How can small companies succeed and thrive?5 November 2015
Ahead of the Professorial Lecture on Wednesday 11 November, Professor Gavin Reid explores the factors behind small business success – drawing on decades of research.
Tickets are free - book your place now on Eventbrite.
Professor Reid will argue at the event that a few key factors, which are relatively easy to measure, have a relatively large impact on small business continuity.
“Here the key factor is product range. In a sense the small firm is not selling a single product, but rather a menu of products, and is not setting a unique price at any point in time, but rather a tariff schedule which sets prices according to certain contingencies.
“The principal insight from empirical work is that the entrepreneur should think of the products offered to customers as a portfolio. This product portfolio helps to spread risk, and allows economies of scope in product delivery. Though even very small firms might have dozens or even hundreds of products, these can typically be gathered together into distinct product groups.
“Statistical analysis suggests that a product range of about five or six product groups will maximise the probability of survival over the short run, meaning by this a three year time-horizon. In reaching that level of product provision, a 1% increase in the product range would raise the probability of staying in business by about 0.3%.”
“The financial structure of even very small firms can be complex in this modern age of advanced financial tools. However, overall financial structure can be resolved into the principal categories of debt and equity. A key aspect of financial structure is ‘gearing’ - the ratio of debt to equity.
“My finding was that a 1% reduction in gearing would increase the probability of business survival by about 0.2%. However, the ‘best’ gearing is a myth – it all depended on two things, the time scale and the relative price of debt and equity.
“If debt is relatively expensive, it is best to carry relatively expensive debt initially to get a toe-hold in the market, and then to retire it rapidly. If debt is relatively cheap, it is possible to ride the tiger of risk, and let debt track business growth over time.”
“A natural desire in an entrepreneurial firm is to grow. However, I find that there is a growth-profitability trade off. It is partly this which explains the tendency of small firms to stay small. What of fast-growth firms, which in a sense are created to be ‘scalable’ to large operations?
“Many high-tech firms come into this category. Here, the finding is that there are really three key sizes. First there is the short run equilibrium in which size is about 100 employees. Then there is an intermediate-run best size of about 1000 employees. And finally there is a stage when high tech-firms can begin to exploit what is sometimes called the ‘Schumpeterian range’ – when there are huge industrial economies of large scale production, which do not kick-in until size is over about 3000 employees.
“I have argued that the best way of achieving this is by takeovers and mergers. In the fast moving world of high-tech, it is too slow to attempt achieving this scale by internally driven growth alone.”
Strategy and performance
“The trade-off between growth and performance is hard to avoid. Indeed with the advance of technology, it typically will pay a mature small firm to downsize.
“The effects can be dramatic. For example, for all small firms, over a five year period, a 10% decrease in full-time employees can raise the survival probability by 2%. Mitigating this is a tendency for headcount to increase survival probability, which increases the importance of part-time workers.
“What can be done to buck this trend to smaller scale? My recent work suggests that diversity in the competitive strategy is the key. A more varied competitive strategy is required, that places emphasis on more customised and specialist products, which are buttressed by a more aggressive approach to competition, for example by raising advertising and marketing effort.”
“The overall finding is that small firms will continue to have an essential role in a modern economy. However, surviving over the long haul, for something like a generation or more, requires the making of tough decisions.
“Improving the ‘human capital’ within the workforce will tend to reduce the workforce, but increasing the diversity of the competitive strategy will allow prospects of growth, including employment growth, combined with workplace excellence.”
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