Chapter 2 LITERATURE REVIEW
2.5 Environment and SME performance
Therefore the larger the capital available, the higher the probability of survival and more importantly, the higher probability of growth.
b. Financial Management
Financial management is important because of its effects on the firm’s profitability and risk, and of course the firm’s value. For instance, on the one hand, maintaining a high inventory prevent the firm any eventual scarcity of products, reduce supply costs and protect against price fluctuations. On the other hand, granting trade credits –practice only possible when a minimum capital is saved- increases customers’
satisfaction and favors the firm’s sales in various ways. SMEs must set up an appropriate financial management team able to manage the assets of the firm according to its needs and its environment. As the owner-manager is generally in charge of the management of the capital, there is no appropriate financial department to take proper investment measures. Moreover, it has been observed that family-owned SMEs spend a part of the firm’s revenues –not profits- to cover their living expenses which makes the capital management irregular and an important part of the firm’s available capital is soaked up.
2.5 Environment and SME performance
a. Competitive Advantage
Firm performance on the market depends on its competitive advantage.
Competitive advantage is based on the firm’s (owner-manager) understanding of the market needs, social codes and the understanding of its own organization’s strength and opportunities (SWOT analysis). The interactions between firms and their competitive
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environment can be seen as market-dependency and resource-dependency. The firm’s environment is one of the sources of competitive advantage. A firm can create a competitive advantage by interpreting and responding to the needs of customers and local market segments better than its competitors do.
The core of strategy consists of adapting the firm’s strength or critical success factors to an environment’s needs. Critical success factors are those activities that must be given special attention so that they go well and bring high performance; (Johnson and Scholes, 1993; Ghosh et al., 2001).
It has been found that only a few of the success factors have a substantial impact on firm performance. For generating a sustainable competitive advantage, Barney (1991) has assessed four criteria to be applied to resources: value, rareness, inimitability and substitutability. Firms can also attain competitive advantage through networks and good relationships with local firms. There are numerous sources of competitive advantages for a firm that knows how to identify them: low costs, knowledge -and in the case of Taiwan- strong network relationships. Network relationships are shaped by the cultural characteristics of the environment, and how the firm interpret and adapt to them. From an external perspective, the rules of competition and competitive advantage are shaped by the structure of an industry which also determines the strategic choices available to firms. The strength of competitive factors from the environment influences the power of competitive advantage of the firms, and thus influence also the concentration of firms in the industry.
However, due to the continuous change of the market conditions, a firm should continuously renew and innovate to maintain competitiveness as the conditions
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for success change. A dynamic view of strategy is required.
b. Flexibility of Resources
Flexibility of resources affects the success rate of responding to environmental changes. The more flexible the resources, the better chances for the implementation of changes (Pasanen, 2003). Flexibility can be segmented into different parts: input, output, internal flexibility, and flexible network relations.
SMEs are considered as flexible because of their simple organizational structures. Hierarchical levels are limited and short chains of command are set which allow a rapid and uncomplicated decision-making. The firm should find a market position which is unique in some extent (Pasanen, 2003). Uniqueness can be found in products, services or in the ways of doing business. In market conditions characterized by over demand, it may be sufficient for the firm to imitate its competitors. Competitive advantage is achieved whenever it has neither competitors nor close substitutes.
Firms that usually operate in market characterized by continuous competition between firms should have some relational competitive advantage, such as the case of Taiwan. A firm has to reach a better market position than its competitors have so that it is valued in some ways by customers. Strategic core capabilities start with the customer:
the identification and satisfaction of their real needs. In Taiwan’s environment in particular, an important success factor is to be able to respond to changes in customer ’s needs.
Five dimensions that are related to successful firms are: i) Speed (or the ability to respond quickly to customer or market demands and to incorporate new ideas
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and technologies quickly into products) ii) consistency (or the ability to produce a product that satisfies customers ‘expectations), iii) acuity (or the ability to see the competitive environment clearly and thus to anticipate and respond to customers’
evolving needs and wants, iv) agility (or the ability to adapt simultaneously to different environments, v) innovativeness (or the ability to generate new ideas and to recombining a set of existing elements to create new sources of value.
c. Cultural issues
SME’s resources for acquiring information about the market are limited.
