Partners in Growth
When is the last time you heard a politician proudly proclaim, “I am the big-business candidate”? More often, those running for public office express ardent support for small business and sometimes equally ardent disdain for corporate America in their attempts to score points with voters.
The big-business-versus-small-business mentality is not limited to politics. Many in the media and general public also see small businesses and large corporations as distinct: even adversarial: sectors of our economy.
Conflicting reports about which sector contributes the most to economic growth and job creation reinforce the tendency to think this way.
Using data from the U.S. Bureau of Labor Statistics (BLS), the U.S. Small Business Administration (SBA) reported earlier this year that companies with 20-499 employees (which the SBA refers to as larger small businesses) represented 63% of the job growth in the United States from the beginning of 2010 to the second quarter of 2011.
More recently, the SBA’s Small Business Economy 2011 report reinforced the conventional belief that small businesses drive employment: “Quarter by quarter, small businesses with fewer than 500 workers outperformed large firms in net job creation about three out of four times from 1992 through 2010 when private-sector employment rose.”
A recent New York Times article, however, cited newer, experimental BLS data showing that from April 1990 through March 2011, employment at companies with 500 or more workers increased 29%, compared with 13.1% at firms with 50-499 employees and 10.5% at those with 1-49 workers.
But the same data also showed that in the manufacturing sector, employment at smaller firms fell more slowly during the Great Recession than at larger companies and climbed faster once the recovery started.
Obviously, using such data to make a cut-and-dried case about the relative economic importance of large and small businesses is tricky because of the number of variables involved, including how companies are classified by size, the time period covered, and differences in the factors being analyzed.
Moreover, research has shown that job creation among large and small companies varies proportionally with business cycle conditions*, something that Chris DiPentima, president of metal fabricator Pegasus Manufacturing in Middletown, can attest to.
DiPentima believes that Connecticut’s diversity of small and large companies helps the state weather ups and downs in hiring cycles. “What the large OEMs [original equipment manufacturers] are doing, the small or midsize guys may not be,” he says.
“In growth periods like we’re in now, a lot of the OEMs send about 80% of their build outside. They certainly aren’t hiring at the rate that companies in their supply chains are, so it’s good to have that mix.”
Debate Misses the Point
CBIA President and CEO John Rathgeber agrees and argues that debate about which company size class creates more jobs turns attention away from the fact that in most economic-base industries, large and small firms depend on each other for survival, and communities depend on both for jobs.
“The important point is that small and large businesses in nearly all sectors are constantly creating mutually beneficial strategic partnerships,” says Rathgeber, “and we need both to be healthy to keep job creation strong and the economy growing.”
Nowhere is that more apparent than in high-end manufacturing, where large companies depend on vast networks of smaller firms to supply materials and components and handle numerous fabrication processes.
“Now more than ever there is a strong partnership between OEMs and their supply chains, the small-to-midsize companies,” says DiPentima.
“The partnership nowadays has to be stronger and stronger, because business cycles: ramp-ups (tremendous growth), downturns, and then quick ramp-ups again: are so much shorter than they used to be. There has to be a tight partnership and strong communication between the two.”
DiPentima also believes that having a diverse range of both small and large companies allows for more job diversity as well.
“The other front to look at is the kind of jobs small and large organizations offer to a state,” he says. “Since most of the big OEMs are subcontracting the build side now, their work mainly consists of engineering, purchasing: more of the technical or front-office side: while the companies in their supply chains have the skilled labor, their machinists, welders, inspectors.”
The critical interdependence of large and small companies in Connecticut was brought to light in 2005 when the federal government’s Base Realignment and Closure (BRAC) Commission put the submarine base in Groton on its closure list.
A coalition of state and local elected officials, businesses, and others fought off the closure, in large part by citing the close working relationship between the base and Groton submarine manufacturer Electric Boat (EB).
The coalition emphasized the devastating impact closure would have on the defense contractor, its numerous subcontractors throughout the state, and thousands of small businesses in the region indirectly supported by the base and EB. A study at the time estimated that Connecticut and parts of Rhode Island would lose 31,000 jobs and $2 billion in annual income if the base closed.
