research on small business

A microscope on small businesses: Spotting opportunities to boost productivity

At a glance.

• Micro-, small, and medium-size enterprises (MSMEs) form the backbone of economies. Across the 16 countries we examine, MSMEs account for two-thirds of business employment in advanced economies—and almost four-fifths in emerging economies—as well as half of all value added. They also power dynamism and will play an important role in preserving competitiveness in an era of shifting global production.
• Boosting MSME productivity relative to large companies could yield significant value. Small business productivity is only half that of large companies, and less in emerging economies. Raising MSMEs to top-quartile levels relative to large companies is equivalent to 5 percent of GDP in advanced economies and 10 percent in emerging economies.
• Capturing this value requires a fine-grained view. Relative productivity of MSMEs and large companies varies widely across subsector and country. For example, in virtually all countries, eight subsectors out of 24 drive more than 60 percent of the value of narrowing the productivity gap in manufacturing, but the top ones vary by country.
• A win-win economic fabric can improve productivity for both MSMEs and large enterprises. MSME and large company productivity move in tandem in most subsectors, indicating spillovers if the right conditions are created. For example, automotive MSMEs have gained operational proficiency through systematic interactions with productive original equipment manufacturers, and small software developers have benefited from talent and capital ecosystems seeded by larger companies.
• All stakeholders have a role to play in developing granular productivity strategies. In subsectors where both small and large companies lag, infrastructure and policy improvements can target both together. Where MSMEs struggle but large enterprises outperform, building networks among them helps. Even where both large and small companies do well, strengthening their interactions could boost productivity.

Micro-, small, and medium-size enterprises (MSMEs) are the lifeblood of economies around the world. They account for more than 90 percent of all businesses, roughly half of value added, and more than two-thirds of business employment. 1 “Micro-, Small and Medium-sized Enterprises Day, 27 June,” United Nations, June 2023.

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But small businesses lag behind large companies on productivity. On average, their labor productivity, or value added per worker, is half that of their larger peers. Accelerating productivity growth has always been the sure way to deliver long-term prosperity, and MSMEs can—must—play a crucial role. Their contribution is potentially even more important amid the beginnings of a reconfiguration of global trade patterns. 2 Geopolitics and the geometry of global trade , McKinsey Global Institute, January 2024. Such shifts are unlikely to translate into a meaningful long-term realignment without a competitive network of MSMEs supporting and complementing large companies.

If MSMEs were to narrow the productivity gap with large companies, not only could that breathe new life into economy-wide productivity, employment, and growth, but economies and companies could raise their resilience in an uncertain world. The question is how.

Only by studying MSMEs at the fine-grained level can we understand where and why opportunities exist and plot a path toward higher productivity for all. After all, MSMEs are immensely varied. They range from a self-employed individual, such as a taxi driver or an online game designer; to a microenterprise with one to nine employees, like a laundry or a dental practice; to a small enterprise with up to 50 employees, such as a bakery or local auto repair chain; to a medium-size furniture manufacturing company or software business employing up to 250 people.

Definitions, scope, and data limitations

The data collected for this research are arguably deeper and broader than those collated in the past. Here we present an overview of our approach. (See the technical appendix for more detail on the data sources and analysis undertaken in this research.)

Types of MSMEs studied. We examine a diverse array of MSMEs, from self-employed workers and entrepreneurs to mom-and-pop shops and small family businesses, across 16 countries. One notable exception is smallholder farmers, most of whom can be considered small business owners and constitute a substantial portion of the workforce, particularly in emerging economies. For example, in 2022, the agriculture sector employed 29 percent of the workforce in Indonesia, 33 percent in Kenya, 38 percent in Nigeria, and 43 percent in India. In this research, we focus on the nonfarm sector and do not examine agricultural productivity, which has its own unique dynamics, meriting a separate study.

MSME size category definitions. Enterprise sizes are typically defined by the number of persons employed. We take each country’s national definition of micro-, small, and medium-size enterprises. For example, for European economies in our sample, we used the OECD’s definition of MSMEs. The OECD thresholds are as follows: microenterprises employ nine people or fewer, small enterprises employ between ten and 49 people, medium-size companies between 50 and 249, and large companies 250 or more. However, definitions of enterprise sizes may vary by country. For example, in the United States, large companies are defined as having 500 or more employees. Indonesia and Kenya define businesses with 100 or more employees as large, and Nigeria sets the threshold at 200. India and Indonesia define MSMEs based on their revenue and their investment in plant and equipment as well as employment. While this makes cross-country comparisons inexact, it enables us to use reported data more directly and to limit assumptions.

Scope of data. We gathered data on value added and employment by sector (classified based on economic activity) across corporate size classes (micro, small, medium, and large) from country-level economic and business censuses, MSME and labor surveys, and aggregated databases, such as those of Eurostat, OECD, ILOSTAT, and S&P Global Market Intelligence. Typically, we use 2019 data to exclude potential distortions due to the COVID-19 pandemic. However, for availability reasons, the dates used range from 2016 to 2019 across countries. 1 To verify stability of the data, we examined data from 2009 and 2014 for some countries but did not collect complete longitudinal data due to the significant effort involved. However, the topic of understanding trends in MSME productivity would be a valuable area for future research.

Level of aggregation. We aggregated data at the level of 12 level-one sectors (for example, manufacturing) and 68 level-two subsectors (for example, manufacturing of textiles within the manufacturing sector), as defined by the International Standard Industrial Classification of All Economic Activities (ISIC), Revision 4 or equivalent. For the United States, Brazil, Mexico, and the European economies in our sample, we also collected data for 219 level-three subsectors (for example, manufacturing of carpets and rugs within manufacturing of textiles). The 12 level-one sectors are mining and quarrying; manufacturing; electricity, gas, steam, and air conditioning supply; water supply, sewerage, waste management, and remediation activities; construction; wholesale and retail trade; transportation and storage; accommodation and food services activities; information and communications technology (ICT); professional, scientific, and technical activities; administrative and support service activities; and other service activities. 2 We grouped two sectors—electricity, gas, steam, and air conditioning supply; and water supply, sewerage, waste management, and remediation activities—into one sector: utilities.

Sectoral data for some countries, typically the emerging economies, are not as granular as for the advanced economies. For cross-country comparisons, we used a combination of data sources, including a sector breakdown of employment from ILOSTAT, and distinguished between MSMEs and large companies using national sources. In some cases, we also conducted comparisons at a less granular level by grouping two or three level-two sectors.

Measuring productivity. Productivity is a measure of output relative to input. 3 Investing in productivity , McKinsey Global Institute, March 2024. In macroeconomic terms, it is defined as the value of the goods and services produced divided by the amount of labor, capital, and other resources required for its production. For this report, we focus on labor productivity, measured as value added per worker (in US dollars at purchasing power parity). While the more accurate measure of labor productivity is value added per hour worked—as the number of weekly hours worked varies substantially among countries, from 31 hours in Australia in 2023 to roughly 46 hours in India—we use the per worker metric as it is more commonly available across size categories by country. Due to the lack of comprehensive data at the individual company level for MSMEs, we rely on subsector-level average productivity to make inferences. 4 We focus on national- or sector-level productivity from a growth economics perspective. Organizational productivity research often studies issues related to attrition, disengagement, skills mismatch, or time inefficiency. See, for example, Aaron De Smet, Marino Mugayar-Baldocchi, Angelika Reich, and Bill Schaninger, “ Some employees are destroying value. Others are building it. Do you know the difference? ,” McKinsey Quarterly , September 2023.

Other important limitations. Our research reflects the challenges of working with significant constraints on data availability. For all the countries in our sample, we included data for both formal and informal sectors, although we recognize that data pertaining to the informal sector are often less reliable. Beyond informality, as consistent data were not always available across countries, we had to exclude certain sectors from our analysis. Because of inconsistent data availability, across countries we exclude financial services; real estate; education; human health and social work activities; arts and entertainment; public administration and defense; and activities of households and extraterritorial organizations. These sectors play a substantial role, particularly in advanced economies where they contribute 37 percent of value added, on average, ranging from 26 percent in Poland to 43 percent in the United States. As noted, we also exclude agriculture despite its significant contribution to the economy. These exclusions imply that our findings may not be entirely representative of the entire economy and are limited to the narrower “business” economy. Similarly, from a country perspective, we do not cover some major emerging economies, such as China, and regions, such as the Middle East and North Africa, due to limited data availability. We also include only a selected set of advanced economies in our research. As such, we cannot state definitively the degree to which our conclusions are globally representative. While we derive broad and generalized implications for emerging and advanced economies, these are directional only.

In this research, the McKinsey Global Institute (MGI) has aggregated a richly granular data set of MSME productivity across sectors and subsectors for 16 countries with different income levels accounting for more than 50 percent of global GDP. In this group (listed by per capita GDP in 2021 in purchasing power parity terms) are ten advanced economies: the United States, Germany, Australia, the United Kingdom, Italy, Israel, Japan, Spain, Poland, and Portugal; and six emerging economies: Mexico, Brazil, Indonesia, India, Nigeria, and Kenya. 3 Countries classified as “advanced emerging,” “secondary emerging,” or “frontier” by FTSE Russell have been categorized as emerging economies for this research. For more detail, see FTSE equity country classification September 2023 annual announcement , FTSE Russell, September 2023. At the sector level, in the manufacturing sector, for instance, our data cover 24 level-two subsectors and 95 level-three subsectors. 4 Levels of subsectors are defined by the International Standard Industrial Classification of All Economic Activities (ISIC), Revision 4 or equivalent. See International Standard Industrial Classification of All Economic Activities (ISIC), Rev. 4 , United Nations, 2008. This enables us to explore the details of businesses that are highly diverse in size, economic context, degree of formalization, and, especially, the nature of economic activity in which they engage (see sidebar “Definitions, scope, and data limitations”). Most previous external analysis has tended to study MSMEs in a single country or has compared productivity among countries within a particular sector. 5 Beldina Owalla et al., “Mapping SME productivity research: A systematic review of empirical evidence and future research agenda,” Small Business Economics , volume 58, issue 3, March 2022.

This research focuses on the variation in MSME productivity relative to large companies across sectors, subsectors, and countries, enabled by our rich data set. We use this microscopic, but cross-country, lens to spot potential value and identify how MSMEs can work with other companies in specific business contexts to capture it.

1. Small businesses power the economies of today and tomorrow

MSMEs are ubiquitous and play vital economic roles across countries, albeit with important differences depending on whether they operate in an emerging or advanced economy.

MSMEs fuel economy-wide production and jobs

MSMEs create enormous value for economies around the world. They account for roughly half of global GDP. That share varies significantly among economies (Exhibit 1). In Portugal, Israel, Indonesia, Italy, and Kenya (ordered by decreasing share of value added), the share is larger than 60 percent. In the United States, Nigeria, and India, it is less than 40 percent.

Image description:

Two scatterplot charts appear side by side. The first one shows the share of value added in the business sector attributable to micro-, small, and medium-size enterprises (MSMEs) for different countries. MSMEs contribute about half of the value added in emerging economies (an average of 49 percent) and advanced economies (54 percent).

The second scatterplot shows that small businesses contribute about 70 percent of all employment in the business sector, with an average of 77 percent in emerging countries and 66 percent in advanced economies.

End of image description.

They are also significant employers, accounting for roughly 40 percent of all employment and 70 percent of employment in the business sector, which we define as excluding the farm, government, and finance sectors. That share is as high as 96 percent in Kenya, where MSMEs account for half of all employment.

MSMEs create enormous value for economies around the world.

The business sector plays a larger role in advanced economies. But within the business sector, MSMEs have a greater impact in emerging economies, employing four-fifths of all workers, compared with two-thirds in advanced economies.

MSMEs are also meaningful job creators. 6 Fredrik Heyman, Pehr-Johan Norbäck, and Lars Persson, “Who creates jobs and who creates productivity? Small versus large versus young versus old,” Economics Letters , volume 164, March 2018. In advanced economies, one 2013 study suggested, they contributed more than half of net job growth in businesses. 7 Is small still beautiful? , International Labour Organization, April 2013. In the United States, for example, SMEs have accounted for two out of every three jobs added in the past 25 years. 8 Daniel Wilmoth, “Small business job creation,” US Small Business Administration Office of Advocacy, April 2022. In emerging economies, MSMEs created seven out of ten new formal jobs over the past decade. 9 Small and medium enterprises (SMEs) finance: Improving SMEs access to finance and finding innovative solutions to unlock source of capital , World Bank, October 2019.

MSMEs play a crucial role in production across sectors, but their contribution is more significant in some (Exhibit 2). While there are differences among countries, MSMEs tend to contribute the majority of the value added in four sectors—accommodation and food, construction, professional services, and trade. Although they contribute only about 45 percent of value added in the manufacturing sector, they are the second-largest contributor to small business value after the trade sector. Across all sectors, MSMEs also employ at least half of all business workers.

A bar chart shows MSME contributions to value added and to employment in different sectors of the economy. MSMEs tend to contribute most of the value added in four sectors—accommodation and food, construction, professional services, and trade. Although they contribute only about 45 percent of value added in the manufacturing sector, MSMEs are the second-largest contributor to small business value after the trade sector. Across all sectors, MSMEs also employ at least half of all business workers.

MSMEs drive business dynamism

Many MSMEs grow rapidly into large companies, adding to the vibrancy and dynamism of the economies in which they operate. They promote innovation and competition among companies, encouraging all businesses to continually improve their products, services, and processes, which, in turn, can enhance overall economy-wide productivity and dynamism.

Many large companies of today were MSMEs not long ago. About one in five of today’s very large companies—defined as having a market capitalization of more than $10 billion in the United States and equivalent values in other economies—were MSMEs at some point after 2000 and have since powered their way to large company status.

The share of scaled-up companies varies by country, indicating different levels of MSME dynamism (Exhibit 3). Dynamic MSMEs can stimulate competition among businesses, driving the entire system to become more innovative and efficient, ultimately resulting in increased productivity. 10 The productivity puzzle: A closer look at the United States , McKinsey Global Institute, March 2017. Yet overall, rising productivity—crucially, that of large companies—can create new market opportunities and build business capabilities for smaller enterprises, raising the rate of scaling up.

A bar chart compares the share of 2022 scaled-up companies (large public companies that were MSMEs at some point since 2000) in different advanced and emerging economies. About one in five large companies scaled up from being MSMEs since 2000 but there is variation among countries. Australia has the largest share of scaled-up companies in the sample with 44 percent, and Spain has the smallest with 5 percent. Indonesia has the largest share among emerging economies in the sample, with 31 percent.

Unique factors at the country level can contribute to dynamism. In Australia, high dynamism reflects a resources boom that has expanded growth opportunities for small mining companies. Israel, by contrast, has a small economy, but one of the most technologically advanced in the world. 11 Prableen Bajpai, “An overview of Israel’s economy,” Nasdaq, November 2023. Its dynamism is connected to entrepreneurial ecosystems, a high density of skilled professionals, an ability to tap into global networks, and large-scale lending to MSMEs. 12 Colin Mason and Ross Brown, Entrepreneurial ecosystems and growth oriented entrepreneurship , OECD LEED Programme, November 2013; and Jonathan Friedrich, Amit Noam, and Elie Ofek, “Right up the middle: How Israeli firms go global,” Harvard Business Review , May 2014. Over the past decade, growth in bank credit to SMEs in Israel was higher than to large businesses, at 61 percent versus 16 percent. 13 “Israel,” in Financing SMEs and entrepreneurs 2022: An OECD scoreboard , OECD, March 2022. In India, only about 10 percent of large companies in 2022 were MSMEs at some point after 2000. Indeed, previous MGI research found that India has a “missing middle” of mid-size companies. 14 India’s turning point: An economic agenda to spur growth and jobs , McKinsey Global Institute, August 2020. MSMEs have faced structural barriers, such as the high cost of compliance and finance, that have tended to constrain their growth.

