Summaries on 'Small businesses and Entrepreneurial economy' written for an Internation Business course, donated in 2015
This article is a study about how and why small firms use a cooperative or autonomous strategy to internationalise their activities and the possible changes in this use of strategy over time. It assumes that small firms opt for a cooperative internationalisation strategy. The empirical investigation uses a sample of Dutch firms from two different sectors: 1) Old economy (i.e. mechanical engineering) and new economy (i.e. computer software).
Results
Small firms follow an evolutionary internationalisation path, while a majority prefer a cooperative internationalisation strategy.
Introduction
Globalisation puts pressure on SME’s to develop strategies for internationalisation. The paper argues that an SME may either choose for the strategic option of go-it-alone or for a cooperative strategy. Studies has indicated that the internationalisation process of small high-technology firms differs from the process of firms operating in more traditional industries. The choice between go-it-alone vs. collaboration is not only a function of structural characteristics, but also of industry-specific characteristics. The article will examine whether there are differences in the extent to which firms operation in the ‘new economy’ or in the ‘old economy’ make use of cooperative or the autonomous strategy.
CM
Internationalisation: the process of adapting exchange transaction modality to international markets. The article discussed three research approaches that are considered most relevant in the context of this paper:
The Uppsala internationalisation process model:
this model claims that firms expand internationally trough various stages:
So, the Uppsala approach says that internationalisation is considered to be a cumulative, path-dependent process where the behaviour of the firm is contingent upon its past international experience.
Critics to the Uppsala approach: fail to account for the phenomenon of de-internationalisation and the jump of stages. It also doesn’t include cooperative modes of entry. At least the Uppsala model tells us that different entry modes represent distinct levels of commitment determined by past experience, but this isn’t true. Burgel says that distinct managerial choices determined by product-and-firm-specific considerations are more important.
Transaction cost economics: is about finding the most efficient arrangement for an economic transaction where the basic choice for a firm consist of carrying out the transaction itself. TCE looks for the opportunities which minimize the transaction costs, but minimizing the transaction costs is not the most important thing for managers when making entry modes choices. Another limitation is that it does not distinguish well between different degrees of externalisation or partnership and does not account for the important role and influence of social relationships.
Network perspective: this approach is rooted in social exchange theory and focuses on firm behaviour in the context of business and social network relationships. Internationalisation is a result of interaction, and the development and management of (trusting) relationships over time.
The basic internationalisation strategies
Many firms will use the strategies both at the same time, but one of them is dominant and this dominance may shift over time.
Autonomous strategy: firm act in an independent way. The autonomous strategy may be referred to as the classic strategy, which was typical for larger firms for a long time.
Cooperative strategy: firms who use this strategy, partly give up their autonomy for the purpose of cooperating in order to facilitate internationalisation. Inter-firm relationships may overcome resource constraints. But it also create costs (creation of incentives and monitoring mechanism) and revenues are shared between the partners (for example: joint ventures/ contractual arrangement). This strategy requires cooperative relationships among firms. International Strategic Alliance is a cooperative relationship with a partner aimed at the development, distribution, and production of product in a foreign market. Firms participate in an ISA preserve their legal independence and, outside the field of the corporation, their economic autonomy.
Types of ISA:
Non-equity strategic alliance: contractual agreements with a company to supply, produce, or distribute a firm’s goods or services without equity sharing (for example: licensing or franchising agreements).
Equity strategic alliance: partners own different percentages of equity in new venture or project or an existing firm.
Joint venture: two or more firms create a separate corporation whose stock is shared by the partners.
Network perspective -> supportive network: internationalisation is driven by supportive linkages that do not involve an explicit contractual agreement such as ISAs. These networks may consist of linkages with firms, institutions and personal ties and may facilitate access to information on foreign markets and reliable business partners.
Conclusion: SMEs are generally characterized by limited resources, and therefore they tend to use the cooperative strategy instead of adopting the classic autonomous strategy.
Empirical study
Hypotheses: internationalisation patterns very much depend on industry characteristics. The sample include particularly resource-scare, small enterprises confronting more far-reaching internationalisation challenges. They interviewed 12 Northern Netherlands firms from the computer software or mechanical engineering sector. The results are summarised in Table 1 of the article.
The distribution of firms across employment size classes in the Netherlands is uniquely characterized by very few very large enterprises on the one hand, and lots of very small enterprises on the other. In comparison with other countries, the mid-field of larger SMEs and smaller large companies is sparsely populated.
Now we examine the degree of internationalisation of the firms in the sample. The findings are presented in an IP-profile consists of five dimensions (based on the work of Daniels and Radebaugh and express the growing commitment idea as advocated by de Uppsala model):
1) This dimension measures the attitude of firms towards internationalisation activities, and ranges from a defensive to an offensive attitude.
2) This dimension is foreign entry mode, and ranges from the adoption of a low risk, low commitment entry mode (exporting) toward a high risk, high commitment entry mode (fully owned foreign subsidiaries).
3) Number of entry modes ranges from one to many.
4) Number of world regions covered by the firm’s internationalisation efforts, ranging from one to many.
5) Measures the market similarity, in this article defined as the economic and cultural similarity between the firm’s domestic country and the foreign countries entered.
Risk reduction and control issues are important as regards dimensions two to five. Dimension one is about management’s prioritisation of available resources and strategic choices.
The IP-profile is to analyse the level of internationalisation of the total sample and relevant subgroups.
Findings
Table 2 shows us that the firms have more a defensive than an offensive strategy, use less than three different entry modes, are moderately committed in terms of entry modes use, and are internationally active in two to three different world regions (world regions that are located relatively far from home)
Findings based on sector
The article also presents that the mechanical engineering sector is in general less offensive, but uses more different and more committed entry modes, and works in more different and more distant regions. The results show us that the mechanical engineering firms in this sample have progressed further in terms of internationalisation than the software firms, but mostly out of defensive motives. This seems logical because most of the mechanical engineering firms are much older than the software firms and started their internationalisation at an earlier date, while their markets are older and in an later life cycle stage.
Findings based on age
The young firms score lower on all IP-dimensions and significantly so on two of them. The youngest companies cover less regions and more similar markets than their larger counterparts. Most of these firms started to internationalise by low risk, low commitment modes of entry.
Findings based on size
Small firms score higher on three IP-dimensions, namely internationalisation attitude, number of regions covered, and market similarity. The difference in internationalisation attitude is significant, which can be explained by the fact that the smallest firms in our sample are mostly software firms that have a more offensive attitude than the mechanical engineering firms. The large (but not significant) difference as regards market similarity can be explained by the fact that all small mechanical engineering firms and 50 percent of the small software firms have the highest score on this variable (they are involved in underdeveloped regions).
The findings contradict the general idea that smaller SMEs would be less internationalised than lager SMEs.
Do small firms prefer to use the cooperative strategy?
Table 3 of the article shows us that eleven out of twelve firms in the sample entered geographically and culturally close markets in the initial stages of internationalisation. This give the firms less risk. This internationalisation process by entering relatively close markets and subsequently expanded into more far way foreign markets, corroborates the Uppsala model. But cultural and economic distend doesn’t provide the only explanation. Client followership and market growth are also important influencing factors.
Almost all the firms make simultaneous use of two or more modes of entry. And in eight of the twelve firms in the sample the current internationalisation strategy is a cooperative one (no difference between software and mechanical engineering firms). Human and financial resources are important reasons to engage in strategic alliance (in particular for the mechanical sector). The resource constraints are not only important for the entry mode choice, but also had an effect on the number of countries firms were able to serve.
The hypothesis that the cooperative strategy is the preferred choice for SMEs that internationalise, provide tentative support.
But alliances are designed in such a way that the partners can be controlled. An important reason for firms to enter strategic alliance is the ability to learn from partners. Internationalisation actions can be explorative or exploitative in nature.
Exploitation: refinement and improvement in efficiency of existing activities.
Exploration: search and innovation activities, and development of capabilities.
The new economy use a combination of both natures. The old economy (with more stable environments) used an more explorative nature. These explorations are typically aimed at developing competences (less at technical innovation)
Most of the firm in the sample consist with the logic of the international process models: both the software and mechanical engineering firms show increasing commitment and involvement into new foreign markets and higher level of investment. But the process is less constrained than many interpretations of the process model imply. The internationalisation path is sometime turning backward, by for example the de-internationalisation of software firms.
Why do firms change from one entry mode to another? The motives for firms that progress from using more low-risk, low-commitment modes of entry to using more high-risk, high-commitment modes of entry can be classified into behavioural and economic reasons. This can be due to managerial learning. In other situations, the firms decide to switch to more committed modes of entry because market potential or market size made them more prone to take risk. The software firms start to internationalise much earlier than the mechanical engineering firms because de CEO tend to be more opportunity seeking and offensive in new economy firms and more risk averse and defensive in the old economy firms.
Earlier I noted that internationalisation can be driven by supportive linkages. This is indeed the case with the firms sampled. Linkages with regional or national institutions promote internationalisation, help the firms in obtaining country-specific information. Also the personal network of the owner often plays a crucial role in finding suitable partners to manage a foreign venture. New communication technology plays an important role in facilitating the communication with existing client and suppliers. At least, the firm’s history play an important role in the internationalisation process.
But even tough informal linkages appear to play an important role in internationalisation, none of the sampled firms have strong linkages with local firms.
