Small Business Labs

Webinar - Improving Profitability in a Downturn

To survive and thrive during the recession small businesses need to control costs, protect margins and hopefully maintain or even improve profitability.

SAP is hosting a webinar featuring Harvard Business School professor Andrew McAfee focusing on innovative ways businesses can can leverage IT and Enterprise 2.0 technologies to drive higher profitability.  Joining Andrew to discuss this topic will be several executives from small and mid-sized firms. 

The webinar is 2:00pm eastern on May 13th.   To register, click here. 

We recently posted on the growing trend of large corporations providing small businesses free tools, advice and news.  SAP is active in this area and regularly hosts or sponsors free webinars on topics of interest and importance to small and growing businesses. 

Ikea Car - Real or Hoax it Shows Power of Social Media

By the time you read this, Ikea will have either:  (1) announced their new car, or (2) let people know this is an April Fools joke. 

There is a third possibility.  Lots of folks are reporting that Ikea will announce a shared car service in France. 

For those that have missed this, information has "leaked" about furniture maker and retailer Ikea announcing a eco-car called the Leko.  It has gotten a ton of coverage in the social media space. 

Since the official news is being released on April 1st, it seems a distinct possibility this is a joke.

Either way, this is a great example of the power of social media.  Even folks blogging about small business are joining in and promoting the Ikea brand.

Seth Godin on the Right Company Size

Seth Godin has a very interesting post  about scale and business size.  Key quote: "Many businesses that are in trouble are in trouble for a simple reason: they're the wrong size."

We've done a lot of work on this topic over the last few years and we certainly agree with Seth.  In particular we are seeing two broad trends on this topic:

1.  Most industries are moving towards a barbell industrial structure with a few global giants on one end and lots of small businesses on the other.  Mid-sized firms (sizes vary by industry) are being acquired by larger firms or squeezed out. 

Driving this is the changing nature of economies of scale.  In many industries scale has become less important due to technology shifts.  And as Seth points out, in some industries scale has become a major competitive problem.

2.  Variable cost business models allow small firms to be competitive with large firms in an increasing number of market spaces.  New technologies have reduced the costs of starting and operating a business. 

And outsourcing, partnering and business infrastructure service companies (UPS for logistics, contract manufacturers for production, Amazon on others for IT and web services, etc.) have created the ability to start and operate businesses using a high degree of variable costs. 

The chart above is taken from an earlier post on this topic.  It shows that in niche markets small firms with low fixed costs have a substantial advantage relative to larger firms with high fixed costs. 

And we see more and more markets becoming niche markets.   

We are not suggesting that large firm are going away.  There are many market segments where scale still matters. 

But a key reason we are forecasting continued growth in the small business sector is their ability to use their size and agile business models to effectively compete in a growing number of markets. 

Farming Developing Barbell Industry Structure

One of the key findings of our research on small business is that more and more industries are developing a barbell like industrial structure.  This structure consists a few giant corporations on one end, a shrinking number of mid-sized corporations and a large and growing number of small businesses balancing the other end. 

The recent USDA farm census shows the same structure is emerging in farming.  Key quote from the press release on the farm census:

"The latest census figures show a continuation in the trend towards more small and very large farms and fewer mid-sized operations."

The shift to barbell industry structures is happening in almost every industry we've looked at.   We cover this trend in more detail in our New Artisan Economy research report.

Variable Cost Business Models and The Growth of Niche Markets

Early in the 20th century Henry Ford was among the first to understand the power of large scale industrial infrastructure. 

Ford's implementation of mass production methods to build economies of scale resulted in the rapid growth of Ford Motor Company.

Others embraced mass production techniques and soon most industries were dominated by large, vertically integrated corporations. 

After all, only big corporations could afford the large fixed cost investments required to build mass production facilities.

But by the beginning of the 21st century, controlling large scale infrastructures with high fixed costs was no longer required for business success in a a growing number of markets.  And in many cases, fixed costs had become a business liability.

New technologies had reduced the costs of starting and operating a business.  And outsourcing, partnering and business infrastructure service companies (UPS for logistics, contract manufacturers for production, Amazon on others for IT and web services, etc.) created the ability to start and operate businesses using a high degree of variable costs. 

Variable cost business models are having a major impact on the small business sector by greatly increasing the number and viability of niche markets.  Variable cost business models:

1.  Lower the capital costs required to enter and serve niche markets.  Lower capital costs also reduce the risk of serving niche markets.

