Why British businesses don’t scale up

OFF a posh square in the south-western city of Bath, Dominic and Ali Bevan are honing their assault on Britain’s lucrative wedding gift market. For now, it is dominated by high street behemoths such as John Lewis. The Bevans set up their company, Prezola, four years ago with £50,000 worth of savings, and by aggregating wedding gifts from over 300 brands onto one website have built a business with an annual turnover of £10m and a staff of 42. They hope to hit £16m next year.

In some respects Prezola is typical: Britain has become a nation of startups. Last year 608,100 new companies were formed, a record. Ever more Britons are prepared, like the Bevans, literally to stake their house on an entrepreneurial hunch.

Yet in another respect the Bath company is all too rare. Britain might be good at startups, but it remains poor at helping them grow. The country has about 5.5m businesses in total, of which 99% count as small or medium-sized enterprises (SMEs). Many of them remain very small indeed—about 4m are sole traders—and many barely grow at all. Those that do, the high-growth companies (HGCs), defined as businesses with more than ten employees that grow by at least 20% over three years in revenues or employees, remain a tiny minority: last year there were just 11,575. Fewer than 4% of startups have ten or more employees after their first decade. This is not too bad compared with much of Europe, but well behind America, where firms are more likely either to soar or crash, rather than plodding along as many British enterprises do.

Many SMEs are quite happy not to grow. But the evidence shows that many others want to, but cannot. The continuing reluctance of banks to lend to firms in startup mode and beyond is one reason for this, but companies also struggle to attract the necessary skilled workers, and often lack the appropriate management skills. Having a biggish domestic market also means the many small firms don’t feel any need to try exporting.

The long tail of underachieving, small companies might have been good at generating jobs after the post-2008 recession, and people are generally more happy working for themselves. But increasingly economists worry that it might be one explanation for Britain’s low productivity. This is notoriously hard to measure. But there is broad agreement that Britain’s is relatively low by rich country standards, and that the country’s large number of very small firms has something to do with it. Government data show that whereas firms with 10-49 employees have an average turnover per person of £134,000, that figure increases to £170,000 for firms with over 250 employees.

These larger companies account for 0.7% of America’s firms, but only for 0.4% of Britain’s. Furthermore, those firms that do scale up generate a disproportionate amount of economic growth. An often-cited paper by Nesta, a think-tank, argues that between 2002 and 2008 the 6% of British businesses with the highest growth rates generated half of all the new jobs created by existing companies.

The implication is clear, argues Paul Nightingale of the University of Sussex. Previous governments were good at encouraging what Mr Nightingale calls muppets, or “marginal undersized poor performance enterprises”. Now they should focus on “gazelles”, the HGCs. He says the government has yet to catch up on the academic research in this area.

It’s time to play the music

There are signs, however, that policy is shifting a little. In his Autumn Statement on November 23rd the chancellor of the exchequer, Philip Hammond, announced that he would give £400m to venture capital funds specifically to invest in startups that want to scale up.

Yet this money, spread over the next four years, won’t do much. In Wiltshire, Robert Perks runs the country’s first local outfit dedicated to helping companies scale up. It is funded by businesses and government. He argues that what firms most need are management skills, and so he arranges mentoring for entrepreneurs who want their companies to grow. Management in Britain is distinctly average, and is most obviously improved by exposure to foreign markets and even takeovers. But, since most SMEs do not export, this remains a problem.

In the absence of home-grown skills, argues Mr Perks, the government needs more immigrants. And to keep the increasing volumes of venture capitalists’ money coming into HGCs, investors must be able to exit easily when companies mature, for instance by selling to bigger foreign companies, so they can take their profits and pour them into new projects. Encouraging more immigration and foreign takeovers; just the ticket for the prime minister’s new brand of Conservatism.