copy the linklink copied!Chapter 7. SME productivity in Ireland
This chapter tackles the SME productivity problem in Ireland. Aggregate statistics point to a productivity gap in Ireland. Analysis of microdata reveals that there is a wide dispersion in the productivity of SMEs. The long tail of low productivity SMEs suggests that there is scope for Ireland to boost its productivity by enhancing the diffusion of best practices to laggard SMEs. The causes of low SME productivity in Ireland are discussed, in particular the prolonged use of low-productivity techniques, the potential to improve management practices, and the need to modernise to prepare for challenges such as the digital revolution and entry into export markets. Suggestions are made for the role of policy with regards to several areas pertaining to SME productivity. The Chapter then presents some inspiring policy practice examples from a set of comparator countries, before closing with some policy recommendations.
copy the linklink copied!What is the issue?
The long-term prosperity of Ireland requires continued efforts to increase the productivity of the employees in its firms. Indeed, the Enterprise 2025 Renewed emphasises productivity growth as a key driver of living standards and quality of life (DBEI, 2018). This Chapter focuses on the productivity of Irish SMEs, illustrating, based on aggregate data their relatively low productivity levels, discussing the heterogeneity of SME productivity, and in particular the long tail of low productivity SMEs. The Chapter then comments on the possible causes of the Irish SME productivity problem and discusses some possible policy responses.
Firms between 10 to 249 account for a relatively low share of output
SMEs are generally less productive than large firms for many reasons. They are less capital intensive, have limited scope for economies of scale, have a more precarious customer base, and lack the market power to increase their prices. It also takes time for new firms to become established and legitimised in a market (Foster et al., 2016).
The SME productivity gap between SMEs and large firms is particularly pronounced in Ireland, however. In terms of value added, Irish SMEs punch below their weight. Irish SMEs account for 99.8% of enterprises (the same proportion as in the EU28 as a whole), but they only account for 36.6% of value added in 2015 (European Commission, 2018). This figure is strikingly lower than the average 56.8% share of value added by SMEs in the EU-28. The existence of extremely high-productivity foreign-owned multinationals headquartered in Ireland can account for some – but not all – of the relatively low share of value added contributed by Irish SMEs. A closer analysis of the SME population shows that the problem does not lie with micro-enterprises, but with small-sized and medium-sized enterprises, that have a particularly low productivity in a comparison of OECD countries.
Figure 7.1 illustrates that firms with 10 to 249 employees account for less than 20% of overall output in Ireland. That is the lowest of all OECD countries, even though the relative proportion of firms in that size class, at around 7% of the overall enterprise population, is rather high in an international context.
Note: Small and medium firms refer to businesses employing between 10 and 249 employees. Micro firms (1-9 employees) are excluded.
Source: OECD SDBS database.
Figure 7.2 presents trends in the evolution of labour productivity, for Ireland as well as selected OECD countries. Looking first at Irish labour productivity using GDP statistics, Ireland has surged ahead to become the most productive country in this sample. However, much of this productivity surge is due to the ability of Ireland’s FDI policy to attract foreign-owned multinationals to become headquartered in Ireland. Looking instead at the trend in GNI (Gross National Income)1the increase in Irish labour productivity is more modest. Ireland has higher productivity than Japan and the United Kingdom, but lags behind France, Germany and the United States. However, even the GNI statistics are potentially misleading, because they emphasise the contributions to productivity of a small number of large firms. To better understand the evolution of productivity for SMEs, and to think about possible policy recommendations, we need to complement the aggregate level statistics with firm-level microdata.
Note: Productivity for Ireland in terms of GDP and GNI Per Hour Worked (USD - 2010 PPPs).
Source: OECD Productivity Statistics, cited in Papa et al. (2018).
The median firm productivity is in decline
Notes: The firm level analysis uses OECD MultiProd. The figure above shows multifactor productivity (using the Solow method) of the median firm in the productivity distribution at each point in time. These results are consistent with labour productivity estimates based on both micro and macro data.
Source: OECD Economic Surveys: Ireland 2018, p70. StatLink: https://doi.org/10.1787/888933683193
Figure 7.3 presents the evolution of (multifactor) productivity for the median firm in Ireland. It shows that the majority of firms have in fact experienced declining multifactor productivity in the years 2006 to 2014. This contrasts with the observed overall strong productivity growth and indicates a widening productivity gap between firms at the technology frontier and others. In other words, aggregate productivity growth seems to be driven by a minority of large high-performing firms. Falling productivity is particularly pronounced in the services sector.
Further analysis suggests there to be a relatively long tail of low-productivity firms at the bottom end of the productivity distribution (Belingieri et al. 2017 and Papa et al, 2018), with firms lagging behind having ample scope to catch up. In Ireland, the productivity dispersion between firms at the 90th percentile and firms at the 10th percentile of the labour productivity distribution is higher than in the OECD average, both for firms active in services and in manufacturing. Please note that this indicator largely excludes large multinational firms that are typically even more productive than enteprises at the 90th percentile (and the productivity gap roughly doubles when comparing with firms at the 97th productivity percentile). In addition, within-sector dispersion accounts for nearly all of the overall labour productivity dispersion (Papa et al, 2018).
The challenge to reduce the productivity gap, therefore, involves encouraging low productivity firms to enhance their productivity, not necessarily by the adoption of cutting-edge technological innovations, although some firms indeed make big steps on the productivity ladder, but often by more modest steps such as adopting existing good management practices, for example applying Enterprise Resource Planning (ERP) as mentioned in Chapter 2) and replacing existing production techniques with (possibly more capital intensive) modern processes. Box 7.1 presents a unifying framework for developing the capabilities in SMEs to boost productivity and innovation potential. Rather than a binary distinction between high-productivity and low-productivity firms, instead SMEs can be placed along a continuum.
