Big Business: Good or Bad?

Stephen DeAngelis

November 18, 2011

I recently read two articles that express very different opinions about big business. The first article, written by entrepreneur and venture capitalist Luke Johnson, took a rather dim view of big business. [“Why big businesses are bad for business,” Financial Times, 18 October 2011] He penned the article after delivering a speech about entrepreneurism to a group of “middle-managers from large companies.” His words, he felt, fell on deaf ears. He explains:

“I realised as I spoke to the audience that my words about entrepreneurship were irrelevant to them – even offensive. For I was preaching the gospel of independence, freedom and risk-taking, while they were entombed in the cosy, airless coffin of big business. All of them were life-long employees of huge institutions and, to them, the struggles of running your own business were totally alien. The more I thought about this disconnect, the more I realised that all too many executives in large public companies actually have more in common with various arms of government than they do with entrepreneurs and start-ups. I used to believe that the great divide was between the public and the private sector: between state and commercial interests. But in truth the real difference is between giant and small organisations, whether they are for profit or not; between huge bureaucracies and owner-run outfits.”

Johnson’s point about large bureaucracies having much in common is a valid one. Clearly Johnson believes that size matters and, from the headline of his column, he apparently thinks that big is bad. What seems to bother him most about big companies is their lack of humanity – their disconnectedness from community. He continues:

“Private firms generally have loyalty to their home country, whereas multinationals are the commercial equivalent of non-doms – everything has a tendency to migrate to the lowest-cost location. Government and big business typically have close, sometimes unhealthy relationships. Corporates pay for lobbyists and lawyers to influence legislators and regulators; politicians seek non-executive directorships and consultancies with large banks and suchlike when they retire from public office. Such organisations as defence companies, builders, IT contractors, security firms and others are vast suppliers to the public sector. Their skill set is not innovation, but contract negotiation: they make money if they persuade the civil servants and regulators to agree price increases. … Most are near-monopolies, and behave much more like arms of government than the sort of companies I have owned or founded.”

In some ways, Johnson has described a straw man corporation – a caricature that is easy to criticize because it is nameless, faceless, and … big. On the other hand, he romanticizes about small businesses and their connections to real people. He asserts that, to make themselves more humanized, big businesses “jazz up their adverts, logos and branding, but such efforts are like putting lipstick on a pig.” He also takes a swipe at the chief executives of large businesses. He writes:

“In companies I own and help direct, the highest-paid executive earns between five and ten times what the lowest-paid staff member earns – and mostly, as founders, they are risking their capital, too. By contrast, in corporate empires, the CEO often earns 50 or even 100 times what the basic workers are paid – and the most they risk is losing their job. Such massive inequality leads to profound dysfunction. It arises because the rewards systems in large firms are broken. Boards become obsessed by governance, bosses become convinced of their genius, while staff feel minimal loyalty. Large businesses tend to be mature and to focus on cost-cutting, outsourcing and automation. Frequently they do not generate additional jobs, but destroy them.”

Johnson’s last point is where his view and that of Charles Kenny, author of the second article, differ dramatically. Before discussing Kenny’s article, however, I want to give Johnson one last opportunity to discuss big business. He concludes:

“Of course certain sectors require huge amounts of capital, such as car manufacturing or mining. Others, like water supply, have to be monopolies. And global enterprises can achieve economies of size that they pass on to the consumer. So I readily accept that big business can be beneficial to society – and is a fact of life. But I still hope that one day the relentless tide of consolidation is reversed, and both government and industry revert to a more human scale.”

Johnson started with spit and fire; but, having sufficiently vented, he finished meekly. In the end, he is forced to conclude that big business isn’t always bad. He nevertheless provides us with an excellent segue for discussing Kenny’s article. Kenny, a fellow at the Center for Global Development and the New America Foundation, has a very different view of big businesses than Johnson; especially when it comes to job creation. He claims, “Big companies are … the key to growth.” [“Rethinking the Boosterism About Small Business,” Bloomberg BusinessWeek, 28 September 2011] He continues:

“In the popular imagination, small firms are more nimble, more innovative, and more virtuous than blue-chip companies that employ thousands. Yet the notion that small business is the force behind prosperity is not true. The longer the U.S. and other countries cling to this myth, the harder it will be to carry out the kinds of economic policies that might actually stimulate job growth.”

