Chapter 3. Market conditions

Prevailing and expected market conditions are important determinants that shape firms’ decision making - whether they scale up or down – or whether new firms are able to enter the market. Firms adapt to market conditions through a range of strategies, e.g. innovation, competition, co-operation or collusion, which can alter market structure and the distribution of market power, with particular impacts on SMEs. This chapter presents recent developments in business conditions from a local, national and global perspective. It shows that although global market conditions for SMEs have improved in recent years, they are particularly exposed to slowing economic growth, trade tensions and retrenchments in global value chains (GVCs), and describes how digitalisation, specialisation and concentration are reconfiguring domestic markets. It also looks at the limited SME participation in public procurement. The chapter concludes with recent policy developments aiming to increase SME participation in GVCs and level the playing field in product markets, public procurement and lead markets, such as circular economy. The chapter gives a particular focus to subnational policy initiatives.

Highlights

Market conditions for SMEs have improved but there are signs that the global economic expansion has now peaked. Fragile economic prospects and inflation pressure may lead to abrupt shifts in market sentiment and higher interest rates and weigh down on SME business and financial capacity.
Trade tensions may also darken the SME outlook as they weaken business confidence and investment. In the event of a new slowdown, SMEs are likely to be hard hit.
Global value chains (GVCs), a major channel of SME internationalisation, have lost momentum since the crisis.
Emerging technologies, such as robotics or 3D printing, may work to reduce the scale of fragmentation, and lead to reshoring, as multinationals aim to improve supply chain resilience and flexibility, but the consequences on the SME sector are uncertain.
Global foreign direct investment (FDI) has slowed reaching its lowest levels since 2013. FDI is increasingly targeted towards the acquisition of digital assets, reinforcing the role of multinationals (MNEs) in building the global digital infrastructure, and the importance of MNE-SME linkages for SME upgrading.
Digitalisation and GVCs allow product differentiation and specialisation, and have durably altered SME market conditions and reduced the efficient firm size. Yet, there are signs of market concentration across many industries.
Governments are paying close attention to market conditions that have significant impacts on SMEs: competition (e.g. by removing anticompetitive regulations); public procurement (e.g. through targeted programmes for increasing SME capacities to bid); and lead markets (e.g. through innovative procurement or support for SME uptake of innovations).
Governments are also helping SMEs overcome difficulties in accessing global markets. National approaches differ. Some incorporate SMEs into broader internationalisation strategies while others adopt more targeted policies. The local dimension appears key for policy implementation.

Why is it important?

Market conditions are of critical importance for SMEs to do business, innovate, compete, increase revenue and profitability and grow. Poor market conditions are a core factor of failure for SMEs, and SME surveys reveal that they are at the heart of their preoccupations (Facebook/OECD/World Bank, 2018[1]).

Market conditions and the optimal size of firms

Markets have a broad range of features, including their size, structure, degree of competition, specialisation, sophistication or digitalisation, their international openness or their informality, that all matter for SMEs.

Prevailing, and expectations of, market conditions determine the optimal size of firms and whether they scale up or down (Figure 3.1). Entry costs, factor endowment or sunk costs (e.g. advertising or R&D investment needed to remain at the frontier), for example, are important factors that determine the optimal size for a firm and its optimal profits (Annex Figure 3.B.1).

Figure 3.1. Market structure, firm conduct and performance

The broader business environment, whether local, national or international, is also an important determinant of optimal firm size. Stringent taxation and regulation can deter formalisation, firm entry and job creation (and firm growth) and poor network infrastructure can increase factor and transaction costs (and firm growth). The business environment can also change market demand: regulation by opening or closing markets (e.g. certification), transport infrastructure by closing the gap with distant markets, or cities through land planning and agglomeration effects.

Firms adapt to market conditions through a range of strategies. However, those available to SMEs are generally more limited than those available to larger firms (for example, via economies of scale). As an example, profit-seeking firms will aim to increase turnover by raising volume and/or pricing, and reduce costs in a number of ways (external economies, economies of scale or scope, network effects etc.) (Annex 3.B). SMEs, due to their size constraints, mainly rely on product differentiation, network effects (e.g. standardisation, inter-firm co-operation) and agglomeration effects (spatial concentration) for scaling-up profits.

At the same time, the relationship between market conditions and firms is not one-way. Business strategies1 can also alter market conditions and, in particular, market structures that reflect the distribution of market power and firm costs, and so the scope for innovating, profits and scaling up.2

Domestic market conditions

Domestic markets remain the prime space where SMEs do business as they are predominantly local actors embedded in nearby markets and ecosystems. Of many factors, two particular features of domestic and local markets that matter for SME operations, and that are covered in this report are public procurement and informality.

Public procurement offers significant opportunities for SMEs to innovate, boost competitiveness and create jobs. Public procurement equates to 30% of government expenditures in the OECD area, over 40% in Japan and the Netherlands (OECD, 2017[2]) and over 50% in developing countries (IBRD/World Bank, 2016[3]), and, in OECD countries, around half3 is administered at the subnational level (by regions and cities that are often particularly engaged in supporting SME development and local employment (OECD, 2018[4]). Through their significant procurement of goods and services for intermediate consumption (equipment and supplies, maintenance and repairs, energy, ICT, consulting, etc.) and the commissioning of services provided directly to consumers, regional and local governments are key buyers for local suppliers. In small municipalities and rural areas in particular, SMEs can have high dependencies on local contracting authorities who may be their main or indeed only client, which, in turn, makes them vulnerable in times of austerity and budget tightening, as illustrated by the contraction of local public markets in 2010-11.

Public procurement, especially because of its diversity, provides scope for engagement with small scale specialist providers, while also offering the benefits of relative stability in demand, security of payment and spill-overs that might accrue through accreditation and recognition of being a supplier to government (e.g. for customer base expansion, or for negotiating other contracts and financing).

Despite these potential benefits however, SMEs’ shares in public procurement markets are often lower than their overall market share (OECD, 2018[5]). In the EU for example, SMEs garner 45% of the value of public contracts above EU thresholds.4

There are factors on both the SME and government sides that explain the lower participation by SMEs to public markets. On the government side, administrative burdens, payment delays, unregulated bid security deposits or performance guarantees, ineffective complaint mechanisms and, in some instances bribery, raise transaction costs for smaller firms to operate on public markets and undermine the level playing field.

On the SME side, the complexity of bidding, pre-qualifications required from suppliers, the need to produce large quantities or a risk aversion to innovation failure all constitute strong entry deterrents. There are also transaction costs associated with the management of the procurement process itself, e.g. the hiring of a legal counsel in case of litigation, that add to capacity constraints of SMEs. The risks of trade secret disclosure also exist when companies interact with public authorities and provide confidential business information in the context of tender procedures (see chapter 7 on access to innovation assets).

Global market conditions

There is a large cross-country diversity in the opportunities and challenges SMEs face in accessing markets (OECD, 2017[6]). Conditions for entering international and domestic markets have generally improved for SMEs in recent years, as explicit barriers to trade and investments have been reduced; increased public attention has been given to levelling the playing field; and improved infrastructure, especially ICT, has helped SMEs reach scale without mass, and reduce transaction costs in their activities.

The global economy, beyond domestic and local market conditions, shapes conditions under which SMEs –and firms of all sizes- operate and perform. Sound macroeconomic and budgetary conditions raise business, investor and consumer confidence, drive corporate investment decisions, encourage risk-taking by both entrepreneurs and investors and stimulate consumer demand. Trends in international finance and labour markets are determinants for the access of domestic SMEs to finance and skills (see also Chapters 5 and 6). The globalisation of finance, education and labour markets has amplified the resonance of local shocks globally, and global shocks locally.

Trade and global value chains (GVCs) create opportunities for SMEs to absorb spill-overs of technology and managerial know-how, broaden and deepen skills sets, innovate, scale up and enhance productivity (OECD, 2018[7]); (Wagner, 2012[8]); (Lileeva and Trefler, 2010[9]); (Caliendo and Rossi-Hansberg, 2012[10]). But engaging in international markets can be expensive, a cost that usually only the most productive firms can afford (Melitz, 2003[11]) (Bernard et al., 2007[12]). Trading costs weigh disproportionately on SME profitability as smaller firms trade smaller volumes (see Chapter 4 on infrastructure).

However, the fragmentation of production worldwide has created significant opportunities for SMEs to enter global markets through a specialisation in parts of value chains where they have comparative advantages, and through specialisation in niche activities. In some niche international markets, SMEs dominate and have become key partners as upstream suppliers to larger multinationals. In Germany, SMEs hold between 70% and 90% of global market shares in some specialised manufacturing segments, and account for the bulk of the German international trade surplus. In 2015, across twelve OECD countries, the share of SME merchandise exports in textiles, apparel and wood manufacturing represented over 60% of the total (OECD, 2018[13]).