2.  Provide niche producers cost advantages relative to their larger competitors. 

The chart above shows the classic cost accounting model for both fixed cost and variable cost business models.  Below the volume where economies of scale kick-in, variable cost business models enjoy a substantial cost and pricing advantage. 

The increasing use of variable cost business models is not the only trend driving the growth of niche markets. 

Customer are increasingly looking for good and services that meet their specific needs.  The Internet is allowing niche producers and customers to find one another more easily.  And technology is lowering the costs of serving niche markets.

Combined, these trends are making more and more niche markets economically viable. 

And we are seeing more and more examples of small businesses using innovative variable cost business models to exploit niche markets and out maneuver larger competitors. 

Beer and the Growth of Niche Markets

Americans drink a lot of beer.  According to the Brewers Association the US beer market had $97 billion in sales in 2007 and Americans bought 211.5 million barrels of beer.  This is roughly 22 gallons per person.    The US beer market is dominated by a few giant corporations, but a growing share of the market is going to small, niche brewers. 

The chart below shows beer brand market shares for 2007 for the top 25 beer brands and our share estimates for the rest of the market.  This data comes from a mix of sources with the primary sources Beverage Industry, the Brewers Association and our estimates based on company specific data. 

As the chart shows the distribution of beer brand market shares follows a power curve, which is more popularly known as the long tail.  The top 10 beer brands combined garnered roughly 56% of all US beer sales in 2007.  In the tail there are thousands brands produced by both large and small brewers, most with less than .001% of the market.   

Since 1980 the number of US small craft brewers has grown from under 20 with a negligible share of the beer market to over 1400 that combine for an industry revenue share of almost 6%.   These firms collectively continue to gain share relative to the global giants.  Since 2004 small brewer sales have grown roughly 54% versus less than 5% for large brewers.  So while corporate giants control the vast majority of the beer market, niche players continue to emerge and thrive.   

There are several broad trends driving the growth of craft brewer sales, and these trends are also driving the growth of niche businesses in general.  These trends include:

1.  The growing market segment of customers looking for unique, unusual, personalized or locally produced products.  We call this group the emerging buy local coalition and this trend is #5 in our top 10 small business trends for 2008.  While this trend description focuses on consumers, industrial buyers are also increasingly looking for goods and services that are customized to meet their specific needs.   

2.  The use of the Internet to find or be found by people interested in buying niche products.  The combination of online search, marketing, social media and the borderless nature of the Internet are combining to greatly increase the addressable market for most niche products.  Because of this, niches that were not viable in the past can successfully support niche products and businesses. 

3.   Technology is reducing the costs of serving niche markets and lowering the barriers to starting niche market businesses.  In many industries technology is driving production costs down.  These cost reductions are allowing niche businesses to provide products and services at prices that open up new market opportunities.  For example, we recently posted on 20X200, an online art gallery with a business model that is viable because of reductions in high quality printing costs allow them to profitably sell prints for $20.

The growth of viable niche market segments creates opportunities for both large and small businesses.  But as is the case in the beer market, small businesses are increasingly able to compete and win in niche market segments.

 

The Long Tail and Small Business

Harvard marketing professor Anita Elberse has caused a stir with her Harvard Business Review article "Should You Invest in the Long Tail."  The article argues that several parts of Chris Anderson's popular Long Tail theory are wrong.  Key quote:

"It was a compelling idea: In the digitized world, there’s more money to be made in niche offerings than in blockbusters. The data tell a different story."

The article has an excellent summary of the long tail theory, so I won't bother covering it here.  But the bottom line of Elberse's research is that for the two markets she studied - online music and home-video sales - the long tail effect as described by Anderson did not show up.  Her data indicates that hits may even be gaining relative share instead of losing share as predicted by Anderson. 

We've spent a lot of time looking at niche markets, small businesses and industrial structures.  Interestingly enough, we think Anderson and Elberse are both right.  Our research shows that the long tail is happening and the number of niches able to support small businesses (or niche products from big companies) is rapidly increasing.  The two main drivers of this are:

1.  Reductions in the cost of doing business in many niche markets.  Technology, outsourcing and access to third-party services are making it easier and cheaper to create niche or highly customized products and services. 

2.  The Internet has made it cheaper and easier for buyers and sellers of niche products and services to find one another.  This means the producers of niche products can cost effectively attract enough customers to create viable niche businesses. 

These two drivers are combining to shift demand curves and create many new niche opportunities - for both digital and physical goods - as shown in orange in the chart below.  This chart is taken from the HBR article.

