Select Committee on European Communities Twentieth Report


PART 2: BACKGROUND

The definition of SMEs

11. The European Commission adopted the present classification of SMEs in its Recommendation of 3 April 1996[2]. Although the number of employees is a key - and the best known - criterion, there are financial issues as well. The full criteria are summarised in Table 1.

TABLE 1: EU DEFINITIONS OF SMES

  
Micro
Small
Medium
i.  Number of employees
Up to 9
10 to 49
50 to 249
ii.  Independence less than 25 per cent owned by one or more enterprises falling outside the definition of an SME
and at least one of the following
  
  
  
iii.  Maximum turnover
  (in million ECUs)
-
7
40
iv.  Maximum balance-sheet total
  (in million ECUs)
-
5
27


12. The definition excludes enterprises in primary sectors of agriculture, fishery, horticulture, forestry etc. Such enterprises are not explicitly covered by the discussion in this report, although much of its content is also relevant to them.

Numbers, employment and turnover

13. The main indicators - numbers, employment and turnover - for SMEs and large scale enterprises (LSEs) within the EU are set out in table 2 below. By definition, these figures exclude the informal or underground economy. In the UK, for example, that has been estimated[3] as contributing some 6-8 per cent of the Gross Domestic Product.

TABLE 2: ENTERPRISES IN THE EU - MAIN INDICATORS 1996

  
SMEs
LSEs
SMEs & LSEs
  
Micro
Small
Medium
All SMEs
  
  
Number of enterprises (000)
17,285
1,105
165
18,555
35
18,590
Employment (000)
37,000
21,110
15,070
73,180
38,220
111,410
Employees per enterprise
2
20
90
4
1,035
6
Turnover per enterprise (m ECUs)
0.2
3.0
16.0
0.5
175.0
0.8
Value added per occu-pied person (000 ECUs)
30
40
50
35
55
40
Source: ENSR[4]


14. As shown, there are over 18 million individual enterprises in the EU, over 99 per cent of which fall within the definition of SMEs - indeed, well over 90 per cent are categorised as "micro". SMEs account for two thirds of the EU workforce and 55 per cent of business turnover.

Sectoral distribution and performance

15. Small enterprises are more common in the service sector than in manufacturing, although we recognise the increased blurring of these boundaries under the impact of flexible manufacturing techniques and information technology. In the EU, approximately 70 per cent of the jobs in the service sector are in SMEs. The trend towards increasingly knowledge-based economies is likely to favour service sector SMEs. The flexibility of SMEs makes them well suited to an economic system characterised by co-operative and synergistic alliances, as advances in telecommunication technology and data processing capabilities, discoveries in science, and social changes have transformed the business environment. Table 3 illustrates the 1996 sectoral distribution and performance of SMEs in Western Europe.

TABLE 3: SECTORAL SME COMPARISONS, WESTERN EUROPE (EUROPEAN ECONOMIC AREA PLUS SWITZERLAND), 1996

  
Average number of employees per enterprise
Labour productivity
(SME value added per occupied person as a percentage of sector average)
Relative profitability
(SME average minus sectoral average, measured by value added minus labour cost, as a percentage of value added)
Extraction
33
84
-7
Manufacturing
14
88
-4
Construction
4
97
-1
Wholesale trade
6
89
-5
Retail distribution
4
95
-1
Transport, communication
9
72
-8
Producer services
5
78
-7
Personal services
5
96
-2
All SMEs
6
84
-6
Source: ENSR


16. As shown, the average size of enterprise is much smaller in the construction, retailing and service sectors than in manufacturing. In all sectors, the overall performance of SMEs, in terms of labour productivity and profitability, is below the average (although SMEs are of course extremely diverse in this, as in other, respects).

Trends in value added, employment and turnover

17. Over the decade to 1998, SMEs grew more slowly than LSEs in the EU as a whole, although in the UK there was no difference. In the EU and - especially in the UK - employment generally declined, but less in SMEs than in LSEs, while the change in profitability was the same for SMEs and LSEs. These trends for the larger EU Member States and the EU as a whole are shown in table 4 below.

