Sustaining Growth And Performance In East Asia: The Role Of Small And Medium Sized Enterprises 9781840648089, 1840648082

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Sustaining Growth and Performance in East Asia

STUDIES OF SMALL AND MEDIUM SIZED ENTERPRISES IN EAST ASIA Series Editors: Charles Harvie and Boon-Chye Lee, University of Wollongong, Australia This series incorporates both theoretical and empirical studies of various aspects of small and medium sized enterprises in East Asia, focusing on a number of key issues, problems and their survival in the wake of the regional financial and economic crisis. It examines the contribution of SMEs to national economies and how best to sustain their growth and performance. Selected geographic regions and/or industrial sectors are studied in greater depth for additional insight. These enterprises are distinct in many ways from SMEs in other parts of the world. The studies will therefore contribute to an improved understanding of the roles played by East Asian SMEs in their domestic economies as well as within one of the most dynamic and rapidly developing regions of the global economy. Titles in the series are: 1. Globalisation and SMEs in East Asia edited by Charles Harvie and Boon-Chye Lee 2. The Role of SMEs in National Economies in East Asia edited by Charles Harvie and Boon-Chye Lee 3. Sustaining Growth and Performance in East Asia: The Role of Small and Medium Sized Enterprises edited by Charles Harvie and Boon-Chye Lee 4. Small and Medium Sized Enterprises in East Asia: Sectoral and Regional Dimensions edited by Charles Harvie and Boon-Chye Lee

Sustaining Growth and Performance in East Asia The Role of Small and Medium Sized Enterprises

Edited by

Charles Harvie Associate Professor and Co-Director, Centre for SME Research and Development, University of Wollongong, Australia

Boon-Chye Lee Senior Lecturer and Co-Director, Centre for SME Research and Development, University of Wollongong, Australia STUDIES OF SMALL AND MEDIUM SIZED ENTERPRISES IN EAST ASIA

Edward Elgar Cheltenham, UK • Northampton, MA, USA

© Charles Harvie and Boon-Chye Lee 2005 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited Glensanda House Montpellier Parade Cheltenham Glos GL50 1UA UK Edward Elgar Publishing, Inc. 136 West Street Suite 202 Northampton Massachusetts 01060 USA

A catalogue record for this book is available from the British Library Library of Congress Cataloguing in Publication Data Sustaining growth and performance in East Asia : the role of small and medium sized enterprises / edited by Charles Harvie, Boon-Chye Lee. p. cm. – (Studies of small and medium size enterprises in East Asia series ; 3) Includes index. 1. Small business–East Asia–Congresses. 2. Small business–Government policy–East Asia–Congresses. 3. East Asia–Economic conditions–Congresses. I. Harvie, Charles, 1954- II. Lee, Boon-Chye. III. Series. HD2346.E18S87 2005 338.6⬘42⬘095–dc22

2004058626

ISBN 1 84064 808 2 Printed and bound in Great Britain by MPG Books Ltd, Bodmin, Cornwall

Dedication Charles Harvie To Sonya Boon-Chye Lee To Timothy and Rachel

Other books published by Charles Harvie Vietnam’s Reforms and Economic Growth (co-authored with Tran Van Hoa). Korea’s Economic Miracle: Fading or Reviving? (co-authored with Hyun-Hun Lee). Causes and Impact of the Asian Financial Crisis (edited with Tran Van Hoa). Contemporary Developments and Issues in China’s Economic transition (editor). The Korean Economy: Post-crisis Policies, Issues and Prospects (edited with HyunHun Lee and Junggun Oh). Globalisation and SMEs in East Asia, Studies of Small and Medium sized Enterprises in East Asia (co-edited with Boon-Chye Lee). The Role of SMEs in National Economies in East Asia, Studies of Small and Medium sized Enterprises in East Asia (co-edited with Boon-Chye Lee). Other books published by Boon-Chye Lee The Economics of International Debt Renegotiation: The Role of Bargaining and Information.

Contents ix xi xiii xix

List of tables List of figures Notes on contributors Acknowledgements PART I

GENERAL AND MACRO ASPECTS

1 Introduction: the role of small and medium-sized enterprises in achieving and sustaining growth and performance Charles Harvie and Boon-Chye Lee

3

2 Small, diversified and sustainable: small enterprises in a sustainable production system Hock-Beng Cheah and Melanie Cheah

28

3 The contribution of micro-enterprises to regional economic recovery and poverty alleviation in East Asia Charles Harvie

72

4 The new national accounts and international standards in the assessment of enterprises and sectors of the economy Dudley Jackson

99

5 On the evolution of firm organization, SMEs and economic growth in the USA and Japan Elias Sanidas

117

6 The East Asian financial crisis in Thailand: distress and resilience of local SMEs Philippe Régnier

148

PART II

INTERNAL (MICRO) ASPECTS

7 Managing knowledge development in SMEs: no longer the poor cousins, as training changes to learning? Llandis Barratt-Pugh

vii

163

viii

Contents

8 Ethical values in business: a study of Malaysian small and medium-sized enterprises Za’faran Hassan and Arawati Agus PART III

187

STRATEGIC ASPECTS

9 Key issues in understanding the internationalization process of the small firm: an Australian perspective Susan Freeman

209

10 Entry mode decisions of Indonesian small and medium-sized manufacturers in the export market Heru Satyanugraha

234

11 Technological sourcing in small and medium-sized Australian manufacturing firms Paul L. Robertson, Thomas Keil and Erkko Autio

253

12 SMEs and the Internet: a comparative study – China and the UK Bob Ritchie and Clare Brindley

277

PART IV

POLICY ASPECTS

13 Public policy and SME development Charles Harvie and Boon-Chye Lee 14 The changing role of local government in promoting China’s collective township and village enterprises Russell Smyth

301

327

15 Supporting SMEs through venture capital policy Barbara Cornelius and Sandra Van der Laan

341

Index

359

Tables 1.1 3.1 3.2 3.3 4.1 4.2 4.3 5.1 5.2 7.1 8.1 8.2 8.3 8.4 10.1 11.1 11.2 11.3 11.4 11.5 11.6 11.7 11.8 11.9

Summary profile of SMEs in East Asia/APEC Major differences between livelihood enterprises and growth-oriented micro-enterprises Growth characteristics of micro-enterprises (% distribution of all enterprises more than one year old that started with 1–4 workers) Characteristics of micro-enterprises: contributions to income and welfare (%) Assessment ratios from the SNA93 for the sector of non-financial corporations SNA93 balance sheet for the sector of monetary financial institutions in the UK Government finance statistics, general government (all levels of government), Australia, 1998–99 Data for establishments Original data used in the regression The emerging themes and dimensions Taxonomy of personal moral philosophies Factor analysis results Reliability of measure Regression analysis Parameter estimates Indicators of R&D performance Demographics of the sample Sectoral comparison of firm demographics Sectoral comparison of firm technology characteristics Sectoral comparison of alliances with competitors Two-sample T-test for differences in competitor relationships between high-technology and low-technology sectors Sectoral comparison of supplier structure Sectoral comparison of knowledge-sharing and product development activities with suppliers Two-sample T-test for differences in supplier relationships between high-technology and low-technology sectors ix

7 78 86 87 104 110 114 141 143 177 192 198 199 200 246 260 263 264 264 265 266 267 268 268

x

11.10 11.11 11.12 11.13 11.14 11.15 12.1 12.2 12.3 13.1 13.2 13.3 13.4 15.1

Tables

Sectoral comparison of customer structure Sectoral comparison of knowledge-sharing and product development activities with customers Two-sample T-test for differences in customer relationships between high-technology sectors and low-technology sectors Sectoral comparison of supplier firm’s geographical distribution Sectoral comparison of customer firm’s geographical distribution Two-sample T-test for differences in the geographical scope between high-technology sectors and low-technology sectors UK study China study Comparison of UK and China sample: demographics Contribution of micro-, small and medium-sized enterprises to private non-agricultural employment, selected APEC countries (%) Number of private non-agricultural SMEs as a percentage of firms, selected APEC countries (%) Categories of SME support policies Finance policies in support of SMEs in APEC countries (% of APEC countries) Total venture capital investments, 1998–99

269 269 270 270 271 272 286 290 291 302 303 305 314 352

Figures 1.1 2.1 2.2 3.1 4.1 5.1 7.1 9.1 11.1 12.1

Stairway to export success The ‘quadruple bottom line’ Tendencies of the old and new systems of production Two types of micro-enterprise programmes Set of accounts relating to the sector of non-financial corporations Summary schema The individual SME organizational responses to the three emerging themes The structure of Australian business 1996–97 Distribution of the firms in the sample SME Internet competitive environment framework

xi

17 38 51 89 102 130 180 214 262 281

Contributors Arawati Agus is an Associate Professor in the National University of Malaysia (UKM). She received her bachelors in Finance from Southern Illinois University, USA and masters in management sciences from St. Louis University, USA. She obtained her PhD from the National University of Malaysia (UKM). Her areas of research are quality management, service quality, management science, business excellence and customer satisfaction. Her papers have been published in the International Journal of Management, Total Quality Management (UK), International Journal of Production Economics, Security Industry Review (Singapore), Singapore Management Review, Malaysian Management Review and Management Journal (UKM-Malaysia). Erkko Autio is a Professor at HEC Universite de Lausanne in Switzerland. He is a graduate of Helsinki University of Technology, in Espoo, Finland. His research interests include strategies of technology-based SMEs, internationalization, technology management and corporate venturing. His research has been published in international journals including the Strategic Management Journal, Academy of Management Journal, Journal of Business Venturing, Research Policy and Technology Analysis and Strategic Management. Llandis Barratt-Pugh is a Senior Lecturer and Associate Head of School in the School of Management at Edith Cowan University, WA. He has recently co-directed the national evaluation of the Frontline Management Initiative for ANTA, and his doctoral thesis illuminates the development of manager identity through workplace learning. Currently he is managing an ARC grant examining the relations between organizational strategy and management development. His research and teaching is framed by constructivist and postmodern perspectives but empirically grounded through 18 years of managing experience. In 2001 he was an inaugural winner of the Vice-Chancellor’s Award for Teaching Excellence. Clare Brindley is Head of Department of Business and Management Studies, Manchester Metropolitan University, and a member of the editorial board of the Internet Research: Networking, Applications and Policy xiii

xiv

Contributors

Journal and the Cyprus International Journal of Management. She recently completed a critical literature review in the field of entrepreneurship and women, on behalf of the DTI Small Business Service in the UK. Along with Bob Ritchie, she has published in the area of risk management and supply chains, for example the 27th Annual Conference of the Academy of International Business, 4th International Conference on the Dynamics of Strategy, 3rd Worldwide Research Symposium on Purchasing and Supply Chain Management, 9th International IPSERA Conference, ISBA National Small Firms Policy and Research Conference and the Academy of Marketing Conference. Hock-Beng Cheah is engaged in teaching and research at the School of Business, University College, University of New South Wales. His interests are presently focused on sustainable development in the Asia-Pacific region, sustainable management and sustainable learning systems. He was previously a visiting Research Fellow at the Snider Entrepreneurial Center, Wharton School, University of Pennsylvania. He has also undertaken research at the Economics Research Center at Nagoya University, Japan, and the Institute of Southeast Asian Studies, Singapore. He has published in a variety of books and notable journals, including the Journal of Business Venturing, Creativity and Innovation Management and Journal of Enterprising Culture. Melanie Cheah has been employed with Allen and Overy in Beijing and Hong Kong, working on legal assignments focused on China. She received a Japanese Government Monbusho scholarship to undertake studies at the National Graduate Institute of Policy Studies in Tokyo, Japan. She has been admitted to legal practice in the states of New York, USA and New South Wales, Australia. She previously worked as an intern at the Capacity Building Unit (Africa Region) at the World Bank in Washington, DC; and as a corporate lawyer at Allen, Allen & Hemsley in Sydney. Barbara Cornelius holds a BA (Cum Laude) from Georgia State University, USA; and an MEc (Finance) and PhD from the University of New England in Armidale NSW, Australia. She is currently employed by the University of Wollongong, in Wollongong, NSW, Australia. Prior to becoming an academic, she worked for an American venture capital firm providing an assessment of and advice on investment opportunities. Her publications have been in the fields of venture capital, small business finance and entrepreneurship and she has presented seminars and lectures on venture capital in Europe, Asia and Australia. She was a founding member of the Small Enterprise Association of Australia and New

Contributors

xv

Zealand and has also been active in local and regional initiatives to promote small firm access to capital for growth and development. She is a board member of a small business incubator in the Sutherland Shire, Sydney, Australia. Susan Freeman is a Lecturer with the Department of Management, Monash University, Caulfield Campus. Her research area includes small firm internationalization; small entrepreneurial firms; internationalization theory, including Stage Models and Network Perspective; and conflict management and exit strategy in supply chain management of international buyer–seller relationships. She holds a doctorate in international business from the Faculty of Business and Economics at Monash University on the internationalization process for Australian small to medium-sized enterprises. Her teaching interests include international business, strategic management, international marketing and strategic marketing, planning and implementation. Charles Harvie is an Associate Professor in the School of Economics and Information Systems at the University of Wollongong, Australia. He is CoDirector of the Centre for SME Research and Development based at the University of Wollongong. He obtained his PhD in economics from the University of Warwick in 1986. He has taught in the UK, Australia, Thailand, Singapore and Vietnam in the areas of macroeconomics, international economics, monetary economics and transition economics. More recently his research interests have focused upon the Asian financial crisis, China’s economic reforms, and the significance of innovation for SME export performance. Dr Harvie has published his research results in the form of numerous journal articles, books and book chapters. Za’faran Hassan is an Associate Professor at Universiti Teknologi MARA, Malaysia. Formerly the Dean of the Faculty of Hotel and Tourism Management, she is currently the Director for Business Development and Head of the Malaysian Entrepreneurship Development Center at the University. She is a member of the editorial review board for the Utara Management Review and the Asian Academy of Management Journal. She is also a member of the Malaysian Institute of Management, Malaysian Society for Training and Development, and the Academy of International Business. Her research interests include strategic management, SMEs and entrepreneurship and she has published in the International Journal of Management, Journal of Productivity, Student Affairs Journal and Journal of Business Management.

xvi

Contributors

Dudley Jackson is an Honorary Professorial Fellow in the School of Economics and Information Systems, University of Wollongong. He has taught at Oxford, Cambridge and Aston universities. He is the author of numerous books and journal articles, including The Australian Economy (Macmillan, 1989), Technological Change, the Learning Curve and Profitability (Edward Elgar Publishing, 1998), Profitability, Mechanisation, and Economies of Scale (Ashgate, 1998) and The New National Accounts: An Introduction to the System of National Accounts 1993 and the European System of Accounts 1995 (Edward Elgar Publishing, 2000). Thomas Keil is an Assistant Professor of Entrepreneurship and Policy at the Schulich School of Business, York University in Toronto, Canada. He is a graduate of Helsinki University of Technology, in Espoo, Finland. His research interests include strategies of small and medium-sized enterprises, corporate venturing, technological standards, and alliances and acquisitions. His research has been published in international journals including the Journal of Management Studies, Technovation, Technology Analysis and Strategic Management and Telecommunications Policy. Boon-Chye Lee is a Senior Lecturer in the School of Economics and Information Systems and Co-Director of the Centre for SME Research and Development at the University of Wollongong, Australia. He has an MBA and PhD from the Australian Graduate School of Management, University of New South Wales. His recent research interests have focused on small and medium-sized enterprises, electronic money, and trust in Internet commerce. His research has been published in international journals including the Asia-Pacific Journal of Management, Journal of International Financial Markets, Institutions and Money, Applied Economics Letters and Netnomics, and as book chapters. Philippe Régnier is Professor at the Graduate Institute of Development Studies, Geneva, Switzerland. He teaches two subjects, namely entrepreneurship and small enterprise economics in developing countries, and the political economy of East Asia. He has devoted most of his research work during the last 15 years to small enterprise dynamics in East and South Asia, and one of his most recent books is Small and Medium Enterprises in Distress: Thailand, the East Asian Financial Crisis and Beyond (London: Gower/Ashgate, 2000). He is also a small enterprise advisor and trainer to several international agencies. Bob Ritchie is a Professor at Lancashire Business School, University of Central Lancashire, specializing in risk management. He is a co-author of

Contributors

xvii

Managing Business Risks (1993), Managing Information Systems (1991) and Business Information Systems (1997) with cumulative sales in excess of 50000. He is also Editor in Chief of the Cyprus International Journal of Management. His work with Clare Brindley concerning risk and supply chains has been published in Long Range Planning, Management Decision, Control (IOM journal), Marketing Intelligence and Planning and Internet Research. They were winners in 2002 of an Emerald Highly Commended Award for their paper in Marketing Intelligence and Planning. Paul L. Robertson is Professor of Management at Griffith University in Australia. He holds a PhD from the University of Wisconsin-Madison and is the co-author of three books including Firms, Markets and Economic Change: A Dynamic Theory of Business Institutions (with Richard N. Langlois). His current research interests are in managing technology in the 99 per cent of modern economies that cannot be classed as ‘high tech’. He has published in many international journals including Research Policy, Industrial and Corporate Change, Technology Analysis and Strategic Management, the Economic History Review and the Journal of Economic History. Elias Sanidas was educated in Greece, France and Australia. He is currently a Lecturer with the Economics Discipline, University of Wollongong, Australia, teaching various subjects in economics, operations research, strategic management and international busisness. Recently, a PhD was successfully completed on the role of organizational innovations in economic growth. He also has extensive non-academic experience. His publications are related to organizational innovations and economic growth, theory of the firm, quantitative analysis and international business. Heru Satyanugraha is a Lecturer in the Faculty of Economics, Trisakti University, Jakarta, Indonesia, where he teaches International Business, International Finance, International Marketing, and Business Ethics. He was previously a visiting professor in International Business at Mikkeli Polytechnic, Finland. He holds a doctorate from Gajahmada University, Jogjakarta, Indonesia, an MSc from the Asian Institute of Technology, Thailand, and a DBA from Nova Southeastern University, Florida, USA. His current research interests are in international business strategy and business ethics. Russell Smyth is a Professor in the Department of Economics and Director of the Asian Business and Economics Research Unit, Monash University. He has Honours degrees in Economics and Law from Monash University

xviii

Contributors

and a PhD in Economics from the University of London. His principal research interests are China’s economic reforms, law and economics and applied econometrics. Sandra Van der Laan is a Lecturer in Accounting and Business Law at Sydney University. She is a member of the Centre for Social and Environmental Accounting Research (CSEAR), the Asia Pacific Centre for Environmental Accountability (APCEA) and the Pacioli Society. Her research and publications focus on corporate finance, corporate disclosures, social accounting and the accountability of ethical investment funds.

