Why serving small business is a smart move (after decades of being a dumb move)


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In 1954, Fortune 500 companies accounted for around 1/3 of GDP in America. By 2000, that share had doubled to 2/3. Hidden in those numbers are the countless family farms that could not withstand the onslaught of Agribusiness and the Mom & Pop shops that closed when Wall Mart came to town.

During those years it was a very dumb move to serve small business. You did better by focussing on either enterprise or consumer – both had a well proven path to success. Small business had the CAC of enterprise with the price point of consumer – OK, I am exaggerating to make a point.

Imagine a world where that cycle reversed. Imagine that small businesses got back the 1/3 of the economy that they lost in the last 50 years.

This may be about to happen. This shift will have dramatic implications for investors, entrepreneurs and employees.

Professor Coase, Please Explain

Ronald Coase won the Nobel Prize for Economics in 1991, but his key work was done in the 1930s.

His main theory, described in his 1937 essay The Nature Of The Firm, is that a company exists because it is cheaper to do transactions within a company than outside the company.

The Internet has resurfaced this theory as a practical consideration.

Coase’s theory about transaction costs was pretty much ignored by business executives because it was only theoretical. Big companies took a bigger chunk of the economy during the last 50 years because they served a very real historical purpose. That purpose was to turn scarcity into abundance by manufacturing mass-produced products and selling them through mass-market distributors to retailers through warehouses and road/rail/air freight logistics. Surrounded as we are today by an abundance of mass produced products, it is hard to remember a time when people were concerned about scarcity of basic things such as food and cars. Big companies solved that problem. Small companies could not solve that problem. The job required economies of scale, vertical integration and large amounts of capital.

Digitization erodes the value of traditional economies of scale and vertical integration. This is what tilts the playing field in favor of small business.

The Internet now enables transactions of all types to be managed more efficiently externally than internally. Start-ups outsource everything that is not the one thing that they have to excel at.

A few brilliant entrepreneurs figured this out early

Scale is not dead. It is just that digital scale based on network effects has replaced analog scale based on purchasing power and vertical integration. Platforms to serve entrepreneurs have done well – think Alibaba, eBay, PayPal, Uber, AirBnB.

What gets Blockchain aficionados excited is the prospect of fully decentralised versions of these platforms with a much lower take (ie more cash for the entrepreneur, lower costs for the consumer). So we are only in the early days of this trend of meeting the needs of small business.

Meet the AirBnB entrepreneur

I dislike the Sharing Economy moniker – it smacks of marketing hype. Uber and AirBnB are not about sharing. Nor do I like the idea that we should regulate them away to protect the incumbents. They do serve a real purpose for entrepreneurs.

One of the pleasures of using AirBnB is talking to the hosts. They are entrepreneurs. Some are mini-hotel entrepreneurs. Most use AirBnB to give them a bit of financial freedom to work on a passion project that may turn into a business or to supplement that business while they get it going.

I am sure the same is true of Uber drivers, I just don’t have enough time on a short cab ride to get to know them.

The reason it is so hard to see the AirBnB host and Uber driver as entrepreneurs is that we look at this through the prism of a very brief period of history in the West.

First the Rest then the West

In the post war era in the West, the economy was dominated by big companies – and their employees who were referred to as consumers once their 9-5 gig was done.  There were very few Entrepreneurs, even though the media hype disguised this statistical reality. Entrepreneurs were much lauded in the media, but only if they later became big companies; Mark Zuckerberg is story that sells pixels, but another restaurant or gift shop is not.

In the Rest of the World (China, India, Africa, Latin America etc) it is a very different story. Most people there are self-employed entrepreneurs. Most of these micro entrepreneurs make less than a minimum wage employee in the West, but in aggregate these billions of micro entrepreneurs is one of the biggest market opportunities around – as long as you don’t try serving them with traditional Western consumer models.

Despite all the talk of the Millennials digital nativeness, the much more critical fact is that Millennials are financially much worse off than their parent’s generation, labouring under student debt loads in a weak job market. This explains the gig economy that Uber and AirBnB serve. However, Uber and AirBnB are only the tools to create some short term cash. For many, there are also platforms such as Alibaba, eBay, PayPal and Skype that let them trade globally as micro multinationals.

The 3 ways that the playing field is getting more level

When small businesses were being crushed by large businesses, from 1950 to 2000, focusing on serving small business would have been Quixotic at best. Now the playing field is getting more level in three key areas:

• Finance.  Real time supply chains are getting rid of the curse of inventory and new low cost financing networks are emerging (tracked by Jessica Ellerm every Wednesday on Daily Fintech).

• IT. Cloud technology with a consumer UX is replacing expensive complex enterprise IT. Innovation is flowing from small business IT to big business IT (a reversal of the historic trend).

• Sales & Marketing. Selling online (via B2B or B2C or B2B2C networks) is replacing those highways and distributors as the key to success.

With this leveling of the playing field, serving small business might be the smartest thing to do. This is especially true if you want to take advantage of the fast growth economies through globalization.

Daily Fintech Advisers provide strategic consulting to organizations with business and investment interests in Fintech. Bernard Lunn is a Fintech thought-leader.

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