“We employ more than 8,300 people in the state and provide contracts to more than 800 Connecticut companies,” says William Lennon, vice president, Maintenance, Modernization, and Lifecycle Programs at EB.
“Any changes that hurt EB can have a negative impact on our employees and our suppliers as well. And the opposite also holds true. For example, when policies increase costs for small businesses in our supply chain, they have to pass along those costs or put their businesses at risk.”
The Cluster Phenomenon
What often drives small-business growth is demand by larger firms for supplies, parts, business services, and more, says CBIA economist Pete Gioia. “For many small companies, larger firms represent part or all of their customer base,” he says, recalling results from the 2011 CBIA/BlumShapiro Survey of Connecticut Businesses.
The survey found that more than half (53%) of the 707 businesses responding: regardless of size: depend on large Connecticut companies for business. Industries represented in the survey included manufacturing (28%); professional services (25%); finance, insurance, and real estate (11%); and construction (10%).
In professional services, says Gioia, “a whole array of smaller firms serve large corporations in a variety of functions. Banks, for example, use appraisers that must be independent of the bank and tend to be small firms or even individual entrepreneurs.”
Farmington-based i-MARK Inc., a developer of e-business software, includes Stanley Black & Decker and Hamilton Sundstrand among its corporate clients.
“In terms of business units, 30% of our business is with large companies,” says i-MARK’s president and CEO Del Merenda. “But they represent roughly 50% of our revenue.”
A similar situation exists in manufacturing. Okay Industries, a New Britain-based manufacturer of metal stampings, mechanical assemblies, and surgical blades, derives about 90% of its business from large corporations, says Jason Howey, the company’s president.
Howey believes that the best thing the state can do for small businesses is keep the big ones here.
“There are a lot of small manufacturers here, and a lot of their customers are the large OEMs,” he says. “It’s the cluster phenomenon, where you’ve got some big companies here in Connecticut and a lot of the small, local guys supplying them.”
Pegasus Manufacturing also relies heavily on a big-company customer base, with 80%-85% of its business coming from the large OEMs, according to DiPentima.
The business that companies like Pegasus and Okay Industries do with large corporations also creates a kind of upstream multiplier effect: As the big OEMs outsource jobs to smaller firms, those firms in turn move some of that work to other small manufacturers in the state.
“Even companies like ours outsource jobs like heat treating, or we purchase components that we put in our subassemblies,” says Howey. “We buy more than $5 million annually in products and services from other Connecticut companies.”
Pegasus operates similarly, and DiPentima finds the number and diversity of small businesses in the state advantageous. “That’s one of the reasons we’re in Connecticut,” he says. “There are a lot of special processes for our parts that we do not do in-house, that we contract out to our supply chain. Most of those companies are local Connecticut shops and raw-materials suppliers.”
Doing business with large corporations not only provides small companies with reliable, repeat customers; smaller firms that sell to big companies also make more money than those that don’t, and they typically show impressive growth in revenue and jobs after signing contracts with large firms.
Last year, the Center for an Urban Future, a New York City think tank, surveyed hundreds of small firms, primarily from in and around NYC. Of the 180 that responded, 65 reported being suppliers to large corporations. Of those companies, nearly two thirds (63%) generate more than $500,000 in revenue per year. In contrast, more than three-quarters (77%) of the 115 non-suppliers responding have annual revenues of $500,000 or less.
The study also found that doing business with large corporations is typically “a springboard for growth” for smaller firms. The corporate suppliers in the survey reported revenue growth of 266%, on average, between the year before and two years after their first sale to a large corporation. In addition, corporate suppliers saw significant employment growth during that time span, increasing their workforces by an average of 164%.
Small businesses gain some unique advantages when the large corporations they serve do business globally: and many of them do, says Gioia.
“Proportionately, more large firms than small companies are involved in international business. That doesn’t mean there aren’t firms with 20 employees exporting their products, but the larger firms: those with 500 or more employees: are much more involved.”
