4 ways to solve the small business productivity puzzle

Investing in skills and technology, lightening the regulatory burden, and fit-for-purpose finance are the solution, says Dominic Buch

The last decade has shown that the UK is a great place to start a business.

As we move into the 2020s, the next 10 years must be focused on how we help these start-ups and small firms grow into mid-sized businesses. That means fixing the UK’s productivity puzzle.

At the end of 2019, there were 5.9 million businesses in the UK, up 200,000 from the year before. This is up 2.4m businesses compared to the turn of the century.

From looking at these statistics, you’d be forgiven for thinking that the UK was a great place to start and grow a business.

However, the headline figures mask a couple of underlying issues.

Too many solopreneurs

The first issue is that while there are more businesses now than in 2000, the number of firms which actually employ people has decreased.

In 2000, 32 per cent of business were employers. By 2019, this had dropped to just 24 per cent, reflecting the increase in the number of freelancers and sole traders.

Productivity has flatlined

Productivity, measured as output per worker, is the main driver of long-term growth and higher living standards, yet its growth has stalled over the last 10 years.

UK productivity has been stagnant since the financial crash, leading to concerns of a “lost decade” for both businesses and workers.

The statistic of the decade

In December, the Royal Statistical Society crowned the 0.3 per cent average annual increase in productivity since 2010 the statistic of the decade.

The latest figures are no better.

The most recent update from the Office of National Statistics (ONS) show that labour productivity, as measured by output per hour, for July to Sept 2019 has risen by just 0.1 per cent compared with the same quarter in 2018.

>See also: Working flexibly is good for business and can improve productivity

This follows four previous quarters of contraction.

‘Significant productivity gains can be achieved by growing small firms into medium-sized firms’

Why we need more scale-up businesses

The causes of this lack of productivity growth, known as the productivity puzzle, are complex and numerous.

The UK is a nation of small businesses. It would do much better as a nation of small and mid-sized firms.

That so many small firms have not grown into mid-sized businesses is one clear explanation for such lacklustre growth.

Importantly, the data shows different levels of productivity by size of business.

Workers at firms with fewer than 10 employees each produce £51,000 of output. Medium-sized firms with 50-249 workers produce £81,000 – or 60 per cent more.

So significant productivity gains can be achieved by growing small firms into medium-sized firms.

The Scale Up Institute, a think tank, estimated that in 2016 just 13,665 business in the UK increased headcount by more than 20 per cent.

4 ways to solve the productivity puzzle

Investing in skills and technology and lightening the regulatory burden on businesses are all part of the solution.

However, it is improving access to the right kind of finance that will most effectively boost productivity.  It is that which best helps small firms become medium-sized businesses.

Very often this can mean looking further than the banks, which can only lend against the value of tangible assets that a firm has. For many businesses in the new economy, whose assets may be based in intellectual properly or the services they offer, this can be a serious constraint on growth.

#1 – Increase access to the right finance

First and most important, too many small firms struggle to grow because they are unable to raise suitable finance, which hampers their productivity.

There is a funding gap both in terms of the size of loans and type of loan in the SME lending market.

Micro businesses can access finance from peer-to-peer platforms. Larger businesses, or those with assets, are well served by banks and debt funds.

The issue is for growing businesses, the “missing middle”, which need to borrow between £500,000 and £5m for growth and do not have assets to use as collateral.

This is because while banks can fund an amount that reflects the tangible assets in a business, they can’t help if a business has no further such assets to borrow against.

For these slightly larger and more complex SMEs, the lack of genuinely unsecured lending is a significant barrier to growth and holds back productivity.

#2 – Implement best practice

Second, skills. Many SMEs owner mangers lack the skills they need to grow their business.

But statistics from the government shows that even small improvements in management practices can increase the growth of a business’ productivity by 5 per cent.

ONS analysis also shows a significant correlation between more structured management practices and labour productivity.

However, there are very few places for small businesses to get the right help or training.

This is a key area for business growth which deserves more attention and should be a focus for all small businesses in the year and decade ahead.

#3 – Adopt the right technology

Third, increasing access to and the adoption of technology. Many large firms benefit from economies of scale that small firms struggle to compete against.

But making use of the right technology can help. The Department for Business, Energy and Industrial Strategy (BEIS) identifies four main technology that can help.

These are customer relationship management systems, accounting software, supply chain management and enterprise resource management.

Research from the Enterprise Research Centre (ERC) shows that adopting such a range of basic technologies is associated with a productivity improvement of between 7pc-18pc, depending on the tech.

This is supported by further ONS analysis that shows that businesses that use two or more business management technologies increase productivity by up to 25 per cent.

So small businesses hoping to grow into mid-sized firms should ensure they have, and know how to use, the right technology for them.

>See also: 5 easy tech wins to improve SME productivity

#4 – Lighten the regulatory burden

Last, regulation and tax could be slimmed down and simplified.

A study of small business owners by the Centre for Policy Studies showed that 75 per cent thought the tax system was too complicated.

It’s not hard to see why when the British tax code runs to more than 17,000 pages, or 10 million words.

Lending that is fit for purpose

To tackle productivity and help small firms grow in the decade ahead, we need to give small firms greater support when it comes to skills, technology, and regulation.

Most importantly, they need lending which is fit for purpose.

Lenders should not focus on a business’s physical assets. Instead they should look at the future of an individual business and assess what cash flows it will generate. This kind of unsecured lending will help small firms become medium-sized businesses and boost productivity across the economy.

Dominic Buch is managing partner and co-founder Caple

Further reading on the productivity puzzle

Is this the missing piece of the productivity puzzle? Why businesses need to understand their employees better


Dominic Buch

Dominic Buch is managing partner and co-founder of Caple International.

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