The binary distinction between innovators and non-innovators is a simplistic representation of firm heterogeneity. More useful would be to consider innovation capabilities as being positioned along a continuum. At the lower end, where the innovation probability is around 0%, low-productivity firms use traditional techniques, apply inefficient routines and managerial practices, and use an outdated capital stock. These firms could make a series of modest changes to improve their capabilities. Managerial skills and practices could be improved, to increase the coordination and effectiveness of employees. Financial management skills could lead to better strategic decision-making. The capital stock could be renewed with recent vintages, and modern production techniques such as lean production and digitalisation could further lift productivity. The adoption of standards (and a fortiori the development of new standards) could improve internal processes, enable outsourcing, enhance collaboration with suppliers and clients, and facilitate scaling up, exporting, and climbing up global value chains. Growing firms may implement organisational innovations to obtain a more efficient organisation of labour (Cruz et al., 2018). Exporting could improve productivity via scale economies and feedbacks in product design (Altomonte et al., 2014).
Small steps and improvements therefore constitute the path to the other end of the continuum. Recognition of the productivity gains from improved management, together with familiarity with advanced machines and equipment, a larger market, and capabilities for learning and applying new techniques, all enhance absorptive capacity and raise the probability that a firm will recognise and successfully exploit innovation opportunities.
Notes: This “capabilities ladder” concept is similar to the “capabilities escalator” approach in Cirera and Maloney (2017).
Data limitations
Further data would be useful to better understand the scale and nature of the SME productivity problem. The Central Statistical Office (CSO), government departments and other partners are seeking to provide more detailed productivity information, including for example through the Productivity Statistics Liaison Group. Efforts should be continued to support the availability of high-quality micro-data for the analysis of the productivity issue in Ireland. At present, CSO only grants access to databases (i.e. Research Microdata Files, RMFs) to approved researchers with pre-arranged appointments who must appear on-site with photo ID every time they wish to access the data.2 In other countries (for example, in the case of Statistics Denmark or the Office for National Statistics, United Kingdom)3, approved researchers can access sensitive microdata through secure internet portals, from their offices.
Some countries have gone even further to provide data for economic analysis – INEGI (National Institute of Statistics and Geography, Mexico) have made some census data freely available and downloadable, while Chile has put its innovation survey data freely available online. CSO should also consider setting up a special survey on Irish firms regarding firm business processes and digitalisation, management skills, financial literacy, adoption and development of standards, use of modern business practices, age of the capital stock, and attitudes to exporting, which would be useful to better monitor the very large dispersion in productivity among Irish SMEs.
copy the linklink copied!Causes of the SME productivity problem in Ireland
Productivity is essentially a technical term, a ratio of outputs (such as sales or value added) over inputs (such as number of employees, hours worked, perhaps also including capital inputs and other materials). However, productivity has a clear everyday meaning because it corresponds to the efficiency of economic activity. A multitude of factors affect SME productivity including skills and human capital, the capital stock of SMEs, access to markets, infrastructure, networks and clusters, economic dynamism, the regulatory environment, and FDI, including business linkages and labour mobility from large to small firms.
This Chapter on the Irish case will focus primarily on management practices, modernising the capital stock, enhancing access to export markets, favouring spillovers from productivity leaders such as foreign-owned multinationals, enhancing innovation capabilities and innovation performance, and stimulating economic dynamism such as entry and post-entry growth of viable young challengers. This Chapter does not address in much depth themes relating to infrastructure or regulation, as these do not represent primary challenges in Ireland as Chapter 3.
Human capital
Managerial skills appear weak
Data from the World Management Survey indicate that Irish managerial skills are weak, when compared to other high-income countries such as Germany, Sweden and the United Kingdom. Figure 7.4 shows that Irish firms, on average, have the third worst management score in a comparison of 15 countries.
Note: The World Management Survey measures the quality of management practices in establishments across multiple dimensions, creating a management score from responses to questions regarding use of short-term targets, provision of incentives for high performance, monitoring performance data, and so on. Graph prepared using the manufacturing 2004-2014 combined survey data. See Bloom et al., (2014) for details.
Source: World Management Survey, worldmanagementsurvey.org.
To address the shortfall in management skills and practices, a network of enterprises was set up in 1999, which has recently been rebranded into Skillnet Ireland. Although Skillnet Ireland’s schemes have had positive feedback, the take-up among SMEs has been relatively low and could be scaled up, in particular its management development programmes.4
In addition, the Irish food board, Bord Bia, works with young firms and entrepreneurs to develop sales and marketing capabilities, with branding initiatives such as superbrands, consumer understanding initiatives though the consumer lifestyle trends, capability building through retailer programmes and meet the buyer events such as “Marketplace International” and industry information events such as the annual small business open day.
The LEOs are geared towards start-ups and small firms. The financial support that they provide is limited to small firms with potential to export and thus to progress to Enterprise Ireland’s regular programmes. Most of the support from LEOs is directed to local start-ups (or nascent entrepreneurs) and micro- firms, and this support is limited predominately to training unless they have export potential. In other words, there may be a gap in policy making for established firms with 10 to 249 employees with limited or no export potential, even though these firms arguably benefit most from productivity-boosting business development services.
Even if training events and other types of policy measures are in principle open to any local firm, there is a question whether LEO are incentivised to reach out to these firms, as their remit is to primarily focus on firms with less than 10 employees. One way in which LEOs could be incentivised to reach out to local medium-sized companies when it comes to training and other activities is to develop specific performance indicators that relate to activities that involve and are geared towards these types of firms.
Lifelong learning activities
Finally, lifelong learning would benefit managerial skills as well. Increasing participation in lifelong learning in Ireland is a key focus under Pillar 3 of Future Jobs Ireland, which sets a participation rate target of 18% of adults by 2025. It will be crucial to fully implement and monitor progress.
Physical capital and technology adoption
Irish firms underinvest
Investment in physical capital plays an important role for Irish SMEs, because more recent vintages of capital improve the productivity of workers, reduce defect rates and accidents, improve working conditions, and put SMEs in a better position for subsequent innovation and productivity growth by familiarising them with current best practice. In contrast, firms with an outdated capital stock will be badly positioned to anticipate industry developments or to contribute innovative products and processes.
