Profiles in Small Business

A Competitive Strategy Approach

Margo Anderson, Lowell R. Jacobsen, Gavin Reid

• Publisher: Routledge
• Year: 2002
• ISBN:
  9781134961481
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

A new analytical approach to small firms' cases, which
* Uses rich primary source data on modern small businesses
* Combines business strategy and industrial organization
* Presents detailed Profiles on diverse small businesses
* Shows how successful small businesses achieve competitive advantage
* Considers both extended rivalry and financial structure
* Shows how to `ground' small business theory in reality
Profiles in Small Businesses has a companion volume Small Business Enterprise by Gavin Reid (also published by Routledge, Hb: 0-415-05681-0: £45.00) which contains a full analysis (ranging from econometrics to the ethics of competition) of the larger sample of small businesses from which the Profiles are drawn.

Part I
Introduction

1 The small business enterprise

1.1 INTRODUCTION

The structure of this book is twofold. On the one hand, it presents what we call ‘Profiles’ of a set of modern small business enterprises (SBEs). These provide detailed pictures of each SBE, constructed within an analytical framework that draws on both industrial economics and business strategy. On the other hand, it engages in comparative analysis of these SBEs. Thus it reaches conclusions about the effectiveness with which certain business strategies are translated into competitive advantage in the marketplace.

The book draws on the same body of evidence that has been treated with some statistical and econometric thoroughness in Reid’s Small Business Enterprise (1993). Its style, approach and indeed content are, however, quite different from that companion volume. Here, our concern has been to ensure accessibility of treatment. Thus readers from diverse backgrounds in economics, accounting, finance and business should be able to follow the arguments of the following chapters.¹ The intention is still to present arguments with clarity and tolerable rigour, but without recourse to that arsenal of technical equipment which is increasingly making economic arguments impenetrable to the non-specialist. We believe that would be unfortunate, because small firms play an important role in the economy. Yet their behaviour, and (on an even more mundane level) their character, are poorly understood.

An important reason for being interested in small firms (i.e. SBEs) is that they are so numerous. Recent figures by Daly and McCann (1992) show that at the end of 1989 there were about 3 million small firms in the United Kingdom. It is estimated that over 95 per cent of all UK businesses employ fewer than twenty people. Despite their small size, their sheer volume is important for employment, a point first articulated clearly in a US context by Birch (1979, 1981). In the United Kingdom, small firms account for 35 per cent of total employment outside of local and central government. Between 1979 and 1989, the period of most relevance to the Profiles presented here, the number of businesses rose by two-thirds, the vast majority being small. To achieve this nationwide, about 500 additional firms were being created every day.² We hope that this book will help to advance the general understanding of how this process works, and may perhaps contribute to enhancing the quality and durability of this abundance of new small firms’ activity.

The plan of the rest of this chapter is as follows. Firstly, we argue in favour of the profit maximization hypothesis, which will be presumed to be applicable to the SBE throughout this book. Secondly, we explain the fieldwork methods by which we were able to gather a large body of data from interviews with owner-managers of SBEs. Thirdly, we look at key features of the Profiles sample, in relation to the parent sample, and provide a characterization of the typical SBE. Fourthly, we look at models of markets, choosing three ‘off the shelf as being of particular utility to our analysis of the Profiles sample of SBEs. Fifthly, we expound the competitive-forces/ competitive-advantage framework associated with the writings of Michael Porter (1980, 1985, 1990).These preliminaries accomplished, we turn to the main substance of the book. In Part II seventeen Profiles of SBEs are presented, classified according to the degree of market concentration in which they function. A consistent framework is used for each Profile, drawing on mainstream industrial economics, and also the business strategy approach, as modified to the small firms case. In Part III, a comparative analysis of the SBEs is undertaken within a framework of ‘extended rivalry’ that goes well beyond the conventional analysis of intra-industry rivalry. Competitive and defensive strategies are considered, and a novel extension is undertaken to financial considerations of competitive advantage. The book concludes by arguing that its subject matter presents a case for a more grounded approach to industrial analysis, which always keeps real business conduct in the foreground. But all this is to delay, by anticipation, the work to be done. We turn, therefore, to substantive analysis.

1.2 THE PROFIT-MAXIMIZING SBE

The way in which economists, both in business and management, look at firms, especially small firms, is in terms of a model. Standards vary as to what may be accorded this term. Some might find a model which views firms as bundles of contractual relations too woolly in conception. Others might find dangerously overprecise in conception those formulations of the firm which run in terms of a smooth, well-behaved profit function which is to be maximized. Our view is that the appropriateness of the model depends on the purpose at hand and the subject discipline of the analyst. It does not seem unreasonable to us, for example, to regard a set of accounts (financial, managerial, etc.) as constituting a model of the firm. It is a precise, consistent, revealing framework, with significant predictive content. It involves abstraction and simplification, which is also characteristic of a model. However, it is unlikely that economists would admit that a set of accounts is an appropriate model.

