In Search Of Factors Affecting Sme Performance The Case Of Eastern Finland

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Abstract explain in search of factors affecting sme performance the case of eastern finland.

KUOPION YLIOPISTON JULKAISUJA H. INFORMAATIOTEKNOLOGIA JA KAUPPATIETEET 1
KUOPIO UNIVERSITY PUBLICATIONS H. BUSINESS AND INFORMATION TECHNOLOGY 1

MIKA PASANEN

In Search of Factors Affecting SME Performance

The Case of Eastern Finland

UNIVERSITY OF KUOPIO

KUOPION YLIOPISTON JULKAISUJA H. INFORMAATIOTEKNOLOGIA JA KAUPPATIETEET 1
KUOPIO UNIVERSITY PUBLICATIONS H. BUSINESS AND INFORMATION TECHNOLOGY 1

MIKA PASANEN

In Search of Factors Affecting SME Performance

The Case of Eastern Finland

Doctoral dissertation

To be presented by permission of the Faculty of Business and Information Technology of
the University of Kuopio for public examination in Auditorium, Microteknia building,
University of Kuopio, on Saturday 29
th
November 2003, at 12 noon

Department of Business and Management
University of Kuopio

KUOPION YLIOPISTO

KUOPIO 2003

Distributor: Kuopio University Library
P.O. Box 1627
FIN-70211 KUOPIO
FINLAND
Tel. +358 17 163 430
Fax +358 17 163 410
www.uku.fi/kirjasto/julkaisutoiminta/julkmyyn.html

Series editors: Professor Markku Nihtilä, Sc.D.
Department of Mathematics and Statistics

Assistant Professor Mika Pasanen, Lic.Sc.
Department of Business and Management

Author’s address: Department of Business and Management
University of Kuopio
P.O. Box 1627
FIN-70211 KUOPIO
FINLAND
Tel. +358 17 163 982
Fax +358 17 163 967
E-mail: [email protected]
www.uku.fi/laitokset/yrit

Supervisors: Professor Mauri Laukkanen, Ph.D.
Department of Business and Management
University of Kuopio

Professor Hannu Niittykangas, Ph.D.
School of Business and Economics
University of Jyväskylä

Reviewers: Professor Frank Hoy, Ph.D.
College of Business Administration
University of Texas at El Paso, USA

Professor Asko Miettinen, Ph.D.
Institute of Industrial Management
Tampere University of Technology

Opponents: Professor Frank Hoy, Ph.D.
College of Business Administration
University of Texas at El Paso, USA

Professor Asko Miettinen, Ph.D.
Institute of Industrial Management
Tampere University of Technology

ISBN 951-781-980-3
ISSN 1459-7586

Kopijyvä
Kuopio 2003
Finland
Pasanen, Mika. In Search of Factors Affecting SME Performance: the Case of Eastern
Finland. Kuopio University Publications H. Business and Information Technology 1.
2003. 338 p.
ISBN 951-781-980-3
ISSN 1459-7586

ABSTRACT

The objective of this study was to identify factors affecting small and medium
enterprise (SME) performance in peripheral locations. The study was carried out in the
field of strategic management. Previous research into business success and failure does
not provide a comprehensive explanation for SME performance. Particularly little
research has been focused on factors affecting the performance of established SMEs in
peripheral regions.
The empirical data were primarily based on an extensive mail survey and in-
depth case interviews. A survey was made of entrepreneurs of 145 successful
independent SMEs in Eastern Finland operating in the manufacturing, business
services, and tourism sectors. In matched case studies, successful and failed cases were
compared. In data analysis, both qualitative and quantitative methods were applied.
Analysis of all successful SMEs revealed that they constitute a heterogeneous
group with a large variety of characteristics, though they also have some common
characteristics. As a result of clustering the successful SMEs according to their growth
mode and strategies three distinct clusters emerged: (1) stable independent survivors;
(2) innovators with continuous growth; and (3) networkers with leapwise growth.
Moreover, the study revealed that SMEs whose existence has never been threatened
and those that have sometime encountered such a situation differ in significant ways.
Also, there were similarities among failed firms, and among successful firms: some of
these were common to all failed or successful firms, while some were cluster specific.
It seems that SME performance can be affected by a variety of interrelated
factors which should taken into consideration in order to achieve success and to avoid
failure in business. The findings suggest that there are several types of successful
SMEs. More importantly, the study revealed the different “success formulas”, i.e. sets
of typical behaviors in each cluster. Comparisons between non-threatened and
threatened SMEs and between successful and failed SMEs provided valuable
information by increasing our understanding of the factors affecting SME
performance. Several theoretical and practical implications are discussed. Nascent and
acting entrepreneurs, organizations fostering SME development, financiers, public
policy makers, and other stakeholders of SMEs can learn from the results. Suggestions
for further research are presented.

Universal Decimal Classification: 65.011.4, 65.016, 65.017.2/.3, 658.11
Thesaurus of Sociological Indexing Terms: performance; success; development;
failure; strategies; small businesses; enterprises; Finland

ACKNOWLEDGEMENTS

This doctoral dissertation is largely based on the research carried out in the ESF
project “Savolaiset selviytymisstrategiat”. The project explored successful strategic
behavior patterns of SMEs in the Northern Savo region in Eastern Finland, and it was
carried out in 1997-2000 at the University of Kuopio’s Department of Business and
Management. The aim of the project was to provide information that could help
increase the competitiveness of local SMEs.
I thank all who have helped me in writing this doctoral dissertation. Firstly I
express my gratitude to my supervisors, Professor Mauri Laukkanen and Professor
Hannu Niittykangas, for their strong support and advice, particularly in the first stages
of this study. I thank the reviewers and opponents, Professor Frank Hoy from the
University of Texas at El Paso and Professor Asko Miettinen from the Tampere
University of Technology, for their valuable comments. The Department of Business
and Management, headed by Professor Markku Virtanen and previously by Professor
Mauri Laukkanen and Professor Hannu Niittykangas, has provided good working
facilities. The personnel of the department has always been very cooperative and
helped in several ways.
Discussions with several professors and other experts in the field have
provided useful insights. I am especially grateful for the discussions with Professors
Allan Gibb (Durham University Business School), David Storey (University of
Warwick Business School), Bengt Johannisson (Växjö University School of
Management and Economics/SIRE), David Kirby (Middlesex University Business
School), Olav Spilling (Norwegian School of Management BI), and Gordon Wright
(Purdue University/Krannert Graduate School of Management). My participation in
the European Doctoral Program in Entrepreneurship and Small Business Management
was a valuable experience, providing new “tools” for research work. Also, the
valuable comments presented by the reviewers and opponents of my licentiate thesis,
Professor Matti Koiranen (University of Jyväskylä School of Business and Economics)
and Dr. Antero Koskinen, clearly promoted my progress with the work.
I am grateful to Veikko Jokela of the Computing Centre for his gui dance in
statistical analysis, and to Vivian Paganuzzi, MA, of the Language Centre for his
valuable contribution in checking the language of this dissertation and making the text
more fluent. I warmly thank Sanna Tihula, MSc, Reija Huttunen, MSc, Tarja
Miettinen, MSc, and Rainer Melander, MSc, for their assistance in different stages of
the study. Local SMEs cooperated generously and they have made the empirical
research possible.
Tentative results have been presented earlier in the following international
arenas: The 20
th
Babson Entrepreneurship Research Conference held at Babson
College in Wellesley, MA, USA, June 8-10, 2000 (Pasanen et al. 2000); the 11
th

Nordic Conference on Small Business Research held at Aarhus Business School in
Aarhus, Denmark, June 18-20, 2000 (Pasanen 2000b); the 21
st
Babson
Entrepreneurship Research Conference held at Jönköping International Business
School in Jönköping, Sweden, June 14-16, 2001 (Pasanen et al. 2001); and the 12
th

Nordic Conference on Small Business Research held at the University of Kuopio in
Kuopio, Finland, May 26-28, 2002 (Pasanen 2002). Some of the results has also been
published (in Finnish) in the author’s licentiate thesis (Pasanen 1999; 2000a).
For financial support, I am indebted to the Liikesivistysrahasto/Kauppaneuvos
Lauri Hallmanin rahasto, Vuorineuvos Tekn. ja Kauppat.tri H.C. Marcus Wallenbergin
Liiketaloudellinen Tutkimussäätiö, Pienyrityskeskuksen tukisäätiö, Kuopion
yliopistosäätiö, and Kuopion yliopiston rehtorin rahasto.
I am also thankful to my sister and brother and their families for being
interested in my work. Finally, I owe my warmest gratitude to my parents for their
endless support.

Mika Pasanen

CONTENTS

1 INTRODUCTION ……………………………………………………..………..13
1.1 Relevance of the topic 13
1.2 Objectives and limitations of the study 18
1.3 Philosophical ground of the study 21
1.4 Outline of the study 22

2 FOUNDATIONS OF SME PERFORMANCE …….………………...………..25
2.1 SME performance: success and failure 25
2.2 Theoretical perspectives on firm performance 28
2.3 The firm and its environment 33
2.4 Strategy and the firm’s strategic choices 34
2.5 Resources and their flexibility 41
2.6 Summary and conclusions 46

3 FACTORS CONTRIBUTING TO SME SUCCESS AND FAILURE …........49
3.1 Previous research on SME performance 49
3.2 Studies of factors affecting SME success 50
3.3 Studies of factors affecting SME growth 56
3.4 Studies of factors affecting SME failure 63
3.5 Studies of factors affecting SME decline and recovery 67
3.6 Comparative studies of success and failure factors 70
3.7 Summary and conclusions 71

4 EMPIRICAL RESEARCH METHODS ……………………………..………..75
4.1 Empirical research approach 75
4.2 Survey 78
4.2.1 Data collection methods 78
4.2.2 Materials: sample characteristics 80
4.2.3 Data analysis methods 83
4.3 Case studies 84
4.3.1 Data collection methods 84
4.3.2 Materials: characteristics of the cases 86
4.3.3 Data analysis methods 88

5 CHARACTERIZING SUCCESSFUL SMES ……………………..……….....89
5.1 Characteristics of entrepreneurs 89
5.2 Characteristics of the SMEs 91
5.3 Life cycles 96
5.4 Strategic choices 100
5.5 Success and survival factors 107
5.6 Summary and conclusions 111

6 A TAXONOMY OF SUCCESSFUL SMES …………………………...…….119
6.1 A need for classification 119
6.2 Clustering successful SMEs 120
6.3 Characteristics of entrepreneurs 123
6.4 Characteristics of the SMEs and their life cycles 125
6.5 Strategic choices 129
6.6 Success and survival factors 134
6.7 Summary and conclusions 138

7 A COMPARISON OF THREATENED AND NON-THREATENED
SMES ……………………………………………………………….…………..145
7.1 Differences between threatened and non-threatened SMEs 145
7.2 Stable independent survivors 148
7.3 Innovators with continuous growth 150
7.4 Networkers with leapwise growth 151
7.5 Summary and conclusions 153

8 CASE STUDIES: COMPARISONS OF FAILED AND SUCCESSFUL
SMES ………………………………………………………..………………….157
8.1 A description of failed SMEs 157
8.2 Stable independent survivors 159
8.2.1 Metal industry firms 159
8.2.2 Bookkeeping agencies 167
8.2.3 A comparison of failed and successful stable independent survivors 172
8.3 Innovators with continuous growth 173
8.3.1 Firms in the electronics industry 173
8.3.2 Electro-technical industry firms 179
8.3.3 Software firms 184
8.3.4 A comparison of failed and successful innovators with continuous
growth 190
8.4 Networkers with leapwise growth 190
8.4.1 Metal industry firms 190
8.4.2 A comparison of failed and successful networkers with leapwise
growth 196
8.5 Lessons from the cases 197
8.6 Summary and conclusions 202

9 CONCLUDING DISCUSSION………………………………………….…….207
9.1 The main results and conclusions 207
9.1.1 Goal setting and previous research on SME performance 207
9.1.2 The empirical study of SME performance 209
9.2 Theoretical and methodological implications 227
9.3 Managerial implications 230
9.4 Policy implications 232
9.5 Evaluation of the study 235
9.6 Suggestions for further research 239

REFERENCES ……………………………………………………...……………..243

APPENDICES ………………………………………………………...……….......279
1 Questionnaire 279
2 List of variables 291
3 Results of the factor analysis 295
4 Differences between the clusters 299
5 Results of the discriminant analyses 303
6 Differences between threatened and non-threatened SMEs 311
7 Frameworks for interviews 319
8 Case comparisons 327

LIST OF FIGURES

5.1 Size of the SMEs 92
5.2 Age of the SMEs 93
5.3 Ownership of the SMEs 95
5.4 Life cycle stages of the SMEs 96
5.5 Factors affecting the fall in turnover of the SMEs 98
5.6 Internationalization of the SMEs 101
5.7 The ways of direct export 102
5.8 Innovativeness and technology of the SMEs 103
5.9 Specialization of the SMEs 105
5.10 Types of interfirm cooperation 106
5.11 Rank order of cooperation partners by their importance for the firm 107
5.12 Unstructured success factors 110
5.13 Survival factors 111
6.1 Characteristics of entrepreneurs in the cluster of stable independent
survivors 124
6.2 Characteristics of entrepreneurs in the cluster of innovators with continuous
growth 124
6.3 Characteristics of entrepreneurs in the cluster of networkers with leapwise
growth 124
6.4 Characteristics of stable independent survivors and their life cycles 126
6.5 Characteristics of innovators with continuous growth and their life cycles 127
6.6 Characteristics of networkers with leapwise growth and their life cycles 128
6.7 Strategic choices for stable independent survivors 130
6.8 Strategic choices for innovators with continuous growth 132
6.9 Strategic choices for networkers with leapwise growth 133
9.1 Factors associated with SME failure 224
A5.1 Canonical discriminant functions 304

LIST OF TABLES

2.1 A comparison of strategic choice and environmental selection perspectives 29
4.1 Number of respondents and response rates by industry sectors 81
4.2 Correlations of performance measures 82
4.3 Characteristics of the cases 87
5.1 Entrepreneurs’ basic education 89
5.2 Entrepreneurs’ further education 90
5.3 Functional areas of entrepreneurs’ prior work experience 90
5.4 The growth factors of the SMEs by the origin of growth 97
5.5 Market areas of the SMEs 101
5.6 Cooperation experiences with different partners 107
5.7 The most important structured success factors 108
5.8 The least important structured success factors 109
6.1 A description of the clusters 121
6.2 Classification results 122
6.3 Statistically significant differences between the clusters 123
6.4 Univariate analysis of variance for success factors 136
6.5 Rankings of unstructured success factors by clusters 137
6.6 Rankings of survival factors by clusters 138
6.7 A comparison of configurations 142
7.1 Statistical differences between threatened and non-threatened SMEs 147
7.2 Statistical differences between the groups in the cluster of stable independent
survivors 149
7.3 Statistical differences between the groups in the cluster of innovators with
continuous growth 151
7.4 Statistical differences between the groups in the cluster of networkers with
leapwise growth 153
9.1 Summary of the characteristics of successful SMEs 217
9.2 Summary of the strategic behavior of the three types of successful SMEs 220
9.3 Summary of the factors associated with SME success and failure by
clusters 226
A3.1 Means and standard deviations of success variables 295
A3.2 Factor analysis with principal component extraction and varimax rotation:
success factors 296
A4.1 The main differences between the clusters 299
A5.1 Eigenvalues 303
A5.2 Wilks’ Lambda 303
A5.3 Standardized canonical discriminant function coefficients 303
A5.4 The correlations between the discriminant function and the discriminating
variables 303
A5.5 Functions at group centroids 304
A5.6 Classification results 304
A5.7 Eigenvalue 305
A5.8 Wilks’ Lambda 305
A5.9 Standardized canonical discriminant function coefficients 305
A5.10 The correlations between the discriminant function and the discriminating
variables 305
A5.11 Function at group centroids 305
A5.12 Classification results 306
A5.13 Eigenvalue 306
A5.14 Wilks’ Lambda 306
A5.15 Standardized canonical discriminant function coefficients 306
A5.16 The correlations between the discriminant function and the discriminating
variables 307
A5.17 Function at group centroids 307
A5.18 Classification results 307
A5.19 Eigenvalue 307
A5.20 Wilks’ Lambda 307
A5.21 Standardized canonical discriminant function coefficients 308
A5.22 The correlations between the discriminant function and the discriminating
variables 308
A5.23 Function at group centroids 308
A5.24 Classification results 308
A5.25 Eigenvalue 309
A5.26 Wilks’ Lambda 309
A5.27 Standardized canonical discriminant function coefficients 309
A5.28 The correlations between the discriminant function and the discriminating
variables 309
A5.29 Function at group centroids 309
A5.30 Classification results 309
A6.1 Differences between threatened and non-threatened SMEs in the whole
sample 311
A6.2 Differences between threatened and non-threatened SMEs in the cluster of
stable independent survivors 313
A6.3 Differences between threatened and non-threatened SMEs in the cluster of
innovators with continuous growth 315
A6.4 Differences between threatened and non-threatened SMEs in the cluster of
networkers with leapwise growth 317
A8.1 A comparison of stable independent survivors in the metal industry 327
A8.2 A comparison of stable independent survivors in the field of bookkeeping
agencies 329
A8.3 A comparison of innovators with continuous growth in electronics 331
A8.4 A comparison of innovators with continuous growth in the electro-technical
industry 333
A8.5 A comparison of innovators with continuous growth in the field of software
firms 335
A8.6 A comparison of networkers with leapwise growth in the metal industry 337
13