A recent study based on survey data found that Irish SMEs have an estimated underinvestment of about 30% (Lawless et al., 2018). Lawless et al. (2018) find that financial market failures explain only part of this investment gap. On the other hand, underinvestment could be because Irish SMEs are reluctant to seek finance, they may be risk averse and lack an appetite for debt, and may instead prefer to finance investment out of retained earnings and internal funds. Survey evidence from 2016 on Irish SMEs offers some support to this alternative interpretation that a sluggish appetite for borrowing is due to the demand side (Gargan et al., 2018). These authors observe that most SMEs are satisfied with their investment levels: 63% of SMEs stated that their current capacity was adequate. Within the subset of 37% of SMEs who were unsatisfied with their investment, only 11.2% reported “the unavailability of external finance as the reason behind their unsatisfactory investment activities” (Gargan et al., 2018, page 17).
The uptake of digital technologies is average
Digitalisation of business processes can provide a significant boost to SME productivity. Table 7.1 below shows Ireland’s performance in a number of dimensions compared to comparator countries. Irish small firms have an average performance in a number of dimensions, such as use of computers in the workplace, and use of digitalised processes such as RFID (radio frequency identification technology) and CRM (Customer Relationship Management software). This implies that there is scope for improvement on these areas. However, the adoption of social media by Irish small firms is relatively high – far higher than the EU28 average (CSO, 2018).
The use of Enterprise Resource Planning and industrial robots is below average
In particular, Irish SMEs are less likely than large firms to use Enterprise Resource Planning (ERP, a software platform that integrates core business processes in real-time), with Irish small firms (10-49 employees) about one-third as likely as large firms (250+ employees) to apply ERP.5 This magnitude of difference between SMEs and large firms is not unusual among OECD countries. However, Irish firms are overall towards the bottom end of the list of ERP adopters, ranking in 22nd place among a group of 30 OECD countries (plus Brazil) in terms of use of ERP in 2015.
Ireland’s performance with regards to investment in industrial robots is relatively disappointing, however. According to 2017 data, Ireland has the second lowest density of industrial robots in the EU-15 (excluding Luxembourg, where data is not available). The prevalence of industrial robots is strongly linked to productivity gains and a central feature of industry 4.0 strategies in many countries.
Ireland faces a digital skills deficit
Ireland’s National Digital Strategy emphasises the importance of strengthening Ireland’s digital skills and contains a specific pillar on digital skills6. Ireland’s 2017-20 e-government strategy7 could help familiarise individuals with the digital realm, lowering the costs for government, and affording broad-based development of national digital skills. In comparison with the EU average, the proportion of adults with basic digital skills is low in Ireland, and relatively few people actively use the internet (OECD, 2018). This is especially problematic for small enterprises who often are at a disadvantage in the labour marked compared to multinationals. Hence, Ireland could increase the share of funding dedicated to training for those in employment, and financial support to workers undertaking postgraduate courses (as the skills gap is likely greatest among older cohorts of the population) (Jin and Westmore, 2018). Box 7.2 describes the Danish “Digital Growth Panel” as a good practice in this regard.
Description of the approach
The Danish Government has instituted “growth panels” formed of invited representatives from trade and industry and professional organisations to formulate strategic recommendations for economic growth and development within significant industrial sectors and clusters. One such growth panel focuses on the maritime cluster, and the development of test facilities for shipbuilding and autonomous ships, and the exploitation of seafood. This box focuses specifically on the Digital Growth Panel, formed of 15 enterprise and business CEOs and experts, led by the CEO of Danfoss.
The Digital Growth Panel seeks to influence investment decisions of national strategic importance, to identify the areas where companies face challenges, and to make proposals for possible remedies. In June 2016, the Danish Government asked the panel to prepare a digital growth plan, in order to create the conditions for exploiting the opportunities of industrial digitalisation.
In May 2017, the recommendations of the Digital Growth Panel in its report “Denmark as a Digital Frontrunner” fed into the Strategy for Denmark’s Digital Growth (Ministry of Industry, Business and Financial Affairs, 2018). The Digital Growth Panel address all aspects of social digitalisation, and their recommendations include appointing a senior minister to lead the digitalisation process, introducing new education technology, supporting SME digitalisation through the provision of both capital and contacts, promoting innovative business models, and engaging in international cooperation on the digital economy. With regards to manufacturing, the report focuses on digital R&D, digitalisation of production technologies, and supply chain management.
Factors for success
In the context of the challenges of the new industrial revolution and the digitalisation of manufacturing processes, the Digital Growth Panel raises awareness on the opportunities provided by the digital transformation of the economy, and provides expert advice on the government’s “Industry 4.0” investment decisions.
The Digital Growth Panel provides a comprehensive set of policy recommendations to address initiatives that can help unleash Denmark’s digital potential. These recommendations are a central input to the Danish government’s digital strategy.
Involvement of industry in policy making can ensure that the business perspective on national investment plans is heard. For example, the Danish telecoms operator TDC praised the 2017 Digital Growth Panel report because of its awareness of the shortage of IT experts and digital skills specialists, and the need to invest in the skills that are sought by industry.
Obstacles encountered
One of the challenges affecting the effectiveness of the Digital Growth panel is the assembling of a group of business leaders. Furthermore, efforts should be made to ensure that the government internalises and acts upon the panel’s recommendations, for example through the development of a roadmap for the possible implementation of the recommendations.
Relevance for Ireland
Setting up an equivalent “Digital Growth Panel” in Ireland would be valuable to formally recognise the importance of digitalisation in Ireland, to formulate a strategy for investing in future challenges of SME digitalisation, and to be attentive to the requirement of industry regarding areas such as investment, infrastructure, and skills gaps. Furthermore, depending upon the composition of the panel, it could be a mechanism for the transfer of best practice from foreign-owned multinationals to indigenous Irish companies and SMEs.
Sources of further information
http://em.dk/nyheder/2016/16-06-01-produktionspanel-4
http://em.dk/~/media/files/2017/05-09-digipanel/276403-digitalt-vækstpanel-web.ashx?la=da
Ministry of Industry, Business and Financial Affairs (2018). Strategy for Denmark's Digital Growth. Ministry of Industry, Business and Financial Affairs. Copenhagen: Danish Government.
https://em.dk/english/publications/2018/strategy-for-denmarks-digital-growth.