Conclusion of the article
Venture capital plays only a minor role in funding basic innovation. The venture money plays an important role in the period of a company’s life when it begins to commercialize its innovation. More than 80% of the money invested goes into building the infrastructure required to grow the business (manufacturing, marketing and sales). It is not long-term money, but the idea is to invest in a companies balance sheet and infrastructure until it reaches a sufficient size and credibility. The venture capitalist buys a stake in an entrepreneur’s idea, nurtures it for a short period of time, and then exits with the help of an investment banker.
The venture capital’s niche exists because of the structure and rules of capital markets. Starting companies often have no other institution to turn to. Bankers will only finance a new business to the extent that there are hard assets against which to secure the debt. But many start-ups have few hard assets. Furthermore, investment banks and public equity are both constrained by regulations and operating practices meant to protect the public investors. Venture capital gives a traditional lower-cost sources of capital availability to ongoing concerns. The challenges of venture capital is to earn a consistently superior return on investments in inherently risky business ventures.
Appendix Profile of the ideal entrepreneur. From a venture capitalist's perspective, the ideal entrepreneur:
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Investors in venture capital funds are very large institutions which put a small percentage of their total funds into high-risky investments (pension funds, financial firms, insurance companies, university endowments). The return of investment is between 25% and 35%.
The venture capitalists meet their investors’ expectations at an acceptable risk level by their investment profile and in how they structure each deal.
Investment profile: The myth is that they invest in god people with good ideas, but the real investment profile is that they invest in good industries (industries that are more competitive forgiving than the market as a whole). Venture capitalists focus on the middle part of the classic industry S-curve. They avoid the early and the later stages. Growing in high-growth segments is a lot easier than doing so in low-, no-, or negative-growth ones. These investment flow reflect that a consistent pattern of capital allocation is into industries where most companies are likely to look good in the near term. The critical challenge for the venture capitalist is to identify competent management that can execute (supply the growing demand).
VC investments in high-growth segments are likely to have exit opportunities because investment bankers are continually looking for new high-growth issues to bring to market. The issue will be easier to sell and likely to support high relative valuations (and therefore high commissions for the investment bankers). As long as VCs are able to exit the company and industry before it tops out, they can reap extraordinary returns at relatively low risk.
| Appendix Timing is everything More than 80% of the money invested by venture capitalists goes into the adolescent phase of a company's life cycle. In this period of accelerated growth, the financials of both the eventual winners and losers look strikingly similar. (See figures on page 134) |
The logic of the deal: it is always the same. Give investors in the venture capital fund both large downside protection and a favourable position for additional investment in the company proves to be a winner. Should the venture fail, they are given first claim to all the companies assets and technology. The deal often include blocking rights or disproportional voting rights over key decisions, including the sale of the company. The clauses protect against equity dilution. When a firm stumble and have to raise more money at a lower valuation, the venture firm will be given enough shares to maintain its original equity owned at the expense of the common shareholders, or management as well as investors. When it goes in the opposite way, investors enjoy upside provisions, sometimes giving them the right to put additional money into the venture at a predetermined price. VC firms also protect themselves from risky by providing further portfolio diversification. That is the ability to invest in more deals per dollar of invested capita. They also decrease the workload of the VC partners by getting others involved in assessing the risks during the due diligence period and managing the deal.
Appendix
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Venture capitalists expect a ten times return of capital over five years, in return for financing one to two years of a company’s start-up. The rate is necessary to deliver average fund return above 20%, because the preferred position is combined with a very high cost capital. A loan with a 58% annual compound interest rate that cannot be prepaid.
The real upside lies in the appreciation of the portfolio. The investors get 70% - 80% of the gains and the venture capitalists get the remaining 20%-30%. The amount of money they receive is a function of the total growth of the portfolio’s value and the amount of money managed per partner. But what part does the venture capitalist play in maximizing the growth of the portfolio’s value? On average, good plans, people and businesses succeed only one in ten times. There are many components critical to a company’s success. Given the portfolio approach and the deal structure of de VCs, only 10%-20% of the companies funded need to b real winners to achieve the targeted return rate of 25%-30%. VC reputations are often built on one or two good investments.
Today’s venture capital fund is structurally as follows: the partnership includes both limited and general partners, and the life of the fund is seven to ten years. The size of the typical fund an the amount of money managed per partners have changed dramatically over the last decades. Today, the average fund is ten times larger, and each partner manages two to five times as many investments. The partners are usually far less knowledgeable about the industry and the technology than the entrepreneurs are.
Despite the high risk of failure in new ventures, engineers and businesspeople leave their jobs because they are unable or unwilling to perceive how risky a start-up can be. Because many entrepreneurs recognize the risk in starting their own businesses, they shy away from using their own money. Ventures capital is an attractive deal for entrepreneur.
The system works well for the players it serves: entrepreneurs, institutional investors, investment bankers, and the venture capitalist. It also serves the support cast of lawyer, advisers and accountants. Whether it meets the needs of the investing public is still the question.
The article provides an inventory of strength and weaknesses of small firms in a dynamic context. Probably the most important characteristic of small business is its diversity and other core characteristics are small scale, personality and independence. In particular in small business obstacles due to limited knowledge and the role of external contracts to overcome these obstacles, are highly relevant tot issues of innovation and diffusion. Characteristics of small firms can also arise in relatively independent units in large firms. With more autonomy of units in large firms and more integration of small firms, large and small firms come to resemble each other more.
In Europe we speak of small and medium sized enterprise (SME), with the boundary between small and medium size between 5 and 50 people (in the Netherlands 10) and boundary between medium sized and large business ranging between 50 and 500 persons engaged (in the Netherlands 100). Often boundaries are drawn differently for manufacturing and services. In consumer services organisations the firm is considered big when it exceeds the 50 or 100 mark, in manufacturing it may not be considered big until it exceeds the 500 mark. In spite of the statistical definition given above, we consider small firms as small, relatively independent business units, so that the analysis may also apply the independent units in large firms.
Theoretical framework
There are reasonably systematic indications that small businesses play only a limited role in major scientific an technological breakthroughs. Not the inventions themselves, but in the process of implementation, application, differentiation and adaptation small business has an important role to play. The article includes a synthesis between the view of the early Schumpeter (1909), proposing an innovative role of creative destruction for small, new firms, and the views of later Schumpeter (1939, 1943), proposing that innovation is primarily produced in large firms and concentrated markets.
The stages for innovation are the following: invention -> development -> tooling/production -> introduction to practice/market -> diffusion.
Diffusion is a process of dissemination in a social system, part of which is adoption by new users. Adaption is a process with the following stages: knowledge (awareness) -> conviction (interest) -> decision (evaluation) -> implementation (trial) -> confirmation.
Diversity
The most important characteristic of a small business is diversity. We will look to the causes of diversity, which are: conditions that allow for diversity and sources that produce diversity.
This depends on the managers or entrepreneurs. Should they release the common standards of profit or conduct. There is a trade-off between perceived returns by releasing the common standards and the risk what it entails. Entrepreneurs will take fewer risks, because they can’t spread the risks. Stakeholders have a portfolio where they can spread the risk, and therefore will take more risky investments. Some providers of private capital (family, friends), will incur more risk for emotional reasons (love, friendship, loyalty). Finally, conditions arise form government regulations with respect tot the environment, labour conditions, permits and demands on schooling, technical and safety standards, liability, zoning laws and other regulations for location and building, etc.
The sources that produce diversity lie in the variance of backgrounds, motives and goals of entrepreneurship. People resort to independent entrepreneurship for a variety of reasons, which may be grouped one of the following factors: push (discontent wit present position), pull (attractiveness of self employment), coincidence (generating a large random component).
There is a relation between entrepreneurship and social security: in many poor countries entrepreneurship is the only way to provide for oneself or for sick or old relatives. In slumps unemployment drives people into self-employment benefits. Important pull factors are the will to power, conquest and riches, and the will to creation. This correspondent with the real entrepreneurs as an agent of creative destruction or the Shumpeterian hero. Another important pull factor is independence as a goal in itself: a large measure of freedom and independence in the setting of goals and the choice of location, method of production, hours and conditions of work, form of organization, etc. Finally, related to independence is the pull factor personality: orientation towards personal values and goals, and relatively unstructured procedures and relations, with an oral rather than written communication. Besides, coincidence is an important factor in both push and pull. In small business there are conditions and sources that generate a large diversity of purpose and conduct. Radical innovation is to be expected only from a minority, which is nevertheless a significant group.
The personal characteristics of entrepreneurs do not determine outcomes directly, by themselves, bus in interaction with contingency factors from the context in which the firm and entrepreneur operate and with the strategies they take. A set of characteristics will be beneficial in one situation and fatal elsewhere.
The figure below represent the Structure-conduct-performance.
The role of institutions is limiting transaction costs in order to enable the division of labour on which property depends. Life cycle means the stage of development of the product or the market in which the firm is involved (Context/structure -> institutions/ life cycle).
Firm structure is the organizational structure, procedures and routines. Search means conduct in the acquisition of knowledge, including the use of external networks. This is an important feature for small business and compensate for internal lack of expertise.
