Description
European Council for Small Business and Entrepreneurship.
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Inter-RENT Online Publication
“ CHALLENGES IN
ENTREPRENEURSHIP
AND SME RESEARCH”
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Editor
Friederike Welter
European Council for Small Business
and Entrepreneurship (ECSB)
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© European Council for Small Business and Entrepreneurship (ECSB) and Authors
Published by
European Council for Small Business and Entrepreneurship
Turku, Finland, 2005
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TABLE OF CONTENTS
Challenges in Entrepreneurship and SME Research (Editorial) ......................................
Friederike Welter ........................................................................................................... 1
Entrepreneurship in a Changing Environment:
Analyzing the Impact of Transition Stages on SME Development ...................................
Ruta Aidis and Arnis Sauka............................................................................................ 5
Indicators of Entrepreneurship Activity: ...........................................................................
Some Methodological Contributions.................................................................................
Rachida Justo, Alberto Maydeu and Julio O. De Castro .................................................. 37
Strategic Change Processes in SMEs – .........................................................................
The longitudinal Analysis of Three Finnish Furniture Firms .............................................
Karita Luokannen and Rodrigo Rabetino ....................................................................... 59
Tracking Small Business Failure Factors and Trajectories ..............................................
Mika Pasanen............................................................................................................. 93
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Challenges in Entrepreneurship and SME Research (Editorial)
Friederike Welter
The Inter-RENT Workshop 2005
The idea for the Inter-RENT workshop came originally from the Board of the ECSB and was
developed by the ECSB secretariat together with a group of ECSB members (such as the
editors of the first Inter-RENT publication, Tom Cooney and Pasi Malinen). For Inter-RENT
2005, a total of eleven RENT conference papers that were presented at the RENT 2004
Conference in Copenhagen were invited to participate in the process. The theme of the
publication was selected to be ‘Challenges of Entrepreneurship and SME Research’ since a
substantial number of good quality papers had been presented on the theme at the
conference. From the initial invitations, nine authors expressed a desire to participate in the
process.
Once the papers had been identified, the process began with an internal peer review of the
papers. Each participant was asked to review two of the papers, which meant that each
author would receive feedback from two of their peers, plus they would develop their own
editing skills by reviewing other papers. Each author was then asked to revise their paper
based upon the feedback received from their peers. After this, expert referees were selected
based on their background and specific expertise in entrepreneurship and small business
research as related to the different papers. Their comments and feedback on how to improve
the papers were incorporated by authors into the next revision. During the course of Inter-
RENT, three people evaluated each paper, before all ECSB members were invited to
comment on the paper through the ECSB website at a later stage of the process.
Finally, a small committee which consisted of the initiator of Inter-RENT, Dr. Tom Cooney,
this year’s Inter-RENT chair Prof. Friederike Welter, the upcoming chairs for 2006, Dr. David
Urbano, and 2007, Dr. Olivier Torres, and ECSB Executive Secretary Paula Kuopusjärvi,
have been reviewing all papers for this electronic best-paper selection of Inter-RENT. The
authors are however free to submit their reworked articles to refereed journals.
The long-term goal of Inter-RENT is to create a forum that will enable especially younger
ECSB members to deepen a selected conference theme from the previous RENT
conference, leading to the publication of a number of high-quality articles. This initiative has
exciting potential for ECSB as an organisation and, more specifically, for its members. It
promotes the progression of conference papers into published articles, as well as developing
the depth and understanding of a new topic each year.
Inter-RENT 2005 built on the previous year’s experiences, and several persons were
involved to make it a success. This includes the authors, who contributed to the process, and
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Paula Kuopusjärvi, who held lead responsibility for the website and for the final publication
online. Paula’s work and support throughout the process has been immense and her huge
contribution is particularly acknowledged.
Our thanks also go to those who were involved in refereeing the papers. Their active
participation and guidance is highly appreciated. The referees of the Inter-RENT were (in
alphabetical order):
• Prof. Alistair R Anderson, Robert-Gordon University, Aberdeen, Scotland
• Dr. Thomas M. Cooney, Dublin University of Technology, Ireland
• Dr. Pasi Malinen, Turku School of Economics and Business Administration, Finland
• Prof. Helle Neergaard, Aarhus School of Business, Denmark
• Dr. Colm O’Gorman, University College Dublin, Ireland
• Dr. Olivier Torres, Assistant Professor, E.M. Lyon, France
• Prof. José M. Veciana, Universidad Autonoma, Spain
• Dr. John Watson, Associate Professor, The University of Western Australia
The Inter-RENT 2005 Best Papers
The four papers presented in this online publication allow us to explore some of the
challenges entrepreneurship and SME research today face, both from a methodological point
of view and from the questions we often neglect to ask.
In their contribution, Ruta Aidis and Arnis Sauka concentrate on SME development in a
transition context. Although more and more studies explore entrepreneurship in a transition
context, there is no systematic study comparing barriers to SME development at different
transition stages. They utilise indicators proposed in previous research, which approximates
three transitional stages, to categorise 23 transition countries into transitional stages. They
proceed to develop a framework which identifies SME development trends, drawing on an
analysis of 35 empirical studies on SME constraints in transition countries. Results indicate
that more fundamental barriers related to legal issues are more characteristic of the early
stages of transition while more specific constraints related to human resources and skill
development characterise later transition stages. These differences suggest that the types of
policies and programmes offered to SME owners should be sensitive to changing transition
conditions. Moreover, since formal barriers such as policy instability and uncertainty seem to
continue to form business barriers throughout the transition process, it is of utmost
importance that policy makers in the transition countries focus on insuring a transparent and
straightforward policy development process.
The question Rachida Justo, Alberto Maydeu and Julio O. De Castro ask in terms of the
overall Inter-RENT topic is related to methodology and measurement of entrepreneurship.
Based on GEM data for Spain, the authors discuss indicators based on levels and the
likelihood of entrepreneurial behaviour. Whilst the notion of measuring the likelihood of
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entrepreneurship is not a new concept, the authors adopt a more dynamic view, which allows
them to examining differences in the likelihood over time within countries as well as across
countries. Moreover, they argue that the level of an individual’s entrepreneurial activity is
affected by the social context in which that activity occurs. This context is not uniform and its
effect varies due to factors such as social networks, education, gender, etc. As a result, an
entrepreneur’s personal social network is treated here as a random variable that changes
from individual to individual.
The next two papers are case-based contributions exploring strategic change and failure in a
SME context. Although the question of strategic change in SMEs as such is not a new
challenge in SME research, the paper by Karita Luokannen and Rodrigo Rabetino brings in a
fresh perspective in terms of the method they use. They draw on three in-depth cases from
the Finnish furniture industry, applying a process perspective and analysing environmental
factors as well as the internal firm perspective. Their data analysis reveals that strategic
changes are the result of multiple, overlapping processes. In a short term perspective, firms’
responses to environmental stimuli often look like reactive tactic. However, in a longer time
perspective, owner-managers were able to identify strategic challenges and to implement
new projects. Moreover, the cases suggest a strategic behaviour in SMES, which reflects
Mintzberg’s emergent strategies. In general, entrepreneurs act with bounded rationality and
strategies are often based on experience and intuition instead of calculation and planning.
Few studies in entrepreneurship focus on failed ventures and failed entrepreneurs. Business
failure often is equalled with personal failure, and entrepreneurs might be reluctant to admit
that they have not achieved their goals. On the other hand, one might expect business failure
enhancing entrepreneurial learning. In this context, the paper by Mika Pasanen concentrates
on identifying failure factors and failure trajectories in SMEs, both conceptually and
empirically. His empirical study was based on in-depth interviews with the ex-entrepreneurs
of 12 failed SMEs. The results reveal three types of failure trajectories: (1) failed borderline
cases; (2) rapid collapse failures; and (3) failed seekers of legitimacy. The empirical results
may help entrepreneurs and those who are fostering entrepreneurship and SME
development, in learning from mistakes and failures during SME development.
Corresponding Editor
Prof. Dr. Friederike Welter, University of Siegen, School of Economic Disciplines,
Hölderlinstr. 3, D-57068 Siegen, T. +49 271 740-2844, E-mail: [email protected]
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Entrepreneurship in a Changing Environment: Analyzing the Impact
of Transition Stages on SME Development
Ruta Aidis* and Arnis Sauka**
*School of Slavonic and East European Studies, University College London (UK),
Faculty of Economics and Econometrics, University of Amsterdam (Netherlands)
**Stockholm School of Economics in Riga (Latvia)
Abstract
An issue gaining importance in transitional literature is the need to develop entrepreneurial
capabilities through a thriving small and medium-sized enterprise (SME) sector. However, it
can be argued, that in order to successfully develop SMEs it is important to understand the
specific barriers they encounter at different transition stages. Though there are a number of
studies on SMEs in transition countries, no systematic analysis has been conducted on the
effects of different types of barriers to SMEs at different stages of transition. In this paper we
address this knowledge gap. We utilise indicators proposed in previous research to
approximate three transitional stages to categorise 23 transition countries into transitional
stages. On this basis, we develop a framework which identifies SME development trends
based on an analysis of 35 empirical studies on constraints facing SME development in
transition countries. Our results indicate that more fundamental barriers related to legal
issues are more characteristic of the early stages of transition while more specific constraints
related to human resources and skill development characterise later transition stages. These
differences indicate that the types of policies and programmes offered to SME owners should
be sensitive to changing transition conditions.
Key Words: transition countries, SMEs, transition stages, business barriers
Introduction
Entrepreneurship can take many forms and can be defined in many ways. In our paper we
focus on entrepreneurship as it takes place in small and medium size enterprises (SMEs)
since the two are often found to be closely related. As Wennekers and Thurik note: ‘Small
firms are the vehicle in which entrepreneurship thrives’ (1999:29).
SMEs are of special importance to transition countries for a number of reasons. Firstly, they
are able to provide economic benefits beyond the boundary of the individual enterprise in
terms of experimentation, learning and adaptability. These characteristics are especially
important in economies undergoing radical transformation such as has occurred in the
formerly centrally planned countries. Secondly, in most transition countries, the SME sector
was largely neglected and even discriminated against in the early transition period with
emphasis placed on the rapid privatization of large scale enterprises and not the
development of the SME sector. This has arguably resulted in less resources and attention
being paid to the needs of SME development. In addition, research in transition countries
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shows, that even if SMEs do not generate net new jobs, they reduce the erosion of human
capital by providing alternative employment opportunities for relatively skilled yet
unemployed workers (EBRD 1995). Though it is often argued that SME development is
especially crucial for the early phases of transition (EBRD, 1995; Smallbone and Welter,
2001), it is, in fact, just as important for the advanced stages of post-transition. As M. Porter
(1990) has argued, invention and entrepreneurship are at the heart of national advantage
and country competitiveness.
In the last ten years, governments in the transition countries have introduced a number of
policies aiming to promote entrepreneurship through SME development. The main impetus
for this ‘intervention’ are the specific constraints encountered by SMEs. It is argued that
though the SME sector can be much more responsive and flexible to changes in the
marketplace, it is also much less able to influence such developments. Limited access to
finance, a low degree of professionalism, difficulties in recruiting qualified personnel,
dependency on clients and suppliers and the absence of economies of scale are identified as
the core SME sector weaknesses and the main areas where SMEs may require special
attention (Burns, 2001). In this respect, understanding the problems faced by SMEs in the
specific context of transition could provide the necessary background to develop policies for
SME support.
One of the most important findings in the SME literature is that context matters as it shapes
not only the role of small firms but also their structure and performance (Karlsson &
Dahlberg, 2003:1). The transition countries of Central and Eastern Europe and the former
Soviet Union seem particularly suited for a study on the influence of context for several
reasons. Though transition countries have chosen different paths of development, they have
all undergone a tremendous amount of economic and social change; an important aspect of
which has been the development of a new private sector. In addition, the unprecedented
degree of institutional change experienced by transition countries has been largely moving in
a similar direction: The switch from a system based on state planning and allocation of
resources dictated by the government to a system characterized by decentralized market
allocation. This system change necessitates substantial change in laws and regulations as
well as norms and expectations (Raiser, et al. 2001:2). Of specific interest to our study is the
effect of context on the emergence and development of a legal SME sector, which under the
central planning system was severely restricted
1
.
To date, though there is no consensus on what constitutes ‘transition stages’, researchers
have developed different categorisations of the transition process. For example, Campos and
Coricelli (2002) created seven stylised facts describing the transition process
2
. Though
insightful, the stylised facts proposed by Campos and Coricelli are not useful from an
1
As Earle and Sakova (2001: 6) have noted: “It is difficult to imagine a regime more hostile towards
entrepreneurship then the centrally planned economies of Eastern Europe”.
2
The seven stylised facts proposed by Campos and Coricelli (2002) describe the main characteristics of the
transition process. They are: 1) Output fell, 2) Capital shrank, 3) Labor moved, 4) Trade reoriented, 5) Structure
changed, 6) Institutions collapsed, and 7) Costs were high.
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entrepreneurship development point of view. More suitable for this purpose seems to be the
transition indicators developed by the European Bank of Reconstruction and Development
(EBRD) that plot the progression of economic transition according to macroeconomic as well
as institutional variables. These indicators have been systematically compiled since 1989 for
the countries undergoing economic transition
3
. Other authors such as Smallbone and Welter
(2001), have used selected EBRD indicators in order to distinguish between transition
countries where market reforms have been slow or not properly installed and countries
where they are more advanced. Furthermore, the three transition stages based on new
institutional theory
4
proposed by Van de Mortel (2002) provide additional conceptual
considerations for the categorisation of barriers useful for the analysis of SME constraints.
A number of authors have identified the distinct characteristics of entrepreneurship and SME
activities in transition countries where the environment is undergoing quite dramatic changes
(Dallago, 1997; Scase, 2000; Chilosi, 2001; Smallbone & Welter, 2001; Aidis, 2006). Some
authors have distinguished between countries at different stages of market reform (Kolodko,
1999; Smallbone and Welter, 2001). Other authors such as Surdej (2003) have shown the
interlinkage between market and institutional changes and the number of start-ups (in
Poland). However, no study has attempted to systematically classify barriers to SME
development during different transition stages across the transition countries.
In this paper we operationalise a selection of indicators proposed in previous research to
approximate transitional stages that would make sense from an entrepreneurship
development perspective. We utilise these indicators to categorise 23 transition countries
into transitional stages. This framework is then used to identify SME development trends
drawn from an analysis of 35 empirical studies on constraints faced by SMEs in transition
countries. The primary objective of this paper’s analysis is to identify which SME barriers are
of the main importance at different transition stages.
Our analysis contributes to the existing literature by providing insights into the dynamic
relationship between barriers and SME development during distinct stages of the transition
process. As such, we fill an important knowledge gap by comparing SME barriers in different
transition stages for 23 transition countries. Our results specifically show that fundamental
barriers related to legal issues are more characteristic of the early stages of transition while
specific constraints related to human resources and skill development characterise later
transition stages. These results indicate a number of policy implications for entrepreneurial
development at specific stages of transition.
The paper is structured as follows: Section two presents the conceptual background
including a discussion of the classification of transition stages. A conceptual framework is
developed in section three. Since our study is limited mainly to economic transition from the
entrepreneurship and SME development viewpoint, we focus our discussion only to relevant
3
For further information regarding EBRD transition indicators please see section 2.2 and appendix 7.
4
Developed by Douglass North (1997a).
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literature. Section four presents the data and methodology used. Section five presents the
results and in section six we discuss the limitations of our approach. The paper ends with
concluding remarks in section six.
Conceptual background
In this section we describe and analyse the main concepts used in the context of our study
based on a review of existing theoretical and empirical studies. Section 2.1 focuses on
defining and understanding transition, transition stages and SME barriers. In section 2.2 we
explore some of the ways transition stages have been classified. Two main methods are
highlighted: the EBRD transition indicators and Mortel’s (2002) three stage approach.
Alternative indicators for measuring transition progress as well as existing single country
studies distinguishing among different transition stages from the entrepreneurship and SME
development viewpoint are also discussed.
Defining and understanding the transitional context
For the 23 countries contained in our sample, transition can simply be defined as a process
of change from a centrally planned to a well functioning market oriented system
5
. According
to the definition introduced by the EBRD (1994) transition is about institutional change,
involving not only the advance of the private sector but also a fundamental transformation of
the role of the state, in particular in the economic, financial and legal institutions underpinning
the market economy. It is the institutional arrangements for the allocation and generation of
goods and resources, and the ownership incentive and rewards structures that institutions
embody, that characterise the differences between a market and a command economy.
Transition may also be regarded as an ultimate objective in itself as well as an end in itself
(EBRD 1994: 3).
However it should be noted that while there are core features that a market economy
possesses, there is no unique destination point for the transition process (EBRD 1995).
Given the different starting points and initial conditions of the transition countries, there can
not be a single, unique route for transition. A priori a large number of variables could
influence transition paths and resulting patterns of institutional change. Three main issues
stand out as influencing the initial conditions for a given country: geographical factors,
cultural factors, and the institutional legacy of central planning (Raiser 2000).
Not all authors agree about the influence of initial conditions. A literature review based on
growth in transition countries by Merlvede (2000) found that though more unfavourable initial
conditions lead to a larger output fall, the effects fade over time and can be offset by
stabilization and reform policies. He further found that the stabilization of inflation which is
5
We restrict our analysis to the 15 countries which formerly comprised the Soviet Union and eight central and
eastern European post-socialist countries. Countries that have emerged from the former Yugoslavia were not
included due to the armed conflicts taking place in this region in the 1990’s which can bias the transition stage
results.
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facilitated by sustainable government balances is a prerequisite for the recovery of growth. A
fixed exchange regime is also important for stabilizing inflation but the empirical evidence is
mixed. Stabilization is not a sufficient condition for output recovery since structural reform is
also necessary (ibid).
Our analysis would be greatly simplified if the transition process followed a simple, linear
progression. Unfortunately it does not. Rather it is a complex process involving a multitude of
influences and factors. Though it is agreed that certain fundamentals of market economies
should be a part of any successful transition, the ‘end of transition’ remains a contestable
issue
6
.
Classification of Transition stages
In the initial stages of our research, we attempted to use all available international indicators
such as GDP levels, the Corruption Perceptions Index from Transparency International or the
Freedom Index from Heritage International in order to classify the transition stages. These
indices would have provided further insights into both informal and formal institutional factors
affecting transition countries. Unfortunately the data available from these indices do not
provide ample coverage for the transition process (please see appendix 6 for a detailed
discussion). The only indicator that does cover the transition period for the 23 transition
countries is the EBRD’s transition indicators. Therefore we focus on introducing the EBRD
indicators in this section. For a more conceptual and theoretical approach, we utilise the
three stage model developed by Van de Mortel (2002) which is presented in greater detail at
the end of this section.
EBRD transition indicators
According to the EBRD, the first or initial phase of transition was dominated by the structure
of the inheritance from the communist system and the political repercussions following the
collapse of this regime. The main reforms characterising this period include: the privatisation
of assets (small-scale privatisation), the liberalisation of markets (through price, foreign
exchange and trade liberalisation) and the establishment of a degree of macroeconomic
stability (EBRD 1997).
The next phase of transitional reforms requires policies, institutions and behaviours
7
that can
foster and accelerate economic growth. Second transition phase reforms include a
continuation of the privatisation of assets (through large-scale privatisation), improving
enterprise performance through governance and enterprise restructuring, the further
liberalisation of markets (through competition policy), the development and maintenance of
6
Though the answer to this question is beyond the scope of this paper, it is perhaps of interest to mention that no
single indicator or definition currently exists that accurately describes the end of transition. A number of authors
have suggested that the end of transition is achieved by reaching the level of an ‘advanced market economy’.
Unfortunately there exists no generally acceptable definition for what precisely characterizes an ‘advanced
market economy’. For further discussion, see Brown 1999).
7
Informal institutions such as changes in attitudes and ‘culture’ (North, 1990).
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infrastructure (through infrastructure reform) and reform to financial institutions (banking and
interest rate liberalisation and the creation of non-banking financial institutions). A main
challenge in this phase is developing and providing market-oriented governance i.e. a
building and deepening of the institutions and behaviour that are at the heart of a well-
functioning market economy (ibid.). These stages are summarised in table 1.
Table 1 - EBRD’s classification of transition phases and requirements
Phase Initial phase Next phase
Main requirements Privatisation of assets, market
liberalisation and macroeconomic
stability
The development of policies,
institutions and behaviour that
accelerates growth
Specific indicators of
progress
• Small scale privatisation • Large scale privatisation
• Price liberalisation
• Governance and enterprise
restructuring
• Foreign exchange and trade
liberalisation
• Competition policy
• Infrastructure reforms
• Banking and interest rate
liberalisation and non-banking
financial institutions
Source: EBRD (2002)
As illustrated in table 2, the EBRD’s classification indicators are based on four main
categories, each containing at least one subcategory. Scores for transition progress are
measured from a minimum score of 1 to a maximum score of 4+. Scores are given with
decimal points to provide more accurate differentiation. In general, a score of 1 indicates little
progress; 2 indicates some progress; 3 indicates substantial, comprehensive progress; 4
indicates a level of progress approaching international standards; and a 4+ score indicates
the standards and performance typical of advanced industrial economies (For a more
detailed presentation please see appendix 7).
Table 2 - EBRD transition indicator classification
Enterprises Markets and trade Financial institutions Infrastructure
Large-scale
privatisation
Price liberalisation
Banking reform & interest rate
liberalisation
Infrastructure reform
Small-scale
privatisation
Trade & foreign
exchange system
Securities markets & non-bank
financial institutions
Governance &
enterprise restructuring
Competition policy
Source: EBRD (2003)
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Though the EBRD indicators provide excellent overall coverage of the transition period, they
tend to overlook the influences of informal factors. A theoretical transition classification model
presented by E. van de Mortel (2002) specifically addresses these missing links.
Van de Mortel’s three stage model
Elma Van de Mortel (2002) classifies three stages of transitional progress using a framework
based on institutional theory as developed by D. North (1990). According to Van de Mortel,
the first stage of transition starts when a country has the freedom or desire to reform, or
when it is forced to start transforming its economy. For those countries willing to transform,
this stage is usually very short. However countries forced to transform may have difficulties
determining their transition strategy since transition starts with the collapse of the former
institutional framework, e.g. total vacuum of legislation, rules, etc. In this stage of transition it
is crucial for the countries to develop their main transition strategies. However this step can
only be taken if a suitable political structure is in place; providing a clear and duly endorsed
power distribution between the president, government and parliament. Van de Mortel notes
that the first stage of transition tends to be more successful in those countries where there
are more stable constitutional institutions able to make decisions about the direction and
speed of strategic processes (2002). But then again the ability of the transition country to
develop such institutions depends mainly on past experience. Considerable impact also
comes from factors we understand as national identity e.g. common language, recognition of
similar values, etc. According to Van de Mortel, it is still too early to speak about property
rights and privatisation during the first stage of transition. The first stage ends when the
decision-making process related to new laws and regulations begins.
The second stage of transition is mainly shaped by formal institutional reforms (e.g.
introduction of legislation and rules). An important precondition has to be met before an
economy arrives at this stage, i.e. a start must have been made with privatization and
decentralization of economic decisions. Instead of being superficial, privatisation has to be
structurally and decidedly focused towards the shift in decision-making power.
Decentralisation, on the other hand, should mean that owners or managers of firms can
decide about selling prices, about where to buy input, which goods will be produced, and so
on. During the second stage of the transition, legislation and rules are reassessed and
replaced, i.e. the legal framework is shaped. For instance, banking laws, protection of private
property, competition, law and bankruptcy laws are to be introduced. Even if slowly, informal
institutions, like personal attitudes, economic behaviour and culture have to change during
the second stage as well. However, as long as the formal institutions have not taken shape
and framework uncertainty persists, there can be no harmony between the formal and
informal institutions.
The third stage of transition starts when the introduction of legal framework is roughly
completed. Marginal changes remain possible, but they mainly concern a refinement of the
newly implemented institutions. During the third stage the main focus is on the change of
economic behaviour of agents. Economic actors experiment in order to see which economic
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decisions lead to better results in the context of the new economic order. Furthermore, it is
crucial that people accept the new formal institutional framework. This stage can last rather
long and can be completed successfully only if harmony between the formal and informal
institutions has arisen. Without this harmony the new institutions are unlikely to persist, and,
if they do, they will in all likelihood not be effective and the transition process may regress to
the previous stage. The probability that harmony will develop between two kinds of
institutions depends among others on the duration and the hardship suffered during the
second stage of transition. When people see their incomes decline and have to live in
poverty for a prolonged period of time, they are likely to blame the new economic and
political order for their difficulties and will have little inclination to accept the new order and
adapt to it (Van de Mortel, 2002: 23). These three transition stages are summarised in figure
1.
Figure 1 - A model of Van de Mortel’s three transition stages
Adapted from Van de Mortel (2002).
Developing a conceptual framework
When we compare Van de Mortel’s three transition stages with the EBRD indicators we find
a general agreement as to the formal institutional changes that need to take place during
stages one and two. EBRD indicators, however, mainly focus on economic and to some
extent also political transition whereas Van de Mortel’s transition stages go a step further by
including a deeper societal dimension, i.e. the more ‘fuzzy’ category of informal institutional
influence such as attitudes, values and culture. She argues that they play a crucial role in
allowing the more formal reforms in the transition process to progress.
But are these two factors reflecting the various influences on SME and entrepreneurship
development? Acs and Karlsson (2002) raise a critical voice against focusing solely on
institutional influences to private enterprise development since they only present a limited
part of the overall economic milieu within which entrepreneurship may develop. Other
important conditions include demand and supply conditions, the degree of competition in
various markets, the state of the infrastructure, the supply and skill level of the labour force,
the entrepreneurial climate and access to knowledge. Authors such as Aidis et al. (2006)
have enhanced their institutional analysis by including economic factors.
Stage one:
Desire or pressure
to reform
Stage two:
Formal
institutional reform
Stage three:
Harmonisation of
formal and
informal
institutions
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In addition to the typical institutional classifications (formal and informal barriers) addressed
by the EBRD indicators and Van de Mortel’s analysis, we agree with Acs and Karlsson’s view
that economic factors must also be included in our analysis of influences to entrepreneurial
development. In the context of this classification for the transition country context, economic
factors mainly include production factors such as access and cost of appropriate financial
and human capital (including training) and infrastructure. Therefore we label this category as
‘economic’ factors. We also feel that an additional category should be added to capture
factors not included in the other three categories. Our analysis therefore identifies four core
influences to SME development and growth: formal, informal, economic constraints as well
as an ‘other category’ in order to capture additional influences (figure 2). The specific areas
and issues classified under each of the four categories as derived from the existing literature
on barriers to SME development in transition countries and are presented in appendix 2. It
should be noted, however that this classification of barriers should be seen as a conceptual
approximation of the sets of factors influencing SME development rather than clear cut-off
points. Some of these categories may overlap and a particular barrier can belong to two or
more categories depending on the interpretation. Moreover one barrier faced by an SME
could be a consequence of some other barrier(s) both in the frame of a particular category as
well as in- between them.
Figure 2 - Four categories of constraints to SME development and growth
Data and Methodology
As already mentioned, the transition process itself is not only a complicated phenomenon but
is also a non- linear process. Thus one would expect that indicators capturing the progress of
the transition process, which make sense from the entrepreneurship development viewpoint,
to be complex as well. Among other factors, transition indicators from an entrepreneurship
perspective, would need to consider differences between various transition countries in terms
of historical influences, both long and short term, affecting the starting points of transition as
well as the speed and path of transition. Informal influences on the transition process, such
as culture and the norms of different actors, including government, regulating (tax inspection,
etc.) and business promotion organisation representatives, the general population and, of
course, SME owners and managers themselves, should also be taken into consideration.
Formal Informal Economic Other
SME development and
growth
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In light of these factors and considering the limitations of other available data, we chose
EBRD’s yearly average indicator (see Table 3 and Appendix 1) as the most suitable option
for approximating the transition stages. There are several reasons for this choice. Firstly,
they cover all 23 transition countries we are interested in throughout the transition process
(data is available starting in 1989). Secondly, the impact of the long and short- term history,
namely, differences in starting points of transition countries are considered by these
indicators. Thirdly, the common measurement scale ensures that the progress of transition,
regardless of the path taken, is measured uniformly for all transition countries. Additional
support for the use of EBRD’s indicators emerges from a number of existing single country
studies (for list see Appendix 5), most of which might be classified following methods similar
to Van de Mortel’s stages framework, indicate the appropriateness of using EBRD transition
stages as the main guideline to approximate different transition stages from an
entrepreneurship development point of view.
In order to classify the countries according to transition stages, we delineated EBRD ranks
into three stages following the EBRD’s 4 score system. A rank of 1 to 1.9 was classified as
indicating little progress i.e. the primary stage; rank 2 to 2.9 was classified as indicating some
progress i.e. the secondary stage; and, rank 3 to 4 was classified as indicating substantial
progress approaching international standards, i.e. the advanced stage.
Table 3 - EBRD transition indicators ranked into three transition stages
country Primary stage* Secondary** Advanced***
Albania 1989 -1993 1994 - 2004 -
Armenia 1989- 1994 1995 - 2001 2002 - 2004
Azerbaijan 1989 - 1996 1997 - 2004 -
Belarus 1989 - 2004 - -
Bulgaria 1989 – 1992 1993 - 1998 1999 - 2004
Czech Republic 1989 - 1990 1991 - 1992 1993 - 2004
Estonia 1989 - 1992 1993 1994 - 2004
Georgia 1989 - 1994 1995 - 1999 2000 - 2004
Hungary 1989 - 1990 1991 - 1992 1993 - 2004
Kazakhstan 1989 - 1994 1995 - 2004 -
Kyrgyzstan 1989 - 1993 1994 - 2004 -
Latvia 1989 - 1991 1992 - 1995 1996 - 2004
Lithuania 1989 - 1992 1993 - 1995 1996 - 2004
Moldova 1989 - 1993 1994 - 2004 -
Poland 1989 1990 - 1992 1993 - 2004
Romania 1989 - 1993 1994 - 1998 1999 - 2004
Russia 1989 - 1992 1993 - 2002 2004
Slovak Republic 1989 - 1990 1991 - 1993 1994 - 2004
Slovenia 1989 - 1991 1992 - 1994 1995 - 2004
Tajikistan 1989 - 1997 1998 - 2004 -
Turkmenistan 1989 - -
Ukraine 1989 - 1994 1995 - 2004 -
Uzbekistan 1989 - 1993 1994 - 2004 -
Source: Various EBRD Transition reports
* = EBRD indicator rating from 1 – 1,9; ** = EBRD indicator rating from 2,0 – 2,9; *** = EBRD indicator rating from
3,0 – 4
As shown in table 3, according to EBRD indicators, as of 2004, two CIS countries were still in
the primary stage (Belarus, Turkmenistan); Eight countries were in the secondary stage
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(Albania, Azerbaijan, Kazakhstan, Kyrgyzstan, Moldova, Tajikistan, Ukraine and Uzbekistan);
and thirteen countries were in the advanced stages of transition (Armenia, Bulgaria, Czech
Republic, Estonia, Georgia, Hungary, Latvia, Lithuania, Poland, Romania, Russia, Slovak
Republic and Slovenia).
Our transition country data is derived from a systematic analysis of previous available
surveys on the barriers to SME development in 23 transition countries. The libraries and
electronic databases of three universities formed the backbone of our search for surveys:
The ICE collection at Jönköping University, the London School of Economics and University
College London. We searched under the following main keywords: SME (entrepreneurship,
small/ medium, business) in transition, SME barriers (constraints) in transition and econ* of
(in) transition. We also searched for single country studies on SME barriers and transition
stages using the ICE collection at Jönköping University. In our search for literature, we
focused on the following main sources:
• Leading peer reviewed journals in entrepreneurship research
8
(such as Small
Business Economics, Journal of Business Venturing, Entrepreneurship: Theory and
Practice, Entrepreneurship and Regional Development, The Journal of Small
Business Management)
• Annual proceedings and research reviews in the field of entrepreneurship (such as
Advances in the study of entrepreneurship, innovation and economic growth edited
by Gary Liebcap, Volumes 2 – 15, published in 1989 – 2004
9
)
• Specialised journals, mainly focusing on transition countries (such as MOCT- MOST,
Baltic Economic Review, Post- Communist Economies)
• Transition and selected country reports from international organisations (such as the
EBRD, the World Bank, OECD)
• Working papers (from sources such as the World Institute for Development Economic
of Research (WIDER), Tinbergen Institute Research Series, Williamson Davidson
Institute (WDI), SSRN papers).
• Proceedings from leading international conferences on entrepreneurship (such as
RENT, Babson, Academy of Management)
The selected 35 studies on constraints facing SMEs cover various transition stages in 23
different countries of transition. To ensure a high quality of analysis, most of the surveys
used were published in high quality academic journals. In addition other sources such as
country reports, etc. which provided a broader picture of the constraints faced by SME were
included. The main focus of our analysis were surveys on SME development barriers. Half of
the studies used were single country surveys while the other half of the studies included two
or more countries. Most of those studies including more than one country analysed SME
constraints within a single transition stage. The vast majority of studies used cover the main
SMEs sectors in a particular country. The unit of analysis used in the studies was SMEs in
transition countries.
8
For more information on selection criteria of leading journals please seehttp://eweb.slu.edu/booklist.htm
9
Published by JAI Press, Greenwich, Connecticut.
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Unfortunately, SMEs are defined in different ways in different country contexts. The most
common classification used was are less than 50 employees (indicating a small enterprise);
less than 200 employees or less than 250 employees (indicating a medium enterprise).
Standard definitions for SMEs can range from under 50 employees to up to 500 employees.
Given our limited access to the raw data used in the surveys analyzed, this presented a
definitional problem. This is not a problem specific to the transition context, though it affected
our ability to analyze across studies
10
. The number of barriers examined in an individual
study ranged from 6 to 65 barriers. The data presented in the 35 surveys used was mainly
collected using mail survey methods, while personal interviews were used less extensively. A
number of studies employed both methods. For the majority of surveys, the respondents
were managers and owners of SMEs. For a more detailed description of the studies used,
see Appendix 4.
Since our primary aim is to identify which SME barriers (e.g. formal, informal, economic or
others) are of ‘main’ importance at different transition stages, we followed a three step
process. In step one, we classified all 35 studies according to transition stage. In step two,
we classified the barriers identified as ‘important’ by the studies into formal, informal,
economic and ‘other’ categories. Finally, in step three, we compared and summarised the
main barriers and barrier groups identified at different transition stages. For further
information on the classification of SME barriers see Appendix 2 and 3. A list of all 35
surveys utilised is presented in Appendix 4.
Given the different methodology and mesurement scales used to analyse SME constraints in
the studies used, some general scales of measurement were developed. These are
described in table 4.
Table 4 - Criteria for the measurement of SME barriers
(1) If the importance of a barrier was measured as a percentage of total respondents considering it to be
important (in some studies- most important, or that barrier was a problem that must be improved). In these cases,
the barrier was considered to be important if at least 30 percent of the total respondents considered it as
important.
(2) If the importance of a barrier was measured by the mean (average) score using different scales, the following
method was used:
Scale from 1 to 5: Where 5 is the most problematic barrier. In this case, we considered the most important
barriers to be those where the mean is more than 3,0
Scale from 1 to 4: Where 1 is the most problematic barrier. In this case, we considered the most important
barriers to be those where the mean is less than 2,0
Scale from 1 to 8: Where 8 is most important problem. In this case, we considered the most important barriers to
be those evaluated with 5 and more.
(3) There were also some surveys where authors did not provide with any quantifiable measurement scales. In
these cases we rely on the author’s judgement and consider those barriers as most important which are
mentioned to be such by the authors themselves.
10
This is the main reason why at this stage we did not employ any quantitative estimation methods. This provides
an exciting opportunity for further research on this topic.
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Results
After classifying the 35 studies into transition stages and identifying the main SME barriers at
each stage, our aggregated barriers for the three transition stages point to a number of
interesting observations. As shown in figure 3, several formal and economic constraints
affected SME owners throughout the three transition stages. This was not the case for
informal or other constraints. The constraints specific to each transition stage are shown in
figure 3 under the headings of formal, informal, economic and other categories. Since a
number of similar barriers were identified affecting both stages 2 and 3, these are listed in a
column located between stages 2 and 3. It should be further noted that given the exploratory
character of our analysis, it is more useful to focus on the general nature and trends that can
be derived from our results and save more specific analysis for later research.
Our results indicate the following three trends. First of all, we can identify a general trend of
more fundamental barriers to more specific constraints being identified as transition
progresses from stage one to stage three. Furthermore, as the transition process moves to
stage three and beyond, SME owners seem to become increasingly more concerned with
human resources (labour) and skill development (training) then at the initial stages. This
changed ultimately to the increased need to develop internal business capabilities to deal
with increasing competition as well as business growth such as specific consulting and
advice and business training programmes. Supporting evidence for this result is provided by
a study in Hungary which identified the need for business training programmes in the more
advanced stage of transition (Acs et. al. 2001). Secondly, we find that three formal
constraints: taxes, policy instability and legal regulations form a barrier for business
development throughout the transition stages. Though taxes are a constraint faced by
businesses worldwide, policy instability and uncertainty seems more specifically related to
the transition process and indicates the effect of the difficulties of adopting a new legal
framework for SME owners. Thirdly, we find that access to and the cost of financing
continues to be a barrier to businesses throughout the three transition stages. Though
access to financing is a constraint identified by many western businesses, this result draws
special attention to the difficulties of developing an adequate independent banking sector
that would serve the capital needs of SMEs in the transition context.
Are informal barriers ‘irrelevant’ at stage 1?
Our results certainly point to the unlikely conclusion that informal barriers are not important at
stage 1. But we believe there may be some other reasons for this seemingly incongruous
result. First of all, it may be the case of missing data because of the few studies available
with data on barriers to SMEs in transition countries at stage one. However it may also be
possible that these results illustrate a situation in which the SME owners may be less aware
of the informal constraints because these constraints ‘stayed constant’ and exemplify a
situation of ‘the fish don’t talk about the water’. In this instance other constraints would seem
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more important such as formal and economic barriers because they are undergoing dramatic
changes and put additional demands on SME owners to adapt to changing conditions.
In addition, business owners in later transition stages may become more vocal about
informal barriers such as corruption as they become more accustomed to the changes in
formal and economic context and become more aware of the fact that informal barriers such
as corruption are fundamentally detrimental to their business development in the long term.
Figure 3 - Main barriers facing SMEs in different transition stages
STAGE 1
INFORMAL:
FORMAL: Taxes, Policy instability/uncertainty, Legal regulations
STAGE 3 STAGE 2
OTHER
• Customs
and trade
regulations
• Macroecono-
mic stability
• Inflation
• Gov’t Attitude
• Organised crime and
mafia
• Anti – corruption
measures
• Business security
• Lack of positive
attitude
• Gov’t non-
transparency
• Commercial law
• Social security
payments
• Frequent changes
to laws
and government
• Business
registration
business
• Too many licenses
• Accounting standards
• Information
• Need for specific
consulting advice
(marketing, financial,
psychological)
• Lack of state support
• Too many tax inspections
• Implementation of
regulations
• Motivation / quality ethics
of the workforce
• Corruption
• Bureaucracy
• Payment
behaviour of
clients
• Physical
infrastructure
• Low product
demand
• High input prices
• Suppliers
• High interest
rates
• Infrastructure
• Unfair
competition
• Premises rental
costs
• Wage costs
• Business
training
• Shortage of qualified
workers
• Strong competition
• Lack of investment/finance
• Business growth into new
markets
Stages 2 & 3
ECONOMIC: Financing: access and cost
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Limitations
The classification of different types of barriers into formal, informal, economic and other
categories forms the core of our analysis but at the same time, it is a difficult distinction to
make. For example policy instability and uncertainty though classified as a formal constraint
is also very closely related to official attitudes (which are informal constraints). One of the
main problems encountered is the ability to empirically distinguish between these categories.
Moreover, if a survey only asks if ‘business inspections’ present a business barrier it remains
unclear as to whether business inspections as such are a barrier or if it is actually the ‘rent
seeking’ characteristic of business inspections that forms the barrier. In our model, we would
classify these two as distinctly different. The former is a formal barrier and the latter an
informal barrier. But if a survey does not ask for the distinction, than we can not extract this
subtle difference from the data available. In this sense, qualitative interview data provides
more depth and detail which facilitates more fine-tuned classification than quantitative data.
However, empirical research could very well capture these institutional differences if the
questions are formulated properly.
Another important issue regarding SME barriers and transitional stages is the fact that the
general characteristics of SMEs prevalent at the different transitional stages are changing as
well. One could expect more basic types of arbitrage entrepreneurship to dominate in the
early stages of transition with more sophisticated forms of entrepreneurship (based on for
example, technological competitiveness) to increase as the market becomes more
competitive in later transition stages. Therefore our results probably reflect the changes to
barriers that are significant for different forms of SMEs as much as for the transition stage.
Though the EBRD indicators provide adequate coverage of the transition period, they have
their limitations. The main drawbacks of EBRD’s measurements are their focus on
instrumental macroeconomic processes such as macroeconomic stabilization, privatization
and liberalisation. These three issues have been emphasized by the International Monetary
Fund and were outlined by the Washington Consensus. However, more recent research has
indicated that these conditions though necessary for the transition process are not sufficient
to realize transitional ‘success’. The limited scale (from 1 to a maximum score of 4) of
change provided by the EBRD indicators poses other difficulties since a very limited range of
variance can actually be captured. Moreover, given that transition is a non-linear process,
some countries such as Russia and Belarus exhibit outlier years. In 1995, Belarus had a total
transition indicator score of 2.00 which would place it in the secondary transition stage for
that year. However, in subsequent years the score decreased to under 1.9. In Russia, a
similar situation occurred in 1997 where the indicator score was 2.96 though in the following
years it decreased back to under 2.9 until 2003 when Russia once again reached the
advanced level of transition (with a score of 2.92). Though not presented in table 3, these
outliers can be seen in the appendix 1 and whenever possible were taken into account while
analyzing the data. Using EBRD average indicator for the approximation of transition stages
rather than analysing each of the four categories (see Table 2) could be a debatable issue.
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Finally, a limitation relevant not only to EBRD indicators but for the approximation of
transition stages in general arises from the phenomena of the transition process. Since it is a
non- linear process, stages as distinguished can partly overlap during the transition process.
Nevertheless this approximation provides some scope to analyse SME development
constraints in the context of the distinctive transitional environment.
Concluding remarks
There is a growing body of literature on entrepreneurship in transition countries and many
studies have identified the barriers to SME development for specific countries at specific
periods of time. Yet there is no systematic study which has compared the barriers to SME
development at different transition stages. In this paper we attempt to fill this knowledge gap.
Using a novel methodology, based on our classification of the EBRD transition indicators, we
classified 23 transition countries into three transition stages: primary, secondary and
advanced stages. We then distilled the main barriers identified in the 35 studies according to
our ‘enhanced’ institutional-based model distinguishing between formal, informal, economic
and other barriers.
Our analysis introduced four main contributions. Firstly we developed a conceptual model to
distinguish three main influences on business development: formal, informal and economic
barriers. Secondly we classified the transition countries into three transition stages we
developed based on the EBRD indicators. Thirdly, through a systematic analysis of 35
existing studies, we operationalise our conceptual model in order to obtain insights into the
main barriers that affect SMEs at different stages of the transition process. Finally, given the
extensive data utilised, we are able to provide a more broad-based illustration of some of the
general trends experienced by SME owners during the transition process that up until now
have been mainly researched using a country-specific approach.
Our results indicate that a number of constraints experienced by SMEs changes as the
transition process progresses. SME owners seem more affected by more fundamental
barriers formal constraints in stages 1 and 2 (the primary and secondary stages of transition)
while in stage 3 (the more advanced stage) SME owners seem to become increasingly more
concerned with human resources (labour) and skill development (training) than in earlier
stages. We also find that three formal barriers such as taxes, policy instability and
uncertainty and one environmental barrier, access to and cost of financing, form business
barriers regardless of the transition stage. Since our results fall in line with much of the
findings indicated by individual transition country studies, we are able to highlight the general
effects of certain business barriers on SME development during stages in the transition
process.
The types of policies and programmes offered to business owners should also be sensitive to
these changes. Since SME owners in stages 1 and 2 seem much more affected by
fundamental formal constraints, at these stages policies that would diminish these barriers
such as information on taxes and simplified tax policies would be most appropriate. Whereas
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businesses in stage 3 may profit more greatly from specific business training programmes to
improve their skills in marketing, obtaining specific forms of financing and growing their
business into new markets. Since formal barriers such as policy instability and uncertainty
seem to continue to form business barriers throughout the transition process, it is of utmost
importance that policy makers in the transition countries focus on insuring a transparent and
straightforward policy development process. Finally, given the fact that access and cost of
financing continued to be a constraint to SMEs regardless of the transition stage, it is a
fundamental issue that should be addressed at all stages of the transition process.
Furthermore, as Pissarides (2004) has indicated, it is important for financing opportunities to
adapt to the requirements of SME owners as transition progresses, allowing for more
complex forms of financing including venture capitalists in more advanced stages.
There is much ground for future research focusing on identifying general characteristics of
SME barriers during different stages of transition. Specifically, it would be very insightful to
implement a more quantitative, meta-analysis approach based on the conceptual model and
transition stage classification developed in this paper.
Acknowledgements
We thank Professor Friederike Welter and our Inter-Rent referees Albert Maydeu-Olivares, Dave Bouckennooghe
and one anonymous referee for their valuable comments. The remaining shortcomings, however, remain our own
responsibility. Both authors contributed equally to the writing of this paper, names are listed in alphabetical order.
E-mail of authors: Ruta Aidis, [email protected], and Arnis Sauka, [email protected]
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Appendix 1 - EBRD Transition indicators (average)
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
2004
Albania 1.00 1.00 1.11 1.63 1.89 2.07 2.33 2.48 2.48 2.48 2.48 2.63 2.67 2.67 2.67
2.81
Armenia 1.00 1.00 1.00 1.48 1.52 1.59 2.11 2.44 2.52 2.67 2.70 2.70 2.85 2.92 2.96
3.00
Azerbaijan 1.00 1.00 1.00 1.19 1.30 1.30 1.70 1.85 2.15 2.33 2.33 2.41 2.48 2.56 2.59
2.63
Belarus 1.00 1.00 1.00 1.26 1.56 1.59 2.00 1.82 1.67 1.52 1.52 1.59 1.67 1.78 1.81
1.81
Bulgaria 1.00 1.11 1.70 1.85 2.04 2.26 2.33 2.37 2.81 2.81 2.92 3.11 3.15 3.22 3.26
3.37
Czech
Republic 1.00 1.00 2.11 2.63 3.07 3.30 3.30 3.41 3.48 3.52 3.55 3.59 3.67 3.67 3.67
3.74
Estonia 1.00 1.18 1.37 1.85 2.63 2.96 3.11 3.18 3.33 3.41 3.52 3.59 3.63 3.67 3.67
3.74
Georgia 1.00 1.00 1.00 1.26 1.41 1.41 1.96 2.44 2.70 2.78 2.81 2.92 2.92 2.92 2.92
2.96
Hungary 1.30 1.78 2.37 2.59 2.96 3.22 3.48 3.52 3.70 3.78 3.81 3.85 3.85 3.85 3.85
3.85
Kazakhstan 1.00 1.00 1.00 1.30 1.52 1.74 2.26 2.67 2.78 2.81 2.70 2.78 2.85 2.85 2.89
2.89
Kyrgyzstan 1.00 1.00 1.00 1.48 1.74 2.52 2.70 2.74 2.81 2.81 2.81 2.81 2.81 2.81 2.81
2.93
Latvia 1.00 1.00 1.19 2.00 2.26 2.81 2.81 3.07 3.11 3.11 3.18 3.22 3.26 3.41 3.48
3.56
Lithuania 1.00 1.15 1.19 1.59 2.44 2.67 2.85 2.96 3.04 3.07 3.15 3.26 3.37 3.48 3.48
3.48
Moldova 1.00 1.00 1.00 1.44 1.70 2.04 2.52 2.56 2.63 2.70 2.70 2.70 2.74 2.74 2.70
2.74
Poland 1.26 2.26 2.41 2.56 3.00 3.11 3.26 3.37 3.44 3.55 3.55 3.63 3.66 3.66 3.66
3.66
Romania 1.00 1.00 1.26 1.59 1.85 2.26 2.41 2.41 2.74 2.85 2.93 3.00 3.04 3.04 3.04
3.18
Russia 1.00 1.00 1.11 1.89 2.19 2.41 2.59 2.85 2.96 2.55 2.48 2.59 2.67 2.85 2.92
2.96
Slovak
Republic 1.00 1.00 2.11 2.52 2.85 3.04 3.11 3.19 3.19 3.22 3.30 3.33 3.41 3.44 3.48
3.56
Slovenia 1.52 1.74 1.89 2.04 2.70 2.85 2.93 3.04 3.07 3.22 3.30 3.33 3.33 3.37 3.37
3.37
Tajikistan 1.00 1.00 1.00 1.30 1.37 1.37 1.70 1.74 1.78 2.00 2.04 2.15 2.15 2.22 2.26
2.30
Turkmenistan 1.00 1.00 1.00 1.00 1.00 1.15 1.26 1.26 1.48 1.45 1.45 1.37 1.30 1.30 1.30
1.30
Ukraine 1.00 1.00 1.00 1.19 1.30 1.48 2.19 2.30 2.52 2.44 2.48 2.59 2.63 2.70 2.74
2.78
Uzbekistan 1.00 1.00 1.00 1.19 1.41 1.96 2.22 2.22 2.15 2.11 2.04 2.00 2.11 2.11 2.08
2.08
Source: EBRD (1994, 1995, 1996, 1997, 1998, 1999, 2000, 2001, 2002, 2003, 2004).
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Appendix 2 - Classification of barriers influencing SME development and growth
Formal Informal Economic Other
High taxes
Government intervention in economy
Laws and regulations (policy
instability/uncertainty, frequent changes,
non- transparency, unpredictability,
operation, customs and trade regulations,
accounting standards, business
registration)
Business inspections
High social security payment
Poorly functioning state (implementation of
business regulations problems arising
from administration as well as lack of
personnel)
Lack of state support (in terms of building
appropriate infrastructure with arising
constraints as information provision to
small firm employees, need for specific
consulting advice (marketing, financial,
psychological) and lack of SME policies)
Financing structure
Payment behaviour of clients
Rent-seeking through inspections
Motivation of the workforce/quality ethics
in the workforce
Bureaucracy
Poorly functioning state (business
security issues such as inadequate
measures against organized crime,
mafia)
Implementation of business regulations
(as a consequence of responsible
officials attitudes)
Lack of state support (represented by
attitude of the government towards
business)
Macroeconomic stability (inflation)
Physical infrastructure – old
unreliable equipment
Shortage of qualified workers
Shortage of high quality managers
Cost of loans, interest rates, collateral
requirements
Loan application
Unfair competition
Strong (domestic and foreign)
competition
Low product demand
High input prices
Suppliers not ready to deliver
(procurement problems)
Business training
Inability to grow into new markets
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Appendix 3 - Classification and types of SME barriers identified in different transition stages
Formal Informal Economic Other
All stages • High taxes/ tax rate
• Policy
instability/uncertainty
• Legal issues / regulations
• Financing problems
• Access to finance/credit
• Cost of finance/credit
Stage 1 • Customs and trade
regulations
• Macroeconomic stability
• Inflation
Stage 2 • Frequent changes to
laws/gov’t
• Time to register business
• Attitude of the gov’t
• Organised crime and mafia
• Inadequate measures against
corruption
• Business security
• Physical infrastructure – old
unreliable equipment
• Low product demand
• High input prices
• Suppliers not ready to deliver
• High interest rates
Stage 2&3 • Gov’t non-transparency
• Operation of commercial
law
• High social security
payments
• Bureaucracy
• Payment behaviour of clients
• corruption
• Unfair competition
• Premises rental costs
• Wage costs
• Infrastructure – lack of telephone
connections
• Business training
Stage 3 • Too many licenses
• Accounting standards
• Unpredictability of
economic regulations
• Information provision to
small firm employees
• Need for specific
consulting advice
(marketing, financial,
psychological)
• Preferential treatment
• Dishonest competition
• Too many tax inspections
• Implementation of business
regulations
• Motivation of the
workforce/quality ethics in the
workforce
• Lack of state support
• Shortage of qualified workers/labour
• Strong competition
• Lack of investment/finance for
expansion
• Inflation
• Inability to grow into new markets
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Appendix 4 - Studies on constraints facing SMEs in transition.
Transition
stage (data
collected)
Country(ies) Sectors
covered
Sample size Definition of SME
Method used Key informants Number of
barriers
examined
Author(s), title and source
III (2000) Slovenia All sectors
except
agriculture
173 Less than 250
employees
Personal interviews.
Random sample
SMEs owners and
managers
51 Barlett, W. and V. Bukvi?. 2001.
Barriers to SME Growth in Slovenia.
MOCT-MOST 11: 177- 195, 2001
II (1997) Albania Manufacturing,
construction,
trade and
service sectors
50 Less than 200
employees
Complete
questionnaire (nearly
400 questions) and
face to face interview
SMEs owners and
managers
15 Hashi, I. 2001. Financial and
Institutional Barriers to SME Growth in
Albania: Results of an Enterprise
Survey. MOCT- MOST 11: 221- 238,
2001
III (1997) The Czech
Republic
Manufacturing,
construction,
trade and
services
100 Less than 200
employees
Interviews SMEs owners and
managers
40 Bohata, M. and J. Mladek. 1999. The
Development of the Czech SME Sector.
Journal of Business Venturing 14, 461-
473, 1999
III (1999) Hungary Small- scale
manufacturing
or production,
services
280 na Mail surveys and
telephone interviews
Small business
owners and
operators
12 Fogel, G. An Analysis of
Entrepreneurial Environment and
Enterprise Development in Hungary.
2001. Journal of Small Business
Management 2001 39(1), pp. 103- 109
II (1996 and
1997)
Kyrgyz
Republic
Concentrated
on service
activities
1996: 160 1997:
219
na Mail questionnaire
Descriptive statistics
and Logit analysis.
Owners of small
non- farm
household
businesses
12 Anderson, K. and R. Pomfret. 2001.
Challenges Facing Small and Medium-
Sized Enterprises in the Kyrgyz
Republic, 1996-97. MOCT- MOST
11:205-219, 2001
II (1993,
1996 and
1998)
Russia All sectors 1993: 277 and
281
1996: 887
1998: 227
According
Russian
Federation
federal law of 14
June, 1995.
Standardized survey SMEs owners and
managers
8 Radaev, V. 2001. The Development of
Small Entrepreneurship in Russia.
WIDER Discussion Paper No. 2001/135
III (1997
and 1998)
Hungary All sectors 2000 na na Owners and
managers of small
enterprise
11 Dallago, B. 1999. Context and Policies
for the Transformation and Growth of
SMEs. The Case of Hungary with
Russian Implications. WIDER Research
for Action 50.
III (1993) Poland na na na Interviews Small business
owners and
managers
11 Robson, G. 1993. The problems facing
small firms in Poland. Discussion Paper
No 93-4 School of Business
Management, University of Newcastle
upon Tyne, UK.
II (1995) Russia and
Bulgaria
All sectors Russia: 216
Bulgaria: 221
Less than 200
employees
Interviews. Random
samples. Tabulation
of responses.
Multinominal
regression analysis.
SMEs owners and/
or chief executive
officers
11 Pissarides, F., Singer, M. and Svejnar,
J. 2003. Objectives and Constraints of
Entrepreneurs: Evidence from Small
and Medium Size Enterprises in Russia
and Bulgaria. Journal of Comparative
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Regionally stratified
random samples.
Economics (2003) 13, 503-531
II (1993-
1996)
Bulgaria All sectors 120 Less than 50
employees
Mail questionnaire Small business
owners and
managers
13 Dmitrov, M. and Todorov, K. 1995.
Small Business Development in
Bulgaria. In Fogel, et al. 1995 (eds).
Moving to Sustainability. How to Keep
Small Business Development Centers
Alive. Averbury. England, USA.
III (1999) Poland All sectors 320 Less than 50
employees
Mail questionnaire Small business
owners
10 Matusiak, K. 1999. Entrepreneurial
Attitudes and Innovations of Small and
Medium- Sized Enterprises in Poland.
