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Economic and Financial Market Update: What small business is saying about the state of the economy

small business economy

22/06/2017

Summary:

  • Small business say conditions have improved a little over the past couple of years;
  • Bigger firms are doing better;
  • Conditions for SME’s differ across industry and state;
  • Signs of an improving Australian economy should prove to be good news for small business.

What was good for our country was good for General Motors, and vice versa

Charles Wilson

Charles Wilson was an American businessman who also served as a Secretary of Defense in the 1950s. According to Wikipedia, during his confirmation hearings before Congress he was criticised for having a potential conflict of interest because of his large holding of General Motor shares. In his defence he made the above statement (although he still ended up selling the shares). Over time his statement evolved into “what is good for General Motors is good for the country” (despite Wilson’s numerous attempts at correction). Who would have thought that a politician would claim to be misquoted! A similar sentiment can be expressed about small business (what is good for the Australian economy is good for small business). If the domestic economy is running strongly then small business tends to do well. A more mixed economy means domestic spending tends to modest, impacting small business performance.

Currently small business believes the economy is doing Ok. Small firms say that while conditions have improved since 2013, they remain well below the ‘salad days’ prevalent pre-GFC. Smaller firms also believe that economic conditions are currently tougher for them than for larger firms. The better performance of larger firms partly reflects their access to a more substantial distribution network enabling them to get greater benefits from the fall in the exchange rate. But smaller firms are also more exposed to consumer spending (according to the ABS, the major clients for around 80% of SME’s are either consumers or other SME’s). And weak jobs growth (until recently), high debt levels and weak growth in disposable income have weighed on consumers desire to spend.

small business economy

small business economy

Unsurprisingly, firms views about business conditions are influenced by the state of their profitability. Profits for larger firms have tended to grow more strongly, helped in recent times by the movement of commodity prices (which has also meant their profitability has been more volatile). Profits for unincorporated firms (which tend to be smaller firms) have lagged, although they have picked up a little in recent quarters in line with the modest strengthening of the economy. The difference in profitability outcomes is also reflected in relative sharemarket performance, where the largest companies have outperformed small companies over the past couple of years (although a small firm listed on the sharemarket is relatively large by economy-wide SME standards).

small business economy

small business economy

 

The difference in SME business confidence by industry provides a mirror to the current pattern of economic activity. Small business that provides services to other businesses are doing best; no surprise given that business confidence is around 9-year highs. The large amount of residential construction and infrastructure spending is helping smaller firms in the construction and manufacturing industries (a significant consumer of domestically-produced manufacturing products is the construction industry). Smaller health firms are doing Ok, and are likely to do better as jobs growth improves disposable income growth in the economy. Confidence in the accommodation, café and restaurant sectors is a little lower, reflecting strong competition (an issue also for the transport sector) and modest consumer spending at the till. A cautious consumer is also holding back the retail industry.

small business economy

So the overall message is that small business is doing OK, although conditions are clearly mixed across industries and regions. The good news is that there are increasing signs that strong confidence amongst medium- and larger-sized firms is leading to a pickup in jobs growth. And in time this should lead to stronger consumer spending that should benefit many SME’s. And if the Australian economy continues to strengthen, this should in time benefit more regions of the domestic economy.

So a better domestic economy should increase demand for SME products and services. But surveys suggest that an even bigger issue for smaller firms in recent times than the level of demand in the economy is the narrowness of their profit margin. In recent years, sluggish demand and strengthening competition has meant that many firms have been unable to achieve sustainable price rises. And with volume growth only modest, this has meant SME’s have had a significant focus on cost constraint to achieve profitability. Responses to surveys seems to imply that while small business are now under less pressure to reduce prices, they are still finding it hard to achieve sustained price rises.

small business economy

An improvement in the cyclical macro environment will obviously be a big help to small business. But many SME’s are also confronted by a range of structural factors that are providing significant challenges. One is that it is becoming increasingly important for business owners to have a greater understanding of what drives the profitability of their firms, given the increasing competitiveness evident in many industries. The good news is that the development of new software products is making it easier for SME’s to measure their cost and profitability drivers, although there is still room for improvement for many smaller firms (one reason is that many SME’s do not contain enough employees with financial skills). But there has been to date less focus on the non-financial elements of the business (such as operational, innovation or HR), all areas that have the potential to substantially boost productivity and profitability.

The greater use of data and technology more generally not only has the potential to reduce costs and boost efficiency, but widen distribution channels and improve efforts to boost marketing and brand awareness. But many SME’s still lag in their use of technology. For example, according to the ABS only 40-60% of small firms in 2014-15 had a web page. Use of social media is increasing, although still is at a low level. And while a majority of firms use the internet to place orders (to reduce cost and get access to a wider range and potentially better quality goods and services), use of the internet to receive orders is less widespread.

The other key issue for a high proportion of small firms (and also larger firms) is that they are reliant on a small number of clients for a significant percentage of their income. And if any of those small number of clients encounters a problem this is potentially a serious risk to the survival of the firm. This underlines the importance of diversification of client base, something that would reduce the chances of business failure.

small business economy

small business economy

small business economy

Small business will always be one of the important weather vanes of the economy. Right now SME’s are going Ok, but have the potential to do much better. Which really is the same story as the wider Australian economy.

We live in interesting times.

This blog post is for general information purposes only and is not intended as financial or professional advice. It has not been prepared with reference to the financial circumstances of any particular person or business and should not be relied on as such. You should seek your own independent financial, legal and taxation advice before making any decision about any action in relation to the material in this article.

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