There is a role for digital technology adoption support especially for larger SMEs
A European Investment Bank8 report for the Department of Business, Enterprise and Innovation on Developing Financing Models for SME Digitalisation shows market failures exist that constrain the implementation of digital projects in Ireland. The report found incidences of a lack of awareness of digital offerings and their benefits (knowledge gap) and barriers to accessing traditional bank finance for technological projects (financing gap). The latter is in line with international evidence indicating that firms face particular difficulties to raise credit for intangible assets such as investments in knowledge-based capital (see for instance, Brassell and Boschmans, 2019). The report recommended the Irish government adopt measures to address these market failures and involve various grants, funds and loans. For larger SMEs, where financial barriers appear to represent a barrier in many instances, the report recommends income contingent and preferential loans.
Box 7.3 describes a French scheme to provide loans for the potentially large investments that SMEs need to make in order to introduce modern production processes. Such a scheme could be introduced in Ireland to galvanise Irish SMEs to the challenges of digitalisation, possibly in the context of the planned DBEI National Industry 4.0 Strategy.
Description of the approach
The programme "Prêt Industrie du Futur – Technologies et usages du futur" ( ”Industry of the Future Loan - Technologies and uses of the future”), recently introduced by the French public investment bank, Bpifrance, explicitly targets the modernisation of productivity capacity in French SMEs. The Bpifrance programme offers co-financing for investment projects that will modernise the industrial capacity, and result in new products brought about by the adoption of modern technologies and processes. It is important to note that the scheme aims to invest in technologies new to the firms, not just any expansion of capital. The support may incentivise firms to adopt unfamiliar production technologies, which is often considered daunting.
The programme consists of five themes:
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Production and control technology: including nanomaterials, nanotechnologies, 3D printing, and robotisation;
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Augmented humans: including virtual reality and intelligent cooperative human-machine interfaces;
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Connected, piloted, and optimised company: including cloud computing, big-data, artificial intelligence, deep learning, and simulation and optimisation of products;
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Innovative digital technologies: including flashcodes, RFID (Radio-frequency identification), and cybersecurity;
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Customer relations, suppliers, and the supply chain: including data exchange tools such as electronic billing.
Factors for success
The strict eligibility criteria of the programme can be expected to bolster its effectiveness in reaching its goals of modernising the capital stock of French SMEs. The programme is targeted to a specific group of firms: SMEs of over three years of age that are in good financial health. The loan has a duration of 7 years, of an amount between EUR 100 000 and EUR 5 million. The loan must be co-financed, on a one-to-one basis, with bank credit (for a period of 5 years minimum) or capital contributions from shareholders or private equity companies. Administrative fees amount to 0.40% of the loan amount.
Relevance for Ireland
The BPI initiative, if implemented in Ireland, could prepare Irish SMEs for the challenges of Industry 4.0 and the digital revolution. It may be relevant given the underinvestment in capital and digital technoligies, especially with respect to Enterprise Resource Planning and the use industrial robots. The eligibility criteria could be set to mainly target established, larger SMEs that have experienced limited or negative productivity growth.
Sources of further information:
Box 7.4 presents a German scheme according to which a relatively large number of regional centres seek to support SMEs in digitising, networking and introducing Industry 4.0 applications. This provides another potential model to be implemented in Ireland, involving the LEOs, to provide support to indigenous SMEs preparing for Industry 4.0.
Description of the approach
Germany has 3.6 million small and medium-sized enterprises (SMEs – many of which are skilled craft workshops) that are confronted with the challenges of remaining competitive amidst the digital revolution. To enhance their productivity growth, “Mittelstand-Digital” is an initiative of the German Federal Ministry of Economic Affairs and Energy (Bundesministerium für Wirtschaft und Energie, BMWi) that seeks to support SMEs in digitising, networking and introducing Industry 4.0 applications.
In total, there are 25 Mittelstand 4.0 Competence Centres nationwide which have learning and demonstration factories that offer opportunities to learn about how digital technologies can transform a business, and provide information sessions and practical examples. Their aim is to assist SMEs in different areas of digitisation. Of these Competence Centres, 18 are regional and support SMEs of all branches in numerous digitisation issues, such as cloud computing, communication, trade, and processes. In addition to such regional centres, there are also dedicated Competence Centres for Digital Crafts, Planning and Construction, eStandards, Usability, Textiles Network, IT Industry, and Communication. These seven specialised centres are supported by regional contact points and offer their support to companies all over Germany. A Competence Centre for Trade is currently being set up and will open in summer 2019.
Factors for success
SMEs and skilled craft workshops usually do not have dedicated IT departments, and lack the financial resources to use external IT support companies. However, they stand to gain a lot from the efficiency gains brought about by modernising their business processes, e.g. through new software solutions, internet applications, and standardised e-business processes. Mittelstand-Digital can help SMEs to overcome the barriers such as a lack of awareness, knowledge, and competence, to support SMEs in the implementation of modern businesses practices.
Lessons learned
During the implementation of programmes such as the Mittelstand-Digital programme, a number of aspects need to be taken into account (OECD, 2016b). First, Competence Centres have to translate information into the “language of SMEs” in order to have sufficient outreach. Second, the challenges of digitisation vary across regions (e.g., with regard to learning cultures), such that the formats of events (e.g. webinars, entrepreneurs’ breakfasts, weekend meetings) and publications need to be tailored to the recipient SMEs. Third, in the context of the programme and advice being offered for free, SMEs may harbour the beliefs that “what costs nothing is worth nothing,” which needs to be overcome by proving that the information provided is actually of value and helpful. However, Mittelstand-Digital can use to its advantage that trust is an important aspect for SMEs. This makes them more willing to accept the official and unbiased information provided by the German federal government as opposed to that provided by private consultants. Mittelstand-Digital further augments the benefits of the programme by enabling and leveraging peer-learning, whereby networked SME participants learn from each other.
Relevance for Ireland
The Mittelstand-Digital scheme, if implemented in Ireland, could assist SMEs with the implementation of productivity-enhancing investments and help them invest for the digital revolution. The model allows for tailoring to regional and local circumstances through 18 regional competence centres nationwide. In Ireland, the LEOs could play a similar role, with the support of regional “competence centres” such as the EI Technology Gateways, EI/IDA Technology Centres and SFI Centres (including Confirm/Smart Manufacturing and I-Form) who have relevant “industry 4.0 / digital manufacturing” expertise. It is also worth considering that these RDI centres also have multinationals as collaborators. The various national RDI Centres mentioned above could help SMEs to identify and implement the relevant industry 4.0 standards, and NSAI could support this process by providing access to international standards development committees via its “national mirror committees.” 3 to 4 of such centres may allow for some regional adaptation, while ensuring critical mass.
