CEO Stories: The untold story of the middle market

Thomas A. Stewart
Executive Director, National Center for the Middle Market

With rigorous academic research and analysis, the National Center for the Middle Market shines a light on a critical but often overlooked segment of the U.S. economy.

Middle market companies—defined by NCMM as companies with revenue between 10 million and a billion dollars—account for one-third of all output in the private sector in the U.S. and for 60 percent of net new job growth. These companies occupy a sweet spot between resilience and runway: surprisingly they can often absorb blows better than large companies and they also have room to grow. Research from NCMM shows that this group almost always outperforms the S&P 500.

Born in 2011 as the recovery from the financial crisis was starting to take hold, NCMM is the leading source of information and research on the approximately 200,000 companies that comprise the middle market. NCMM tracks the inflection points companies hit as they mature and grow, their changing needs surrounding capital and other resources, and their shifting priorities. Top of mind now are customer-centricity, digital transformation, and cybersecurity.

Lack of advocacy— The Small Business Administration exists to advocate for small business and K Street law firms and lobbyists advocate for big business—a shortage of talent, and lack of awareness about the middle market are seen as the biggest challenges. NCMM aims to help companies overcome those challenges with data, benchmarking tools, strategic partnerships, and by creating resources for knowledge sharing among companies.

This Is Capitalism, Tom Stewart

RH: This is Capitalism, I’m Ray Hoffman. The venerable lyric advice, “accentuate the positive, eliminate the negative, latch onto the affirmative, and don’t mess with Mr. In-between?” Well, meet, Mr. In-between. Tom Stewart is Executive Director of the National Center for the Middle Market, which is part of the Fisher College of Business at Ohio State, THE Ohio State University.

It’s the leading source of information and research on the companies whose output accounts for one-third of the private sector in the U.S., the middle third of the U.S. gross domestic product. These are firms that have grown out of being small businesses, but with their revenues running between 10 million dollars and a billion, they’re still a long way from being in the Fortune 500. And no one shines a brighter light on the middle market companies than the National Center’s Tom Stewart, Mr. In-between.

TS: When the National Center for the Middle Market was founded eight years ago…. Well, one of the first questions is “what is the middle market?” And with a combination of census bureau data, R&D data, and analysis here, that’s where we were able to set the sliders you get: about a third of private GDP and employment for small business under 10 million a year in revenue and another third from the big guys with a billion or more. That’s a big spread, it’s two orders of magnitude, but that’s where the middle third is.

You see some interesting differences. Down at 15 million bucks, you’ve got basically small businesses but large small businesses. And up there toward a billion, you start seeing things that resemble Fortune 500 companies in some ways. You’ve got some very interesting transitions along the way as companies grow inside that middle market.

RH: Yes, it’s not just a wide fairway in terms of revenue, it’s a wide pasture. So in your role, how much differentiation do you have to do between these companies that sometimes are barely beyond being small businesses or small capitalization firms, if they’re public, and the ones that could almost be in the S&P 500?
TAS: Well, actually divide them into three internal groups. One is between 10 and 50, the next between, 50 and 100, and the next between a 100 million and a billion in revenue. But I think the more interesting way of looking at it is almost a…you might call it a maturity model in the way these companies are organized.

Somewhere around 50 million dollars, give or take, in revenue, companies begin to need to create functions. They no longer can make do with the accountant who’s in the accounting firm that they use; they need a chief financial officer and they bring in somebody to become the CFO. And they no longer can manage personnel out of the founders or the founding families’ spare time, they need a person to be in charge of HR. So they create functions.

And then somewhere, a hundred million, a little bit more…first of all the functions get deeper, you know, you get more expertise in HR, and beyond just a couple of generalists who are doing pay and benefits and job descriptions, you start developing some HR expertise, similarly with finance function and other functions. And the other thing is somewhere along there you’re likely to get multiple P&Ls.

So you get functionalization and then you get divisionalization. And those two things are sort of major inflection points in the way a business grows and the way a business behaves and its need for capital and its need for resources and the things toward which it puts them. You know, they’re really beginning to expand markets beyond the geography in which they started. For example, they may be beginning to think about international expansion and what that means in terms of not just the markets they’re approaching but the skills and capabilities they need to have in order to be able to take advantage of those markets.

RH: When you started this in 2011, did you think in terms of those three different differentiations, which are obviously very critical in terms of the development of a business?
TS: You know, we started originally with those three splits simply because it seemed to be fairly logical. It’s over time that we’ve begun to realize that they roughly correspond to these major inflection points in a business. And we’ve begun to develop, I think, a pretty sophisticated understanding of how that works, and got some pretty good stories out of companies about how they’re exploring this. And you know, it’s all complicated by some other questions, which are questions of ownership.

