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attribution as requested by the work’s original creator or licensee.

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Preface

Imagine a text that your students might actually read. Imagine a book that is the core of your course without the bloat. Imagine a book that uses customer value, digital technology, and cash flow as key themes rather than afterthought add-ins. Imagine a text that contains extensive ancillary materials— PowerPoints, websites, videos, podcasts, and guides to software—all geared to enhancing the educational experience. Sound good? Small Business Management in the 21st Century is your text.

This text offers a unique perspective and set of capabilities for instructors. It is a text that believes “less can be more” and that small business management should not be treated as an abstract theoretical concept but as a practical human activity. It emphasizes clear illustrations and real-world examples.

The text has a format and structure that will be familiar to those who use other books on small business management, yet it brings a fresh perspective by incorporating three distinctive and unique themes that are embedded throughout the entire text. These themes ensure that students see the material in an integrated context rather than a stream of separate and distinct topics.

First, we incorporate the use of technology and e-business as a way to gain competitive advantage over larger rivals. Technology is omnipresent in today’s business world. Small business must use it to its advantage. We provide practical discussions and examples of how a small business can use these technologies without having extensive expertise or expenditures.

Second, we explicitly acknowledge the constant need to examine how decisions affect cash flow by incorporating cash flow impact content in several chapters. As the life blood of all organizations, cash flow implications must be a factor in all business decision making.

Third, we recognize the need to clearly identify sources of customer valueand bring that understanding to every decision. Decisions that do not add to customer value should be seriously reconsidered.

Another unique element of this text is the use of Disaster Watch scenarios. Few texts cover, in any detail, some of the major hazards that small business managers face. Disaster Watch scenarios, included in most chapters, cover topics that include financing, bankers, creditors, employees, economic downturns, and marketing challenges.

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Chapter 1

Foundations for Small Business

The Twenty-First-Century Small-Business Owner

Source: Used with permission from Frank C. Trotta III.

Frank Trotta III is a recent college graduate, class of 2009, and an excellent example of the

twenty-first-century small business owner. At 23, he is already running his own business and

planning to open a second. This may be second nature because Frank III is a third-generation

small business owner. His grandfather, Frank Trotta Sr., opened a supermarket in 1945. His son,

Frank C. Trotta Jr., began his career by working in the supermarket. Soon he had his own

hardware department within the store and was beginning to understand what it takes to be a

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successful grocer. He observed his dad interacting with his customers and providing value

through customer service.

Frank Jr. now owns and operates one of Long Island’s most successful travel companies: the

Prime Time Travel Club. The experience Frank Jr. garnered from his father in customer service

became the tenet of his business philosophy: give customers value through personal attention

and service. At an early age, Frank III worked in his dad’s office when he was not busy with

school activities. He had a strong entrepreneurial leaning and became very interested in the

travel industry. In high school, Frank III worked for his dad and learned different facets of the

travel business. While attending a Connecticut university, Frank III reached out to other

students on campus and started his own side business: booking spring break trips. The same

people are now repeat customers who call him to book their vacations, honeymoons, and family

trips.

In his junior year, Frank III created a travel site of his own: Cruisetoanywhere.com. He is

involved with every aspect of the site: he takes all calls from the customer service number,

produces all the marketing campaigns, and works on contracts with both major and smaller

cruise lines. Although the site is still young, it has been very successful. Frank III is learning how

larger competitors do business and from their successes and mistakes. Customer service and

attention are his first priority. Frank III believes his competitive business edge comes from what

he learned from his father’s company and business skills such as planning and managing cash

flow from his professors. In addition to his cruise website, Frank III plans to launch another site,

Tourstoanywhere.com. He exemplifies the skill set that will characterize the twenty-first-century

small business owner: a clear focus on creating value for his customers, a willingness to exploit

the benefits of digital technology and e-commerce, and the ability to apply basic business skills

to the effective operation of the firm.

