Enterprise and Small Business Principles

Managing growth

Since one of the major challenges facing the contemporary small business is that of coping with unknowable, unpredictable open-ended change, a key issue relates to how small firms attempt to strategically control their operations. This section first considers the potential and limitations of formal, rational long-term planning modes of manage­ment to underpin small-firm development. Empirical insight is then utilised to suggest the potential utility of an organisational learning perspective to effecting small-business growth.

6.7.1 The uses and limitations of rational long-term planning modes of management

Considerable support continues to be afforded to the view that a rational, systematic step approach to managing the dynamic, volatile and fast-changing operating envir­onment in which the modern-day small business finds itself is the most effective way to underpin sustainable long-term development. Brown and McDonald (1994) emphasise how it is critical ‘to recognise that a series of systematic steps can be useful in formu­lating strategies when the stakes are high and the resource commitment is significant to the firm. It reduces the risk of leaving out key issues, and it highlights the assump­tions on which strategies are based and resources are committed’. McDonald (1980) underlines that business problems are in fact less amenable to highly structured ana­lytical methods to be found in the sciences, but that it is the very complexity of busi­ness problems which lends itself to some kind of structured procedure to help identify problems.

A structured approach to problem solving underpins the rational analytical plan­ning models of management, which typically involves the following:

■ awareness of the problem

■ exploration of the problem

■ deciding what to do

■ taking action to implement the decision

■ examination and feedback of results (Luffman et al., 1991).

Within a strategic planning context, the approach assumes that a small business can approach the strategic control of its fast-changing operating environment through undertaking a series of rational, systematic steps. This process is depicted in Figure 6.3.

The propounded strength of this model lies in its processual form. Strategic plan­ning encourages a careful and systematic reading of shifts in technology, competitor position and customer tastes, leading to the formulation of actions in response. More­over, it has been suggested that strategic planning helps the small business concentrate on its competitive nature by encouraging an external focus on key environmental factors to determine where the firm fits, as well as internally focusing on the firm’s strengths and weaknesses. The overall analytical and evaluatory process should then lead to the setting of a formal direction for the business, helping to determine where the business is going (Fry and Stoner, 1995).

Figure 6.3 Indicative steps in strategic analysis

External analysis (reveal opportunities and threats in the operating environment) 1

Internal analysis (identify the organisation's strengths and weaknesses)

1

SWOT analysis 1

Formulate long-term development objectives 1

Choice of strategies (for achieving of objectives)

1

Development of action plans 1

Implementation of strategies (through action plans)

1

Control and review (monitor progress and feedback)

However, the real utility of rational planning models in small organisations is debat­able (Wyer et al., 2000). First, the utility of rational analytical planning should be con­sidered within the context of the assumptions upon which the approach is based, which include the quality of information and an ability to extrapolate future events from past experiences. Its value is also affected by the fact that resource constraints limit the ability of most small firms to formally scan their external environment. Much of the change that contemporary small businesses must be able to cope with is open-ended change, which is unknowable and unpredictable rather than closed or contained change. In addition, coping must be undertaken in the context of more limited internal resources than are available to larger firms. As a consequence, it is questionable whether formal, rational long-term planning methods of management are compatible with the challenges facing small business managers, and the idiosyncrasies and informalities of small-firm management processes, or whether such modes of management are adequate for deal­ing with open-ended change situations (Stacey, 1990).

Whilst some studies do suggest positive correlation between formal planning activ­ity and growth (Schwenk and Shrader, 1993) and some association is suggested between strategic planning intensity and success in achieving primary business objectives (Peel and Bridge, 1998), there is still little evidence of causal relationship between planning and long-term business performance. Moreover, as Shane (2003) points out, similar cor­relation has been found in studies that have examined the founder’s tendency to plan, rather than the creation of business plans per se (Miner et al., 1989; 1994), thereby emphasising the role of planning as a process.

