Bruised But Not Battered by Benjamin Tal

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1 Small Business Report October 5, 2009 April 17, 2007 Economics Avery Shenfeld (416) Benjamin Tal (416) Peter Buchanan (416) Warren Lovely (416) Meny Grauman (416) Krishen Rangasamy (416) Bruised But Not Battered by Benjamin Tal Against all odds Canadian small- and medium-sized enterprises (SMEs) were not only able to endure the recent recession with less damage than in any other postwar recession, but also to outperform their larger, more established, peers. Can SMEs maintain their advantage during the upcoming recovery? The short answer is yes. The domestic orientation of most SMEs makes them more exposed to ongoing fiscal and monetary stimulus and will partly shield them from the soaring dollar and weak export market in SME Outperforming This Time Around By almost any measure, Canadian SMEs surprised on the upside during the recent recession. The number of these enterprises, in fact, rose during the year ending March 2009, while the cumulative number of business bankruptcies during the year ending July 2009 is still 6.1% below the same period in the previous year. As well, SME employment was hardly changed during the first six months of 2009 vs. a 10% drop among larger companies (Chart 1). The Canadian Federation of Independent Business Confidence Index is now at a twoyear high, and CIBC s SME economic activity index fell by only 3% (AR) during the year ending June 2009 vs. a 4.7% (AR) drop in the economy as a whole (Chart 2). This is in sharp contrast to the situation in the US where SME activity has plummeted during the recession. The secret behind SME s outperformance lies in the relative strength of the Canadian consumer. The consumer is the chief determinant of the destiny of a SME, and more confident consumers are a precondition for success. By almost any measure, Canadian consumers are outpacing not only their American counterparts but also any other consumer sector in the G-7. The duration of unemployment in Canada, while Chart 1 Employment Growth By Firm Size No. of Emp < Q4-2009Q % Source: Industry Canada, CIBC Chart 2 CIBC's SME Economic Activity Index % GDP SME's Econ Activity Index Source: Statistics Canada, CIBC Fcst CIBC World Markets Inc. PO Box 500, 161 Bay Street, Brookfield Place, Toronto, Canada M5J 2S8 WGEC1 (416) C I B C W o r l d M a r k e t s C o r p M a d i s o n A v e n u e, N e w Yo r k, N Y ( ) , ( )

2 rising, is still well below the level seen in any other G-7 country and any equivalent point in previous recessions. Canadian households sit on three times more cash than in the US, income growth in Canada over the past two years was twice as fast as in the US, and the 6.5% decline in net wealth since the beginning of the crisis was only a fraction of the drop seen stateside (Table 1). Table 1 Canada Better Positioned Than the US Chart 3 Canadians Less Traumatized Than Americans Aug-07 Mar-08 Oct-08 May-09 Canada Canada Consumer Confidence Index* (Jan07=100) US US Avg. Duration of Unemployment in weeks as of Aug09 (on a 3-mn mov avg. basis) Change in Employment Quality Index since Dec07 (%) Change in number of Business Bankruptcies since Dec07 (%) Change in Real Disposable Income since Dec07 (%) Change in Net Worth since Dec07 (%) Excess Cash held by Households as a share of Market Cap (%) Source: Statistics Canada, CIBC And those small pockets of success made a significant difference in how the recession impacted the psyche of consumers in Canada. After falling during the recession, consumer confidence in Canada has made a strong comeback, as opposed to the US where confidence has only improved marginally from a deeper recessionary hit (Chart 3). Higher confidence means that every basis point cut in interest rates by the Bank of Canada achieves much more consumer spending here than stateside, as Canadians are more willing to take on debt. That can be seen in the still-strong credit numbers in Canada and lessthan-stellar credit conditions in the US. So, not only is the financial sector in Canada in a much better position to provide credit, but Canadian consumers are in a better position to receive that credit as their balance sheets have not been as hard hit by housing market developments as their American counterparts. In a final analysis, Canadian consumers have outperformed due to the simple fact that this recession was made-inthe-usa, not Canada. The resiliency of the SME sector will likely see it continue to play an increasingly important role in the Canadian economy as we rebound from the current recession. The domestic orientation of SMEs is also shielding it from the recent rise in the value of the Canadian dollar. To be sure, the strong currency will have a negative impact on the sector, but the damage will be much less significant than seen among larger corporations. More specifically a strong dollar is particularly harmful to the 20% of enterprises that export their products and to those firms that have direct links to larger exporting firms. Vulnerability to increased import penetration and reduced tourism are also important negatives. At the same time, the increase in the value of the dollar means cheaper imports a clear positive for small firms that import raw materials or finished goods. As illustrated in Table 2, only one in four SMEs in Canada are in sectors that are directly impacted by a stronger dollar. By region, SMEs in Ontario are the most vulnerable to the impact of a stronger dollar largely due to the province s large exposure to the US and its reliance on the auto industry. In addition, disproportionately high numbers of SMEs in Ontario are indirectly linked to large exporting corporations. British Columbia is also highly sensitive to a rise in the dollar, largely due to its reliance on the forestry industry. The surprisingly high rate of dollar sensitivity of these enterprises in the province of Quebec is likely due to its reliance on the forestry industry, and its indirect exposure to the US market via Ontario. However, SMEs in Alberta, Saskatchewan, and Newfoundland & Labrador are less sensitive to the potential damage of a stronger dollar, in part due to their reliance on the oil & gas sector. * Source: Conference Board, CIBC 2

