Focus

August 26, 2022 | 12:55

Small Businesses—Big Challenges

Economist

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Douglas Porter , CFA

Chief Economist and Managing Director
Economics

Douglas Porter has over 30 years of experience analyzing global economies and financial markets. As Chief Econom... (Read more)

Benjamin Reitzes

Managing Director, Canadian Rates & Macro Strategist
Fixed Income Strategy

Benjamin has been with the Bank of Montreal for over a decade. He is responsible for the Canadian macro-economic... (Read more)

Shelly Kaushik

Economist
Economics

Shelly joined BMO Economics in 2020 and conducts research on U.S. regional economies. She also provides support ... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Douglas Porter , CFA

Chief Economist and Managing Director
Economics

Douglas Porter has over 30 years of experience analyzing global economies and financial markets. As Chief Econom... (Read more)

Benjamin Reitzes

Managing Director, Canadian Rates & Macro Strategist
Fixed Income Strategy

Benjamin has been with the Bank of Montreal for over a decade. He is responsible for the Canadian macro-economic... (Read more)

Shelly Kaushik

Economist
Economics

Shelly joined BMO Economics in 2020 and conducts research on U.S. regional economies. She also provides support ... (Read more)

Feature

Small Businesses—Big Challenges

After struggling to navigate the pandemic waters, small business owners now face a barrage of new waves, from high inflation to staff shortages and supply chain glitches. Their seasickness casts a cloud over the economy.

There are several reasons why small businesses are struggling more than large firms. First, many operate in industries that were slammed by the pandemic and are thus on a weaker footing than bigger companies. For example, the leisure and hospitality sector is one of the few still operating with less staff than before the pandemic, as many workers have fled the sector (Chart 1). Second, many small shops cater to office commuters who are still working from home about half the time, on average, in U.S. cities. Third, construction accounts for a larger slice of payrolls at small companies, and the housing slowdown is hitting this sector hard. Fourth, although companies of all sizes borrowed to survive the pandemic, small firms likely took on more debt, as they usually can’t raise equity; and, this debt is now much more expensive. Fifth, small shops have a harder time retaining and keeping staff as they tend to provide less compensation and perks. They also have limited flexibility in dealing with staff illness. Sixth, small firms have less sway in influencing suppliers to maintain a steady flow of low-cost parts and materials. Seventh, they are also less able to pass higher costs to customers as many operate in highly competitive industries such as retail and dining. And finally, owners with low incomes spend more of their budget on necessities such as fuel, food, and rent, which are now much more expensive than before.

Not surprisingly, the data suggest small shops are having a rougher ride than large firms. Confidence among U.S. small business owners is close to a decade low and has fallen faster than that of corporate bosses (Chart 2). High inflation and labour quality are major gripes, with nearly half of small stores unable to fill positions. Canadian small business owners claim the outlook hasn’t been this bad since the pandemic shutdowns, though overall sentiment did improve slightly in August and remains less dire than in past recessions (Chart 3). Retailers and farmers are especially dour. Rising energy costs and wages are the biggest issues, while worker shortages pose the largest hurdle to growth.

The worst of the pandemic may be over, but many small stores still bear its effects. In late June, the Canadian Federation of Independent Business found that nearly two-thirds of small shops held debts incurred during the pandemic; nearly four-fifths suffered from pandemic-related stress; and, just over half were taking in less revenue than before the crisis. The Census Bureau’s Small Business Pulse Survey found that one-fifth of owners still claimed large negative effects of the pandemic in the spring. Given the high degree of uncertainty about the economy due to the possibility of continued high inflation, an escalation of the Ukraine war, and new variants of COVID-19, many small business owners are reluctant to expand, even at the risk of losing customers.

Therefore, it’s not surprising that payrolls at U.S. small shops shrank this spring, while large firms expanded their staff (Chart 4). However, the recent divergence should not be overstated, as the net increase in payrolls (regardless of firm size) has been similar in the past 2½ years. The dip for small firms follows a period of strength when pandemic restrictions were lifted. This was notable in construction and retail, sectors dominated by sole proprietorships, as well as in health care, which saw higher demand from illnesses and an aging population. Moreover, several large firms recently announced plans to lay off staff. In Canada, however, payrolls at large firms have risen more than twice as fast since February 2020 than staff at small shops.

Despite the downturn in confidence, U.S. business applications are elevated, while the number of openings in Canada is still above pre-virus levels (Chart 5). This suggests entrepreneurs remain optimistic about the longer-run outlook at least.

It’s worth asking whether the sour mood of small businesses foreshadows wider economic pain. As shown in Chart 6, confidence among small business owners tends to sag well before the economy contracts (the one exception was the U.S. double-dip recession in 1982). Still, levels matter, and the current degree of pessimism is generally more consistent with a moderate slump than a deep downturn.

Bottom Line: Compared with big firms, small businesses are having a tougher time dealing with a slew of economic ills. While their challenges may not yet flag a painful reckoning for the economy, a further lurch downward in sentiment would be concerning.