That means smaller companies gain access to markets that they normally wouldn’t reach, says Luis Ramirez, CEO of GE Energy Industrial Solutions in Plainville. His firm employs 15,000 people worldwide and has 195 direct and indirect suppliers based or working in Connecticut, translating into approximately $37 million in annual business for those small firms.
“Some of the products we’re buying from companies here in Connecticut will show up in products that we sell all over the world,” says Ramirez.
Gioia notes that small firms partnering with big international players also benefit from the diversity of the larger companies’ markets during economic downturns.
“Global companies are cushioned against the impact of economic cycles because some of their worldwide markets may not be severely affected. That, in turn, helps protect the smaller firms that sell to the larger, global ones.”
Small-Business Breeding Grounds
Often, small businesses are created from large corporations through the spin-off process. A company can choose to spin off part of its operation into a separate business in a downsizing or restructuring initiative, or a spin-off can be entrepreneurial in nature, where an employee or group of employees decide to leave a company and start a new business based on knowledge and experience gained from the parent firm.
Either way, the large corporation serves as a de facto business incubator, and in many cases spin-off companies maintain a business relationship with the firms they came from, selling products or services to the parent.**
“If you were to go through a lot of the industrial parks in Connecticut, you’d find that quite a few of the small companies have their roots in what were once divisions of much larger firms,” says CBIA’s Rathgeber.
Ramirez agrees. “A lot of small companies were started by people who came from the corporate world,” he says. “It always helps to have friends in different industries that have worked with you before. When people do leave our organization, we tend to maintain good relationships. I even had a situation last year where the company we bought: Lineage Power: was actually being run by someone who had left GE a few years earlier and had inculcated a lot of things from the GE culture into that business. So when it came into our portfolio, it felt like it had always been part of the company in some ways.”
In the biosciences: one of Connecticut’s key growth sectors: small biotech firms benefit from doing business with large pharmaceutical companies in several ways, some unique to the industry.
As in manufacturing, professional services, and other sectors, small firms in the biosciences will sometimes act as subcontractors, doing research for a bigger company as a way to maintain a revenue stream while simultaneously working on their own proprietary projects.
In many cases, however, a smaller firm’s ultimate goal is to sell its innovations: or more: to a large corporation.
“The hope from the [small] biotechs’ perspective is that the fruits of their research: or their entire company: will be purchased by big pharma,” says Paul Pescatello, president and CEO of Connecticut United for Research Excellence (CURE), an advocacy group for the bioscience industry in the state.
According to a 2011 study by professional services firm BDO USA, small biotechs nationwide have seen healthy revenue increases as a result of deals with big companies. In 2010, average revenues for all companies in the biosciences sector jumped by 11% to $77 million, with small biotechs (those with less than $50 million in revenue) leading the way.
“The demand for more innovative products has helped smaller, more flexible biotechs increase average revenue to $41 million, a notable jump from $24 million in 2009,” the report states.
“The overall increase in revenue has been spurred by strategic partnerships with large pharmaceutical companies who increasingly rely on biotechs to fill potential gaps in the pipeline of drugs. These partnerships have afforded biotech companies additional product and licensing revenue opportunities.”
A case in point is the recent licensing agreement between Meriden-based biotech Protein Sciences Corp. and pharmaceutical giant Merck.
The agreement grants Merck the use of Protein Sciences’ proprietary vaccine production technology (PS Technology) in return for an up-front fee and payments contingent on the development, regulatory approval, and commercialization by Merck of vaccines using PS Technology.
The Protein Sciences deal points to another advantage small biotechs derive from partnerships with larger firms: big pharma’s experience at the later stages of product development: clinical trials and commercialization.***
“It takes between $1 billion and $1.5 billion and 12 to 15 years to bring a new drug from idea to an approved product on the market,” says Pescatello. “So it’s very different from other industries. Clinical trials are a whole art form unto themselves. Small companies often don’t have the capacity to design and manage a clinical trial and bring it before the Food and Drug Administration (FDA). So a small biotech: if not purchased outright by a larger company: will often contract with a big pharma to do the clinical trials and agree to share any profits that come from commercialization of the product.”
