Small business bulking up for success: RBC Economics

Growth in number of small businesses slowing; but moving up the size chain

TORONTO — The latest small business report from RBC Economics shows that small businesses have grown larger since the start of the decade, but that overall growth in the number of small businesses has slowed in the last five years, partly reflecting softer economic conditions.

According to the RBC report entitled “Small Businesses and Industries in Canada - Recent Trends,” technological advances, globalization, the lessening of regulation and the high Canadian dollar have upped the ante for small businesses in a wide spectrum of industries over the past decade.

These factors have exerted increasing pressure on small businesses to take steps to become more competitive - including combining with other organizations. Small businesses in sectors directly exposed to foreign exchange, such as tourism, were most affected. Suppliers of goods or services to larger, export-dependent organizations also felt the effects, but to a lesser extent, of the sharp appreciation in the Canadian dollar. And even though the manufacturing sector is experiencing generalized declines in the number of small businesses, the average firm size appears to be increasing.

“While consolidation in the manufacturing sector has led to a loss of small businesses, there is evidence that average firm size has grown in most manufacturing industries,” said Robert Hogue, senior economist, RBC. “Through the challenging markets of the past several years, the decline in the number of small manufacturing firms might actually be a positive sign if it reflects a movement towards them becoming larger in size. Larger firms tend to be in better position to make the investments necessary to become or remain globally competitive.”

Although the extent to which small firms are part of this bulking up phenomenon is difficult to determine, the report found that output is being produced by larger and larger enterprises in Canada. “Whether this size expansion is a result of smaller firms becoming bigger, or larger firms gaining heft, or both, we see this as positive news for our economy. Productivity performance tends to get stronger the larger the size of enterprises,” Hogue added.

Specifically, the report found that within the micro/small business category, the share of the larger firms (those with between 10 and 99 employees) has increased in all manufacturing industries between 2002 and 2007. Even though such a shift does not appear to extend to the medium-sized enterprise category, it does suggest that Canada’s smallest manufacturers are moving up the size chain. Only the hardest hit industries within manufacturing such as textile and clothing have failed to show a gain in average firm size.

A Look Ahead

With the Canadian economy expected to gradually emerge from its “soft patch” during 2009, the report found that general business conditions should improve later next year and stimulate the small business environment. However, the rate of growth in small businesses is unlikely to pick up much, if at all, as the maturation process continues and the focus for several key sectors remains on consolidating and restructuring.

As well, when economic growth starts to re-accelerate, the average output per firm is set to continue rising overall for the majority of industries. Although the size of firms in Canada is low on the list of alleged culprits for Canada’s lagging productivity, the growth in average firm size will become a positive factor enhancing Canada’s productivity prospects.

“While it is still too early to pass a definitive judgment on whether or not small businesses in Canada are successfully adapting to the tough economic challenges, the evidence is encouraging to the extent that firms are gaining heft across the spectrum of industries,” said Hogue. “In the meantime, Canada should aim to strive for a policy environment that reduces business irritants such as red tape, complex regulation and the disincentives to grow that are imbedded in the current tax structure. This would help Canada’s firms and entrepreneurs to be more globally competitive and achieve their full potential.”