Strengths and weaknesses
Core characteristics and their implications are not simply personal characteristics of the entrepreneur, but combinations of such characteristics, contingency factors and forms of conduct. According to Noteboom (1987), core characteristics of small business are: independence, personality and small scale. Figure 4 of the article (page 334) give a summary of the strengths and weaknesses (study this framework, fundamental part of the article!!). Characteristics or traits by themselves do not explain behaviour. They contribute the playing of roles or taking of actions for which the need or opportunity occurs depending on the circumstances (contingency perspective). The core characteristic of personality represent the private and business affairs, independence indicates relative freedom as regards to capital markets, allowing for more idiosyncratic goals and conduct. As firms grow from small trough medium-sized to large size, the characteristics turn into their opposite. In a small firm we might find a simple structure with direct, centralized supervision by the owner-manager, but also a more federative, decentralized structure and processes of mutual adjustment. Among medium-sized and large firms one might find a professional bureaucracy with professionals with standardized shills and mutual adjustment.
The figure presents that the strengths and weaknesses suggest appropriate core strategies. Both strategies of innovation and niche markets exploit the strengths in providing unique competencies and customized products, and the associated proximity to customers. Innovation further exploits the strengths of motivated management and labour, to survive the harsh times of making novelty work and the strength of limited bureaucracy and internal flexibility.
Large vs. small
Large firms tend to be strong where small firms tend to be weak, and vice versa. Small business tend to be strong in efficient, final and exemplary causes (labour, entrepreneurship, motivation, design, ideas) and large business in material, formal and conditional causes (resources, knowledge, science, method, control of external conditions). Small and large firms are good at different things and in different ways, in different stages or aspects of innovation.
In a static framework of given technology and given consumer preferences, large firms will provide efficiency due to large scale production. The role of small firms is that they inhibit cartels or other forms of collusion, they undermine entry barriers based on threats of retaliation with a low price to potential entrants in a monopolistic market, fill the market niches for specialized products that cannot effectively be filled on a large scale, they provide minimal standards for evaluation of the performance of management and provide labour in large firms.
But large business not stood still. They has become more like small businesses. Large firm focus has shifted from efficiency to quality, flexibility and innovativeness. Thereby, its organization has shifted from centralized hierarchy with tight control to central direction with incentives and subsequently to decentralized and divisionalization and more autonomy of business units. Besides, important differences do remain. Differences in scale have decreased in production units, but have remained on the corporate level (in management, R&D, finance and marketing). Differences in available knowledge and science stay the same. And large firms face a paradox: to obtain similar advantages as small firms they must loosen control, but to obtain the advantage of size they must maintain coordination and control.
But also small firms do try to obtain some of the advantages of large size, without the disadvantages, by forms of partial coordination in networks of independent firms, also known as the arrangement of flexible specialization. They take advantages of scope while maintaining variety, selection efficiency and flexibility.
Tacit knowledge
Tacit knowledge is particularly important in the context of innovation and diffusion, because it has implications for capacity to absorb new information. Tacit knowledge is knowledge we have typically acquired in learning by doing and teaching rather than by abstract learning and teaching by explicit definitions and explanations. This has become something like second nature. We are not even aware that we have that knowledge. There are in fact three dimensions of knowledge: width, depth and tacitness. In small businesses the knowledge tends to be undeep (no functional specialist) and tacit. The undeepness of knowledge can be compensated by supplementing form external sources.
The tacit knowledge sets an obstacle in the first stage of adoption (knowledge/ awareness). Because knowledge in small business is more tacit than in large firms, adaption is more problematic for them. In large firms tasks become more specialized, more people become involved and layers of hierarchy are added, knowledge has to become less tacit, more explicit, formal and documented.
Tacit knowledge is not only a problem, but also has a positive side. When knowledge is tacit, it is more difficult to transfer and copy it. Furthermore, tacit knowledge is often also cumulative: it is based on skills that must be acquired in practice and without the underlying skills it is not implementable. When the knowledge is embodied in teams, or the firm more as a whole, and is cumulative, it is transferrable only by complete take-over. Often successful small innovators are taken over by less innovative large firms.
Innovativeness
There are mixed evidence whether small or large firms are more innovative. Small firms were found to be more productive in innovations than large firms in industries with relatively low capital intensity, low concentration and high level of innovation. In many cases, the R&D intensity is used as measurement for innovativeness. The hypothesis will be: how bigger the R&D intensity, how more innovative a business is.
The intensity of R&D sometimes first rises and then declines. Most of the empirical findings indicate that R&D activity appear to increase with firm size up to a point and then to level off or decline. But there is a lack of evidence of a clear causal relationship beyond a size threshold running from firm size to innovative activity.
But a study in the Netherlands shows us that small firms systematically participate less in R&D than large firms do. The explanation for this is that while expected returns increase with firm size, risk does not increase with firm size, or declines with increasing firm size. A second study shows that when small firms participate in R&D they do so at higher level of intensity than large firms.
So the overall evidence points to a lesser participation in R&D of small firms, but a greater intensity and greater productivity when they participate.
The different stages of the innovation process are not as linear as the article says (invention -> development -> tooling/production -> introduction to practice/market -> diffusion). So perhaps we should speak of aspects or dimensions rather than stages. In the intervention aspect the strength of large business is material and that of small business behavioural. The strength of large business lies in its deeper level of specialization, abstract, science-based knowledge, economy of scale, scope and experience, larger and cheaper financial resources, spread of risk. The strength of small firms lies in greater motivation, better survey of the entirety of a project, tacit knowledge in unique skills, more informal communication, greater proximity to the market and to own production. Small business is likely to be better in application, in development and introduction to market. For radical new products, the dicision to develop an invention, to take it into production and to introduce an innovation to practice, is riskier for small business, due to lesser spread of risk (narrow market, fewer products).
The stages development and introduction interact and occur in parallel. Due to their small size, internal flexibility and proximity to customers, small business may have an opportunity here.
Large firms have more stakes in existing older generation products, because of their larger number of products and longer history (correlated with the firm size).
In the decision making process, small firms have an advantage, because decision making is faster and there are fewer filters to eliminate radical novelty compared with large firms. Small firms also bring innovations to market more quickly than large business.
In the stage of introduction to practice there should be an distinguish between process innovation (producer of the innovation is also the user) or product innovation (product is introduced to the market). In process innovation, small business is likely to be at an advantage due to the condition that the (internal) user is closer to the (internal) developer of the innovation. So mismatch, misunderstanding and the obstacle of the not invented here syndrome are not apply. In markets with many consumers, at a distance from the producer, the set-up and exploitation of market research, communication and distribution is required, where large business has an advantage due to economy of scale and scope.
A survey of the results indicates not so much that small business is always better or worse in innovation, but that large and small business are good at different types or aspects or stages of innovation. Large firms are generally better at production of fundamentally new basic technologies, small firms at their implementation in new products brought on to the market, large firms at the large scale, efficient production and marketing of the products, small firms at specialities for niche markets and at provision for residual markets at the end of the life cycle.
Market share will start out higher for small firms, who are then surpassed by large firms, until in the decline phase large business move out, leaving residual markets to small business. Small firms is seen as market pioneers and the laggards. Large business will dominate in the phase of expansion (due the growth of small innovators to large size), imitation by large business and the take-over of successful small innovators by large business.
Typically the basic technology and opportunity arise in large firm, but product/market opportunities are first taken by small business. The hypothesis in response to the lifecycle-model, says that scale is small and profit margins are reasonable during the initial stage of the life cycle, scale is large and profit margin large during expansion, scale is large and profit margin lower during saturation and scale small and profit margin low but stabilizing during decline.
The article presents a framework to evaluate HRM in small and medium-sized enterprises. The findings of the article show that a interplay of external structural factors and internal dynamic shaped HRM in each of the companies. HRM was often informal and emergent.
HRM in SMEs
The role of HRM as a means to meet strategic objectives and impact on organisational performance is demonstrate by the following statement: management of people is strategic to success. The open system perspective, used in this article, provides a deeper understanding of the type and form of HRM adopted in SMEs. In the SMEs there is limited understanding of HR activity within the company. This is explained by the definitional complexities, access difficulties or resource constraints inherent within SMEs. The HR prescription has a little big business syndrome, because the HR prescription assume a ready-made, large-scale, bureaucratic corporation.
Practice has shown that SMEs are characterised by complexity and unevenness with HR practices mediated trough a web of social and economic relationship. HRM in SMEs can be best described as complex. HR decisions are heavily influenced by labour and product market contingencies. At the moment, the HRM in SMEs is rather been manufactured than designed. Dominant theoretical models do not adequately capture the complexity of HRM in SMEs. Rational closed models only capture the part of how HR systems work.
There are variances in HRM across organisations, and there is also substantial variance across individuals and groups. So there are many prescriptions about HRM, but limited descriptive data and sparse in analytical research. Therefore HRM in SMEs will necessarily be heavily shaped by contextual contingencies. The open system approach may better accommodate the contextual determinant of HRM.
Open system theory
The open system theory emphasises two important features of organisations: their system characteristics and their openness to environmental influences. From a open system perspective, organisations are viewed as a set of interdependent parts so that movement in any part of the organisations inevitably leads to movement in the other parts. Utilising an open system perspective we assume that firms are integrated in social and economic networks. Small firms have less control over their environment than large firms, therefore research considers SMEs in isolation and that is ultimately misleading. An open system perspective suggest that organisation are collectivities that depend on and are influenced by flows of personnel, resources and information form the outside. Consideration of HRM in SMEs form an open system perspective therefore provides the potential for a more descriptive and analytical research contribution.
