September 2003 Economics & Strategy www.cibcwm.com/research Jeffrey Rubin Avery Shenfeld Benjamin Tal Peter Buchanan Warren Lovely Leslie Preston (416) 594-7357 (416) 594-7356 (416) 956-3698 (416) 594-7354 (416) 594-7359 (416) 956-3219 Contents EXECUTIVE SUMMARY ...................... 2 SMALL BUSINESS AND THE ECONOMIC CYCLE ....................... 4 Consumers—Key to Small Business Resiliency ......................... 5 Recent External Shocks Bruised Small Business .................................. 8 Dollar Appreciation ....................... 8 Impact of SARS, Mad Cow Disease, Softwood Lumber Dispute and Forest Fires ..................................... 11 Regional Performance .................. 12 THE NEXT TWELVE MONTHS ............ 15 THE BIGGER PICTURE ........................ 18 The Quest for Small Business Heaven ............................ 19 The Services Industry—The Main Engine of Small Business .............. 22 TEN THINGS YOU MIGHT NOT KNOW ABOUT CANADIAN SMALL BUSINESS .............................. 24 SMALL BUSINESS STATISTICS .......... 25 CANADIAN SMALL BUSINESS — A GROWING FORCE Benjamin Tal The likelihood is that by the end of the decade one in five Canadians will be his/her own boss. Irreversible forces such as the structural shift to a strong culture of individualism and self- betterment, the role of technology in driving the transition from boardrooms to basements, and the growing sophistication and rapid change in consumer tastes, all suggest that we are in the midst of a structural increase in the role played by small businesses in Canada’s social and economic landscape. This report explores the roles played by consumers and low interest rates in supporting small business activity and identifies the regions and sectors poised for growth in this dynamic segment of the Canadian economy. The impacts of a higher Canadian dollar and the other shocks which hit small business are also examined.
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September 2003
Economics & Strategywww.cibcwm.com/research
Jeffrey Rubin Avery Shenfeld Benjamin Tal Peter Buchanan Warren Lovely Leslie Preston
9.0% of All Small Business91 - Accommodation Service Industries92 - Food and Beverage Service Industries96 - Amusement and Recreational Service Industries
5) Limited Vulnerability 75.4% of All Small Business
10 Canadian Small Business — A Growing Force 11Canadian Small Business — A Growing Force
As illustrated in Table 2, approximately one in four small firms in Canada are
in sectors that are directly impacted by a stronger dollar. But one should not
lose sight of the indirect impact of a stronger currency (for example, a lawyer
whose main client is an exporting firm). All of this is consistent with the result
of a recent CFIB survey2, which suggests that 29% of small businesses face
reduced profit due to the strong dollar, while 21% are net beneficiaries. An
indirect benefit of a stronger dollar, which probably cannot be captured in any
survey, is that a higher dollar reduces the need to increase interest rates, and,
in fact, might lead to lower interest rates. This positive effect is much more
broadly-based, as it impacts the entire small business sector and not only those
firms that are affected by the value of the dollar.
Overall, we expect the Canadian dollar to trade at the $0.70-$0.75 (US) level in the
foreseeable future. While at this level many small firms will hardly be impacted,
one should not ignore the significant damage of the dollar appreciation on
sectors and regions that rely heavily on the manufacturing sectors and on exports
to the US. Heavy machinery, the auto sector and primary industries are some
examples. The tourism industry is another casualty of a strong dollar. Reduced
tourism via its negative impact on transportation, accommodation, food and
beverage services and other related services might cost the economy close to
$5 billion over the next twelve months. With small businesses accounting for
two-thirds of this industry, the fallout will be significant.
By region, small businesses in Ontario are the most vulnerable to the impact
of a stronger dollar — largely due to the province’s large exposure to the US
and its reliance on the auto industry. In addition, a disproportionately high
number of small businesses in Ontario are indirectly linked to large exporting
corporations. British Columbia is also highly sensitive to a rise in the dollar,
largely due to its reliance on the forestry industry. The surprisingly high rate of
dollar sensitivity of small businesses in the province of Quebec is in part due to
the importance of the forestry industry. Small firms in Alberta, Saskatchewan
and Newfoundland are less sensitive to the potential damage of a stronger
dollar, in part due to their reliance on the oil & gas sector (Table 3)3.