SMEs integrate into GVCs as direct exporters (trading), upstream suppliers of exporting firms (supplying) or importers of foreign inputs and technologies (sourcing). They can also partner5 with multinationals (partnering) or become multinationals (investing). GVCs provide benefits for direct SME exporters who are able to capitalise on cheaper intermediate imports to boost their own international competitiveness (Bas and Strauss-Kahn, 2015[14]). The SME contribution to direct exports6 is for most countries below their contribution to value added. This masks their overall level of integration in GVCs and exposure to trade, via ‘indirect channels’ as upstream suppliers to larger domestic exporters (OECD, 2018[7]).

Indirect channels are especially important for independent SMEs (i.e. those that are not owned by a domestic or foreign firm), and in sectors where GVCs are important and where scale matters, e.g. in the transport equipment sector. Indeed indirect channels enable SMEs to access foreign markets and capitalise on spill-overs without incurring direct trade-related costs. In the United States, SMEs account for over 40% of the total domestic value-added exported by the transport equipment industry, with nearly all of that contribution reflecting upstream component and services supplies (Bas and Strauss-Kahn, 2015[14]).

Upstream and downward linkages with larger companies can be essential for SMEs. Multinationals through their international production networks have long served as ‘internalised’ cross-border transmission channels for goods and services, financial flows, and intellectual property. MNEs also increasingly serve as vehicles for the diffusion of digital technologies globally, as they contribute to build the digital infrastructure needed (Gestrin and Staudt, 2018[15]).

Yet, SME ability to engage in trade remains constrained by internal capacity (managerial skills, technology capital or innovation assets) as well as a range of external factors, including access to trade finance, the quality of logistics services and physical infrastructure, and intellectual property protection (see Chapters 5, 6 and 7 on access to strategic resources as well as Chapter 4 on infrastructure).

However, integrating into GVCs does not automatically translate into technological or economic upgrading (Gereffi, Humphrey and Sturgeon, 2005[16]) (Humphrey, 2004[17]) (OECD, 2013[18]). Success is determined in part by the way value is created or captured within the GVC and in part by its mode of governance (Box 3.1). And several factors, including physical distance, MNE size and the country of FDI origin, mediate the extent to which SMEs can translate collaboration with multinationals into productivity gains (OECD, 2017[19]).

Box 3.1. How can small firms gain knowledge and capacity within GVCs?

Value creation within GVC results from the low replicability of products and firms’ capability to innovate and differentiate their output (Kaplinski and Morris, 2002[20]; OECD, 2013[18]).

The scope for SMEs to benefit from GVC participation depends on the nature of inter-firm linkages, especially between lead firms and suppliers, and the co-ordination within GVCs, i.e. the complexity versus the codification of transactions and overall capabilities of the supply base to meet buyers’ requirements (Gereffi, Humphrey and Sturgeon, 2005[16]).

Lead firms can increase complexity by requesting just-in-time supply or high product differentiation. They can lower complexity by setting technical or process standards. If the supply base capabilities are low, the lead firm is likely to exert more direct control on suppliers and the value chain is likely to be vertically integrated and governed with a high degree of explicit coordination and large power asymmetry (in favour of the lead firm). In a vertically integrated value chain, functional upgrading, i.e. firms’ capabilities to move along the GVC and become competitive in upstream or downstream segments generating higher value-added (or rather profits), is heavily dependent on the lead firms willingness to transfer technology and knowledge to their suppliers.

Several factors mediate the extent to which SMEs can translate collaboration with MNEs into productivity gains (OECD, 2017[21]).

Physical distance: Knowledge spillovers from MNEs are the strongest up to 10 km from the lead firm and progressively decay between 10 and 50 km, partly reflecting production linkages but also through other channels such as the mobility of managers. Much depends on the nature of the activity and increased digitalisation may be able to reduce the importance of distance.
Size: Smaller MNEs may be more likely to buy from, or subcontract to, domestic SMEs, limiting the scope for knowledge spill-overs, whereas larger MNEs are more able to draw on internal resources.
Finally, the country where FDI originate matters. FDI outflows from OECD countries have been found to generate more positive impacts on SME productivity through backward linkages and technology absorption. However, in the case of China, FDI from culturally similar places such as Hong Kong and Chinese Taipei have stronger impact on local SME productivity than FDI from Western countries.

Sources: Kaplinski, R. and M. Morris (2002[20]), A Handbook for Value Chain Research; OECD (2013[18]), Interconnected Economies: Benefiting from Global Value Chains, https://doi.org/10.1787/9789264189560-en; Gereffi, G., J. Humphrey and T. Sturgeon (2005[16]), “The governance of global value chains”, https://doi.org/10.1080/09692290500049805; OECD (2017[21]), Banking Sector Leverage, https://data.oecd.org/corporate/banking-sector-leverage.htm.

Global and domestic market conditions: Recent trends

Global economy: The expansion has peaked, confidence and investments are at risk.

Market conditions for SMEs have improved in recent years but there are signs that the expansion has now peaked (Figure 3.2). Global GDP is projected to slow from 3.7% in 2018 to 3.5% in 2019-20, marginally below pre-crisis norms and the economic recovery remains fragile (OECD, 2018[22]) (OECD, 2018[23]).7

The upturn is less broad-based than in the latter part of 2017 as growing differences across countries and sectors have emerged. The growth outlook is weaker in some emerging economies, such as Brazil, South Africa and Argentina, which slipped into recession in 2018. There are also signs that domestic demand has been softening in China. In the United States, tax reductions and public spending have given a substantial short-term boost to domestic demand, but higher tariffs and uncertainty are likely to weigh on future investments and GDP growth is expected to ease in 2019. Japan’s growth outlook remains low by international standards as slow wage progression weighs down on private consumption. In Europe growth started to slow in 2018 with wide intra-EU disparities and uncertainties caused by Brexit.

In addition, growing inflation pressures may lead to higher interest rate which may in turn increase debt burdens on households and firms that borrowed highly in recent years of cheap credit and raise asset prices (e.g. houses, equities). If inflation rises sharply and central banks are forced to raise rates at a faster pace, market sentiment could shift abruptly, leading to a sudden correction in asset prices. A swifter rise in interest rates in advanced economies might also lead to significant currency depreciation and volatility in emerging economies highly reliant on external financing.

Figure 3.2. After recent improvements, market conditions have tightened again

A deepening of trade tensions might exacerbate vulnerabilities. New restrictive trade measures are already having visible effects on import costs and trade volumes propagating through GVCs. In addition, geopolitical tensions might contribute to sudden market corrections or a further rise in oil prices. Investment, which has been a key driver of the recent economic upturn, is at risk. In the OECD area, business investment growth is projected to ease to just over 3% per annum over 2019-20, from over 4% during 2017-18.

Weakening long-term growth projections and narrowing market prospects, a lack of business dynamism in some economies, and uncertainty, especially around global trade policy, is likely to deter future investment. And a further rise in trade tensions would have significant adverse effects on global trade and investment. In a scenario of tightening growth conditions, SMEs are likely to be the first and most severely hit because of their high sensitivity to cyclical changes and deficient business environment (Figure 3.3).

Figure 3.3. Market conditions are the most pressing challenges for SMEs

GVCs have lost momentum

Global trade growth slowed in 2018 as trade tensions began to impact on confidence and investment plans (OECD, 2018[22]). Global trade volume growth eased to around 3.9% in 2018, from 5.2% in 2017 and appears set to remain at under 4% per annum over 2018-20. In recent years, trade expansion had been driven by recovery in Europe, a strong pick-up in electronics trade in Asia, and a shift in the composition of global demand towards more import-intensive investment (in line with the upsurge in investment). In particular, the strong infrastructure investment engaged by China in the framework of its “Belt and Road Initiative” has stimulated the growth of emerging markets, boosting external demand, especially in Asia, and contributing to the recovery underway in commodity-exporting economies.

Since 2018, however, a series of tariffs and retaliatory counter-measures have come into effect, and more may be implemented in the coming months. Uncertainty about future trade policies may be contributing to the sharper-than-expected trade slowdown, with some firms choosing to delay international orders or change their supply chains and production locations to minimise the effect of possible new trade barriers (OECD, 2018[22]).

Global foreign direct investment (FDI) is also slowing, reaching its lowest levels since 2013. Global FDI flows fell 35% in the first half of 2018 to USD 432 billion (from USD 632 billion in the second half of 2017), i.e. 44% lower than a year earlier (Figure 3.4) (OECD, 2018[24]), with recent decreases were driven by large repatriations of earnings by US parent companies following 2017 US tax reforms.8

Figure 3.4. Global investments are slowing, reaching their lowest levels since 2013

Overall GVCs have lost momentum since the 2008-2009 crisis. The global trade and FDI slowdown and the increasing need for improving supply chain resilience and production flexibility may have weakened the rationale9 for maintaining long and complex GVCs (De Backer and Flaig, 2017[26]).

New business models may also become incompatible with long value chains as they require firms to improve responsiveness to end-user demand and reduce time to markets (see chapter 7 on access to innovation assets), leading to a remodelling of supply chains into ‘demand chains’ (Christopher and Ryals, 2014[27]). Likewise, the greater emphasis (and value) placed on protecting corporate data and innovation assets may discourage firms from offshoring high value added activities in countries and jurisdictions where the protection and enforcement of intellectual property rights are weaker or uncertain.