Acknowledgements This book consists of a collection of selected papers presented at two international SME conferences organized by the Centre for SME Research and Development, Faculty of Commerce, University of Wollongong, Australia in 2000 and 2002, supplemented by invited papers. The conference in 2000 focused upon the role and contribution of SMEs in national economies in East Asia and their role in the economic recovery of the region. The conference in 2002 focused upon issues relating to sustaining regional recovery through measures that assist in the continued growth and development of regional SMEs. The editors would like to extend their appreciation and gratitude first and foremost to the contributors to this book, without whose dedicated, timely, thought-provoking and scholarly contributions, as well as patience, this book would not have been possible. At Edward Elgar Publishing we wish to thank Edward Elgar himself for his encouragement of, and support for, this book initiative from a very early stage, which provided the impetus for its completion. In addition, at Edward Elgar Publishing, we would like to thank Alex Minton and Francine O’Sullivan for their patience and highly professional assistance. Last, but not least, we would like to thank our respective families and colleagues for their support and patience during the completion of this book. Charles Harvie and Boon-Chye Lee Wollongong, Australia May 2004

xix

PART I

General and macro aspects

1.

Introduction: the role of small and medium-sized enterprises in achieving and sustaining growth and performance Charles Harvie and Boon-Chye Lee

1.1

OVERVIEW

This volume is the third in a series on small and medium-sized enterprises in East Asia, defined broadly to include the countries along the western rim of the Pacific from Japan and China in the north to Australia and New Zealand in the south, taking in the ASEAN countries along the way. The focus of the first volume was on the changing global economic environment and the role, contribution, problems and opportunities facing SMEs in East Asia (Harvie and Lee, 2002a). The second focused upon the role and contribution of SMEs in a number of countries in East Asia, ranging from developing and transition economies such as China, Vietnam and Indonesia, to the newly industrialized economies of Korea, Taiwan and Malaysia, to the mature developed economies of Australia, New Zealand, Japan and Singapore (Harvie and Lee, 2002b). The focus in the current volume, as the title suggests, is on both how SMEs contribute to achieving and sustaining growth and performance in their economies, as well as the ways in which governments can assist and enhance that contribution. This is of particular concern given the trauma that many of the East Asian economies experienced in the wake of the financial and economic crisis of 1997–98, including severe declines in GDP, rising unemployment and poverty (see for example World Bank, 1998; Tran and Harvie, 2000; and Harvie, 2002). Faced with the need to restructure and reform their economies, putting them on a solid foundation for future sustainable growth, many East Asian countries actively pursued growth of the SME sector, focusing upon the encouragement of entrepreneurialism in the private sector (Hall, 1999a). This was particularly noticeable in the transition economies of Vietnam and China, but also in economies such as

3

4

General and macro aspects

Korea which had, in the past, given more emphasis to the growth of the large industrial conglomerates. This chapter briefly reviews the contribution of the SME sector to the sustainable recovery of the region, and in doing so identifies barriers to their development, key factors essential for their capacity building, strategies to enhance their competitiveness in the global marketplace, and key components relating to their export success. In the following section key issues relating to SME development are highlighted. Section 1.3 focuses upon key issues relating to SME capacity building. Section 1.4 focuses upon globalization and the key ingredients for SME export success. Section 1.5 highlights key policy issues. Finally, section 1.6 presents the structure of the remaining chapters of this book.

1.2

KEY ISSUES

While the region consists of many diverse, although closely integrated, economies, a common characteristic is the significance of a sizeable and rapidly expanding SME sector. As the first and second volumes of this series indicated (Harvie and Lee, 2002a, 2002b), this sector has considerable potential to provide a solid foundation and contribution to the sustained recovery of the region. This contribution, and type of contribution, will vary by country and be dependent upon a number of factors, including country stage of economic development, country institutions, the nature and extent of domestic entrepreneurialism and innovation, the extent of market opening and competitiveness, access to technology, access to finance, development of human resources, access to market information, an ability to exploit export opportunities either directly or as part of the supply chain of transnational corporations, and market-friendly and supportive government policies. Irrespective of the stage of development of regional economies there are clear trends towards globalization and increased regional economic integration with the opening up of regional markets and increased reliance on exporting (OECD, 1997). In this context it is essential that the full potential of small business exports is exploited. There is evidence to suggest however that SME exports are lagging due to existing difficulties in terms of red tape and the cost of logistics that can make exporting prohibitive (Hall, 2002b). Since the early 1990s the economies of East Asia, and of APEC more generally, have been opening up their markets and in the process have achieved significant gains in exports and economic growth. In conjunction with this increased economic integration there has been increased recognition by regional governments of the potential for a substantial increase

Introduction

5

in the participation by small businesses in the generation of regional income, employment, exports, investment and expanded economic growth. Advances in information and communications technology have further added credence to this potential. In addition, developing economies are especially seeing small businesses as potential instruments for the alleviation of poverty. Further momentum for this was provided after the financial and economic crisis of 1997–98. The crisis resulted in many of the countries of East Asia: re-evaluating their industrial policies; placing greater emphasis on improving corporate governance; improving the efficiency and competitiveness of their enterprises; and developing business sectors more able to overcome the vicissitudes of domestic, but more importantly global, market developments (Pomerleano, 1998). The latter is of particular importance in the context of increased economic interdependence and open regionalism. The need to develop more adaptable and flexible economies, and business sectors, has resulted in increased emphasis on the development of the SME sector, particularly given the relative resilience of the Taiwanese economy, dominated by SMEs, and the potential platform they provided (Ministry of Economic Affairs, 1999). The SME sector will continue to play a key role in the sustained economic recovery of the region, and this will be made most effective where it is in a position to take best advantage of rapidly increasing business opportunities and in doing business in new ways (for example, developing knowledge-based services and technology-intensive goods, finding market niches, exploiting the Internet and e-commerce, and through global mergers and joint ventures). A number of observations can be made about the contribution of SMEs as the Entrepreneurial Engine of East Asia (see Hall, 2002a). First, it is clear that SMEs do provide the lion’s share of growth. Typically, in the economies for which there are reliable data, about 70 per cent of employment growth comes from SMEs. Anecdotally, even in economies for which there are no data, SMEs play a major role; for example, almost all net employment creation in China, Vietnam and Indonesia since the early 1990s has been in SMEs. In China and Indonesia, for example, large firms have been net job destroyers as they downsize – a phenomenon also common in Europe and the USA. Second, the ‘entrepreneurial engine’ is underpowered in much of East Asia, especially in the less-developed economies of China, Indonesia, the Philippines, Thailand and Vietnam (Hall, 2002a). In these economies there are simply fewer SMEs than might be expected. The number of people per SME in these economies is much higher than in the more developed economies (Hall, 2002a). This means that there are fewer start-ups, and the pool of SMEs from which high-growth SMEs can emerge is much smaller. Consequently, there is less growth than there would otherwise be.

6

General and macro aspects

In a very rough order of magnitude calculation, for these economies to achieve a benchmark level of 20 people per SME, there would have to be about 70 million new SMEs created. This needs to be compared with the 20 million or so SMEs in all of East Asia at present. This means 70 million or more people will need managerial skills and training. Most of these are in China but there is also considerable room for advancement in countries such as Indonesia and Thailand. The potential for SME start-ups in countries such as China, Indonesia and Vietnam could be a major source of job creation and growth for these economies in the future (Hall, 2002a). Third, in developing East Asia the bulk of the SME contribution to growth will probably come from net start-ups, while in developed East Asia, the growth contribution will tend to come more from high-growth firms. Start-up rates tend to be relatively low, especially in Japan, which is the largest economy in the region. Japan’s net start-up rate (domestically at least) has been negative for some time. Part of this is the economic downturn, and part of it is cultural and institutional inhibitions to taking risks and starting a business. These cultural and institutional factors need to be actively addressed if East Asia is really to make use of the potential of its entrepreneurial engine. Fourth, the entrepreneurial engine is being internationalized. For example, a small but significant proportion of SMEs in Japan, Korea and Taiwan have already expanded operations abroad; about 13 per cent of Japan’s manufacturing output is now sourced abroad. It is becoming easier for SMEs to operate across borders. This is partly as a result of efforts to reduce trade and non-trade impediments by the WTO, APEC and ASEAN. It is also part of the general globalization of business occurring as a result of improved communications (particularly e-commerce and the Web) and other technological and social changes. This SME internationalization is not limited to specific regions, such as East Asia, but is global. Table 1.1 summarizes key common features, differences and policy issues in the profile of SMEs in East Asia.

1.3

SME CAPACITY BUILDING

For SMEs to participate fully in the process of globalization they must develop capacities enabling them to be internationally competitive in global markets. This will involve building upon the potential advantages already possessed by them – entrepreneurial spirit, flexibility, resourcefulness and an ability to identify business opportunities and market niches based upon their unique products and services. Despite this they face a number of barriers in their development – their small size means that they have limited

7

1. There are about 20 to 30 million SMEs in East Asia. 2. They account for 98% of all enterprises. 3. Micro-enterprises account for about 73% of all private sector enterprises. 4. On average there are about 85 people for every SME.

5. SMEs employ about 60% of the private sector workforce, and 30% of the total workforce. 6. Micro-enterprises employ about 21% of total APEC-wide employment. 7. Over 95% of enterprises employ less than 100 people, and over 80% employ less than 5 people. 8. SMEs contribute about 70% of net employment growth. 9. SMEs provide about 80% of employment in the services sector, and about 15% in the manufacturing sector.

Employment

Key features

Summary profile of SMEs in East Asia/APEC

Numbers of Enterprises

Table 1.1

3. In developing economies (below about US$15 000 per head income) SMEs employ about 75% of people, above $15 000 the level is closer to 50%. Japan is a major exception – Japan’s SMEs employ around 80% of the workforce. 4. More-developed economies seem to have more medium-sized SMEs and they play a greater role. Developing economies seem more likely to have a ‘missing middle’. 5. In developed economies most of this growth probably comes from fast-growth firms, in developing economies a higher proportion probably comes from net start-ups.

1. Most of the SMEs are in China (8 million), Japan (5 million) and Korea (2.6 million) which together have 70% of the SMEs in East Asia. 2. In developed economies there are only about 20 people per SME, but the ratio is above 100 in the developing economies, especially in China, Vietnam, Philippines and Indonesia.

Regional differences and policy issues

8

11. SMEs contribute about 50% of sales, value added or output.

12. SMEs generate about 30% of direct exports (US$930 billion in 2000), much less than the SME contribution to employment (about 60% to 70%) or output (about 50%). 13. SMEs contribute indirectly to trade through supply chain relationships with other firms. SME contribution to total trade could rise to 50%.

14. SMEs generate about 50% of cases of FDI, but only less than 10% of value of FDI.

Exports

FDI

10. Women make up about 30% of employers and self-employed in APEC – mainly in micro-enterprises

Key features

Output measures (sales, value added etc)

Table 1.1 (continued)

9. Korean, Japanese and Taiwanese SMEs contribute most FDI originating in the East Asian region.

7. SME export figures are difficult to verify, but they range from about 5% or less (Indonesia) to around 40% (Korea) of total exports. 8. Tariff cuts have increased total APEC member trade, but the SME contribution to direct exports has remained static or declined. Reductions in tariffs have not benefited SMEs; more emphasis needs to be put on tackling non-tariff barriers if SMEs are to benefit from trade expansion.

6. The contribution varies from lows of 15% (Singapore) and 30% (Australia) to about 60% for most other economies.

Regional differences and policy issues

9

15. SMEs already contribute the bulk of growth, and SMEs could make a much bigger contribution to the Asian regional economy if efforts were made to address impediments to SME internationalization. This could add as much as US$1.18 trillion in trade over a five-year period. 16. SMEs moving towards services and away from agriculture and manufacturing.

Source: Hall (2002a) supplemented by information from Hall (2002b).

‘Entrepreneurial engine’, international potential and the new economy 10. The developing economies need to create about 50 to 70 million more SMEs if they are to achieve ‘benchmark’ levels of SME activity. 11. To achieve the maximum gain from trade it is essential to the improve governance, building capacity, reducing transaction costs, promoting further liberalization, addressing non-tariff barriers, increasing Internet access and facilitating trade and investment to improve the capacity of SMEs to export. 12. Capacity building includes: access to finance; improved professional skills (IT, management, accounting and entrepreneurship); improved business infrastructure; removal of trade barriers that particularly adversely affect SMEs. 13. E-commerce use of SMEs lags larger enterprises. It is important for cost saving and growth potential. Usage of technology is a problem due to: set-up and usage costs; lack of adequate infrastructure and IT skills.

10

General and macro aspects

resources and access to finance, they lack economies of scale, they have high relative costs in accessing and utilizing information technology, they have skill deficiencies in the utilization of IT, they have entrepreneurial, managerial, accounting and marketing skill deficiencies, they lack information on market opportunities, they have high transaction costs arising from gaining access to transport infrastructure and the cost of transportation, and from achieving quality accreditation, they lack skills in dealing with customers both in the domestic market and in the export market, they have limited knowledge about language and culture as well as the legal and bureaucratic issues involved in exporting, they may experience a lack of business infrastructure support and in some countries may be discriminated against relative to large firms. Building capacity, improving governance, reducing transaction costs, promoting further market liberalization, addressing non-tariff barriers, increasing Internet access, and facilitating trade and investment are all directly relevant to improving the capacity of small businesses to exploit export market opportunities and for their regional growth. At the Ottawa meeting of APEC in September 1997, for example, five key areas of importance to the capacity building of SMEs were emphasized (APEC, 1998). These are access to markets, technology, human resources, financing and information. ●

Access to Markets

It is recognized that SMEs face special problems relating to their size and that, in the context of rapid trade liberalization, they need to develop capacities to take advantage of opportunities arising from a more open regional trading system. The Internet is regarded as being of particular importance in this regard (Hall, 1999b, 2000; OECD, 2000c), as is the need to identify appropriate partners for joint ventures or strategic alliances, to harmonize standards and professional qualifications, including investment laws and taxation procedures, and to harmonize the protection of intellectual property rights. Despite cuts in average tariffs in APEC from 12 per cent in 1995 to 8 per cent in 2000, contributing to an estimated growth rate in merchandise exports of 4.7 per cent per annum over this period, small businesses have been unable fully to exploit opportunities to export (Hall, 2002b). The SME contribution to direct exports in APEC has remained static or declined. Reductions in tariffs have not benefited SMEs, and more emphasis by regional governments needs to be put on tackling non-tariff barriers (customs procedures, mobility of business people, standards of labelling requirements, access to finance, recognition of professional qualifications,

Introduction

11

consumer protection particularly regarding on-line transactions, and intellectual property rights) if SMEs are to benefit from trade expansion and to enhance their exporting capacity. Greater participation by SMEs in trade is likely to generate a number of benefits. With access to a larger market, individual firms will be able to benefit from economies of scale and generate additional revenue (Hall, 2002b). In terms of efficiency, firms that expose themselves to more intense competition in global markets can acquire new skills, new technology and new marketing techniques. Exporters tend to apply knowledge and technologies at a faster rate and more innovatively than non-exporters. This can result in greater efficiency and productivity. A larger number of SME exporters assists skill and technology applications by spreading these over many small buyers which extends the gains over the entire economy and not just firms that export. Ultimately the economy will benefit from more flexible and environmentally responsive firms, higher growth rates and long-term improvements in productivity and employment levels. Exporting has a positive effect on living standards, as competition drives firms to invest in staff development, which in turn improves productivity, wages and working conditions. Exporting also encourages cultural diversity and the building of relationships and reputations with other countries. ●

Access to Technology

In a knowledge-based economy, applications of information and communications technology can be a great leveller for SMEs (Hall, 1999b, 2000; OECD, 2000c). However, when SMEs have limited access or understanding of these technologies, their prospects of acquiring and utilizing these for their benefit is reduced. In terms of the Internet, e-commerce use amongst small businesses is currently lagging behind their larger counterparts. However, many small businesses view e-commerce as providing cost savings and growth potential, and the gap relative to larger enterprises is closing, but further action by regional governments will be required (in terms of improved infrastructure, cost and IT training, as well as information relating to the business opportunities that e-commerce can generate). Enhancing the role and participation of small businesses in the global marketplace through e-commerce will be of critical importance. E-commerce presents small businesses with the opportunity to compensate for their traditional weakness in areas such as access to new export markets and competing with larger firms. It can provide global opportunities by enabling the flow of ideas across national boundaries, improving the flow of information and linking increased numbers of buyers and sellers. This provides opportunities for greater numbers of trading partners dealing in goods,