Sources of further information
OECD, (2016b). Stimulating digital innovation for growth and inclusiveness: The role of policies for the successful diffusion of ICT. OECD Digital Economy Papers, No. 256, OECD Publishing, Paris. https://doi.org/10.1787/5jlwqvhg3l31-en; https://www.mittelstand-digital.de.
Access to foreign markets
“Across a wide range of countries and industries, exporters have been shown to be larger, more productive, more skill- and capital-intensive, and to pay higher wages than non-exporting firms” (Bernard et al., 2007, p105). This is also the case in Ireland, according to a recent report by InterTradeIreland. Exporting firms are larger (in terms of turnover and employment) and more productive. The productivity gains from exporting are larger for firms that export to more distant export markets (but far from negligible for firms that export into nearby Northern Ireland and the rest of the United Kingdom), and are larger for Irish goods firms than for Irish service firms.9 A 2013 study by InterTradeIreland shows that exporters are more likely to innovate according to a variety of indicators (including product and process innovation), and that the innovation premium is larger for experienced exporters than for inexperienced exporters.10
Chapter 2 illustrates that export activities are highly concentrated in Ireland with 50 firms accounting for more than two-thirds of the value of exports. It also shows that Ireland has one of the lowest ratios of exporters in the EU. Hence, there is a clear need for Irish firms to improve their export performance, and there may be a role for policy to provide assistance to potential exporters. Given the uncertainties surrounding Brexit, as well as the development of the Digital Single Market in Europe, it is also a priority to look to continental Europe – and beyond – as an export market. According to the EY Entrepreneur of the Year Alumni Survey, 32% of entrepreneurs believe Brexit will force them to explore new export markets. Exporting could require complementary investments by SMEs, upgrades of the capital stock, and standardisation.
Most exporting firms in Ireland export into Northern Ireland, and this first step in internationalisation can be seen as a “stepping stone” towards broader international exporting to markets further afield for many small firms.11 Furthermore, the first steps of exporting into Northern Ireland are accompanied by further productivity increases (InterTradeIreland, 2018). Stimulating greater cross-border collaboration on trade can therefore be a relatively gentle and low-risk means to encourage productivity increases, and to stimulate the appetite for further export activity.
Support for growth and internationalisation of Irish SMEs is provided both by Local Enterprise Offices (LEOs) and Enterprise Ireland (EI), and InterTradeIreland discussed in Chapter 4 of this report.
Ireland provides small-scale exploratory grants to help with the search for export opportunities (e.g. trade fairs, gathering information), and InterTtrade Ireland can facilitate trade across the Irish border, and EI provides advisory support for exporting through its “Exporter Development” section,12 and specifically its “Market Discovery Fund”13, but there is limited assistance provided to would-be exporters. This could potentially be an area for improvement, spreading assistance to a wider cohort of SMEs, as well as working more closely with SMEs on longer-term exporting strategies, if new initiatives can be developed that comply with EU State aid rules, specifically, the GBER, or General Block Exemption Regulation.14
There may also be need for a more detailed mapping and targeting of export-capable firms by Enterprise Ireland, which could lead to both export and productivity gains for the economy.
Productivity externalities and spillovers
Within sectors, foreign-owned firms tend to be more productive than indigenous firms (Papa et al., 2018). These “superstar” firms can be many times more productive than lagging firms, in terms of output per worker. Moreover, the productivity gap between top-performers and laggards seems to be increasing in recent years. Given the prominent role of foreign-owned multinationals in the Irish economy, and their superior productivity, multinational-SME linkages could be strengthened, for example in terms of upstream or downstream linkages, or perhaps through industry-wide horizontal collaborative activities. The challenge, therefore, is to encourage the diffusion of their superior management practices and organisational capabilities such that they can be adopted by indigenous firms, in order to stimulate the latter’s productivity growth.
Productivity spillovers from multinationals have been hard to detect, however. Indeed, cooperation between SMEs and multinationals have proved difficult to foster, and supply chains do not automatically include local SMEs.
A 2018 OECD study using micro-level firm data from Ireland confirms this picture. The evidence confirms that indigenous firms raise their productivity levels by supplying inputs to foreign large firms. These knowledge and technology transfers from foreign direct investments do not occur automatically, however and heavily depend on the absorptive capacity of domestic suppliers. In addition, the study demonstrates that spill-over effects to non-suppliers are limited at best. In fact, the data point to a negative link between the presence of foreign-owned firms in the same industry and the performance of domestic firms at large, while no evidence could be found for intra-region productivity spillovers (Di Ubaldo, Lawless and Siedschlag, 2018[7]).
The role of standards remains largely untapped
Productivity spillovers from multinationals to indigenous Irish SMEs could be supported in different ways. First, compliance with industry standards could help SMEs to meet quality requirements and to overcome trust barriers, thus facilitating their insertion into supply chains. Standards are a powerful, yet overlooked, tool for enhancing productivity in Irish SMEs. Standards are the requirements, guidelines, specifications or characteristics that are consistently applied to ensure that products, processes, materials, and services are fit for purpose. Standards play a key role for quality assurance, enhancing interoperability and technology adoption, and facilitating the division of labour.
Standards could be a valuable platform to facilitate the interactions of SMEs and foreign-owned multinationals, thus enhancing productivity spillovers. Standards also facilitate process innovations, can improve the quality of products, can facilitate entry into global value chains, and can facilitate outsourcing. Standards can also lead to the development of Intellectual Property (IP) and innovation. They can also support and enable e-commerce, as illustrated by the example of the European standard on e-invoicing.15
There seems to be a lack of awareness of the benefits of standards for Irish SMEs, however. The NSAI (National Standards Authority of Ireland) could therefore collaborate more closely with the DBEI (Department of Business, Enterprise and Innovation), and also with Enterprise Ireland (EI) in order to better support SMEs with international aspirations. To a lesser extent, the LEOs (who may currently lack awareness of the importance of standards for SMEs) could also benefit from closer collaboration with the NSAI. In addition, support grants, compliant with EU State aid rules, could be explored.
