SCHOOL OF BUSINESS & ECONOMICS

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1 SCHOOL OF BUSINESS & ECONOMICS School of Business & Economics Working Paper SBE 2010/3 A Longitudinal Analysis of Business Characteristics and Growth Performance of SMEs in UK Assisted Areas Pornsawan Evans, Nick Wilson, Barry Ip and Ali Altanlar School of Business & Economics Swansea University Singleton Park SWANSEA SA2 8PP UK Tel: (International: ) Fax: (International: ) b.a.john@swansea.ac.uk 1

2 A Longitudinal Analysis of Business Characteristics and Growth Performance of SMEs in UK Assisted Areas Pornsawan Evans 1, Nick Wilson 2, Barry Ip 3, Ali Altanlar 4 Abstract This study provides a longitudinal analysis of business performance, financial health and growth potential of SMEs in Wales, a UK region which qualifies for high EU assistance. An extensive database consisting of financial information and non-financial information on over 58,000 firms in Wales was constructed, from which various salient aspects were analysed. The key findings draw attention to the characteristics of Welsh SMEs (small and medium enterprises) in terms of business structure, development, sector composition, technology utilisation, geographic distribution, growth, and insolvency. Specifically, it was discovered that the Welsh economy is distinctly more reliant on SMEs in terms of employment and turnover as compared to SMEs in England and Scotland. Prior to the recession in 2007 and 2008, Welsh SMEs performed with consistent levels of growth, with around 70% of small and medium firms showing positive growth during the 1995 and 2006 period. Of these, 30% were high-growth firms with a growth rate of 20% or more. Among the 23,589 SMEs with sufficient data for the growth monitoring over the 2001 to 2008 period, it was discovered that 47% of these firms appear to possess a high level of growth sustainability during the recession in the UK. Furthermore, as one of the main recipients of EU grants in the UK, Wales has received a considerable amount of financial assistance provided by the European Structural Programmes. This study has formed a basis for further research into the impact of EU financial assistance on the business failures of the UK regions which receive substantial financial support from the government and European Union. Keyword: Regional Economics, Small and medium-sized enterprises, Firm performance, Longitudinal Analysis, Growth performance, Firm growth. JEL Classifications: C4, C5, G32, R0, R1, R5 1 Contact author: School of Business and Economics, Swansea University, Singleton Park, Swansea, SA2 8PP, UK ; Tel: +44 (0) ; Fax: +44 (0) ; p.evans@swansea.ac.uk 2 Contact author: Credit Management Research Centre, Leeds University Business School, Maurice Keyworth Building, Leeds LS2 9JT UK; Tel: +44 (0) ; Fax: +44 (0) ; nw@lubs.leeds.ac.uk 3 Faculty of Applied Design & Engineering, Swansea Metropolitan University, Mount Pleasant, Swansea SA1 6ED,UK; barry.ip@smu.ac.uk 4 Credit Management Research Centre, Leeds University Business School, Maurice Keyworth Building, Leeds LS2 9JT UK; A.Altanlar@lubs.leeds.ac.uk 2

3 Introduction The significant role of small and medium enterprises (SMEs) as a key driver for the economic development and growth of the local economy has been recognized worldwide. Over the past few decades, a large volume of research has been dedicated to examine various aspects of SMEs. Porter (2006) has reported that the health and growth of SMEs are crucial factors for sustaining competitive advantage and economic development at local, regional, and national levels. However, despite there being a large quantity of SMEs within a given economy, only a small percentage of these achieve notable growth. For this reason, SMEs generally take on secondary roles in helping to support the activities of larger, more established firms (Reynolds et al, 1999). Yet among the SMEs able to achieve further growth, these firms are then able to represent a sizeable contribution to the wealth and employment creation within the local (and possibly even national) economy. SMEs which experience growth often enjoy favourable market conditions or are able to take advantage of localised or niche markets, and consequently, it has been acknowledged that growth-oriented SMEs can exert notable influence on the health of the wider economy. However, while many small firms can experience the benefits of local or niche markets to foster growth, sustained success is increasingly determined by the ability of a firm to manage its resources and competencies in response to business and political environmental changes (see Penrose, 1995; O Farrell and Hitchen, 1998; O Gormon, 2000; Packham, 2001). Many studies evaluate SMEs based on strengths, weaknesses, opportunities, and threats (SWOT). One of the key determinants of the opportunities and threats to a business is reported to be the business environment (Barney, 1991; Mintzberg and Quinn, 1996; Thompson, 1999), which Foreman-Peck et al (2006) highlights as being closely linked to government legislation (in particular, taxes and subsidies) and the intensity of competition. On the other hand, a firm s internal resources and methods of operation are usually a strong indicator of any strengths and weaknesses (Foreman-Peck et al, 2006; Porter 1985). Porter (1985) indicates that when favourable conditions exist within a given industry, firms which successfully develop and implement an effective business strategy are also more likely to attain superior performance. More recently, an increasing number of small and medium-sized foreign inward investors have further fuelled the intensity of competition for indigenous SME firms of the same sector in the region. In addition to SWOT analyses, SME performance is also commonly measured according to profitability and/or growth. It is reported that profitability is dependent upon a firm s ability to manage competencies and resources effectively in order to achieve (and sustain) growth and competitive advantage (Porter, 1985; Wernerfelt 1984, 1985, 1995). In a competitive environment, although profits are necessary for a firm s survival in the longterm, it is not the only condition necessary for growth a factor which is often captured by other measures such as turnover or employment rates. In a comprehensive review of the SME literature, Storey (1994) concluded that growth determinants fall into three categories: business strategy, management characteristics, and firm characteristics. These factors are vital for the analysis of SMEs with growth potential, especially as they can 3