Nonetheless, it is difficult to foresee the trajectory of GVCs (Box 3.2), certainly rising trade tensions will, and are beginning to work to slow them. Digitalisation has helped increase the tradability of many services and reduce the hidden costs (additional management, logistics and operations) that fragmented chains raise (Contractor et al., 2010[28]). But digitalisation may also work (especially if 3D printing is coupled with automation) to reverse and re-orientate some production back to OECD economies (De Backer and Flaig, 2017[26]).

Box 3.2. 3D printing, a game-changer for GVCs?

3D-printing provides both threats (particularly for low-skilled SMEs in exposed sectors) and opportunities for SMEs because it might transform the structure of GVCs, although it is hard to predict when and to which extent. It could in particular play a leading role in mass customisation (see Chapter 7 on access to innovation assets).

The potential for 3D printing to fully substitute traditional manufacturing methods remains uncertain. Currently, a major barrier to its expansion is the cost of switching away from mass manufacturing methods. Consequently rates and modes of adoption of 3D printing differ widely across industries and GVC segments (Wohlers, 2015[29]). 3D printing has been penetrating rapidly in high-cost low-volume industries (e.g. aerospace, medical and dental, defence, education and increasingly the automotive industry) and is expected to progress more slowly in moderate-cost moderate-volume industries or low-cost high-volume industries (OECD, 2017[30]). Similarly 3D printing has seen more applications in upstream activities, like prototyping, product development and R&D.

With 3-D printing, the source of a firm’s competitive advantage shifts away from lowering unit costs through scale and mass production, towards reducing time and distance to end customers through enhanced business intelligence (Rehnberg and Ponte, 2016[31]). In turn 3D printing reduces opportunities for low-wage low-skills firms to enter value chains.

Sources: Wohlers (2015[29]), 3D Printing and Additive Manufacturing State of the Industry: Annual Worldwide Progress Report; OECD (2017[30]), The Next Production Revolution: Implications for Governments and Business, https://dx.doi.org/10.1787/9789264271036-en; Rehnberg, M. and S. Ponte (2016[31]), “3D printing and global value chains: How a new technology may restructure global production”, http://gpn.nus.edu.sg/file/Stefano%20Ponte_GPN2016_010.pdf (accessed on 31 October 2018).

Digitalisation has also become a key factor in the way multinationals organise their operations globally as it has weakened the market-seeking and efficiency-seeking rationales for investing abroad (Gestrin and Staudt, 2018[15]). MNEs can reach foreign markets in the downstream parts of value chains without physical presence. The same is true for born-global SMEs that can attain global reach with minimal cross-border investment. By contrast, FDI is likely to continue to underpin corporate internationalisation strategies in more traditional “bricks and mortar” industries (UNCTAD, 2017[32]).

The FDI landscape is also likely to change as firms increasingly adopt knowledge-seeking FDI strategies (Figure 3.5). A large share of international investment is now going into digital infrastructure, especially intangible (Gestrin and Staudt, 2018[15]). Cross-border investment to acquire digital data storage assets reached USD 13.8 billion in 2016, the highest level on record. Cross-border acquisitions of software developers increased fifteen-fold since 2009 to USD 102 billion in 2017.

Non-digital firms have been a key driver of the rapid growth in mergers and acquisitions (M&A) directed at acquiring digital assets. MNEs in traditional sectors, such as agri-business, real estate, construction, healthcare, professional services, and retail, have started building up in-house digital capacities since 2013-14. While acquisition of digital assets by digital and non-digital firms were roughly equal until 2014, acquisitions by the non-digital sector skyrocketed from USD 78 billion in 2013 to USD 591 billion in 2017, as compared to USD 158 billion by digital firms.

Figure 3.5. Non-digital firms are increasingly adopting knowledge-seeking FDI strategies

The consequences of a slowdown in GVC expansion on the SME sector are uncertain but are likely to be country-, region- and sector-specific.

First, a slowdown in trade is likely to reduce the opportunities for small companies to engage in international activities, whether as direct or indirect exporters, which may also slow knowledge diffusion.

Lower FDI may also weigh on the productivity of local SMEs as it reduces channels to superior, technology, production processes and management techniques.10

The concentration of foreign investment on digital assets also stresses the growing role of multinationals in building digital infrastructure and diffusing technologies through their supply chains. SME integration into GVC can therefore be an enabler of their digital transformation (see chapter 7 on access to innovation assets).

On the other hand, foreign disinvestment may relax domestic competition for talent, resources and markets that tend to limit the market shares domestic firms can gain. Overall, SME productivity gains from exposure to foreign firms located in their region and in the same sector, are limited, at least on aggregate (Lembcke and Wildernova, 2019[33]), unless SMEs have similar technological capabilities (Fons-Rosen et al., 2017[34]). On the whole, spillovers from technology transfer seem to be offset by the pressure MNEs exert on competing domestic SMEs and their market shares. The benefits of FDI-driven cross-fertilisation are more evident if domestic firms and multinationals are in different sectors, especially if local firms are of medium size (Lembcke and Wildernova, 2019[33]).

Digitalisation and concentration are reshaping markets

Digitalisation has durably altered market conditions by reducing the efficient firm size (Figure 3.6) (Annex 3.A).

Digitalisation enables a reduction in transaction costs associated with market activities, i.e. access to information, communication and networking, reducing de facto incentives for firms to internalise such activities. Digitalisation also helps gain flexibility and reactivity in supply while at the same time creating a better informed and more differentiated demand that requires more flexibility and reactivity in supply (see chapter 7 on access to innovation assets).

Smaller firms due to their shorter operation lines and proximity to markets have a competitive advantage over larger firms as they can respond and adapt more rapidly to changing market conditions and new modes of production based on “just-in-time’ and differentiation. Differentiation in turn increases the potential for economies of scope. And online platforms, such as Ebay or Amazon, enable SMEs engage in cross-border trade as they reduce the cost of reaching markets, connecting them to global production chains and end-customers and help them reach scale without mass and become micro multinationals.

Moreover, GVCs and the fragmentation of production have created conditions for a greater specialisation of domestic and local markets in search for better positioning within the value chain (and de facto conditions for reducing the efficient firm size). Specialisation patterns have deepened with an increasing global integration. OECD product mix has grown in complexity, while countries narrowed the range of goods produced to remain competitive. On the contrary, emerging markets, especially China, have broadened the product portfolio they export, while they have moved up the quality ladder.

Figure 3.6. Cyclical trends, megatrends and efficient firm size

Market concentration is also a concern for SMEs, in particular, but not only, in digitally dependent sectors. Several recent studies11 point to increasing market concentration in the United States with the top firms capturing growing shares of returns to capital, profit margins and market power across many industries (Furman and Orszag, 2015[35]) (Grullon, Larkin and Michaely, 2017[36]) , and suggesting a reallocation of business activity towards “superstar” firms that are large, highly productive and taking higher mark-up12 (Autor et al., 2017[37]).

These signs of market concentration may also be driving increasing profit shares (as a % of GDP) and even larger increases in mark-ups, raising concerns that antitrust policies and competition enforcement may be failing to secure a level playing field and a supportive business environment for US firms.

Similar studies for Japan or Europe are less conclusive however. There seems to have been a gradual concentration of industrial markets -that were already highly concentrated- in Japan since 2000, but with no sufficient data for concluding on an economy-wide basis (Honjo, Doi and Kudo, 2014[38]). In Europe trends are mixed across countries and industries (Valetti et al., 2017[39]).

Bajgar et al. (2018) measure sales at the group level, so including subsidiaries and former competitors in case of buyout. Results show that concentration seems to have strongly increased both in Europe and North America between 2000-14, with similar increases in manufacturing and services industry within both regions and in digital-intensive and less-digital sectors since the mid-2000s.

However in the absence of complementary evidence on changes in output and price levels (that would be expected to decrease and increase respectively as competition conditions weaken), mark-ups and profits (that would be expected to increase), and churning rates in business demography (that would be expected to decrease), it is difficult to categorically conclude at this stage on whether there has been a change in competitive intensity or not (OECD, 2018[40]).

Spatial concentration remains, on the other hand, extremely prominent and seems to have further intensified in some countries (OECD, 2018[41]). In 2016, within countries, the richest regions were more than twice as rich as the poorest regions,13 with wealth gap increasing faster in 15 out of the 30 OECD countries considered over 2011-16. The economic importance of capital regions in particular has increased, their contribution to national GDP growing by almost 12% between 2000 and 2016 to an average 26% of national total. Similar gaps persist in labour productivity. Spatial concentration is also intense for innovation activities. The top R&D performing region accounted for nearly 45% of the country’s business R&D expenditure in 2013 (OECD, 2016[42]) and R&D expenditure in capital regions was higher than in the rest of the country in almost all OECD countries (OECD, 2018[41]). In addition, the top regions in Canada, France and the US host almost half venture capital investment (2014). And, more generally, metropolitan areas are the places where most inventions take place.