1 INTRODUCTION

1.1 Relevance of the topic

Research into small and medium sized enterprises (SMEs) and entrepreneurship has
grown strikingly during the last decade. A huge majority of firms worldwide are
SMEs, and they play a significant role in the economy. Consequently, the performance
of the SME sector is closely associated with the performance of the nation. In Finland,
for instance, more than 99% of all firms are SMEs, i.e. firms with fewer than 250
employees, and they constitute more than one half of all firms, if measured by the
number of personnel (61%) or by turnover (51%) (Statistics Finland 2002; cited by
Federation of Finnish Enterprises 2003). Moreover, SMEs make a remarkable
contribution to regional economic development. They are often the only feasible
engines of development, especially in peripheral regions. They generate societal
growth in terms of new jobs and revenues. SMEs create innovations, and they form
flexible production networks.
The secret of firm success has long fascinated people, but most studies have
focused on large companies. It has also been claimed that there are no secrets, because
if there were, every firm would find out what they are and they would not be secrets
anymore. However, as we know, some firms succeed and others fail. This study
focuses on factors affecting SME performance. SME success is often closely
associated with firm growth (e.g. Johannisson 1993a), so this study concentrates
largely, but not solely, on growth firms. In western countries in the last decade the
major proportion of net new jobs was created by small firms (e.g. Frank & Landström
1997: 3; see also Storey 1994; Davidsson & Delmar 1998). At the same time, much
interest in the SME sector has been targeted at growing firms in particular, and this
focus is clearly seen in policy-making, in small firm support, and in related research.
To date, a number of studies have dealt with firm growth and development. In
fact, the research community largely shares the view that growth SMEs have a special
importance in the economy (see e.g. Storey 1994). In Finland, the SME sector was the
only sector increasing net new jobs in the 1990s. The number of jobs was decreasing at
the same time in both the large company sector and the public sector (cf. Spilling
1996). It is argued that a relatively small proportion of all small firms are responsible
for the major part of the small firm contribution to net new jobs (Storey 1994; Storey
et al. 1987; Birch et al. 1993). At the same time, in Finland, for instance, the role of
14
Nokia as a new job creator has been remarkable, even though the number of jobs in the
large company sector has been falling. It is important to keep in mind that changes in
the production volume of large companies may often cause significant repercussions in
the SME sector.
Most of the new jobs are created by existing, not new, SMEs (see e.g.
Davidsson et al. 1993). Fast-growing small firms have been described as ‘gazelles’,
‘fliers’, ‘growers’ and ‘winners’, and the targeting of effort towards them has been
described as ‘picking’, ‘stimulating’, or ‘backing’ winners (see e.g. Gibb 1997b; Freel
1998; Beaver & Jennings 1995). However, more recently, the role of fast-growing
small firms has been questioned, and the issue is known as the ‘mice vs. gazelles’
(Birch et al. 1993) or ‘flyers vs. trundlers’ (Storey 1994) debate. In other words, which
of these actually has the major impact on net employment (Davidsson & Delmar
1998)?
A critical precondition for growth is firm survival. However, few firms have
succeeded in avoidi ng threats in their way, and only a very small fraction of SMEs
avoid significant problems in the long run. The study of these SMEs might reveal how
difficulties could be avoided. Many firms face, at least once, a situation where their
existence is threatened (Pasanen 2000). From a study of firms which have faced a
crises and survived, it may be possible to discern those factors that led the firm into
difficulties, and discover how these SMEs have survived and achieved success in their
subsequent development.
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 have never even achieved it.
In this study, failure means that a firm has gone into liquidation, i.e. it has ended its
business, leaving behind unpaid creditors. For instance, in Finland in 1997, more than
half (52%) of the firms that closed down had survived less than four years (Statistics
Finland 1998: 8; see also Mustaniemi 1997). It could be assumed that much could be
learned from failed firms, but to date comparison of the success and failure factors has
been rare in research. It has been found that entrepreneurs’ chances of financial success
are substantially greater than chances of loss (Dennis & Fernald 2001), but not nearly as
favourable as new firm owners seem to believe (Cooper et al. 1988).
Previous studies dealing with the conditions of successful business have
focused on large companies rather than SMEs. However, 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
its business areas, but this is not usually possible in a single-business firm. The options
15
for responding are limited by the firms’ resources and strategic choices as well as by
the opportunities offered by the industry and location. Those ways may also differ
between the development stages of the firm.
Previous studies on SME performance have also focused on the success of
new ventures rather than on existing SMEs and on the factors behind their longevity
and growth (e.g. Tsai et al. 1991; Duchesneau & Gartner 1990; Keeley & Roure 1990;
Roure & Keeley 1990; see also Cooper 1993). However, 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). As a matter of fact, as Mustaniemi (1997) found in her study of real
enterprise birth in Finland, new firms employed only a few employees in their first
three years. Moreover, her analysis, based on the business register of Statistics
Finland, showed that only 63% of all enterprise openings in manufacturing and 54% in
the retail trade could be classified as real births.
This suggests that greater attention should be paid to established SMEs. They
have also invariably proven extremely resilient to fluctuations in the economy over
time (North et al. 1992; Stewart & Gallagher 1985; see also Smallbone et al. 1993b).
Moreover, it is a major challenge for policy-makers to help firms to develop the
attributes and business practices which increase firms’ survival chances and their
ability to grow (cf. Smallbone & North 1995). Moreover, as Reynolds et al. (1993)
have argued, governments should invest more time and resources in encouraging the
survival and growth of established firms rather than encouraging the formation of ever
more new firms, many of which are born to die (see also North & Smallbone 1996).
Moreover, few studies have focused on the foundations of SME performance
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). The context often
has a critical role: what works in one context will not necessarily work in another. This
means that factors that lead to success in one context may lead to failure in another
(Low & Abrahamson 1997).
However, the environment of firms has changed over the years and is
changing continuously. Business is done at global level now more than ever before. It
means that competition is also increasing in local markets. Such development is also
supported by public policies, e.g. the intention to eliminate or mitigate the factors
limiting competition within the European Union (EU). At the same time, customers’
needs may change rapidly, and this shortens the life cycle of products. Changes in
demand require a quick response and continuous product development. Rapid
technological change affects the methods of production as well as product
development. Paradoxically, on the one hand customers prefer individualized products,
16
but on the other hand customers’ habits are becoming more uniform in western
countries.
Most studies of strategic management and entrepreneurship have focused on
investigating a very limited set of variables, and many investigators (e.g. O’Farrell &
Hitchens 1988; Sandberg & Hofer 1987; McDougall et al. 1994; Landström & Sexton
2000: 437) have called for a more integrated and holistic approach. This study
approaches holistically and extensively to factors affecting SME performance.
However, the scope of any study is limited, so several choices had to be made.
Though the focus of this study is on the strategic management of the firm, the
results also have implications for regional economic development. For instance, the
study approaches strategic choices made by SMEs through four central strategic
dimensions: the innovativeness (see e.g. Markides 1997; Kleinknecht & Poot 1992;
Birchall et al. 1996; Koberg et al. 1996; Hyvärinen 1995; Gilbert 1994), specialization,
networking (see e.g. Gilley & Rasheed 2000; Johannisson 2000; Curran et al. 1993;
Quinn 1999; Varamäki 1996; 2001) and internationalization of SMEs (see e.g.
McCarty et al. 2000; Chen & Martin 2001; Korhonen 1999; Christensen & Lindmark
1993; Veciana 1994).
Today, the importance of innovativeness for the firm’s continuous renewal is
emphasized. In the SME context, it is argued that firm success is based on a focused
differentiation strategy (e.g. Carter et al. 1994; see MacMillan & McGrath 1997).
Moreover, productivity can be increased through specialization (Dyer 1997).
Therefore, a highly specialized and innovative firm which has adopted a niche strategy
can focus on its core business, but usually also needs numerous network partners.
Starting in a small domestic market, as in Finland, for example, very soon a firm will
face the need to expand the market areas from national to global markets.
Organizational networks may be a primary driver of internationalization (Hitt &
Ireland 2000: 50).
These dimensions are relevant not only at a micro, i.e. firm, level, but also for
the macro, i.e. regional and national, level (see e.g. Maskell et al. 1998).
Innovativeness can be regarded as one of the major forces for development in an
economy (see e.g. Grönroos 1999). However, new ideas and innovations are often
created by small firms that grow rapidly and sometimes even create new industries.
Specialization and cooperation produce efficiency in, for example, the labour markets
in an economy. Exporting is a necessity for a country with open markets.
A successful business is important not only for the firm, but is also associated
with the success of the region and the well-being of people living in the area.
Successful regions, such as the so-called Third Italy or the Gnosjö region in Sweden
(see e.g. Wiklund & Karlsson 1994), are characterized by well-developed and
successful business life. Several concepts are used in describing and explaining
17
regional industrial development, for example industrial districts (see e.g. Pyke &
Sengenberger 1992), new industrial spaces (Isaksen 1994: 34-35), innovative milieus
(Camagni 1995), learning regions (Asheim 1997), and clusters (Porter 1998).
Industrial districts are usually characterized by large-scale production, and
new industrial spaces refer to new industrial growth centres which consist of
production chains of independent SMEs. Therefore, SMEs can be seen as flexible
production units which can attain the scale of economics by cooperation. The concept
of the innovative milieu has many aspects in common with that of the industrial
district, in particular, a strong sense of territorial identity combined with a key role for
network externalities. The central features of an innovative milieu are synergies and
innovativeness (Camagni 1995). However, it is different in that many areas associated
with milieu development have no significant past industrial traditions. The major
features of learning regions are the firm’s innovativeness and cooperation (e.g. Asheim
1997: 142-176; 1998). The most recent research in this area has emphasized clusters
(see e.g. Porter 1998).
It has been suggested that the key for success of peripheral regions in the
future will be endogenous growth. Endogenous growth models highlight the roles of
factors such as local entrepreneurship, social networks, innovative milieu, factor
flexibility, and institutional structure in regional development (see e.g. D’Arcy &
Guissani 1996: 160-161). In addition to relations between firms connected with buying
and selling goods and services, the development of industrial districts is based on a
number of social and cultural factors, which are territorially specific (Isaksen 1994:
33-34). These factors can contribute to the creation of positive attitudes to starting up
small firms, and promote cooperation between firms. The central concept of social
capital refers to the resources available through social networks (see e.g. Putnam 1993).
Firms and investments are necessary for successful regional development. In the
short run, regional development should be based on existing strengths to attain rapid
improvement in economic development and employment. Accordingly, developmental
actions should be targeted at the firms operating in the industry sectors characteristic of
the area. Such firms can benefit from the operation of other firms by cooperation and
learning. At the same time, it is advisable to create the preconditions for novel
knowledge-intensive businesses that can serve as a basis for the future development of
the region. A core question is, what kind of growth alternatives do firms have, and which
factors are associated with firm growth (see e.g. Storey 1994)?
However, attending exclusively to firm-level growth and jobs may be too
narrow, especially in the local development of peripheral areas. Firms, even very small
and non-growing ones, can have different strategic roles or positions in the local
economic system (Laukkanen 1999). Some are critical facilitators of other firms’
growth or of their very emergence, and thus are important for job creation at the local
18
level. Therefore, in this study, the concept of successful firm was broadened to
encompass, in addition to growth firms, firms which make a significant impact on
local and regional economies. Successful non-growth firms can, however, have an
important role in the economy in terms of maintaining existing jobs. The importance
of their role is unclear so far. In any case, the EU, for example, seems to recognize
their importance by using the number of maintained jobs as one of the criteria for the
objectives of regional development programmes.
The target firms in this study are located in the peripheral area which is also
one of the EU’s Objective 1 target areas. The environment can be regarded as difficult
surroundings (see Laukkanen 2000). Firms in peripheral regions may face many
impediments for their development (see e.g. Birley & Westhead 1990: 538): venture
capital availability is more limited (Mason 1987), as are opportunities for small firm
expansion based upon local and regional markets (O’Farrell & Hitchens 1988: 1378).
Peripheral economies dominated by large firms may not provide an ideal source of
labour for small firms. The supply of managerial and organizational skills is restricted,
firms are more vertically integrated, and the lack of specialization reduces
competitiveness and the rate of growth of local firms (Del Monte & Giannola 1986:
282). The lower rates of innovation may also cause technical impediments (Oakey et
al. 1980).
However, in terms of local and regional development, future actions should be
based on the proven knowledge of successful businesses in the area. Many
development projects are carried out today without a comprehensive knowledge base.
Identifying the conditions of success in the SME sector is very important for acting
and nascent entrepreneurs, organizations fostering SME development, financiers,
public policy makers, and other stakeholders of SMEs. Using the results obtained,
organizations fostering entrepreneurship and SME development can direct their actions
and develop their products, education and advisory services. It is also relevant to know
what kind of success strategies SMEs have used for the allocation of public actions. It is
important to remember that the performance of a region is based largely on the
performance of SMEs located in the area.

1.2 Objectives and limitations of the study

Success relates to the achievement of goals and objectives. On the most general level
possible, the goal of the firm is continuity in business, i.e. survival. Closure can
constitute success to owners in certain situations, but in general it means failure and
causes losses in economic output. Firm performance is much affected by firm strategy,
which aims at achieving a fit between the firm and its environment. Strategy involves
19
choices along a number of dimensions and can be represented by a firm’s overall
collection of individual business-related decisions and actions (see Mintzberg 1978;
Miles & Snow 1978). Though there is a variety of definitions for the concept of strategy,
it can accurately be conceptualized as a pattern of strategic variables, because the
elements of strategy – the individual business-related decisions and actions – are
interdependent and interactive (Galbraith & Schendel 1983). It is argued that the
identification of strategy patterns permits a more complete and accurate depiction of
overall strategic behavior (see e.g. Hambrick 1983a; Robinson & Pearce 1988).
The purpose of this study is to obtain information about the interaction between
firms and their environment, since firm performance is dependent on the match between
the firm and its environment. The objective is to identify factors affecting SME
performance. This is approached by studying configurations of successful SMEs.
Configurations are groups of firms sharing a common profile of organizational
characteristics (Meyer et al. 1993). In this study, an SME is defined as a firm with
fewer than 250 employees, and firm performance as the firm’s ability to continue in
operation. Therefore, logically, firm performance can have two different outcomes:
success (continuity of operation) or failure (ceasing of operation). However, because
there are differences in performance among successful firms, they are divided further
into two groups according to whether or not they have ever faced a threat to the
continuity of their operation.
In view of all this, the empirical data in this study were divided into three
categories of SMEs, representing three different levels of performance: (1) successful
SMEs that have never had any threat to their existence; (2) successful SMEs that have
at sometime been in such a situation and have survived; and (3) SMEs that have failed.
In this study, success is defined as continuity in business, i.e. longevity of the firm, and
threat refers to a threat to firm success. Failures in this study are defined as those
SMEs which have gone out of business with loss to creditors. Bankruptcies as a
deliberate strategy (see e.g. Moulton & Thomas 1993) are beyond the scope of this
study.

The central research question is,

what are the main factors affecting SME performance?

To solve the research problem, the following six research questions were formulated.
Answers to the first two questions were searched for in the theoretical literature and
previous empirical studies. The last four questions will be approached through an
empirical study of SMEs in Eastern Finland.

20
1 How can SME performance be approached theoretically? (chapter 2)
2 What is known about the factors affecting SME performance in the light of
previous studies? (chapter 3)
3 How can successful SMEs be characterized? (chapter 5)
4 How can successful SMEs be clustered? (chapter 6)
5 How do non-threatened and threatened but survived SMEs differ from each
other? (chapter 7)
6 How do successful and failed SMEs differ from each other? (chapter 8)

Within economic and other limits which restrict the conduct of the research, an
extensive search was carried out to identify factors affecting SME performance, trying
to capture holistically potential factors. Goal setting has an exploratory, empirical and
pragmatic emphasis (see Aldrich 1992: 209). It is believed that it is possible to improve
SME performance by paying attention to these factors and that SMEs can learn from
the results. However, the results are useful not only for the SMEs, but also for local
and regional economic development.
There clearly is no general law of firm success or of SME success, and each
firm is individual and unique, with its specific characteristics. However, between these
two extremes – general laws and firm-specific factors – it may be possible to identify
types of typical patterns of successful firm behavior. As these patterns are transferable,
they are useful to both existing firms for strengthening their competitiveness, and to new
ventures by creating the preconditions for successful new venture development.
In the empirical part of the study, successful and failed SMEs in Eastern
Finland, mainly in Northern Savo, were studied. The location of the region is
peripheral for the main market areas of many of the SMEs, particularly for those
operating in global markets. This may cause more problems in achieving high
performance for these SMEs than for firms located near their main market areas (see
e.g. Smallbone et al. 1993a; see also Niittykangas 1999; Silander et al. 1997). As few
studies have focused on the foundations of SME performance in peripheral locations
(Vaessen & Keeble 1995: 1-2), this study is exploratory.
In studies of this kind, defining the scope of the study explicitly is often
problematic. No natural or clear-cut boundaries exist, so the researcher has to make a
number of choices in order to keep the study manageable. The following theoretical,
methodological and empirical decisions limit the scope of this study. First, from the point
of view of theory this study is carried out in the field of strategic management, more
specifically adopting the configurational approach (e.g. Miller & Friesen 1984). Certain
issues, e.g. scientific discussions related to the personality traits of entrepreneurs (see e.g.
Chell et al. 1991; see also Laukkanen 1999: 19-32), locational issues and peripherity
(see e.g. Silander et al. 1997), and industry impact (see e.g. Porter 1980), are beyond the
21
scope of this study. Also, financial firm failure prediction models (see e.g. Keasey &
Watson 1991) were left out of this study. The organization theory and organizational
effectiveness literature, e.g. organization structure and structural contingency theory
(see e.g. Pfeffer 1982; Donaldson 1995), is not reviewed comprehensively, but some
sections relevant to the study are presented. Second, from the point of view of method,
the non-randomness of the sample limits the generalizability of the results.
Third, empirically the scope of the study is limited to the content of empirical
data which are based on the survey and interviews, and on the documentary and archival
material. The study focuses on established, i.e. more than four years old, not new, SMEs
with roughly 5 to 249 employees operating in industry sectors of manufacturing, business
services, and tourism, and located in Eastern Finland. The data were collected between
1998 and 2001. The performance of the selected firms is not compared with that of firms
in other geographic areas. Also, the peripherity of the selected geographical area is
neither studied nor compared with other areas, but is taken as given (e.g. Savon Arkki
1998; Ministry of the Interior 1996). However, the results of a comparative study of
the growth and success of SMEs in peripheral and core regions in the United Kingdom
showed that a higher proportion of SMEs in peripheral locations were more successful
than those in core regions (Vaessen & Keeble 1995: 24; see also North & Smallbone
1995a; 1995b).

1.3 Philosophical ground of the study

In common with all scientific research, this study is based on certain philosophical
assumptions. In general, this study can be said to follow the subjectivist rather than the
objectivist approach (Burrell & Morgan 1985; Morgan 1980). Hence, one of the
ontological assumptions of this study is that reality is subjective and multiple, and
participants in the study may see it in different ways. Accordingly, reality is
considered to be a socially constructed product based on individuals’ cognitions.
Perceptions are important, because they are the basis for entrepreneurs’ actions.
One of the epistemological assumptions of this study is that the world can be
understood only from the point of view of the individuals directly involved in the
activities in question. In line with this assumption, the entrepreneur or small firm
owner-manager is seen to be the most appropriate informant, and the research methods
used is believed to provide valid information about the research phenomena. In this
study, an entrepreneur is defined as the person who actually leads the firm, and is the
respondent in empirical surveys and case studies. Thus, s/he may be a founder or a
successor of the firm, and an owner-manager or a hired manager of the firm. The
reason for using such a definition for the term entrepreneur was that in Finnish there is
22
a single term encompassing founders and successors, purchasers and inheritors,
regardless of their growth orientation, i.e. whether or not we may call them
entrepreneurs or a firm owners. Moreover, as shown later, most respondents were
owner-managers of successful, i.e. growth, SMEs.
Therefore, the research is conducted from a firm-internal viewpoint, which –
in the case of SMEs – means the entrepreneur’s viewpoint. The information collected
is based on the subjective understandings and interpretations made by the
entrepreneurs. Obviously, the use of and the reliance on only one informant and
her/his recollection of past decisions and events which may have happened many years
or even decades ago, may reduce the reliability of the results. This has to be taken into
account in interpreting the results.
Regarding human nature, the study emphasizes a voluntaristic rather than a
deterministic view. This study adopts an intermediate standpoint which allows for the
influence of both situational, i.e. environmental, and intentional factors in accounting
for the activities of human beings. This is related to the intentionality of human beings:
intentionality refers to goal-seeking and conscious behavior, emphasizing the
comprehensions, attitudes and objectives of human beings. A human being or group of
human beings can set future goals and objectives which make their present behavior
understandable. However, an entrepreneur may choose to pursue goals that are not
necessarily economically rational: for instance, profit maximization may not be the
goal of the firm.