1.1 Small Business in the US Economy

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L E A R N I N G O B J E C T I V E S

1. Explain the significance of small business in American history and the US economy.

2. Define small business.

3. Explain how small business contributes to the overall economy.

4. Explain how small business impacts US employment. It’s an exciting time to be in small business. This is certainly not anything new, but you might not know it. Scan any issue of the popular business press, and in all probability, you will find a cover story on one of America’s or the world’s major corporations or a spotlight on their CEOs. Newspapers, talk radio, and television seem to have an unlimited supply of pundits and politicians eager to pontificate on firms that have been labeled as “too big to fail.” Listen to any broadcast of a weekday’s evening news program, and there will be a segment that highlights the ups and downs of the Dow Jones Industrial Average and the Standard and Poor’s (S&P) 500. These market measures provide an insight into what is going on in Wall Street. However, they are clearly biased to not only large firms but also huge firms. This creates the false notion that “real” business is only about big business. It fails to recognize that small businesses are the overwhelming majority of all businesses in America; not only are the majority of jobs in small businesses, but small businesses have also been the major driving force in new job creation and innovation. Small business is the dynamo of innovation in our economy. In 2006, Thomas M. Sullivan, the chief counsel for advocacy of the Small Business Administration (SBA), said, “Small business is a major part of our economy,…small businesses innovate and create new jobs at a faster rate than their larger competitors. They are nimble, creative, and a vital part of every community across the country.” [1]

This text is devoted to small business, not entrepreneurship. There has always been a challenge to distinguish—correctly—between the small business owner and the entrepreneur. Some argue that there is no difference between the two terms. The word entrepreneur is derived from a French word for “to undertake,” which might indicate that entrepreneurs should be identified as those who start businesses. [2] However, this interpretation is too broad and is pointless as a means of distinguishing between the two. Some have tried to find differences based on background, education, or age.[3] Often one finds the argument that entrepreneurs have a different orientation toward risk than small business owners. The standard line is that entrepreneurs are willing to take great risks in starting an enterprise and/or willing to start again after a business failure. [4] Others try to make the distinction based on the issue of innovation or the degree of innovation. Given this focus, entrepreneurs need not even work for small business because they can come up with innovative products, services, production, or marketing processes in large organizations. [5] Perhaps the most common interpretation of the entrepreneur is an individual involved in a high-tech start-up who becomes a billionaire. That is not the focus of this text. It centers on the true driving force of America’s economy—the small business.

This chapter gives a brief history of small business in the United States, the critical importance of small business to the American economy, the challenges facing small business owners as they struggle to survive and prosper, the requisite skills to be an effective small business owner, the critical importance of ethical behavior, and how these businesses may evolve over time. In addition, three critical success factors for the twenty-first-century small business are threaded through the text: (1) identifying and providing customer value, (2) being able to exploit digital technologies with an emphasis on e-business and e-commerce, and (3) properly managing your cash flow. These three threads are essential to the successful decision making of any contemporary small business and should be considered of paramount importance. They are everyday considerations.

A Brief History of Small Business

Throughout American history, from colonial times until today, most businesses were small businesses, and they have played a vital role in America’s economic success and are a forge to our national identity. It would not be an exaggeration to say that the small businessperson has always held an important—even exalted—position in American life. Americans in the early republic were as suspicious of large economic

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enterprises as threats to their liberty as they were of large government. The historian James L. Houston discussed American suspicion of large economic enterprises: “Americans believed that if property was concentrated in the hands of a few in the republic, those few would use their wealth to control other citizens, seize political power, and warp the republic into an oligopoly.” [6] In fact, much of the impetus behind the Boston Tea Party was the fear on the part of local merchants and tradesmen that the East India Company, at that time the world’s largest corporation, was dumping low-priced tea in the colonies, which would have driven local business to ruin. [7] Jefferson’s promotion of the yeoman farmer, which included small merchants, as the bulwark of democracy stemmed from his fear of large moneyed interests: “The end of democracy and the defeat of the American Revolution will occur when government falls into the hands of lending institutions and moneyed incorporations.” [8] So great was the fear of the large aggregation of wealth that the colonies and the early republic placed severe restrictions on the creation of corporate forms. In the first decades of the nineteenth century, state governments restricted the corporate form by limiting its duration, geographic scope, size, and even profits. [9] This was done because of the concern that corporations had the potential of becoming monopolies that would drive entrepreneurs out of business.

Eventually, however, some businesses grew in size and power. Their growth and size necessitated the development of a professional management class that was distinct from entrepreneurs who started and ran their own businesses. However, not until the post–Civil War period did America see the true explosion in big businesses. This was brought about by several factors: the development of the mass market (facilitated by the railroads); increased capital requirement for mass production; and the 1886 Supreme Court case of Santa Clara County v. Southern Pacific Railroad, which granted corporations “personhood” by giving them protection under the Fourteenth Amendment.

