Aug 22, 2019

The Relationship between Cities and Small Businesses

We hear from politicians, think tanks, and the media that small businesses are the backbone of the American economy. Even though the idiom is nebulous, the pervasiveness of small businesses throughout the United States is striking—80% of all US businesses have no employees at all beyond the owner, and over 99% of companies with employees have fewer than 500, according to a new JPMorgan Chase Institute report.  

The researchers, Diana Farrell and Chris Wheat, specifically looked at how small businesses interact with urban economies. They found that not only are small businesses crucial to the overall US economy, but these companies are important for their local economies, too.

“The financial and economic health of the small business sector can play a significant role in shaping the financial and economic health of local communities,” Farrell and Wheat wrote in the report, which was published in May 2019.” “Places with larger shares of small businesses have stronger per capita income growth, faster employment growth, and lower poverty rate.”

Small Businesses Experiencing Decreasing Revenue

The researchers looked at the financial transactions of nearly 300,000 businesses from 2013 to 2017 across 25 cities in the US.  

“Small businesses are one of the pillars of urban economies, making substantial contributions to economic growth and dynamism,” wrote Farrell and Wheat. “However, the fragility of the small business sector is an ongoing challenge that limits how much it contributes to economic growth in cities.”

They found that the annualized revenue growth rate for small businesses during this time is not very promising—a total average growth decrease of 0.76% across the 25 cities. The best city was San Francisco with a 2.6% annualized revenue growth rate, and the worst was Indianapolis, with -3.9% growth rate.  

Additionally, 9 out of 10 American cities are losing small businesses faster than they are adding them.

Of course, the fact that operating a small business is hard work is common knowledge, but further findings from Farrell and Wheat show what factors are driving the small business sector across urban America.  

New Firms Account for Most Revenue Growth

The first key point the researchers make is that new businesses account for most revenue growth in the small business sector, as well as the biggest growth in terms of net new employment. However, the contributions of new businesses to growth varies widely depending on the city.

In total, new firms have a 6% annual revenue growth rate, but that growth rate dropped by about 1 percentage point per year after their first year.

Location Matters

New small businesses in some cities saw growth far above this average—new businesses in Columbus, Ohio had a 13% annual revenue growth rate, the highest. San Francisco, Austin, Denver, New York, and Chicago also had above-average growth, while new firms in cities including Detroit, Portland, New Orleans, Sacramento, and Miami actually had negative growth rates. It seems that for new small businesses, location matters.

There is also an inequality to how small businesses grow revenue in a city—the researchers found that 5% of firms account for almost all of the aggregate revenue growth. Importantly, they saw that this growth is usually organic, meaning it was derived from earned profits instead of external financing.

Some Sectors Drive Growth More Than Others

The researchers found that, across most cities, some industries drive aggregate growth more than others. Small firms in construction, non-construction professional services, health care services, and high tech are the biggest growth drivers.

Even with these businesses, though, the amount of growth varies significantly depending on the city. Much of this depends on the physical development of the city, which benefits construction, as well as the skills of the workers based in the city.  

On the other hand, certain sectors lead in the number of shuttered small businesses across cities. Retail and other professional services, such as accounting, engineering, and legal, drive small business exits, the researchers found.  

Can Cities Change?

One goal of the report was to find how stakeholders across cities can better support local small businesses.

“These findings suggest that both local and national policymakers interested in the financial health of the small business sector might benefit from paying closer attention to themes that are similar across cities and important differences between cities,” the researchers said.

Supporting businesses as they age and experimenting how to boost businesses in sectors that lead in closures could improve growth, the researchers suggest.

“Across cities, a relatively small share of businesses drove aggregate revenue growth, but most of these firms grew without substantial reliance on external finance, and most of these firms were outside of industries typically thought of as high-growth,” reported Farrell and Wheat. 

Allowing for organic growth and reducing the number of exits in the small business sector can help the overall health of a city.

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About the author

Barry Eitel
Barry Eitel has written about business and technology for eight years, including working as a staff writer for Intuit's Small Business Center and as the Business Editor for the Piedmont Post, a weekly newspaper covering the city of Piedmont, California.

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