Unpublished
III and II
(1993)
Poland,
Hungary, the
Czech Republic
(III) and Slovak
Republic (II)
All sectors 140 in each
country
Less than 500
employees
Mail questionnaire SMEs owners and
managers
16 OECD working papers, vol. IV. Small
Business in Transition Economies,
1996.
II (1999) Albania All sectors 101 Less than 250
employees
Mail questionnaire SMEs owners and
managers
9 Muent, H. 2001. Taxes, Competition
and Finance for Albanian Enterprises:
Evidence from a Field Study. MOCT-
MOST 11: 239-251, 2001.
II (1996) Russia and
Poland
Shops 55 in Russia
(Moscow)
50 in Poland
(Warsaw)
Less than 50
employees
Survey Owners 6 Frye, T. and A. Shleifer. 1997. The
Invisible Hand and the Grabbing Hand.
American Economic Review, 1997,
87/2, 354 – 358.
I, II and III
(1997)
All 23 countries All sectors Different sample
size in different
countries
Less than 200
employees
Mail questionnaire Owners and
mangers
31 World Development Report 1997. World
Bank.
I, II and III
(1999)
All 23 countries All sectors Different sample
size in various
countries
Less than 200 Mail questionnaires SMEs owners and
managers
65 BEEPS 1999, EBRD and World Bank.
I, II and III
(2002)
All 23 countries All sectors Different sample
size in various
countries
Less than 250 Mail questionnaires SMEs owners and
managers
25 BEEPS 2002, EBRD and World Bank.
I and II
(1997)
Ukraine (II) and
Belarus (I)
All sectors 343 in Ukraine
200 in Belarus
Less than 200 Quantitative survey
and in- depth case
studies
SMEs owners and
managers
17 Smallbone, D. et al. 2001. The
contribution of Small and Medium
Enterprises to Economic Development
in Ukraine and Belarus: Some Policy
Perspectives. MOCT-MOST 11: 253-
273, 2001.
III (2000) Lithuania All sectors 332 Less than 50
employees
Mail questionnaire
SMEs owners and
managers
19 Aidis, R. 2003. By law and by custom:
Factors affecting small- and medium-
sized enterprises during the transition in
Lithuania. Tinbergen Institute Research
Series, PhD Thesis.
III (2000) Lithuania All sectors 1500 Less than 50 Mail questionnaire SMEs owners and 11 Survey by the Employer’s House, the
2
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employees managers Lithuanian Business Employers’
Confederation and SIC Market
Research. Lithuania, 2000.
III (1998) Latvia All sectors 295 Less than 250
employees
Interviews SMEs owners and
managers
16 Tisenkopfs, et al. 1998. How does small
entrepreneur feel? Report to the
Government of Latvia. Philosophy and
Sociology Institute of the University of
Latvia. (In Latvian)
III (1997) Latvia All sectors 180 Less than 250
employees
Mail questionnaires
and interviews
SMEs owners and
managers
9 Kuzmina, I. 1999. Socially economical
aspects of entrepreneurship in Latvia
during transition period to market
economy. PhD Thesis, University of
Latvia. (In Latvian)
III (2001) Latvia All sectors 541 Less than 250
employees
Interviews Top managers of
SMEs
12 Latvian Development Agency and the
World Bank Foreign Investment
Advisory Service. 2001.
III (2002) Latvia All sectors 300 Less than 250 Face to face
Interviews or
questionnaire
SMEs owners and
managers
16 SKDS. 2002. Environment of Small and
Medium size entrepreneurship in Latvia.
Results of enterprise survey. (In
Latvian)
III (1997-
1999)
Lithuania All sectors 1750 Not only SMEs
but only 3
percent of the
respondents had
more than 49
employees
Face to face
administration of the
questionnaire
owners and
managers
14 Jancauskas, E. 2000. Verslo Pletra:
Lietuvoje ir vidurio Europoje, Statistikos
Tyrimai, Vilnius. (In Lithuanian)
II (1999) Ukraine All sectors 900 SMEs (less than
250 employees)
Face to face
interviews
Directors/
managers
19 Yacoub, M. and B.Senchuk. 2000. The
state of small business in Ukraine. An
IFC Survey of Ukrainian small
enterprises.
II (1999) Ukraine All sectors 3800 SMEs (up to 250
employees)
Face to face
interviews
Directors and
managers
17 Gray, A.T. and W.B. Whiston. 1999. A
survey of business in Ukraine. By
Management Systems International and
Kiev International Institute of sociology.
II (1995 and
1996)
Russia All sectors N/a SMEs (up to 250
employees)
N/a N/a 8 OECD, 1999. Financing Newly
Emerging Private enterprises in
transition economies. Survey by
Russian Independent Institute of Social
and National Problems.
III (1997) The Czech
republic
All sectors 100 SMEs (up to 200
employees)
Interviews N/a 11 Csaba, L. 1998. (ed.). The Hungarian
SME sector development in
comparative perspective. By Center for
international Private Enterprise USAID.
funded and KOPINT- DATORG
Foundation for Economic Research.
III (1995) Poland, Manufacturing Total 600 SMEs (up to 250 Face to face Managers 16 Smallbone, D. et al. The development
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Estonia, Latvia,
Lithuania
interviews employees) interviews of Manufacturing SMEs in Poland and
the Baltic States: Policy issues and
priorities. In Ram, M. et al. 1997. Small
Firms Enterprising cultures. Published
by Paul Chapman Publishing.
II (1992) Poland All sectors 190 SMEs (up to 250
employees)
Mail questionnaires Owners 11 Study by the Department of Economics
and Management. 1992. In Daskiewicz,
N. Barriers of growth of small and
medium size enterprises in Poland
according to the opinion of their owners.
III (1999) Poland All sectors 93 SMEs (up to 250
employees)
Mail questionnaires Owners 17 Study by the Department of Economics
and Management. 1999. Follow up of
1992 study.
In Daskiewicz, N. Barriers of growth of
small and medium size enterprises in
Poland according to the opinion of their
owners.
III (1998) Estonia Manufacturing
and service
sectors
100 SMEs (up to 250
employees)
Interviews N/a 29 Phare 1998 report. The state of small
business in Estonia. Ch. 4. Problems
and priorities of Estonian SMEs.
III (1998) Poland All sectors 742 SMEs (up to 250
employees)
Mail questionnaire N/a N/a Dzierzanovski, W. 1998. (ed). Report
on the condition of the small and
medium size enterprise sector in
Poland for the years 1997-1998.
Chapter 9. SME development barriers.
III (1999) Poland All sectors 150 SMEs (up to 250
employees)
Structured interviews N/a 10 Couch, B. 1999. Growth strategies for
SMEs in a transition economy: the case
of Poland. 22
nd
ISBA National Small
Firms Policy and Research Conference
Proceedings. Leeds, United Kingdom.
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Appendix 5 - Single country studies distinguishing among different stages of economic transition
Country Stages Approach Author(s), title and source
Belarus
Three
stages
1991- 1994;
1995- 2000;
2001
onwards.
During the 10 years of its independence, Belarus is classified into
three periods. The first one represents the beginning of the market
transformations, second- starting of the system crisis and time
when economic transformation took place. Third stage, however,
is characterised by overcoming of the economic crisis, relative
stabilisation and beginning of a stable growth. But as the author
notes classification is no easy task since there is “contradicting
economic transition in Belarus … “ (Kobiakov, 2003: 3)
Kobiakov, A. 2003. Socio-economic
development of Belarus. In Best Practice
in the Development of Entrepreneurship
and SMEs in Countries of Transition: The
Belarussian Experience. United Nations,
Geneva, Switzerland.
Estonia
Three
Stages:
1988-1991;
1992-1997;
1998
onwards.
Four
stages:
late 1980s;
1990-1991;
1992-1993;
1994-
onwards.
Three
stages
1986- 1989;
1990- 1993;
1994
onwards.
Stages classified according development of SME sector.
Phases of transition classified according development of private
enterprising in Estonia. First stage in this classification represents
pre transition period, e.g. first steps in order to develop new forms
of entrepreneurship, Fourth one, however, represents the
beginning of micro and macro stabilisation.
Stages classified according business development in Estonia.
Kilvits, K. R. Lumiste, R. Lumiste. 2002.
SME policy influence on the economic and
regional development of entrepreneurship
in Estonia. RENT XVI Conference
Proceedings. Barcelona, Spain.
Aho, S., T. Piliste and J. Teder. 1998.
Abstract. In Private Entrepreneurship in
Estonia 1989-1996. Experiences and
Challenges of Transitional Economy.
University of Tampere, Research Institute
for Social Sciences. Työraportteja 54/1998
Working Papers.
Teder, J. Experiences and Challenges of
the Estonian Entrepreneur. In Private
Entrepreneurship in Estonia 1989-1996.
Experiences and Challenges of
Transitional Economy. Chapter 4.
University of Tampere, Research Institute
for Social Sciences. Työraportteja 54/1998
Working Papers
Latvia
Three
stages.
Late 80
th
-
end of
1990;
1991-1993;
1994 -
Stages of transition distinguished from the point of view of the
development of the Latvian small business sector.
Kuzmina, I. 1999. Entrepreneurship and
Small Business development in Latvia.
RENT XIII Conference Proceedings.
London, UK, 1999.
2
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onwards.
Lithuania
Two stages:
pre 1994;
post 1995.
Two distinct transition periods towards market economy are
distinguished. First one is mainly characterized by negative
economic developments, as decrease in total industrial
production, domestic turnover and international trade, upsurge in
inflation and fall of the standard of living as well as weakening in
labour and financial control (UNDSP 1999: 9 in Aidis, 2003). The
period after 1994, however, are characterized by macro
stabilisation, represented by stable growth of GDP and
investment, decrease in inflation, increased foreign investment,
relatively low and stable unemployment and other indicators.
Aidis, R. 2003. By law and by custom:
Factors affecting small- and medium-sized
enterprises during the transition in Lithuania.
Thela Thesis: Amsterdam.
Poland
Three
stages:
1989- 1990;
1991-1992;
1993
onwards.
Transition phases are distinguished from the viewpoint of
entrepreneurship and specifically private sector development.
Biesbroucc, W. and V. Bilsen. 1995. The
importance of SMEs Restructuring with
and Application to Poland. In Industrial
Organisation and entrepreneurship in
Transition. 1996. Dimitrov, M. and
K.Todorov. (eds.). Proceedings of the
international conference, Varna- Albena,
Bulgaria, June 5-8, 1995.
Romania
Three
stages:
1990-1993;
1994-1998;
1998 –
onwards.
Three distinct stages of transition that overlap the political
developments are classified in the context of the process of
economic and social reform.
Sergio, A. 1998. Transition and
Democracy in Romania: the Pains of a
Gradualist Restructuring. In Larcon, J.P.
(ed.). 1998. Entrepreneurship and
Economic Transition in Central Europe.
Kluwer Academic Publishers.
Russia
Three stages:
1987-1988 (pre transition);
1989-1991;
1992- onwards.
Four stages
1986-1991;
1992-1994;
1995-1997;
1998 – onwards.
Stages are distinguished considering development of
Russian entrepreneurship and entrepreneurs.
Stages are distinguished from the viewpoints of
macroeconomic policy, legislation and institutional
change from the point of view of SME sector
development. First stage represents pre transition
period, the third one- relative stabilisation followed by
the fourth stage classified as ‘crisis’, when “belief that
economic stabilisation has been achieved collapsed
in August 1998 with the end of the ‘financial pyramid’
built on state short term securities”. (Radaev, 2003:
117).
Lynch, R.D. and V.V. Makoukha. 1997. Entrepreneurs in Post-
Communist Russia. In Privatization and Entrepreneurship. The
managerial Challenge in Central and Eastern Europe by Ullmann A.A.
and A. Lewis (Eds). New York : International Business Press, cop..
Radaev, V. The Development of Small Entrepreneurship in Russia. In
McIntyre, R.J. and B. Dallago (Eds.). 2003. Small and Medium
Enterprises in transitional Economies. Palgrave Macmillan, Great
Britain.
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Appendix 6 - Alternative indicators
A seemingly obvious and straightforward indication of economic transition progress
would be GDP growth figures. Though all transition countries experienced a decline in
output, a number of countries have been able to record high levels of GDP growth especially
in the mid to late 1990’s. Table A6 presents the estimated level of real GDP in 2003 as
compared to pre-transition GDP rates measured in 1989. Ten out of twenty-three countries
have surpassed their 1989 GDP levels. However, the arbitrariness of this development and
incongruity with other EBRD transition indicators seriously questions its explanatory value.
Hungary and Poland’s high degree of economic recovery corresponds to their economic and
political reforms however Albania’s high score is matched by only a secondary level of
transition. Closer inspection of Albania’s GDP level shows high levels of international aid has
resulted in increasing its GDP figures to an artificially high level.
Table A6 - Estimated GDP level of real GDP in 2003 (1989 = 100)
Country Estimated GDP 2003 Country Estimated GDP 2003
Albania 129 Lithuania 84
Armenia 89 Moldova 41
Azerbaijan 71 Poland 135
Belarus 100 Romania 92
Bulgaria 84 Russia 77
Czech Republic 108 Slovak Republic 114
Estonia 102 Slovenia 120
Georgia 41 Tajikistan 62
Hungary 115 Turkmenistan 105
Kazakhstan 94 Ukraine 51
Kyrgyzstan 75 Uzbekistan 107
Latvia 83
Source: EBRD 2004
Unfortunately, when searching for other possible indicators, substantial data
problems were encountered. A study by Raiser et al. (2001) investigated the relevance of a
number of factors to institutional change in 25 transition countries. They developed a
structural model of institutional change using both time series and cross-sectional data on
transition countries. In their results, Raiser et al. find strong evidence that economic reforms
and political liberalisation are more powerful forces influencing institutional change than
changes in economic structures induced by such reforms. Hence the importance of political
liberalisation for economic transition. The results of the study by Raiser et al. (2001)
indicating the political liberalisation is an important determinant of institutional change
inspired us to refer to measures of political liberalization. Therefore we consulted the surveys
conducted by Freedom House measuring the levels of civil liberties and political freedom. We
were able to find data for our entire country sample however the earliest observation year is
1993. According to our estimates using the EBRD transition indicators, by 1993, ten
countries had already entered the second stage of transition. Therefore if we were to use the
Freedom House data, we would miss four crucial observation years.
Another possibility was to use data on levels of corruption such as those presented in
the corruption index by Transparency International. Measures of corruption can provide an
indication of a harmonisation of informal and formal institutions. However here we run into
even greater data problems since the earliest observation year is 1995 and then only for
Hungary. Most countries are represented in the sample only by 1999 however even by 2003
not all countries are represented.
We also consulted the measurement of informal markets in the Index for Economic
Freedom compiled by the Heritage Foundation. The level of informal markets can indicate
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the level of compliance with formal rules. However, in this index the earliest observation year
for most of the transition countries is 1995 and not all of them are included.
In addition, we referred to the Heritage Foundation’s index for government
intervention. Decreasing rates of government intervention could serve as an indication of a
shift of economic power from government control to private economic agents. However, the
Heritage Foundation’s index for most transition countries begins in 1995. Using this index for
evaluating transition seems highly suspect given the fact that some advanced Western
countries exhibit very high levels of governmental intervention such as France (score = 5)
and Norway (score = 3.5) and seem to be able to combine it with an efficient market
economy. The score for Belarus is the same as for Norway (score = 3.5) in 2003 which
reveals nothing regarding the actual transition progress since Belarus continues to be an
example of a transition country that is unreformed and reluctant to introduce any fundamental
market-oriented mechanisms. According to EBRD indicators, Belarus is only at the primary
stage of transition (EBRD 2003).
Another alternative measure would be to look at human development related
indicators such as poverty, income distribution, years of schooling and mortality rates. Here
once again data is limited and only available in the mid 1990’s and late 1990’s for most
transition countries. We also consulted various macroeconomic indicators in order to assess
the transition stages such as inflation levels, exchange rate regimes, current account balance
and percentage of GDP created by the private sector. But for each one of these indicators,
we found quite serious inconsistencies in terms of their relation to actual transition progress
measured by the EBRD.
In sum, most indicators measuring transition do not provide coverage of the entire
transition period and are therefore not suited for our study. The most appropriate
combination that can be used from the existing literature seems to be the EBRD transition
indicators and Van de Mortel’s classification of transition indicators (2002).
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Appendix 7 - EBRD transition indicators
In order to understand the development of EBRD’s transition indicators, it is important
to understand the motivation behind their creation. EBRD’s analysis of reform patterns in
transition countries since 1989 suggests that three factors are crucial for sustaining reform
progress: (1) Comprehensive economic liberalization to create market competition and
generate demand for market-supporting institutions; (2) Market liberalization is more effective
combined with political competition; (3) The process of transition is facilitated by international
integration (EBRD 2002).
According to the EBRD, the first or initial phase of transition was dominated by the
structure of the inheritance from the communist system and the political repercussions
following the collapse of this regime. The main reforms characterising this period include: the
privatisation of assets (small-scale privatisation), the liberalisation of markets (through price
liberalisation and foreign exchange and trade liberalisation) and the establishment of a
degree of macroeconomic stability (EBRD 1997).
The next phase of transitional reforms requires policies, institutions and behaviours
that can foster and accelerate economic growth. Second transition phase reforms include a
continuation of the privatisation of assets (through large-scale privatisation), improving
enterprise performance through governance and enterprise restructuring, the further
liberalisation of markets (through competition policy), the development and maintenance of
infrastructure (through infrastructure reform) and reform to financial institutions (banking and
interest rate liberalisation and the creation of non-banking financial institutions). A main
challenge in this phase is developing and providing market-oriented governance i.e. a
building and deepening of the institutions and behaviour that are at the heart of a well-
functioning market economy (ibid.).
The EBRD transition indicators are based on annual scores indicating
transitional progress and are calculated based on an average score of nine separate
indicators grouped into four categories
11
: Enterprises, markets and trade, financial institutions
and infrastructure. The ‘Enterprises’ category includes separate indicators for progress in
large-scale privatization, small-scale privatization and governance and enterprise
restructuring. ‘Markets and trade’ includes three separate indicators measuring price
liberalisation, trade and foreign exchange system and competition policy. Financial
institutions include two separate indicators measuring banking reform and interest rate
liberalisation and securities markets and non-bank financial institutions. Infrastructure
includes only one indicator measuring infrastructure reform.
In brief, the ‘enterprises’ category measure indicates the process of large-scale
privatisation; the implementation of reforms to cut production subsidies; the introduction of
effective bankruptcy procedures; and sound corporate governance practices (EBRD 2001).
The ‘markets and trade’ category indicates the extent and effectiveness of competition policy
in combating the abuses of market dominance and anti-competitive practices. With regards
to ‘financial institutions’, this indicator measures the extent to which interest rates have been
liberalised; the establishment of two-tier banking; and the creation of securities markets. In
addition, ‘financial institutions’ also assesses the extent to which prudential regulations have
been raised towards international standards, whether they have been enforced effectively
and if procedures exist for resolving the failure of financial institutions. Finally, the
infrastructure indicator measures the extent of tariff reform; the commercialisation of
enterprises; and the extent of regulatory and institutional development (ibid.).
11
For a more detailed description please refer to EBRD (2003:17).
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Indicators of Entrepreneurship Activity:
Some Methodological Contributions
12
Rachida Justo, Alberto Maydeu and Julio O. De Castro
Instituto de Empresa Business School
Abstract
Using a model-based approach, this paper re-examines the measurement of entrepreneurial
activity at the national level. Our contribution centres on two main aspects. First, our study
allows for the measurement of the likelihood of entrepreneurial behaviour, or entrepreneurial
propensity. Second, utilizing social network theory, we introduce the social entrepreneurial
environment as a key indicator of likelihood of entrepreneurial activity.
Using the data provided by the Global Entrepreneurship Monitor (GEM) project, we provide
an alternative measure of entrepreneurial activity which includes entrepreneurial social
environment, assumes the existence of a continuum in entrepreneurial behaviour and
provides a measure of entrepreneurial propensity. Results indicate that our model provides
support for the combined use of entrepreneurial propensity and the entrepreneur’s social
context.
Key Words: Entrepreneurship, Cross-country-Measurement
Introduction
Our contribution centres on two main aspects. First, our study allows for the measurement of
the likelihood of entrepreneurial behaviour. Different than prior measures of entrepreneurial
activity, where individuals are or are not considered entrepreneurs, we argue theoretically
and analyze empirically the notion of levels and likelihood of entrepreneurial behaviour.
Rather than classifying individuals as entrepreneurs or non-entrepreneurs, we adopt a more
dynamic view of the phenomenon by letting individuals differ in their propensity to engage in
entrepreneurial activities. In doing so, we argue for examining differences over time within
countries, as well as across countries.
Second, utilizing a social network theory approach, we introduce the social entrepreneurial
environment as a key indicator of likelihood of entrepreneurial activity. We contend that the
level of an individual’s entrepreneurial activity is affected by the social context in which that
activity occurs. This context is not uniform and its effect varies due to factors such as social
networks, education, gender, etc. As a result, an entrepreneur’s personal social network is
treated here as a random variable that changes from individual to individual.
The core of our proposed theoretical model lies in the use of two latent continuous variables:
the first one reflects an individual’s entrepreneurial propensity, that is, his likelihood of
12
Support for this research comes from a Grant from Fundación BBVA, Madrid. Spain
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engaging in venture creation. The second dimension reflects the individual’s social
entrepreneurial environment, and captures the elements of a person’s adjacent environment
that may affect his entrepreneurial propensity. We argue that this measure should be built
into the analysis of entrepreneurial activity, and should help provide a strong indicator of the
pervasive effects of entrepreneurship.
The purpose of the paper is to propose a new approach to measuring entrepreneurship, one
that is complementary to the approaches that have been used recently in cross-country
comparisons. Our hypotheses will be tested using data available the GEM project for
comparing entrepreneurship levels across countries. Whilst we recognize the contribution of
prior studies measuring entrepreneurial activity
13
- such as the GEM project - as a means of
gaining insights into the dynamics of entrepreneurship, we seek to provide a new model of
entrepreneurship that, in conjunction with existing measures, will help us reach a more
consistent and comprehensive view of the variation of the entrepreneurial phenomena within
and across countries.
The Measurement of Entrepreneurial Activity
While most scholars concur about the need to measure new venture creation,
entrepreneurial activity, and its impact on the wealth of societies, there is no consensus
about how to measure this phenomenon or about the adequacy of previous and current
measures (Davidsson, 2004; Dennis 1997, 1999; Gartner and Shane, 1995; Verheul et. al
2002; Williams 1993). There are several reasons for this lack of scholarly agreement. First,
the extant literature on entrepreneurship has proposed a broad array of different definitions
of this phenomenon (Gartner 1990; Hébert, and Link 1989; Praag 1999; Shane and
Venkataraman 2000). Entrepreneurship is indeed a multidimensional concept, which,
depending on the focus of the research and the theoretical perspective adopted, can address
very distinct social realities (Davidsson 2004; Verheul et al. 2002). Underlying these social
realities two major views exist in the entrepreneurship literature (Bruyat and Julien 2000;
Davidsson 2004). The first, following the seminal works of two French theorists, Turgot and
Say, considers entrepreneurship as anything related to independently owned businesses and
their owner-managers. The second follows the approach of Cantillon and Schumpeter
14
, and
studies entrepreneurs through their fundamental role in economies as innovators.
This diversity of definitions has, in turn, significant implications for the measurement of
entrepreneurship levels (Reynolds, 1992a). For instance, final counts can vary depending on
the view adopted by researchers to determine who is an entrepreneur; in particular, whether
a firm is started for the purpose of self-employment is to be included in the measure of
entrepreneurship or whether only firms started with the prospect of value creation are
included. Indeed, many firms that are started with the purpose of creating self employment
13
See for example the PSED project (http://projects.isr.umich.edu/PSED/index.cfm).
14
For more information about J. Turgot, J.B. Say, R. Cantillon and J. Schumpeter, see Herbert and Link (1982).
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would not be included in the measure of entrepreneurial activity if the baseline for inclusion
was firm/value creation and the expectation of future growth.
Second, the measurement of entrepreneurial activity in a country depends on the level of
analysis chosen by the researcher. In their review of longitudinal studies on
entrepreneurship, Gartner and Shane (1995) identified two types of research: research
focusing on individual level activity (e.g., self-employment) in order to measure the
entrepreneurial phenomenon, and that mostly concerned with firm level activity (e.g.,
organization creation). However, both approaches present inherent shortcomings; measures
focusing on individuals not only ignore firms but might also undercount some specific kinds of
entrepreneurs (e.g. self-employed who hire employees). By contrast, firm creation measures
often fail to capture businesses started as proprietorships or partnerships.
A third issue raised by researchers deals with the methodological approaches used to
measure entrepreneurial activity. Scholars have expressed concerns regarding the
undercounting of new firm entries and exits in the market, and the effect of this
undercounting on the assessment of the impact of entrepreneurial activity (Bates 2005;
Birley, 1984; Davidsson 2004; Dennis 1997, 1999; Williams 1993). Moreover, many of the
databases used by entrepreneurship scholars have been designed for purposes other than
the study of entrepreneurship, making them a less than suitable tool for gauging the
phenomenon of entrepreneurship from an academic point of view.
Applied to cross-country comparisons, the measurement issues associated with
entrepreneurship become even more problematic and the researcher is faced with additional
elements to take into account. On the one hand, the absence of universally agreed upon
indicators makes it particularly difficult to provide meaningful and reliable comparisons of the
level entrepreneurship across nations (OECD 1998). Verheul et al. (2002) assert that country
levels of venture creation can indeed be determined by a wide spectrum of factors, the
importance of which varies according to “the disciplinary approach, the level of analysis, the
discrimination between demand and supply factors and a distinction between influences on
the actual and equilibrium rate of entrepreneurship” (Verheul et al. 2002: p.7).
On the other hand, levels of entrepreneurial activity in a country can be affected by
contextual issues such as the existence of a supportive or hostile macro or microenvironment
for venture creation. This argument is consistent with Gartner and Shane’s (1995) claim that
measures of entrepreneurial rates need to reflect both a longer time frame and some kind of
measure of the effect of the environment.
Measuring Entrepreneurial Activity in the GEM Project
The GEM project constitutes a very important research tool that can allow entrepreneurship
scholars to address the issues related to the measurement of entrepreneurial activity across
countries. However, operationalizing and implementing the measures used in this project is
not ideal and, like any other measure, can be improved. Moreover, the GEM provides a very
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rich database that has not been fully exploited and we believe that our study can help to
present this data in a way that is more respectful of the complex entrepreneurial realities.
One of the better known outcomes of the GEM project is an estimate of a nation’s
entrepreneurial activity, the Total Entrepreneurship Activity (TEA) index. The GEM study is
designed to overcome a number of concerns raised in prior research about the measurement
of entrepreneurship. Heeding the advice of Gartner and Shane (1995), it is a yearly ongoing
measure designed to capture entrepreneurial activity and its effects over time. Trying to meet
the challenge of obtaining a representative sample of on going, independent start-up
processes and, therefore, addressing the concerns of Dennis (1997), Williams (1993) and
Birley (1984), the GEM project is also based on a very large random sample of adult
individuals. These individuals are presented with three focal screening questions aimed at
identifying those in the process of creating a venture:
• q1: whether the individual is currently involved in a startup (indication of being
nascent entrepreneur)
• q2: whether their current job involves a start-up (nascent intrapreneur)
• q3: whether the individual is the owner/manager of a new business (owner-manager)
Individuals who identify themselves as a nascent entrepreneur/ nascent intrapreneur/ or, an
owner-manager of a new firm, are directed to a longer interview where they are asked
specific questions about themselves and their firms. Therefore, the resulting TEA index has
the advantage of addressing the issue of levels of analysis raised by Gartner and Shane
(1995), because it allows for the capture of individual self-employment as well as new firm
creation.
Despite its utility, the GEM project is still striving to reach full scholarly recognition with
respect to its TEA index being a reliable tool for measuring entrepreneurship across
countries (Hindle, 2005). We believe that one possible way to diminishing researchers´
reticence to make the most of the GEM data is by enhancing the measure of
entrepreneurship levels for each country
15
. Therefore, a significant contribution of this paper
is a re-examination of the way entrepreneurial activity is measured using the existing GEM
data.
Theoretical Background
In this study we propose an alternative model-based approach to measuring and comparing
entrepreneurial activity within and across countries, an approach that introduces two main
modifications to the traditional ones used in measuring the extent of entrepreneurial activity
in a country.
15
While we acknowledge that the GEM Project would benefit from a substantial rework of the questionnaire
currently used, changes in the questionnaire affect the ability for continuous and longitudinal analysis. The
improvements proposed in this paper relate to the approach taken in measuring entrepreneurial activity, not to
the questionnaire itself.
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First, rather than viewing entrepreneurial activity as either/or proposition, that is, individuals
either are or not entrepreneurs, we introduce the notion of a likelihood for entrepreneurial
behaviour. In doing so, our model measures this likelihood and creates an index that is a
continuous variable that allows individuals to vary in their propensity to undertake
entrepreneurial activities.
Secondly, and drawing upon social network theory, we base our model on the assumption
that entrepreneurial activity is affected by the social context in which that activity occurs, so
that a measure of the entrepreneur’s personal network, in combination with a measure of its
propensity to undertake an entrepreneurial activity, provides a richer measure of the impact
and strength of entrepreneurial behaviour in specific countries. Whereas the measurement of
direct entrepreneurial activity is important, we believe that it is incomplete without an
examination of the entrepreneurial social environment and its impact on the likelihood of
venture creation.
Measuring a Country’s Entrepreneurial Propensity
Following Gartner’s (1989) view that “who is an entrepreneur?” is the wrong question, we
similarly argue that “how many entrepreneurs there are in a country?” or “which country has
the highest rate of entrepreneurs?” is an incomplete enquiry (Hindle, 2005) and should be
replaced with an assessment of a country’s relative propensity for entrepreneurship.
Assuming that entrepreneurs “are not a well defined population but a hazy and moving
target” (Davidsson, 2004, p. 70), we believe that researchers should be cautious when
comparing the level of nascent entrepreneurial activity across countries and should qualify
the TEA index with a measure that captures a country’s actual and future entrepreneurial
potential.
The TEA national index is computed as the proportion of respondents classified as nascent
entrepreneurs in a representative national sample. Each individual in the sample is classified
as either an entrepreneur or non-entrepreneur based on his or her responses to the
questions q1 to q3 in the GEM survey. We argue that the use of this classification overlooks
an essential dimension of the entrepreneurship phenomenon, that is, individuals can show a
varying propensity or degree of entrepreneurship.
The concept of “degrees of entrepreneurship” was first introduced by Cooper and
Dunkelberg (1986) to illustrate how the different ways of becoming a business owner
exhibited different levels of entrepreneurial intensity. Several scholars took over this notion to
explore individual-level (Tay 1998), as well as organizational-level variations (Schafer 1990)
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in entrepreneurial inclination
16
. More recently, Davidsson (2004) built on this idea and
stressed the importance of studying “Why, when and how do individuals, organizations,
regions, industries, culture, nations (or other units of analysis) differ in their propensity for the
discovery and exploitation of new venture ideas” (Davidsson 2004, p. 29). Following this
reasoning, we present an improvement in the TEA measure based on the proposition that
entrepreneurial behaviour should be measured on a continuum. Specifically, we claim that
rather than treating entrepreneurship as a dichotomous variable, it seems more legitimate to
consider that some economic actors show a greater propensity
17
for entrepreneurship than
others.
H
1a
: Individuals’ propensity for entrepreneurial activity is a latent continuous
variable with multiple possible indicators.
H
1b
: Particular instances of entrepreneurial activity (such as being involved in a
start up) are linked to individuals’ propensity for entrepreneurial activity via a
threshold relationship.
The Role of the Entrepreneur’s Social Network
Research in sociology suggests that positions in a social structure influence the attitudes,
behaviours and outcomes of the actors occupying those positions (Granovetter, 1985). This
social influence has become an emerging subject of research in the field of entrepreneurship
(Dodd, 1997; Stuart and Sorenson, 2004) with the development of two main streams: inter-
organisational networks and the entrepreneur’s personal network
18
. Our study draws on this
second theoretical construct and studies its impact on the incidence of venture creation.
Bearing in mind researchers have adopted a variety of definitions of a personal network,
each one differing in scope, we adopt Gilmore and Carson’s (1999) definition of a network
as: “A collection of individuals who may or may not be known to each other and who, in some
way contribute something to the entrepreneur, either passively, reactively or proactively
whether specifically elicited or not” (Gilmore and Carson 1999, p. 31).
16
It is important to note that the notion of propensity to entrepreneurship used in this paper is different from the
similar concept used by some scholars which adopts a trait’s approach to defining entrepreneurs and the odds
of a person to become an entrepreneur. This is the case, for example, of the “entrepreneurial attitude
orientation” construct, which is positioned in the field of sociology (Robinson et al., 1991), and which used to
measure the entrepreneurial attitude along three dimensions: behaviour, belief and emotion. It is, however,
interesting to note that Kollmann et al. (2005) consider all these three factors to be connected to the individual’s
attitude towards a particular environmental stimulus. Our study establishes the same kind of connection.
17
Although we acknowledge that the idea of entrepreneurial propensity should not be limited to quantitative
differences, in this article we will concentrate on this dimension since the GEM explores the qualitative
dimension quite effectively. The project uses the distinction between “opportunity-based” and “necessity-based”
entrepreneurship to illustrate how nations may have similar start-up rates that represent very different levels of
real and profitable entrepreneurial opportunities (see Acs et al. 2005; Davidsson 2004; Reynolds et al. 2004).
18
See O’Donnell, Gilmore and Cummins (2001) for a thorough literature review on the different perspectives and
research streams encompassing network analyses in entrepreneurship.
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The most prevalent tenet in personal network-based entrepreneurship studies is that persons
involved in pro-entrepreneurship networks are more likely to engage in entrepreneurship.
This argument emanates from Aldrich and Zimmer’s (1986) pioneering investigation
highlighting the need to examine entrepreneurial processes in their environmental context.
Indeed, if we think of ideas, knowledge, and capital as the main components entrepreneurs
must assemble in firm creation, social relations provide the connections required to unite
these ingredients. Social relations shape information flows allowing for the identification of
promising opportunities, and trace the ties through which capital flows, helping entrepreneurs
to overcome obstacles to resource mobilization.
Although there have been few attempts to link micro social structures empirically to the
incidence of entrepreneurial activity, sociology scholars repeatedly insist that personal links
have a direct impact on an individual’s decision to launch a new venture. For example, Stuart
and Sorenson (2004) reported a previous research finding demonstrating that “individual
academic scientists’ propensities to transition to entrepreneurial activity in the early academic
life sciences depended to a large degree on the extent to which their networks and work
settings included pro-entrepreneurship scientists. […] In any situation in which
entrepreneurial activity either violates norms or rarely occurs, one might expect that network-
based social influence processes will underlie the diffusion of new venture formation in a
population.” (Stuart and Sorenson 2004: p.223). These findings reinforce Aldrich and
Zimmer’s argument (1986) that traditional approaches to research on international
entrepreneurship have neglected the relational nature of the entrepreneurial process,
overemphasizing deterministic models based on national culture.
The personal social network construct is particularly useful in studying countries’
entrepreneurial propensity as an aggregate of the individuals’ odds of engaging in
entrepreneurship. In line with O’Donnell et al.’s (2001) argument, we believe that this
approach provides several advantages over others in explaining the creation of new firms.
These advantages include: a) the integration of the environmental context, b) its dynamic
perspective and, c) its ability to explain why some individuals start firms while others do not
(Aldrich and Zimmer, 1986; Johannisson, 1987). Based on GEM data, our study introduces
three types of variables that reflect the extent of an individual’s inclusion in an
entrepreneurial social network:
Knowing an Entrepreneur is one of the most obvious drivers of an individual’s familiarity with
and inclination towards an entrepreneurial career. As stated above, entrepreneurs need to
establish connections in order to identify an opportunities and assemble the resources
needed to begin operations. At some point before or during this process, entrepreneurs
might be influences by relations with socializing agents who motivate and help them to start
their ventures.
Business angel activity is not only a direct manifestation of entrepreneurial endeavours; it is
also proof of a person’s privileged position in an entrepreneurial network. As Stuart and
Sorenson (2004, p. 213) stated: “One reason why social networks shape the entrepreneurial
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process so importantly is that they provide the conduits through which private information
flows. To the extent that individuals occupy heterogeneous positions in networks, they vary in
their access to this information. And to the degree that the recognition of entrepreneurial
opportunities hinges on access to private information, differences in network positions can
thus explain much of the inter-individual variance in access to the knowledge required to
discern attractive opportunities for new ventures”.
In this sense, when individuals contribute to entrepreneurial activity as investors, they
become part of the entrepreneurial network involved in the venture creation process. Their
integration in this particular circle process provides them with continuous feedback and
information that is likely to stimulate even more interest in and knowledge about the
entrepreneurial process.
The perception of good opportunities in one’s region
19
: The geography of entrepreneurial
activity is considered by several scholars as a significant implication flowing from the
influence of social network structure on opportunity identification and resource mobilization,
giving birth to the popular “industrial district thesis”. This perspective can be typified by the
idea that: “Because entrepreneurs utilize the contacts in their social networks to found firms,
because individuals’ contact networks concentrate in the region in which they work and live,
and because established firms produce many of the resources consumed in new venture
creation (tacit knowledge and skilled labour), new firms in an industry tend to arise in the
same locations as existing ones” (Stuart and Sorenson, 2004, p.221). Our research builds on
this idea and connects it with the above mentioned argument that a person’s likelihood of
engaging in entrepreneurship depends on his privileged position within an entrepreneurial
network. Indeed, there are reasonable arguments to assume that the identification of a good
opportunity in ones region reflects, to some extent, the opportunities and constraints that
arise from the relations that embed a focal individual in a social circle. The more individuals
are embedded in social circles that are favourably disposed towards to entrepreneurship, the
more good opportunities they will see.
The Relationship between Entrepreneurial Propensity and Social Networks
The evidence and arguments from previous research point to the fact that research
concentrating only on measuring firm entries understates the extent of entrepreneurial
activity and its impact on society. Krueger and Brazeal (1994) argue that “Few research
studies have conceptualized or measured entrepreneurial potential, though interest in pre-
emergence entrepreneurial activity has recently grown […]. However, measures of
entrepreneurial potential seem to remain wedded to various ad hoc profiles of personality
19
It should be noted here that the perceived opportunity is also used in some models as a measure of an
individual’s propensity to entrepreneurship. For example, Parnell, Crandall and Carden, (1995) included “one's
beliefs concerning entrepreneurial opportunities in the economy (i.e., financial rewards, employment, etc.)” as
one of the perceptual factors that measure entrepreneurial propensity, that is, one's proclivity for choosing an
entrepreneurial career. However, these models focus on the individuals’ perceptions to explain behaviour, while
our approach stresses the inclusion of the external environment condition, in particular the one immediately
related to the individual, as a trigger for entrepreneurial behaviour.
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and demographic characteristics with minimal predictive validity…” (Krueger and Brazeal
1994, p. 92). Recognizing that entrepreneurial activity does not occur in a vacuum, the
authors discussed the importance of developing an “entrepreneurial potential” so that
potential entrepreneurs can find suitable conditions to develop their ideas. Implicit in their
notion of “entrepreneurial potential” is the idea that
“The group, organization, or community possesses some potential for entrepreneurial
activity. The environment need not be already rich in entrepreneurs, but has the
potential for increasing entrepreneurial activity […]. Regardless of the existing level of
entrepreneurial activity, such “seedbeds” establish fertile ground for potential
entrepreneurs when and where they perceive a personally viable opportunity. That is,
“entrepreneurial potential” requires “potential entrepreneurs” (Krueger and Brazeal,
1994, p. 92).
Some traditional approaches to entrepreneurship have posited the existence of differing
“propensities to entrepreneurship” according to national or cultural origins. Although it is
widely recognized that culture and social norms have an indirect effect on entrepreneurial
career choices (Hofstede, 1980; Davidson, 1995; Verheul et al. 2001; Wennekers et al.
2001), there is a feeling among some researchers that these socio-cultural models of
entrepreneurship are overly deterministic. Aldrich and Zimmer (1986) state that “The major
problem with this approach is that groups alleged to possess a propensity to
entrepreneurship display their predisposition only under limited, country-specific and
historically-specific conditions. Research findings strongly suggest that we should attribute
the flowering of a group’s predisposition to situational, rather than deterministic, conditions”
(Aldrich and Zimmer 1986, p. 7-8).
In this study we build on previous literature and argue the existence of environmental
influence that affects an individual’s entrepreneurial propensity. But rather than drawing on
over deterministic models, we turn our attention to the situational conditions under which
entrepreneurs undertake venture creation. Specifically, we contend that the social
entrepreneurial environment affects the level of entrepreneurial activity and the addition of a
model of social network to entrepreneurial activity provides a robust description of the
entrepreneurship process. Thus:
H
2
: Entrepreneurial activity will be positively affected by the social entrepreneurial
environment.
Methods and Analysis
For this study we used a sample of 7,000 Spanish respondents to the 2003 GEM survey.
The sample was obtained through interviews by a survey firm specialized in phone surveys.
While the current TEA index is built around direct measures of an individual’s entrepreneurial
activity (independent start-up, current job involves start-up, current owner/manager of
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business), it does not include other indirect or environmental indicators of activity that also
have a real impact on an individual’s entrepreneurial activity. Nevertheless, GEM’s datasets
do provide several types of environmental indicators: macro-level measures of a country’s
environment for entrepreneurship, expert’s assessment of their country’s entrepreneurial
environment and adult individuals’ assessment of their perceived proximate environment.
This third set of variables is of special interest for this paper since it offers the possibility of
using responses from a sample of entrepreneurs and non-entrepreneurs; two groups that
show significant differences in their perceptions of the entrepreneurial environment.
Moreover, consistent with Dennis (1997) and Aldrich et al. (1990), within the analysis of the
environment we concentrate on the examination of environment familiarity and intra-
population processes, since these variables relate to the proximate entrepreneurial
environment of individuals, that is, the elements of the environment that are close to a
person, and that may foster her/his propensity to launch a business. This proximate
environment is, in our opinion, more likely to influence an individual’s behaviour.
Our model is based on the assumption that an individual’s entrepreneurial activity and
proximate environment are latent continuous variables that are related to the observed
survey questions through a threshold relationship. We provide an assessment of the
goodness of fit of our proposed model, and we propose linear combinations of the GEM
indicators that can be used as valid proxies of the latent variables in our model.
Consistent with GEM’s specification of TEA, we used three indicators of direct
entrepreneurial activity (q1, q2 and q3) and included 3 indicators from the GEM survey of the
Social Entrepreneurial Environment:
q4: business angel activity,
q5: know an entrepreneur, and
q6: good start-up opportunities in your area within the next 6 months.
An important assumption of this research is that the variables q1-q3 and q4-q6 are proxies
for two unobservable (continuous) constructs, Entrepreneurial Activity, and Social
Entrepreneurial Environment, respectively. Table 1 provides the frequencies for the GEM
variables used in this study. Five individuals refused to respond to one or more of these
variables and were deleted from further analysis. Thus, the effective sample size is 6995
observations.
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Table 1: Frequencies of Selected Variables
Code Variable No Don’t know Yes Total
q1 Independent startup? 6708 0 297 7005
q2 Current job involves a start-up? 6877 4 114 6995
q3 Owner/manager of a business? 6333 1 661 6995
q4 Business angel in past 3 years? 6766 0 229 6995
q5 Know entrepreneur in last 2 years? 4769 144 2082 6995
q6 Start-up opportunities within next 6 months? 3097 1580 2318 6995
We hypothesize that a two-factor model underlies an individual’s response to our survey
questions as depicted in Figure 1. The first latent variable (factor) corresponds to the
individual’s propensity to engage in entrepreneurial activity (EP). This factor has four
indicators (q1 to q4)
20
. The second latent variable corresponds to the individual’s social
entrepreneurial environment (SEE) with three indicators (q4, q5, q6). We also hypothesize
that individuals’ entrepreneurial propensities are determined by their social entrepreneurial
environment, which is unique for each individual (that is, it changes from individual to
individual).
Consistent with this view, we present a model of entrepreneurial propensity and social
entrepreneurial environment and argue there is a relationship between these two dimensions
–both determined on the basis of a number of proxy variables-. Figure 1 presents our model.
Since the model’s random errors and latent variables are likely to be induced by a large set
of specific causes, we assume that the random errors and latent variables are normally
distributed. Now, to link this theoretical model to the observed individual responses, we
assume a threshold relationship such that for each observed variable
*
,1
*
,1 ,2
*
,2
No if
Don't know if
Yes if
i i
i i i i
i i
q
q q
q
?
? ?
?
? <
?
= ? ?
?
?
>
?
(1)
where the ?’s are thresholds that change from variable to variable, and the
*
1i
q ’s are
propensity scores assumed to underlie each of the observed categorical responses.
20
It is interesting to note that from our point of view being a business angel is also a form of EA, although it
is not taken into account in the TEA index. We include angel investing in our EA measure and believe GEM
should reconsider and recalibrate the TEA measure, even if that entails reanalyzing the data from previous
years so that year-to-year comparisons are adequate and valid.
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Figure 1: A Two Dimensional Model of Entrepreneurship
Note: * parameter fixed for identification purposes
known entre-
preneur last 2
years?
individual's social
entrep.
environment
business
angel?
start-up opport. in
you area?
1* b
4
b
5
b
6
u
4
u
5
u
6
independent
start-up?
individual’s
entrep.
propensity
Business owner
/manager?
job involves
start-up?
1* b
1
b
2
b
3
u
1
u
2
u
3
b
7
b
8
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Note that we assume that ‘Don’t know’ responses provide information about the individuals’
entrepreneurial propensities and social environment
21
. Furthermore, the incorporation of
‘Don’t know’ responses into the model leads to a substantial reduction in missing patterns.
Had we discarded ‘Don’t know’ responses, the effective sample size would be 5313 (a 24%
data loss).
We fitted this structural equation model using Mplus (Muthén and Muthén 2001). The model
fits well given the large sample size employed: ?
2
= 15.1 on 7 df (p = 0.03), RMSEA = 0.01.
Table 2 provides the slope parameter estimates for the model in Figure 1 along with their
standard errors. Also, Table 3 provides the R
2
for each of the six variables used.
As can be seen from these tables, the variable worst accounted for by the model is whether
there will be good start-up opportunities within the next 6 months (R
2
= 6%). On the other
hand, the variable best accounted for by the model is whether the current job involves a start
up (R
2
= 90%). The latter is the best indicator of the individuals’ propensity to engage in
entrepreneurial activities (see Table 2). On the other hand, the best indicator of the
individuals’ business environment is whether they have known an entrepreneur in the last
two years. Finally, as we had hypothesized being a business angel is a weak (although
significant) proxy of an individual’s propensity to be involved in entrepreneurial activities.
Table 2: Parameter Estimates and Standard Errors for the Slope Parameters
Parameter b1 b2 b3 b4 b5 b6 b7 b8
Value 0.51 0.86 0.45 0.65 0.24 0.30 0.18 0.47
SE 0.04 0.06 0.04 0.08 0.03 0.08 0.07 0.09
Table 3: Proportion of Variance Accounted For
Code variable R
2
q1 Independent startup? 0.32
q2 Current job involves a start-up? 0.90
q3 Owner/manager of a business? 0.25
q4 Business angel in past 3 years? 0.18
q5 Know entrepreneur in last 2 years? 0.42
q6 Start-up opportunities within next 6 months? 0.06
21
Our model is based on the assumption that data in GEM is not missing randomly. Davidsson (2004) expressed
concerns about the problem of the GEM relying on “the respondent’s subjective interpretation of what should
and should not be counted as `now trying to start a business´”. He also claimed that the problem could vary
according to cultural differences, noting the example of Germany and Ireland, where a considerable proportion
of “no” and “don’t know” answers might occur when the respondent would have liked to say “yes”. Following the
idea of “degrees of entrepreneurship” stated before, we assume that the pattern observed by missing data is
the following: when the respondent answers “Don’t know”, he is in fact choosing an intermediate answer
between the “yes” and the “no”.
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Of particular interest is the effect of an individual’s propensity to engage in entrepreneurial
activities on their social entrepreneurship environment. This effect is significant and strong,
R
2
=18%.
In closing, we have verified that our model for GEM’s measure of entrepreneurship is
supported by the data. This model assumes two continuous latent variables as opposed to
the TEA’s current binary classification of respondents as either entrepreneurs or non-
entrepreneurs. Our model enables researchers to draw powerful statistical inferences
regarding the entrepreneurship phenomenon. In our model, the main quantities of interest
are the means for the latent variables concerning an individual’s propensity to engage in
entrepreneurial activities and an individual’s entrepreneurial environment. Interest lies in
investigating how these means change over time within a country and across countries.
Furthermore, the model allows for the comparison of thresholds and latent variable slopes
over time within a country, and for comparisons across different countries. Finally, and most
interestingly, by incorporating additional exogenous variables into our model, such as an
individual’s background, country economic variables, and a country’s cultural environment, it
is possible to investigate the effects of these background variables on the model’s latent
means, thresholds, and latent variable slopes, in a manner similar to multivariate probit
analysis (see Muthén 1979; Browne, and Arminger 1995; Tay 1998). However, although
statistically optimal, the approach advocated here requires considerable statistical expertise.
Therefore, we consider in the next section constructing linear combinations of the indicators
that can be used as an approximation for our model’s latent variables.
Proxies for the Latent Variables
Point estimates and standard errors for each individual’s standing on the two latent variables
in our model of the level of entrepreneurship can be obtained by integrating the posterior
distribution of the latent variables, given their responses to the six indicators considered in
this study. We investigate in this section whether suitable proxies for these estimates can be
alternatively obtained by the following procedure. We code the responses to the indicators q1
to q6 as ‘No’ = 0, ‘Don’t know’ = 1, and ‘Yes = 2’. Then we compute
EP = (q1 + q2 + q3 + q4)/8 (2)
SEE = (q4 + q5 + q6)/6 (3)
Here, EP and SEE are normalized indices (that is, they range between 0 and 1) of an
individual’s propensity to engage in entrepreneurial activities and of an individual’s
entrepreneurial environment, respectively. To investigate the convergent and discriminant
validity of these proxies, we calculated the correlations between these proxies and the point
estimates of the latent variables. These are shown in Table 4.
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Table 4: Correlations among the TEA, Point Estimates of the Latent Variables, and
Latent Variables Proxies
TEA EP SEE
Entrepreneurial Activity .73 .89 .47
Social Entrepreneurial Environment .29 .41 .90
TEA 1 .70 .10
EP .70 1 .22
SEE .10 .22 1
Notes: All correlations are significant (? = .01); entrepreneurship activity and environment are the point estimates
of the latent variables, EP and SEE are our proxies of those latent variables
As can be seen in the Table, our proposed proxies correlate .90 with the point estimates of
our model’s latent variables. Hence, they show high convergent validity and can be used as
valid proxies for the latent variables. However, note that the use of proxies underestimates
the correlation between entrepreneurial activity and entrepreneurial environment because it
does not take into account the unreliability of the proxies. The correlation between the
proxies is only 0.22 (see Table 4) whereas the correlation between the latent variables is
0.47 (see b8 in Table 2).
Most interestingly, the TEA index correlates 0.70 with the proxy of entrepreneurial activity but
only 0.10 with the proxy of social entrepreneurial environment. Thus, although based on
rather different principles, our measure of economic activity correlates quite highly with the
TEA index.
Discussion and conclusions
The measurement of entrepreneurial activity in different countries is an important concern
both for researchers interested in entrepreneurship and for public policy concerns (Birley
1984; Dennis 1997; Haswell, and Holmes 1989; Laitinen 1992; Williams 1993). In this paper
we have re-examined the approach at measuring entrepreneurial activity, introducing the
notion of likelihood of entrepreneurial activity. This implies a significant change in the way
entrepreneurship is viewed from one in which a person is or not an entrepreneur to the
notion of levels of entrepreneurship in individuals. Moreover, we include and measure the
effects of entrepreneurial environment on entrepreneurial activity. We believe these are
significant contributions to the examination and measurement of entrepreneurial activity.
One important addition in our measure is that it provides a model-based approach to
measuring entrepreneurial activity; one that incorporates an individual’s social
entrepreneurial environment in the measure. Network-based arguments clearly have
significant potential to enhance our understanding of an individual’s propensity to engage in
entrepreneurship. In this sense, our study addresses the concerns of sociology scholars by
providing an empirical tests and validation of the general assertion that the incidence of
entrepreneurial activity hinges on the structure of an individual’s social network (Stuart and
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Sorenson, 2004). Indeed, consistent with these theoretical arguments, our results indicate
that an individual’s personal context significantly affects his odds of undertaking direct
entrepreneurial activity, and suggest that failing to consider such effect significantly
understates the extent of entrepreneurship in a country.
The metrics in this study are also an improvement over previous approaches because they
are transparent and result in a propensity score for entrepreneurial activity that is normalized
and continuous. This point is a significant departure from prior research in entrepreneurship,
and in particular from the GEM’s TEA measure. The use of a classification, as in the TEA, in
which individuals are determined to be either entrepreneurs or not entrepreneurs reflects a
static approach at the phenomena, whereas the use of propensity, calculated as a variable
ranging from 0 to 1, allows researchers to take a dynamic view of the process and to
incorporate the notion of the likelihood of entrepreneurship over time. This, we believe, is a
significant contribution, and one that merits rethinking the traditional approaches to
examining entrepreneurial activity.
Important also is the introduction of the notion of thresholds in the context of new venture
creation. On top of the examination of entrepreneurial activity (in terms of propensity), our
model also allows us to examine the thresholds that determine when people start firms. This
is a very important point for both research and public policy. From the perspective of
research it gets us closer to determining the points that determine the likelihood of new
venture creation. Our future examinations in this area will focus in better determining the
characteristics of those thresholds.
The research also allows for an analysis of the percentage of the variance accounted for by
each element in the model. Our model has a 90% prediction rate for entrepreneurial activity
based on whether the current job of the person involves a start up, and a 32%, 25% and,
18% prediction rate based on whether it involves an independent start up, an owner manager
of a business or being a business angel, respectively. Consistent with previous evidence, the
strongest predictor of entrepreneurial activity is whether the current job of the individual
involves a start up.
As long as we adhere to a dynamic perspective of the entrepreneurship phenomenon and
view individuals as having a certain propensity to be entrepreneurs, then we can more
effectively make inferences about a country’s comparative strength in entrepreneurship. This
approach may not completely resolve the question of how to ideally compare one country’s
entrepreneurial activity with another, but it takes a step closer to measuring this difference in
a more consistent manner. Moreover, we believe that this approach challenges us to develop
research questions, methodologies and techniques that will do justice to the complexity of
entrepreneurship (Gartner, 1985 and 1988). Indeed, we argue that entrepreneurial activity is
not a clear-cut reality that can be roughly put down in numbers; rather, entrepreneurship is a
potential that people have in certain degrees and that, combined with specific circumstances,
can give birth to actual venture creation.
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One caveat is important to discuss at this point. It is important to realize that both the TEA
and our measures of EP and ESE are simply indices. They do not represent the% of actual
and potential entrepreneurs. While it is tempting to think about the TEA as percentage of
entrepreneurs, and there is evidence that it is sometimes misused as such, the value of
these indices lies in the ability to compare across time, and countries and regions rather than
providing absolute values of entrepreneurial activity.
Finally, we recognize that the measurement of entrepreneurial activity will always be a
contentious matter and it is not our intention to reopen up the debate on a definition of
entrepreneurship. Nevertheless, we consider that proposing an alternative and consistent
measure for international comparison of entrepreneurship could significantly contribute to the
advancement of academic knowledge as well as provide policy-makers with useful inputs for
designing programmes to enhance the economic welfare of their countries in the context of
global competition.
