Key Characteristics of EU SMEs undertaking FDI

According to data from the European Commission (The European Commission, 2016), small and medium-sized enterprises (SMEs) represent 99% of all businesses in the EU and the main factors to determine whether an enterprise is an SME are:

• staff headcount, and
• either turnover or balance sheet total.
• Table 1

Source: (The European Commission, 2016)

These ceilings apply to the figures for individual firms only. A firm that is part of a larger group may need to include staff headcount / turnover / balance sheet data from that group too.

SMEs can avail of the following two categories of potential benefits if they meet the criteria:

• Eligibility for support under many EU business-support programmes targeted specifically at SMEs: research funding competitiveness and innovation funding and similar national support programmes that could otherwise be banned as unfair government support.
• Fewer requirements or reduced fees for EU administrative compliance.

SMEs, when undertaking FDI, are more likely than large transnational corporations to:

• Transfer appropriate technology to developing countries.
• Look for joint-ventures partners, rather than establish wholly owned affiliates.
• Have a favourable impact on the trade balance.
• Have more flexible local arrangements and contribute more to the local economy by using subcontracting to a greater extent.

SMEs have the following impacts on economic growth:

• SMEs have played a major role in the development of all the leading economies in Asia (although their contribution differs among countries).
• SMEs contribute about 40 to 60% of all capital investment and about the same proportions for productivity growth.
• About 10% of SMEs are growth-oriented and can make a significant entrepreneurial contribution to development in their home countries and to the host countries through FDI.

According to the Annual Report on European SMEs (Publications Office of the European Union, 2018) only a small number of SMEs (4%) undertake FDI in the EU, although there is variation across Member States. SMEs employing 50-249 staff, with turnover exceeding €10m and with growth of more than 25% between 2008 and 2014 were more likely to undertake FDI than the average SME. Firms that are part of an international group were also more likely to undertake FDI, perhaps due to access to resources provided by other companies in the group. While the above firm characteristics are all significantly more likely to result in an SME deciding to invest abroad, the results should be interpreted in the context of low levels of FDI activity by SMEs overall.

The Flash Eurobarometer 421, presented in the Annual Report on European SMEs (2017-2018) (Publications Office of the European Union, 2018, p. 111) analysed SMEs that had undertaken FDI, and compared them in terms of overall and firm characteristics. The results are given at the EU level and for individual Member States. Overall, few of the SMEs surveyed had undertaken FDI. In the EU, on average, only 4% had made any FDI. However, the prevalence of FDI activity by SMEs was relatively more common in some countries, such as Luxembourg (10%), Malta (11%), Denmark and Austria (8% each), than in other countries. Larger SMEs have a greater association with FDI activity than other SMEs. Medium-sized firms, employing 50-249 staff, are associated with FDI to a greater degree than the average EU level and several Member States. For example, 15% of medium-sized firms in the EU had made some form of FDI, as opposed to 4% of all SMEs surveyed. Similarly, firms with higher turnover (annually greater than €2m) are more likely to be associated with foreign direct investments.

According to the same report, fast growing firms, namely, SMEs that have grown by 25% or more since 2008, are also associated with FDI to a greater extent than average. In addition, firms that are part of an international group are more associated with FDI than other firms. 11% of SMEs that are part of an international group have made foreign direct investments, while, as noted previously, this figure is 4% across all surveyed SMEs. There is some evidence of a relationship between FDI and sector groups at the level of individual Member States, but not in the EU overall. In particular, manufacturing SMEs have a greater association with FDI in a number of countries (Denmark, Germany, Ireland and others). No relationship was identified between firm age and FDI, with the exception of firms founded between 2009 and 2014 (and surveyed in 2015) in Denmark and Poland, which are more associated with FDI. Finally, firms with experience of other forms of internationalisation are more strongly associated with FDI than average.

Moreover, according to the OECD (OECD, 2016), more than one third of European SME investors undertake more than one investment. SMEs that invest in multiple FDI projects are more likely to make their first investment within the EU. For SMEs in EU countries, other EU countries are the destination in a little under half of all recurrent projects. This implies that recurrent SME investors from the EU keep investing within the EU. SME investors from the candidate and EFTA countries gradually reduce their share of investments within the EU, the more projects they carry out. SMEs from these countries undertake close to two thirds of their first projects within the EU. However, this number is reduced to close to one third for subsequent projects. EU SMEs undertaking multiple FDI projects continually increase the size of the projects within the EU, while the projects outside of the EU remain at a constant level. Most likely, this is due to the standardised rules within the EU.

The fact that SMEs tend to continually increase the size of their projects within the EU, as they invest in multiple projects, suggests that SMEs can utilise the experience they gain from one project to the next. This reduces the risk of investing, allowing the SMEs to continue to increase the size of projects. While most SMEs from the EU that invest multiple times either invest exclusively within the EU or outside of the EU, several EU SMEs also carry out investments both within and outside of the EU. Of these, around half make their first investment within the EU, while the other half undertakes their first FDI project outside the EU.

