September 19, 2014

Do Small Businesses Matter in High Tech?

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Small businesses are much less important in technology-intensive industries than in the rest of the economy.

They account for a slender portion of high tech sales. A recent report by the National Science Foundation (NSF) indicates that, in 2008, businesses with between 5 and 499 employees accounted for 11 percent of sales of companies that conduct research and development (R&D).

Even for domestic sales, the contribution of small business isn’t very large. The NSF report found that small companies were responsible for only 14 percent of the U.S. sales of firms that perform R&D.

Small business’s share of sales by R&D-performing companies is much lower than its percentage of sales by all businesses. Back in 2002 – the last year for which comparable data exist – firms with between 5 and 499 employees accounted for 59 percent of revenues of all businesses with five or more employees, but only 20 percent of sales of companies that conducted R&D.

Small business also accounts for a smaller portion of technical employment than its share of overall hiring. In 2006, businesses with between 5 and 499 employees were responsible for 48 percent of employment of all firms with more than 4 employees. But in the same year, firms of this size accounted for only 27 percent of employment of scientists and engineers and only 14 percent of domestic employment of these personnel.

Large firms account for the lion’s share of R&D expenditures. The NSF report also shows that only 19 percent of R&D expenditures belong to small businesses. (Small companies paid for 22 percent of R&D undertaken in the U.S.)

This number is much smaller than the R&D expense accounted for by giant firms. Businesses with more than 25,000 employees paid for 42 percent of R&D. (Giant companies accounted for one third of the R&D conducted in the U.S.)

However, small high tech firms focus more on R&D than large high tech companies. Elsewhere I have explained that small R&D performing businesses devote a larger share of their employment and sales to R&D. And the NSF report shows that in 2008, R&D conducting businesses with at least 5 employees spent an average of 3 percent of their sales on R&D. In contrast, R&D performing businesses with between 5 and 499 employees spent 5 percent.

Small firms are certainly important to the U.S. economy. Businesses with between 5 and 499 employees account for over 99 percent of all companies with more than 4 employees. They also account for the majority of business revenues and nearly half of private sector employment.

But when it comes to the high tech part of our economy, small businesses are less central. Despite spending a greater share of their sales on research and development, small R&D performing companies only account for a slender portion of high tech company sales and technical employment.

This pattern provides a conundrum for policy makers who believe that small business is a central pillar of the American economy and that high tech is the future of the nation. Efforts to promote technoligcal innovation depend disproportionately on large companies. And as high technology becomes a more important part of our economy, the overall contribution of small business to sales and employment will decline.

3 Comments ▼

Scott Shane


Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

3 Reactions

  1. Seems to me that in the high-tech industry, small companies often do come up with breakthroughs, but they are usually acquired by a large company before they reach a point where they would start to influence the statistics. Thoughts Scott?

  2. Scott,

    I’m the coauthor of a new book coming out from Harvard Business Press entitled “Great Again,” about innovatiuon policy, and I must say that like a lot of your work.

    But this statement of yours is really strange: “Efforts to promote technological innovation depend disproportionately on large companies.”

    What?

    In the last 100 years, every single breakthrough or “transformative” innovation that lead to the development of a new industry and millions of new jobs was made by an entrepreneurial inventor or small firm.

    Just since World War II, semiconductors, PCs, software, the Internet (now responsible for $4 trillion in ecommerce, according to the Census Bureau) — and all the millions of jobs that go with each — was launched by a small startup.

    The only exception to the rule that startups always create breakthrough job-creating innovations may be the cellphone industry where, owing to government control of spectrum, the legacy of the AT&T monopoly, and the enormous investments needed to create an FCC-approved mobile cellphone device, Motorola could be said to have made the big leap forward.

    The startups-only rule applies not just to infotech advances, but to industrial age innovations as well (and you know very well from the work of Sokoloff, Lamoreaux, and Khan that it certainly applied to 19th century innovations, too).

    But you may want to check out Jonathan Jewkes seminal 1958 work,

  3. Dear David and Robert,

    Thank you for the thoughtful comments on my post. (And David, congratulations on the book.)

    In response to Robert’s point that small firms are “usually acquired by a large company before they reach a point where they would start to influence the statistics,” I agree that those that are acquired tend to be small when they are purchased. However, so few small businesses grow and so few get acquired by large companies that the influence of the growing companies getting acquired does not change the overall numbers very much.

    In terms of David’s comments, I think that our positions are not that far apart because we are talking about different things. First, I was discussing all innovation, not breakthrough innovation. Because virtually all innovation is incremental, this distinction is important. While I would not go so far as to say all breakthrough innovations were developed by small businesses, it’s entirely possible that small businesses have accounted for the minority of all innovations and the majority of breakthrough innovations. But please note that I was talking about overall innovations, not the small number of breakthrough ones.

    Second, when I said “small businesses are much less important in technology-intensive industries than in the rest of the economy” I was referring to the three measures that I then discussed: sales, employment and R&D spending. On these three dimensions small businesses account for a smaller share of high tech industries than low tech ones.

    Third,when I said,

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