4 differ significantly between firms, and determine how a firm utilises resources effectively (Klofsten, 1998). Many previous studies have reported the access in finance as the major cause of business failures among SMEs. To resolve this issue, governments have introduced a number of intervention programmes to provide and/or facilitate the access to finance of smaller businesses so that the SME sector can be further developed to achieve its optimal level. Another popular topic for study on SMEs is the method of financing employed by SMEs. The majority of growth-orientated SMEs typically rely on long-term funding from external financial sources, such as banks, other financial institutions, and venture capitalists (Donkles, 2000; Mason and Harrison, 2000). Research by Petersen and Schulman (1987) reported that bank financing is the most popular choice among UK SMEs since capital raised via venture capitalists usually erodes the power and profits of the original business owners. However, some recent research indicates that UK SMEs have encountered problems in obtaining the necessary finance to support fixed-capital investment and working capital (Tucker and Lean, 2001). And even in cases where businesses manage to secure additional financing, these are usually short-term solutions which limit the ability for SMEs to plan for the longer term (Deakins and Hussain, 1994). Consequently, most SMEs appear to operate with high levels of debt, and exhibit an increased reliance on short-term debt (Holmes and Kent, 1991). In the UK, numerous studies on SMEs are undertaken by various bodies, both government and private organisations, as well as by academics. More recent reports on the SME growths (i.e. Rowlands Report, 2009 and BERR, 2008) demonstrate an increasing evidence of SMEs being highly prioritised by the government in search for growth impetus of the private sector. Most investigations have, however, covered businesses of the whole UK economy. The empirical investigation on SMEs at a regional level is sparse. Main Objectives of the Study In this study, Welsh SMEs are the subject of an empirical investigation on UK regional small and medium enterprises. The unique contribution of the study is based on the observation that most areas in Wales are classified as assisted areas by the EU standard of area classifications for financial assistance. Therefore, firms located in these areas are entitled for financial aids not only from the internal source of the local government but also from the external source via the EU Structural Funds Programmes. The study will commence with a brief summary on the development of SMEs and large enterprises over the past decade in the UK. A comparative study is undertaken to examine how businesses in Wales have performed in relation to other three UK regions: England, Scotland and Northern Ireland. An in-depth, longitudinal analysis of the regional SME characteristics, firm growth as well as business insolvency in the Principality is the main coverage of the investigation. Unlike most previous studies, SMEs are observed at both aggregate and sector levels in 4

5 order to provide greater insight into individual SME sectors in Wales over the past decade. As widely documented, the recent credit crisis and depression in badly affected economies worldwide. Therefore, this study will also seek to examine the performance of Welsh SME businesses and their sustainability, particularly during the recession, and to examine whether businesses in Wales are more severely affected by the recession as compared to those in other UK regions. An investigation on SME growth patterns is additionally carried out to help provide underpinning evidence for the identification of high-growth firms in Wales, an aspect that has received considerable attention from the UK government, at both local and national levels. In summary, the aims of this article are: To provide a brief summary of the development of all UK businesses based on the data from the UK Department of Business, Innovation and Skills (BIS). To provide an analysis of the current scope and dimension of SMEs in Wales and their importance to the Welsh economy. To highlight the development of growth patterns of Welsh SMEs from 1995 to To conduct a sectoral analysis of the composition of current SMEs in Wales, including the comparison and contrast with the SMEs over the past decade. To examine start-up and well-established firms among Welsh SMEs. To highlight the strengths and weaknesses of industry sectors by looking at the concentration of SMEs in each sector across sub-regions and local authorities. To identify the utilisation of technology among the manufacturing SMEs of both active and dissolved companies. To identify the high-growth versus negative-growth firms among SMEs in Wales, as well as their growth sustainability during the recession period. A change in asset formation is used as a measure for growth of SMEs in this study. 5