Researchers have found that high-growth businesses in advanced economies tend to be younger and intangibles heavy. Enterprises that tend to rely on profits rather than external financing to fund their growth are also more likely to scale up. 15 Alex Coad and Stjepan Srhoj, “Catching gazelles with a lasso: Big data techniques for the prediction of high-growth firms,” Small Business Economics , volume 55, number 3, October 2020. Our analysis finds that in the information and communications technology (ICT) and mining sectors, one in three enterprises that are large today have grown from being MSMEs in the past two decades (Exhibit 4). These sectors seem to experience a fast pace of innovation and technological disruption as well as higher rates of investment. 16 Felipe Sánchez and Philipp Hartlieb, “Innovation in the mining industry: Technological trends and a case study of the challenges of disruptive innovation,” Mining, Metallurgy & Exploration , volume 37, number 5, October 2020; Critical minerals market review 2023 , International Energy Agency, December 2023; and McKinsey Technology Trends Outlook 2023 , July 2023.

A bar chart shows the share of 2022 scaled-up companies (large public companies that were MSMEs at some point since 2000) in different sectors (mining, information and communications technology (ICT), construction, utilities, manufacturing, trade, and transportation). A set of bars shows the numbers for advanced economies, and another set shows them for emerging economies. Mining and ICT companies scaled up more overall, representing more than 30 percent of all large companies in advanced economies. Construction, utilities, and transportation MSMEs were more dynamic in emerging economies.

MSMEs in the emerging economies in our sample seem to exhibit greater dynamism than in advanced economies in core sectors like construction, utilities, and transportation. Investment in physical infrastructure tends to rise faster in countries that are in the earlier stages of their development. Where such sector growth opportunities have been captured, we see greater business dynamism.

Some emerging economies have powered national growth through the manufacturing and trade sectors as well. In a similar analysis of companies founded after 1950, in China—not included in our sample, as noted—the dynamism of the manufacturing and trade sectors is higher than in the advanced economies on average.

MSMEs can boost national productivity while staying small or by fueling larger companies

In emerging economies, the MSMEs that are so vital to sustaining livelihoods are heavily skewed toward microenterprises. In India, Kenya, and Nigeria, microenterprises employ more than 90 percent of MSME workers, of whom some 90 percent are self-employed own-account workers and contributing family members. They face challenges of particularly low productivity. 17 The low productivity challenges of microenterprises in emerging economies could be linked to informality. According to the World Bank, almost 80 percent of all MSMEs in emerging economies are informal. These businesses typically have limited access to markets, finance, and government support, restricting their productivity. We estimate that informal employment in our sample emerging economies is only one-quarter to one-fifth as productive as formal employment. See Micro-, small and medium-sized enterprises (MSMEs) and their role in achieving the Sustainable Development Goals , United Nations Department of Economic and Social Affairs, 2020; and Guillermo E. Perry et al., Informality: Exit and exclusion , World Bank, 2007.

In emerging economies, the MSMEs that are so vital to sustaining livelihoods are heavily skewed toward microenterprises.

As these emerging economies climb the income ladder, microenterprises may grow their revenue and productivity, but most tend to stay small or medium size. 18 For instance, over the past two decades, as Brazil transitioned from being a lower-middle-income to an upper-middle-income economy, about nine percentage points of tiny microenterprises (with fewer than five employees) advanced into larger micro- and small enterprises (with five to 30 employees), but there was no net movement into higher size categories from 2002 to 2021. As a result, MSMEs as a group continue to contribute larger shares to national output, and in that sense, MSMEs directly lift aggregate productivity growth.

In richer economies, the dynamic is different. Much of employment has shifted away from microenterprises to small and medium-size companies or even to larger ones. Only about half of all MSME workers are employed in microenterprises. As these advanced economies climb the income ladder, beyond a certain point more MSMEs tend to scale up into larger companies, are taken over and merged into them, or simply exit in the process known as creative destruction. As a result, the contribution of large businesses to the national output of the richest economies rises, relative to that of small companies. As such, MSMEs may not increase their share of economies, but they still contribute to business dynamism.

2. Boosting MSME productivity could yield significant value

Despite their central role in economies across the world, MSMEs are only about half as productive as large companies, and narrowing that gap could create significant value. Yet somewhat unexpectedly, this gap is by no means monolithic: relative productivity performance varies enormously across countries and sectors, and even within the same sector among countries.

MSME productivity lags behind that of large companies

The MSME productivity gap—defined as the distance between MSME productivity and that of large companies—varies among countries. For example, in Kenya, MSMEs are just 6 percent as productive as large companies, translating to a hefty 94 percent productivity gap. Among the countries we investigate, MSMEs are relatively most productive in the United Kingdom, at 84 percent of the levels of large companies, translating to a productivity gap of only 16 percent (Exhibit 5). In general, the productivity gap is larger in emerging economies than advanced ones.

A bar chart compares the productivity of small companies (MSMEs) with that of large companies in different countries. The countries are divided into two groups: emerging economies and advanced economies. MSME productivity lags behind that of larger firms across all countries in the samples, with a wider gap in emerging economies. On average, MSMEs in emerging economies are 29 percent as productive as large companies. In advanced economies, MSMEs are 60 percent as productive as large firms. Productivity is measured in value added per worker.

As discussed in the previous chapter, within increasing income levels in emerging economies, MSME productivity rises steeply relative to that of large companies, whereas in advanced economies, the productivity of large companies rises noticeably.

The MSME productivity gap—defined as the distance between MSME productivity and that of large companies—varies among countries.

The size of MSMEs certainly plays a role in their productivity relative to that of large companies. Microenterprises trail large companies by a greater margin than do small and medium-size ones (Exhibit 6), and microenterprises account for much more employment in the emerging economies in our sample.

Yet in our sample advanced economies, only about 15 percent of the differences in MSME productivity among countries can be explained by the mix of micro-, small, and medium-size enterprises. The rest of the variation comes from differences in sector mix as well as how MSMEs in each country fare at a subsector level.

A bar chart shows the same metric as in the previous exhibits, comparing the productivity of small companies (MSMEs) with that of large companies in different countries. The countries are divided into emerging economies and advanced economies. In this case, MSMEs are broken down into three categories: micro-, small, and medium-size enterprises. Microenterprises typically have a smaller productivity ratio relative to large companies than other MSMEs, with the United Kingdom being the only exception in the sample. The countries shown are Kenya, Brazil, and Mexico in the emerging economies group, and Portugal, Poland, Israel, Spain, Australia, Italy, Germany, Japan, the United States, and the United Kingdom in the advanced economies group.

Lack of scale matters more to the MSME productivity gap in some sectors than in others

Considering the broad sectors of our sample advanced economies, the MSME productivity ratio, averaged across economies, ranges from 49 percent in ICT to 104 percent in the administrative services sector. In other words, MSMEs in the ICT sector face the largest gap in productivity relative to large companies in ICT, while MSMEs in administrative services tend to outperform their large peers in productivity. Country-level differences within each sector are greatest in mining and utilities, and smallest in manufacturing and ICT (Exhibit 7).

A dot-plot chart compares the ratio of MSME productivity to large company productivity in different sectors for a sample of advanced economies. The economies are Australia, Germany, Israel, Italy, Japan, Poland, Portugal, Spain, the United Kingdom, and the United States. The sectors are administrative services, accommodation and food services, utilities, trade, transportation, construction, professional services, mining, manufacturing, ICT, and other services. The MSME productivity ratio varies among and within sectors and among countries, but less so in manufacturing and ICT. The only sector where the MSMEs are more productive than large companies for the median of all countries in the sample is administrative services. MSMEs in the ICT sector are the least productive on average when compared to large companies.

Larger scale is generally associated with higher productivity. Yet being small has its advantages, too. Small businesses can be a vehicle for individuals to channel their entrepreneurial ambitions as well as for people who simply own and run a business for a living. 19 Sander Wennekers and Roy Thurik, “Linking entrepreneurship and economic growth,” Small Business Economics , volume 13, August 1999. They shape our social fabric and day-to-day life in important ways and are trusted by citizens. In the United States, for example, MSMEs are considered the most trusted institutions by the general public, more even than the military or the police. 20 Lydia Saad, Historically low faith in U.S. institutions continues , Gallup, July 2023. While small businesses do not have as much time and resources to innovate as large companies, their relative advantage comes from being closer to customers, being less bureaucratic, and reacting nimbly to changing market dynamics. 21 Robert W. Vossen, “Relative strengths and weaknesses of small firms in innovation,” International Small Business Journal , volume 15, issue 3, December 2012; Ming-Jer Chen and Donald C. Hambrick, “Speed, stealth, and selective attack: How small firms differ from large firms in competitive behaviour,” Academy of Management Journal , volume 38, number 2, April 1995. They are able to effectively mobilize local labor and offer flexible work arrangements.

Small businesses also play a crucial role in enabling the productivity of large companies, which tend to focus on core competencies and outsource less essential activities to other businesses, a phenomenon called work fissuring. 22 David Weil, “Understanding the present and future of work in the fissured workplace context,” RSF: The Russell Sage Foundation Journal of the Social Sciences , December 2019. This results in greater concentration of higher-value-added activities in large companies, with smaller businesses taking on lower-value work. Similarly, in many advanced economies, as waves of labor-intensive manufacturing moved to countries with low labor costs—often to MSMEs in those countries—higher-value work remained with larger enterprises.

Moreover, being engaged in higher-value work enables large businesses to build three types of competencies: intangible capital, which comprises both better technology and superior human capital; global connections; and financial capital. Consequently, the MSME productivity ratio tends to be lower, and the productivity gap wider, in sectors where these competencies play a significant role in driving business competitiveness (Exhibit 8).

Three scatterplot charts are used to show that the ratio of MSME productivity to large company productivity is smaller in sectors where three competencies play a significant role in driving business competitiveness: intangible capital, global connections, and financial capital. The first scatterplot shows that the ratio is smaller in intangibles-heavy sectors such as ICT, manufacturing, and professional services. The second scatterplot shows that the ratio is smaller in export-intensive sectors such as manufacturing and mining. The third scatterplot shows that the ratio is smaller in sectors that rely more on traditional financing such as bank loans to secure working capital; for example, manufacturing and transportation.

Intangible capital. In sectors like ICT, manufacturing, and professional services, intangibles drive a larger share of value added and MSMEs have a wider productivity gap. Manufacturing productivity depends on organizational efficiency, the application of technology, and the effective utilization of capital—areas where scale makes a difference. In the mining sector, large companies have an advantage in undertaking explorations because they can invest effectively in acquiring geological information and in developing specialized know-how. In the ICT and professional services sectors, productivity drivers like automation, connectivity, and access to high-skill talent also become more powerful with scale. According to the World Bank Enterprise Surveys conducted between 2013 and 2022 and the OECD ICT Access and Usage by Businesses database, these are areas where MSMEs struggle. 23 World Bank Enterprise Survey; The OECD model survey on ICT usage by businesses , second revision, OECD, 2015. The share of MSMEs that adopt technologies like customer relationship management systems and artificial intelligence is only half the share of large companies. Large companies are twice as likely to provide formal skilling programs and are more active in monitoring performance and awarding performance bonuses. Large enterprises also contributed to 84 percent of research and development spending in the United States in 2015, spending more than five times as much as small businesses. 24 Gary Anderson and Audrey Kindlon, “Indicators of R&D performance by size of company,” National Science Foundation, 2019.

In sectors where intangibles matter less to competitiveness, the MSME productivity gap tends to be narrower. In such sectors, companies drive productivity through local reach and access to lower-skill labor. Examples are accommodation and food services, administration and support services, trade, and transportation.

Global connections. In sectors like manufacturing and mining where exports drive a larger share of value added, MSMEs have a wider productivity gap with large companies. In trade, however, MSMEs actively participate in cross-border activities, likely driven by commodity brokering in wholesale trade. This translates into a 70 percent share for MSMEs in all trade exports and a higher MSME productivity ratio.

MSMEs are typically less able than larger companies to gain access to global markets and benefit from global procurement. According to the World Bank Enterprise Survey, MSMEs derive just 5.0 percent of their total sales from direct exports, but large enterprises triple that. In emerging economies, on average, MSMEs account for 2.5 percent or less of exports. 25 Trade finance and SMEs: Bridging the gaps in provision , World Trade Organization, 2016. In Indonesia, for instance, only 1.5 percent of small enterprises and 10.0 percent of medium-size enterprises participate in global value chains, compared with more than one-quarter of all large companies. 26 Shujiro Urata, ed., Enhancing SME participation in global value chains: Determinants, challenges, and policy recommendations , Asian Development Bank Institute, March 2021. Moreover, only about one-fifth of purchases of material inputs by MSMEs were of foreign origin, compared with more than one-third for large companies.

Financial capital. Access to finance is the second most cited obstacle for MSMEs in the World Bank Enterprise Survey. In sectors like manufacturing, other services, transportation, construction, and trade, where businesses typically rely more on traditional financing such as bank loans to secure working capital, MSMEs have a wider productivity gap. When the sector as a whole relies less on bank financing—perhaps because it is less necessary, as is the case in ICT—this may create a more level playing field, resulting in relatively smaller productivity gaps.

In addition to these competencies, small businesses may be disproportionately affected by lack of public infrastructure, such as reliable logistics networks, access to basic utilities like uninterrupted power supply, and the availability of 5G. Large businesses often have the ability to establish their operations in areas with robust infrastructure. They also can develop infrastructure themselves, such as investing in power generators and building last-mile connectivity. While this enabler is critical for MSMEs overall, it is difficult to differentiate at the sector level.

Narrowing the productivity gap is equivalent to 5 to 10 percent of GDP

The tremendous variation in MSME productivity ratios across countries indicates potential for improvement. In any given country, overall productivity stands to gain when the ratio of MSME productivity to large company productivity is brought closer to its full potential.

That potential varies by country given different underlying economic conditions. It depends on the industry structure in each business domain, as well as the specific nature of existing bottlenecks to growth, and the extent to which they are addressed to achieve the optimal economic structure. The productivity improvement itself may manifest in various ways. It could stem from some MSMEs increasing their productivity while remaining in their size bracket. Or it could result from a shift in the industry structure in which some small firms transition within the MSME category from micro to small or small to medium, or scale up to become large companies.

Estimating the value of narrowing the productivity gap

To assess the value for each country, we compare the ratio of MSME productivity to large company productivity in the country in each subsector to a benchmark level in the same subsector. We considered three benchmarks—a higher threshold representing the top quartile, a midpoint threshold representing the median, and a lower threshold representing the bottom quartile among all advanced economies. We assumed no change in subsectors in countries that have already achieved the benchmark levels.

As an illustration, the MSME productivity ratio in the manufacturing of food products subsector varies from 46 percent in the United States to 88 percent in the United Kingdom. In addition to the United Kingdom, Israel and Spain are in the top quartile of advanced economies. The value of narrowing the productivity gap in this case is the difference between the actual productivity ratio and the top-quartile threshold of 61 percent.

As MSME productivity improves, the interlinked economics of small and large firms may create feedback loops, altering its overall economic impact. While we recognize that increasing MSME productivity could have multiplier effects on the broader economy, estimating those effects is more challenging. Therefore, we focus only on estimating the first-order effects.

We estimated value only in accommodation and food services, administrative services, construction, ICT, manufacturing, mining, other personal services, professional services, trade, transportation and storage, and utilities. We excluded other sectors, including agriculture, financial services, and real estate, because of inconsistent data that make it difficult to compare across countries. We also excluded self-employed individuals—who are often sustenance workers in emerging economies—in order to be able to compare the remaining MSMEs in emerging economies with those in advanced economies using the same benchmarks. 1 By not considering self-employed workers, who are more prevalent in emerging economies, we establish a lower benchmark for these countries. To be conservative, we chose this approach instead of adjusting the benchmarks for each country based on their per capita GDP.