E-mail of corresponding author: Rachida Justo, [email protected]
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Strategic Change Processes in SMEs – The longitudinal Analysis of
Three Finnish Furniture Firms
Karita Luokkanen (a), Rodrigo Rabetino (b, c)
(a) Department of Marketing, University of Vaasa, Finland
(b) Departamento de Economía de la Empresa, Universidad Autónoma de Barcelona,
Spain
(c) Instituto de Industria, Universidad Nacional de General Sarmiento, Argentina
Abstract
This study focuses on SMEs’ strategic changes in dynamic environments. In order to deeper
understand these changes, the specific characteristics of SMEs’ strategic behaviour, and the
interaction of internal and external factors are included simultaneously in the analysis. The
conceptual framework is based on studies of strategic adaptation and SMEs’ strategic
behaviour. The empirical research consists of three longitudinal case studies in the Finnish
furniture industry, for which processes are analysed. The data analysis reveals that strategic
changes are the result of multiple, overlapping processes. In short term, firms’ responses to
environmental stimuli often look like reactive tactics. However, in a longer time orientation,
owner-managers were able to identify and implement new ideas and projects in their
business environment. Additionally, owner-managers’ ways to make strategic decisions in
turbulent situations seems to be based more on experience and intuition instead of being
calculated and planned.
Key Words: SMEs’ strategic changes, strategic decision-making, Finnish furniture industry
Introduction
Dynamism, uncertainty, and discontinuity are words often used to describe today’s business
environment. Firms continuously face changes and new situations in their environments,
which challenge their traditional ways of acting and, in the names of survival and success,
evoke the necessities for adaptation and change. This is true especially in the context of
small and medium sized firms, which are recognized to be relatively strongly dependent on
their environmental conditions. As Chell et al. (1998) and Cope et al. (2000) suggest the
triggers for changes in SMEs often originate from a critical situation faced by a company,
which might open opportunities for new development.
Scholars have been interested in the phenomena of organizational change and adaptation
already for decades, starting from the earliest studies of contingency theorist in 1950s (Miller
and Friesen, 1980). As a consequence, different school of thoughts have emphasised
different aspects of change
22
. As main streams, population ecology and strategic adaptation
22
For example, Garud and Van de Ven (2002) present four different theories to explain the process of change
(teleological, life cycle, dialectical and evolutionary).
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have dominated the literature about the relationship between organization-environment and
strategy (Tsai, MacMillan and Low, 1991:9). In this context, the relationship between firm and
environment is usually presented as a continuum with its extremes in environmental
determinism and managerial voluntarism (Hrebiniak and Joyce, 1985; Vesalainen, 1995).
The deterministic perspective suggests that the survival of organizations is mainly
determined by environmental selection (Hannan and Freeman, 1977, 1984), and firms
possess different “inertial forces” which constrain their possibilities to adapt when
environmental conditions change (Hannan and Freeman, 1977). Thus, external factors are
essential to explain change; and because managers hardly have options for decision-
making; the role of management is passive.
However more commonly, strategic changes are studies from the voluntaristic perspective,
which assumes that the managers have substantial discretion to decide independently about
the firms’ strategies. The success of the organization is a function of the manager’s abilities
to evaluate the environmental conditions and the internal capabilities of his firm, in order to
formulate and implement effective strategies (Porter, 1980). In other words, even the
environment is a big restriction for the strategy development, it can be manipulated (Child,
1972), and managers are seen as active and often proactive persons. The contingency
approach, in turn, adopts an intermediate perspective, emphasizing the predetermined
nature of environmental contingencies for firms’ strategies, structures, and performance.
Thus, managers choose strategies and preferences consciously as a reflection about what
constitute the best strategy for a certain environment (Shane and Kolvereid, 1995). In this
case, managers are seen mainly in a reactive light.
When adaptation theories (mainly strategic and contingency approaches) are applied to
small firms, most of the studies conclude that a common pattern of change is “reactive
adaptation”, suggesting also that changes at strategic level do not happen frequently, and
often small firms are poorly managed. However, if we consider the heterogeneity of the SME
population, and the owner-manager’s strong personal influence on his/her firm behavior, the
common view of SME change pattern evokes many questions with regard to the simplicity of
the strategic change phenomena in SMEs. Moreover, due to the strong emotional link
between owner-managers and SMEs, generic theories on strategy do not represent correctly
the situation of the small and medium-sized companies (Chan and Foster, 2001). This makes
us wonder if it is really possible to characterize these processes by using the traditional
classification from the strategy literature.
In the light of these shortcomings, we believe that the answer for the previous question is no,
mainly for two reasons. First, basically all theoretical development related to strategic
changes has happened in a large firm context, explaining the transition from one steady state
to another (Nicholls-Nixon et al., 2000). Additionally, the literature is mainly concentrated on
the firm’s competitive positioning, while the interaction between market positioning and the
internal resources of a firm has not been studied deeply in SME context (Bosch, Huse and
Senneseth, 1999:50-51). The orientation of these studies is extremely strategic, and leans on
variables which are suitable for measuring changes in/of large firms. Many of these studies
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are also normative, aiming to give advice on how a change process should be managed.
However, SMEs are not simply smaller large firms. Moreover, strategic planning is not an
activity commonly carried out in SMEs, and their everyday life is more based on routines
predetermined by the nature of the production process, their manufactured products, and
environmental conditions. Thus, if strategic change is analysed by focusing on strategic
planning and implementation variables, we can easily understand the conclusions literature
so far has associated with change in SMEs.
Secondly and at a more general level, most of the studies are cross-sectional. Instead of
explaining the process of change itself, studies mainly had focused on analysing whether
change has happened or not, than “to observe managers facing obstacles and making
decisions that initiate change. The longitudinal observation required for such research is
difficult and costly to do at the organizational level” (Gersick, 1994:11). We argue that the
cross-sectional nature of these studies is somehow limiting our understanding of the
processual nature of change and adaptation. As suggested by Pettigrew, Woodman and
Cameron (2001), the inclusion of time, history, process and action in the analysis would give
us a better understanding of the phenomena of change.
In this context, we suggest that purely strategic approach is not suitable for studying small
firms’ strategic change processes. Instead, the framework which recognizes the special
characteristics of SMEs’ which affect the change processes (strategic behavior), explicitly
takes into account the interaction between internal and external factors, and reveals
dynamism of change processes, could enrich the knowledge of the phenomenon. This study
intends to contribute to the existing knowledge about SMEs’ strategic changes in a dynamic
environment. Due to the scarcity of this kind of studies, we need a much deeper
understanding of the characteristics of strategic changes in SMEs. The purpose of the study
is to answer the following questions:
• Which are the critical incidents triggering strategic changes, and to which extent are
these changes provoked by internal factors within the firm or by the environment?
• Which are the main factors that affect SMEs’ strategic changes, and how do they
interact? In which way do owner-managers’ characteristics affect these changes?
• On which levels and for which functions do changes happen, and how are they inter-
linked? To which extent are strategic changes proactive and reactive?
Two implicit tensions are notable in the analysis. The first tension is the relationship between
the macro-economic conditions and the micro-economic responses. Regarding these
responses, a second tension appears between the managerial discretion to make strategic
decisions vs. environmental determinism.
We aim to answer these questions with a longitudinal case study of three Finnish furniture
manufacturing firms. In the next section, we present the conceptual framework based on
studies of strategic adaptation and strategic entrepreneurship (Hitt, Ireland, Camp and
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Sexton, 2001) This is followed by a methodological discussion in the third section, whereas
the fourth section is dedicated to the case analysis. Finally, we present our main findings and
conclusions in sections five and six.
Conceptual framework
Strategic change and adaptation
In adaptation studies, strategic change is understood as the means by which organisations
can maintain or find the fit between themselves and the environment. Additionally,
organizational change primarily reflects the decisions and strategies of leaders and dominant
coalitions in organisations in response to changes in environmental threats and opportunities
(Singh, House and Tucker 1986). Previous studies are notable in the versatile
characterisation of changes. For example, change is measured in relation to the “radicalism”
of change (first order and second order changes), changes in core and peripheral features,
different change levels, and the nature of change (proactive or reactive) (e.g., Garud and
Van de Ven, 2002; Hannan and Freemann, 1984; Miles and Snow, 1978; Kelly and
Amburgey, 1991). These studies offer a good basis for analysing strategic changes, mainly
by pointing out different levels and functions where firms usually change.
According to Hannan and Freemann (1984), organizational changes can be divided into two
types, which both include strategic elements: core feature changes (i.e. stated goals, forms
of authority, core technology, and marketing strategy) and peripheral feature changes (i.e.
horizontal and market-extension mergers, joint ventures, and interlocking directorates). The
authors concluded that changes are more common in peripheral features, and relatively rare
in core features.
Perhaps more concrete, Vesalainen (1995:68) classifies changes as: (1) core feature
(redefinition of business’s values and believes), (2) strategic (product development or market
development in order to change the organisation/environment relationship), (3) competitive
(using a variety of competitive and functional strategies), and (4) operative adaptation
(resource allocation adjusting the quantity of resources in the internal transformation
process). In his study of small firms, adaptation commonly occurred on operative and
competitive levels.
In general, several classifications of a firm’s adaptive behaviour have been developed
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.
These typologies highlight the essential features of situation-specific strategies; capture the
major commonalties and provide guidance at the corporate level on how to develop a
business (Herbert and Deresky 1987: 136). In addition, typologies and classifications try to
build a comprehensive picture about the phenomena under investigation, and make
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This includes Miller and Friesen (1980): nine organisational transition archetypes; Ansoff’s (1975) competitive
and entrepreneurial behaviour; Mintzberg (1973) entrepreneurial, adaptive, and planning; Mintzberg (1978)
intended, realised and emergent strategy; Greenwood and Hinings (1993): archetypes mainly regarding
organisational design.
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generalisations about it. Among well-known typologies of strategic behavior one could
highlight two: Porter’s (1980) distinction between differentiation, focus, and cost leadership
and the typology of Miles and Snow (1978).
Miles and Snow (1978) use the adaptive cycle to present a dynamic process of adaptation.
This adaptive cycle is divided into three major problems resp. change areas: an
entrepreneurial (choice of product-market domain), engineering (choices of technologies for
production and distribution), and administrative problem (uncertainty reduction and
innovation enhancement). In the process of adaptation, the management has to solve these
problems continually (Miles and Snow 1978). Miles and Snow’s ideas are interesting from
our point of view because they include proactive and reactive aspects of adaptation in their
classification. Moreover, they take into account the interactive nature of different (strategic)
change elements. They classify firms into four groups based on their strategic orientations:
(1) prospector (companies looking continually for new opportunities), (2) analyzer
(companies working in stable domains and searching for new opportunities, mainly by
imitating successful offensive answers), (3) defender (companies protecting their market
niche, and not searching for new opportunities), and (4) reactor (passive companies without
long term goals that do not follow a consistent model of behaviour).
In this context, Segev (1989) suggests that Porter’s (1980) differentiation type could be
compared with Miles and Snow’s (1978) prospectors, while cost leadership could be
matched with the defender type. Additionally, analyzers and reactors would be part of a
continuum between these previous extremes (Miles and Snow 1978). In terms of
appropriateness of the strategy, prospectors, defenders and analyzers are the successful
types, while reactors could be classified as “stuck in the middle", and their behaviour labelled
as unsuccessful strategies.
However, the processes of adaptation and change are rarely as simple as single typologies
let us assume. Mintzberg et al. (1998) use the term ‘domino effect’ to illustrate how a firm’s
routines are inter-linked, and a change in one issue is often followed by changes in other
issues (Mintzberg et al., 1998). These changes do not include just internal changes, but also
variations in the relationships with different stakeholders (Venkataraman et al., 1998).
Pettigrew et al. (2001), in turn, have clearly stressed the importance of a processual
approach in change studies. Following their argumentation, history and future are present at
the same moment, which affect a firms’ change capability in the sense of positive and
negative path dependencies. Finally, like adaptation studies suggest, strategic changes are
usually linked to strategic decision making in the context of environmental opportunities and
threats.
SMEs’ strategic behaviour
In a SME context, the strategic change process results from an interaction between internal
and external factors. Although the environmental influence is strong, and strategic decision-
making process is highly influenced by outside parties (Lawrence and Lorsch, 1969;
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Tushman and Romanelli, 1985), the strategic management process is also case-specific and
strategy formulation is a highly contextual activity. Additionally, goals are not consistent
across people and time, and search behaviour is local and cognitively limited (Cyert and
March, 1963) instead of being rational. As Eisenhardt et al. (1992:20-22) have stated: “Goals
are unclear and shift over time. People often search for information and alternatives
haphazardly and opportunistically. Analysis of alternatives may be limited and decisions
often reflect the use of standard operating procedures rather than systematic analysis” …
“Decision makers satisfice instead of optimize, rarely engage in comprehensive search, and
discover their goals in the process of searching”
In this context, an owner-manager’s personal characteristics (i.e., the willingness for risk
taking and need for achievement) and his/her ideas influence strongly to SME goals, and the
processes of strategy formulation and implementation (Covin and Slevin, 1989; McCarthy,
2003). Mintzberg and Waters (1982) argue that the organisation’s size influences the
rationality of strategic decision-making (in SMEs rationality is lower); and many studies found
that high uncertainty, external control, and threatening environments reduced the rationality
of strategic decision-making (Fredrickson, 1984; Miller, 1987; Dean and Sharfman, 1993).
Moreover, it has been recognized that owner-managers act based on the way they interpret
the environment (Bourgeois, 1980). Thus, even when agents face similar stimuli, they make
different decisions, due to the varied perceptions that they have about the reality (Penrose,
1959). In this way, persons are restricted by the way in which they socially build their reality
(Silverman, 1970). As Tsoukas (1994:13) has stated: the organisation and the environment
are “subjectively constructed entities which may change once individuals’ understandings
and interpretations change” (Tsoukas, 1994:13).
Therefore, when facing environmental changes, owner-managers make adaptation decisions
based on heuristic and mental models. Hence, managers rely on simplified and imperfect
representations of the world in order to process information. These mental models affect their
interpretation of strategic issues. Together with heuristics used to make decisions (strongly
linked to key believes and experiences) and with intuition (Eisenhardt et al., 1992; Brouthers
et al., 1998) they influence the decision-making process (Barr; Stimpert and Huff, 1992).
Thus, entrepreneurs can make decisions and exploit opportunities in situations where a
structured decision-making mechanism could be a barrier (Alvarez and Busenitz, 2001).
Within this heuristic perspective, strategic decision-makers are rational and irrational at the
same time (Eisenhardt et al., 1992; Brouthers et al., 1998).
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However, mental models also include many inertial
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elements, and strategic change often is
difficult (Barr; Stimpert and Huff, 1992). As a consequence, changes can involve
experimentation, driven by trial and error logic. This experimentation in turn can reconstruct
the owner-manager’s mental models, and new understanding related to changed
environmental conditions can develop (Nicholls-Nixon; Cooper and Woo, 2000). This process
can involve the unlearning of old beliefs, the building new perception, and the development
of a cause-effect understanding about the new environmental situation as well as the
development of experience and insight to act in a spontaneous and improvised way (Barr;
Stimpert and Huff, 1992; Crossan, 1998; Eisenhardt, 1989; Alvarez and Busenitz, 2001).
Improvisation is the capability to make decisions within a short time and with limited
resources and information (Leybourne, 2003). At the same time, when the company acquires
a larger experience for the improvisation, it also continues to optimise this process to apply it
in future events (Chelariu et al, 2002). However, improvisation requires not only risk-taking
and error-tolerance, but also a deep understanding of customers, competitors and industry,
together with the capacity to use resources.
In short, in the context of SMEs the interpretation of the environment is unique and based on
manager’s learning and experience (Bowman and Ambrosini, 2000). Thus, strategic
development and change are rather a result of a combination of knowledge (mainly learning
from experience) and reaction to critical events (in which owner-managers learn to process
information, adjust strategy and make decisions) than of planned developments (Deakins
and Freel, 1998:146; McCarthy, 2003). As a consequence, owner-manager rarely formalise
their strategic vision (Covin and Slevin, 1989), and strategies can be characterized as being
empirical and intuitive with only little formalisation (Eisenhardt et al., 1992; Brouthers et al.,
1998). Further, the processes of strategy-generation are fragmented, evolutionary and
intuitive, and strategies emerge out of a series of conscious decisions, together with and
interacted in a turbulent environment. Moreover, sometimes a flexible and experimental way
of acting is considered as convenient (Mintzberg, 1978). Finally, it can be stated that the
implementation of the strategy rarely has an impact on the structure of a small firm (Lobontiu,
2002).
Based on the previous theoretical discussion, we want to shortly emphasize three aspects
which most importantly guide our empirical analysis. First, following adaptation studies
suggestions, we will analyse changes through their main adaptive elements (customer
relationships and markets; technology investments; product and product development; and
strategic decisions) and levels (strategic, competitive, and operative). Secondly, we will direct
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Inertia, originating from path dependency, is seen as a factor that complicates adaptation. Inertia may appear in
many forms, e.g. top management’s cognitive models, resistance to make changes in strategy and routines,
investments, production and product decision, and relationships to different stakeholders (Huff, Huff
andThomas, 1992). With regard to SMEs’ inertia and their capability for change, one can conclude that in
general and compared to large firms, small firms are considered to be more flexible due to the flat organization
structure (or the lack of formal structure), fast decision-making and an ability to react quickly. On the other
hand, scarce resources (i.e. lack of financing options and skilled employees in different expertise areas) are
hindering possibilities for change.
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our attention to some essential aspects of owner-manager personality (levels of rationality,
risk aversion, and proactiveness), their decision-making style (planned vs. emergent) and
their strategic orientation (Miles and Snow types), which might influence the strategic change
processes within the small firm. Thirdly, we will analyse strategic changes by taking into
account the interaction between internal and external factors in the long run.
Methodology
We draw on results from a longitudinal, multiple case study. Longitudinal cases are suitable
for analysing processes in their natural settings in a comprehensive way. This methodology
also allows for high sensibility in data analyses because the number of variables is not
limited in advance. This is a particular important issue in process studies, where it can be
expected that non-linear and even unexpected relationships between variables exist.
Moreover, multiple cases allow us to analyse strategic change processes at the level of
(each) individual firm, and later on to make inter-case comparisons (Yin, 1994; Denzin and
Lincoln, 1994).
Our analysis follows the main ideas of a processual analysis (Pettigrew, 1997). The driving
assumption is that a social reality is a dynamic process, and it occurs rather than merely
exists. A process can be defined as a sequence of events that describes how things change
over time, where the context, agents and actions, and time and history are embedded in a
process (Pettigrew, 1997). The analysis is guided by five internally consistent assumptions:
1) embeddedness: studying processes across a number of levels of analysis (inter-related
levels of macro, sectoral, organisational and individual factors are analysed); 2) temporal
interconnectedness: studying processes in past, present and future (path dependence, and
owner-managers’ interpretation are shaping the processes); 3) a role in the explanation for
context and action (context and action are intertwined); 4) a search for holistic rather than a
linear explanation of processes (the focus is to find many inter-linking conditions which link
feature of context and process to certain outcomes); 5) a need to link the process analysis to
the location and explanation of outcomes (providing a focal point for the whole investigation,
and allowing to compare cases against and with each others).
We chose the Finnish furniture industry as a target sector for empirical analysis, mainly for
three reasons. First, during the past 15 years, the furniture industry has faced many
changes: economic boom and recession on the macro-level, increasing international
competition and strengthened position of retailer chains on industry level, and changing
consumer preferences in the end market. Secondly, the industry is highly SME-dominated
and can be characterised as a mature and production-oriented manufacturing industry with
traditional business models. Third, we have access to longitudinal data of furniture
manufacturers which allow for our long-term orientated and processual research.
The case selection was based on the longitudinal, qualitative interview data of 60 Finnish
furniture manufacturers. This data was collected, using the same format, in 1986, 1990,
1993, 1995, and 2000 within the Furniture Project in the Department of Marketing of the
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University of Vaasa. The thematic phone interviews were based on structured interview
guidelines and consisted of mainly open ended questions, focusing on customer
relationships and markets domains; products and product development; technology and
investments; co-operation with other furniture producers; strategy; and the competitive
situation. Related to each theme, the possible changes and reasons for changes (“why
questions”) were discussed. Additionally, accounting information from 1986-2000 is
available.
From that data, we selected three case firms for a deeper, process-oriented analysis. The
case selection was based on the following criteria: First, all firms had to have survived the
whole research period without insolvency or other financial reorganisations. In this way, all
firms have “lived through” the same environmental conditions without support from
authorities. This similarity in basic conditions improves the validity of the inter-firm
comparisons. Secondly, strategic level changes can be identified in all cases, thus reflecting
the phenomena under investigation. Third, each firm’s strategic change processes had to
differ from each other. This criterion was set up in order to present strategically different
kinds of cases, and to analyse inter-firm similarities and differences. Under these conditions,
the first case presents a process in which a mainly domestically operating firm went though a
strategic reorientation from being home furniture producer to becoming a business-to-
business subcontractor. In the second case, the case firm’s internationalization efforts are
characterising the change process. Finally, the third case illustrates a change process
whereby a traditional furniture manufacturer becomes a system subcontractor of an
international furniture giant.
The empirical analysis was partly based on the longitudinal data described earlier. Because
this data include mainly firm level information, we interviewed by phone the owner-managers
of selected firms in order to obtain information on strategic-decision making and strategic
behaviour, and to complete (and validate) the longitudinal data. These interviews included
both qualitative and quantitative elements. First, with the guidance of open ended questions,
we discussed the owner-manager’s strategic decision-making style. Secondly, following the
method of Dean and Sharfman (1993), we tested the rationality of the decision-making of
owner-managers. This was done in order to evaluate the theoretical discussion related to the
rationality of SME decision-making. Third, following the method of Kickul and Gundry (2002),
we studied the owner-managers’ personal tendency to be proactive. This was done in order
to see if the firm level strategic actions reflect the characteristics of owner-managers. In
addition, willingness to take risks was measured. Both, the rationality of decision-making and
proactive personality were measured by using seven-point Likert scale. Finally, we asked
owner-managers to classify their firms within the typology of Miles and Snow (1978). This
was done by reading the descriptions of each strategic type (James and Hatten, 1995;
Brouthers et al., 1998), and owner-managers were asked to comment on each category
based on its suitability to describe their own business. This was done in order to see how
owner-managers see their firm strategy in a long time perspective.
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In this context, the analysis progressed through three main steps:
• First, we wrote descriptive case histories in order to build a general picture of case firms.
In these case descriptions, our aim was to identify the most essential changes, and to
explore the possible interactions between internal and external factors.
• Secondly, we arranged the external and internal events chronologically into charts, and
marked the most important interconnections between environmental influences, the firm’s
responses, and events (the arrows do not represent cause-effect relationships; instead,
they are used to link stimulus and responses that are related in one way or another).
These charts are divided in five levels (general environment, business environment,
external relationships, answers, and internal factors). The general environment illustrates
macro economic conditions, while the business environment includes the issues related
to the furniture industry. Answers address the responses and actions the firm has made
related to environmental changes and internal factors. Internal factors point to the main
strengths and weaknesses of a firm to cope with and in its environment. Finally, external
relationships show the results of the interplay between environmental changes, firm
answers and the reallocation of internal factors (external and internal forces).
Thus, the purpose of the chart is to illustrate how the stimulus and stress of different
environmental levels (general and business environment), firm’s internal capabilities and
resources (technology, products, and human resources), and the interaction between
these internal factors, external relationships and environment are shaping the change
process (answers). The issues presented in the chart are based on the interpretations of
the owner-managers, and on critical events faced by the company.
• Third, with the outcome of the analysis in mind, we analysed the data, concentrating on
the most important changes and processes. Case findings were linked to our broader
theoretical discussion, and the results were discussed in the context of (SME) strategic
behaviour and adaptation.
With regard to the reliability and validity of the study, certain aspects should be emphasized.
(Yin, 1994; Lincoln and Guba, 1985). When considering construct validity, the search for
change patterns is guided by theoretical discussion and concepts. Regarding the information
correctness, even the longitudinal data was not designed for this study, and it was only
partially collected by the authors; the interviews conducted in different years increase data
truthfulness as “current” data from each year. On the other hand, external validity is
commonly tested through generalisation of results. The objective of this study is analytical
generalisation, not scientific generalisation for a population. Lastly, the interpretation of
qualitative data is always subjective. In this study, the data was interpreted and validated
through an in-depth dialogue between both authors, thus reaching a richer interpretation. The
quantitative measures (seven-point Likert scales) we applied to asses the rationality of
decision-making and personality proactiveness were not used statistically, but to asses the
rationality of decision-making and personality proactiveness of these three owner-managers.
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In both cases, Cronbach’s alpha which is higher than .79 indicates the internal reliability of
measured items (cf. Dean and Sharfman, 1993 and Kickul and Gundry, 2002).
Industry description and case analysis
The Finnish furniture industry can be described as a traditional, SME dominated
manufacturing industry. Basically all manufacturers are SMEs, often lead by owner-
managers, and management is highly based on the entrepreneurs´ attitudes and beliefs
about the business and what it should be. During the past 15 years, the Finnish furniture
industry has faced many changes, thus offering an interesting field to study firm behaviour in
a dynamic environment.
The 1980s was a good decade for producers and due to high demand the challenges faced
by the companies were mostly at the productive level. During the 1980s, furniture producers
invested much in production facilities and production processes, whilst active product
development was not their main concern or activity. Even though the competition was hard,
companies enjoyed the freedom to make strategic decisions and choices (Aravuo, 1994).
At the beginning of the 1990s, the Finnish economy fell into a deep recession and the total
sales of the furniture industry crashed. In 1990-1993, the amount of furniture producers
declined by 25%, turnover by 35%, and the number of employees by 38%. In 1994, the total
sale decreased by about 7%, and the overall investment rate was low (Alanko, 1996). Also
competition got new rules during the recession. The pressure for price competition was high,
and many firms had to reduce prices at the expense of their revenues. Also the power of
retailer chains became a major determinant; they reduced their purchases, and many did not
conclude yearly contracts with producers any longer. As a common consequence, production
series were shortened and manufacturing firms had to store products themselves. Many
furniture producers had to lay off people or temporarily close down their business.
Additionally, furniture imports increased, proving to be competitive both in quality and price,
which further increased the difficulties for Finnish producers. Furniture exports increased in
1993-1994, however mainly due to government supported exports projects during the worst
recession.
The Finnish economy started to recover in 1994; however the corresponding developments
in furniture industry took their time. The industry started to grow again slowly and steadily in
the late 1990s. Also exports had increased, and the amount of investments had grown
continuously. However, despite these positive signs of industry development, many
companies still faced enormous problems. Technologically and production oriented
manufacturers still had difficulties in being competitive regarding their prices and design. Also
the co-operation between small furniture producers had been problematic, and many firms
had difficulties to build close relationships with retail chains. Finland became a member of
the European Union in 1995, which also created tension in the industry in the sense of
competition and legislation (Laine-Kangas, 1998).
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Case 1: MF (see figure “Case 1” in Annex)
MF was established in 1987 as a consequence of a spin-off. In its first years, the company
had 95 employees, and it operated in three kinds of businesses: own product development
and production (home furniture), home furniture production as a subcontractor, and public
furniture production as a subcontracted order. About 30% of the turnover consisted of
subcontracting sales, and 70% of own home furniture sales to domestic retailer stores.
Exports accounted for about 20% of the turnover. According to the owner-manager, delivery
times, quality, and price were the competitive strengths that MF possessed.
By the end of the 1980s, hard competition and product imitation constrained MF’s
possibilities to differentiate its products. As short term responses, MF implemented
competitive and operative level changes by increasing its product development (including
better quality raw material), changing the product mix, and technologically catching up in
order to achieve more effective production. In this regard, the business environment pushed
(or alerted) MF to focusing its business activities. However, nothing changed dramatically,
and the operative and competitive level changes were mainly incremental.
In the threshold of recession at the beginning of the 1990s, operating in three different
businesses was difficult for MF, and the owner-manager saw many threatening elements in
the environmental conditions (especially in the home furniture business): a decreasing
demand, increasing price competition, decreasing product prices, the increasing power of
retail chains, and the arrival of the economic depression. Under these circumstances the
owner-manager realized that focusing on subcontracting would be the best option for MF.
Benefits from this strategic change would be continuing customer relationships, and
possibilities to anticipate orders in a longer time perspective. The owner-manager
commented the situation as follows: “We have been producing book shelves [home furniture]
for a long time and when we anticipated that retail would become centralised in chains and
they would be bigger entities, we would not survive in that competition… and we started to
strengthen subcontracting”.
As a consequence, MF had to develop and compete in the home furniture business, as well
as develop its operations in subcontracting business. For this purpose, MF actively searched
for co-operation partners and invested in machinery and production process development.
Thus, their intention to increase subcontracting started active processes internally and with
regard to external relationships. Thus, the owner-manager’s perception of environmental
circumstances and their consequences for business proactively triggered the necessity for
strategic change.
Even though the intention to be a subcontractor was strong, the process itself was not easy.
Mainly due to difficulties to find subcontracting customers and large-scale investments made
in production facilities, MF had to continuously put effort also into the development of the
home furniture business. Thus, it broadened its home furniture product mix and increased
product development activities. At the same time, the environmental conditions (decreased
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demand and increased power of retail chains) forced MF to adapt its internal activities,
downscaling to smaller production series. In this context, the owner-manager’s survival
recipe was simply “try to make business instead of competing with prices”. Furthermore, it
had to lay off 30% of its employees, and freeze all investments. In this point, MF’s actions
seem to be mainly a reactive adaptation on competitive and operative levels.
Regardless of the difficulties and due to the environmental uncertainty in the domestic
market, MF actively continued the development of subcontracting business. This had
strategic level consequences when MF established the “JT-marketing company” together
with four local furniture manufacturers. The aim of this co-operation was to increase export
by sharing marketing expenditures and to offer a complete set of products for hotels and big
customers (each of the five firms was specialised on its own product). This was a big
investment of both money and productive factors, and went hand in hand with lots of
expectations. In 1995 the owner-manager saw the business through JT as a stone
foundation of MF. The owner-manager assessed the JT-marketing company as a
subcontracting customer, and in this sense its establishment presented a conscious action
toward his strategic intention. The establishment of JT marketing company is a clear
example of proactive strategic level change.
Although subcontracting was slowly increasing in the mid 1990s, many external incidents
hindered this process. First, changes in the domestic industry limited the customer base.
This was due to generalised investments in new technology in the furniture sector: customers
who used to buy semi products from MF started to produce these parts themselves.
Secondly, the low value of Swedish crown and Ikea’s decision to freeze its subcontracting in
Sweden increased the competition with Swedish subcontractors, as a consequence of which
MF lost exports. However, the JT marketing company increased sales to Germany, which
compensated for the losses in domestic and Swedish markets. At the same time, MF was
negotiating business possibilities with Ikea, albeit without a result. Simultaneously in 1995,
MF was able to develop its business by investing in machines and putting some effort in
product development and marketing. Additionally, an external designer was contracted for its
own product development. We would characterise this period as a period of normal
development, guided by both environmental conditions and internal intentions.
The simultaneous development of the home furniture business (own products) and the
subcontracting business finally proved to be a too heavy business model for MF, and MF
faced its probably most critical period in the late 1990s. Despite of product development
efforts, the competition in the home furniture market was extremely hard, and MF lost an
important retailer chain customer. Additionally, MF had problems with exports, the
subcontracting business did not developed as strong as it was expected, and large debts
caused extra pressure.
In this context, in 1998 MF’s owner-manager finally made a clear decision to implement a
strategic level change and become 100% subcontractor in business-to-business markets. As
a consequence, basically all its business went through four business-to-business customers
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in different segments (office furniture, ships, caravans and hotel furniture), and it stopped
home furniture producing. This decision caused clear changes on the operative level, when
MF stopped its own product design and marketing activities, and sales activities were
organized through customer-focused sales engineers. Also the cost burden was reduced due
to the discontinued marketing and product development activities. This seemed to be a
correct decision in the sense that MF managed to survive the critical years, reaching a
satisfactory performance level. During 1997-2000, MF made the biggest investments in its
history and as a consequence, extended its possibilities of producing customized products.
In 1999, MF had 96 employees, just one more than at the beginning of observation period.
Case 2: RP (see Figure “Case 2” in Annex)
RP is a family business, founded in 1965. At the beginning of our observation period in the
1980s, RP operated mainly in the domestic market, and its business consisted of own
product development and production (mainly bookshelves), which was sold to several
retailers. RP did not do any subcontracting sales; nor was its own product sale concentrated
on any special customers or chains. At this time, RP’s machines were relatively new and
highly automated, and it continuously developed cost-effective production. Since 1984, one
shelf series, “T-shelf”, has been its most important product. In 1985, RP had 35 employees.
In the context of the economic boom and fast growing demand at the end of the 1980s, RP
invested heavily into production automatization and T-shelf effect production. Additionally,
they extended the T-shelf product by developing new modules. According to the owner-
manager, 1988-89 were really good years for RP, and they managed to increase profitability
and sales.
A decade of growth and success, however, was followed by deep economic recession in the
beginning of the 1990s, which clearly affected RP’s business. First, triggered by macro level
problems, RP lost 30% of its sales due to the bank crisis. Secondly, RP experienced credit
losses from its customers and as a consequence, it had to redefine the customer base
according to their solvency. Additionally, RP had to give bigger discounts to its customer.
However, it was also able to continue product development, whereas investments were only
necessary improvements. According to the owner-manager, the general situation in the
furniture market at that moment was the most difficult after Second World War. He also
believed that it was mainly due to their relatively good production facilities and product, that
RP managed to avoid the mindless price competition and keep all its employees. It seems
that in this period, RP mainly received negative ‘surprises’ from the environment, which
forced it to reactively adapt to these circumstances.
However, it seems that difficulties in the domestic market and the consequently declining
performance awakened the owner-manager to think about his business more carefully. In
this context he perceived exports as a means of survival and success for the so far solely
domestically operating RP. As a result of this decision, RP made several proactive actions in
order to achieve this goal. Later on, the owner-manager commented the critical decision to
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invest in export activities as follows: “The decision to start to broaden strongly export market
has been one important decision. If we would have decided that in any case we will not start
export and stay just in home market, it is possible that we [RP] surely not exist anymore or
our business would be in a totally different level.” Therefore, environmental conditions
worked as a trigger for a strategic intention, which in turn lead to many relevant proactive
processes.
Thus, after the devaluation of the Finnish Mark in 1991, RP started to increase slowly its
exports, mainly by participating in several co-operation projects with other Finnish furniture
producers. For these purposes, it put a lot of effort into new product development and
production issues, but also continued its T-shelf development and production.
As an initial and the biggest co-operation project at the beginning of the 1990s, RP tried to
establish a business in the USA, together with three sofa producers. For this purpose, the
firms prepared brochures and business place in that market. However, two out of the three
sofa manufacturers went bankrupt, and RP continued the process only with one of the
partners. Products, however, proved to be unsuitable for the US market, the distribution
chain selection was unsuccessful, and finally the low value of the currency complicated the
project. A second remarkable export effort was directed to Hungary, where RP tried to
develop business with two other Finnish furniture manufacturers. Although this project did not
lead to bankruptcies, it did not fulfil expectations. Poland was their third big export target,
where RP directed its efforts together with eight Finnish furniture firms. Like the two previous
projects, this market entry again faced enormous problems. One by one, the Finnish partners
either gave up or went bankrupt, and finally RP was left alone in the project.
Clearly, these exports efforts were mainly consuming RP’s resources without bringing forth
the expected economical results. They also reflect the difficulties related to the “smallness” of
SMEs in export development activities: partner selection, marketing, product adaptation for
foreign market, and distribution channel selection. However, RP’s activities all present
concrete and proactive efforts for developing export transactions, which included joint
activities with other firms as well as changes in internal projects (i.e. product and processes
adaptation).
In 1995, exports amounted to 20% of total sales, and the domestic market was still clearly
RP’s biggest income contributor. The owner-manager was carefully deliberating about the
market characteristics. Recession had eliminated lots of small retailers from the market, and
centralized chains were holding the power. His perception was that chains did not buy design
products, but cheaper serial products. On the other hand, chains expected just-in-time
deliveries from the producers, as they cut down on stockholding. Additionally, he saw the
imports from the Baltic countries as a big threat. Facing this, the owner-manager realized the
importance of co-operation and long term relationships with chains. As a result, he started to
co-operate with a retailer chain. Our data do not reveal if this relationship was initiated by RP
or the chain, but one important reason for such a relationship might be the fact that furniture
sales were strongly concentrated on chains and RP had to adapt to this reality.
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In the second half of the 1990s, RP continued its active product and production process
development, and it increased its efforts to export, especially marketing. As a result, RP’s
exports grew. For example, export to Russia was really significant in 1997-98, until the value
of Russian currency collapsed in 1998. RP also tried to re-enter the US market with a new
product. In 1997, RP took its biggest step in export operations, establishing a delivery and
sales company in Poland. This affiliated company operated in the Warsaw area, and fifteen
independent dealers were selling RP’s products in different areas of the country. The
decision to establish business in Poland resulted from the Polish co-operation project at the
beginning of the decade. In a sense, Poland was a familiar market, and RP also believed in
the potential of this particular market.
At the same time, some important developments also happened in the context of the above
mentioned retail chain relationships, when a retail chain, operating in Sweden and Finnland,
became interested in the “T-shelf“ (RP’s most important product). As a result of their
negotiations, RP slightly the T-shelf, and started to manufacture it for a retailer chain as a
private label product. Thus, exports to Sweden increased and compensated the loss in
Russian market. According to our knowledge, this was the first time RP extended the
contract to include exclusive sale rights for a retailer, manufacturing one of their successful
products in a customer’s name.
Thus, it seems that despite of many disappointments in export co-operations, and thanks to
the initial growth in exports and the experience resulting from these attempts, RP kept
believing in the strategic importance of export operations, proactively continuing the search
for new opportunities. What happened to the Russian export activities serves as a good
example for how macro economic conditions can determine the business of a small firm. The
relationship with the retailer chain and the production of a private label product, in turn,
reflect a change in RP’s product and customer philosophy. The reasons for this change could
be partly due to positive experiences RP had made with a Finnish retail chain, and partly
because it was the only way to start business with this particular customer.
In 2000, exports constituted 50% of RP’s sales. According to the owner-manager, as a
lesson they learnt from the recession, RP had tried to enter as many markets as possible in
order to diversify its risk. Even more interestingly, the owner-manager judged that the firm’s
philosophy had switched from production orientation to market and customer orientation.
Moreover, RP’s own machinery construction was an important competitive factor in
differentiating products and preventing imitation. In 1999, the firm had 40 employees, five
more than at the beginning of the observation period.
In the RP case, environmental pressure had a clear effect on the firm’s activities. During the
recession, the firm faced difficulties and, as a response, it attempted to find new markets. At
a strategic level, the main decisions were long term export orientation as well as the
establishment of a new company in Poland. In this sense, exports became more important
and were more than a tactic to survive the recession. At a competitive level, RP increased its
marketing efforts and co-operations with other furniture producers and, also, started closer
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co-operation with retail chains. Finally, at an operative level, the continuing process of
technology catch-up was a dominant characteristic of the firm’s development. Also, its
important internal competitive factors were a distinctive product, good quality and price
relationships, and good delivery times. On the other hand, the greatest difficulties were a lack
of marketing knowledge, finding foreign marketing channels, and building effective working
co-operations with other furniture producers.
Case 3: PH (see Figure “Case 3” in annex)
PH was established at the beginning of the 1980s. Within the first ten years, its business
pattern was common and traditional in the furniture market: a broad product mix (home
furniture) and a domestic market. In 1985, PH had 15 employees, and its customer base
consisted of one big retail chain and several small retailers. As product philosophy, PH both
wanted to launch new products into a market and follow other firms’ actions.
The economic boom and an intense competition simultaneously characterised PH’s business
environment at the end of the 1980s. These circumstances became apparent especially in
product and labour related issues: as a response to fast product imitation, PH had to
increase its product differentiation efforts. Its peripheral location however complicated the
process of recruiting skilled employees. However, a fast and flexible delivery, product quality,
price, and good customer relationships were PH’s strengths within these years. PH’s
operations did not change much (mainly incremental development), and this period could be
characterised as a normal way of acting in an intensely competitive environment.
An important turning point for PH’s development occurred in 1990, when Ikea “found” PH
through the Finnish Ikea Trading Service. PH seized this opportunity to start business on a
large-scale basis with Ikea. The owner-manager was aware of the changes this decision
would bring to PH’s internal processes because Ikea’s production would be demanding in
terms of production resources and time. This would lead to clear changes in the use of
production facilities, and it might also limit the possibilities of PH’s own product development
and production. The reasons why the owner-manager decided to start business with Ikea
were perhaps a result of combination of two factors: an extremely good possibility for large-
scale business, and growing competition in the domestic market. Whatever reason, this is an
example for a conscious strategic decision.
Starting from this decision and its realization, PH developed both its own product related
business and the Ikea business. Ikea business proved challenging, and PH had to learn and
invest heavily in order to meet the requirements. Actions included, e.g., investments in new
machinery and recruitment of new employees. At the same time, Finland experienced its
economic recession, and the furniture business became more demanding. The owner-
manager also perceived imports from Soviet Union and Baltic countries as threats. The
increased power of retail chains forced PH to give them special prices. In order to avoid
direct price competition, PH increased its own product development. Finally, its domestic
sales were concentrated mainly on two retailer chains. At this time, the owner-manager
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perceived exports as a worthy investment, and an extra effort was directed to design
products for foreign markets. As a result, PH managed to grow even in a period when the
domestic market suffered from a deep recession. Growth happened due to increased exports
(50% of the turnover in 1991), which in turn mainly resulted from the Ikea business.
However, the broad product mix caused efficiency problems and PH had difficulties to
maximize the benefits from their focused customer relationships.
As was expected, the relationship with Ikea triggered many changes on the operative level,
which at the same time could be characterised as voluntary (based on strategic decision)
and as forced (the only way to do business). In the domestic market, retail chains showed
their power in pricing issues, forcing PH to adapt to their rules. These issues also might have
triggered PH’s proactive actions towards exports markets.
During the first half of the 1990s, the relationship with Ikea increased in importance. Sales to
Ikea amounted to 60% of PH’s total sales in 1993 and to 75% in 1995 respectively. At the
same time, PH grew as a company, both as regards the number of employees and turnover.
However, this growth did not come easily, and PH needed to develop it operations constantly
in order to be competitive in this relationship. Thus, PH continuously invested in modern
production facilities, and developed Ikea’s products. It also needed to present a three years
plan for Ikea, and it had to obtain ISO 9000 quality status. The owner-manager also saw the
employees’ commitment and motivation as important in order to reach PH’s goals. Thus, he
implemented an employee motivating programme. Moreover, he organized team work and a
bonus salary system. Moreover, PH actively cooperated with other Finnish Ikea
subcontractors. In the domestic market, PH continued business with two retail chains, based
on annual contracts and with the chains being responsible for product design, while PH’s
own product development activities decreased. As in previous periods, this period included
several internal changes and developments, which were directed by PH’s strategic intention.
It also seems that the biggest pressure PH faced was triggered from present relationships,
whereas the macro environment did not strongly affect PH.
In the late 1990s, PH’s development and growth continued in a similar way, characterised by
Ikea’s increasing role, its investments in machinery and new employees. However, the broad
product mix still caused efficiency problems. This lead the owner-manager to making a
strategic decision and to narrowing down the product assortment, and concentrate only on
kitchen tables. Moreover, he decided to stop PH’s own product development. Production
from now on would be based on customers’ products, especially on foreign large customers.
These decision and intentions triggered an active search for financially healthy large
customers, mainly in USA, Japan and France. Additionally, PH hired a marketing manager in
order to intensify this process. At the beginning of 2000, PH had 90 employees, exports
represented about 90% of the sales, whereas Ikea presented 96% of total sales.
In this last period, PH continued its conscious and purposeful development of the Ikea-
related business. However, interestingly, the decisions and intentions related to the own
product development and its customer policy reflected a change in strategic level. If PH were
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to realize its intentions, it would become a subcontractor without own products and product
development. We suggest that there are several reasons affecting this intention. Firstly, due
to the positive experiences with Ikea (i.e., firm growth, long term contracts, and serial
production) the subcontracting business seems a promising operating mode. Secondly, the
alarmingly large dependence on Ikea probably evoked a necessity to diversify the risk
involved here and find new customers. Thirdly and again related to Ikea, large investments in
production made it possible for PH to operate on a larger scale and thus, to produce for other
large customers. On the other hand, the broad product mix had caused efficiency problems,
and the large-scale production did not allow for customized, small-scale production. In this
sense, its own earlier decision forced the company to change its product and customer
policies.
The relationship with Ikea was essential for PH’s development, assisting the firm to grow
even in recession years. The development of the relationship was based on continuous
efforts to improve production efficiency, which also allowed PH to search for new big volume
customers. In this case, the main change occurred at a strategic level when the firm, in the
long run, switched from a more traditional business way (broad product mix, domestic
market) to being an Ikea system subcontractor. However, this was not an isolated decision.
From the beginning, the owner-manager understood continuous development of production
facilities and labour force to be an essential element for the firm’s strategic intention. It was a
process that started with the initial decision to produce for Ikea, including many minor
decisions and changes at the competitive and operative levels: ISO 9000, team work,
continuous improvements in production facilities (machines and labour force), narrowing the
product mix, and co-operation with other producers. As a consequence, PH was focusing on
one product, decreasing its own product design and development. Thus, PH’s specific
context was redefined, and main competitive challenges now arise from international
competition as Ikea’s subcontractor.
Discussion
The case analyses showed that each firm had changed at different levels (strategic,
competitive and operative) and in relation to different adaptive elements (product and market
domains, production and technology; and management). At strategic level, many changes
were proactive decisions, triggered both from the owner-manager’s strategic intention and
environmental conditions. In competitive level, changes include both proactive and reactive
responses to competitive situations and normal development. On the operative level,
technology development seemed to be a continuous target for development, whereas
production and labour related changes reflected environmental conditions. Finally, as
common characteristics of the main strategic change processes, two issues can be
emphasized: firstly, all firms had an intention towards strategic change, and secondly, the
realization of main changes took a long time. However, change processes themselves
differed with regard to their nature and contents.
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In the case of MF, the process was chaotic, and the final decision to concentrate on b-to-b
customers was critical for the firm’s survival. At the same time, MF faced new challenges in
its production process, mainly because the production of caravan and ship products was
different from its normal products. Also, the general survival demanded several overlapping
change and adaptation processes, including development of own products, marketing, the
establishment of the JT marketing company, and subcontracting. MF was the only firm,
which had to lay off employees during recession time.
Table 1 – Summary of main characteristics and changes in case companies
CHARACTERISTICS MF RP PH
Written strategy No No No
Personality proactiveness High Medium Medium
Willingness for risk-taking High Relatively high Low
Rationality of decision-making Rational-irrational Rational-irrational Rational-irrational
Decision-making style
Intuition, improvisation,
experimentation
Intuition,
improvisation,
experimentation
Intuition
S
T
R
A
T
E
G
I
C
C
H
A
R
A
C
T
E
R
I
S
T
I
C
S
M&S classification
(strategic orientation)
Before recession: D
During the strategic
change process: A
After change: P
Before recession: D
During the strategic
change process: A,P
Mainly D
Main strategic change
From home furniture
producer to b-to-b
subcontractor
From domestically to
export and
internationally oriented
producer
From traditional
home furniture
producer to Ikea
subcontractor
Strategic level change processes
Establishment of J T-
marketing company
Concentration on b-to-b
customers and stop own
product activities
Several export oriented
co-operation projects
Establishment of
delivery and sale
company in Poland
Private-label for
Swedish chain
Ikea business
Product
concentration: tables
Competitive level change processes
Product development and
designer
Product mix and material
Marketing
Discounts
Marketing
New market penetration
Co-operation with other
producers
Product mix
Product
development
Co-operation related
to Ikea sub-
contracting
C
H
A
N
G
E
P
R
O
C
E
S
S
E
S
Operative level
change
processes
Technological catch up
Production: production and
series
Employer lay off
Task organization
(finishing own
product development;
customer
based sales engineers
Technology catch up
Marketing learning
ISO 9000
Team work
Continuing cost
efficiency
Technology catch up
EMPLOYMENT CHANGE IN THE
PERIOD
From 95 to 96 employees
From 35 to 40
employees
From 15 to 90
employees
P =prospector, A =analyzer, D =defender.
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In the firm RP, the change toward internationalization was characterized by experimentation,
mainly in the form of several co-operation projects with other furniture manufacturers.
Additionally, a critical step was taken, when the firm established its own delivery and sale
company in Poland. Moreover, the strategic importance of chain relationships (i.e., the
private label product for a Swedish chain), and the development of marketing activities
increased when competition hardened. Changes related to product development and to
production were mainly incremental.
In the last case (PH), the main change process appeared more linear compared to the
previous cases. The owner-manager saw the sale concentration on one customer as risky
behaviour and he tried to develop other relationships at the same time. In this case, there
were remarkable changes in product mix and production, mainly due to the concentration on
tables, and finally the termination of own product development. On the operative level, team
work and ISO 9000 were the most remarkable changes.
Next, we will discuss the case firms’ strategic change processes from the perspectives of
strategic decision-making and strategic orientation.
Strategic decision-making
Starting with the personal characteristics of owner-managers, none of the owner-managers
appears rational or irrational in their decision-making processes (measured on the method by
Dean and Sharfman, 1993). This result is supporting the idea of heuristics (Eisenhardt et al.,
1992). Additionally, in all cases, the owner-managers differed in their attitudes toward risk-
taking. Whilst MF owner-manager’s willingness to take risks seems to be high, in RP’s case it
seems to be relatively high, and in PH’s case relatively low.
Furthermore, none of the owner-managers based their change processes on any analytical
planning or a written strategy. According to the owner-manager, MF did not have a written
strategy but long-term goals in mind. In RP, planning is not common activity, and it is only
carried out related to important topics with a two to three years timeframe for implementation.
Finally, in the PH case, planning occurs at a general level and with a long term perspective.
Additionally, owner-managers neither use much formal information in decision-making
(information comes mainly from customers), nor do they generally compare different options.
Only MF’s owner-manager admitted to have compared options before making decisions.
According to him, “decisions come quite fast… it is a different thing to be able to implement
them as fast…There is no time to think and investigate from every side…” PH’s owner-
manager (more rational and more risk averse) said that when he makes a decision, firstly he
thinks about how this decision will affect the firm’s competitiveness and secondly, how this
decision will affect routines, and which kind of long term effect it will have.
In all cases, strategic decision-making was a mix of intuition, experience, and the evaluation
of the internal resource-base of a firm. However, the owner-managers of MF and RP, who
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showed a higher risk-orientation, recognized certain components of improvisation in their
strategic behaviour, stating that in situations where risk is not high and the opportunity
appears a good one, they also made experiments. The owner-manager of RP described
decision-making in the following way: “It is like intuition… It is based on own knowledge,
skills and experience, but there also is a lot of feelings… we are of the opinion that this has
to be a good solution, and we act based on this. Rarely do we have any special factual
information”. PH’s owner-manager (more averse to risk and more rational) thought that
experience is important (especially at an operative level), and he recognised that decision-
making is generally based on intuition: “Apparently it is more to this side… [intuition] and it is
more this way than it would be based on some exact calculation and decision would come
that way. It precisely just come this kind of feeling that this is that way, and this kind of
decision has to be done in this situation.” However, he rejects the idea of improvisation and
experiments in decision-making.
In all cases, owner-managers said that their ways to make decisions has not been changed
much throughout time, and that they had made all decisions individually. However, they
concluded that their ability and willingness to take risks is decreasing with age. In this
context, PH’s owner-manager is trying to implement decision-making in teams, but this
process is at the beginning and learning stage. Additionally, important strategic decisions are
made in all case firms not only when problems appear, but also anticipating the future.
As was expected, strategic planning as understood in the conventional strategy literature
does no fit the context of SMEs. Instead, we would characterise the case firms’ strategies as
intentional and emergent. Firstly, even change processes were not based on analytical
planning, owner-managers had clear ideas in mind as to business development, and several
decisions supported these ideas. Secondly, change processes were not linear, but they
included improvisation and experimentation, which themselves shaped the change
processes.
Strategic orientation: Miles and Snow’s typology
In terms of the adaptive cycle introduced by Miles and Snow (1978), environmental
pressures challenged the market areas in all cases, and, in that sense, the entrepreneurial
problem was activated. In the first case, MF could balance entrepreneurial, engineering and
administrative problems, but the process was difficult and took time because it was
continuously interrupted by external forces. On the other hand, RP could balance
entrepreneurial and engineering problems: the main difficulties appeared as an
administrative problem related to the implementation of their export intentions. However, in
the long term RP learnt to manage its foreign activities. Finally, it seems that in the PH case,
the entrepreneur managed to maintain the equilibrium between the three areas in the change
process.
Classifying the case firms according to the typology of Miles and Snow leads to interesting
results. MF’s strategic orientation varied during the observation period. The main reasons
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were a changed behaviour and discrepancies with its strategic intentions and its actual
behaviour. At the beginning, MF behaved as a defender. At the same time, the owner-
manager showed a proactive attitude by anticipating problems in actual business and by
searching for new opportunities both in products and markets. After the decision to focus on
subcontractor activities, MF showed analyzer behaviour by operating on the home furniture
market and looking for new opportunities in the supplier business. Additionally, when MF
worked as a 100% supplier, it showed prospector behaviour when it changed its business
sectors. Finally, the entrepreneur’s own interpretation was that MF behaviour could be
characterised as a reactor, defender or analyzer, depending on which part of the firm’s life
cycle and which activities of the company were analysed. As regards the connection
between firm strategic behaviour and the personality of the owner-manager (high
proactiveness and high willingness to take risks), the strategic behaviour appears to reflect
the personality of the owner-manager.
RP could be classified as a defender before the economic crisis. However, after the decision
to focus on export, RP behaved like an analyzer in the domestic market, and a prospector in
foreign markets, mainly because its export decisions were often experimental in nature,
showing fast reactions to new opportunities. In addition, the entrepreneur’s own interpretation
was that RP’s behaviour had many characteristics of defender and analyzer, but he also
identified the firm as a prospector in foreign markets. In this case, the personal
characteristics of the owner-manager (medium proactiveness and relatively high willingness
to take risks) and the firm’s strategic behaviour also seem to go hand in hand.
Finally, PH seems to be a defender as concerns the realised strategy in the sense of Ikea’s
proportion of sales and those technological adjustments made in order to be competitive.
However, if we analyse the entrepreneur’s intentions and efforts in finding new large-scale
customers in new foreign markets, we can also see characteristics of an analyzer in intended
strategy. The entrepreneur’s own interpretation was that in the domestic market, before his
business with Ikea, his strategy was closer to an analyzer with many and innovative
products. However, as Ikea’s subcontractor, he classifies his strategic behaviour mainly as a
defender. As it was in two previous cases, the owner-manager personality (medium
proactiveness and low willingness to take risks), and firm strategic behaviour are matching.
In this context, we could have forced each firm to fit one of the categories of Miles and Snow
typology. However, as a side effect, we would have ignored many small but important steps
and changes, and limit the analysis to a more general level. By doing this, we would have
lost the richness of the change processes as explored here, the important elements of SME
strategic behaviour (especially intuition and experimentation), and the success of
implementing changes in a long run. Based on our analysis we therefore suggest that
typologies proposed by the adaptation theory are not adequate in describing SME behaviour.
In general, proactive behaviour is related to successful firms and reactive behaviour to less
successful. In that sense, following traditional adaptation typologies, small firms are often
classified as behaving either reactive or defensive (e.g., Vesalainen, 1995) and, as a
consequence, they are often described as poorly-managed. Thus, when Miles and Snow’s
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typology is applied to SMEs, a large part of the sample is labelled “defender” or “reactor”.
This result could be related to a combination of factors:
• The difficulties of a small firm to allocate resources for a continuous search of new
opportunities and implementing the actions needed to benefit these opportunities
(i.e., needed to be a prospector). Also, the lack of resources to obtain information, the
lack of strategic planning, and the decision-making style of the owner-manager can
reduce the probability to be classified as an analyzer. Moreover, Brouthers,
Andriesen and Nicolaes (1998) suggest that small firms could pursue a defender
strategy, not because it is the best, but because managers act in a non-rational way,
basing decisions on their personal preferences.
• As Kickul and Gundry (2002) suggest, strategies classified as "prospector" by Miles
and Snow’s typology are strongly related to the personality of the owner-manager.
Specifically, this type of strategies goes hand in hand with a proactive owner-
manager personality. When applying the Kickul and Gundry (2002) method to our
cases, RP’s and PH’s owner-managers seem to have a medium level ‘proactive
personality’. Interestingly, the MF owner-manager showed a proactive personality,
and he also was more of a risk-taker and prospector in our analysis.