6 1. General Overview of UK Businesses 1.1 Business Characteristics: Size Bands, Employment, and Turnovers A Brief Overview of UK and Welsh Businesses In 2007, over 4.6 million businesses were operating in the UK private sector, providing jobs for over 22.7 million people and generating turnovers of around 2,795 billion. Almost all UK businesses are in the form of small and medium enterprises (SMEs), whichh account for 99.9% of all businesss units and nearly 60% of the UK workforce, as well as generate 52% of the overall turnover in the UK private sector. In terms of the number of business units, the proportion of SMEs to large enterprises stands at 99.9% to 0.1% (BIS, 2007) ). This proportion is similar across the four UK regions: Wales, England, Scotland, and Northern Ireland. However, the dominance of England as compared to the other three UK regions, in terms of business units (86.8% of all UK SMEs), employment (87.5%), and turnover (89.9%) comes as no real surprise since these findings, among other factors, are in line with population and workforce distribution. More telling differences, however, however, lie in the contributions of SMEs towards regional employment and business turnover within the local economies of each region (see Figure 1). Figure 1 Distribution of SMEs in UK Regions, 2007 In Wales, a total of 194,560 businesses were operating in 2007, providing employment for approximately 737,000 people. Taking the combined turnover of all local business 6

7 units in Wales, as well as parent companies residing either within or outside Wales, these companies generated an overall turnover of around 69.3 billion for the Welsh economy (see Table 2). An examination of the distribution of regional businesses reveals that medium and large enterprises account for merely 0.6% and 0.1% of all businesses in Wales respectively. Although these proportions are identical to those for the UK as a whole, Wales has, in fact, recorded a higher share of small-sized businesses (27.4% as compared to 25.3% for the UK) and a lower share of sole proprietors (71.9% as compared to 74% for the UK) (see Table 1). The distribution of the number of SMEs in Wales is thus largely consistent to the proportions reflected across the UK as well as its constituent regions % UK England Wales Scotland N Ireland SMEs Large SMEs Large SMEs Large Business units Employees Turovers Figure 2 Contribution of SMEs in Each UK Region Unlike other UK regions, SMEs in Wales play a more significant role in the Welsh economy. The contribution of SMEs towards job creation and business turnover for the local economy, in particular, are more significant than in England and Scotland. This is reflected in the figures shown in Table 2 and Figure 2, where SMEs in Wales accounted for 77.3% of employment and 61.7% of business turnover in 2007, as compared to lower percentages of 57.8% and 50.5% (employment and business turnover respectively) in England, and61% and 53.8% in Scotland. These statistics for Wales are also more than 10% above the equivalent figures for the UK as a whole (approximately 17% higher in case of employment, and 10% higher for turnover), signifying the critical role played by SMEs in the Welsh economy. Among the four UK regions, Northern Ireland is found to have the highest level of dependence on SMEs, with the shares of around 80% for both employment and business turnover (see Table 1). 7

8 Table 1 Distribution of UK Businesses by Region, 2007 In row percentage Total None Business units in row % Employment in row % Turnover in row % Size (number of employees) Size (number of employees) Size (number of employees) Total (in 1000) None Total ( million) None UK 4,679, , ,794, England 4,060, , ,513, Wales 194, , Scotland 292, , , N. Ireland 132, , In column percentage Total None Business units in column % Employment in column % Turnover in column % Size (number of employees) Size (number of employees) Size (number of employees) Total (in 1000) None Total ( million) None UK England Wales Scotland N. Ireland Source: BERR Enterprise Directorate Analytical Unit 8

9 Table 2 Distribution of UK Businesses by Region in 2007 Business units Size (number of employees) Total None SMEs Large SMEs % of Total Large % of total UK 4,679,080 3,462,519 1,183,807 28,074 4,679 4,674,400 4, England 4,060,155 3,016,695 1,015,039 24,361 4,060 4,056,095 4, Wales 194, ,889 53,309 1, , Scotland 292, ,847 82,145 2, , N. Ireland 132,040 94,012 36, , Employment (thousands) Total None SMEs Large SMEs % of Total Large % of total UK 22,734 3,774 7,025 2,660 9,275 13,459 9, England 19,895 3,283 5,969 2,248 8,396 11,500 8, Wales Scotland 1, N. Ireland Turnover ( million) Total None SMEs Large SMEs % of Total Large % of total UK 2,794, , , ,050 1,355,422 1,442,057 1,355, England 2,513, , , ,816 1,244,014 1,269,145 1,244, Wales 69,317 6,724 23,914 12,130 26,548 42,768 26, Scotland 160,720 13,340 48,537 24,590 74,092 86,467 74, N. Ireland 51,488 5,612 24,354 10,761 10,761 40,727 10, Source: BERR Enterprise Directorate Analytical Unit 9