1.4 Outline of the study

This study is divided into nine chapters. Briefly, the contents of the remaining chapters
are as follows. Chapters 2 and 3 elaborate the theoretical frame of reference of the
study and connections to pertinent scientific discussions are presented. Also, the main
results of previous research are reviewed. In chapter 2, the two most frequently used
theoretical approaches to firm performance are presented. The strategic choice
perspective is contrasted with the environmental selection perspective, in order to
provide a better understanding of the diversity of aspects and variety of potential
factors affecting firm performance. Also, the main concepts and issues used in this
study, i.e. performance, success, failure, environment, strategy, and resources, are
discussed. In chapter 3, previous literature focused on factors affecting SME
performance is reviewed. The major contribution of previous studies concentrated on
the success and growth, and failure, decline and recovery of SMEs is compiled.
Chapter 4 outlines the empirical research methods used. Also, the selected
empirical research approach, with the abductive, taxonomic and configurational
23
approach, are introduced. Data collection and analysis methods for survey and case
materials together with descriptions of the survey sample and the cases are presented.
In chapters 5 to 8, the empirical findings are presented. Chapter 5 presents the
research findings concerning the characteristics of successful SMEs. The homogeneity
of the sample of successful SMEs is analyzed, and factors characterizing all successful
SMEs are identified. In chapter 6, in order to achieve a more precise understanding of
successful SMEs, the firms are grouped into mutually distinctive clusters based on
their growth mode and strategies, and the characteristics of each cluster are described.
Chapter 7 makes another distinction, dividing successful SMEs into two
groups: non-threatened and threatened but survived SMEs. The firms in these two
groups are compared with each other, and the causes of the threat and the ways the
threatened SMEs have adjusted are elaborated. Some of the differences between these
two groups of SMEs may be due to the fact that threatened SMEs may have learned
from the threatening experience. On the other hand, it could be that non-threatened
SMEs have avoided potential threats by wise decision making. Chapter 8 presents the
results of the comparative case studies. Matched triplets of successful and failed SMEs
are compared with each other, in search of answers to the question: why have
successful SMEs succeeded, and failed ones failed?
Finally, chapter 9 summarizes the main contribution of this study and
underscores the major conclusions and implications. Also, an evaluation of the study is
presented, together with some suggestions for further research. At the end of most
chapters there is a brief summary of the main points, with reference to previous
research.

24

25

2 FOUNDATIONS OF SME PERFORMANCE

2.1 SME performance: success and failure

Firm performance refers to the firm’s success in the market, which may have different
outcomes. Firm performance is a focal phenomenon in business studies. However, it is
also a complex and multidimensional phenomenon. Performance can be characterized
as the firm’s ability to create acceptable outcomes and actions (Pfeffer & Salancik
1978: 11, 34). However, performance seems to be conceptualized, operationalized, and
measured in several ways. Strategically, firm performance is often referred to as firm
success or failure (see Dess & Robinson 1984; Ostgaard & Birley 1995).
Success, in general, relates to the achievement of goals and objectives in
whatever sector of human life. In business life, success is a key term in the field of
management, although it is not always explicitly stated. Success and failure can be
interpreted as measures of good or indifferent management (Jennings & Beaver 1997).
In business studies, the concept of success is often used to refer to a firm’s financial
performance. However, there is no universally accepted definition of success, and
business success has been interpreted in many ways (see e.g. Foley & Green 1989;
Morel d’Arleux 1997). Due to the central role of an entrepreneur in a small firm, and
since different stakeholders may have different objectives and aspirations for a firm,
Jennings and Beaver (1997; 1995; Beaver & Jennings 1995) suggest that it would be
appropriate to regard an entrepreneur as the primary stakeholder and to begin by
considering how s/he might define success and failure.
There are at least two important dimensions of success: 1) financial vs. other
success; and 2) short- vs. long-term success. Hence, success can have different forms,
e.g. survival, profit, return on investment, sales growth, number of employed,
happiness, reputation, and so on (see e.g. Vesper 1990: 31). In other words, success
can be seen to have different meanings by different people. In spite of these
differences, people generally seem to have a similar idea of the phenomenon, i.e. of
what kind of business is successful (cf. Kay 1995: vi).
The main goals and objectives of the small firm can be other than financial,
and they can change over time. Rather than maximizing the financial performance of
the firm, the owner-manager may prefer independence and style of life, for example
(see e.g. Gray 1992; Jennings & Beaver 1995; Koiranen 1998: 29). Therefore, the role
of an entrepreneur’s values and expectations may be very important. However, in the
26
long run, even firms with lifestyle goals should attain at least a minimum profitability
in their operations, i.e. their incomes should exceed costs, to ensure the continuity of
operations. Moreover, according to Foley and Green (1989), whatever the goals for a
small firm, many successful firms have similar characteristics.
There is a wide range of measures of organizational performance (e.g.
Campbell 1976; Brush & Vanderwerf 1992; Matikka 2002). Often, performance has
been measured by growth (turnover, number of employees, market share), profitability
(e.g. profit, return on investment), and survival (see e.g. Storey 1994; Kauranen 1993;
Smith et al. 1988; Robinson et al. 1984; Dess & Robinson 1984). However, few
studies have sought to determine whether the factors that enhance one measure of
performance, such as survival, are the same as those that lead to others, such as growth
(Cooper 1993).
Firm growth has been used as a simple measure of success in business (e.g.
Storey 1994). Also, as Brush and Vanderwerf (1992) suggest, growth is the most
appropriate indicator of the performance for surviving small firms. Moreover, growth
is an important precondition for the achievement of other financial goals of business
(de Geus 1997: 53; Storey 1994; Reynolds 1993; Day 1992: 128; Phillips & Kirchhoff
1989). From the point of view of an SME, growth is usually a critical precondition for
its longevity (Storey 1994: 158). Phillips and Kirchhoff (1989) found that young firms
that grow have twice the probability of survival as young non-growing firms. It has
been also found that strong growth may reduce the firm’s profitability temporarily, but
increase it in the long run (McDougall et al. 1994; cf. MacMillan & Day 1987).
In research, firm growth has been operationalized in many ways and different
measures have been used. This may be one reason for the contradictory results
reported by previous studies (e.g. Weinzimmer et al. 1998: 235; see also Davidsson &
Wiklund 2000). The most frequently used measure for growth has been change in the
firm’s turnover (e.g. Weinzimmer et al. 1998: 238; Hubbard & Bromiley 1995; Hoy et
al. 1992; Venkatraman & Ramanujam 1986). Another typical measure for growth has
been change in the number of employees. However, it has been found that these
measures, which are frequently used in the SME context, are strongly intercorrelated
(North & Smallbone 1993; Storey et al. 1987). It may be supposed that such an
intercorrelation does not exist among capital-intensive large companies. Firm growth
is discussed in detail in Chapter 3.3.
A firm’s profitability can be a useful measure of performance in the case of
large companies. The measurement of performance is more complicated when
studying SMEs, for several reasons. First, the central goals and objectives of an SME
may be other than financial. Second, it is difficult to obtain reliable information on the
factors affecting the financial performance of an SME: for example, in family
businesses it is difficult to take into account the inputs of family members that are not
27
recorded by means of the accounting system. Third, organizational form can create
artificial differences, e.g. procedures for handling owner compensation can present
major sources of error (Dess & Robinson 1984). Fourth, SMEs may be very reluctant
to provide financial data on their performance (e.g. Dess & Robinson 1984). Fifth, it
may take several years before a new business venture becomes profitable (Biggadike
1979).
However, instead of performance indicators calculated from financial
statements, subjective assessment of firm performance has been used (e.g. Powell
1992a; Robinson & Pearce 1988). The use of subjective assessment of performance
has clearly some advantage over performance indicators calculated from financial
statements. For instance, in cross-sectional studies, the profitability of firms in
different industry sectors is not comparable due to the different degrees of capital
intensiveness (Kauranen 1993: 24).
The definition of success may depend on the time frame: SME performance
can be approached as a short- or long-term phenomenon. Even one year high economic
output can be interpreted as success. However, the existence of the firm in the long
run, i.e. longevity, can be interpreted as success meaning firm survival. 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. On the one
hand, the probability of survival decreases over time. On the other hand, the
probability of survival of new firms is lower than that of older firms, which refers to
their ‘liability of newness’ (Stinchcombe 1965; Aldrich & Auster 1986: 194).
There are also several definitions of business failure (see e.g. Watson &
Everett 1996a; 1993). Firm failure has been described with several terms, 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.
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. Hence, in this study, a failed firm is defined as a firm
which has gone into liquidation, i.e. it has ended its business and left behind unpaid
28
creditors. On the other hand, a business which is sold because, for example, the
entrepreneur wants to realize a profit, is an exit, and closer to a success than a failure.

2.2 Theoretical perspectives on firm performance

Firm performance is often seen to relate to the match between the firm and its
environment (e.g. Johnson & Scholes 1993; Powell 1992a; see also Hrebiniak & Joyce
1985; Thompson 1999). The environment carries needs and expectations, i.e. market
opportunities, which the firm tries to respond to with its resources and capabilities.
The better the match, the better the success (cf. Kay 1995: 271). For example,
according to contingency theory (see e.g. Donaldson 1995; Burns & Stalker 1961),
firm performance is the result of a proper alignment of firm design with the context it
operates in. Similarly, there is no one best way to organize, and contextual factors
should be taken into account (Pfeffer 1982). In the configurational approach (e.g.
Miller & Friesen 1984) successful firms are considered to be aligned in a small
number of typical patterns. However, as the environment of many firms is changing all
the time, there is a continuous need for adjustment of the fit between the firm and its
environment. From the firm’s viewpoint, this process of adapting to changes in its
environment is called strategic management (Schendel & Hofer 1979).
Firm performance can be approached from many perspectives, e.g. from an
internal (firm) or external (environment) perspective. Recently, the most popular
theoretical approaches in research have been strategic management and population
ecology (Tsai et al. 1991: 9). They explain firm performance from opposite directions:
the first from the firm-internal viewpoint, and the second from the firm-external point
of view. A central dimension is their voluntaristic vs. deterministic nature in
explaining firm performance (e.g. Astley & Van de Ven 1983; Bourgeous 1984;
Hrebiniak & Joyce 1985). In other words: do firms shape their destiny, or are they
powerless victims of changes in their environment? The main features of these
approaches are contrasted in Table 2.1. Later studies of firm performance have
discovered the benefits of an integrated approach, i.e. a dialectical approach (Amit et
al. 1993: 823; see also Jick 1979: 609; Vesalainen 1995; Leppäalho 1991).
There are several theoretical views or schools of thought on strategy
development. These schools of thought and their ideas have been organized in several
ways, and the schools are not mutually exclusive (see e.g. Mintzberg et al. 1998;
Thorelli 1995a; Johnson & Scholes 1993; Kay 1992; Kettunen 1997; Näsi 1986). By
way of example, Johnson and Scholes (1993: 35-54) have named six views of strategy
development: natural selection, planning, logical incrementalism, cultural, political
and visionary view.
29

Table 2.1 A comparison of strategic choice and environmental selection perspectives
Strategic choice Environmental selection
Example of the school of
thought
• strategic management • population ecology
Level of analysis • micro • macro
Point of view • firm-internal • environmental
Orientation • voluntaristic • deterministic
Relationship between the firm
and its environment
• the firm creates and shapes
its environment
• the firm has many
alternatives in creating its
environment and in adapting
to environmental changes
• change is based on
independent and free
choices made by the
management

• performance is based on the
strategic choices made by
the firm
• the firm has little affect to
its environment
• the inertial forces of the firm
significantly restrict the
adaptation of the firm

• change is based on the
natural evolution of
environmental variation,
selection and retention, and
a firm population
mechanically reacts to
environmental changes
• performance is based on
environmental selection
Role of entrepreneur • independent
• proactive
• interactive
• lacking independence
• passive and reactive
• symbolic
Main factors restricting the
scope of business
• entrepreneur’s limited
ability to see business
opportunities
• environmental carrying
capacity, legitimation, and
competition
Nature of the firms • heterogeneous
• independent actors
• homogeneous within a
population
• parts of a population

On the other hand, Mintzberg et al. (1998; also Mintzberg & Lampel 1999) present ten
schools of thought on strategy formation. The schools are the (1) design school (main
contributors e.g. Selznick 1957; Andrews 1971); (2) planning school (e.g. Ansoff
1965; Steiner 1969); (3) positioning school (e.g. Porter 1980); (4) entrepreneurial
school (e.g. Schumpeter 1950); (5) cognitive school (e.g. Simon 1957); (6) learning
school (e.g. Cyert & March 1963; Weick 1979); (7) power school (e.g. Pfeffer &
Salancik 1978); (8) cultural school (e.g. Rhenman 1973; Normann 1977); (9)
environmental school (e.g. Hannan & Freeman 1977); and (10) configurational school
(e.g. Chandler 1962; Miles & Snow 1978).
Each school has its own perspective focusing on one major aspect of the
strategy formation process. However, on the other hand, they are not mutually
exclusive, but share elements of thinking with other schools of the same typology. The
configurational school, in particular, can be said to be a combination of the others.
30
In practice, entrepreneurs us ually see strategies developing through a mix of
different processes (Johnson & Scholes 1993: 54; Kettunen 1997: 218). Moreover, it
should be remembered that the schools are also the products of their times, and reflect
the thoughts of researchers sharing ideas of which factors are critical for firm success.
For instance, one school of thought (e.g. Ansoff 1965) emphasizes planning as a
critical condition for success, whereas another (Boston Consulting Group) is based on
portfolio thinking, according to which success is seen to be based on the
developmental balance of strategic phenomena (e.g. Hofer & Schendel 1978).
According to business idea thinking, success is achieved by the continuous fit between
products, markets, and the way of doing business (Normann 1976; see e.g.
Niittykangas et al. 1998).
The differences between the schools relate to different emphases and different
ways of conceptualizing phenomena. As can be seen, then, a variety of approaches
have been used to try to better understand why some firms succeed and others fail.
However, many models and other theoretical constructions have been created on the
basis of empirical findings made in the context of large companies. From the point of
view of small firms, the business idea thinking introduced by Normann (1976) is seen
to be one of the most applicable in practice.
Strategic choice perspective. A strategic choice approach (Child 1972; 1997)
assumes that firms are in a state of continuous change, which is directed according to
the actors’ subjective interpretations of the situation and the preferences they have
(Vesalainen 1995: 31; see also Laine 2000). Naturally, there are some external and
internal constraints, but management has a certain discretion in strategy formulation.
According to Astley and Van de Ven (1983), the strategic choice approach draws
attention to individuals and their interactions, social constructions, autonomy, and
choices, as opposed to the constraints of their role incumbency and functional
interrelationships in the system. Both environment and structure are enacted to embody
the meanings and actions of individuals. According to this approach, managers are
regarded as performing a proactive role. Their choices are viewed as autonomous, and
their acts are viewed as energizing forces that shape the organizational world. However,
the decisions made by entrepreneurs restrict the number of alternatives available in
subsequent decisions. The major strategic choices that the firm has to make are dealt with
in Chapter 2.4.
Strategic management research encompasses several research streams, and this
may make it difficult to see and understand the role of different factors and
mechanisms affecting firm performance. In view of the existence of this variety of
research streams, it can be concluded that the theory behind strategic management
research has more than one ‘hard core’ (Lakatos 1972). The most popular recent
research stream in the field of strategic management has been the resource-based view
31
of the firm (e.g. Wernerfelt 1984; Barney 1991) and its extension, the knowledge-
based view of the firm (e.g. Kogut & Zander 1992; Spender & Grant 1996; Grant
1996).
These theoretical perspectives are founded on firm-internal aspects. However,
the roots of the resource-based view of the firm can be seen to be based on Penrose’s
(1959) idea of viewing a firm as a bundle of resources. Subsequently, since the
appearance of Wernerfelt’s (1984) work “A resource-based view of the firm”, the
popularity of the resource-based view of the firm has grown rapidly, and researchers
attempted to explain differences in firm performance by differences in firm resources.
The development of the resource-based view and the knowledge-based view of the
firm, and the strategic management research as a whole, is reviewed in more detail by
e.g. Hoskisson et al. (1999). Resources and capabilities are dealt with in more detail in
Chapter 2.5.
Environmental selection perspective. The opposite approach, environmental
selection, emphasizes the determinism of environmental forces and tries to explain
organizational behavior mainly through environmental determinants. According to the
population ecology approach, the adaptation of the firm to environmental changes is
strictly limited due to the inertial forces of the firm. Consequently, as a result of
differences in inertial forces between firms, the natural selection made by environments
favours some firms and affects their performance. It means the survival of the fittest, and
the destruction of the less well-fitted firms. However, fundamental to population
ecology is the study of firm populations rather than single firms (Young 1988: 2).
Variation, selection, and retention constitute the three stages of the
evolutionary change process (Campbell 1969; Hannan & Freeman 1977; Weick 1979;
Aldrich 1979; Vesalainen 1995). Due to variations in firm populations, environmental
changes affect firms differently. Selection refers to this process, where firms congruent
with new environmental conditions will survive and others will become extinct. There
are three types of environmental selection (Aldrich 1979: 40-46). The first type is the
selective survival or elimination of entire organizations: they either are fit for their
environment, or fail. The second type is selective diffusion or imitation of successful
innovations in structure or activities across firms in a population. The third type of
selection is that of advantageous activities that are happened upon in the normal course
of variation in their performance over time. Finally, predominant environmental
conditions reinforce the characteristics of the surviving firms until the next
environmental change will happen.
Dialectical approach. Rather than keeping the strategic choice and
environmental selection approaches separate, it is suggested that it might be useful to
combine these approaches, and see that the firm is operating in a continuum where it
has more or less power and control depending on the issues at hand. Such a combined
32
approach can be called dialectical (Bourgeois 1984: 593). Thus, environmental
determinism and management’s free choice can be viewed as a continuum. Hrebiniak
and Joyce (1985) suggest a multidirectional relationship in which organizations neither
mechanistically react to environmental forces nor exercise unrestricted free will.
Therefore, the interdependence and interactions between strategic choice and
environmental determinism define organizational adaptation.
In addition, as Bedeian (1990) has argued, this interaction is derived from two
factors: organizations do not only react to their respective environments, but also create
or enact them. Moreover, the resulting new environments influence future organizational
strategies and resource allocation, which will again bring about subsequent
environmental change. At the same time, the firm itself creates new restrictions for its
own operation (Weick 1979: 164; see also Koskinen 1996: 20-21; Child 1997).
As a matter of fact, strategic management and population ecology have come
much closer to each other during the last ten years than they were two decades ago,
when they were clearly distinct theoretical perspectives (see Amburgey & Rao 1996:
1268). At the same time, in research focusing on the relationship between the firm and
its environment, researchers have started to consider it desirable to deal with these two
approaches in the same continuum, not separately (e.g. Bourgeois 1984: 593). As
Hrebiniak and Joyce (1985) put it, “what is needed is a greater emphasis on integration
rather than differentiation of views”.
The role of firm-internal factors and that of environmental factors may vary
between environments. In some environment, e.g. in customer markets, the firm may
have fewer external restrictions than it has in other environments, e.g. in financial
markets. On the other hand, asymmetric, i.e. insufficient information of alternative
market opportunities in e.g. financial markets, may hinder business development.
Moreover, there are temporal variations in the role of firm-internal factors and firm-
external factors. In the short run, the extant markets may significantly restrict firm
growth, whereas in the long run, the firm can change the markets or even create new
markets for achieving growth.
However, firm performance is bounded with firm-internal factors such as firm
resources and the firm’s strategic choices, and with firm-external factors such the
carrying capacity of the environment and competition, and further, their fit. The
environment provides a chance to cease operation all the time. Only a few firms can
avoid or overcome in the long run all the threats which cause an actual or potential
threat for the firm. However, a number of firms face these threats and become under
threat, but survive. Those firms which are not able to overcome the threats and their
consequences are closed down.

