What small businesses do better than corporate America by Michael Mazzeo @FortuneMagazine June 10, 2014, 11:06 AM EDT E-mail Tweet Facebook Google Plus Linkedin Share icons Small businesses – those with 500 employees or less – remain an essential piston of America’s economic growth. After the number of startups dropped to record lows in 2009,they bounced back 12% in 2011. Small businesses accounted for 42% of US private sector payroll in 2012 and 63% of new jobs, according to the Small Business Administration. And as business professors, we three have recently watched entrepreneurship programs sprout like dandelions in American business schools, partly in response to students who no longer aspire to an organization-man (or woman) career. Despite this surge in interest, running a small business remains a bumpy road. About 10% to 12% of small businesses close each year and there’s only a 50/50 chance a new small business will survive to see its fifth birthday. As the success of behemoths like Google GOOG , Wal-Mart WMT and Amazon AMZN shows scale confers many advantages in business. Which should prompt every small businessperson to ask: How can I compete with the big boys in my industry? We debated this question endlessly as we traced America’s blue highways researching our book, Roadside MBA: Backroad Wisdom for Executives, Entrepreneurs, and Small Business Owners. Over the past four years, we’ve driven 4,200 miles, visited 27 states, endured bitter cold (Oklahoma) and drenching heat (Arizona and Iowa), and interviewed around 100 small business owners. We visited with a mixer manufacturer in California’s High Desert, a flying orthodontist in Arkansas, a doggy day care in Georgia, and even a composting plant in Montana. And in all cases, we probed on the crucial questions of competitive strategy: Who are your competitors, and why do your customers choose you over them? We learned that small businesses thrive by taking on activities that big businesses aren’t good at. As we’ve seen again and again on the road, size is a double-edged sword. Big firms have squads of salesmen, massive marketing budgets and loads of leverage at the bargaining table. Size makes many important business activities easier, and big companies dominate the market segments where these size-advantaged activities are especially valuable. However, size makes other valuable activities harder, and smart entrepreneurs can drive a wedge into these big-business cracks to create profitable markets for small business. Here are five lessons from the road on how small business can battle the big boys – and win: Talk across functions: In Pueblo, Colorado, we met with Allen Gross and Phil Coiner of GPS Source, an engineering company that specializes in developing and manufacturing systems that bring a GPS signal indoors. The firm thrives by nurturing a close connection between its sales force and its engineering staff. Bigger companies have trouble matching this capability, simply because size necessitates that the various parts of the organization be split into manageable chunks. This leads to informational silos, where both sales and engineering are too focused on their own goals — and hence miss opportunities for collaboration. At GPS Source, there is only one water cooler, and employees in different functions can’t avoid talking to each other. GPS Source recently won a big military contract against much larger firms, in part because they were already developing the system before the request for proposal was announced. Innovate and redesign: In Marietta, Georgia, we met with Itamar Kleinberger and Shakeel Merchant of Prodew, a firm that designs and sells misting systems for the produce section of your local supermarket. The two are engineers with years of experience in the industry – working for established companies that are now Prodew’s competitors – and built their business around a radical redesign of the misting system. Installing a standard system involved drilling holes in rubber tubing; this work was labor intensive and technicians often had difficultly insuring an even distribution of water pressure. The Prodew system features molded, Lego-like pieces that snap together quickly and generate even pressure (“We call it ‘plug and spray'”, Shakeel grinned). This innovation cut install time and overall costs, and allowed Prodew to gain a commanding market share. Innovation can work better in smaller businesses, for two reasons: First, an entrepreneur/innovator captures more of the resulting value (and hence has stronger incentives) than an employee/innovator. Second, small-firm innovators rarely have to overcome resistance from internal rivals who favor the status quo. Use local information: In Bloomington, Illinois, we met Erik Prenzler, owner of Prenzler Outdoor Advertising. The company owns more than 60 billboards in and around Bloomington, Illinois, renting them to local and national advertisers, and Prenzler said he competes in two ways: “I have better locations, and I offer better service.” Why can’t his national competitors match him on these dimensions? One of Prenzler’s main competitors — a national chain — manages all of its Bloomington billboards out of an office in Decatur, 46 miles away. Using his local network connections, Prenzler quickly spots opportunities to buy prime billboard locations in town, and is also fast to fix problems (like burned-out light bulbs) on the boards he sells. Listen to the customer: Mike Bodart, owner of Hoosier Sporting Goods in Columbus, Indiana, admits he can’t compete on price with national chains. Instead, Bodart relies on superior customer service: “If you have a problem with (our product), we will solve it,” he said. Bodart adjusts his inventory to accentuate this advantage, refusing to stock items a customer can buy at Target and instead focusing on products where his expertise can help customers make better buying decisions. Mike’s customer knowledge helps the timing of his inventory decisions as well: “When the two high schools — East and North —play each other in football each year, it’s just nuts. One high school is blue and white, the other is brown and orange.” And unless you’re in tune with the local community, you probably wouldn’t know to stock a lot of brown-and-orange t-shirts in time for rivalry week. Monitor quality: In Gresham, Oregon, we met with Leah McMahon, owner of the gourmet coffee shop Silk Espresso. Silk competes with “the green giant up the road” (as she referred to Starbucks) with a relentless focus on quality. McMahon’s extensive checklist includes “Are your beans coming from the right place? Are they stored properly? Are they ground properly? Is the temperature of your water correct? Are you double-filtering it?” McMahon’s type-A approach has paid off, as Silk has won multiple awards for quality and maintains a loyal customer base. This hands-on attention to detail – McMahon trains every barista herself and spends 10 to 12 hours per day at work — is an advantage a chain store cannot easily match. Big-company problems are largely rooted, we have learned, in problems with providing the right incentives for lower-level employees to create value. And as long as bureaucracy, corporate politics, and internal rivalries are present in big firms, smaller companies will be able to exploit the resulting inefficiencies and thrive. Michael Mazzeo is an associate Professor of Management and Strategy at Northwestern University’s Kellogg School of Management. Paul Oyer is the Fred H. Merrill Professor of Economics at Stanford University’s Graduate School of Business, and author of Everything I Ever Needed to Know About Economics I Learned From Online Dating. Scott Schaefer holds the Kendall D. Garff Chair in Business Administration and is Professor of Finance at the University of Utah’s David Eccles School of Business.