10 1.1.2 Distribution of SMEs by Firm Size As of 2007, there were around 194,365 SME units in Wales, with the remaining 195 businesses operating at a large scale (250 employees or more) Table 2. Among the SMEs, the majority were sole traders (70%), followed by small- (27%) and medium-sized (0.6%) businesses. The SME employment accounted for around 77.3% of the regional workforce (or approximately 570,000 people), and generated 42.8 billion, or 61.7% of total turnover, in the Welsh private sector. A further breakdown of SME data, shown in Table 3, reveals that small businesses accounted for the largest shares in both SME employment and SME turnover by some margin, with proportions of 54.2% and 55.9% respectively. These are followed by the contribution from medium-sized businesses which generated nearly one-third of SME turnover (28.4%) despite recording an employment share of only one-fifth (18.1%) in the total SME workforce. Despite having the largest share of over two-thirds of local SME business units (72%), sole traders contributed a relatively small proportion of SME turnover (15.7%) and just over 28.4% of the SME employment. Table 3: Distribution of SMEs for Employment and Business Turnover in Wales Percentage Shares of Businesses in Wales Number of Employees Business units Employment Turnover Sole Traders Small Medium Large Total Businesses SMEs versus Large enterprises SMEs Large Enterprises Percentage Shares Among SMEs in Wales Number of Employees Business units Employment Turnover Sole traders Small Medium Total SMEs in Wales

11 1.1.3 Business Structure Development of SMEs: 1999 versus 2007 The study was initially intended to examine the development of SMEs over the past decade starting from the year 1999 to However, the latest BIS government statistics available at the commencing of this study is merely of the year SME Business Units There has been evident change in SME composition in Wales between 1999 and With a notable decline in the number of large enterprises during this period, the increase in the number of business units from 144,135 in 1999 to 194,560 in 2007 was therefore wholly attributable to the establishment of new SMEs. This increase was accompanied by a significant increase in the number of sole traders (from 63.8% to 71.9%) and a drop of nearly 10% in the share of small businesses (from 35.5% to 27.4%), whilst the shares of medium and large enterprises remain unchanged at 0.6% and 0.1% respectively (see Tables 4 and 6). The number of sole traders and medium-sized businesses had increased by 52.1% and 39.5% respectively from 1999 to 2007, while only a 4.2% growth was recorded for the number of small businesses. Large enterprises experienced the lowest level of growth in terms of business units having registered a 5.9% drop in number of firms (see Table 5) SME Employment A continued increase in employment rates of companies in Wales, from 728,000 workers in 1999 to 737,000 workers in 2007 (see Table 4), was again contributed by SMEs due to the decline in both the number of large enterprises as well as their employment figures. The number of jobs created by SME businesses in Wales had increased by nearly 20%: from 482,000 in 1999 to 570,000 in In terms of job distribution, a 5.9% drop in the number of large enterprises resulted in a 10% decrease in its employment share, from 33.9% in 1999 to 22.3% in 2007 (Table 6). On the contrary, smaller businesses (sole traders, and SMEs) all experienced increased shares in the regional workforce, that is, from 15.2% to 21.4% for sole traders, 39.2% to 41.9% for small businesses, and 11.8% to 14.0% for medium businesses. During this period, the employment by sole traders, small, and medium businesses grew by 42.5%, 8.2% and 20.1% respectively, whilst that for large enterprises fell by 33.4% (see Table 5) SME Turnover The overall turnover of the private sector in Wales grew at a rate of 34.2%, from 51.6 billion in 1999 to 69.3 billion in 2007 (see Tables 4 and 5). For SMEs, however, even higher rates of growth were recorded with a 44.7% increase in turnover, rising from 29.6 billion in 1999 to 42.8 billion in Despite an increase in the nominal amount of turnover across all size bands, small and large enterprises nevertheless appear to have experienced a fall in their turnover shares from 42.8% in 1999 to 38.3% in 2007, while the shares for sole traders and medium-sized businesses increased by modest amounts (see Table 6). 11

12 Table 4 Regional UK Businesses Units, Employment, and Turnover in 1999 and Business Units, N 1999 Business Units, N Total None SMEs (0-250) Total None SMEs (0-250) UK 4,679,080 3,462,519 1,183,807 28,074 4,679 4,674,401 3,676,940 2,324,340 1,321,685 24,185 6,735 3,670,210 England 4,060,155 3,016,695 1,015,039 24,361 4,060 4,056,095 3,214,755 2,040,800 1,147,325 20,680 5,960 3,208,805 Wales 194, ,889 53,309 1, , ,135 91,958 51, ,963 Scotland 292, ,847 82,145 2, , , ,657 92,438 1, ,990 N. Ireland 132,040 94,012 36, ,908 84,620 53,057 30, , Employment, Thousands 1999 Employment, Thousands UK 22,734 3,774 7,025 2,660 9,275 13,459 21,746 2,708 6,849 2,491 9,697 12,048 England 19,895 3,283 5,969 2,248 8,396 11,499 19,117 2,365 5,840 2,139 8,772 10,344 Wales Scotland 1, , N. Ireland Turnover, Millions 1999 Turnover, Millions UK 2,794, , , ,050 1,355,422 1,442,057 1,943,880 91, , , , ,379 England 2,513, , , ,816 1,244,014 1,269,146 1,754,972 79, , , , ,286 Wales 69,317 6,724 23,914 12,130 26,548 42,769 51,657 3,419 19,391 6,745 22,102 29,555 Scotland 160,720 13,340 48,537 24,590 74,092 86, ,448 5,347 35,980 17,387 47,735 58,713 N. Ireland 51,488 5,612 24,354 10,761 10,761 40,727 30,803 2,261 15,050 5,700 7,792 23,011 Source: BERR Enterprise Directorate Analytical Unit 12