This may improve the business processes of lagging SMEs in the long tail of the productivity distribution. On the other hand, SMEs could be encouraged to engage not only in standards adoption, but also standards development, in order to help them influence new standards and to get “ahead of the curve” by developing first (or early) market standards – thus offering informed new products and services, and exporting to international markets that trust standards-based innovative products.
Enterprise-led networks including large firms
In addition, clustering and cooperative activity between SMEs is an opportunity for peer-based learning, knowledge diffusion, and productivity growth. While chambers of commerce have important roles in several European countries, such as Germany and Italy, chambers of commerce are less prominent in Ireland. While Ireland does have industry-led networks (such as the Foodwise 2025 strategy for the agriculture industry), there is scope to augment Irish industry-led business networks. Clustering and inter-firm business relationships could allow Irish SMEs to collaborate on common problems, and could enhance the diffusion of best practices. Box 7.5 presents a Chinese initiative to promote business meetings among SMEs, with clearly-identified performance benefits. Such a scheme could potentially be adopted in Ireland to boost SME productivity via peer-based learning.
Description of the approach
The intervention reported in Cai and Szeidl (2018) is an elaborate policy experiment that allocates willing participant firms into business association groups, and allows to clearly identify the causal effects of interfirm relationships on firm performance.
The experimental site was Nanchang, the capital city of Jiangxi province in southeastern China (a large city that ranked 19th among the 32 capital cities in China). The intervention was conducted by the Commission of Industry and Information Technology (CIIT), one of the main government departments for private sector development, in collaboration with the authors. In Summer 2013, all microenterprises and SMEs established in the previous three years in Nanchang were invited to participate in business associations. Of the 5 400 firms that expressed interest, 2 820 firms were randomly selected as the study sample. 1 500 of these were randomised into meetings groups with about 10 firms each, and the remaining 1 320 firms were taken as the control group (they were informed that there was no room for them in the meetings).
The SME managers from each meeting group were expected to meet once a month, every month, for one year. Each meeting was attended by a representative of the author team. To provide incentives to participate, managers were offered a CIIT certificate stating that the firm was selected to be in the official Nanchang city database on SMEs, which was valued by the participants because it provided recognition to the SMEs and allows for improved access to government funding and admission to training programmes. Typical meetings involved taking a tour of a group member’s firm, which lasted for about half a day. Participants discussed topics such as borrowing, management, suppliers and clients, hiring, recent government policies, and marketing.
Additional interventions built into the experimental design allowed to investigate the relevance of peer effects, information diffusion within the group, and the role of meeting frequency.
Factors for success
Organising the meetings was a relatively cost-effective way to bring together SMEs into a series of business meetings, which were a platform for peer-to-peer learning. For the average firm, the profit gains from the meetings were estimated to be twice as high as the costs of organising and attending. Firms often underestimate the productivity gains that come from incorporating external knowledge into their business practices (Bruhn et al, 2018), or business support more generally (OECD, 2017; Jin and Westmore, 2018). Cao and Szeidl (2018) also show that they underestimate the gains from business associations or from changing business practices.
Quantitative analysis provides significant, robust, large and persistent effects of the meetings on sales, profits, efficient use of inputs, number of partners, borrowing, innovation, and improved management practices. For example, firm revenue increased by 8.1%, while firms randomised to have better peers exhibited higher growth. There is also direct causal evidence that the meetings diffused information that was initially only given to a randomly-selected subset of managers. Peers provided more business referrals, and continued to do so after the conclusion of the meetings. Managers exhibited significantly more trusting behaviour towards their peers, half-way through and also at the end of the intervention. The meetings therefore reduced the costs of referrals and partnerships.
Obstacles encountered and responses
To address the risk that firms might hold contempt for business association meetings that are offered for free, a competitive element was introduced (in that only a subset of interested SMEs were invited to participate), and mild incentives were given to firms, such as being officially registered in the Nanchang administrative database, and receiving information about relatively unknown financial products (a government funding opportunity for firms, and an attractive savings opportunity for the manager). This helped foster a receptive mindset among participants. Average attendance at the meetings was quite satisfactory at a level of 87%.
Relevance for Ireland
Business associations and chambers of commerce do not play a prominent role in Ireland as they do in many other EU countries. The organisation of business meetings and SME associations could therefore be a useful mechanism for helping lagging Irish SMEs to reduce search costs and overcome trust barriers, to adopt superior management skills and practices, and to reduce their gap with respect to the productivity frontier.
Source:
Cai and Szeidl (2018). Interfirm relationships and business performance. Quarterly Journal of Economics, 133(3), 1229-1282.
Impediments to the flow of labour
Another potential barrier to productivity spillovers is the limited role for the labour flows channel of spillovers (Holm et al., 2017), which is potentially due to non-compete clauses in employment contracts. The extent to which non-compete agreements are constraining workers moving to local firms could be evaluated (Jin and Westmore, 2018).
Infrastructure
The installation of high-speed broadband internet across Ireland should be a priority. McCoy et al. (2018) observe that the availability of broadband infrastructure across Ireland is a significant determinant of the location of new business establishments, especially in areas of high human capital. Ireland has a national broadband plan, but the rollout of broadband access throughout Ireland has been delayed.
Economic dynamism
The Irish economy lacks dynamism in the sense of having relatively low levels of business entry and exit, and a relatively high survival rate (see Chapter 2 for more information). A low start-up rate (for example, due to credit market imperfections) could hold back productivity growth if vigorous entrants with modern business processes are few in number. A low exit rate (for example, if personal guarantees and bankruptcy law are unfavourable to exit) could result in entrepreneurs (and employees) being trapped in low-productivity employment rather than having the freedom to pursue more attractive opportunities. Hence, increasing economic dynamism and Schumpeterian creative-destruction could contribute to productivity growth. According to the EY Entrepreneur of the Year Alumni survey, 90% of entrepreneurs who have exited a business have reinvested in another. Increasing the incentive to exit, could help to alleviate some of the issues around funding for start-ups.