10 Canadian Small Business — A Growing Force 11Canadian Small Business — A Growing Force
TABLE 3Vulnerability of Small Business to Higher Dollar - By Province
The Impact of SARS, Mad Cow Disease, Softwood Lumber Dispute and Forest Fires — Narrow but Deep
According to a recent CFIB survey4, 8% of small businesses in Ontario were
significantly hurt by SARS, while 19% of small businesses in Alberta were
drastically damaged by the finding of a single case of mad cow disease in the
province. While these two shocks are (hopefully) a thing of the past, the same
cannot be said about the softwood lumber dispute with the US — a dispute
that is significantly hurting one-third of small businesses in British Columbia.
But an even greater challenge facing Canadian small businesses is the recent
hike in insurance prices, which according to the CFIB survey is considerably
hurting more than one-third of all small firms in the country.
These difficulties have been captured by recent economic statistics. We monitor
three different measures of small business economic activity: The CIBC World
Market Small Business Economic Activity Index; The Canadian Federation of
Independent Business (CFIB) Quarterly Business Barometer; and Industry Canada’s
Small Business Condition Survey. All measures showed a notable decline in
activity/sentiment in the second quarter. While this by itself, is hardly a surprise,
the more encouraging finding is that despite the major economic shocks to
small businesses over the past six months, all indexes remain at a relatively high
level — indicating resiliency in the face of difficult conditions (Chart 7).
Province Ranking by Higher Vulnerability
Ontario 1
British Columbia 2
Quebec 3
New Brunswick 4
Manitoba 5
Prince Edward Island 5
Nova Scotia 6
Alberta 7
Saskatchewan 8
Newfoundland & Labrador 8
12 Canadian Small Business — A Growing Force 13Canadian Small Business — A Growing Force
CHART 7Economic Shocks Have Damaged Small Business Activity
Calculated from Industry Canada's survey of business conditions for firms with less than $10 million in sales. Based on average Balance of Opinion.
Note that these statistics do not capture the impact of the recent blackout
in Ontario, which according to a recent CFIB survey has negatively impacted
more than 80% of small business in the province5. The survey indicates that
micro enterprises were hit about twice as hard as mid-size and larger firms.
While some of this damage will be recouped, there is little doubt that the
one-off damage to the small business sector in Ontario was significant.
REGIONAL PERFORMANCE
The most significant improvement in small business activity was in Ontario,
with the numbers of establishments with less than 50 employees rising by more
than 2% in 2002. In many respects this reflects the expanding service sector and
strong retail performance in the province. Currently, 36% of all small businesses
establishments are located in Ontario. Alberta, the host of 13% of Canadian
small businesses, also showed strong growth in business formation, reflecting the
positive spin-offs from the energy sector as well as robust consumer spending.
Despite a relatively strong economy, small business formation in Quebec, where
one in five Canadian small businesses are located, was weak with the number
of firms with less than 50 employees falling by 0.7% in 2002. This might reflect
the reliance of small firms in the province on the manufacturing sector, which
has yet to recover notably. The weakness in British Columbia (which is the base
0
1
2
3
4
5
2001 2002 2003
85
90
95
100
105
110
115
120
CIBCWM Small Business Economic Activity Index (L)
CFIB Quarterly Business Barometer (R)
y/y % chg Index 1988=100
-20
-15
-10
-5
0
5
2001 2002 2003
Small BusinessCondition Index
(Manufacturing Sector)
12 Canadian Small Business — A Growing Force 13Canadian Small Business — A Growing Force
of 14% of all small businesses) is a clear reflection of the overall soft economic
conditions in the province (Chart 8).
All the growth in small business formation during 2002 was in large urban
centres with the number of firms in rural areas falling by 0.5% during the year.
This trend is not new and has been observed over the past five years. Currently,
62% of Canadian small businesses are located in large urban centres with the
largest proportion (75%) being in Ontario. The fastest rate of growth in small
business formation in 2002 was in Oshawa, followed by Toronto (Chart 9).
CHART 8Business Formation By Province
Rate of GrowthDecember 2001 - December 2002
Distribution December 2002
0-49 Employees
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
Atl. Que. Ont. Man/SAS Alb. B.C.