Within that group of 200,000 middle market companies, there’s only about 15 percent that are public. Eighty-five percent of those companies are private companies. And within that big group of private companies about a third are family businesses. About a third have private equity investment of some kind. And about a third are “other.” They may be sole proprietorships, they may be partnerships, you know, closely held corporations of one kind or another.

But when you think about that, there also are some interesting transitions that happen for these companies. Family businesses present some of the most dramatic examples. I saw a datum somewhere that said something like 65 percent of family business owners expect to pass the business on to their children, and only about 30 percent do. And then the next generation is down to about 12 percent.

So family businesses, for example, frequently cease to become family businesses. Often private equity companies make investments in them. They may get sold to strategic buyers. So you get a lot of interesting transactions and transitions, not only as these companies grow but also as their ownership goes through life cycles, particularly because they’re private companies. The median age of middle market companies is 31. So these are not start-ups for the most part, but there are these transitions that happen to them.

RH: And yet obviously these firms have a certain core something in common.
TS: Oh, they have a lot in common. They’re bigger than small; they’re smaller than big. One of the things that I think is really interesting about these companies—and we’ve documented this from the beginning—remember the Center was started here at Ohio State in 2011.

So we were basically just coming out of the financial crisis and were able to document that during the financial crisis, first of all, middle market companies were much more likely to survive than small businesses. And then compared to big businesses, those middle market companies that survived, the vast, vast, vast majority of them, actually added jobs. So while a lot of big companies were cutting, a few middle market companies were going under but the others were actually, on a net basis, increasing employment.

And you can almost look at these companies and say one of the things that’s magical about the middle market is that these companies occupy a sweet spot between resilience and runway. The resilience in the sense that they can take a licking and keep on ticking, they could be knocked down and get back up. But they also have room to grow. And when we look at the numbers, and this is the astonishing thing about these companies, middle market companies count for 60 percent of net new job growth in the United States.

This is the forgotten middle child. We talk about entrepreneurs as the engine of job creation and yes, that’s true, but in small business, is also the furnace of job destruction as a lot of companies fail. But in the middle market, you get these companies that have got traction and have started growing and they’re adding job after job after job after job. And it’s really an extraordinary and largely untold story about these most successful American capitalists.

RH: I’ll tell you how untold it is. I’ve had CNBC on in front of me every Monday through Friday essentially for the last 25 years. No, it’s their 30th anniversary, so it’s for the last 30 years now, and all I hear is, small business is the engine of job growth. I’ve never heard small business is also the furnace of job destruction.
TS: That’s partly the romance of “the guy in the garage” is always exciting. And there is a lot of job growth down there. But I think—I can’t remember what these data are—but I think most businesses die within six years of being founded. So it’s a lot of dreams that don’t come true. And the other reason you’re not seeing the middle market on CNBC is as I said, 85 percent of them are private. So there’s no stock market stories. You can’t sort of say, “big move in XYZ stock.”

RH: So in regards to what you do in Columbus, I shouldn’t spend too much time looking at the S&P 400 mid-cap index as some sort of a publicly traded correlation?
TS: Well, that tells you something about the public companies in the middle market but it doesn’t tell you about the other 85 percent. And you can’t really draw strict analogies.

What’s interesting is we’ve done over the years…we do a quarterly middle market indicator. So every three months, we send out a survey and we get a thousand responses from middle market companies in all parts of the country, all industries, so on and so forth. And we ask them, “how’s business?” And we ask them, “how’s your top line? How’s your bottom line? What was your revenue growth? What was your employment growth? What were your investment plans? What are your investment plans? What investments did you make in the last 12 months? What are your biggest challenges?”

So we do all that and we now have about eight years of data on that. We recently, last year, took five years, so that’s data points from 20,000 companies, and we put them into a great big statistical Cuisinart and put them together to do a factor analysis and Bayesian analysis, which is stuff that statisticians understand that I don’t, and were able to basically identify the key factors that these companies’ growth depends on, the drivers of growth.

We were able to create a cluster analysis so that we were able to say, “here are families of growth, growth types, ways of putting these factors together to drive growth,” and really be able to create a portrait of the kinds of decisions that these companies make, or the paths they follow. We talked earlier about paths and runways and so on and so forth, but there’s more than one. But we’re able to say, “these are the kinds of styles of growth that middle market companies, the most successful middle market companies, follow.” It’s a really revealing analysis.