12

General and macro aspects

and increasingly in services. Studies suggest that small businesses with higher levels of e-commerce capabilities are more likely to identify using e-commerce to reach international markets as an important benefit. Hence the desire to export for many SMEs may have a fundamental influence on promoting the rapid development of more advanced e-commerce capabilities. For many small businesses in the Asia-Pacific region, integrating the development of e-commerce into their future strategies for accessing international markets is seen as being crucial (Hall, 1999b). E-commerce also has the potential to lead to cost savings and efficiency gains. Raising the awareness as well as the understanding of the benefits to be obtained from e-commerce will be important in increasing its uptake by small business. To incorporate the technology into their operations small business needs to find ways to deal with high set-up costs, as well as lack of adequate infrastructure and IT skills. If these can be overcome small business will play an important part in the region’s ‘new economy’ at least as much as it will for more traditional forms of commerce. In this regard the role of the government is likely to be crucial. This includes development of the telecommunications infrastructure; addressing legal and liability concerns; ensuring that fair taxation practices are applied to e-commerce; addressing security issues; and raising the awareness of the business benefits of e-commerce, including the potential for export growth. ●

Access to Human Resources

Human resource development for SMEs requires a comprehensive approach including social structures and systems such as broad educational reforms; encouragement of entrepreneurship, business skills acquisition and innovation in society; mechanisms for self-learning and ongoing training and enhancement of human resources; and appropriate governmental support programmes. Among small and micro-enterprises a shortage, and the cost, of skills in information technology are a major hindrance to business growth. Consequently staff training in IT as well as in skills required to successfully enter export markets are required. Improved IT skills would enable more efficient management of the business, workload sharing, and the development of more market opportunities including that of exports. Other desired exporting skills include language and cultural expertise, as well as legal and logistical knowledge. ●

Access to Financing

The opportunity to access small amounts of finance can be an important catalyst for small businesses to get access to the resources they need to gain

Introduction

13

a foothold in the market. This is particularly critical for micro-enterprises. Many SMEs lack awareness of financing resources and programmes available from commercial banks and other private sector and government sources, and they have difficulty defining and articulating their financing needs. Financial institutions need to be responsive to their needs and for continuing simplification of trade documentation. ●

Access to Information

Accurate and timely information on, for example, market opportunities, financial assistance and access to technology is crucial for SMEs to compete and grow in a global market environment. This is an important role that both the government and relevant business organizations can play. In addition to these key areas for capacity building, others relate to the development of business networks, including the development of strategic alliances and joint ventures, and the ability to be innovative. Inter-firm networking Entrepreneurs who develop and maintain ties with other entrepreneurs tend to outperform those who do not. A network is a group of firms using combined resources to cooperate on joint projects. Business networks take different forms and serve different objectives. Some are structured and formal, even having their own legal personality. Others are informal, where, for instance, groups of firms share ideas or develop broad forms of cooperation. Some aim at general information-sharing while others address more specific objectives (such as joint export ventures). Soft networks generally encompass a larger number of firms than hard networks, with membership often open to all that meet a minimum requirement (such as payment of an annual fee). Networks have come to encompass agreements with research bodies, education and training institutions and public authorities. Hard networks are more commercially focused, involving a limited number of preselected firms, sometimes formally and tightly linked through a joint venture or strategic alliance. Networks can allow accelerated learning. Moreover, peer-based learning – which networks permit – is the learning medium of choice for many small firms. Furthermore, to innovate, entrepreneurs often need to reconfigure relations with suppliers, which networks can facilitate. Networks can allow the sharing of overhead costs and the exploitation of specific scale economies present in collective action. Networks need not be geographically concentrated. Once trust among participants is established, and the strategic

●

14

General and macro aspects

direction agreed, operation dialogue could be facilitated through electronic means. Innovation Recent studies have shown that, despite the fact that a very small fraction of total business R&D in the developed economies is accounted for by SMEs, they contribute greatly to the innovation system by introducing new products and adapting existing products to the needs of their customers (OECD, 2000a). Small firms account for a disproportionate share of new product innovation despite their low R&D expenditures (Acs and Audretsch, 1990). In addition, they have also been innovative in terms of improved designs and product processes and in the adoption of new technologies. Investment in innovative activities is on the rise in SMEs and is increasing at a faster rate than that for large firms. Scherer (1991) has suggested that SMEs possess a number of advantages relative to large firms when it comes to innovative activity. First, they are less bureaucratic than highly structured organisations. Second, many advances in technology accumulate on a myriad of detailed inventions involving individual components, materials and fabrication techniques. The sales possibilities for making such narrow, detailed advances are often too small to interest large firms. Third, it is easier to sustain high interest in innovation in small organizations where the links between challenges, staff and potential rewards are tight. Firms in the developed high-cost economies can no longer compete in labour-intensive areas of production where they have lost their comparative advantage, but rather must shift into knowledgebased economic activities where comparative advantage is compatible with both high wages and high levels of employment. This emerging comparative advantage is based on innovative activity. For the developed economies of East Asia, their future international competitiveness will also depend upon their ability to develop, and have a capacity in, knowledge-intensive firms, many of which will be SMEs based upon the experience of the developed OECD economies. ●

The Role of Government In addition to fostering market liberalization and securing appropriate framework conditions, governments also have an important role in promoting entrepreneurship; facilitating firm start-up and expansion (and not hindering exit); improving access to venture capital and other types of financing; improving access of new firms and SMEs to information, innovation networks and business services; reducing the regulatory burden on smaller firms; and promoting enterprise

Introduction

15

partnerships, networks and clusters of international, national and local-level small firms. Regional governments have an important role to play in the capacity building of their small businesses. While government strategies to assist SME capacity building depend upon the country’s stage of development, there are some basic principles of successful SME development strategies emphasizing a market-oriented approach (see Hallberg, 2000). First, the establishment of a level playing field. The fundamental key to a successful SME development strategy is the establishment of a business environment that helps SMEs compete on a more equal basis. To establish a level playing field, governments need to re-evaluate the costs and benefits of regulations that place a disproportionate burden on SMEs, implement regulations with the flexibility needed by SMEs, and place greater emphasis on competition and procurement policies to open SME access to markets. Second, to target public expenditure carefully in order to use scarce public resources effectively. Governments need to design a clear, coordinated strategy for SME development that carefully separates equity and efficiency objectives. Public expenditure should be confined to those services and target groups that are underserved by the market and for which there is a clear justification based on public goods or equity considerations. Using the methodology of micro-finance, good practice in the delivery of services to SMEs can be judged according to the performance criteria of coverage, cost-effectiveness, financial sustainability and impact. Third, to encourage the private provision of a wide array of financial and non-financial services. In most developing countries, SMEs do not have access to institutions and instruments appropriate to their needs. To ensure SMEs have access to a diverse range of financial and non-financial services, governments should strive to develop private markets for services suitable for SMEs, stimulating market development on both the demand and the supply side. Government assistance can also play an important role in the business and exporting success of SMEs through access to finance, infrastructure provision, the provision of training programmes, reducing bureaucracy and establishing a pro-business environment, and the staging of seminars and trade fairs. Support at the local level through investment in infrastructure that assists directly the business efficiency of small business is important. Examples include transport and information technology infrastructure, both of which are important for export success. Policy makers also need to focus on removing barriers affecting trade. Barriers to trade for small businesses are not just tariff related, however, but also involve issues of product presentation standards, warehousing and financial transactions. Because small businesses lack the economies of scale and the internal expertise of larger businesses, they need more practical external support.

16

1.4 1.4.1

General and macro aspects

GLOBALIZATION AND EXPORT SUCCESS Stairway to Export Success

The key drivers of export success for small businesses can be usefully described using the model of export development as set out in Figure 1.1. This model identifies four key components of export success: ability, attitude, stimuli and learning. The four components of the stairway to export success are not necessarily sequential, hence there is no one set track to export success. Firms can venture into exporting at different stages of their development and by different means. It is possible for some businesses to be ‘born global’ and identify their export market very early in the development of their business, while others may only look for an export opportunity after they have consolidated their domestic market, and then attempt to increase turnover or see improved margins. Others only contemplate exporting when confronted by a customer from another country seeking to access a particular product. A key step towards export success relates to company fundamentals or core competencies. This would include the possession of strategic assets or competencies that provide the business with a unique product or process, upon which the enterprise can capitalize through the development of domestic and overseas markets. The skills (IT for example) and abilities of the management and workforce are also another key ingredient. The introduction of the Internet, together with good communications and transport infrastructure, now makes it possible to sell the firm’s product to global customers. The flexibility and innovation association with the enterprise can be another firm asset. Finally, access to finance in order to develop and fully exploit the core competencies of the enterprise itself is important. A second key ingredient is the attitude of the owner-manager of the business in terms of desire and commitment to the successful development of the business: ability to have an outlook for the future development of the business beyond that of the domestic market, and the perceptions towards risk. That is the attitude towards the development of markets overseas relative to that of merely focusing upon the domestic market, and the willingness to take risks in developing markets overseas. A third component relates to stimuli to exporting. This could occur externally to the enterprise arising from a marketing opportunity, or the result of internal decision-making within the business to seek out exporting opportunities. The stimuli could be proactive or reactive. The final component relates to the development of exporting skills, including those of developing partnerships; market selection and development; strategy development; and the development of logistics and operations.

17

Introduction

EXPORT SUCCESS Learning Developing export skills • Partnering • Market selection/ development • Strategy development • Logistics/operations Stimuli Export initiation • External/internal • Proactive/reactive

Attitude Management mindset • Desire/commitment • International outlook • Perceptions of risk

Ability Company fundamentals • Possession of strategic assets • Skills/abilities of management • Innovation/flexibility • Access to resource

Source: Exporter community, identifying potential exporters, literature review, Hall (2002b).

Figure 1.1

1.4.2

Stairway to export success

Competitiveness Strategies

As many of the economies in East Asia develop further, for example, Singapore, Hong Kong, Taiwan and Korea and the newly industrializing economies of Malaysia, Thailand and Indonesia, they will increasingly find it difficult to compete in labour-intensive, low-skilled and low value added activities. The ability of their SMEs to create, access and commercialize knowledge on global markets will become an increasingly important source of their new competitiveness in global markets. Based upon the experiences of developed country members of the OECD, some of the

18

General and macro aspects

principal competitiveness strategies that have been used by innovative SMEs in these countries have included the following (see OECD, 2000a, p. 11): ●

●

●

●

●

●

Innovation strategy, in which SMEs try to appropriate returns from their knowledge base (which may or may not involve own investments in R&D). Information technology strategy, which makes innovative uses of information technology in order to reduce SME costs and increase productivity. Niche strategy, in which SMEs choose to become sophisticated global players in a narrow product line. Network strategy, in which SMEs work and cooperate with other firms, be they SMEs or large enterprises, in order to improve their ability to access and absorb innovations. Cluster strategy, in which SMEs locate in close proximity with competitors in order to take advantage of knowledge spillovers, especially in the early stages of the industrial life cycle (OECD, 2000b). Foreign direct investment strategy, in which SMEs exploit firmspecific ownership advantages overseas.

Membership of clusters and inter-firm networks can enhance the productivity, rate of innovation and competitive performance of firms. Clusters and networks can allow small firms to combine the advantages of small scale (flexibility) with the benefits of large scale (economies of scale) (OECD, 2000b). A clusters policy provides a framework for dialogue and cooperation between firms, the public sector (local and regional governments) and non-governmental organizations. This dialogue can lead to efficiency-enhancing collaboration amongst firms, such as in joint marketing initiatives, the creation of mutual credit guarantee associations, joint design and sponsorship of training, a more efficient division of labour amongst firms and so on. In a period of globalization, inter-firm networks hold the promise of allowing small firms to compete on a par with larger companies. Networks can allow firms to engage in accelerated – and peerbased – learning. They can facilitate the reconfiguration of relationships with suppliers, and offer scope for increased efficiency through collective action. As with clusters, networks can pave the way for greater specialization amongst small firms, opening opportunities for economies of scope and scale. While not all networks need be geographically concentrated, networking of different sorts is central to the competitive advantage derived from membership of a cluster.

Introduction

1.5

19

IMPLICATIONS FOR POLICY

This chapter has briefly reviewed the strategic importance of SMEs to the sustained growth and development of the East Asian economy, key issues relating to the building of their capacity to grow and export, and key issues relating to their export success and strategies for global competitiveness. In the process a number of key issues for policy makers were identified. First, SMEs (generally those enterprises with less than 100 employees) are important to economic growth, and are especially important to jobs and job creation. SMEs already contribute over half the private sector jobs in the East Asian region, and about 70 per cent of new job creation seems to be coming from SMEs. In developing economies the contribution of SMEs to employment tends to be higher, around 70 per cent of the workforce, but as economies develop to higher income per head levels, the contribution to employment by SMEs tends to decline to around 50 per cent. In developing economies the jobs tend to be created more by start-ups, but in the developed economies jobs seem to be created more by high-growth SMEs. It is important for policy makers to understand and to foster the way this ‘entrepreneurial engine’ works and evolves. Second, the entrepreneurial engine in developing East Asia is underpowered. The job-creating potential of SMEs is less than it could be. There are about 2 billion people in East Asia, and about 20 million SMEs. In most of the developed economies there are about 20 people per SME, but in developing East Asia there are about 100 people per SME. This means that the ability to create jobs by start-ups is greater, and the pool of SMEs from which fast-growth SMEs emerge is smaller. This is largely due to historical and political reasons; for example, China and Vietnam have only recently pursued policies to stimulate SME growth, and there is a lot of catching up to do. Policy makers in both the developing and developed economies need to work with the private sector to address this aspect of catch-up. Third, internationally, SMEs have more opportunities than ever before, but they seem to be growing only at about the same rate as the international economy. SMEs contribute about 30 per cent or so of direct exports, about what they contributed at the start of the 1990s, but this is less than might be expected in an increasingly globalized economy. Part of the problem here is the paucity of statistics on SME international activity. Part of it is that the trade barriers that have been addressed so far by APEC and WTO tend to favour larger trading firms, and do not address the more specific non-border non-trade impediments that SMEs tend to be obstructed by when operating across borders. These impediments need to be identified and addressed more aggressively.

20

General and macro aspects

Fourth, SMEs have tended to become more important economically and politically. SMEs are given political recognition by most national and provincial governments because they employ so many people. However, politically, SMEs have tended to be taken for granted by many national governments because they are a relatively weak domestic political force. Only since the early 1990s have SMEs had the real choice of being able to internationalize, just as larger enterprises did in the 1950s and 1960s. SMEs, especially those fast-growth SMEs that contribute much to economic and employment growth, can increasingly decide where to locate their business activity. This is very much a two-edged sword for policy makers. However they need to see that as much as 70 per cent of the longer-term growth for their economies comes from SMEs, and that there is a need to work together to build an attractive and conducive entrepreneurial business environment in the region and, more specifically, in their own economies. Fifth, key to the future success of SMEs will be capacity building which will enable them to take advantage of the market opportunities that arise from the process of globalization and from greater economic integration within East Asia and APEC more generally. In particular SMEs and regional governments will need to focus upon attaining greater access to markets, technology, skilled human resources, finance and information. In addition their competitiveness and capacity can be further enhanced through the nurturing of networks and by becoming more innovative in terms of both new products and services as well as processes. The role of government is crucial. It will be required to find means for enhancing SME access to finance, new technology and encouraging the take-up of e-commerce by SMEs through improved telecommunications infrastructure; to provide training programmes in the requisite skills for SMEs; to open up domestic markets and reduce non-tariff barriers in trade with other countries. Finally, there is no single track to SME exporting success. This will vary depending upon the circumstances of the SME – its product, industry, internal skills and motivations, as well as access to resources. In the future there will be an increasing need as regional economies develop to ensure that SMEs become more innovative in terms of both product and processes. The creation, access and commercialization of knowledge will increasingly provide the basis for the future global competitiveness of regional firms both large and small. The increasing economic integration of regional economies, and ongoing developments in information and communications technology, will provide market opportunities for SMEs that, if taken advantage of, will enable them to be the economic powerhouse of the region into the future. A primary objective of the remainder of this book is to elaborate further upon a number of these issues: the contribution of SMEs to sustained

Introduction

21

economic recovery and poverty alleviation; strategies for SME development; internationalization strategies including usage of the Internet; public policy and SME sector development; and the importance of access to venture capital.

