Looking to improve productivity? Think small.

For many people, small business is a part of their everyday life: the corner bodega, the dog walker, the food truck, the plumber. In the US, people trust small businesses more than any other institution. “They are the one thing, literally, that we interact with every single day, and they make a big difference to the lives of people,” explains Anu Madgavkar, an MGI partner.

Looking to improve productivity? Think small.
From left, Anu Madgavkar, MGI partner; María Jesús Ramírez Larraín, McKinsey associate partner; Kanmani Chockalingam, MGI fellow
Looking to improve productivity? Think small.

This week, as the United Nations marks Micro-, Small and Medium-sized Enterprises Day on June 27, we look at the McKinsey Global Institute’s (MGI) first-time report on this small, but mighty, business sector. Our analysis ranges from sole proprietors to mid-size companies of 200+ employees. It goes broad, spanning 16 countries, and deep, covering 200 plus subsectors.

In this post, Anu, Kanmani “KC” Chockalingam, an MGI fellow, and María Jesús Ramírez Larraín, a McKinsey associate partner, share what they learned from their research.

What prompted MGI to focus on this sector now?

Anu: Productivity, for us, is an important research theme and small businesses are a powerful force. They account for more than 90 percent of all businesses, roughly half of the global GDP, and more than two-thirds of business employment. They form the backbone of many economies.

But micro, small, and medium-size enterprises (MSMEs) are only half as productive as large companies, and even less so in emerging economies. If we can raise their productivity to top-quartile levels relative to large companies, that is equal to 5 percent of GDP in advanced economies and 10 percent in emerging economies. They have an important role to play in long term prosperity, resilience, and growth. You can't really lift productivity systematically unless you take the MSME sector with you.

An image of a small business owner sharing a laugh at her design studio, where she makes leather goods to sell in her shop.

A microscope on small businesses: Spotting opportunities to boost productivity

MSMEs are vital for growth and jobs, but struggle with productivity. The route to higher productivity lies in creating a win-win economic fabric for all companies.

What was your key takeaway from the findings?

María: For me, a very powerful idea is the fact that creating and increasing these linkages between small and large companies is actually a win-win situation. A lot of large companies would think about it as a bit of a philanthropic act: “You're doing it from the goodness of your heart.” But actually no. There's a true business case for working with smaller companies. You reduce the risk in your supply chain; small companies have local insight and resources; greater flexibility; and access to certain skills. That's incredibly powerful.

KC: The granularity of the data allowed us to see the incredible complexity of the MSME sector across countries you would think are similar. It also highlighted opportunities to improve productivity. For example, in Mexico, the sector is about food products, whereas in Brazil, it's chemicals; in India, the information and communications sector (ICT) could potentially drive up productivity, whereas in Indonesia, it's construction.

With such a complicated landscape, is there a universal formula to lift productivity?

Anu: More than a set formula, there are universal principles. One of them is to think about: which intangible is really the critical one? Is it capital? Is it technology?  Skills? Access to global markets? Because each business is quite different in terms of these things.

The second is really being thoughtful about the power of those networks. Because almost nowhere is it the case that small businesses can flourish without very meaningful relationships with productive larger businesses.

Sometimes they are highly functioning as collectives of small businesses: that is, with each other. But often, they are interacting with a larger company, as a consumer or a buyer. But understanding those kinds of networks is, I think, the most powerful idea that came from this research.

What actions can leaders take to “lift up” the small business sector?

María: From the perspective of associations, policymakers and large companies, there's a lot you can do. It's basically a combination of better access to the intangibles Anu talked about. Leaders should focus on creating the “economic fabric” where both MSMEs and large companies can perform well.

For example, in Japan, large automakers have a history of tight integration with smaller suppliers, and very much live by the credo “we're in this together. ” It provides them with access to talent, operational efficiencies, and leading-edge technology. They are intertwined, and highly productive together.

KC: We found a number of these win-win examples, each with a different formula. The Italian government provides its winemakers, generally smaller family-owned enterprises, with centralized branding and marketing resources for access to the international market. They can command premium prices, and a highly networked industry association gives them a powerful voice.

In Australia, the government has fostered a high rate of public and private partnerships between small and large companies in specialized construction, especially mining. This enables them to be highly productive in a remote, harsh environment—they’ve streamlined red tape, and provide strong vocational training.

Do small businesses stay small forever?

Anu: Some do, yes…but when we looked at the data over a 15-year period we found that almost 19 percent of all the largest companies actually started as small businesses. So this gives us a sense of how things evolve.

The other trend which is really important is that at some point, less-productive firms will exit. Small businesses that are uncompetitive will down their shutters, or merge with others. But large businesses exit at a healthy rate, too–and that opens up opportunities for the newer, more productive, small businesses, right?

Never miss a story

Stay updated about McKinsey news as it happens