13 Table 5 UK Regional Business Growth in 1999 and 2007 Business Unit Growth 1999 versus 2007, % Total None SMEs (0-250) UK England Wales Scotland N. Ireland Employment Growth 1999 versus 2007, % UK England Wales Scotland N. Ireland Turnover Growth 1999 versus 2007, % UK England Wales Scotland N. Ireland Source: BERR Enterprise Directorate Analytical Unit Table 6 Distribution of UK Regional Businesses by Company Size in 1999 and Business Units, % 1999 Business Units, % Total Sole Trader Total Sole Trader UK England Wales Scotland N. Ireland Employment, % Employment, % UK England Wales Scotland N. Ireland Turnover, % Turnover, % UK England Wales Scotland N. Ireland Source: BERR Enterprise Directorate Analytical Unit 13

14 1.1.4 SME Productivity As a consequence of the increasing competition from emerging regions such as Eastern Europe, the Far East, and India, particularly for inward investors who consider labour cost as a determinant factor for their location decisions, Wales has become a relatively less attractive destination for these companies considering continued investment or future expansion. Nevertheless, some businesses have, in fact, placed higher priority on labour productivity than labour costs, as documented in the findings in Evans et al (2008) which investigated the underlying reasons for the continuing operations of foreign direct investments in Wales. In this study, labour productivity is measured by the nominal amount of turnovers per worker. The calculation of average labour productivity was undertaken for each size band from 1999 to The investigation revealed that, in 2007, large enterprises have enjoyed the highest level of labour productivity provided by the Welsh workforce, with an approximate turnover of 161,534 per worker, followed by medium businesses ( 117,763), small businesses ( 77,442) and sole traders ( 42,631). Notably, mediumsized businesses in Wales, in particular, demonstrated higher labour productivity than any other UK region, having a growth rate of around 50% over the 1999 to 2007 period. There were also positive growths in labour productivity of other groups, but small business productivity appeared to have the least increase at 14% as compared to 40% for sole traders (see Table 7). Table 7 UK Business Productivity Growth, 1999 versus Productivity, 1999 Productivity, Total Sole Sole Total Trader Trader UK 122,930 59, , , ,130 89,390 33,738 93, ,788 98,226 England 126,321 59, , , ,173 91,802 33,589 97, ,738 99,827 Wales 94,053 42,631 77, , ,535 70,957 30,897 67,950 78,519 89,556 Scotland 102,369 58,196 93, , ,006 71,634 31,287 68,204 87,972 80,915 N Ireland 96,600 53, , , ,546 74,224 37,069 76,347 83,244 88,144 Productivity growth 1999 versus 2007, % Total Sole Trader UK England Wales Scotland N Ireland Note: Productivity is measured as turnover per worker. The above comparison of SME labour productivity in Wales with other UK regions shows that apart from medium-sized businesses, both sole traders and small businesses in Wales appear to have recorded lower productivity levels than those for the rest of the UK. 14

15 1.1.5 SME Sector Composition In terms of the number of businesses, UK SMEs in 2007 were predominantly led by the Construction (24.5% nearly a quarter of all SMEs), Finance Intermediation, Property and Business Services (19.8%) and Trade and Hotels & Restaurants (17.4%) sectors. In terms of employment, SME businesses created jobs for nearly 60% of the UK private sector workforce. A further breakdown reveals that the combined share of the Finance intermediation, Property and Business Services sector accounts for almost a half of SME employment. Despite Manufacturing SMEs being ranked only fifth in terms of the number of units (with only 6.8% share) their employment share is ranked third amongst UK SMEs, accounting for 14% in the total SME workforce in Britain (see Figures 3 and 4, and Table 8) % 15 Welsh SMEs UK SMEs A, B C, D, E F G, H I J, K M, N, O Figure 3 SME Unit Distribution by Industry Sector, 2007 Wales versus UK % 15.2 Welsh SMEs UK SMEs A, B C, D, E F G, H I J, K M, N, O Figure 4 SME Employment by Industry Sector, 2007 Wales versus UK 5 See Table 8 for Sector Codes and Descriptions 15