33
2.3 The firm and its environment

The firm interacts with its environment. There are in fact different levels of
environment, each encompassing several components. Thus, the environment of the
firm consists of several environments. Environment as a general term refers here to all
those arenas (Koskinen 1996) the firm is operating in and is attached to. Moreover,
environments and their components affect firm performance in many ways, directly or
indirectly.
On the one hand, the general environment is often described by the PESTE
frame of political/legal, economic, socio-cultural, technological, and ecological factors
which have an indirect connection with firms. The general environment defines the
political, economic, social, technological and ecological boundaries of the firm. On the
other hand, there is the task environment, whose components have a direct impact on
the firm. This environment can be divided into the external and internal environments,
which refer to the firm’s external and internal stakeholders, respectively. The external
environment is also called the operating environment and comprises external
stakeholders, e.g. customers and suppliers. The internal environment comprises
internal stakeholders such as the management and personnel.
Hence, the firm operates in many environments simultaneously collaborating
with other actors in the market and at the same time competing for scarce resources
with others. For instance, from the firm’s point of view, one of the most critical market
is the customer market, where the firm sells the products which have gone through the
process of combining the production factors. On the other side of the supply chain, in
the supplier market, the firm buys production factors. In the financial market, the firm
acquires necessary financing for the business.
Several environmental dimensions have been presented in the literature for
describing the qualities of organizational environments. For instance, Dess and Beard
(1984: 55; see Aldrich 1979) distinguish between dimensions such as munificence,
dynamism, and complexity. Munificence refers to the environmental capacity as the
extent to which the environment can support sustained growth. In general, a munificent
environment is regarded as more favourable for business success than a scarce
environment. Dynamism is related to the turbulence, i.e. the dimension of stability vs.
instability. It has been found that small firms that face an environment with increasing
dynamism tend to grow faster than others (Wiklund 1998: 238). Environmental
complexity indicates that there are several different segments of the market with varied
characteristics and needs that are being served by the firm. Thus, the firm sees a
heterogeneous environment as complex.
A distinction can also be made between hostile and benign environments (e.g.
Covin & Slevin 1989). Hostile environments are characterized by precarious industry
34
settings, intense competition, harsh, overwhelming business climates, and the relative
lack of exploitable opportunities. On the other hand, benign environments provide a safe
setting for business operations due to their overall level of munificence and richness in
investment and marketing opportunities. Perhaps the most elaborate typology of
environmental dimensions is the one presented by Jurkovich (1974), who identified 64
types of environments based upon the following dimensions: complex/non-complex,
routine/non-routine, organized/unorganized, direct/indirect, low-change/high-change, and
stable/unstable.
However, it seems that the environmental dimensions commonly used are
uncertainty, dynamism, homogeneity, munificence, and complexity (see e.g. Miller
1987c). It is important to notice that the environment may play a bigger role for small
firms than for larger firms because of small firms’ higher vulnerability to environmental
influences. Paradoxically, environment is a threat for the firm, but also an opportunity in
providing resources the firm needs. Different environmental conditions and the suggested
strategies for firms operating in them are discussed in the next section.

2.4 Strategy and the firm’s strategic choices

There is a huge number of definitions for the concept of strategy. According to
Johnson and Scholes (1993: 10), “strategy is the direction and scope of an organization
over the long term: ideally, which matches its resources to its changing environment,
and in particular its markets, customers or clients so as to meet stakeholder
expectations”. Therefore, strategy may depend on but is not completely determined by
environment. However, strategic management is needed not only to cope with changes
in the firm’s external environment but also to cope with changes caused by processes
internal to the firm.
Strategic management has traditionally focused on business concepts that
affect firm performance (Hoskisson et al. 1999: 418). According to Bhide (1996), the
questions every entrepreneur must answer are (1) what are my goals?; (2) do I have the
right strategy?; and (3) can I execute the strategy? In order to achieve high
performance, firms need to adapt their strategies to their environment. The strategic
management process consists of three main elements: (1) strategic analysis; (2)
strategic choice; and (3) strategy implementation (Johnson & Scholes 1993: 16).
Often, strategy is defined as top management’s plans to attain outcomes consistent
with the organization’s missions and goals (e.g. Wright et al. 1992: 3). In general,
strategy consists of four components: (1) scope, i.e. product/market combination; (2)
deployment of organizational resources; (3) competitive advantage; and (4) synergy
35
among activities, resources, and scope (Hofer & Schendel 1978: 25; Sandberg 1992:
74).
One set of interpretations of strategy is given by Mintzberg (1987a: 7-17;
1987b), who defines the concept through five Ps, i.e. strategy can be seen as (1) plan;
(2) plot; (3) pattern; (4) position; or (5) perspective. Strategy can be a plan to attain
objectives and goals. It can be a plot against competitors. Regularity in firm behavior
can be interpreted as a strategy which can be retrospectively seen as a pattern. Using
strategy makes it possible to change the firm’s position in the market, and adapt to
different kinds of situations and environments. Strategy as a perspective refers to the
firm’s fundamental way of doing business its own way.
Strategy and strategic issues in a firm can also be described in terms of the
following features (cf. Johnson & Scholes 1993: 5-10): One characteristic of strategy
is that it concerns both a firm and its environment, i.e. the firm utilizes strategy to deal
with the changing environment. Strategy affects the overall welfare of the firm, i.e.
firm performance is much affected by the firm’s strategy. Hence, strategy is holistic. In
addition, strategy has a key role in achieving the goals of the firm, and is strongly
related to the management’s and owners’ interests. Moreover, typical of strategy is a
long time horizon.
Strategies are often divided into three levels: (1) corporate; (2) business; and
(3) functional i.e. operational strategies. Thus, there are two major strategic choices
that the firm has to make. First, the firm has to choose the business the firm is in.
Naturally, this choice limits further choices significantly. Second, the firm has to
choose the means by which it competes and attempts to achieve its goals within an
industry. For a small firm, issues of business strategy are likely to be especially
important (Johnson & Scholes 1993: 26). The first choice is related to the choice of
corporate strategy, and the second choice refers to the firm’s business strategy, which
is also called competitive strategy (e.g. Chaffee 1985: 89; cf. Hofer & Schendel 1978:
27-29).
Studies of strategy can be roughl y organized into two categories: those
focused on the strategy process (see e.g. Pettigrew 1992); and those focused on the
strategy content, i.e. on the competitive advantage (see e.g. Olson & Bokor 1995).
Further, studies of strategy process can be divided into two groups according to
whether the strategy process is seen as a rational process (e.g. Ansoff 1965); or as a
social, emergent process (e.g. Mintzberg 1973; 1978). Similarly, the studies of strategy
content can be divided into two groups according to their perspective: external view
(e.g. Porter 1980); and internal view (e.g. Wernerfelt 1984).
There are several strategy-making process models (e.g. Mintzberg 1973;
Chaffee 1985; Ansoff 1987; Nonaka 1988; see Hart & Banbury 1994). These are the
methods and practices firms use to interpret opportunities and threats, and to make
36
decisions about the effective use of skills and resources (Shrivastava 1983). Strategy-
making can be delineated through a number of characteristics of the organization
itself, such as its size and the nature of its leadership, and the features of its
environment, such as competition and stability (Mintzberg 1973: 49). Hart (1992: 334)
has proposed an integrative framework of strategy-making processes that includes key
dimensions, contingencies, and performance implications for five modes of strategy-
making: command, symbolic, rational, transactive, and generative.
Mintzberg (1973: 44-49; Mintzberg et al. 1976) identifies three modes of
strategy-making processes, entrepreneurial, adaptive and planning, and later added a
fourth type, bargaining. In the entrepreneurial mode, strategy-making is dominated by
the active search for new opportunities. Strategy-making is characterized by dramatic
leaps forward in the face of uncertainty. Power is centralized in the hands of the chief
executive, and growth is the dominant goal. In the adaptive mode, strategy-makers
consciously seeks to avoid uncertainty. The adaptive organization does not have clear
goals. In such firms the strategy-making process is characterized by reactive solutions
to existing problems rather than a proactive search for new opportunities. Decision
making is incremental, and decisions are disjointed. In the planning mode, analyses
play a major role in strategy-making, which is also straightforward. The bargaining
mode is typically a political process involving negotiations among decision makers
with conflicting goals.
However, strategic choices are not unchangeable. Changes reflect partly the
firm’s ability to adapt to envi ronmental changes. In addition, the realization of plans is
not always straightforward. Intentions that are fully realized can be called deliberate
strategies, and those that are not realized at all can be called unrealized strategies.
Thus, intended strategy and realized strategy is not always the same. Realized strategy
can be considered the result of intended strategy and emergent strategies (Mintzberg &
Waters 1982: 465-466; cf. Johnson & Scholes 1993: 38-39). Moreover, strategies are
often in informal, i.e. non-written, form in small firms in particular.
Firm performance in the market is based on its competitive advantage. The
interaction between firms and their competitive environment can be seen as market-
dependency and resource-dependency. Sources of competitive advantage are often
bound with the firm’s environment. A firm can attain competitive advantage by
satisfying the needs of customers of some market segments better than its competitors
do. Firms in local market can attain competitive advantage through good relationships
with local firms. Also, resources in the region can be a source of competitive
advantage. Other sources of competitive advantage of the firm can be low costs, high
know-how, or strong network relations. The firm’s competitiveness is based on its
sustainable competitive advantage.
37
In the external view, the rules of competition and competitive advantage are
determined by the structure of an industry. Industry structure influences the rules of
competition and the strategic choices available to firms. In any industry, the rules of
competition are embodied in five competitive forces: (1) the entry of new competitors;
(2) the threat of substitutes; (3) the bargaining power of buyers; (4) the bargaining
power of suppliers; and (5) the rivalry among existing competitors (Porter 1985: 4-5).
The external forces of industry influence firms relatively, because they influence all
firms in the industry. Firms’ abilities to get on with the factors influencing the industry
are not the same in all firms. The strength of competitive forces influences the
concentration of industry. The number of firms and business size structure indicate the
concentration or fragmentation of industry. Industry structure consists of several
factors, such as entry and exit barriers, changes in industry growth, innovations etc.
(see Porter 1980: 200-221). Porter (1980: 229-335) describes competitive strategies in
fragmented industries, emerging industries, industries undergoing a transition to
maturity, declining industries, and global industries (see also Low & Abrahamson
1997).
In the internal view, the competitive advantage is seen to be based on the
firm’s resources and capabilities. A good example of the research stream representing
the internal perspective is the resource-based view (Penrose 1959; Wernerfelt 1984),
which has gained favour among strategic management scientists in the last decade.
The resources and capabilities of the firm are discussed more detailed in the next
section.
The core of strategy consists of the critical success factors (CSFs) or key
success factors (KSFs). Critical success factors are those few things that must go well
to ensure success for a firm, and so they represent those enterprise areas that must be
given special and continual attention to bring about high performance (Boynton &
Zmud 1984; Johnson & Scholes 1993: 328; see also Sousa de Vasconcellos &
Hambrick 1989; cf. Selznick 1957; Ghosh et al. 2001). To establish a competitive
position for the firm Hofer and Schendel (1978) recommend concentrating on only a
few key success factors, the most relevant ones. It has been found that only a few of
the success factors have a substantial impact on firm performance (see e.g. Stalk et al.
1992; Hewitt-Dundas et al. 1997).
It is extremely important to identify the firm’s critical success factors. They
are often bound up with the nature of the business, and may change as the firm and
business develop (Ghosh et al. 2001). The firm should pay particular attention to
nurturing those factors with special care. Moreover, some of them can be general, i.e.
common to all successful firms, some are industry specific, i.e. characteristic of the
firms in the same industry sector, and some are firm specific, i.e. they relate to the
firm’s competitive advantage.
38
However, due to the continuous change of the environment, competitiveness
calls for continuous renewal and innovativeness as the conditions of success change
(see e.g. Abell 1999; see also Lengnick-Hall 1992). This calls for a dynamic view of
strategy (Markides 1999). The firm should find a market position which is unique in
some respect. Uniqueness can appear in products or in the ways of doing business, for
example. In market conditions characterized by overdemand, it may be sufficient that
the firm is acting like its competitors. The firm has an absolute competitive advantage
if it has neither competitors nor close substitutes. In such cases the firm often has a
protected market position, due to a patent, for example. Usually firms operate in
markets characterized by continuous competition between the firms. In such case, it
should have some relational competitive advantage, i.e. it has to reach a better market
position than its competitors have in some respect that is valued by customers (see Kay
1995: 61; Porter 1980; 1996; see also Henderson 1989).
From the firm’s point of view, it can be seen that a firm has two strategic
options (Neilimo 1993: 63; cf. Mintzberg 1973; 1978). Leading firms in global
markets and high-technology firms operating in narrow product and customer
segments may follow an active, market-creating strategy. However, usually firms have
to choose an adaptive strategy, i.e. they have to adapt to the changes determined by the
environment.
Jennings and Beaver (1995; 1997) contrast the management process of large
and small firms. They claim that in larger organizations, management is seen primarily
as a predictive process concerned with the clarification of long-term objectives, the
formulation of appropriate policies, and the feedback of information. In contrast,
management in small firms is primarily an adaptive process concerned with
manipulating a limited amount of resources, controlling the operating environment,
adapting as quickly as possible to the changing demands of that environment and
devising suitable tactics for mitigating the consequences of any changes which occur.
Competitive advantage in the smaller firm often arises accidently as a result of the
particular operating circumstances surrounding the enterprise.
Adaptation is used as a general term for the process of accommodation
between a firm and its environment (e.g. Lawrence & Dyer 1983; see also Boulding
1978). The term is used in many ways (Hrebiniak & Joyce 1985: 337). In its broadest
meaning, it encompasses both voluntaristic and deterministic perspectives. However,
more frequently adaptation refers to the voluntaristic and managerial approach which
was, especially in the beginning, the dominant approach in research focusing on the
relationship between the firm and its environment (Hannan & Freeman 1977: 929). On
the other hand, adaptation is a sub-term for the term ‘strategic choice’.
There are at least four approaches to operationalizing business strategy
(Hambrick 1980; see also Ginsberg 1984). Some researchers have viewed strategy as a
39
situational art that can best be studied through in-depth case studies; others have relied on
one or a few key variables to portray strategic behavior; a third group have viewed
strategy as a quantifiable interaction of a broad set of variables; and the fourth group’s
approach to operationalizing strategy is through strategic typologies, in which each
strategic type is viewed as having its own distinct pattern of characteristics.
The strength of typologies is that they aim at capturing both the
comprehensiveness and the integrative nature of strategy. For example, Miles and Snow
(1978) have presented a typology composed of four types of firms: defenders,
analysers, prospectors, and reactors. Each is described as having a particular strategy
for responding to the environment, and a combination of structure, culture, and
processes which support that strategy. Another influential theoretical construction of
strategy types has been the generic strategies presented by Porter (1980). According to
him, there are three generic competitive strategies: cost leadership, differentiation, and
focus strategy. They are based on the combination of two dimensions: competitive
advantage (lower cost or differentiation) and competitive scope (broad target or
narrow target).
However, a number of researchers have questioned the appropriateness of
these generic types in explaining the strategies of firms. In particular, these strategic
options have been considered inadequate in explaining the breadth of strategies
pursued by small firms (see Carter et al. 1994; Ostgaard & Birley 1995). Moreover,
they have received only limited empirical support in the small firm context (e.g.
Chaganti et al. 1989; Fombrun & Wally 1989). Porter, for instance, warns against
being “stuck in the middle” and not trying multiple strategies. However, it has been
shown that successful strategies can be based on a mix of cost leadership and
differentiation (e.g. Thompson 2001: 309; see also Johnson & Scholes 1993: 205-209).
These generic strategies have also been criticized because of their strong competition-
based approach. Nevertheless, the generic strategy frameworks created e.g. by Miles &
Snow (1978) and Porter (1980) have been applied in a high number of subsequent
studies of competitive strategies. Different types of strategic behavior are dealt with
more closely in Chapter 6.
Recently, as a response to criticism of competition-based approaches, the
popularity of customer- and capability-based strategy approaches has risen. One
example of such approaches is Mewes’s EKS-strategy model, which offers detailed
practical guidance for strategy formulation (see Friedrich & Seiwert 1994). The EKS
strategy is based on four principles: (1) focus; (2) the point of greatest impact; (3) the
bottleneck factor; and (4) benefit maximisation. The process of strategy making
consists of seven stages: (1) analysis of current situation and special strengths; (2)
selection of the most promising field of business; (3) selection of the most promising
target group; (4) identification of the target group’s most pressing problem; (5)
40
planning an innovation strategy; (6) planning a cooperation strategy; and (7) satisfying
a constant basic need and safeguarding the firm’s long-term market position (Friedrich
& Seiwert 1994).
In addition to generic strategies, the firm may have strategies which are more
specific, e.g. objective- or situation-based strategies: for instance, a growth strategy or
a turnaround strategy. As a matter of fact, firms may apply several simultaneous
strategies. Firm growth is discussed in more detail in Chapter 3.3, and turnaround in
Chapter 3.5. However, the strengths of a firm’s resources and environment determine
the strategies that are available in different situations. It should be noted that no one
strategy is always the best strategy. Hence, firms can be clustered into types according
to the strategies that they have used in different situations and circumstances (see e.g.
Vesper 1990; McDougall et al. 1992).
Organizations are often divided into two categories according to their
structural characteristics. An organization with an organic structure is seen to fit better
with a turbulent environment characterized by continuous and rapid change. Achieving
high performance in such an environment is often seen to relate to entrepreneurial
strategic orientation (Lumpkin & Dess 2001). Moreover, an entrepreneurial strategic
posture and an organic structure are characteristic of successful firms with build-
oriented strategic missions (Covin et al. 1994). In contrast, a mechanistic
organizational structure and a conservative strategic orientation are seen to fit with an
unchanging, stable environment. This is explained by the fact that an environment
characterized by rapid change requires rapid reaction by the firm (Mintzberg 1979:
269; see also Miles & Snow 1978; Miller & Friesen 1983b; Covin & Slevin 1989: 77;
Slevin & Covin 1997; Mintzberg & Quinn 1991). However, a competitive
environment can be more unstable for a firm operating in an environment with stable
changes in the demand than for a firm operating in an environment with growing
demand.
In response to dynamic environments, the development of new products or
new marketing, production, or administrative practices are suggested to be suitable
strategies. Surviving in a hostile environment, characterized by increased rivalry or
decreased demand for the firm’s products, may require diversification. In such
conditions firms may benefit from their competitive aggressiveness as a response to
threats (Lumpkin & Dess 2001). Another way to avoid direct competition is by
building customer loyalty through advertising or by tailoring products to the least
competitive market segments.
According to selection theories, survivor selection differs with environmental
change and type of organization, such as specialist versus generalist. These types
represent different exploitation strategies of resource opportunities in a niche. A
specialist organization is one that does a smaller number of things more intensively
41
than a generalist. In business organizations, one way of thinking about specialization is
that it is the opposite of diversification. Specialist organizations serve a narrower range
of product markets, but often because of this specialization, they know these markets
and can serve them more efficiently. Specialist organizations maximize their
exploitation of the environment over a relatively narrow range of environmental
conditions and have little slack or excess capacity. Generalist organizations can
survive over a wider range of environmental conditions but are not optimally suited to
any single condition. Specialist organizations are more suited to rapid change, while
generalist organizations accommodate more effectively to slow change.
According to niche width theory, population ecology suggests that the focused
strategy of specialism has distinct advantages over adaptive strategies where
environments are uncertain, characterized by rapid change, and where change is
dramatic. When this set of conditions exists, adaptive strategies are unable to respond
quickly enough to attain any degree of production efficiency, while specialists who bet
correctly will reap large potential profits. Such conditions are not so rare as to be
unimportant (Wholey & Brittain 1986: 523). Moreover, it has been found that
generalists have lower death rates only when there are relatively few but large changes
in environmental conditions. Specialist organizations were favoured in all the other
environmental conditions.

