Size matters – and in business, scale matters. Scale often brings lower overheads and reduces the cost of production, which allows firms to improve their profit margins and expand operations. Although this is often a recipe for success, some businesses tend to flourish with smaller scale operations.
IBISWorld’s business information analysts have identified the top industries in which Australian small and medium-sized enterprises (SMEs) thrive. IBISWorld defines SMEs as companies that generate annual revenue of between $750,000 and $25.0 million, and employ fewer than 50 staff.
“Dental services, wine production, road freight transport, specialist medical services and restaurants are some of the industries where consolidation and traditional bolt-on acquisitions do not necessarily improve profit margins,” said Andrei Ivanov, IBISWorld senior industry analyst.
Despite the maturity of most of these industries, they are generally characterised by low market share concentration and low to medium barriers to entry. SMEs typically thrive in industries that have low market share concentrations, as this means there are few major players occupying the industry.
The wine production industry produces bulk goods and, unlike other similar producers, it remains largely fragmented and SMEs dominate. With anticipated growth spurred by increasing premiumisation and a resurgent taste for Australian wine, SMEs in the wine production industry are tipped to be the main beneficiaries. The core reason for the number of SMEs operating in this industry relates to the ownership structure of wineries.
“Smaller scale wineries are often family owned and operated, with many families unwilling to sell their businesses to larger companies that may be seeking to consolidate operations,” said Ivanov. This trend is common across a number of agricultural industries with a large degree of family ownership.
“In addition, the reputation of local wine brands and varieties is crucial for producers, which further limits the scope for larger firms to consolidate and expand volumes,” said Ivanov.
Outsourcing non-core functions
With limited scale, SMEs often rely on outside support for back-end operations. Since there is little opportunity to spread overhead costs across a range of products, these industries tend to cut these costs by outsourcing non-core business processes.
“Provided this does not undermine the quality of the product or service, outsourcing makes economic sense and reduces the risks of fixed costs blowing out, whereas blue chip companies often have the size and scope to complete these processes in-house,” said Mr Ivanov. “By spending less time on non-core operations, managers can focus more on strategy and growth.”
Services such as accounting, human resources, recruitment and payroll administration are among the most common functions outsourced by SMEs. For example, wine producers may outsource distribution, minimising the need for costly vehicles and transport operators.
High variable costs
For service-based industries, where wages are the dominant expense and tend to be higher than other industries, the cost of additional employees (in terms of profit margins) does not decline with a greater headcount. This trend contrasts with non-service industries, where automated production processes can reduce the costs of additional employees and allow companies to benefit from economies of scale.