16 According to ONS data for 2007, the largest proportion of Welsh SMEs were engaged in the Construction sector, which constituted around a quarter of local SME units. This was followed by those pertaining to the Finance (20%) and Trade (17%) sectors. Despite being the smallest sector in terms of the number of business units, the Manufacturing sector is the third largest employer among Welsh SMEs after the Trade and Hotels & Restaurants sector (26%) and the Finance intermediation, Property and Business Services sectors (17%) (Figures 3 and 4). Figures 4 and 5 show the comparison of SMEs in Wales and those of the UK as a whole. It can be seen that Wales has a higher concentration of SMEs than the UK average in four sectors Agriculture & Mining; Construction; Trade, Hotels & Restaurants; and Transport but lower in Manufacturing, Financial Intermediation, etc and Education, Health, Other Services. Despite recording a lower share in business units than the UK equivalent figure, Manufacturing SMEs in Wales appear to contribute a larger share towards regional SME employment, which indicates the significant role played by SMEs in creating jobs in Wales. Table 8 Distribution of Business Sectors in Wales in 2007 Number of Units Sector Code A, B C, D, E Sector Description Agriculture, Hunting and Forestry; Fishing Mining & Quarrying; Manufacturing; Electricity, Gas & Water Supply Size (Number of Employees) Size % of Total Total None SMEs Large SMEs Large 16,735 12,555 4, , ,225 8,660 4, , F Construction 47,585 40,445 7, , G, H I J, K M, N, O Wholesale, Retail & Repairs; Hotels & Restaurants Transport, Storage and Communication Financial Intermediation; Real Estate, Renting & Business Activities Education; Health; Other Services 33,895 15,735 17, , ,020 11,725 2, , ,585 27,565 10, , ,515 23,295 7, , All sectors 194, ,980 53,320 1, , Note: Data includes public corporations and nationalised bodies. 16

17 2. An Overview of SMEs in Wales 2.1 SME Definition In spite of the vast quantities of work carried out on SMEs, there is yet to be a single, universally agreed definition for SMEs. Even within the UK, there are variations in the thresholds used for SME classification among government and non-government organisations such as BIS, the department which provides support for the development of SMEs in the UK, and the British Bankers Association (BBA). According to the UK Companies Act 2006 (sections 382 and 465), a company is classified as small if it has a business turnover of not more than 6.5 million, a balance sheet total of not more than 3.26 million, and no more than 50 employees. A mediumsized company must have a turnover of no more than 25.9 million, a balance sheet total of no more than 12.9 million, and no more than 250 employees. This particular set of definitions is thus designed for use in view of established accounting conventions and requirements. BIS have additionally issued its own criteria for SME classification. Here, a company qualifies as a small- or medium-sized company (or group) if two out of three criteria in relation to turnover, balance sheet total, and the number of employees are met. The BIS balance sheet threshold is basically half of that of turnover, as shown in the summary in Table 10. Table 10 SME Definition Criteria by BIS Size band Balance sheet total Turnover Employees Small company No more than 2.8m No more than 5.6m Small group No more than 2.8m net (or 3.36m gross) No more than 5.6 m net (or 6.72m gross) Medium company No more than 11.4m No more than 22.8m Medium group No more than 11.4m net (or 13.68m gross) No more than 22.8 m net (or 27.36m gross) No more than 50 No more than 250 Source: BERR Enterprise Directorate Analytical Unit Alternatively, the BBA have embedded SMEs in the Business Banking Code (March 2008) defining small businesses as sole traders, partnerships, limited liability partnerships, and limited companies with an annual turnover of less than 1 million. In the case of a business group, the turnover threshold applies to the combined turnover of all limited companies within the group, not an individual company. Unlike the UK and European Union which applied various SME definitions to all industries, other countries such as the USA, Canada, Malaysia, and Thailand, have specifically defined and adopted different SME definitions for individual industries. Such 17

18 variations aim to better reflect and accommodate for industry differences. The idea behind this approach is that any government supports available for SMEs can thus be more efficiently allocated. Due to the restricted availability of data in profit and loss accounts and employee figures described above, the decision was made to use the thresholds of Balance Sheet total (i.e. total assets) set by the BIS as a guideline towards identifying the size of individual firms in the database. Table 11 shows the criteria adopted in this study to distinguish between SMEs and large enterprises for the remainder of this analysis. All data of total assets used are in nominal term for the firm size classification as well as for examining the growth performance of SMEs in Section Size band Table 11 SME Criteria Adopted for the Following Analyses Balance Sheet Total (Total Assets) 1, Small No more than 3.36 million 2, Medium No more than million 3, Large More than million 2.2 Data The database obtained for the analysis conducted in this project consists of 319,083 sets of financial accounts and basic company information (such as location, age, and sector) belonging to a total of 58,716 businesses located in Wales over a 32-year period from 1977 to Each set of accounts include both the annual balance sheet and income statement (profit and loss account) for companies registered at the Companies House in the UK. Around 70% (40,965) of the businesses from the database are currently active while the remaining 30% (17,751) are dissolved. A basic summary of the businesses in terms of status and size are shown in Table 12. Table 12 Business Distribution of the Project Database Firm size Number of firms Percentages Dissolved Active Total Dissolved Active Total Unidentified* 2,307 1,809 4, Small 15,272 37,612 52, Medium , Large Total 17,751 40,965 58, Total SMEs 15,403 38,664 54, * Missing data or incorrect entry of data see below 18

