Enterprise and Small Business Principles

Explaining growth in small firms

Although a great deal has been written about the growth of small enterprises, there is no single theory which can adequately explain growth patterns in small businesses nor, as Gibb and Davies (1990; 1991) have suggested, is there much likelihood of such a theory being developed in the future. The main reason for the absence of such a growth model is the variety of different factors which can affect the growth of small firms, as well as the way in which these factors interact with one another. At the same time, there is broad agreement about what the main influences on small business growth are, summarised in the framework developed by Storey (1994). As a result, a slightly modified version of the Storey framework is used in this chapter to consider the factors influencing small firm growth. This will incorporate aspects of the four main theoretical approaches to small business growth identified by Gibb and Davies (1990; 1991) as well as selected empirical evidence where appropriate. The aim is to highlight those aspects which appear to be characteristic of growing and high-growth enterprises.

Our framework includes the three influences on growth identified by Storey - namely characteristics of the entrepreneur, characteristics of the firm and management strategies - but also the influence of the external environment, which Storey does not consider separately. The external environment is separately identified here in order to emphasise its influence, since one of the size-related differences between large and small firms is connected with their differing abilities to control or shape external environmental influ­ences. Hence it is our intention to make explicit that a prime influence on the growth performance of small firms is the way in which their managers address the enabling and constraining forces emanating from their operating context (see Figure 6.1). Each of the four components identified in Figure 6.1 will be discussed in turn.

6.4.1 Characteristics of the entrepreneur

Since one of the distinguishing characteristics of small firms compared with large firms is the close correspondence between ownership and management, the characteristics of

Source: Based on Fig. 5.1 in Storey (1994: 124)

individuals who start and run small firms can have a major impact on their growth ori­entation and performance, as well as on their organisational culture (see Chapter 8 for a more detailed discussion). In this context, one of the approaches to understanding small business growth identified by Gibb and Davies (1990; 1991), was the so-called ‘personality-dominated approach’, in which the entrepreneur is seen as the key to the development of the business. For example, the personal goals of an entrepreneur are likely to influence why a business was started in the first place, as well as the strength of the firm’s growth orientation once it was established. A priori, one might expect that a business which was set up to exploit a clearly defined market opportunity for a pro­duct or service (and/or because the entrepreneur is strongly motivated to make money) would show a higher propensity to grow than a start-up where the main drivers are ‘push’ factors, such as unemployment (or the threat of it), dissatisfaction with present employment or personal lifestyle reasons. This distinction refers to what is described in the GEM study as ‘opportunity driven’ and ‘necessity-driven’ entrepreneurship.

In their seminal work on small business growth, Stanworth and Curran (1976) dis­tinguished between three different identities of small business owners, thus emphasis­ing the variety of goals that are apparent in relation to why individuals start and run businesses. The identities were defined as:

■ an artisan identity, where the owner’s role centres on the intrinsic satisfaction asso­ciated with the personal autonomy that running one’s own business can entail;

■ the classical entrepreneurial identity, where the owner’s role emphasises earnings and the generation of profits; and

■ the managerial identity, where it is suggested that the owner’s priorities are focused on looking for the recognition of others.

Empirical evidence suggests that whilst growth orientation, in the sense of growth being actively sought as a business objective, does not necessarily lead to actual growth per­formance, one of the characteristics which distinguishes high-growth firms from other firms is the commitment of the owner(s) to expand the business. For example, in a study of 306 established manufacturing SMEs (up to 100 employees) referred to earlier in the chapter, it was found that the propensity to achieve high growth from 1979-90 was significantly associated with the strength of their commitment to grow: 70% of high-growth firms referred to strong commitment to grow during this period compared with 32% of other firms (Smallbone et al., 1995).