The criticism advanced by economists would perhaps be that the set of accounts lacks behavioural content or, what often amounts to the same thing, some optimization hypothesis. The central maximization hypothesis which economists choose when they model the firm is, of course, profit maximization, which carries with it the corollary hypothesis of cost minimization. The advantage of this central hypothesis is that it can be turned to many uses and, despite its simplicity, has implications with surprisingly powerful predictive content. We shall not engage in explicit model building, and narrow statistical testing of models so derived, in this book. That has been the concern of Reid (1993) in the companion volume. However, we shall use the categories of economic models, very often by appeal to classes of models—for example, oligopoly, as competition amongst few firms in significant interdependence, and monopolistic competition as free competition amongst many firms with brand monopolies. In both these cases, profit-maximizing conduct is assumed: the economist’s central behavioural hypothesis is being asserted. In using these classes of models, appeal will be made to general properties that they may display, like excess capacity, a kinked demand curve, and so on. The implications of this approach for models of markets will be explored further in section 1.5 of this chapter, but our concern here is with models of the firm, rather than the market, and the appropriateness of the profit maximization hypothesis.

In the extensive fieldwork that the authors engaged in to gather the evidence for this book, it became apparent that of all the competing hypotheses to which one could appeal in modelling the individual SBE, the profit maximization one was the most robust. It has both descriptive and prescriptive content. The typical SBE usually looks as if its owner-manager is trying to maximize profit, and if he is not quite succeeding, it is his avowed aim to maximize profit. This, of course, does not mean that profitability is high. Indeed, it typically is not, as SBEs frequently function in highly competitive market environments. Precisely because of the sharpness of competition, and therefore the fierceness of the SBE’s struggle for survival, profit maximization becomes more than an economist’s hypothesis: it acquires both descriptive and prescriptive connotations. Managerial economists take profit maximization as a prescription (Reekie, Allen and Crook 1991), and certainly small business counsellors will motivate their clients in this way.

It is no criticism of the profit maximization hypothesis to say that problems arise in taking account of risk, variations in abilities of entrepreneurs, and features of the internal structure of the firm like monitoring and coordination mechanisms.³ In an earlier volume by two of the authors, Reid and Jacobsen (1988, ch. 2), a fairly detailed account of the small business enterprise is presented, and it is shown how these complexities may be incorporated within the profit maximization hypothesis. For example, for the internally monitored firm, the marginal product is not set equal to price but to price plus the implicit cost of monitoring: a small adjustment to the standard theorem.

We say all this in praise of profit maximization by way of making our job of using models simpler and thus more accessible. But there is more to it than mere convenience, because the competitive strategy approach we introduce in section 1.6 and use extensively in Part III, has as an unwritten but important tenet, that firms maximize profits. Indeed, the rigorous industrial organization literature on which this analytical approach is erected, invariably is founded on the profit maximization hypothesis.

Finally, it should be said that the SBE is particularly suited, of all firm types, to the profit maximization hypothesis. It is notably free of the ‘agency costs’ which dog larger enterprises. There is no divorce of ownership from control, with managers or directors pursuing unprofitable personal goals at the stockholders’ expense. The manager typically is the owner. For all the SBEs in our sample there is no external equity. The owner-manager is typically hiring in informationally efficient local labour markets where reputations are accurately established, so problems of adverse selection (e.g. a slow worker trying to mimic a fast worker at the hiring interview) are mitigated. Once personnel are in the firm, problems of moral hazard (e.g. of relaxing effort once one has got the job) are attenuated because monitoring of effort is almost continuous and virtually costless.⁴ Within the SBE, because it is so small, problems associated with hierarchy, like information degradation between hierarchical levels, control loss, and incomplete compliance, do not arise.⁵ Certainly there are specific problems of SBEs of which small firm counsellors are aware, exposure to risk being the most obvious, but few of them militate against the presumption of profit maximization. In conclusion, therefore, it will be taken as a working hypothesis throughout the rest of this book.

1.3 FIELDWORK

A distinctive feature of the analysis contained in the Profiles in this book is that all the data used were gathered by fieldwork methods.⁶ We went out and talked to owner-managers, gathering data as we went. These are primary source data, and they were gathered with a specific analytical purpose in mind (e.g. investigating how competitive advantage is achieved). As a result, many of the questions one would wish to ask about small business enterprises (SBEs) can actually be answered directly, without having to use unsatisfactory proxy variables or similar devices for bridging the gulf of ignorance. This puts within our purview simple matters of fact like capacity utilization, expectational phenomena like forecasts of the trajectory for the debt-equity ratio over three years, and strategic considerations like the formulation and implementation of a policy of market preemption. A wide range of data types, both qualitative and quantitative, are provided by the fieldworker, and they have advantages over most alternative data sources so far as accuracy, completeness and relevance are concerned. They are, however, expensive types of data to gather, and in an era of tight budgetary constraints on research grants, severe financial limits are imposed on the extent to which fieldwork is pursued. One therefore gathers data in this way with great care, adhering to a rigorous methodology, and fully exploring the potential of the data from a research standpoint.