3 Table 2 Distribution of SMEs Based On Vulnerability to Higher C$ 1) Vulnerability Due To Both High Share of Exports and High Rate of Import Penetration 26 - Furniture and Fixture Industries 1.7% of All SME 33 - Electrical and Electronic Products Industries 2) Vulnerability Due To High Share of Exports 04 - Logging Industry 05 - Forestry Services Industry 06 - Mining Industries 25 - Wood Industries 27 - Paper and Allied Products Industries 29 - Primary Metal Industries 31 - Machinery Industries (Except Electrical Machinery) 11.3% of All SME 32 - Transportation Equipment Industries 37 - Chemical and Chemical Products Industries 39 - Other Manufacturing Industries 45 - Transportation Industries 55 - Motor Vehicle, Parts and Accessories Industries, Wholesale 56 - Metals, Hardware, Plumbing, Heating and Building Materials Industries, Wholesale 57 - Machinery, Equipment and Supplies Industries, Wholesale 3) Vulnerability Due To Increased Import Penetration 10 - Food Industries 11 - Beverage Industries 12 - Tobacco Products Industries 18 - Primary Textile Industries 2.6% of All SME 24 - Clothing Industries 28 - Printing, Publishing and Allied Industries 30 - Fabricated Metal Products Industries (Except Machinery and Transp. Equip. Industries) 4) Vulnerability Due To Reduced Tourism 91 - Accommodation Service Industries 9.0% of All SME 92 - Food and Beverage Service Industries 96 - Amusement and Recreational Service Industries 5) Limited Vulnerability 75.4% of All SME Where Will SMEs Bloom? Beyond the cyclical upswing of the next year or two, SMEs will continue to play an increasingly important role in the Canadian economy. In our previous review of trends in the SME sector, we have identified key drivers that will work to enhance the importance of SMEs and result in a situation in which one in five Canadians workers will end up being his/her own boss. These forces include the structural shift to a strong culture of individualism and self-betterment; the role of technology in driving the transition from boardrooms to basements; the more global and inter-connected markets that require greater specialization; flexibility and speed; as well as SME-friendly demographic push. While many view SMEs and large organizations as separate and at times competing entities, this could not be further from the truth. Canadian SMEs are in a co-evolutionary relationship with corporate businesses in the economic landscape. SMEs are needed by large corporations to create the necessary reach and depth in local markets as distributors and agents for products and services. They are important customers of the corporate providers of basic technology and infrastructure and they create a diversity 3