TABLE 4: CHANGES IN SME AND LSE VALUE ADDED, EMPLOYMENT AND PROFITABILITY, 1988 TO 1998

   
Value added
(Average annual percentage change, adjusted for inflation)
Employment
(Average annual percentage change)
Profitability
(Average annual percentage points change)
 
SMEs
LSEs
SMEs
LSEs
SMEs
LSEs
France
1.3
2.0
-0.1
0.0
0.4
0.4
Germany
2.6
3.2
-0.1
-0.6
0.6
0.6
Italy
1.4
1.9
-0.7
-0.7
0.5
0.6
Spain
1.9
2.3
0.5
0.3
0.5
0.6
UK
1.7
1.7
-0.4
-0.9
0.1
0.1
All EU
1.9
2.3
-0.2
-0.5
0.4
0.4
Source: ENSR


18. The divergence in growth rates in value added began in 1993, possibly because LSEs were the main beneficiaries from export-led growth as the economy recovered from the recession of the early 1990s. Similarly, the greater decline in employment in LSEs was concentrated in the recession years 1990-93.

General characteristics of SMEs

19. Size is the only feature that SMEs have in common. The sector displays great diversity in the motivation for starting up businesses; the nature and volume of effort deployed to achieve success in business; aspirations for growth and for market penetration at both home and abroad; and in internal organisation - all as illustrated below.

    ·  There are among SMEs some "dynamic" businesses (including some future large enterprises), and - at other extreme - "lifestyle" businesses, where the proprietors' main priority is job satisfaction rather than expansion of the business.

    ·  While some SMEs are long established enterprises, business start-ups have a high failure rate.

    ·  Entrepreneurs manage their own enterprises. Other businesses are mainly run by managers on behalf of the owners.

    ·  Where the potential market is very large compared to the size of the firm, there is scope for expansion, but vulnerability to competition. Where the market is smaller, the firm faces limits to its growth although, in some instances, specialisation in niche markets may give protection from competition.

    ·  A firm with a large number of customers is not over dependent on individual customers - but relationships with individual customers may be weak. Conversely, a small customer base allows relationships to be strong - but with a danger of over-dependence.

    ·  A firm selling consumer products requires customer awareness, whereas suppliers to other companies may have problems with technical specifications.

    ·  Specialised and "hi-tech" operations employ highly skilled people, and need to ensure that their skills remain marketable. It is difficult for businesses with low skills to stand out from the competition.

    ·  High profitability may be an indicator of success, or of failure to spend adequately to ensure long term success. Low profits may indicate failure, or a transitional phase on the way to success.

    ·  Where turnover and profits are prone to fluctuate over time, the business has high risks and - possibly - high rewards over the long term. Where fluctuations are less, the risk is lower.

20. As a very broad generalisation, SMEs tend to have lower wages, higher insecurity and poorer working conditions than LSEs. Compared to LSEs, SMEs also employ a higher proportion of women and younger workers, and their workers tend to have lower educational attainment.

Key Policies at EU level

21. The purpose of enterprise policy at the EU level is mainly to enable businesses (including SMEs) to take advantage of the competitive opportunities offered by the European Single Market. The Single Market programme, formally completed in 1992, was designed to facilitate free movement of goods, services, capital and labour. Technical barriers to movement are diminished by harmonisation of standards at EU level or, in the absence of harmonisation, by mutual recognition of national standards. VAT levies and refunds at national frontiers have been superseded by a system of EC sales declarations.

22. Governments of EU Member States have been concerned to limit the impact of "harmful" tax competition in the Single Market. A Code of Conduct was agreed by the ECOFIN Council in December 1997, which restricts tax concessions which affect the location of business activity. In principle, tax concessions for SMEs could come within the Code of Conduct, although, as was noted in our recent report on taxes in the EU[5], the implications of the Code of Conduct are not clear.