Canada
%
0-49 Employees
Atl.6%
Que.23%
Man/Sask8%
Alb.13%
B.C.14%
Ont.36%
TABLE 4Growth in Business FormationBy Category and ProvinceDecember 2001 - December 2002
TABLE 5Share in Business FormationBy Category and ProvinceDecember 2002
0-49 Employees
Large UrbanCentres
Small Cities &Rural Area
CANADA 1.3% -0.5%
ATLANTIC -0.3% -2.4%
QUEBEC -0.4% -1.2%
ONTARIO 2.6% 0.4%
MANITOBA -0.2% -0.6%
SASKATCHEWAN 0.0% -1.0%
ALBERTA 2.3% 1.4%
BRITISH COLUMBIA 0.2% -0.8%
0-49 Employees
Large UrbanCentres
Small Cities &Rural Area
CANADA 62.0% 38.0%
ATLANTIC 27.4% 72.6%
QUEBEC 62.5% 37.5%
ONTARIO 74.9% 25.1%
MANITOBA 50.2% 49.8%
SASKATCHEWAN 29.3% 70.7%
ALBERTA 58.7% 41.3%
BRITISH COLUMBIA 60.4% 39.6%
14 Canadian Small Business — A Growing Force 15Canadian Small Business — A Growing Force
CHART 9Growth in Business Formation By Major CitiesDecember 2001 - December 2002
Firms with 0-49 Employees
-4 -3 -2 -1 0 1 2 3 4 5
Oshawa
Toronto
Calgary
Kitchener
Hamilton
Edmonton
Ottawa - Hull
Windsor
London
Victoria
St. Catharines - Niagara
Sherbrooke
Vancouver
Saskatoon
Halifax
Regina
Montréal
Winnipeg
St. John's
Sudbury
Thunder Bay
Trois-Rivières
Saint John
Québec
Chicoutimi - Jonquière%
14 Canadian Small Business — A Growing Force 15Canadian Small Business — A Growing Force
THE NEXT TWELVE MONTHS
With the economic shocks of 2003 resulting in sub-par growth during the year,
2004 is poised to be a recovery year. And, in fact, the ingredients for a firming in
economic activity by mid-2004 are already in place. Monetary policy is expected
to remain accommodative, with the Bank of Canada unlikely to raise rates until
late-2004. As well, the US manufacturing sector, an important engine of growth
for Canada, is in early stages of recovery. Having said that, the likelihood is that
overall growth in 2004 will remain below the economy’s potential growth rate
of 3%, reflecting the impact of the stronger dollar, weakening labour market
activity, and only a limited lift-off from the US economy. Accordingly, we expect
real GDP to expand by 2.8% in 2004 following a 1.9% growth in 2003 (Chart
10). Given that small firms tend to outpace the economy during recovery years,
small business economic activity is projected to rise by 3.5% next year. Note,
however, that the projected pace of growth is notably below the average rate
seen over the past five years.
CHART 10Economic Activity To Rebound In 2004
Quarterly Pattern
-1
0
1
2
3
4
5
6
7
01:4 02:3 03:2 04:1 04:4
y/y q/q (AR)
% chg
Forecast
16 Canadian Small Business — A Growing Force 17Canadian Small Business — A Growing Force
■ The retail sector, while not as strong as in 2002, continues to surprise
on the upside. Continued relatively strong demand for furniture and
appliances, along with solid spending on retail services, will more than
offset the projected softening in auto sales during 2004.
■ As mentioned earlier, the construction sector has been an important
engine behind recent small business economic activity. While this sector
is now at its peak, the overall level of activity will probably remain strong
for the next year or two. Housing starts in 2004 will remain at the 180,000
level, still a full 15% higher than their long-term average.
■ Assuming no other major economic shocks, the accommodation and
food services sector, a major small business force, should recover from a
disastrous 2003. But unlike the impact of the Iraq war and SARS, which
largely dissipated, the sector will continue to feel the negative effects of
the strong Canadian dollar.
■ While the forestry industry, where small businesses account for more than
two-thirds of total employment, is likely to struggle in the near-term,
there are many reasons to believe that by the end of the year, Canada
and the US will make progress in resolving the softwood lumber dispute.
This should ensure a recovery in 2004.
■ The concentration of small firms in the manufacturing sector is relatively
minor, but the indirect impact of this sector on the overall health of small
businesses via outsourcing and contracting should not be underestimated.
