Job Creation in the New Political Economy: Small Companies, Not Big Companies, Create Jobs

Michael Evans
Mon, 06 Feb 2017 13:30:46 +0000

With the presidential inauguration over and the business of governing now at hand, creating jobs, addressing over-regulation, and downsizing big government are key issues for the new Trump Administration. Executive orders are already in place freezing new government hiring and new regulations, and trade deals such as NAFTA are dead or under renegotiation. The new president has had widely publicized meetings with CEOs of the Big Three auto companies, tech behemoths like Apple and Amazon, and other giants.

But will the new administration be doing enough to support middle-market business (defined as those businesses with 10 million to 1 billion dollars in revenue)? Will tax benefits focused on large manufacturing companies generate jobs in middle-market services companies, and will dismantling trade agreements increase or decrease employment in the United States? Who really drives the U.S. economy? Let’s look at the facts.

A recently published study has provided another piece of evidence that the middle market—not large companies—is driving the growth of U.S. economy. According to the National Center for the Middle Market (NCMM):

“In every quarter except one (the first quarter of 2012) middle market revenue growth has outpaced that of the S&P 500, often by huge margins (6.9% to 4.4% in this quarter (4Q 2016), for example). Revenue for the middle market increased nearly twice as fast as GDP. While one cannot compare those two numbers one-to-one, the proportion is revealing. So, too, are the employment numbers. By our estimation, the middle market produces three out of five net new private-sector jobs. It is often asserted that small business is the engine of job creation in America; the cliché ignores the fact that small companies, with high failure rates, destroy many jobs as well. Five years of MMI data consistently show the middle market producing jobs one-and-a- half or two times faster than either big or small business.” —Middlemarketcenter.org

This study is an important indicator that the mid-market continues to expand its role as a key engine of our country’s economic strength, although the focus of the administration on job creation appears to be on large corporations such as the automakers and large software and technology companies. The question to be answered by the new administration is whether middle-market businesses will be left behind by new policies affecting large multinational companies but not middle-market businesses, the core of U.S. job creation.

The trend towards increased job creation by middle-market companies and not large corporations seems set to continue. However, new job creation has been positively affected by several factors. The same quoted study indicated:

“[F]or the last five years the U.S. has enjoyed steady and moderate growth, low interest rates, cheap energy, negligible inflation, slower increases in healthcare costs, and little cost pressure from materials or wages. It’s unlikely that these favorable conditions will entirely persist.”

But several other factors are in play:

Speed to Market. Middle-market companies tend to be more agile than larger firms. A basic fact about today’s business environment, whether global or local, is its extraordinary fluidity. The scope and pace of change are constantly increasing. Opportunities open and close swiftly. A host of trends (disruptive changes in markets and products; volatile shifts in demand; global complex supply chains that make it hard to say what is actually “made in America” vs. “made in China,” capital flows across borders, the reach of technology, and radically new business models that leverage technology) reward speed, adaptability, and decisiveness. Middle-market companies’ smaller size and concentrated ownership means they can change direction faster, adapt more aggressively, and innovate more nimbly. Powerful mechanisms are available to rapidly ramp up global expansion.

Technology. Powerful tools and methods that have become available to smaller companies are driving growth in the middle market. With the cloud they can access specialized software tools as a service, customized to their needs, without incurring upfront capital costs or big in-house IT departments. A wide range of alternatives to outsource all but a company’s most core, strategic activities enables them to do more on a smaller capital base—and to make expenses more variable, lowering their break-even point. Several decades of experience in outsourcing have created best principles and practices for contracting with external service providers while maintaining controls over the quality of services delivered that require the provider to “earn the business” again every day. Ingenious online commerce and social media marketing enable upstarts to disrupt incumbents. Global expansion can occur earlier in a company’s life cycle than ever before. Large companies are trading labor for automation en masse. Automakers are producing the same volume of autos with one-third of the number of workers needed decades ago.

Money. Extraordinary amounts of capital are available to fund the creation and deployment of industry-disrupting technologies and business models that promise to be profitable. Middle-market companies that can grow profitably have an extraordinary range of options for financing. One key source of capital: middle-market private equity firms have a tremendous amount of “dry powder,” investment capital they are ready to use to acquire promising companies. Entrepreneurs who can get their company close to scale, producing net cash flow of as little as $1 million a year, have many options to get financing to fund their growth.

Regulations. Most middle-market companies are private, and therefore not constrained as public companies are by a straitjacket of analyst expectations about their next quarter’s earnings. Middle-market companies are also unburdened by the bureaucracy that can slow down decision making in larger companies. If they are venture capital or private equity owned, their top team typically has a far larger equity stake in the company than the top management of larger companies.

At its best, the middle market is the realm of ambitious, determined entrepreneurs who have the drive to innovate and disrupt. The middle market is also the territory of solid family businesses, such as manufacturers that have improved their craft over successive generations. These family firms build on a legacy of goodwill in their markets and communities.

The leaders of middle-market firms bring energy, inventiveness, and an intimate knowledge of markets and customers. They are quick to spot and address underserved market niches. For these reasons, growth of the middle-market sector is expected to exceed that of the economy through the balance of this year—and beyond. Companies of all sizes need to understand the opportunity to target and sell to these companies. Let this vital segment of the economy help to power your own success.