• Due to the heterogeneity of internal factors, environmental changes affect each
company in a different way. In this sense, the ability to survive, the capacity to exploit
new opportunities; and the ability to take advantage of those difficulties to obtain
earnings will depend on each company and each entrepreneur (Venkataraman et al,
1998). “It is reasonable to believe then, that adaptive behaviour, will vary from one
organisation to another….the causal direction and the magnitude of bivariate
relationships among environmental, organisational, and strategy-making variables
differ systematically among several different homogeneous sub-samples. The
research for simple, universal findings is therefore likely to obscure important
relationships” (Miller and Friesen 1980: 269-270) Thus, it is not always possible to
make non-redundant classifications within a typology. This was clearly demonstrated
in our analysis in two senses. Firstly, the classifications changed over time and
depending on the phases of the change processes. Secondly, the analysis of the
owner-manager intentions and actual strategic behaviour would have resulted in
different kinds of classifications.
Conclusions
In our cases, the main strategic change processes resulted from several inter-related factors,
which both enabled and hindered the processes: the environmental conditions, the owner-
manager and his personality, and internal resources. In terms of environmental influences,
macro economic conditions appear to play an important role in determining SME behaviour
and change processes. At industry level, powerful actors (mainly retail chains) interfered in
change processes by offering new opportunities or by tightening conditions. Interestingly, this
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often resulted in proactive actions in other areas. Moreover, other external stakeholders (co-
operation with other producers) partly enabled, party complicated the intended changes.
Additionally, it seems that the owner-manager’s personality, and his individualistic and
determinant decision-making style are characterising change processes (in all cases the
firm’s strategy was in harmony with the owner’s personality). Also internal resources and the
capability to change were affecting the process. Especially resource development,
production flexibility, expertise (or the lack of it) in different management areas, and product
differentiation were critical to the capability of the SMEs analysed to implement change.
Moreover, the smallness of the firms seems to be an extra hurdle for strategic changes. It
also appears that practising and developing two kinds of businesses at the same time (during
the change processes) is a heavy operation mode for small firms, and sooner or later they
need to concentrate on one core business. In general, the results of the case studies suggest
the importance of analysing change processes as an interaction of a firm’s internal and
external factors.
Secondly, strategic change processes take time. MF’s owner-manager described firm
change process in the following words: “[Change to be supplier] has happened slowly in our
case… we did not change suddenly. The reason for that is that because we are this kind of
private firm, we have had to keep cash flow constant … so we have been changing gradually
throughout a longer period of time. We have changed it in small steps… we were not able to
blaze new trails with one big jump”. Thus, in order to better understand a small firm’s change
processes, longitudinal research methods are recommended.
Thirdly, within our case firms, two principal triggers for main strategic changes could be
identified. In the first two cases, it seems that the owner-managers’ perceptions of present
(and future) environmental conditions (tightening competition, industry power structure) and
their consequences for own business (i.e., the threatening or decreasing performance level,
several reactive adaptations) motivated the owner-managers to think about their business
more seriously, and this evoked the necessity for strategic reorientation. In the third case, the
main strategic change was triggered per chance, when new business opportunities occurred.
Fourthly, strategic change in small firms seems to be a result of multiple, overlapping
processes, where firms need to be able to develop short-term survival tactics and, at the
same time, keep or change normal routines. In a short term perspective, a firm’s response to
any environmental stimuli might often look like a reactive tactic, whereas the same action in a
longer perspective might be a first step to start an intentional change process. In this context,
the main challenges faced by our case-study firms are the necessity to redefine market
positions, redefine productive specialisation, and surpass scale restrictions.
Finally, as the adaptation literature suggests, the case firms tended to act in defensive ways
when they faced environmental turbulence. Within a short term, companies tried to reduce
personnel costs, redefined internal tasks, and implemented product-market decisions (on
competitive and operational levels of adaptation). However, in a longer term perspective,
owner-managers were able to identify new ideas and projects in their business environment.
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Here, the owner-managers were able to take advantage of resources and experience
developed throughout their maturity path (strategic level of adaptation). All three case firms
usually included in their strategic agenda some of the following activities: i) narrowing
product mix, ii) product differentiation/innovation, iii) focusing key customers, and iv) a
greater propensity to co-operate with other companies. In addition, the analysis of the
decision-making processes helped to appropriately understand how the firms reacted to
environmental signals and how individual decisions can affect the process. In general,
entrepreneurs act with bounded rationality and strategies are often based on experience and
intuition instead of calculation and planning. Thus, an alternative to the rigid thought of the
strategic planning school would be shifting attention to improvisation modes.
Limitations
The main problems and limitations of the study are related to the data collection method. The
interviews in different years have been conducted mainly through telephone (face-to-face
interviews were conducted just in 1986), and different people were involved. Additionally,
secondary data mainly refers to firm related issues, and there is only limited information
available related to the owner-manager characteristics. However, longitudinal studies often
are based on secondary data, i.e., records, annual reports and other public information, or on
retrospective reconstructions of the past based on memory. These data collection methods
have their weaknesses such as impression management, the bounded human ability to
remember past events and an automatic tendency to rationalize and glorify past decisions. In
small firms, annual reports or records are not often available, and thus, the reconstruction of
the past is even more complicated. In our study, most questions were open ended and
qualitative in nature, and “why questions” had been presented in order to clarify the changes
and developments in different themes. Additionally, we included some new interviews in
order to get some more information related to owner-managers, and also to validate a few
issues related to the secondary data. Despite the data collection limitations, the data seem to
be adequate from a research point of view. It gives us a rich understanding of the change
processes in the case firms. However, the fact that our sample includes just three firms in
one industry also needs to be considered a limitation.
Implications and future research
Especially in the conventional strategic and adaptation literature, the majority of the studies
are concentrated on large firms, and SMEs are often considered as a homogenous group, or
as smaller copies of large firms. However, researchers within the SME and entrepreneurship
field have criticised this for a long time. In this context, we hope that our study stimulates the
discussion in the field of strategy research, mainly by taking into account the complexity and
richness of SME change processes in changing environments. We also wish for our results
to assist researchers in directing their attention to those critical and inter-related factors that
affect strategic change processes. Additionally, due the long term implementation of strategic
changes in SMEs, a longitudinal research approach is recommended. As a practical
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implication, this study can help policy makers and SME advisors to better understand SME
behaviour, which in turn might assist them in improving support and training activities
directed at small business managers and entrepreneurs.
As one question for future research, one interesting possibility is to broaden this study to
include more cases, and thus reveal the richness of the phenomena. Moreover, it could be
relevant to replicate the study in other industries. In this way, we could see if the strategic
change variables are the same in different contexts, and to which extent industry and
strategic industry factors is characterising change processes in small firms. Additionally, the
relationship between small firm and environment appears to be an essential phenomenon. It
would be interesting to concentrate on this issue by deeply analysing specific inter-related
events in order to tease out how the same environment treats firms in different ways, and at
which point and which aspects commonalities start to appear.
E-mails of corresponding authors: Karita Luokannen, [email protected]; Rodrigo
Rabetino, [email protected]
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YEA
1987
1991 1993 1995 2001 t
B
u
s
i
n
e
s
s
E
n
v
i
r
o
n
m
e
n
t
E
x
t
e
r
n
a
l
R
e
l
a
t
i
o
n
s
h
i
p
s
G
e
n
e
r
a
l
e
n
v
i
r
o
n
m
e
n
t
A
n
s
w
e
r
s
I
n
t
e
r
n
a
l
F
a
c
t
o
r
s
Exports
decrease 5%
Exports 25%
Subcontractin
g 30%
Customer
concentration
40%
Fast product
imitation
Low
possibility to
diff ti t
Hard
competition
Extra time
Sector decreased
prices
Same prices
Distributors buy
smaller series
Subcontractin
g increase
Exports 20%
Subcontractin
g 40%
Lack of productive capacity
Delivery, quality and
price (+)
Capital cost
2 Phone
ll
Marketing
manager
Decrease price
competitiveness
Big investments
(cooperation J T)
Lot of debts
Lack of
it l
Needs to improve
basic operations
Marketing
Company
(cooperation J T)
Subcontracting 100%
4 customers
Home furniture almost
inexistent
Lots of debts
Flexibility in
machines (+)
90% capacity in use
Average
lit / i
Exports 20%
Subcontractin
g 30-40%
No exports
Big
domestic
chain stops
relationship
Difficulties in
domestic market
Ikea in
Finnish
k t
Home furniture
40%
Slow increase in
subcontractor
activities 53%
Exports 15%
Industry
invested in
new
t h l
Component
subcontracting
decreased
Increased
domestic
subcontracting
Exports
decreased
Swedish
economy
Ikea frozen
subcontracting in
Sweden
Product
development
Investment in
technology
Search for cooperation
Changes materials but not
prices
No investment
Increased
prices
Product
development
Increase product
i
Wants to
subcontract as
business idea:
Anticipated
orders and
long-term
relationships
C
A
S
E
1
.
S
t
r
a
t
e
g
i
c
c
h
a
n
g
e
p
r
o
c
e
s
s
e
s
o
f
M
F
Investment in
technology
Increased product
development
External designer
5 new employees
Increased prices
Failed
negotiation
with Ikea
Lots of
investment in
technology
Decreased
marketing
DECISION to
subcontract all
2 new areas
Process and products
development
30 new employees
Buy semi-products
Economic
Recession
Devaluation
Finnish Mark
Inflation
Laid off employees
Laid off 30% of employees
Flexibility (+)
Technology (+)
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YEAR
1987 1991 1993 1995 2001 t
B
u
s
i
n
e
s
s
E
n
v
i
r
o
n
m
e
n
t
E
x
t
e
r
n
a
l
R
e
l
a
t
i
o
n
s
h
i
p
s
G
e
n
e
r
a
l
e
n
v
i
r
o
n
m
e
n
t
A
n
s
w
e
r
s
I
n
t
e
r
n
a
l
F
a
c
t
o
r
s
Home furniture
(mainly
domestic)
No
subcontracting
One important
product
Hard
competition
Increasing power
of distributors
Quality (+)
Lost 30% of
sales
Domestic home
furniture 95%
Technology, delivery,
quality and price (+)
Production
facilities (+)
Delivery (+)
Location (-)
Marketing (-)
Delivery (+)
Bad marketing
skills despite of
efforts
Good products (+)
Cooperation in
exports
Home furniture:
50% domestic
50% exports
Quality (+)
High but competitive
prices (+)
Almost 100%
capacity in use
Lot of marketing
Exports 10%
Increasing
exports
Relationships with
retailers are
important in
competitive
situation
No
subcontracting,
no main
customer
Increasing exports:
- decreased
to Russia
- increased
to Sweden
No demand for
designed
products, just
for series
Smaller retailers disappearing
Centralized chains
and J IT
Exports 20%
Most difficult situation
after war (Highly
deterministic)
Increased exports
Swedish economy
New automatic machines
Cash discounts
Customer selection
based on ability to pay
Integrated activities
Increased marketing
activities (cooperation)
No big investment
Pressure to laid off
personnel
Trying to
maintain prices
Product
development
Strong
intentions to
export
C
A
S
E
2
.
S
t
r
a
t
e
g
i
c
c
h
a
n
g
e
p
r
o
c
e
s
s
e
s
o
f
R
P
New products
Continuous product
development
New machines and
better quality
Cooperation projects to
export to Poland,
Hungary and USA
Cooperation with
Stemma chain
Increased
marketing in
exports
Pricing policy:
customers
classification
Fromproduct
orientation to
market/customer-
oriented
Special model for
EM chain
Investments and
products development
10 new employees
Buy semi-products
Economic
Recession
Devaluation
Finnish Mark
Inflation
Bank Crisis
Russian crisis
Daughter company in
Poland
Threat from
products from
Baltic countries
Automated production
(+)
Location (-)
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YEA
R
1987
1991 1993
1995 2001 t
B
u
s
i
n
e
s
s
E
n
v
i
r
o
n
m
e
n
t
E
x
t
e
r
n
a
l
R
e
l
a
t
i
o
n
s
h
i
p
s
G
e
n
e
r
a
l
e
n
v
i
r
o
n
m
e
n
t
A
n
s
w
e
r
s
I
n
t
e
r
n
a
l
F
a
c
t
o
r
s
100%
domestic
sales: one big
chain as
customer
(50%)
No
subcontracting
Broad product mix
Hard
competition
Increasing power
of domestic
chains and
distributors
Exports 50%
of sales to Ikea
Domestic
sales: 50% (2
h i )
Location (-)
2 turns work in factory
Broad product mix
Employees and delivery
(+)
Automated production (+)
Employee
motivation
4% of sales were
domestic
(1 chain)
One main
product
(t bl )
Almost 100%
capacity in use
Domestic
chains 40% of
sales
Increased sales
to Ikea
Export 96% of
sales (mainly
Ikea) Increasing
business with
Ikea
Exports 60%
to Ikea
Domestic chains
20%
Exports 75%
to Ikea
Increased sales to
Ikea
Investment in
hi
Special prices to
chains
Personnel
ti ti
Increased product
development
8 new employees
Investments in
technology
Fast and
flexible
delivery
Big effort in
product
differentiation
Design
products for
export
C
A
S
E
3
.
S
t
r
a
t
e
g
i
c
c
h
a
n
g
e
p
r
o
c
e
s
s
e
s
o
f
P
H
ISO 9000
Chains are doing
product design
Investments in
technology
Cooperation with
Finnish subcontractors
Small own
product
development
Teamwork and
employee
motivation
Search for new
foreign markets
(USA, France,
J apan) based on
volume and
ability to pay
Marketing manager
DECISION to
concentrate on
ONE product
and exports
42 new employees
Bonus salary system
New machines and
no own design
Economic
Recession
Devaluation
Finnish Mark
Inflation
Bank Crisis
Exports to UK
Fast
product
i it ti
Lack of skillful
employees (-)
Difficulties to maximize benefits
( )
Started
business with
Ikea
17 new employees
Product
development
Broad product
mix
Threat fromproducts from
Soviet Union and Baltic
t i
More retail concentration
Decreasing prices in furniture
sector
Annual contracts with chains
8 new employees
3-year plan
Vertical networking
with small
d
Delivery, quality and
price and relationships (+)
Professional skills (+)
New production facilities (+)
Customer relationships
(+)
Location and broad product mix (-
)
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Tracking Small Business Failure Factors and Trajectories
Mika Pasanen, PhD
University of Kuopio, Finland
Abstract
The aim of this study was to identify SME failure factors and trajectories. The empirical study
was based on in-depth interviews with the ex-entrepreneurs of 12 failed SMEs. The results
reveal that several factors related to the entrepreneurs, the firms and their environments
were associated with SME failure. There were also more firm-type specific factors
contributing to SME failure. Moreover, three types of failure trajectories were identified: (1)
failed borderline cases; (2) rapid collapse failures; and (3) failed seekers of legitimacy. The
results indicate that many factors associated with failure are internal, and so under the
management’s control. One or a few major factors seem to cause firm failure, though there
are several inter-related factors and processes contributing to SME failure. In many cases,
the root cause of failure can be traced to problems in management and to the lack of
strategic management in particular.
Key Words: small businesses, performance, failure, strategic management
Introduction
This paper focuses on failed small and medium enterprises (SMEs) in peripheral locations.
The objective was to identify SME failure factors and trajectories. A number of studies have
focused on firm success, but few recent studies have focused on firm failure (Thompson
2001: 619). However, as we know, some firms succeed and others fail. It has been found
that entrepreneurs’ chances of financial success are substantially greater than the chances
of loss (Dennis & Fernald 2001). However, they are not nearly as favourable as new firm
owners seem to believe (Cooper et al. 1988). It seems reasonable to assume that much
could be learned from failed firms.
A high proportion of new ventures are closed down during their first years of life, and many
SMEs are closed down every year, indicating that these firms were not able to maintain the
alignment with their environment, or had never even achieved it. For instance, in Finland in
2002, half (50.2%) of the firms that closed down had survived less than five years (Statistics
Finland 2004). However, managers are as much responsible for avoiding failure as for
achieving success (Argenti 1976: 182). As a matter of fact, it has been argued that the most
important and most challenging business goal is long-term survival (e.g. Simon 1996: 12).
Moreover, survival is, at least in the long term, a prerequisite for success in other terms, such
as market share or profitability. To date, however, studies of firm longevity have focused on
large companies.
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However, SMEs are often the only feasible engines of development, especially in peripheral
regions. They generate societal growth in terms of new jobs and revenues; they create
innovations, and form flexible production networks. In fact, relatively speaking, the number of
jobs created by expanding small firms is larger than the number of jobs created by new firms
during their first year of operation or by large firms (Wiklund 1998: 1). However, few studies
have focused on the foundations of performance of SMEs in peripheral locations. This is
unfortunate, as business is not managed in the same way in different areas (see e.g. Lussier
& Pfeifer 2000; Yusuf 1995).
Changes in the environment cause more uncertainty in SMEs than in large companies. Their
resources for acquiring information about the market and changing the course of the
enterprise are more limited. The response to environmental changes is different in SMEs
than in large companies (e.g. Chen & Hambrick 1995). Large firms may even exit from one of
their business areas, but this is not usually possible in a single-business firm. The options for
responding are limited by the firms’ resources and strategic choices as well as by the
opportunities offered by the industry and location.
Previous research on SME failure
Challenges in research
There are several definitions of business failure (see e.g. Watson & Everett 1996a; 1993).
Firm failure has been defined in several ways, e.g. bankruptcy, insolvency, liquidation, death,
deregistering, discontinuance, ceasing to trade, closure, and exit (e.g. Storey 1994: 78-81;
Bruno et al. 1987). These definitions overlap each other to some extent (Sten 1998), and
they may have different meanings in different countries. As a result of this conceptual
pluralism, comparisons between results of previous studies of failure are difficult. In this
study, a failed firm is defined as one which has gone into liquidation, i.e. it has ended its
business and left behind unpaid creditors, and so the empirical cases in this study are
unequivocal failures. Aggregating closures with failures has been a typical problem in several
previous studies.
It is important to notice that not all firms that go out of business do so as a result of failure,
and those that do not should be separated from failures. For instance, according to
Thompson (2001: 631), ultimate business failure happens when a business is liquidated or
sold. However, a distinction should be made between two kinds of situations: optional and
non-optional. When there are no options, the discontinuance of the firm or business can be
defined as failure: in other cases the situation can be labelled as exit. On the other hand, a
business which is sold because the entrepreneur wants to realize a profit, for example, is an
exit, and closer to a success than a failure.
It is also important to understand the root causes of failure, not only the symptoms. In many
studies, it seems that a clear distinction is not made between the symptoms and causes of
failure (see e.g. Boyle & Desai 1991). For instance, financial ratios are seen to be symptoms
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rather than causes of failure (Argenti 1976). However, prior empirical studies of failure have
concentrated almost exclusively on financial ratio data, though the usefulness of ratio-based
firm failure prediction models has been questioned (Lussier 1995). It has often been argued
that a firm failed because it had run out of money, whereas the root cause may be poor or
ineffective management, for example. Revealing the underlying reasons for failure, in
particular, and their dynamics would obviously be useful for the creation of the business on a
sustainable basis.
Moreover, many firm failures do not happen suddenly, but develop over time as a
consequence of decline or crisis. The factors contributing to firm failure are often closely
related to the causes of decline and crises. Although small firms are more vulnerable than
large ones, few studies have focused on the failure, decline, crises, and turnaround of small
firms (Chowdhury et al. 1993).
The findings of previous studies can be described as fragmented, while several common
themes are evident. To date, research into firm performance has not provided a
comprehensive explanation for SME failure. There is disagreement among previous studies
concerning the factors contributing to firm failure (Lussier 1996). A huge number of variables
seem to be associated with firm failure. In addition, most studies have focused on large
companies, and those investigating small firms often concentrate on new ventures.
Moreover, a large variety of research approaches has been used. Narrowness and the lack
of a holistic approach are characteristic of many studies. In addition, few studies have
focused on the factors affecting the performance of SMEs in peripheral locations.
However, there are several difficulties in studying failed firms (Bruno et al. 1987). These are:
(1) difficulties in sampling; (2) the unwillingness of founders to discuss failure; (3) the inability
of founders to understand and articulate causation; and (4) the multidimensional complexity
of the problem. Difficulties in sampling relate to the selection of appropriate sampling frames
of reference, but also to problems in locating the ex-entrepreneurs. The second and third
problems relate to the length of time between failure and data collection. Multiple causation
leads to categorization and comparison difficulties for researchers investigating the problem.
Research approaches
Many methodological approaches have been used to explain and understand firm failure.
Here, studies of firm failure are divided into case studies, surveys, and database analyses,
on the basis of their methodological approach to data acquisition. There are also some
compilations of the results of previous studies of the factors associated with firm failure.
Perhaps the most extensive is the one made by Storey (1994: 92-110). Boyle and Desai
(1991) have reviewed the literature concerning the causes of small firm failure. They
proposed a typology dividing the causes into four categories based on a matrix of two
dimensions: (1) environment, i.e. internal vs. external; and (2) nature of response, i.e.
administrative vs. strategic. Lussier and Corman (1995) have also reviewed the research
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literature on factors contributing to small firm success versus failure. Vesper (1990: 38, 55)
presents a list of failure causes in high-technology start-ups.
Case studies have been carried out by Bruno et al. (1987) and Zacharakis et al. (1999).
Bruno et al. (1987) studied ten failed high-technology firms in emerging industries in
California. Zacharakis et al. (1999) in their study of perceptions of new venture failure carried
out matched case studies of venture capitalists and entrepreneurs.
In addition, there are some survey studies concerning the failure factors of firms. Carter et al.
(1997) studied discontinuance among new firms in retail in the U.S. with a focus on the
influence of initial resources, strategy, and gender. Lussier (1996) identified the ten most
common reasons for small firm failure in a survey of 100 failed small firms representing the
population of small firms in six states in the U.S.A. Gaskill et al. (1993) studied the perceived
causes of small firm failure in apparel and accessory retailing in Iowa. Smallbone (1990)
conducted a follow-up study of new ventures who were clients of an enterprise agency in the
UK. Sommers and Koc (1987) studied high-growth firms in the telecommunications,
computer equipment, instruments, and electronic components industries. Cressy (1996)
analyzed the shape and the underlying temporal stability of firm failure distribution, using a
large UK start-up database.
Failure factors
Many studies have concentrated on entrepreneur characteristics in explaining firm failure.
However, the importance of the entrepreneur’s personality traits has been seriously
questioned (see e.g. Storey 1994: 109). Findings concerning the entrepreneur’s age, gender,
lack of work experience, and family background have been contradictory. Only the
entrepreneur’s education has been quite consistently verified in empirical studies to influence
firm performance positively (Storey 1994: 109). However, there are also exceptions: In their
study, Lussier and Corman (1995) found that the owners of failed firms had a higher level of
education. In his literature review, Lussier (1996) shows that there is considerable evidence
that firms managed by people without management experience have a greater chance of
failure than firms managed by people with such experience (cf. Westhead et al. 1995: 88).
Also, in some studies, lacking experience in the industry sector has been found to contribute
to firm failure (Gaskill et al. 1993; Vesper 1990). Moreover, lack of motivation and
commitment on the part of the entrepreneur is associated with firm failure.
Poor management is often associated with firm failure in several studies (Haswell & Holmes
1989; Gaskill et al. 1993; O’Neill & Duker 1986). An incomplete start-up team (Roure &
Maidique 1986) and disagreement with partners (Hall & Young 1991) contribute to firm
failure. In their study of failed high-technology firms, Bruno et al. (1987) report that an
effective management team was more important for firm success than overall management
competence. Indeed, in seven cases out of ten, an ineffective management team was seen
to be one of the major reasons for firm failure. Lack of management skills was seen to be a
major failure determinant by Zacharakis et al. (1999). Also, the entrepreneur’s inability to
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perform both planning and administrative functions is seen to be associated with firm failure
(Boyle & Desai 1991).
Many failure factors are related to products and services, customers and markets, and
cooperation with other stakeholders. The greater the product range, the higher the probability
that the firm will survive (Reid 1991). Unsuccessful product timing has been found to be one
cause of failure, i.e. early and late introductions are problematic (Bruno et al. 1987; see also
Vesper 1990: 38). Also, dependency on a single customer or only a few customers is a major
factor affecting firm failure (Reid 1991; see also Hewitt-Dundas & Roper 1999; Hall & Young
1991). High reliance on a single customer as well as ineffective distributor relations are
factors associated with failure (Bruno et al. 1987). Hence, a diversified customer base plays
an important role in firm survival (Storey 1994: 107). Obtaining sufficient sales is a challenge
particularly for smaller firms (Cromie 1991; Hall & Young 1991). Cressy (1996) found that
fluctuations in firm sales increase the probability of firm failure. Moreover, it has been shown
that those firms which do not use professional advisers are more likely to fail than those
which do (Vesper 1990; Gaskill et al. 1993; Lussier 1995).
Firm resources and finance are seen to have a critical role in many studies. Firms that start
undercapitalized have a greater chance of failure than other firms (Lussier 1996; Hall &
Young 1991). The failed new firms studied by Smallbone (1990) also suffered from
undercapitalization, and lack of business was characteristic of them. Financial inadequacies
such as undercapitalization and problems in venture capital relationship are the major factors
affecting firm failure (Bruno et al. 1987; see also Zacharakis et al. 1999; Boyle & Desai 1991;
Cromie 1991). In their study of discontinuance among new firms in the retail industry, Carter
et al. (1997) showed that lack of human and financial resources is associated with business
discontinuance. Such an association was also confirmed by Cressy (1996) in his database
analysis. The lower the levels of external borrowing are, the higher is the probability that the
firm will survive (Reid 1991). Labich and de Llosa (1994; also O’Neill & Duker 1986; Hall &
Young 1991) claim that mishandling of debt loads is an important factor associated with
failure. Moreover, inadequate record keeping and financial control has been found to be a
cause of failure (Gaskill et al. 1993; Boyle & Desai 1991; Vesper 1990). Often, rapid firm
growth generates problems with finance, which ultimately may lead to firm failure. Thus,
problems in working capital management are associated with firm failure (Gaskill et al. 1993).
The firm’s inability to attract and retain competent employees may also lead to failure
(Sommers & Koc 1987; Boyle & Desai 1991; Lussier 1995). Cromie (1991) claims that the
biggest problem related to personnel in young firms is getting good staff with the right
attitudes. Labich and de Llosa (1994) claim that low employee morale and hostility may be
an important reason for failure.
It has been found that young firms are more likely to fail than older firms (e.g. Dunne et al.
1989; Storey 1994: 109; Westhead et al. 1995). Similarly, smaller and especially very small
firms are more likely to fail than their larger counterparts (e.g. Gallagher & Steward 1985;
Dunne & Hughes 1992; Storey 1994: 109; Westhead et al. 1995; see also Watson & Everett
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1996b). For the survival of young firms, their growth after startup is critical (Phillips &
Kirchhoff 1989; Storey 1994: 109). Moreover, there is some evidence that the higher the firm
growth rate, the higher the probability of survival, and also that firms which start larger have
higher survival rates (Phillips & Kirchhoff 1989). The causes of crises and failure related to
the management of transitions from one stage of development to another are described in
the studies of organizational life cycles (see e.g. Flamholtz & Randle 2000; Kazanjian 1988;
Greiner 1972; see also Boyle & Desai 1991).
A weak business concept or unclear business definition, i.e. lack of clarity about what
business we are in, and lack of focus have been presented as causes of failure (Bruno et al.
1987; Smallbone 1990; Zacharakis et al. 1999; Labich & de Llosa 1994). Also, failure of
vision has been found to be an important factor behind firm failure in the United States
(Labich & de Llosa 1994). Resistance to change relates to the fact that “success can often be
the seed of future failure”, which underlines the importance of continuous development
(Labich & de Llosa 1994; see also Miller 1994). It has also been shown that lack of a
business plan is associated with firm failure (Sommers & Koc 1987; Gaskill et al. 1993;
Lussier 1995). Lack of planning and especially strategic planning is often seen to be
characteristic of failed firms (Boyle & Desai 1991). Also, an overextension of the business
may cause failure (Gaskill et al. 1993). Jennings and Beaver (1997) claim that the root cause
of either small firm failure or poor performance is almost invariably lack of management
attention to strategic issues.
Turning now to the external environment of the firm, we find Storey (1994: 94-95) arguing on
the basis of his compilation of previous studies, that the industry sector seems to play a
minor role in firm failure. However, the results of previous studies have been contradictory on
this issue. For example, North et al. (1992) found wide sectoral variation in the survivability of
SMEs, while many other studies have argued that there are no sectoral differences in failure
rates (e.g. Phillips & Kirchhoff 1989; Kalleberg & Leicht 1991). One explanation for these
conflicting findings may be found in a study carried out by Watson and Everett (1999), who
claim that some definitions of failure are biased against certain industry sectors. Moreover,
contrary to general belief, many firms filing for bankruptcy actually have growing sales and
are situated in growing industries (Moulton & Thomas 1988).
The macroeconomic situation and changes in it have also been found to have an association
with firm failure. Firms started during a recession seem to have a greater probability of failure
than other firms (Bruno et al. 1987; Vesper 1990). Moreover, slow economic activity or
recession has been found to be a major reason for failure (Lussier 1996). Poor external
market conditions, including stiff competition, slow market growth, and small market size,
have been found to be major factors associated with firm failure not only by entrepreneurs
but also by venture capitalists (Zacharakis et al. 1999). Other studies have also found that
stiff and increased competition, and the firm’s inability to respond to it, is associated with firm
failure (Roure & Maidique 1986; Gaskill et al. 1993).
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Failure trajectories
Few recent studies have focused on firm failure processes and trajectories. Moreover, on the
basis of the studies we do have, it seems that most studies have focused on large
companies, and those investigating small firms often concentrate on new ventures.
In their study of large corporation failures, Hambrick and D’Aveni (1988) matched failed and
survived firms. They describe the decline of the firm as a downward spiral. The significant
features of the downward spiral include early weaknesses in slack and performance, extreme
and vacillating strategic actions, and abrupt environmental decline. Moreover, they found that
the failures showed signs of relative weakness very early, so it can be concluded that the
deaths are protracted processes. Moreover, in his study of strategic and managerial
consequences of organizational decline in large companies, D’Aveni (1989) found that
bankruptcy may be delayed or even avoided in an environment of growing demand.
In fact, there are several ways to classify and describe the factors and mechanisms affecting
firm failure. The basic classification divides the reasons into two categories: (1) firm-internal
causes; and (2) firm-external causes. In addition to firms falling into these categories, there
are also businesses that never start trading. Moreover, some firms cease to trade due to
health problems, ageing or other reasons related to the person of the entrepreneur.
Factors affecting firm failure are often described by using life cycle stage models. Adizes
(1979) has identified the four premature mortality outcomes in different life cycle stages: (1)
aborted idea; (2) infant mortality; (3) founder’s trap; and (4) divorce. Greiner (1972) has
described firm development through different stages of organizational crisis. Failure to adapt
to a series of crises caused by growth is one of the principal causes of failure for all
organizations (Greiner 1972). Argenti (1976) has presented three types of failure trajectories:
(1) never get off the ground; (2) obsessed by speed; and (3) insidious development.
Moreover, Miller (1990) has named four development types of failing firms: (1) tinkerer; (2)
imperialist; (3) escapist; and (4) drifter. He argues that the factors affecting firm failure are
bound with the type of the firm.
The challenges of this study
Altogether, the findings of previous studies can be described as fragmented, although
several common themes are evident. There is disagreement among previous studies
concerning the factors contributing to firm failure (Lussier 1996). However, taking into
account the several choices that researchers have to make concerning their study design,
and therefore the diversity of studies, it is to some extent understandable that the results of
studies are inconsistent with each other.
However, in the light of previous research, it can be suggested that there do seem to be
certain factors related to failure. Firm failure often seems to be related the entrepreneur’s
lacking higher education and experience, and the lack of an effective management team,
innovativeness in products, good customer relationships and avoidance of dependency on
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only a few customers, good cooperation relationships, adequate financing, skilled personnel,
strategic planning, firm growth, firm flexibility, focusing on core business, and operation in
favourable economic conditions. Moreover, the classifications presented also suggest that
there are contingency factors, e.g. firm life cycle stage, which may affect the results.
All this calls for the holistic investigation of failure factors and trajectories. There are firm-
internal and firm-external factors, which may make either an immediate or a long term
contribution to firm failure. The results can also be dependent on context and contingency
factors such as firm type, which might explain inconsistencies in the results of previous
research. The context often plays a critical role: what works in one context will not
necessarily work in another. Moreover, investigating failure trajectories is important in order
to identify the processes leading to firm failure.
On the basis of the literature review, the following research questions can be set:
1) What are the most common factors affecting SME failure?
2) Are there differences in failure factors between firm types?
3) What kind of failure trajectories can be identified among SMEs?
Data and methods
Data collection methods
This paper is based on the data of a larger exploratory study of the factors affecting SME
performance (Pasanen 2003), and it utilizes the taxonomy of SMEs presented by Pasanen et
al. (2000). Twelve failed SMEs were identified, based primarily on the information gained
from local authorities, e.g. representatives of business development departments of
municipalities and towns. Failures were defined as those SMEs which had gone out of
business with loss to creditors. The entrepreneurs of the 12 failed SMEs in Eastern Finland
were interviewed, and the main material was based on these in-depth case interviews carried
out in 1999-2001. In addition to interviews, document material such as annual reports, financial
statements, newspaper articles, etc. were collected and used as complementary secondary
data.
Times for the interviews were fixed in advance, and the entrepreneur was asked to prepare for
the interview by collecting the available annual financial statements. In some cases, other long-
term key persons in the firm were also interviewed to provide complementary information.
These were the cases where the principal interviewee had started as a CEO of the firm after
the firm was founded, and there were some key person(s) who had longer experience in the
firm, or the key person was more deeply involved than the CEO in some critical incident in
the firm’s history, and so had a better understanding of the issue in question. No
discrepancies were found in the answers given by the entrepreneurs and the key persons.
Some of the interviewees were re-interviewed later to obtain more detailed information about
important incidents revealed in the first interview.
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The framework for interviews was constructed on the basis of the results of the previous survey
results and of the research literature. The interview was started by asking the interviewee about
her or his view of the events and factors associated with the failure. The potential role of failure
factors found in the relevant literature were also examined among cases. Each of the
personal on-site interviews took from one to three hours. The interviews were recorded and
transcribed.
Sample characteristics
The twelve failed SMEs in the sample can be characterized as follows. They shared four
features: (1) size: SMEs, i.e. they employed fewer than 250 persons; (2) location: peripheral,
i.e. outside major cities and not in core areas; (3) performance: a firm has gone into
liquidation, i.e. it has ended its business, leaving behind unpaid creditors; and (4) ownership:
independent firms, not subsidiaries of other companies.
Most entrepreneurs of failed SMEs were men (92%) and owner-managers (75%). Among
owner-managers, two thirds of entrepreneurs were founders of these SMEs. The
entrepreneur’s average age was 47 years. Failed SMEs operated in several industry sectors,
most of them (83%) in manufacturing, and the rest (17%) in the service sector. The average
number of full-time personnel before the firm went out of business was 16 employees.
However, these SMEs had typically reduced the number of employees during their last year
of operation, and hence the number of employees did not indicate the highest number of
personnel during the firm’s life cycle.
The firms’ average age was 14 years. Half of the failed SMEs were founded by at least two
founders. However, interestingly, 58% of failed SMEs were owned by only one owner just
before the firm went out of business. More than half (58%) were family firms, and most (58%)
had consciously defined and specified goals and objectives. Moreover, there were failed
SMEs in each stage of development.
All failed SMEs, except one, had stayed near to their original business. One third had faced
at least once a situation where the firm’s existence, i.e. survival, had been threatened (apart
from the threat which had finally led the firm into liquidation). Two thirds had grown in terms
of turnover during recent years of operation. Also, two thirds had operated in markets where
demand had grown during recent years. Almost half of the failed SMEs (42%) were export
firms. One quarter had products which were considered unique in the markets. On average,
the most important customers accounted for 29% of the turnover for failed SMEs. One third
were subcontractors, and half bought subcontracting.
Data analysis methods
In data analysis, first the situations before the failure of the cases were briefly described. In
the description of the past development of the cases, the most important transitions, events
and decisions affecting firm performance were identified and described. In this searching
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process, the critical incident technique (Chell 1998; Flanagan 1954) was applied. Special
attention was paid by the interviewee or the researcher to the factors which showed a
potential or proven impact on firm performance. Though significant occurrences in the firms’
history were identified by respondents, the final evaluation of their importance was based on
the researcher’s interpretation.
In particular, the researcher looked for the factors affecting the development of firm failure.
The ways of responding to environmental changes and the strategic choices made by SMEs
were clarified. The methods of qualitative research used made it possible to acquire an in-depth
understanding of the events and processes that can explain a firm’s responses and choices
(see e.g. Mintzberg & Waters 1982: 466-468).
The interviews were coded and analyzed applying the grounded theory protocol (Glaser &
Strauss 1967; Strauss & Corbin 1990). First, the qualities emerging from the data were
identified and coded. After this conceptualization, the concepts were classified into
categories that emerged from the data. Next, connections between the categories and sub-
categories were analyzed. Finally the core category was selected, the story line was
explicated, and sub-categories were related to the core category. However, the case
descriptions, apart from one illustrative case, are not presented in this paper.
Results
Failure factors
Of the factors studied, typical of the entrepreneurs of the failed SMEs were lack of prior
experience as an entrepreneur, lack of marketing skills, lack of prior managerial experience,
and parents who were not entrepreneurs. Typical of the failed SMEs were a firm managed by
one individual, lack of planning, a firm founded by one individual, no use of business
advisors, dependency on one or a few big customers, small amount of products/services,
and unfavourable macro economic conditions. In addition, characteristic of many failed SMEs
was inadequate financing. The most common factors associated with SME failure among the
sample cases are presented in Figure 1. It seems that there are several factors that may
contribute to firm failure and they occur in different combinations in different firms. However,
the root causes of failure seem to be largely firm internal, and so under the management’s
control (cf. Boyle & Desai 1991).
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0 % 25 % 50 % 75 % 100 %
lack of prior experience as an entrepreneur
lack of marketing skills
lack of prior managerial experience
parents who were not entrepreneurs
a firm managed by one individual
lack of planning
a firm founded by one individual
no use of business advisers
dependence on one or a few big customers
small amount of products/services
unfavourable macroeconomic conditions
inadequate financing
Figure 1 – The most common factors associated with SME failure (% of failed SMEs)
Differences in failure factors between firm types
However, the sample of failed SMEs was not a homogeneous group of SMEs, though many
of the firms had some characteristics in common. It can be argued that due to the diversity of
SMEs, understanding the phenomenon can be advanced through grouping them into
homogeneous types of SMEs according to their characteristics. This makes it possible to
study SMEs in homogeneous groups in which the SMEs within the group are similar and
different from firms in other groups (e.g. Woo et al. 1991; Hornaday 1990).
In the following, the failed SMEs are studied in three clusters of SMEs: (1) stable,
independent firms with no growth aspirations, operating in local markets (n=4); (2) innovators
with continuous growth, operating in growing markets (n=5); and (3) efficiency-oriented
networkers with leapwise growth (n=3) (for cluster descriptions, see Pasanen 2004). The
distinction between the first and the other clusters reflects especially the difference between
non-growth and growth firms. The second distinction between the two clusters of growth
firms reflects the difference between incremental and organic, and leapwise, non-organic
growth, in particular.
When looking at different types of SMEs, it seems that there are differences in the factors
affecting SME failure between the clusters of SMEs. In the cluster of stable independent
firms, failed SMEs had risks in customers and the timing of investments. Demand was
unstable and unpredictable, and they were dependent on a few big customers. Big
investments in premises and production facilities just before the economic recession and the
collapse in demand were typical of these firms. As a matter of fact, unexpected and sudden
changes in the environment seem to be a major source of causes of SME failure in this
cluster.
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In the cluster of innovators with continuous growth, characteristic of the entrepreneurs of
failed SMEs was lack of prior managerial experience and of marketing skills. The failed
SMEs were led by one person, they had products tailored individually for each customer, and
their strategic planning and risk management were inadequate. They were vulnerable due to
their dependency on one provider of some critical resource, i.e. being a customer of one
bank only, or operating in a very narrow customer or product segment and in a very limited
market area. The general economic recession of the 1990s had a great impact on the
failures.
In the cluster of networkers with leapwise growth, in the case of the failed SMEs, the number
of potential customers in the market was very limited, and firms expanded their operation to a
new business area where they had no know-how.
The key findings concerning the factors associated with SME failure by clusters are
summarized in Table 1.
Table 1 – Summary of the factors associated with SME failure by clusters
Firm type Factors associated with failure
Stable independent
firms
• risks in customers
• risks in the timing of investments
• unstable and unpredictable demand
• unexpected and sudden changes in the environment
Innovators with
continuous growth
• products tailored individually for each customer
• inadequate strategic planning and risk management
• dependence on one provider of some critical resource
Networkers with
leapwise growth
• small number of potential customers in the market
• expansion into a new business area where the firms had no know-how
Failure trajectories
Turning now to the life cycles of failed SMEs, three types of failure trajectories were
identified: (1) failed borderline cases; (2) rapid collapse failures; and (3) failed seekers of
legitimacy.
Failed borderline cases were failures characterized by long term weak and insidious
development. Their existence had been under threat many times during their life cycle. They
had faced several severe problems during their life cycle, but survived until they faced the
last problem which led them failure. In fact, these firms had many major problems, which
they could not resolve and they caused a downward vicious spiral. In some point of time the
load of these vicious spirals exceeded the carrying capacity of the firm. However, the load
was accumulated during a long period of time. Typical of these failures were the lack of
strategic thinking, and lack of business-like thinking, in particular.
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Typical of rapid collapse failures was the fast development of the process leading to firm
failure. Often these firms had had no big problems before the one which caused the firm
failure. In these cases, failures were based on high risk-taking which exceeded the firm’s
carrying capacity. Excessive risk-taking combined with the firms’ low tolerance of
environmental disturbances was fatal to these firms. They had a wrong view of the
development of their environment in the future. The firms had made wrong decisions which
they could not cancel anymore. On the other hand, the firms had no plans for the difficult
incidents and circumstances, and so they were extremely vulnerable to the changes in their
environment.
Failed seekers of legitimacy were firms lacking of a real competitive advantage. During their
life cycle they sought their place in the markets, but were never able to achieve an alignment
with their environment and legitimacy in the markets. They tried to correct their course of
action several times but they could not find any way to compete successfully against their
competitors. These firms had a wrong view about how the firm will succeed in the future.
Moreover, compared with the other types of failed SMEs, these firms had the weakest
preconditions, in terms of e.g. weak customer basis or inadequate financing, for successful
business.
The key findings concerning the failure trajectories are summarized in Table 2.
Table 2 – Summary of the failure trajectories
Failure trajectory Typical characteristics
Failed borderline
cases
• long term weak and insidious development
• many accumulative unresolvable major problems caused a downward vicious spiral
• lack of strategic and business-like thinking
Rapid collapse
failures
• fast development of firm failure without previous major problems
• excessive risk-taking, but low tolerance of environmental disturbances
• wrong view of the development of environment in the future, wrong and irreversible
decisions, and no plans for unexpected environmental development
Failed seekers of
legitimacy
• firms lacking of a real competitive advantage
• never able to achieve an alignment with their environment and legitimacy in the
markets
• wrong view about how the firm will succeed in the future
• weak preconditions for successful business
An illustrative case
In order to achieve a more comprehensive view of the failed SMEs, one illustrative case
description is presented below. The example firm represents the cluster of stable
independent firms in terms of firm type and failed borderline cases in terms of failure
trajectory.
The situation before failure. The firm produced tailor-made metallic roofing sheets. Customers were hardware
stores, wholesale firms, building firms, and consumers. Production was carried out almost exclusively by the
firm itself. Time, i.e. rapid delivery of the tailor-made products, was the firm’s most important source of
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competitive advantage. The firm could deliver tailor-made products to customers in two days, whereas its
main competitors took two weeks. The main competitors were big firms with a strong resource base, which
appeared in their aggressive marketing, for instance. The firm was highly dependent on the economic activity
in the construction sector.
Life cycle. The firm was founded in the late 1950s by the entrepreneur’s father. Travelling abroad, he had
come across metallic roofing sheets which could be installed without using a professional plater. After
returning home, he developed the first machine in Finland for producing such metallic roofing sheets. He had
seen a business opportunity, a clear niche in the market for such products. At the beginning, sales were
made through wholesale firms because they dominate in the building material trade, but in the last years
more than 50% of products were sold directly to consumers. Research and development had been
continuous. Old machines had been improved or replaced by new ones every other year, to increase
production speed. In the early days, products were standard, but a dramatic change was made in the mid-
1960s, since when products were tailor-made for each customer. Starting in the 1970s, metallic roofing
sheets were used in constructing the walls of factories, and later also in the walls of dwelling houses and
office buildings, where they are still much used today.
The entrepreneur had run the family firm since 1980, when his father had retired. In the 1980s, new
machines had been bought and production lines had been renewed to increase production speed. The year
1983 was a turning point in the field because of the launch of a new production technique. The firm had been
the second in Finland to start producing tile-patterned metallic roofing sheets which gave roofs a new look
and were a real success in the market. The entrepreneur compared it with “a transition from the era of the
telephone to the era of the mobile phone”. The product range expanded considerably, and marketing had
become more focused. Previous investments had been made using cash flow financing, but in the early
1990s, just before the beginning of the general economic recession, the firm had had to invest in new
production facilities using borrowed capital.
In the early 1990s, the firm started exporting metallic roofing sheets to the Baltic countries, Russia and
Central Europe. Soon after, some Finnish competitors also expanded their market areas into the same areas,
and severe price competition started. Three years later, the firm had to withdraw from foreign markets. In the
1990s, the field changed very much as a result of acquisitions, mergers and other restructuring in the industry
sector. This meant that new contacts had to be established, with suppliers for example. The number of
competitors had been reduced but the new or mergered competitors had become bigger and stronger than
ever before.
In the mid-1990s, the firm bought an installation firm. At the beginning, they had some good projects, and the
size of the workforce rose rapidly from two to seven men. However, very soon the profitability of the
installation business collapsed due to the oversupply of assemblers from all around the country who were
willing to do the work for “ridiculously” low prices, as the entrepreneur put it. After three years of operation,
the installation unit was closed down. During this three year period, personnel relations suffered because of
the wage differences between assemblers and employees in the workshop, and this caused dissatisfaction
among employees in the workshop. Both the installation business and exporting turned out to be unprofitable.
Another problem had been caused by the steel supplier, who had guaranteed the quality of the steel. There
were some problems with the quality, and consumers directed their complaints to the firm and not to the
supplier, who, as a matter of fact, was responsible. This caused the firm a lot of extra work and probably
influenced negatively the firm’s reputation in the market.
A high seasonal variation in demand had caused a major problem for the firm. In winter, demand was low,
but in summer there were more orders than the firm could handle. In the last years of the firm’s operation, the
production of the production lines partly replaced the lower demand in winter. The production of the
production lines was rare among the competitors. The production lines were sold to customers in the Baltic
countries, Poland and Russia.
The entrepreneur reported that his mental resources were running out in the early 1990s. He was tied up in
every-day business and routines, and had no time for strategic thinking and planning. In fact, he was facing
one problem after another, particularly concerning the tax authorities. For many consecutive years, certain
writeoffs had been accepted by the tax authorities only after appeal, and the entrepreneur felt that some of
the decisions were unjust. Consequently, he had lost his faith in justice. Finally, he neglected to deal with
some matters and this led to the situation where the tax authorities got the upper hand.
During the economic recession, the firm had also had hard times with credit losses arising from the failure of
many customer firms. In addition, the entrepreneur had not been capable of laying people off, keeping all
personnel throughout the year, even during winter time when there was no work for all of them, for several
reasons. On the one hand, he had known the people a long time and wanted to take care of them. On the
other hand, once let go it was by no means sure that they would come back when the high season started.
However, it seems that the entrepreneur was not sufficiently business-like in this matter. As he said:
“Employing people is expensive”. It seems that he acted more on the basis of feelings than sense, and
treated the personnel as a big family. He described his feelings in the 1990s thus: “I was running up a steep
sand bank but my feet were sliding down all the time and I was getting nowhere”.
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The case was characterized by the following factors, which often associated with firm failure:
the entrepreneur lacked prior experience as an entrepreneur and prior managerial
experience, and the firm was managed by one individual, lacked planning, did not make use
of business advisors, and operated in unfavourable macroeconomic conditions. Moreover,
the firm had risks in customers (credit losses) and the timing of investments (big investment
in new production facilities using borrowed capital just before the economic recession).
Demand was also unstable (high seasonal fluctuations) and unpredictable (rapid decrease in
demand due to the general economic recession).
The firm’s long-term weak and insidious development was related to the lack of strategic
thinking and of business-like thinking (e.g. not laying off employees). The entrepreneur was
tied up in routine tasks and had no time for strategic thinking and planning. Moreover, there
appeared to be some resistance to renewal, which was revealed in the way of thinking “we
have always done things this way and survived, so why shouldn’t we do things this way also
in the future?” The problems with the tax authorities over several consecutive years also ate
up the entrepreneur’s mental resources. Moreover, the market position of the firm was highly
challenging: it had to keep ahead of the giants (major competitors) all the time. The attempts
to find new business directions (exporting and installation business) turned out to be
unprofitable.
Several severe problems accumulated in the 1990s, leading to a downward vicious spiral (for
main problems and related adverse processes, see Table 3). The firm survived until the end
of the 1990s, when the weight of these problems exceeded the carrying capacity of the firm
and the adverse development led to a shortage of money and liquidation. However, the load
was accumulated over a long period of time. Moreover, typical of this failure was the lack of
strategic thinking, and lack of business-like thinking.
Table 3 – Main problems and related adverse processes
Main problems Related adverse processes
Lack of strategic
thinking
• the firm was managed by one individual ? tied up in routine tasks ? no time for
strategic thinking and planning
Lack of business-like
thinking
• acting more on the basis of feelings than sense ? the decision ‘not laying off
employees’ ? continuous costs but no incomes
• the way of thinking “we have always done things this way and survived, so why
shouldn’t we do things this way also in the future” ? the entrepreneur treated the
personnel as a big family
• social pressures to continue the family firm
Weaknesses in
strategic
management and
inability to adapt to
rapid environmental
changes
• a significant investment with borrowed capital was made just before the economic
recession ? poor timing of investments ? collapse of securities and market demand
? rapid decrease in revenues? problems in repayment of the loan and interests
• general economic recession ? rapid decrease in demand ? liquidation of many
customer firms ? sudden credit losses
• general economic recession ? industry restructuring ? the firm had to try to keep
up with giants (competitors) with superior market power and to find new cooperation
partners (e.g. suppliers) and negotiate new contracts with them
Challenging nature of • coping with high seasonal fluctuations ? no work for all personnel in winter ? the
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business decision ‘not laying off employees’ ? continuous costs but no incomes
Problems with public
authorities
• the firm had continuous problems with the tax authorities ? it was burdened with
financially unfavourable taxation decisions ? the entrepreneur’s mental resources
were running out ? oversights in tax issues ? costly consequences
Unsuccessful
attempts to expand
the scope of the
business
• starting exporting ? competitors also expanded their market areas into the same
areas ? severe price competition ? exporting turned out to be unprofitable ?
withdrawal from foreign markets
• purchase of the installation business ? the atmosphere in the firm suffered from
conflicts between assemblers and employees in the workshop
• oversupply of assemblers after the purchase of the installation business ?
profitability of the installation business collapsed ? turned out to be unprofitable ?
the installation unit was closed down
Problems with the
supplier
• supplier’s quality problems ? affected negatively the firm’s reputation ? loss of
customers
The case clearly shows that there were several inter-related factors and adverse processes
affecting firm failure. In this case, credit losses, costly consequences of neglecting taxation
matters, and the decision to ‘not lay off employees’ finally led to a shortage of money and
liquidation. However, as we can see, there were both firm-internal issues (such as
weaknesses in strategic management and their consequences) and firm-external issues
(such as unexpected and sudden changes in the environment and their consequences)
affecting firm failure. There were wrong strategic choices made by the entrepreneur as well
as stochastic factors which made it very difficult for the firm to survive.
Discussion
Despite the fact that SMEs in different industry sectors differ from each other in numerous
and significant ways, it was possible to identify similarities among the failed firms. It seems
that some of these similarities are common to failed SMEs in general, and some are more
cluster specific. On the other hand, each failure has its own story. Moreover, the failure
trajectories crossed the clusters.
On the basis of the empirical results, one or a few major factors and processes seem to
cause firm failure. The factors contributing to firm failure are often closely related to the
causes of decline and crises. There was some evidence of a close relationship of factors
causing a threat and failure, i.e. one severe problem may be a major cause of threat, and the
co-existence of such problems may lead to SME failure. Failure factors and processes also
seem to be inter-related. In many cases, the lack of strategic management (Boyle & Desai
1991; Jennings & Beaver 1997) was strongly associated with SME failure. However, it may
also be that not all cases could have been saved from liquidation even by means of thorough
strategic management, because of the sudden, unexpected and large-scale external shocks
they faced in their environment.
Often, there was one initial triggering reason which, together with other problems, caused a
downward vicious spiral generating new problems (cf. Hambrick & D’Aveni 1988). Thus,
failure seems to generate self-reinforcing downward spirals. When a vicious spiral has
begun, one problem feeds the creation of others and stopping such development becomes
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more and more difficult. Several very different factors may be involved in these processes,
and thus a holistic approach in studying them is required. Also, there can be several
simultaneous adverse processes interacting with each other. However, in some cases the
causes of firm failure seem to be highly situation specific and the process leading to failure
progressed rapidly. Moreover, in some cases there were not proper preconditions for
successful business, and so the failure could have been anticipated already in early stages
of the firm’s life cycle.
In general, a firm’s inability to adjust to changing circumstances can be seen to be the
reason for failure. Many firms are not prepared for potential external shocks in their
environment. Anticipation of and preparation for potential threats could have helped very
much in many cases. There were also failed cases with major problems originating from the
lack of business-like thinking. Several studies have shown that factors related to poor
management, e.g. managerial inadequacy, incompetence, inefficiency, and inexperience, are
frequently causes of firm failure, in the small firm context particularly (Haswell & Holmes
1989). Moreover, poor management issues are often related to poor financial conditions,
inadequate accounting records, and lack of good managerial advice. However, financial
problems are often due to a lack of planning. In the stage of rapid growth, in particular,
inability to manage growth and change may lead to firm failure (MacMillan et al. 1985;
Hambrick et al. 1985). Many times, the root cause of failure can be traced to problems in
management.
Relatively little research has focused on established firm failure in the SME context and in
peripheral locations, in particular. However, information from failed SMEs can significantly
expand our knowledge of SME performance, and so this exploratory study of failed SMEs in
peripheral locations can be justified. Future research into failed SMEs calls for multisource
interviews, i.e. interviews with entrepreneurs, members of management teams or key
employees, financiers, cooperation partners, etc. As Zacharakis et al. (1999), for instance,
show there are differing perceptions of the causes of firm failure between entrepreneurs and
venture capitalists. It is worth noting that there may be several explanations for firm failure,
not only one right answer to the question of why a firm failed. It has been found that several
factors and processes may affect the creation of vicious spirals, and so in-depth studies of
failure processes, i.e. of the factors and their causal relationships are highly important.
Moreover, it would be useful to study these issues by using larger sample of SMEs. In this
study, the small number of cases was a central problem for the investigation of cluster-
specificity of the factors affecting SME failure.
Finally, the results can be useful for entrepreneurs and those who are fostering
entrepreneurship and SME development. In studying the factors affecting SME performance,
the investigation has produced knowledge which is valuable for nascent and acting
entrepreneurs and those in charge of the firm. It seems likely that many SMEs and their
stakeholders could learn from others’ failures. Venture capitalists, financiers, and consultants
can take advantage of these results. Moreover, on the basis of the results, organizations
fostering entrepreneurship and SME development can better direct their actions and develop
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their products, advisory services and education. For those who are responsible for public
SME policy, the results provide some guidelines for decision making and the allocation of
public actions, as well as an opportunity to evaluate the present SME policy and its
developmental needs.