23. The Commission has noted[6] "a perception ... that the principle of mutual recognition is not operating satisfactorily" and proposed a number of remedies, including:

    ·  monitoring of the application of mutual recognition;

    ·  dialogue with citizens and businesses;

    ·  training;

    ·  quicker responses to individual complaints; and

    ·  action by Member States to facilitate mutual recognition.

24. The cornerstone of EU policies for SMEs are the Multiannual Programmes (MAPs). The third MAP (1997-2000) is now well under way. This has an overall budget of ?128 million to pursue the following main objectives[7]:

    ·  to simplify and improve the administrative and regulatory business environment;

    ·  to improve SME policy instruments;

    ·  to improve the financial environment for enterprises;

    ·  to help SMEs to Europeanise and internationalise their strategies, in particular through better information and co-operation services;

    ·  to enhance SME competitiveness and improve access to research, innovation and training;

    ·  to promote entrepreneurship[8] and support target groups.

25. The MAP was the subject of a recent evaluation report by Deloitte & Touche[9]. This concluded that "DG XXIII[10] has a committed leadership ... continuing to keep SME and Enterprise issues at the forefront of the Union's agenda" and that "the real gains for DG XXIII often come from expert policy work", rather than pilot projects or provision of information. The cost-effectiveness of the Commission's activities under the MAP was characterised as "broadly acceptable", although "in some cases, there are grounds for concern, that the results of some of the pilot actions will be inadequately analysed and/or that the results will not be disseminated in a timely fashion".

Legislation

26. Administrative burdens are estimated to cost European businesses 540 billion ECUs/year (3 - 4 per cent of GDP) and SMEs are particularly hard hit[11]. To meet these concerns, the Commission procedure for developing legislative proposals includes a Business Impact Assessment (BIA). The Deloitte & Touche evaluation report concluded that the BIA system "does not work optimally, but the fact that BIAs must be done gives DG XXIII some leverage over the other DGs and scope to influence their activity ... the procedure is still cost-effective".

27. The EU has established the SLIM (Simplified Legislation in the Internal Market) project, to identify ways in which Single Market legislation can be made less burdensome for business. The Commission has also produced an action plan for SMEs, based on the recommendations of the Business Environment Simplification Task Force (BEST), which reported in May 1998[12]. BEST was established to propose measures to improve the quality of legislation and eliminate unnecessary burdens on enterprises. Its recommendations included the establishment of an EU Better Regulation Unit.

EU structural funds and other assistance

28. EU institutions make only limited use of financial instruments to assist SMEs. There is no organisation comparable to the US Small Business Administration (SBA) which has an extensive programme of support through loan guarantees. A European mechanism was established in November 1997 to finance high technology projects in small firms, with the collaboration of EU financing institutions including the European Investment Bank and the European Investment Fund[13].

29. Between 1994-99, 15-20 per cent (?23-30 billion) of Structural Fund resources were earmarked for measures to stimulate small firms and improve their productive facilities and economic environment. This was particularly targeted on SMEs in regions whose development is lagging behind, areas undergoing industrial conversion, rural areas and very thinly populated areas. Structural Fund financing supports[14]:

  • aid for capital investment through direct grants or financial engineering measures;
  • part-financing business start-up areas;
  • training, including management training;
  • advisory and information services;
  • measures to promote research and technological development;
  • measures relating to the information society;
  • assistance for internationalisation.

Competition policy

30. Competition policy at EU level has two facets: first, cartels, abuse of market dominance and mergers; and, second, the regulation of state aid. SMEs are unlikely to be constrained by the rules, because their scope for anti-competitive practices or abuse of market power is necessarily limited by their size. The Commission has acknowledged this: "agreements entered into by independent SMEs whose annual turnover and balance-sheet total do not exceed ECU 40 million and ECU 27 million respectively and which have a maximum of 250 employees will not in principle be investigated by the Commission"[15].