A 2017 study from the European Central Bank estimated that around 5% of Irish firms (of all sizes) can be classified as “zombies,” i.e. they have negative returns, negative investment, and debt servicing capacity (EBITDA/financial debt) below 5% for at least two consecutive years in 2014, the most recent year for which data are available. This is below the percentage in Italy, Portugal and Spain, but well above levels observed in France and Germany (Storz et al., 2017[8]). A 2018 study from the European Commission, using a different methodology, indicates that Ireland has a higher incidence of “zombie firms” than any other of the 19 euro zone countries under investigation, bar Greece and Spain. It should be noted that these firms are generally small in Ireland, and do not account for much capital, and that their share is decreasing over time (Hallak, Harasztosi and Schich, 2018[9]).
Firms that are categorised as zombies typically have below-average productivity growth. In addition, there is a risk that they negatively affect the performance of other firms indirectly, for example by competing for scarce talent and access to finance, driving up overall costs. (Hallak, Harasztosi and Schich, 2018[9]).
This issue merits further research, so as to better understand the drivers, the possibility of these firms to return to financial health and policy measures that have the unintended consequence of keeping unviable afloat. It is worth exploring, for example, whether a reduction in the Capital Gains Tax, which is relatively high in Ireland among OECD countries (see Chapter 3), would have a causal effect on increasing business dynamism large enough to offset the foregone tax revenues. This effect could operate via encouraging more entrepreneurs to start a business venture, by stimulating the post-entry growth of these ventures, and also by accelerating entrepreneurial exit from these ventures in terms of business sales.
Innovation
In their analysis of Irish firms, Di Ubaldo and Siedschlag (2017) note that innovation is positively linked to labour productivity. This result holds for all types of innovation. The strongest link between innovation and productivity is found for firms with R&D spending and with product innovation.” For Irish SMEs, an additional benefit is that innovative activity can enhance the absorptive capacity needed to benefit from productivity spillovers with MNEs. A study of productivity spillovers into Irish firms from foreign-owned multinationals found that the strongest evidence of productivity spillovers was among R&D investing indigenous firms (Di Ubaldo et al., 2018), presumably because these firms have developed the absorptive capacity to be more receptive to, and to better internalise, productivity spillovers from foreign MNEs. Hence, these spillovers that are enjoyed by R&D investing SMEs emphasise the need to boost the numbers of R&D investing SMEs.
Innovation activities are positively correlated with firm size and lower among indigenous businesses
Chapter two illustrates that the innovation performance of Irish SMEs is solid. Nonetheless, Ireland’s innovation performance is skewed by the presence of non-indigenous (foreign-owned) firms. Foreign-owned enterprises based in Ireland are involved in technological innovation activities on average more than Irish-owned firms across all size classes, notably in the small (10-49 employees) and large categories (see Figure 7.5).
Source: www.cso.ie, graph by author.
The share of total turnover of industrial and selected service sectors generated by the technological innovation active enterprises was on average 69%, but in the 10-49 size class this figure drops to 46% and to only 30% for Irish-owned firms compared to 66% of non-Irish-owned small firms. There is almost no gap in terms of the medium-sized Irish/non-Irish firms (58.6% of turnover produced by technologically active Irish-owned firms compared to 60% for non-Irish).
During 2014-16, 36% of Irish-owned enterprises (all size classes) had innovation expenditure compared to 43% of foreignowned enterprises (all size classes); while 23% of Irish-owned enterprises performed in-house R&D relating to innovation activities compared to 30% of foreign-owned enterprises. The differential in innovation investment between indigenous and foreign-owned firms is reflected in outcomes, as 21% of the turnover of foreign-owned enterprises was the result of new to firm or new to market innovations compared to only 11% of the turnover of Irish-owned enterprises. In terms of type of innovation carried out by technological active innovation firms, there is a noticeable gap between Irish-owned and non-Irish-owned in terms of firms engaged in both product and process innovation and product innovation. The gap is less important for firms only engaged in process innovation.
The largest 50 enterprises with innovation expenditure, representing 0.7% of all enterprises, accounted for 72% of total innovation expenditure. Only 20% of small firms were engaged in in-house R&D (34% medium and 52% large) and only 7.4% purchased external R&D (14% and 25.6% for medium and large firms respectively). Hence, there is an innovation under-investment in small Irish enterprises.
The “innovation gap” is confirmed by business expenditure on R&D (BERD) data which points to a significant gap between foreign and indigenous firms in terms of R&D expenditure and activity. In 2015, foreign-owned enterprises accounted for 64% of all R&D expenditure, with EUR 1.36 billion spent on R&D; Irish-owned enterprises in comparison spent over EUR 800 million on R&D. In comparison, on average about 40% of business R&D expenditures in the EU28 is made by foreign affiliates (EIS 2018). In the United Kingdom, for instance, the proportion of R&D performed by UK-owned businesses was marginally greater than that performed by foreign-owned businesses, at 50.1% in 2016.
Considering innovation cooperation, 25.7% of Irish-owned technologically innovative firms reported co-operation compared to 46.5% of non-Irish-owned; while the rate of co-operation with Universities and third level institutions was 11.2% for Irish-owned technologically innovative firms and 19.5% for non-Irish-owned. Similar differences in co-operation patterns are visible between small firms and medium and large firms, with on average 24% of small technological active innovative enterprises engaged in co-operation compared to 39% of medium and 64% of large. Only 10.5% of small firms reported co-operation with universities or third-level institutes compared to 14% of medium and 35% of large firms.
The hampering factors for innovation
Small firms (10-49 employees) report much higher rates of importance for all factors, notably lack of funds (41% of firms), innovation costs (36%), too much competition (31%) and lack of skilled employees (27%). Medium and large firms (by number of employees) main concerns are lack of skilled employees (16%) and uncertain demand for innovative goods (15%) respectively. By ownership, the differences are as important with 37% of Irish-owned firms reporting lack of funds as a hampering factor compared to only 14% of non-Irish-owned firms. For non-Irish-owned firms, the most important hampering factor is lack of skilled employees (16%) (see Figure 7.6).
Source: www.cso.ie, graph by authors.