E-mail of corresponding author: [email protected]
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doc_595479780.pdf
European Council for Small Business and Entrepreneurship.
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“ CHALLENGES IN
ENTREPRENEURSHIP
AND SME RESEARCH”
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Editor
Friederike Welter
European Council for Small Business
and Entrepreneurship (ECSB)
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© European Council for Small Business and Entrepreneurship (ECSB) and Authors
Published by
European Council for Small Business and Entrepreneurship
Turku, Finland, 2005
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TABLE OF CONTENTS
Challenges in Entrepreneurship and SME Research (Editorial) ......................................
Friederike Welter ........................................................................................................... 1
Entrepreneurship in a Changing Environment:
Analyzing the Impact of Transition Stages on SME Development ...................................
Ruta Aidis and Arnis Sauka............................................................................................ 5
Indicators of Entrepreneurship Activity: ...........................................................................
Some Methodological Contributions.................................................................................
Rachida Justo, Alberto Maydeu and Julio O. De Castro .................................................. 37
Strategic Change Processes in SMEs – .........................................................................
The longitudinal Analysis of Three Finnish Furniture Firms .............................................
Karita Luokannen and Rodrigo Rabetino ....................................................................... 59
Tracking Small Business Failure Factors and Trajectories ..............................................
Mika Pasanen............................................................................................................. 93
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Challenges in Entrepreneurship and SME Research (Editorial)
Friederike Welter
The Inter-RENT Workshop 2005
The idea for the Inter-RENT workshop came originally from the Board of the ECSB and was
developed by the ECSB secretariat together with a group of ECSB members (such as the
editors of the first Inter-RENT publication, Tom Cooney and Pasi Malinen). For Inter-RENT
2005, a total of eleven RENT conference papers that were presented at the RENT 2004
Conference in Copenhagen were invited to participate in the process. The theme of the
publication was selected to be ‘Challenges of Entrepreneurship and SME Research’ since a
substantial number of good quality papers had been presented on the theme at the
conference. From the initial invitations, nine authors expressed a desire to participate in the
process.
Once the papers had been identified, the process began with an internal peer review of the
papers. Each participant was asked to review two of the papers, which meant that each
author would receive feedback from two of their peers, plus they would develop their own
editing skills by reviewing other papers. Each author was then asked to revise their paper
based upon the feedback received from their peers. After this, expert referees were selected
based on their background and specific expertise in entrepreneurship and small business
research as related to the different papers. Their comments and feedback on how to improve
the papers were incorporated by authors into the next revision. During the course of Inter-
RENT, three people evaluated each paper, before all ECSB members were invited to
comment on the paper through the ECSB website at a later stage of the process.
Finally, a small committee which consisted of the initiator of Inter-RENT, Dr. Tom Cooney,
this year’s Inter-RENT chair Prof. Friederike Welter, the upcoming chairs for 2006, Dr. David
Urbano, and 2007, Dr. Olivier Torres, and ECSB Executive Secretary Paula Kuopusjärvi,
have been reviewing all papers for this electronic best-paper selection of Inter-RENT. The
authors are however free to submit their reworked articles to refereed journals.
The long-term goal of Inter-RENT is to create a forum that will enable especially younger
ECSB members to deepen a selected conference theme from the previous RENT
conference, leading to the publication of a number of high-quality articles. This initiative has
exciting potential for ECSB as an organisation and, more specifically, for its members. It
promotes the progression of conference papers into published articles, as well as developing
the depth and understanding of a new topic each year.
Inter-RENT 2005 built on the previous year’s experiences, and several persons were
involved to make it a success. This includes the authors, who contributed to the process, and
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Paula Kuopusjärvi, who held lead responsibility for the website and for the final publication
online. Paula’s work and support throughout the process has been immense and her huge
contribution is particularly acknowledged.
Our thanks also go to those who were involved in refereeing the papers. Their active
participation and guidance is highly appreciated. The referees of the Inter-RENT were (in
alphabetical order):
• Prof. Alistair R Anderson, Robert-Gordon University, Aberdeen, Scotland
• Dr. Thomas M. Cooney, Dublin University of Technology, Ireland
• Dr. Pasi Malinen, Turku School of Economics and Business Administration, Finland
• Prof. Helle Neergaard, Aarhus School of Business, Denmark
• Dr. Colm O’Gorman, University College Dublin, Ireland
• Dr. Olivier Torres, Assistant Professor, E.M. Lyon, France
• Prof. José M. Veciana, Universidad Autonoma, Spain
• Dr. John Watson, Associate Professor, The University of Western Australia
The Inter-RENT 2005 Best Papers
The four papers presented in this online publication allow us to explore some of the
challenges entrepreneurship and SME research today face, both from a methodological point
of view and from the questions we often neglect to ask.
In their contribution, Ruta Aidis and Arnis Sauka concentrate on SME development in a
transition context. Although more and more studies explore entrepreneurship in a transition
context, there is no systematic study comparing barriers to SME development at different
transition stages. They utilise indicators proposed in previous research, which approximates
three transitional stages, to categorise 23 transition countries into transitional stages. They
proceed to develop a framework which identifies SME development trends, drawing on an
analysis of 35 empirical studies on SME constraints in transition countries. Results indicate
that more fundamental barriers related to legal issues are more characteristic of the early
stages of transition while more specific constraints related to human resources and skill
development characterise later transition stages. These differences suggest that the types of
policies and programmes offered to SME owners should be sensitive to changing transition
conditions. Moreover, since formal barriers such as policy instability and uncertainty seem to
continue to form business barriers throughout the transition process, it is of utmost
importance that policy makers in the transition countries focus on insuring a transparent and
straightforward policy development process.
The question Rachida Justo, Alberto Maydeu and Julio O. De Castro ask in terms of the
overall Inter-RENT topic is related to methodology and measurement of entrepreneurship.
Based on GEM data for Spain, the authors discuss indicators based on levels and the
likelihood of entrepreneurial behaviour. Whilst the notion of measuring the likelihood of
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entrepreneurship is not a new concept, the authors adopt a more dynamic view, which allows
them to examining differences in the likelihood over time within countries as well as across
countries. Moreover, they argue that the level of an individual’s entrepreneurial activity is
affected by the social context in which that activity occurs. This context is not uniform and its
effect varies due to factors such as social networks, education, gender, etc. As a result, an
entrepreneur’s personal social network is treated here as a random variable that changes
from individual to individual.
The next two papers are case-based contributions exploring strategic change and failure in a
SME context. Although the question of strategic change in SMEs as such is not a new
challenge in SME research, the paper by Karita Luokannen and Rodrigo Rabetino brings in a
fresh perspective in terms of the method they use. They draw on three in-depth cases from
the Finnish furniture industry, applying a process perspective and analysing environmental
factors as well as the internal firm perspective. Their data analysis reveals that strategic
changes are the result of multiple, overlapping processes. In a short term perspective, firms’
responses to environmental stimuli often look like reactive tactic. However, in a longer time
perspective, owner-managers were able to identify strategic challenges and to implement
new projects. Moreover, the cases suggest a strategic behaviour in SMES, which reflects
Mintzberg’s emergent strategies. In general, entrepreneurs act with bounded rationality and
strategies are often based on experience and intuition instead of calculation and planning.
Few studies in entrepreneurship focus on failed ventures and failed entrepreneurs. Business
failure often is equalled with personal failure, and entrepreneurs might be reluctant to admit
that they have not achieved their goals. On the other hand, one might expect business failure
enhancing entrepreneurial learning. In this context, the paper by Mika Pasanen concentrates
on identifying failure factors and failure trajectories in SMEs, both conceptually and
empirically. His empirical study was based on in-depth interviews with the ex-entrepreneurs
of 12 failed SMEs. The results reveal three types of failure trajectories: (1) failed borderline
cases; (2) rapid collapse failures; and (3) failed seekers of legitimacy. The empirical results
may help entrepreneurs and those who are fostering entrepreneurship and SME
development, in learning from mistakes and failures during SME development.
Corresponding Editor
Prof. Dr. Friederike Welter, University of Siegen, School of Economic Disciplines,
Hölderlinstr. 3, D-57068 Siegen, T. +49 271 740-2844, E-mail: [email protected]
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Entrepreneurship in a Changing Environment: Analyzing the Impact
of Transition Stages on SME Development
Ruta Aidis* and Arnis Sauka**
*School of Slavonic and East European Studies, University College London (UK),
Faculty of Economics and Econometrics, University of Amsterdam (Netherlands)
**Stockholm School of Economics in Riga (Latvia)
Abstract
An issue gaining importance in transitional literature is the need to develop entrepreneurial
capabilities through a thriving small and medium-sized enterprise (SME) sector. However, it
can be argued, that in order to successfully develop SMEs it is important to understand the
specific barriers they encounter at different transition stages. Though there are a number of
studies on SMEs in transition countries, no systematic analysis has been conducted on the
effects of different types of barriers to SMEs at different stages of transition. In this paper we
address this knowledge gap. We utilise indicators proposed in previous research to
approximate three transitional stages to categorise 23 transition countries into transitional
stages. On this basis, we develop a framework which identifies SME development trends
based on an analysis of 35 empirical studies on constraints facing SME development in
transition countries. Our results indicate that more fundamental barriers related to legal
issues are more characteristic of the early stages of transition while more specific constraints
related to human resources and skill development characterise later transition stages. These
differences indicate that the types of policies and programmes offered to SME owners should
be sensitive to changing transition conditions.
Key Words: transition countries, SMEs, transition stages, business barriers
Introduction
Entrepreneurship can take many forms and can be defined in many ways. In our paper we
focus on entrepreneurship as it takes place in small and medium size enterprises (SMEs)
since the two are often found to be closely related. As Wennekers and Thurik note: ‘Small
firms are the vehicle in which entrepreneurship thrives’ (1999:29).
SMEs are of special importance to transition countries for a number of reasons. Firstly, they
are able to provide economic benefits beyond the boundary of the individual enterprise in
terms of experimentation, learning and adaptability. These characteristics are especially
important in economies undergoing radical transformation such as has occurred in the
formerly centrally planned countries. Secondly, in most transition countries, the SME sector
was largely neglected and even discriminated against in the early transition period with
emphasis placed on the rapid privatization of large scale enterprises and not the
development of the SME sector. This has arguably resulted in less resources and attention
being paid to the needs of SME development. In addition, research in transition countries
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shows, that even if SMEs do not generate net new jobs, they reduce the erosion of human
capital by providing alternative employment opportunities for relatively skilled yet
unemployed workers (EBRD 1995). Though it is often argued that SME development is
especially crucial for the early phases of transition (EBRD, 1995; Smallbone and Welter,
2001), it is, in fact, just as important for the advanced stages of post-transition. As M. Porter
(1990) has argued, invention and entrepreneurship are at the heart of national advantage
and country competitiveness.
In the last ten years, governments in the transition countries have introduced a number of
policies aiming to promote entrepreneurship through SME development. The main impetus
for this ‘intervention’ are the specific constraints encountered by SMEs. It is argued that
though the SME sector can be much more responsive and flexible to changes in the
marketplace, it is also much less able to influence such developments. Limited access to
finance, a low degree of professionalism, difficulties in recruiting qualified personnel,
dependency on clients and suppliers and the absence of economies of scale are identified as
the core SME sector weaknesses and the main areas where SMEs may require special
attention (Burns, 2001). In this respect, understanding the problems faced by SMEs in the
specific context of transition could provide the necessary background to develop policies for
SME support.
One of the most important findings in the SME literature is that context matters as it shapes
not only the role of small firms but also their structure and performance (Karlsson &
Dahlberg, 2003:1). The transition countries of Central and Eastern Europe and the former
Soviet Union seem particularly suited for a study on the influence of context for several
reasons. Though transition countries have chosen different paths of development, they have
all undergone a tremendous amount of economic and social change; an important aspect of
which has been the development of a new private sector. In addition, the unprecedented
degree of institutional change experienced by transition countries has been largely moving in
a similar direction: The switch from a system based on state planning and allocation of
resources dictated by the government to a system characterized by decentralized market
allocation. This system change necessitates substantial change in laws and regulations as
well as norms and expectations (Raiser, et al. 2001:2). Of specific interest to our study is the
effect of context on the emergence and development of a legal SME sector, which under the
central planning system was severely restricted
1
.
To date, though there is no consensus on what constitutes ‘transition stages’, researchers
have developed different categorisations of the transition process. For example, Campos and
Coricelli (2002) created seven stylised facts describing the transition process
2
. Though
insightful, the stylised facts proposed by Campos and Coricelli are not useful from an
1
As Earle and Sakova (2001: 6) have noted: “It is difficult to imagine a regime more hostile towards
entrepreneurship then the centrally planned economies of Eastern Europe”.
2
The seven stylised facts proposed by Campos and Coricelli (2002) describe the main characteristics of the
transition process. They are: 1) Output fell, 2) Capital shrank, 3) Labor moved, 4) Trade reoriented, 5) Structure
changed, 6) Institutions collapsed, and 7) Costs were high.
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entrepreneurship development point of view. More suitable for this purpose seems to be the
transition indicators developed by the European Bank of Reconstruction and Development
(EBRD) that plot the progression of economic transition according to macroeconomic as well
as institutional variables. These indicators have been systematically compiled since 1989 for
the countries undergoing economic transition
3
. Other authors such as Smallbone and Welter
(2001), have used selected EBRD indicators in order to distinguish between transition
countries where market reforms have been slow or not properly installed and countries
where they are more advanced. Furthermore, the three transition stages based on new
institutional theory
4
proposed by Van de Mortel (2002) provide additional conceptual
considerations for the categorisation of barriers useful for the analysis of SME constraints.
A number of authors have identified the distinct characteristics of entrepreneurship and SME
activities in transition countries where the environment is undergoing quite dramatic changes
(Dallago, 1997; Scase, 2000; Chilosi, 2001; Smallbone & Welter, 2001; Aidis, 2006). Some
authors have distinguished between countries at different stages of market reform (Kolodko,
1999; Smallbone and Welter, 2001). Other authors such as Surdej (2003) have shown the
interlinkage between market and institutional changes and the number of start-ups (in
Poland). However, no study has attempted to systematically classify barriers to SME
development during different transition stages across the transition countries.
In this paper we operationalise a selection of indicators proposed in previous research to
approximate transitional stages that would make sense from an entrepreneurship
development perspective. We utilise these indicators to categorise 23 transition countries
into transitional stages. This framework is then used to identify SME development trends
drawn from an analysis of 35 empirical studies on constraints faced by SMEs in transition
countries. The primary objective of this paper’s analysis is to identify which SME barriers are
of the main importance at different transition stages.
Our analysis contributes to the existing literature by providing insights into the dynamic
relationship between barriers and SME development during distinct stages of the transition
process. As such, we fill an important knowledge gap by comparing SME barriers in different
transition stages for 23 transition countries. Our results specifically show that fundamental
barriers related to legal issues are more characteristic of the early stages of transition while
specific constraints related to human resources and skill development characterise later
transition stages. These results indicate a number of policy implications for entrepreneurial
development at specific stages of transition.
The paper is structured as follows: Section two presents the conceptual background
including a discussion of the classification of transition stages. A conceptual framework is
developed in section three. Since our study is limited mainly to economic transition from the
entrepreneurship and SME development viewpoint, we focus our discussion only to relevant
3
For further information regarding EBRD transition indicators please see section 2.2 and appendix 7.
4
Developed by Douglass North (1997a).
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literature. Section four presents the data and methodology used. Section five presents the
results and in section six we discuss the limitations of our approach. The paper ends with
concluding remarks in section six.
Conceptual background
In this section we describe and analyse the main concepts used in the context of our study
based on a review of existing theoretical and empirical studies. Section 2.1 focuses on
defining and understanding transition, transition stages and SME barriers. In section 2.2 we
explore some of the ways transition stages have been classified. Two main methods are
highlighted: the EBRD transition indicators and Mortel’s (2002) three stage approach.
Alternative indicators for measuring transition progress as well as existing single country
studies distinguishing among different transition stages from the entrepreneurship and SME
development viewpoint are also discussed.
Defining and understanding the transitional context
For the 23 countries contained in our sample, transition can simply be defined as a process
of change from a centrally planned to a well functioning market oriented system
5
. According
to the definition introduced by the EBRD (1994) transition is about institutional change,
involving not only the advance of the private sector but also a fundamental transformation of
the role of the state, in particular in the economic, financial and legal institutions underpinning
the market economy. It is the institutional arrangements for the allocation and generation of
goods and resources, and the ownership incentive and rewards structures that institutions
embody, that characterise the differences between a market and a command economy.
Transition may also be regarded as an ultimate objective in itself as well as an end in itself
(EBRD 1994: 3).
However it should be noted that while there are core features that a market economy
possesses, there is no unique destination point for the transition process (EBRD 1995).
Given the different starting points and initial conditions of the transition countries, there can
not be a single, unique route for transition. A priori a large number of variables could
influence transition paths and resulting patterns of institutional change. Three main issues
stand out as influencing the initial conditions for a given country: geographical factors,
cultural factors, and the institutional legacy of central planning (Raiser 2000).
Not all authors agree about the influence of initial conditions. A literature review based on
growth in transition countries by Merlvede (2000) found that though more unfavourable initial
conditions lead to a larger output fall, the effects fade over time and can be offset by
stabilization and reform policies. He further found that the stabilization of inflation which is
5
We restrict our analysis to the 15 countries which formerly comprised the Soviet Union and eight central and
eastern European post-socialist countries. Countries that have emerged from the former Yugoslavia were not
included due to the armed conflicts taking place in this region in the 1990’s which can bias the transition stage
results.
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facilitated by sustainable government balances is a prerequisite for the recovery of growth. A
fixed exchange regime is also important for stabilizing inflation but the empirical evidence is
mixed. Stabilization is not a sufficient condition for output recovery since structural reform is
also necessary (ibid).
Our analysis would be greatly simplified if the transition process followed a simple, linear
progression. Unfortunately it does not. Rather it is a complex process involving a multitude of
influences and factors. Though it is agreed that certain fundamentals of market economies
should be a part of any successful transition, the ‘end of transition’ remains a contestable
issue
6
.
Classification of Transition stages
In the initial stages of our research, we attempted to use all available international indicators
such as GDP levels, the Corruption Perceptions Index from Transparency International or the
Freedom Index from Heritage International in order to classify the transition stages. These
indices would have provided further insights into both informal and formal institutional factors
affecting transition countries. Unfortunately the data available from these indices do not
provide ample coverage for the transition process (please see appendix 6 for a detailed
discussion). The only indicator that does cover the transition period for the 23 transition
countries is the EBRD’s transition indicators. Therefore we focus on introducing the EBRD
indicators in this section. For a more conceptual and theoretical approach, we utilise the
three stage model developed by Van de Mortel (2002) which is presented in greater detail at
the end of this section.
EBRD transition indicators
According to the EBRD, the first or initial phase of transition was dominated by the structure
of the inheritance from the communist system and the political repercussions following the
collapse of this regime. The main reforms characterising this period include: the privatisation
of assets (small-scale privatisation), the liberalisation of markets (through price, foreign
exchange and trade liberalisation) and the establishment of a degree of macroeconomic
stability (EBRD 1997).
The next phase of transitional reforms requires policies, institutions and behaviours
7
that can
foster and accelerate economic growth. Second transition phase reforms include a
continuation of the privatisation of assets (through large-scale privatisation), improving
enterprise performance through governance and enterprise restructuring, the further
liberalisation of markets (through competition policy), the development and maintenance of
6
Though the answer to this question is beyond the scope of this paper, it is perhaps of interest to mention that no
single indicator or definition currently exists that accurately describes the end of transition. A number of authors
have suggested that the end of transition is achieved by reaching the level of an ‘advanced market economy’.
Unfortunately there exists no generally acceptable definition for what precisely characterizes an ‘advanced
market economy’. For further discussion, see Brown 1999).
7
Informal institutions such as changes in attitudes and ‘culture’ (North, 1990).
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infrastructure (through infrastructure reform) and reform to financial institutions (banking and
interest rate liberalisation and the creation of non-banking financial institutions). A main
challenge in this phase is developing and providing market-oriented governance i.e. a
building and deepening of the institutions and behaviour that are at the heart of a well-
functioning market economy (ibid.). These stages are summarised in table 1.
Table 1 - EBRD’s classification of transition phases and requirements
Phase Initial phase Next phase
Main requirements Privatisation of assets, market
liberalisation and macroeconomic
stability
The development of policies,
institutions and behaviour that
accelerates growth
Specific indicators of
progress
• Small scale privatisation • Large scale privatisation
• Price liberalisation
• Governance and enterprise
restructuring
• Foreign exchange and trade
liberalisation
• Competition policy
• Infrastructure reforms
• Banking and interest rate
liberalisation and non-banking
financial institutions
Source: EBRD (2002)
As illustrated in table 2, the EBRD’s classification indicators are based on four main
categories, each containing at least one subcategory. Scores for transition progress are
measured from a minimum score of 1 to a maximum score of 4+. Scores are given with
decimal points to provide more accurate differentiation. In general, a score of 1 indicates little
progress; 2 indicates some progress; 3 indicates substantial, comprehensive progress; 4
indicates a level of progress approaching international standards; and a 4+ score indicates
the standards and performance typical of advanced industrial economies (For a more
detailed presentation please see appendix 7).
Table 2 - EBRD transition indicator classification
Enterprises Markets and trade Financial institutions Infrastructure
Large-scale
privatisation
Price liberalisation
Banking reform & interest rate
liberalisation
Infrastructure reform
Small-scale
privatisation
Trade & foreign
exchange system
Securities markets & non-bank
financial institutions
Governance &
enterprise restructuring
Competition policy
Source: EBRD (2003)
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Though the EBRD indicators provide excellent overall coverage of the transition period, they
tend to overlook the influences of informal factors. A theoretical transition classification model
presented by E. van de Mortel (2002) specifically addresses these missing links.
Van de Mortel’s three stage model
Elma Van de Mortel (2002) classifies three stages of transitional progress using a framework
based on institutional theory as developed by D. North (1990). According to Van de Mortel,
the first stage of transition starts when a country has the freedom or desire to reform, or
when it is forced to start transforming its economy. For those countries willing to transform,
this stage is usually very short. However countries forced to transform may have difficulties
determining their transition strategy since transition starts with the collapse of the former
institutional framework, e.g. total vacuum of legislation, rules, etc. In this stage of transition it
is crucial for the countries to develop their main transition strategies. However this step can
only be taken if a suitable political structure is in place; providing a clear and duly endorsed
power distribution between the president, government and parliament. Van de Mortel notes
that the first stage of transition tends to be more successful in those countries where there
are more stable constitutional institutions able to make decisions about the direction and
speed of strategic processes (2002). But then again the ability of the transition country to
develop such institutions depends mainly on past experience. Considerable impact also
comes from factors we understand as national identity e.g. common language, recognition of
similar values, etc. According to Van de Mortel, it is still too early to speak about property
rights and privatisation during the first stage of transition. The first stage ends when the
decision-making process related to new laws and regulations begins.
The second stage of transition is mainly shaped by formal institutional reforms (e.g.
introduction of legislation and rules). An important precondition has to be met before an
economy arrives at this stage, i.e. a start must have been made with privatization and
decentralization of economic decisions. Instead of being superficial, privatisation has to be
structurally and decidedly focused towards the shift in decision-making power.
Decentralisation, on the other hand, should mean that owners or managers of firms can
decide about selling prices, about where to buy input, which goods will be produced, and so
on. During the second stage of the transition, legislation and rules are reassessed and
replaced, i.e. the legal framework is shaped. For instance, banking laws, protection of private
property, competition, law and bankruptcy laws are to be introduced. Even if slowly, informal
institutions, like personal attitudes, economic behaviour and culture have to change during
the second stage as well. However, as long as the formal institutions have not taken shape
and framework uncertainty persists, there can be no harmony between the formal and
informal institutions.
The third stage of transition starts when the introduction of legal framework is roughly
completed. Marginal changes remain possible, but they mainly concern a refinement of the
newly implemented institutions. During the third stage the main focus is on the change of
economic behaviour of agents. Economic actors experiment in order to see which economic
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decisions lead to better results in the context of the new economic order. Furthermore, it is
crucial that people accept the new formal institutional framework. This stage can last rather
long and can be completed successfully only if harmony between the formal and informal
institutions has arisen. Without this harmony the new institutions are unlikely to persist, and,
if they do, they will in all likelihood not be effective and the transition process may regress to
the previous stage. The probability that harmony will develop between two kinds of
institutions depends among others on the duration and the hardship suffered during the
second stage of transition. When people see their incomes decline and have to live in
poverty for a prolonged period of time, they are likely to blame the new economic and
political order for their difficulties and will have little inclination to accept the new order and
adapt to it (Van de Mortel, 2002: 23). These three transition stages are summarised in figure
1.
Figure 1 - A model of Van de Mortel’s three transition stages
Adapted from Van de Mortel (2002).
Developing a conceptual framework
When we compare Van de Mortel’s three transition stages with the EBRD indicators we find
a general agreement as to the formal institutional changes that need to take place during
stages one and two. EBRD indicators, however, mainly focus on economic and to some
extent also political transition whereas Van de Mortel’s transition stages go a step further by
including a deeper societal dimension, i.e. the more ‘fuzzy’ category of informal institutional
influence such as attitudes, values and culture. She argues that they play a crucial role in
allowing the more formal reforms in the transition process to progress.
But are these two factors reflecting the various influences on SME and entrepreneurship
development? Acs and Karlsson (2002) raise a critical voice against focusing solely on
institutional influences to private enterprise development since they only present a limited
part of the overall economic milieu within which entrepreneurship may develop. Other
important conditions include demand and supply conditions, the degree of competition in
various markets, the state of the infrastructure, the supply and skill level of the labour force,
the entrepreneurial climate and access to knowledge. Authors such as Aidis et al. (2006)
have enhanced their institutional analysis by including economic factors.
Stage one:
Desire or pressure
to reform
Stage two:
Formal
institutional reform
Stage three:
Harmonisation of
formal and
informal
institutions
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In addition to the typical institutional classifications (formal and informal barriers) addressed
by the EBRD indicators and Van de Mortel’s analysis, we agree with Acs and Karlsson’s view
that economic factors must also be included in our analysis of influences to entrepreneurial
development. In the context of this classification for the transition country context, economic
factors mainly include production factors such as access and cost of appropriate financial
and human capital (including training) and infrastructure. Therefore we label this category as
‘economic’ factors. We also feel that an additional category should be added to capture
factors not included in the other three categories. Our analysis therefore identifies four core
influences to SME development and growth: formal, informal, economic constraints as well
as an ‘other category’ in order to capture additional influences (figure 2). The specific areas
and issues classified under each of the four categories as derived from the existing literature
on barriers to SME development in transition countries and are presented in appendix 2. It
should be noted, however that this classification of barriers should be seen as a conceptual
approximation of the sets of factors influencing SME development rather than clear cut-off
points. Some of these categories may overlap and a particular barrier can belong to two or
more categories depending on the interpretation. Moreover one barrier faced by an SME
could be a consequence of some other barrier(s) both in the frame of a particular category as
well as in- between them.
Figure 2 - Four categories of constraints to SME development and growth
Data and Methodology
As already mentioned, the transition process itself is not only a complicated phenomenon but
is also a non- linear process. Thus one would expect that indicators capturing the progress of
the transition process, which make sense from the entrepreneurship development viewpoint,
to be complex as well. Among other factors, transition indicators from an entrepreneurship
perspective, would need to consider differences between various transition countries in terms
of historical influences, both long and short term, affecting the starting points of transition as
well as the speed and path of transition. Informal influences on the transition process, such
as culture and the norms of different actors, including government, regulating (tax inspection,
etc.) and business promotion organisation representatives, the general population and, of
course, SME owners and managers themselves, should also be taken into consideration.
Formal Informal Economic Other
SME development and
growth
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In light of these factors and considering the limitations of other available data, we chose
EBRD’s yearly average indicator (see Table 3 and Appendix 1) as the most suitable option
for approximating the transition stages. There are several reasons for this choice. Firstly,
they cover all 23 transition countries we are interested in throughout the transition process
(data is available starting in 1989). Secondly, the impact of the long and short- term history,
namely, differences in starting points of transition countries are considered by these
indicators. Thirdly, the common measurement scale ensures that the progress of transition,
regardless of the path taken, is measured uniformly for all transition countries. Additional
support for the use of EBRD’s indicators emerges from a number of existing single country
studies (for list see Appendix 5), most of which might be classified following methods similar
to Van de Mortel’s stages framework, indicate the appropriateness of using EBRD transition
stages as the main guideline to approximate different transition stages from an
entrepreneurship development point of view.
In order to classify the countries according to transition stages, we delineated EBRD ranks
into three stages following the EBRD’s 4 score system. A rank of 1 to 1.9 was classified as
indicating little progress i.e. the primary stage; rank 2 to 2.9 was classified as indicating some
progress i.e. the secondary stage; and, rank 3 to 4 was classified as indicating substantial
progress approaching international standards, i.e. the advanced stage.
Table 3 - EBRD transition indicators ranked into three transition stages
country Primary stage* Secondary** Advanced***
Albania 1989 -1993 1994 - 2004 -
Armenia 1989- 1994 1995 - 2001 2002 - 2004
Azerbaijan 1989 - 1996 1997 - 2004 -
Belarus 1989 - 2004 - -
Bulgaria 1989 – 1992 1993 - 1998 1999 - 2004
Czech Republic 1989 - 1990 1991 - 1992 1993 - 2004
Estonia 1989 - 1992 1993 1994 - 2004
Georgia 1989 - 1994 1995 - 1999 2000 - 2004
Hungary 1989 - 1990 1991 - 1992 1993 - 2004
Kazakhstan 1989 - 1994 1995 - 2004 -
Kyrgyzstan 1989 - 1993 1994 - 2004 -
Latvia 1989 - 1991 1992 - 1995 1996 - 2004
Lithuania 1989 - 1992 1993 - 1995 1996 - 2004
Moldova 1989 - 1993 1994 - 2004 -
Poland 1989 1990 - 1992 1993 - 2004
Romania 1989 - 1993 1994 - 1998 1999 - 2004
Russia 1989 - 1992 1993 - 2002 2004
Slovak Republic 1989 - 1990 1991 - 1993 1994 - 2004
Slovenia 1989 - 1991 1992 - 1994 1995 - 2004
Tajikistan 1989 - 1997 1998 - 2004 -
Turkmenistan 1989 - -
Ukraine 1989 - 1994 1995 - 2004 -
Uzbekistan 1989 - 1993 1994 - 2004 -
Source: Various EBRD Transition reports
* = EBRD indicator rating from 1 – 1,9; ** = EBRD indicator rating from 2,0 – 2,9; *** = EBRD indicator rating from
3,0 – 4
As shown in table 3, according to EBRD indicators, as of 2004, two CIS countries were still in
the primary stage (Belarus, Turkmenistan); Eight countries were in the secondary stage
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(Albania, Azerbaijan, Kazakhstan, Kyrgyzstan, Moldova, Tajikistan, Ukraine and Uzbekistan);
and thirteen countries were in the advanced stages of transition (Armenia, Bulgaria, Czech
Republic, Estonia, Georgia, Hungary, Latvia, Lithuania, Poland, Romania, Russia, Slovak
Republic and Slovenia).
Our transition country data is derived from a systematic analysis of previous available
surveys on the barriers to SME development in 23 transition countries. The libraries and
electronic databases of three universities formed the backbone of our search for surveys:
The ICE collection at Jönköping University, the London School of Economics and University
College London. We searched under the following main keywords: SME (entrepreneurship,
small/ medium, business) in transition, SME barriers (constraints) in transition and econ* of
(in) transition. We also searched for single country studies on SME barriers and transition
stages using the ICE collection at Jönköping University. In our search for literature, we
focused on the following main sources:
• Leading peer reviewed journals in entrepreneurship research
8
(such as Small
Business Economics, Journal of Business Venturing, Entrepreneurship: Theory and
Practice, Entrepreneurship and Regional Development, The Journal of Small
Business Management)
• Annual proceedings and research reviews in the field of entrepreneurship (such as
Advances in the study of entrepreneurship, innovation and economic growth edited
by Gary Liebcap, Volumes 2 – 15, published in 1989 – 2004
9
)
• Specialised journals, mainly focusing on transition countries (such as MOCT- MOST,
Baltic Economic Review, Post- Communist Economies)
• Transition and selected country reports from international organisations (such as the
EBRD, the World Bank, OECD)
• Working papers (from sources such as the World Institute for Development Economic
of Research (WIDER), Tinbergen Institute Research Series, Williamson Davidson
Institute (WDI), SSRN papers).
• Proceedings from leading international conferences on entrepreneurship (such as
RENT, Babson, Academy of Management)
The selected 35 studies on constraints facing SMEs cover various transition stages in 23
different countries of transition. To ensure a high quality of analysis, most of the surveys
used were published in high quality academic journals. In addition other sources such as
country reports, etc. which provided a broader picture of the constraints faced by SME were
included. The main focus of our analysis were surveys on SME development barriers. Half of
the studies used were single country surveys while the other half of the studies included two
or more countries. Most of those studies including more than one country analysed SME
constraints within a single transition stage. The vast majority of studies used cover the main
SMEs sectors in a particular country. The unit of analysis used in the studies was SMEs in
transition countries.
8
For more information on selection criteria of leading journals please seehttp://eweb.slu.edu/booklist.htm
9
Published by JAI Press, Greenwich, Connecticut.
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Unfortunately, SMEs are defined in different ways in different country contexts. The most
common classification used was are less than 50 employees (indicating a small enterprise);
less than 200 employees or less than 250 employees (indicating a medium enterprise).
Standard definitions for SMEs can range from under 50 employees to up to 500 employees.
Given our limited access to the raw data used in the surveys analyzed, this presented a
definitional problem. This is not a problem specific to the transition context, though it affected
our ability to analyze across studies
10
. The number of barriers examined in an individual
study ranged from 6 to 65 barriers. The data presented in the 35 surveys used was mainly
collected using mail survey methods, while personal interviews were used less extensively. A
number of studies employed both methods. For the majority of surveys, the respondents
were managers and owners of SMEs. For a more detailed description of the studies used,
see Appendix 4.
Since our primary aim is to identify which SME barriers (e.g. formal, informal, economic or
others) are of ‘main’ importance at different transition stages, we followed a three step
process. In step one, we classified all 35 studies according to transition stage. In step two,
we classified the barriers identified as ‘important’ by the studies into formal, informal,
economic and ‘other’ categories. Finally, in step three, we compared and summarised the
main barriers and barrier groups identified at different transition stages. For further
information on the classification of SME barriers see Appendix 2 and 3. A list of all 35
surveys utilised is presented in Appendix 4.
Given the different methodology and mesurement scales used to analyse SME constraints in
the studies used, some general scales of measurement were developed. These are
described in table 4.
Table 4 - Criteria for the measurement of SME barriers
(1) If the importance of a barrier was measured as a percentage of total respondents considering it to be
important (in some studies- most important, or that barrier was a problem that must be improved). In these cases,
the barrier was considered to be important if at least 30 percent of the total respondents considered it as
important.
(2) If the importance of a barrier was measured by the mean (average) score using different scales, the following
method was used:
Scale from 1 to 5: Where 5 is the most problematic barrier. In this case, we considered the most important
barriers to be those where the mean is more than 3,0
Scale from 1 to 4: Where 1 is the most problematic barrier. In this case, we considered the most important
barriers to be those where the mean is less than 2,0
Scale from 1 to 8: Where 8 is most important problem. In this case, we considered the most important barriers to
be those evaluated with 5 and more.
(3) There were also some surveys where authors did not provide with any quantifiable measurement scales. In
these cases we rely on the author’s judgement and consider those barriers as most important which are
mentioned to be such by the authors themselves.
10
This is the main reason why at this stage we did not employ any quantitative estimation methods. This provides
an exciting opportunity for further research on this topic.
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Results
After classifying the 35 studies into transition stages and identifying the main SME barriers at
each stage, our aggregated barriers for the three transition stages point to a number of
interesting observations. As shown in figure 3, several formal and economic constraints
affected SME owners throughout the three transition stages. This was not the case for
informal or other constraints. The constraints specific to each transition stage are shown in
figure 3 under the headings of formal, informal, economic and other categories. Since a
number of similar barriers were identified affecting both stages 2 and 3, these are listed in a
column located between stages 2 and 3. It should be further noted that given the exploratory
character of our analysis, it is more useful to focus on the general nature and trends that can
be derived from our results and save more specific analysis for later research.
Our results indicate the following three trends. First of all, we can identify a general trend of
more fundamental barriers to more specific constraints being identified as transition
progresses from stage one to stage three. Furthermore, as the transition process moves to
stage three and beyond, SME owners seem to become increasingly more concerned with
human resources (labour) and skill development (training) then at the initial stages. This
changed ultimately to the increased need to develop internal business capabilities to deal
with increasing competition as well as business growth such as specific consulting and
advice and business training programmes. Supporting evidence for this result is provided by
a study in Hungary which identified the need for business training programmes in the more
advanced stage of transition (Acs et. al. 2001). Secondly, we find that three formal
constraints: taxes, policy instability and legal regulations form a barrier for business
development throughout the transition stages. Though taxes are a constraint faced by
businesses worldwide, policy instability and uncertainty seems more specifically related to
the transition process and indicates the effect of the difficulties of adopting a new legal
framework for SME owners. Thirdly, we find that access to and the cost of financing
continues to be a barrier to businesses throughout the three transition stages. Though
access to financing is a constraint identified by many western businesses, this result draws
special attention to the difficulties of developing an adequate independent banking sector
that would serve the capital needs of SMEs in the transition context.
Are informal barriers ‘irrelevant’ at stage 1?
Our results certainly point to the unlikely conclusion that informal barriers are not important at
stage 1. But we believe there may be some other reasons for this seemingly incongruous
result. First of all, it may be the case of missing data because of the few studies available
with data on barriers to SMEs in transition countries at stage one. However it may also be
possible that these results illustrate a situation in which the SME owners may be less aware
of the informal constraints because these constraints ‘stayed constant’ and exemplify a
situation of ‘the fish don’t talk about the water’. In this instance other constraints would seem
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more important such as formal and economic barriers because they are undergoing dramatic
changes and put additional demands on SME owners to adapt to changing conditions.
In addition, business owners in later transition stages may become more vocal about
informal barriers such as corruption as they become more accustomed to the changes in
formal and economic context and become more aware of the fact that informal barriers such
as corruption are fundamentally detrimental to their business development in the long term.
Figure 3 - Main barriers facing SMEs in different transition stages
STAGE 1
INFORMAL:
FORMAL: Taxes, Policy instability/uncertainty, Legal regulations
STAGE 3 STAGE 2
OTHER
• Customs
and trade
regulations
• Macroecono-
mic stability
• Inflation
• Gov’t Attitude
• Organised crime and
mafia
• Anti – corruption
measures
• Business security
• Lack of positive
attitude
• Gov’t non-
transparency
• Commercial law
• Social security
payments
• Frequent changes
to laws
and government
• Business
registration
business
• Too many licenses
• Accounting standards
• Information
• Need for specific
consulting advice
(marketing, financial,
psychological)
• Lack of state support
• Too many tax inspections
• Implementation of
regulations
• Motivation / quality ethics
of the workforce
• Corruption
• Bureaucracy
• Payment
behaviour of
clients
• Physical
infrastructure
• Low product
demand
• High input prices
• Suppliers
• High interest
rates
• Infrastructure
• Unfair
competition
• Premises rental
costs
• Wage costs
• Business
training
• Shortage of qualified
workers
• Strong competition
• Lack of investment/finance
• Business growth into new
markets
Stages 2 & 3
ECONOMIC: Financing: access and cost
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Limitations
The classification of different types of barriers into formal, informal, economic and other
categories forms the core of our analysis but at the same time, it is a difficult distinction to
make. For example policy instability and uncertainty though classified as a formal constraint
is also very closely related to official attitudes (which are informal constraints). One of the
main problems encountered is the ability to empirically distinguish between these categories.
Moreover, if a survey only asks if ‘business inspections’ present a business barrier it remains
unclear as to whether business inspections as such are a barrier or if it is actually the ‘rent
seeking’ characteristic of business inspections that forms the barrier. In our model, we would
classify these two as distinctly different. The former is a formal barrier and the latter an
informal barrier. But if a survey does not ask for the distinction, than we can not extract this
subtle difference from the data available. In this sense, qualitative interview data provides
more depth and detail which facilitates more fine-tuned classification than quantitative data.
However, empirical research could very well capture these institutional differences if the
questions are formulated properly.
Another important issue regarding SME barriers and transitional stages is the fact that the
general characteristics of SMEs prevalent at the different transitional stages are changing as
well. One could expect more basic types of arbitrage entrepreneurship to dominate in the
early stages of transition with more sophisticated forms of entrepreneurship (based on for
example, technological competitiveness) to increase as the market becomes more
competitive in later transition stages. Therefore our results probably reflect the changes to
barriers that are significant for different forms of SMEs as much as for the transition stage.
Though the EBRD indicators provide adequate coverage of the transition period, they have
their limitations. The main drawbacks of EBRD’s measurements are their focus on
instrumental macroeconomic processes such as macroeconomic stabilization, privatization
and liberalisation. These three issues have been emphasized by the International Monetary
Fund and were outlined by the Washington Consensus. However, more recent research has
indicated that these conditions though necessary for the transition process are not sufficient
to realize transitional ‘success’. The limited scale (from 1 to a maximum score of 4) of
change provided by the EBRD indicators poses other difficulties since a very limited range of
variance can actually be captured. Moreover, given that transition is a non-linear process,
some countries such as Russia and Belarus exhibit outlier years. In 1995, Belarus had a total
transition indicator score of 2.00 which would place it in the secondary transition stage for
that year. However, in subsequent years the score decreased to under 1.9. In Russia, a
similar situation occurred in 1997 where the indicator score was 2.96 though in the following
years it decreased back to under 2.9 until 2003 when Russia once again reached the
advanced level of transition (with a score of 2.92). Though not presented in table 3, these
outliers can be seen in the appendix 1 and whenever possible were taken into account while
analyzing the data. Using EBRD average indicator for the approximation of transition stages
rather than analysing each of the four categories (see Table 2) could be a debatable issue.
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Finally, a limitation relevant not only to EBRD indicators but for the approximation of
transition stages in general arises from the phenomena of the transition process. Since it is a
non- linear process, stages as distinguished can partly overlap during the transition process.
Nevertheless this approximation provides some scope to analyse SME development
constraints in the context of the distinctive transitional environment.
Concluding remarks
There is a growing body of literature on entrepreneurship in transition countries and many
studies have identified the barriers to SME development for specific countries at specific
periods of time. Yet there is no systematic study which has compared the barriers to SME
development at different transition stages. In this paper we attempt to fill this knowledge gap.
Using a novel methodology, based on our classification of the EBRD transition indicators, we
classified 23 transition countries into three transition stages: primary, secondary and
advanced stages. We then distilled the main barriers identified in the 35 studies according to
our ‘enhanced’ institutional-based model distinguishing between formal, informal, economic
and other barriers.
Our analysis introduced four main contributions. Firstly we developed a conceptual model to
distinguish three main influences on business development: formal, informal and economic
barriers. Secondly we classified the transition countries into three transition stages we
developed based on the EBRD indicators. Thirdly, through a systematic analysis of 35
existing studies, we operationalise our conceptual model in order to obtain insights into the
main barriers that affect SMEs at different stages of the transition process. Finally, given the
extensive data utilised, we are able to provide a more broad-based illustration of some of the
general trends experienced by SME owners during the transition process that up until now
have been mainly researched using a country-specific approach.
Our results indicate that a number of constraints experienced by SMEs changes as the
transition process progresses. SME owners seem more affected by more fundamental
barriers formal constraints in stages 1 and 2 (the primary and secondary stages of transition)
while in stage 3 (the more advanced stage) SME owners seem to become increasingly more
concerned with human resources (labour) and skill development (training) than in earlier
stages. We also find that three formal barriers such as taxes, policy instability and
uncertainty and one environmental barrier, access to and cost of financing, form business
barriers regardless of the transition stage. Since our results fall in line with much of the
findings indicated by individual transition country studies, we are able to highlight the general
effects of certain business barriers on SME development during stages in the transition
process.
The types of policies and programmes offered to business owners should also be sensitive to
these changes. Since SME owners in stages 1 and 2 seem much more affected by
fundamental formal constraints, at these stages policies that would diminish these barriers
such as information on taxes and simplified tax policies would be most appropriate. Whereas
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businesses in stage 3 may profit more greatly from specific business training programmes to
improve their skills in marketing, obtaining specific forms of financing and growing their
business into new markets. Since formal barriers such as policy instability and uncertainty
seem to continue to form business barriers throughout the transition process, it is of utmost
importance that policy makers in the transition countries focus on insuring a transparent and
straightforward policy development process. Finally, given the fact that access and cost of
financing continued to be a constraint to SMEs regardless of the transition stage, it is a
fundamental issue that should be addressed at all stages of the transition process.
Furthermore, as Pissarides (2004) has indicated, it is important for financing opportunities to
adapt to the requirements of SME owners as transition progresses, allowing for more
complex forms of financing including venture capitalists in more advanced stages.
There is much ground for future research focusing on identifying general characteristics of
SME barriers during different stages of transition. Specifically, it would be very insightful to
implement a more quantitative, meta-analysis approach based on the conceptual model and
transition stage classification developed in this paper.
Acknowledgements
We thank Professor Friederike Welter and our Inter-Rent referees Albert Maydeu-Olivares, Dave Bouckennooghe
and one anonymous referee for their valuable comments. The remaining shortcomings, however, remain our own
responsibility. Both authors contributed equally to the writing of this paper, names are listed in alphabetical order.
E-mail of authors: Ruta Aidis, [email protected], and Arnis Sauka, [email protected]
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Appendix 1 - EBRD Transition indicators (average)
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
2004
Albania 1.00 1.00 1.11 1.63 1.89 2.07 2.33 2.48 2.48 2.48 2.48 2.63 2.67 2.67 2.67
2.81
Armenia 1.00 1.00 1.00 1.48 1.52 1.59 2.11 2.44 2.52 2.67 2.70 2.70 2.85 2.92 2.96
3.00
Azerbaijan 1.00 1.00 1.00 1.19 1.30 1.30 1.70 1.85 2.15 2.33 2.33 2.41 2.48 2.56 2.59
2.63
Belarus 1.00 1.00 1.00 1.26 1.56 1.59 2.00 1.82 1.67 1.52 1.52 1.59 1.67 1.78 1.81
1.81
Bulgaria 1.00 1.11 1.70 1.85 2.04 2.26 2.33 2.37 2.81 2.81 2.92 3.11 3.15 3.22 3.26
3.37
Czech
Republic 1.00 1.00 2.11 2.63 3.07 3.30 3.30 3.41 3.48 3.52 3.55 3.59 3.67 3.67 3.67
3.74
Estonia 1.00 1.18 1.37 1.85 2.63 2.96 3.11 3.18 3.33 3.41 3.52 3.59 3.63 3.67 3.67
3.74
Georgia 1.00 1.00 1.00 1.26 1.41 1.41 1.96 2.44 2.70 2.78 2.81 2.92 2.92 2.92 2.92
2.96
Hungary 1.30 1.78 2.37 2.59 2.96 3.22 3.48 3.52 3.70 3.78 3.81 3.85 3.85 3.85 3.85
3.85
Kazakhstan 1.00 1.00 1.00 1.30 1.52 1.74 2.26 2.67 2.78 2.81 2.70 2.78 2.85 2.85 2.89
2.89
Kyrgyzstan 1.00 1.00 1.00 1.48 1.74 2.52 2.70 2.74 2.81 2.81 2.81 2.81 2.81 2.81 2.81
2.93
Latvia 1.00 1.00 1.19 2.00 2.26 2.81 2.81 3.07 3.11 3.11 3.18 3.22 3.26 3.41 3.48
3.56
Lithuania 1.00 1.15 1.19 1.59 2.44 2.67 2.85 2.96 3.04 3.07 3.15 3.26 3.37 3.48 3.48
3.48
Moldova 1.00 1.00 1.00 1.44 1.70 2.04 2.52 2.56 2.63 2.70 2.70 2.70 2.74 2.74 2.70
2.74
Poland 1.26 2.26 2.41 2.56 3.00 3.11 3.26 3.37 3.44 3.55 3.55 3.63 3.66 3.66 3.66
3.66
Romania 1.00 1.00 1.26 1.59 1.85 2.26 2.41 2.41 2.74 2.85 2.93 3.00 3.04 3.04 3.04
3.18
Russia 1.00 1.00 1.11 1.89 2.19 2.41 2.59 2.85 2.96 2.55 2.48 2.59 2.67 2.85 2.92
2.96
Slovak
Republic 1.00 1.00 2.11 2.52 2.85 3.04 3.11 3.19 3.19 3.22 3.30 3.33 3.41 3.44 3.48
3.56
Slovenia 1.52 1.74 1.89 2.04 2.70 2.85 2.93 3.04 3.07 3.22 3.30 3.33 3.33 3.37 3.37
3.37
Tajikistan 1.00 1.00 1.00 1.30 1.37 1.37 1.70 1.74 1.78 2.00 2.04 2.15 2.15 2.22 2.26
2.30
Turkmenistan 1.00 1.00 1.00 1.00 1.00 1.15 1.26 1.26 1.48 1.45 1.45 1.37 1.30 1.30 1.30
1.30
Ukraine 1.00 1.00 1.00 1.19 1.30 1.48 2.19 2.30 2.52 2.44 2.48 2.59 2.63 2.70 2.74
2.78
Uzbekistan 1.00 1.00 1.00 1.19 1.41 1.96 2.22 2.22 2.15 2.11 2.04 2.00 2.11 2.11 2.08
2.08
Source: EBRD (1994, 1995, 1996, 1997, 1998, 1999, 2000, 2001, 2002, 2003, 2004).
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Appendix 2 - Classification of barriers influencing SME development and growth
Formal Informal Economic Other
High taxes
Government intervention in economy
Laws and regulations (policy
instability/uncertainty, frequent changes,
non- transparency, unpredictability,
operation, customs and trade regulations,
accounting standards, business
registration)
Business inspections
High social security payment
Poorly functioning state (implementation of
business regulations problems arising
from administration as well as lack of
personnel)
Lack of state support (in terms of building
appropriate infrastructure with arising
constraints as information provision to
small firm employees, need for specific
consulting advice (marketing, financial,
psychological) and lack of SME policies)
Financing structure
Payment behaviour of clients
Rent-seeking through inspections
Motivation of the workforce/quality ethics
in the workforce
Bureaucracy
Poorly functioning state (business
security issues such as inadequate
measures against organized crime,
mafia)
Implementation of business regulations
(as a consequence of responsible
officials attitudes)
Lack of state support (represented by
attitude of the government towards
business)
Macroeconomic stability (inflation)
Physical infrastructure – old
unreliable equipment
Shortage of qualified workers
Shortage of high quality managers
Cost of loans, interest rates, collateral
requirements
Loan application
Unfair competition
Strong (domestic and foreign)
competition
Low product demand
High input prices
Suppliers not ready to deliver
(procurement problems)
Business training
Inability to grow into new markets
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Appendix 3 - Classification and types of SME barriers identified in different transition stages
Formal Informal Economic Other
All stages • High taxes/ tax rate
• Policy
instability/uncertainty
• Legal issues / regulations
• Financing problems
• Access to finance/credit
• Cost of finance/credit
Stage 1 • Customs and trade
regulations
• Macroeconomic stability
• Inflation
Stage 2 • Frequent changes to
laws/gov’t
• Time to register business
• Attitude of the gov’t
• Organised crime and mafia
• Inadequate measures against
corruption
• Business security
• Physical infrastructure – old
unreliable equipment
• Low product demand
• High input prices
• Suppliers not ready to deliver
• High interest rates
Stage 2&3 • Gov’t non-transparency
• Operation of commercial
law
• High social security
payments
• Bureaucracy
• Payment behaviour of clients
• corruption
• Unfair competition
• Premises rental costs
• Wage costs
• Infrastructure – lack of telephone
connections
• Business training
Stage 3 • Too many licenses
• Accounting standards
• Unpredictability of
economic regulations
• Information provision to
small firm employees
• Need for specific
consulting advice
(marketing, financial,
psychological)
• Preferential treatment
• Dishonest competition
• Too many tax inspections
• Implementation of business
regulations
• Motivation of the
workforce/quality ethics in the
workforce
• Lack of state support
• Shortage of qualified workers/labour
• Strong competition
• Lack of investment/finance for
expansion
• Inflation
• Inability to grow into new markets
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Appendix 4 - Studies on constraints facing SMEs in transition.
Transition
stage (data
collected)
Country(ies) Sectors
covered
Sample size Definition of SME
Method used Key informants Number of
barriers
examined
Author(s), title and source
III (2000) Slovenia All sectors
except
agriculture
173 Less than 250
employees
Personal interviews.
Random sample
SMEs owners and
managers
51 Barlett, W. and V. Bukvi?. 2001.
Barriers to SME Growth in Slovenia.
MOCT-MOST 11: 177- 195, 2001
II (1997) Albania Manufacturing,
construction,
trade and
service sectors
50 Less than 200
employees
Complete
questionnaire (nearly
400 questions) and
face to face interview
SMEs owners and
managers
15 Hashi, I. 2001. Financial and
Institutional Barriers to SME Growth in
Albania: Results of an Enterprise
Survey. MOCT- MOST 11: 221- 238,
2001
III (1997) The Czech
Republic
Manufacturing,
construction,
trade and
services
100 Less than 200
employees
Interviews SMEs owners and
managers
40 Bohata, M. and J. Mladek. 1999. The
Development of the Czech SME Sector.
Journal of Business Venturing 14, 461-
473, 1999
III (1999) Hungary Small- scale
manufacturing
or production,
services
280 na Mail surveys and
telephone interviews
Small business
owners and
operators
12 Fogel, G. An Analysis of
Entrepreneurial Environment and
Enterprise Development in Hungary.
2001. Journal of Small Business
Management 2001 39(1), pp. 103- 109
II (1996 and
1997)
Kyrgyz
Republic
Concentrated
on service
activities
1996: 160 1997:
219
na Mail questionnaire
Descriptive statistics
and Logit analysis.
Owners of small
non- farm
household
businesses
12 Anderson, K. and R. Pomfret. 2001.
Challenges Facing Small and Medium-
Sized Enterprises in the Kyrgyz
Republic, 1996-97. MOCT- MOST
11:205-219, 2001
II (1993,
1996 and
1998)
Russia All sectors 1993: 277 and
281
1996: 887
1998: 227
According
Russian
Federation
federal law of 14
June, 1995.
Standardized survey SMEs owners and
managers
8 Radaev, V. 2001. The Development of
Small Entrepreneurship in Russia.
WIDER Discussion Paper No. 2001/135
III (1997
and 1998)
Hungary All sectors 2000 na na Owners and
managers of small
enterprise
11 Dallago, B. 1999. Context and Policies
for the Transformation and Growth of
SMEs. The Case of Hungary with
Russian Implications. WIDER Research
for Action 50.
III (1993) Poland na na na Interviews Small business
owners and
managers
11 Robson, G. 1993. The problems facing
small firms in Poland. Discussion Paper
No 93-4 School of Business
Management, University of Newcastle
upon Tyne, UK.
II (1995) Russia and
Bulgaria
All sectors Russia: 216
Bulgaria: 221
Less than 200
employees
Interviews. Random
samples. Tabulation
of responses.
Multinominal
regression analysis.
SMEs owners and/
or chief executive
officers
11 Pissarides, F., Singer, M. and Svejnar,
J. 2003. Objectives and Constraints of
Entrepreneurs: Evidence from Small
and Medium Size Enterprises in Russia
and Bulgaria. Journal of Comparative
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Regionally stratified
random samples.
Economics (2003) 13, 503-531
II (1993-
1996)
Bulgaria All sectors 120 Less than 50
employees
Mail questionnaire Small business
owners and
managers
13 Dmitrov, M. and Todorov, K. 1995.
Small Business Development in
Bulgaria. In Fogel, et al. 1995 (eds).
Moving to Sustainability. How to Keep
Small Business Development Centers
Alive. Averbury. England, USA.
III (1999) Poland All sectors 320 Less than 50
employees
Mail questionnaire Small business
owners
10 Matusiak, K. 1999. Entrepreneurial
Attitudes and Innovations of Small and
Medium- Sized Enterprises in Poland.