While meaningful benchmarks would vary based on local conditions, we compare the average ratio of MSME productivity to that of large companies in each country with the top quartile ratio across countries at a subsector level (see sidebar “Estimating the value of narrowing the productivity gap” for an overview of our approach). This exercise is a useful thought experiment to motivate an investigation of the specific drivers of MSME productivity and where to focus.

The gap between the actual productivity ratio and the top quartile level is equivalent to an average of 5 percent of GDP in advanced economies and an average of 10 percent in emerging economies. It ranges from 2 percent in Israel and the United Kingdom to 10 percent in Japan among advanced economies, and from 3 percent in Brazil to 15 percent in Indonesia and Kenya among emerging economies (Exhibit 9). On a per business worker basis, the amount is meaningful, ranging from about $3,000 in Israel to $12,900 in Japan among advanced economies, and from $3,200 in Mexico to $8,800 in Indonesia among emerging economies (all in purchasing power parity terms).

A map is used to locate several countries and indicate their MSME productivity gap with large companies. It measures the difference as a percentage of GDP, between current and top-quartile productivity ratio across subsectors. Narrowing the productivity gap would represent value equivalent to an average of 5 percent of GDP in advanced economies and an average of 10 percent in emerging economies. The potential value ranges from 2 percent in Israel and the United Kingdom to 10 percent in Japan among advanced economies and from 3 percent in Brazil to 15 percent in Indonesia and Kenya among emerging economies.

If we used lower thresholds to set benchmarks, the gap is lower, but still meaningful. For example, comparing the current MSME productivity ratio against the median ratio in each subsector, it is equivalent to 2 percent of GDP in advanced economies on average and 8 percent in emerging economies. Using bottom-quartile benchmarks, it would be about 1 percent of GDP on average in advanced economies and 7 percent in emerging economies.

Among advanced economies, the impact of narrowing the gap is larger in Italy, Japan, Poland, and the United States. In Japan, two-fifths of all MSME value added is in manufacturing and construction where, in many subsectors, MSMEs achieve only the bottom quartile of performance across countries. Similarly, in Italy and Poland, MSMEs in two-fifths of subsectors are in the bottom quartile of performance. In automotive trade, for instance, Poland has the highest productivity gap (73 percent) and Italy the second highest (67 percent) of our sample advanced economies. In the United States, MSMEs in almost half the subsectors are in the bottom quartile of the productivity ratio.

Where the overall gaps are smaller, as in Israel and the United Kingdom, the impact is limited. In these countries, about half the subsectors are already in the top quartile of MSME productivity relative to large companies.

The value is highest in four emerging economies—Kenya, India, Indonesia, and Nigeria—where MSME productivity gaps are the most substantial. In Kenya, the productivity of small businesses is the lowest of all the sample countries, explaining the wide gap. In Indonesia, the productivity of large companies is double that of the figure for other emerging economies, and therefore its MSMEs have further to go.

The sectors that produce the most economic output account for the largest share of GDP from improving their MSME productivity ratios. The three largest are trade, manufacturing, and construction (Exhibit 10). Nevertheless, some sectors in some countries punch above their weight relative to their role in economies. A standout example is ICT, particularly—in order of importance—in India, Nigeria, Brazil, the United Kingdom, Indonesia, and the United States. In these countries, the ICT sector contributes about 8 percent of economic value added on average, but about one-fifth of the value from narrowing the productivity gap. Other examples include transportation and storage in Australia, Kenya, and Israel; administrative services in Portugal, Kenya, and Germany; professional services in Nigeria and India; and accommodation and food services in Germany and the United Kingdom.

A heat map compares the contributions of different sectors of the economy to narrowing productivity gaps for a sample of ten advanced economies and six emerging economies. The heat map is darker for sectors in each county with a large share, with the darkest color indicating a share greater than 30 percent. The lightest color indicates sectors in each country with a share less than 10 percent. Trade, manufacturing, construction, and ICT offer the largest potential, driving more than half the value at stake in most countries.

3. Looking through a microscope to fill the gaps

To move the needle beyond broad-brush solutions, we need to look in detail at variations in relative MSME productivity performance to identify specific opportunities to achieve potential additional value. Consistent with MGI’s micro-to-macro analytical approach, we have looked at MSME productivity through a microscope, homing in on 68 level-two subsectors and 219 level-three subsectors. See the technical appendix for details of each of the 16 countries in our sample.

A granular approach helps prioritize where to act to boost MSME productivity

MSME productivity ratios vary across sectors, but the spread is even wider at the subsector level (Exhibit 11). For instance, in Germany’s sectors, ratios range from 55 percent in manufacturing to about 100 percent in transportation. In subsectors, the range is even wider. The spread is largest in administrative services, where the ratio is about 20 percent in rental and leasing activities and about 120 percent in building services and landscaping activities. There is a wide range in manufacturing, too. Small businesses engaged in the manufacture of tobacco products are only 35 percent as productive as larger counterparts, while those manufacturing basic metals are 85 percent as productive. In transportation, MSMEs engaged in postal and courier activities are less productive than large companies, while in warehousing, they are closely matched.

A dot-plot chart focuses on Germany and compares the ratio of MSME productivity to large company productivity for different subsectors in each of ten broader sectors. The economy sectors are administrative services, accommodation and food services, utilities, trade, transportation, construction, professional services, mining, manufacturing, ICT, and other services. Within German sectors, the ratio of MSME productivity to large company productivity varies significantly, and the spread is even larger at the subsector level. The spread is largest in administrative services, where the ratio is about 20 percent in rental and leasing activities and about 120 percent in building services.

This granular view at the subsector level is important when setting aspirations for, and thinking about ways to boost, MSME productivity. No single country can be considered the north star for all MSME productivity. The truth is that the best-performing MSMEs are found in one country for one type of activity, but in another country for another type of activity.

MSME productivity ratios vary across sectors, but the spread is even wider at the subsector level.

The trade sector illustrates this (Exhibit 12). In automotive trade, Japan’s MSMEs are more vertically integrated with large manufacturers than in many other advanced economies, including the United States (see chapter 5). This enables them to have more efficient logistics that follow just-in-time principles and respond effectively to market fluctuations, making them top-quartile performers. 27 Christina L. Ahmadjian and Joanne E. Oxley, “Vertical relationships, hostages, and supplier performance: Evidence from the Japanese automotive industry,” Journal of Law , Economics & Organization , volume 29, number 3, June 2013. However, in retail and wholesale trade (excluding automotive trade), vertical integration among Japanese MSMEs appears to be weaker, and they fall into the bottom two quartiles of relative performance. In these sectors, the United Kingdom and Germany, respectively, present compelling benchmarks for Japan.

A box-plot chart shows the ratio of MSME productivity to large company productivity for trade subsectors in different advanced economies. The three subsectors shown are automotive trade, retail trade, and wholesale trade. Trade is shown as an example of a larger trend: within subsectors, the productivity ratio varies significantly among countries. For example, Japan’s MSMEs are in the top quartile in automotive trade but lag behind MSMEs in other advanced economies in retail trade and wholesale trade.

Viewing MSMEs at a fine-grained level brings high-value subsectors into sharp focus. Considering manufacturing, for example, in almost all countries eight sizable subsectors (out of 24) account for more than 60 percent of the value from narrowing productivity gaps. 28 The 24 subsectors within the manufacturing sector are manufacturing of food products; beverages; tobacco products; textiles; wearing apparel; leather products; wood products; paper products; recorded media; coke and refined petroleum products; chemical products; pharmaceutical products; rubber and plastics; nonmetallic mineral products; basic metals; fabricated metal products; electronics; electrical equipment; machinery and equipment; automotives; other transport equipment; furniture; repair and installation of machinery and equipment; and other manufacturing, for example, of medical instruments and sports goods. In advanced economies, this ranges between five and 11 subsectors, while in emerging economies, the opportunity is more concentrated in four to eight subsectors.

While the sector overall contributes 18 percent of total value from narrowing productivity gaps in advanced economies and 25 percent in emerging economies, the opportunity is not uniform—the subsectors that offer the largest opportunities differ depending on the country (Exhibit 13). For instance, if we compare Indonesia and Australia, there are important differences. Manufacturing of basic metals, chemicals, rubbers and plastics, and food products are important sources of value in both economies. But in Indonesia, the apparel manufacturing subsector appears to offer meaningful value, whereas in Australia the textiles subsector is a sizable opportunity. For Indonesia, electrical equipment and automotive manufacturing would be higher priorities, but in Australia the comparable subsectors would be machinery and equipment, and fabricated metal.

A stacked bar chart shows the contributions of different subsectors from narrowing productivity gaps in the manufacturing sector for ten advanced economies and six emerging economies. To measure the value of narrowing productivity gaps for each country, we assume that the productivity ratio of MSMEs in the country in each subsector reaches a benchmark level (top quartile among all advanced economies) in the same subsector. The takeaway is that the subsectors that offer the largest opportunities vary significantly by country.

Looking through the microscope also helps to tailor efforts to build MSME competencies

The importance of scale for productivity and the hurdles that stand in the way of MSMEs gaining that scale are well recognized. So, too, are ways to address this issue, such as building national infrastructure and providing access to markets, finance, and technology. But national-level action is only one aspect of the competencies that MSMEs require to thrive and raise their productivity.

Which competencies matter most can vary depending on the type of MSME. For example, drawing on the World Bank Enterprise Survey, we find that more than one-third of MSMEs in the apparel manufacturing subsector report an “inadequately educated workforce” as their biggest obstacle to operations, but less than 15 percent in chemicals manufacturing do so. Because the business needs and hurdles to creating value are somewhat different in each subsector, solutions need to be tailored to local business and industrial contexts.

Because the business needs and hurdles to creating value are somewhat different in each subsector, solutions need to be tailored to local business and industrial contexts.

Take US construction as an example. This sector has one of the highest potentials for adding value because MSMEs perform poorly on productivity relative to large companies, at 46 percent against the top-quartile level of 60 percent in Germany. Large companies in the building construction subsector tend to concentrate on residential and nonresidential construction projects that typically involve larger projects, greater standardization, modular construction methods, and advanced technology and equipment—all of which help to boost productivity. However, MSMEs in the building construction subsector tend to focus on small-scale residential construction and refurbishments. They are subject to comprehensive building codes, regulations, and standards governed by local and state laws—factors that make it challenging for MSMEs to achieve higher productivity. This degree of stratification is not present in all countries in this sector. In the United Kingdom, for example, construction MSMEs receive incentives to participate in projects similar to those undertaken by large companies and are much more productive, relative to large companies, than their counterparts in the United States. Residential construction MSMEs in the United States could potentially diversify by becoming subcontractors to major players, helping them tap into potential additional value.

4. Creating value through networks and interactions

No MSME operates in a vacuum. Its prospects are shaped by its interactions with other companies. These interactions can be mutually beneficial, creating a “win-win” for businesses small and large. When the economic fabric surrounding companies of all sizes enables them to interact productively with one another and grow, the overall economy attains the greatest benefits.

B2B MSMEs tend to be more productive than B2C, suggesting that business interactions matter

Business-to-business (or B2B) companies interact closely with other companies, often larger ones, as part of their supply chains. In five sectors that account for the largest share of GDP from improving their MSME productivity ratio—construction, ICT, manufacturing, trade, and transportation—the productivity gap with large companies is narrower for B2B MSMEs than it is for business-to-customer (B2C) MSMEs that sell primarily to individuals. In fact, the gap is a significant 40 percent narrower on average (Exhibit 14). 29 This is the simple average for nine sample countries for which we have data for 219 level-three subsectors: Brazil and Mexico among emerging economies, and Germany, Italy, Poland, Portugal, Spain, the United Kingdom, and the United States among advanced economies.

A bar chart compares the ratio of MSME productivity to large company productivity for two types of MSMEs: business-to-business (B2B) MSMEs and business-to-consumer (B2C) MSMEs. The types are compared across five sectors: transportation, ICT, manufacturing, construction, and trade. The conclusion is that B2B MSMEs have smaller productivity gaps relative to large companies than B2C MSMEs. The difference is most pronounced in the transportation sector.

The superior performance of B2B MSMEs can be attributed to both a selection bias, because business customers have higher expectations of their providers, and the fact that these MSMEs can benefit from lessons learned in the course of working with larger enterprises. Other research has also noted how large companies have an incentive to help the smaller businesses they work with to become more productive. 30 Sangeeta Bharadwaj Badal, “How large corporations can spur small-business growth,” Gallup Business Journal , January 2013. There can, of course, be situations in which large companies take advantage of MSMEs, leading to less equitable division of benefits. 31 Dougal Jamieson et al., Large businesses and SMEs: Exploring how SMEs interact with large businesses , ORC International, July 2012.

The difference in productivity gaps between B2B and B2C MSMEs is particularly pronounced in the transportation and storage sector, where the productivity ratio of B2B MSMEs that transport commodities (typically via pipelines) is almost double that of B2C MSMEs, which are typically involved in passenger transportation. In the manufacturing sector, B2B MSMEs include manufacturers of iron and steel and of locomotives that, on average, have 60 percent of the productivity of large companies. In comparison, B2C MSMEs in the sector that, for instance, make consumer electronics and jewelry are only 40 percent as productive.

In the trade sector overall, the difference in the productivity gaps of B2B wholesalers and B2C retailers is not large. But in some subsectors, that is not the case. Take the specialized trade subsector where stores sell one type of product rather than a wide variety of products as nonspecialized supermarkets or department stores do. In this subsector, B2B MSMEs are 75 percent as productive as large companies operating in the sector—1.2 times higher than B2C MSMEs, which are only 63 percent as productive. The advantage in terms of absolute productivity is even higher. On average, B2B specialized trade MSMEs are 2.5 times more productive than their B2C counterparts. Interestingly, B2B and B2C MSMEs differ not only on productivity but also on their dynamism. B2B MSMEs are 1.5 times more likely to have scaled up than B2C MSMEs. Twenty percent of large B2B companies were MSMEs two decades ago, against 14 percent of B2Cs.

These gaps between B2B and B2C MSMEs reflect different levels of business competencies to some extent. Our analysis of the World Bank Enterprise Survey indicates that B2B MSMEs have an edge over B2C counterparts on some of the competencies that we discussed earlier, such as the following:

• B2B MSMEs have a technology and innovation edge. B2B MSMEs are 30 percent more likely than B2C MSMEs to have introduced a process innovation in the past three years. International quality certifications are also 60 percent more common in B2Bs than in B2Cs, perhaps because they are often a requirement when doing businesses with large corporations.
• B2B MSMEs invest more in building human capital than their B2C counterparts. B2B MSMEs track performance metrics more often and in more detail than B2C MSMEs. They also provide formal training to 60 percent of their employees, compared with about 35 percent of B2C MSMEs. One micro digital marketing agency in the United Kingdom offers employees a 20 percent “development time” commitment—for every ten hours worked in a week, employees can spend two hours on courses of their choosing.
• B2B MSMEs are more globally connected. B2B MSMEs derive 6 percent of their revenue from direct exports, almost triple the share for B2C MSMEs. B2B e-commerce platforms that facilitate exports of products between small manufacturers and wholesalers or even offshore software services between companies have become increasingly popular. 32 Busting the five biggest B2B e-commerce myths , McKinsey & Company, January 2022. One microenterprise launched in 2000 created a platform to enable a transparent and mutually beneficial system of centralized MSME purchasing across European countries.

Large and small companies perform in tandem, and the right economic fabric can enable both

MSME interactions with other companies matter, but it is arguably a mistake to view those interactions as adversarial, necessitating policies that attempt to create incentives, quotas, or protections that tilt the balance toward either small enterprises or larger ones. 33 The impact of trade policies and agreements on MSMEs’ sustainability , Global Council for the Promotion of International Trade; and “The private sector and the catalytic role of micro, small and medium-sized enterprises,” in Development Co-operation Report 2018: Joining forces to leave no one behind , OECD, 2018. Is this really a zero-sum game? The truth—broadly—is that both MSMEs and large companies can benefit when they are operating within the right economic fabric.