While the long tail theory and Elberse's article focus on companies aggregating long tail demand, we are seeing a growing number of successful small businesses that serve narrow long tail niches. An example is My Beating Heart, a pillow company we've profiled in the past.  They serve a very narrow specialty niche way down the US pillow market long tail. According to their founder, the company wouldn't exist without the use of Internet based marketing to reach their customers.  They also would not be able to make their product at a price low enough to attract customers without outsourced manufacturing and services.  They are a long tail small business.   

At the same time we agree with Elberse's research showing that hits will continue to be important.  We think this is true for both digital and physical goods.  So while economically viable niches will grow in number, hits and highly successful products will continue to garner large relative market shares. 

The market share losers, in our view, will be products caught in the middle.  These are products that aren't hits, but also aren't unique enough to be niche products.  We see customers moving away from these products on a relative basis, creating in many cases an even steeper demand curve than shown in the chart above. It is important to note that while mid level products will lose relative market share, the overall growth and size of the global economy means these products can still be successful. 

The growth of long tail niche markets is creating many new opportunities for small businesses.  We also are seeing a strong trend towards large corporations partnering with small companies to serve niche markets, instead of trying to aggregate long tail demand on their own.  We cover these trends in more detail in The New Artisan Economy research report.

 

   

The Beer Industry and Small Brewers

The beer industry continues its global consolidation with Belgium based InBev making a $46 billion offer for US brewer Anheuser-Busch.  It is expected the bid will be rejected, but regardless of the outcome of this corporate battle, most beer industry analysts expect to see more mergers.

While the global beer giants merge, small craft brewers are having a greater competitive impact on the industry.  MSN has an interesting article on this topic called Will microbrews kill the King of Beers.  The gist of the article is the growth of craft brewers (small, independent brewers that produce less than 2 million of barrels of beer per year) is putting a lot of competitive pressure on big beer companies. 

In our most recent forecast report we use the beer industry as an example of an industry moving to a barbell structure comprised of relatively few global giants, lots of small firms and very few mid-sized firms.  In 1980 the US beer industry had fewer than 20 craft brewers with a negligible share of the US beer market.  Today there are over 1400 and combined they own about 6% of the US beer market. 

In 1980 there were roughly 35 national beer companies that controlled about 70% of the US beer market.  By the end of this summer, 2 companies (Anheuser-Busch and the combination of SABMiller and Molson Coors) will control over 85%. 

We're seeing this structure happening in almost all industries.  The need for global scale and investor and competitive pressures are driving big companies to get bigger (see our recent post Will Large Corporation Survive).  And small firms are exploiting the growing number of niche opportunities either too small, too specialized or not attractive to the giants.

We expect this trend to continue over the next decade with more industries having a barbell structure.

 

IBM Buys Cognos; Software Industry Dominated by Giants

Businessweek has an article covering IBM's recent acquisition of business intelligence software company Cognos.  The article points out that IBM has made 23 software acquisitions since 2006 and points out that the software industry is is now dominated "by a handfull of giants".  Key quote:

"The software industry, once populated by hundreds of so-called best-of-breed companies, is now dominated by a handful of giants, including Microsoft (MSFT), IBM, SAP, and Oracle, with vast portfolios of products. It's very difficult for midsize companies to compete against the giants because large corporations prefer to buy their technology from a few strategic suppliers rather than a lot of smaller companies."

While mid-sized software companies are becoming rare, there are thousands of small software companies - many based on Web 2.0 technologies.  As with other industries, the software industry is developing a barbell structure with a few very large companies, lots of small companies and very few mid-sized companies.  We will covering this trend in more detail in our next Future of Small Business forecast report.

Defining Small Business

Anita Campbell's Selling to Small Business Blog has a post on size definitions for small business.  While this is a rather arcane topic, it is actually is quite important.  Many times I've seen people get very confused because they use differing definitions of small business.

We define small business as less than 500 employees.  We do this mostly to be consistent with governement statistics.  We define mid-sized as between 500 and 10,000 employees.  We use personal businesses to mean single person companies, or what the governement calls "businesses without employees".  We chose not to use the government's name because it is too long and too confusing. 

We use micro-businesses to refer to businesses with 5 or fewer employees.  Our usage includes personal businesses in the micro-business category. 

On a pretty much unrelated topic, I was recently on Anita's Small Business Radio show.  It was great fun and my 86 year old mom listened in live.  She was told me I was "just like Jack Benny except he was funny".  Not sure what this means, but I am taking it as a compliment.