RH: Could you take me back to 2011, to the creation of the National Center?
TAS: The founding story actually has to do with GE Capital. GE Capital, coming out the financial crisis, was very interested in the middle market. And a lot of financial services providers are, and a lot of business service providers are. After all, they’re only 500 customers in the Fortune 500 but the middle market occupies this unknown but very potentially lucrative spot in the market.

So GE Capital approached a number of business schools, including us, about doing a study of the middle market. And when that request landed here we—I wasn’t here at the time—but we came back to them and said, “we’ll see you and raise you. Anybody can do a study, but why don’t we don’t we actually create a center, a research center, so that there’s an ongoing stream of studies?”

And then, as you know, GE has sold off most of GE Capital, starting about four years ago. We were refunded and are now sponsored by Cisco Systems, Grant Thornton, and Chubb Insurance. We work a lot with outside organizations, like Brookings. I remember one of the guys at Brookings once said to me, “these are companies with big company problems and small company resources.” And finding the stuff that really helps them address their challenges—talent, M&A, so on and so forth—is one of the most important contributions we make.

RH: I can see what drew you to this, but where did you come from?
TS: Me? I’ve had various previous incarnations, the most immediate incarnation before this was the consulting firm, Booz & Company. I was the Chief Marketing and Knowledge Officer for Booz for five years. For half a dozen years before that, I was the Editor-in-Chief and Managing Director of the Harvard Business Review. And I was at Fortune before that. So I spent a lot of time thinking about business from the point of view of large companies mostly. That’s the field that all three of those generally play in. And when I arrived here, I discovered this extraordinary universe of some of the most interesting companies with some of the most interesting challenges.

And let me put something to you, which I quite like. I was talking to a group of strategy academics a few years ago and I got this sort of mischievous gleam in my eye, which sometimes happens. And I presented to them some of the things that I’ve just told you, about 60 percent of job growth, about how every quarter we look at the revenue growth of the middle market, and we could compare it to the S&P 500. And in all of these quarters that we’ve been studying, and in every quarter but one, the middle market outperforms the S&P 500, sometimes by two or three percentage points. It’s a substantial difference.

So I said to these strategy academics, “all your work on strategy has been based on largely looking at the best performing companies that you can get data for.” But I said, “you’re like drunks looking for their lost keys under lamppost because the light is better. Because the actual best-performing companies are here in the middle. And you’re not looking at them because, you know, the light’s not shining on them.”

And so one of the really exciting things about this group of companies, there are some cool companies, there are some cool stories. But also when you look at it, you think, “wow, these guys are making some powerful decisions and they’re making them right and nobody knows about it.” And there are best practice companies and examples here that people can really learn from to help improve business and competitiveness across the country and around the world.

RH: And I’m sure over these first eight years of the Center, there are a number of companies, a fairly significant number of companies, that have moved from the first third to the second third, to the third third.
TS: We might want to call them the graduating class, yes, yes.

RH: Now almost exactly two years ago, you did a video conversation with your colleague at Fisher, the director of the Business Analytics Initiative, Ralph Greco—it’s a very good and relevant conversation on YouTube—well-worth seeing now. You were talking about a then brand-new study about middle market companies entitled “How Digital Are You?” And as you covered in that 2016 conversation, many companies have to digitize old legacy operations, sometimes entrenched legacy operations.
TS: Yup.

RH: And that can be a very time-consuming process to get them up to speed with what has to be done today.
TS: One of the things in that initial study was, if it took a dollar of digital spending, about 40 cents on that dollar, back then, was focused on the back office, paying the bills, doing the books, keeping the books, you know, the basic data processing functions. About 40 percent, another 40 cents on the dollar, was spent on managing the current business. And that’d be sales and logistics and enterprise research planning and operations. That’s another 40 cents. And about 20 cents was spent on the future of the business—would be spent on analytics, on marketing, on innovation, demand gen, this sort of thing.

So it was 40-40-20 and our hypothesis was that that money was going to start to move from the back office to the customer interface, that you’d see more and more digital spending moving toward the edge of the company and toward the customer relationship. We are starting to see that. Except for one thing. We’re also starting to see a lot more defensive investment in cybersecurity, the awareness of the criticality of cybersecurity was less important but we are really seeing an evolution of digital investment from counting the beans to planting the beans and harvesting and growing them. It’s a real change as every part of business becomes more digital.

And we’re seeing in some of our preliminary findings in this big new study that the companies that are most advanced in their digital transformation are growing substantially faster than the companies that are behind them. We sort of created four categories that we call strategic, advanced, defensive, and deniers. And the strategic companies are substantially outperforming the advanced and the advanced are substantially outperforming the defensive and the deniers.