We looked at whether large company productivity moves in tandem with that of smaller businesses in subsectors (Exhibit 15). In accommodation, for instance, the correlation appears strong—the productivity of large and small enterprises moves hand in hand. 34 Of the 68 subsectors analyzed, 46 subsectors showed a correlation of more than 60 percent between large company and MSME productivity, and 56 subsectors showed a correlation of more than 40 percent. In Italy, Mexico, Poland, Spain, and the United States, both large and small companies tend to outperform the average productivity levels of their peers across countries. In Australia, Brazil, Germany, Israel, Portugal, and the United Kingdom, both large and small companies tend to underperform their respective averages.

Four scatterplot charts are used to illustrate that in two-thirds of subsectors, there is a strong correlation between large company and MSME productivity. The accommodation subsector is shown as an example in a scatterplot, and another scatterplot shows the 45 strong-correlation subsectors. In the other one-third of subsectors, the correlation between large company and MSME productivity across countries is weak. The advertising and market research subsector is shown in a scatterplot as an example, and another scatterplot shows all 23 weak-correlation subsectors.

In other subsectors, the correlation is weaker. In advertising and market research, for instance, in Indonesia, Japan, and Nigeria, large companies outperform the average cross-country productivity while small companies underperform, and vice versa in Australia, Germany, Italy, and Spain.

In the vast majority of cases—66 percent, or 45 subsectors—the fortunes of MSMEs and large companies go hand in hand. This interdependent relationship is even more pronounced in manufacturing, where productivity levels of MSMEs and large companies are highly correlated (across countries) in about 80 percent of the 24 subsectors analyzed.

Within each subsector, we categorize countries where both large and small companies perform better than peers as win-win domains. If only one outperforms while the other lags behind, we classify it as either a “large firms outperform” or a “small firms outperform” domain. If both large and small firms lag behind their peers, it is considered a “challenged” domain.

How large is the win-win advantage? In the 45 subsectors where large and small companies are closely intertwined, the overall productivity of the win-win domain is $163,000 (in purchasing power parity terms). That is 1.5 times higher than in the domains where only small businesses or only large businesses outperform. This relationship holds true even for the subsectors in which the correlation is weak.

Other studies corroborate our finding that MSME productivity and large firm productivity are interconnected. One analysis of 26 European countries found that a 1.0 percent rise in MSME productivity is associated with a 0.124 percent increase in the productivity of large firms. While the analysis does not establish a causal relationship, there do appear to be some knowledge spillovers through the sharing of ideas, best practices, and even talent. 35 Andre van Stel, Boris Lokshin, and Nardo de Vries, “The effect of SME productivity increases on large firm productivity in the EU,” KYKLOS , volume 72, number 2, May 2019.

5. Seven examples of win-win domains

Working closely with thriving large companies is one important route to higher MSME productivity, but not the only one. Network effects among small enterprises can help them attain competencies associated with scale. While MSMEs do not have significant market power because they have limited scale, creation of sector-wide infrastructure and boosting interfirm networks and linkages can provide “collective productivity”—the competitive advantage derived from local external economies and joint action—and substitute for direct benefits of scale. 36 Albert Berry, SME competitiveness: The power of networking and subcontracting , Inter-American Development Bank, January 1997.

As countries try to reduce concentration and geopolitical risks, they are aiming to realign their global manufacturing and services footprints, but for this to happen, MSMEs need to raise their productivity game. Without MSMEs getting more productive, it’s hard to imagine a meaningful realignment of global production. Industrial policies that aim to create new manufacturing capabilities also need to focus on MSMEs in those specific ecosystems.

To illustrate examples of how win-win domains have been created in some countries, benefiting both small and large companies, we looked in detail at examples in the largest sectors for MSME value potential (Exhibit 16). Each of these case studies demonstrates how MSMEs have achieved high productivity through network effects.

Six scatterplot charts are used to illustrate seven examples of win-win domains, or domains in which both large companies and MSMEs outperform their counterparts. The examples shown, all in advanced economies, are: in manufacturing, the auto sector in Japan and beverages (wine) in Italy; in trade, wholesale trade in Germany; in construction, examples from both Australia and the United Kingdom; in ICT, software publishing in the United States; and in professional services, R&D in Israel.

In manufacturing, we examine the auto sector in Japan and beverages (wine) in Italy; in trade, the wholesale trade sector in Germany; in construction, examples from both Australia and the United Kingdom; in ICT, US software publishing; and in professional services, Israel’s R&D. Within each of these sectors, both MSMEs and large companies in the highlighted country generally exhibit higher productivity levels compared with their counterparts in other advanced economies. However, this does not necessarily imply that their productivity has increased over time. It is possible that they attained high productivity levels in the past and managed to sustain them over the years.

By looking through the microscope at these examples, a clear message emerges: there is no single path to success, but rather a range of promising possible approaches. A common characteristic of these approaches is their focus on addressing the issue of scale through structural changes, enabling MSMEs to become “collectively large” by creating network efficiencies.

There is no single path to success, but rather a range of promising possible approaches.

1. Japanese auto manufacturing MSMEs benefit from deep integration with large companies

On average, MSMEs in auto manufacturing in Japan have double the productivity of MSMEs in other advanced economies. This is predominantly because medium-size enterprises have close linkages to large companies. Benefits from best practices such as Keiretsu networks and vertical integration trickle down to them. 37 Keiretsu networks are business networks made up of different companies, including manufacturers, supply chain partners, distributors, and sometimes financiers.

With the overall credo of “we are all in this together,” large Japanese OEMs have built deep links with MSMEs, enabling their operational proficiency, and enhancing technological capabilities and access to talent for smaller companies. These deep linkages also extend to financing, with large OEMs often having crossover share investments with their MSME partners. 38 Jeffrey Liker and Thomas Y. Choi, “Building deep supplier relationships,” Harvard Business Review , December 2004.

Toyota is an example of a company that has unusually high integration with its ecosystem partners. Some contractual partnerships with suppliers have lasted for more than 30 years. Toyota has directly involved itself in raising the operational standards of its partners through knowledge transfer, from demand planning and cost reduction to raising management capabilities. In the 2000s, Toyota created three cost-reduction programs for its suppliers, in combination aiming to reduce costs by 60 percent. While many of Toyota’s MSME partners remain reliant on Toyota for more than 70 percent of their revenue, some have developed independently. 39 Stephane Heim, “Capability building and functions of SMEs in business groups: A case study of Toyota’s supply chain,” International Journal of Automotive Technology and Management , volume 13, number 4, October 2013. These MSMEs share some common traits; they often harness their ecosystem partnerships to enhance their technological capabilities and venture into highly specialized production.

2. Italian winemaker MSMEs gain global market access through collective branding and marketing

Italy’s MSME beverage manufacturing sector—particularly its winemakers—is highly fragmented but superproductive. These enterprises are 1.5 times more productive than their counterparts in other advanced economies.

Winemaking typically has some very large players. In the United States, for instance, most wine is made by less than 0.5 percent of makers. But Italy’s wine business is dominated by small, often family-led enterprises. Fragmentation and a plethora of small players are not usually associated with high productivity, but there is a “paradox of scale” in productivity in Italy’s wine business. 40 Mike Veseth, “Italian wine and the paradox of scale: Three case studies,” Wine Economist , July 2023. Why?

Italy has created an environment that delivers small players access to branding and marketing. The “Made in Italy” campaign has championed traditional and local production, with a particular focus on the international market. Italy has more than 500 wines that have Protected Designation of Origin or Protected Geographical Indications certifications. Similar designations have delivered success elsewhere, for instance in the cases of Alphonso mangos and basmati rice in India, and Guadarrama beef in Spain. These are stamps of quality in the eyes of consumers and apply to the 42 percent of Italy’s wine production that is exported, enabling small producers to charge premium prices and obviating the need to produce at scale. Where they are located is a key part of marketing. Layered on top of this is that Italy’s MSME winemakers are highly networked with one another through membership of associations or in cooperatives, giving them collectively a louder voice.

3. Construction MSMEs in the United Kingdom profit from better access to new markets and finance

In the United Kingdom, construction sector productivity has stagnated over time. 41 Productivity in the construction industry , UK: 2021, UK Office for National Statistics, October 2021. But small businesses exhibit higher productivity than those in our other sample countries, as policy interventions in the United Kingdom have boosted their ability to respond to burgeoning demand. UK policy makers simplified procurement processes, reduced bidding costs, and accelerated payment timelines for construction projects, enabling MSMEs to compete with large companies for government contracts on a broadly equal footing. 42 “Big opportunities for small firms: Government set to spend £1 in every £3 with small businesses,” UK Government, August 2015. The government has also, more recently, orchestrated demonstrator projects to showcase modern construction methods and to enable small businesses to learn from one another. 43 Transforming UK construction: Demonstrator projects , Innovation Funding Service, UK Government, 2019.

Although the impact of these enablers on productivity growth is not fully evident yet, they seem to have triggered a wave of creative collaborations among MSMEs. For instance, Cara EPS built a digital platform to bring together specialist retrofitter microenterprises, enabling them collectively to undertake substantial contracts leveraging their distinct expertise. 44 Cara EPS: SME Retrofit Consortia , Constructing Excellence, accessed March 4, 2024. MSMEs need to invest in innovation and technology to compete in the same markets as large companies. For ProBuild360, this involved developing capabilities in modern methods of construction and enlisting similar-sized MSMEs not only as suppliers but also as mentors to assist in the adoption of new techniques and materials. This enabled the company to emerge as a key building partner for social housing authorities. 45 Probuild360 , Constructing Excellence, accessed March 4, 2024.

4. Construction MSMEs in Australia gain from subcontracting for larger companies and access to skilled workers

In specialized construction, particularly in the mining sector, Australia’s large players have higher productivity than those in our other sample countries, and MSMEs the second highest among their peers. This is attributable to collaborations between large and smaller players that have developed partly due to the country’s remoteness and climatic extremes, and partly due to effective public policies that encourage partnerships and facilitate a robust system of mutual cooperation.

MSMEs specialize in niche construction projects that are more often subcontracted than in other countries. Australia has one of the highest shares of public–private partnership construction projects in the world. 46 Linda M English, “Public private partnerships in Australia: An overview of their nature, purpose, incidence and oversight,” UNSW Law Journal , volume 29, number 3, November 2006. The government has reduced red tape, cutting the number of regulatory procedures from 14 to ten and the average time it takes to approve permits from 150 days to 112. 47 Reinventing construction: A route to higher productivity , McKinsey Global Institute, February 2017. Skills building has also been a priority. Construction workers go through rigorous certification and licensing processes and benefit from a national system of vocational education and training, formal apprenticeship programs, and industry-led initiatives, such as Construction Skills Queensland. 48 Construction Skills Queensland funding , TAFE Queensland, accessed March 4, 2024.

5. Germany’s wholesale trade MSMEs benefit from vertical integration with European manufacturers and strong logistics infrastructure

Germany’s MSME wholesalers are 1.3 times more productive than the average among advanced economies in our sample and are more productive even when excluding commodity traders. They are able to tap into global markets through the European single market, which is further bolstered by Germany’s central location, contributing to their productivity. They also benefit from Germany’s industry-wide logistics backbone, which is reinforced by a range of benefits conferred by free trade port zones, including tax reductions for imports and reexports, and simplified customs regulations.

German wholesalers are also among the most innovative in Europe. 49 Bernhard Dachs et al., EU wholesale trade: Analysis of the sector and value chains , European Commission, June 2016. These enterprises gain spillover benefits from being part of a larger ecosystem. They often operate as legally independent affiliates or subsidiaries that are vertically integrated with upstream purchasers for retail supermarkets or distributors for large manufacturers for the entire European Union. 50 Matthias Fauth, Benjamin Jung, and Wilhelm Kohler, “German firms in international trade: Evidence from recent microdata,” Journal of Economics and Statistics , volume 243, number 3–4, June 2023. An example is Coffee Friend, a medium-size wholesaler of coffee makers that mediates transactions for several manufacturers based in Europe. 51 Coffee Friend.

6. US software development MSMEs benefit from the network created by industry giants

In the dynamic US software publishing business, MSMEs are 1.7 times more productive on average than those in the same sector in other advanced economies. MSMEs gain from talent and capital ecosystems seeded by successful large companies. Large companies serve as reputational anchors, delivering market access and branding. A virtuous cycle of robust capital ecosystems and the agglomeration of a strong talent pool have enabled the growth of large businesses and continue to support the growth of MSMEs in this sector.

MSMEs in this sector are highly innovative and internationally minded. Small technology firms have patented more per employee than their large counterparts. 52 Robert D. Atkinson, The National Economic Council gets it wrong on the role of big and small firms in U.S. innovation , Information Technology & Innovation Foundation, July 2023. Tech startups are also often seen as “born global” because they create products and services for a global market. 53 A review of micro, small and medium enterprises in the ICT sector , International Telecommunication Union, 2016. Almost half of all US ICT MSMEs were engaged in international trade as long ago as 2007. 54 Small and medium-sized enterprises: Characteristics and performance , United States International Trade Commission, November 2010.

Large companies in the sector are important clients, frequent buyers, and potential partners, and multiple connections mean that MSMEs are able to leverage a larger pool of resources and experience, including talent and capital.

7. Israel stands out for its ability to connect different stakeholders engaged in scientific R&D

The productivity of MSMEs in Israel’s scientific R&D subsector is almost double that of those in other advanced economies in our sample. 55 The scientific R&D subsector includes basic and applied research, and experimental development on natural sciences, engineering and technology, medical sciences, biotechnology, agricultural sciences, social sciences, and humanities. Israel is a unique economy that ranks high among the world’s economies on the quality of its research organizations. The government has long been committed to promoting innovation and R&D, and has helped forge strong links between companies large and small, academia, and venture capitalists.

The productivity of MSMEs in Israel’s scientific R&D subsector is almost double that of those in other advanced economies in our sample.

The close proximity of businesses, research institutions, and venture capital firms in cities such as Jerusalem and Tel Aviv facilitates collaboration and networking. Universities actively encourage researchers to work on projects with commercial potential. Ties between academia and the private sector are strong, encouraged by the government setting up technology transfer offices to facilitate the process of licensing technologies to industry partners and creating startups based on the research undertaken. These close ties are particularly vital because Israel focuses on highly technical (and highly regulated) innovation, such as biotech, health tech, and pharmaceuticals. The Israeli venture capital industry has also thrived since the 1990s with help from governmental programs such as Yozma, which offered incentives to foreign companies willing to back Israeli startups.

6. Delivering a win-win future

Productivity is a hot-button issue for economies navigating particularly turbulent times. Indeed, accelerating productivity growth may be the only route out of current financial stress, reconfiguring global trade patterns, and shifts in companies’ manufacturing and services footprint to build resilience that delivers rising wealth and robust growth in GDP and incomes. 56 The future of wealth and growth hangs in the balance , McKinsey Global Institute, May 2023.

This research indicates that narrowing the MSME productivity gap with large companies can yield considerable value, and that large companies, policy makers, and MSMEs themselves can contribute to capturing that value by acquiring key competencies.

Improving the productivity of small businesses merits immediate attention. It may be a self-resolving issue—a natural progression as employment shifts to larger enterprises as economies develop. As discussed, this progression can play out in different ways. Some MSMEs may scale into larger companies, others may be acquired by larger enterprises, and some may cease operations and make room for new businesses. Indeed, previous MGI research suggests that high-growth emerging economies tend to be the ones where large companies are allowed to scale rapidly. 57 Outperformers: High-growth emerging economies and the companies that propel them , McKinsey Global Institute, September 2018. However, the extent of this natural progression is limited. Even in the most advanced economies, MSMEs continue to contribute the majority of all workers employed by businesses. Change is also likely to be slow. The clear implication is that, overall, MSMEs will continue to play an important role in the long term, and that acting now to boost their productivity growth can make the difference to economy-wide growth.

