Executive summary

View the most recent version.

A growing literature focuses on how firm turnover contributes to productivity growth. Competition leads some firms to grow and others to decline. Those that grow become more productive than those in decline. This process contributes to aggregate productivity growth as the more productive supplant the less productive. Much of the research in this area has focused on the manufacturing sector. In this paper, we examine firm turnover and aggregate productivity growth in the service sector. In particular, we will focus on the retail trade sector in Canada.

The paper focuses on six questions:

First: How much turnover is there in the retail sector?

Answer: The Canadian retail trade sector has high firm turnover. About 60% of firms that were present in 1984 were no longer in operation in 1998. The exiting firms accounted for 25% of total sales and 30% of total employment of the retail trade sector. About 70% of firms that were in operation in 1998 were new firms that had entered the retail sector during the 1984-to-1998 period, accounting for 42% of total sales and 41% of total employment.

In addition to firm turnover through entry and exit, firm turnover can also occur through gains and losses in market share in existing firms. During the 1984-to-1996 period, about 50% of market share was transferred from firms that either contracted or closed to new firms or firms that expanded. The continuing firms that increased market share acquired an additional 11 percentage points in market share over the period. The entering firms captured 36 percentage points. The continuing firms that lost market share lost a total of 22 percentage points over the period, while exiting firms relinquished 25 percentage points.

Second: What is the profile of entrants to the industry?

Answer: Entering firms are much more productive than exiting firms. On average, the firms that entered the retail sector in the 1986-to-1998 period had labour productivity and multifactor productivity that were about 20% higher than the firms that exited in that period. Together, these results suggest that entrants had an advantage over exits with regard to both labour and multifactor productivity. Entrants at birth have similar labour productivity and higher multifactor productivity in comparison with incumbents, but are much smaller than incumbents.

Third: Does the ongoing reallocation make a positive and significant contribution to aggregate productivity growth?

Answer: The overall productivity growth in the retail sector can be decomposed into a within-firm effect and the effect of firm turnover. The within-firm effect measures the contribution to overall productivity growth of growth within the surviving firms, holding their shares of inputs or outputs constant. The effect of firm turnover and ongoing re-allocation on aggregate productivity consists of the between-effect that represents the effect of the re-allocation of output and inputs among surviving firms and the effect of firm entry and exit.

Growth in labour and multifactor productivity in the Canadian retail trade sector is entirely accounted for by firm turnover and restructuring in the retail trade sector over the period from 1984 to 1998. Entry and exit accounted for 70% of labour productivity growth in the retail trade sector. Restructuring and firm turnover among surviving firms accounted for 35% of overall productivity growth. The within-effect is small and slightly negative, as there was little productivity growth at an average retailing firm. The results for the Canadian retail trade sector stand in sharp contrast to the results for the Canadian manufacturing sector, where entry and exit and firm turnover account for about 50% of labour productivity growth in a 10-year period.

The results for the retail sector suggest that the well-documented productivity gains from the increased use of information and communication technologies (ICTs) in the retail sector comes from the effect of firm turnover, as entering firms and existing firms that use ICTs and adopt innovative organizational practices gain market share from exiting firms and less productive existing firms. The results also suggest that the much-discussed Wal-Mart effect on retail sector productivity mainly comes from the Wal-Mart-created competitive pressure and restructuring that shifts market share from exitors and incumbents that lost market share to entrants and incumbents that gained market share.

Fourth: What is the contribution of foreign-controlled firms to aggregate productivity growth?

Answer: Foreign-controlled firms contributed 5.7 percentage points or 30% of labour productivity growth in the retail trade sector for the period from 1984 to 1998. They contributed 4.7 percentage points or 45% of multifactor productivity growth in the same sector. The contribution of foreign-controlled firms to productivity growth is disproportionately larger than their contribution to sales, which was about 20% over the period, and is mainly due to the entry of foreign-controlled firms and the expansion of more productive foreign-controlled existing firms.

Fifth: What is the nature of the selection process that entrants undergo after birth? Do they start life with the same productivity level as incumbents or do they start well behind and then experience a catch up? Is the selection process one that culls the smallest and least productive?

Answer: Entrants undergo a selection process after birth. Of an entering cohort, the least productive firms exit and the more productive ones survive. The surviving firms of the entering cohort exhibit declining failure rates as they learn about best business practices. About one quarter of the entrants exit during the first three years after birth, and about one half of the entrants survive until the eighth year. The surviving firms of an entering cohort reach the size of incumbents in the ninth year. Successful entrants have rapid output growth after the fifth year and have rapid labour productivity growth after the seventh year. During earlier years of their life, entrants show little significant change in output and labour productivity.

Sixth: What is the type of learning process that takes place after birth?

Answer: Learning takes place among large entrants. For the average entrant, labour productivity growth and multifactor productivity growth are negative after birth. The growth in output, capital and labour is also lower than the incumbent population. The average entrant would reach a peak in output in about its ninth year and would not catch up to the size of incumbents. Unlike the average entrant that would not catch up to the size of incumbents, the entering cohort of larger entrants reaches the size of incumbents in its ninth year. The output of the entering cohort that survived until the ninth year is about 2.2 times as large as the output at birth, which is slightly bigger than the output difference between the entrants at birth and the incumbents.

The evidence then, in this paper, suggests that the retailing sector differs from the manufacturing sector with respect to both firm turnover and the dynamics of productivity growth. Entry is far more important in absolute size. At any point in time, a larger percentage of firms are recent entrants and more will shortly become exits. Entry and exit contributes more to aggregate productivity growth in the retail sector than in manufacturing. Entrants experience a very different life cycle. They do not start with as large a productivity disadvantage early in life as they do in manufacturing, nor do they experience a slow catch up in their productivity growth as does the manufacturing sector. Entrants start off with a productivity of about the level of incumbents. They tend to decline in relative productivity after birth. The process that leads to changes in firm size differs substantially for the smaller and larger entrants: the former do not catch up to incumbents, while the latter do. Small and larger retail entrants follow very different paths.