1.6

STRUCTURE OF THE BOOK

The book is organized according to four broad sub-themes: general and macro aspects, internal (micro) aspects, strategic aspects and policy aspects. General and Macro Aspects In the first section of the book, the contributions are focused on broader issues relating to SMEs, and to issues and lessons arising from the experience of the Asian economic crisis of 1997–98. In Chapter 2, Hock-Beng Cheah and Melanie Cheah present a thoughtful analysis of the concept of sustainable development in the economic sphere. They reject the orthodox model of development, which they argue is prone to crisis, has little meaning for a substantial proportion of the world’s population, has generated considerable inequities and, perhaps more significantly, may prove unsustainable in the longer term. Cheah and Cheah suggest that the alternative is to be found in the notion of what they call a ‘diversified production system’, or DPS, which they contrast with the mass production system (MPS) that has held sway in many economies in the last century. Some of the characteristics of the DPS include goods and services of ‘any kind’, that are potentially available at ‘no charge’, ‘anytime’, ‘anywhere’, and with the facility to ‘do it yourself’. The authors argue that momentous changes are already in progress that point in the direction of such a DPS. Furthermore, they argue, this directional shift holds great significance for SMEs whose characteristics of spontaneity, flexibility, diversity and multiplicity may allow them to capitalize sufficiently on the DPS to substantially offset the current difficulties faced by their economies. In addition, because of their significance in employment terms (SMEs account in most countries for more than half, and in some cases as much as 90 per cent, of the labour force), they represent an important force for promoting upward social mobility and reduction of social inequalities in times of economic growth. The ability of SMEs to carry out their economic functions sustainably and to connect via local clusters with the global economy may therefore engender a different mode of production that will have far more encouraging results for sustainability than has been the case under the orthodox model of development.

22

General and macro aspects

Charles Harvie then takes up, in Chapter 3, the related theme of economic recovery and poverty alleviation, and, in particular, the role of micro-enterprises in East Asia. Although micro-enterprises occupy the extreme small end of the size spectrum of businesses, they represent a highly significant avenue of employment and economic opportunity for relatively disadvantaged groups in many countries – particularly the poor and women, many of whom have no other means of livelihood. However, micro-enterprises themselves tend to be disadvantaged in a variety of ways, including government policies that are often biased against them in favour of larger firms, and lack of access to market information, to opportunities for skills development and, crucially, to credit. Harvie looks at the various types of micro-enterprises in East Asia, and argues that it is important to differentiate between the different types in the formulation of policy. He identifies two distinct types of micro-enterprise: (1) livelihood enterprises, which do not generate much employment and are unlikely to grow, but whose development and growth as a whole can generate more employment as well as alleviate poverty; and (2) growth-oriented micro-enterprises, which have the potential to grow and to be sustainable in terms of income and employment generation, and for that reason represent a better prospect for the longer-term development of their economies. Harvie goes on to examine how micro-enterprises, with appropriate micro-finance support, can contribute to the attainment of four major economic and social development objectives: poverty reduction, empowerment of women, employment generation and private sector enterprise development. This is an important issue because micro-enterprise development contributes to a widening of the pool of entrepreneurship available to society, increases the number of direct participants in the development process, and broadens the base of the private sector. Harvie argues that micro-finance institutions can play an important role for both major types of micro-enterprise. In Chapter 4, Dudley Jackson focuses on the importance of uniform international standards for the purpose of assessing both economic sectors and economic enterprises. In the case of sectors, the exercise promotes transparency in the economy and in addition may provide earlywarning signals of impending problems; in the case of enterprises, such assessment will be necessary if and when an enterprise reaches the stage where it feels ready to approach the capital markets for external funding. Jackson discusses the development of the United Nations System of National Accounts 1993, which brought about changes to the reporting of balance-of-payments statistics and of government transactions under the Government Finance Statistics framework. He then discusses assessment measures that may be applied to the ‘enterprise sector’ of the economy.

Introduction

23

The move towards an internationally standardized system of reporting of economic activity is surely a positive development that will promote the comparison and benchmarking of both economic sectors and enterprises, with associated benefits in terms of transparency and good governance. Elias Sanidas then examines, in Chapter 5, the comparative story of economic growth in the US and Japan in terms of the organization of firms and industries in the two countries. Using a novel approach, he reaches two major conclusions. First, economies such as Japan and Italy which had more pronounced competition elements, as proxied by the number of SMEs in each country, experienced higher growth rates than those such as the US and Germany. Second, inter-firm economies of scope and nonintegration were a major moving force behind Japan’s higher economic performance, contrary to the intra-firm economies of scale and scope and vertical integration of American firms. These findings have implications for industrial and competition policy insofar as they suggest that a more intensely competitive environment comprising many firms in each industry is more likely to produce benefits in the form of higher growth rates; this in turn has direct implications for SME policy. Philippe Régnier’s study, in Chapter 6, of how SMEs in Thailand coped with the financial crisis that engulfed the country (and the wider region) in 1997–98, is of great interest for the insights it provides into the sources of the resilience of small firms, and the strategies they employed, for example through their links with large transnational corporations (TNCs), during difficult times. Indeed, as he points out, it was the SMEs with links to TNCs that proved the most resilient, particularly in Thailand, during the crisis. For example, he documents the case of TNCs which maintained a sustainable level of orders from their most reliable SME suppliers in order to prevent them from falling into bankruptcy, offered delayed terms of payment for deliveries and facilitated SME access to credit facilities by not only introducing them to foreign bankers but also acting as guarantors – highlighting the value of the ‘dense interpersonal networks’ maintained by the businesses concerned. Ironically, as Régnier notes, in the case of the Thai SMEs, Japanese and overseas Chinese financial networks provided more support than did the Thai commercial bankers. He concludes by examining the lessons to be learnt from the experiences of the Thai SMEs during this period. Internal (Micro) Aspects The second section of the book comprises two chapters, on two issues which may not ordinarily be at the forefront of SME managers’ concerns because of their philosophical nature, but which are nonetheless important.

24

General and macro aspects

Llandis Barratt-Pugh’s chapter explores the relationship between our changing concepts of knowledge and the resulting implications for organizational growth, with particular emphasis on SMEs. The development of new knowledge, as he points out, is at the heart of organizational competition. He reports on a research study that explores the values held by managers in organizations concerning training, learning and knowledge development, and examines the potential for managing knowledge development within SMEs. In Chapter 8, Za’faran Hassan and Arawati Agus investigate the ethical ideologies of owner-managers of Malaysian SMEs regarding the perceived importance of ethics in their business operations, based on a survey of Malaysian SMEs in the state of Selangor. Two main issues investigated are, first, the question of whether a business believes it is ultimately responsible to its stockholders or to its various stakeholders and, second, the personal moral philosophies of the managers surveyed. The key findings are that SME owner-managers tend to score higher on the stockholder view as compared to the stakeholder view, and that they tend to hold more idealistic views as compared to relativistic ones. These findings are explained by the authors in terms of cultural factors. Strategic Aspects The third section of the book turns to the strategic aspects of business decisions facing SMEs. Two of the contributions, those by Susan Freeman and by Heru Satyanugraha, study the attempts by SMEs to expand beyond their domestic markets; the chapter by Paul Robertson, Thomas Keil and Erkko Autio looks at informational sourcing strategies of Australian SMEs; while Bob Ritchie and Clare Brindley investigate the comparative Internet strategies of SMEs in China and the UK. Two reviews of the literature on the internationalization of firms are provided, by Freeman in Chapter 9, and by Satyanugraha in the following chapter. Freeman notes that recent research has tended to shift from a focus on SMEs and exporting to focusing on the processes and patterns that explain how firms increase their international involvement over time, and how relationship networks may be involved in this process. The applicability of the research to SMEs is open to question because it has tended to concentrate on large multinationals. Not much research has been carried out on the internationalization decision process of smaller firms, though she foreshadows also that network approaches for market selection and entry decisions may yield useful insights. Satyanugraha’s chapter on the entry mode decisions of Indonesian SMEs nicely complements Freeman’s and in addition provides some concrete results from a survey of

Introduction

25

more than 200 Indonesian small and medium-sized manufacturers of industrial goods. The chapter by Paul Robertson, Thomas Keil and Erkko Autio begins with the observation that access to external sources of information and knowledge can improve the ability of firms, especially smaller ones, to learn and to increase their efficiency and competitiveness. The authors review the ways in which technological knowledge can be obtained externally by firms from both suppliers and customers, then go on to explore how SMEs in Australia, a geographically isolated country with relatively low levels of domestic R&D activity, cope with their need for external information and knowledge. There is widespread fear among Australian firms of losing competitive knowledge to rivals through networks; the authors suggest that there is potential for them to gain from increased networking behaviour and that government policy should be geared towards encouraging not just formal networks but also other looser forms of ‘embeddedness’, considering carefully what sorts of relationships between firms are likely to lead to the largest gains in innovative learning. This is a finding reached also by Harvie and Lee in Chapter 13. An aspect of strategy that is becoming increasingly important is the incorporation of the Internet as part of the competitive approach of SMEs. This is the subject of Chapter 12, by Bob Ritchie and Clare Brindley, who surveyed SMEs in the UK and in Beijing, China on how the businesses currently (at the time of the survey) or prospectively viewed the application of the Internet as fitting into their strategies in terms of market competition and supply chain management. Their findings that both groups of SMEs viewed the Internet primarily as a marketing communications tool to promote their products and services is not a surprising one. As they point out, the study provides merely a snapshot in a rapidly evolving environment, but it is nonetheless important to form an idea of usage patterns and perceptions of the Internet within SMEs. Policy Aspects The fourth section of the book is a collection of three chapters on aspects of policy. In the first of these, Charles Harvie and Boon-Chye Lee examine the arguments for government intervention in markets for the purpose of providing assistance to SMEs in a range of activities. Their review suggests that many of the arguments put forward for subsidizing SME activities (as distinct from some activities of firms regardless of size) are not economically justified. Nonetheless, it is widely acknowledged that SMEs suffer from disadvantages relative to large firms, principally in the areas of access to information and technology. They then examine the possibilities

26

General and macro aspects

offered by networks in helping SMEs deal with the disadvantages they experience, indicating that there are benefits firms can derive from participating in networks. Further, because networks can assist firms to overcome some of their inherent disadvantages, they can become less reliant on public assistance and more able to compete on an equal footing with larger firms once the initial impetus is provided for the formation of cooperative networks that can enable firms to compete more effectively. Three conclusions are reached regarding policies targeted at encouraging cooperative networks of SMEs. First, policies should seek to encourage the establishment of these links and networks. Further, while it is not clear what role policy plays in the process of encouraging the formation of firm networks, some decentralization of policy to regional and local government seems warranted in the case of geographical clusters and industrial districts. Second, if public assistance to SMEs is deemed justified, delivery of this assistance to a network is more cost-effective than assistance to individual enterprises, as transaction costs are lower. Third, given the disadvantages that smaller firms tend to suffer in terms of access to better-qualified personnel, policy emphasis can usefully be placed on upgrading the skills of small firms. The issues considered in this part of the chapter therefore relate closely to those looked at by Robertson, Keil and Autio in Chapter 11. In Chapter 14, Russell Smyth reviews the policies of local governments in China aimed at fostering collective township and village enterprises (CTVEs), the Chinese equivalent of SMEs. Unlike other East Asian economies, where SME policies have been implemented by central government, in China it is local governments that have taken on this function. Smyth argues that as monitoring costs have increased, local governments have adopted indirect forms of governance over CTVEs while retaining direct control over the most profitable firms. Barbara Cornelius and Sandra Van Der Laan round off the section (and the volume) with their chapter on venture capital policy. Their comparative survey of policies takes in the experiences, both positive and negative, of seven countries. The major lesson the authors draw from this is that well thought out, comprehensive policies with clear objectives that are appropriate to the culture of the societies they are meant to serve (rather than simply imported wholesale from another country), stand a better chance of success.

REFERENCES Acs, Z.J. and D.B. Audretsch (1990), Innovation and Small Firms, Cambridge, MA: MIT Press. APEC (1998), ‘Profile of SMEs in East Asia’ (available at http://www.actetsme.org)

Introduction

27

Hall, C. (1999a), ‘Using the international entrepreneurial engine to restart Asian growth’, in Leo Paul Dana (ed.), International Entrepreneurship, an Anthology, Singapore: NTU Entrepreneurship Development Centre. Hall, C. (1999b), ‘The challenges and the opportunities of e-commerce and international SMEs; implications for HRM in APEC’, paper to the APEC HRM Symposium, Kaohsiung, 29–31 October. Hall, C. (2000), ‘E-commerce and SMEs in APEC – HRD implications and the role of PECC’, paper presented to the ninth annual meeting of PECC – HRD, Pacific Economic Cooperation Council Human Resource Development Task Force, Hua, Taiwan, 21–22 October. Hall, C. (2002a), ‘Profile of SMEs and SME issues in East Asia’, in C. Harvie and B.C. Lee (eds), The Role of Small and Medium Enterprises in National Economies in East Asia, Cheltenham: Edward Elgar Publishing, pp. 21–49. Hall, C. (2002b), ‘Small business and trade in APEC’, a report prepared for the APEC Ministers Responsible for Trade Meeting, Puerta Vallarta, Mexico, 29–30 May. Hallberg, K. (2000), ‘A market-oriented strategy for small and medium-scale enterprises’, IFC Discussion Paper No. 40, World Bank, Washington, DC. Harvie, C. (2002), ‘The Asian financial and economic crisis and its impact on regional SMEs’, in C. Harvie and B.C. Lee (eds), Globalisation and Small and Medium Enterprises in East Asia, Cheltenham: Edward Elgar Publishing, pp. 10–42. Harvie, C. and B.C. Lee (2002a) (eds), Globalisation and Small and Medium Enterprises in East Asia, Cheltenham: Edward Elgar Publishing. Harvie, C. and B.C. Lee (2002b) (eds), The Role of Small and Medium Enterprises in National Economies in East Asia, Cheltenham: Edward Elgar Publishing. Ministry of Economic Affairs (1999), White Paper on Small and Medium Enterprises in Taiwan, Small and Medium Enterprises Administration, Taiwan, September. OECD (1997), Globalisation and SMEs, Vols 1 and 2, Paris: OECD. OECD (2000a), ‘Enhancing the competitiveness of SMEs through innovation’, workshop paper no. 1, Bologna Meeting, OECD, Paris. OECD (2000b), ‘Local partnership, clusters, and SME globalisation’, workshop paper no. 2, Bologna Meeting, OECD, Paris. OECD (2000c), ‘Realising the potential of electronic commerce, for SMEs in the global market’, workshop paper no. 3, Bologna Meeting, OECD, Paris. Pomerleano, M. (1998), ‘The East Asia crisis and corporate finances: the untold micro story’, mimeo, International Finance Corporation. Scherer, F.M. (1991), ‘Changing perspectives on the firm size problem’, in Z.J. Acs and D.B. Audretsch (eds), Innovation and Technological Change, an International Comparison, Ann Arbor, MI: University of Michigan Press, pp. 24–38. Tran, V.H. and C. Harvie (2000) (eds), The Causes and Impact of the Asian Financial Crisis, Basingstoke: Macmillan. World Bank (1998), East Asia: The Road to Recovery, Washington, DC: World Bank.

2.

Small, diversified and sustainable: small enterprises in a sustainable production system Hock-Beng Cheah and Melanie Cheah

With three billion people still living under [US]$2 a day, with growing inequity between rich and poor, with forests being degraded at the rate of an acre a second, with 130 million children still not in school, with 1.5 billion people still not having access to clean water, and two billion people not having access to sewage [facilities], we cannot be complacent. More than this, we must be concerned that 80 to 90 million people are being added annually to our planet, mainly in the developing world. Two billion more souls must feed themselves by the year 2025, hampered by wars, with growing inequity, and with distortions of economies and politics as evidenced in crises from Indonesia to Russia and from Latin America to Africa. With the reduction in Overseas Development Assistance and current instability in the international financial markets, there is much to be concerned about. (Wolfensohn, 1999)

2.1

INTRODUCTION

Since the President of the World Bank, James Wolfensohn, offered the remarks above, it is arguable that the situation has worsened. Japan has remained in the economic doldrums since 1990, with no sign of improvement in the near future. Singapore, ranked for several years as the second most competitive economy in the world (after the USA), has slipped into recession. The USA too is experiencing slower growth (Godley and Izurieta, 2001), with ominous implications for many countries in Asia that, for many years, relied on substantial exports to the US market to support their economic development. A recent World Bank report offered this bleak prognosis: ‘As 2001 draws to a close, the global economy is slipping precariously toward recession. Developing countries have seen their economic growth rates plunge. Growth in trade has undergone one of the most severe decelerations in modern times – from over 13 per cent in 2000 to 1 per cent in 2001’ (Newfarmer, 2001, p. xi).1 28

Small, diversified and sustainable

29

The recent economic crisis has demonstrated clearly that, for several Asian countries, the path towards higher levels of development is not a smooth one, and that success in the past does not assure future success in the development process. However, the difficulties lie not just in the relatively slow pace and the fluctuations of the development process but, more significantly, in the very nature of the development model that has been adopted so far. It is a model in which excessive emphasis has been placed on the economic aspects, a model that has generated significant inequities, a model that is not meaningful for a large proportion of the world’s population, a model that is crisis-prone, and a model that may not be sustainable in the longer term. These concerns have provoked questioning of present forms and processes of development, and have led to a search for better and more viable alternatives; for instance, alternatives flowing from the concept of ‘sustainable development’. Increasingly, business organizations too must incorporate sustainability concerns into their planning and operational activities. This also has to be related to the significant changes that are presently transforming the mass production system (MPS) that has dominated many economies for most of the twentieth century. These changes lead in the direction of what may be called a ‘sustainable production system’ (SPS). Some of the principal outcomes of the new production system lead to outputs of goods and services that are potentially available at ‘anytime’, ‘anywhere’, ‘any kind’, with ‘no matter’, at ‘no charge’, and with the facility to ‘do-it-yourself’. These developments have major ramifications for SMEs, as they play a significant role in most countries.2 SMEs are particularly important in developing countries, because of the large aggregate number of people that they employ. In many developing countries, SMEs represent almost the only employment opportunity available to a large proportion of the population. In addition to creating jobs, they play a major role in the evolution of a dynamic private sector and serve as a significant force for economic growth. Their small size, flexibility and proximity to local markets enable them to be responsive to changing market conditions. In addition, they provide possibilities for promoting empowerment, security and opportunity. Where economic growth occurs, and the number of small and medium-scale enterprises increases, they serve as a major force promoting upward social mobility, by increasing employment and drawing in people from lower-productivity occupations (IFC, 2000, p. 15). On the other hand however, SMEs face significant constraints. Owing to their smaller scale, they tend to have more limited resources (including knowledge, skills, technology, finance and influence), and consequently to be more marginal and more unstable. Furthermore they are more vulnerable to market and institutional failures, and they also confront more

30

General and macro aspects

problems with corruption and crime (Hallberg, 2000; Schiffer and Weder, 2001). Consequently any development that helps to reduce their difficulties and vulnerabilities, and to enhance the positive contributions that SMEs can offer, has the potential to lead to very significant improvements. In this respect it is arguable that an SPS offers several possibilities for the capabilities of SMEs to be enhanced significantly. This is due to the other characteristics of SMEs, including their spontaneity (ease of materializing into existence), flexibility (adaptability), diversity (variety) and multiplicity (ubiquity). These characteristics may enable SMEs to capitalize significantly on the tendencies emanating from the SPS. In particular, the deflationary tendency (‘no charge’) will assist to lower financial barriers to entry, reduce operating costs and increase access to resources. These are complemented by the other SPS tendencies (‘anywhere’, ‘anytime’, ‘any kind’, ‘no matter’ and ‘do-it-yourself’), which would further enhance SME capacity for spontaneity, flexibility and diversity. If these enhanced capabilities are directed effectively towards the promotion of sustainable development, in time this contribution could counteract very substantially the effects of the various difficulties that are currently afflicting several Asian countries. The chapter proceeds as follows. Section 2.2 examines the crisis of development in Asia, with particular attention to the case of Indonesia. Section 2.3 then identifies four principal dimensions and associated imperatives of sustainable development. Section 2.4 demonstrates that small farms can play a significant role in promoting sustainable agriculture. Section 2.5 then examines the experiences of small firms in industrial clusters and global production networks, and the possibilities flowing from the transition from the mass production system to a sustainable production system. Section 2.6 identifies some policy related issues. Finally, section 2.7 provides the major conclusions drawn from the preceding analysis.