The growth of corporations evoked several responses that were designed to protect small businesses from their larger competitors. The Interstate Commerce Act (1887) was a federal law designed to regulate the rates charged by railroads to protect small farmers and businesses. Other federal laws—the Sherman Act (1890) and the Clayton Act (1914)—were passed with the initial intent of restricting the unfair trading practices of trusts. In the early years, however, the Sherman Act was used more frequently against small business alliances and unions than against large businesses. Congress continued to support small businesses through the passage of legislation. The Robinson-Patman Act of 1936 and the Miller-Tydings Act of 1937 were designed to protect small retailers from large chain retailers. [10]

The Depression and the post–World War II environments posed special challenges to small business operations. The Hoover and Roosevelt administrations created organizations (the Reconstruction Finance Corporation in 1932 and the Small War Plants Corporation in 1942) to assist small firms. The functions of several government agencies were subsumed into the Small Business Administration in 1953. The designated purpose of the SBA was to “aid, counsel, assist and protect, insofar as is possible, the interests of small business concerns.” [11] The SBA functions to ensure that small businesses have a fair chance at securing government contracts. It also has the responsibility of defining what constitutes a small business.

If anything is to be learned from the passage of all this legislation, it is that, as Conte (2006) eloquently put it, “Americans continued to revere small businesspeople for their self-reliance and independence.” [12]

Definition of Small Business

The SBA definition of a small business has evolved over time and is dependent on the particular industry. In the 1950s, the SBA defined asmall business firm as “independently owned and operated…and not dominant in its field of operation.” [13] This is still part of their definition. At that time, the SBA classified a small firm as being limited to 250 employees for industrial organizations. Currently, this definition depends on the North American Industry Classification System (NAICS) for a business. The SBA recognizes that there are significant differences, across industries, with respect to competitiveness, entry and exit costs, distribution by size, growth rates, and technological change. Although the SBA defines 500 employees as the limit for the majority of industrial firms and receipts of $7 million for the majority of service, retail, and construction firms, there are different values for some industries. Table 1.1 "Examples of Size Limits for Small Businesses by the SBA" presents a selection of different industries and their size limits.

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Table 1.1 Examples of Size Limits for Small Businesses by the SBA

NAICS Code NAICS US Industry Title

Size Standards (Millions of $)

Size Standards (Number of Employees)

111333 Strawberry farming 0.75

113310 Timber tract operations 7.00

114112 Shellfish fishing 4.00

212210 Iron ore mining

500

236115 New single family housing construction 33.50

311230 Breakfast cereal manufacturer

1,000

315991 Hat, cap, and millenary manufacturing

500

443111 Household appliance store 9.00

454311 Heating oil dealers

50

483111 Deep sea freight transportation

500

484110 General freight trucking, local 25.50

511130 Book publishers

500

512230 Music publishers

500

541214 Payroll services 8.50

541362 Geophysical surveying and mapping services 4.50

541712

Research and development in physical,

500

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NAICS Code NAICS US Industry Title

Size Standards (Millions of $)

Size Standards (Number of Employees)

engineering, and life sciences

Except aircraft

1,500

722110 Full-service restaurants 7.00

722310 Food service contractors 20.50

811111 General automotive repair 7.00

812320 Dry cleaning and laundry services 4.50

813910 Business associations 7.00

Source: “Table of Small Business Size Standards Matched to North American Industry Classification System Codes,” US Small Business Administration, August 22, 2008, accessed June 1, 2012,http://www.sba.gov/content/small-business-size-standards.

The SBA definition of what constitutes a small business has practical significance. Small businesses have access to an extensive support network provided by the SBA. It runs the SCORE program, which has more than 12,000 volunteers who assist small firms with counseling and training. The SBA also operates Small Business Development Centers, Export Assistance Centers, and Women’s Business Centers. These centers provide comprehensive assistance to small firms. There can be significant economic support for small firms from the SBA. It offers a variety of guaranteed loan programs to start-ups and small firms. It assists small firms in acquiring access to nearly half a trillion dollars in federal contracts. In fact, legislation attempts to target 23 percent of this value for small firms. The SBA can also assist with financial aid following a disaster.

Small Business in the American Economy

In 1958, small business contributed 57 percent of the nation’s gross domestic product (GDP). This value dropped to 50 percent by 1980. What is remarkable is that this 50 percent figure has essentially held steady for the last thirty years. [14] It is interesting to note that the contribution of small businesses to the GDP can vary considerably based on particular industries.Table 1.2 "Small Businesses’ Component of Industry Contribution to GDP"presents data for selected industries for the period 1998–2004. It can be seen that in some industries—construction and real estate—80 percent or more of that industry’s contribution to the GDP comes from small businesses, while in the information industry that number is 20 percent or less.