RH: I want to go back to the cybersecurity thing. I see your figures from the fourth quarter of 2018 showing 71 percent of middle market companies planning to invest with a large percentage of that money going toward IT, a larger percentage in fact than anywhere else. But that cybersecurity issue, it seems to be now the biggest technology priority for middle market companies. And so, does that crowd out the kind of IT innovation that needs to be funded right now in basic operations?
TS: I don’t think so, for two reasons. First of all…one of the things is that the data show us that companies that are prioritizing cybersecurity are also growing faster than those that do not. Secondly, a lot of that cybersecurity is on the customer’s skin, is helping to create secure transactions, and so on and so forth. And so it’s almost an index of the companies that are out there.

That having been said, we went back… about two and a half years ago, we did a survey of middle market companies and we asked, “how important is cybersecurity?” And approximately, I can’t remember exactly, but about 55 percent, a majority but not a big majority, said that it was either “extremely” or “very important”—you know, the top two boxes on a five-point scale.

Two years later we went back and more than 70 percent put it in the top two boxes—“extremely,” or “very important.” So it was a jump of about 20 percentage points, a big jump. The problem is it should be 99 percent, it should be 99.9 percent. A lot of mid-size companies don’t yet recognize that cybersecurity isn’t just a problem for JPMorgan Chase and Target, that it’s a ransomware business. It’s not like mysterious hackers are out there saying, “gee, let me find Fort Knox.” They’re just going out to find anybody.

RH: Since you did that conversation, the video that I was referring to, and one of the things you mentioned in there is how a number of companies have moved toward digitization but they haven’t connected the dots in digitization.
TS: Yes.

RH: Now, two years later, is there conclusive evidence that more companies, many more companies are getting the dots connected and actually using technology to transform the way they do business?
TS: There is evidence. But let me begin by throwing some jargon at you. The first thing that has happened is people are now creating a distinction among three things. Digitization, which is basically saying, this used to be on paper and I’m going to do it with a computer. Digitalization—I’m going to try to do the whole process, I’m going to digitize things end-to-end so that my HR is now digitalized, is a digital function, or a digital finance function. And then digital transformation, which is that third and most mature or maybe most advanced level, in which you really think of the whole business as being digital first.

So we’ve created this distinction. I think there’s some validity in that distinction. And I think we see more companies moving from one to the other. This is that connect the dots point, they are connecting the dots. And as you start connecting the dots, you take something that you digitized and connect about four or five dots, and you have digitalized a process or a sub process. It’s when you reconceive it as digital to begin with and digital from end to end and omnichannel and so on and so forth, that’s when you get that whole digitally transformed enterprise that we’re starting to see emerge as well.

So yes, there’s progress in that direction but at the same time there are defensive companies that are just doing what they have to do to keep up, and those ostriches, those denying companies that are saying, “well, Windows 95, worked well for Dad, it’ll work well for me.”

RH: Even though the evidence is out there that it pays off.
TS: And this is one of the interesting things though, you do see, as executive teams age, and sometimes in these closely held companies, the whole executive team started out as pals together in their twenties and they aged together along with the lawyer and a few other things. As executive teams age, they sometimes…they may fall behind in terms of technology but they may also be more interested in harvesting than in planting.

And that’s often where you see outside capital come in, often a private equity investor come in, and say, “wow, here is a great company that has been under-invested in in the last 15-20 years as they’ve been in harvest mode. And some of that’s technology, some of it may be innovation, new product development. So you often see a burst of growth in some of these companies if new capital comes in.

RH: And I was looking at the relative growth rates—and you touched on this just very briefly before—the relative growth rates of the middle market companies that are using technology as a cornerstone, they grew last year at an average 10 percent rate. The laggards that haven’t connected the dots only grew at 6 percent.
TS: Yes.

RH: And I have to believe that gap is widening or is going to widen with every passing year.
TS: I’m sure you’re right for a number of reasons. First of all, you just start compounding those growth rates and you can see the effect of them. Second of all, you start compounding the advantages and power of technology. Think about as we now move into a 5G world, it’s almost impossible to imagine the new kinds of businesses that can be created with even faster technology.

But if you just think back, those of us who have been around the block a couple times remember a world before there was GPS. Now, with GPS and the ability to know always where you are, always where your product is, always where everything is, all kinds of new businesses, the Lyfts and Ubers of the world, and other things created with GPS, take that another 10X factor and you’re going to see some real changes. And companies that don’t get with it are likely, simply to be left high and dry.