The starting-point for fieldwork is typically unstructured, simply because one usually starts from the standpoint of relative ignorance. In the case of the fieldwork on which this book is based the unstructured fieldwork was of two types: networking and participant observation. Networking involved using personal contacts, referrals, reference books, trade literature, and so on, to access ‘the field’. The relevant field here is the collection of markets in which small business enterprises are active. We talked to academic specialists on small businesses, on entrepreneurship, on business strategy, and so on; to directors of quangos of various sorts (enterprise trusts, development corporations, etc.) concerned with enterprise stimulation; to entrepreneurs and businessmen experienced in setting up and running businesses of various sizes and types; to accountants and financial specialists of various sorts who provide services to owner-managers of small firms; and to members of chambers of commerce and small business clubs. From these multifarious contacts, ‘high communicators’ were identified (i.e. those who had access to particularly rich information sources) who were pivotal points in an informal network of communication which enmeshes the small business world. The director of Scottish Business in the Community (SBC) provides one such example. By this stage we were already beginning to get a good feel for what the field looked like, and for general characteristics of ‘sites’ within the field, that is, SBEs.

Of equal status with networking as an aspect of our unstructured fieldwork, was participant observation. One of the authors became a participant observer in the first enterprise trust to be established in Scotland.⁷ During a period of eight months he was regularly involved with the internal functioning of this institution, and for a period of two months was fully involved on a daily basis. He became familiar with the project involvements of 157 clients, and had full knowledge of thirty-nine completed projects (a ‘project’ being a proposal taken to the enterprise trust for advice on a client basis). Completion meant that the project had resulted in a new small business being set up. New business starts were tracked with follow-up involvements by the enterprise trust. Client involvement typically required looking at the assistance required, the business plan, premises, marketing, funding and possibly employment created. This part of the unstructured fieldwork gave us considerable insight into SBEs and helped us to clarify the questions we wished to ask. It had an important bearing on the type of instrumentation chosen.⁸

Through these two forms of unstructured fieldwork (namely, networking and participant observation) we were able, firstly, to get access to sites (i.e. SBEs) in the field, for the purposes of gathering data by interviews, this being a benefit from networking, and secondly, to put in place ideas for interview procedures (i.e. ‘instrumentation’), this being a benefit from participant observation. We ended up investigating seventy-three sites in the field in our main study, after a phase of pilot work. We used three different instruments: an administered questionnaire and a semi-structured interview in the first phase of fieldwork proper, and a reinterview questionnaire in the second phase three years later, using the same sites (if available). Thus the data offer variety both in a cross-site and in a longitudinal sense.

The technical details of the instruments are of little interest here, and the Appendix to this book provides a summary of the main points they covered. Briefly, the administered questionnaire covered employment, products, markets, pricing, costs and financial structure; the semi-structured interview, which was inspired by Michael Porter’s writings,⁹ covered competitive forces, competitive strategy and defensive strategy; and the reinterview questionnaire covered matters like survival rates, skills gaps, company structure, scale economies and the enterprise culture. Participant observation influenced the choice of designs of the first two instruments. They appealed to the mainstream literature of industrial economics in the first case (administered questionnaire) and to the business strategy literature in the second case (semi-structured interview). What we were aiming for was what is sometimes called a crossover analysis that brings closer together different methodologies (broadly, economics and management) with the intention of each enriching the other. Our feelings as authors who have worked with both methodologies is that the consequences in this case have been clearly synergistic: the value of the integrated approach exceeds the sum of the values of the unidisciplinary approaches. The design of the re-interview questionnaire itself drew on our (by then) extensive fieldwork experience, as well as models of small firm growth and survival.¹⁰ A key insight which was used in the latter case was simply that non-negative profit (defined net of exit costs) was a prerequisite to small firm survival over a period as long as three years.¹¹

These instruments were all used in personal face-to-face interviews with owner-managers, typically at their place of work. Data were hand recorded on schedules, and these were la...

Table of contents

• COVER PAGE
• TITLE PAGE
• COPYRIGHT PAGE
• LIST OF FIGURES AND TABLES
• PREFACE
• PART I: INTRODUCTION
• PART II: CASE PROFILES
• PART III: COMPARATIVE ANALYSIS
• PART IV: CONCLUSION
• APPENDIX: SUMMARY OF INSTRUMENTATION
• NOTES
• REFERENCES