Do small firms compete with large firms?

Despite the pervasive phenomenon of scale economies, the majority of firms have always been small firms. The emergence of small firms as a means of economic development on both sides of the Atlantic has been one of the major new topics of economic policy since the 1980s. This has drawn renewed attention to the question: How are small firms able to exist? The theories of strategic niches and dynamic complementarity imply that small firms seek out markets where they are able to avoid competition with their larger counterparts. This paper tests the validity of these theories by examining the extent to which small-firm profitability is set by large-firm profitability. Considerable evidence shows that the price-cost margins of small firms do not tend to follow those of large firms. This supports the theory that small firms pursue a strategy of producing in distinct product niches.