That is reflected in the fact that over time, trends in small and large firms
in the manufacturing sector are highly correlated (Chart 11). Without a
general recovery in that sector, small firms will not be able to grow and
expand to their fullest potential. In this regard, there are some reasons to
be cautiously optimistic. The US economy is in the early stages of recovery,
and while the magnitude of this upswing is still a matter of debate, the
likelihood is that 2004 will see the American economy expanding by
3%. That will be an important shot in the arm to a bruised Canadian
manufacturing sector, with growth in the industry during 2004 projected
at over 2.5%, following a very weak 2003.
16 Canadian Small Business — A Growing Force 17Canadian Small Business — A Growing Force
CHART 11Small and Large Firms in the Manufacturing Sector are Highly Inter-Related
18 Canadian Small Business — A Growing Force 19Canadian Small Business — A Growing Force
Beyond the cyclical upswing of the next year or two, small businesses will continue
to play an increasingly important role in the Canadian economy. In our previous
review of trends in small business, “Small Business: Today and Tomorrow”, we
identified key trends that will work to enhance the importance of the small
business sector and result in a situation in which, by the end of the decade,
one in five Canadians workers will be his/her own boss. The structural shift to
a strong culture of individualism and self-betterment; the role of technology in
driving the transition from boardrooms to basements; the more global and inter-
connected markets that require greater specialization, flexibility and speed; as
well as small business friendly demographic forces are among these forces (see
http://research.cibcwm.com/res/Eco/EcoResearch.html for a full discussion).
While many view small firms and large organizations as separate and, at times,
competing entities, this could not be further from the truth. Canadian small
businesses are in a co-evolutionary relationship with corporate business in the
economic landscape. Small businesses are needed by large corporations to create
the necessary reach and depth in local markets as distributors and agents for
products and services. Small businesses are important customers of the corporate
providers of basic technology and infrastructure and they create a diversity of
uses and the rapid exploitation of technologies and niche markets. Similarly,
small businesses provide many of the inputs to production, management and
distribution systems of corporate business.
Small business and large business not only work together, but are also dependent
upon each other. Small businesses exist to simultaneously service large business
and to fulfill the gaps left by large corporations. In fact, outsourcing activity
is playing a significant role behind small business success with one in two
Canadian businesses beginning operation after receiving their first outsourcing
contracts. Furthermore, two-thirds of Canadian entrepreneurs could not have
begun operations or survived without outsourcing (Table 6).
THE BIGGER PICTURE
18 Canadian Small Business — A Growing Force 19Canadian Small Business — A Growing Force
TABLE 6Outsourcing — An Important Source of Small Business Formation
Source: A Study of the Outsourcing Activities of Canadian Businesses : A Comparison of the Country's Four Major Regions, August 25, 2000, by Alain Halley, Ecole des Hautes Etudes Commerciales de Montreal (HEC)
Small businesses are also needed by society for employment and as an alternative
career. They are needed by consumers who increasingly demand customer service
and choice that requires niche-oriented suppliers. In short, the present-day
landscape favours not only the continuation of the role played by entrepreneurs,
but increasingly will turn them into a super-nova of power and influence.
THE QUEST FOR SMALL BUSINESS HEAVEN
Given this prognosis, we have decided to dig deeper and point to the regions
that are best positioned to take advantage of the projected structural increase
in small business activity. We identified eight macro factors that in aggregate
can help in determining which environment will be more beneficial for small
businesses in the coming five years:
■ Momentum Indicator — Growth in self-employment over the past five
years;
■ Economic Growth — The extent to which the macro environment supports
small business activity;
■ Industry Mix — The extent to which the fastest growing sectors in the
economy are also small business friendly;
■ Urban/Rural Mix — The concentration of small businesses in large urban
centres. In recent years, growth in small business formation in large urban
centres has outpaced growth in rural areas;
■ Small Business Survival Rate — the likelihood that a small business survives
beyond three years of existence6;
■ Net Migration — The contribution of new immigrants to growth in the
Quebec OntarioAtlantic Canada
Western Canada
TOTAL
Company created after receiving its first contract from a work provider
57.6% 45.1% 37.8% 43.7% 49.8%
Company created in another context 42.4% 54.9% 62.2% 56.3% 50.2%
20 Canadian Small Business — A Growing Force 21Canadian Small Business — A Growing Force
labour force. New immigrants have a higher tendency to become self-
employed;
■ Outsourcing Activity — The propensity by large corporations to outsource
core activity; and
■ Age Structure — Growth in the age group 35-55. This age group has a
higher propensity to become self-employed.