Environmental degradation and urban congestion provide however rationale for rethinking industrial systems and business models with a double objective of improving economic efficiency and reducing negative externalities. The circular economy for instance carries a high profit potential for a broad range of industries, including those where SMEs are majority (Box 3.3).

Box 3.3. New market conditions for SMEs: The business case of the circular economy

The green transition is creating new market conditions and opening up opportunities for SMEs. First, as important suppliers of green goods and services, SMEs are especially well positioned to operate in green supply chains in local markets that may be unattractive or impenetrable for large global firms, including in emerging economies and low-income countries. In Finland and the UK, SMEs represent over 90% and 70% of clean tech businesses respectively. A quarter of European SMEs is already producing green products and more is expected for the future (Guerrier, 2018[43]).

Climate change and environmental degradation, combined with economic and demographic prospects, are putting natural resources under strong pressure, offering a business case for the circular economy. In economies of “take, make and dispose”, most of the value created is ‘lost’ in landfills, and products, components, and materials are under-utilised. In value terms, Europe recycled and recovered only 5% of the original raw material value of discarded goods (Ellen MacArthur Foundation, 2015[44]). In addition to driving a sub-optimal factor productivity, this linear system increases firms’ exposure to risks, notably related to higher and less predictable resource prices and supply disruptions.

The circular economy, whereby the value of products, materials and resources is maintained in the economy for as long as possible and the generation of waste minimised (European Commission, 2015[45]), has emerged as a new paradigm for further decoupling economic growth from resource use. The circular economy aims to improve the preservation of natural resources, optimise resource yields (and increase the productivity of resources) and reduce negative environmental externalities (McKinsey Center for Business and Environment, 2016[46]).

Circular industrial systems encourage the creation of ‘local value loops’, based on more local production and more diverse exchanges of value in local economies, with large potential impact on consumption patterns. There is therefore a key spatial dimension in circular economy models that require both minimum geographical proximity and enough agglomeration effects to be scalable. The circular economy also encourages a shift in business strategies towards more customer-focused design thinking (Ellen MacArthur Foundation, 2015[44]) for which smaller firms may have a comparative advantage (chapter 7 on innovation assets).

Digital technologies will be particularly instrumental for the development of the circular business as they enable better monitoring product life-cycle and consumption (e.g. automation, remote sensing, big data), brokering goods, materials and related services (e.g. online marketplaces), peer-to-peer sharing (e.g. private car and home sharing), delivering utility virtually (e.g. books) or reducing the use of old materials (e.g. 3D printing).

Shifting from a linear approach to a circular system is estimated to add as much as USD 4.5 trillion for economic growth by 2030 (Accenture, 2015[47]). Projections show that resource productivity in Europe can improve by 3% and generate a GDP increase of up to 7% by 2030 (McKinsey Center for Business and Environment, 2016[46]). Business surveys results are convergent, with over 41% of European SMEs reporting that investing in resource efficiency paid off and helped decrease production costs (European Commission, 2018[48]). Yet, this potential still needs to be unlocked: today, less than 10% of the global economy is circular (Circle Economy, 2019[49]), and there are large differences between industries such as pulp and paper or steel where recycling waste is well established and the market penetration of circular models reaches 30-40% of the physical output, and most other sectors where it is no more than 5-10%.

The circular economy carries a transformational and high profit potential for a broad range of industries, including those where SMEs are in the majority (Ellen MacArthur Foundation, 2015[44]). ‘Share’ models can help cut costs and improve performance in distributive trades (i.e. wholesale and retail trade) or accommodation and food services; ‘virtualise’ models in administrative and support services, legal and accounting and head-office consulting, as well as in a range of knowledge-intensive services; ‘loop’ models in construction, transportation and storage. The building sector, for example, could halve construction costs with industrial and modular processes. The European Executive Agency for SMEs (EASME) strongly believe that there is an economic case for SMEs to transition from linear to circular models.

Sources: Guerrier, J. (2018[43]), World Circular Economy Forum, https://www.sitra.fi/en/projects/world-circular-economy-forum-2018/#programme; Ellen MacArthur Foundation (2015[44]), Growth Within: A Circular Economy Vision For A Competitive Europe, https://www.ellenmacarthurfoundation.org/assets/downloads/publications/EllenMacArthurFoundation_Growth-Within_July15.pdf (accessed on 19 March 2019); European Commission (2015[45]), Closing the Loop - An EU Action Plan for the Circular Economy, https://eur-lex.europa.eu/resource.html?uri=cellar:8a8ef5e8-99a0-11e5-b3b7-01aa75ed71a1.0012.02/DOC_1&format=PDF (accessed on 19 March 2019); McKinsey Center for Business and Environment (2016[46]), The Circular Economy: Moving from Theory to Practice, https://www.mckinsey.com/~/media/McKinsey/Business%20Functions/Sustainability/Our%20Insights/The%20circular%20economy%20Moving%20from%20theory%20to%20practice/The%20circular%20economy%20Moving%20from%20theory%20to%20practice.ashx (accessed on 19 March 2019); Accenture (2015[47]) (2015), Creating Advantage in a Circular Economy - Waste to Wealth; European Commission (2018[48]), SMEs, Resource Efficiency and Green Markets, https://publications.europa.eu/en/publication-detail/-/publication/3e0eeaef-0259-11e8-b8f5-01aa75ed71a1/language-en/format-PDF/source-63762994 (accessed on 19 March 2019); Circle Economy (2019[49]), Circularity Gap Report.

Little progress has been made in increasing SME participation in public procurement

The average level of public procurement spending in the OECD countries has remained rather constant over time (OECD, 2017[2]). However, there is currently no consensus among the policy community on the active use of public procurement to foster SME growth, nor on the share or amount of contracts that should go to SMEs. Also, despite the potential benefits of SME participation, their share in public contracts have remained lower than their market share (OECD, 2018[5]).

Governments have increasingly recognised the strategic dimension of public procurement (OECD, 2018[5]). Given its magnitude in public spending, public procurement have become a tool for governments to achieving key policy goals and delivering green, socially responsible and innovative policies (OECD, 2016[50]). Yet, the European Commission estimates that 55% of public procurement procedures still use the lowest price as the award criterion at the exclusion of other qualitative and grand challenges-oriented criteria, such as energy consumption, life-cycle costs, environmental impact etc. (European Parliament, 2018[51]).

Many of the challenges SMEs faced in participating in public procurement in the 1980s and 1990s persist today. Public procurers have increasingly been asked to aggregate needs and generate economies of scale, making access to public markets more complex. Between 2006 and 2016 the number of tenders with only one bid increased from 17% to 30% (Makgill, 2018[52]). In the same period, the number of offers per tender fell from five to three. SMEs won only 45% of the total value of public contracts above the EU thresholds. And little progress has been made in recent years (OECD, 2018[5]). In most countries for which data are available, the share of SME-awarded contracts, being in terms of number or in terms of contract value, has remained stable or even decreased.

Complexity of bidding, the need to produce large quantities and risk aversion have constituted strong entry deterrents for smaller firms. In addition, payment delays, unregulated bid security deposits, excessive performance guarantees, ineffective complaint mechanisms or bribery, have undermined the level playing field in public tenders.

Despite governments’ efforts to remove administrative barriers and facilitate access, discussions still focus on how to remedy the situation (OECD, 2018[5]). In fact, a recent OECD survey to public procurement revealed that policy makers and practitioners remain inconclusive on the extent to which constraints on SMEs pose burden on their participation and its evolution over time (OECD, 2018[5]). But the complexity of public procurement systems seem to persist as one of the main impediments for SME participation. In addition, these constraints and limitations arise at every stage of the process, from access to information, to pre-qualification, to tendering, to the contract administration and the management of the relationship.

Market conditions for SMEs and entrepreneurship: recent national policy trends

Thinking global, acting local

Governments in the OECD area and abroad have been paying high policy attention to increasing participation in trade and GVCs, including or especially for SMEs. Indeed national approaches differ as some governments include the SME rationale into broader internationalisation strategies while others adopt more targeted policies. Nevertheless, the local dimension appears key for policy implementation.

While not their core objective, helping SMEs overcome their difficulties in accessing global markets is a key dimension of a number of national export strategies (Table 3.1). In some other cases, SME export support is framed within new industrial-innovation policies.

Countries have also revisited their governance arrangements in order to improve efficiency in their export support system (Table 3.2). National export and investment promotion agencies have gone through restructuring. Export hubs have sprouted worldwide, transferring SME export support to the local level.

In addition, more targeted efforts have been aimed both at SMEs, in order to mitigate the costs inherent to internationalisation and trading across borders, and at multinationals, in order to attract more and better quality FDI (Table 3.3).

SMEs are provided with financial support (in the form of grants, loans or credit or export guarantees) and non-financial support (such as information, mentorship, networking or marketing services) for expanding markets abroad. In some cases, public support is targeted to certain populations of entrepreneurs and certain types of SMEs.

On the other hand, multinationals receive particular attention with attractive financial packages and simplified investment procedures. And governments have also played a role in connecting multinationals with domestic actors.