RH: Do you think there’s any bigger, untold story in the world of business than the middle market?
TS: Well, I’m biased. (Laughter). But you know, it’s interesting. I mean, I mentioned my own career having come from Fortune and Harvard Business Review and Booz, and to have come here was to really see a landscape opened up before me of whose existence I had been basically unaware. And part of it, one piece of this story is, if this is the case, and it is the case, then, this story is not being sufficiently understood or told in policy circles. So it’s, you know, city halls, state houses, Congress, regulatory agencies.

The Small Business Administration exists to advocate for small business and K Street law firms and lobbyists advocate for big business, but who is telling this story? And so from a policy point of view, this is a huge area, a huge topic that needs to be addressed in a huge conversation.

You now, with nearly full employment, companies across the country are complaining about a shortage of talent. Mid-size companies tell us—47 percent—tell us that a lack of talent is restraining their growth. Google doesn’t have a shortage of job applicants ’cause everybody knows about Google, resumes fly into the place. But there’s some extraordinary opportunities here. And the more that story gets out, the more talent can find the opportunities in these companies.

And there’re some really cool companies. Varidesk, which makes the stand-up desk. Every professional sports team, craft breweries, every beer that’s worth drinking and that you’ve heard of, is a middle market. And if you have heard of it and it’s not worth drinking, it’s a big brewery, but in the middle, all of these extraordinary brewers, middle market companies, Brewdog, Victory Beer, Revolution Beer. I mean any beer that’s worth drinking that you’ve heard of is a middle market company.

RH: And as I stand here at my Varidesk, which I bought last year. (Laughter.)  Again I’ll go back to that point, that the middle market represents a third of private of private sector GDP.
TS: Yes, 60 percent of all new jobs.

RH: And looking out over the next eight years, this Center being eight years old, is there one dream you have about how this can evolve?
TS: That’s a really good question. I’ve sometimes thought of this in terms of…when I was at Fortune, I liked to ask a CEO, “what will your successor’s successor’s biggest challenge be?” And that’s a way of getting out from the immediate questions to sort of beyond, and I haven’t asked myself that question.

But I do imagine a couple of things. I imagine a hubbub of interactions. I could imagine a lot of ways in which companies get together to share ideas, use tools, create knowledge, and share knowledge. I think one of the real opportunities that we have as an academic institution is that we can provide academic rigor but also ideally, provide an opportunity for people to share and talk. I think we’re better at the academic rigor than at the share and talk in terms of our convening capability. So I would love to have something that is robust and active where we have a lot of data but also a lot of people saying, “yes, that is how that applies to me,” and teaching each other and learning from each other.

I think another thing would be to have continued to create a body of knowledge about middle market companies. When I think about a body of knowledge, I think not just about a library of research papers and white papers and documents and so on and so forth, but cases and videos and benchmarking tools and things like this. A body of knowledge that will really help these companies perform even better.

And the third I think would be more connections with policymakers on the one hand and with the global community of middle market companies on the other. You know, the German Middlestand is world famous and recognized in Germany as the center of the German economy. I think there are real opportunities to create some stronger connections between the U.S. middle market or among the middle markets of U.S., Germany, Japan, Korea, France, the U.K., so on and so forth, and at the same time, then create some sort of greater awareness in policymaking circles.

You know, the mayor doesn’t get his picture in the paper when a company opens a new training room or expands its facility. Open an incubator for startups, the mayor’s picture’s in the paper; manage to get a big company to open a plant, your picture’s in the paper. But the core work of prosperity in communities and cities is helping the companies that are already there grow. And the heart of that is identifying your middle market companies.

Think about public investment, recognize that this is where it ought to go. Then we’ll not only have helped those companies, but will help everybody who’s living in those communities.

RH: Sounds to me like you’re on the road to doing just that.
TS: Well, we’re trying.

RH: This is Capitalism with Mr. In-between. I’m Ray Hoffman.

About the Series: Featured stories from the intersection of the free market and entrepreneurial success. Here we speak with leading CEOs, academics, philanthropists and up and comers on their contributions and perspectives on the American economy.

About Ray Hoffman: Ray Hoffman, a veteran business journalist, is highly-regarded for his news and analysis features and insightful CEO interviews. Representing BusinessWeek on air for twenty-one years, Mr. Hoffman was the morning business news voice on the ABC Radio Networks from 1995 to 2006. Mr. Hoffman also represented The Wall Street Journal, on air, for eleven years. His daily WCBS CEO Radio feature was recognized by the New York Press Club as best radio business news report in both 2012 and 2015. In this podcast, Mr. Hoffman invites some of America’s most dynamic CEOs to share their stories as business builders and perspectives on free enterprise.