Institutional theory and resource dependency
The institutional theory depicts normative and isomorphic pressure that arise from social and economic interrelations among firms and therefore provides a thorough base for inclusion of the context of HRM. This perspective demonstrate that HR activities may be adopted as legitimacy-enhancing responses to broader structural relationships. Complementary to the institutional theory is the resource dependency, which focuses on the nature of resource exchange. HR activities and processes tend to reflect the distribution of power among organisational stakeholders. The open system theory acknowledges that the relationships between organisations and environment are variable. We need theoretical models and accompanying research design that take into account the institutional setting and allow reality to emerge and enable us to analyse the underlying process. Therefore, a complementary perspective that have the potential to deal with emergent issues (legitimacy, institutional conformity and resource dependency) is explored in the next paragraph.
Conceptual framework
Figure 1 of the article (page 54) represent the conceptual framework which developed a more holistic approach for looking at HRM in SMEs. The framework is of high relevance to this article, so you have to study it well. It graphically represent the main contributions in each domain identified in the literature. The framework indicates how firm size interact with other factors such as labour and product market influences, ownership, managerial style, dependency and relations with customers and suppliers to shape HRM. The way in which these factors impact on small firms, makes the situation for small firms different from that of large firms. The framework emphasises that external structural factors shape the parameters of HRM, but the actual form HRM takes is likely to be contingent on idiosyncratic firm responses. HRM in SMEs has been noted for its marked heterogeneity, complexity and high unevenness. The research instruments in the conceptual framework focused on the extent to which internal dynamics and external factors characterise how and why SMEs have adopted aspects of HRM. The framework includes four key areas:
Defining the organisations as SMEs was taken from the current European definition: Micro (less than 10 employees), small (10-49 employees) and medium-sized (50-249 employees).
Findings
Initial analysis of the range of practices reported by managerial respondents suggest diversity in terms of the type and form of HR practices in use. Table 2 represent this statement. HRM is not necessarily homogeneously applied within firms.
In the case study, none of the companies had an explicit or formalised HR strategy. This is not surprisingly given the limited formal strategic planning that took place. This hints at the validity of an open system approach to HRM as it does not presuppose or assume alignment. A common focus was the terminology deployed by mangers which suggested a focus on survivability and adaptability in terms of HR decisions.
External factors
The article describes the following external factors:
Internal dynamics
Ownership and managerial style: the various ownership structures and management styles clearly influence responses to intensified competition. For example, in one of the case study companies the manager engendered loyalty form employees by maintaining a high degree of informality. Furthermore, the actual type and form of HRM adopted was shaped by internal dynamics within firms. The structural conditions shape only the broad parameters for action. The case study represent that autonomy on all decision-making processes matters.
Unionisation: examples of it are friendly work atmosphere, use of team working, a staff suggestion scheme etc.
Analysis of the results
External literature on HRM and SMEs tends to be characterised by size determinism. Evidence from the theoretical framework and the case study suggest that size per se did not determine HRM. Rather, size mediated differing priorities such as labour and product markets, supply changing relationships, management attitudes and the political context in which each of these small firms operated.
The conceptual framework with an open systems theoretical underpinning provided an analytical purchase on the influences on HRM in an SME context. This facilitated a move to more understanding, accommodation and explanation of situational factors. Research findings presented in this paper indicate that a complex interplay of external structural factors and internal dynamics, including resource constraints, managerial influence and proximity to environmental forces, shaped HRM in each of the case study companies.
HRM could not be documented as strategic in the traditional sense of the word, but rather reactive to external pressure. This means that more attention should given to issues of survivability rather than simply being consumed by the sustainable competitive advantage. The institutional and resource dependency approaches is importance to understand the type and form of HRM adopted. Finally we can state that HR needs and often make sense in a particular an appropriate context. And also the employees are of importance to the equation.
There is a long-run equilibrium relationship between economic development and the proportion of the working population. Too few firms is not good for the economic growth, but too many neither. But there are only policies focused on increasing the rates of firm formation. Seeking the raise rates of new firm formation may lead to an increase in the quality of the new firms, but is also associated with a market fall in quality.
The article describes three decades of enterprise policy in the Tees Valley. The distinct phases of enterprise policy in the UK in the past 30 years are:
1970s: no effective policy (policy off).
1980s: policy to maximise the number of individuals that started a business.
1990s: concentration on business quality by providing support for existing small firms with growth potential
The article suggest that businesses in the 1980s were more numerous but of lower quality than those from the 1970s and 1990s.
It also provide 3 hypotheses to this subject:
H1) The new firm formation rate would be higher in the 1980s than in either the 1970s and 1990s.
H2) Business founded in the 1980s will be of lower quality than those founded either in the 1970s or the 1990s
H3) Founders of new firms who were previously unemployed are less likely to establish quality businesses.
The policies
The government policy before the 1970s encouraged mergers and acquisitions in order to create firms with internationally competitive economies of scale. So the policy focused on large firms instead of small firms, because small firms were less productive than larger firms. At the end of 1960s the disappearance of the small firms lead to monopolies. The Bolton Committee reported in 1971 and pointed to the key competitive role that firms played in a dynamic economy (for example, providing an actual or potential competitive threat and being a source of radical new innovation). This ensure a much more positive view of small firms as source of wealth and job creation.
After the work by Bolton, the work by Birch claimed to show that small firms created two-third of new jobs, across all sectors of the US economy between 1969 and 1976. The ideas for an enterprise policy clearly date from 1979 and earlier, policy only really changed in 1981 when unemployment reached 2.5 million and widespread rioting created an intense pressure for change. The pressure for change had forced the government to intervene to encourage more people, particularly to unemployed, to start their own business. The most important single programme was the Enterprise Allowance Scheme (EAS). The focus of the 1980s enterprise policy was to maximise the number of people starting a business on the grounds that this would directly reduce unemployment. The enterprise industry did not just target the unemployment. Young motivated people were also a focus of attention.
The EAS was not as effective as expected before. The businesses established by EAS were short-lived affairs leading to a cycle of uncreative destruction. EAS provides a subsidy which lead to displacing other small firms in the locality as a result of being able to charge lower prices to customers through having lower costs (through the subsidy). The business owner of the bankruptcy business became unemployed and they, too, became eligible for the public subsidy. They start again a small business with the subsidy and displacing the original recipients of EAS whose funding was exhausted.
The net effect to the country was zero.
Solution to this problem was a new strategy designed by Business Links. Business Links were to give a single point of access to public assistance for small enterprises but they also gave a fresh set of ideas to the new entrepreneur. The new policy was a shift in emphasis from start-up and micro businesses toward established business with a growing potential. The focus shifted to those businesses that were more likely to grow to a significant size.
The hypotheses
Explanation hypothesis 1: The 1980s knew a policy focused upon start-ups.
Explanation hypothesis 2: The number of businesses might have increased in the 1980s, but the quality of those businesses may be lower. This might be because individuals without entrepreneurial skills were encouraged by a combination of public subsidies, propaganda and a lack of alternative employment opportunities (because of the high unemployment rate). Three dimensions support this hypothesis: during the 1980s there have been a lack of human capital attributes (education), lower survival rate for firms and poorer performance.
Explanation hypothesis 3: the relationship between the employment status of the founder and business quality is addressed in this hypothesis. If unemployed individuals are likely to establish lower-quality businesses, then a decade in whit high unemployment rates will lead to the establishment of more lower-quality businesses.
Testing
Table two of the article shows that middle-aged male and educated founders are the most likely to begin businesses that grow quickly. Other factors that are of positive influence on growth rates are prior managerial experience, having previously owned a business. The impact of having worked in de same trade is unclear, but entering self-employment from unemployment is hypothesised to be associated with slower growth rates. Firms in some sector grow faster than in others (these sectors differ over time).
Results
Hypothesis 1: the article represent that almost three times as many firms were established over a five year period in the 1980s as were established over a five year period in the 1970s. Also the VAT data (see figure 1 of the article) support the hypothesis. So hypothesis 1 is upheld.
Hypothesis 2: For this hypothesis the human capital characteristics and the employment size and change over time are of importance. Table 5 shows us that there is a significant difference in the pre-start-up variables and at-start-up variables in the 1980s from either of the two other decades. First, de proportion of graduates starting a business were significantly lower in the 1980s than in either the 1970s and 1990s. Secondly, the proportion of people who starting a own business from unemployment was highest in the 1980s. Thirdly, the proportion of founders with prior business experience is significantly lower in the 1980s. Fourthly, the 1980s founders were significantly more likely than those from the other decades to have no formal qualifications. The 1980s is also the decade with the lowest proportion of businesses starts by males (even this says nothing about the quality of the businesses). Furthermore, there is no human capital measure of quality in which the 1980s outperform start-ups in either the other two decades. Finally, table 5 shows the proportion of new businesses that were specialised companies was also much lower in the 1980s. So the 1980s new firms were less qualified as those in the other two decades.
Table 6 shows a, extreme concentration of businesses in sectors where there is likely to be only very limited growth prospect for the 1980s. Even the proportion of firms in professional services is low, particularly in the 1980s.
So there is a strong body of evidence implying that the 1980s was a decade in which new firms in Cleveland exhibited significantly fewer characteristics of quality than in either the previous or the later decade.