You have to admit that statement stands in stark contrast to what Johnson wrote. Kenny continues:

“In the U.S. in 2007 there were around 6 million companies with workers on the payroll. Ninety percent of those businesses employed fewer than 20 people, according to analysis of the latest census data by Erik Hurst and Ben Pugsley of the University of Chicago. Collectively, those companies accounted for 20 percent of all jobs. Most small employers are restaurateurs, skilled professionals or craftsmen (doctors, plumbers), professional and general service providers (clergy, travel agents, beauticians), and independent retailers. These aren’t sectors of the economy where product costs drop a lot as the firm grows, so most of these companies are going to remain small. And according to Hurst and Pugsley’s survey evidence, the majority of small business owners say that’s precisely their intent—they didn’t start a business for the money but for the flexibility and freedom. Most have no plans to grow.”

Kenny admits that “some small companies do grow, of course,” but he adds the sobering fact that “eighty percent of U.S. small companies that remained in business from 2000 to 2003—the most recent period for which Hurst and Pugsley compiled data—didn’t add a single employee.” He continues:

“Looking at a sample of companies created from 2004 to 2008, Hurst and Pugsley found that only 3 percent added more than 10 employees during that time. An even smaller proportion had applied or were in the process of applying for patents. (So much for being seedbeds of innovation.) Many small businesses simply go bust after a few years. In 2009 economist Scott Shane at Case Western Reserve University surveyed the evidence on net job creation by each year’s cohort of new companies. He found that among small companies in their second year of business, more jobs were lost to bankruptcy than were added by those still operating. The same was true in years three, four, and five.”

To read more about Professor Shane’s research, see my post entitled Entrepreneurship Not for the Faint of Heart. Kenny next gets to the heart of his argument about why big companies are good.

“If you’re looking for a lot of good-paying, stable jobs, you’d better hope there are some big companies around that want to hire. Kansas City Federal Reserve economist Kelly D. Edmiston’s analysis of U.S. data found that each year, 22 percent of staff in companies with fewer than 100 employees quit or are fired, compared with only 8 percent for companies with 2,000 or more workers. Edmiston also found that the jobs offered at large businesses were better than those at small businesses. Hourly wages at the largest companies, those with more than 2,500 employees, average around $27, compared with $16 in companies with payrolls of fewer than 100. Companies with more than 100 workers are almost twice as likely to offer retirement benefits and insurance, and considerably more likely to offer health care. The story is the same in the rest of the world. A cross-country analysis of business surveys by economists Rafael La Porta of Dartmouth College and Harvard University’s Andrei Schleifer reveals that a society’s wealth is inversely proportional to the number of people who earn their livings from small businesses. Among the poorest quarter of the world’s economies, the proportion of people who are self-employed is 46 percent, compared with 13 percent in the richest quarter. The higher you go up the national-wealth ladder, the lower the number of small enterprises.”

You have to admit that those are pretty sobering statistics. Kenny goes on to report that “large companies are far more productive—with value added per worker an average of 59 percent higher.” One reason for this “productivity gap” is that “managers in larger companies are significantly better educated” than those in small companies. “La Porta and Schleifer conclude that the ‘hope of economic development lies in the creation of large registered firms, run by educated managers and utilizing modern practices.'” Kenny isn’t against small businesses, especially those in developing countries. He asserts, however, that “microenterprises run by poor people in the developing world are usually the result of an absence of other opportunities rather than an abundance of entrepreneurial zeal.” He further claims that “poor people consistently say is that they’d rather work for a stable employer” than for themselves. Massachusetts Institute of Technology economists Abhijit Banerjee and Esther Duflo told Kenny that finding stable employment “is the way rural people in India have been making their way out of poverty over the past couple of decades.”

 

Professor Shane agrees that more, not fewer, big companies are needed. “Because the average existing firm is more productive than the average new firm,” he told Kenny, “we would be better off economically if we got rid of policies that encouraged a lot of people to start businesses instead of taking jobs working for others.” Kenny concludes, “Extolling small business might be a good way for politicians to win elections. But when it comes to creating jobs, size still matters.” Big business versus small business comparisons are interesting to make; but, the fact of the matter is we need all sizes of business. Every job is important in today’s economy.