In order for SMEs to undertake investments abroad, they need to be productive enough to overcome the fixed costs of setting up an affiliate in a different country and to compete successfully against incumbents in that market. One way in which SMEs can improve their productivity is through engaging with foreign investors in their home market. Foreign firms hold technical, operational and managerial knowledge that local firms can tap into and improve their productivity, via so-called productivity spillovers. European firms of all sizes, in general benefit from productivity spillovers arising from European inward FDI, but SMEs and smaller firms benefit especially. As European SMEs become more productive, they are also in a better position to undertake outward FDI. Inward FDI may thus help facilitate outward FDI by European SMEs and other firms.

According to Epson’s annual report (Seiko Epson Corporation, 2018) there were a total of 25,683 FDI projects undertaken by European SMEs over the period 2003- 2015. This is close to 30 per cent of the total 87,087 FDI projects completed by European enterprises in the same period. The total deal value of SME FDI is more than €900 billion, which is around 19 per cent of the total value. From these figures it is apparent that SMEs are highly important for the aggregate FDI patterns, highlighting the relevance of analysing the FDI patterns of these firms. In this same study, every investment was categorised according to its sector and type. It was found that 12,806 projects by European SMEs were M&A deals, while the remaining 12,877 were greenfield projects. For both types of FDI projects mentioned, this is close to 30 per cent of the total number of FDI projects undertaken by all European enterprises. Hence, SMEs are not over or underrepresented in either of the two FDI types relative to all firms. The M&A deals are on average larger than greenfield projects, with an average deal size of €92 million for M&A deals compared to an average project size of €31 million for greenfield investments. This is lower than the corresponding figures for all firms, where the average deal sizes are €158 million and €42 million for M&A deals and greenfield projects, respectively.

The United Kingdom dominates as the source country for SME FDI. UK SMEs account for 27 per cent of the number of all the projects undertaken by European SMEs and 35 per cent of the total value of these projects. This approximately corresponds to the combined value of FDI projects by SMEs from France, Belgium, the Netherlands, Germany and Scandinavia, and highlights the significance of the United Kingdom as the origin of European FDI by SMEs. The main destination is Germany which receives 8 per cent of the total number of European SME FDI projects. There is a larger share of SME FDI projects in the service sector than in the manufacturing sector. In the period 2003-2015, 14,357 FDI projects undertaken by SMEs were in the service sector and 9,477 in the manufacturing sector. Relative to all European FDI projects undertaken in that period, SMEs thus accounted for 32 per cent of all service sector FDI projects and 27 per cent of all manufacturing sector FDI projects, cf. Table 2. SME FDI projects in the manufacturing sector (average deal size of €48 million) are slightly larger than those in the service sector (average deal size of €41 million). The same pattern, however, exists for all firms, where the average deal size in the manufacturing sector is €76 million and €57 million in the service sector. One of the reasons, why SMEs account for a relatively larger share of FDI projects in the service sector, than in the manufacturing sector, may be that the service sector is generally less capital intensive than the manufacturing sector. This reduces the costs and makes it easier for smaller firms to undertake FDI projects in this sector. This is consistent with micro firms also accounting for a relatively larger share of service projects than manufacturing projects, while the opposite is true for large firms.[1]

In addition, the average deal size increases in firm size, implying that larger firms undertake larger FDI projects, cf. the last column of Table 2. The average deal size for an FDI project undertaken by an SME is €50 million while the corresponding number for large firms is more than twice the size.[2]

Table 2 Number and average deal size across firm sizes, 2003-2015

Note: The shares of all firms reported in column one are taken from the Small Business Act (SBA) Fact Sheets and cover the EU. Each investment is classified as either services, manufacturing or other, where other includes agriculture, mining, quarrying and construction.

Source: ESPON FDI (2018) based on data from BvD’s Zephyr and Financial Times’ fDi Markets databases (Sunesen & Henriksen, 2018, p. 5)

This shows that the number of SME FDI projects has been increasing every year from 2003 to 2015 (except for the years 2008 to 2009). The aggregate deal value, on the other hand, has not reached the pre-crisis level. Hence, the average deal value has decreased over time. This indicates that the barriers to undertake FDI projects have been lowered during the period 2003-2015, allowing smaller projects to be carried out. Further, this has shown that SMEs are slightly overrepresented in FDI projects in the service sector.

[1] An additional explanation may be that there is a higher share of SMEs in the service sector (53 per cent) compared to large firms (47 per cent) (own calculations based on data from Eurostat for 2014).

[2] The average deal size of € 45 million for micro enterprises seems relatively high. In the construction of the dataset, we used the consolidated data at the firm level to identify firm sizes. This reduces the risk that subsidiary companies in the dataset are treated as part of a larger group instead of being recorded as micro enterprises. As consolidated data are not always available, this risk is not fully eliminated. Also, small holding companies that are not part of a larger group are recorded as micro enterprises, which may increase the average deal size. This concern is largest for micro enterprises where data is most limited.