6.7.2 An organisational learning perspective

Drawing upon Personal Construct Theory (Kelly, 1955) and contemporary learning theory (Hawkins, 1994), Wyer and Boocock (1996) have offered insight into the ways in which small business owner-managers learn and have provided foundations for con­sidering how small firms cope with open-ended change. The thrust of their work is founded on Kelly’s proposition that all individuals utilise a personal construct system (derived from inherent personal characteristics and accumulated experience) which is used as a frame of reference to interpret the world. In brief, we all have personal con­structs that act as frames of reference to help us view the world which confronts us and deal with new situations which arise.

If change situations impact on small firm owner-managers they will use their exist­ing personal constructs to cope with the change. On many occasions, minor adjust­ments to the construct may allow the owner-manager to deal with the change, simply because a similar situation has been dealt with in the past. This can be characterised as simple learning (Stacey, 1996) which takes place when the owner-manager her confirmed the validity of their current constructs by using them to make sense of a new situation. However, sometimes change situations arise for which existing constructs are inadequate. This requires them to be extended through a process that entails the questioning of the underlying assumptions upon which the existing constructs are based. This is a more complex learning process which is why simple learning is more common (Stacey, 1996).

Such a conceptualisation of how individuals cope with change has far-reaching implications for the growth-oriented small business. If owners are confronted by un­knowable, unfolding change forces, success in coping with such a challenge in a man­ner that can lead to sustainable business development will depend to a considerable extent on their ability and willingness to ‘extend’ personal construct systems; that is, to change their mindset or frames of reference and to engage in complex learning. This may include an ability and willingness to anchor the understanding and learning of other key members of the organisation to enhance collective organisational understanding (Wyer and Mason, 1998). This means that the role of dialogue, both between internal organisational members and with key external informants on the boundaries of the small firm’s operating environment, is a crucial learning activity.

Foundation studies that have drawn on an organisational learning perspective to investigate strategic development processes in small firms based on in-depth case studies have revealed a number of insights into strategic management processes (Wyer, Mason and Theodorakopoulos, 2000; Wyer and Mason, 1998a). They confirm that whilst few small firms have written short - or long-term plans, many owner-managers demon­strate strategic awareness (Gibb and Scott, 1985) in the sense of having a mental tar­get of the preferred development path for the business. The study also demonstrated the role of informal networking with key external actors and informants in contri­buting to emergent strategy, which was typically developed in a trial and error way (see Chapter 16). Significantly, however, some of the most successful firms in the study were able to loop back the results of what they had learned to make adjustments to their strategic or operational activities. In other words, successful SMEs in the study were led by owner-managers who appeared to have learned how to learn.

6.7.3 Managing finance to facilitate expansion

In order to facilitate sustainable growth it is necessary for the small firm’s management to progressively enhance its financial management capabilities (see Chapter 18). In the early stages of development, when activity and sales levels are relatively low, control can be maintained through the use of relatively informal systems. However, as the business grows, it is necessary to enhance finance skills and formalise the approach to financial management, but also to recognise the interdependencies between finance and other areas of functional activity within the firm. For example, the projection of fin­ancial requirements to underpin a period of expansion must derive to a considerable extent from the forecasting of future sales and the determination of income and costs associated with that sales expansion. This requires a marketing capability to provide an understanding of the target customer base and of change forces to which that cus­tomer base is, or may become, sensitive, in order to provide such estimates. In other words, effective financial management depends to some extent on other functional management capabilities.

With regard to the financing of growth, two crucial areas are the management of fixed and working capital. Expansion will require close attention to fixed capital needs in terms of the firm’s ability to acquire requisite premises, plant and/or equipment. In this context, the firm’s management needs to acquaint itself with the various methods of raising long-, medium - and short-term finance and to develop understanding of what would be an appropriate mix of these categories of finance to effectively underpin development. Integral to this is consideration of the wider variety of sources of such finance, including the ability to recognise innovative sources of finance (such as ‘busi­ness angels’ discussed above and, in more depth, in Chapter 19) and how innovative ‘finance packages’ can be used to leverage further funds from elsewhere (Krantz, 1999). A crucial ability in this regard relates to the need to consider the appropriate balance of external and internal funds. For example, the balance of debt (long - and medium - term external funding) to equity (the owner’s own internal funding) is a crucial issue. The ratio of this funding (known as the gearing ratio) can be critical in terms of facilitating or constraining small firm growth. With a high gearing ratio (where the firm is relying on external interest-bearing borrowings), in times of slow sales and high interest rates a firm may find its potential for future growth severely constrained because of the financial drain imposed upon it by having to meet high interest costs on borrowings.