Often, SMEs do not know their customers and their real needs which can cause tensions between the firm and its environment which may explain some failures. This case applies well to foreign SMEs; if the owner-manager fail to understand the cultural difference of the local market, a psychic distance divides them from the local customers.
However, Ghosh and Kwan (1996), Wijewardena and Cooray (1996) found that good customer relationships and customer service have been found to be the most important factor contributing to SME success.
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CHAPTER 3
METHODOLOGY
3.1 Research Model
In this paragraph, I will focus on the specific factors and variables included in my model.
Several models appearing in the literature can be distinguished by the sizes of businesses to which they apply and the type of data they use to predict failure. Many researches in which purpose is to assess large firm performance are based on financial data and ratios. However, when it comes to assessing SME performance, the usefulness of such ratios have been questioned. Storey et al. (1987) argue that qualitative data can assess performance at least as good as financial ratios or data. Moreover, since financial data is less available and less reliable in the context of small-to-medium-sized firms, models based on financial ratios are not really relevant.
This study adopts the strategic choice perspective to approach and evaluate SME performance. Both firm’s internal and external viewpoint are considered. Firm performance has been assessed based on the entrepreneur’s interpretations, actions and decisions, taking into consideration the effects of political, economic, and cultural environment on both the firm and its entrepreneur.
The model formulated by Maes, Sels and Roodhooft (2003) is my starting point; the author identifies two endogenous factors affecting small firm performance:
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1) Owner-manager human capital, and 2) Management practices. Within the researches focusing on explaining small-and-medium firm performance, I also observe authors who look for factors at the entrepreneur’s level, internal or management-related factors, and factors related to finance and capital. Many researches have focused on the individual characteristics of the owner-manager to explain the success and/or failure of SMEs. I have already emphasized on the importance and the influence exerted by the entrepreneur on their firms (d’Ambroise and Muldowney, 1988); within this area, authors were concerned with traits of personality, job experience, social history and connections, etc specific to the owner-manager…
Other series of researches are centered on internal factors related to management practices. Many authors attribute the failure of small-and-medium sized companies to the lack of managerial experience, and inefficient practices (d’Ambroise and Muldowney, 1988). The environment exerts strong influence on the entrepreneur’s interpretations and decision-making, and consequently also changes the management orientation, the strategies and actions to cope with the competition. A general overview of the environment foreign SME face in Taiwan has been drawn from the entrepreneurs’
perceptions.
However, following my theoretical perspective in assessing small firm performance, I assume that the external environment also greatly influence the development of a firm. Thus, I also need to consider its effects on the entrepreneur’s individual interpretation, judgment, the management and competitive strategies. To finalize this aspect, I look back at the empirical study of Lussier and Pfeifer (2001) which, based on previous studies, uses both endogenous and external variables to predict firm performance. Based on the previous researches, I expect firm performance
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to be affected by three endogenous factors: 1) Owner-manager characteristics, 2) Management practices and 3) Capital. The research model is shown on figure 1.
3.2 Variables definition
In this study, I refer to four dependent variables to measure success (assessed by performance). As I stated earlier, this study is using non-financial data to measure a firm’s performance, consequently, the nature of the dependent variables are non-financial and based on the individual perception of the owner-manager.
A successful firm would be considered as being efficient enough to survive and/or to grow. Owners were asked four questions –corresponding to the four dependent variables: 1) whether the company is still in activity or not – which I could either classify as “fail to survive” or “succeed to survive”. There are without doubts many reasons for a company to stop its activities, (liquidation, lack of financial resources or a capital gain from the sale of the business), therefore other measures have to be included; 2) whether the initial investment has or has not been already paid back –which would indicate an financially autonomous or dependent start-up. 3) Whether the company makes (or was making) more profits than the industry-average –which clearly indicates a good performance of the firm (growth) or a lack of efficiency–.
Nonetheless, a firm cannot be considered successful as long as its purpose hasn’t been met. Therefore, I consider a firm “successful” having achieved its purpose of creation and met its entrepreneur’s expectations.