2.5 Resources and their flexibility

In the resource-based view, the firm is viewed as a bundle of resources that
management must deploy systematically to add value. A firm’s resources can be
defined as all tangible and intangible assets that are tied to the firm in a relatively
permanent fashion (Wernerfelt 1984). Resources refer to both physical, concrete
resources and intangible, invisible resources i.e. capabilities. Also, resources can be
divided into human, social, physical, organizational, and financial types (Greene et al.
1997b). They can yield sustained competitive advantage when they are relatively
scarce, hard to imitate, and hard to replace (Mahoney & Pandian 1992; Peteraf 1993;
Collins & Montgomery 1995; Lubit 2001; cf. Miller & Whitney 1999). Flexibility of
resources refers to a firm’s ability and way to respond to environmental changes. It
increases the compatibility between a firm and its environment.
Resources have a central role in gaining a competitive advantage (see e.g.
Praest 1998: 178; Greene et al. 1997b). Both the strategic choice approach and
population ecology approach emphasize the role of the nature of resources. In the
resource-based view, firm performance is based on firm-internal resources (e.g. Powell
42
1992a). Firms may start with a similar resource base, but with time they become
differentiated such that their resources cannot be perfectly imitated (Rumelt 1984).
Competitive advantage is seen to be based on the combination of the firm’s
tangible resources and capabilities. Capabilities refer to knowledge-based tangible or
intangible processes, and by combining them the firm can attain its goals and
objectives. For generating a sustainable competitive advantage, four criteria to assess the
economic implications of resources have been suggested by Barney (1991): value,
rareness, inimitability, and substitutability (cf. Grant 1991). However, the entrepreneur’s
limited perception may be a central bottleneck factor, and a management team can
significantly improve management performance. The knowledge-based view
emphasizes top management’s ability to select, retain and develop critical capabilities.
In the firm, there are usually few core capabilities which are difficult to imitate
(see Prahalad & Hamel 1990: 83-84; Aaker 1989). The firm’s core capabilities are
usually created by the firm, and they promote its ability in adapting to the needs of a
rapidly changing environment (Prahalad & Hamel 1990: 81). In particular, taking
advantage of the firm’s unique nature is emphasized. Moreover, as e.g. Hamel and
Prahalad (1989) point out the management’s visionary skills and vision for the future
in which the firm is unique are important. Management’s task is to create the future,
which should be fitted to the strengths of the firm in a unique way (see also Mintzberg
1994; Heene & Sanchez 1997). The core capabilities which are created in the firm
serve as a basis for its growth. Business processes based on core capabilities can be
transferred both into new geographical and business contexts (Stalk et al. 1992: 65-
67). In such cases, the unique elements of the firm, the personnel’s qualifications, and
the flexibility of business processes play important roles.
Strategic core capabilities start with customer, the identification of their real
needs, and stop at customers, the satisfaction of their real needs (Stalk et al. 1992: 62;
see also Long & Vickers-Koch 1995; Miller et al. 2002). An important success factor
is the firm’s ability to respond to changes in customer needs. Five dimensions
characterizing successful firms are (1) speed, i.e. the ability to respond quickly to
customer or market demands and to incorporate new ideas and technologies quickly
into products; (2) consistency, i.e. the ability to produce a product that unfailingly
satisfies customers’ expectations; (3) acuity, i.e. the ability to see the competitive
environment clearly and thus to anticipate and respond to customers’ evolving needs
and wants; (4) agility, i.e. the ability to adapt simultaneously to many different
business environments; and (5) innovativeness, i.e. the ability to generate new ideas
and to combine existing elements to create new sources of value (Stalk et al. 1992:
63).
Due to the scarcity of resources, firm performance is built on two principles.
First, allocating resources to objectives which will provide the maximum benefit will
43
lead to effectiveness. Second, the firm should develop resources into a resource pool
characterized by continuous learning, inimitability and attractiveness in the market
(see e.g. Montgomery & Wernerfelt 1991: 955; Kay 1995: 23, 272; Barney 1991; see
also Foss 1996; cf. Hofer & Schendel 1978). The term resource pool here refers to a
learning organization. In this task, top management’s role is significant. In particular,
the role of owner-manager is emphasized in small firms more than in large companies.
Moreover, personal networks of top management may play a critical role in firm
success (see e.g. Johannisson 2000; Ostgaard & Birley 1994).
Flexibility of resources affects the success rate of responding to environmental
changes. The more flexible the resources, the better chances for the implementation of
changes. Flexibility can be divided into internal and external types. Wiklund and
Karlsson (1994: 109) has further made a more fine-grained classification by dividing
firm flexibility into four types which they call input, output, and internal flexibility,
and flexible network relations. Internal flexibility refers to the firm’s resources as a
source of flexibility, e.g. flexibility of factors of production or the structure of the firm.
External flexibility refers to the firm’s relations with its stakeholders: for instance, a
firm’s cooperation through networks can be a source of competitive advantage
(Isaksen 1994: 35-36; Dyer & Singh 1998). However, network relations may also
cause dependency on other actors, which may have negative effects for the business
(see Pfeffer & Salancik 1978). Determining which business activities to bring inside a
firm and which to outsource is a critical strategic decision. Failure in this decision may
lead to either losing strategic focus or losing competitive advantage (Barney 1999).
The concept of flexibility is closely related with that of slack. The difference
between total resources and total necessary payments, or between potential and actual
performance, is described as organizational slack (Cyert & March 1963: 36). Also,
slack has been more broadly considered as a ‘cushion of actual or potential resources’
(Bourgeois 1981). There are different kinds of organizational slack: economic,
political and managerial. Economic slack refers to liquid financial assets, easily
convertible assets, and generalizable capital assets. Political slack encompasses
goodwill and consumer loyalty, for example. Managerial slack refers to a surplus of
managerial resources and capabilities. Moreover, slack related to the firm’s network
relations may be extremely important particularly for small firms (see e.g. Johannisson
1990).
For the creation of slack resources, operation in growing and developing
markets is seen to be important (Cyert & March 1963: 278; Covin & Slevin 1989).
Firms commonly use slack resources for developmental actions. On the other hand,
slack resources are the outcome of a firm’s strategic behavior (Peltoniemi 1993).
During growth, firms can use uncommitted resources to maintain their adaptability.
Operating in a market characterized by stiff competition often means that the net cash
44
flow is used for running the every-day business. When no slack exists, as often in
times of decline, the positive organizational processes dependent on slack resources
are inhibited. However, the existence of slack resources is a necessary condition for
adaption to environmental changes and firm development.
SMEs are regarded as flexible because of their simple organizational
structures. They are characterized by a small number of hierarchical levels and short
chains of command, and decision making in them is rapid and uncomplicated. In many
SMEs, the personnel is a central resource. Unionism of personnel may be rarer in
small firms than in large companies, and employees may see the link between their
personal contribution and firm performance more clearly than in the case of a large
company. Consequently, employees may be more motivated and committed in
working for SMEs than for large companies. As Peters and Waterman (1982) have put
it, “small in almost every case is beautiful”, referring to the efficiency of a small
facility based on turned-on, motivated, highly-productive workers, who outproduce
workers in big facilities.
Firm development is determined by firm-internal and firm-external factors.
The sources of internal inertia include investments, information, power relations and
culture. The firm’s renewal can be restricted as a results of sunk costs or routines (e.g.
Dutton 1993: 340), which can also be important factors for the transfer of the firm’s
accumulated know-how to new employees, and therefore, for firm success in the long
run (e.g. Nelson & Winter 1982). SMEs may have rigidities because of their old-
fashioned, inflexible and inefficient resources and loose network relations. Hence,
some resources may acquire negative value by creating core rigidities. Possible causes
of inertia related to the external environment include legal restrictions, insufficient
legitimation, or financial- or information-related restrictions.
Changes in the environment cause more uncertainty in SMEs than in large
companies. SME’s resources for acquiring information about the market and changing
the course of the firm are more limited. Often, SMEs do not know their customers and
their real needs as well as large companies do. This may cause tension between the
firm and its environment. Moreover, the firm’s inertia may restrict its ability to
mitigate this friction. However, there is much variation in the liquidity of resources.
Monetary resources are highly liquid. Their continuous adequacy is necessary for
maintaining the liquidity of the firm. Underestimation of the need for working capital
may lead the firm into liquidation, for example in the case of high growth caused by a
big investment in production equipment.
It is characteristic of SMEs that their operation is closely related to the person
who is the entrepreneur. In the resource-based view, the entrepreneur is a critical firm
resource, but it might also be that s/he is an important factor which limits the
achievement of firm success (see Whittington 1988: 524; Dutton 1993: 340; Spender
45
1989). The entrepreneur’s interpretations and limited ability to see new business
opportunities and the boundaries set by him/her may limit firm development more than
the boundaries set by the external environment (see Barr et al. 1992; Barr 1998).
Moreover, the firm’s manager is often also the owner of the firm. Thus, ownership,
management and the person of an entrepreneur may be combined in an SME.
Firms, like other organizations, are apt to retain the established ways of
thinking and action, especially if there is no direct pressures for change in the
environment (e.g. Koberg 1987; see also Burgelman 1990). As Miller (1994) argues in
his study of how past performance influences the way a firm evolves, makes decisions,
and adapts to its environment, after a long successful period firms are especially apt to
(1) exhibit inertia in many aspects of structure and strategy-making process; (2) adopt
extreme process orientations; (3) reduce intelligence gathering and information
processing activity; and (4) demonstrate insularity by failing to adapt to changes in the
environment. In an analysis of why good companies go bad, Sull (1999) claims that
the causes of failure are associated with four inertial factors: (1) strategic frames, i.e.
the set of assumptions that determine how managers view the business; (2) processes,
i.e. the way things are done, (3) relationships, i.e. ties to stakeholders, and (4) values,
i.e. the set of shared beliefs that determine corporate culture. Proactively changing a
tradition which has been successful may be too challengi ng a task for management.
Strategically, one of the most important environments for the firm is the
customer environment (Johnson & Scholes 1993: 10; see also Vesper 1990: 55).
Adequate demand is one of the most critical conditions which affect other conditions
significantly. Also, in population ecology, customers are the firm’s most important
resource and a factor determining the carrying capacity of the environment. It has been
shown that growth of the industry is one of the most important factors facilitating firm
growth (Lumme 1994: 3). Growth of the industry sector is a critical condition for
venture capitalists’ investment decisions (MacMillan et al. 1985; Bygrave & Timmons
1992: 8-10). Also, growth in demand is one of the most significant factors for the
intensity of competition which the firm faces in the market (Porter 1980).
Intensity of growth in demand refers to the stage of development of the
industry sector (e.g. Porter 1980). Strong growth in demand is related to the growth
stage which is characterized by expanding customer segments, product improvements
and differentiation, strong marketing, lack of capacity, increase in the number of
competitors, bigger profits and opportunities for acquisitions (Porter 1980). Stable
demand is related to mature industry sectors which are characterized by mass
consumption, high quality, standardization, market segmentation, over-capacity, long
production series, importance of service and low costs, and price competition.
The population ecology approach explai ns organizational change by
examining the nature and distribution of resources in organizations’ environments
46
(Aldrich 1979: 27-28). Environmental pressures make competition for resources the
central force in organizational activities, and the resource dependence perspective
focuses on tactics and strategies used by actors in seeking to manage their
environments as well as their organizations. Environmental niches are distinct
combinations of resources and other constraints that are sufficient to support an
organizational form. The niche is assumed to have a particular carrying capacity.
Organizational forms – specific configurations of goals, boundaries, and activities –
are the elements selected by environmental criteria, and change may occur either
through new forms eliminating old ones or through the modification of existing forms.
Organizational forms, then, are organized activity systems oriented toward exploiting
the resources within a niche. Selection pressures may favour or eliminate entire groups
of organizations, such as industries, and the changing population distribution of
organizations in a society reflects the operation of such selection pressures.
Organizational evolution is a consequence of the opposing force of two
sociological processes: legitimation and competition. Legitimation of an
organizational population means that its organizational form acquires the status of a
“taken-for-granted” solution to given problems of collective action. Competition refers
to constraints arising from the joint dependence of multiple organizations on the same
set of finite resources for building and sustaining organizations.
Selection of new or changed organizational forms occurs as a result of
environmental constraints. Environments are described in terms of either the resources
or the information they make available to organizations (Aldrich 1979: 29-30). The
information approach relies heavily on theories of perception, cognition, and decision
making, with organizational members acting on the information they glean from
typically incomplete searches of their environments. A major factor explaining
organizational change is thus variation in information. The resource approach treats
environments as consisting of resources for which organizations compete, highlighting
the amount of resources and the terms on which they are made available. An effective
organization is one that has achieved a relatively better position in an environment it
shares with others. There are six dimensions that are used to characterize the way in
which environments make resources available to organizations: environmental
capacity, homogeneity/heterogeneity, stability/instability, concentration/dispersion,
domain consensus/dissensus, and degree of turbulence.

2.6 Summary and conclusions

Firm performance can have two strategic outcomes: success or failure. Performance
can be approached, conceptualized, operationalized, and measured in many ways.
47
Success refers to the achievement of goals and objectives. At least two important
dimensions of success can be distinguished: financial vs. other success, and short- vs.
long-term success. Performance is often measured by growth, profitability, and
survival. It seems that survival and growth may be the most appropriate measures of
success in small firms. Failure is also not an unambiguous concept, as it can have
different interpretations. However, discontinuance of the firm can be defined as failure
when the firm has ended its business and left behind unpaid creditors.
Firm performance is based on the match between the firm and its environment.
It can be approached by several theoretical perspectives. Recently, the two most
popular theoretical approaches have been the strategic management approach and the
population ecology approach. They attempt to explain firm performance from opposite
directions, using several contrasts. However, they can also be seen as the ends of the
same continuum, and such a combined perspective can be called a dialectical
approach. Altogether, firm performance is bounded with firm-internal factors and with
environmental factors and their fit.
The firm operates simultaneously in several environments which can be
divided into different levels and characterized by several qualities. Strategy matches
the firm’s resources to its changing environment. Also, strategy can be defined in
several ways and different levels of strategy can be distinguished. A major distinction
can be made between strategy content and strategy process. Strategy content, which is
closely related to the competitive advantage and the critical success factors of the firm,
can be approached from the firm-internal or -external view. In general, firms may
follow an active, market-creating strategy, or, as usually, they have to adapt to the
changes in their environment. Moreover, there are usually several strategies that a firm
follows, i.e. in addition to generic strategies, firms often have objective- and situation-
based strategies, e.g. growth and turnaround strategies.
Both the strategic management and the population ecology emphasize the role
of resources and the firms’ ability to exploit them. In the resource-based view,
resources are seen as the major source of competitive advantage. Resources encompass
physical, concrete resources and intangible resources, i.e. capabilities. The flexibility
of resources increases the compatibility between a firm and its environment, and thus
enhances the chances of high performance. Slack resources are important for firm
development. However, firm flexibility is restricted by several inertial forces.

48

49

3 FACTORS CONTRIBUTING TO SME SUCCESS AND FAILURE

3.1 Previous research on SME performance

To date, research into firm success and failure does not provide a comprehensive
explanation for SME performance. Much research has been carried out in trying to
discover the factors responsible for firm success and failure (see e.g. Lussier 1995;
Duchesneau & Gartner 1990). However, the findings of previous studies of such
factors have been contradictory. This may be explained, at least partly, by differences
in research designs, operationalization of variables and different limitations of the
studies – some potential factors may have not taken into account in the research, for
example.
Most such studies have been carried out in the large-company context, or have
focused on the success and failure of new ventures rather than on established SMEs,
and on the factors affecting their longevity and growth (e.g. Tsai et al. 1991;
Duchesneau & Gartner 1990; Keeley & Roure 1990; Roure & Keeley 1990; Littunen
2001; Kauranen 1993; see also Cooper 1993) or failure (e.g. Zacharakis et al. 1999;
Carter et al. 1997; Venkataraman et al. 1990; Sommers & Koc 1987; Lussier &
Corman 1995; 1996). Moreover, few studies have focused on the foundations of the
performance of SMEs in peripheral locations (Vaessen & Keeble 1995: 1-2).
However, many studies have found that there are cross-national differences in the
factors affecting firm performance (e.g. Lussier & Pfeifer 2000; Yusuf 1995).
There are several approaches to investigating SME success and failure.
Several studies have been based on a single specific and often narrow perspective on
factors affecting firm performance, e.g. on decision making (e.g. Eisenhardt 1999).
Many studies have focused on firms with a certain age or size, or on a single industry
sector. Moreover, the type of firm may affect the success and failure factors of the
firm. Also, several methodological approaches to investigating SME success and
failure have been used. For instance, there are studies focused on a very limited
number of potential success or failure factors, comparative studies of success and
failure factors, and studies focused on the holistic profiles or configurations of
successful or failed firms. Most studies have concentrated on studying the role of a
small number of variables for firm success (e.g. Lussier & Corman 1996; 1995; Cressy
1996; McDougall et al. 1992; Tsai et al. 1991; Keeley & Roure 1990; Stuart & Abetti
1990; Sandberg & Hofer 1987).
50
In reaction to the contradictory nature of the results of previous studies, recent
research has called for a more integrated and holistic approach in studying firm
performance (e.g. O’Farrell & Hitchens 1988; Sandberg & Hofer 1987; McDougall et
al. 1992; 1994). Few studies have investigated how different types of factors may be
inter-related with small firm performance (Gadenne 1998). It can be argued that the
field is fragmented and several research streams exist. For instance, attempts have
been made to explain firm success or failure in terms of the personality traits of the
entrepreneur. However, as Storey (1994: 109) argues using “the analogy of the rowing
boat on a rough sea” in describing the role of the entrepreneur’s personality in SME
performance in the event of unpredictable external shocks, it might be that firm
performance is not easily predicted on the basis of the entrepreneur’s personality.
Also, Birley and Westhead (1994) could not find any empirical support for strategies
for picking winners based solely upon the characteristics of an owner-manager and the
business start-up reasons (cf. Miner 1997).
It seems that a number of studies have focused on firm success, but few recent
studies focus on firm failure (Thompson 2001: 619). For some reason, many studies of
firm failure were carried out in the 1980s. Some studies have explored and compared
the potential influence of certain factors on both the success and failure of firms.
However, to date comparative studies have been rare. Moreover, it is worth noting that
studies focused on the causes of decline and crises and on recovery strategies may also
contribute to the understanding of SME performance in the long run.