2.2

THE CRISIS OF DEVELOPMENT IN ASIA AND THE CASE OF INDONESIA

Development in Asia was focused largely on the economic realm, with ‘trickle-down’ benefits to the poor. When growth rates were relatively high for two or more decades, this strategy appeared to succeed. However there were two important shortcomings. First, while many people escaped from poverty through this process, disparities were widening. Secondly, when the economies were buffeted by the crisis, the social safety nets were absent or grossly deficient to cope with the resulting demands. Consequently while poverty had been reduced significantly during preceding decades, the economic crisis in Asia resulted in many people sinking back into poverty.

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While much blame for the economic crisis has been placed on domestic factors within the affected Asian countries, broader external factors were also involved. Dieter (1998, p. 24) argued that while mistakes were made in the affected countries, ‘The more important causes of the crisis were the flow of “hot money” into South-East Asia, the sudden withdrawal of capital and the speculation against the currencies . . . The world financial system . . . failed to provide both adequate warning signals as well as solutions once the Asian crisis developed.’ Cheah (2000a, pp. 102–8) also suggested that from a global evolutionary perspective, the so-called Asian crisis is part of a larger systemic process of relative convergence and divergence, of ‘catching up’ and ‘slowing down’, in the development process. In this process, development does not occur in the form of continuously harmonious evolutionary change. Indeed crises are an inherent feature of this process (see Stiglitz, 1998). They contribute to periodic major discontinuities in the development process, and lead to radical shifts towards new forms and directions. Furthermore, efforts to promote economic development in Asia incurred significant environmental and social costs (Kurien, 1991; Brookfield and Byron, 1993; Howard, 1993; Barraclough and Finger-Stich, 1996; Glover and Jessup, 1999).3 Even in countries that have been successful in the pursuit of economic development, attention to environmental concerns has been limited and constrained (Perry and Teng, 1999). In Asia, many enterprises continue to engage in practices that are grossly detrimental to the local and wider environment. Recent occurrences that came to public notice include the events that contributed to the explosion at the nuclear materials processing plant at Tokaimura in Japan on 30 September 1999; the extensive smog over Indonesia, Singapore and Malaysia resulting from the repeated practice of land clearance by the use of fire over several years; and the problems resulting from the OK Tedi mine in Papua New Guinea (Harper and Israel, 1999) and elsewhere. The enterprises and other actors involved in the situation may also not willingly change or improve their practices (Dasgupta et al., 1997b; Banks, 1999). While business enterprises are keenly aware of the need for economic sustainability, and the more enlightened ones are increasingly conscious of the need for ecological sustainability, very few are attuned to the importance of social sustainability in their operations. For some, corporate philanthropy serves to enhance corporate image and public goodwill towards the enterprise, but the organizations’operations are not directly concerned with, and consciously geared towards, poverty alleviation, reduction of social inequity, tensions and conflict, or the direct enhancement of the community’s social well-being. These enterprises knowingly or unknowingly adopt the philosophy that ‘the business of business is business’, and that social

32

General and macro aspects

and other needs in the community and society are the concerns of ‘others’, such as the government or charitable and non-profit organizations. However, in the aftermath of the crisis, popular concern has increased over the rise in poverty, widening social disparities, corruption, foreign domination, and exploitative employment and trade practices. Firms that have been subjected to criticism include McDonald’s (Wong, 2000; Vidal, 1998) and Nike (UNITE, 2000). Criticisms have also been directed against the World Bank and, in particular, the IMF (Oxfam International, 2000).4 During the crisis, Oxfam International (1998, p. 8) highlighted the ‘discrepancy between the macroeconomic framework of the IMF, and the social policy framework of the World Bank. In effect, these are pulling in different directions. The World Bank is in the hapless position of erecting social safety nets which are collapsing under the weight of rising poverty and the mass unemployment resulting from IMF programs.’ This discord compounded both the economic difficulties and the social strains. An illustration of such a crisis in the development process may be observed in the case of Indonesia under the rule of President Suharto from 1965 to 1998. This experience was associated with the following major economic, ecological, social and ethical developments in the country. On the economic dimension, Suharto’s ‘strong-man rule’ was viewed positively in various domestic and international circles as providing the security and stability necessary for ‘investor confidence’that would lay the foundations for sustained economic development. Indeed Indonesia experienced a period of rising economic growth from 1967 to 1996. It benefited from its exports of petroleum and natural gas, as well as primary commodities such as coffee, tea, timber and palm oil, the growth in tourism, and its promotion of low labour cost manufacturing industries such as textiles, garments, plywood and electrical appliances with support from foreign multinational companies. It was widely regarded as a ‘second-generation’ newly industrializing country.5 These positive developments encouraged the conviction and the rationalization that concerns over human rights and other ethical lapses should not be pressed or should be postponed, as economic development would lay the foundations for such transgressions to be diminished or eliminated in the future. Such support helped Suharto to entrench his control and to dominate the Indonesian political scene for three decades. His family members gained substantial financial benefits from this situation, through the many business ventures that they initiated, were co-opted into, or were associated with. These numerous business activities ranged from the domestic arena to international ventures, with a web of connections among them (Aditjondro, 1998; Celarier, 1998; Head, 1998; Root, 2000, pp. 230–33). Selected local and foreign business interests benefited from, and directly and indirectly supported, the consolidation of this structure. As a

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consequence, a group of wealthy Indonesian businessmen emerged, with close connections to Suharto and his family. Foreign business interests also established links with Suharto’s family, and foreign governments provided economic and political support, as well as other links, such as military supplies and training (Inbaraj, 1997). In contrast, support from government and the banks to SMEs in Indonesia was absent or ineffective (Supangkat et al., 1998), despite the fact that about 39 million SMEs provided employment for more than 58 million people (54 per cent in agriculture, 23 per cent in trade and 10.6 per cent in the manufacturing sector). The extreme fragility of this structure was only widely recognised ex post, during the so-called ‘Asian crisis’, when foreign investors took fright and withdrew financial investments from Indonesia in 1997. As a consequence, the currency lost 80 per cent of its value relative to the US dollar, the stock market crashed, and per capita income dived from US$1300 to US$340 per annum (Root, 2000, p. 228). Many business ventures failed and the country’s banks were left with high levels of bad debts. Several decades of development progress had been reversed within two years. This had a particularly severe negative effect on small enterprises.6 In this situation the government was compelled to turn to the IMF for assistance. Following its normal practice the IMF imposed stringent conditions that required policies of economic and financial tightening, involving reductions in government expenditure and cuts in subsidies for essential goods, as well as public assumption of responsibility for bad debts incurred by the private sector. These efforts compounded the economic distress in the country, and impacted most severely on the poorer groups in the population (Oxfam International, 1998). The previous poverty reduction strategy, based on ‘policies, programs and projects . . . defined in a top-down manner’ (Dillion, 2001), and trickle-down effects from economic growth, was grossly deficient and needed major changes. On the ecological dimension the most glaring illustration of the harm caused to the environment by policies and practices traceable to Suharto and his government was the forest fires that blighted substantial areas in Sumatra and Kalimantan, and blanketed vast areas of South-East Asia with haze and smog (Glover and Jessup, 1999; Aditjondro, 2000; Barber and Schweithelm, 2000). In relation to Indonesia’s environment and ecology, the connections between the Suharto administration’s policies, his family’s business ventures, other local and foreign vested interests, and a variety of corrupt practices, paralleled the situation depicted for the economy. Specifically: In the forest and natural resources sector, the New Order political economy was characterised by a heavily centralised bureaucracy and industry, effectively dominated by a small number of corporate conglomerates with close connections to

34

General and macro aspects top politicians. These business groups and their bureaucratic cronies were essentially above the law for three decades, seeking short-term profits at the expense of the environment and local communities while enjoying the protection of a legal and political system in which neither industry nor the bureaucracy could be held accountable. Indonesian forest policies have provided powerful legal incentives for ‘cutand-run’ resource extraction and have failed to create effective mechanisms for enforcing even minimum standards of forest resource stewardship. (Barber and Schweithelm, 2000, p. 1)

Among those most severely afflicted were the indigenous groups who resided in areas where logging concessions, new timber and oil palm plantations, and other development projects were located. They lost land and livelihoods, with little or no compensation in return.7 On the social dimension, improvements have not been sustained. In concert with the rise in economic growth rates following Suharto’s ascendancy to power, living standards improved generally in Indonesia from the 1960s to 1990s before the economic crisis. Poverty levels declined from estimates of 60 per cent in 1970, to 28 per cent in 1980, to between 15 to 17 per cent in 1996. However, following the crisis, they rose to 27 per cent in February 1999 (Root, 2000, p. 229; Suryahadi et al., 2000, p. 23). Furthermore, beneath the appearance of rising social well-being, there were increasingly serious and intense social divisions and resentment in many parts of Indonesia. These were being fuelled by discrimination against minorities and official and unofficial expropriation of property and resources, especially in the regions, from Aceh to Kalimantan to Irian Jaya to East Timor, as well as by poorly formulated and badly implemented transmigration and other development programmes. The tensions led to outbreaks of conflict in which the massacres that occurred in East Timor, conducted by militia with direct and indirect support from the military, were only the most publicized of a host of attacks, retaliations and rebellions that occurred and that continue in the country.8 Indonesia’s development experience flounders most significantly on the ethical dimension. General Suharto came to power in 1967, following murky circumstances beginning in October 1965, in which an estimated 500 000 to 1 million people were killed during a wave of anti-communist hysteria, with American involvement (Scott, 1985). With Suharto’s ascendancy the Indonesian military came to play a major political role in the country, in a manner that undermined genuine democratic practices. The human rights record of Indonesia during the period of Suharto’s rule was far from exemplary.9 Corruption was also a significant feature in Indonesia during this period, and vested business interests, linked to members of the political leadership, to the military and, specifically, to

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35

members of Suharto’s family, thrived in a situation appropriately described as ‘crony capitalism’. The ethical failings of the regime in the economy, the environment and society caused substantial harm to its people and to the country (Sari, 1999). The moral lapses of the regime in power eventually infected the whole country,10 and created a contagion that preceded the economic crisis and undermined its capacity to respond correctly and effectively to the crisis. While that crisis had larger causes beyond Indonesia, the foundations of the Indonesian economy, society, polity and, in particular, its value system, had been significantly eroded such that, arguably, some trigger would eventually have sparked an unravelling of the situation (see Clad, 1996). In short, the form of development in Indonesia was not sustainable.11 Yet, before the crisis, no significant measures were undertaken domestically by corporate interests and the government, or by international institutions such as the International Monetary Fund, the World Bank or the World Trade Organization, to change significantly the focus and the direction of Indonesia’s development process. Similar examples of development processes that would be unsustainable in the long term may be found in other countries in Asia and elsewhere. Furthermore, the times immediately ahead are likely to be more difficult. In the near future, we are likely to see, in a more forceful fashion, the collapse of other established companies, and the (further) disintegration of some previously viable economies. In these circumstances, it would be necessary to look ahead at least a decade or more, after the combined crises have demolished the present tottering financial and industrial structures. Then it would be necessary to rebuild from the debris of the collapse new industries and institutions that are more sustainable and more appropriate for the twenty-first century. It is principally in relation to that future context, not just the present one, that attention must be focused. In that respect, the problems that have emerged demonstrate the need for new thinking and new development strategies.12

2.3

TOWARDS SUSTAINABILITY: FROM ECOLOGY TO THE QUADRUPLE BOTTOM LINE

The rising interest in issues relating to sustainable development13 corresponded with growing concerns that the previous dominant focus on economic growth, in general, and the gross national product, in particular, have been severely inadequate, unbalanced and even deceptive (Cobb et al., 1995; Cobb et al., 1999). Initial concerns over sustainability centred around the issues relating to environmental and ecological sustainability, resulting

36

General and macro aspects

from concerns raised, among others, by Carson (1962), Meadows et al. (1972, 1992) and Lovelock (1979).14 Subsequently, the World Commission on Environment and Development helped to expand sustainability concerns to include economic and social aspects. This led to the concept of the ‘triple bottom line’, a significant extension beyond the traditional concerns solely with commercial profitability (the conventional ‘bottom line’) of business enterprise. In this regard, Robinson and Tinker (1998, pp. 14, 22) identified the economy, the ecological system and human society as three interconnected, overlapping and coequal ‘prime systems’, with corresponding imperatives, namely: the economic imperative to ensure and maintain adequate material standards of living for all people; the ecological imperative to remain within planetary biophysical carrying capacity; and the social imperative to provide social structures, including systems of governance, that effectively propagate and sustain the values that people wish to live by.15 Robinson and Tinker (1998) pointed out that these three imperatives are interconnected and mutually reinforcing, with direct and indirect effects on each other, such that ‘any attempt to address one system in isolation not only runs the risk of intensifying problems in the other systems, but also may give rise to feedback effects from the other systems which overwhelm the effects of the first intervention’ (p. 24), and ‘addressing any of these issues in isolation, without considering their interacting effects, can give rise to unanticipated higher order consequences in other realms, which cause problems of their own or undercut the initial policies’ (p. 12).16 Furthermore, they claim that ‘anthropogenic stress generated on a global scale is increasing in all three prime systems’ (p. 17), and that ‘accurately predicting system change in response to stress . . . requires greater knowledge than we have at present. Such change often goes in counter-intuitive directions’ (p. 18). From this perspective, the crux of sustainable development lies in the fact that satisfying any one imperative without also satisfying the other two is unsustainable, because each is independently crucial to societal functioning, each is urgent in light of the scope and scale of problems currently being faced in the world, and each of the three imperatives are interconnected. Consequently, ‘addressing any one of the three imperatives in isolation virtually guarantees failure. Nevertheless, this is what current policy-making commonly does’ (Robinson and Tinker, 1998, p. 24).17 Specifically, ‘the current tendency is to concentrate on the economic imperative combined with a post hoc attempt to reconcile this with the ecological imperative, while ignoring the social imperative and its questions of North–South and intra-country equity’ (p. 35). In contrast, Robinson and Tinker see the necessity for an integrated approach that explicitly and

Small, diversified and sustainable

37

jointly addresses all three prime systems in a complementary manner that can generate positive synergies.18 Whilst Robinson and Tinker have significantly enhanced the analytical foundations of the sustainable development framework, an explicit recognition and incorporation of an ethical imperative could further strengthen that analytical framework and the sustainable development process. Indeed the evidence demonstrates that unethical practices undermine significantly the efficacy and viability of the overall development process (Gill, 1998; Haq, 1999, pp. 95–110; Mirsky, 1999; Hawley, 2000; UNDP, 2000). Such considerations highlight the need to extend the original three-dimensional sustainable development analytical framework to include explicitly an ethical dimension focusing on the ‘value system’ (Anderson, 1997). Furthermore, the quest for sustainable development at the national and international (macro) levels requires a corresponding concept, ‘sustainable management’, at the organizational and enterprise (micro) level (Cheah and Cheah, 2002, 2003); that is, management directly focused on the creation and effective management of economically, ecologically, socially and ethically sustainable enterprises. Where business enterprises had previously focused their concerns and activities largely, or completely, on competitiveness and the creation of material wealth (measured by various indicators of profitability),19 in the future enterprises will need to adopt broader and more balanced foci to include concerns for habitability (measured by various indicators of eco-efficiency), community (measured by various indicators of quality of life), and legitimacy (measured by indicators of corporate reputation, corporate social responsibility, and ethical investment).20 The specific foci and criteria for these four dimensions are identified in Figure 2.1. Thus, an extended sustainable development framework would incorporate four principal dimensions and associated imperatives: (a) the economic imperative, that business activities must be economically profitable, (b) the ecological imperative, that the activities must also be ecologically friendly and not damaging to the environment, (c) the social imperative, that in addition to individual or private gain, the activities must also promote community and societal well-being, for instance by reducing social divisions, inequity and conflict, and (d) the ethical imperative. The ethical imperative may be defined simply and positively as a moral responsibility to ‘do the right thing’, or alternatively as the admonition to ‘do no harm’.21 Based on these guiding principles, further progress can be made to promote sustainable management and sustainable development, which have become increasingly important concerns among researchers, governments, NGOs and development organizations (see Douthwaite, 1999; GRI, 2000; UNRISD, 2000; Wheeler et al., 2000). Increasingly business organizations too, including SMEs, must incorporate sustainability issues into