19 In the UK, all registered companies of large size are officially required to submit both the balance sheet and income statements to the public records, whilst small companies are eligible for exemptions in the full reporting of accounting statements. The British legal framework for financial reporting allows small companies (with less than 5 million turnover) the option to submit abridged accounts instead of full accounts. An abridged account consists only of a modified balance sheet but not the information on profit and loss or business turnover. Most small companies have, in practice, taken advantage of such exemptions, and hence specific figures on items in the profit and loss account for small businesses, most importantly profit (or loss) and business turnovers, are often unreported. As the result of this tendency, the incompleteness of some of the variables within the data represented a notable limitation during the analyses carried out in this project areas where this issue proved most problematic will be explained in the following sections. 2.3 Firm Size and Business Distribution Using the balance sheet total (total assets) of the latest accounts available for each firm, all companies in the database were then classified into three size bands: (1) small, (2) medium and (3) large enterprises according to the above criteria. Note that the group designated 0 includes all firms with missing data or incorrect data entry (i.e. those with a value of zero). Among the 40,965 active businesses, the vast majority almost 95% or 38,664 firms were classified as SMEs. The firm size breakdown shows that the number of small, active firms constitutes the largest percentage share of successfully classified companies at 91.8% (37,612 firms), followed by medium-sized businesses at 2.6% (1,052 firms) and large enterprises at 1.2% (492 firms). The percentage of unidentified businesses stands at 7% of the entire database, while around 30% of companies have dissolved (see Table 12). 2.4 Business Age In addition to examining how well firms can prosper in Wales, it is also vital to explore how long companies can sustain their competitive advantage and operations in the Principality. While a firm s profitability is generally considered as a measure of its success, business sustainability can be observed from its longevity or length of continued operation. In order to examine this aspect, businesses in the database were classified into five age groups according to their length of operation in Wales: 1 Start-ups 0 to 2 years 2 Young 3 to 5 years 3 Mature 6 to 9 years 4 Established 10 to 19 years 5 Well-established 20 years or more 19

20 Table 13 Distribution of Businesses in Wales by Age Group Business Counts by Age Group, N Dissolved Companies Active Companies No Data Small Medium Large Sub-Total No Data Small Medium Large Sub-Total Total 1: Start-ups , ,604 4,366 2: Young 919 5, , , ,295 18,825 3: Mature 648 4, , , ,347 17,476 4: Established 437 3, , , ,320 11,859 5i: Well-established 1, years 129 1, , , ,617 5,171 5ii: Well-established 2, years iii: Well-established 3, years iv: Well-established 4, 120+ years Total 2,307 15, ,751 1,809 37,612 1, ,965 58,716 Percentage by Age Group Dissolved Companies Active Companies No Data Small Medium Large Sub-Total No Data Small Medium Large Sub-Total Total 1: Start-ups : Young : Mature : Established i: Well-established 1, years ii: Well-established 2, years iii: Well-established 3, years iv: Well-established 4, 120+ years Total Percentage by Size Group Dissolved Companies Active Companies Active Only Total No Data Small Medium Large Sub-Total No Data Small Medium Large Sub-Total SMEs Large 1: Start-ups : Young : Mature : Established i: Well-established 1, years ii: Well-established 2, years iii: Well-established 3, years iv: Well-established 4, 120+ years Total

21 A further breakdown was undertaken to evaluate four sub-groups among the wellestablished companies: (i) 21 to 50 years, (ii) 51 to 99 years, (iii) 100 to 120 years, and (iv) 120 years or more. Among the 40,965 active firms, start-up companies and well-established firms (groups 1 and 5 above) account for approximately 10% of this dataset, whilst young and mature businesses (groups 2 and 3) have equal shares at around 30%, followed by established firms (group 4) which represent 20% of the data see Table 13 for summary. Also shown in the table is that when large enterprises are separated from SMEs, the distribution of SMEs by age groups remains similar to the results already presented above. 2.5 Sectoral Composition of SMEs This section provides a further investigation on the sectoral composition in each age group in order to highlight any changes in SME business structure in Wales. Tables 14 and 15 reveal that the majority of SMEs in Wales are concentrated within the non-production sectors, led by three sub-sectors including (1) Financial & Business Services, (2) Distribution, Hotels, Restaurants & Transport and (3) Construction. Their combined percentage shares have formed around 60% to 70% among currently active SMEs. The dominance of these three sub-sectors is apparent in all age groups, which indicates that these sectors have maintained their leading status in terms of both business units and length of operation among SMEs in Wales. Meanwhile, there has been a sharp decline in the significance of the Production sector amongst younger SMEs, particularly for start-ups. This is illustrated by the eroding percentage shares across the younger age groups, i.e. the 15% share of well-established SMEs (21 to 50 years old) as compared to the 5% share of start-up SMEs in the Production sector as shown in Table 15. A further breakdown shows that the majority of companies (83% or 3,400 firms) in the well-established group have been operating between 21 and 50 years, with the remaining 17% (706 firms) having operated in the Principality for more than 50 years. Notably, 53 of these companies are more than 100 years old. Possible reasons for the ability of the firms to operate over such extended periods of time may include a myriad of factors such as the availability of high-skilled labour and access to appropriate technologies, opportunities to gain external funding or support from governmental or financial institutions, less competition as well as the unique competencies established by the companies themselves in order to gain and maintain competitive advantage. 21