The predictor variables focus on facts, practices and perceptions of facts proper to the firm. Following Hambrick and Mason’s (1984) upper-echelon model, the
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first predictor variable related to the owner-manager is the age. According to Lussier and Pfeifer (2001), “younger people who start a business have a greater chance of failing than older people starting a business”; I will measure this variable according to the number of years of the owner.
According to Lussier and Pfeifer (2001), Cooper, Gascon and Woo (1994) , I believe that education –the second independent variable– is an important factor affecting firm performance: “people without any college education who start a business have a greater chance of failing than people with one or more years of college education”
(Lussier and Pfeifer, 2001).
Industry experience is my third predictor variable. I expect entrepreneurs with industry experience to achieve higher performance and profits than those who do not have any experience in their firm’s industry.
I evaluate management practices considering four components or predictor variables. The fourth variable, “business strategy” is expected to be positively related to firm performance; firms which do not formulate any strategy or plans have greater chance of failure than the ones who do. The entrepreneurs were also asked to assess their ability to attract and retain qualified employees which refer to the fifth variable
“Staffing”. Firms that fail to retain qualified employees are expected to face difficulties due to the frequent rotation of the staff
.
Moreover, I believe “market research” to be fundamental to evaluate foreign firms’ degree of preparation and understanding of the local environment and consequently, have a positive effect on firm performance. The marketing ability of the
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firm is the seventh component of the “management practices” factor. According to previous studies, marketing is the main tool used by successful SMEs to face the competition, therefore, business owners without marketing skills have a greater chance of failure than owners with marketing skills (Lussier and Pfeifer, 2001). Due to their small size, the lack of financial resources and expertise is the main challenge that SMEs face.
Capital variables. Entrepreneurs have evaluated their firm’s financial situation on two aspects: the initial investment (eighth independent variable) and the debt of the firm. They were required to assess the following statements: 1) the initial investment was enough to cover the initial expenses and support the activities of your firm during the payback period; 2) your company’s debts are heavy and absorb an important part of the company’s revenues. Businesses which start undercapitalized have greater chance of failure than firms that start with adequate capital. Moreover, a heavy debt may absorb an important part of the firm’s resources which will slow down its ability to compete in the market.
To examine the relationship between those factors and firm performance, I follow Maes, Sels and Roodhooft (2003) to control for the company’s size. Previous studies have found that company size is a significant predictor of corporate failure.
Companies with larger numbers of employees have a higher survival probability. The table 2 shows in detail the different variables and their definition.
3.3 Measures
In thus section, I will briefly introduce the measures of the variables used in
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the model. I construct operationalization of the measures in two steps; 1) for the variables selected from my main source (Maes, Sels and Roodhooft, 2003), the measures were used as long as they provided acceptable measurement quality with minor changes to fit the respondents and the Taiwanese context. 2) For the variables that has not been measured, I developed operational measures (score range) based on previous studies methods of evaluation.
Dependent variables. When it comes to assess the firms’ performance, I do not use financial statements for different reasons. Most importantly, Lussier and Pfeifer (2001) called for a totally non-financial approach to valuing SMEs which can lead to a more accurate assessment. A “successful firm” is determined on four criteria (or four dependent variables): the payback of the investment (0=not paid back, 1= paid back), if the firm is still in activity (0= no, 1= yes), if the company has made more profits than industry-average (1 to 5 where 1=strongly disagree and 5= strongly agree), and whether the purpose of creation has been achieved (1 to 5 where 1=strongly disagree and 5=
strongly agree).
Owner-manager characteristics. Concerning this factor, the measures have been selected as follow (score range in brackets): age (number of years of the owner-manager), education (1 to 4; where 1= Primary school and 4= higher education), industry experience (0 to 3; where 0= No experience and 3= Ample experience).
Management practices. All the variables of this factor (business strategy, staffing, market research, marketing) have been measured through a Likert scale, ranging from 1 to 5, where 1=strongly disagree and 5= strongly agree. The degree of accuracy of the business strategy is also evaluated by the owner via a scale from 1 to 5.