Unpublished
III and II
(1993)
Poland,
Hungary, the
Czech Republic
(III) and Slovak
Republic (II)
All sectors 140 in each
country
Less than 500
employees
Mail questionnaire SMEs owners and
managers
16 OECD working papers, vol. IV. Small
Business in Transition Economies,
1996.
II (1999) Albania All sectors 101 Less than 250
employees
Mail questionnaire SMEs owners and
managers
9 Muent, H. 2001. Taxes, Competition
and Finance for Albanian Enterprises:
Evidence from a Field Study. MOCT-
MOST 11: 239-251, 2001.
II (1996) Russia and
Poland
Shops 55 in Russia
(Moscow)
50 in Poland
(Warsaw)
Less than 50
employees
Survey Owners 6 Frye, T. and A. Shleifer. 1997. The
Invisible Hand and the Grabbing Hand.
American Economic Review, 1997,
87/2, 354 – 358.
I, II and III
(1997)
All 23 countries All sectors Different sample
size in different
countries
Less than 200
employees
Mail questionnaire Owners and
mangers
31 World Development Report 1997. World
Bank.
I, II and III
(1999)
All 23 countries All sectors Different sample
size in various
countries
Less than 200 Mail questionnaires SMEs owners and
managers
65 BEEPS 1999, EBRD and World Bank.
I, II and III
(2002)
All 23 countries All sectors Different sample
size in various
countries
Less than 250 Mail questionnaires SMEs owners and
managers
25 BEEPS 2002, EBRD and World Bank.
I and II
(1997)
Ukraine (II) and
Belarus (I)
All sectors 343 in Ukraine
200 in Belarus
Less than 200 Quantitative survey
and in- depth case
studies
SMEs owners and
managers
17 Smallbone, D. et al. 2001. The
contribution of Small and Medium
Enterprises to Economic Development
in Ukraine and Belarus: Some Policy
Perspectives. MOCT-MOST 11: 253-
273, 2001.
III (2000) Lithuania All sectors 332 Less than 50
employees
Mail questionnaire
SMEs owners and
managers
19 Aidis, R. 2003. By law and by custom:
Factors affecting small- and medium-
sized enterprises during the transition in
Lithuania. Tinbergen Institute Research
Series, PhD Thesis.
III (2000) Lithuania All sectors 1500 Less than 50 Mail questionnaire SMEs owners and 11 Survey by the Employer’s House, the
2
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employees managers Lithuanian Business Employers’
Confederation and SIC Market
Research. Lithuania, 2000.
III (1998) Latvia All sectors 295 Less than 250
employees
Interviews SMEs owners and
managers
16 Tisenkopfs, et al. 1998. How does small
entrepreneur feel? Report to the
Government of Latvia. Philosophy and
Sociology Institute of the University of
Latvia. (In Latvian)
III (1997) Latvia All sectors 180 Less than 250
employees
Mail questionnaires
and interviews
SMEs owners and
managers
9 Kuzmina, I. 1999. Socially economical
aspects of entrepreneurship in Latvia
during transition period to market
economy. PhD Thesis, University of
Latvia. (In Latvian)
III (2001) Latvia All sectors 541 Less than 250
employees
Interviews Top managers of
SMEs
12 Latvian Development Agency and the
World Bank Foreign Investment
Advisory Service. 2001.
III (2002) Latvia All sectors 300 Less than 250 Face to face
Interviews or
questionnaire
SMEs owners and
managers
16 SKDS. 2002. Environment of Small and
Medium size entrepreneurship in Latvia.
Results of enterprise survey. (In
Latvian)
III (1997-
1999)
Lithuania All sectors 1750 Not only SMEs
but only 3
percent of the
respondents had
more than 49
employees
Face to face
administration of the
questionnaire
owners and
managers
14 Jancauskas, E. 2000. Verslo Pletra:
Lietuvoje ir vidurio Europoje, Statistikos
Tyrimai, Vilnius. (In Lithuanian)
II (1999) Ukraine All sectors 900 SMEs (less than
250 employees)
Face to face
interviews
Directors/
managers
19 Yacoub, M. and B.Senchuk. 2000. The
state of small business in Ukraine. An
IFC Survey of Ukrainian small
enterprises.
II (1999) Ukraine All sectors 3800 SMEs (up to 250
employees)
Face to face
interviews
Directors and
managers
17 Gray, A.T. and W.B. Whiston. 1999. A
survey of business in Ukraine. By
Management Systems International and
Kiev International Institute of sociology.
II (1995 and
1996)
Russia All sectors N/a SMEs (up to 250
employees)
N/a N/a 8 OECD, 1999. Financing Newly
Emerging Private enterprises in
transition economies. Survey by
Russian Independent Institute of Social
and National Problems.
III (1997) The Czech
republic
All sectors 100 SMEs (up to 200
employees)
Interviews N/a 11 Csaba, L. 1998. (ed.). The Hungarian
SME sector development in
comparative perspective. By Center for
international Private Enterprise USAID.
funded and KOPINT- DATORG
Foundation for Economic Research.
III (1995) Poland, Manufacturing Total 600 SMEs (up to 250 Face to face Managers 16 Smallbone, D. et al. The development
2
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Estonia, Latvia,
Lithuania
interviews employees) interviews of Manufacturing SMEs in Poland and
the Baltic States: Policy issues and
priorities. In Ram, M. et al. 1997. Small
Firms Enterprising cultures. Published
by Paul Chapman Publishing.
II (1992) Poland All sectors 190 SMEs (up to 250
employees)
Mail questionnaires Owners 11 Study by the Department of Economics
and Management. 1992. In Daskiewicz,
N. Barriers of growth of small and
medium size enterprises in Poland
according to the opinion of their owners.
III (1999) Poland All sectors 93 SMEs (up to 250
employees)
Mail questionnaires Owners 17 Study by the Department of Economics
and Management. 1999. Follow up of
1992 study.
In Daskiewicz, N. Barriers of growth of
small and medium size enterprises in
Poland according to the opinion of their
owners.
III (1998) Estonia Manufacturing
and service
sectors
100 SMEs (up to 250
employees)
Interviews N/a 29 Phare 1998 report. The state of small
business in Estonia. Ch. 4. Problems
and priorities of Estonian SMEs.
III (1998) Poland All sectors 742 SMEs (up to 250
employees)
Mail questionnaire N/a N/a Dzierzanovski, W. 1998. (ed). Report
on the condition of the small and
medium size enterprise sector in
Poland for the years 1997-1998.
Chapter 9. SME development barriers.
III (1999) Poland All sectors 150 SMEs (up to 250
employees)
Structured interviews N/a 10 Couch, B. 1999. Growth strategies for
SMEs in a transition economy: the case
of Poland. 22
nd
ISBA National Small
Firms Policy and Research Conference
Proceedings. Leeds, United Kingdom.
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Appendix 5 - Single country studies distinguishing among different stages of economic transition
Country Stages Approach Author(s), title and source
Belarus
Three
stages
1991- 1994;
1995- 2000;
2001
onwards.
During the 10 years of its independence, Belarus is classified into
three periods. The first one represents the beginning of the market
transformations, second- starting of the system crisis and time
when economic transformation took place. Third stage, however,
is characterised by overcoming of the economic crisis, relative
stabilisation and beginning of a stable growth. But as the author
notes classification is no easy task since there is “contradicting
economic transition in Belarus … “ (Kobiakov, 2003: 3)
Kobiakov, A. 2003. Socio-economic
development of Belarus. In Best Practice
in the Development of Entrepreneurship
and SMEs in Countries of Transition: The
Belarussian Experience. United Nations,
Geneva, Switzerland.
Estonia
Three
Stages:
1988-1991;
1992-1997;
1998
onwards.
Four
stages:
late 1980s;
1990-1991;
1992-1993;
1994-
onwards.
Three
stages
1986- 1989;
1990- 1993;
1994
onwards.
Stages classified according development of SME sector.
Phases of transition classified according development of private
enterprising in Estonia. First stage in this classification represents
pre transition period, e.g. first steps in order to develop new forms
of entrepreneurship, Fourth one, however, represents the
beginning of micro and macro stabilisation.
Stages classified according business development in Estonia.
Kilvits, K. R. Lumiste, R. Lumiste. 2002.
SME policy influence on the economic and
regional development of entrepreneurship
in Estonia. RENT XVI Conference
Proceedings. Barcelona, Spain.
Aho, S., T. Piliste and J. Teder. 1998.
Abstract. In Private Entrepreneurship in
Estonia 1989-1996. Experiences and
Challenges of Transitional Economy.
University of Tampere, Research Institute
for Social Sciences. Työraportteja 54/1998
Working Papers.
Teder, J. Experiences and Challenges of
the Estonian Entrepreneur. In Private
Entrepreneurship in Estonia 1989-1996.
Experiences and Challenges of
Transitional Economy. Chapter 4.
University of Tampere, Research Institute
for Social Sciences. Työraportteja 54/1998
Working Papers
Latvia
Three
stages.
Late 80
th
-
end of
1990;
1991-1993;
1994 -
Stages of transition distinguished from the point of view of the
development of the Latvian small business sector.
Kuzmina, I. 1999. Entrepreneurship and
Small Business development in Latvia.
RENT XIII Conference Proceedings.
London, UK, 1999.
2
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onwards.
Lithuania
Two stages:
pre 1994;
post 1995.
Two distinct transition periods towards market economy are
distinguished. First one is mainly characterized by negative
economic developments, as decrease in total industrial
production, domestic turnover and international trade, upsurge in
inflation and fall of the standard of living as well as weakening in
labour and financial control (UNDSP 1999: 9 in Aidis, 2003). The
period after 1994, however, are characterized by macro
stabilisation, represented by stable growth of GDP and
investment, decrease in inflation, increased foreign investment,
relatively low and stable unemployment and other indicators.
Aidis, R. 2003. By law and by custom:
Factors affecting small- and medium-sized
enterprises during the transition in Lithuania.
Thela Thesis: Amsterdam.
Poland
Three
stages:
1989- 1990;
1991-1992;
1993
onwards.
Transition phases are distinguished from the viewpoint of
entrepreneurship and specifically private sector development.
Biesbroucc, W. and V. Bilsen. 1995. The
importance of SMEs Restructuring with
and Application to Poland. In Industrial
Organisation and entrepreneurship in
Transition. 1996. Dimitrov, M. and
K.Todorov. (eds.). Proceedings of the
international conference, Varna- Albena,
Bulgaria, June 5-8, 1995.
Romania
Three
stages:
1990-1993;
1994-1998;
1998 –
onwards.
Three distinct stages of transition that overlap the political
developments are classified in the context of the process of
economic and social reform.
Sergio, A. 1998. Transition and
Democracy in Romania: the Pains of a
Gradualist Restructuring. In Larcon, J.P.
(ed.). 1998. Entrepreneurship and
Economic Transition in Central Europe.
Kluwer Academic Publishers.
Russia
Three stages:
1987-1988 (pre transition);
1989-1991;
1992- onwards.
Four stages
1986-1991;
1992-1994;
1995-1997;
1998 – onwards.
Stages are distinguished considering development of
Russian entrepreneurship and entrepreneurs.
Stages are distinguished from the viewpoints of
macroeconomic policy, legislation and institutional
change from the point of view of SME sector
development. First stage represents pre transition
period, the third one- relative stabilisation followed by
the fourth stage classified as ‘crisis’, when “belief that
economic stabilisation has been achieved collapsed
in August 1998 with the end of the ‘financial pyramid’
built on state short term securities”. (Radaev, 2003:
117).
Lynch, R.D. and V.V. Makoukha. 1997. Entrepreneurs in Post-
Communist Russia. In Privatization and Entrepreneurship. The
managerial Challenge in Central and Eastern Europe by Ullmann A.A.
and A. Lewis (Eds). New York : International Business Press, cop..
Radaev, V. The Development of Small Entrepreneurship in Russia. In
McIntyre, R.J. and B. Dallago (Eds.). 2003. Small and Medium
Enterprises in transitional Economies. Palgrave Macmillan, Great
Britain.
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Appendix 6 - Alternative indicators
A seemingly obvious and straightforward indication of economic transition progress
would be GDP growth figures. Though all transition countries experienced a decline in
output, a number of countries have been able to record high levels of GDP growth especially
in the mid to late 1990’s. Table A6 presents the estimated level of real GDP in 2003 as
compared to pre-transition GDP rates measured in 1989. Ten out of twenty-three countries
have surpassed their 1989 GDP levels. However, the arbitrariness of this development and
incongruity with other EBRD transition indicators seriously questions its explanatory value.
Hungary and Poland’s high degree of economic recovery corresponds to their economic and
political reforms however Albania’s high score is matched by only a secondary level of
transition. Closer inspection of Albania’s GDP level shows high levels of international aid has
resulted in increasing its GDP figures to an artificially high level.
Table A6 - Estimated GDP level of real GDP in 2003 (1989 = 100)
Country Estimated GDP 2003 Country Estimated GDP 2003
Albania 129 Lithuania 84
Armenia 89 Moldova 41
Azerbaijan 71 Poland 135
Belarus 100 Romania 92
Bulgaria 84 Russia 77
Czech Republic 108 Slovak Republic 114
Estonia 102 Slovenia 120
Georgia 41 Tajikistan 62
Hungary 115 Turkmenistan 105
Kazakhstan 94 Ukraine 51
Kyrgyzstan 75 Uzbekistan 107
Latvia 83
Source: EBRD 2004
Unfortunately, when searching for other possible indicators, substantial data
problems were encountered. A study by Raiser et al. (2001) investigated the relevance of a
number of factors to institutional change in 25 transition countries. They developed a
structural model of institutional change using both time series and cross-sectional data on
transition countries. In their results, Raiser et al. find strong evidence that economic reforms
and political liberalisation are more powerful forces influencing institutional change than
changes in economic structures induced by such reforms. Hence the importance of political
liberalisation for economic transition. The results of the study by Raiser et al. (2001)
indicating the political liberalisation is an important determinant of institutional change
inspired us to refer to measures of political liberalization. Therefore we consulted the surveys
conducted by Freedom House measuring the levels of civil liberties and political freedom. We
were able to find data for our entire country sample however the earliest observation year is
1993. According to our estimates using the EBRD transition indicators, by 1993, ten
countries had already entered the second stage of transition. Therefore if we were to use the
Freedom House data, we would miss four crucial observation years.
Another possibility was to use data on levels of corruption such as those presented in
the corruption index by Transparency International. Measures of corruption can provide an
indication of a harmonisation of informal and formal institutions. However here we run into
even greater data problems since the earliest observation year is 1995 and then only for
Hungary. Most countries are represented in the sample only by 1999 however even by 2003
not all countries are represented.
We also consulted the measurement of informal markets in the Index for Economic
Freedom compiled by the Heritage Foundation. The level of informal markets can indicate
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the level of compliance with formal rules. However, in this index the earliest observation year
for most of the transition countries is 1995 and not all of them are included.
In addition, we referred to the Heritage Foundation’s index for government
intervention. Decreasing rates of government intervention could serve as an indication of a
shift of economic power from government control to private economic agents. However, the
Heritage Foundation’s index for most transition countries begins in 1995. Using this index for
evaluating transition seems highly suspect given the fact that some advanced Western
countries exhibit very high levels of governmental intervention such as France (score = 5)
and Norway (score = 3.5) and seem to be able to combine it with an efficient market
economy. The score for Belarus is the same as for Norway (score = 3.5) in 2003 which
reveals nothing regarding the actual transition progress since Belarus continues to be an
example of a transition country that is unreformed and reluctant to introduce any fundamental
market-oriented mechanisms. According to EBRD indicators, Belarus is only at the primary
stage of transition (EBRD 2003).
Another alternative measure would be to look at human development related
indicators such as poverty, income distribution, years of schooling and mortality rates. Here
once again data is limited and only available in the mid 1990’s and late 1990’s for most
transition countries. We also consulted various macroeconomic indicators in order to assess
the transition stages such as inflation levels, exchange rate regimes, current account balance
and percentage of GDP created by the private sector. But for each one of these indicators,
we found quite serious inconsistencies in terms of their relation to actual transition progress
measured by the EBRD.
In sum, most indicators measuring transition do not provide coverage of the entire
transition period and are therefore not suited for our study. The most appropriate
combination that can be used from the existing literature seems to be the EBRD transition
indicators and Van de Mortel’s classification of transition indicators (2002).
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Appendix 7 - EBRD transition indicators
In order to understand the development of EBRD’s transition indicators, it is important
to understand the motivation behind their creation. EBRD’s analysis of reform patterns in
transition countries since 1989 suggests that three factors are crucial for sustaining reform
progress: (1) Comprehensive economic liberalization to create market competition and
generate demand for market-supporting institutions; (2) Market liberalization is more effective
combined with political competition; (3) The process of transition is facilitated by international
integration (EBRD 2002).
According to the EBRD, the first or initial phase of transition was dominated by the
structure of the inheritance from the communist system and the political repercussions
following the collapse of this regime. The main reforms characterising this period include: the
privatisation of assets (small-scale privatisation), the liberalisation of markets (through price
liberalisation and foreign exchange and trade liberalisation) and the establishment of a
degree of macroeconomic stability (EBRD 1997).
The next phase of transitional reforms requires policies, institutions and behaviours
that can foster and accelerate economic growth. Second transition phase reforms include a
continuation of the privatisation of assets (through large-scale privatisation), improving
enterprise performance through governance and enterprise restructuring, the further
liberalisation of markets (through competition policy), the development and maintenance of
infrastructure (through infrastructure reform) and reform to financial institutions (banking and
interest rate liberalisation and the creation of non-banking financial institutions). A main
challenge in this phase is developing and providing market-oriented governance i.e. a
building and deepening of the institutions and behaviour that are at the heart of a well-
functioning market economy (ibid.).
The EBRD transition indicators are based on annual scores indicating
transitional progress and are calculated based on an average score of nine separate
indicators grouped into four categories
11
: Enterprises, markets and trade, financial institutions
and infrastructure. The ‘Enterprises’ category includes separate indicators for progress in
large-scale privatization, small-scale privatization and governance and enterprise
restructuring. ‘Markets and trade’ includes three separate indicators measuring price
liberalisation, trade and foreign exchange system and competition policy. Financial
institutions include two separate indicators measuring banking reform and interest rate
liberalisation and securities markets and non-bank financial institutions. Infrastructure
includes only one indicator measuring infrastructure reform.
In brief, the ‘enterprises’ category measure indicates the process of large-scale
privatisation; the implementation of reforms to cut production subsidies; the introduction of
effective bankruptcy procedures; and sound corporate governance practices (EBRD 2001).
The ‘markets and trade’ category indicates the extent and effectiveness of competition policy
in combating the abuses of market dominance and anti-competitive practices. With regards
to ‘financial institutions’, this indicator measures the extent to which interest rates have been
liberalised; the establishment of two-tier banking; and the creation of securities markets. In
addition, ‘financial institutions’ also assesses the extent to which prudential regulations have
been raised towards international standards, whether they have been enforced effectively
and if procedures exist for resolving the failure of financial institutions. Finally, the
infrastructure indicator measures the extent of tariff reform; the commercialisation of
enterprises; and the extent of regulatory and institutional development (ibid.).
11
For a more detailed description please refer to EBRD (2003:17).
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Indicators of Entrepreneurship Activity:
Some Methodological Contributions
12
Rachida Justo, Alberto Maydeu and Julio O. De Castro
Instituto de Empresa Business School
Abstract
Using a model-based approach, this paper re-examines the measurement of entrepreneurial
activity at the national level. Our contribution centres on two main aspects. First, our study
allows for the measurement of the likelihood of entrepreneurial behaviour, or entrepreneurial
propensity. Second, utilizing social network theory, we introduce the social entrepreneurial
environment as a key indicator of likelihood of entrepreneurial activity.
Using the data provided by the Global Entrepreneurship Monitor (GEM) project, we provide
an alternative measure of entrepreneurial activity which includes entrepreneurial social
environment, assumes the existence of a continuum in entrepreneurial behaviour and
provides a measure of entrepreneurial propensity. Results indicate that our model provides
support for the combined use of entrepreneurial propensity and the entrepreneur’s social
context.
Key Words: Entrepreneurship, Cross-country-Measurement
Introduction
Our contribution centres on two main aspects. First, our study allows for the measurement of
the likelihood of entrepreneurial behaviour. Different than prior measures of entrepreneurial
activity, where individuals are or are not considered entrepreneurs, we argue theoretically
and analyze empirically the notion of levels and likelihood of entrepreneurial behaviour.
Rather than classifying individuals as entrepreneurs or non-entrepreneurs, we adopt a more
dynamic view of the phenomenon by letting individuals differ in their propensity to engage in
entrepreneurial activities. In doing so, we argue for examining differences over time within
countries, as well as across countries.
Second, utilizing a social network theory approach, we introduce the social entrepreneurial
environment as a key indicator of likelihood of entrepreneurial activity. We contend that the
level of an individual’s entrepreneurial activity is affected by the social context in which that
activity occurs. This context is not uniform and its effect varies due to factors such as social
networks, education, gender, etc. As a result, an entrepreneur’s personal social network is
treated here as a random variable that changes from individual to individual.
The core of our proposed theoretical model lies in the use of two latent continuous variables:
the first one reflects an individual’s entrepreneurial propensity, that is, his likelihood of
12
Support for this research comes from a Grant from Fundación BBVA, Madrid. Spain
2
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engaging in venture creation. The second dimension reflects the individual’s social
entrepreneurial environment, and captures the elements of a person’s adjacent environment
that may affect his entrepreneurial propensity. We argue that this measure should be built
into the analysis of entrepreneurial activity, and should help provide a strong indicator of the
pervasive effects of entrepreneurship.
The purpose of the paper is to propose a new approach to measuring entrepreneurship, one
that is complementary to the approaches that have been used recently in cross-country
comparisons. Our hypotheses will be tested using data available the GEM project for
comparing entrepreneurship levels across countries. Whilst we recognize the contribution of
prior studies measuring entrepreneurial activity
13
- such as the GEM project - as a means of
gaining insights into the dynamics of entrepreneurship, we seek to provide a new model of
entrepreneurship that, in conjunction with existing measures, will help us reach a more
consistent and comprehensive view of the variation of the entrepreneurial phenomena within
and across countries.
The Measurement of Entrepreneurial Activity
While most scholars concur about the need to measure new venture creation,
entrepreneurial activity, and its impact on the wealth of societies, there is no consensus
about how to measure this phenomenon or about the adequacy of previous and current
measures (Davidsson, 2004; Dennis 1997, 1999; Gartner and Shane, 1995; Verheul et. al
2002; Williams 1993). There are several reasons for this lack of scholarly agreement. First,
the extant literature on entrepreneurship has proposed a broad array of different definitions
of this phenomenon (Gartner 1990; Hébert, and Link 1989; Praag 1999; Shane and
Venkataraman 2000). Entrepreneurship is indeed a multidimensional concept, which,
depending on the focus of the research and the theoretical perspective adopted, can address
very distinct social realities (Davidsson 2004; Verheul et al. 2002). Underlying these social
realities two major views exist in the entrepreneurship literature (Bruyat and Julien 2000;
Davidsson 2004). The first, following the seminal works of two French theorists, Turgot and
Say, considers entrepreneurship as anything related to independently owned businesses and
their owner-managers. The second follows the approach of Cantillon and Schumpeter
14
, and
studies entrepreneurs through their fundamental role in economies as innovators.
This diversity of definitions has, in turn, significant implications for the measurement of
entrepreneurship levels (Reynolds, 1992a). For instance, final counts can vary depending on
the view adopted by researchers to determine who is an entrepreneur; in particular, whether
a firm is started for the purpose of self-employment is to be included in the measure of
entrepreneurship or whether only firms started with the prospect of value creation are
included. Indeed, many firms that are started with the purpose of creating self employment
13
See for example the PSED project (http://projects.isr.umich.edu/PSED/index.cfm).
14
For more information about J. Turgot, J.B. Say, R. Cantillon and J. Schumpeter, see Herbert and Link (1982).
2
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would not be included in the measure of entrepreneurial activity if the baseline for inclusion
was firm/value creation and the expectation of future growth.
Second, the measurement of entrepreneurial activity in a country depends on the level of
analysis chosen by the researcher. In their review of longitudinal studies on
entrepreneurship, Gartner and Shane (1995) identified two types of research: research
focusing on individual level activity (e.g., self-employment) in order to measure the
entrepreneurial phenomenon, and that mostly concerned with firm level activity (e.g.,
organization creation). However, both approaches present inherent shortcomings; measures
focusing on individuals not only ignore firms but might also undercount some specific kinds of
entrepreneurs (e.g. self-employed who hire employees). By contrast, firm creation measures
often fail to capture businesses started as proprietorships or partnerships.
A third issue raised by researchers deals with the methodological approaches used to
measure entrepreneurial activity. Scholars have expressed concerns regarding the
undercounting of new firm entries and exits in the market, and the effect of this
undercounting on the assessment of the impact of entrepreneurial activity (Bates 2005;
Birley, 1984; Davidsson 2004; Dennis 1997, 1999; Williams 1993). Moreover, many of the
databases used by entrepreneurship scholars have been designed for purposes other than
the study of entrepreneurship, making them a less than suitable tool for gauging the
phenomenon of entrepreneurship from an academic point of view.
Applied to cross-country comparisons, the measurement issues associated with
entrepreneurship become even more problematic and the researcher is faced with additional
elements to take into account. On the one hand, the absence of universally agreed upon
indicators makes it particularly difficult to provide meaningful and reliable comparisons of the
level entrepreneurship across nations (OECD 1998). Verheul et al. (2002) assert that country
levels of venture creation can indeed be determined by a wide spectrum of factors, the
importance of which varies according to “the disciplinary approach, the level of analysis, the
discrimination between demand and supply factors and a distinction between influences on
the actual and equilibrium rate of entrepreneurship” (Verheul et al. 2002: p.7).
On the other hand, levels of entrepreneurial activity in a country can be affected by
contextual issues such as the existence of a supportive or hostile macro or microenvironment
for venture creation. This argument is consistent with Gartner and Shane’s (1995) claim that
measures of entrepreneurial rates need to reflect both a longer time frame and some kind of
measure of the effect of the environment.
Measuring Entrepreneurial Activity in the GEM Project
The GEM project constitutes a very important research tool that can allow entrepreneurship
scholars to address the issues related to the measurement of entrepreneurial activity across
countries. However, operationalizing and implementing the measures used in this project is
not ideal and, like any other measure, can be improved. Moreover, the GEM provides a very
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rich database that has not been fully exploited and we believe that our study can help to
present this data in a way that is more respectful of the complex entrepreneurial realities.
One of the better known outcomes of the GEM project is an estimate of a nation’s
entrepreneurial activity, the Total Entrepreneurship Activity (TEA) index. The GEM study is
designed to overcome a number of concerns raised in prior research about the measurement
of entrepreneurship. Heeding the advice of Gartner and Shane (1995), it is a yearly ongoing
measure designed to capture entrepreneurial activity and its effects over time. Trying to meet
the challenge of obtaining a representative sample of on going, independent start-up
processes and, therefore, addressing the concerns of Dennis (1997), Williams (1993) and
Birley (1984), the GEM project is also based on a very large random sample of adult
individuals. These individuals are presented with three focal screening questions aimed at
identifying those in the process of creating a venture:
• q1: whether the individual is currently involved in a startup (indication of being
nascent entrepreneur)
• q2: whether their current job involves a start-up (nascent intrapreneur)
• q3: whether the individual is the owner/manager of a new business (owner-manager)
Individuals who identify themselves as a nascent entrepreneur/ nascent intrapreneur/ or, an
owner-manager of a new firm, are directed to a longer interview where they are asked
specific questions about themselves and their firms. Therefore, the resulting TEA index has
the advantage of addressing the issue of levels of analysis raised by Gartner and Shane
(1995), because it allows for the capture of individual self-employment as well as new firm
creation.
Despite its utility, the GEM project is still striving to reach full scholarly recognition with
respect to its TEA index being a reliable tool for measuring entrepreneurship across
countries (Hindle, 2005). We believe that one possible way to diminishing researchers´
reticence to make the most of the GEM data is by enhancing the measure of
entrepreneurship levels for each country
15
. Therefore, a significant contribution of this paper
is a re-examination of the way entrepreneurial activity is measured using the existing GEM
data.
Theoretical Background
In this study we propose an alternative model-based approach to measuring and comparing
entrepreneurial activity within and across countries, an approach that introduces two main
modifications to the traditional ones used in measuring the extent of entrepreneurial activity
in a country.
15
While we acknowledge that the GEM Project would benefit from a substantial rework of the questionnaire
currently used, changes in the questionnaire affect the ability for continuous and longitudinal analysis. The
improvements proposed in this paper relate to the approach taken in measuring entrepreneurial activity, not to
the questionnaire itself.
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First, rather than viewing entrepreneurial activity as either/or proposition, that is, individuals
either are or not entrepreneurs, we introduce the notion of a likelihood for entrepreneurial
behaviour. In doing so, our model measures this likelihood and creates an index that is a
continuous variable that allows individuals to vary in their propensity to undertake
entrepreneurial activities.
Secondly, and drawing upon social network theory, we base our model on the assumption
that entrepreneurial activity is affected by the social context in which that activity occurs, so
that a measure of the entrepreneur’s personal network, in combination with a measure of its
propensity to undertake an entrepreneurial activity, provides a richer measure of the impact
and strength of entrepreneurial behaviour in specific countries. Whereas the measurement of
direct entrepreneurial activity is important, we believe that it is incomplete without an
examination of the entrepreneurial social environment and its impact on the likelihood of
venture creation.
Measuring a Country’s Entrepreneurial Propensity
Following Gartner’s (1989) view that “who is an entrepreneur?” is the wrong question, we
similarly argue that “how many entrepreneurs there are in a country?” or “which country has
the highest rate of entrepreneurs?” is an incomplete enquiry (Hindle, 2005) and should be
replaced with an assessment of a country’s relative propensity for entrepreneurship.
Assuming that entrepreneurs “are not a well defined population but a hazy and moving
target” (Davidsson, 2004, p. 70), we believe that researchers should be cautious when
comparing the level of nascent entrepreneurial activity across countries and should qualify
the TEA index with a measure that captures a country’s actual and future entrepreneurial
potential.
The TEA national index is computed as the proportion of respondents classified as nascent
entrepreneurs in a representative national sample. Each individual in the sample is classified
as either an entrepreneur or non-entrepreneur based on his or her responses to the
questions q1 to q3 in the GEM survey. We argue that the use of this classification overlooks
an essential dimension of the entrepreneurship phenomenon, that is, individuals can show a
varying propensity or degree of entrepreneurship.
The concept of “degrees of entrepreneurship” was first introduced by Cooper and
Dunkelberg (1986) to illustrate how the different ways of becoming a business owner
exhibited different levels of entrepreneurial intensity. Several scholars took over this notion to
explore individual-level (Tay 1998), as well as organizational-level variations (Schafer 1990)
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in entrepreneurial inclination
16
. More recently, Davidsson (2004) built on this idea and
stressed the importance of studying “Why, when and how do individuals, organizations,
regions, industries, culture, nations (or other units of analysis) differ in their propensity for the
discovery and exploitation of new venture ideas” (Davidsson 2004, p. 29). Following this
reasoning, we present an improvement in the TEA measure based on the proposition that
entrepreneurial behaviour should be measured on a continuum. Specifically, we claim that
rather than treating entrepreneurship as a dichotomous variable, it seems more legitimate to
consider that some economic actors show a greater propensity
17
for entrepreneurship than
others.
H
1a
: Individuals’ propensity for entrepreneurial activity is a latent continuous
variable with multiple possible indicators.
H
1b
: Particular instances of entrepreneurial activity (such as being involved in a
start up) are linked to individuals’ propensity for entrepreneurial activity via a
threshold relationship.
The Role of the Entrepreneur’s Social Network
Research in sociology suggests that positions in a social structure influence the attitudes,
behaviours and outcomes of the actors occupying those positions (Granovetter, 1985). This
social influence has become an emerging subject of research in the field of entrepreneurship
(Dodd, 1997; Stuart and Sorenson, 2004) with the development of two main streams: inter-
organisational networks and the entrepreneur’s personal network
18
. Our study draws on this
second theoretical construct and studies its impact on the incidence of venture creation.
Bearing in mind researchers have adopted a variety of definitions of a personal network,
each one differing in scope, we adopt Gilmore and Carson’s (1999) definition of a network
as: “A collection of individuals who may or may not be known to each other and who, in some
way contribute something to the entrepreneur, either passively, reactively or proactively
whether specifically elicited or not” (Gilmore and Carson 1999, p. 31).
16
It is important to note that the notion of propensity to entrepreneurship used in this paper is different from the
similar concept used by some scholars which adopts a trait’s approach to defining entrepreneurs and the odds
of a person to become an entrepreneur. This is the case, for example, of the “entrepreneurial attitude
orientation” construct, which is positioned in the field of sociology (Robinson et al., 1991), and which used to
measure the entrepreneurial attitude along three dimensions: behaviour, belief and emotion. It is, however,
interesting to note that Kollmann et al. (2005) consider all these three factors to be connected to the individual’s
attitude towards a particular environmental stimulus. Our study establishes the same kind of connection.
17
Although we acknowledge that the idea of entrepreneurial propensity should not be limited to quantitative
differences, in this article we will concentrate on this dimension since the GEM explores the qualitative
dimension quite effectively. The project uses the distinction between “opportunity-based” and “necessity-based”
entrepreneurship to illustrate how nations may have similar start-up rates that represent very different levels of
real and profitable entrepreneurial opportunities (see Acs et al. 2005; Davidsson 2004; Reynolds et al. 2004).
18
See O’Donnell, Gilmore and Cummins (2001) for a thorough literature review on the different perspectives and
research streams encompassing network analyses in entrepreneurship.
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The most prevalent tenet in personal network-based entrepreneurship studies is that persons
involved in pro-entrepreneurship networks are more likely to engage in entrepreneurship.
This argument emanates from Aldrich and Zimmer’s (1986) pioneering investigation
highlighting the need to examine entrepreneurial processes in their environmental context.
Indeed, if we think of ideas, knowledge, and capital as the main components entrepreneurs
must assemble in firm creation, social relations provide the connections required to unite
these ingredients. Social relations shape information flows allowing for the identification of
promising opportunities, and trace the ties through which capital flows, helping entrepreneurs
to overcome obstacles to resource mobilization.
Although there have been few attempts to link micro social structures empirically to the
incidence of entrepreneurial activity, sociology scholars repeatedly insist that personal links
have a direct impact on an individual’s decision to launch a new venture. For example, Stuart
and Sorenson (2004) reported a previous research finding demonstrating that “individual
academic scientists’ propensities to transition to entrepreneurial activity in the early academic
life sciences depended to a large degree on the extent to which their networks and work
settings included pro-entrepreneurship scientists. […] In any situation in which
entrepreneurial activity either violates norms or rarely occurs, one might expect that network-
based social influence processes will underlie the diffusion of new venture formation in a
population.” (Stuart and Sorenson 2004: p.223). These findings reinforce Aldrich and
Zimmer’s argument (1986) that traditional approaches to research on international
entrepreneurship have neglected the relational nature of the entrepreneurial process,
overemphasizing deterministic models based on national culture.
The personal social network construct is particularly useful in studying countries’
entrepreneurial propensity as an aggregate of the individuals’ odds of engaging in
entrepreneurship. In line with O’Donnell et al.’s (2001) argument, we believe that this
approach provides several advantages over others in explaining the creation of new firms.
These advantages include: a) the integration of the environmental context, b) its dynamic
perspective and, c) its ability to explain why some individuals start firms while others do not
(Aldrich and Zimmer, 1986; Johannisson, 1987). Based on GEM data, our study introduces
three types of variables that reflect the extent of an individual’s inclusion in an
entrepreneurial social network:
Knowing an Entrepreneur is one of the most obvious drivers of an individual’s familiarity with
and inclination towards an entrepreneurial career. As stated above, entrepreneurs need to
establish connections in order to identify an opportunities and assemble the resources
needed to begin operations. At some point before or during this process, entrepreneurs
might be influences by relations with socializing agents who motivate and help them to start
their ventures.
Business angel activity is not only a direct manifestation of entrepreneurial endeavours; it is
also proof of a person’s privileged position in an entrepreneurial network. As Stuart and
Sorenson (2004, p. 213) stated: “One reason why social networks shape the entrepreneurial
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process so importantly is that they provide the conduits through which private information
flows. To the extent that individuals occupy heterogeneous positions in networks, they vary in
their access to this information. And to the degree that the recognition of entrepreneurial
opportunities hinges on access to private information, differences in network positions can
thus explain much of the inter-individual variance in access to the knowledge required to
discern attractive opportunities for new ventures”.
In this sense, when individuals contribute to entrepreneurial activity as investors, they
become part of the entrepreneurial network involved in the venture creation process. Their
integration in this particular circle process provides them with continuous feedback and
information that is likely to stimulate even more interest in and knowledge about the
entrepreneurial process.
The perception of good opportunities in one’s region
19
: The geography of entrepreneurial
activity is considered by several scholars as a significant implication flowing from the
influence of social network structure on opportunity identification and resource mobilization,
giving birth to the popular “industrial district thesis”. This perspective can be typified by the
idea that: “Because entrepreneurs utilize the contacts in their social networks to found firms,
because individuals’ contact networks concentrate in the region in which they work and live,
and because established firms produce many of the resources consumed in new venture
creation (tacit knowledge and skilled labour), new firms in an industry tend to arise in the
same locations as existing ones” (Stuart and Sorenson, 2004, p.221). Our research builds on
this idea and connects it with the above mentioned argument that a person’s likelihood of
engaging in entrepreneurship depends on his privileged position within an entrepreneurial
network. Indeed, there are reasonable arguments to assume that the identification of a good
opportunity in ones region reflects, to some extent, the opportunities and constraints that
arise from the relations that embed a focal individual in a social circle. The more individuals
are embedded in social circles that are favourably disposed towards to entrepreneurship, the
more good opportunities they will see.
The Relationship between Entrepreneurial Propensity and Social Networks
The evidence and arguments from previous research point to the fact that research
concentrating only on measuring firm entries understates the extent of entrepreneurial
activity and its impact on society. Krueger and Brazeal (1994) argue that “Few research
studies have conceptualized or measured entrepreneurial potential, though interest in pre-
emergence entrepreneurial activity has recently grown […]. However, measures of
entrepreneurial potential seem to remain wedded to various ad hoc profiles of personality
19
It should be noted here that the perceived opportunity is also used in some models as a measure of an
individual’s propensity to entrepreneurship. For example, Parnell, Crandall and Carden, (1995) included “one's
beliefs concerning entrepreneurial opportunities in the economy (i.e., financial rewards, employment, etc.)” as
one of the perceptual factors that measure entrepreneurial propensity, that is, one's proclivity for choosing an
entrepreneurial career. However, these models focus on the individuals’ perceptions to explain behaviour, while
our approach stresses the inclusion of the external environment condition, in particular the one immediately
related to the individual, as a trigger for entrepreneurial behaviour.
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and demographic characteristics with minimal predictive validity…” (Krueger and Brazeal
1994, p. 92). Recognizing that entrepreneurial activity does not occur in a vacuum, the
authors discussed the importance of developing an “entrepreneurial potential” so that
potential entrepreneurs can find suitable conditions to develop their ideas. Implicit in their
notion of “entrepreneurial potential” is the idea that
“The group, organization, or community possesses some potential for entrepreneurial
activity. The environment need not be already rich in entrepreneurs, but has the
potential for increasing entrepreneurial activity […]. Regardless of the existing level of
entrepreneurial activity, such “seedbeds” establish fertile ground for potential
entrepreneurs when and where they perceive a personally viable opportunity. That is,
“entrepreneurial potential” requires “potential entrepreneurs” (Krueger and Brazeal,
1994, p. 92).
Some traditional approaches to entrepreneurship have posited the existence of differing
“propensities to entrepreneurship” according to national or cultural origins. Although it is
widely recognized that culture and social norms have an indirect effect on entrepreneurial
career choices (Hofstede, 1980; Davidson, 1995; Verheul et al. 2001; Wennekers et al.
2001), there is a feeling among some researchers that these socio-cultural models of
entrepreneurship are overly deterministic. Aldrich and Zimmer (1986) state that “The major
problem with this approach is that groups alleged to possess a propensity to
entrepreneurship display their predisposition only under limited, country-specific and
historically-specific conditions. Research findings strongly suggest that we should attribute
the flowering of a group’s predisposition to situational, rather than deterministic, conditions”
(Aldrich and Zimmer 1986, p. 7-8).
In this study we build on previous literature and argue the existence of environmental
influence that affects an individual’s entrepreneurial propensity. But rather than drawing on
over deterministic models, we turn our attention to the situational conditions under which
entrepreneurs undertake venture creation. Specifically, we contend that the social
entrepreneurial environment affects the level of entrepreneurial activity and the addition of a
model of social network to entrepreneurial activity provides a robust description of the
entrepreneurship process. Thus:
H
2
: Entrepreneurial activity will be positively affected by the social entrepreneurial
environment.
Methods and Analysis
For this study we used a sample of 7,000 Spanish respondents to the 2003 GEM survey.
The sample was obtained through interviews by a survey firm specialized in phone surveys.
While the current TEA index is built around direct measures of an individual’s entrepreneurial
activity (independent start-up, current job involves start-up, current owner/manager of
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business), it does not include other indirect or environmental indicators of activity that also
have a real impact on an individual’s entrepreneurial activity. Nevertheless, GEM’s datasets
do provide several types of environmental indicators: macro-level measures of a country’s
environment for entrepreneurship, expert’s assessment of their country’s entrepreneurial
environment and adult individuals’ assessment of their perceived proximate environment.
This third set of variables is of special interest for this paper since it offers the possibility of
using responses from a sample of entrepreneurs and non-entrepreneurs; two groups that
show significant differences in their perceptions of the entrepreneurial environment.
Moreover, consistent with Dennis (1997) and Aldrich et al. (1990), within the analysis of the
environment we concentrate on the examination of environment familiarity and intra-
population processes, since these variables relate to the proximate entrepreneurial
environment of individuals, that is, the elements of the environment that are close to a
person, and that may foster her/his propensity to launch a business. This proximate
environment is, in our opinion, more likely to influence an individual’s behaviour.
Our model is based on the assumption that an individual’s entrepreneurial activity and
proximate environment are latent continuous variables that are related to the observed
survey questions through a threshold relationship. We provide an assessment of the
goodness of fit of our proposed model, and we propose linear combinations of the GEM
indicators that can be used as valid proxies of the latent variables in our model.
Consistent with GEM’s specification of TEA, we used three indicators of direct
entrepreneurial activity (q1, q2 and q3) and included 3 indicators from the GEM survey of the
Social Entrepreneurial Environment:
q4: business angel activity,
q5: know an entrepreneur, and
q6: good start-up opportunities in your area within the next 6 months.
An important assumption of this research is that the variables q1-q3 and q4-q6 are proxies
for two unobservable (continuous) constructs, Entrepreneurial Activity, and Social
Entrepreneurial Environment, respectively. Table 1 provides the frequencies for the GEM
variables used in this study. Five individuals refused to respond to one or more of these
variables and were deleted from further analysis. Thus, the effective sample size is 6995
observations.
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Table 1: Frequencies of Selected Variables
Code Variable No Don’t know Yes Total
q1 Independent startup? 6708 0 297 7005
q2 Current job involves a start-up? 6877 4 114 6995
q3 Owner/manager of a business? 6333 1 661 6995
q4 Business angel in past 3 years? 6766 0 229 6995
q5 Know entrepreneur in last 2 years? 4769 144 2082 6995
q6 Start-up opportunities within next 6 months? 3097 1580 2318 6995
We hypothesize that a two-factor model underlies an individual’s response to our survey
questions as depicted in Figure 1. The first latent variable (factor) corresponds to the
individual’s propensity to engage in entrepreneurial activity (EP). This factor has four
indicators (q1 to q4)
20
. The second latent variable corresponds to the individual’s social
entrepreneurial environment (SEE) with three indicators (q4, q5, q6). We also hypothesize
that individuals’ entrepreneurial propensities are determined by their social entrepreneurial
environment, which is unique for each individual (that is, it changes from individual to
individual).
Consistent with this view, we present a model of entrepreneurial propensity and social
entrepreneurial environment and argue there is a relationship between these two dimensions
–both determined on the basis of a number of proxy variables-. Figure 1 presents our model.
Since the model’s random errors and latent variables are likely to be induced by a large set
of specific causes, we assume that the random errors and latent variables are normally
distributed. Now, to link this theoretical model to the observed individual responses, we
assume a threshold relationship such that for each observed variable
*
,1
*
,1 ,2
*
,2
No if
Don't know if
Yes if
i i
i i i i
i i
q
q q
q
?
? ?
?
? <
?
= ? ?
?
?
>
?
(1)
where the ?’s are thresholds that change from variable to variable, and the
*
1i
q ’s are
propensity scores assumed to underlie each of the observed categorical responses.
20
It is interesting to note that from our point of view being a business angel is also a form of EA, although it
is not taken into account in the TEA index. We include angel investing in our EA measure and believe GEM
should reconsider and recalibrate the TEA measure, even if that entails reanalyzing the data from previous
years so that year-to-year comparisons are adequate and valid.
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Figure 1: A Two Dimensional Model of Entrepreneurship
Note: * parameter fixed for identification purposes
known entre-
preneur last 2
years?
individual's social
entrep.
environment
business
angel?
start-up opport. in
you area?
1* b
4
b
5
b
6
u
4
u
5
u
6
independent
start-up?
individual’s
entrep.
propensity
Business owner
/manager?
job involves
start-up?
1* b
1
b
2
b
3
u
1
u
2
u
3
b
7
b
8
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Note that we assume that ‘Don’t know’ responses provide information about the individuals’
entrepreneurial propensities and social environment
21
. Furthermore, the incorporation of
‘Don’t know’ responses into the model leads to a substantial reduction in missing patterns.
Had we discarded ‘Don’t know’ responses, the effective sample size would be 5313 (a 24%
data loss).
We fitted this structural equation model using Mplus (Muthén and Muthén 2001). The model
fits well given the large sample size employed: ?
2
= 15.1 on 7 df (p = 0.03), RMSEA = 0.01.
Table 2 provides the slope parameter estimates for the model in Figure 1 along with their
standard errors. Also, Table 3 provides the R
2
for each of the six variables used.
As can be seen from these tables, the variable worst accounted for by the model is whether
there will be good start-up opportunities within the next 6 months (R
2
= 6%). On the other
hand, the variable best accounted for by the model is whether the current job involves a start
up (R
2
= 90%). The latter is the best indicator of the individuals’ propensity to engage in
entrepreneurial activities (see Table 2). On the other hand, the best indicator of the
individuals’ business environment is whether they have known an entrepreneur in the last
two years. Finally, as we had hypothesized being a business angel is a weak (although
significant) proxy of an individual’s propensity to be involved in entrepreneurial activities.
Table 2: Parameter Estimates and Standard Errors for the Slope Parameters
Parameter b1 b2 b3 b4 b5 b6 b7 b8
Value 0.51 0.86 0.45 0.65 0.24 0.30 0.18 0.47
SE 0.04 0.06 0.04 0.08 0.03 0.08 0.07 0.09
Table 3: Proportion of Variance Accounted For
Code variable R
2
q1 Independent startup? 0.32
q2 Current job involves a start-up? 0.90
q3 Owner/manager of a business? 0.25
q4 Business angel in past 3 years? 0.18
q5 Know entrepreneur in last 2 years? 0.42
q6 Start-up opportunities within next 6 months? 0.06
21
Our model is based on the assumption that data in GEM is not missing randomly. Davidsson (2004) expressed
concerns about the problem of the GEM relying on “the respondent’s subjective interpretation of what should
and should not be counted as `now trying to start a business´”. He also claimed that the problem could vary
according to cultural differences, noting the example of Germany and Ireland, where a considerable proportion
of “no” and “don’t know” answers might occur when the respondent would have liked to say “yes”. Following the
idea of “degrees of entrepreneurship” stated before, we assume that the pattern observed by missing data is
the following: when the respondent answers “Don’t know”, he is in fact choosing an intermediate answer
between the “yes” and the “no”.
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Of particular interest is the effect of an individual’s propensity to engage in entrepreneurial
activities on their social entrepreneurship environment. This effect is significant and strong,
R
2
=18%.
In closing, we have verified that our model for GEM’s measure of entrepreneurship is
supported by the data. This model assumes two continuous latent variables as opposed to
the TEA’s current binary classification of respondents as either entrepreneurs or non-
entrepreneurs. Our model enables researchers to draw powerful statistical inferences
regarding the entrepreneurship phenomenon. In our model, the main quantities of interest
are the means for the latent variables concerning an individual’s propensity to engage in
entrepreneurial activities and an individual’s entrepreneurial environment. Interest lies in
investigating how these means change over time within a country and across countries.
Furthermore, the model allows for the comparison of thresholds and latent variable slopes
over time within a country, and for comparisons across different countries. Finally, and most
interestingly, by incorporating additional exogenous variables into our model, such as an
individual’s background, country economic variables, and a country’s cultural environment, it
is possible to investigate the effects of these background variables on the model’s latent
means, thresholds, and latent variable slopes, in a manner similar to multivariate probit
analysis (see Muthén 1979; Browne, and Arminger 1995; Tay 1998). However, although
statistically optimal, the approach advocated here requires considerable statistical expertise.
Therefore, we consider in the next section constructing linear combinations of the indicators
that can be used as an approximation for our model’s latent variables.
Proxies for the Latent Variables
Point estimates and standard errors for each individual’s standing on the two latent variables
in our model of the level of entrepreneurship can be obtained by integrating the posterior
distribution of the latent variables, given their responses to the six indicators considered in
this study. We investigate in this section whether suitable proxies for these estimates can be
alternatively obtained by the following procedure. We code the responses to the indicators q1
to q6 as ‘No’ = 0, ‘Don’t know’ = 1, and ‘Yes = 2’. Then we compute
EP = (q1 + q2 + q3 + q4)/8 (2)
SEE = (q4 + q5 + q6)/6 (3)
Here, EP and SEE are normalized indices (that is, they range between 0 and 1) of an
individual’s propensity to engage in entrepreneurial activities and of an individual’s
entrepreneurial environment, respectively. To investigate the convergent and discriminant
validity of these proxies, we calculated the correlations between these proxies and the point
estimates of the latent variables. These are shown in Table 4.
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Table 4: Correlations among the TEA, Point Estimates of the Latent Variables, and
Latent Variables Proxies
TEA EP SEE
Entrepreneurial Activity .73 .89 .47
Social Entrepreneurial Environment .29 .41 .90
TEA 1 .70 .10
EP .70 1 .22
SEE .10 .22 1
Notes: All correlations are significant (? = .01); entrepreneurship activity and environment are the point estimates
of the latent variables, EP and SEE are our proxies of those latent variables
As can be seen in the Table, our proposed proxies correlate .90 with the point estimates of
our model’s latent variables. Hence, they show high convergent validity and can be used as
valid proxies for the latent variables. However, note that the use of proxies underestimates
the correlation between entrepreneurial activity and entrepreneurial environment because it
does not take into account the unreliability of the proxies. The correlation between the
proxies is only 0.22 (see Table 4) whereas the correlation between the latent variables is
0.47 (see b8 in Table 2).
Most interestingly, the TEA index correlates 0.70 with the proxy of entrepreneurial activity but
only 0.10 with the proxy of social entrepreneurial environment. Thus, although based on
rather different principles, our measure of economic activity correlates quite highly with the
TEA index.
Discussion and conclusions
The measurement of entrepreneurial activity in different countries is an important concern
both for researchers interested in entrepreneurship and for public policy concerns (Birley
1984; Dennis 1997; Haswell, and Holmes 1989; Laitinen 1992; Williams 1993). In this paper
we have re-examined the approach at measuring entrepreneurial activity, introducing the
notion of likelihood of entrepreneurial activity. This implies a significant change in the way
entrepreneurship is viewed from one in which a person is or not an entrepreneur to the
notion of levels of entrepreneurship in individuals. Moreover, we include and measure the
effects of entrepreneurial environment on entrepreneurial activity. We believe these are
significant contributions to the examination and measurement of entrepreneurial activity.
One important addition in our measure is that it provides a model-based approach to
measuring entrepreneurial activity; one that incorporates an individual’s social
entrepreneurial environment in the measure. Network-based arguments clearly have
significant potential to enhance our understanding of an individual’s propensity to engage in
entrepreneurship. In this sense, our study addresses the concerns of sociology scholars by
providing an empirical tests and validation of the general assertion that the incidence of
entrepreneurial activity hinges on the structure of an individual’s social network (Stuart and
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Sorenson, 2004). Indeed, consistent with these theoretical arguments, our results indicate
that an individual’s personal context significantly affects his odds of undertaking direct
entrepreneurial activity, and suggest that failing to consider such effect significantly
understates the extent of entrepreneurship in a country.
The metrics in this study are also an improvement over previous approaches because they
are transparent and result in a propensity score for entrepreneurial activity that is normalized
and continuous. This point is a significant departure from prior research in entrepreneurship,
and in particular from the GEM’s TEA measure. The use of a classification, as in the TEA, in
which individuals are determined to be either entrepreneurs or not entrepreneurs reflects a
static approach at the phenomena, whereas the use of propensity, calculated as a variable
ranging from 0 to 1, allows researchers to take a dynamic view of the process and to
incorporate the notion of the likelihood of entrepreneurship over time. This, we believe, is a
significant contribution, and one that merits rethinking the traditional approaches to
examining entrepreneurial activity.
Important also is the introduction of the notion of thresholds in the context of new venture
creation. On top of the examination of entrepreneurial activity (in terms of propensity), our
model also allows us to examine the thresholds that determine when people start firms. This
is a very important point for both research and public policy. From the perspective of
research it gets us closer to determining the points that determine the likelihood of new
venture creation. Our future examinations in this area will focus in better determining the
characteristics of those thresholds.
The research also allows for an analysis of the percentage of the variance accounted for by
each element in the model. Our model has a 90% prediction rate for entrepreneurial activity
based on whether the current job of the person involves a start up, and a 32%, 25% and,
18% prediction rate based on whether it involves an independent start up, an owner manager
of a business or being a business angel, respectively. Consistent with previous evidence, the
strongest predictor of entrepreneurial activity is whether the current job of the individual
involves a start up.
As long as we adhere to a dynamic perspective of the entrepreneurship phenomenon and
view individuals as having a certain propensity to be entrepreneurs, then we can more
effectively make inferences about a country’s comparative strength in entrepreneurship. This
approach may not completely resolve the question of how to ideally compare one country’s
entrepreneurial activity with another, but it takes a step closer to measuring this difference in
a more consistent manner. Moreover, we believe that this approach challenges us to develop
research questions, methodologies and techniques that will do justice to the complexity of
entrepreneurship (Gartner, 1985 and 1988). Indeed, we argue that entrepreneurial activity is
not a clear-cut reality that can be roughly put down in numbers; rather, entrepreneurship is a
potential that people have in certain degrees and that, combined with specific circumstances,
can give birth to actual venture creation.
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One caveat is important to discuss at this point. It is important to realize that both the TEA
and our measures of EP and ESE are simply indices. They do not represent the% of actual
and potential entrepreneurs. While it is tempting to think about the TEA as percentage of
entrepreneurs, and there is evidence that it is sometimes misused as such, the value of
these indices lies in the ability to compare across time, and countries and regions rather than
providing absolute values of entrepreneurial activity.
Finally, we recognize that the measurement of entrepreneurial activity will always be a
contentious matter and it is not our intention to reopen up the debate on a definition of
entrepreneurship. Nevertheless, we consider that proposing an alternative and consistent
measure for international comparison of entrepreneurship could significantly contribute to the
advancement of academic knowledge as well as provide policy-makers with useful inputs for
designing programmes to enhance the economic welfare of their countries in the context of
global competition.
