Firms led by women or ethnic minorities tend to be smaller and less well capitalized than the average business, inhibiting their ability to compete on an equal footing across all industries. In many industries, the minimum efficient scale (the company size required to compete effectively on cost) may be far beyond the capacity of most minority-owned firms. For example, the chemical industry, with its large capital expenditure requirements, tends to have fewer and larger competitors.
In the U.S., across the full spectrum of industries, the average firm has around $1 million in annual sales (according to the 2002 Economic Census, the most recent data available). Recognizing that this average includes goliaths like $379 billion Wal-Mart highlights how many extremely small firms must also be in the mix. Minority-owned firms averaged only $163,000 in annual sales in 2002, and the average woman-owned firm garnered $145,000.
In addition to the variance between publicly traded and majority-owned firms, there are significant differences by sector due to capital requirements and economies of scale. For example, the average utility achieved $22.6 million in sales, whereas the average construction company had sales of only $477,000. Strategically, a company is more likely to find a cost-competitive diverse supplier in an industry with more small players, such as apparel, and a higher concentration of minority owners.
Consider the transportation and warehousing industry, another industry with small-scale competitors. Black-owned businesses in the U.S. account for 10.2 percent of the industry, despite representing only 5.2 percent of all U.S. firms. There are nearly 39,000 black-owned trucking companies and more than 16,000 black-owned courier companies. Similarly, Asian entrepreneurs own only 4.8 percent of all U.S. firms, but they own 15.5 percent of accommodation and food-service firms, another industry with many small players. With average sales of $313,000, even the average Asian-owned company in this segment faces only limited scale disadvantages; the overall industry average sales are just $692,000.
Of course, companies that limit their diversity sourcing to small-scale service businesses may miss the opportunity to tap into manufacturing innovations. Although manufacturing in total has greater scale economies — as indicated by the average annual sales of $6.7 million across all U.S. firms — certain manufacturing segments demonstrate lower-scale economies. Take the textile industry as an example. The average textile mill achieved annual sales of more than $9 million, but the average apparel manufacturing firm achieved only $1.1 million. Furthermore, although women own just 28 percent of businesses across all industries and 18 percent of manufacturing firms, they own 50 percent of apparel manufacturing firms and even 28 percent of the more capital-intensive textile mills.
Companies can strategically source a majority of their purchases from minority owners in particular segments, chosen through detailed understanding of the industry economics, rather than simply trying to achieve “reasonable” targets of “5 to 10 percent diversity sourcing” in all purchasing categories. Benchmarks are helpful to gauge progress, but should not become goals in and of themselves. Though most women-owned and minority-owned businesses are very small concerns, many represent diamonds in the rough that can grow to be strategic suppliers with the right type of mentoring and support. Over time, they can then grow into publicly traded companies that can expand into related industry segments.
Crossing the Capital Gap
Even in industries with low minimum efficient scale, entrepreneurs need access to money in order to fund inventory and receivables. The need for funds can be particularly acute in high-growth firms: Solid profit margins cannot provide the working capital needed to support rapidly expanding sales. Minority businesses, in particular, face a dramatic capital gap.
For example, in the U.S., most black and Hispanic business owners originally capitalized their business using personal financing of a few thousand dollars. Small-business owners typically supplement the initial investment with commercial loans. Whereas 22.5 percent of majority-owned firms are able to fund 25 to 100 percent of their business with commercial loans, only 12.5 percent and 14.9 percent of black-owned and Hispanic-owned businesses, respectively, can do so.