Table 7 shows us that the implied failure rate is significantly higher in the 1980s. The examination of the trajectory of employment change over time amongst new firms suggest that the 1980s firms that survived for at least five year have lower employment levels.
So hypothesis 2 is supported.
Hypothesis 3: The above section provide evidence that the new firms started in the 1980s were of lower quality than those in either of the two other decades, such differences cannot necessarily be attributed to policy change. This is because the 1980s was also a decade in which unemployment was double as high as the other decades. Differences in business quality may reflect the greater willingness of unemployed individuals to become business owners. If they have lower human capital than the employed that start an own business, then it may be this, rather than policy, that explains the low quality of businesses started in the 1980s. It is clear that there are significantly difference between the quality characteristics of new form founders in the 1980s and those in the other two decades, but this do not reflect differences in the proportion of the unemployed in the sample of the study. Table 8 of the article suggests that the unemployed who become business owners, in all three decades, have very similar characteristics to the employed making that switch. The results have not found support for the third hypothesis.
Summing up, there were more businesses started in the 1980s than the other two decades. The quality of these businesses appears to be poorer in terms of growth in employment, the human capital of their founders and their choice of their founders and their choice of legal form. These differences were not a result of the higher unemployment rates in the 1980s because there were no significant human capital differences between those who were employed previously and those who were unemployed previously.
After all, the UK Treasury has shown how an enterprising SME sector contributes to more productive potential, greater competition and greater innovation which all add to the growth of productivity in the economy. Also replacing the older businesses by new start-up firms does seem to increase productivity, at least in newer industries.
The article is about the evaluation of the impact of public policies to support small businesses in developed economies. The six steps include six approaches, beginning with the most simple and ending up with the most sophisticated. The six steps can be subdivides in two broader phases, the monitoring and evaluation phase. Step 1 to 3 include the monitoring phase and step 4 to 6 is being classified as the evaluation phase.
Small business policy in general
No developed country produces a clear set of objectives for each component of small business policy. Analysts therefore are required to infer the objectives of policy, rather than having these clearly defined. Only then it is possible to determine whether or not the target is achieved and hence able to judge whether or not policy is successful. The absence of clear objectives for SME policy is not the only problem, the implied objectives can often be conflicting. As you can see in table 1, there are some conflicting objectives. Most developed countries have SME policies because they believe that SMEs are both currently a major source of employment and likely to be an increasing source of new jobs in the future. But most of the time political leaders define their objectives in terms of reducing the unemployment rate in state of employment creation. So increases in employment can be considered as an intermediate objective with the final objective being that of reducing unemployment. But research has shown that job creation in SMEs is likely to have only a modest effect upon reducing registered unemployment. This is because SMEs are disproportionately likely to provide part time work and these part time workers (most females) are less likely to be registered as unemployed. Secondly, policies of job creation can lead to lower rates of out-migration because workers feel there is a prospect of getting a job in the locality. So success of creating jobs can also lead to increased unemployment.
Also objective can be related to objective 1. More people starting a business leads directly to additional jobs or to reducing the numbers of unemployed. But the new enterprises are most likely started by individuals who are unemployed and they choose often for entering trades with low entry barriers. This sectors, such as vehicle repairers, window cleaners, taxi drivers etc., have a finite and highly localised demand. But the policy lead to displacement of other unsubsidised traders in the locality with no obvious benefit either to the local consumer or to the economy in general. So there has to be made a choice between objective 1 or objective 2. The government should set objectives, with an indication of which takes priority. Once the objectives are set, then numerical targets need to be specified. These targets also have to be measurable. Only then can evaluation take place.
The six steps
As we stated before, the first 3 steps can be seen as monitoring phase, and the last 3 steps as evaluation phase. The difference between monitoring and evaluation is that evaluation attempts, demonstrating analytical rigour to determine the impact of the policy initiatives. Monitoring, merely either documents activity under the programme or reports participant’s perception of the value of the scheme. Monitoring relies exclusively upon the views of the recipients of the policy. Evaluation focus on the non-recipients in order to present the difference between the results with or without the policy. We call this the counter-factual which compare the data change because of the policy. Table 2 of the article shows the six steps.
Step 1: Take up of Schemes
Table 3 of the article describes the first step. This monitoring procedure identifies the characteristics and nature of the take up of the scheme (for example, it might quantify the number of firms participated in the particular policy, the size of such firms etc.). These data are primarily collected by the public sector for accounting purposes.
So step 1 serves an accounting and legal function, but plays no economic role. This step provide no insight into policy effectiveness. Step 1 only gives a building block for evaluation.
Questions asked for this step:
How many firms participated?
What sector were they in?
What location were they in?
How big were these firms?
How much money was spent?
Problems:
Tells you almost nothing about the effectiveness.
Tells you almost nothing about satisfying objectives.
Step 2: Recipients opinions
Those firms who participated in the schemes are asked for their opinions. They also asked about the application procedures to participate in the Scheme to determine whether these can be streamlined. Step 2 seeks to obtain the viewpoint of the firms both n the effectiveness of the scheme and on its accessibility. The problem is, despite the frequency of such studies, step 2 information does not help determine whether objectives are achieved. Step 2 shows us that the assistance does not necessarily relate to the economic objectives of the policy, such as increasing the competitiveness of the firm or job creation.
In this step it is very important to monitoring all the relevant companies, whether or not they applied, to reduce the biases. So step 2 can offer some insight into policy delivery, but they remain almost irrelevant to determining the effectiveness of the policy. This is because there may be no link between the views of the firm on the value of the policy and the ability of the policy to achieve the objectives specified in table 1 of the article. On the other hand the truthfulness of the participants asked is questionable.
Questions asked for this step:
Course participants:
Firms:
Problems:
Even if they like it, it does not tell you if it is effective
All it can do is offer insights into policy delivery (but that is not the key question).
Step 3: Recipients views of the difference made by the Assistance
In this step the participants are asked not simply whether they liked the policy, but also whether they thought this made any difference to the performance of their firm. In this more sophisticated step firms may also be asked questions as to what would have happened to them if they had not been in receipt of the policy initiative. Perhaps most difficult, firms may be asked to estimate the extent to which this is at the expense of other firms.
The most important problem is the extent to which participants are capable to answer these questions. Moreover it is an understandable reaction of participants to provide the answers they think the questioner wishes to hear in order to be able to continue untroubled with the running of their business. There is no way of checking this. Another reason to give the answers they think the questioner wishes to hear is to get them out of the door. The arrogant ones would say that the success of the business is not because of the policy, but because of its own entrepreneurial skills. Furthermore, it is difficult to decide when such questions should be asked an of whom. Finally, the interviews can only be conducted for firms which continue to trade (even as in step 2).
Overall, therefore, monitoring alone is not enough to give a reliable representation of the policy effectiveness. The effect of the policy cannot be estimated simply by seeking the views of recipients firms, even if these views were honestly provided. We have to compare the assisted firms with groups of firms not assisted by the policy. This is the evaluation process described in step 4 to 6. The challenge in this process is to isolate the appropriate group of firms with which to make the comparison, and to hold constant all other influences.
Questions asked for this step:
Did firms think it provided additionally?
Would firms have done it anyway?
Does it cause displacement?
Problems:
Provide answers they think you want to hear
No way of checking
Only snapshot of surviving firms
Step 4: Comparison of the Performance of Assisted and Typical firms
To evaluate the impact of the policy it is necessary to decide what would have happened to businesses in the absence of it (counter-factual). Step 4 estimates the impact of the policy by comparing the performance of the assisted firms and the typical firms. Table 6 represent this comparison. For example, employment or sales growth is compared, and the differences in survival rate. The advantage of this approach is that, for the first time, a control group present. So we can compare the assisted en the control group.
The problem with this step is that firms in receipt of assistance may not be typical of firms in the economy as a whole. For example, firms who seeks training (subsidised or not), may be more likely to be growth orientated than firms more generally throughout the economy. Those seeking training are generally younger and significantly better educated than the population of firms as a whole. They may also be starting businesses in different sectors. There can also be sectorial or geographical characteristic of influence to the recipients, which distinguish them from the population of firms overall.
The firms founded by young people, have a lower survival rate than those of other age groups. Furthermore, the difference in economic and trading environment can be of influence to the survival rate. Summing up, there is a marked differences in age, sector and education are all of influence to the subsequent performance of the firm. It is therefore necessary to more explicitly take into account the factors likely to influence the performance of the assisted and non-assisted firms and to seek to hold these constant. This process is called matching.
Approaches:
Employment/sales growth of assisted firms compared with typical firms.
Survival rates of assisted firms compared with typical firms
Problems:
Assisted firms are not typical
Step 5: Matching
This step identify a specific control group with which to compare the assisted businesses. If a policy were implemented to enhance the survival rates of new businesses then it would clearly be inappropriate to compare survival rates of assisted new businesses with that of typical small firms because existence firms have higher survival rates than young businesses. It is also consistently shown that larger firms have higher survival rates than smaller firms. Hence it would be unreasonable to compare the performance of two groups of firms with significant differences. So the control group has to be formally identify. These firms are called the match firms, and matching takes place on four factors.
The control firm and the assisted firm would be expected to be identical on the basis of age, sector, ownership and geography. Then it is possible to analyse the performance of both groups and compare the results. This has to be on the same time period. Any difference in performance between the two groups are attributable to the policy.