Manon Cox, president and CEO of Protein Sciences, also believes that big pharma’s key contribution comes at the later stages of product development.
“The experience of having brought something across the finish line even once is super important,” she says. “At the commercialization stage, you can use the muscle of the larger company.”
Small Firms’ Specialization Pays Off
Clearly, small companies can profit immensely from partnering with big corporations, but what’s in it for the larger firms? “Big companies need smaller ones for specific niche competencies,” says Gioia.
A good example is e-business software developer i-MARK, whose direct clients are primarily small businesses, many of which are owned by major corporations.
“What we do for the big company that has a lot of smaller companies in its portfolio is provide corporate-level services to the smaller companies,” says Merenda. “Their IT departments are small, and they don’t have the necessary skill sets to do the job themselves.”
GE’s Ram_rez believes that the development of specialties or niche competencies by small businesses is critical for their: and his company’s: success.
“We have a lot of complexity because we’re running large-scale organizations with a lot of products and customer bases,” he says. “If you are a smaller player or a player that’s more focused, you’re an expert in that niche or that space. I have the benefit of having more scale, but they have the benefit of being able to focus on and get much deeper into areas that we sometimes can’t, because we’re worrying about broader issues. The fact that smaller firms have expertise that they’ve built over time in areas that we can leverage helps us make better, more insightful decisions as we develop business plans.”
The advantage of partnering with small, specialized firms is especially clear when a large company builds things that are big and complicated: like submarines.
“A nuclear submarine is the most complex machine ever created, with more than a million parts,” says EB’s Lennon. “It’s hard to imagine one company that would be able to be the best in the business at manufacturing every one of those parts. And because these ships will take America’s finest young people to sea, we want the highest-quality parts available on our submarines.”
Of course, in addition to quality, cost is a major consideration for Lennon, and there again, small manufacturers often shine.
“Our make-versus-buy decisions look at whether we can procure a part more efficiently from a supplier than we can manufacture it,” he says. “So it’s a question of experience, quality, and cost. A company that makes electrical controllers every day, all year long, is probably going to be able to produce a quality product at a lower price than we could if we’re making only one ship set per year.”
For Pegasus Manufacturing, keeping costs down means teaming up with customers to make every project as lean as possible.
“In most of our partnerships with the large OEMs, we have cost-driving initiatives where we work together to remove waste from processes to drive down costs,” says DiPentima. “We both benefit from that; there’s usually a 50-50 sharing agreement. So, while we may do a lot of the heavy lifting at Pegasus relative to reducing waste out of processes, the OEMs certainly work with us on the design-change side or on source- and method-change opportunities.”
It also helps, says Ram_rez, that smaller firms have fewer people to go through, “less bureaucracy,” in the decision-making process. “We benefit from having [companies] to work with that are nimble, efficient, and able to make decisions quickly.”
The same holds true in the bioscience industry, says Pescatello, where the large pharmaceutical companies are realizing that the smaller biotechs, just by virtue of their size, may be more effective at early-stage research.
“They’re able to pivot quickly if something goes wrong in the lab or if there is an unexpected positive development,” he says. “So the big pharmas look to the smaller companies for the early research or the basic insights that might lead to a big project.”
“I think things can be done much faster in a small company,” adds Protein Sciences’ Cox, who also argues that smaller biotechs are better at cultivating innovative, riskier ideas than are the large pharmaceutical firms. “What we can bring to the table is that we’re willing and able to pick up daring concepts.”
When it comes to being nimble and quick, being located close to a major customer can help a small firm respond effectively to an unexpected change or request and keep costs down, important considerations for a large company.
“[Being nearby] shortens lead times and lowers transportation costs,” says Okay Industries’ Howey. “Typically, most Connecticut companies still in manufacturing are doing very complex, high-end types of components, so it helps [the big OEMs] to have an R&D partner that’s a quick drive away. It’s much better to be sitting across a table talking face-to-face about new product development than doing it from a distance.”
Pegasus Manufacturing’s large Connecticut customers also see the company’s proximity to its own subcontractors as a benefit.