Table 3.1. Helping SMEs go global: Selected examples of mainstreamed approaches
National export strategies
Norway	Strategy for Export and Internationalisation (launched in 2017)	Increasing the export potential of small businesses and diversifying trade towards emerging economies. The government is in parallel negotiating trade agreements with Argentina, Brazil, China, India, Indonesia and Russia.
Spain	Internationalisation Strategy of the Spanish Economy (2017-27)	Supporting SME exports and investments abroad and plans financial support accordingly.
Slovenia	Programme for Internationalisation (2015-20)	Includes several measures for SME internationalisation. Support is given for developing new business models, establishing partnerships within GVCs, creating one-stop-shops for exporters and investors, undertaking feasibility studies, establishing export plans and exploring new international market opportunities.
UK	Export Strategy (launched in 2018)	Includes specific measures aimed at encouraging SMEs to consider exporting at key points in their business lifecycle and informing SMEs about exporting via access to specialist advice and support.
New industrial policies
Hungary	Digital Export Development Strategy (2016-20).	Promoting the digital economy, through a strong modernisation, especially of the SME sector, that could serve as a pilot industry for the export and SME development plans of other industries. Given the size of the domestic market, the long-term growth of domestic ICT SMEs requires enhancing their export sales.
Italy	“Special plan” - Piano Straordinario	Promoting the “Made in Italy” abroad and lifting up low inward FDI. Includes support to innovative promotion strategies, e-commerce and investment in fixed capital assets and technologies.
	Industry 4.0 National Plan (2017)	Systematic tax credit on R&D and hyper-depreciation allowances for high-tech investments.

Table 3.2. Helping SMEs go global: Selected examples of governance improvement
Revising the export support system
Australia	Small and Medium Enterprises export hubs (since 2018)	Providing local authorities and non-profit organisations with grants from AUD 150 000 to AUD 1.5 million for facilitating SME export opportunities in the six Growth Centre sectors (i.e. advanced manufacturing, cyber security, food and agribusiness, medical technologies and pharmaceuticals, mining equipment, technology and services and oil, gas and energy resources). AUD 20 million were earmarked in 2018 over a four-year period for the creation or operation of SME export hubs.
France	Trade Strategy (since early 2018)	Re-organising the export support system in order to make it simpler and more attractive. Business France (the national export and investment promotion agency since 2015) is to disengage from some countries as private structures such as international chambers of commerce take over. Conversely the reform plans to make Bpifrance the contact point for SMEs to access export guarantees and funding. The range of instruments has also been enlarged while the procedures have been streamlined.
UK	UK Export Finance partnerships	Introducing new partnerships between UK Export Finance, the UK’s export credit agency, with five retail banks to help smaller exporters and companies that supply exporters easily access Government-backed trade finance.

Table 3.3. Helping SMEs go global: Selected examples of targeted approaches
SME-targeted support
Australia	Market Development Grant (EMDG)	Financial assistance programme for aspiring and current exporters. The EMDG scheme encourages Australian SMEs to develop export markets by reimbursing up to 50 per cent of eligible export promotion expenses above AUD 5 000 provided that the total expenses are at least AUS 15 000. Up to eight grants can be awarded to each eligible applicant.
Canada	CanExport programme (launched in 2016, budget increased in 2018)	Provides financial support to SMEs (from CAD 20 000 to 100 000 by project) for a wide range of export marketing activities, especially towards high-growth emerging markets. The 2018 Fall Economic Statement committed an additional CAD 100 million over six years to the initial budget of CAD 50 million over 5 years.
Czech Republic	NOVUMM, NOVUMM KET & DESIGN (launched in 2016)	Supporting SME participation in exhibitions and fairs abroad in priority sectors, including key enabling technologies and design.
Germany	Mittelstand Global (launched in 2016)	Cross-industry SME market development programme that supports export initiatives in key areas of the future such as energy, environmental technology, civil security technology and services, and healthcare.
Hungary	Mentorship programme (since 2016)	Incentives for SMEs to hire or buy expertise through mentor networks.
Korea	SME Export Support Centre and online /offline support platforms	Expanding assistance to SME exporters and facilitating contacts between SMEs and overseas buyers.
	K-Gobal Accelerator programme (2017)	Providing SMEs with support in adapting products to global demand, setting a business model and liaising with foreign investors.
Lithuania	Export credit guarantee (2018)	Introduced a short-term export credit guarantee scheme.
Netherlands	Brexit desks (since 2016)	Online and physical desks for helping SMEs calculate the impact of Brexit on their business Taking account of their deep trade and investment linkages with the UK,
Population-targeted support
Belgium	First-time exporters	Targets first-time exporters of innovative goods by reimbursing 80% to 100% of the costs incurred under certain conditions. The programme is administrated by Finexpo, the federal SME export agency
Canada	Women Entrepreneurship Strategy (WES)	Foresees nearly CAD 2 billion to help women start and grow their businesses and reach new markets with an aim to doubling the number of women-owned businesses by 2025. Key export-related investments under the whole-of-government WES include connecting women with expanded export services and opportunities and providing financing and insurance solutions, on commercial terms, to women-owned and women-led businesses.
Korea	Tech Incubator Programme for Start-ups	Targets start-up by attracting initial investment from private accelerators and, starting from 2016, supporting mentoring, funding, and overseas networking, such as the establishment of overseas subsidiaries.
Poland	Polish Tech Bridges (2018)	Funded by the European Regional Development Fund, to support foreign expansion of start-ups and SMEs with high potential.
Multinationals and foreign investment
Estonia	Startup Estonia	Number of measures, as part of the programme in support of start-ups and scale-ups, for attracting foreign investors.
	“E-residency” status	Easing access of foreign entrepreneurs to the domestic market and public services.
Netherlands	Reduced corporate income tax rate (2018)	Stimulating FDI with a more competitive statutory corporate income tax. The basic rate is reduced from 25% to 21% for profits above the threshold of EUR 200 000, and from 20% to 16% for profits below.
Poland	Revised tax relief for foreign investments	Re-organising tax relief for foreign investments with a view to granting support on investment quality rather than location. The support criteria have been adapted to increase investment coming from small businesses.
Indonesia	Investment One-Shop service (since 2015)	Facilitating inward FDI processes. In addition, the Indonesia Investment Co-ordinating Board can grant tax breaks of up to 30% of strategic foreign investments, including large investments, investments on high local content or export-oriented investments.
	Tax breaks on strategic foreign investments	The Indonesia Investment Co-ordinating Board can grant tax breaks of up to 30% of strategic foreign investments, including large investments, investments on high local content or export-oriented investments.
Connecting MNEs and SMEs
Ireland	Ireland Global Sourcing (since 2017)	Providing SMEs with opportunities to become suppliers to multinationals, and stimulating MNE-SME collaboration more generally. During a two-day workshop IDA Ireland that has overall responsibility for promoting and facilitating FDI and Enterprise Ireland that promotes joint ventures and strategic alliances between indigenous and foreign companies organised 455 meetings between Irish exporters and multinationals.

Levelling the playing field…

… In product markets…

Competition policy has two pillars: i) pro-competition market regulation for enabling contestability, firm entry and rivalry in the market; and ii) the enforcement of antitrust laws (i.e. rules against abuse of dominance and anticompetitive agreements, as well as merger control) and state aid control (World Bank/OECD, 2017[53]). While the former pillar involves the improvement of regulations and administrative procedures, including the removal of anticompetitive sectoral regulations, the second focuses on business behaviours (e.g. anticompetitive cartel agreements) and requires enacting a Competition Law and a Competition Enforcement Authority.

Competition authorities typically support pro-competition market regulation (pillar 1) with advocacy efforts, conducting research on the effect of public interventions on competition, and providing evidence and recommendations on how to minimize market distortions (Table 3.4).

In Europe, the European Commission (EC) has been playing a key role in fighting abuses of dominant position, which have negative effects on smaller competitors, and defending consumer interests.

The EC fined Google USD 5 billion in 2018 for favouring its own applications on Android devices and abusing its mobile operating systems for ensuring the popularity of its search engine. This sanction came after the USD 2.7 billion fine Google was requested to pay in 2017 for taking illegal advantage of its search engine to propose its shopping service. Examples of record sanctions against large IT companies infringing anti-competition laws have multiplied over the past decade.
In 2019, the EC fined Mastercard EUR 570 million for obstructing access to cross-border card payment services and limiting the possibility for merchants to benefit from better conditions offered by banks established elsewhere in the Single Market.

The EC fight against cartels has also intensified in the 2000s and remains at historical highs, as per the amount of fines imposed:

In 2016, the EC condemned the ‘truck cartel’ to a USD 2.5 billion fine, the largest cartel fine ever, for years of collusion in delaying the diffusion of low-carbon technologies and agreeing on prices and delivery terms.
The EC established an anonymous whistleblower tool in 2017 in order to encourage individuals to report inside knowledge and uncover cartels and anti-competitive practices, including in procurement bids.
In 2018, the EC antitrust authority opened a series of cartel investigations across various sectors (e.g. carmakers, airline services, metal packing, etc.).