But, even here, there are some problems, namely the technical and inferential problems. The technical problem is that perfect matching upon all four criteria simultaneously can be difficult (almost impossible). So it is difficult to analyse the survival/non-survival impact of the policy, and yet this is a crucial element of the SME policy. Even when the four matching characteristics are held constant, there may be other factors where the two groups differ. This is the inferential problem. We take account of the observables (age, sector etc.), but it is much more difficult to take account the unobservables (motivation and selection).
If the two groups differ in terms of motivation, any performance differences may reflect motivation rather than policy impact. The motivated firms are self-selected and this has to be taken into account (referred to as ‘self selection’). The second source of selection bias is the administrative selection. The scheme providers choose some applicants and not others. It is reasonable that the selectors will seek to identify the best cases, or at least seek to avoid the worst cases. The performance of the selected group will be superior to that of the match group since the better cases are being selected.
Two factors are likely to enhance this bias. First, the extent of competition for the funds. Secondly the ability of the selectors to make good decisions is also considerable importance.
Approaches:
Compare assisted with match firms on the basis of: age, sector, ownership and geography.
Compare performance of both groups over same time period.
Problems:
Perfect matching on four criteria can be very difficult.
Sample selection bias: more motivated firms apply, attribute differential performance to scheme and not to motivation.
Step 6: Taking account of Selection Bias
This step seek to compare assisted with matched firms, taking account of sample selection. There are two procedures to make this possible. First, is the use of statistical techniques which seek to explicitly take account of sample selection bias. The analysis utilising the technique originally formulated by Heckman (the Heckman 2-step). This technique formulate a single equation to explain the selection procedure and then formulates a second equation to explain performance change, taking account of the factors included in the selection equation.
Many policy makers, however are not happy with these statistical methods because the procedures are so complicated and technical that they feel uncomfortable with them. The effect of the impact of the policy would be the difference in performance between the assisted and the control group, after also eliminating the influence of selection.
The problems remain, the complex statistical analysis in the Heckman 2-step procedure is difficult to communicate in simple language. It is a kind of statistical “hocus pocus”. So it is unattractive for the politicians.
Overall the key message is that selection, both the form of self-selection and administrative selection is an important issue.
Approaches:
Use of statistical techniques: Heckman 2 Step Estimator for testing and adjustment.
Use of random panels.
Problems:
Policy makers (and some academics) feel uneasy about statistical adjustment.
Use of random panels could mean public money is given to firms/people who we know will not benefit.
Conclusion
Evaluation is necessary to analyse the impact of money spend on SME support. Evaluation is not possible unless objectives are clear and measurable specified. This is the basis for deciding whether or not the policies are successful. These objectives should be quantified and become explicit targets.
You also have to keep in mind that evaluation and monitoring are not identical. Monitoring exist of the collecting of information about the firms and the financial information of monies expended. Monitoring includes only the opinion of the recipients of the scheme.
Evaluation seek to compare performance of recipients with other groups of individuals or enterprises.
Government is failing in their responsibilities to their taxpayers if they do not achieve at least a stage level of 5 evaluation.
The article tell us that the economic performance of small enterprises is inferior to that of large enterprises. Productivity levels as well as profit rates appear to be lower in small firms. The capacity for innovation and technological improvement is also smaller. The average social standard of the quality of jobs and the conditions of work are inferior in the small firm. So we can state that the superiority of the small firms in the age of flexibility should be examine again.
Concentration without centralization
The smaller firms act as suppliers and subcontractors of large firms. The production of the large firms is increasingly being decentralized. But decentralization of production does not imply the end of unequal economic power among firms. There is still a global web which include the largest institutions (multinational corporations, key government agencies, etc.). The author therefore characterize the emerging paradigm of networked production as one of concentration without centralization. Companies are reorganizing their external relationships, but the same underlying principles apply to those external relationships. This principle include especially the consistency of decentralized activity with concentrated control over resources.
The decentralisation of firms take place because of four building blocks:
The dark side of the flexible production exist of the gap that is measurably reflected In the by now widely acknowledged phenomenon of growing earning inequality among American.
The world’s largest companies, their alliances, and their suppliers have found a way to ramin at the centre of the world stage. They only wearing a new costume, armed with new techniques and a new deployment of labour with a dramatic decentralization of the location of actual production.
Flexibility
It were said that small enterprises were creating most of the new jobs in all of the world’s highly industrialized countries. But hard evidence shows that the importance of small businesses as job generators an as engines of technological dynamism has been greatly exaggerated.
Economist talk about the concept of economies of scale to describe the potential saving in unit production costs as production take place in higher volumes. On the other hand, economies of scope are said to exist when the joint cost of making more than one product on the same basic platform in the same facility is less than the cost of turning out the same set of products in separate facilities. Now computer-based technologies take place for the economic of scale and scope. The firms need to be flexible to meet the continually fluctuating demands of the world market. The growing complexities of a global economy make it ever more difficult for large firms to compete.
The small business sector
From the 1980s the theory of small firm-led growth become very popular. The public policy was all in the interest of promoting and nurturing the growth of small businesses. Also the recession has ensured that more people start their own business which result in an increase in the small business sector. In the 1980s the small firm renaissance and the Italian model caught the interest of several politicians. These politicians have been working harder than ever to improve their performance and to gain political interest with the growing popularity of the small business sector.
Failure of the small business story
Why are the manufacturing companies getting smaller? Large companies are outsourcing work they used to perform in-house. They are also partnering with other existing firms to get new technical know-how, markets, territories and capital without having to make new capacity-expanding investments themselves. So the increasing number of small firms is a result of the decentralization of the big companies. It is the strategic downsizing of the big firms that is responsible for driving down the average size of business organizations in the current era, not some spectacular growth of the small business sector, per se. In Japan data actually showed a slight decline in the small firm sector. Only in the U.K. did the small firms shares grow steadily between the 1970s and the mid-1980s. But this looks to be mainly result of the decentralization of large businesses.
It is also the question how independent the small firms really are, especially in relation to the large firms for whom they act as suppliers and subcontractors.
During the first three decades after the second World Wore the economies of western Europe and North America faced similar economic policies. This policy approach was concerned with restricting and restraining the power of large enterprises: the managed economy. This economy was based on stable inputs, which consisted of land, labor and capital, and outputs, which were mainly manufactured products.
Several qualitative and quantitative changes in the labor market, such as divergence in job creation as well as the reduction of unemployment, signaled a hint of economic change. Audretsch and Thurik name this newly emerging economy as the entrepreneurial economy. The main inputs in entrepreneurial economy are no longer land, labor and capital, but knowledge. This is a hint that these two economic worlds differ in a lot of ways. Audretsch and Thurik have identified fourteen trade-offs.
Fourteen trade-offs between managed and entrepreneurial economy.
1.Localization vs. Globalization.
2. Change vs. Continuity.
3. Employment & high wages vs. Employment / High wages.
4. Turbulence vs. Stability.
5. Diversity vs. Specialization.
6. Heterogeneity vs. homogeneity.
7. Motivation vs. control.
8. Market exchange vs. firm transaction.
9. Competition and co-operation as complements vs. competition and co-operation as substitutes.
10. flexibility vs. scale.
11. Stimulation vs. regulation.
12. Targeting inputs vs. targeting outputs.
13. Local policy vs. national policy.
14. Risk capital vs. low-risk capital.
Conclusion
The managed economy was based on relative certainty as supposed to outputs and inputs consisted mostly of labor, capital and land. Firm failures is viewed as a drain on societies resources and is therefore a negative development. This economy flourished for most of the 20th century. The entrepreneurial economy is based largely on knowledge, which is the most important input is economic activity in this type of economy. Firm failure is an experiment, and the externality of failure is learning.
This article was written by Bhave in 1994, and is one of the most favorite articles for this course for Chris Streb. Because this paper describes the process of venture creation it uses two different terms which are usually used to describe firms. In this paper, however, the term firm is used to describe the conceptual entity and the terms venture and business are used to describe the actual business.
De venture creating process starts with the idea for the business and culminates when the business is in business as far as selling the products of services it is based upon. The process model developed in the article by Bhave provides researchers and economists with an integrative framework in order to bring cohesion to the literature about this process. What is missing from the current literature is the explanation of the birth of firms, the absence of grounded process models in this field exist for two reasons. (1)These processes are very time consuming and need a large amount of resources and (2) the existence of stages is rarely substantiated by empirical evidence. This paper attempts to fill this gab in the literature about venture creation.
Diverse personal circumstances prompt venture creation, all of these can be divided into two subgroups, namely:
(1)externally stimulated opportunity recognition and;
(2)internally stimulated opportunity recognition.
These two different paths of opportunity recognition are shown in figure 1 on page 229.
Externally stimulated opportunity recognition.
In this case the opportunity recognition occurs after the decision to start a venture. Most entrepreneurs that start a venture in this way have recognized far more opportunities than they seriously choose to pursue. In this case the entrepreneur searches for opportunities that align market needs with the entrepreneurs knowledge, experience, skills and other resources. After this filtering of opportunities a commitment to persue was made towards particular opportunities and these opportunities were then refined. The refinement of the chosen opportunities results in the identification of business concepts.
Internally stimulated opportunity recognition.
In this case the decision to start their own venture is the result of an opportunity they recognize. The entrepreneurs find a need that can not me easily met in the current market place and therefore try to meet this need on their own. This stage is the meta-opportunity stage in which there are no clearly defines business objectives. Once the solution to satisfy the needs in the market place is found, the decision to start a venture can be made, again this is followed by the refinement of opportunities and after this the business concept.