But given the enormous variation in productivity performance evident at the subsector level and even among enterprises with different business models, getting the conditions right for raising productivity requires a microscopic view to help prioritize, design, and implement solutions.

Three considerations can help shape stakeholder actions

Even with an abundance of initiatives and examples of efforts that stakeholders can make, understanding how to capture the MSME productivity opportunity is a complex exercise. Opportunities vary a great deal on the ground, and there are few one-size-fits-all solutions. Intentional measures targeted at helping small enterprises may even raise questions about how this might affect the overall productivity of economies. We suggest three considerations for stakeholders as they develop their approaches.

Creating a win-win economic fabric is important

The global business landscape is deeply interconnected. The success or failure of large companies can have ripple effects throughout entire economic ecosystems. As such, stakeholders, including policy makers, regulatory bodies, associations, and large companies need to foster the right enabling conditions for the growth and prosperity of all enterprises. These conditions may require measures that go beyond conventional policies focused on MSMEs, such as facilitating access to credit for MSMEs and encouraging training for MSME employees. In addition to such measures, it may involve strategies to build “collective productivity.”

Strengthening networks and interactions between large and small businesses can yield productivity gains in the win-win domains and in domains where large companies outperform their peers but smaller ones lag behind. Where small businesses outperform while larger ones do not, there would be benefit in enabling those small enterprises to evolve into large ones or merge with them to promote business dynamism. When both large and small companies lag behind their peers, more fundamental steps to improve the economic fabric as a whole may be needed; for instance, investing in physical and digital infrastructure, establishing transparent and fair regulatory frameworks that boost competition, reducing trade barriers, and ensuring equal access to financial capital.

Prioritization can pay off

Stakeholders first need to decide which economic domains to focus on to make MSMEs more productive. Failing to prioritize which opportunities to pursue can lead to a dilution of efforts and place a burden on the often-limited resources at hand. Some countries have selected and supported “national champion” sectors, as has happened with beverage manufacturing in Italy, automotive manufacturing in Japan, and R&D in Israel. Such prioritization requires meticulous identification of the nation’s competitive advantages and a keen eye for demand trends, as well as allocating resources toward innovation, facilitating access to capital, and cultivating supportive networks.

A granular and tailored approach matters

Measures designed to help MSMEs improve their performance tend to be broad, but the granular lens of this research reveals that different subsectors have varied needs. Stakeholders may need to design a menu of measures for each prioritized opportunity. 58 Abdulaziz Albaz, Marco Dondi, Tarek Rida, and Jörg Schubert, “ Unlocking growth in small and medium-size enterprises ,” McKinsey & Company, July 2020. In other words, taking a microscopic approach that reflects the dynamics of each subsector and country and that addresses barriers to productivity and scale in that context is warranted.

All stakeholders can boost MSME competencies through a variety of proven approaches

All stakeholders—policy makers, large companies, and MSMEs themselves—can adopt strategies designed to boost productivity, which may involve structural changes that go beyond traditional approaches. Policy makers can provide access to better infrastructure, while large companies can help MSMEs build scale-related competencies. MSMEs can collaborate with others to achieve network efficiencies.

Policy makers can boost access to technology, new markets, and finance

Supportive policy interventions can create advantages of scale for MSMEs and help overall business dynamism. The following three broad contributions stand out:

• Being intentional in improving technology access and building management skills of businesses. Singapore’s GoBusiness initiative provides financial support for all businesses that adopt technology solutions to improve their business processes, aligned to industry road maps. 59 Productivity solutions grant (PSG) , GoBusiness, Singapore. Governments can also make direct investments in digital infrastructure that help businesses expand their market reach. For example, in India, the Open Network for Digital Commerce aims to build an e-commerce platform, which can particularly assist small retailers reach new consumers because they lack the resources and financial capacity to develop their own platforms. 60 Democratising digital commerce in India: An open network for inclusive, competitive marketplaces , Open Network for Digital Commerce, May 2023. The Help to Grow program in the United Kingdom aims to help small businesses scale up by offering management courses taught by entrepreneurs and industry experts to develop leadership skills and establish business networks. 61 Help to scale-up and grow , Gov.UK, February 2024.
• Opening up access to new markets. One example is Europe’s “Small Business, Big World” initiative, which offers guidance on customs procedures, trade regulations, and market entry requirements in various countries to enable SMEs to expand their export activities. 62 Small business, big world , European Economic and Social Committee, European Union, May 2012. Canada’s CanExport program supports MSMEs in exploring new export opportunities, enabling them to participate in trade shows, conduct market research, and develop marketing materials for the international market. 63 CanExport funding for exporters, innovators, associations and communities , Trade Commissioner Service, Government of Canada, February 2024.
• Boosting financial infrastructure that helps underfinanced MSMEs. An open data framework, for instance, can enable financial institutions to use nontraditional data sources for credit underwriting, targeted at a range of underfinanced companies including MSMEs. An Experian study showed that including utility data allowed 20 percent of “thin-file” credit customers with scant documentation to support their credit application to become “thick-file” customers who have higher loan approval rates. 64 Let there be light: The impact of positive energy-utility reporting on consumers , Experian, 2015. For small businesses, this can increase access to financing, provide greater convenience, and improve product options. 65 Financial data unbound: The value of open data for individuals and institutions , McKinsey Global Institute, June 2021. Financial institutions could also benefit from efficiency improvements, better fraud prediction, and reduced friction and cost of data intermediation. Governments can also help businesses improve their working capital management by improving tax-related infrastructure and systems. In Latin America, countries such as Brazil, Chile, Colombia, and Peru have launched initiatives aimed at radically simplifying business registration and tax payment processes. One reform enabled businesses to formally register in a day. 66 Regis Augusto Ely, Daniel de Abreu Pereira Uhr, and Júlia Gallego Ziero Uhr, “The impact of the individual microentrepreneur program on the Brazilian labor market,” Economic Analysis of Law Review , volume 10, number 2, May–August 2019; and Tu empresa en un día , Chilean Subsecretaría de Economía y Empresas de Menor Tamaño, July 26, 2023.

In addition to these interventions, policy makers can also facilitate the availability of globally consistent yet granular data to enable all stakeholders to take a microscopic approach to understanding and thereby improving the productivity of MSMEs.

Large companies can boost the competencies of MSMEs within their value chains

As discussed earlier in this report, networks and linkages between MSMEs and large companies benefit the growth and performance of both. One study of small businesses in New York found that seven out of ten of them increased their revenue within two years of becoming part of a corporate supplier base. 67 Giving small firms the business , Center for an Urban Future, 2011. A 2023 study of Belgian companies found that when MSMEs started supplying superstar companies for the first time, their productivity increased by about 8 percent after four years. They also achieved an increase in sales to businesses other than the new superstar partner. 68 Mary Amiti et al., FDI and superstar spillovers: Evidence from firm-to-firm transactions , National Bureau of Economic Research, working paper number 31128, October 2023.

But it is not a one-way street. As noted earlier, large companies also appear to benefit when their MSME partners and suppliers are more productive. This could be because large companies often depend on MSMEs in most parts of the value chain, from development to supply, production, service delivery, distribution, and sales and post-sales. For example, a large logistics player works with local delivery partners for last-mile delivery, and a small recruiting agency might help a large company fill key positions. Large companies therefore had an incentive to raise MSME capabilities. The following three ways are pivotal:

• Assisting MSME partners to build digital and R&D capabilities. Unilever’s open innovation platform Foundry connects its different divisions with startups to engage in joint ideation and mentorship opportunities, for instance. 69 Shameen Prashantham, “The two ways for startups and corporations to partner,” Harvard Business Review , January 2019. Google helps small businesses that purchase ad placements from it in gaining a deeper understanding of customer behavior and in improving the utilization and efficiency of ad spaces. 70 Google for Small Businesses. In India, Maruti Suzuki set up a “comprehensive excellence” program for its main MSME suppliers. In 2018–19, 50 percent of the company’s suppliers met the performance standards laid out and reported improved efficiency, more interest from investors, and broader access to procurement and R&D opportunities. 71 Falendra Kumar Sudan, Leveraging the participation of small and medium-sized enterprises in global value chains of the automotive Industry: Insights from Maruti Suzuki India Limited , ADBI working paper number 1167, Asian Development Bank Institute, July 2020. Nestlé’s Nescafe Plan has provided training to small coffee farmers for techniques to increase crop yields. 72 Mark Segal, “Nestle commits over $1 billion to sustainable coffee farming plan,” ESG Today , October 4, 2022.
• Conferring MSME partners with an ability to build workforce capabilities. One example is Apple, which launched a $50 million fund in collaboration with the International Labour Organization and the International Organization for Migration to provide learning and skills development opportunities for the employees of its suppliers. 73 “Apple launches $50 million Supplier Employee Development Fund,” Apple, March 30, 2022. In India, Walmart launched a Supplier Development Program to train and prepare 50,000 small businesses to better integrate into global supply chains. 74 “Walmart empowers MSMEs to accelerate growth and access new markets,” Walmart, December 9, 2019.
• Lending weight to the reputation of MSMEs when requesting finance. For example, DuPont leveraged its relationship with a financial institution to secure working capital credit for its MSME suppliers in rural areas, thereby strengthening its supply chain and increasing sales. 75 Partnerships for small enterprise development , United Nations Industrial Development Organization, 2009. Large financial institutions have a particularly important role in providing affordable credit and better product options to MSMEs. Innovative underwriting approaches that use alternative credit data can help; an Experian survey found that 70 percent of small businesses are willing to furnish additional financial information if it will improve the chances of loan approval or reduce borrowing rates. 76 Stefani Wendel, What is alternative credit data? , Experian, September 2018.

MSMEs can collaborate with one another to achieve network efficiencies

Collaboration among MSMEs can help build their capabilities. In Europe, for instance, 30 to 40 percent of SMEs do not belong to any formal network, but can still forge collaborations. 77 OECD SME and Entrepreneurship Outlook 2023 , OECD, June 2023; and Firouze Pourmand Hilmersson and Mikael Hilmersson, “Networking to accelerate the pace of SME innovations,” Journal of Innovation and Knowledge , volume 6, number 1, January–March 2021. That collaboration can even be at the level of individual MSMEs. Innovative companies cooperate on business activities with other organizations more than those that are not innovative. 78 OECD SME and Entrepreneurship Outlook 2023 , OECD, June 2023. One OECD study of SMEs operating in Association of Southeast Asian Nations economies found that they perform better when they are allied with large enterprises, but also when they strike partnerships with other MSMEs. 79 “Productivity, technology and innovation,” in SME Policy Index: ASEAN 2018: Boosting competitiveness and inclusive growth , OECD, 2018. Japan’s Small and Medium Enterprise Agency has shown that SMEs that have partnered with other small enterprises in order to implement technology solutions in their operations have 76 percent more sales per employee than those that haven’t taken this route. 80 White paper on small and medium enterprises in Japan , National Association of Small and Medium Enterprise Promotion Organizations, 2018. For example, a small sheet-metal processor in Japan wanted to incorporate in-house cloud computing into its operations and partnered with two other enterprises in the same sector, but with different specialties. Together, the three companies built a joint order reception system, which enables them to collaborate on a range of projects with the same clients. All three MSMEs improved the digital and management capabilities of their manufacturing operations. 81 White paper on small and medium enterprises in Japan , National Association of Small and Medium Enterprise Promotion Organizations, 2018.

Broader MSME collaborations at the association or group level can help more small businesses raise productivity through knowledge sharing, mentoring, networking, and online platforms. The SME Finance Forum works with more than 240 active member institutions—financial institutions, technology companies, development finance institutions, and relevant large corporations—to facilitate resources to help MSMEs bridge their financial access gap. 82 SME Finance Forum. The DIGITAL SME Alliance in Europe launched a platform for traditional SMEs to access a catalog of digital solutions ranging from videoconferencing to AI modeling. 83 OECD Digital for SMEs Global Initiative (D4SME), OECD, 2022.

Other companies can also facilitate the creation of such MSME networks. For example, IBM, in collaboration with other Fortune 500 companies, launched a Supplier Connection initiative that connects small suppliers to one another and to large businesses to access new opportunities. 84 Freddie Pierce, “IBM launches new Supplier Connection portal,” Supply Chain Digital , May 17, 2020. SABI, an African digital infrastructure provider, fosters connections between MSME merchants, wholesalers, distributors, and manufacturers. It also provides them with enterprise resource planning tools, B2B commerce interfaces, and financial services, enabling MSMEs to reach new customers, improve their cash flow, and streamline their logistics. 85 Sabi.

Raising productivity is, and always has been, the optimal route to healthier incomes and business resilience. In a world beset by uncertainty amid geopolitical tensions and shifts in manufacturing and services footprints, raising the game of the world’s MSMEs—which are so central to jobs, livelihoods, value creation, and economic growth—is a priority. The potential is large, but efforts to capture it need to be thoughtful and very likely targeted. Only by having a granular understanding of MSME productivity can effective action be taken. That action can create a win-win for all companies, small and large.

This report is the latest publication in MGI’s work on productivity and prosperity. The research was led by Anu Madgavkar , an MGI partner in New Jersey; Marco Piccitto , a senior partner and chairman of the MGI Council; Olivia White , a McKinsey senior partner and a director of MGI in San Francisco; María Jesús Ramirez , a consultant in the Silicon Valley office; Jan Mischke , an MGI partner in Zurich; and Kanmani Chockalingam , an MGI fellow in San Francisco. The report was edited by Janet Bush, an MGI executive editor in London, and the exhibits were designed by Juan M Velasco, a senior data visualization editor based in Washington DC.

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• Small Business

What Is a Small Business? Definition, Characteristics, and Challenges

Katie Miller is a consumer financial services expert. She worked for almost two decades as an executive, leading multi-billion dollar mortgage, credit card, and savings portfolios with operations worldwide and a unique focus on the consumer. Her mortgage expertise was honed post-2008 crisis as she implemented the significant changes resulting from Dodd-Frank required regulations.

Definition of a Small Business

A small business is a company of relatively limited size, as measured by its revenue, number of employees, or both. Often described as the backbone of the U.S. economy , small businesses range from sole proprietorships to partnerships and corporations with multiple owners and sometimes hundreds of workers.

According to the U.S. Small Business Administration (SBA) , there are more than 33 million small businesses in the country today, employing close to 62 million Americans.

Key Takeaways

• Small businesses are generally defined in terms of their revenue or number of employees.
• The criteria for what’s considered small can vary from one industry to another.
• The U.S. Small Business Administration (SBA) sets the revenue and employee limits for specific types of business.
• Qualifying as a small business can make a company eligible for government contracts and other financial benefits.
• Small businesses can structure themselves in a variety of ways for tax and legal purposes, including insulating their owners from financial liability.

Understanding Small Businesses

Small businesses are typically defined by metrics such as their number of employees and their annual revenues.

For simplicity’s sake, the SBA’s Office of Advocacy generally defines one as “an independent business having fewer than 500 employees.” But, as explained in the next section of this article, under the SBA’s official standards, a small business can have as many as 1,500 employees, depending on the industry, and its annual revenue can range as high as $40 million.

Most small businesses, however, are truly small. In 2023, according to SBA data, close to 82% of small businesses in the United States were one-person operations, with no employees aside from the owner.

What Are NAICS Codes?

The federal government established the North American Industry Classification System (NAICS) in 1997. Its purpose, according to the U.S. Census Bureau, was to create a standard that federal statistical agencies could use in “classifying business establishments for the purpose of collecting, analyzing, and publishing statistical data related to the U.S. business economy.”

The NAICS assigns six-digit codes to businesses. The first two digits refer to the sector of the economy in which they operate, the next two to their particular subsector and industry . The remaining digits further narrow the type of business it is, to the point that NAICS codes can be highly specific. For example, an orange grove is a 111310, while an apple orchard is a 111331, and an advertising agency is a 541810, while a public relations agency is a 541820.

