Wednesday, November 7, 2012

Where the Jobs Are Coming From: Midsized Private Companies

Politicians love to extol the virtues of small businesses, referring to them as engines of job creation. Such statements have been repeated so often that they seem to have become political dogma. Unfortunately, data does not support this contention. Most small businesses create few net jobs because the failure rate is high, and most small businesses do not scale in size. Most small business owners seek the satisfaction of running their own business rather than the hassle of becoming some more complex entity. It seems the "small" businesses that generate jobs are those who begin with a concept that is scalable, but start small by necessity. Apple might have been considered a small business at one point, but it never belonged in the same category as restaurants, gas stations, and beauty salons.

An article in The Economist points out that the discussion of job creation might be missing an important ingredient if we are only considering small businesses and large corporations.

"America has around 197,000 medium-sized firms, defined as those with annual revenues between $10m and $1 billion, according to data from the National Centre for the Middle Market at Ohio State University. Together, they employ over 40m people in the country and account for around one-third of private-sector GDP (equivalent to the economies of India and Russia combined)."

The interest in companies of this size is because they seem to have performed better in the difficult recent period in terms of job creation.

"Some 82% of medium-sized firms survived the dark years of 2007-10, compared with 57% of small firms. And although the survival rate among the 2,100 big firms (with revenue over $1 billion) was 97%, these giants shed 3.7m jobs during those years. Mid-sized companies, by contrast, added 2.2m jobs. This trend has continued as the economy has struggled back to its feet."

This intermediate class of companies is compared to Germany’s Mittelstand businesses.

"America’s mid-sized firms have much in common with the Mittelstand businesses that are the engine of Germany’s economy. They are concentrated in the industrial heartland, rather as Mittelstand firms are in southern Germany. They have typically been around a while; the average age is 31 years."

One interesting characteristic of these companies is that they are mostly privately owned.

"....they tend to be privately owned: 31% by a family, and a further 40% by some combination of private equity and family. Only 14% are traded on a stockmarket. By contrast, two-thirds of big firms are publicly owned."

Benefits from private ownership are suggested.

"The freedom from short-term stockmarket pressures is one reason why middling firms have been more willing to invest for the long term despite the tough economy, says Anil Makhija, who runs the National Centre for the Middle Market."

The fact that these midsized firms continued to add jobs across the recession suggests that they had a business posture that kept product output and the number of employees growing.

"Mr Makhija has studied the fastest-growing mid-sized firms, to see what they were doing differently. They turn out to be more focused on what their customers want (those with social-media strategies did especially well) and to use more state-of-the-art management methods. They also tend to be remarkably globalised, again like Mittelstand firms."

An article from Forbes provides some additional insight into private versus public companies.

"Private U.S. companies’ profitability has lagged that of public companies in the Standard & Poor’s 500-Stock Index through the recession and recovery, according to data from Sageworks Inc., a financial information company. At the same time, private companies took a less drastic hit to sales, on a percentage basis, than did S&P 500 companies between late 2008 and mid-2010, according to Sageworks."

This suggests that private companies are more recession-proof than public companies, and public companies respond to recessions by laying-off workers and cutting spending. It would seem that private companies respond to recessions by trying to maintain their business plans, while public companies respond by trying to maintain their profit levels. Or in simpler terms: private companies try to do something helpful, while public companies try to do something harmful.

These midsized companies and their private nature deserve further consideration. It seems that many public corporations are going private if the possibility presents itself—presumably because they recognize advantages to being private. Is it possible that public corporations have evolved to a state where their focus on short-term profitability and stock price has rendered them economically deficient? In other words, are they becoming obsolete? Should they become obsolete?

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