Scalers and the economy

A small group of SMEs that grow fast over a short period of time, i.e. “scalers”, provide a large part of the growth in jobs and economic value in OECD countries. This section contains an overview of the recent trends in the number of scalers in Latvia and benchmark their contributions to job and value creation with other countries.

Around a quarter of Latvian SMEs are scalers

In Latvia, about 2 000 small or medium-sized enterprises (SMEs) became scalers between 2018 and 2021, accounting for 23% of the 8 500 SMEs in the non-financial business sector. Among those, about 800 were scalers in employment, 1 700 were scalers in turnover, and 500 were scalers in both employment and turnover.

Scalers in year 2020 are defined as enterprises with 10 to 249 employees (SMEs) that increased employment or turnover by at least 10% per year, on average, over the three previous years (2017-20). This means they grow by at least 33% over the three-year period.

The number of scalers in turnover declined from 2013 to 2016, but experienced a rebound in 2017, continuing an upward trend until 2019, peaking at 2 200. The number of scalers in employment was relatively constant over the same period and peaked in 2015, reaching 1 200. The number of scalers declined sharply in 2020 as the COVID-19 pandemic spread. The reason is that SMEs that grew in 2018 and 2019 and were on track to become scalers by 2020 were unable to continue growing and might even had to reduce output or employment.

High-growth scalers, defined as SMEs with annual growth rates exceeding 20% over three consecutive years, may exhibit distinct trends through economic cycles. Compared to other scalers, high-growth scalers may be faster to react to economic shifts and new market opportunities, but they may also be more constrained by lack of financial resources or tight labour markets. About one in three scalers grows by more than 20% per year on average over three consecutive years, qualifying as “high-growth” scalers. In 2021, there were 300 high-growth scalers in employment and 750 high-growth scalers in turnover. The number of high-growth scalers in employment has been stable over time, starting from 300 in 2013. High-growth scalers in turnover instead followed a similar trend to all scalers in turnover, reaching a peak of 1 000 in 2019.

Scalers in employment created 21 000 jobs over three years

In Latvia, scalers in employment created 21 000 jobs over the 2017-20 period, which accounts to 7.8 jobs for every 100 workers in SMEs in 2017. The contribution of Latvian scalers in employment is slightly below the average of all countries for which data are available.

The contribution of scalers in turnover was above the average of other countries

The total turnover of Latvian scalers in turnover in 2020 was EUR 5 billion larger than in 2017. The increase corresponds to 15.5% of the total turnover of all Latvian SMEs in 2017. This compares to 12% on average across countries with available data, indicating that the contribution of scalers in turnover to value creation is about 29% higher in Latvia.

Scalers’ characteristics

All types of SMEs can scale up. This section describes the characteristics of scalers in terms of sector of activity, size, age, and geographical distribution. It also compares the likelihood of SMEs to scale up in Latvia and in other countries across different groups of SMEs.

Latvian SMEs operating in Medium-high tech manufacturing and construction are more likely to scale up

Most Latvian scalers operate in non-tradable services, construction, or medium-low tech manufacturing and extractive industries (26%, 19%, and 18%, respectively). The distribution of scalers across economic activities mirrors largely the distribution of SMEs across these activities.

However, in certain sectors scalers are overrepresented, particularly in the construction sector, which comprise 19% of scalers but 13% of all SMEs. This reflects the higher probability of SMEs to scale up in these sectors. About 38% of SMEs in the construction sector become scalers, compared to 20% among SMEs in the other tradable services sector. Relative to other countries, Latvian SMEs have a higher likelihood to become scalers in the manufacturing, education/social/health services and construction sector.

Sector groups include the following two-digit NACE sectors:

• Low and medium-low technology manufacturing and extractive industries: food, textile, paper, wood, refined petroleum, rubber, plastic, basic metal products, mining.

• Medium-high and high technology manufacturing: chemical products, pharmaceuticals, computer, electronic/electrical equipment, machinery, transport equipment.

• Advanced tradable services: software, telecommunications, consultancy, legal services, accounting services, architectural activities, scientific research.

• Other tradable services: travel agency, services to buildings/landscape, employment activities, veterinary, accommodation/food services, services for transportation.

• Other non-tradable services: electricity, gas and water supply, waste management, wholesale and retail trade, repair of motor vehicles/household goods, real estate activities.

• Education, social care and health services: Education, human health activities, residential care, social work.

• Construction: construction of buildings, civil engineering, specialised construction activities.

Source: Manufacturing sectors are aggregated using Eurostat’s high-technology classification of manufacturing industries. The classification of tradable and non-tradable services is based on Piton, S. (2021). Economic integration and unit labour costs. European Economic Review, 136, 103746.

SMEs across all size classes scale up

54% of Latvian scalers have between 10 and 19 employees at the beginning of the growth period, and 30% of scalers have between 20 and 49 employees. In contrast, SMEs with 100 to 249 employees represent only 5% of scalers. The likelihood to scale up is similar across SMEs of different sizes, therefore the size distribution of scalers closely follows that of all SMEs. About 26% of SMEs in the 10-19 size class become scalers, compared to 25% of SMEs in the 100-249. Differences in the likelihood to scale up across size classes in Latvia are aligned with the cross-country averages.