The NAICS codes do not differentiate between small and large businesses. For example, both a single-person ad agency and one with thousands of employees and offices all over the world would have the same six-digit number.

However, the Small Business Administration uses the codes and applies its own “size standards,” either in terms of annual receipts or number of employees, to determine what constitutes a small business within a particular field. The SBA defines annual receipts as the company’s total income or gross income plus cost of goods sold (COGS) .

For example, an orange grove qualifies as a small business if it takes in no more than $4 million annually, while an apple orchard can take in up to $4.5 million. An ad agency is small if its revenue is under $25.5 million, while a PR agency can only have revenue of up to $19 million and remain small by definition.

When the SBA divides businesses into small and large by the number of employees, the maximums can vary widely across industries. For example, a fruit and vegetable wholesaler can have no more than 100 employees and be considered small, while an aircraft manufacturer can have as many as 1,500. Generally speaking, 1,500 is about the maximum for any enterprise under current rules.

The SBA size standards are especially important for businesses competing for government programs or contracts, as explained below. The SBA website has a Size Standards Tool that businesses can use to see if they qualify as small under its criteria.

Most small businesses will have a primary NAICS code, but they may also have additional codes if they offer multiple products and services.

Importance of Small Businesses

Small businesses are vital to the U.S. economy. In fact, by its definition, the SBA’s Office of Advocacy says small businesses constitute 99.9% of U.S. businesses overall. Together, they account for 43.5% of the country’s gross domestic product (GDP) and 39.4% of private-sector payrolls.

Small businesses also accounted for 62.7% of net new job creation from 1995 to 2023, the SBA says.

Small Business Resources

Small businesses that qualify are eligible for funding and other forms of assistance through the federal government, state and local governments, and private and nonprofit sources. Among the major ones:

The SBA doesn’t offer loans itself but provides guarantees to approved lenders, making it easier for small businesses to borrow money. SBA loans range from $500 to $5.5 million and can be used for working capital or to finance the purchase of fixed assets, such as machinery. The SBA also has a loan program for exporters.

Small-business grants , which normally do not have to be paid back, are harder to obtain than loans. The SBA doesn’t provide grants for starting or expanding small businesses, but the federal government has several grant programs for specific types of businesses. Two of them are the Small Business Innovation Research (SBIR) program and the Small Business Technology Transfer (STTR) program.

The U.S. Treasury Department, through its State Small Business Credit Initiative, also provides money to states, U.S. territories, and tribal governments, which they can then use to support small businesses in their area.

In addition, some state and local governments and a number of private corporations have their own grant-making initiatives aimed at encouraging small business.

Government Contracting

As the SBA points out, “The U.S. government is the largest customer in the world. It buys all types of products and services—in both large and small quantities—and it’s required by law to consider buying from small businesses.”

To facilitate that, the SBA offers programs to help small businesses compete for federal contracts, some targeting specific types of business owners, such as women, Native Americans, or military veterans. It also administers Small Business Development Centers in every U.S. state and territory, in conjunction with the private sector, educational institutions, and state and local governments. Their goal is to provide resources to current and would-be small business owners.

Types of Small Business Structures

Small businesses can choose to structure themselves in a variety of ways for tax and legal purposes . Here are the common types, listed in relative order of complexity.

Sole Proprietorship

The simplest and most common type of small business, sole proprietorships can have only one owner. The owner doesn’t have to file a separate tax return but reports their business income (or losses) on a Schedule C form attached to their regular 1040 tax return.

Partnership

If two or more people want to own a business together, they can form a partnership. Partnerships come in two basic types: limited partnerships (LPs) and limited liability partnerships (LLPs) .

In a limited partnership, one person serves as the general partner and takes on most of the liability, or risk, for the company, while the other partner or partners have more limited exposure. In a limited liability partnership, all partners have limited liability. In both cases, the income from the business passes through to the owners, who report it on their individual tax returns.

Limited Liability Company

A limited liability company (LLC) can have one or more owners. As with the two types of partnerships, it is set up to reduce the owner’s or owners’ personal liability in the event of a lawsuit or other financial difficulty. LLC income can be reported on either an individual tax return or a business tax return.

Corporation

Corporations can also shield their owners from financial liability resulting from the actions of the business. There are two basic types: S corps and C corps .

S corps can have from one to 100 owners, who report their share of the company’s profits or losses on their individual tax returns. C corps, which are probably what most people think of as a corporation, can have a single owner or many thousands of them, in the form of shareholders. C corps file corporate tax returns, and any dividends they pay out are also taxable on the recipients’ individual tax returns, a situation sometimes referred to as double taxation .

Benefits of a Small Business

Small businesses can benefit their owners in a range of ways. The business is likely to be less bureaucratic than a large company, allowing its owner or owners a greater degree of autonomy. If the business is profitable, its owners also stand to benefit more directly than they would as employees of a larger enterprise.

Owning a business can also entitle a person to a long list of tax deductions for which might not otherwise be eligible. For example, if they work from home and maintain an office there, they may be able to write off a portion of their housing costs.

Challenges Facing Small Businesses

Running a small business isn’t for everyone. Just as owners stand to profit more if the business succeeds, they may suffer more financially if it fails. Many times, they will have put their life savings on the line.

Small businesses can face other challenges based on their size. They may find it harder to raise capital for expansion or other purposes. They may also have more trouble hiring employees in a tight labor market if they’re unable to offer wage and benefit packages that are competitive with their larger counterparts.

However, many small businesses manage to overcome the obstacles. Looking at the pre-COVID years of 1994 to 2000, the SBA reports that an average of 67.7% of new businesses survived at least two years. In other words, about a third of new businesses failed, but two-thirds made it that far. The five-year survival rate for that period was 48.9%.

How Many Employees Does a Small Business Have?

Depending on its industry, a small business can have as few as one employee to as many as 1,500 or so and still meet the U.S. Small Business Administration (SBA) size criteria. According to the most recent SBA figures, among small firms with paid employees (as opposed to sole proprietorships where the owner is the lone employee), the average number was 11.7.

What Are the Most Common Types of Small Businesses?

The most common type of small business by far is a sole proprietorship, with a single owner. Among the least common would be a C corporation, which is far more costly to set up and administer.

What Criteria Define a Small Business?

The SBA defines small businesses based on their revenues and numbers of employees, in accordance with their particular industry. They must also meet these general criteria, reprinted here verbatim:

• Be a for-profit business of any legal structure
• Be independently owned and operated
• Not be nationally dominant in its field
• Be physically located and operate in the U.S. or its territories

Why Are Small Businesses Important to the Economy?

Small businesses are of critical importance to the economy in large measure because of the jobs they provide. According to the latest SBA figures, small businesses employ nearly half of all private-sector workers (46.4%), or close to 62 million people. In addition, small businesses are often seen as more nimble than their larger counterparts, making them a major source of new innovations.

The Bottom Line

Small businesses play a big role in the U.S. economy. While they can be risky for their owners, they also hold the potential for significant financial rewards. In addition, studies have shown that small business owners are often happier in their jobs than people who work for others. A 2023 Pew Research Center study, for example, reported that “Most self-employed workers (62%) say they are extremely or very satisfied with their job, compared with 51% of those who are not self-employed.”

U.S. Small Business Administration, Office of Advocacy. “ Frequently Asked Questions About Small Business 2023 .”

Code of Federal Regulations. “ 13 CFR Part 121—Small Business Size Regulations: § 121.201 What size standards has SBA identified by North American Industry Classification System codes? ”

U.S. Small Business Administration, Office of Advocacy. “ Frequently Asked Questions: March 2023 ,” Page 1.

U.S. Census Bureau. “ North American Industry Classification System .”

Executive Office of the President, Office of Management and Budget, via U.S. Census Bureau. “ North American Industry Classification System: United States, 2022 ,” Pages 18, 25, and 61 (Pages 20, 27, and 63 of PDF).

Executive Office of the President, Office of Management and Budget, via U.S. Census Bureau. “ North American Industry Classification System: United States, 2022 ,” Page 74 (Page 76 of PDF).

U.S. Small Business Administration. “ Size Standards .”

U.S. Small Business Administration. “ Basic Requirements .”

U.S. Small Business Administration. “ Loans .”

U.S. Small Business Administration. “ Grants .”

U.S. Department of the Treasury. “ State Small Business Credit Initiative (SSBCI) .”

U.S. Small Business Administration. “ Contracting Guide .”

U.S. Small Business Administration. “ Grow Your Business .”

U.S. Small Business Administration. “ Office of Small Business Development Centers .”

U.S. Small Business Administration. “ Choose a Business Structure .”

Internal Revenue Service. “ Sole Proprietorships .”

Internal Revenue Service. “ Limited Liability Company (LLC) .”

Internal Revenue Service. “ Forming a Corporation .”

Internal Revenue Service. “ S Corporations .”

Internal Revenue Service. “ Topic No. 509, Business Use of Home .”

U.S. Small Business Administration, Office of Advocacy. “ Frequently Asked Questions: March 2023 ,” Page 3.

U.S. Small Business Administration, Office of Advocacy. “ Frequently Asked Questions: March 2023 ,” Page 4.

Pew Research Center. “ Self-Employed People in the U.S. Are More Likely than Other Workers to Be Highly Satisfied with Their Jobs .”

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A Way Forward for Small Businesses

• Alexander W. Bartik,
• Marianne Bertrand,
• Zoë B. Cullen,
• Edward L. Glaeser,
• Michael Luca,
• Christopher Stanton

In the face of existential uncertainty, you must balance urgency with prudence.

Small businesses with fewer than 500 employees account for 48% of American jobs and 43.5% of GDP, and they are facing an existential threat in the wake of the coronavirus crisis.  To understand the economic impacts on small business, the authors surveyed roughly 5,800 companies nationwide. They found these companies to be cash-strapped, with many having shut down or laid off workers, and uncertain about whether federal assistance will work for them. They offer five recommendations for small businesses navigating an uncertain future: 1) Don’t rush decisions, but do make plans; 2) Get in line for the Paycheck Protection Program now; 3) Understand how your customers’ needs have changed; 4) Do some realistic accounting; and 5) Keep your best employees loyal.

In these difficult times, we’ve made a number of our coronavirus articles free for all readers. To get all of HBR’s content delivered to your inbox, sign up for the Daily Alert newsletter.

It will be years before we fully understand the economic impact of the coronavirus, but one thing is painfully clear right now: Small businesses across the country are facing an existential threat. Businesses with fewer than 500 employees account for 48% of American jobs and 43.5% of GDP . Yet while these smaller firms are an essential part of the U.S. economy, they’re often financially fragile, with little cash on hand or resources to buffer even a minor financial shock. In the throes of the sweeping disruptions caused by the coronavirus, businesses around the country have closed temporarily. Many have ongoing expenses and little or no revenue and face the prospect that they may never reopen.

• Alexander W. Bartik is an assistant professor of economics at the University of Illinois at Urbana Champaign.
• Marianne Bertrand is the Chris P. Dialynas Distinguished Service Professor of Economics at the University of Chicago Booth School of Business, where she is the faculty director of the Rustandy Center for Social Sector Innovation.
• Zoë B. Cullen is an assistant professor of economics at Harvard University, in the Entrepreneurial Management Unit of Harvard Business School.
• Edward L. Glaeser is the Fred and Eleanor Glimp Professor of Economics at Harvard.
• Michael Luca is the Lee J. Styslinger III Associate Professor of Business Administration at Harvard Business School and a coauthor (with Max H. Bazerman) of The Power of Experiments: Decision Making in a Data-Driven World (forthcoming from MIT Press).
• CS Christopher Stanton is the Marvin Bower Associate Professor of Business Administration at Harvard Business School.

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A look at small businesses in the U.S.

Most U.S. adults (86%) say small businesses have a positive effect on the way things are going in the country these days, according to a recent Pew Research Center survey . Small businesses, in fact, receive by far the most positive reviews of any of the nine U.S. institutions we asked about, outranking even the military and churches.

Despite their name, small businesses loom large in the United States. These businesses – defined here as those with 500 employees or fewer – account for 99.9% of U.S. firms, according to the Small Business Administration . While most of these 33 million firms don’t have paid employees, about 6 million of them do . They account for just under half of total private sector employment (46%).

As National Small Business Week approaches, here’s a look at small businesses in the U.S. and public attitudes about them, based on federal data and Center surveys.

Pew Research Center conducted this analysis to provide a glimpse into the state of American small businesses ahead of National Small Business Week .

In this analysis, “small businesses” are defined as employer firms with fewer than 500 workers. The analysis relies primarily on data from several Census Bureau sources: the Annual Business Survey (ABS), the Business Dynamics Statistics (BDS), and the Business Formation Statistics (BFS).

The ABS – conducted annually since 2017 – includes all non-farm U.S. firms with paid employees and receipts of $1,000 or more. Majority business ownership is characterized in the survey as having 51% or more of the stock or equity in the firm. The Census Bureau counts multiracial firm owners under all racial categories they identify with; Hispanic firm owners may be of any race. Read more about the  ABS methodology .

Data on the age of small business comes from the BDS. Data on the annual number of high-propensity business applications in the United States is based on the number of Employer Identification Number applications used for tax purposes and is not seasonally adjusted. Read more about the BFS methodology . Per capita calculations use state-level resident population data from the Census Bureau; estimates are as of July 1, 2023.

This analysis also draws on findings from recent Center surveys. More information on the methodology for these surveys can be found by following the links in the text.

There’s no single way to define a “small business.” Economists sometimes use the size of the establishment or firm, or turn to industry-specific size standards based on average revenue. For this analysis, we’ve used the U.S. Small Business Administration’s broadest definition: employer firms with fewer than 500 workers .

An establishment is a business with one physical location. A firm is a business organization that may have multiple locations (i.e., multiple establishments).

Just how ‘small’ are small businesses ?

Among the roughly 6 million small businesses with employees, 49% have just one to four workers, according to the latest estimates for 2021 from the Census Bureau’s Annual Business Survey (ABS). About a quarter (27%) have between five and 19 employees; 8% have 20 to 99; and just 1% have 100 to 499 workers. The remaining 14% had paid employees at some point during the year, but not during the March 12 pay period, which the ABS uses to determine employment size.

Overall, small businesses employed an estimated 56.4 million workers in 2021 and brought in over $16.2 trillion in revenue, according to ABS data. Perhaps unsurprisingly, small businesses with more employees tend to account for larger shares of overall revenue than those with fewer workers.

Who owns and runs small businesses?

Some small businesses are family-owned, but the vast majority are not. Among small businesses that reported this type of information for 2021, 27% were family-owned and 73% were not.

So-called “mom and pop shops” account for a relatively modest share of small businesses for which information is available. Overall, 10% of small businesses in the U.S. were jointly owned and operated equally by spouses in 2021. Another 11% were jointly owned by spouses but separately operated, with men more likely than women to serve as primary operators.

Franchises aren’t very common among small businesses. Just 5% of small businesses that reported this information were fully or partially operated as franchises in 2021.

In terms of demographics, men own a greater share of small businesses overall. About six-in-ten small businesses (61%) were majority-owned by men in 2021, while 22% were majority-owned by women. Another 14% were owned equally by men and women. (The ABS defines majority ownership as having at least 51% equity in the firm.)

Looking at small businesses where estimates of majority owners’ race and ethnicity are available, most (85%) had majority-White ownership in 2021. Smaller shares were majority-owned by Asian Americans (11%), Hispanic adults (7%), and Black or African American adults (3%). About 1% were estimated to have either American Indian and Alaska Native, or Native Hawaiian and other Pacific Islander majority owners.

Related: A look at Black-owned businesses in the U.S.

Despite owning small shares of these firms overall, many Black and Asian Americans see entrepreneurship as a marker of success, according to Center surveys.