Some insight into the distinctive characteristics of entrepreneurs involved in high - growth performing small businesses can be obtained from research undertaken in relation to a recent government initiative in England, to provide targeted support for start-ups with high growth potential. When the programme was introduced in 1999, it was intended to be a highly selective intervention aimed at the top 0.5% of start-ups, in terms of their growth potential. The research involved surveying young businesses that had actually achieved high growth during the first years of trading, defined as reaching an annual sales of £150,000 by the end of the first year and/or £1m by the end of year three (Smallbone et al., 2002). By surveying a sample of businesses drawn from Dun and Bradstreet, it was found that 75% of these businesses were started by people with previous management experience, which was typically gained in a medium or large enterprise. In fact, 29% had been developed out of a previous business, which typically reflected a situation where entrepreneurs had worked in a larger firm in a related activity, but had reached a stage where they felt they could start their own firm (sometimes with others) in a similar or related business activity, either in competition with their previous employer, or as a supplier, and/or by exploiting a new market niche which they had identified. The profile that emerges from this research appears distinc­tive in comparison with the small business population as a whole.

Researchers who have focused on the role of the entrepreneur’s personality on the firm’s growth performance (e. g. Chell et al., 1991; Kets de Vries, 1977; Smith-Hunter, Kapp and Yonkers, 2003), have highlighted its influence on attitudes to risk (which can affect the willingness of a business owner to use external finance), the emphasis placed on personal autonomy (which can affect the willingness of the entrepreneur to collaborate with other firms, or even to use consultants), and managerial competen­cies, particularly in relation to strategic management skills. With regard to the role of the entrepreneur’s personality, a Euro-wide study of fast-growing enterprises found the most successful firms to be characterised by ‘strong leadership’ and pursuing highly outward-looking, customer-focused strategies (EFER, 1996).

With regard to the role of the entrepreneur’s personality in contributing to business growth, a recent longitudinal study by Moran (1999) found high-growth performance to be associated with personalities that showed a strong orientation towards being in charge of people, who were decisive and showing a preference for hands-on engagement with the world (i. e. learning by doing). At the same time, it should be noted that all of the firms featuring in Moran’s study had been through some form of management development programme that may have contributed to building their personal capab­ilities and a more strategic outlook on their businesses.

Whilst such factors can undoubtedly affect the performance of the firm in a number of respects, some types of research in this paradigm are more controversial. These include attempts to use typologies based on profiling the personality traits of entrepreneurs to predict business success, which tend to ignore the capacity of people to learn and change over time, or indeed their motivation. For example, an owner’s motivation for expand­ing a business may decline once they have achieved what they consider to be a satisfact­ory level of income from their enterprise and/or their personal/family circumstances change as they grow older. In this respect, Chell and Haworth (1992) have pointed to an association between the age and experience of the leader of the firm and the stage of development of the business reached.

Some of the manufacturing SMEs that achieved high growth in the longitudinal study referred to above (Smallbone et al., 1995 op. cit.), were started by what Stanworth and Curran characterised as ‘artisans’ but who changed to a more entrepreneurial stance over time. This is an important point because it demonstrates how individuals can change their orientation to growth in response to changes in external circumstances, as well as their own learning experiences, and/or in their personal circumstances. An example includes a business started by a founder from a craft printing background but who ten years later was beginning to think like an entrepreneur seeking to manage the assets of the business to increase his returns, rather than simply to run a production plant. This had involved firms setting up a property management arm to the business which the owner ran himself, recruiting a production manager to run the core print­ing activity which the owner had become increasingly bored with.

Storey’s emphasis on the role of the characteristics of entrepreneurs on business per­formance places less emphasis on personality per se and more on those personal char­acteristics which influence access to resources. These include educational background and qualifications, which can affect the management resource base of the business, as well as the entrepreneur’s motivation for running it, because of the higher earnings expectations of more educated business owners. Whilst recognising that educational qualifications are no guarantee of business success, Storey suggests that their role is likely to vary between sectors and will be higher in technology and knowledge-based activities and lower in the more traditional and craft-based sectors (see Chapter 13). Other personal characteristics of entrepreneurs considered by Storey include:

■ previous management and/or entrepreneurial experience (if any) prior to establish­ing the current enterprise

■ family history

■ functional skills and previous training

■ previous knowledge and/or experience of the sector in which the business has been established.