22 Table 14 Sector Distribution by Age Group (Active and Dissolved Firms) Sector Start-ups 0-2 yrs Young 3-5 yrs Mature 6-9 yrs Established yrs Wellestablished yrs Wellestablished yrs Wellestablished yrs Wellestablished 120+ yrs Agriculture Construction 460 1,742 1, Distribution, Hotels, Restaurants & Transport 591 2,535 2,620 1, Financial and Business Services 1,473 4,627 4,621 2, Other Services 286 1,032 1,020 1, Private Sector, Health and Education Production No Data Total 3,415 11,653 11,808 7,682 3, Table 15 Sector Distribution by Age Group in Percentage Shares Sector Start-ups 0-2 yrs Young 3-5 yrs Mature 6-9 yrs Established yrs Wellestablished yrs Wellestablished yrs Wellestablished yrs Wellestablished 120+ yrs Agriculture Construction Distribution, Hotels, Restaurants & Transport Financial and Business Services Other Services Private Sector, Health and Education Production No Data Total

23 2.6 Start-Ups versus Well-Established SMEs Within the well-established (20 years and over) SME group, the Fabricated-Metal Products industry within the Production sector represents a major contributor to the economy, as indicated by the high concentration of SME businesses. This is followed by Other Manufacturing, Wood & Paper, Rubber & Plastic Products, Precision Instruments and Food Industry sectors. However, the potential role of these sectors may be diminished amongst new SMEs, particularly in terms of start-ups where, for example, the percentage share of the Fabricated-Metal Industry has dropped substantially from 23.4% in the well-established group to 13.8% for start-ups 6. Among the start-ups, new SME businesses are seen to have increasingly diverged towards relatively less capital-intensive manufacturing sectors with low or medium-low levels of technology such as Other Transports, Utilities, Clothing, Machinery & Equipment, and Wood & Paper industries. A closer look at service sectors reveals that Computer-Related and Business Services have become the main focus for start-ups, with a percentage share of over 80% of start-up SMEs within the same category and sector (i.e. 1,244/1,473 from Table 16) as compared to its 46% share in the well-established group (more than 20 years). Largely as a consequence of the financial crisis, the Property sector the second most important sector among well-established SMEs has experienced a dramatic reduction across the board, with its percentage share dropping from 44% in the well-established group to only 10% among SME start-ups. As expected, the Motor Trade as well as the Wholesale & Retail industry has been severely affected by the recession, both of which have recorded a large decrease in the number of business units amongst recently established SMEs. 6 Data can be provided upon request. 23

24 Table 16 Sector Composition by Age Group Start-ups 0-2 yrs Young 3-5 yrs Mature 6-9 yrs Established yrs Wellestablished yrs Wellestablished yrs Wellestablished yrs Agriculture Agriculture Agriculture Total Construction Construction 460 1,742 1, Construction Total 460 1,742 1, Distribution, Hotels, Restaurants and Transport Hotels & Restaurants Motor Trade Telecommunications Transports Wholesale & Retail Trade 226 1,213 1, Distribution, Hotels, Restaurants and Transport Total 591 2,535 2,620 1, Financial and Business Services Computer-Related and Business Services Wellestablished 120+ yrs 1,244 3,581 3,531 2, Finance Property R&D Financial and Business Services Total 1,473 4,627 4,621 2, Other services Other Services 286 1,032 1,020 1, Other Services Total 286 1,032 1,020 1, Private Sector, Health and Education Education Health Public Admin Private Sector, Health and Education Automotive Production Basic Metals Chemicals

25 Clothing Computers & Office Equipment Electrical Machinery Electronics-Communication Fabricated Metal Products Food Machinery & Equipment Mining & Quarrying Non-Metallic Mineral Products Other Manufacturing Industry Other Transports Petroleum Refining Precision Instruments Rubber & Plastic Products Utilities Wood & Paper Production Total No Data Grand Total 3,415 11,653 11,808 7,682 3,