For example, 30% of Asian Americans say owning a business is important to their own view of the American dream, according to a Center survey conducted from July 2022 to January 2023 . And 36% of Black adults say owning a business is important to their personal definition of financial success, with another 22% saying it’s essential , according to a September 2023 survey .

Still, Black and Asian Americans are more likely to place emphasis on other measures asked about in these surveys, such as owning a home, having a good family life and being debt-free, among others.

How old are most small businesses?

Many small businesses have stood the test of time. In 2021, the majority of these firms (59%) had been operational for at least six years, according to the Census Bureau’s Business Dynamics Statistics . This includes 15% that had been in business for more than 25 years.

On the other end of the spectrum, about a third of small businesses (35%) had been running for five years or fewer in 2021, including 9% that had launched in the last year. (The bureau could not determine the age of the remaining 6% of firms.)

How often do new businesses open?

Small businesses have reported financial and staffing challenges in the years following the coronavirus pandemic . But federal data reveals the staying power of entrepreneurship in the U.S.

The number of high-propensity business applications – those that are highly likely to turn into businesses with payrolls – remained relatively stable between 2009 and 2019, according to Census Bureau data . But the number of applications has risen since before the pandemic: There were nearly 1.8 million high-propensity business applications in 2023, up from about 1.3 million in 2019.

On the state level, places with larger populations saw the most high-propensity business applications in 2023. Florida (225,809) topped the list, followed by California (221,571), Texas (151,888), New York (131,206) and Georgia (80,403). But Missouri, Wyoming, Delaware, Florida and Colorado had the most applications per capita that year.

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Rebecca Leppert is a copy editor at Pew Research Center .

Half of Latinas Say Hispanic Women’s Situation Has Improved in the Past Decade and Expect More Gains

A majority of latinas feel pressure to support their families or to succeed at work, majorities of adults see decline of union membership as bad for the u.s. and working people, a look at black-owned businesses in the u.s., from businesses and banks to colleges and churches: americans’ views of u.s. institutions, most popular.

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RESEARCH Scaling to $1 Million: How Small Businesses Fare by Owner Race and Gender

Small businesses rarely scale to $1 million annual revenues, especially those with Black, Hispanic, and/or female owners.

While policymakers often focus on how to scale smaller businesses into larger ones, there is surprisingly little empirical evidence on the process by which these firms scale and grow revenues. Using $1 million annual revenues as a milestone of small business growth, we ask how commonly young firms reach this milestone, how the incidence of this phenomenon varies across industries and owners of different races and genders, and how it relates to firm's initial size. Our findings have implications for understanding small business growth and equitable access to growth opportunities and resources, and suggest opportunities for policymakers in both the public and private sector to address the differential opportunities and barriers to growth these entrepreneurs may face.

Select Findings

• A small share of small businesses reach $1 million in revenues in the first five years, with the likelihood of reaching that milestone showing a direct relationship to revenues in a firm’s first year.
• Black-, Hispanic-, and/or female-owned firms were least likely to earn $1 million in revenue within five years of starting business. Industry of operation and lower levels of revenue in the initial year help to explain those differences, though some persist.

View the Text Version View Infographic Version

Scaling to $1 Million: How Small Businesses Fare by Owner Race and Gender

We tracked firm revenues for the first five years of business (or fewer, if they ended their banking relationship prior to completing five years of business.) and recorded initial annual revenues and whether they attained $1 million in revenue in that time span.

This figure has two panels stacked vertically, each of which is a vertical grouped bar chart. The title reads “Incidence of $1 million firms by initial revenues.” In the top panel, subtitled “Owner race,” firms are grouped by initial year revenue and owner race. Initial year revenues are bucketed into five groups: less than $100,000; $100,000-$249,999; $250,000-$499,999; $500,000-$749,999; and $750,000-$999,999. Bars represent the share of firms in the given initial revenue bucket and owner race that attain $1 million in revenues. Across all races, firms with lower initial revenues are less likely to attain $1 million in revenues, but within initial revenue buckets, Black-owned firms are consistently less likely to attain $1 million in revenue than Asian-, Hispanic-, and White-owned firms. Among firms with initial revenues less than $100,000, 2 percent of Asian-owned firms, 0.3 percent of Black-owned firms, 0.7 percent of Hispanic-owned firms, and 1.3 percent of White-owned firms attain $1 million in revenue. Among firms with initial revenues between $750,000 and $999,999, 51 percent of Asian-owned firms, 42 percent of Black-owned firms, 55 percent of Hispanic-owned firms, and 53 percent of White-owned firms reach $1 million in revenue.

In the bottom panel, subtitled “Owner gender,” firms are grouped by initial year revenue and owner gender. Initial year revenues are bucketed into five groups: less than $100,000; $100,000-$249,999; $250,000-$499,999; $500,000-$749,999; and $750,000-$999,999. Bars represent the share of firms in the given initial revenue bucket and owner gender that attain $1 million in revenues. Across both genders, firms with lower initial revenues are less likely to attain $1 million in revenues, but within initial revenue buckets, female-owned firms had consistently lower shares of reaching $1 million. Among firms with initial revenues less than $100,000, 0.6 percent of female-owned firms and 1.4 percent of male-owned firms attain $1 million in revenues. Among firms with initial revenues between $100,000 and $249,999, 2.8 percent of female-owned firms and 4.4 percent of male owned firms reach $1 million in revenue. Among firms with initial revenues between $250,000 and $499,999, 10 percent of female-owned firms and 13 percent of male-owned firms reach $1 million in revenue. Among firms with initial revenues between $500,000 and $749,999, 28 percent of female-owned firms and 31 percent of male-owned firms reach $1 million in revenue. Among firms with initial revenues between $750,000 and $999,999, 52 percent of both female-owned and male-owned firms reach $1 million in revenue. The chart note reads, “Firms with unknown race or gender or no classifiable majority ownership by race or gender are not shown in their respective charts. Source: JPMorgan Chase Institute.”

We thank our research teammate, Laura Wilcox, for her hard work and contribution to this research. We also thank Elizabeth Ellis, Alfonso Zenteno, Annabel Jouard, Stephen Harrington, and Kate Finnerty for their support. We are indebted to our internal partners and colleagues, who support delivery of our agenda in a myriad of ways, and acknowledge their contributions to each and all releases. We would like to acknowledge Jamie Dimon, CEO of JPMorgan Chase & Co., for his vision and leadership in establishing the Institute and enabling the ongoing research agenda. We remain deeply grateful to Tim Berry, Head of Corporate Responsibility, Heather Higginbottom, Head of Research, Policy & Insights, and others across the firm for the resources and support to pioneer a new approach to contribute to global economic analysis and insight.

This material is a product of JPMorgan Chase Institute and is provided to you solely for general information purposes. Unless otherwise specifically stated, any views or opinions expressed herein are solely those of the authors listed and may differ from the views and opinions expressed by J.P. Morgan Securities LLC (JPMS) Research Department or other departments or divisions of JPMorgan Chase & Co. or its affiliates. This material is not a product of the Research Department of JPMS. Information has been obtained from sources believed to be reliable, but JPMorgan Chase & Co. or its affiliates and/or subsidiaries (collectively J.P. Morgan) do not warrant its completeness or accuracy. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. No representation or warranty should be made with regard to any computations, graphs, tables, diagrams or commentary in this material, which is provided for illustration/reference purposes only. The data relied on for this report are based on past transactions and may not be indicative of future results. J.P. Morgan assumes no duty to update any information in this material in the event that such information changes. The opinion herein should not be construed as an individual recommendation for any particular client and is not intended as advice or recommendations of particular securities, financial instruments, or strategies for a particular client. This material does not constitute a solicitation or offer in any jurisdiction where such a solicitation is unlawful.

Wheat,Chris.Chan, Stacey. Tremper,Nicholas. 2024. “Scaling to $1 Million: How Small Businesses Fare by Owner Race and Gender.” JPMorgan Chase Institute https://www.jpmorganchase.com/institute/research/small-business/1-million-annual-revenues-as-a-small-business-milestone

Chris Wheat

Stacey Chan

Inclusive Banking Research Lead

Nicholas Tremper

Senior Research Associate

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What is a US small business? One owner explains

Small businesses are difficult to define – and even more difficult to run – but here’s what I’ve learned as a small business owner

L ast week was National Small Business Week, which went virtually unnoticed by most business owners who were busy working. The Small Business Administration and big brands try so hard to celebrate small businesses with events like these. But what they miss are a few sobering facts.

The number of actual small businesses is much fewer than reported.

According to Pew Research , almost two-thirds of our country’s 33m small businesses have fewer than four employees, with most of them being solely owned and operated.

Yes, the number of startups grew during and in the immediate aftermath of Covid. But these are mostly freelance, side gig or independent “businesses” for workers who need extra money.

Is a side gig a small business? Maybe? To me, a real business is an employer-owned business, one that has paychecks and workmen’s compensation and HR policies. According to the US Census Bureau, there are only about 7m employer-owned companies in the country. That’s a far cry from 33m.

Small businesses still aren’t very diverse.

Black-owned businesses are regularly featured in the TV shows from Queen Sugar to Atlanta and Insecure. Anne Hathaway is the cool entrepreneur running an online fashion business in The Intern. Lorelai Gilmore owns and runs the Dragonfly Inn in Gilmore Girls. Mindy Lahiri starts her own fertility clinic in The Mindy Project. Things are changing but this is not reality.

According to Pew Research, 85% of our nation’s business owners are white and 76% are men. And, according to the Small Business Administration , more than half are over the age of 50.

I speak at many associations and groups representing industries around the country, and when I look out at the audience I have to look pretty hard to find a female or a Black or brown face in the crowd. The numbers are creeping up but there’s still a long, long way to go before we see the kind of the equal representation that we see on TV or on the Small Business Administration’s website.

Most small businesses don’t earn much money.

Do you ever walk by that coffee shop, or that boutique with three pairs of shoes in the window, or the store that just sells cookies and wonder to yourself how many cups of coffee, pairs of shoes or cookies they have to sell to earn enough profit to pay themselves? You’re not wrong to wonder. The fact is that most of these small businesses don’t make much money at all.

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According to research from the financing site Fundera , small businesses with no employees have an average annual revenue of $46,978, the average small business owner makes $71,813 a year, and 86.3% of small business owners make less than $100,000 a year in income. Opening up a retail location requires rent, utilities, insurance and payroll – and that’s even before you start buying the ingredients for coffee or cookies or inventorying shoes.

The business owners who make money are generally the ones that have people, machines and multiple locations that generate a higher volume of revenue which, at a certain margin, can sustain a profitable cashflow above overhead. This requires capital and sweat and time and even then there are no guarantees that a Starbucks won’t open across the street or a slowing economy forces people to reconsider a $5 cookie. Profits are needed to sustain a business, not just sustainable materials.

Finally, no one really knows how “small businesses” are faring.

Not a week goes by for me without getting some survey or research gauging small business “optimism” or “sentiment”, and they’re all in conflict. The National Federation of Independent Businesses says that small business confidence is the lowest it’s been since 2012. The US Chamber of Commerce says that small businesses see a “stable” economic environment. Latino business owners are showing a “growing optimism” according to Verizon . A poll of 500-plus business owners from a marketing firm “paints a picture of cautious optimism and resilience”. The messaging platform Slack says that many small business owners are calling 2024 a “make or break year”. Republicans say small businesses are struggling. Democrats say they’re doing just fine.

Just as opinions differ for the economy and the weather, no one really knows how small businesses in this country are doing. And you can’t blame them – we live in a big country. A roofing company can be crushing it in Texas yet a similar company can be struggling in Wisconsin. A tech company may be facing cashflow issues where an energy company is flush. You can’t just generalize.

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How to Start a Small Business in 10 Steps

Learn how to start a small business from scratch with expert guidance. Get essential tips and steps for launching your dream journey successfully.

Brett Grossfeld

Share article.

Do you have a killer idea that you think would be perfect for launching a small business? If you believe what you see on TikTok, becoming an entrepreneur is just about as easy as posting a 30-second video. But in the real world, launching a small business can be a bit more challenging.

Starting a small business may seem daunting, but if you ask those same business owners if it’s worth the risk — few would trade the opportunity to shape their own destiny.

But where to start? Thankfully, you don’t need to have everything figured out before going out on your own. Successful small business owners are constantly learning from their mistakes — and improving their ideas and dreams along the way.

If you’re ready to take the leap and become a small business owner, keep reading.

Here’s what you’ll learn:

What is a small business, how much does it cost to start a small business, how to start a small business in 10 steps, what do you need to start a small business, start small — but think big.

Small businesses are generally defined by the U.S. Small Business Administration (SBA) as independent operations having fewer than 200 employees. And the majority of small businesses in the United States have fewer than five employees, according to the U.S. Census Bureau . 

But the number — or lack — of employees doesn’t necessarily define a “small business.” A business’s size can also be determined by the number of sales, the range of individual business locations, and other factors.

Along with size requirements, the SBA considers a company to be small if it’s:

• Independently owned and operated
• Not dominant in its field
• Physically located and operated in the U.S. (or a U.S. territory)

If your company meets the SBA’s definition of a small business, many government programs offer resources and local assistance for you to turn your dreams into reality.

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If you’re skilled in a certain trade — say, bookkeeping — you can launch a business with almost no money . But if your idea needs to be fleshed out and developed by researchers, scientists, and engineers, your startup costs can run into the hundreds of thousands of dollars and beyond. But most startup costs fall somewhere in the middle. 

Factors that influence cost

A sole proprietor working from home is going to have very different startup costs than a Silicon Valley startup flush with venture capital funds. But it doesn’t matter if you have $1,000 or $1 million to launch your small business — you’ll need to have a budget.

Are you moving the clutter out of your garage to make room for a desk? Or are you going to hire an architect to remodel a warehouse space in a trendy neighborhood? Obviously, both businesses are going to have wildly different expenses.

Think about your budget and what you can afford to get started. And it’s good to assume that unexpected expenses will pop up along the way — especially in your first year of business.

What kinds of costs to expect

The SBA has a worksheet that will help you calculate typical expenses for a small business, including one-time expenses such as:

• Rent : This includes security deposit, first month’s rent and utilities. If you’re working from home, you can deduct a percentage of your rent or mortgage on your taxes .
• Improvement costs: Anything that you might spend on your physical place of business to make it suitable for work.
• Inventory : If you’re selling a product, you’ll need goods to keep up with customer demand.
• Employees : This includes payroll, payroll taxes, and health insurance.
• Professional services: Accountants, lawyers, and consultants will all need to be paid
• Supplies : Think office supplies, such as paper and pencils, and operating supplies, like computers and printers.
• Marketing: Business cards, stationery, flyers, and advertising all fall under this category.
• Miscellaneous : This includes licenses, permits, legal fees, signage, technology, and accounting software. Everything else — liability insurance, repairs, maintenance, and dues.

The most difficult part of starting a small business is committing to your vision. It’s easier if you break down the process into small, achievable goals. Here are 10 steps that will get you on your way:

1. Do your research

If you don’t do basic market research before you launch your business, you may be down for the count before you even get started. Ask neighbors, friends, and even your barista if they would be interested in your product or service — and ask how much they’d be willing to pay for it. 

Conduct competitor research, local and global searches, and even offer surveys to consumers to see what the need versus want ratio is. 

2. Write a business plan

A business plan is your roadmap; it helps guide you as you start and grow your company. If you need capital to get started, most investors will want to review a business plan before they commit to any financing. 

To organize your ideas, download and fill out a business plan template . A well-written business plan provides clarity, confirms the math, and helps you establish goals so your business has the best chance of success.

3. Choose a business name

Finding the perfect brand name is a vital step in launching a new business. But hiring a professional naming company doesn’t come cheap — it can cost as much as $100,000 , according to Fast Company. 

If that’s outside your budget, there are countless AI-powered business name generators available online, and Fiverr has entrepreneurs who will help brainstorm business names for three figures or less.