38

General and macro aspects

Dimension

Focus

Corporate performance criterion

Societal performance criterion

Global Performance criterion

Economic imperative Ecological imperative

Competitiveness Habitability

Social imperative

Community

Corporate profitability Corporate ecoefficiency2 Corporate reputation3

Ethical imperative

Legitimacy

Corporate values

Societal wealth1 Societal ecoefficiency Societal quality of life4 Societal values

Global wealth Global ecoefficiency Global quality of life Human values

All dimensions

Combined foci

Sustainable Sustainable management development index5 index6

Sustainable development index

Notes: 1. An improved version of, or an alternative to, the orthodox gross national product (GNP) should be formulated for the societal (and the global) wealth indicator (SWI). At the very least the gross national product should be converted to a net national product, after appropriate offsets of the associated costs and disbenefits imposed on people and society by certain aspects of wealth creation and related activities. 2. See WBCSD (1999). 3. See Fombrun (1986), Kahn et al. (1999). 4. This should take into account the ‘human poverty index’ (UNDP, 2000). Another relevant concept is the ‘index of social progress’ (Estes, 1992). See also Hirschhorn (2000). 5. See the sustainability reporting guidelines presented by GRI (2000). For the rising trend in socially responsible investment or ethical Investment, see Social Investment Forum (2001). 6. Existing relevant concepts include the ‘human development index’ (UNDP, 2000) and the ‘genuine progress indicator’ (Cobb et al., 1999). Another intriguing concept, adopted in Bhutan, is that of ‘gross national happiness’. See: http://www.unicef.org/bhutan/ kingdom.htm

Figure 2.1 The ‘quadruple bottom line’: dimensions, foci and performance criteria for sustainable management and sustainable development their planning and operational activities. For business enterprises, sustainability, or the concern for long-term viability, also includes four main dimensions: (1) economic sustainability – business activities must be economically profitable, (2) ecological sustainability – the activities must also be ecologically friendly and not damaging to the environment, (3) social sustainability – in addition to individual or private gain, the activities must also promote community and societal well-being, for instance by reducing social divisions, inequity and conflict, and (4) ethical responsibility – the

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39

activities must provide adequate regard to moral responsibility, and corporate reputation. In this respect, the quest for sustainable development at the national and international (macro) level must complement ‘sustainable management’, at the organizational and enterprise (micro) level; that is, management directly focused on the creation and effective management of economically, ecologically, socially sustainable and ethical enterprises. Thus, while economic viability has been a traditional concern of private enterprises, at present and in the future this concern can no longer be pursued with a narrow focus (see de Bono, 1992; Prahalad, 1997; Harman and Porter, 1997). Private enterprises need to be more concerned about both the immediate environmental effects and long-term ecological impact of their activities (WBCSD, 1996, 1999), and the social impact on the present well-being and future viability of communities (see Yunus, 1999). These concerns also need to be linked to a humane value system that upholds the sanctity of diverse life forms and the need for their protection and nurturing to promote local and global sustainability.

2.4

SMALL IS VIABLE: THE SUSTAINABILITY OF SMALL FARMS

Possibilities for sustainable enterprises may be illustrated by various developments that have been observed in agriculture, in particular the sustainability of small farms. Contrary to the common perception of the superiority of large farms and extensive agriculture, focused on monocultures that need large tracts of land to be cleared of their original vegetative cover, and that are heavily reliant on capital-intensive mechanization, chemical fertilizers and pesticides and, increasingly, on genetically modified plant varieties, there is growing evidence that small farms using low-input, natural farming methods are more sustainable (D’Souza and Ikerd, 1996; Van Zyl and Miller, 1996; Rosset, 1999; Kwa, 2001; Pretty and Hine, 2001; Von der Weid and Tardin, 2001; Stabinsky and Sarno, 2001). In terms of economic performance, significant evidence indicates that small farms have higher overall output and total factor productivity per unit of land cultivated than large farms. In ecological terms, widespread land clearance, deforestation and the strong reliance on chemical fertilizers and pesticides on large farms is more damaging to the long-term fertility of the soil, to the environment and to human health (Ikerd, 1995; Pretty, 2000a, 2001). In its social impact there are serious adverse consequences for the well-being of the people who previously farmed in those areas with very different methods (Shiva, 2000; Posner, 2001; Rosset, 2001). Among other effects, capital-intensive mechanized agriculture leads to employment

40

General and macro aspects

losses, impoverishment and undermining of rural communities, and displacement of population from rural to urban locations. These may compound the problems of unemployment, poverty, overcrowding, pollution, corruption, crime and stresses on housing, health and other infrastructure in urban areas.22 Despite these problems, there are strong vested interests that support the continuation and further extension of industrial forms of agriculture, most recently in the form of genetic modification of food crops. The purported rationale for this has been to address food shortages, declining productivity, hunger and malnutrition in the world (among others, see Adamu, 2000; de la Cruz, 1999; Sharma, 1999; Zhang, 1999). However various studies have demonstrated that while there is famine, hunger and malnutrition in some parts of the world, the proposition that there is a general scarcity of food in the world is a myth23 (see Sen, 1981; Lappe et al., 1998; Mittal, 2000). A stronger criticism maintains that it is in fact the dominance of industrial agriculture that leads to displacement, marginalization and impoverishment of a substantial proportion of the population, and that contributes to growing disparity, poverty, lack of access to resources for basic needs, hunger and malnutrition. For instance, without rights to resources and income, people lose their right to food.24 Thus, further increases in food production through unsustainable forms of industrial agriculture, whether through the so-called ‘green revolution’ or the ‘gene revolution’, will not solve the problems of hunger and malnutrition (Altieri and Rosset, 1999; Rosset et al., 2000; Rosset, 2000a; Wertheim, 2000). What are necessary are forms of sustainable agriculture that also address the causes of poverty and inequality. It is in this respect that small farms may offer a significant contribution. One of the most striking examples of the development of sustainable agriculture based on small farms may be observed in Cuba (Enriquez, 2000; Rosset, 2000b). Following the dissolution of the former USSR in 1991 and consequent cessation of support from the Soviet-led Council of Mutual Economic Assistance (COMECON), Cuba was deprived of material aid, production inputs and preferential access to export markets for its agricultural products, such as sugar and rice. These agricultural exports flowed from development policies and a production system that was biased against smaller private farms, and in favour of large state farms that relied on mechanized farming methods, and chemical fertilizers and pesticides, with the associated population migration away from rural areas. The dissolution of COMECON resulted in a crisis that compelled major policy changes that led to the diversion of land from former state farms to smaller-scale cooperative and individual farming arrangements, to avoid potential food shortages by permitting people to grow their own food.

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More importantly, it led to a transformation away from the previously dominant method of agriculture in Cuba, in the form of heavy mechanization and high inputs of chemical fertilizers and pesticides to produce monocultures such as sugar and rice for export, towards greater reliance on lower-input organic and natural farming practices geared towards mixed crops such as vegetables, root crops and bananas, for direct consumption and for sale in local markets, increasingly through direct marketing efforts by the producers themselves. This turn towards smaller-scale production and more direct incentives for increasing output has led to greater benefits for both producers and consumers. According to Enriquez (2000), at present ‘providing everyone who wants to farm with access to land is a key priority of the Cuban government . . . Where de-peasantisation is becoming the accepted norm in most places, the Cuban government has launched a concerted effort to make and keep land available for small farmers.’ Thus, the crisis of Cuban agriculture in the 1990s was a crisis of the classical model of large-scale collective farms that has been significantly ameliorated by a shift towards smaller farms. This process has parallels with developments in China (as well as Vietnam and Eastern Europe), where there have been significant benefits from an even more substantial shift towards household and family farms (see Gray, 1982; Oi, 1989; Bramall, 1993). However, such developments have a broader relevance beyond the transitional socialist economies. In the USA, within the heartland of capitalist agriculture, Ikerd (2001b, p. 6) has argued that the present industrialization of agriculture, characterized by specialization, standardization and centralization of control, has put farmers in direct conflict with their ecological, social and economic environment: ‘As farms have become more specialised and more mechanised, they have become larger in size, and thus, fewer in number. The struggle for ever-greater economic efficiency has forced many farmers to fail so that a few might survive . . . we are destroying our environment in the process of trying to produce cheap food . . . we are destroying the social fabric of our society in the process of trying to make agriculture more efficient.’ Ikerd (2001b, pp. 9–11) suggested that the twenty-first century will see the emergence in America of sustainable agriculture that is ‘ecologically sound, economically viable and socially responsible’. In his view: the new farming opportunities arise directly from exploiting the weaknesses resulting from misuses of industrialization – specialization, standardization and centralized decision making. The new farm relies instead on the advantages of diversity, individuality, and decentralized networks of independent decision-makers. New farmers focus on working with nature rather than against it . . . [they] utilise practices such as management intensive grazing, integrated crop and

42

General and macro aspects livestock farming, diverse crop rotations, cover crops, and intercropping. They manage their land and labour resources to harvest solar energy, to utilize the productivity of nature, and thus, are able to reduce their reliance on external purchased inputs . . . New farmers market in niches. They market direct to customers through farmers’ markets, roadside stands, CSAs [Community Supported Agriculture],25 home delivery, mail order, or customer pick-up at the farm. They use everything from the Internet to word-of-mouth to advertise their services. They market to people who care where their food comes from and how it is produced – local grown, organic, humanely raised, hormone and antibiotic free, etc. . . . They increase value, reduce costs, and increase profits while protecting the environment and helping to build stronger local communities . . . New farmers focus on creating value through uniqueness – among consumers, among producers, and within nature . . . By linking their unique productive capacities with unique sets of natural resources to serve the needs and wants of unique groups of customers they create unique systems for meeting human needs that cannot be industrialized. The more unique their combinations of person, purpose and place, the more sustainable will be the value to customers and producers alike.26

These developments are also responding to innovative approaches to sustainable farming such as ‘permaculture’ developed by Bill Mollison (1988, 1990) in Australia, ‘natural systems farming’ developed by Wes Jackson (1985, 1994) in the USA, the ‘push pull system’ of intercropping developed by Dr Zeyaur Khan (Nielsen, 2001) in India and Africa,27 and ‘natural farming’ developed by Masonobu Fukuoka (1978, 1985, 1987) in Japan. These and other related systems have led to positive results in various locations around the world (see D’Souza and Ikerd, 1996; Mazhar et al., 2001; Nielsen, 2001; Uphoff, 2001; Greenpeace, 2001; Pretty and Hine, 2001; Berton, 2001).28 Based on such developments, Ikerd (2001a, pp. 9–10) contended that: many ‘low-input’ farmers today are already achieving yields equal to or greater than conventional ‘high-input’ systems of farming . . . many [more] are capable of acquiring this knowledge and expertise, if they realize it was possible, and had an incentive to do so. In addition, sustainable agriculture today is in its infancy – sustainable farmers are but the early explorers on a new frontier. As they accumulate increased understanding and know-how, their productivity abilities will increase as well. If we had invested a fraction of the R & D efforts on regenerative farming methods that we have invested in industrial methods, our ability to produce sustainably might easily surpass our ability to produce conventionally . . . Over time, sustainable systems will be far more productive and far less costly than will industrial systems of farming. Those who think that we can’t meet the legitimate food and fibre needs of humanity with a sustainable agriculture are the ‘new Malthusians.’

Such developments suggest that smaller-scale sustainable agriculture could potentially move from the periphery to a mainstream role in the

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production of food, fibre and related products, with significant economic, ecological and social benefits. Among other effects, it would also help people, communities and countries to avoid or mitigate the recurring economic crises that now afflict modern economies. Furthermore, the demonstrated viability and sustainability of small-scale farming, compared to the hazards and problems resulting from large-scale agriculture, also serve to highlight serious problems associated with the mass-production methods that originated in industry. Within the industrial sector itself, these problems have led to significant and evolving changes that are transforming the mass-production system.

2.5

SMALL IS DYNAMIC: INDUSTRIAL CLUSTERS AND NETWORKS IN A SUSTAINABLE PRODUCTION SYSTEM

Increasingly the dynamism of small firms has also been noticed in industry. This may be related to three sets of broader changes that are themselves interconnected: the growing importance of industrial clusters and global production networks; the spread of information communication technology (ICT); and a transition from the mass-production system towards a sustainable production system. 2.5.1 Industrial Districts and Global Production Networks Aided by Information Communication Technology The dynamism of small firms organized in the form of industrial districts has been noted by various observers, beginning with Alfred Marshall (1920, p. 221) and extending to more recent studies of industrial clusters and networks in various parts of the world. Marshall suggested that industrial districts provided useful external economies that facilitated the division of labour among the participants. More recently, studies have highlighted the dynamism of industrial districts in Italy, producing shoes, furniture, musical instruments, processed foods and other products, associated with clusters of firms in specific sectors and locations (Piore and Sabel, 1984). Sengenberger et al. (1990) suggested that a shift towards smaller enterprises has also occurred in other industrialized countries. However, this capability is not limited to a few centres. It appears to exist in a range of locations around the world. In developing countries, Nadvi (1995) provided analyses of industrial clusters and networks in Brazil, Mexico, Korea and India that engaged in producing a variety of products ranging from shoes to knitwear to

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General and macro aspects

electronics and other products. Tewari (1996) examined the dynamism of small manufacturing firms in the Ludhiana region of Punjab state in India. Similarly, Christerson and Lever-Tracy (1997) noted the existence of small firms in China that formed rural industrial clusters to produce a variety of goods for export markets, and that were effectively integrated into global commodity chains. These firms benefited from their links with overseas Chinese business networks, which helped to provide material, financial, information and other resources (Weidenbaum and Hughes, 1996; Cheah, 2000b). On a broader front, the dynamism of such clusters and networks, combined with adaptive entrepreneurship and opportunities for technological leapfrogging, facilitated a process of ‘catching up’ in Asia (Hobday, 1995; Cheah, 1998). The possibility for small enterprises to establish effective links and significant roles within global production networks has helped to reduce or eliminate the isolation and marginalization previously associated with small firms (Humphrey and Schmitz, 1995; Berry, 1997; Ceglie and Dini, 1999; Cook, 2000; Kaplinsky and Readman, 2001). This has led to restructuring of national economies and the strengthening of ‘regional architectures’ in America, Europe and Asia, and opened up new opportunities for competition, innovation and growth in association with the emergence of cross-national production networks (Borrus and Zysman, 1997a). These developments are aided by the growing diffusion of information communication technology. ICT, comprising the computer, Internet, telephone, facsimile, mobile phones, and their associated hardware, software and networks, have provided human beings with a range of new and powerful tools. Cohen et al. (2000, p. 8) have contended that ‘the E-conomy29 is about more than just better technology. It is about where and how these new technological tools, these tools for thought, are used by industries, organizations, and people to transform what they do and how they do it and to do wholly new things.’30 Evans and Wurster (1999) also suggest that the new technology alters the economics of information delivery, by removing the previous unavoidable trade-offs between ‘richness’ (quality of information) and ‘reach’ (number of recipients). This will alter the dynamics of business strategy and business operations. Specifically: When everyone can exchange rich information without constraints on reach, the channel choices for marketers, the inefficiencies of consumer search, the hierarchical structure of supply chains, the organizational pyramid, asymmetries of information, and the boundaries of the corporation itself will all be thrown into question. The competitive advantages that depended on them will be challenged. The business structures that had been shaped by them will fall apart. (Evans and Wurster, 1999, p. 37)

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This process will create new forms of innovation and competition, introduce new players and strategies, and undermine previous pecking orders in industry and the economy. This will also provide new means and opportunities for smaller enterprises to enter the market and to find or create profitable spaces to operate in. It also provides possibilities for developing countries to advance the process of economic and social transformation, if they can introduce appropriate policies, infrastructure and institutions to capitalize on the opportunities (Holderness, 1995; Hamelink, 1997; Quibria and Tschang, 2001; Tschang, 2001). In this process, ‘Wintelism’31 is changing the terms of competition and shifting control away from those engaged in the final assembly of products, so that market power can now be lodged anywhere in the value chain of production (Borrus and Zysman, 1997a, 1997b). Concomitantly, cross-national production networks lead to a ‘dis-integration of the industry’s value chain into constituent functions that can be contracted-out to independent producers wherever those companies are located in the global economy. This strategic and organizational innovation, at an extreme, can convert production of even complex products into a commodity that can be purchased in the market . . . together these developments promise to alter the kinds of product-markets and competitive strategies that can be pursued by smalland medium-sized firms and thus their place in world markets’ (Borrus and Zysman, 1997b). These developments may be postulated to be a part of the fundamental changes occurring in the mass-production system. 2.5.2 From the Mass-Production System to a Sustainable Production System In the past, the production system had evolved from the craft production system (CPS) dominant in pre-industrial economies, to the mass-production system (MPS) that has dominated the industrial economies. Since the 1970s, various developments have led to significant changes in the mass-production system that dominated the major economies in the twentieth century. These changes have been described as ‘flexible specialization’ (Piore and Sabel, 1984), ‘diversified quality production’ (Streeck, 1991), ‘productive diversity’ (Cope and Kalantzis, 1997), and ‘mass customization’ (Pine, 1999). These developments have been characterized by Womack et al. (1990) as constituents of a lean production system (LPS). In the twenty-first century, the imperatives of sustainability will contribute to further substantial changes in the lean production system, which will evolve eventually into what may be termed a sustainable production system (SPS). The SPS refers to the emergence of a relatively new technological and organizational configuration, significantly different from the technological