Table 3.4. Levelling the playing field in product markets: Selected country examples
Pro-competition market regulation
Austria	Revision of regulations and administrative rules in retail and professional services sectors (2015)	Exempts small facilities, especially for the retail sector, from authorisation procedures. This is part of a broader range of regulatory and administrative reforms aiming to address a lack of competition in some professional services and retail trade (see also below).
	Recognition and Evaluation Act (2016	Eases the procedures for recognising professional qualifications obtained abroad and opens up the professions to foreigners.
	Amendment of the Industrial Code (2017)	Abolishes fees and bureaucratic requirements for business license registration.
Australia	Reform of the Competition Law (2017)	Limits the misuse of market power and provides greater protection to small businesses as well as broader choice to consumers. Due to the large distances, the remoteness of global markets and the concentration of business activities in a small number of urban areas, SMEs operate in environments that may be less conducive to competition and innovation diffusion.
	Australian Competition and Consumer Commission	Includes a new internal working group in charge of tracking disruption in markets and assessing the impact of new business models and products on competition.
Mainstreaming competition policy objectives in other policy domains
Switzerland	Free Trade Agreement (FTA) Network	New FTAs were concluded in 2016 and negotiations are ongoing with India, South-East Asian countries and Mercosur States, in order to facilitate cross-border flows and limit the inflation on domestic mark-ups.

… In public procurement…

SMEs have been at the centre of the public procurement policy agenda. In fact, the 2013 survey carried out by the United Nations Environment Programme (UNEP) identified employment and SME development as top priority areas for governments’ sustainable public procurement policies (UNEP, 2013[54]). Policy intervention in the field is polymorph.

A first policy approach consists in developing framework strategies for increasing the number of SMEs in public markets. The legal and regulatory frameworks that govern public procurement include provisions that aim to give SMEs a fair chance of participating in bidding and ensure equal and fair treatment of bidders and suppliers (e.g. simplified procedures, less size-related selection criteria, smaller contract lots, shorter payment delays etc.) (Table 3.5). In Europe, the 2014 EU Directives on public procurement include new rules that aim to simplify procedures and make them more flexible, with SMEs expected to benefit in particular. These rules have been subsequently transposed into the national laws of Member Countries. The 2017 EU Procurement Strategy also puts priority in making procurement markets more accessible for SMEs.

Another policy approach consists in implementing targeted programmes for increasing SME capacity to bid in public markets. Acknowledging that resource constraints are a particular obstacle to SME participation in public procurement, some governments have adopted explicit measures in support of SMEs, such as dedicated financial instruments and preferential programmes.

Only a few OECD countries have legislative provisions for bid preference and set-asides. Under such programmes, only bidders that are eligible to participate in procurement set-asides compete against each other. Such measures have proven to positively impact social cohesion and employment by providing opportunities to groups of workers and entrepreneurs that are generally excluded from the labour market.

Finally, governments have designed public procurement policies that have the secondary objective of fostering innovation in SMEs. In fact, public procurement policies and strategies are increasingly incorporating broader socio-economic objectives. Increasingly, strategic public procurement initiatives aims to use government’s contracts for promoting innovation, protecting the environment, strengthening social cohesion and addressing issues related to gender and social inclusiveness. These strategic initiatives often also pay special attention to SMEs. In the 2017 OECD survey on the strategic use of public procurement to support SMEs, 44% of OECD countries reviewed declared that national strategies for green public procurement and public procurement for innovation commonly reflect the secondary objective of supporting SMEs (OECD, 2018[5]). In particular, while the level of innovative SME participation in public procurement markets is still relatively low, it is higher than that of general SME population.

With the large amounts of money and interests at stake, public procurement is the government activity most vulnerable to corruption and fraud (IBRD/World Bank, 2016[3]). Promoting transparency could help reduce the opportunity for opaque decisions and encourage participation.

There is a clear move toward the use of electronic means in conducting public procurement. Electronic platforms range from a website that does not support interactions but allows users to merely access tendering information, to sophisticated platforms for conducting the entire procurement process online. The benefits of digital procurement include equal market access and competition, enhanced transparency and integrity and lower transaction costs. It can inter alia reduce in-person interactions that create opportunities for corruption.

Table 3.5. Levelling the playing field in public procurement: Selected country examples
Framework strategies
Australia	Commonwealth Procurement Rules (2019)	Includes the principle of fair competition and commit non-corporate Commonwealth entities to source at least 10% of procurement by value from SMEs.
Denmark	Public Procurement Act (2016)	Increases the flexibility of requirements for bidding companies and incentivise the splitting of public contracts into smaller lots that are more accessible to SMEs.
Mexico	Public Procurement legal framework	Includes specific provisions for SME participation in public procurement, e.g. 10%-50% of advance payment if the supplier is a manufacturing SME, and preferential treatment of SMEs using innovative technology to produce goods.
Portugal	Code of Public Contracts (2017)	Simplifies and increases flexibility in procedures.
Spain	Public Sector Contracts Act (2017)	Simplifies opened procedure, shortens payment terms and makes contract lots smaller.
Sweden	National Procurement Strategy (2017)	Aims to improve trust in public markets, raise the multiplicity of suppliers and ensure well-functioning competition. The government encourages contracting authorities to give a real chance to small enterprises by dividing public contracts into smaller lots and removing excessive capacity criteria.
Targeted initiatives for increasing SME capacity to bid
Hungary	Training and consulting services (since 2016)	Aim to raise awareness and capacity among SMEs to foster their participation in public markets. The programme is based on a co-operation between the Public Procurement Authority and the Young Entrepreneurs Association Hungary (FIVOSZ).
Switzerland	Information events	Regularly organised by central purchasing bodies to increase awareness of opportunities to bid for government purchases, the types of procedures and the types of purchases (goods/services/construction).
UK	Supply chain focused approach	Aims to level the playing field and increase the visibility of supply chain opportunities. Assists suppliers, including SMEs, in bidding for work in its supply chains.
	Contracts Finder Platform	Enables suppliers to Government to advertise subcontracting opportunities. In addition, the Government wants to have greater visibility of spend with SMEs in its supply chains.
Population-targeted set-asides provisions
Canada	Procurement Strategy for Aboriginal Business	Helps fulfill the Government of Canada's priority to strength Aboriginal entrepreneurship (mostly SMEs) as outlined in the Federal Framework for Aboriginal Economic Development since 2009. Canada has a set-aside programme for Aboriginal businesses since 1996.
United States	Range of set-asides legislative provisions	Targets different categories of small businesses – including women-owned, disadvantaged, service-disabled veterans - and businesses from historically under-utilised business zones.
Strategic public procurement for innovation
Austria	Action Plan on Public Procurement Promoting Innovation	Stipulates that public authorities should tender/procure in lots and define qualification and award criteria in a way that gives SMEs a chance to participate in competitions.
Canada	Innovative Solutions Canada (ISC) (2017)	New innovation procurement programme designed to scale-up Canadian small businesses. Consolidates the previous Build in Canada Innovation Programme that provided procurement opportunities for SMEs with innovations ready for testing or commercialisation by making the government their first client.
Estonia	Support for Innovative Public Procurement programme (2016)	Aims to increase SME capacity to meet the innovation demand of the public sector.
Improving the administration of public procurement
Canada	Innovation Canada Platform	Interactive digital platform which helps businesses find federal programmes and services to grow their business (innovation.canada.ca). The platform provides businesses with a tailored list of results, selected from more than 1 000 federal, provincial and territorial supports, including the Innovative Solutions Canada procurement programme.
Slovak Republic	Training	Training of contracting authorities on SME facilitation.
UK	Supplier Registration Service	Provides suppliers and buyers with a single place to create and share commercial information. Contracting authorities can access a bank of questions to assess the suitability of a supplier. This saves time and resources in the bidding process.

… In lead markets

Governments are also active in encouraging SME access to “lead” markets where demand for innovative products is still insufficiently developed (e.g. certain renewable energy technologies) but where technology or products have high potential for increasing economic benefits, including competitiveness and job creation, and meeting societal needs (Edler, 2007[55]).

The circular economy, through the development of innovative business models, financial innovations and new organisational and logistical innovations, and for its transformational and high profit potential, as well as its local dimension, provides an example of lead market.

Box 3.4. Lead markets: Principles and key policy instruments

A lead market is a “new” market with the potential to expand geographically and create above-average rents for firms. The term “lead market” has been defined as: regional markets with specific attributes that increase the probability that a locally preferred innovation design becomes internationally successful as well (Beise and Cleff, 2004[56]) (Edler, 2007[55]). Once an innovation or technology has taken hold of a market, it can be characterised as operating in a “lead market”.

A key characteristic of a lead market is that uptake is not due solely to the technological superiority of an innovation, but also to the ability of market players – competitors, consumers and government regulations – to influence its adoption (e.g. via pricing) and adoption in other markets, including in other countries.

Lead markets are defined around broad market segments and typically cover six major areas: eHealth, recycling, renewable energy, sustainable construction, protective textiles and bio-based products.