3.2 Studies of factors affecting SME success

There is considerable variation in the criteria for success used in previous studies.
Empirical studies of factors affecting SME success can be roughly divided into two
groups according to whether they focus on a quite limited set of variables or try to
capture more holistic profiles of successful SMEs. Previous empirical research has
used both surveys and case studies. There are also some compilations of the results of
previous studies of the factors contributing to firm success. For instance, Storey (1994)
has compiled the results of previous studies focused on the birth, growth and death of
small firms, on the basis of which he presents some normative “dos and don’ts”
lessons for small firms.
The following recent studies based on surveys have dealt with the factors
affecting SME success. Westhead et al. (1995: 94) studied factors influencing the
survival of 227 high-technology small firms. Ghosh and Kwan (1996) made a cross-
national intersectoral study of the key success factors of 152 SMEs in Singapore and
164 SMEs in Australia. Kauranen (1996) carried out a follow-up study of 37 new
51
manufacturing firms in Finland and studied the determinants of the future success of
the firm in the short term and in the long term. Yusuf (1995) explored critical success
factors for small firms in several industry sectors based on the perceptions of 220
South Pacific entrepreneurs. Wijewardena and Cooray (1996) explored the importance
of a set of success factors by studying a sample of 300 small manufacturing firms in
Japan. Gadenne (1998) investigated the effect of various management practices on
small firm performance by studying 369 small businesses in the retail, service, and
manufacturing industry in Australia. Bracker and Pearson (1986) studied planning and
financial performance of small mature firms in the dry cleaning business. Baker et al.
(1993) studied planning in successful high-growth small firms. Pelham (2000)
explored the relationship between market orientation and the performance of
manufacturing SMEs in eight industry sectors.
Case studies have also been conducted. Duchesneau and Gartner (1990)
studied 13 successful and 13 less successful (or failed) small young firms in an
emerging industry (see also Duchesneau 1987). Lehtonen (1997) analyzed seven
Finnish knowledge-based firms’ paths to success. Taylor (1997) explored high-growth
medium-sized firms in the UK, Germany and the US, and presented four lessons based
on the 15-year study. Foley and Green (1989) presented five tips for business success
in general, based on the views of business advisers and case study entrepreneurs of
small firms with different goals.
On the basis of empirical studies concentrating on a limited set of variables
rather than on holistic profiles of successful SMEs, the factors affecting SME success
are classified into the following categories: (an) entrepreneur(s), management and
know-how, products and services, customers and markets, the way of doing business
and cooperation, resources and finance, strategy, and the external environment.
Of the factors related to entrepreneurs, several personal qualities and traits,
such as self-confidence and perseverance, have been suggested to affect firm success
(e.g. Yusuf 1995). In their study of new small firms, Duchesneau and Gartner (1990)
found that lead entrepreneurs in successful firms were more likely to have been raised
by entrepreneurial parents, to have had a broader business experience and more prior
startup experience, and to believe that they had less control of their success in
business, than unsuccessful entrepreneurs. They also found that lead entrepreneurs in
successful firms worked long hours, had a personal investment in the firm, and were
good communicators. Moreover, successful firms were those initiated with ambitious
goals, and lead entrepreneurs had a clear and broad business idea (Duchesneau &
Gartner 1990). Firms with more than one shareholder when it was set up were
significantly more likely to survive (Westhead et al. 1995). Education and prior
experience in business have been seen as critical success factors for small firms ( Yusuf
1995; Wijewardena & Cooray 1996).
52
Management of the firm plays a critical role in determining the firm’s strategy.
Effective management has been found to be an important success factor for an SME
(Ghosh & Kwan 1996; Yusuf 1995; Wijewardena & Cooray 1996). Firms that have a
diverse range of management skills and competencies, i.e. a large number of
management functions covered by individuals in the management team, have a
significantly greater propensity to survive (Westhead et al. 1995). Firms with a
management team that contains individuals with personnel backgrounds have been
found to be more likely to survive (Westhead et al. 1995). Wiklund (1998: 240) found
that well performing firms had larger management teams than others. An
entrepreneurial team is fundamental to firm success, especially in terms of firm growth
(Birley & Stockley 2000). A number of empirical studies have revealed that firms
founded by teams are on average more successful than firms founded by single
persons (see e.g. Lechler & Gemuenden 1999). Gadenne’s study (1998) claimed that
entrepreneur’s personal characteristics are not related to successful management
practices.
Innovation and proactiveness have been found to be the key strategic
dimensions in successful small firms (Wiklund 1998; Chaganti & Chaganti 1983; see
also Hitt & Ireland 2000: 48-50). In one study, a new product idea distinguished
successful firms from unsuccessful ones in the short term but not in the long term
(Kauranen 1996). In his study of paths to success of knowledge-based firms, Lehtonen
(1997) found that the necessary condition for success was the ability to create an
innovative product giving added value to the customer. Taylor (1997) also claimed
that the high-growth medium-sized firms he studied succeeded because they innovate.
In addition to innovations, Wijewardena and Cooray (1996) found that the second
most important success factor for small manufacturing firms was high quality of
products. It is important to achieve a suitable balance between product quality and
costs (Chaganti & Chaganti 1983).
Good customer relationships and customer service have been found to be the
most important factor contributing to SME success (Ghosh & Kwan 1996; Taylor
1997; Wijewardena & Cooray 1996). In his study of high-technology firms, Räsänen
(1999) revealed the importance of close customer relationships (also Halborg et al.
1997). Duchesneau and Gartner (1990) showed that successful firms embarked upon
sales to broad sectors of the market, whereas less successful ones were restricted to
narrow market sectors consisting of customers characterized by small size and those
more difficult to service. On the other hand, in his study of high-growth medium-sized
firms, Taylor (1997) emphasized the importance of a market niche the firm can
defend. Foley and Green (1989: 109) emphasized the importance of operation in a
market which the firm knows and understands.
53
Marketing has been found to be an important success factor for an SME
(Ghosh & Kwan 1996¸ Yusuf 1995). Market orientation has been found to have a
strong relationship with measures of performance (Pelham 2000). Kauranen (1996)
found that market-orientedness distinguished successful firms from unsuccessful ones
in the short term but not in the long term. In his study of knowledge-based firms’
developing into superior players in their branches, Lehtonen (1997) claims that a high
tech company should, after conducting marketing tests in the home country,
immediately drive global market wedges into major international markets. The success
of internationalization may be a critical success factor promoting the attainment of
some positive outcomes such as enhanced organizational learning, greater
innovativeness and increased strategic competitiveness (Hitt & Ireland 2000: 52).
Several studies show that interfirm cooperation is important for small firms
because it can, for instance, contribute positively to gaining organizational legitimacy
and to developing a desirable marketplace reputation. Moreover, cooperation may
enable the small firm to improve its strategic position, focus on its core business, enter
international markets, reduce transaction costs, learn new skills, and cope positively
with rapid technological changes (see Hitt & Ireland 2000: 50-51; Jarillo 1988).
However, Gilley and Rasheed (2000) found that outsourcing has no significant direct
effect on firm performance. On the other hand, firms that had gained access to
resources and skills from local higher education institutes showed a significantly
greater propensity to survive (Westhead et al. 1995).
The use of outside professionals and advisors, and the advice and information
provided by customers and suppliers is also important for success (Duchesneau &
Gartner 1990; also Kent 1994; Storey 1994: 310; Halborg et al. 1997). Duchesneau
and Gartner (1990) found that lead entrepreneurs of successful firms were likely to
spend more time communicating with partners, customers, suppliers, and employees
than those of unsuccessful firms. Storey (1994: 310) reminds us about the importance
of maintaining good relationships with the bank and keeping it aware of the firm’s
financial developments. The role of informal relations and social capital, i.e. personal
networks, has been found to be critical to firm success (Malecki 1997; Lechler &
Gemuenden 1999).
Many studies point out the important role of financial planning. The study
conducted by Gadenne (1998) revealed that the only common success factor for small
firms in different industry sectors was financial leverage, i.e. small firms in general
tend to be more successful if there are sufficient financial resources either contributed
by the owner or generated through profits and cash flows from operations (see also
Yusuf 1995). Small business owners should invest in their own business and avoid
taking out large sums in ‘good’ years (Storey 1994: 310; also Laureen 1996). Small
firms should also keep and use current financial data for making key decisions, and
54
small business owners should be prepared to consider selling equity (Storey 1994:
310).
Availability of skilful employees was seen to be an important success factor in
Wijewardena and Cooray’s (1996) study. Maintaining staff loyalty and policies and
mechanisms for motivating staff are vital (Foley & Green 1989: 109). Also, hard work
and commitment from all staff have been found to be important. According to Taylor
(1997), it is characteristic of high-growth firms to have organizational structures built
on teams that can communicate easily and take decisions quickly.
Many studies have analyzed the importance of planning for firm success.
Several studies show the importance of planning in firm performance (Bracker &
Pearson 1986). Baker et al. (1993) found that in a sample of fast-growth small firms,
over half conduct strategic planning on a regular basis. Moreover, they found that fast-
growth small firms develop written business plans as a product of strategic planning
and that they are used more for internal management purposes than for start-up
funding, as is widely recommended. It has been suggested that entrepreneurs should
adopt a clear business plan and carefully monitor the firm’s performance and changes
in the market (Foley & Green 1989: 109).
It has also been found that most successful firms did not have written business
plans but, on the other hand, spent more time on planning than unsuccessful firms, and
entrepreneurs in successful firms seek to reduce risk in their business (Duchesneau &
Gartner 1990). However, in some situations, e.g. for seizing a business opportunity,
there may not be much time for deep investigation (e.g. Bhide 1994). Miller and
Cardinal (1994) analyzed previous studies of the planning-performance relationship,
and found that strategic planning positively influences firm performance and that
factors related to methods are primarily responsible for the inconsistencies in the
literature (see also Powell 1992b; Slevin & Covin 1997). In their study of generic
retailing types, Conant et al. (1993) revealed that firms with the most clearly defined
strategy patterns performed better than other firms.
Successful firms have been found to be more flexible and adaptive
organizations (e.g. Taylor 1997). Foley and Green (1989: 109) suggested that for
business success, it is important to be lucky, and that well-calculated planning and
marketing can minimize risks and enhance luck. In the long term, successful firms
concentrate on what they are good at (Kauranen 1996). However, Taylor (1997)
suggested that after establishing a position in a niche market, the firm should diversify
quickly into related market niches in order not to become over-dependent on one
product, one customer or the economy of a small region. Small firms which grow are
more likely to sur vive than others (Storey 1994: 310).
Related to the external environment, firms that directly compete with a large
number of organizations on a regular basis are significantly more likely to survive
55
(Westhead et al. 1995). In developing areas, satisfactory government support has been
shown to be important for small firm success (Yusuf 1995). It is also important that the
firm leaves the industry before ‘the window of opportunity’ (Timmons 1994: 91)
closes (Taylor 1997).
In addition to these studies focusing on a quite limited set of variables, more
holistic empirical studies of the strategic profiles of successful firms have been
conducted. Studies focusing on the profiles of successful firms have been carried out
by Peters and Waterman (1982), Kay (1992; 1995), Collins and Porras (1994), Simon
(1996), and de Geus (1997), among others. Peters and Waterman studied long-lived,
continuously innovative large companies and their characteristics, and found that
excellent companies were brilliant on the basics. They show that the eight attributes
characterizing successful American companies are: (1) a bias for action; (2) closeness
to the customer; (3) autonomy and entrepreneurship; (4) productivity through people;
(5) being hands-on, value driven; (6) sticking to the knitting; (7) have a simple form,
lean staff; and (8) simultaneous loose-tight properties (Peters & Waterman 1982: 13-
16).
On the other hand, in his study of successful large companies Kay (1992;
1995) found that their success rests on distinctive capabilities, i.e. on those
characteristics that others cannot easily replicate. Therefore, what differentiates these
firms is more striking than what they have in common. Kay (1995: 23) argues that if
there were effective generic strategies, i.e. recipes for corporate success, then all firms
would adopt them, and they would cease to yield returns for any firm.
Collins and Porras (1994; 1996) found that the successful firms they studied
were characterized by vision, but it is important to note that this study was done
through retrospective historical analysis. In line with these results are those reported
by de Geus (1997), who investigated 30 long-lived large companies. The companies,
which were found to be very good at management for change, ranged in age from 100
to 700 years. De Geus (1997) found four common characteristics of successful
companies that could explain their longevity: (1) conservatism in financing; (2)
sensitivity to the world around them; (3) awareness of their identity; and (4) tolerance
of new ideas (see also Collins & Porras 1994; Kotter & Heskett 1992). Both studies
emphasize the importance of preserving a core identity while simultaneously
managing change, the importance of experimentation, and taking into account the
needs of all stakeholders, not only those of owners (cf. Kotter & Heskett 1992).
Simon (1996) studied “hidden champions”, i.e. SMEs that have occupied
leading positions in their world markets, but are unknown to the public. These were
long-lived SMEs, their mean age being 67 years and median average 47 years. In
contrast to high-growth firms, characteristic of these firms were slow growth and
remaining relatively small or medium in their size. Nine important characteristics of
56
these low-profile high-performance German firms were identified: (1) ambitious goals;
(2) narrow market focus; (3) global orientation; (4) closeness to customer; (5)
continuous innovation; (6) clear-cut competitive advantages; (7) reliance on own
strength; (8) motivated employees; and (9) strong leadership. Also, “both-and” lessons
were presented, for instance, it is important not to have either a technology or a market
orientation but both a technology and a market orientation (see Simon 1996: 272-274).
The studies by Peters and Waterman (1982), Collins and Porras (1994), and de
Geus (1997) focus on the profiles of successful large companies, with only Simon’s
study (1996) investigating successful SMEs. The main criteria for selection as
successful firms have been longevity and good annual financial performance in the
long-run. However, most studies have been carried out when the firms are old and big.
The reliability of these studies may be questioned: we may ask, how accurately is it
possible to analyze things that happened a long time ago? Also, it should be noted that
small firms are not small large firms (Simon 1996: 245). Moreover, the research
results are usually not valid for other types of businesses or environmental conditions.
Therefore, taking into account the context is critical when applying the results and
advices presented above.