“They like the fact that our supply chain is very close to us, so that if there are issues, they can be remedied very quickly with a short drive,” says DiPentima. “Our customers really like that, and I believe that’s why Connecticut has seen an increase in business in the aerospace manufacturing sector in the past couple of years: because that network and that supply base is here.”
Despite the vital interconnectedness between small and large businesses throughout Connecticut, policymakers sometimes argue that the two part ways when it comes to key policy issues involving business costs, workforce matters, and government regulation.
“In my 35 years of experience with the business community, that’s rarely been the case,” says CBIA’s Rathgeber.
His experience is supported by data. “We’ve done numerous surveys where we’ve segregated the results by size of firm,” says Pete Gioia. “In every case, there is no statistically significant divergence in responses on key public policy issues: such as taxes, labor costs, and regulations: between large corporations and small firms with 50 or fewer employees.”
Rathgeber suggests that policymakers may sometimes get a distorted view of what issues small and large businesses care about because a smaller firm may engage in an issue with more intensity than a large corporation. Why? Legislation and regulations can impact smaller businesses in a much bigger way, he says, because they don’t have the option of shifting production or service centers somewhere else like a large corporation does: unless they want to uproot entirely or start a whole new division somewhere else.
“But that doesn’t mean they don’t care about the same things,” he says. “There are differences, of course: small companies won’t care as much about the corporate income tax if they’re S corps., for example: but they do care about the same root causes that result in tax increases, which are things like government inefficiency and fiscal irresponsibility. ”
Policy Decisions Rarely Happen in a Vacuum
It’s no secret that some government leaders and interest groups have a bias against large corporations, but that attitude sometimes reflects an incomplete understanding of the role big companies play in the state’s economy, says Rathgeber.
“They fail to understand that those large corporations are often the key customers of the smaller businesses that they think they’re supporting. So if the state adopts policies that drive the large companies away or make investing in Connecticut risky for them, it ultimately hurts the small businesses that rely on them as customers.”
If a policy increases business costs for a large company, says i-MARK’s Merenda, it will, for example, impact that firm’s decisions about how much inventory to carry and the prices they expect from their suppliers: all of which will have a negative outcome for the small companies. “The larger firm still has to make up the difference, they still have to keep up their margins, so it absolutely impacts the smaller companies,” he says.
Given the symbiotic relationship between many of the state’s small and large firms, it’s important that policymakers realize that a law or regulation directed at one sector will almost always affect the other as well.
“Policy decisions rarely happen in a vacuum,” says Joe Brennan, CBIA’s senior vice president of public policy, adding that he and his government affairs team are often astounded when policymakers believe they can take action toward one segment of the economy and have the impact contained just to that one area.
“Efforts to create a stronger business climate in Connecticut need to take the entire business community into consideration,” says Brennan. “As a businessperson who talks to policymakers, be sure to not only discuss the ramifications of their decisions for your company, but also for the businesses in your supply chain and those in your area that may be indirectly supported by your firm’s presence.”
EB’s William Lennon agrees. “I can’t think of a large company that doesn’t rely on a network of smaller suppliers to maintain production,” he says. “So there’s a very direct connection and a need for a business climate in Connecticut that nourishes companies of any size.”
* A 2009 study co-authored by Yale economist Giuseppe Moscarini found that since the mid 1970s, firms with more than 1,000 employees shed more jobs during and just following recessions than do companies with fewer than 50 workers. Larger firms, however, create proportionally more jobs later during economic recoveries. Read the full report here.
** Universities also spin off companies through the process of commercializing inventions or research breakthroughs. Typically, this involves transferring or licensing intellectual property rights to the nascent business entity.
*** Pharmaceutical companies seeking to sell a new prescription drug in the U.S. must first get FDA approval, a lengthy and costly process that includes testing the drug in various ways. First are laboratory and animal tests (preclinical tests), followed by tests in humans: clinical trials: to see if the drug is safe and effective. Preclinical tests alone can take three to six years. After testing, the company sends the FDA a New Drug Application (NDA), which typically run 100,000 pages or longer. The FDA’s, physicians and scientists then analyze the application and determine if the drug is safe and effective enough to be marketed in the U.S.
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