The development of lead markets can help innovating firms achieve the critical mass and competitiveness needed to bring prices down and encourage further diffusion and adoption of the innovation. The promotion of lead markets has therefore received increased attention from OECD governments in recent years.

Innovation-oriented public procurement is one the instrument commonly used to target SME – and firms of all sizes – demand but it is not the only one. Regulations and standards, as well as tax policies, are also key policy instruments.

Demand-side innovation policies are often sector-specific. For instance, in the energy sector, guaranteed tariffs (for renewables), specific power purchase agreements with local utilities or eco labelling aim to improve the uptake of energy efficient technologies. In the pharmaceuticals sector, regulation has been used to promote the development of orphan drugs.

Sources: Abridged from OECD (2011[57]), Demand-side Innovation Policies, https://dx.doi.org/10.1787/9789264098886-en; (Beise and Cleff, 2004[56]); Edler, J. (2007[55]), “Demand-based innovation policy”, Manchester Business School Working Paper, Vol. 529.

Several national, regional and local circular economy strategies recognise the role of SMEs in the transition towards a circular economy (OECD, 2018[58]) (Table 3.6). The European Commission has been especially active in this area, including through initiatives that aim to stimulate the demand by SMEs for circular solutions (Box 3.5).

Box 3.5. Engaging SMEs in the transition towards a circular economy: The European approach

In 2015, the European Commission adopted an ambitious Circular Economy Action Plan for stimulating Europe's transition towards a circular economy. Measures cover the whole cycle from production to consumption to waste management, as well as the market for secondary raw materials. In July 2018, a revised legislative framework on waste entered into force, setting clear targets for waste reduction and a long-term path for waste management and recycling.

In 2017, a total of EUR 218 million was earmarked to circular economy projects through the Programmes Horizon 2020 (H2020) and LIFE. After 2021, the HEurope will replace H2020 and is likely to further increase the budget dedicated to promoting the circular economy and to widen its geographical scope (Guerrier, 2018[43]).

In 2019, the EC launched the European Strategy for Plastics in a Circular Economy in order to reduce the leakage of plastics into the environment. Measures aim to transform the way plastics and plastics products are designed, produced, used and recycled. By 2030, all plastics packaging should be recyclable. Special attention is given to boosting a weak demand for recycled plastics that remains a major obstacle to transforming the plastics value chain.

Against this backdrop, accounting for SME difficulties in adopting circular strategies and practices - due to more limited organisational, technological and financial capacity and lesser access to eco-financing-, the EC implemented a range of initiatives in order to boost the demand of circular solutions within the SME sector, including capacity building in SME support organisations (e.g. associations, networks, chambers of commerce etc.), policy advice for regional authorities, and support for providers of circular solutions to match with SMEs.

Sources: EC (2018[59]), A European Strategy for Plastics in a Circular Economy, https://eur-lex.europa.eu/legal-content/EN/TXT/?qid=1516265440535&uri=COM:2018:28:FIN, (accessed on 28 January 2019); EC (2017[60]), Boosting the Circular Economy Amongst SMEs in Europe, https://ec.europa.eu/regional_policy/en/newsroom/news/2017/07/27-07-2017-boosting-the-circular-economy-amongst-smes-in-europe (accessed on 28 January 2019); Guerrier, J. (2018[43]), World Circular Economy Forum, https://www.sitra.fi/en/projects/world-circular-economy-forum-2018/#programme.

Table 3.6. Levelling the playing field in lead markets: Selected initiatives for a circular economy
National strategies and plans for a circular economy
Denmark	Strategy for Circular Economy (2018)	Its first pillar aims to promote circular business development and upscale circular business models in SMEs. Enterprises are to be offered 50% co-financing for the procurement of consultancy and, if needed, the procurement of machinery and equipment.
Greece	Action Plan on Circular Economy	Aims to lift bureaucratic constraints, increase incentives for businesses, enhance knowledge and awareness, and establish conducive governance structures. It plans the establishment of a permanent ‘Circular Economy’ Dialogue Forum with SMEs, industry and civil society.
Slovenia	Roadmap towards the Circular Economy (2018)	Considers SMEs as important actors in the transition. In the wood chain in particular, SMEs are seen are those who need assistance and support for developing projects and participating in European tenders.
Spain	National Strategy of Circular Economy (2019)	Series of short-term action plans aiming to support the ecological transition by 2030. Identifies five priority sectors in SME-dominated industries: construction, agri-food, industry, consumer goods and tourism.
Subnational strategies or plans for a circular economy
Scotland	Making Things Last (2016)	Particular support earmarked to SMEs in meeting the new Scottish food waste reduction target of 33% by 2025 or delivering scalable and reproducible building projects in the construction sector.
City of Glasgow	Circular Glasgow Initiative (2017)	Aims to inspire businesses of all sizes to look at their business models differently and adopt new circular design-based strategies. The current phase of work targets SMEs and provide them support, tools and expert knowledge. The Circular Glasgow Initiative is supported by the Chamber of Commerce.
Horizontal and vertical coordination for a circular economy
Greece	Growth Strategy (2018)	Identifies the circular economy as a priority sector for growth.
Finland	Coordination across the board	Finland ambitions to move towards a regenerative and collaborative economy. Different levels of government actively support SMEs by offering them an environment conducive to development (SITRA, 2016).

Other relevant aspects of market conditions for SMEs and entrepreneurship are related to:

Institutional and regulatory framework conditions, e.g. administrative burden and stringent regulations, high corporate income and/or labour taxation and high tax compliance costs, (dis)trust in public governance etc. that may increase factor and transaction costs and alter business dynamics and market structure etc.
Infrastructure, e.g. affordable and quality transport, energy and digital infrastructure that can help reduce factor costs and distance to markets, including foreign markets, create new business segments, increase the scope for product differentiation, network effects and agglomeration economies and help smaller firms achieve scale without mass, etc.
Access to finance, e.g. broader range of financing options that better fit the heterogeneous needs of the SME population and can help reduce factor costs, or scale-up activities.
Access to skills, e.g. labour shortages that increase factor costs, especially for smaller firms, and may increase the optimal firm size; new platform-based jobs that may both lower labour costs and raise informality and transaction costs etc.
Access to innovation assets, e.g. technology diffusion such cloud computing that help lower operation costs and achieve technology leapfrog, open data and open innovation models that bring network benefits and support the rise of new products and niche markets.

References

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Annex 3.A. Market conditions, efficient firm size and market structure

Market conditions determine the optimal size of firms within the market, i.e. its accessibility to new (and most likely small) entrants, the opportunities and rationale for firms to scale-up - or down – or, in last resort, to exit the market. There are several economic drivers behind firm size evolution and several economic theories that intend to explain shifts in firm size distribution and cross-country and cross-industry differences (see (You, 1995[61]) for a more detailed overview). In fact the great diversity of theories reflects (and accounts for) the large heterogeneity of the SME sector.

Firm size and firm size distribution within an industry or within a country is determined by several factors:

First are the economies of scale. Economies of scale are often technology-based and contribute to reduce long-term average unit cost of production, which determines the efficient scale of production. Firms grow up to the minimum efficient size as they achieve increasing economies of scale. The number of active firms within the industry is thereafter given by the market size, i.e. market demand, that sets the total volume of industry output required (Panzar, 1989[62]). External economies of scale are generated by the industry’s growth while internal economies of scale are generated by the firm’s growth. Likewise the economies of scope allow firms lowering the average cost of production by diversifying the range of products and services that could be produced with the same asset portfolio.

Technologies that generate the largest economies of scale tend to be more capital-intensive. This explains cross-industry and cross-country variations in average firm size. Typically manufacturing that is more capital-intensive counts larger firms whereas services that are less capital-intensive count more SMEs. The same stands for high-income high-capital versus low-income low-capital countries. However small-scale technologies may have cost advantages due to their greater adaptability to fluctuating demand, by offsetting the disadvantages of achieving lower economies of scale. As an example, the technological change that took place from the industrial Revolution up to the early XX^th century contributed to increase the minimum efficient scale of manufacturing plants while the introduction of new materials (like plastics)14 and ICT in the decades after had the opposite effects in reducing the minimum efficient scale.

Firm size distribution then varies across countries and industries due to an uneven access to technology (or to the finance needed for constant upgrading) and to the skills needed for managing the change. In this approach, the number of small firms increases during recessions, as wages fall, unemployment rise and out-of-job wage-earners switch to setting up their own businesses.

Nevertheless firm size expansion through economies of scale remains limited, first by entrepreneur’s willingness to take risks and second by inefficiencies arising from a certain loss of control and growing organisation costs that reduce firm’s effectiveness in decision-making and implementation.
Second are the market transaction costs. Transaction costs arise from the process of resource allocation (e.g. information, bargaining, contracting etc.) and tend to increase with asset specificity and the difficulty of measuring all aspects of the good/service exchanged. If transaction costs are high, or if the market (e.g. through outsourcing) offers a too costly form of governance for these activities, firms may seek an alternative solution to the market and internalise their governance (Coase, 1937[63]). Firms enlarge as they integrate new functions, up to the point that increasing intrafirm governance costs offset the benefits of vertical integration and limit the efficient firm size. The transaction cost theory implies that the efficient firm size can also increase when organisational innovation reduce internal bureaucratic costs.