Few people realize that the overwhelming majority of businesses in the United States are small businesses with fewer than five hundred employees. The SBA puts the number of small businesses at 99.7 percent of the total number of businesses in the United States. However, most of the businesses are nonemployee businesses (i.e., no paid employees) and are home based.

Table 1.2 Small Businesses’ Component of Industry Contribution to GDP

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Year Construction (%)

Real Estate and Leasing (%)

Wholesale Trade (%)

Transportation and Warehousing (%)

Information (%)

1998 88.0 80.4 59.1 39.1 26.4

1999 87.2 80.0 57.5 39.4 25.4

2000 85.4 79.8 56.8 39.0 22.7

2001 85.1 80.3 55.3 41.1 19.7

2002 84.6 79.4 56.3 41.0 20.3

2003 85.4 79.5 54.6 39.1 20.3

2004 85.6 79.6 55.4 38.6 18.0

Source: Katherine Kobe, “Small Business Share of GDP (Contract No. SBAHQ-05-M-0413),” SBA Office of Advocacy, April 2007, accessed October 7, 2011, http://archive.sba.gov/advo/research/rs299tot.pdf.

One area where the public has a better understanding of the strength of small business is in the area of innovation. Evidence dating back to the 1970s indicates that small businesses disproportionately produce innovations. [15] It has been estimated that 40 percent of America’s scientific and engineering talent is employed by small businesses. The same study found that small businesses that pursue patents produce thirteen to fourteen times as many patents per employee as their larger counterparts. Further, it has been found that these patents are twice as likely to be in the top 1 percent of highest impact patents. [16]

It is possible that small size might pose an advantage with respect to being more innovative. The reasons for this have been attributed to several factors:

• Passion. Small-business owners are interested in making businesses successful and are more open to new concepts and ideas to achieve that end.

• Customer connection. Being small, these firms better know their customers’ needs and therefore are better positioned to meet them.

• Agility. Being small, these firms can adapt more readily to changing environment.

• Willingness to experiment. Small-business owners are willing to risk failure on some experiments.

• Resource limitation. Having fewer resources, small businesses become adept at doing more with less.

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• Information sharing. Smaller size may mean that there is a tighter social network for sharing ideas. [17]

Regardless of the reasons, small businesses, particularly in high-tech industries, play a critical role in preserving American global competitiveness.

Small Business and National Employment

The majority—approximately 50.2 percent in 2006—of private sector employees work for small businesses. A breakdown of the percentage of private sector employees by firm size for the period 1988 to 2006 is provided in Table 1.3 "Percentage of Private Sector Employees by Firm Size". For 2006, slightly more than 18 percent of the entire private sector workforce was employed by firms with fewer than twenty employees. It is interesting to note that there can be significant difference in the percentage of employment by small business across states. Although the national average was 50.2 percent in 2006, the state with the lowest percentage working for small businesses was Florida with 44.0 percent, while the state with the highest percentage was Montana with a remarkable 69.8 percent. [18]

Table 1.3 Percentage of Private Sector Employees by Firm Size

Year 0–4 Employees

5–9 Employees

10–19 Employees

20–99 Employees

100–499 Employees

500+ Employees

1988 5.70% 6.90%% 8.26% 19.16% 14.53% 45.45%

1991 5.58% 6.69% 8.00% 18.58% 14.24% 46.91%

1994 5.50% 6.55% 7.80% 18.29% 14.60% 47.26%

1997 5.20% 4.95% 6.36% 16.23% 13.73% 53.54%

2000 4.90% 5.88% 7.26% 17.78% 14.26% 49.92%

2003 5.09% 5.94% 7.35% 17.80% 14.49% 49.34%

2006 4.97% 5.82% 7.24% 17.58% 14.62% 49.78%

Source: US Census Bureau, “Statistics of U.S. Business,” accessed October 7, 2011, http://www.census.gov/econ/susb.

Small business is the great generator of jobs. Recent data indicate that small businesses produced 64 percent of the net new jobs from 1993 to the third quarter of 2008. [19] This is not a recent phenomenon. Thirty years of research studies have consistently indicated that the driving force in fostering new job creation is the birth of new companies and the net additions coming from small businesses. In the 1990s, firms with fewer than twenty employees produced far more net jobs proportionally to their size, and two to three times as many jobs were created through new business formation than through job expansion in small businesses. [20] The US Census Bureau’s Business Dynamics Statistics data confirm that the greatest

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number of new jobs comes from the creation of new businesses. One can get a sense of the extent of net job change by business size in Table 1.4 "Job Creation by Firm Size".

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