The above information indicates that there is scope to improve the innovation potential of Irish indigenous enterprises, especially in the 10-49 size class. Even though grant aid exists, innovation policy in Ireland emphasises tax credits to stimulate firm-level R&D investments as judged from expenditure (OECD, 2018). These tax credits seem to have been effective in stimulating R&D investment, and should be continued. However, tax incentives may favour less dynamic incumbents at the expense of young innovative challengers (Jin and Westmore, 2018).
Innovative young firms in emerging sectors might benefit more from other innovation policy instruments, such as risk finance (Brown et al., 2017), especially since a lack of funds is often identified as a major obstacle to innovative for indigenous SMEs. The development of grants, loans and loan guarantees, in addition to risk finance instruments –which are not well developed in Ireland may therefore be valuable tools. The recommendation is therefore to maintain R&D tax credits, while exploring avenues to increase their take-up by smaller enterprises. At the same time, the role R&D grants, loans, and loan guarantees could be strengthened. Finally, innovation capabilities could also be enhanced by broad-based upskilling, perhaps targeting skilled workers whose skills are in need of updating.
copy the linklink copied!Policy recommendations
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Continue efforts to facilitate researcher access to Central Statistics Office (CSO) micro data on SME productivity to support evidence-based policymaking.
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Encourage a wider take-up of Skillnet Ireland programmes to develop management capabilities in Irish SMEs, and consider a further push to target firms that are not at the technological frontier.
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Consider the establishment of a national panel comprising industry representatives that feeds into government decision-making and strategy formulation.
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Further support digitalisation of business processes in SMEs, for example through targeted loans or vouchers and creation of a small number of regional competence centres.
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Introduce policy initiatives to encourage the adoption of productivity-enhancing techniques such as ERP and industrial robots. A twin track approach to accelerate digital transformation via e-invoicing in Irish SMEs could be adopted, by educating via Skillnet Ireland as well as by designing appropriate Enterprise Ireland and/or LEO grant schemes.
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Increase policy attention to the role that adopting and developing international standards can play in enhancing SME productivity. This could include increased collaborations between NSAI and SFI, EI, and IDA on incorporating standards adhesion in company SME programmes and enhanced treatment of standards in Skillnet Ireland management development programmes.
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Increase export assistance for SMEs, for example through grants to complement existing initiatives by LEOs and EI to support would-be exporters.
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Augment Irish industry-led business networks involving both SMEs and large firms, to support collaboration on common issues such as training and innovation and the diffusion of good practice management approaches.
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Roll out broadband infrastructure across Ireland, in keeping with the National Broadband Plan.
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Maintain R&D tax credits, while trying to increase their take-up by smaller enterprises by design changes and awareness raising.
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Strengthen the offer of grants, vouchers, loans, and loan guarantees for R&D and innovation in SMEs as well as measures to facilitate risk capital markets.
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Notes
← 1. This is an alternative indicator that adjusts GDP for MNE’s outflow of profits, to better represent the output and income produced in Ireland that is available to benefit those living in Ireland (see FitzGerald, 2018),
← 2. https://www.cso.ie/en/aboutus/lgdp/csodatapolicies/dataforresearchers/researchmicrodatafilesrmfs/
← 3. https://www.ukdataservice.ac.uk/get-data/how-to-access/accesssecurelab
← 4. https://www.skillnetireland.ie/management-development/.
← 5. http://www.oecd.org/cfe/smes/ministerial/documents/2018-SME-Ministerial-Conference-Parallel-Session-4.pdf
← 6. National Digital Strategy (2019)
← 7. See https://egovstrategy.gov.ie/ Ireland's 2017-2020 eGovernment strategy builds upon Ireland's first eGovernment Strategy (eGovernment 2012-2015).
← 8. European Investment Bank (2018), “Investigation into Development of Financial Models for the Digitalisation of SMEs” Luxembourg (forthcoming)
← 9. https://intertradeireland.com/insights/publications/export-participation-and-performance-of-firms-across-the-island-of-ireland/
← 10. https://intertradeireland.com/insights/publications/analysis-of-the-key-features-of-an-exporting-sme-on-the-island-of-ireland/
← 11. https://intertradeireland.com/insights/publications/analysis-of-the-key-features-of-an-exporting-sme-on-the-island-of-ireland/
← 12. EI's Exporter Development section has a structured approach to supporting potential exporters – including one-to-many and other more tailored supports. These companies are eligible for many of Enterprise Ireland’s grants and advisory supports. See: https://www.enterprise-ireland.com/en/export-assistance/exporter-development/
← 13. EI’s "Market Discovery Fund" provides 50% grant funding, up to a maximum grant of EUR150’000, to incentivise companies to research viable and sustainable market entry strategies in new geographic markets. EI’s network of overseas offices also provide in-market support to exporters: e.g. help with customs procedures/tariffs, and introductions to distributors.
← 14. This legislation specifies certain categories of aid compatible with the internal market in application of Articles 107 and 108 of the Treaty. More information can be found here: http://ec.europa.eu/competition/state_aid/legislation/block.html
← 15. The European standard on e-invoicing (EN16931) has been developed to make it possible for companies including SMEs to send invoices to many customers by using a single e-invoicing format. The resultant automated e-invoicing process will deliver cost savings of 60-80% in most cases for SMEs (Billentis, 2017; see https://www.billentis.com/e-invoicing-businesscase.pdf). Currently the Scandinavian countries are leading on the implementation of e-invoicing standards, and - in the experience of the NSAI e-invoicing committee experts - Ireland is lagging behind, with the only initiatives undertaken being those enforced by the EU. It is now mandated for all public bodies throughout Europe to be capable of processing invoices in this new standard format. This represents an opportunity for Irish SMEs to increase their digital sales/e-commerce capabilities and productivity, giving them a strategic advantage in the EU market post Brexit. The fact that e-invoicing is now based on an EU standard will bestow legitimacy upon this innovation, and enable resources to be deployed to speed up its implementation. However, NSAI e-invoicing committee experts have observed that awareness of these standards is still at a very low level in Ireland. A twin track approach to accelerate digital transformation via e-invoicing in Irish SMEs could be adopted: by educating via Skillnet Ireland and implementing using appropriate Enterprise Ireland and/or LEO grant schemes.
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