The business concept.
Every venture has it’s own unique characteristics that give the business competitive advantage and create certain opportunity windows, risks, and advantages. Most ventures are based on business concepts that are quite familiar to their customers, and only few are built upon truly novel business concepts. The business concept development refers to the process of clarifying the concept of the business in order to provide a good fit between market needs and a entrepreneurs perception of these same needs. Providing a truly novel business concept, poses challenges in the concept developing phase as well as in the marketing phase.
Commitment to venture creation.
After the business concept phase is complete, the entrepreneur starts to develop the business requiting physical and other resources. These resources are usually beyond the entrepreneurs private means and thus need to be provided for in some other way, in order to develop the business concept into a marketable product or service. This stage, gathering financial and other resources, is no issue of strategic consequence but rather something that has to be taken care of. Production technology set-up and creating the physical structure (organization creation) are set-up simultaneously. Here feedback from customers and constant learning leads to formalization.
When the venture introduces novel products to the customers the next phase consists of product development. The marketable form of the business concept is changed due to changing customer needs and technical change as well.
Marketing of the product is usually the next phase, however, some entrepreneurs will already have their clients lined up and waiting for the product to market. Sometimes, however, business concept appear to be to early for the marketplace and customer need to be educated before they will buy the product, before this they simply have no idea they need this product.
When products of services are introduced to the marketplace this usually generates customer feedback. This initial feedback can be used to conclude the venture creation process by acting upon the wishes of customers. A signal effecting the business concept itself is called a strategic feedback, because it interferes with the entrepreneurs conception of the venture. Failing to act upon important feedback may well undermine the venture. Additional signals for altering the products are operating feedback (requires operational and tactical changes, but there is no direct threaten to the validity of the business concept) signals.
Entrepreneurial firm creation.
This process can be divided into three main phases, namely the opportunity phase, the creation phase and the exchange phase, which have all been discussed in this article by Bhave. The process is also shown again in figure 2 on page 235, which is the second important figure in the article. The exchange phase consists of the marketing efforts and initial customer feedback, the creation phase consists of the actual creation of a marketable business concept. The opportunity ends with the creation of the business concept before any physical creation.
Sarasvathy states that entrepreneurs have and important job, namely to transform the world we live in today into a world we want to live in. This must be achieved by uncovering new questions and phenomena, that will push the old ones to the background. This in turn will create new ideas and vocabulary, that will better fit the world we want to live in. This article creates new meaning for three different sets of concepts, namely:
1. Failing of succeeding is not the end of the line, but success and failure are a continuous stream that make up the entrepreneurial process.
2. The firm and the entrepreneur are two separate entities, therefore the successful entrepreneur can be viewed separately from the successes and failures of the firm.
3. The new world is based on the nature of aspiration that is allowed to break through the old and into the new.
Ad. 1 Succes or failure vs. successes and failures.
Common entrepreneurial myths talk about risk-loving entrepreneurs, that take on the world and also strive to be what they have always wanted to be. The story ends when the entrepreneur succeeds and lives happily ever after.
However this is not always the case in reality. In reality the entrepreneur is still a risk taker, but is now constantly trading of lower priority values for higher ones. He is risking to lose, what he can afford to loose, but only if he feels he is gaining something of higher value to him like independence. This process is accompanied by a constant stream of failures and successes, what makes an successful entrepreneur is an entrepreneur that learns from failures, survives them, and rises above to cumulate successes over time.
Economic failures are not personal failures but are in fact crucial for learning for two reasons:
1. Failures create learning, and learning creates success, therefore the economy needs lots of entrepreneurs to crash and burn in order for learning to occur so others can succeed.
2. By creating and sustaining an enterprise throughout the failures and successes, will also provide the economy with learning.
Throughout failures and successes new ideas, wishes and desires emerge and so determines new paths. This is why Sarasvathy argues is this article that entrepreneurs are a source of imagination in the economy.
Ad. 2 The entrepreneur = the firm vs. The entrepreneur & the firm.
In the initial stages of the venture creation the entrepreneur tend to think of the firm as part of themselves, however an important aspect an new entrepreneurs experience is finding a way to disconnect the firm from themselves. Key to accomplishing this is for the entrepreneur is realizing that the firm exist only if and as long as the entrepreneur chooses the firm to exist. This is exactly the reason why firms were created. This is an entity, existing only in contemplation of the law, creates to free the entrepreneur to take on uncertainties and an unpredictable future.
Entrepreneurs themselves do not fail, only the firms they create may fail, but will they fail these firms are an important asset in providing the economy with learning in order to accomplish what we want to be. Optimists and pessimists are both were important, as Sarasvathy puts it: the optimist invents the airplane and the pessimist invents the parachute.
Ad. 3 The nature of aspirations.
Josiah Wedgewood know very well that people will pay more for what they aspire, then for what they actually are. In those days, no self respecting Brittan would spend more then two pence for a table plate, however Josiah was able to charge up to four times as much for his plates. Although these plates where no different in terms of quality, people were willing to pay more for one of Josiah’s plate then they would for any other brand. Josiah had created an image for his product, a brand as you will. A Wedgewood dinner plate was worth more then any other plate, because people tend to put they money were there aspirations are. Needless to say, Josiah Wedgwood made a fortune, and marketing and brands were born.
Economist used to feel that the only way to charge more for your products as competitors do, is to produce better products, or to produce cheaper. In other words, money can only be made through new technological advantages. Creating new products and markets are the bases of entrepreneurial activities, this involves bettering all aspects of the consumers’ lives. Entrepreneurs should discover humans aspirations and create products that fulfill these wishes.
Entrepreneurs today are taught to meet external performance measures such as ROI, although Sarasvathy argues that they should be taught to create the world we want to life. He also argues that at the end this is what every entrepreneurs ends up doing any way.
Two Tales.
This article concludes with two different tales of two different firms. This is quite interesting to read, but not really useful to learn by heart. The most important this to take away from this article is that what sets entrepreneurs apart from economics is that entrepreneurs are able to envision our aspirations and attempt to get us to this world.
Entrepreneurial performance should not be measures by linking them to the performance of other firms. It should must rather me measured by looking at the opportunity costs in relation to the performance. Shane and Venkataraman propose a couple of assumptions at the start of their paper, namely:
1. These authors assume the disequilibrium approach to economy. In the equilibrium approach to economy, entrepreneurial opportunities are either believed to be non existing or are randomly distributed. Entrepreneurs are believed to be people that prefer uncertainty, and there ability to succeed is believed to be a coincidence.
2. Entrepreneurship does not necessarily involve the creation of a new firm. Entrepreneurship can however lead to the creation of a new firm.
3. The authors factor on several population-level factors that influence the creation of new firm, namely:
3.1. Focusing on the existence, discovery and exploitation of opportunities.
3.2. The influence of individuals and opportunities, but not the environmental consequences.
3.3. Shane and Venkataraman consider a framework that goes beyond the borders of firm creation.
4. In the process of firm creation the authors limit their interest to the discussion of opportunity exploitation.
Existence of opportunities.
Situations in which new products, services, and methods can be sold at a price greater then the cost of production are called entrepreneurial opportunities. What differs entrepreneurial opportunities from any other opportunities is that entrepreneurial opportunities require new means-to-ends relationships. Previously researchers would argue that the only reason opportunities exist are because of different believes between people. This causes people to value opportunities differently. Shane and Venkataraman argue there are two reasons as to why entrepreneurship needs these different believes:
1. Entrepreneurship involves different resources to be put together in order to create something new.
2. If all entrepreneurs would value the same, they would all chase the same competitive advantage and therefore this advantage would vanish.
Eventually the entrepreneurial opportunities will become worthless because the assymitry between information and beliefs will disappear over time. At first an opportunity will be an incentive for many potential economic actors. Demand for the resources increases over time, this will cause suppliers to raise prices until the advantage is gone.
Discovery of opportunities.
Only if an opportunity is valued, will the individual that values is gain any profit by pursuing it. Research suggest two categories of factors that influence the discovery of opportunities, namely the possession of prior information, and the cognitive properties necessary to value the opportunity.
Exploitation of opportunities.
Whether a specific opportunity that is discovered by an entrepreneur is exploited depends on the nature of the opportunity and individual differences.
Concluding.
Due to differences in the nature of industrial organizations some opportunities are exploited through selling these to existing companies, while others might me pursued by creating new organization or a new hierarchy within an organization.
This is an explorative research conducted by Cohen and Klepper. The amount of research on firm size and innovative activities are excessive. The only unanimous conclusion is that is most industries except for the really small firms, there is no significant difference in research intensiveness between small and large firms. This paper proposes that there is no difference in R&D abilities between small and large firm, but only social benefits for both categories. This is possible because there are many different ways of innovating and because different firms have different capabilities and will thus pursue different opportunities.
For this reason there will always be some tradeoff between a few large firms or lots of small firms in pursuing technological innovations. The optimal number of firms will depend among other things on the industry specific needs.
R&D investment.