E-mail of corresponding author: Rachida Justo, [email protected]
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Strategic Change Processes in SMEs – The longitudinal Analysis of
Three Finnish Furniture Firms
Karita Luokkanen (a), Rodrigo Rabetino (b, c)
(a) Department of Marketing, University of Vaasa, Finland
(b) Departamento de Economía de la Empresa, Universidad Autónoma de Barcelona,
Spain
(c) Instituto de Industria, Universidad Nacional de General Sarmiento, Argentina
Abstract
This study focuses on SMEs’ strategic changes in dynamic environments. In order to deeper
understand these changes, the specific characteristics of SMEs’ strategic behaviour, and the
interaction of internal and external factors are included simultaneously in the analysis. The
conceptual framework is based on studies of strategic adaptation and SMEs’ strategic
behaviour. The empirical research consists of three longitudinal case studies in the Finnish
furniture industry, for which processes are analysed. The data analysis reveals that strategic
changes are the result of multiple, overlapping processes. In short term, firms’ responses to
environmental stimuli often look like reactive tactics. However, in a longer time orientation,
owner-managers were able to identify and implement new ideas and projects in their
business environment. Additionally, owner-managers’ ways to make strategic decisions in
turbulent situations seems to be based more on experience and intuition instead of being
calculated and planned.
Key Words: SMEs’ strategic changes, strategic decision-making, Finnish furniture industry
Introduction
Dynamism, uncertainty, and discontinuity are words often used to describe today’s business
environment. Firms continuously face changes and new situations in their environments,
which challenge their traditional ways of acting and, in the names of survival and success,
evoke the necessities for adaptation and change. This is true especially in the context of
small and medium sized firms, which are recognized to be relatively strongly dependent on
their environmental conditions. As Chell et al. (1998) and Cope et al. (2000) suggest the
triggers for changes in SMEs often originate from a critical situation faced by a company,
which might open opportunities for new development.
Scholars have been interested in the phenomena of organizational change and adaptation
already for decades, starting from the earliest studies of contingency theorist in 1950s (Miller
and Friesen, 1980). As a consequence, different school of thoughts have emphasised
different aspects of change
22
. As main streams, population ecology and strategic adaptation
22
For example, Garud and Van de Ven (2002) present four different theories to explain the process of change
(teleological, life cycle, dialectical and evolutionary).
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have dominated the literature about the relationship between organization-environment and
strategy (Tsai, MacMillan and Low, 1991:9). In this context, the relationship between firm and
environment is usually presented as a continuum with its extremes in environmental
determinism and managerial voluntarism (Hrebiniak and Joyce, 1985; Vesalainen, 1995).
The deterministic perspective suggests that the survival of organizations is mainly
determined by environmental selection (Hannan and Freeman, 1977, 1984), and firms
possess different “inertial forces” which constrain their possibilities to adapt when
environmental conditions change (Hannan and Freeman, 1977). Thus, external factors are
essential to explain change; and because managers hardly have options for decision-
making; the role of management is passive.
However more commonly, strategic changes are studies from the voluntaristic perspective,
which assumes that the managers have substantial discretion to decide independently about
the firms’ strategies. The success of the organization is a function of the manager’s abilities
to evaluate the environmental conditions and the internal capabilities of his firm, in order to
formulate and implement effective strategies (Porter, 1980). In other words, even the
environment is a big restriction for the strategy development, it can be manipulated (Child,
1972), and managers are seen as active and often proactive persons. The contingency
approach, in turn, adopts an intermediate perspective, emphasizing the predetermined
nature of environmental contingencies for firms’ strategies, structures, and performance.
Thus, managers choose strategies and preferences consciously as a reflection about what
constitute the best strategy for a certain environment (Shane and Kolvereid, 1995). In this
case, managers are seen mainly in a reactive light.
When adaptation theories (mainly strategic and contingency approaches) are applied to
small firms, most of the studies conclude that a common pattern of change is “reactive
adaptation”, suggesting also that changes at strategic level do not happen frequently, and
often small firms are poorly managed. However, if we consider the heterogeneity of the SME
population, and the owner-manager’s strong personal influence on his/her firm behavior, the
common view of SME change pattern evokes many questions with regard to the simplicity of
the strategic change phenomena in SMEs. Moreover, due to the strong emotional link
between owner-managers and SMEs, generic theories on strategy do not represent correctly
the situation of the small and medium-sized companies (Chan and Foster, 2001). This makes
us wonder if it is really possible to characterize these processes by using the traditional
classification from the strategy literature.
In the light of these shortcomings, we believe that the answer for the previous question is no,
mainly for two reasons. First, basically all theoretical development related to strategic
changes has happened in a large firm context, explaining the transition from one steady state
to another (Nicholls-Nixon et al., 2000). Additionally, the literature is mainly concentrated on
the firm’s competitive positioning, while the interaction between market positioning and the
internal resources of a firm has not been studied deeply in SME context (Bosch, Huse and
Senneseth, 1999:50-51). The orientation of these studies is extremely strategic, and leans on
variables which are suitable for measuring changes in/of large firms. Many of these studies
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are also normative, aiming to give advice on how a change process should be managed.
However, SMEs are not simply smaller large firms. Moreover, strategic planning is not an
activity commonly carried out in SMEs, and their everyday life is more based on routines
predetermined by the nature of the production process, their manufactured products, and
environmental conditions. Thus, if strategic change is analysed by focusing on strategic
planning and implementation variables, we can easily understand the conclusions literature
so far has associated with change in SMEs.
Secondly and at a more general level, most of the studies are cross-sectional. Instead of
explaining the process of change itself, studies mainly had focused on analysing whether
change has happened or not, than “to observe managers facing obstacles and making
decisions that initiate change. The longitudinal observation required for such research is
difficult and costly to do at the organizational level” (Gersick, 1994:11). We argue that the
cross-sectional nature of these studies is somehow limiting our understanding of the
processual nature of change and adaptation. As suggested by Pettigrew, Woodman and
Cameron (2001), the inclusion of time, history, process and action in the analysis would give
us a better understanding of the phenomena of change.
In this context, we suggest that purely strategic approach is not suitable for studying small
firms’ strategic change processes. Instead, the framework which recognizes the special
characteristics of SMEs’ which affect the change processes (strategic behavior), explicitly
takes into account the interaction between internal and external factors, and reveals
dynamism of change processes, could enrich the knowledge of the phenomenon. This study
intends to contribute to the existing knowledge about SMEs’ strategic changes in a dynamic
environment. Due to the scarcity of this kind of studies, we need a much deeper
understanding of the characteristics of strategic changes in SMEs. The purpose of the study
is to answer the following questions:
• Which are the critical incidents triggering strategic changes, and to which extent are
these changes provoked by internal factors within the firm or by the environment?
• Which are the main factors that affect SMEs’ strategic changes, and how do they
interact? In which way do owner-managers’ characteristics affect these changes?
• On which levels and for which functions do changes happen, and how are they inter-
linked? To which extent are strategic changes proactive and reactive?
Two implicit tensions are notable in the analysis. The first tension is the relationship between
the macro-economic conditions and the micro-economic responses. Regarding these
responses, a second tension appears between the managerial discretion to make strategic
decisions vs. environmental determinism.
We aim to answer these questions with a longitudinal case study of three Finnish furniture
manufacturing firms. In the next section, we present the conceptual framework based on
studies of strategic adaptation and strategic entrepreneurship (Hitt, Ireland, Camp and
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Sexton, 2001) This is followed by a methodological discussion in the third section, whereas
the fourth section is dedicated to the case analysis. Finally, we present our main findings and
conclusions in sections five and six.
Conceptual framework
Strategic change and adaptation
In adaptation studies, strategic change is understood as the means by which organisations
can maintain or find the fit between themselves and the environment. Additionally,
organizational change primarily reflects the decisions and strategies of leaders and dominant
coalitions in organisations in response to changes in environmental threats and opportunities
(Singh, House and Tucker 1986). Previous studies are notable in the versatile
characterisation of changes. For example, change is measured in relation to the “radicalism”
of change (first order and second order changes), changes in core and peripheral features,
different change levels, and the nature of change (proactive or reactive) (e.g., Garud and
Van de Ven, 2002; Hannan and Freemann, 1984; Miles and Snow, 1978; Kelly and
Amburgey, 1991). These studies offer a good basis for analysing strategic changes, mainly
by pointing out different levels and functions where firms usually change.
According to Hannan and Freemann (1984), organizational changes can be divided into two
types, which both include strategic elements: core feature changes (i.e. stated goals, forms
of authority, core technology, and marketing strategy) and peripheral feature changes (i.e.
horizontal and market-extension mergers, joint ventures, and interlocking directorates). The
authors concluded that changes are more common in peripheral features, and relatively rare
in core features.
Perhaps more concrete, Vesalainen (1995:68) classifies changes as: (1) core feature
(redefinition of business’s values and believes), (2) strategic (product development or market
development in order to change the organisation/environment relationship), (3) competitive
(using a variety of competitive and functional strategies), and (4) operative adaptation
(resource allocation adjusting the quantity of resources in the internal transformation
process). In his study of small firms, adaptation commonly occurred on operative and
competitive levels.
In general, several classifications of a firm’s adaptive behaviour have been developed
23
.
These typologies highlight the essential features of situation-specific strategies; capture the
major commonalties and provide guidance at the corporate level on how to develop a
business (Herbert and Deresky 1987: 136). In addition, typologies and classifications try to
build a comprehensive picture about the phenomena under investigation, and make
23
This includes Miller and Friesen (1980): nine organisational transition archetypes; Ansoff’s (1975) competitive
and entrepreneurial behaviour; Mintzberg (1973) entrepreneurial, adaptive, and planning; Mintzberg (1978)
intended, realised and emergent strategy; Greenwood and Hinings (1993): archetypes mainly regarding
organisational design.
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generalisations about it. Among well-known typologies of strategic behavior one could
highlight two: Porter’s (1980) distinction between differentiation, focus, and cost leadership
and the typology of Miles and Snow (1978).
Miles and Snow (1978) use the adaptive cycle to present a dynamic process of adaptation.
This adaptive cycle is divided into three major problems resp. change areas: an
entrepreneurial (choice of product-market domain), engineering (choices of technologies for
production and distribution), and administrative problem (uncertainty reduction and
innovation enhancement). In the process of adaptation, the management has to solve these
problems continually (Miles and Snow 1978). Miles and Snow’s ideas are interesting from
our point of view because they include proactive and reactive aspects of adaptation in their
classification. Moreover, they take into account the interactive nature of different (strategic)
change elements. They classify firms into four groups based on their strategic orientations:
(1) prospector (companies looking continually for new opportunities), (2) analyzer
(companies working in stable domains and searching for new opportunities, mainly by
imitating successful offensive answers), (3) defender (companies protecting their market
niche, and not searching for new opportunities), and (4) reactor (passive companies without
long term goals that do not follow a consistent model of behaviour).
In this context, Segev (1989) suggests that Porter’s (1980) differentiation type could be
compared with Miles and Snow’s (1978) prospectors, while cost leadership could be
matched with the defender type. Additionally, analyzers and reactors would be part of a
continuum between these previous extremes (Miles and Snow 1978). In terms of
appropriateness of the strategy, prospectors, defenders and analyzers are the successful
types, while reactors could be classified as “stuck in the middle", and their behaviour labelled
as unsuccessful strategies.
However, the processes of adaptation and change are rarely as simple as single typologies
let us assume. Mintzberg et al. (1998) use the term ‘domino effect’ to illustrate how a firm’s
routines are inter-linked, and a change in one issue is often followed by changes in other
issues (Mintzberg et al., 1998). These changes do not include just internal changes, but also
variations in the relationships with different stakeholders (Venkataraman et al., 1998).
Pettigrew et al. (2001), in turn, have clearly stressed the importance of a processual
approach in change studies. Following their argumentation, history and future are present at
the same moment, which affect a firms’ change capability in the sense of positive and
negative path dependencies. Finally, like adaptation studies suggest, strategic changes are
usually linked to strategic decision making in the context of environmental opportunities and
threats.
SMEs’ strategic behaviour
In a SME context, the strategic change process results from an interaction between internal
and external factors. Although the environmental influence is strong, and strategic decision-
making process is highly influenced by outside parties (Lawrence and Lorsch, 1969;
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Tushman and Romanelli, 1985), the strategic management process is also case-specific and
strategy formulation is a highly contextual activity. Additionally, goals are not consistent
across people and time, and search behaviour is local and cognitively limited (Cyert and
March, 1963) instead of being rational. As Eisenhardt et al. (1992:20-22) have stated: “Goals
are unclear and shift over time. People often search for information and alternatives
haphazardly and opportunistically. Analysis of alternatives may be limited and decisions
often reflect the use of standard operating procedures rather than systematic analysis” …
“Decision makers satisfice instead of optimize, rarely engage in comprehensive search, and
discover their goals in the process of searching”
In this context, an owner-manager’s personal characteristics (i.e., the willingness for risk
taking and need for achievement) and his/her ideas influence strongly to SME goals, and the
processes of strategy formulation and implementation (Covin and Slevin, 1989; McCarthy,
2003). Mintzberg and Waters (1982) argue that the organisation’s size influences the
rationality of strategic decision-making (in SMEs rationality is lower); and many studies found
that high uncertainty, external control, and threatening environments reduced the rationality
of strategic decision-making (Fredrickson, 1984; Miller, 1987; Dean and Sharfman, 1993).
Moreover, it has been recognized that owner-managers act based on the way they interpret
the environment (Bourgeois, 1980). Thus, even when agents face similar stimuli, they make
different decisions, due to the varied perceptions that they have about the reality (Penrose,
1959). In this way, persons are restricted by the way in which they socially build their reality
(Silverman, 1970). As Tsoukas (1994:13) has stated: the organisation and the environment
are “subjectively constructed entities which may change once individuals’ understandings
and interpretations change” (Tsoukas, 1994:13).
Therefore, when facing environmental changes, owner-managers make adaptation decisions
based on heuristic and mental models. Hence, managers rely on simplified and imperfect
representations of the world in order to process information. These mental models affect their
interpretation of strategic issues. Together with heuristics used to make decisions (strongly
linked to key believes and experiences) and with intuition (Eisenhardt et al., 1992; Brouthers
et al., 1998) they influence the decision-making process (Barr; Stimpert and Huff, 1992).
Thus, entrepreneurs can make decisions and exploit opportunities in situations where a
structured decision-making mechanism could be a barrier (Alvarez and Busenitz, 2001).
Within this heuristic perspective, strategic decision-makers are rational and irrational at the
same time (Eisenhardt et al., 1992; Brouthers et al., 1998).
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However, mental models also include many inertial
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elements, and strategic change often is
difficult (Barr; Stimpert and Huff, 1992). As a consequence, changes can involve
experimentation, driven by trial and error logic. This experimentation in turn can reconstruct
the owner-manager’s mental models, and new understanding related to changed
environmental conditions can develop (Nicholls-Nixon; Cooper and Woo, 2000). This process
can involve the unlearning of old beliefs, the building new perception, and the development
of a cause-effect understanding about the new environmental situation as well as the
development of experience and insight to act in a spontaneous and improvised way (Barr;
Stimpert and Huff, 1992; Crossan, 1998; Eisenhardt, 1989; Alvarez and Busenitz, 2001).
Improvisation is the capability to make decisions within a short time and with limited
resources and information (Leybourne, 2003). At the same time, when the company acquires
a larger experience for the improvisation, it also continues to optimise this process to apply it
in future events (Chelariu et al, 2002). However, improvisation requires not only risk-taking
and error-tolerance, but also a deep understanding of customers, competitors and industry,
together with the capacity to use resources.
In short, in the context of SMEs the interpretation of the environment is unique and based on
manager’s learning and experience (Bowman and Ambrosini, 2000). Thus, strategic
development and change are rather a result of a combination of knowledge (mainly learning
from experience) and reaction to critical events (in which owner-managers learn to process
information, adjust strategy and make decisions) than of planned developments (Deakins
and Freel, 1998:146; McCarthy, 2003). As a consequence, owner-manager rarely formalise
their strategic vision (Covin and Slevin, 1989), and strategies can be characterized as being
empirical and intuitive with only little formalisation (Eisenhardt et al., 1992; Brouthers et al.,
1998). Further, the processes of strategy-generation are fragmented, evolutionary and
intuitive, and strategies emerge out of a series of conscious decisions, together with and
interacted in a turbulent environment. Moreover, sometimes a flexible and experimental way
of acting is considered as convenient (Mintzberg, 1978). Finally, it can be stated that the
implementation of the strategy rarely has an impact on the structure of a small firm (Lobontiu,
2002).
Based on the previous theoretical discussion, we want to shortly emphasize three aspects
which most importantly guide our empirical analysis. First, following adaptation studies
suggestions, we will analyse changes through their main adaptive elements (customer
relationships and markets; technology investments; product and product development; and
strategic decisions) and levels (strategic, competitive, and operative). Secondly, we will direct
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Inertia, originating from path dependency, is seen as a factor that complicates adaptation. Inertia may appear in
many forms, e.g. top management’s cognitive models, resistance to make changes in strategy and routines,
investments, production and product decision, and relationships to different stakeholders (Huff, Huff
andThomas, 1992). With regard to SMEs’ inertia and their capability for change, one can conclude that in
general and compared to large firms, small firms are considered to be more flexible due to the flat organization
structure (or the lack of formal structure), fast decision-making and an ability to react quickly. On the other
hand, scarce resources (i.e. lack of financing options and skilled employees in different expertise areas) are
hindering possibilities for change.
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our attention to some essential aspects of owner-manager personality (levels of rationality,
risk aversion, and proactiveness), their decision-making style (planned vs. emergent) and
their strategic orientation (Miles and Snow types), which might influence the strategic change
processes within the small firm. Thirdly, we will analyse strategic changes by taking into
account the interaction between internal and external factors in the long run.
Methodology
We draw on results from a longitudinal, multiple case study. Longitudinal cases are suitable
for analysing processes in their natural settings in a comprehensive way. This methodology
also allows for high sensibility in data analyses because the number of variables is not
limited in advance. This is a particular important issue in process studies, where it can be
expected that non-linear and even unexpected relationships between variables exist.
Moreover, multiple cases allow us to analyse strategic change processes at the level of
(each) individual firm, and later on to make inter-case comparisons (Yin, 1994; Denzin and
Lincoln, 1994).
Our analysis follows the main ideas of a processual analysis (Pettigrew, 1997). The driving
assumption is that a social reality is a dynamic process, and it occurs rather than merely
exists. A process can be defined as a sequence of events that describes how things change
over time, where the context, agents and actions, and time and history are embedded in a
process (Pettigrew, 1997). The analysis is guided by five internally consistent assumptions:
1) embeddedness: studying processes across a number of levels of analysis (inter-related
levels of macro, sectoral, organisational and individual factors are analysed); 2) temporal
interconnectedness: studying processes in past, present and future (path dependence, and
owner-managers’ interpretation are shaping the processes); 3) a role in the explanation for
context and action (context and action are intertwined); 4) a search for holistic rather than a
linear explanation of processes (the focus is to find many inter-linking conditions which link
feature of context and process to certain outcomes); 5) a need to link the process analysis to
the location and explanation of outcomes (providing a focal point for the whole investigation,
and allowing to compare cases against and with each others).
We chose the Finnish furniture industry as a target sector for empirical analysis, mainly for
three reasons. First, during the past 15 years, the furniture industry has faced many
changes: economic boom and recession on the macro-level, increasing international
competition and strengthened position of retailer chains on industry level, and changing
consumer preferences in the end market. Secondly, the industry is highly SME-dominated
and can be characterised as a mature and production-oriented manufacturing industry with
traditional business models. Third, we have access to longitudinal data of furniture
manufacturers which allow for our long-term orientated and processual research.
The case selection was based on the longitudinal, qualitative interview data of 60 Finnish
furniture manufacturers. This data was collected, using the same format, in 1986, 1990,
1993, 1995, and 2000 within the Furniture Project in the Department of Marketing of the
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University of Vaasa. The thematic phone interviews were based on structured interview
guidelines and consisted of mainly open ended questions, focusing on customer
relationships and markets domains; products and product development; technology and
investments; co-operation with other furniture producers; strategy; and the competitive
situation. Related to each theme, the possible changes and reasons for changes (“why
questions”) were discussed. Additionally, accounting information from 1986-2000 is
available.
From that data, we selected three case firms for a deeper, process-oriented analysis. The
case selection was based on the following criteria: First, all firms had to have survived the
whole research period without insolvency or other financial reorganisations. In this way, all
firms have “lived through” the same environmental conditions without support from
authorities. This similarity in basic conditions improves the validity of the inter-firm
comparisons. Secondly, strategic level changes can be identified in all cases, thus reflecting
the phenomena under investigation. Third, each firm’s strategic change processes had to
differ from each other. This criterion was set up in order to present strategically different
kinds of cases, and to analyse inter-firm similarities and differences. Under these conditions,
the first case presents a process in which a mainly domestically operating firm went though a
strategic reorientation from being home furniture producer to becoming a business-to-
business subcontractor. In the second case, the case firm’s internationalization efforts are
characterising the change process. Finally, the third case illustrates a change process
whereby a traditional furniture manufacturer becomes a system subcontractor of an
international furniture giant.
The empirical analysis was partly based on the longitudinal data described earlier. Because
this data include mainly firm level information, we interviewed by phone the owner-managers
of selected firms in order to obtain information on strategic-decision making and strategic
behaviour, and to complete (and validate) the longitudinal data. These interviews included
both qualitative and quantitative elements. First, with the guidance of open ended questions,
we discussed the owner-manager’s strategic decision-making style. Secondly, following the
method of Dean and Sharfman (1993), we tested the rationality of the decision-making of
owner-managers. This was done in order to evaluate the theoretical discussion related to the
rationality of SME decision-making. Third, following the method of Kickul and Gundry (2002),
we studied the owner-managers’ personal tendency to be proactive. This was done in order
to see if the firm level strategic actions reflect the characteristics of owner-managers. In
addition, willingness to take risks was measured. Both, the rationality of decision-making and
proactive personality were measured by using seven-point Likert scale. Finally, we asked
owner-managers to classify their firms within the typology of Miles and Snow (1978). This
was done by reading the descriptions of each strategic type (James and Hatten, 1995;
Brouthers et al., 1998), and owner-managers were asked to comment on each category
based on its suitability to describe their own business. This was done in order to see how
owner-managers see their firm strategy in a long time perspective.
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In this context, the analysis progressed through three main steps:
• First, we wrote descriptive case histories in order to build a general picture of case firms.
In these case descriptions, our aim was to identify the most essential changes, and to
explore the possible interactions between internal and external factors.
• Secondly, we arranged the external and internal events chronologically into charts, and
marked the most important interconnections between environmental influences, the firm’s
responses, and events (the arrows do not represent cause-effect relationships; instead,
they are used to link stimulus and responses that are related in one way or another).
These charts are divided in five levels (general environment, business environment,
external relationships, answers, and internal factors). The general environment illustrates
macro economic conditions, while the business environment includes the issues related
to the furniture industry. Answers address the responses and actions the firm has made
related to environmental changes and internal factors. Internal factors point to the main
strengths and weaknesses of a firm to cope with and in its environment. Finally, external
relationships show the results of the interplay between environmental changes, firm
answers and the reallocation of internal factors (external and internal forces).
Thus, the purpose of the chart is to illustrate how the stimulus and stress of different
environmental levels (general and business environment), firm’s internal capabilities and
resources (technology, products, and human resources), and the interaction between
these internal factors, external relationships and environment are shaping the change
process (answers). The issues presented in the chart are based on the interpretations of
the owner-managers, and on critical events faced by the company.
• Third, with the outcome of the analysis in mind, we analysed the data, concentrating on
the most important changes and processes. Case findings were linked to our broader
theoretical discussion, and the results were discussed in the context of (SME) strategic
behaviour and adaptation.
With regard to the reliability and validity of the study, certain aspects should be emphasized.
(Yin, 1994; Lincoln and Guba, 1985). When considering construct validity, the search for
change patterns is guided by theoretical discussion and concepts. Regarding the information
correctness, even the longitudinal data was not designed for this study, and it was only
partially collected by the authors; the interviews conducted in different years increase data
truthfulness as “current” data from each year. On the other hand, external validity is
commonly tested through generalisation of results. The objective of this study is analytical
generalisation, not scientific generalisation for a population. Lastly, the interpretation of
qualitative data is always subjective. In this study, the data was interpreted and validated
through an in-depth dialogue between both authors, thus reaching a richer interpretation. The
quantitative measures (seven-point Likert scales) we applied to asses the rationality of
decision-making and personality proactiveness were not used statistically, but to asses the
rationality of decision-making and personality proactiveness of these three owner-managers.
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In both cases, Cronbach’s alpha which is higher than .79 indicates the internal reliability of
measured items (cf. Dean and Sharfman, 1993 and Kickul and Gundry, 2002).
Industry description and case analysis
The Finnish furniture industry can be described as a traditional, SME dominated
manufacturing industry. Basically all manufacturers are SMEs, often lead by owner-
managers, and management is highly based on the entrepreneurs´ attitudes and beliefs
about the business and what it should be. During the past 15 years, the Finnish furniture
industry has faced many changes, thus offering an interesting field to study firm behaviour in
a dynamic environment.
The 1980s was a good decade for producers and due to high demand the challenges faced
by the companies were mostly at the productive level. During the 1980s, furniture producers
invested much in production facilities and production processes, whilst active product
development was not their main concern or activity. Even though the competition was hard,
companies enjoyed the freedom to make strategic decisions and choices (Aravuo, 1994).
At the beginning of the 1990s, the Finnish economy fell into a deep recession and the total
sales of the furniture industry crashed. In 1990-1993, the amount of furniture producers
declined by 25%, turnover by 35%, and the number of employees by 38%. In 1994, the total
sale decreased by about 7%, and the overall investment rate was low (Alanko, 1996). Also
competition got new rules during the recession. The pressure for price competition was high,
and many firms had to reduce prices at the expense of their revenues. Also the power of
retailer chains became a major determinant; they reduced their purchases, and many did not
conclude yearly contracts with producers any longer. As a common consequence, production
series were shortened and manufacturing firms had to store products themselves. Many
furniture producers had to lay off people or temporarily close down their business.
Additionally, furniture imports increased, proving to be competitive both in quality and price,
which further increased the difficulties for Finnish producers. Furniture exports increased in
1993-1994, however mainly due to government supported exports projects during the worst
recession.
The Finnish economy started to recover in 1994; however the corresponding developments
in furniture industry took their time. The industry started to grow again slowly and steadily in
the late 1990s. Also exports had increased, and the amount of investments had grown
continuously. However, despite these positive signs of industry development, many
companies still faced enormous problems. Technologically and production oriented
manufacturers still had difficulties in being competitive regarding their prices and design. Also
the co-operation between small furniture producers had been problematic, and many firms
had difficulties to build close relationships with retail chains. Finland became a member of
the European Union in 1995, which also created tension in the industry in the sense of
competition and legislation (Laine-Kangas, 1998).
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Case 1: MF (see figure “Case 1” in Annex)
MF was established in 1987 as a consequence of a spin-off. In its first years, the company
had 95 employees, and it operated in three kinds of businesses: own product development
and production (home furniture), home furniture production as a subcontractor, and public
furniture production as a subcontracted order. About 30% of the turnover consisted of
subcontracting sales, and 70% of own home furniture sales to domestic retailer stores.
Exports accounted for about 20% of the turnover. According to the owner-manager, delivery
times, quality, and price were the competitive strengths that MF possessed.
By the end of the 1980s, hard competition and product imitation constrained MF’s
possibilities to differentiate its products. As short term responses, MF implemented
competitive and operative level changes by increasing its product development (including
better quality raw material), changing the product mix, and technologically catching up in
order to achieve more effective production. In this regard, the business environment pushed
(or alerted) MF to focusing its business activities. However, nothing changed dramatically,
and the operative and competitive level changes were mainly incremental.
In the threshold of recession at the beginning of the 1990s, operating in three different
businesses was difficult for MF, and the owner-manager saw many threatening elements in
the environmental conditions (especially in the home furniture business): a decreasing
demand, increasing price competition, decreasing product prices, the increasing power of
retail chains, and the arrival of the economic depression. Under these circumstances the
owner-manager realized that focusing on subcontracting would be the best option for MF.
Benefits from this strategic change would be continuing customer relationships, and
possibilities to anticipate orders in a longer time perspective. The owner-manager
commented the situation as follows: “We have been producing book shelves [home furniture]
for a long time and when we anticipated that retail would become centralised in chains and
they would be bigger entities, we would not survive in that competition… and we started to
strengthen subcontracting”.
As a consequence, MF had to develop and compete in the home furniture business, as well
as develop its operations in subcontracting business. For this purpose, MF actively searched
for co-operation partners and invested in machinery and production process development.
Thus, their intention to increase subcontracting started active processes internally and with
regard to external relationships. Thus, the owner-manager’s perception of environmental
circumstances and their consequences for business proactively triggered the necessity for
strategic change.
Even though the intention to be a subcontractor was strong, the process itself was not easy.
Mainly due to difficulties to find subcontracting customers and large-scale investments made
in production facilities, MF had to continuously put effort also into the development of the
home furniture business. Thus, it broadened its home furniture product mix and increased
product development activities. At the same time, the environmental conditions (decreased
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demand and increased power of retail chains) forced MF to adapt its internal activities,
downscaling to smaller production series. In this context, the owner-manager’s survival
recipe was simply “try to make business instead of competing with prices”. Furthermore, it
had to lay off 30% of its employees, and freeze all investments. In this point, MF’s actions
seem to be mainly a reactive adaptation on competitive and operative levels.
Regardless of the difficulties and due to the environmental uncertainty in the domestic
market, MF actively continued the development of subcontracting business. This had
strategic level consequences when MF established the “JT-marketing company” together
with four local furniture manufacturers. The aim of this co-operation was to increase export
by sharing marketing expenditures and to offer a complete set of products for hotels and big
customers (each of the five firms was specialised on its own product). This was a big
investment of both money and productive factors, and went hand in hand with lots of
expectations. In 1995 the owner-manager saw the business through JT as a stone
foundation of MF. The owner-manager assessed the JT-marketing company as a
subcontracting customer, and in this sense its establishment presented a conscious action
toward his strategic intention. The establishment of JT marketing company is a clear
example of proactive strategic level change.
Although subcontracting was slowly increasing in the mid 1990s, many external incidents
hindered this process. First, changes in the domestic industry limited the customer base.
This was due to generalised investments in new technology in the furniture sector: customers
who used to buy semi products from MF started to produce these parts themselves.
Secondly, the low value of Swedish crown and Ikea’s decision to freeze its subcontracting in
Sweden increased the competition with Swedish subcontractors, as a consequence of which
MF lost exports. However, the JT marketing company increased sales to Germany, which
compensated for the losses in domestic and Swedish markets. At the same time, MF was
negotiating business possibilities with Ikea, albeit without a result. Simultaneously in 1995,
MF was able to develop its business by investing in machines and putting some effort in
product development and marketing. Additionally, an external designer was contracted for its
own product development. We would characterise this period as a period of normal
development, guided by both environmental conditions and internal intentions.
The simultaneous development of the home furniture business (own products) and the
subcontracting business finally proved to be a too heavy business model for MF, and MF
faced its probably most critical period in the late 1990s. Despite of product development
efforts, the competition in the home furniture market was extremely hard, and MF lost an
important retailer chain customer. Additionally, MF had problems with exports, the
subcontracting business did not developed as strong as it was expected, and large debts
caused extra pressure.
In this context, in 1998 MF’s owner-manager finally made a clear decision to implement a
strategic level change and become 100% subcontractor in business-to-business markets. As
a consequence, basically all its business went through four business-to-business customers
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in different segments (office furniture, ships, caravans and hotel furniture), and it stopped
home furniture producing. This decision caused clear changes on the operative level, when
MF stopped its own product design and marketing activities, and sales activities were
organized through customer-focused sales engineers. Also the cost burden was reduced due
to the discontinued marketing and product development activities. This seemed to be a
correct decision in the sense that MF managed to survive the critical years, reaching a
satisfactory performance level. During 1997-2000, MF made the biggest investments in its
history and as a consequence, extended its possibilities of producing customized products.
In 1999, MF had 96 employees, just one more than at the beginning of observation period.
Case 2: RP (see Figure “Case 2” in Annex)
RP is a family business, founded in 1965. At the beginning of our observation period in the
1980s, RP operated mainly in the domestic market, and its business consisted of own
product development and production (mainly bookshelves), which was sold to several
retailers. RP did not do any subcontracting sales; nor was its own product sale concentrated
on any special customers or chains. At this time, RP’s machines were relatively new and
highly automated, and it continuously developed cost-effective production. Since 1984, one
shelf series, “T-shelf”, has been its most important product. In 1985, RP had 35 employees.
In the context of the economic boom and fast growing demand at the end of the 1980s, RP
invested heavily into production automatization and T-shelf effect production. Additionally,
they extended the T-shelf product by developing new modules. According to the owner-
manager, 1988-89 were really good years for RP, and they managed to increase profitability
and sales.
A decade of growth and success, however, was followed by deep economic recession in the
beginning of the 1990s, which clearly affected RP’s business. First, triggered by macro level
problems, RP lost 30% of its sales due to the bank crisis. Secondly, RP experienced credit
losses from its customers and as a consequence, it had to redefine the customer base
according to their solvency. Additionally, RP had to give bigger discounts to its customer.
However, it was also able to continue product development, whereas investments were only
necessary improvements. According to the owner-manager, the general situation in the
furniture market at that moment was the most difficult after Second World War. He also
believed that it was mainly due to their relatively good production facilities and product, that
RP managed to avoid the mindless price competition and keep all its employees. It seems
that in this period, RP mainly received negative ‘surprises’ from the environment, which
forced it to reactively adapt to these circumstances.
However, it seems that difficulties in the domestic market and the consequently declining
performance awakened the owner-manager to think about his business more carefully. In
this context he perceived exports as a means of survival and success for the so far solely
domestically operating RP. As a result of this decision, RP made several proactive actions in
order to achieve this goal. Later on, the owner-manager commented the critical decision to
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invest in export activities as follows: “The decision to start to broaden strongly export market
has been one important decision. If we would have decided that in any case we will not start
export and stay just in home market, it is possible that we [RP] surely not exist anymore or
our business would be in a totally different level.” Therefore, environmental conditions
worked as a trigger for a strategic intention, which in turn lead to many relevant proactive
processes.
Thus, after the devaluation of the Finnish Mark in 1991, RP started to increase slowly its
exports, mainly by participating in several co-operation projects with other Finnish furniture
producers. For these purposes, it put a lot of effort into new product development and
production issues, but also continued its T-shelf development and production.
As an initial and the biggest co-operation project at the beginning of the 1990s, RP tried to
establish a business in the USA, together with three sofa producers. For this purpose, the
firms prepared brochures and business place in that market. However, two out of the three
sofa manufacturers went bankrupt, and RP continued the process only with one of the
partners. Products, however, proved to be unsuitable for the US market, the distribution
chain selection was unsuccessful, and finally the low value of the currency complicated the
project. A second remarkable export effort was directed to Hungary, where RP tried to
develop business with two other Finnish furniture manufacturers. Although this project did not
lead to bankruptcies, it did not fulfil expectations. Poland was their third big export target,
where RP directed its efforts together with eight Finnish furniture firms. Like the two previous
projects, this market entry again faced enormous problems. One by one, the Finnish partners
either gave up or went bankrupt, and finally RP was left alone in the project.
Clearly, these exports efforts were mainly consuming RP’s resources without bringing forth
the expected economical results. They also reflect the difficulties related to the “smallness” of
SMEs in export development activities: partner selection, marketing, product adaptation for
foreign market, and distribution channel selection. However, RP’s activities all present
concrete and proactive efforts for developing export transactions, which included joint
activities with other firms as well as changes in internal projects (i.e. product and processes
adaptation).
In 1995, exports amounted to 20% of total sales, and the domestic market was still clearly
RP’s biggest income contributor. The owner-manager was carefully deliberating about the
market characteristics. Recession had eliminated lots of small retailers from the market, and
centralized chains were holding the power. His perception was that chains did not buy design
products, but cheaper serial products. On the other hand, chains expected just-in-time
deliveries from the producers, as they cut down on stockholding. Additionally, he saw the
imports from the Baltic countries as a big threat. Facing this, the owner-manager realized the
importance of co-operation and long term relationships with chains. As a result, he started to
co-operate with a retailer chain. Our data do not reveal if this relationship was initiated by RP
or the chain, but one important reason for such a relationship might be the fact that furniture
sales were strongly concentrated on chains and RP had to adapt to this reality.
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In the second half of the 1990s, RP continued its active product and production process
development, and it increased its efforts to export, especially marketing. As a result, RP’s
exports grew. For example, export to Russia was really significant in 1997-98, until the value
of Russian currency collapsed in 1998. RP also tried to re-enter the US market with a new
product. In 1997, RP took its biggest step in export operations, establishing a delivery and
sales company in Poland. This affiliated company operated in the Warsaw area, and fifteen
independent dealers were selling RP’s products in different areas of the country. The
decision to establish business in Poland resulted from the Polish co-operation project at the
beginning of the decade. In a sense, Poland was a familiar market, and RP also believed in
the potential of this particular market.
At the same time, some important developments also happened in the context of the above
mentioned retail chain relationships, when a retail chain, operating in Sweden and Finnland,
became interested in the “T-shelf“ (RP’s most important product). As a result of their
negotiations, RP slightly the T-shelf, and started to manufacture it for a retailer chain as a
private label product. Thus, exports to Sweden increased and compensated the loss in
Russian market. According to our knowledge, this was the first time RP extended the
contract to include exclusive sale rights for a retailer, manufacturing one of their successful
products in a customer’s name.
Thus, it seems that despite of many disappointments in export co-operations, and thanks to
the initial growth in exports and the experience resulting from these attempts, RP kept
believing in the strategic importance of export operations, proactively continuing the search
for new opportunities. What happened to the Russian export activities serves as a good
example for how macro economic conditions can determine the business of a small firm. The
relationship with the retailer chain and the production of a private label product, in turn,
reflect a change in RP’s product and customer philosophy. The reasons for this change could
be partly due to positive experiences RP had made with a Finnish retail chain, and partly
because it was the only way to start business with this particular customer.
In 2000, exports constituted 50% of RP’s sales. According to the owner-manager, as a
lesson they learnt from the recession, RP had tried to enter as many markets as possible in
order to diversify its risk. Even more interestingly, the owner-manager judged that the firm’s
philosophy had switched from production orientation to market and customer orientation.
Moreover, RP’s own machinery construction was an important competitive factor in
differentiating products and preventing imitation. In 1999, the firm had 40 employees, five
more than at the beginning of the observation period.
In the RP case, environmental pressure had a clear effect on the firm’s activities. During the
recession, the firm faced difficulties and, as a response, it attempted to find new markets. At
a strategic level, the main decisions were long term export orientation as well as the
establishment of a new company in Poland. In this sense, exports became more important
and were more than a tactic to survive the recession. At a competitive level, RP increased its
marketing efforts and co-operations with other furniture producers and, also, started closer
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co-operation with retail chains. Finally, at an operative level, the continuing process of
technology catch-up was a dominant characteristic of the firm’s development. Also, its
important internal competitive factors were a distinctive product, good quality and price
relationships, and good delivery times. On the other hand, the greatest difficulties were a lack
of marketing knowledge, finding foreign marketing channels, and building effective working
co-operations with other furniture producers.
Case 3: PH (see Figure “Case 3” in annex)
PH was established at the beginning of the 1980s. Within the first ten years, its business
pattern was common and traditional in the furniture market: a broad product mix (home
furniture) and a domestic market. In 1985, PH had 15 employees, and its customer base
consisted of one big retail chain and several small retailers. As product philosophy, PH both
wanted to launch new products into a market and follow other firms’ actions.
The economic boom and an intense competition simultaneously characterised PH’s business
environment at the end of the 1980s. These circumstances became apparent especially in
product and labour related issues: as a response to fast product imitation, PH had to
increase its product differentiation efforts. Its peripheral location however complicated the
process of recruiting skilled employees. However, a fast and flexible delivery, product quality,
price, and good customer relationships were PH’s strengths within these years. PH’s
operations did not change much (mainly incremental development), and this period could be
characterised as a normal way of acting in an intensely competitive environment.
An important turning point for PH’s development occurred in 1990, when Ikea “found” PH
through the Finnish Ikea Trading Service. PH seized this opportunity to start business on a
large-scale basis with Ikea. The owner-manager was aware of the changes this decision
would bring to PH’s internal processes because Ikea’s production would be demanding in
terms of production resources and time. This would lead to clear changes in the use of
production facilities, and it might also limit the possibilities of PH’s own product development
and production. The reasons why the owner-manager decided to start business with Ikea
were perhaps a result of combination of two factors: an extremely good possibility for large-
scale business, and growing competition in the domestic market. Whatever reason, this is an
example for a conscious strategic decision.
Starting from this decision and its realization, PH developed both its own product related
business and the Ikea business. Ikea business proved challenging, and PH had to learn and
invest heavily in order to meet the requirements. Actions included, e.g., investments in new
machinery and recruitment of new employees. At the same time, Finland experienced its
economic recession, and the furniture business became more demanding. The owner-
manager also perceived imports from Soviet Union and Baltic countries as threats. The
increased power of retail chains forced PH to give them special prices. In order to avoid
direct price competition, PH increased its own product development. Finally, its domestic
sales were concentrated mainly on two retailer chains. At this time, the owner-manager
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perceived exports as a worthy investment, and an extra effort was directed to design
products for foreign markets. As a result, PH managed to grow even in a period when the
domestic market suffered from a deep recession. Growth happened due to increased exports
(50% of the turnover in 1991), which in turn mainly resulted from the Ikea business.
However, the broad product mix caused efficiency problems and PH had difficulties to
maximize the benefits from their focused customer relationships.
As was expected, the relationship with Ikea triggered many changes on the operative level,
which at the same time could be characterised as voluntary (based on strategic decision)
and as forced (the only way to do business). In the domestic market, retail chains showed
their power in pricing issues, forcing PH to adapt to their rules. These issues also might have
triggered PH’s proactive actions towards exports markets.
During the first half of the 1990s, the relationship with Ikea increased in importance. Sales to
Ikea amounted to 60% of PH’s total sales in 1993 and to 75% in 1995 respectively. At the
same time, PH grew as a company, both as regards the number of employees and turnover.
However, this growth did not come easily, and PH needed to develop it operations constantly
in order to be competitive in this relationship. Thus, PH continuously invested in modern
production facilities, and developed Ikea’s products. It also needed to present a three years
plan for Ikea, and it had to obtain ISO 9000 quality status. The owner-manager also saw the
employees’ commitment and motivation as important in order to reach PH’s goals. Thus, he
implemented an employee motivating programme. Moreover, he organized team work and a
bonus salary system. Moreover, PH actively cooperated with other Finnish Ikea
subcontractors. In the domestic market, PH continued business with two retail chains, based
on annual contracts and with the chains being responsible for product design, while PH’s
own product development activities decreased. As in previous periods, this period included
several internal changes and developments, which were directed by PH’s strategic intention.
It also seems that the biggest pressure PH faced was triggered from present relationships,
whereas the macro environment did not strongly affect PH.
In the late 1990s, PH’s development and growth continued in a similar way, characterised by
Ikea’s increasing role, its investments in machinery and new employees. However, the broad
product mix still caused efficiency problems. This lead the owner-manager to making a
strategic decision and to narrowing down the product assortment, and concentrate only on
kitchen tables. Moreover, he decided to stop PH’s own product development. Production
from now on would be based on customers’ products, especially on foreign large customers.
These decision and intentions triggered an active search for financially healthy large
customers, mainly in USA, Japan and France. Additionally, PH hired a marketing manager in
order to intensify this process. At the beginning of 2000, PH had 90 employees, exports
represented about 90% of the sales, whereas Ikea presented 96% of total sales.
In this last period, PH continued its conscious and purposeful development of the Ikea-
related business. However, interestingly, the decisions and intentions related to the own
product development and its customer policy reflected a change in strategic level. If PH were
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to realize its intentions, it would become a subcontractor without own products and product
development. We suggest that there are several reasons affecting this intention. Firstly, due
to the positive experiences with Ikea (i.e., firm growth, long term contracts, and serial
production) the subcontracting business seems a promising operating mode. Secondly, the
alarmingly large dependence on Ikea probably evoked a necessity to diversify the risk
involved here and find new customers. Thirdly and again related to Ikea, large investments in
production made it possible for PH to operate on a larger scale and thus, to produce for other
large customers. On the other hand, the broad product mix had caused efficiency problems,
and the large-scale production did not allow for customized, small-scale production. In this
sense, its own earlier decision forced the company to change its product and customer
policies.
The relationship with Ikea was essential for PH’s development, assisting the firm to grow
even in recession years. The development of the relationship was based on continuous
efforts to improve production efficiency, which also allowed PH to search for new big volume
customers. In this case, the main change occurred at a strategic level when the firm, in the
long run, switched from a more traditional business way (broad product mix, domestic
market) to being an Ikea system subcontractor. However, this was not an isolated decision.
From the beginning, the owner-manager understood continuous development of production
facilities and labour force to be an essential element for the firm’s strategic intention. It was a
process that started with the initial decision to produce for Ikea, including many minor
decisions and changes at the competitive and operative levels: ISO 9000, team work,
continuous improvements in production facilities (machines and labour force), narrowing the
product mix, and co-operation with other producers. As a consequence, PH was focusing on
one product, decreasing its own product design and development. Thus, PH’s specific
context was redefined, and main competitive challenges now arise from international
competition as Ikea’s subcontractor.
Discussion
The case analyses showed that each firm had changed at different levels (strategic,
competitive and operative) and in relation to different adaptive elements (product and market
domains, production and technology; and management). At strategic level, many changes
were proactive decisions, triggered both from the owner-manager’s strategic intention and
environmental conditions. In competitive level, changes include both proactive and reactive
responses to competitive situations and normal development. On the operative level,
technology development seemed to be a continuous target for development, whereas
production and labour related changes reflected environmental conditions. Finally, as
common characteristics of the main strategic change processes, two issues can be
emphasized: firstly, all firms had an intention towards strategic change, and secondly, the
realization of main changes took a long time. However, change processes themselves
differed with regard to their nature and contents.
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In the case of MF, the process was chaotic, and the final decision to concentrate on b-to-b
customers was critical for the firm’s survival. At the same time, MF faced new challenges in
its production process, mainly because the production of caravan and ship products was
different from its normal products. Also, the general survival demanded several overlapping
change and adaptation processes, including development of own products, marketing, the
establishment of the JT marketing company, and subcontracting. MF was the only firm,
which had to lay off employees during recession time.
Table 1 – Summary of main characteristics and changes in case companies
CHARACTERISTICS MF RP PH
Written strategy No No No
Personality proactiveness High Medium Medium
Willingness for risk-taking High Relatively high Low
Rationality of decision-making Rational-irrational Rational-irrational Rational-irrational
Decision-making style
Intuition, improvisation,
experimentation
Intuition,
improvisation,
experimentation
Intuition
S
T
R
A
T
E
G
I
C
C
H
A
R
A
C
T
E
R
I
S
T
I
C
S
M&S classification
(strategic orientation)
Before recession: D
During the strategic
change process: A
After change: P
Before recession: D
During the strategic
change process: A,P
Mainly D
Main strategic change
From home furniture
producer to b-to-b
subcontractor
From domestically to
export and
internationally oriented
producer
From traditional
home furniture
producer to Ikea
subcontractor
Strategic level change processes
Establishment of J T-
marketing company
Concentration on b-to-b
customers and stop own
product activities
Several export oriented
co-operation projects
Establishment of
delivery and sale
company in Poland
Private-label for
Swedish chain
Ikea business
Product
concentration: tables
Competitive level change processes
Product development and
designer
Product mix and material
Marketing
Discounts
Marketing
New market penetration
Co-operation with other
producers
Product mix
Product
development
Co-operation related
to Ikea sub-
contracting
C
H
A
N
G
E
P
R
O
C
E
S
S
E
S
Operative level
change
processes
Technological catch up
Production: production and
series
Employer lay off
Task organization
(finishing own
product development;
customer
based sales engineers
Technology catch up
Marketing learning
ISO 9000
Team work
Continuing cost
efficiency
Technology catch up
EMPLOYMENT CHANGE IN THE
PERIOD
From 95 to 96 employees
From 35 to 40
employees
From 15 to 90
employees
P =prospector, A =analyzer, D =defender.
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In the firm RP, the change toward internationalization was characterized by experimentation,
mainly in the form of several co-operation projects with other furniture manufacturers.
Additionally, a critical step was taken, when the firm established its own delivery and sale
company in Poland. Moreover, the strategic importance of chain relationships (i.e., the
private label product for a Swedish chain), and the development of marketing activities
increased when competition hardened. Changes related to product development and to
production were mainly incremental.
In the last case (PH), the main change process appeared more linear compared to the
previous cases. The owner-manager saw the sale concentration on one customer as risky
behaviour and he tried to develop other relationships at the same time. In this case, there
were remarkable changes in product mix and production, mainly due to the concentration on
tables, and finally the termination of own product development. On the operative level, team
work and ISO 9000 were the most remarkable changes.
Next, we will discuss the case firms’ strategic change processes from the perspectives of
strategic decision-making and strategic orientation.
Strategic decision-making
Starting with the personal characteristics of owner-managers, none of the owner-managers
appears rational or irrational in their decision-making processes (measured on the method by
Dean and Sharfman, 1993). This result is supporting the idea of heuristics (Eisenhardt et al.,
1992). Additionally, in all cases, the owner-managers differed in their attitudes toward risk-
taking. Whilst MF owner-manager’s willingness to take risks seems to be high, in RP’s case it
seems to be relatively high, and in PH’s case relatively low.
Furthermore, none of the owner-managers based their change processes on any analytical
planning or a written strategy. According to the owner-manager, MF did not have a written
strategy but long-term goals in mind. In RP, planning is not common activity, and it is only
carried out related to important topics with a two to three years timeframe for implementation.
Finally, in the PH case, planning occurs at a general level and with a long term perspective.
Additionally, owner-managers neither use much formal information in decision-making
(information comes mainly from customers), nor do they generally compare different options.
Only MF’s owner-manager admitted to have compared options before making decisions.
According to him, “decisions come quite fast… it is a different thing to be able to implement
them as fast…There is no time to think and investigate from every side…” PH’s owner-
manager (more rational and more risk averse) said that when he makes a decision, firstly he
thinks about how this decision will affect the firm’s competitiveness and secondly, how this
decision will affect routines, and which kind of long term effect it will have.
In all cases, strategic decision-making was a mix of intuition, experience, and the evaluation
of the internal resource-base of a firm. However, the owner-managers of MF and RP, who
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showed a higher risk-orientation, recognized certain components of improvisation in their
strategic behaviour, stating that in situations where risk is not high and the opportunity
appears a good one, they also made experiments. The owner-manager of RP described
decision-making in the following way: “It is like intuition… It is based on own knowledge,
skills and experience, but there also is a lot of feelings… we are of the opinion that this has
to be a good solution, and we act based on this. Rarely do we have any special factual
information”. PH’s owner-manager (more averse to risk and more rational) thought that
experience is important (especially at an operative level), and he recognised that decision-
making is generally based on intuition: “Apparently it is more to this side… [intuition] and it is
more this way than it would be based on some exact calculation and decision would come
that way. It precisely just come this kind of feeling that this is that way, and this kind of
decision has to be done in this situation.” However, he rejects the idea of improvisation and
experiments in decision-making.
In all cases, owner-managers said that their ways to make decisions has not been changed
much throughout time, and that they had made all decisions individually. However, they
concluded that their ability and willingness to take risks is decreasing with age. In this
context, PH’s owner-manager is trying to implement decision-making in teams, but this
process is at the beginning and learning stage. Additionally, important strategic decisions are
made in all case firms not only when problems appear, but also anticipating the future.
As was expected, strategic planning as understood in the conventional strategy literature
does no fit the context of SMEs. Instead, we would characterise the case firms’ strategies as
intentional and emergent. Firstly, even change processes were not based on analytical
planning, owner-managers had clear ideas in mind as to business development, and several
decisions supported these ideas. Secondly, change processes were not linear, but they
included improvisation and experimentation, which themselves shaped the change
processes.
Strategic orientation: Miles and Snow’s typology
In terms of the adaptive cycle introduced by Miles and Snow (1978), environmental
pressures challenged the market areas in all cases, and, in that sense, the entrepreneurial
problem was activated. In the first case, MF could balance entrepreneurial, engineering and
administrative problems, but the process was difficult and took time because it was
continuously interrupted by external forces. On the other hand, RP could balance
entrepreneurial and engineering problems: the main difficulties appeared as an
administrative problem related to the implementation of their export intentions. However, in
the long term RP learnt to manage its foreign activities. Finally, it seems that in the PH case,
the entrepreneur managed to maintain the equilibrium between the three areas in the change
process.
Classifying the case firms according to the typology of Miles and Snow leads to interesting
results. MF’s strategic orientation varied during the observation period. The main reasons
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were a changed behaviour and discrepancies with its strategic intentions and its actual
behaviour. At the beginning, MF behaved as a defender. At the same time, the owner-
manager showed a proactive attitude by anticipating problems in actual business and by
searching for new opportunities both in products and markets. After the decision to focus on
subcontractor activities, MF showed analyzer behaviour by operating on the home furniture
market and looking for new opportunities in the supplier business. Additionally, when MF
worked as a 100% supplier, it showed prospector behaviour when it changed its business
sectors. Finally, the entrepreneur’s own interpretation was that MF behaviour could be
characterised as a reactor, defender or analyzer, depending on which part of the firm’s life
cycle and which activities of the company were analysed. As regards the connection
between firm strategic behaviour and the personality of the owner-manager (high
proactiveness and high willingness to take risks), the strategic behaviour appears to reflect
the personality of the owner-manager.
RP could be classified as a defender before the economic crisis. However, after the decision
to focus on export, RP behaved like an analyzer in the domestic market, and a prospector in
foreign markets, mainly because its export decisions were often experimental in nature,
showing fast reactions to new opportunities. In addition, the entrepreneur’s own interpretation
was that RP’s behaviour had many characteristics of defender and analyzer, but he also
identified the firm as a prospector in foreign markets. In this case, the personal
characteristics of the owner-manager (medium proactiveness and relatively high willingness
to take risks) and the firm’s strategic behaviour also seem to go hand in hand.
Finally, PH seems to be a defender as concerns the realised strategy in the sense of Ikea’s
proportion of sales and those technological adjustments made in order to be competitive.
However, if we analyse the entrepreneur’s intentions and efforts in finding new large-scale
customers in new foreign markets, we can also see characteristics of an analyzer in intended
strategy. The entrepreneur’s own interpretation was that in the domestic market, before his
business with Ikea, his strategy was closer to an analyzer with many and innovative
products. However, as Ikea’s subcontractor, he classifies his strategic behaviour mainly as a
defender. As it was in two previous cases, the owner-manager personality (medium
proactiveness and low willingness to take risks), and firm strategic behaviour are matching.
In this context, we could have forced each firm to fit one of the categories of Miles and Snow
typology. However, as a side effect, we would have ignored many small but important steps
and changes, and limit the analysis to a more general level. By doing this, we would have
lost the richness of the change processes as explored here, the important elements of SME
strategic behaviour (especially intuition and experimentation), and the success of
implementing changes in a long run. Based on our analysis we therefore suggest that
typologies proposed by the adaptation theory are not adequate in describing SME behaviour.
In general, proactive behaviour is related to successful firms and reactive behaviour to less
successful. In that sense, following traditional adaptation typologies, small firms are often
classified as behaving either reactive or defensive (e.g., Vesalainen, 1995) and, as a
consequence, they are often described as poorly-managed. Thus, when Miles and Snow’s
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typology is applied to SMEs, a large part of the sample is labelled “defender” or “reactor”.
This result could be related to a combination of factors:
• The difficulties of a small firm to allocate resources for a continuous search of new
opportunities and implementing the actions needed to benefit these opportunities
(i.e., needed to be a prospector). Also, the lack of resources to obtain information, the
lack of strategic planning, and the decision-making style of the owner-manager can
reduce the probability to be classified as an analyzer. Moreover, Brouthers,
Andriesen and Nicolaes (1998) suggest that small firms could pursue a defender
strategy, not because it is the best, but because managers act in a non-rational way,
basing decisions on their personal preferences.
• As Kickul and Gundry (2002) suggest, strategies classified as "prospector" by Miles
and Snow’s typology are strongly related to the personality of the owner-manager.
Specifically, this type of strategies goes hand in hand with a proactive owner-
manager personality. When applying the Kickul and Gundry (2002) method to our
cases, RP’s and PH’s owner-managers seem to have a medium level ‘proactive
personality’. Interestingly, the MF owner-manager showed a proactive personality,
and he also was more of a risk-taker and prospector in our analysis.