4. Decide on your location

Take a look at the taxes, zoning laws, and regulations in your location. You may find that operating your business in a different location could offer financial advantages. Review the fees, costs, and tax benefits of each state to see which location makes the most sense for your business . A strategic move may put you ahead of the game before you even open the doors.

5. Get your finances in order

Startup costs discourage many would-be entrepreneurs, but the reality is that many successful businesses got started with little more than a vision, discipline, and hard work. However, if you really need cash for that newly opened business bank account, here are four ways of getting that money:

• Self-funding: If you have the means, you may use your own earnings to kickstart your business or see out financial counsel to work it into your budget.
• Outside investors: For a stake in your company, relatives or venture capitalists may be willing to invest in your business.
• Small business loans: If you want to keep full ownership of your business, a small business loan may be the way to go.
• Crowdfunding: If you’re feeling creative and confident, try sites such as Kickstarter or GoFundMe to generate capital.

6. Take care of the legal stuff

Register your business in the state where it was formed — and make sure that you’re set up to pay state income and unemployment tax. Review whether your local municipality requires filing for a license or permit to operate your business. 

To satisfy Uncle Sam, apply for an EIN from the IRS . Confirm that no one else is using your business name by contacting your state filing office or online database. Some business structures require using a doing business as (DBA) name, and you may be required to open a business bank account.

7. Develop a marketing plan

Once you have a terrific name for your company locked down, you’ll want to create an online presence for your business. Be consistent on your social media channels , ideally creating accounts on the channels — meeting them online where they are. 

Develop a website that’s intuitive and filled with all the information your customers need. Your marketing may also include advertising campaigns and public relations.

8. Set up your CRM software

To enhance your marketing efforts and grow your small business, try customer relationship management ( CRM) for Small Business . This will be your solution for storing and managing prospect and customer information such as contact information, accounts, leads, and sales opportunities — all in one single source of truth. 

With Salesforce’s Starter Suite , you can start in minutes and easily manage your marketing, sales, and customer service as your business scales.

9. Launch your product or service

Congratulations: You’ve done all the hard work and you’re ready to introduce your product to the world. Make sure to announce your launch on social media — and consider throwing a media-friendly bash to celebrate.

10. Keep your customers happy

When you use CRM software, you can keep track and personalize support for all your customers. And happy customers are good for business — 80% of them say the experience a company provides is just as important as its products or services .

The United States has more than 33 million small businesses, according to the U.S. Chamber of Commerce , and that number represents 99.9% of all U.S. businesses. And most of those small businesses started the same way — with an entrepreneur and an idea. But it takes more than just a dream to launch a small business.

So, where to start?

It’s time to take some notes. First, start outlining your business plan. If you’re stuck, ask yourself these four questions when developing your plan :

• Goals : What do you need to accomplish to achieve your vision?
• Methods : What are the steps you need to follow to get you there?
• Measurements : How will you determine when each objective has been met?
• Obstacles : What could throw you off course along the way?

Once you’ve written a business plan and are feeling confident, you’re ready to establish:

A name for your business

A great business name should succinctly identify your company and its audience. Brainstorm and get feedback from friends, family, and potential customers. And before you fall in love with your new company name, make sure that an established business in your industry isn’t already using that name.

A location for your business

Choosing where to conduct business is one of the most important decisions you can make for your small business. While staying close to home may be your first instinct, a change of venue may prove to be financially advantageous.

A business structure

For tax purposes and protection of personal assets, you need to choose a business structure that offers the right balance of legal protections and benefits. Common business structures include sole proprietorship, partnership, limited liability company (LLC), corporation, and cooperative.

A legal presence

If you want personal liability protection, legal protection, and tax benefits for your company, you’ll need to register your business with state and local governments.

Federal and state tax ID numbers

Your Employer Identification Number (EIN) works like a personal Social Security number, but for your business. You need an EIN to pay state and federal taxes for your company.

Licenses and permits

Whether your business needs to apply — and pay for — licenses and permits depends on your business activities, location, and government rules. Review regulations from city, state, and federal agencies.

A business bank account

Opening up a bank account exclusively for business use will help keep your personal finances separate, making life easier at tax time. There are several banks that will allow you to open a business checking account with a zero balance, but traditionally banks will require an opening deposit of anywhere from $1,000 to $25,000.

Start-up funds

Even if you open a business checking account with a zero balance, you’re going to want to have some funds to cover basic operating expenses. The SBA offers guidance on obtaining funding for your small business, including loans, grants, and investors.

Starting a new business may feel like a gamble, but business insurance will help you cover your bet. The right insurance policy will help protect you against accidents, natural disasters, and lawsuits.

You should also consider:

Customer relationship management

A CRM platform keeps your customer data organized and provides the foundation to build connected customer experiences (that can be made even better through artificial intelligence). Starting with a suite of sales, service, marketing, and commerce tools is easy.

Invoice and billing software

While it is possible to keep track of your financial records on a traditional paper ledger, modern invoice and billing software makes the process much, much easier.

A graphic designer

A well-designed logo can make or break a business. The Nike “swoosh” was created by a graphic design student — and the $35 Nike initially spent paid for itself many times over.

Many small businesses exist with just a presence on social media, but having a professionally designed website adds legitimacy to your business.

Marketing experts

Like graphic design, marketing expenses are costs that many small business owners initially want to avoid. But strategically investing in a marketing campaign can be a boon for a small business that wants to make noise in a crowded marketplace.

A Human Resources department

Once your business grows to a certain size, it’s time to create a human resources (HR) department — or, at least, to hire an HR professional. This professional can focus on things such as labor law compliance, employee recruitment, employee engagement and development, and compensation and benefits management while you manage your business.

An assistant

For most small businesses starting out, hiring an assistant to perform administrative and clerical duties is something of a luxury. If your budget is tight, consider a virtual assistant .

What are some popular small business ideas?

If you have a unique idea for a small business, great. But some of the best small business ideas build on your strengths and experience. What do you love to do? What lights you up when you are helping the community? Do you have a pull to do something more?

What are the odds that my small business will succeed?

Starting a small business is no guarantee of success. Approximately 80% of small businesses survive their first year, according to the Bureau of Labor Statistics. The survival rate decreases to 50% after five years and 30% after 10 years.

What are some Fortune 500 companies that started small?

Not all big companies started with millions of dollars in venture capital. Some of America’s biggest brand names had far more modest beginnings . Apple famously got started in a Silicon Valley garage, while Mattel was building dollhouse furniture from picture frame scraps in its early days.

What are the most business-friendly states?

Before setting up shop in New York or California, consider launching your small business in North Dakota, Indiana, Arkansas, South Dakota, or North Carolina. These states offer the best conditions to start a business , according to Forbes Advisor.

What can I deduct for my small business at tax time?

(Almost) everyone knows that you can deduct entertainment and travel expenses as a small business owner. But you can also deduct software subscriptions, office furniture, and interest on small business loans, according to NerdWallet .

Taking the leap to start your own small business is just the first step on your entrepreneurial path. But you’re in good company. Nearly half of all U.S. employees are employed by a small business — and more than 80% of those small businesses are solo ventures , according to Forbes Advisor. There’s no better time than the present to start turning your dreams into reality.

Want to grow your new small business? Sign up for a Salesforce free trial .

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Brett Grossfeld is a Product Marketing Manager supporting Salesforce's CRM, data, and AI tools. He's written for multiple websites across various industries and interests, including tech, wellness, and modern customer experiences.

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https://www.nist.gov/news-events/news/2024/05/nist-awards-over-12-million-small-businesses-advance-cybersecurity

NIST Awards Over $1.2 Million to Small Businesses to Advance Cybersecurity, Biopharmaceuticals, Semiconductors and More

GAITHERSBURG, Md. — The U.S. Department of Commerce’s National Institute of Standards and Technology (NIST) has awarded more than $1.2 million to 12 small businesses in eight states under the Small Business Innovation Research (SBIR) Program. The awards will fund research and development of new products relating to cybersecurity, quantum computing, health care, semiconductor manufacturing and other critical areas.

The award-winning projects were competitively selected from proposals submitted in response to a call for innovative projects that address technical needs related to NIST’s research areas.

These are all Phase I SBIR awards, which are meant to establish the merit, feasibility and commercial potential of the proposed research and development projects. After completing their Phase I projects, awardees are eligible to apply for Phase II funding of up to $400,000 to continue their efforts. 

2024 Phase I SBIR Awardees

AMAG Consulting LLC (Schenectady, New York) — $100,000 Advanced SEM simulation software for the semiconductor industry — a graphical user interface for software that simulates the interaction of electron beams with solid materials in scanning electron microscopy and that will help solve critical problems in the measurement of very small components in semiconductors and other devices.

Applied Imaging Solutions LLC (Quincy, Massachusetts) — $99,759 Hyperspectral imaging with AI/deep learning for online monitoring of NISTCHO viability and cell culture metabolites in real-time — to advance the safe and efficient adoption of contactless AI/deep learning sensing systems for fine control of bioreactor environments, which is an important need in the fast-growing biopharmaceutical industry.

Calimetrix LLC (Madison, Wisconsin) — $105,284 Multimodality quantitative phantom for magnetic resonance imaging and computed tomography measurements of steatotic liver disease — to develop an imaging test object, or “phantom,” of the human liver, to promote accurate and comparable measurements of liver fat concentration using MRI, CT scans and other methods, with the goal of improving clinical outcomes for patients.

Dapple Security Inc. (Centennial, Colorado) — $100,000 Evaluating biometrics for a cryptographic application — to evaluate the security of a novel authenticator for passwordless login access that uses an innovative combination of biometrics and cryptography.

EMode Photonix LLC (Boulder, Colorado) — $100,000 Quantum waveguide infrared photodetector — a new type of room-temperature photodetector that can be integrated with chip-scale components to enhance the efficiency of gas and chemical detection and make high-precision measurement technologies more accessible and cost-effective.

HighRI Optics Inc. (Oakland, California) — $99,995 Binary pseudo-random array (BPRA) for the enhancement of optical imagers — to demonstrate the feasibility of a product that enhances the performance of high-end imaging systems through the use of accurate calibration and advanced image processing techniques.

Icarus Quantum (Boulder, Colorado) — $100,000 Noise-free excitation of semiconductor quantum dots — a novel method to enhance the efficiency and compactness of quantum dot technologies for generating quantum light, which is crucial in quantum networking and computing.

MyExposome Inc. (Philadelphia, Pennsylvania) — $98,800 Using silicone wristbands as personal monitors of PFAS exposures — to conduct fundamental research needed to enable silicone wristbands that monitor personal exposure to perfluorinated compounds, or PFAS, which have been associated with increased risk of cancer and other health risks.

NUTS Technologies Inc. (Glencoe, Illinois) — $99,990 Easing transitions to new cryptography with structured data folding with transmutations (SDFT) — SDFT provides a framework for efficiently updating encryption algorithms in response to changing threats. This project will extend the SDFT framework to handle NIST’s newly standardized post-quantum cryptography algorithms. 

ObjectSecurity LLC (San Diego, California) — $106,403 Operational Technology Artificial Intelligence — NIST Compliance Tool (OTAI-NCT) — a new tool that streamlines and automates cybersecurity analysis and maps vulnerabilities directly to NIST standards, making it easier for industry to address risks without modifying physical devices.

Tiami LLC (Elk Grove, California) — $100,000 Zero-trust cybersecure cellular vehicle-to-anything (v2x) for autonomous vehicles — a cybersecurity architecture that safeguards real-time data exchange between vehicles and their surroundings with the goal of protecting vehicles from cyberattacks while enhancing road safety.

Universal Schedule and Booking LLC (Harpers Ferry, West Virginia) — $106,500 Home-by-home residential building energy-load profile optimization for rapid decarbonization using scalable and personalized sensor-independent efficiency and emissions guides for households — proof of concept for a machine learning-based tool for energy-efficiency modeling in residential homes that will help homeowners reduce energy consumption and use renewable energy.

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Research: Technology is changing how companies do business

By sarah mangus-sharpe.

A new study from the Cornell SC Johnson College of Business advances understanding of the U.S. production chain evolution amidst technological progress in information technology (IT), shedding light on the complex connections between business IT investments and organizational design. Advances in IT have sparked significant changes in how companies design their production processes. In the paper " Production Chain Organization in the Digital Age: Information Technology Use and Vertical Integration in U.S. Manufacturing ," which published April 30 in Management Science, Chris Forman , the Peter and Stephanie Nolan Professor in the Dyson School of Applied Economics and Management , and his co-author delved into what these changes mean for businesses and consumers.

Forman and Kristina McElheran, assistant professor of strategic management at University of Toronto, analyzed U.S. Census Bureau data of over 5,600 manufacturing plants to see how the production chains of businesses were affected by the internet revolution. Their use of census data allowed them to look inside the relationships among production units within and between companies and how transaction flows changed after companies invested in internet-enabled technology that facilitated coordination between them. The production units of many of the companies in their study concurrently sold to internal and external customers, a mix they refer to as plural selling. They found that the reduction in communication costs enabled by the internet shifted the mix toward more sales outside of the firm, or less vertical integration.

The research highlights the importance of staying ahead of the curve in technology. Companies that embrace digital technologies now are likely to be the ones that thrive in the future. And while there are still many unanswered questions about how these changes will play out, one thing is clear: The relationship between technology and business is only going to become more and more intertwined in the future.

Read the full story on the Cornell SC Johnson College of Business news site, BusinessFeed.

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Research: Technology Is Changing How Companies Do Business

In the fast-paced world of modern business, technology plays a crucial role in shaping how companies operate. One area where this impact is particularly significant is in the organization of production chains—specifically the way goods are made and distributed.

A new study from the Cornell SC Johnson College of Business advances understanding of the U.S. production chain evolution amidst technological progress in information technology (IT), shedding light on the complex connections between business IT investments and organizational design.

Advances in IT have sparked significant changes in how companies design their production processes. In the paper “ Production Chain Organization in the Digital Age: Information Technology Use and Vertical Integration in U.S. Manufacturing ,” which published April 30 in Management Science, Chris Forman, the Peter and Stephanie Nolan Professor in the Dyson School of Applied Economics and Management, and his co-author delved into what these changes mean for businesses and consumers.

In running a manufacturing plant, a key decision is how much of the production process is handled in-house and how much is outsourced to other companies. This decision, known as vertical integration, can have big implications for a business. Advances in information and communication technology, such as those brought about by the internet, shifted the network of production flows for many firms.

Forman and Kristina McElheran, assistant professor of strategic management at University of Toronto, analyzed U.S. Census Bureau data of over 5,600 manufacturing plants to see how the production chains of businesses were affected by the internet revolution. Their use of census data allowed them to look inside the relationships among production units within and between companies and how transaction flows changed after companies invested in internet-enabled technology that facilitated coordination between them. The production units of many of the companies in their study concurrently sold to internal and external customers, a mix they refer to as plural selling. They found that the reduction in communication costs enabled by the internet shifted the mix toward more sales outside of the firm, or less vertical integration.

“The internet has made it cheaper and faster for companies to communicate and share information with each other. This means they can work together more efficiently without the need for as much vertical integration,” said Forman.

While some might worry that relying on external partners could make businesses more vulnerable, the research suggests otherwise. In fact, companies that were already using a plural governance approach before the internet age seem to be the most adaptable to these changes. Production units that were capacity-constrained were also among those that made the most significant changes to transaction flows after new technology investments.

“Technology is continuing to reshape the way companies operate and are organized,” Forman said. “More recently, changes in the use of analytics in companies have been accompanied by changes in organizations, and the same is very likely ongoing with newer investments in artificial intelligence.”

The research highlights the importance of staying ahead of the curve in technology. Companies that embrace digital technologies now are likely to be the ones that thrive in the future. And while there are still many unanswered questions about how these changes will play out, one thing is clear: The relationship between technology and business is only going to become more and more intertwined in the future.

• SC Johnson College