However, whilst most of these factors can be shown to contribute to small business growth in one or more major empirical studies, none appears to make a dominant contribution. Indeed, the search for the identikit picture of the successful entrepreneur has not proved fruitful and, whilst undoubtedly relevant, the characteristics and pre­vious experience of the founder appear to have only a modest effect on the success of the business in terms of its growth performance. Moreover, for many of us who have spent some years researching small business behaviour it is the unpredictability and variety of conditions associated with small business success that help to make the topic so fascinating.

One characteristic that has been attracting increasing attention in recent years has been portfolio ownership (Scott and Rosa, 1997) which refers to the fact that some entrepreneurs may be involved in a number of enterprises. Some studies have suggested that portfolio entrepreneurs are more likely to be associated with growth-orientated firms, since multiple ownership is itself a sign of a degree of entrepreneurial flair. It has also been pointed out that, whilst early studies of portfolio entrepreneurship tended to emphasise its role in reducing business risk, it has been increasingly recognised as an important growth strategy, particularly in sectors where economies of scale can be achieved at a low level (Carter, 1999).

6.4.2 Characteristics of the firm

Although organisational characteristics may reflect those of the entrepreneur, they are different in the sense that they are based on decisions made by the owner either at the time the business was started or at some time after. Storey’s review of the relationship between organisational profile characteristics and the propensity of small firms to grow includes age and size as well as other variables. With respect to age, Storey reports that most UK and US research shows that younger firms grow more rapidly than older firms, reflected in the statement that ‘most small firms grow only in the first few years and stabilise’ (Burns, 1989). Whilst this may be statistically accurate as far as surviv­ing businesses are concerned, it partly reflects the need for newly established firms to increase the scale of their operations if they are to accumulate sufficient resources to be able to withstand unforeseen external shocks. At the same time, other research has demonstrated that even some very mature firms can grow strongly, sometimes follow­ing a long period of stagnation (Smallbone and North, 1996). Indeed, growth in small firms (where it occurs) is rarely a continuous and sustained process, so that a firm’s age will never be a completely reliable predictor of its growth prospects.

One of the approaches used to explain small business growth identified by Gibb and Davies (1990) was the so-called ‘organisational’ approach, which emphasises the development sequences of a firm as it passes through a series of stages at different points in its life-cycle. The original idea was that since every product or service faces a life-cycle, then so do businesses. There are a number of variants of the ‘life-cycle’ or ‘stages of growth’ models. Churchill and Lewis (1987) propounded a five-stage devel­opmental model. This model considers each development stage of a firm in terms of enterprise factors and management factors, the nature, form and significance of which change over time as the firm develops.

Application of such a model (see the example in Figure 6.2) might, for instance, high­light the pivotal management roles and activities of the owner-manager at the start-up

Figure 6.2 An indicative 'stages' of growth/life-cycle model

and survival stages of the business, when simple organisation structure and informal management processes predominate. Significantly, the model focuses attention on the ways in which these enterprise and management factors will need to be adapted through the various development stages of the firm. Corresponding development hurdles that the small firm may face at identified development stages and the likely changing nature of impacting problems are also mapped onto some models.

Typical of such models is the highlighting of the inadequacy of informal manage­ment approaches as a small business strives to grow, with a subsequent need for the owner-manager to relinquish all-embracing control of management tasks and begin to formalise the organisation structure. As the business progresses toward a sustainable growth path, recruitment of quality staff may become a priority and formalisation of organisation structure necessary, including the increasing delegation of management responsibilities. Tighter control over day-to-day operations and finances may be required, as may the ability to identify and act upon development opportunities, together with a more formalised approach to planning and monitoring activities and assessment of competitor actions.

Although critical thresholds separating distinctive phases of the development of a small firm often exist, the formalised ‘stages’ models, such as those of Churchill and Lewis (1987) or Steinmetz (1969), have little application as tools to explain the growth of small firms for a number of reasons. In practice, boundaries between phases may be fuzzy rather than distinct and some small businesses commonly develop more rapidly in relation to certain functions or dimensions than others. As a result, it is often difficult to position firms empirically and thus apply the model in practice.