• Due to the heterogeneity of internal factors, environmental changes affect each
company in a different way. In this sense, the ability to survive, the capacity to exploit
new opportunities; and the ability to take advantage of those difficulties to obtain
earnings will depend on each company and each entrepreneur (Venkataraman et al,
1998). “It is reasonable to believe then, that adaptive behaviour, will vary from one
organisation to another….the causal direction and the magnitude of bivariate
relationships among environmental, organisational, and strategy-making variables
differ systematically among several different homogeneous sub-samples. The
research for simple, universal findings is therefore likely to obscure important
relationships” (Miller and Friesen 1980: 269-270) Thus, it is not always possible to
make non-redundant classifications within a typology. This was clearly demonstrated
in our analysis in two senses. Firstly, the classifications changed over time and
depending on the phases of the change processes. Secondly, the analysis of the
owner-manager intentions and actual strategic behaviour would have resulted in
different kinds of classifications.
Conclusions
In our cases, the main strategic change processes resulted from several inter-related factors,
which both enabled and hindered the processes: the environmental conditions, the owner-
manager and his personality, and internal resources. In terms of environmental influences,
macro economic conditions appear to play an important role in determining SME behaviour
and change processes. At industry level, powerful actors (mainly retail chains) interfered in
change processes by offering new opportunities or by tightening conditions. Interestingly, this
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often resulted in proactive actions in other areas. Moreover, other external stakeholders (co-
operation with other producers) partly enabled, party complicated the intended changes.
Additionally, it seems that the owner-manager’s personality, and his individualistic and
determinant decision-making style are characterising change processes (in all cases the
firm’s strategy was in harmony with the owner’s personality). Also internal resources and the
capability to change were affecting the process. Especially resource development,
production flexibility, expertise (or the lack of it) in different management areas, and product
differentiation were critical to the capability of the SMEs analysed to implement change.
Moreover, the smallness of the firms seems to be an extra hurdle for strategic changes. It
also appears that practising and developing two kinds of businesses at the same time (during
the change processes) is a heavy operation mode for small firms, and sooner or later they
need to concentrate on one core business. In general, the results of the case studies suggest
the importance of analysing change processes as an interaction of a firm’s internal and
external factors.
Secondly, strategic change processes take time. MF’s owner-manager described firm
change process in the following words: “[Change to be supplier] has happened slowly in our
case… we did not change suddenly. The reason for that is that because we are this kind of
private firm, we have had to keep cash flow constant … so we have been changing gradually
throughout a longer period of time. We have changed it in small steps… we were not able to
blaze new trails with one big jump”. Thus, in order to better understand a small firm’s change
processes, longitudinal research methods are recommended.
Thirdly, within our case firms, two principal triggers for main strategic changes could be
identified. In the first two cases, it seems that the owner-managers’ perceptions of present
(and future) environmental conditions (tightening competition, industry power structure) and
their consequences for own business (i.e., the threatening or decreasing performance level,
several reactive adaptations) motivated the owner-managers to think about their business
more seriously, and this evoked the necessity for strategic reorientation. In the third case, the
main strategic change was triggered per chance, when new business opportunities occurred.
Fourthly, strategic change in small firms seems to be a result of multiple, overlapping
processes, where firms need to be able to develop short-term survival tactics and, at the
same time, keep or change normal routines. In a short term perspective, a firm’s response to
any environmental stimuli might often look like a reactive tactic, whereas the same action in a
longer perspective might be a first step to start an intentional change process. In this context,
the main challenges faced by our case-study firms are the necessity to redefine market
positions, redefine productive specialisation, and surpass scale restrictions.
Finally, as the adaptation literature suggests, the case firms tended to act in defensive ways
when they faced environmental turbulence. Within a short term, companies tried to reduce
personnel costs, redefined internal tasks, and implemented product-market decisions (on
competitive and operational levels of adaptation). However, in a longer term perspective,
owner-managers were able to identify new ideas and projects in their business environment.
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Here, the owner-managers were able to take advantage of resources and experience
developed throughout their maturity path (strategic level of adaptation). All three case firms
usually included in their strategic agenda some of the following activities: i) narrowing
product mix, ii) product differentiation/innovation, iii) focusing key customers, and iv) a
greater propensity to co-operate with other companies. In addition, the analysis of the
decision-making processes helped to appropriately understand how the firms reacted to
environmental signals and how individual decisions can affect the process. In general,
entrepreneurs act with bounded rationality and strategies are often based on experience and
intuition instead of calculation and planning. Thus, an alternative to the rigid thought of the
strategic planning school would be shifting attention to improvisation modes.
Limitations
The main problems and limitations of the study are related to the data collection method. The
interviews in different years have been conducted mainly through telephone (face-to-face
interviews were conducted just in 1986), and different people were involved. Additionally,
secondary data mainly refers to firm related issues, and there is only limited information
available related to the owner-manager characteristics. However, longitudinal studies often
are based on secondary data, i.e., records, annual reports and other public information, or on
retrospective reconstructions of the past based on memory. These data collection methods
have their weaknesses such as impression management, the bounded human ability to
remember past events and an automatic tendency to rationalize and glorify past decisions. In
small firms, annual reports or records are not often available, and thus, the reconstruction of
the past is even more complicated. In our study, most questions were open ended and
qualitative in nature, and “why questions” had been presented in order to clarify the changes
and developments in different themes. Additionally, we included some new interviews in
order to get some more information related to owner-managers, and also to validate a few
issues related to the secondary data. Despite the data collection limitations, the data seem to
be adequate from a research point of view. It gives us a rich understanding of the change
processes in the case firms. However, the fact that our sample includes just three firms in
one industry also needs to be considered a limitation.
Implications and future research
Especially in the conventional strategic and adaptation literature, the majority of the studies
are concentrated on large firms, and SMEs are often considered as a homogenous group, or
as smaller copies of large firms. However, researchers within the SME and entrepreneurship
field have criticised this for a long time. In this context, we hope that our study stimulates the
discussion in the field of strategy research, mainly by taking into account the complexity and
richness of SME change processes in changing environments. We also wish for our results
to assist researchers in directing their attention to those critical and inter-related factors that
affect strategic change processes. Additionally, due the long term implementation of strategic
changes in SMEs, a longitudinal research approach is recommended. As a practical
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implication, this study can help policy makers and SME advisors to better understand SME
behaviour, which in turn might assist them in improving support and training activities
directed at small business managers and entrepreneurs.
As one question for future research, one interesting possibility is to broaden this study to
include more cases, and thus reveal the richness of the phenomena. Moreover, it could be
relevant to replicate the study in other industries. In this way, we could see if the strategic
change variables are the same in different contexts, and to which extent industry and
strategic industry factors is characterising change processes in small firms. Additionally, the
relationship between small firm and environment appears to be an essential phenomenon. It
would be interesting to concentrate on this issue by deeply analysing specific inter-related
events in order to tease out how the same environment treats firms in different ways, and at
which point and which aspects commonalities start to appear.
E-mails of corresponding authors: Karita Luokannen, [email protected]; Rodrigo
Rabetino, [email protected]
References
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YEA
1987
1991 1993 1995 2001 t
B
u
s
i
n
e
s
s
E
n
v
i
r
o
n
m
e
n
t
E
x
t
e
r
n
a
l
R
e
l
a
t
i
o
n
s
h
i
p
s
G
e
n
e
r
a
l
e
n
v
i
r
o
n
m
e
n
t
A
n
s
w
e
r
s
I
n
t
e
r
n
a
l
F
a
c
t
o
r
s
Exports
decrease 5%
Exports 25%
Subcontractin
g 30%
Customer
concentration
40%
Fast product
imitation
Low
possibility to
diff ti t
Hard
competition
Extra time
Sector decreased
prices
Same prices
Distributors buy
smaller series
Subcontractin
g increase
Exports 20%
Subcontractin
g 40%
Lack of productive capacity
Delivery, quality and
price (+)
Capital cost
2 Phone
ll
Marketing
manager
Decrease price
competitiveness
Big investments
(cooperation J T)
Lot of debts
Lack of
it l
Needs to improve
basic operations
Marketing
Company
(cooperation J T)
Subcontracting 100%
4 customers
Home furniture almost
inexistent
Lots of debts
Flexibility in
machines (+)
90% capacity in use
Average
lit / i
Exports 20%
Subcontractin
g 30-40%
No exports
Big
domestic
chain stops
relationship
Difficulties in
domestic market
Ikea in
Finnish
k t
Home furniture
40%
Slow increase in
subcontractor
activities 53%
Exports 15%
Industry
invested in
new
t h l
Component
subcontracting
decreased
Increased
domestic
subcontracting
Exports
decreased
Swedish
economy
Ikea frozen
subcontracting in
Sweden
Product
development
Investment in
technology
Search for cooperation
Changes materials but not
prices
No investment
Increased
prices
Product
development
Increase product
i
Wants to
subcontract as
business idea:
Anticipated
orders and
long-term
relationships
C
A
S
E
1
.
S
t
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h
a
n
g
e
p
r
o
c
e
s
s
e
s
o
f
M
F
Investment in
technology
Increased product
development
External designer
5 new employees
Increased prices
Failed
negotiation
with Ikea
Lots of
investment in
technology
Decreased
marketing
DECISION to
subcontract all
2 new areas
Process and products
development
30 new employees
Buy semi-products
Economic
Recession
Devaluation
Finnish Mark
Inflation
Laid off employees
Laid off 30% of employees
Flexibility (+)
Technology (+)
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YEAR
1987 1991 1993 1995 2001 t
B
u
s
i
n
e
s
s
E
n
v
i
r
o
n
m
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n
t
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r
n
a
l
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l
a
t
i
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n
s
h
i
p
s
G
e
n
e
r
a
l
e
n
v
i
r
o
n
m
e
n
t
A
n
s
w
e
r
s
I
n
t
e
r
n
a
l
F
a
c
t
o
r
s
Home furniture
(mainly
domestic)
No
subcontracting
One important
product
Hard
competition
Increasing power
of distributors
Quality (+)
Lost 30% of
sales
Domestic home
furniture 95%
Technology, delivery,
quality and price (+)
Production
facilities (+)
Delivery (+)
Location (-)
Marketing (-)
Delivery (+)
Bad marketing
skills despite of
efforts
Good products (+)
Cooperation in
exports
Home furniture:
50% domestic
50% exports
Quality (+)
High but competitive
prices (+)
Almost 100%
capacity in use
Lot of marketing
Exports 10%
Increasing
exports
Relationships with
retailers are
important in
competitive
situation
No
subcontracting,
no main
customer
Increasing exports:
- decreased
to Russia
- increased
to Sweden
No demand for
designed
products, just
for series
Smaller retailers disappearing
Centralized chains
and J IT
Exports 20%
Most difficult situation
after war (Highly
deterministic)
Increased exports
Swedish economy
New automatic machines
Cash discounts
Customer selection
based on ability to pay
Integrated activities
Increased marketing
activities (cooperation)
No big investment
Pressure to laid off
personnel
Trying to
maintain prices
Product
development
Strong
intentions to
export
C
A
S
E
2
.
S
t
r
a
t
e
g
i
c
c
h
a
n
g
e
p
r
o
c
e
s
s
e
s
o
f
R
P
New products
Continuous product
development
New machines and
better quality
Cooperation projects to
export to Poland,
Hungary and USA
Cooperation with
Stemma chain
Increased
marketing in
exports
Pricing policy:
customers
classification
Fromproduct
orientation to
market/customer-
oriented
Special model for
EM chain
Investments and
products development
10 new employees
Buy semi-products
Economic
Recession
Devaluation
Finnish Mark
Inflation
Bank Crisis
Russian crisis
Daughter company in
Poland
Threat from
products from
Baltic countries
Automated production
(+)
Location (-)
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YEA
R
1987
1991 1993
1995 2001 t
B
u
s
i
n
e
s
s
E
n
v
i
r
o
n
m
e
n
t
E
x
t
e
r
n
a
l
R
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l
a
t
i
o
n
s
h
i
p
s
G
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n
e
r
a
l
e
n
v
i
r
o
n
m
e
n
t
A
n
s
w
e
r
s
I
n
t
e
r
n
a
l
F
a
c
t
o
r
s
100%
domestic
sales: one big
chain as
customer
(50%)
No
subcontracting
Broad product mix
Hard
competition
Increasing power
of domestic
chains and
distributors
Exports 50%
of sales to Ikea
Domestic
sales: 50% (2
h i )
Location (-)
2 turns work in factory
Broad product mix
Employees and delivery
(+)
Automated production (+)
Employee
motivation
4% of sales were
domestic
(1 chain)
One main
product
(t bl )
Almost 100%
capacity in use
Domestic
chains 40% of
sales
Increased sales
to Ikea
Export 96% of
sales (mainly
Ikea) Increasing
business with
Ikea
Exports 60%
to Ikea
Domestic chains
20%
Exports 75%
to Ikea
Increased sales to
Ikea
Investment in
hi
Special prices to
chains
Personnel
ti ti
Increased product
development
8 new employees
Investments in
technology
Fast and
flexible
delivery
Big effort in
product
differentiation
Design
products for
export
C
A
S
E
3
.
S
t
r
a
t
e
g
i
c
c
h
a
n
g
e
p
r
o
c
e
s
s
e
s
o
f
P
H
ISO 9000
Chains are doing
product design
Investments in
technology
Cooperation with
Finnish subcontractors
Small own
product
development
Teamwork and
employee
motivation
Search for new
foreign markets
(USA, France,
J apan) based on
volume and
ability to pay
Marketing manager
DECISION to
concentrate on
ONE product
and exports
42 new employees
Bonus salary system
New machines and
no own design
Economic
Recession
Devaluation
Finnish Mark
Inflation
Bank Crisis
Exports to UK
Fast
product
i it ti
Lack of skillful
employees (-)
Difficulties to maximize benefits
( )
Started
business with
Ikea
17 new employees
Product
development
Broad product
mix
Threat fromproducts from
Soviet Union and Baltic
t i
More retail concentration
Decreasing prices in furniture
sector
Annual contracts with chains
8 new employees
3-year plan
Vertical networking
with small
d
Delivery, quality and
price and relationships (+)
Professional skills (+)
New production facilities (+)
Customer relationships
(+)
Location and broad product mix (-
)
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Tracking Small Business Failure Factors and Trajectories
Mika Pasanen, PhD
University of Kuopio, Finland
Abstract
The aim of this study was to identify SME failure factors and trajectories. The empirical study
was based on in-depth interviews with the ex-entrepreneurs of 12 failed SMEs. The results
reveal that several factors related to the entrepreneurs, the firms and their environments
were associated with SME failure. There were also more firm-type specific factors
contributing to SME failure. Moreover, three types of failure trajectories were identified: (1)
failed borderline cases; (2) rapid collapse failures; and (3) failed seekers of legitimacy. The
results indicate that many factors associated with failure are internal, and so under the
management’s control. One or a few major factors seem to cause firm failure, though there
are several inter-related factors and processes contributing to SME failure. In many cases,
the root cause of failure can be traced to problems in management and to the lack of
strategic management in particular.
Key Words: small businesses, performance, failure, strategic management
Introduction
This paper focuses on failed small and medium enterprises (SMEs) in peripheral locations.
The objective was to identify SME failure factors and trajectories. A number of studies have
focused on firm success, but few recent studies have focused on firm failure (Thompson
2001: 619). However, as we know, some firms succeed and others fail. It has been found
that entrepreneurs’ chances of financial success are substantially greater than the chances
of loss (Dennis & Fernald 2001). However, they are not nearly as favourable as new firm
owners seem to believe (Cooper et al. 1988). It seems reasonable to assume that much
could be learned from failed firms.
A high proportion of new ventures are closed down during their first years of life, and many
SMEs are closed down every year, indicating that these firms were not able to maintain the
alignment with their environment, or had never even achieved it. For instance, in Finland in
2002, half (50.2%) of the firms that closed down had survived less than five years (Statistics
Finland 2004). However, managers are as much responsible for avoiding failure as for
achieving success (Argenti 1976: 182). As a matter of fact, it has been argued that the most
important and most challenging business goal is long-term survival (e.g. Simon 1996: 12).
Moreover, survival is, at least in the long term, a prerequisite for success in other terms, such
as market share or profitability. To date, however, studies of firm longevity have focused on
large companies.
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However, SMEs are often the only feasible engines of development, especially in peripheral
regions. They generate societal growth in terms of new jobs and revenues; they create
innovations, and form flexible production networks. In fact, relatively speaking, the number of
jobs created by expanding small firms is larger than the number of jobs created by new firms
during their first year of operation or by large firms (Wiklund 1998: 1). However, few studies
have focused on the foundations of performance of SMEs in peripheral locations. This is
unfortunate, as business is not managed in the same way in different areas (see e.g. Lussier
& Pfeifer 2000; Yusuf 1995).
Changes in the environment cause more uncertainty in SMEs than in large companies. Their
resources for acquiring information about the market and changing the course of the
enterprise are more limited. The response to environmental changes is different in SMEs
than in large companies (e.g. Chen & Hambrick 1995). Large firms may even exit from one of
their business areas, but this is not usually possible in a single-business firm. The options for
responding are limited by the firms’ resources and strategic choices as well as by the
opportunities offered by the industry and location.
Previous research on SME failure
Challenges in research
There are several definitions of business failure (see e.g. Watson & Everett 1996a; 1993).
Firm failure has been defined in several ways, e.g. bankruptcy, insolvency, liquidation, death,
deregistering, discontinuance, ceasing to trade, closure, and exit (e.g. Storey 1994: 78-81;
Bruno et al. 1987). These definitions overlap each other to some extent (Sten 1998), and
they may have different meanings in different countries. As a result of this conceptual
pluralism, comparisons between results of previous studies of failure are difficult. In this
study, a failed firm is defined as one which has gone into liquidation, i.e. it has ended its
business and left behind unpaid creditors, and so the empirical cases in this study are
unequivocal failures. Aggregating closures with failures has been a typical problem in several
previous studies.
It is important to notice that not all firms that go out of business do so as a result of failure,
and those that do not should be separated from failures. For instance, according to
Thompson (2001: 631), ultimate business failure happens when a business is liquidated or
sold. However, a distinction should be made between two kinds of situations: optional and
non-optional. When there are no options, the discontinuance of the firm or business can be
defined as failure: in other cases the situation can be labelled as exit. On the other hand, a
business which is sold because the entrepreneur wants to realize a profit, for example, is an
exit, and closer to a success than a failure.
It is also important to understand the root causes of failure, not only the symptoms. In many
studies, it seems that a clear distinction is not made between the symptoms and causes of
failure (see e.g. Boyle & Desai 1991). For instance, financial ratios are seen to be symptoms
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rather than causes of failure (Argenti 1976). However, prior empirical studies of failure have
concentrated almost exclusively on financial ratio data, though the usefulness of ratio-based
firm failure prediction models has been questioned (Lussier 1995). It has often been argued
that a firm failed because it had run out of money, whereas the root cause may be poor or
ineffective management, for example. Revealing the underlying reasons for failure, in
particular, and their dynamics would obviously be useful for the creation of the business on a
sustainable basis.
Moreover, many firm failures do not happen suddenly, but develop over time as a
consequence of decline or crisis. The factors contributing to firm failure are often closely
related to the causes of decline and crises. Although small firms are more vulnerable than
large ones, few studies have focused on the failure, decline, crises, and turnaround of small
firms (Chowdhury et al. 1993).
The findings of previous studies can be described as fragmented, while several common
themes are evident. To date, research into firm performance has not provided a
comprehensive explanation for SME failure. There is disagreement among previous studies
concerning the factors contributing to firm failure (Lussier 1996). A huge number of variables
seem to be associated with firm failure. In addition, most studies have focused on large
companies, and those investigating small firms often concentrate on new ventures.
Moreover, a large variety of research approaches has been used. Narrowness and the lack
of a holistic approach are characteristic of many studies. In addition, few studies have
focused on the factors affecting the performance of SMEs in peripheral locations.
However, there are several difficulties in studying failed firms (Bruno et al. 1987). These are:
(1) difficulties in sampling; (2) the unwillingness of founders to discuss failure; (3) the inability
of founders to understand and articulate causation; and (4) the multidimensional complexity
of the problem. Difficulties in sampling relate to the selection of appropriate sampling frames
of reference, but also to problems in locating the ex-entrepreneurs. The second and third
problems relate to the length of time between failure and data collection. Multiple causation
leads to categorization and comparison difficulties for researchers investigating the problem.
Research approaches
Many methodological approaches have been used to explain and understand firm failure.
Here, studies of firm failure are divided into case studies, surveys, and database analyses,
on the basis of their methodological approach to data acquisition. There are also some
compilations of the results of previous studies of the factors associated with firm failure.
Perhaps the most extensive is the one made by Storey (1994: 92-110). Boyle and Desai
(1991) have reviewed the literature concerning the causes of small firm failure. They
proposed a typology dividing the causes into four categories based on a matrix of two
dimensions: (1) environment, i.e. internal vs. external; and (2) nature of response, i.e.
administrative vs. strategic. Lussier and Corman (1995) have also reviewed the research
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literature on factors contributing to small firm success versus failure. Vesper (1990: 38, 55)
presents a list of failure causes in high-technology start-ups.
Case studies have been carried out by Bruno et al. (1987) and Zacharakis et al. (1999).
Bruno et al. (1987) studied ten failed high-technology firms in emerging industries in
California. Zacharakis et al. (1999) in their study of perceptions of new venture failure carried
out matched case studies of venture capitalists and entrepreneurs.
In addition, there are some survey studies concerning the failure factors of firms. Carter et al.
(1997) studied discontinuance among new firms in retail in the U.S. with a focus on the
influence of initial resources, strategy, and gender. Lussier (1996) identified the ten most
common reasons for small firm failure in a survey of 100 failed small firms representing the
population of small firms in six states in the U.S.A. Gaskill et al. (1993) studied the perceived
causes of small firm failure in apparel and accessory retailing in Iowa. Smallbone (1990)
conducted a follow-up study of new ventures who were clients of an enterprise agency in the
UK. Sommers and Koc (1987) studied high-growth firms in the telecommunications,
computer equipment, instruments, and electronic components industries. Cressy (1996)
analyzed the shape and the underlying temporal stability of firm failure distribution, using a
large UK start-up database.
Failure factors
Many studies have concentrated on entrepreneur characteristics in explaining firm failure.
However, the importance of the entrepreneur’s personality traits has been seriously
questioned (see e.g. Storey 1994: 109). Findings concerning the entrepreneur’s age, gender,
lack of work experience, and family background have been contradictory. Only the
entrepreneur’s education has been quite consistently verified in empirical studies to influence
firm performance positively (Storey 1994: 109). However, there are also exceptions: In their
study, Lussier and Corman (1995) found that the owners of failed firms had a higher level of
education. In his literature review, Lussier (1996) shows that there is considerable evidence
that firms managed by people without management experience have a greater chance of
failure than firms managed by people with such experience (cf. Westhead et al. 1995: 88).
Also, in some studies, lacking experience in the industry sector has been found to contribute
to firm failure (Gaskill et al. 1993; Vesper 1990). Moreover, lack of motivation and
commitment on the part of the entrepreneur is associated with firm failure.
Poor management is often associated with firm failure in several studies (Haswell & Holmes
1989; Gaskill et al. 1993; O’Neill & Duker 1986). An incomplete start-up team (Roure &
Maidique 1986) and disagreement with partners (Hall & Young 1991) contribute to firm
failure. In their study of failed high-technology firms, Bruno et al. (1987) report that an
effective management team was more important for firm success than overall management
competence. Indeed, in seven cases out of ten, an ineffective management team was seen
to be one of the major reasons for firm failure. Lack of management skills was seen to be a
major failure determinant by Zacharakis et al. (1999). Also, the entrepreneur’s inability to
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perform both planning and administrative functions is seen to be associated with firm failure
(Boyle & Desai 1991).
Many failure factors are related to products and services, customers and markets, and
cooperation with other stakeholders. The greater the product range, the higher the probability
that the firm will survive (Reid 1991). Unsuccessful product timing has been found to be one
cause of failure, i.e. early and late introductions are problematic (Bruno et al. 1987; see also
Vesper 1990: 38). Also, dependency on a single customer or only a few customers is a major
factor affecting firm failure (Reid 1991; see also Hewitt-Dundas & Roper 1999; Hall & Young
1991). High reliance on a single customer as well as ineffective distributor relations are
factors associated with failure (Bruno et al. 1987). Hence, a diversified customer base plays
an important role in firm survival (Storey 1994: 107). Obtaining sufficient sales is a challenge
particularly for smaller firms (Cromie 1991; Hall & Young 1991). Cressy (1996) found that
fluctuations in firm sales increase the probability of firm failure. Moreover, it has been shown
that those firms which do not use professional advisers are more likely to fail than those
which do (Vesper 1990; Gaskill et al. 1993; Lussier 1995).
Firm resources and finance are seen to have a critical role in many studies. Firms that start
undercapitalized have a greater chance of failure than other firms (Lussier 1996; Hall &
Young 1991). The failed new firms studied by Smallbone (1990) also suffered from
undercapitalization, and lack of business was characteristic of them. Financial inadequacies
such as undercapitalization and problems in venture capital relationship are the major factors
affecting firm failure (Bruno et al. 1987; see also Zacharakis et al. 1999; Boyle & Desai 1991;
Cromie 1991). In their study of discontinuance among new firms in the retail industry, Carter
et al. (1997) showed that lack of human and financial resources is associated with business
discontinuance. Such an association was also confirmed by Cressy (1996) in his database
analysis. The lower the levels of external borrowing are, the higher is the probability that the
firm will survive (Reid 1991). Labich and de Llosa (1994; also O’Neill & Duker 1986; Hall &
Young 1991) claim that mishandling of debt loads is an important factor associated with
failure. Moreover, inadequate record keeping and financial control has been found to be a
cause of failure (Gaskill et al. 1993; Boyle & Desai 1991; Vesper 1990). Often, rapid firm
growth generates problems with finance, which ultimately may lead to firm failure. Thus,
problems in working capital management are associated with firm failure (Gaskill et al. 1993).
The firm’s inability to attract and retain competent employees may also lead to failure
(Sommers & Koc 1987; Boyle & Desai 1991; Lussier 1995). Cromie (1991) claims that the
biggest problem related to personnel in young firms is getting good staff with the right
attitudes. Labich and de Llosa (1994) claim that low employee morale and hostility may be
an important reason for failure.
It has been found that young firms are more likely to fail than older firms (e.g. Dunne et al.
1989; Storey 1994: 109; Westhead et al. 1995). Similarly, smaller and especially very small
firms are more likely to fail than their larger counterparts (e.g. Gallagher & Steward 1985;
Dunne & Hughes 1992; Storey 1994: 109; Westhead et al. 1995; see also Watson & Everett
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1996b). For the survival of young firms, their growth after startup is critical (Phillips &
Kirchhoff 1989; Storey 1994: 109). Moreover, there is some evidence that the higher the firm
growth rate, the higher the probability of survival, and also that firms which start larger have
higher survival rates (Phillips & Kirchhoff 1989). The causes of crises and failure related to
the management of transitions from one stage of development to another are described in
the studies of organizational life cycles (see e.g. Flamholtz & Randle 2000; Kazanjian 1988;
Greiner 1972; see also Boyle & Desai 1991).
A weak business concept or unclear business definition, i.e. lack of clarity about what
business we are in, and lack of focus have been presented as causes of failure (Bruno et al.
1987; Smallbone 1990; Zacharakis et al. 1999; Labich & de Llosa 1994). Also, failure of
vision has been found to be an important factor behind firm failure in the United States
(Labich & de Llosa 1994). Resistance to change relates to the fact that “success can often be
the seed of future failure”, which underlines the importance of continuous development
(Labich & de Llosa 1994; see also Miller 1994). It has also been shown that lack of a
business plan is associated with firm failure (Sommers & Koc 1987; Gaskill et al. 1993;
Lussier 1995). Lack of planning and especially strategic planning is often seen to be
characteristic of failed firms (Boyle & Desai 1991). Also, an overextension of the business
may cause failure (Gaskill et al. 1993). Jennings and Beaver (1997) claim that the root cause
of either small firm failure or poor performance is almost invariably lack of management
attention to strategic issues.
Turning now to the external environment of the firm, we find Storey (1994: 94-95) arguing on
the basis of his compilation of previous studies, that the industry sector seems to play a
minor role in firm failure. However, the results of previous studies have been contradictory on
this issue. For example, North et al. (1992) found wide sectoral variation in the survivability of
SMEs, while many other studies have argued that there are no sectoral differences in failure
rates (e.g. Phillips & Kirchhoff 1989; Kalleberg & Leicht 1991). One explanation for these
conflicting findings may be found in a study carried out by Watson and Everett (1999), who
claim that some definitions of failure are biased against certain industry sectors. Moreover,
contrary to general belief, many firms filing for bankruptcy actually have growing sales and
are situated in growing industries (Moulton & Thomas 1988).
The macroeconomic situation and changes in it have also been found to have an association
with firm failure. Firms started during a recession seem to have a greater probability of failure
than other firms (Bruno et al. 1987; Vesper 1990). Moreover, slow economic activity or
recession has been found to be a major reason for failure (Lussier 1996). Poor external
market conditions, including stiff competition, slow market growth, and small market size,
have been found to be major factors associated with firm failure not only by entrepreneurs
but also by venture capitalists (Zacharakis et al. 1999). Other studies have also found that
stiff and increased competition, and the firm’s inability to respond to it, is associated with firm
failure (Roure & Maidique 1986; Gaskill et al. 1993).
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Failure trajectories
Few recent studies have focused on firm failure processes and trajectories. Moreover, on the
basis of the studies we do have, it seems that most studies have focused on large
companies, and those investigating small firms often concentrate on new ventures.
In their study of large corporation failures, Hambrick and D’Aveni (1988) matched failed and
survived firms. They describe the decline of the firm as a downward spiral. The significant
features of the downward spiral include early weaknesses in slack and performance, extreme
and vacillating strategic actions, and abrupt environmental decline. Moreover, they found that
the failures showed signs of relative weakness very early, so it can be concluded that the
deaths are protracted processes. Moreover, in his study of strategic and managerial
consequences of organizational decline in large companies, D’Aveni (1989) found that
bankruptcy may be delayed or even avoided in an environment of growing demand.
In fact, there are several ways to classify and describe the factors and mechanisms affecting
firm failure. The basic classification divides the reasons into two categories: (1) firm-internal
causes; and (2) firm-external causes. In addition to firms falling into these categories, there
are also businesses that never start trading. Moreover, some firms cease to trade due to
health problems, ageing or other reasons related to the person of the entrepreneur.
Factors affecting firm failure are often described by using life cycle stage models. Adizes
(1979) has identified the four premature mortality outcomes in different life cycle stages: (1)
aborted idea; (2) infant mortality; (3) founder’s trap; and (4) divorce. Greiner (1972) has
described firm development through different stages of organizational crisis. Failure to adapt
to a series of crises caused by growth is one of the principal causes of failure for all
organizations (Greiner 1972). Argenti (1976) has presented three types of failure trajectories:
(1) never get off the ground; (2) obsessed by speed; and (3) insidious development.
Moreover, Miller (1990) has named four development types of failing firms: (1) tinkerer; (2)
imperialist; (3) escapist; and (4) drifter. He argues that the factors affecting firm failure are
bound with the type of the firm.
The challenges of this study
Altogether, the findings of previous studies can be described as fragmented, although
several common themes are evident. There is disagreement among previous studies
concerning the factors contributing to firm failure (Lussier 1996). However, taking into
account the several choices that researchers have to make concerning their study design,
and therefore the diversity of studies, it is to some extent understandable that the results of
studies are inconsistent with each other.
However, in the light of previous research, it can be suggested that there do seem to be
certain factors related to failure. Firm failure often seems to be related the entrepreneur’s
lacking higher education and experience, and the lack of an effective management team,
innovativeness in products, good customer relationships and avoidance of dependency on
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only a few customers, good cooperation relationships, adequate financing, skilled personnel,
strategic planning, firm growth, firm flexibility, focusing on core business, and operation in
favourable economic conditions. Moreover, the classifications presented also suggest that
there are contingency factors, e.g. firm life cycle stage, which may affect the results.
All this calls for the holistic investigation of failure factors and trajectories. There are firm-
internal and firm-external factors, which may make either an immediate or a long term
contribution to firm failure. The results can also be dependent on context and contingency
factors such as firm type, which might explain inconsistencies in the results of previous
research. The context often plays a critical role: what works in one context will not
necessarily work in another. Moreover, investigating failure trajectories is important in order
to identify the processes leading to firm failure.
On the basis of the literature review, the following research questions can be set:
1) What are the most common factors affecting SME failure?
2) Are there differences in failure factors between firm types?
3) What kind of failure trajectories can be identified among SMEs?
Data and methods
Data collection methods
This paper is based on the data of a larger exploratory study of the factors affecting SME
performance (Pasanen 2003), and it utilizes the taxonomy of SMEs presented by Pasanen et
al. (2000). Twelve failed SMEs were identified, based primarily on the information gained
from local authorities, e.g. representatives of business development departments of
municipalities and towns. Failures were defined as those SMEs which had gone out of
business with loss to creditors. The entrepreneurs of the 12 failed SMEs in Eastern Finland
were interviewed, and the main material was based on these in-depth case interviews carried
out in 1999-2001. In addition to interviews, document material such as annual reports, financial
statements, newspaper articles, etc. were collected and used as complementary secondary
data.
Times for the interviews were fixed in advance, and the entrepreneur was asked to prepare for
the interview by collecting the available annual financial statements. In some cases, other long-
term key persons in the firm were also interviewed to provide complementary information.
These were the cases where the principal interviewee had started as a CEO of the firm after
the firm was founded, and there were some key person(s) who had longer experience in the
firm, or the key person was more deeply involved than the CEO in some critical incident in
the firm’s history, and so had a better understanding of the issue in question. No
discrepancies were found in the answers given by the entrepreneurs and the key persons.
Some of the interviewees were re-interviewed later to obtain more detailed information about
important incidents revealed in the first interview.
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The framework for interviews was constructed on the basis of the results of the previous survey
results and of the research literature. The interview was started by asking the interviewee about
her or his view of the events and factors associated with the failure. The potential role of failure
factors found in the relevant literature were also examined among cases. Each of the
personal on-site interviews took from one to three hours. The interviews were recorded and
transcribed.
Sample characteristics
The twelve failed SMEs in the sample can be characterized as follows. They shared four
features: (1) size: SMEs, i.e. they employed fewer than 250 persons; (2) location: peripheral,
i.e. outside major cities and not in core areas; (3) performance: a firm has gone into
liquidation, i.e. it has ended its business, leaving behind unpaid creditors; and (4) ownership:
independent firms, not subsidiaries of other companies.
Most entrepreneurs of failed SMEs were men (92%) and owner-managers (75%). Among
owner-managers, two thirds of entrepreneurs were founders of these SMEs. The
entrepreneur’s average age was 47 years. Failed SMEs operated in several industry sectors,
most of them (83%) in manufacturing, and the rest (17%) in the service sector. The average
number of full-time personnel before the firm went out of business was 16 employees.
However, these SMEs had typically reduced the number of employees during their last year
of operation, and hence the number of employees did not indicate the highest number of
personnel during the firm’s life cycle.
The firms’ average age was 14 years. Half of the failed SMEs were founded by at least two
founders. However, interestingly, 58% of failed SMEs were owned by only one owner just
before the firm went out of business. More than half (58%) were family firms, and most (58%)
had consciously defined and specified goals and objectives. Moreover, there were failed
SMEs in each stage of development.
All failed SMEs, except one, had stayed near to their original business. One third had faced
at least once a situation where the firm’s existence, i.e. survival, had been threatened (apart
from the threat which had finally led the firm into liquidation). Two thirds had grown in terms
of turnover during recent years of operation. Also, two thirds had operated in markets where
demand had grown during recent years. Almost half of the failed SMEs (42%) were export
firms. One quarter had products which were considered unique in the markets. On average,
the most important customers accounted for 29% of the turnover for failed SMEs. One third
were subcontractors, and half bought subcontracting.
Data analysis methods
In data analysis, first the situations before the failure of the cases were briefly described. In
the description of the past development of the cases, the most important transitions, events
and decisions affecting firm performance were identified and described. In this searching
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process, the critical incident technique (Chell 1998; Flanagan 1954) was applied. Special
attention was paid by the interviewee or the researcher to the factors which showed a
potential or proven impact on firm performance. Though significant occurrences in the firms’
history were identified by respondents, the final evaluation of their importance was based on
the researcher’s interpretation.
In particular, the researcher looked for the factors affecting the development of firm failure.
The ways of responding to environmental changes and the strategic choices made by SMEs
were clarified. The methods of qualitative research used made it possible to acquire an in-depth
understanding of the events and processes that can explain a firm’s responses and choices
(see e.g. Mintzberg & Waters 1982: 466-468).
The interviews were coded and analyzed applying the grounded theory protocol (Glaser &
Strauss 1967; Strauss & Corbin 1990). First, the qualities emerging from the data were
identified and coded. After this conceptualization, the concepts were classified into
categories that emerged from the data. Next, connections between the categories and sub-
categories were analyzed. Finally the core category was selected, the story line was
explicated, and sub-categories were related to the core category. However, the case
descriptions, apart from one illustrative case, are not presented in this paper.
Results
Failure factors
Of the factors studied, typical of the entrepreneurs of the failed SMEs were lack of prior
experience as an entrepreneur, lack of marketing skills, lack of prior managerial experience,
and parents who were not entrepreneurs. Typical of the failed SMEs were a firm managed by
one individual, lack of planning, a firm founded by one individual, no use of business
advisors, dependency on one or a few big customers, small amount of products/services,
and unfavourable macro economic conditions. In addition, characteristic of many failed SMEs
was inadequate financing. The most common factors associated with SME failure among the
sample cases are presented in Figure 1. It seems that there are several factors that may
contribute to firm failure and they occur in different combinations in different firms. However,
the root causes of failure seem to be largely firm internal, and so under the management’s
control (cf. Boyle & Desai 1991).
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0 % 25 % 50 % 75 % 100 %
lack of prior experience as an entrepreneur
lack of marketing skills
lack of prior managerial experience
parents who were not entrepreneurs
a firm managed by one individual
lack of planning
a firm founded by one individual
no use of business advisers
dependence on one or a few big customers
small amount of products/services
unfavourable macroeconomic conditions
inadequate financing
Figure 1 – The most common factors associated with SME failure (% of failed SMEs)
Differences in failure factors between firm types
However, the sample of failed SMEs was not a homogeneous group of SMEs, though many
of the firms had some characteristics in common. It can be argued that due to the diversity of
SMEs, understanding the phenomenon can be advanced through grouping them into
homogeneous types of SMEs according to their characteristics. This makes it possible to
study SMEs in homogeneous groups in which the SMEs within the group are similar and
different from firms in other groups (e.g. Woo et al. 1991; Hornaday 1990).
In the following, the failed SMEs are studied in three clusters of SMEs: (1) stable,
independent firms with no growth aspirations, operating in local markets (n=4); (2) innovators
with continuous growth, operating in growing markets (n=5); and (3) efficiency-oriented
networkers with leapwise growth (n=3) (for cluster descriptions, see Pasanen 2004). The
distinction between the first and the other clusters reflects especially the difference between
non-growth and growth firms. The second distinction between the two clusters of growth
firms reflects the difference between incremental and organic, and leapwise, non-organic
growth, in particular.
When looking at different types of SMEs, it seems that there are differences in the factors
affecting SME failure between the clusters of SMEs. In the cluster of stable independent
firms, failed SMEs had risks in customers and the timing of investments. Demand was
unstable and unpredictable, and they were dependent on a few big customers. Big
investments in premises and production facilities just before the economic recession and the
collapse in demand were typical of these firms. As a matter of fact, unexpected and sudden
changes in the environment seem to be a major source of causes of SME failure in this
cluster.
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In the cluster of innovators with continuous growth, characteristic of the entrepreneurs of
failed SMEs was lack of prior managerial experience and of marketing skills. The failed
SMEs were led by one person, they had products tailored individually for each customer, and
their strategic planning and risk management were inadequate. They were vulnerable due to
their dependency on one provider of some critical resource, i.e. being a customer of one
bank only, or operating in a very narrow customer or product segment and in a very limited
market area. The general economic recession of the 1990s had a great impact on the
failures.
In the cluster of networkers with leapwise growth, in the case of the failed SMEs, the number
of potential customers in the market was very limited, and firms expanded their operation to a
new business area where they had no know-how.
The key findings concerning the factors associated with SME failure by clusters are
summarized in Table 1.
Table 1 – Summary of the factors associated with SME failure by clusters
Firm type Factors associated with failure
Stable independent
firms
• risks in customers
• risks in the timing of investments
• unstable and unpredictable demand
• unexpected and sudden changes in the environment
Innovators with
continuous growth
• products tailored individually for each customer
• inadequate strategic planning and risk management
• dependence on one provider of some critical resource
Networkers with
leapwise growth
• small number of potential customers in the market
• expansion into a new business area where the firms had no know-how
Failure trajectories
Turning now to the life cycles of failed SMEs, three types of failure trajectories were
identified: (1) failed borderline cases; (2) rapid collapse failures; and (3) failed seekers of
legitimacy.
Failed borderline cases were failures characterized by long term weak and insidious
development. Their existence had been under threat many times during their life cycle. They
had faced several severe problems during their life cycle, but survived until they faced the
last problem which led them failure. In fact, these firms had many major problems, which
they could not resolve and they caused a downward vicious spiral. In some point of time the
load of these vicious spirals exceeded the carrying capacity of the firm. However, the load
was accumulated during a long period of time. Typical of these failures were the lack of
strategic thinking, and lack of business-like thinking, in particular.
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Typical of rapid collapse failures was the fast development of the process leading to firm
failure. Often these firms had had no big problems before the one which caused the firm
failure. In these cases, failures were based on high risk-taking which exceeded the firm’s
carrying capacity. Excessive risk-taking combined with the firms’ low tolerance of
environmental disturbances was fatal to these firms. They had a wrong view of the
development of their environment in the future. The firms had made wrong decisions which
they could not cancel anymore. On the other hand, the firms had no plans for the difficult
incidents and circumstances, and so they were extremely vulnerable to the changes in their
environment.
Failed seekers of legitimacy were firms lacking of a real competitive advantage. During their
life cycle they sought their place in the markets, but were never able to achieve an alignment
with their environment and legitimacy in the markets. They tried to correct their course of
action several times but they could not find any way to compete successfully against their
competitors. These firms had a wrong view about how the firm will succeed in the future.
Moreover, compared with the other types of failed SMEs, these firms had the weakest
preconditions, in terms of e.g. weak customer basis or inadequate financing, for successful
business.
The key findings concerning the failure trajectories are summarized in Table 2.
Table 2 – Summary of the failure trajectories
Failure trajectory Typical characteristics
Failed borderline
cases
• long term weak and insidious development
• many accumulative unresolvable major problems caused a downward vicious spiral
• lack of strategic and business-like thinking
Rapid collapse
failures
• fast development of firm failure without previous major problems
• excessive risk-taking, but low tolerance of environmental disturbances
• wrong view of the development of environment in the future, wrong and irreversible
decisions, and no plans for unexpected environmental development
Failed seekers of
legitimacy
• firms lacking of a real competitive advantage
• never able to achieve an alignment with their environment and legitimacy in the
markets
• wrong view about how the firm will succeed in the future
• weak preconditions for successful business
An illustrative case
In order to achieve a more comprehensive view of the failed SMEs, one illustrative case
description is presented below. The example firm represents the cluster of stable
independent firms in terms of firm type and failed borderline cases in terms of failure
trajectory.
The situation before failure. The firm produced tailor-made metallic roofing sheets. Customers were hardware
stores, wholesale firms, building firms, and consumers. Production was carried out almost exclusively by the
firm itself. Time, i.e. rapid delivery of the tailor-made products, was the firm’s most important source of
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competitive advantage. The firm could deliver tailor-made products to customers in two days, whereas its
main competitors took two weeks. The main competitors were big firms with a strong resource base, which
appeared in their aggressive marketing, for instance. The firm was highly dependent on the economic activity
in the construction sector.
Life cycle. The firm was founded in the late 1950s by the entrepreneur’s father. Travelling abroad, he had
come across metallic roofing sheets which could be installed without using a professional plater. After
returning home, he developed the first machine in Finland for producing such metallic roofing sheets. He had
seen a business opportunity, a clear niche in the market for such products. At the beginning, sales were
made through wholesale firms because they dominate in the building material trade, but in the last years
more than 50% of products were sold directly to consumers. Research and development had been
continuous. Old machines had been improved or replaced by new ones every other year, to increase
production speed. In the early days, products were standard, but a dramatic change was made in the mid-
1960s, since when products were tailor-made for each customer. Starting in the 1970s, metallic roofing
sheets were used in constructing the walls of factories, and later also in the walls of dwelling houses and
office buildings, where they are still much used today.
The entrepreneur had run the family firm since 1980, when his father had retired. In the 1980s, new
machines had been bought and production lines had been renewed to increase production speed. The year
1983 was a turning point in the field because of the launch of a new production technique. The firm had been
the second in Finland to start producing tile-patterned metallic roofing sheets which gave roofs a new look
and were a real success in the market. The entrepreneur compared it with “a transition from the era of the
telephone to the era of the mobile phone”. The product range expanded considerably, and marketing had
become more focused. Previous investments had been made using cash flow financing, but in the early
1990s, just before the beginning of the general economic recession, the firm had had to invest in new
production facilities using borrowed capital.
In the early 1990s, the firm started exporting metallic roofing sheets to the Baltic countries, Russia and
Central Europe. Soon after, some Finnish competitors also expanded their market areas into the same areas,
and severe price competition started. Three years later, the firm had to withdraw from foreign markets. In the
1990s, the field changed very much as a result of acquisitions, mergers and other restructuring in the industry
sector. This meant that new contacts had to be established, with suppliers for example. The number of
competitors had been reduced but the new or mergered competitors had become bigger and stronger than
ever before.
In the mid-1990s, the firm bought an installation firm. At the beginning, they had some good projects, and the
size of the workforce rose rapidly from two to seven men. However, very soon the profitability of the
installation business collapsed due to the oversupply of assemblers from all around the country who were
willing to do the work for “ridiculously” low prices, as the entrepreneur put it. After three years of operation,
the installation unit was closed down. During this three year period, personnel relations suffered because of
the wage differences between assemblers and employees in the workshop, and this caused dissatisfaction
among employees in the workshop. Both the installation business and exporting turned out to be unprofitable.
Another problem had been caused by the steel supplier, who had guaranteed the quality of the steel. There
were some problems with the quality, and consumers directed their complaints to the firm and not to the
supplier, who, as a matter of fact, was responsible. This caused the firm a lot of extra work and probably
influenced negatively the firm’s reputation in the market.
A high seasonal variation in demand had caused a major problem for the firm. In winter, demand was low,
but in summer there were more orders than the firm could handle. In the last years of the firm’s operation, the
production of the production lines partly replaced the lower demand in winter. The production of the
production lines was rare among the competitors. The production lines were sold to customers in the Baltic
countries, Poland and Russia.
The entrepreneur reported that his mental resources were running out in the early 1990s. He was tied up in
every-day business and routines, and had no time for strategic thinking and planning. In fact, he was facing
one problem after another, particularly concerning the tax authorities. For many consecutive years, certain
writeoffs had been accepted by the tax authorities only after appeal, and the entrepreneur felt that some of
the decisions were unjust. Consequently, he had lost his faith in justice. Finally, he neglected to deal with
some matters and this led to the situation where the tax authorities got the upper hand.
During the economic recession, the firm had also had hard times with credit losses arising from the failure of
many customer firms. In addition, the entrepreneur had not been capable of laying people off, keeping all
personnel throughout the year, even during winter time when there was no work for all of them, for several
reasons. On the one hand, he had known the people a long time and wanted to take care of them. On the
other hand, once let go it was by no means sure that they would come back when the high season started.
However, it seems that the entrepreneur was not sufficiently business-like in this matter. As he said:
“Employing people is expensive”. It seems that he acted more on the basis of feelings than sense, and
treated the personnel as a big family. He described his feelings in the 1990s thus: “I was running up a steep
sand bank but my feet were sliding down all the time and I was getting nowhere”.
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The case was characterized by the following factors, which often associated with firm failure:
the entrepreneur lacked prior experience as an entrepreneur and prior managerial
experience, and the firm was managed by one individual, lacked planning, did not make use
of business advisors, and operated in unfavourable macroeconomic conditions. Moreover,
the firm had risks in customers (credit losses) and the timing of investments (big investment
in new production facilities using borrowed capital just before the economic recession).
Demand was also unstable (high seasonal fluctuations) and unpredictable (rapid decrease in
demand due to the general economic recession).
The firm’s long-term weak and insidious development was related to the lack of strategic
thinking and of business-like thinking (e.g. not laying off employees). The entrepreneur was
tied up in routine tasks and had no time for strategic thinking and planning. Moreover, there
appeared to be some resistance to renewal, which was revealed in the way of thinking “we
have always done things this way and survived, so why shouldn’t we do things this way also
in the future?” The problems with the tax authorities over several consecutive years also ate
up the entrepreneur’s mental resources. Moreover, the market position of the firm was highly
challenging: it had to keep ahead of the giants (major competitors) all the time. The attempts
to find new business directions (exporting and installation business) turned out to be
unprofitable.
Several severe problems accumulated in the 1990s, leading to a downward vicious spiral (for
main problems and related adverse processes, see Table 3). The firm survived until the end
of the 1990s, when the weight of these problems exceeded the carrying capacity of the firm
and the adverse development led to a shortage of money and liquidation. However, the load
was accumulated over a long period of time. Moreover, typical of this failure was the lack of
strategic thinking, and lack of business-like thinking.
Table 3 – Main problems and related adverse processes
Main problems Related adverse processes
Lack of strategic
thinking
• the firm was managed by one individual ? tied up in routine tasks ? no time for
strategic thinking and planning
Lack of business-like
thinking
• acting more on the basis of feelings than sense ? the decision ‘not laying off
employees’ ? continuous costs but no incomes
• the way of thinking “we have always done things this way and survived, so why
shouldn’t we do things this way also in the future” ? the entrepreneur treated the
personnel as a big family
• social pressures to continue the family firm
Weaknesses in
strategic
management and
inability to adapt to
rapid environmental
changes
• a significant investment with borrowed capital was made just before the economic
recession ? poor timing of investments ? collapse of securities and market demand
? rapid decrease in revenues? problems in repayment of the loan and interests
• general economic recession ? rapid decrease in demand ? liquidation of many
customer firms ? sudden credit losses
• general economic recession ? industry restructuring ? the firm had to try to keep
up with giants (competitors) with superior market power and to find new cooperation
partners (e.g. suppliers) and negotiate new contracts with them
Challenging nature of • coping with high seasonal fluctuations ? no work for all personnel in winter ? the
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business decision ‘not laying off employees’ ? continuous costs but no incomes
Problems with public
authorities
• the firm had continuous problems with the tax authorities ? it was burdened with
financially unfavourable taxation decisions ? the entrepreneur’s mental resources
were running out ? oversights in tax issues ? costly consequences
Unsuccessful
attempts to expand
the scope of the
business
• starting exporting ? competitors also expanded their market areas into the same
areas ? severe price competition ? exporting turned out to be unprofitable ?
withdrawal from foreign markets
• purchase of the installation business ? the atmosphere in the firm suffered from
conflicts between assemblers and employees in the workshop
• oversupply of assemblers after the purchase of the installation business ?
profitability of the installation business collapsed ? turned out to be unprofitable ?
the installation unit was closed down
Problems with the
supplier
• supplier’s quality problems ? affected negatively the firm’s reputation ? loss of
customers
The case clearly shows that there were several inter-related factors and adverse processes
affecting firm failure. In this case, credit losses, costly consequences of neglecting taxation
matters, and the decision to ‘not lay off employees’ finally led to a shortage of money and
liquidation. However, as we can see, there were both firm-internal issues (such as
weaknesses in strategic management and their consequences) and firm-external issues
(such as unexpected and sudden changes in the environment and their consequences)
affecting firm failure. There were wrong strategic choices made by the entrepreneur as well
as stochastic factors which made it very difficult for the firm to survive.
Discussion
Despite the fact that SMEs in different industry sectors differ from each other in numerous
and significant ways, it was possible to identify similarities among the failed firms. It seems
that some of these similarities are common to failed SMEs in general, and some are more
cluster specific. On the other hand, each failure has its own story. Moreover, the failure
trajectories crossed the clusters.
On the basis of the empirical results, one or a few major factors and processes seem to
cause firm failure. The factors contributing to firm failure are often closely related to the
causes of decline and crises. There was some evidence of a close relationship of factors
causing a threat and failure, i.e. one severe problem may be a major cause of threat, and the
co-existence of such problems may lead to SME failure. Failure factors and processes also
seem to be inter-related. In many cases, the lack of strategic management (Boyle & Desai
1991; Jennings & Beaver 1997) was strongly associated with SME failure. However, it may
also be that not all cases could have been saved from liquidation even by means of thorough
strategic management, because of the sudden, unexpected and large-scale external shocks
they faced in their environment.
Often, there was one initial triggering reason which, together with other problems, caused a
downward vicious spiral generating new problems (cf. Hambrick & D’Aveni 1988). Thus,
failure seems to generate self-reinforcing downward spirals. When a vicious spiral has
begun, one problem feeds the creation of others and stopping such development becomes
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more and more difficult. Several very different factors may be involved in these processes,
and thus a holistic approach in studying them is required. Also, there can be several
simultaneous adverse processes interacting with each other. However, in some cases the
causes of firm failure seem to be highly situation specific and the process leading to failure
progressed rapidly. Moreover, in some cases there were not proper preconditions for
successful business, and so the failure could have been anticipated already in early stages
of the firm’s life cycle.
In general, a firm’s inability to adjust to changing circumstances can be seen to be the
reason for failure. Many firms are not prepared for potential external shocks in their
environment. Anticipation of and preparation for potential threats could have helped very
much in many cases. There were also failed cases with major problems originating from the
lack of business-like thinking. Several studies have shown that factors related to poor
management, e.g. managerial inadequacy, incompetence, inefficiency, and inexperience, are
frequently causes of firm failure, in the small firm context particularly (Haswell & Holmes
1989). Moreover, poor management issues are often related to poor financial conditions,
inadequate accounting records, and lack of good managerial advice. However, financial
problems are often due to a lack of planning. In the stage of rapid growth, in particular,
inability to manage growth and change may lead to firm failure (MacMillan et al. 1985;
Hambrick et al. 1985). Many times, the root cause of failure can be traced to problems in
management.
Relatively little research has focused on established firm failure in the SME context and in
peripheral locations, in particular. However, information from failed SMEs can significantly
expand our knowledge of SME performance, and so this exploratory study of failed SMEs in
peripheral locations can be justified. Future research into failed SMEs calls for multisource
interviews, i.e. interviews with entrepreneurs, members of management teams or key
employees, financiers, cooperation partners, etc. As Zacharakis et al. (1999), for instance,
show there are differing perceptions of the causes of firm failure between entrepreneurs and
venture capitalists. It is worth noting that there may be several explanations for firm failure,
not only one right answer to the question of why a firm failed. It has been found that several
factors and processes may affect the creation of vicious spirals, and so in-depth studies of
failure processes, i.e. of the factors and their causal relationships are highly important.
Moreover, it would be useful to study these issues by using larger sample of SMEs. In this
study, the small number of cases was a central problem for the investigation of cluster-
specificity of the factors affecting SME failure.
Finally, the results can be useful for entrepreneurs and those who are fostering
entrepreneurship and SME development. In studying the factors affecting SME performance,
the investigation has produced knowledge which is valuable for nascent and acting
entrepreneurs and those in charge of the firm. It seems likely that many SMEs and their
stakeholders could learn from others’ failures. Venture capitalists, financiers, and consultants
can take advantage of these results. Moreover, on the basis of the results, organizations
fostering entrepreneurship and SME development can better direct their actions and develop
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their products, advisory services and education. For those who are responsible for public
SME policy, the results provide some guidelines for decision making and the allocation of
public actions, as well as an opportunity to evaluate the present SME policy and its
developmental needs.
E-mail of corresponding author: [email protected]
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