Most of Latvian scalers are mature SMEs

Most Latvian scalers (52%) are mature SMEs that are more than 10 years old. 24% of scalers are less than 6 years old (i.e. young) and the rest (24%) are between 6 and 10 years old.

Young SMEs are 1.8 times as likely to scale up as mature SMEs. About 36% of young SMEs scale up, compared to 31% of SMEs aged 6 to 10, and 21% of mature SMEs. This results in scalers being overall younger than other SMEs. The share of young scalers in all scalers is equal to 24%, i.e., seven percentage points more than the share of young SMEs in all SMEs. However, half of SMEs are mature firms in Latvia. It follows that most scalers are mature SMEs, as the lower likelihood to scale up is counterbalanced by a larger base. Similar to size, differences in the likelihood of scaling up across age classes are similar in Latvia and in the 15 other countries.

SMEs in remote areas are as likely to scale up as SMEs in metropolitan areas

Almost 70% of Latvian scalers are located in metropolitan regions. However, SMEs in non-metropolitan region show the same likelihood to scale up than SMEs in metropolitan regions, as the distribution of scalers and other SMEs is very similar across typologies of regions. This indicates that SME proximity to metropolitan regions does not significantly influence its scaling up potential.

The OECD metropolitan/non-metropolitan typology for small regions (TL3) helps assess differences in socio-economic trends in regions by controlling for the presence/absence of metropolitan areas and the extent to which the latter is accessible by the population living in each region. TL3 regions are classified as “metropolitan” if more than half of their population lives in a functional urban area (FUA) of at least 250 000 inhabitants and as “non-metropolitan” otherwise. A “metropolitan region” becomes a “large metropolitan region” if the FUA accounting for more than half of the regional population has over 1.5 million inhabitants. The typology further classifies “non-metropolitan” regions based on the size of the FUA that is most accessible to the regional population. More specifically, “non-metropolitan” TL3 regions are subclassified into three possible types: i) with access to a metropolitan area, if at least half of the regional population can reach an FUA of at least 250 000 inhabitants within a 60-minute car ride; ii) With access to a small/medium city, if at least half of the regional population can reach an FUA of between 50 000 and 250 000 inhabitants within a 60-minute car ride; iii) remote, if reaching the closest FUA by car takes more than 60 minutes for more than half of the regional population.

Source: Fadic, M., et al. (2019), ‘Classifying small (TL3) regions based on metropolitan population, low density and remoteness’, OECD Regional Development Working Papers, No. 2019/06, OECD Publishing, Paris, https://doi.org/10.1787/b902cc00-en

At 26%, the likelihood for Latvian SMEs to scale up in metropolitan regions is only marginally higher than in remote regions (25%). This indicates that SME proximity to metropolitan regions is not a strong predictor of their scaling up potential, in Latvia as well as in most other countries.

Growth trajectories

While many SMEs consolidate at their new size after scaling up, rapid growth also brings new challenges, with some scalers failing to adapt. This section illustrates the growth trajectories of scalers in the three years following their (first) expansion phase.

The majority of scalers maintained their new size or even continued to grow

Between 2016 and 2019, 14% of Latvian scalers in employment continued to scale up in employment after a first scaling up in the previous three years. These 60 firms employed 3 500 more people after six years. Among scalers in turnover, 32% achieved two high-growth periods in a row, reaching a total turnover that was 322% higher in 2019 compared to 2013.

In addition, 32% of scalers in employment and 37% of scalers in turnover maintained their size or grew moderately in the following three years. The share of scalers that consolidated at the new size or continued growing was 12 percentage points higher for scalers in employment and 3 percentage points higher for scalers in turnover than the cross-country average.

Almost half of scalers in employment contracted after scaling up

Scaling up also brings challenges for SMEs. Firms may need to comply with stricter regulations, improve their managerial practices, or adopt a different financial model. Some scalers may struggle to adapt and experience a contraction after growing. In Latvia, 47% of SMEs that scale up in employment between 2013 and 2016 reduced their workforce over the following three years. Similarly, 21% of scalers in turnover had a lower turnover three years after scaling up, underscoring the challenges inherent in maintaining an expanded scale. Relative to other countries, the share of scalers having a reversal was 20 percentage points higher for scalers in employment and 3 percentage points higher for scalers in turnover than the cross-country average.

One in ten scalers was inactive three years after scaling up

For 8% of scalers in employment and 10% of scalers in turnover, there was no information available on their employment or turnover levels in 2019. This lack of information is open to different interpretations. First, the firm may be closed or about to close, which in most cases indicates that the business has not been successful. Second, the company may have been acquired by another entity, which often indicates success rather than failure. Third, the lack of information may simply be a “nuisance” in the data, e.g. due to reporting errors. It is not possible to know the exact incidence of each of the three alternatives. However, it is known that acquisitions are rare events even for growth-oriented businesses. Conversely, around 8-10% of businesses close each year. Therefore, it is likely that most former scalers with missing information have ceased operations.