Right Place, Right Time

Small businesses aren't just surviving. They're growing -- and hiring

During the explosive '90s, M. Ann Padilla got orders for thousands of temporary office workers from such pillars of the Denver business community as AT&T (T ), Qwest Communications (Q ) International, and Adolph Coors (RKY ) But those aren't her most important clients anymore; they've cut thousands of workers locally. Now, Padilla says, small business is what's keeping her Sunny Side Inc./Temp Side going. Orders are coming from companies with 10 to 100 employees: construction contractors, distributors, nurseries. And they're picking up speed. "For the past two years, the orders were short-term," says Padilla, who owns the company. "Now they keep extending them."

You wouldn't know it from reading the headlines about corporate downsizing, but across the U.S., small business is quietly holding its own -- and in some cases even thriving. Small businesses have several things going for them. First, they're concentrated in the service sector of the economy, which is healthier than manufacturing. Second, they have picked up work from big companies that are outsourcing peripheral functions in order to save money and focus on core businesses. Third, many of the Bush tax cuts benefit small biz. Fourth, easy money from the Federal Reserve has lowered the cost of 1- to 3-year bank loans, which many small businesses depend on. And finally, small business is benefiting from the growth acceleration of the overall U.S. economy.

The good news for small business is reflected in the optimism of owners. The National Federation of Independent Business says that in August, its Index of Small Business Optimism reached its highest level since monthly readings began in 1986. Fifteen percent of small businesses expected to add employees over the next three months; only 7% expected to cut them. By contrast, a July survey by the Business Roundtable of some of the nation's very largest companies found that only 16% planned to increase U.S. employment in the next six months, while 42% planned to cut jobs. Says William J. Dennis Jr., a senior research fellow at the independent business federation: "Things are clearly looking better. By the end of the year, we expect very good things to be happening."


Small businesses are in the right place at the right time. Take single-family home construction, which has been thriving. According to the Small Business Administration, 87% of employment in the sector is in companies with fewer than 100 employees. Or take ambulatory health-care services, including doctors' offices. It's the fastest-growing part of the health-care business, which is thriving as a whole. Some 58% of the jobs in the subsector are in companies with fewer than 100 employees. In real estate, 65% of all jobs are in such outfits.

Meanwhile, relatively few small businesses occupy the hardest-hit niche of the economy, heavy manufacturing. In transportation-equipment production, which includes autos, only 8% of the jobs are in companies with fewer than 100 employees. For primary-metal manufacturing, including steel, the figure is 12%. Another slow-growth sector with few small businesses: utilities, such as electricity and water companies, where just 9% of workers are employed by small companies.

Outsourcing also plays into the hands of small outfits. Big companies long ago began ditching functions such as maintenance, food service, and security. In recent years they've begun turning over more central functions, such as technical support, public relations, legal, and accounting, all of which have heavy small-business representation. Robert I. Fernandez, who runs a four-person Fort Worth accounting firm, says his business is booming in part because of work picked up from TXU (TXU ) Corp., the big Dallas-based electric-utility holding company, which has laid off many of its accountants in a cost-saving move. He's looking to hire another accountant to handle the influx of work. Says Fernandez: "Last year was our best year ever, and this year will surpass [it]."

Outsourcing is a mixed blessing. Big companies don't pay top dollar: After all, their goal is to cut costs. And they can yank business without warning. But there's still money to be made by performing functions more efficiently than large companies can. Small-biz guru David Birch says his own small outfit, Cognetics Inc. of Waltham, Mass., took over the marketing function for several large companies, setting up telemarketing programs and checking out possible customers. "It probably adds a little bit to volatility, but on balance, it's been good," says Birch, whose company has since been bought by French advertising giant Publicis (PUB ) and renamed Arc Analytics.

Two parts of the Bush tax-cut program are especially advantageous to small business. Most small companies are sole proprietorships or Subchapter S corporations, so they pay taxes at individual income tax rates, which have been slashed. Also, businesses are allowed to deduct from taxable income up to $100,000 of new equipment, up from $25,000. That's trivial to giants but a major incentive for small fry.

At the same time, loans are cheap and relatively easy to get. Greenwich Associates, a consulting firm for financial institutions in Greenwich, Conn., says that in a July survey, 27% of small businesses cited easier credit conditions, while 19% reported tighter credit conditions. A year earlier, the responses to the same question were almost exactly the opposite. Banks are getting credit to small businesses more rapidly by using online data about them, combined with credit-scoring software similar to what's used for approving home-mortgage loans. Wells Fargo (WFC ) & Co., for instance, offers unsecured lines of credit of up to $100,000, without requiring financial reports or tax returns. The business owner personally guarantees the loan.

Of course, small businesses can't thrive with the rest of the economy in the tank. That's why their owners take heart from the long-awaited growth pickup. Gross domestic product grew at a 3.3% annual rate in the second quarter and is expected to expand at a rate of 4% to 5% in the second half. And while consumer spending has sustained the economy until now, business investment is finally accelerating. That's good for small businesses that mainly sell to other businesses.

Business is far from booming, but at least there are signs of progress. "Everyone was in a maintenance mode for the longest time," says Keith M. Parent, CEO of Court Square Data Group Inc., a Springfield (Mass.) information-technology consultancy. "I'm starting to see people loosen up on the purse strings." David W. Bland, president of Trivis Inc., a Birmingham (Ala.) company that advises nuclear-plant operators on how to deal with their spent fuel rods, also sees a pickup in spending. "People are still cautious, but they can't wait forever," he says. "We've had 60 to 90 days of pretty good orders. I believe the economy has turned."


Even in manufacturing, some small companies are managing to grow. Wolverine Proctor & Schwartz Inc., the leading maker of ovens for dry cereal, was founded in 1930 and developed the process that puts the snap, crackle, and pop in Rice Krispies. But it was so heavily in debt by 2001 that it couldn't post standby letters of credit against customers' deposits on the ovens they were buying. That year, Parthenon Capital LLC, a Boston investment firm, took it over and paid off its obligations. Since then, revenue has risen 20% and earnings have doubled.

In some ways, the resilience of small business during this recovery fits in with the trends of the past two decades. In the early 1980s, the output of companies with fewer than 500 employees was 4% less than the output of businesses larger than that, according to an analysis of Commerce Dept. and Internal Revenue Service data by Joel Popkin & Co., a Washington-based economic consulting firm. Since then, though, small business has rebounded and produces about 15% more than the big guys, according to the Popkin report, which was published in July by the Small Business Administration.

Advocates for small business, including the SBA, like to argue that the sector accounts for the vast majority of U.S. job growth. That's usually an overstatement -- there are times when big businesses account for the lion's share of job growth. However, what small businesses do provide is a relatively stable employment base. They hold on to workers in hard times because they know they'll be hard to replace when good times return. What's more, small businesses are flexible and innovative. Small companies often initiate products and services that are later perfected by big companies, from the helicopter and air conditioning to the personal computer and the heart valve. "There's this romantic notion that we need lots of small business to generate jobs. What we need is a mix of small and large businesses," says Robert E. Litan, a senior fellow at the Brookings Institution and vice-president for research at Ewing Marion Kauffman Foundation in Kansas City, Mo., which promotes entrepreneurship and education.

Small businesses can't make it all by themselves. But they kept their heads above water during the hard times. And now they're doing more than their share to get the U.S. economy growing again.

By Peter Coy

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