3.3 Studies of factors affecting SME growth

Besides studies of the success factors of firms in general, much research effort has
been targeted particularly at investigating the factors affecting firm growth, which in
general refers to increase in size. Firm growth has been one focus area in strategy,
organizational and entrepreneurship research. However, there are several conceptual
and empirical challenges in the study of firm growth (Davidsson & Wiklund 2000;
Delmar 1997). Managing growth is a major strategic issue for a growing firm (see e.g.
Arbaugh & Camp 2000). Early studies of growth focused on large companies and their
diversification strategies.
For one of the most comprehensive compilations of results of previous studies
focusing on small firm growth, see Storey (1994). Although there has been much
interest in understanding small firm growth during the last ten years (e.g. Davidsson &
Delmar 1999; Delmar 1997; Wiklund 1998), there is still not much of a common body
of well-founded knowledge about the causes, effects or processes of growth
(Davidsson & Wiklund 2000). Moreover, the existing research on the growth and
strategy of SMEs has focused mainly on new ventures (Olson & Bokor 1995). There
are few studies of the growth of established SMEs: one instance is Davidsson (1989a),
who studied the subsequent growth of an SME from the psychological point of view.
57
There is no comprehensive theory to explain which firms will grow or how
they grow (e.g. Garnsey 1996). It seems that not even very strong explanatory factors
have been identified (Davidsson 1991). Moreover, although several determinants of
firm growth have been suggested, researchers have been unable to gain a consensus
regarding the factors leading to firm growth (Weinzimmer 2000). Most of the research
work in this area fails to provide convincing evidence of the determinants of small
firm growth as a basis for informing policy makers (Gibb & Davies 1990: 26).
Attempts to build models for predicting the future growth of the firm, i.e. picking
winners, have not been particularly successful. The general preconditions for growth
can be considered to be (1) entrepreneur’s growth orientation; (2) adequate firm
resources for growth; and (3) the existence of the market opportunity for growth (cf.
Davidsson 1991).
Storey (1994: 158) claims that there are three key influences upon the growth
rate of a small independent firm: (1) the background and access to resources of the
entrepreneur(s); (2) the firm itself; and (3) the strategic decisions taken by the firm
once it is trading. The most important factors associated with an entrepreneur are
motivation, education, having more than a single owner, and having middle-aged
business owners. The growth of the smallest and youngest firms is the most rapid. The
location and industry sector also affect the growth. The most important strategic
factors are shared ownership, an ability to identify market niches and introduce new
products, and an ability to build an efficient management team. Storey argues that
these three components need to combine appropriately for growth to be achieved. In
their study of small manufacturing firms, Barkham et al. (1996) present more evidence
that certain owner-manager characteristics, business strategies and firm characteristics
are essential for small firm growth.
In her study of the factors affecting the growth of large Finnish companies,
Hajba (1978) presents four groups of growth determinants: (1) direct growth
determinants (size, fusion, exports); (2) parallel growth determinants (age,
innovations); (3) background determinants (strategy, diversification); and (4)
stochastic determinants (e.g. chance, luck). However, many studies of the growth
factors of the firm, including Hajba’s study, have focused on the growth of large
companies. In such cases the role of diversification, for example, may be significantly
bigger than in the case of SMEs. Growth through diversification may be necessary for
the growth of a large company (Kay 1997).
Various explanatory approaches have been used. One way of organizing
studies focused on firm growth is grouping them into four types by the factors
explaining growth (Gibb & Davies 1990: 16-17; Gibb 1997b: 2-3; Pistrui et al. 1997;
Poutziouris et al. 1999). These are: (1) personality-dominated approaches, which
explore the impact of personality and capability on growth, including the
58
entrepreneur’s personal goals and strategic business aspirations (e.g. Chell & Haworth
1992a); (2) firm development approaches, which seek to characterize the growth
pattern of the firm across stages of development and the influence of factors affecting
growth process (e.g. Scott & Bruce 1987); (3) business management approaches,
which pay attention to the importance of business skills and the role of functional
management, planning, control and formal strategic orientation in terms of shaping the
growth and performance of the firm in the marketplace (e.g. Bamberger 1989; 1983);
and (4) sectoral and broader market-led approaches which focus largely on the
identification of growth constraints and opportunities relating to small firm growth in
the context of regional development or the development of specific industrial sectors
such as high-technology small firms (e.g. Smallbone et al. 1993a). This organization of
approaches is used in the following review, though these categories, however, are not
mutually exclusive.
The behavior of entrepreneurs is strongly affected by intentions (e.g. Krueger
& Carsrud 1993: 315; Bird 1988: 442). The firm’s strategic behavior and subsequent
growth is understandable in the light of its growth intention. Therefore, firm growth is
based not merely on chance, but on the management’s conscious decision making and
choice. Naturally, the firm can grow even though it is not the management’s aim, but
in such a case the growth is not planned and so may include more risks. Planning helps
in managing growth.
In general, goals and objectives can be divided into two categories. On the one
hand, there are final goals which are valuable as such. On the other hand, there are
goals which have instrumental value for achieving some other goals. Growth can be
regarded as the second most important goal of a firm, the most important one being
firm survival, i.e. the continuity of the business. Moreover, growth is an important
precondition for a firm’s longevity. Negative growth of an SME is often a sign of
problems, while stagnation, i.e. a situation where growth has stopped, is usually
indicative of problems that a firm will face in the future.
As a matter of fact, growth often has instrumental value. For new ventures,
firm growth is needed to ensure an adequate production volume for profitable
business. Growth can serve as an instrument for increasing profitability by enlargening
the firm’s market-share. Other similar goals include securing the continuity of business
in the conditions of growing demand or achieving economies of scale. Moreover,
growth may bring the firm new business opportunities (cf. the corridor principle), and
a larger size enhances its credibility in the market. Also, achieving a higher net value
of the firm can be regarded as a motive for firm growth.
In SMEs, growth objectives are often bound up with the owner-manager’s
personal goals (e.g. Jennings & Beaver 1997). Much has been written about the
importance of the entrepreneur’s growth motivation (e.g. Perren 2000; Davidsson
59
1991; Miner 1990). The close connection between an owner-manager and the firm is
the dominant characteristic of small firms (Vesalainen 1995: 18). Instead of profit
maximization or growth, a firm’s primary goal may be the entrepreneur’s
independence or self-realization (see e.g. Foley & Green 1989). Moreover, there may
be no adequate resources for growth, or the expected increase in business risks may
limit a firm’s growth willingness. However, aversion to growth has been said to be the
principal reason why most SMEs stagnate and decline (Clark et al. 2001).
It is assumed that the share of growth-seeking firms would be about twenty
per cent of all SMEs (e.g. Hakim 1989; Cambridge Small Business Research Centre
1992). However, not all growth-seeking SMEs will grow significantly. It is important
that the firm’s goals and the personal goals of the entrepreneur support each other, and
that there is harmony between the goals and the environments in which the firm
operates.
In several typologies, entrepreneurs and firms are categorized by their
business goals, so growth has been a widely used dimension in many typologies. There
are two broad approaches in the studies of small firm success: (1) the business
professionals’ model, and (2) the small business proprietors’ model (Bridge et al.
1998: 140-142). These two approaches can be identified in several typologies of
entrepreneurs (e.g. Smith 1967; Stanworth & Curran 1976). According to the business
professionals’ model, a successful firm is one that achieves its highest potential in
terms of growth, market share, productivity, profitability, return on capital invested or
other measures of the performance of the firm itself. In the small business proprietors’
model, the owner-managers’ main concern is whether the firm is providing them with
the benefits they want from it. These benefits are often associated with a lifestyle and
an income level to maintain it. In the latter model, firm success therefore means being
able to reach a level of comfort rather than achieving the business’s maximum
potential.
In firm development approaches firms are seen as temporal phenomena which
are born, grow, mature, decline and die. Firm growth is the basic dimension of the
models of organizational life cycles (e.g. Greiner 1972; 1998; Mintzberg 1979;
Churchill & Lewis 1983; 1991; Miller & Friesen 1983c; Scott & Bruce 1987).
Numerous models of organizational life cycles have been presented, e.g. a three stage
model (Smith et al. 1985), four stage models (Quinn & Cameron 1983; Kazanjian 1988),
five stage models (Greiner 1972; Galbraith 1982; Churchill & Lewis 1983; Scott &
Bruce 1987), and a seven stage model (Flamholtz 1986). These multistage models use a
diverse array of characteristics to explain organizational growth and development.
According to Greiner (1972; 1998), a firm’s failure to adapt to a series of crises caused
by growth is one of the principal causes of firm failure.
60
Common to these growth pattern models is the claim that changes in an
organization follow a pattern characterized by discrete stages of development (Dodge et
al. 1994). Typical of these patterns are the sequence of events that show how things
change over time, a hierarchical progression that is not easily reversed, and a composite
of a broad range of organizational activities and structures. There is also substantial
agreement about a consistent pattern of development and the differing characteristics
associated with the various stages. For instance, organizational life cycle models are
important in understanding the differences in success factors of the firm between the
stages of the life cycle.
However, organizational life cycle models have been criticized because of their
extreme simplification of reality: in some cases not all stages of development are found,
some stages of development may occur several times, the stages of development may
occur in an irregular order, and there is a lack of empirical evidence to support the
theories (e.g. Gibb & Davies 1990; Bridge et al. 1998: 105; Koskinen 1996: 206-207;
Eggers et al. 1994; Birley & Westhead 1990; Miller & Friesen 1983a; Vinnell &
Hamilton 1999; cf. Dodge et al. 1994). In addition, on the basis of the results of their
study of high-growth firms, Willard et al. (1992) concluded that “the applicability of
conventional wisdom regarding the leadership crisis in rapid growth entrepreneurial
firms may no longer be valid, if, in fact, it ever was”. Organizational life cycle models
is one application of the configurational approach in describing the stages of life
cycles and the transformation from one stage to another (Mintzberg et al. 1998). It has
been suggested that the status of being a growth firm may be rather temporary
(Spilling 2001).
Several growth strategies related to business management approaches have
been presented in the literature. It has been suggested that strategy is the most
important determinant of firm growth (Weinzimmer 2000). Among high-growth firms,
Dsouza (1990) identified three primary strategic clusters: (1) build strategy, i.e.
emphasis on vertical integration; (2) expand strategy, i.e. emphasis on resource
allocation and product differentiation; and (3) maintain strategy, i.e. emphasis on
market dominance and/or efficiency. Thompson (2001: 563-565) presents four growth
strategies: (1) organic growth; (2) acquisition; (3) strategic alliance; and (4) joint
venture.
On the other hand, when looking at the product/market strategy, four options
can be seen: (1) market penetration; (2) new product development; (3) new market
development; and (4) moving into new markets with new products (Burns 1989: 47).
However, there is a lack of agreement in empirical findings concerning product- and
market-based strategies. While Sandberg and Hofer (1987) argue that product-based
strategies perform better than focused strategies, Cooper (1993) claim that focused
strategies outperform differentiated product strategies (Pistrui et al. 1997). Perry
61
(1986/87) investigated growth strategies for an established small firm, and concluded
that the most appropriate growth strategies are niche strategies, i.e. market
development and product development strategies, in that order. However, it seems that
most empirical studies focus on new venture strategies. Studies of competitive
strategies related to firm growth have been carried out in the new venture context by
McDougall and Robinson (1990), McDougall et al. (1992), Carter et al. (1994), and
Ostgaard and Birley (1995), among others.
As opposed to the organic growth strategy, acquisitions are usually regarded
rather as a large companies’ growth strategy which can be either synergistic or
nonsynergistic (Anslinger & Copeland 1996). Forward or backward vertical
integration means that the acquired firm is located at a different level of the value-
addition chain, i.e. the acquired firm is a customer or supplier of the firm. In contrast,
horizontal integration refers to a firm which is at the same level of value-addition, i.e.
it is a competitor. Lateral integrations refer to unrelated businesses which represent a
diversification strategy. In addition to becoming bigger and thus acquiring greater
market power, there might be several other reasons for acquisitions, e.g. acquiring
synergies, industry restructuring, reduction of business risk, acquiring new knowledge
and other necessary resources, overcoming barriers to entry, and entering new markets
quickly (see Vermeulen & Barkema 2001; Empson 2000; Birkinshaw 1999;
Tetenbaum 1999; Chatterjee 1992). Despite the fact that growth through acquisitions is
more typical of larger firms than smaller ones (see e.g. Davidsson & Delmar 1998), it
is one option for the growth of an SME. However, it seems that there are few studies
focused on acquisitions made by small firms.
Also, one often neglected way of growing is by setting up new firms. Studies
using a firm as the unit of analysis have not been able to identify growth through a
portfolio of firms as one way of growing (see Scott & Rosa 1996). However, it has
been found that portfolio entrepreneurship appears to be more common than suspected,
and that it is characteristic of entrepreneurs who own and manage growth firms
(Pasanen 2003). Wiklund (1998: 239) concluded that growth through portfolios of
firms does not seem to be an alternative to growing a single firm, but entrepreneurs
leading rapidly growing firms tend more often to start subsidiaries and independent
new firms and to grow these firms. Small business growth through geographic
expansion is a challenging growth strategy, as during the course of opening a new
geographical site an entrepreneur will be confronted with the task of managing an
existing business and a start-up at the same time (Barringer & Greening 1998).
Penrose (1959) proposed already in the late fifties that firm growth is
constrained by the availability and quality of managerial resources. Many studies draw
attention to the important role of an entrepreneurial team for firm growth (see Birley &
Stockley 2000). Also, in their study of technology-based ventures, Eisenhardt et al.
62
(1990) found an association between a strong management team and firm growth (see
also Weinzimmer 1997). In addition to the importance of favourable firm-internal
conditions, the strategies should be in harmony with the environmental conditions.
Different growth environments may require different business strategies for SMEs. For
instance, Chaganti (1987) found that for small manufacturing firms, different growth
environments required distinctly different strategies. Interestingly, this was contrary to
the findings concerning large companies. It was concluded that strategic flexibility is a
critical requirement for small firms (Chaganti 1987).
Sectoral and broader market-led approaches focus largely on the
identification of growth constraints and opportunities. It has been found, for instance,
that economic fluctuations strongly affect the growth probability of small firms
(Kangasharju 2000). Also, for firm growth, it seems that aiming at growing market
niches is more important than taking market shares from competitors (Wiklund 1998).
However, growth can happen only if there are no growth barriers. Such barriers can be
related to firm-internal and firm-external factors (see e.g. Barber et al. 1989;
Smallbone & North 1993a; Vaessen & Keeble 1995; Jones-Evans 1996; Vesper 1990:
174-175; Hay & Kamshad 1994).
The growth barriers characteristic of small firms in peripheral locations have
been presented by Birley and Westhead (1990: 538). In the study carried out by the
Cambridge Small Business Research Centre (1992), the most frequent growth barriers
were related to factors on the macro level. The most important growth barriers were
related to difficulties in obtaining finance (cf. Lumme 1994: 15) and the price of
money, the level of and decrease in demand (also Perren 2000), and tightening
competition (also Hay & Kamshad 1994). Other growth barriers were caused by
restrictions determined by authorities, problems in obtaining a skilled workforce, and
the small number or lack of potential cooperation partners in the area. The firm-
internal factors affecting unwillingness to grow include the entrepreneur’s fear of
losing her or his autonomy, difficulties in fitting together personal and the firm’s
goals, and weak managerial or marketing skills (see also MacNabb 1995; Perren
2000). These issues are particularly typical when an entrepreneur “transfers” from the
role of entrepreneur to that of manager, or when the firm hires a new manager.
In the population ecology approach, the three stages of variation, selection,
and retention constitute a general model of organizational change which explains how
organizational forms are created, survive or fail, and are diffused throughout a
population (Aldrich 1979: 28-31). Variation generates the raw material from which
selection, according to environmental or internal criteria, is made. Then, the retention
mechanism preserves the selected form. Variation within and between organizations is
the first requirement for organizational change, and there must also be variation across
environments if externally directed change is to occur. Selection serves as the driving
63
force of long-term change (Hannan & Carroll 1995: 23). The environment also sets the
conditions under which organizations operate and survive. Each population tends to
become isomorphic to the environment through the mechanism of competition among
organizational foundings in excess of available resource space. It is assumed that as
the di versity of the resource base increases, the diversity in a set of adapting
organizations increases.

3.4 Studies of factors affecting SME failure

It is 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 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.
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) also 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 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.
The most recent 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.
64
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.
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.
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 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) reported 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
65
failure. Lack of management skills was seen to be a major failure determinant by
Zacharakis et al. (1999). Also, the entrepreneur’s inability to 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 in
particular 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 inadequaces 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, the higher the probability that the firm will
survive (Reid 1991). Labich and de Llosa (1994; also O’Neill & Duker 1986; Hall &
Young 1991) claimed 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
66
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 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, Storey (1994: 94-95)
argues, based on 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).
67
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).
The findings of previous studies can be described as fragmented, while several
common themes are evident. There is disagreement among the results of 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 somehow understandable that
the results of studies are inconsistent with each other.

3.5 Studies of factors affecting SME decline and recovery

Many firm failures do not happen suddenly, but develop over time as a consequence of
decline or crisis. Although small firms are more vulnerable than large ones, few
studies have focused on the decline, crises, and turnaround of small firms (Chowdhury
et al. 1993). Decline is often seen as a relatively smooth trend, involving a sustained
low rate of performance deterioration. In contrast, crisis is usually seen as a sudden
performance drop, involving a major downward shift in performance trends. Weitzel
and Jonsson (1989) have presented a model of decline consisting of five stages: (1)
blindness; (2) inaction; (3) faulty action; (4) crisis; and (5) dissolution.
Slatter (1984) presents ten major symptoms of firm decline: (1) falling
profitability; (2) reduced dividends; (3) falling sales; (4) increasing debt; (5)
decreasing liquidity; (6) delays in publishing financial results; (7) declining market
share; (8) high turnover of managers; (9) top management fears, e.g. ignorance of
important tasks or problems; and (10) lack of planning or strategic thinking. Most of
these seem to be related to the firm’s finance. However, they are not causes of failure,
but indicators of severe problems, and no action should be taken before the underlying
primary, or root, causes are identified. For instance, Masuch (1985) analysed vicious
circles which cause underperformance, stagnation, and decay in organizations, and
found that such vicious circles are usually conceived as spiraling processes.
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Thompson (2001: 625-630) grouped the factors associated with decline into
three categories (see also Weitzel & Jonsson 1989). First, factors related to inadequate
strategic leadership: (1) poor management; (2) acquisitions which fail to match
expectations; (3) mismanagement of big projects; and (4) dishonesty. Another
category of factors associated with decline relate to poor financial management: (5)
poor financial control; and (6) cost disadvantages. Then there are factors which relate
to competitive forces: (7) the effect of competitive changes; (8) resource problems;
and (9) inadequate or badly directed marketing. According to Thompson (2001: 632),
there is usually more than one factor causing firm failure. Most of these factors
associated with decline were also identified in the study conducted by Thain and
Goldthorpe (1990); their analysis also revealed lack of information as a factor
associated with decline.
Recovery strategies refer to both retrenchment strategies and turnaround
strategies (Thompson 2001: 635; cf. Pearce & Robbins 1993). On the one hand,
retrenchment can be defined as a set of organizational activities aimed at achieving
cost and asset reductions and disinvestment (e.g. Robbins & Pearce 1993). Hence,
retrenchment strategies aim to reduce costs by concentrating and consolidating, which
typically involves changes in functional strategies. Retrenchment strategies usually
have a short time horizon and are designed to yield immediate results. For small firms,
retrenchment has been identified as a common but not universal response to economic
recession (Michael & Robbins 1998). However, it has also been claimed that
retrenching plays a minor role in facilitating recovery (e.g. Barker & Mone 1994).
On the other hand, turnaround strategies relate to changes in competitive
strategies and frequently feature repositioning for competitive advantage (Thompson
2001: 647-648). Turnaround strategies are likely to address those areas which must be
developed if there is to be a sustained recovery. In addition, they are designed to bring
quick results and at the same time contribute towards longer-term growth. However, in
the short term small firms typically have no resources required for diversification, for
instance. Hence, strategies aiming at increasing organizational efficiency may be more
available to small firms.
Retrenchment can be regarded as the first stage of a two-stage turnaround
strategy, where the retrenchment phase is overlapped and often obscured by a
subsequent recovery stage as the firm implements its strategic redirection (Michael &
Robbins 1998). In fact, as Robbins and Pearce (1992: 304) point out, retrenchment is
an integral component of any turnaround strategy for the successful recovery of
declining firms. In contrast, Barker and Mone (1994) and Castrogiovanni and Bruton
(2000) question this with evidence that retrenchment has no beneficial effects on firm
performance in all contexts (cf. DeDee & Vorhies 1998). However, it is important to
distinguish between declines which represent a threat to firm survival and those which
69
do not. To date, in many studies focused on retrenchment and turnaround, the
distinction between them has been blurred.
On the basis of case studies, Hofer (1980) identified three successful operating
turnaround strategies: (1) cost cutting; (2) asset reduction; and (3) revenue-generation.
In a later large sample study of retrenchment strategies, Hambrick and Schecter (1983)
found only the cost cutting and asset reduction strategies. According to Slatter (1984),
sustained recovery often requires (1) asset reduction, e.g. by divestment of part of the
business; (2) a new leader; and (3) improvement of financial control systems. In a
study of twenty firms in the manufacturing and service sectors in the U.K., Slatter
(1984) found ten turnaround strategies: (1) change of management; (2) strong central
financial control; (3) organizational change and decentralization; (4) product/market
reorientation; (5) improved marketing; (6) growth through acquisitions; (7) asset
reduction; (8) cost reduction; (9) investment; and (10) debt restructuring and other
financial strategies. However, these strategies were often used in combination. Thain
and Goldthorpe (1990) present a matrix of recommended turnaround recovery actions
depending on the stage of decline, i.e. potential, actual and crisis, and on the key
factors determining turnaround success or failure.
It has been found that superior management emphasizing the protection of
margins, the efficient use of capital, and a concentration on markets or segments where
distinctive competitive advantage is possible are characteristic of firms that have
survived most successfully through an economic recession (Clifford 1977; cited by
Thompson 2001: 657). Bacot et al. (1993), following Hall’s (1980) study of survival
strategies in a hostile environment, studied adaptive strategies and firm survival in an
environment dominated by economic decline. Both these studies found that firms
employed one or both of strategies which targeted (1) the lowest cost, and (2) a
differentiated position. Although Hall (1980) cautioned against diversification, the
firms in Bacot et al.’s (1993) study did diversify, primarily through acquisition or by
modifying technologies for use in other markets. However, both studies focused on
large companies, and diversification may play a different role in such firms than in
small ones.
In their study of the characteristics and strategic adjustments of surviving and
non-surviving firms, Smallbone et al. (1992) found five broad types of adjustment: (1)
product and market adjustments; (2) production process adjustments; (3) employment
and labour process adjustments; (4) ownership and organizational adjustments; and (5)
locational adjustments. The main findings were that firms which had been most active
in making adjustments were the most successful. To achieve real growth, active
market development, i.e. identifying new market opportunities and increasing the
breadth of customer care, is essential.
70
It has been found that successful recovery strategies are associated with the
primary causes of decline (Pearce & Robbins 1993). For firms whose decline was due
primarily to external problems, turnaround was most often achieved through strategies
based on an entrepreneurially driven reconfiguration of business assets. On the other
hand, for firms that declined primarily as the result of internal problems, turnaround
was most frequently achieved through recovery responses with an emphasis on
efficiency strategies. Contextual factors such as the nature of the competitive
environment play a major role in the firm’s turnaround success (e.g. O’Neill 1986). It
is therefore important to take into account the turnaround situation, i.e. the
contingencies. According to Finkin (1985), no two turnaround situations are ever
exactly alike, so understanding and controlling nuances becomes important in each
particular case, and will have much to do with achieving success (see also Thain &
Goldthorpe 1990). Burns (1989: 51) claims that the crisis that triggers the decline to
failure is often based on firm-external events.
Most of the studies reviewed above were carried out in the large-firm context.
Therefore, the applicability of the results for the small firm sector can be questioned.

3.6 Comparative studies of success and failure factors

Little research has been carried out on reasons why some SMEs will survive, while
others will fail (Hall & Young 1991: 54). According to the studies we do have, it
seems that there are few differences between successful and failed firms (Smallbone
1990; Lussier & Corman 1995).
Hambrick and D’Aveni (1988) studied large corporation failures, matching
failed and survived firms. They describe the decline of the firm as a downward spiral.
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. 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.
On the basis of their literature review, Lussier and Corman (1995) presented a
list of 15 variables contributing to firm success versus failure. They found that the
findings of previous studies are contradictory. In their study of 216 matched pairs of
successful and failed firms, only two variables which may explain success and failure
showed a significant difference between successful and failed firms: (1) firms that do
not use professional advisers have a greater chance of failure than other firms; and (2)
71
firm owners whose parents did not own a firm have a greater chance of failure than
owners whose parents did own a firm. However, there were also some exceptions,
indicating that no general rule can be formulated. Moreover, in another study Lussier
(1995) concluded that successful firms develop more specific business plans than
those who fail.
Lussier and Corman (1995) concluded that there are few differences between
successful and failed small firms, and that consequently there may not be a valid and
reliable set of variables that can distinguish success from failure. They also suggested
that in further research the most promising variables shoul d be applied according to
the specific situation at hand. This means taking into consideration the contingencies
of businesses, and provides support for examining success in different types of firms.
In their study of factors influencing the survival of 227 high-technology small
firms, Westhead et al. (1995: 94) found that of 69 variables studied, only 13 were
statistically significantly associated with survival/non-survival of firms. Such variables
related to the work experience of key founders, characteristics of the business,
competitive structure, financial base, and management functions. In addition, and
perhaps more interestingly, they found that none of the technology-related variables
were significant, suggesting that the factors influencing survival/non-survival of
independent technology-based firms are no different from those influencing similar
firms operating outside high technology.
Statistically significant does not always mean important. In addition to
empirical association, there should also always be theoretical rationales for such
associations before the findings can be regarded as conclusive. This seems not always
to be the case. For instance, on the basis of their empirical analysis, Lussier and
Corman (1995) found that failed firm owners had a significantly higher education than
successful ones, and similarly Westhead et al. (1995: 88) argue that founders with
management experience prior to start-up were more likely to have a firm that closed.
However, such empirical associations do not mean that higher education or prior
managerial work experience are not important for firm success, nor that they are
causes of failure. Usually such findings can be explained by problems of measurement
or the influence of confounding variables.