The small business will also have to make sufficient provision for working capital in order to facilitate growth. Working capital relates to the ongoing provision of stocks of appropriate levels of raw materials and component parts, the financing of debtors and the access to cash to meet day-to-day expenditures and running costs. It thus incorporates the firm’s current assets and current liabilities. The complexity of the management tasks underpinning the determination of the forms and levels of working capital to facilitate growth include: the need to forecast sales, from which estimates of the costs likely to be incurred and anticipated income can be made; plans for future growth, including time scales for each step and estimation of all inherent costs; con­sideration of possible developmental problems which may result in delay (hold-ups and inefficiencies); and examination of the current and likely costs of borrowing and consideration of repayment periods (Bennett, 1989).

Inevitably, over time, growth will require additional fixed and working capital and the ability to ensure that adequate and appropriate funding underpins that growth clearly points to the need for an ongoing enhancement of financial capabilities. For example, the management of working capital will require close control of debtors to ensure a balance between, for example, credit being used as a ‘promotional’ and com­petitive tool, while controlling debtor periods to avoid undue financial pressures on the business. Stock levels must be managed to ensure a free-flowing production activity and an ability to serve customers in a timely manner, though not at a level that results in stocks of raw materials or component parts idling on the shelves and thus tying up cash. With regard to creditors, there is a need to negotiate credit periods which contribute effectively to a positive cash flow, while at the same time recognising that creditors should not be exploited in a manner that can sour the relationship and lead to a deterioration in the quality or timing of supplies, or which precludes the uptake of discounts for early settlement.

However, a crucial issue is that the nature of financial management skills developed by the growing small business must reflect and accommodate the nature and form of the growth and change patterns of the business. For example, Bennett’s proposition that decisions on working capital needs should be based on a consideration of anti­cipated activity levels, requiring the forecasting of sales and costs, will be a more straightforward task if the small business is operating in a relatively stable external environment, in which it has been able to track a pre-determined development path. However, if a small firm is facing open-ended unknowable change, in which it may have to seek development opportunities through trial and error, the relationship between financial management skills, marketing capabilities and strategic awareness are closely inter-related.

6.7.4 Developing the marketing function

Analysis of a small business in its early stages of development is unlikely to reveal a marketing approach or activity which even vaguely reflects formal marketing manage­ment as represented by the mainstream marketing literature (see Chapter 17). Instead, it is an understanding and application of the concept of marketing that is important, namely ‘a matching between a company’s capabilities and the wants of customers in order to achieve the goals of the firm’ (McDonald, 1984). Whilst this may appear to be an obvious and fundamental concept, which must underpin the sustained develop­ment of any successful small business, there is much evidence of small firms going out of business because of a failure to fully understand the needs of its targeted customers and of firms founded on the mistaken premise that they have the ‘company capability’ to serve the needs of an identified group of customers (Smallbone, 1990). In the early stages of small business development the nature and form of marketing are often embedded in the owner-manager. In many instances it is the owner-manager’s close interface and relationship with his customers that allows for the ‘matching process’ between the small firm capability and the wants of customers to be effectively achieved.

Whilst an informal ‘market orientation’ may be a keystone for sustainable growth and development of the small firm, the effective facilitation of sustainable growth may require an increasing formalisation of the firm’s marketing activity. For McDonald, it is not essential for a firm ‘to have a formalised marketing department for the analysis, planning and control of the matching process’. However, with growth in a firm’s product range and customer types, the management of marketing may need to be brought under one central control function. Growth brings with it the need to coordinate all of those functional activities within the firm, which participate in the matching process. The crucial issue is not whether a department, an individual or group of individuals is responsible for a firm’s marketing, but the extent to which mar­keting is embedded within the organisation. This means that key individuals within the firm have a clear understanding that the profit which the company strives to earn is a return founded on depth of understanding of the needs of the firm’s target cus­tomer groups and their ability to organise the firm’s resources in their totality so as to satisfy those needs. Within the context of the growing small business, a key man­agement art appears to relate to the ability to extend the marketing concept in the business as it develops.