More fundamentally, such an approach implies that a firm’s development path is determined, whereas in practice the number of stages that can be identified is variable. Moreover, in practice, the order of stages is not fixed, which means that some firms that may ultimately grow further may move back then forward rather than continu­ously forward in the sequence of stages. Overall, the value of such models is more to help diagnose organisational problems and bottlenecks that need to be addressed by the owner-manager if a firm is to grow further, rather than as an explanation of what actually occurs. Nevertheless, such models are only concerned with internal constraints and thresholds, divorcing the firm’s development path from any inter-relationship with the firm’s external environment (for an excellent critique of stage models of growth, see O’Farrell and Hitchens, 1988).

Empirical studies have shown that one of the most critical thresholds with respect to growth as far as organisational development is concerned relates to the willingness of the owner to delegate decisions (Storey, 1994; Lybaert, 1998). This can be illustrated with reference to an analysis of the distinctive characteristics and strategies of a group of high-growth SMEs over an 11-year period, referred to earlier in the chapter (Smallbone et al., 1995). One of the most significant differences between high-growth firms and their low-growth or non-growth counterparts was their propensity to have made changes that were designed to create more time for the leaders to manage the firm strategically. Previous writers had suggested that ‘creating time to manage is one of the key internal factors influencing the process of change in small firms’ (Gibb and Dyson, 1982). The results from the long-term longitudinal research showed it to be a key discriminating feature between firms which were able to achieve high growth over 11 years and those that were simply able to survive. Whether this is a cause or effect of growth is less important in practical terms than recognising that the issue needs to be prioritised by entrepreneurs if sustained growth over a long period of time is to be achieved.

6.4.3 Management strategy

In considering the role of strategy as a factor influencing small firm growth, we refer to management actions taken by the owner once the business has started to trade that affect the development path of the firms. These actions may be planned and explicit but more typically are implicit and emergent in smaller companies (see Chapter 21). Storey’s review of areas where management strategy may influence the growth of a small firm includes product development and innovation, market strategy, business planning, production technology, the financial base and external equity, management training and recruitment, workforce training and the use of external advice and assistance (Storey, 1994). As a result, strategies for mobilising resources are included and, by implication, management competence, since this underpins management actions and is central to the way in which finance, labour and other resources are mobilised.

Several key strategy factors which are evident in growing firms were identified by Storey, from his review of key empirical studies. First, a willingness to share equity with external individuals or organisations was frequently identified in small firms that actu­ally achieved high rates of growth. A second factor relates to the ability of rapidly grow­ing firms to identify market segments or niches where they can build customer bases founded on their distinct advantages and selling points (see Chapter 17). Moreover, exploitation of this type of non-price competitive advantage will often relate to the utilisation of relevant technologies and a willingness to introduce new products. Finally, an owner-manager’s willingness to delegate and devolve decision making was found to be a crucial facilitator of growth in a number of studies which would also require an ability to attract, retain and enthuse managerial personnel who are capable of accept­ing this delegated authority.

One of the main approaches to understanding the growth process identified within the literature is characterised by Gibb and Davies (1990; 1991) as the ‘business man­agement’ approach, which focuses on the importance of business skills and the role of functional management, planning, control and formal strategic orientations. This body of literature offers valuable guiding insights into how a growing business might achieve sustainable development, by making internal adjustments that are commensurate with identified opportunities in its external change environment. Thus, informative works on business strategy such as that of Johnson and Scholes (2004) emphasise the growing need for managers to sensitise themselves to what is an increasingly turbulent operat­ing environment, offering management approaches and techniques to aid the manager in this respect. Certainly, the work of Johnson and Scholes offers support for Storey’s propositions with respect to key strategy factors. However, much work within the ‘business and management’ field continues to be based upon assumptions that organ­isations utilise rational decision-making approaches to identifying, and acting upon, development opportunities within their external change environment. This rationality manifests itself in recommendations and prescriptions with regard to the essential roles of long-term planning and financial control for underpinning organisational growth. However, such prescription seems to overlook the ability of management tools of this nature to accommodate the nature, form and variety of change situations which impact on contemporary businesses. This particularly applies in the case of smaller firms, which have limited ability to shape or control external environmental influences (see Chapter 21).

