Here are five insights from our faculty about the financial risks and opportunities for small businesses today.
Climate change can hit small businesses particularly hard.
In a recent study, Kellogg’s Jacopo Ponticelli and colleagues looked at how US manufacturing companies of different sizes responded to extreme weather events from 1980 to 2019.
In the short term, the researchers found that high temperatures in particular increased costs (mainly in the electricity and fuel sectors, for temperature management) and hindered worker productivity—but only in factories with fewer than 50 workers. The larger facilities appeared unaffected by the temperature shocks soon after.
Over the four-decade period, the picture for small businesses was even bleaker. Areas that warmed faster saw a greater decrease in the number of small plants but no significant change in the number of large plants. The result, in the long run, is higher local concentration in the manufacturing industry.
The researchers point to three possible explanations for the adaptive superiority of larger firms. First, larger manufacturing plants are more likely to be part of a national or international network, which allows them to compensate for weather shocks by moving production when necessary. A second possibility is that larger firms have more consistent access to external financing, reducing their need to lay off workers or close factories when heat waves or natural disasters strike. The final possible explanation—and the most instructive, perhaps, for smaller firms—is the role of managerial foresight.
“It’s possible that larger companies have more forward-looking managers,” says Ponticelli, an associate professor of economics. Such managers could have proactively invested in building insulation, purchased equipment less prone to overheating, negotiated better deals with power companies, or installed solar energy systems. For small businesses in particular, then, thinking proactively about how to deal with climate change is just a good thing.
When Apple began urging iPhone users to opt out of sharing their data in 2021, it limited the ability of digital advertisers to track leads across all apps. The move, hailed as a victory for user privacy, ultimately cost major tech platforms billions of dollars.
But when Kellogg marketing professors Anna Tuchman and Nils Wernerfelt looked into the issue, they found very few studies showing the effect on businesses that advertised on these apps.
Tuchman, Wernerfelt and colleagues decided to fill the gap by conducting a large-scale experiment with more than 70,000 advertisers on Facebook and Instagram. They wanted to know how much companies benefit from using off-site data—that is, user data tracked and shared across apps—to serve targeted ads.
Quite a bit, as it turns out: the team found that removing the ability to use off-site data would result in a 35 percent increase in the cost of acquiring each new customer—and would disproportionately hurt smaller advertisers. In fact, their analysis showed that the impact of off-site data loss was five times greater for these advertisers than for larger ones. This is because small advertisers are often little known and rely on such off-site data and ad targeting to attract niche incremental customers.
This disadvantage is important to consider in policy making. “You can protect privacy that way, but it can come at a real cost on the advertiser’s side,” Wernerfelt says. “There is no privacy ‘free lunch’ here.”
All of this may seem like tough news for small businesses. But there are many ways for small but tough businesses to get ahead.
For example: larger loans. Not surprisingly, small businesses have historically relied on relatively modest loans when seeking to grow. But Kellogg’s Dean Karlan, professor of economics and finance, wanted to understand if and when more capital could help.
Karlan and his colleagues produced a study that aimed to answer two big questions: Do big loans help small businesses grow? And can lenders predict whether a particular company will effectively use a larger loan?
The results showed that larger loans had little effect on earnings on average. But importantly, the results differed widely among borrowers: top performers significantly increased earnings, while poor performers saw declines, suggesting that lenders would be wise to strategically select recipients of large loans.
Researchers were surprised to discover what differentiates successful borrowers from struggling borrowers. The mindset of loan borrowers proved to be highly predictive, as it turned out, much more so than education and experience levels or loan officer predictions.
In contrast, borrowers who fit the “protagonist” profile—strongly agreeing with the statements “Failure is not an option” and “I tend to act first and worry about the consequences later,” for example—did worse with large loans. The researchers hypothesize that more committed borrowers are more realistic about the possibility of failure and perhaps more risk averse.
So for small business owners whose egos are in check and their ambitions are realistic, a bigger loan can be a path to success.
Karlan also found that small businesses can benefit from working with consultants.
Researchers know that SMEs often struggle to expand beyond a certain size, particularly in developing economies like Mexico.
But why? One theory holds that business owners may lack the skills and business knowledge, such as managing people or creating a business plan, needed to help their companies get to the next level.
In a 2018 study of small businesses in Mexico, Karlan and colleagues examined whether working with an experienced consultant could fill these gaps in management expertise and help companies grow.
For the experiment, 80 randomly selected companies ended up as consultants. The consultants held a one-day diagnostic session with each company and then planned a consulting routine for the coming year. Meanwhile, a control group of 282 companies continued to operate as normal, without expert advice. A year later, the researchers found, the companies offered consultants saw both their productivity and return on assets increase relative to the control group.
Over the next five years, the average company that had received advice increased its staff by 57%, while the average company in the control group remained about the same size. In addition, the total wages paid by companies that had consultants increased by 72%, indicating that they were increasing workers’ compensation during this period as well.
After the first year of the experiment, the researchers conducted a survey asking company owners what had made their advisor so valuable. The responses varied widely: some said the consultants improved their marketing or accounting, while others pointed to different dimensions such as pricing or human resources.
The researchers also measured the owners’ “entrepreneurial spirit” and found that owners randomly selected to receive subsidized advice said they were more goal-oriented, driven and more confident in their problem-solving abilities than before from counseling.
The lesson for small business owners? Don’t be afraid to ask for expert advice. Your company can come out stronger for it.
While small businesses face unique challenges, they also have their own advantages.
An analysis by Kellogg marketing professor Gregory Carpenter and colleagues suggests that companies with smaller budgets can spend their R&D dollars differently than industry giants and achieve greater increases in sales and stock prices.
The researchers created a statistical model to assess how investments in different sectors affected product sales for 2,500 companies of all sizes in different industries. They found that while sales in the pharmaceutical industry were significantly affected by both marketing and R&D spending, consumer goods were only affected by marketing: R&D investment overall had little impact on sales.
Further analysis, however, revealed a difference between the much larger firms in their sample and the smaller firms. Unlike their giant counterparts, smaller businesses with tighter R&D budgets saw a significant impact of R&D spending on sales.
Finally, the researchers compared the performance of the giants P&G and Unilever with that of the much smaller Reckitt Benckiser. They found that over the past ten years, Reckitt Benckiser’s share prices have risen by almost 138 percent – more than four times that of P&G and Unilever.
The difference, the team suggests, comes not from how much a company spends on R&D, but from how it spends those dollars. Rather than aiming for major breakthroughs, Reckitt Benckiser’s modest R&D spending was aimed at meeting specific consumer needs, which produced a series of incremental but substantial innovations rather than an occasional blockbuster.
Larger companies could take a lesson from this success story by incorporating more customer research into their R&D efforts. “For a lot of consumer goods companies,” says Carpenter, “that really means bringing R&D to the fore and becoming an influential team member.”