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General and macro aspects

and organizational features of the MPS. Firstly, the SPS benefits from the use of the new information and communication technology. This changes the dynamics of the production and communication process radically. According to Jain (1992, p. 245), it provides the capacity for decentralized production, de-scaling, better use of local resources and skills, reduced effluent discharges, improved energy efficiencies and lower capital–labour ratios. Each of these benefits would be significant; in combination they have the capability to be revolutionary. The outcomes for product or service delivery in this shift from MPS to SPS are manifested in at least eight distinct dimensions: location, time, variety, material, price, provider, scale and focus. Location The emergence of global production and marketing networks is leading to a tendency where various forms of production and marketing can potentially be undertaken anywhere. The possibility for large and relatively rapid capital, technology and other resource flows to various locations in the world mean that the Ricardian concept of ‘comparative advantage’ based on natural resource endowments is increasingly invalid. Instead, ‘competitive advantage can be directly and institutionally created and enhanced’ (see Porter, 1990, 1997; North, 1990). At the same time, in the shift away from mass production and mass marketing, niche production and niche marketing assumes increasing importance. The growing importance of production and marketing niches raises the significance of the capacity to identify and capitalize on niche locations. In this regard, some small enterprises may have greater advantages over large enterprises in identifying, responding to and reaching niche locations more effectively. Time The new dynamics of production are leading to outcomes where there is a tendency that customers are served the product or service that they desire in the shortest possible time. Improvements in this capability lead to a tendency where the desired product or service becomes available at any time. This can be seen in the examples of home delivery of pizza in the case of products, and home banking in the case of services. In the ultimate, it generates a tendency towards immediate gratification of consumer wants the moment they are conceived. To facilitate this possibility, organizations will need to endeavour to create ‘real-time structures; structures that change continually in tiny increments, not in large static quantum jumps. Each change is so minute that the overall effect is one of a structure in constant, seamless motion’ (Davis, 1987, p. 41). Concomitantly, the notion of ‘niche timing’ becomes important in this regard, as windows of opportunity

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appear and disappear more fleetingly. In this regard, certain small enterprises may have greater advantages over large enterprises in identifying and responding more quickly to these fleeting windows of opportunity. Variety Another significant change resulting from the new dynamics of production is the increasing range and diversity of products and services. This can be observed in the evolution from the corner grocery store to supermarkets, to shopping emporiums and shopping malls. Indeed customers are now capable of being offered not just a range of goods and services produced in one location, but from throughout the globe.32 This is complemented by the shift from mass production towards mass customization (see Davis, 1987, pp. 140–90; Pine, 1999). In the ultimate, the tendency is that customers will be able to have any kind of good or service tailored to their specific desires or specifications, at any time and anywhere. In this regard, the ability of a growing multiplicity of small and diversified enterprises to produce and market a large range of niche goods and services will also help to fulfill the requirements of mass customization. Material Another significant outcome is the development of products that use less or no materials, for instance new (digital) cameras that do not require film.33 The miniaturization of products has led to a dramatic shrinking of the space that they previously occupied. This is illustrated most vividly by the evolution of mainframe computers to palm-held portable computers, but the process is also observable in many other products; for instance, the encapsulation of the 32-volume contents of Encyclopaedia Britannica (plus dictionary and world atlas) within one DVD-ROM.34 This spatial contraction has generally been accompanied by increased product capability, functionality, sophistication and, consequently, value. Miniaturization and increased portability means that transportation constraints are reduced tremendously, such that products and services can be more easily delivered any time and anywhere. The growth of the Internet is only one means through which this process is being spread and intensified. Consequently, ‘The meaning of market “place” is being fundamentally transformed for both the seller and the buyer’ (Davis, 1987, p. 56). These developments also make it more feasible for small producers and traders to enter the market. An even more significant development in the shift away from materials is related to the rapid expansion of services in the economy. This has accelerated the shift away from tangibles such as physical resources towards intangibles (no matter) such as information. This has the important consequence

48

General and macro aspects

that economic activity is shifting away from resources that are potentially and/or actually finite, to resources (for example information) that are potentially or actually infinite. Indeed, the increasing importance (value added) of intangibles attaches both to goods as well as to services. According to Davis (1987, p. 99), ‘in the new economy, both inputs (resources) and outputs (goods and services) are increasingly intangible, and value will increasingly be attached to intangibles’.35 Price There has been a deflationary tendency leading towards a general fall in prices (see Davidse, 1983, pp. 127–8; Makridakis, 1989; Shilling, 1998); and to a growing number of products and services becoming available at no charge. Software that is freely and legally available to be downloaded from the Internet provides examples of the latter. Free access to the on-line contents of a host of on-line libraries, as well as many other resources on the World Wide Web, provide other examples. This does not mean that no revenues will be available to private producers of such goods and services; only that not all elements of the products and services that are provided, even in the private sector, will be transacted at a price. Nevertheless it is intriguing that it may be postulated as a general tendency that goods and services will become progressively cheaper, and that many privately produced goods and services will assume the characteristics of public (‘free’) goods (see Gross et al., 1995). The deflationary tendency in relation to raw materials, equipment and machinery, finance and other inputs will contribute to the lowering of barriers to entry for more small enterprises. These also enhance the ability of small enterprises to reduce their production costs and to lower prices of their outputs, or to upgrade their operations and products. This process will encourage more competition, and also broaden and intensify the deflationary tendency even further. At the same time, falling price levels will encourage a rise in demand, with the possibility that profits may rise despite a decline in unit price. By such means, small enterprises, with their lower overhead costs, may thrive where larger enterprises cannot survive. Provider An increasing range of goods and services are self-made or self-serviced. That is, there is a growing capacity to shift from ‘do (make) it for me’ to ‘do (make) it yourself’. Indeed, according to Kelly (1997, p. 188), ‘The Network Economy rewards schemes that allow decentralized creation . . . An automobile maker in the Network Economy will establish a web of standards and outsourced suppliers, encouraging the Web itself to invent the car, seeding

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the system with knowledge it gives away, engaging as many participants as broadly as possible, in order to create a virtuous loop where every member’s success is shared and leveraged by all.’ In this regard it is noteworthy that, more than two decades ago, Gershuny (1978, pp. 145–51), had perceptively predicted that in post-industrial society the household would become more important in production as well as in consumption. This tendency would lower significantly the minimum scale for an enterprise as well as other entry barriers, increase collective flexibility and responsiveness, and increase competition and innovation. Scale Systems will become radically more ‘scalable’. Decreasing economies of scale, increasing economies of scope and other processes, described above, lead away from the tendency for production to be dominated by large, unsustainable mega-corporations based on monopolistic competition under the regime of the MPS (see Ginzberg and Vojta, 1985; Estes, 1996; Lawler, 1997; Korten, 2001), and towards a tendency for production to be organized and managed by a wide range of small and diversified enterprises based on organic, self-organizing principles (see Miles et al., 1997; Townsend et al., 1998; Korten, 1999; Weinberger, 2002). The deflationary tendency in relation to raw materials, equipment, machinery and other inputs contributes to the lowering of barriers to entry for small enterprises. It also enhances the ability of smaller enterprises to reduce their production costs and lower prices of their outputs, and to upgrade their activities and thus to become more competitive. These improvements, in combination with the option to do-it-yourself (internalize activities) if necessary or desired, and the external economies from the division of labour in the cluster or network, will help to enhance the flexibility of small enterprises, expand opportunities for creativity and adaptivity, and strengthen their capabilities to produce ‘anywhere’, ‘anytime’, ‘any kind’ (see Sturgeon, 1997). These tendencies are complemented by the growing reliance on intangible inputs such as information and knowledge, and the relative diminution in the contribution of tangible inputs. When information, knowledge and production capabilities become more widely diffused, it will become much more feasible to ‘do-it-yourself’ and to focus on ‘sustainable abundance’. Then, small may indeed be beautiful (see Schumacher, 1974). Focus In the MPS, the focus on cost minimization generated a tendency towards ‘zero cost’. Subsequently, the Toyota production system added emphases on ‘zero defects’ and ‘zero inventory’ (Womack et al., 1990; Monden,

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General and macro aspects

1993). In the SPS, management focus will shift from short-term market performance to longer-term multidimensional sustainability, pursued in a parallel and integrated fashion. In this regard Pauli (1995) noted that, after the quest for ‘zero defects’ and ‘zero inventory’, the new industry clusters of the twenty-first century will be focused on the search for ‘zero emissions’. This would ‘give rise to an industrial integration quite distinct from the vertical integration traditionally sought after by industrial groupings. Sectors which seem to have little in common will become closely linked’ (Pauli, 1995, p. 147). Furthermore, he noted, ‘If manufacturing is based on a decentralized concept with lower levels of economies of scale, then it will be better equipped for global competition. It represents lower levels of capital investment, easier adaptation to changes in demand, and greater involvement of local capital. The lower level of economies of scale will facilitate environmental stewardship. After all, it is easier to take care of waste in a small operation than in a 10 000 employees, billion dollar turnover type of operation’ (Pauli, 1995, pp. 149–50. See also Pauli et al., 2000). Beyond the environmental concerns driving the quest for ‘zero emissions’, growing social and ethical concerns will spur the quests for ‘zero inequity’ and ‘zero harm’. Concerns over standard of living will be supplanted by concerns over the quality of life, and the search for ‘sustainable abundance’.36 These characteristics of the old versus the new dynamics of production are summarized in Figure 2.2, which identifies the eight general tendencies that lead ultimately to the provision of goods and services ‘anywhere’, ‘anytime’, of ‘any kind’, with ‘no matter’ and at ‘no charge’. Furthermore, you may ‘do it yourself’, guided by the imperatives of sustainability and the enhanced possibilities for small enterprises. The process of dynamic interactions between these tendencies has the capacity to produce increasing returns based on enhanced system efficiency.37 This refers not just to improvements within individual enterprises but, more importantly, to a metamorphosis into a global distributed production or service network with significantly enhanced overall outcomes. In summary, the demonstrated capability of smaller firms to produce sustainably, and to form dynamic local clusters effectively connected to distributed production (service) networks with associated entities dispersed at various locations around the world, suggest that smaller firms have the ability to become a more effective force that can produce superior outcomes within a very different mode of production. Consequently, in time, this may constitute the foundation of a new phenomenon, a twenty-first-century sustainable production system, associated with the diversified and sustainable small enterprise.

Small, diversified and sustainable Dimension

Old tendencies of the mass-production system

New tendencies of the sustainable production system

Location

The product or service is available only at specific or limited locations. The product or service is available only at specific or limited times. The product or service is available only in specific or limited forms. The product is tangible and bulky.

The product or service is available everywhere (anywhere). The product or service is always available (anytime).

Time

Variety

Material

Price Provider Scale

Focus

Figure 2.2

2.6

The product or service is available at a price. The product or service is provided by others. Production or service provision is dominated by large mega-corporations. Production or service provision is focused on short-term market performance.

51

The product or service is available in multiple or customized forms (any kind). The product is miniaturized, or intangible, or available as a service (no matter). The product or service is available for free (no charge). The product or service can be self-catered (do-it-yourself). Products or services are offered by a wide range of providers of varying scale (scalability). Production or service provision is focused on long-term viability (sustainability).

Tendencies of the old and new systems of production

SOME RELATED POLICY ISSUES

At present, the possibilities offered by a new SPS are at an infant stage, and these possibilities confront significant constraints (Cheah and Cheah, 2002, pp. 415–17). Consequently, there are at least five areas where policy makers should devote special attention. First, there is a need to encourage business organizations to incorporate sustainability issues into their planning and operational activities, and governments themselves should take the lead in this regard. To take proper account of these issues it would be necessary to revise the aggregate calculus of costs and benefits, to include the effects of externalities and presently neglected costs and benefits. This would help to strengthen the case for the need to reorient goals and alter priorities in favour of efforts to promote sustainable management and sustainable development; and for

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General and macro aspects

the inclusion of specific sustainability objectives and criteria in corporate activities, as well as in development policies and programmes. In this regard sustainability, or the concern for long-term viability, would be facilitated by introducing an effective monitoring system, in the form of a ‘sustainability scorecard’, to track progress in implementation and goal attainment. Furthermore, the results from these efforts need to be supported by an appropriate system of rewards and incentives. Through such means, it would be possible to address sustainability in a more integrated manner at both the micro and macro levels. Second, it is important to provide greater institutional support for small enterprises, in view of the significant role that such enterprises can play in the promotion of sustainable development. In particular, special attention must be devoted to the significant contribution that small farms can provide to the development of sustainable agriculture and, concomitantly, to ensure food security for the general population. In this regard, a key priority must be to reverse the active or de facto discrimination against small enterprises that commonly results from oversight and neglect, especially of small enterprises in rural communities, and the corresponding bias in favour of large enterprises, especially those in major urban centres (see Lipton, 1977; National Commission on Small Farms, 1998; Lilliston and Ritchie, 2000; Rosset, 2000c). This skewed treatment can be redressed through a variety of measures including the promotion of more effective outreach programmes to areas that are presently marginalized, and by improving general access to educational, technical, financial, communication and other resources. In the case of agriculture, effective land reforms may be necessary (see Monbiot, 2000; Riddell, 2000a, 2000b), and efforts to promote a more sustainable production system may also help to enhance economic security significantly (see Goland, 1992; Goletti, 1999). Furthermore, governments and employer associations can promote institutions and mechanisms to help small enterprises to establish or join information, production, marketing and other relevant networks. In this regard, Humphrey and Schmitz (1995) suggested that public resources could gain greater leverage when applied to groups of enterprises, as this lowers transaction costs and facilitates mutual learning. They also indicate that SME networks and clusters are more productive when these are buyer-driven and become more customer-oriented. Rasiah (2002) also noted that more effective institutional and network coordination help to produce greater skilled, technical and entrepreneurial synergies for new firms. Consequently, public resources may be better directed to encourage enterprise efforts in this direction. Third, the transition from the MPS to a SPS would be facilitated through greater public investments in ICT infrastructure and, in particular, through

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more vigorous efforts to eliminate the ‘digital divide’ and other barriers that impede or block small enterprises from increased access to and more effective use of ICT (see Bridges.org, 2001; Richardson, 1997). Some significant developments have already been initiated in China (Borton, 2002), India (Wetzler, 2000), Bangladesh (Richardson et al., 2000), Korea (MIC, 1999), and Malaysia (Rahim and John, 2000). However, the process remains very challenging (Baark and Heeks, 1998). For most small enterprises in Asia, the most relevant development will be associated initially with better access to reliable and economical shared facilities, such as multi-purpose telecentres (IDRC, 1999; Camp and Anderson, 1999).38 Through enhanced ICT, and the associated shift towards distributed production and service networks, there are possibilities for improved provision of a wide range of goods and services in communication, commerce, education, health, entertainment and other areas. However, local, regional and international efforts to facilitate these advances could complement each other more effectively to achieve better outcomes. Fourth, in the realm of intellectual property rights (IPR), a better balance needs to be established between IPR holders and IPR users (see Patry, 1997; Aoki, 1998; Cole, 2001; Oxfam International, 2001; Samuelson, 2001). At present the increasingly restrictive IPR regime that is being promoted by the World Trade Organization through the Agreement on Trade-related Aspects of Intellectual Property Rights (TRIPS) is stifling for small enterprises, especially those in less-developed countries, as these restrictions increasingly impede their access to and ability to benefit from knowledge and technology. In contrast, under the present converging international IPR regime, the advantages and benefits tend to be skewed heavily in favour of the large enterprises, especially those in more-developed countries. Small enterprises would benefit significantly from greater limits to IPRs (specifically, through a reduction in the duration and the scope of IPRs, instead of the current developments progressing in the opposite direction), and from an open systems environment (exemplified in the case of open source software, and a copyleft license or a GNU General Public License).39 Other developments that are favourable to small enterprises may be found in various reactions against the increasing oppressiveness of the official IPR regime, such as the Public Library of Science initiative,40 and the ‘No Logo’ counter-movement (Klein, 1999). These and other efforts to ‘reclaim the commons’ (Bollier, 2001) would be congruent with both the realities and the spirit of the emerging SPS. Fifth, national and international policies need to be able to counter more effectively the ability of powerful vested interests in the status quo to block progressive change. For the shift from the MPS to the SPS will impinge significantly on the present relationships between the haves and the

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General and macro aspects

have-nots, the large and the small enterprises, the more-developed and the less-developed countries. In this context, as Pretty (2000b, p. 119) noted, most reforms remain piecemeal, with the particular example of sustainable agriculture still remaining largely at the margins of conventional policy concerns. Specifically, he pointed out that, ‘Vested interests in maintaining the status quo will make any reform difficult. Why should fertilizer companies support a transition to legume based farming or biofertilizers when this would cost them huge amounts of revenue? Why should a pesticide company be balanced in its presentation of different types of farming, when it knows some types of sustainable agriculture mean that little or none of its products will be used?’ Such problems will be very difficult to overcome. Furthermore, Oxfam International (2002) drew attention to even more serious systemic problems stemming from rigged rules and double standards that operate to entrench dominance, exacerbate inequities and undermine reforms. Oxfam argued that: What is happening today is not just indefensible, it is also unsustainable. Large parts of the developing world are becoming enclaves of despair, increasingly marginalized and cut off from the rising wealth generated through trade. Ultimately, shared prosperity cannot be built on such foundations. Like the economic forces that drive globalization, the anger, despair, and social tensions that accompany vast inequalities in wealth and opportunity will not respect national borders. The instability that they will generate threatens us all. (Oxfam International, 2002, p. 7)41

2.7

CONCLUSION

John Kenneth Galbraith (1999, p. 2), wrote recently: ‘the two greatest needs we have now are peace and the avoidance of another world depression’. However, the events that have occurred since 11 September 2001 suggest that peace may be a very fragile prospect in the years ahead. Furthermore, Oxfam International (1998) had reported that ‘The crisis now gripping East Asia bears comparison in terms of its destructive impact with the Great Depression of 1929.’ In this situation a large proportion of the population in Asia and elsewhere must look for development alternatives that are more sustainable during the years ahead, because the previous development strategies and engines of growth in the global economy have lost much of their potency. In this regard, the manifestations of unsustainable development extend far beyond the case of Indonesia, examined above. As Stiglitz (1998, p. 17) noted: Today, with the continuing decline in economic activity in East Asia, with the new crisis in Russia, with the contagion threatening economies elsewhere, faith

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55

in the market economy is eroding in many parts of the world. It is now clear that the emphasis on privatization, liberalization, and macroeconomic stability that dominated thinking about developing economies . . . neither fully captured the essentials of a market economy, nor provided a recipe for growth and stability, let alone for the broader goals of democratic, sustainable, and equitable development.