Table 7 provides a summary of the results. For each province, we aggregated
the findings and calculated a score which provides the relative prospects for
small businesses in the coming five years7.
Ontario has emerged as the most promising province for small business growth
in the coming five years, closely followed by Alberta. Small businesses in Ontario
will benefit from above-average economic growth, a favourable industry mix, a
strong wave of new immigrants, and relatively high levels of outsourcing activity.
While overall economic growth in Alberta will slow somewhat in the coming
few years, the level of activity will remain strong. The positive spin-offs from
the energy sector will continue to support small business and the favourable
industry mix in the province is a clear reflection of the increased diversification
of the Albertan economy. Projected above-average growth among workers in
the age-group 35-55 years is also a positive for overall small business activity
in Alberta. Quebec will remain a strong base for small business in the coming
five years, largely due to its expanding service industry, growing reliance on
manufacturing activity, and high level of co-operation between large and
small businesses. British Columbia, the province with the largest economic
contribution of small businesses, will remain an attractive spot for entrepreneurs
due to economic growth that is likely to match the national average, a high
small business survival rate, and a projected strong inflow of new immigrants.
While the Manitoba economy will be able to provide small businesses with a
gradually improving environment, the still large focus on rural areas and no
significant inflow of new immigrants will limit its potential. Saskatchewan’s
ranking reflects below national average projected growth, a less favourable
industry mix and high concentration of small businesses in rural areas. Low
economic growth, an unenviable sectoral mix and weak demographic factors
will be the main factors limiting small business growth in Atlantic Canada in
the coming five years.
20 Canadian Small Business — A Growing Force 21Canadian Small Business — A Growing Force
TABLE 7Ranking Small Business Potential By Province
Momentum Indicator
Economic Growth Industry Mix Rural/Urban Mix
Outsourcing
Growth in self-employment over the past five years
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This report does not take into account the investment objectives, financial situation or specific needs of any particular client of CIBC World Markets Inc. Before making an investment decision on the basis of any information contained in this report, the recipient should consider whether such information is appropriate given the recipient’s particular investment needs, objectives and financial circumstances. CIBC World Markets Inc. suggests that, prior to acting on any information contained herein, you contact one of our client advisers in your jurisdiction to discuss your particular circumstances. Since the levels and bases of taxation can change, any reference in this report to the impact of taxation should not be construed as offering tax advice; as with any transaction having potential tax implications, clients should consult with their own tax advisors. Past performance is not a guarantee of future results.
The information and any statistical data contained herein were obtained from sources that we believe to be reliable, but we do not represent that they are accurate or complete, and they should not be relied upon as such. All estimates and opinions expressed herein constitute judgements as of the date of this report and are subject to change without notice.
Although each company issuing this report is a wholly owned subsidiary of Canadian Imperial Bank of Commerce (“CIBC”), each is solely responsible for its contractual obligations and commitments, and any securities products offered or recommended to or purchased or sold in any client accounts (i) will not be insured by the Federal Deposit Insurance Corporation (“FDIC”), the Canada Deposit Insurance Corporation or other similar deposit insurance, (ii) will not be deposits or other obligations of CIBC, (iii) will not be endorsed or guaranteed by CIBC, and (iv) will be subject to investment risks, including possible loss of the principal invested. The CIBC trademark is used under license.
Unless indicated otherwise, data sources used in this study are Statistics Canada, Industry Canada and CIBC World Markets. As well, unless indicated otherwise, small businesses in this study are defined as firms with less than 50 employees.
Notes:
1. Canadian Bankers’ Association.
2. Canadian Federation of Independent Business (CFIB) “Quarterly Business Barometer” June 2003.
3. The ranking is based on the net trade position of a given province with the US.
4. Canadian Federation of Independent Business (CFIB) “Quarterly Business Barometer” June 2003.
5. Canadian Federation of Independent Business (CFIB) "Power Struggle: Survey Results on Impacts of the August 14 Power Failure in Ontario" September 2003.
6. John Baldwin et al., “Failure Rates for New Canadian Firms: New Perspective on Entry and Exit”, Statistics Canada, 2000.
7. The weights of the different variables are based on logistic regressions against overall small business activity in each province.
8. “The Regulation of Entry” Djankov et al., August 2000.
9. BC Stats.
10. Statistics Canada, Industrial Research and Development – 2002 Intentions, Cat. No. 88-202-XIB.