Why The Total Number of US Businesses Should Triple in 10 Years

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Why The Total Number of US Businesses Should Triple in 10 Years

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I just read the first installment of the Institute for The Future's report entitled The Intuit Future of Small Business Report. The main theme of the report was that we are in the midst of an economic revolution that started in the 1980's when 80% of American workers were at companies with greater than 1000 employees to today where 40% of American workers are at companies with greater than 1000 employees to some percentage far less than that 10 years from now. I happen to wholeheartedly agree with the Institute's thesis. Prior to the 1980's, most people worked for a company for life and received retirement checks from their employer in retirement. From the 1980's to today, most people work for a company for a "few years" and roll their 401k plans over. I suspect by 2017, most people will become more like free agent contractors who more often than not have a "client" than an "employer" and need to worry about their own retirement.

The report lists some reasons why this shift is happening and will continue, but I think it missed some of the fundamentals behind the economic decentralization, much of which can be explained with Coase's theorums.

Ronald Coase was a Nobel Prize winning economist who wrote an essay entitled "The Nature of The Firm" back in the 1930's that tried to predict the number/size of "business firms" by analyzing the conditions under which we expect a firm to decide whether to hire help versus contract out for a particular task. Coase uses a term called "transaction costs" to describe the friction between a company and a task contracted out (presumably to another company). These transaction costs include things like contract creation, contract negotiation, time zones, distance, language barriers, process/definition differences, etc. Coase's theory says that the lower the transaction costs, the higher the likelihood for outsourcing a function to another company.

Among lots of other reasons, Coase would likely explain the decentralization of business (more firms) since the 1980's as being induced by a reduction in "transaction costs" between firms. Much of this reduction can be attributed to networking technology. New networking infrastructures tend to lower transactions costs and enable firm specialization, including railroads, highways, telephones, fax machines, and email. There's no doubt that the widespread use of broadband networks has reduced transaction costs which often make the choice of outsourcing a task versus hiring a new worker more "efficient" which overall increases the number of firms. The most famous example of this being the outsourcing of entire business processes to India as was so well articulated in "The World Is Flat."

Another major contributor to the decentralization of business is that small/new businesses no longer need to rely on huge sales organizations to "find" customers. Search engines make every niche market more "efficient" enabling smaller businesses to be "found" by the right customers who are shopping in a newly efficient niche. I believe search engine optimization further lowers the transaction costs between companies making the decision to outsource versus hire more attractive and making the barrier to starting a business lower which should lead to a further decentralization of business.

This article talks about decentralization in a macro-economic sense and how the new network infrastructure has led to a widespread decentralization of the economy. Well, it turns out that not every industry is decentralizing. For example, the enterprise software industry has been centralizing (consolidating) over the past several years. My next article will talk about how/why the boundaries between companies within industries change and how you might go about predicting whether your industry will be consolidating or decentralizing. If you can predict that, you should be able to figure out a way to make money from it.

-- Brian Halligan

Posted by Brian Halligan on Fri, Feb 09, 2007 @ 10:55 AM

COMMENTS

Another aspect of this trend is the massive influx of immigrants-- both legal and illegal--who don't attempt or expect to work for a corporation for their whole lives.

These people are becoming more savvy to the budding "entrepreneurial mainstream" in the United States and, in fact, are starting to lead the way in it's development.

posted on Friday, February 09, 2007 at 3:26 PM by Felicia Roberts

I think there is a big difference between an independent "contractor" and a small business. One person "companies" have different motivations, requirements for work, flexibility than small businesses of 2 or more people. So categorizing them all as small businesses inherently overstates the number of small businesses by at least 50% Mukund

posted on Saturday, February 10, 2007 at 11:13 AM by Mukund Mohan

Brian: My name is Steve King and I am part of the Institute for the Future team working on the Future of Small Business Project.

Nice post and analysis. I totally agree with your discusion about Coase. Without a doubt, technology is decreasing transaction costs and this is leading to decentralizaion. The third installment of our report - due out in early summer - will focus on industrial structure issues. We've spent a fair amount of time reviewing Coase's work, and will cover this in more detail in that report.

We are also spending a lot of time on industry consolidation and fragmentation. In many industries we are seeing both consolidation and fragmentation. While counter intutitive, many industries are moving to a structure with a few very large firms, many small firms, and very few mid sized firms. We're also seeing an increasing number of symbiotic relationships between small and large firms.

posted on Sunday, February 11, 2007 at 11:09 PM by Steve King

Steve,

Thanks for your comment. I enjoyed your report and look forward to future installments. I'm pleased Coase will be involved in your future analysis.

You make an interesting point about industry consolidation. I spent many years in the enterprise software market and it's dynamics are evolving exactly as you describe. There are a handful of very large companies (i.e. Microsoft, Oracle, SAP), a ton of very small companies, and very few midsize companies. There are a number of interesting reasons for this in the enterprise software industry and I suspect some of those reasons may be common across industries.

Brian.

posted on Monday, February 12, 2007 at 9:47 AM by

Great post Brian, I think you are quite right about the decrease in transaction costs leading to a smaller size of business. Beyond just search as a means of reaching customers it seems logical that the web has decreased the total effort necessary to start a business. In my businesses I wouldn't have known how to find suppliers, find employees, complete the necessary legal paperwork and government registrations, find our location, file my taxes, etc. without the web. I would have had to take much more time, make decisions based on less information and rely much more heavily on intermediaries (who I probably can't trust that well). Now, on trust, it seems to me that blogs are becoming an important force in developing trust with strangers. If I can read your braindump on your blog it goes a long way in establishing you as somebody who is trustworthy or with whom I have something in common. This low-cost way of developing trust reduces the competitive value of having a big brand. Where do you get the data for the claim that small businesses will increase 3x? That Intuit article was very weak, however, there are almost no citations or data and lots of generalizations. I wish someone would publish a similar report with a lot more data.