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Capital. In order to draw an appropriate financial situation of the firm, two variables where used: sufficient initial investment (1 to 5 where 1=strongly disagree and 5= strongly agree) and debt (1 to 5 where 1=strongly disagree and 5= strongly agree).
Control variables. Company size is measured by the number of employees (0= 0 employees, 1= 1 to 3 employees, 2= 4 to 7 employees, 3= 8 to 15 employees, 4=
more than 16 employees), and product competitiveness (1 to 5 where 1=strongly disagree and 5= strongly agree).
3.4 Data analysis
This empirical research is using two different models to examine the effects of the four factors –Owner-manager characteristics, management practices, capital and environment- on foreign SMEs performance, and analyze the primary data collected:
Ordinary Least Square regression and Logistic regression.
The research model is comprised of four dependent variables (YACT, YPAY, YPRO, YACH) to measure success: activity status of the firm –close or still in activity- (0, 1), YACT; the payback situation –the investment has been paid back or not (0, 1), YPAY; profits above industry-average- (score range 1 to 5), YPRO; and the achievement of the firm’s purpose of creation (score range 1 to 5), YACH.
Our first 2 dependent variables – YACT and YPAY– present binary outcomes – firm active or not, investment paid back or not. When Y is a binary variable, predicted Y values estimate the probability that Yi=1 (for a case i), when probabilities range
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between 0 and 1. I choose to use the Logistic regression analysis to measure the relationship between a categorical dependent variable and one or more independent variable by using probability scores as the predicted values of the outcome variable.
The variables measured through score range values have been analyzed under Ordinary Least Square regression (OLS regression) model.
3.5 Source data and collection
This study uses a survey to gather primary data about the foreign owner-manager’s background, perceptions of the local market in terms of competitiveness, cultural asymmetries and the actual management practices in small-and-medium scaled firms in Taiwan.
In general, this study can be said to follow the subjectivist rather than the objectivist approach. Hence, one of the assumption of this study is that reality is subjective and the participants in this study may see it in different ways, based on their cognitions. Perceptions are important because they are the basis for entrepreneurs’
actions ( Pasanen (2003) ). My perspective follows the one of Pasanen (2003):“I believe that the world can be understood only from the point of view of the individuals directly involved in the activities in question”. The owner-manager is then seen as the most appropriate informant, and the research method used is believed to provide valid information about the object of the research. A questionnaire was designed and send to foreign owners of small-to-medium- scale companies in Taiwan. According to their expectations, previous experiences and the nature of their interactions with the local environment, the entrepreneurs assess the performance, strengths or weaknesses of their
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firm. Therefore, it is necessary that the owners or executives officers complete the questionnaire themselves.
An important step in the data collecting process is gaining direct access to the firm’s original owners. As I stated earlier, the community of foreign expatriates in Taiwan having grown during the past few years, is still rather small, compared to other countries (such as China or Japan). Consequently, they tend to gather into small social groups where members present common characteristics and experiences. The use of social networks is stronger among such small groups, especially when living abroad.
On the first hand, I used online social networks –Facebook- and e-mails to personally contact foreign entrepreneurs and collect questionnaires. On the second hand, I conduct personal interviews with 6 foreign owner-managers, which helps improve the reliability level of the survey answers. All of the interviewees were owners of restaurants and come from Asian cultures (Philippines, Korea and Thailand).
The questionnaire was designed to cover the four factors expected to influence firm performance, with one or more questions covering each type of variable.
Refer to appendix 1 for a complete version of the questionnaire. To assess the validity and accuracy of the survey items, the questions were pre-tested and refined by 5 foreign owners of SMEs and students chosen from the IMBA program of the National University of Kaohsiung.
The selection of the sample has been made without any restriction regarded the type of industry; I target foreign entrepreneurs gathered in common social groups on online networks.
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The sampled firms are all owned by foreigners settled in Taiwan for a period of at least 4 months and present all the following features: 1) they employed fewer than 20 persons; 2) they are all located in Taiwan, on the main island or the peripheral small
The sampled firms are all owned by foreigners settled in Taiwan for a period of at least 4 months and present all the following features: 1) they employed fewer than 20 persons; 2) they are all located in Taiwan, on the main island or the peripheral small