6.7.5 Broadening the customer base while coping with existing customers

A major challenge facing the growth-oriented small business is to sustain the level of service provision to an existing clientele, which may itself be increasing demands on the firm, both quantitatively and qualitatively, while at the same time seeking to broaden its customer base. However, as we have already seen, the actual process of identifying opportunities which can facilitate a widening of customer base is itself a difficult one. It is likely to exert considerable strain upon the small firm’s ability to continue to serve the increasing demands of its existing customer base. The process of effecting internal adjustments to exploit new opportunities can place such stress on the operations of the small firm that its ability to service the needs of existing customers is adversely affected. The broadening of the firm’s product-market definition will require an expan­sion of physical, financial and human resources at a time when the existing customer base may be demanding ongoing management attention and additional resource alloca­tions. Within a highly competitive environment, the small firm will find itself having to continuously seek efficiency improvements, both within the business and in its inter­face with service providers such as suppliers and distributors, in order to maintain a competitive edge in its existing markets. This, together with the need to improve exist­ing products, will be a prerequisite to protecting existing customer bases and market shares, so as to cement current foundations, both to maintain current levels of activ­ity and to facilitate any future expansion. Clearly, any move to broaden the existing product-market definition within the small business must be accompanied by a careful evaluation of the adequacy of existing resources and abilities, as a basis for sustainable development of the firm in its totality (that is, an ability to expand into new areas of activity while effectively maintaining and enhancing those existing areas with ongoing developmental potential). Such evaluation should also incorporate the potential for complementing existing resources and abilities in a manner that can facilitate the iden­tified expansion opportunities.

6.7.6 Deciding when to introduce new managers and modify organisational structure

A key developmental issue is to what extent a small business, which is striving for growth, can continue to rely upon an organisational framework in which the owner - manager is the pivotal centre of all activity, based on an informal structure for the direction and fulfilment of operational activities. The answer is likely to be contingent upon the individual business and its personnel, the nature of the firm’s development path and of the environment and markets it is operating in.

Handy (1976) explains how ‘each organisation, each part of an organisation has a culture, and a structure and systems appropriate to that culture’. Thus, in a large com­pany we may find several sub-cultures and different forms of structure throughout the organisation. However, in small businesses it is common to find culture in a form which Handy terms a power culture. Its structure is depicted by a web: that is, ‘the cul­ture depends on a central power source, with rays of power and influence spreading from that central figure. They are connected by functional or specialist strings but the power rings are the centre of activity’. The organisation with its few rules and proced­ures tends to work on precedent with staff often anticipating the wishes and decisions of the owner-manager, the central power source. The owner-manager often exercises control by selection of key individuals for particular activities, or through ‘occasional summonses to the centre’.

As the small business grows this culture/structure is likely to prove inadequate to facilitate a rapid pace of development. Indeed, as reported earlier in the chapter, firms that are successful in achieving high growth over an extended period are characterised by an ability to modify the structure to accommodate an evolving role for the leader of the firm. A typical evolving response by the owner-manager might be to gradually formalise structure in terms of the allocation of formal responsibilities and the devel­opment of linking mechanisms between the newly emerging roles. The result is a formal hierarchy type of structure and an underpinning role type culture (see the pioneering work in this area by Taylor (1947) and Fayol (1949)). However, for a small business to evolve into a formal hierarchical structure in its pure form would be to overlook the inherent weaknesses of such a structure. The classical organisational model views a business in terms of a network of inter-linking job descriptions rather than a network of human relationships, treating the organisation as a closed system (the inputs of the business are viewed as easily controlled), when in reality any business is faced with the complexities of a dynamic external environment, that is, it is an open system (Lawrence and Lee, 1989). Thus, the timing and form of adjustment to organisational structure in a small firm context is a complex issue, with a danger that adjustment towards a formal hierarchy, with its rigidity and inward focusing tendency, may reduce the ability of the firm to relate and adapt to its fast-changing environment.