The transaction and governance costs, and consequently the efficient governance structure and firm size, are characteristics of the available technology. The more specific the assets, the larger the firm is likely to become. By contrast flexible manufacturing technologies and technical standards can drive firm disintegration.

Firm size distribution varies across countries and industries due to differences in technology endowment, the institutions in place (e.g. laws, history, power structure, culture, norms and values) and consequently the behavioural standards that can influence technological change.

Inter-firm cooperation provides an alternative to integration as well. A well-functioning cooperation network of small firms can have a competitive advantage over large integrated firms owing to the benefits of flexibility and specialisation (Piore and Sabel, 1984) and informational efficiency (Aoki, 1988). So, if inter-firm co-operation is more widespread, there might be more room for small firms to flourish. The subcontracting system that links Japanese small suppliers to their prime manufacturer within long-term co-operation relationships provides an example of such form of governance of transaction costs. Another example is the industrial districts of Northern Italy where geographical proximity ensures cohesiveness among local institutions and eases co-operation.
Third is the market structure. The market structure reflects the distribution of market power and the distribution of firm costs. A firm’s market share increases if the costs incurred by the firm are lower (and the firm gets larger). Dominant firms can fix price or coordinate pricing, especially when products are homogeneous. Smaller firms are pushed out of business when oligopolists cut prices, e.g. during recessions for adapting to excess capacity. Hence SMEs serve as a buffer to cyclical fluctuations in industrial output.

Pricing over marginal costs (i.e. mark-ups)15 and the existence of profits as long run equilibrium signal imperfect competition in product markets and monopolistic positions. The entry flow of new firms is insufficient for bringing prices down to average costs. Long-term cost differentials between small and large firms arise from a differential in factor prices and a gap in smaller firms’ capacity to access production factors (e.g. finance, skills or innovation assets).

However, product differentiation enables price-setting and market competition. The size of firms serving different market segments may differ. Larger firms tend to produce mass-consumption goods and gain competitiveness through economies of scale while smaller firms address more specialised and fragmented demand and generate economies of scope. As a consequence, the firm size distribution shifts towards small firms if flexibility becomes an important source of competitiveness.

Cross-industry and cross-country differences in firm size distribution reflects disparities in entry conditions (fixed sunk costs), the scope for product differentiation (e.g. through R&D and advertising) as well as regulatory and policy framework conditions.
Fourth are the network effects. Network effects increase as the firm increases its user base. Any additional user adds to the value of the product that can attract an even broader community of users. Beyond a certain threshold of users (critical mass), the revenues cover the production costs and the unit cost decreases. Network effects differ from economies of scale as the production capacity remains unchanged while the demand increases. Therefore network effects can drive firm growth (in terms of revenues, profit or product portfolio) while the firm size (in terms of number of employees or capital investment) remain unchanged. Considerations around the impact of network externalities have become prominent with the rise of the platform economy, the success of online social networks and digital marketplaces.

Network effects are reinforced by the interoperability of systems that improve the connections within and between networks and increase utility and value for internal and external users. Interoperability is in turn reinforced by standardisation and/or co-operation. Intellectual property right (IPRs) can also be instrumental to the diffusion of the technology (e.g. software, protocols), brand, design etc. that gives sense to networking.

Conversely, firms with a technological leadership can choose to enter the market first, sometimes with a still immature product (beta version), with a view to taking control of resources and growing fast enough to set the market standards. The first-mover advantage contribute to create monopolistic positions, if not for the first mover, for the second-mover who would have gained efficiency and competitiveness in the meantime.

Limitations of network effects are related to risks of congestion when the network has reached a volume of users that is detrimental to its efficiency. Other limitations included risks of technology lock-ins and, increasingly, security concerns (see chapter 4 on infrastructure).
Fifth are agglomeration externalities. Positive agglomeration economies occur when the spatial proximity of firms, workers and customers allows reducing production costs through both external economies of scale and network effects.

Knowledge spillovers and agglomeration economies help explain the spatial concentration of firms and the increasing attractiveness of urban areas. Different mechanisms underpin agglomeration economies. First, when more firms locate in the area the variety of goods and services increases and greater specialisation is possible as demand for (specialised) local inputs increases. Second, a larger pool of workers allows SMEs accessing a wider spectrum of skills and better filing vacant positions. And third, positive knowledge spillovers through staff mobility, trade or foreign investments can increase productivity. Combined together, these effect can help SMEs reduce costs in accessing resources, infrastructure and markets, and therefore increase their productivity.

Agglomeration costs balance positive agglomeration economies. They arise from the inevitable upward pressure on local natural resources (land, environment, water etc.) and exacerbated competitive behaviours that will tend to increase factor costs and reduce mark-ups. Risks also arise that are associated with economies of scale, e.g. growing transaction costs and corruption, and with network effects, including congestion and security (OECD, 2015[64]).

Overall there is no ideal firm size but an equilibrium size distribution that is determined by resource endowment, technology, markets and institutions (Hallberg, 2000[65]). In addition the firm size distribution evolves over time with changing production terms (factor endowment and economies of scale), disruptive technology and innovation, and changing cost structure, e.g. transportation costs (that can affect the spatial concentration of production and market size) or transaction costs (that can affect business demographics).

Annex 3.B. SME scale-up dynamics

Annex Figure 3.B.1. What are the drivers behind SME scale-up? A profit-based approach

Annex Figure 3.B.2. How are market structure and scale-up dynamics interrelated? The example of product differentiation

Notes

← 1. E.g. organisational innovation by reducing transaction costs, competition by lowering factor costs and dissuading predatory pricing of small producers’ output, research co-operation by reducing sunk costs or collusion, by raising entry costs.

← 2. Although there is not a clear consensus on the nature of this relationship (Symeonidis, 1996[69]).

← 3. 62% in federal states and 38% in unitary countries. Subnational governments’ contribution can even be significantly higher in federal and decentralised systems such as Canada, Spain, Italy, Switzerland and Sweden. Or lower in more centralised countries such as Greece, Ireland, New Zealand or Slovak Republic where local public procurements are quite limited (less than 20%).

← 4. EU law sets minimum harmonised rules for tenders whose monetary value exceeds a certain amount and which are presumed to be of cross-border interest. The European rules ensure that the award of contracts of higher value must be fair, equitable, transparent and non-discriminatory. For tenders of lower value, national rules apply, which nevertheless have to respect general principles of EU law. See thresholds at https://ec.europa.eu/growth/single-market/public-procurement/rules-implementation/thresholds_en (accessed on 18 March 2019).

← 5. Partnerships are repeated transactions involving joint business objectives and some degree of knowledge flow (irrespective of equity or contracts). They often take the form of joint ventures or contract manufacturing agreements and they prevail in food processing, chemicals, plastic, metals, machinery and transport equipment (OECD/UNIDO, 2019[67]).

← 6. The SME share of total exports varies largely across OECD countries, from less than 10% in Mexico to more than 80% in Latvia. This partly reflects their different weight in tradable sectors and presence in capital-intensive (and exporting) manufacturing and mining industries (see Chapter 1 on SME sector trends and performance).

← 7. Abridged from OECD (2018[22]) and (2018[23]), unless specified differently.

← 8. The 2017 US Tax Cut and Jobs Act (TCJA) enabled cash held overseas in US foreign affiliates to be repatriated with no additional tax.

← 9. The main reason for offshoring production and distribution activities is greater efficiency and lower costs. A second important driver is access to foreign markets as local presence often helps firms better understand and exploit markets abroad. A third driver, which has gained in importance in recent years, is access to knowledge and tapping into foreign knowledge has become an important factor in the internationalisation of R&D activities (OECD, 2013[18]).

← 10. A recent OECD study on the impact of FDI on firm-level productivity conducted across 13 countries shows that delocalisation, as measured by a drop in FDI in one region, has a negative impact on local firms’ productivity (Lembcke and Wildernova, 2019[33]).

← 11. See OECD (2018[40]) for a more comprehensive overview.

← 12. Mark-ups are defined as the ratio of unit price over marginal cost. Mark-ups are different from 1 when markets are not perfectly competitive, e.g. when products are differentiated or there are barriers to entry. Other features of production, such as large fixed costs, a high degree of innovation or a high value of embedded intangibles may also rise mark-up pricing (Calligaris, Criscuolo and Marcolin, 2018[68]).

← 13. Measured by the average GDP per capita of the richest regions that account for 10% of total population, as compared to the average GDP per capita of the poorest regions that account for another 10% of total population.

← 14. Owing to their low cost, ease of manufacture, and flexibility of use as well as the availability of raw materials, plastics have displaced conventional materials such as wood, paper, metal, ceramic, leather and glass in many industrial applications.

← 15. With perfect competition, price equals marginal cost. When prices exceed marginal cost, mark-ups increase. Consequently the greater the mark-ups, the greater the degree of monopoly power.

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