SMEs to do things that were once the province of much larger companies. The ability to export once required an international sales force, advertising campaign, or both. But Amazon data suggests that British SMEs selling through the Seattle-based company’s online platforms have not only created a quarter of a million jobs in the UK, but that more than half export overseas.

Using AI intelligently

The rise of artificial intelligence (AI) may prove to have more of an impact on SMEs than even e-commerce. The OECD argues that AI will both allow smaller businesses to scale up, while easing the conditions under which they do business.

Although the automation of tasks often has a negative connotation, it can be a boon for SMEs. It lessens the need to hire staff with niche technical knowledge. For instance, AI can perform predictive analytics of big datasets in order to help an SME understand its market. It can “view” product images and write descriptions of them. It can respond to queries via chatbots, and even recommend products and services to customers. Dreary data-entry tasks can be automated, again reducing the workload for SMEs and allowing their lean staff to focus on the core business.

Goldman Sachs forecasts that AI-powered tools like ChatGPT could automate as many as 300 million jobs, or 18% of the global workforce. Some large companies are already operating on the assumption that AI will reduce their need for labour. IBM has frozen hiring for jobs that could potentially be completed by AI, while telecoms giant BT has announced plans for a 40% reduction in its global headcount, with some of the roles to be replaced by AI.

If Goldman’s forecasts are accurate, one consequence is that some larger companies could even shrink to the point that they become SMEs themselves – the definition differs by country, with the US viewing companies with fewer than 500 employees as an SME (in the EU, it’s 250). Conversely, displaced workers may well end up founding new SMEs themselves, or working for others.

It is therefore hard to escape the conclusion that important as they already are, SMEs are going to become even more so in the years ahead. While economies of scale will continue to give corporations an advantage, scale is not what it once was, and smaller and nimbler businesses that avail themselves of the latest innovations may find that they can compete in ways that until now were impossible.