4 of uses and the rapid exploitation of technologies and niche markets. Similarly, SMEs provide many of the inputs to production, management and distribution systems of corporate business. SMEs and large businesses not only work together but are also dependent upon each other. SMEs exist to simultaneously service large businesses and to fulfill the gaps left by them. In fact, outsourcing activity is playing a significant role behind the sucess of SMEs with one in two Canadian businesses beginning operation after receiving their first outsourcing contracts. Furthermore, two-thirds of Canadian SMEs could not have begun operations or survived without outsourcing. SMEs are also needed by society for employment and as an alternative career. They are needed by consumers who increasingly demand customer service and choice that requires niche-oriented suppliers. In short, the presentday landscape favours not only the continuation of the role played by SMEs, but increasingly will turn them into a centre of power and influence. Given this prognosis, we have determined the regions that are most likely to benefit from the projected structural increase in SME activity. We identified eight macro factors that in aggregate can help us to determine regional growth for SMEs in the coming five years: Macro Factors Momentum indicator Growth in self-employment over the past three years. Economic Growth The extent to which the macro environment supports SME activity. Sectoral Mix The extent to which the fastest growing sectors in the economy are also SME-friendly. Urban/Rural Mix The concentration of SMEs in large urban centers. Recent years have seen growth in SME formation in large urban centers outpacing growth in rural areas. SME Survival Rate The likelihood that an SME survives beyond three years of existence. Net Migration The contribution of new immigrants to growth in the labour force. The motivation here is that new immigrants have a higher tendency to become selfemployed. Outsourcing Activity The propensity by large corporations to outsource core activity. Age Structure Growth in the age group. This age group has the highest propensity to become selfemployed. Table 3 provides a summary of the results. For each province, we aggregated the findings and calculated a score which indicates relative prospects for SMEs in the coming five years. We then ranked the provinces according to their scores. SME Outlook by Province Alberta has emerged as the most promising province for SME growth in the coming five years, closely followed by Ontario. SMEs in Alberta will benefit from above average economic growth and a favourable industry mix. At the same time, while the Ontario s overall economy will see below average economic growth, it is still enjoying an SME-friendly industry expansion, a high concentration of SMEs in the province s urban centres as well as strong outsourcing activity and a relatively strong growth in the age cohort. British Columbia, the province with the largest economic contribution from small business, will remain an attractive spot for SMEs due to economic growth that is likely to match the national average, high small business survival rates, and a projected strong inflow of new immigrants. Quebec will remain a strong base for small business in the coming five years, largely due to its expanding service industry and high level of cooperation between large companies and SMEs. Saskatchewan s ranking reflects above national average projected growth but it is held back by less favourable sectoral mix and high concentration of SMEs in rural areas. In Manitoba, the economy will be able to provide small business with a gradually improving environment, but the still large focus on rural areas and no significant inflow of new immigrants will limit its potential. Lower economic growth and unenviable sectoral mix will be the main factors limiting small business growth in Atlantic Canada in the coming five years.

5 Table 3 Ranking SMEs Activity By Province Momentum Indicator Economic Growth Industry Mix Rural/Urban Mix Outsourcing Growth in selfemployment over the past five years Projected average annual GDP Growth for Share of selfemployed in industries with above-average projected growth. Base: Total selfemployed Share of SME in large urban centers Share of SME that are subcontractors for other companies BC 6.9% 2.3% 44.8% 61.4% 61.3% Alberta 8.2% 2.5% 46.0% 60.5% 61.3% Saskatchewan -7.5% 2.9% 27.6% 33.7% 61.3% Manitoba -3.9% 2.3% 37.0% 53.2% 61.3% Ontario 3.8% 1.6% 51.4% 78.3% 66.0% Quebec -10.2% 2.0% 47.2% 63.8% 64.2% New Brunswick -8.6% 2.0% 41.0% 30.7% 62.7% Nova Scotia -1.0% 2.0% 40.4% 30.7% 62.7% PEI -4.7% 1.8% 28.8% 30.7% 62.7% Newfoundland & Labrador -4.0% 2.0% 32.7% 30.7% 62.7% Survival Rate Probability of staying in business for more than 3 years -- SME (6-50 employees) Immigration Share of foreign-born population (2006) Age Projected growth in the age group ( ) BC 68% 26.1% 4.4% Alberta 65% 14.9% 2.8% Saskatchewan 65% 5.0% -1.1% Manitoba 65% 12.1% -0.9% Ontario 69% 26.8% 4.3% Quebec 68% 9.9% -3.7% New Brunswick 65% 3.1% -2.0% Nova Scotia 65% 4.6% -1.3% PEI 65% 3.1% -0.5% Newfoundland & Labrador 65% 1.6% -3.7% SCORE Alberta 10.0 Ontario 9.8 BC 9.5 Quebec 9.5 Saskatchewan 9.2 Manitoba 9.0 Nova Scotia 8.8 PEI 8.8 New Brunswick 8.7 Newfoundland & Labrador 8.5 Data sources used in this study: Statistics Canada published and unpublished tabulations, Industry Canada, The Conference Board of Canada, Decima research and CIBC 5

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