31. State aid to industry is regulated by the European Commission under Article 93 of the EC Treaty. The Commission has issued guidelines on state aid for SMEs[16] and, under Council Regulation (EC) No 994/98, may exempt aid for SMEs from the notification requirements of Article 93. In the period 1995-97, state aid targeted at SMEs accounted for 7 per cent of the total amount of state aid payments for manufacturing industry in the EU[17]. There is considerable variation between countries: the highest figure (for Finland) was 19 percent, while Greece had no state aid in this category. The UK figure was 9 per cent.

Key policies at national level

32. The monetary, fiscal, trade and other policies that bear on business generally also have an impact on SMEs. There is a general recognition that SMEs have a unique contribution to make towards the development of local economies, the promotion of technological change and the evolution of new industries. At the same time, it is also acknowledged that SMEs face particular problems as a result of their size and consequent circumstances.

33. Those problems, together with SMEs' potential for enhancing economic well-being, have led the governments of EU Member States to seek to create a favourable business environment through specific policy measures. These include general legislative measures (company law, bankruptcy and insolvency laws) together with the creation of relevant government bodies with specific responsibilities for regulation and promotion of SMEs. Table 5 gives a brief summary of the types of policies existing or proposed in a selection of EU Member States as of 1997.

TABLE 5: SUMMARY OF MEASURES DESIGNED TO ASSIST SMES IN LARGER EU MEMBER STATES 1997


34. In the UK, the national network of Business Links was completed in 1996. These are designed to provide a "one stop shop" for SMEs seeking advice and services. In 2000, a new Small Business Service (SBS) will be established in England[18]. It will have a budget of £100m, and, reporting directly to the Secretary of State for Trade and Industry, the right to scrutinise draft legislation. The SBS will act as an advocate for small businesses, and also take over responsibility for Business Links and the UK's Enterprise Fund for high technology companies. The SBS draws on the model of the US SBA, established in 1953, which provides financial, technical and management assistance to SMEs in the US. With a loan portfolio worth more than US$45 billion, the SBA is the largest single financial backer of small businesses in the United States. There is also an Advocate for Small Business who directly advises the President on the impact of proposed legislation.


2   Official Journal 1996 L 107/4. Back

3   Inland Revenue, House of Commons Treasury Committee 6th Report 1998-99 HC 199. Back

4   European Network for SME Research in The European Observatory for SMEs, fifth annual report, 1997, ISBN 90-371-0643-9.  Back

5   Taxes in the EU: can co-operation and competition co-exist?, HouseofLordsSelectCommitteeontheEuropeanCommunities,15thReport,1998-99,HLPaper92. Back

6   Mutual recognition in the context of the follow-up to the Action Plan for the Single Market, EC Communication COM(99)299. Back

7   9th Annual Report on the Structural Funds, 1997, European Commission (1998). Back

8   New measures to foster entrepreneurship have recently been proposed in the Global Entrepreneurship Monitor, London Business School and Apax Partners & Co, 1999. Back

9   Report on the evaluation of the third Multiannual Programme (MAP) for Small and Medium-sized Enterprises (SMEs) in the European Union, European Commission (1999), COM(99)319. Back

10   The then European Commission Directorate General with responsibility for SMEs. This role has been taken over by the Directorate General for Enterprise. Although DGs are no longer referred to by number, this Report makes a number of references to DGXXIII where it was the relevant DG at the time. Back

11   The Report on Regulatory Reform OECD (1998). The report recommended that regulations should be subject to rigorous appraisal, both when introduced and at regular intervals thereafter (a process known as "life cycle management of regulations"). Back

12   Report on the evaluation of the third Multiannual Programme (MAP) for Small and Medium-sized Enterprises (SMEs) in the European Union, European Commission (1999), COM(99)319. Back

13   9th Annual Report on the Structural Funds, 1997, European Commission.  Back

14   9th Annual Report on the Structural Funds, 1997, European Commission. Back

15   XXVIIth Report on Competition Policy, European Commission. Back

16   Official Journal 1996 C 213, European Commission. Back

17   Seventh Survey on State aid for manufacturing industry (1995-97), European Commission. Back

18   The Small Business Service: a public consultation, DTI 1999, URN 99/815. Back


 
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