Whilst management activities such as ‘strategic planning’ and ‘control’ may have a part to play in sustaining the growth of some small businesses, the use of formal plan­ning is rare in small firms, being more characteristic of larger businesses. This is partly because of the higher propensity of large firms to employ managers that are profession­ally trained, although it also reflects a greater ability to reduce some of the uncertainties in the external environment that is typical in the case of small firms. It appears, there­fore, that whilst management approaches contained in the wider business literature have some potential for aiding our understanding of organisational growth, there is a need to be selective in applying this knowledge to the small business context, where owners and managers typically face an uncertain external environment with a limited resource base.

6.4.4 External environmental influences

Arguably, it is the impact of external influences and the unpredictable manner in which they emerge, or change, which provide the greatest impact on the nature and pace of small business growth (Wyer, Mason and Theodorakopoulos, 2000). Small businesses can face major problems in identifying and dealing with environmental change because of a lack of understanding, management expertise and time. In this context, Cohn and Lindberg (1974) emphasise that ‘because small firms generally engage in a narrower range of activities, use a narrower range of materials, employ fewer skills and serve single markets, it is probably even more important for them to anticipate changes in the factors impinging on their welfare than it is for large firms. A great change in one factor is likely to have more effect on a small company [than a large one]’. For example, in relation to finance, Welsh and White (1984) underline how ‘external forces tend to have more impact on small businesses than on large businesses. Changes in government regu­lations, tax laws and labour and interest rates usually affect a greater percentage of expenses than they do for large organisations’.

Certainly, two of the broad categories of approaches to explaining growth in small firms, identified by Gibb and Davies (1990; 1991), address the importance of the impact of the external environment upon organisations: first, the so-called ‘business manage­ment’ approaches discussed above; and second, the so-called ‘sectoral and broader market led approaches’. For Gibb and Davies (1991), these sectoral studies concen­trate on the identification of external constraints and opportunities facing small firms. For example, within the context of small high-tech businesses, the need to keep abreast of technological change and ‘the importance of building marketing into quality, design and development from the early stages’ are key sectoral conditions affecting potential business success. In other sectors, the position and role of large firms in the external operating environment can exert considerable influence over the ability of small firms to grow, because of supply chain based relationships, which in some cases can result in highly dependent relationships between small firms and their dominant large-firm customers. For example, the strategies of large firms with regard to sub-contracting, ‘make or buy’ decisions and strategic partnerships can be key influences on the growth potential of individual small firms. Integral to the concept of partnership is the potential for the small firm to access know-how and resources from large firms, in relation to R&D, technology and management skills. While Gibb and Davies emphasise that the existing literature does not provide clear guidelines in the form of predictive theory, the existing knowledge base provides some insight that may be used as a guiding frame of reference with regards to small firm growth processes.

In relation to external environmental influences, sectoral variations on the growth rates of small firms are to be expected because of differences in market trends and com­petitive conditions between different activities, which may themselves vary over time. However, since market conditions vary between individual product markets, the amount of sectoral variation in growth performance, which is identified in practice, tends to vary according to the level of sectoral disaggregation. This is because the narrower the sectoral definition that is used, the less variety that exists within sectoral categories, which means there is less of a tendency for buoyant conditions in one product market to be offset by weak trends in another, or vice versa.

A firm’s location is another characteristic that can affect its growth prospects, since it reflects spatial variations in local environmental conditions. On the demand side, variations in the size, scope and buoyancy in local markets might be expected to affect a firm’s opportunities to grow. On the supply side, variations in the cost and avail­ability of some factors of production (such as labour and premises) and resources (such as access to information and business services) may also be an influence. At the same time, the adaptability of SMEs to local external conditions should not be underestim­ated (Smallbone et al., 1999a). Whilst the employment growth of small firms may vary considerably between different types of location (Keeble et al., 1992; Hoogstra and Van Dijk, 2004) because of differences in labour market conditions, the growth per­formance of small firms measured in terms of sales growth tends to show much less variation (Smallbone et al., 1993). This is because of differences in the types of strategy used by SME owners or managers to develop their businesses in different locations, which is an indication of the adaptability of successful SMEs to local conditions (North and Smallbone, 1996).