3.7 Summary and conclusions

To date, research into firm success and failure does not provide a comprehensive
explanation for SME performance. A huge number of variables seem to be associated
with firm success and failure. The findings of previous studies of the factors associated
with firm success and failure are contradictory. In addition, most studies have focused
72
on large companies, and those investigating small firms often concentrate on new
ventures. Moreover, a large variety of research approaches have been used.
Narrowness and a lack of a holistic approach are characteristic of many studies. It is
encouraging to find that small firms, not only large companies, may become world
leaders (Simon 1996; see Markides & Stopford 1995). In addition, few studies have
focused on the factors affecting the performance of SMEs in peripheral locations.
Hence, it seems that there is a gap in the research focused on the profiles of successful
SMEs in peripheral locations.
Firm success is closely related to firm growth. Much has been written about
firm growth, and there are several explanatory approaches. However, there is no
comprehensive theory to explain which firms will grow or how they grow. It seems
that not even very strong explanatory factors have emerged. Moreover, the growth of
established SMEs seems to have attracted less attention in research, most studies
focusing on large companies or new ventures.
While a number of studies have focused on firm success and growth, few
recent studies have focused on firm failure. The factors contributing to firm failure are
often closely related to the causes of decline and crises. Recovery strategies may
provide valuable information on successful turnarounds. However, few studies have
focused on the turnaround strategies of SMEs. Moreover, to date, comparative studies
of firm success and firm failure factors have been rare. It seems that there are few
differences between successful and failed firms in general.
However, in the light of previous research, it can be suggested that there seem
to be certain factors related to success and failure. Success seems to be associated with
the entrepreneur’s higher education and experience, an effective management team,
innovativeness in products, good customer relationships and avoidance of dependency
on 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. On the other hand, failure often
seems to be related to the lack of these qualities.
In general, a firm’s inability to adjust to changing circumstances can be seen
to be the reason for failure. 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.
73
Given the high number of studies focused on firm performance, it is surprising
that much of the research is non-cumulative. There can be several reasons for this.
There is a striking diversity in the definitions of central concepts, for example, and the
field of research focusing on firm performance is fragmented due to the existence of
several research streams and approaches. In addition, there are several contingency
factors which may affect and blur the results. It is also worth noting that research
results always represent selected views of reality, so research is always partial and can
never thoroughly capture all the bits of the phenomenon in question.

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75

4 EMPIRICAL RESEARCH METHODS

4.1 Empirical research approach

Over the years, the field of business studies has become fragmented (e.g. Landström et
al. 1997; Landström & Huse 1996), and this has been facilitated by the conceptual
pluralism in the field (see e.g. Bygrave & Hofer 1991). Recent research in strategic
management and entrepreneurship has called for a more integrated and holistic
approach (e.g. O’Farrell & Hitchens 1988; Storey 1994: 327; Gadenne 1998;
Landström & Sexton 2000: 437; Sandberg & Hofer 1987; McDougall et al. 1994).
This study tries to respond to this call via its versatile research design. A multimethod
approach is applied, so that the limitations of one method are compensated for by the
counter-balancing strengths of another (Snow & Thomas 1994: 464; see also Jick 1979).
The study follows an abductive approach (Peirce 1958). As opposed to studies
using a deductive approach, which is theory-driven, this study is characterized rather
by a data-driven, empirical i.e. taxonomic, approach. Taxonomies refer to empirically
derived groupings of organizations (Sanchez 1993). As noted by Miller and Friesen
(1984: 32), “Attempts are then made to identify natural clusters in the data, and these
clusters, rather than any a priori conceptions, serve as the basis for the configuration”.
Whereas an induction (e.g. Johnson 1998) starts from the empiric, and a
deduction from the theory, abductive reasoning starts from the empiric but also
recognizes the existence of theory as a background. However, the central element of
abductive reasoning is thought. The reasoning can be based on an intuitive supposition
but it can also be based in the actual facts, and in observed experiences. Using the
literature, theories can be well used as support, not so much to be leaned on but as the
source of inspiration and ideas. Thus, the facts are always somehow charged with the
theory.
Abductive reasoning is based on the assumption that the formation of a new
theory is only possible when a guiding principle is connected to observations.
Therefore, a new theory is created not merely on the basis of observations, as is the
case with inductive reasoning. The guiding principle may be a vague intuitive i dea or a
hypothesis. The guiding principle can be used to concentrate the observations in some
points or conditions, because it is believed that it can produce new views and ideas,
new theory from the phenomenon in question (see Peirce 1958: 96-97; Grönfors 1982:
33).
76
An abductive approach can overcome the problems of a purely inductive
approach, as when, for example, inductive reasoning refers to a data-driven approach,
the empirical material has to capture the phenomenon under investigation. Due to the
exploratory nature of this study, it was considered advisable not to commit to a single
theory only. Theories, models and concepts are used in organizing the phenomena and
identifying the relevant issues for research. On the other hand, this study can be
characterized as hypotheses testing, though no hypotheses are presented explicitly –
however, the data acquisition and selection of variables are based on their expected
relevance in the investigation of the phenomena (cf. Bygrave 1989).
The strength of taxonomies lies in the fact that they are derived empirically,
through multivariate analysis, based upon common patterns or relationships identified
in the data (Hanks & Watson 1993). As Gartner et al. (1989) put it: “Taxonomic
approaches are an important methodology for uncovering relationships in complex
phenomena, and many organization researchers suggest that the development of
taxonomies is an essential part of the research process (Miller 1981; Miller &
Mintzberg 1983; McKelvey 1975)”. Taxonomic approaches are valuable for the
development of both descriptive parsimony and theory (Gartner et al. 1989). However,
taxonomic approaches have been rarely used because they require much work.
Along with the call for more integrated and holistic research, a configurational
approach has gained more popularity among scholars in the field of strategic
management and entrepreneurship. Configurations is used as an umbrella term that
encapsulates a variety of research streams (Ketchen & Shook 1996). Examinations of
organizational configurations have been conducted under many labels, including
strategic groups (e.g. Hatten & Schendel 1977), organizational typologies (e.g. Miles
& Snow 1978), taxonomies (e.g. Galbraith & Schendel 1983), and archetypes (e.g.
Miller & Friesen 1978).
Organizational configurations are groups of firms sharing a common profile of
organizational characteristics (Meyer et al. 1993). The underlying assumption of a
configurational approach is that better understanding can be achieved by identifying
distinct, internally consistent sets of firms than by seeking to uncover relationships that
hold across all firms. A configuration represents a number of specific and separate
attributes which are meaningful collectively rather than individually (Rosenberg 1968;
Dess et al. 1993). Such attributes often fall into patterns because of their
interdependencies.
In this study, configurations refer to sets of SMEs with similar patterns of
strategic behavior. The value of configurational inquiry is its holistic perspective of the
firm. Firms are complex configurations of many individual conditions (Rich 1992).
Configurations are a means of achieving parsimony while presenting rich, complex
descriptions of firms (Hambrick 1983b). In addition, configurations are said to be
77
predictively useful in that they are composed of tight constellations of mutually
supportive elements. Configurational inquiry represents a holistic stance, an assertion
that the parts of a social entity take their meaning from the whole and cannot be
understood in isolation (Meyer et al. 1993; Sheppeck & Militello 2000). Moreover, the
presence of certain elements can lead to the reliable prediction of the remaining
elements (Miller & Mintzberg 1984).
This study clusters successful SMEs into homogeneous groups according to
their growth mode and strategies, because these factors were expected to be very
important, especially in terms of practical implications. The configurations are based
on data referring to the characteristics of entrepreneurs and enterprises, their life cycle,
the strategic choices made and success factors of the SMEs, and the nature of their
environment (see Appendix 2). The configurations holistically describe conditions and
circumstances related to the performance of successful SMEs. Some previous studies
of small firm strategy have been criticized because of their narrow definition of
strategy and because they force firms into a priori classification schemes (McDougall
et al. 1992). This study tries to avoid this by using several clustering variables and
collecting high number of other variables for the description of the configurations.
Moreover, previous studies have not been holistic and only a fraction have
applied empirical, quantitative taxonomic approaches. Many previous studies have
been qualitative, a priori conceptual typologies (Woo et al. 1991). Another concern,
revealed in the study of new venture strategies by Carter et al. (1994: 23), is that many
previous studies have focused on firms within a single industry. Such an approach may
discriminate strategy archetypes across competitive methods by controlling for varying
industry effects, i.e. it is not known whether the archetypes revealed are industry
specific or not. There has been also a tendency for research in this area to be restricted
to activities in certain functional areas only, so that it is not possible to identify
patterns across functional areas and to define wholly a firm’s strategy (Kotey &
Harker 1998).
The empirical material used in this study is based primarily on two sources of
information: data of an extensive survey (see e.g. Church & Waclawski 2001; Fowler
2001), and in-depth case studies (see e.g. Chetty 1996; Eisenhardt 1989a; Romano
1989). The data were complemented with documentary data. A versatile research
design also enables triangulation (see e.g. Jick 1979; Denzin 1978: 291). However, not
all results based on these empirical data sources are reported in this report.

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4.2 Survey

4.2.1 Data collection methods

Empirical data were collected from 145 successful independent SMEs located in
Eastern Finland in 1998. The definition of successful SMEs was based on the results
of the previous studies of the financial state of SMEs, and on the expertise of local
actors who evaluated these SMEs as the most successful ones in their industry sectors
in the region. Thus, the concept of successful firm was broadened to include, in
addition to growth firms, firms which make a significant impact on local and regional
economies. In addition to their possible strategic roles in local economic system,
successful non-growth firms have, however, an important role in the economy in terms
of maintaining existing jobs. The EU, for example, seems to recognize their
importance by using the number of maintained jobs as one of the criteria for objectives
of regional development programmes.
For the customer markets of the target firms, the geographic area of the
empirical study can be regarded as peripheral. This may create additional challenges
for firm performance (see e.g. Smallbone et al. 1993a). There are few studies of the
success of SMEs in peripheral locations, and the research focused on this phenomenon
is fragmented (Vaessen & Keeble 1995: 1-2).
Sample selection was based on the results of previous studies of the financial
state of SMEs in the area and local actors’ expertise regarding local SMEs (cf. Laureen
1996; Lumme 1994). These studies were carried out by local development
organizations: (1) Kera Ltd. (now Finnvera Ltd.) (Kera Ltd. 1996; Aira 1995a, 1995b,
1995c; Kuittinen 1995a, 1995b; Kuittinen & Karjunen 1995; Tengvall & Tuunala
1995); (2) Kuopion lääninhallitus (Heikkinen & Jääskeläinen 1996; Janakka 1996;
Juntunen 1996; Karpansaari 1996; Lampelo 1996; Remes 1996); and (3) Savon Liitto.
Multi-perspective evaluations of SMEs were conducted by several local actors such as
representatives of the local authorities, e.g. business development departments of
municipalities and towns, business associations, and trade unions. Despite the
judgemental sampling employed, each of these studies identified largely the same
firms (cf. Kay 1995: vi; see also Brush & Vanderwerf 1992).
A mail survey was made of entrepreneurs of SMEs operating in the sectors of
manufacturing, business services, and tourism. The data received were largely based
on the respondent’s subjective evaluations and perceptions. A mail survey was chosen
as a data collection method because it made it possible to obtain comparable data for
statistical analysis. Personal interviews were out of the question because of financial
restrictions. It was felt to be important to obtain large amounts of data so that SMEs of
different types could be captured into the sample. Data collection was based on a pre-
79
tested questionnaire, i.e. three pilot tests were made before sending the questionnaire
to the target SMEs. The questionnaire contained both questions with forced choices as
well as open-ended questions.
The study focused on SMEs because of their high societal relevance and their
distinctive features in comparison with large companies. An SME was defined in
terms of the number of personnel, so that firms with fewer than 250 employees are
SMEs (Statistics Finland 1997b: 9). On the other hand, to limit the sample, SMEs with
fewer than five employees were excluded. Such firms are often new or recently
founded, or if they are older they are not within the scope of this study (cf. Cambridge
Small Business Research Centre 1992; Hakim 1989). Moreover, selection of such
firms would had been difficult, because the anal yses made by Kera Ltd. (1996: 5)
covered firms with five or more employees only. Moreover, firms with 5 to 249
employees were considered to have greater potential impact on regional economic
development than smaller ones.
Manufacturing SMEs were chosen because they have an important place in the
economy, especially from the point of view of the development of local and regional
economies (cf. Barkham et al. 1996). Their products can be exported, and they are not
bound up with the demand of local markets. Business services may have critical
importance for the development of manufacturing firms (Illeris 1989). Moreover, their
role is emphasized for growth firms (see e.g. Niittykangas & Tervo 1995). On the
other hand, the development of manufacturing firms may play a critical role in the
start-up or relocation of business service firms. Like manufacturing firms, SMEs in the
sector of tourism are not bound up with the demand of local markets. In terms of the
national industrial classification of economic activities (TOL 1995), the industry
sectors represented in the study are: manufacturing: 15, 17-22, 24-37; tourism: 55, 92-
93; and business services: 72-74 (Statistics Finland 1995).
The variables used in this study relate to the characteristics of entrepreneurs
and enterprises, their life cycles, the strategic choices made, and success factors of
SMEs, and the nature of their environment. As was already mentioned in previous
chapters, several factors in these areas are associated with firm performance. The
questionnaire used can be found in Appendix 1, and the list of variables is presented in
Appendix 2. The characteristics of entrepreneurs consist of variables relating to
entrepreneurs’ education, experience and other demographic factors. Variables related
to the characteristics of SMEs and their life cycle include the firm’s demographic
characteristics and growth behavior indicators. For the strategic choices made by the
firm, the focus is on internationalization, innovativeness, specialization and
networking (cf. e.g. Niittykangas et al. 1998). These strategic choices include three
important elements affecting SME performance: markets, products, and the way of
doing business (Normann 1976). Internationalization refers to the markets of the firm,
80
innovativeness to the products of the firm, and specialization and networking to the
way of doing business. Environment was approached by studying the characteristics of
customer, industry and location environment.
The success factors of SMEs were presented as statements that describe their
importance relating to the firm’s competitive advantage. A set of 55 structured success
factor statements was drawn up, based on the literature concerning entrepreneurship,
strategic management and SMEs, discussions with colleagues, and the researcher’s
intuition. In the questionnaire, success was not predefined, i.e. the definition of success
was based on the entrepreneurs’ own understanding of the concept. The entrepreneurs
ranked the success factor statements using a 7-point Likert-type scale (1 = not at all
important, 7 = very important). The open-ended questions related to SME performance
were: (1) “What has been the most critical for the firm’s success?” (success factors),
and (2) “What has been the most critical for the firm’s survival, when the firm has
faced problems?” (survival factors).
At the end of the questionnaire respondents were asked whether or not they
were interested in participating in further case studies and in having a summary of the
results. To facilitate contacting the respondent and mailing the summary, respondents
were asked to state their names. Since almost all answered these questions, it was
possible to verify that the respondents were the firm leaders, i.e. the CEOs of the
firms.

4.2.2 Materials: sample characteristics

All SMEs in the sample shared four features: (1) size: SMEs, i.e. they employed fewer
than 250 persons; (2) location: peripheral, i.e. located in Eastern Finland; (3)
performance: evaluated as the most successful SMEs in the industry sectors in the
region; and (4) ownership: independent firms, not subsidiaries of other companies. The
original sample was 270 SMEs, of which 145 responded, giving an overall response
rate of 53.7%. The representativeness of the sample could be assessed by three
measures: industry sector, location, and being one of the firms in the group of “top
firms” (Kera Ltd. 1996) in the region. These measures show that there were no
differences between firms that responded and those that did not.
The response rate varied by industry sectors (see Table 4.1): in manufacturing,
it was 54.5% (n=121), and in the service sector, i.e. business services and tourism, it
was 50.0% (n=24). Some of those who did not respond reported that they had no time
to reply and so returned an empty questionnaire form. The sample can be considered to
represent successful SMEs in the selected industry sectors in their location.
81
Also, there were no differences in the distribution of SMEs that responded and
those who did not by location. The response rates were between 56% and 58% in the
regions of Inner Savo, Kuopio, and Upper Savo. The response rates were slightly
lower in the Varkaus region (45%) and North-Eastern Savo (29%). In the latter region
the relative impact of one response was emphasized due to the smaller total number of
SMEs selected. Moreover, the lower response rates in North-Eastern Savo and the
Varkaus region can be explained to some degree by the differences in sectoral activity
in responding, i.e. SMEs in the sector of tourism (see Table 4.1) in those regions were
somewhat reluctant to participate in the research.

Table 4.1 Number of respondents and response rates by industry sectors
Industry sector No. of respondents Response rate
Food industry 12 48%
Textile, clothing, leather, and shoe industry 12 52%
Mechanical woodworking industry 23 56%
Printing industry 11 50%
Chemical industry 3 30%
Building material industry 8 53%
Metal industry 26 63%
Machinery industry 7 50%
Electro-technical industry 19 61%
Business services 18 67%
Tourism 6 29%
Total/Average 145 54%

Moreover, there were no differences in the response activity of SMEs that were
classified as “top firms” in the region (Kera Ltd. 1996) by their industry sectors. The
response rate of the “top firms” in the region was 58.1%, which means that the
material can be regarded as representative of the “top firms” as well.
The success of SMEs in the sample can also be evaluated by five performance
measures: (1) firm age; (2) growth in terms of turnover; (3) the entrepreneur’s self-
evaluation of firm success; (4) the entrepreneur’s satisfaction with firm success; and
(5) the firm’s competitive power in the market of the main products. The average age
of the SMEs was 20 years. Four out of five of the SMEs have grown during the last
decade in terms of turnover. Here growth was interpreted as a linear trend of turnover
between two points of time, ignoring any decline in turnover during, for example, the
economic recession. The firm’s turnover at the beginning of the 1990s was compared
with its turnover at the end of the 1990s. However, growth is obviously not an
applicable performance measure for firms which do not have growth as an aim. On the
other hand, it seems that firms aiming at growth have succeeded if measured by
growth of their turnover, and especially if we take into consideration the economic
cycles in the Finnish economy and the fact that economic recovery clearly took more
time in Eastern Finland than in Southern Finland, for example.
82
Consequently, entrepreneurs’ subjective evaluations of the firm’s business
success during recent years were elicited (cf. O’Neill et al. 1987; Jennings & Beaver
1995: 190). This made it possible to overcome the problem of incommensurability of
goals and objectives. Almost two thirds of the respondents (61%) thought that their
firm has succeeded better than their most important competitors. Only one out of ten
thought that the firm’s success has been weaker than that of their most important
competitors.
They were also asked how satisfied they were with their firm’s success, and
more than four out of five (82%) reported that they were satisfied with this. Moreover,
a firm’s market share can be seen to be related to firm success, since the bigger the
market share, the more competitive power and influence a firm has in the market. Five
out of six respondents (85%) considered that their firm had at least quite good
competitive power in the market of the firm’s main products. Thus, the common
problem of SMEs – the transfer of costs forward in the supply chain – which is based
on the weaker power of SMEs in the market compared with large companies, seems
not to be as significant a problem for the SMEs studied as it may be for other firms.
In the light of this evi dence it can be argued that the SMEs in this sample are
more successful than SMEs in general, i.e. those chosen by random sampling. It seems
that these performance measures measure partly different aspects of performance
because of their moderate correlations (see Table 4.2) (cf. McMahon 2001). Moreover,
it should be noted that an SME can be seen as successful when measured by one
performance measure and unsuccessful when measured by another.

Table 4.2 Correlations of performance measures
a

Measures 1 2 3 4
1 Firm age
2 Growth in turnover -.16
3 Business success compared with competitors .08 .42**
4 Entrepreneur’s satisfaction with business success .16 .47** .46**
5 Competitive power in the market of the main products .19* -.02 .30** .21*

a.
r
s
, **=p