The industry is subjected to ongoing technological change, different approaches to product improvement do not represent mutually exclusive or competing approaches to satisfying the same performance objective. Differences in firms’ expectations are assumed to reflect the differences in expertise in different firms. Different expectations cause firms to pursue different opportunities. Some firms may experience great rates of innovation and technical advancement, and other may not depending on the choices they make. If a firm does not experience enough innovation and technical improvements, they will find there product prices falling below the costs of the products and will finally have to exits the industry. Therefore, the authors argue that new firms with more suitable expertise will in the long run replace the existing industry leaders.
This paper assumes that a firm will pursue an opportunity if they poses the corresponding expertise. It is independent of pursuing any other opportunity and independent of firm size. Marginal revenue schedules are assumed to be different while marginal productivity schedules for all approaches are assumed to be identical across firms. A firms sales prior to a certain R&D project is called ex ante sales, and these are assumed to be proportional for the earning that come from any R&D project. Another assumption is that the number of approaches pursued by a firm a binomially distributed across each industry. Firm R&D intensities will also be binomially distributed across industries. The firm that pursues the most approaches has the largest R&D intensities, and visa versa.
The model that is proposed in this article has two central tenets:
1. Returns to R&D are scaled by firm size.
2. Differences in R&D intensities are attributable to differences in the number of approaches pursued.
Advantages of larger firms.
A large firm is a firm that has a large output of products. As mentioned before the returns of R&D are scaled by the firms ex ant sales (before R&D project). This argument implies that larger firms have an advantage over smaller firms in R&D competition. The advantage for the individual firm are also an advantage for society, The best way to explain this is considering two firms merging that are identical on the bases of the approaches they pursue, R&D expenditure, the same firm size, and of course producing the same product. The advantage that these firms will create for themselves as well as for society consist of increased profitability, and increased effectiveness and change.
If this assumption of benefits because of firm size is true, then the optimal situation would be a monopoly. This however will never happen because firms don’t grow fast enough and technology involves in such a way that some approaches might work one time, but not the next. For any given opportunity it would however pay of for any firm to pool their efforts among other firms. Firms have different reasons for cooperation in R&D, but it also posses challenges such as communication difficulties and concerns about competitive advantage.
I would like to stress again that these assumptions are build upon the belief that the firms’ returns to innovate are scaled by ex ante scales, would this not be the case, then the social benefits from cooperation would be lower.
Advantages of diversity.
Diversity in innovative activities stem from different approaches to innovation that are not mutually exclusive, and that are different independent ways of achieving technological change. If there are X different firms in an industry, the possibility for an approach being persued by any of these firms is (1-P)^X. Therefore, the extent of diversity within an industry is directly related to the number of firms in that industry. Thus industries that are composed of many small firms are characterized by a greater amount of technological diversity, some small amount of industries however seem to be more innovative when the organizations in the industry are bigger.
The reason why many smaller firms are better at innovating then a few bigger firms is because the amount of approaches to be pursued is larger when there are more firms. The tradeoffs however are that reducing the average firm size would impose social cost. The innovations that are developed are applied over a smaller amount of output and also measured against a smaller amount of ex ante sales and it will take longer to earn back. If firma are able to sell their innovations to different firms in the industry and there is no duplication in R&D effort, this will promote social welfare. After all if a greater number of firms are looking for an approach to innovate, the chance that a successful approach is overlooked is smaller. This also depends on the vitality of the science and technology in a certain industry, while science and technology are past its best, this will cause little diversity in the approach that are pursued in a given industry.
The tradeoff between size and diversity.
Both increasing diversity and increasing firm size by consolidation of firms are accomplished with certain costs. The nature of the tradeoff is: the extent to which firms can sell their innovations or grow rapidly due to their innovations one the one side. On the other side: the vitality of an industries technology represented by the amount of possible innovation approaches within an industry. A greater amount of firms is only desirable as long as there are enough approaches to innovation to go around.
Most previous research have only looked at particular stages of the process on the supply-side perspective. Major assumptions and conclusions conclude that venture capitalists and business angels make natural comparison groups for different firms. For this paper face-to-face interview were conducted with 30 different Scotland-based business angels. These 30 angels have made a total of 130 investments. The data analysis framework is shown in table one on page 112 of the article by Paul et al. (2007).
Findings.
Analysis of the interviews with the 30 business angels suggest that the process of investment consist of five stages, namely: familiarization, screening, bargaining, managing, and harvesting. These stages are also shown in figure 2 on page 114 of the article. Iteration is a key characteristic of the process, while it spans the first three stages of the investment process. At these first three stages the angel has the opportunity to end the investment process at any given time. It is also possible for any step to lead to a loop backwards to a previous step.
Formal networks (such as BAN’s, syndicates, and economic development agencies) and informal networks (such as friends, co-investors, and business associates) play an important role in the investment process. An angel’s personal investment objectives play an important role as well in the investment process. It also acknowledges the impact that the general environment will have on the investment process. Consider the economic crisis for instance, this has impacted a lot of investments, back in 2008 and still.
I will continue the summary of this article by briefly describing each stage mentioned in the article and at the end I will briefly mention the key points of the discussion part of this article.
Familiarization stage.
This stage of the investment process consist of two main activities, namely [1] meeting the entrepreneur, and [2] learning about the investment proposed by this entrepreneur. For an entrepreneur to present their ideas it was key that they would present themselves and the idea as best they could. It’s not just about the right opportunity for the angel, but the personality of the entrepreneur should also match up with that of the angel. An angel is not going to invest in someone that he/she doesn’t like.
Screening stage.
This stage involves further meeting with the entrepreneur, where the angels tries to confirm first impressions and to elaborate on the business opportunity. In this stage the angel will make a thorough study of the business plan, and they will asses what they can do to help pursue this opportunity in the best way. This may be providing knowledge for running a business or perhaps to bring the entrepreneur in contact with certain important people. This mostly leads to the business plan being altered, mostly in the areas of marketing and finance. Sometimes the angels decided that they should be enforced by other angels.
Bargaining stage.
Thoroughness is key in this stage. All lose ends are tied up, like negotiations of finance are completed. If the entrepreneur and/or the angel suspect they will be needing additional funding, these agreement will also be finalized in this stage. These finalizations turned out to be more difficult than was originally expected. The conclusion of this stage (if successful) is a formal agreement between angel and entrepreneur. This formal agreement sets out the detail of the agreement the entrepreneur and angels have reached.
Managing stage.
All of the business angels in the study had an active role in the business after investing. This is the reason why the number of businesses the angels invested in at one point in time was limited. Not just the available funds were a constricting factor, the available time was as well. Most angels spend about one or two days a week in the businesses they invest in.
Harvesting stage.
None of the interviewees had reached this face when the interviews were conducted. But most of them estimated that this fase would most likely be reached by an IPO (initial public offering) or a management buy-back. Most angels wanted to keep their investments for at least long enough to maximize tax advantages, but other than that there was no general timescale for the harvesting stage.
Discussion.
After composing this model the authors realize that the process does not always fit into neat compartments. Furthermore angels base their investment decisions on personal relationships with the entrepreneur, finding it very important that the entrepreneur will behave reliably. Secondly, hard data is evaluated, but they emphasize on the soft data (relationships). This can be attributed to two factors, namely:
1. Assets are often intangible and knowledge based in the initial stages, causing the angels to find another factor for evaluate the entrepreneur.
2. Angels use their own funds for investing and are thus fully exposed to risk and reward.
De ideal definition for small business differs for a persons perspective and the goal of research. There are two basic kinds of definitions for small businesses, namely:
1. The statistic definition: these include the SME’s for which size is determined by the amount of employees, which differs for the different countries in Europe;
2. Kwalitative definition: small, independent business units, this definition includes small independent divisions in larger ventures.
Small and large enterprises a getting more alike due to integration of small business and autonomous units in larger business.
Diffusion.
Diffusion is defines by Schumpeter as ‘creative destruction’ and the assumption that innovation is primarily accomplished by large businesses and is concentrated in markets. Diffusion is defines as the process of spreading, partly through application by new users, in a social system.
Diversity.
Diversity is one of the most important features for small business. The conditions under which diversity may exist the environment in which the business is operating like standards and rules and regulations, and secondly it depends on the resources available. The later often causes a problem for smaller business in gaining access to funding.
The sources of diversity can be divided into push and pull factors:
Another important factor to consider is coincidence, being at the right place at the right time.
Relevant entrepreneurial characteristics.
Three general characteristics for small business.
Small business are bound to several important characteristics, we distinguish three general characteristics. As defined by Nooteboom:
1. Personality (private and business);
2. Independence (relative freedom for the entrepreneur);
3. Small scale.
Strengths and weaknesses.
Figure 4 summarizes several strengths and weaknesses for small business, related to the small business characteristics. You can find this figure on page 334 of the article by Nooteboom.
Innovation in small businesses vs. large enterprises.
Research suggests that small business participate less in R&D, but is they do they display great intensity and productivity in R&D compared to larger enterprises. The process of innovation consists of five stages, namely:
1. Invention: large enterprises benefit from their large amount of specialization, smaller businesses tend to by highly motivated and have a better overlook on the entire project, their scale allows them to make quick decisions.
2. Development: smaller business are stronger because they can work faster.
3. Production: large businesses tend to wait until the old products are sold before producing new ones.
4. Introduction to practice: large businesses benefit is large markets and smaller businesses benefit is smaller personalized markets (customization).
Conclusion.
The lack of small businesses engaging in R&D can be explained by the trade-off between risk and profit. Risk tends to decrease as business size increases, whereas profit tends to increase with size.
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