Productivity in SMEs: Management Practices or Effective Leadership?

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As the UK has started to grapple with the challenge of stagnant productivity growth over the past decade, increased attention has turned to questions of how to raise productivity in the small and medium enterprise (SME) sector. This is one important element of the work of the Productivity Insights Network. SMEs are highly diverse and, while they account for three-fifths of UK private sector employment and just over half of UK business turnover, the range includes both ‘frontier’ performers and low productivity laggards.

A recent McKinsey Global Institute report provides a very comprehensive national-level analysis, highlighting both issues of changing demand patterns and patterns of business investment and innovation, as well as ‘deep dives’ into a number of key global business sectors. But the McKinsey analysis focuses very much on the significance of the big corporates and has relatively little to say about the importance of innovation and productivity in the small business sector. This is odd given the numerical importance of SMEs and the contribution of SMEs to the economy.

Influential recent research has focused on the importance of effective management practice as a driver of productivity. A recent survey conducted by the UK Office for National Statistics, covering 25,000 UK enterprises of all sizes across manufacturing and services, computes a management practices score (normalised as an index between 0 and 1) from reported use of a range of practices in four key areas of use: continuous improvement (lean) techniques, key performance indicators, management targets and employee performance. The key finding is that an improvement in the score of 0.1 in a given business is associated with a 9.6% improvement in labour productivity. However larger firms, and foreign-owned firms are much more likely to report higher use of management practices that smaller, and family-owned ones.

I want to highlight two particular issues relating productivity improvement in SMEs, in the particular context of small (below 50 employees) rather than medium sized businesses. The first concerns the importance of successful SME leadership. The second concerns the ‘mediation chain’ through which business practice translates into better productivity.

On the first of these, my own experience is that SMEs vary enormously in their attitudes to innovation and growth, and in the leadership capacity of their owner-managers. This is something that UK policy officials and statisticians in BEIS and ONS are beginning to recognise and investigate, and is central to the recent UK Industrial Strategy. Evaluation of hands-on working with SME owner-managers suggests that productivity improvement may be as much to do with the personal skills, attributes and mind-set of the business leader. It is only through improvements in leadership skill that SMEs are able to introduce effectively those changes in management practice, as seen in the ONS analysis, that lead to better productivity. We can’t assume, in the absence of any improved ability on the part of the business owner, that ‘box ticking’ a range of good management practices alone will enhance productivity.

On the second issue, my own recent research undertaken with my colleague Dr Meng Song at Cardiff Business School suggests the following. For the smallest of SMEs, it is the need to innovate, often to take advantage of emerging international market opportunities, that leads to productivity improvement. Yet in the recent sample of UK micro-businesses analysed, only 11% of micro-businesses (under 10 employees) have brought to the market new product, service or process innovation in the last three years, and only 17% derived any sales from exporting. However, the data suggest that it is the self-imposed discipline of selling internationally that necessitates innovation and leads to improved productivity. So management and leadership advice and support that promotes innovation and encourages exporting is most likely to yield better productivity for these businesses.

Both of these issues offer pointers towards why there is such a diversity of performance across the SME sector. They also suggest that the design of appropriate support for productivity enhancement in small businesses is challenging. It needs to be targeted carefully towards business owner-managers who have both an appreciation of the market opportunities they face, and a realistic appreciation of how and why their own management and leadership practices need to adapt to address those opportunities.

Andrew Henley