Robust investment in information technology (IT) played a major role in the acceleration of output and productivity growth from 1996 to 2000. Until now, however, very little was known about the extent to which small and medium size enterprises (SMEs) were taking part in the digital economy. This report examines new evidence of how small and medium-sized businesses are faring in the new economy—their IT investment, their online activities, and the computer experience of their employees.

Small businesses are indeed investing in and using the tools of the new economy. Small and medium-sized firms invest about a quarter of their total capital expenditures on computers and communications equipment. A Federal Reserve Board study found that over 70 percent of small and medium-sized firms use computers in their businesses and our best evidence from a combination of Census and private sector data suggests that a majority of SMEs are also Internet subscribers.

Yet, the evidence also shows that while SMEs and larger firms spend roughly the same proportion of their investment budget on IT, SMEs invest less on a per employee basis. In two IT categories, computers and communications, enterprises with more than 500 employees invested roughly $8,700 per employee in 1998, those with between 100 and 499 employees $3,700, and those with fewer than 100 employees less than $2,500. As a result, firms with more than 500 employees invested twice as much per worker in IT as the 100 to 499 group and four times as much as the below 100 employee firm.

SMEs are also less likely than larger firms either to buy and sell over the Internet. And finally, employees of SMEs are much less likely than those at larger firms to regularly use a computer at work.

However, these general facts paint too simple a picture, obscuring the differences that arise from industry and occupational variations—differences that explain much of the disparity that exists at the aggregate level. SMEs are a very heterogeneous group and some of the differences observed in capital spending arise from the fact that smaller firms are more prevalent in industry sectors such as retail, services and construction that have overall lower levels of capital equipment. For example, in construction where firms with fewer than 25 employees account for almost one-half of total employment, average industry expenditures on computers and peripherals was only $151 per employee. In durable manufacturing, on the other hand, where firms of 500 or more employees account for over 60 percent of total employment, average industry expenditures on computers and peripherals was $1,088 per employee.

Despite their lower investment per employee, SMEs in every industry are investing and exploring new business uses of information technologies. The Internet aids this process by offering businesses of every size a low cost entry point to examine the possibilities for themselves and businesses of all size are increasingly connected. For example, 84 percent of all manufacturing plants responding to a Census survey had Internet access in 1999. Over 75 percent of manufacturing plants with between 20-49 employees (still small for a manufacturer) reported having Internet access.

Census Bureau data indicate, that as early as 1999, selling goods and services online was taking place in almost all sectors of the economy, but at low levels relative to overall sales revenues or shipments in most industries. In manufacturing (where we have data by plant size), e-commerce transactions (e.g., Internet sales, EDI, etc.) accounted for a smaller proportion of the shipments made by small manufacturing plants than those made by large manufacturing plants. A National Association of Purchasing Managers/Forrester Research report based on more recent data confirm the Census Bureau’s findings: Although, large volume purchasers (firms purchasing more than $100 million per year) are the furthest along, most firms are in the early stages of incorporating Internet technologies into their purchasing processes.

And, even though employees of smaller firms are less likely to use a computer at work, a substantial proportion of the SME employees who do not use a computer at work, regularly use a computer at home or some other location. This means that with their current workforce, SMEs have a pool of workers capable of using computers at work should the business need arise.