With much of the world’s population beyond the reach of many of the world’s business enterprises, because their goods and services are not affordable or are simply irrelevant to the needs of that population, those enterprises that cater largely to the wealthy are limited to a relatively small segment of the potential world market (see Illich, 1973). Indeed those enterprises whose operations serve to make the rich richer, and the poor poorer, are directly and indirectly narrowing their potential client base further, and consequently eroding their own long-term sustainability in this respect. Furthermore, in cases where the deepening of such social divisions compounds ethnic, religious and other differences, the result could be a very volatile environment that is not conducive to normal business activity and to further investment in that location. The social divisions, tensions and upheavals in Indonesia are among the most recent experiences that support this point. In this regard, the demonstrated capability of small firms, firstly, to produce sustainably, and secondly, to form dynamic local clusters that can also be effectively connected to globally distributed networks, suggest that small firms have the ability to become a more effective force. It may be possible to promote a very different mode of production with substantially better outcomes, if both sets of capabilities can be integrated effectively. If this can be achieved, small enterprises can play a more significant role in the evolving transformation to a more viable system of economy and society: a system where people matter, a system where natural capital and social capital are at least as highly valued as economic (financial) capital, and a system based on sustainable communities that are well integrated locally and well connected globally (see Schumacher, 1974; Hawken et al., 1999). With the extension of ICT and its associated networks, there is significant potential for more affordable and better-integrated communication services to be provided, even to people in relatively isolated and economically impoverished locations. With this development, affordable but good-quality educational, health and other services could follow. As these groups are increasingly connected to the providers of goods and services that can potentially be provided ‘anywhere’, ‘anytime’ and at a decreasing price or with ‘no charge’, the economic and other capabilities of these groups could improve significantly, including their ability to raise their purchasing power. This will make them more attractive to an even wider range of private and public

56

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providers of goods and services. Through such processes, these groups can be reintegrated into the mainstream economy and society. Moreover, small sustainable enterprises, whose activities serve essential needs and whose operations help to reduce social disparities and alleviate societal tensions and conflict, generate virtuous circles that expand their own market potential over time, and generate positive externalities for the society as well. Furthermore, where small sustainable enterprises increase individual and community empowerment, security and opportunity, they concomitantly reduce the likelihood that people will become participants in corrupt and criminal activities. Thus for SMEs and other business enterprises, recovery from the crisis should not mean a return to ‘business as usual’. To achieve a major reorientation of business objectives and strategies, firms will need to adopt a significantly broader perspective in their planning and operational efforts. First, these efforts should take into account the evolving shift from the mass-production system towards a sustainable production system, and capitalize on the new dynamics of the SPS. Secondly, firms must manage for multidimensional sustainability. To do so, it is necessary to recognize that the four principal dimensions of sustainability do not necessarily involve inherent trade-offs. Instead, the different dimensions of sustainability may actually be complementary and synergistic. In this context, the concept of ‘sustainable advantage’ acquires greater analytical and empirical significance over preceding notions of ‘comparative advantage’ and ‘competitive advantage’. In short, managing for sustainable advantage in a sustainable production system is, or will be, the sine qua non for success. From this perspective, progress in the future may be spearheaded not by the large mega-corporation but by the diversified and sustainable small enterprise.

NOTES 1.

2.

3.

Moreover, the United Nations (2002) noted that the volatility in the global economy in recent years, has had an asymmetric impact, with most developing countries tending to benefit less than the leading developed economies in the upturns, but suffering equally, or more, in the downturns. There are various definitions for SMEs (see Kayanula and Quartey, 2000, pp. 6–10). For our purposes it may be useful to adopt UNIDO’s definition for developing countries, in which large enterprises have 100 or more employees, medium-sized enterprises have 20 to 99 employees, small enterprises have 5 to 19 employees, and micro-enterprises have less than five employees (Elaian, 1996). One study of the consequences of economic development in China reported: ‘Unfortunately, serious environmental damage has accompanied . . . rapid growth. Many of China’s waterways are close to biological death from excessive discharge of organic pollutants. In many urban areas, atmospheric concentrations of pollutants such as suspended particulates and sulphur dioxide routinely exceed World Health

Small, diversified and sustainable

4. 5.

6.

7 8.

9. 10.

11.

12.

13.

14.

57

Organisation safety standards by very large margins. As a result, hundreds of thousands of people are dying or becoming seriously ill from pollution-related respiratory disease each year’ (Dasgupta et al., 1997a, p. 1). See also: http://www.worldbank.org/nipr/china/ video/index.htm See also Bello, et al. (1982), Danaher (1994), Chossudovsky (1997), Boafo-Arthur (1999). One account noted that ‘This populous, resource-rich country was the flagship model of assisted development . . . The World Bank endorsed the Indonesian model with US$25 billion over three decades. International investors interpreted the World Bank’s enthusiasm to lend as a sign that Indonesia was a prime investment environment. Foreign investment peaked at US$18 billion in 1996.’ (Root, 2000, p. 228). One report indicated a significant fall in the number of small enterprises between 1997 and 1998 (amounting to –7.4 per cent overall, and as high as –74 per cent in the finance sector), and a retreat to low value added or less knowledge-intensive industries (Turpin, 2000). It is also probable that many Indonesians turned to subsistence farming and other informal sector activities, beyond the scope and reach of official employment and occupational surveys. For descriptions of the gross outcomes of some mega-projects undertaken in Kalimantan and Irian Jaya, see Barber and Schweithelm (2000, pp. 33–7). ‘At the root of instability in Indonesia are not the insurgent movements but rather the impunity of the Indonesian armed forces which fuels these movements.’ This observation was made by Hendardi, the founder and director of Legal Aid Indonesia, at the inaugural conference for the Indonesian Human Rights Network, in Washington, DC, on 28 February 2001. See various reports by Amnesty International, Human Rights Watch, United Nations Commission on Human Rights. Smith (1998) also provide graphic accounts of abuses and complicity. On a scale of 0 (highly corrupt) to 10 (highly clean) on the Corruption Perception Index, Transparency International ranked Indonesia 85th among 90 countries with a score of 1.7 in 2000, and 88th among 91 countries with a score of 1.9 in 2001. See: http:// www.gwdg.de/~uwvw/2000Data.html and http://www.gwdg.de/~uwvw/2001Data.html This point had been recognized in an earlier report which noted that: ‘Government policies and programs, many of them supported by international donors, have undermined local self-reliance and destroyed community social safety nets, leaving millions more vulnerable to hunger, disease, and dispossession. By and large, government actions have not achieved food security, sustainable land use, improvements in health and education, respect for human rights, accountable and transparent governance, an independent judiciary, or other key components of sustainable development’ (Abrash, 1998, p. 1). In this regard, the experiences of Indonesia, Argentina, Russia and other countries seeking to recover from crisis, suggest that the economic liberalization, privatization and associated free market ‘solutions’ offered by the IMF, and other orthodox policy advisors, should be treated with caution. As Wedel (1998) reported: ‘After seven years of economic, “reform” financed by billions of dollars in US and other Western aid, subsidised loans and rescheduled debt, the majority of Russian people find themselves worse off economically. The privatisation drive that was supposed to reap the fruits of the free market instead helped to create a system of tycoon capitalism run for the benefit of a corrupt political oligarchy that has appropriated hundreds of millions of dollars of Western aid and plundered Russia’s wealth.’ The concept of sustainable development has been broadly defined as development that ‘meets the needs of the present without compromising the ability of future generations to meet their own need . . . Sustainable development is not a fixed state of harmony, but rather a process of change in which the exploitation of resources, the direction of investments, the orientation of technological development, and institutional change are made consistent with the future as well as present needs’ (World Commission on Environment and Development, 1987). These concerns have continued with more recent work by Leakey and Lewin (1995), Colborn et al. (1996), and others.

58 15.

16. 17.

18.

19. 20. 21.

22. 23.

24. 25.

General and macro aspects It may be suggested that specific concerns for morality and the ethical imperative could receive appropriate attention in this sphere. However in practice they have not, and other social concerns relating to poverty, inequality and other matters have dominated this space, to the exclusion of specific attention to values and ethics. They provide the example that ‘raising energy prices significantly to reduce energy emissions will disproportionately affect poorer citizens, thus increasing income disparities and contributing to social unsustainability’ (Robinson and Tinker, 1998, p. 12). In this regard, Oxfam International (1998, p. 8) emphasized that ‘it is crucial that the artificial separation of social and economic policy be ended. Human development and poverty considerations should be integral parts of the macro-economic policy framework, which is currently dominated by narrow – and deeply flawed – financial targets. Second, an institutional framework must be created within which the IMF and the World Bank can provide a more integrated response to financial crisis. The alternative is for the World Bank to continue its present policy of arriving after the event in a largely futile effort to counteract the negative consequences of IMF prescriptions.’ They suggest that this integrated approach should incorporate two sets of policy measures that aim to promote ‘dematerialization’ of the economy and ‘resocialization’ of the society. The former involves the uncoupling of (1) economic growth and improvements in living standards (consumption of goods and services) from (2) increased consumption of energy and materials (for instance, by further development and greater utilization of more environmentally benign technologies). The latter involves the uncoupling of (3) human well being from (1), for instance, by greater participation in the informal economy. In this regard the maxim that ‘greed is good’, pronounced by the fictional Wall Street financier Gordon Gecko, is matched by China’s former Premier Deng Xiao Ping’s exhortation, ‘to get rich is glorious’. From this perspective there has been an excessive dominance of economics and the profession of economists in the public policy arena, as well as an excessive emphasis on competitiveness by business schools and the management profession in the corporate arena. Confucius expressed it as follows: ‘Do not unto others what you would not have them do unto you’ (Analects 15:23); while the Judeo-Christian tradition advised followers to ‘Do unto others as you would have them do unto you.’ More recently, Immanual Kant’s Categorical Imperative advised that ‘we should act in such a way that we could wish the maxim of our action to become a universal law’. Ikerd (2001a, p. 7) has contended that ‘Virtually every environmental and social problem today can be traced to overuse, or misuse of the corporate, industrial paradigm of development.’ Prof Jean Ziegler, UN Special Rapporteur on the Right to Food, reported that in 2000, 36 million people died of hunger or hunger-related illnesses, and over 800 million people were seriously and chronically malnourished. However he emphasized explicitly that: ‘Hunger and malnutrition are not dictated by fate or a curse of nature; they are manmade. To die of hunger is to be murdered; a silent genocide. This silent tragedy occurs daily in a world overflowing with riches. A world which already produces enough food to feed the global population of 6 billion people. According to the UN Food and Agriculture Organization, we can produce enough food to feed 12 billion people.’ Thus the problem is not one of food scarcity, but principally one of unequal wealth distribution and widening disparities. Citing World Bank data, Ziegler noted that ‘average income in the richest 20 countries is 37 times the average in the poorest 20 countries, a gap which has doubled in the last 40 years. More people live in extreme poverty now than 10 years ago. The equation is simple: those who have the money eat, those without suffer from hunger and often die’ (Posner, 2001, p. 3). The French organization Action contre la Faim (Action against Hunger) noted starkly that, ‘Many poor people around the world do not get enough to eat because food production is geared to cash payment’ (Ziegler, 2001, p. 5). See http://www.umass.edu/umext/csa/about.html

Small, diversified and sustainable 26.

27.

28. 29.

30.

31. 32. 33. 34. 35. 36.

37.

38.

39. 40. 41.

59

See also Ikerd (2001a, p. 11), where he emphasized that ‘Sustainability is not a sacrifice; it is an opportunity. Sustainability is about achieving harmony and balance among the economic, social, and ecological – the personal, interpersonal and spiritual. A life of harmony and balance is a life of quality. Sustainability gives people an opportunity to achieve a more desirable quality of life. Sustainability, ultimately, is about people.’ For endorsement of the importance of sustainable agriculture in England, see Curry (2002). Nielsen (2001, p. 18) noted that, ‘The push-pull system is an ideal option as it builds on existing resources, does not create dependency, is manageable by small farmers and does not pose a threat to the eco-systems. It is estimated that full adoption of the push–pull system by small-scale farmers in East Africa will increase food production sufficiently to feed 6–8 million more people. However, this system is of little interest to profit-oriented private companies, as it does not require any external inputs. And it is this very fact that may be the biggest obstacle to its dissemination.’ Indeed farming activities need not be restricted to rural areas, but can also be conducted sustainably in urban locations. See Smit, Ratta and Nasr (1996), Smit, Ratta and Bernstein (1996) and Kaufman and Bailkey (2000). There are several other concepts in the literature that have an overlapping meaning or focus. They include: new economy, information economy, knowledge economy, Internet economy, digital economy, weightless economy, attention economy and network economy. For Kelly (1997), these developments lead towards a ‘network economy’. In this regard, Kelly pointed to ‘the widespread, relentless act of connecting everything to everything else. We are now engaged in a grand scheme to augment, amplify, enhance, and extend the relationships and communications between all beings and all objects. That is why the Network Economy is a big deal.’ This refers to the phenomenon associated with computer systems based on the alliance between Microsoft Windows software and Intel microprocessors. For an account of how water, bottled in Fiji, is exported to the USA to compete against 600 versions of this product, see Cossar (2000, pp. 20, 22). Ayres (1996), and Robinson and Tinker (1998) suggest that ‘dematerialization’ is a positive development that promotes sustainability. See also Larson et al. (1986) and Gershuny (1978). There is also an online subscription option for those who do not wish to be encumbered by the physical constraints of a DVD-ROM. See also Itami (1987). Examples of companies that have sought to integrate such sustainability concerns into their operations include the Body Shop, Interface Inc., and the New Belgium Brewing Company. See Roddick (2001), Anderson (1999) and http://www.terrain.org/articles/ wann.htm See Young (1928), Arthur (1990, 1996) and Schmitz (1997). Other related concepts referring to multiple-orders-of-magnitude improvements are ‘factor four’ (von Weizsäcker et al., 1997) and ‘factor ten’ (see: http://www.factor 10-institute.org/Factor 10.htm and http://www.factor 10-institute.org/F10Manif.pdf). See also Fleury (1999), Owen and Darkwa (2000) and http://www.telecommons. com/reports.cfm?itemid=107 http://europe.cnn.com/SPECIALS/2000/virtualvillages/ story/bangladesh/ http://europe.cnn.com/SPECIALS/2000/virtualvillages/story/india/ and http://www.xlweb. com/indiashop/ http://www.idrc.ca/reports/read_article_english. cfm?article_num=611 See http://www.gnu.org/copyleft/copyleft.html http://www.publiclibraryofscience.org/ In this regard, Wallerstein (1973, p. 277) had earlier posed the pertinent question: ‘under what circumstances can will and possibility be conjoined such that substantial and rapid social transformation . . . can take place[?]’. Specifically, Wallerstein (1973, pp. 282–3) highlighted the dilemma in the development process that, ‘For a movement

60

General and macro aspects with the will to develop, to gain power is difficult. For a movement that has gained power, to retain power against counterforce, is also difficult. For such a movement not to be eaten away in its will by the counter-pressures of those against whose interests they act but on whose goodwill they partially depend is the most difficult of all. And to be able to implement such a program at a specific moment in time, when the international conjuncture is favorable, may seem like a quixotic dream. And nevertheless it has been done – sometimes.’

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Illinois, 11 December, http://www.ssu.missouri.edu/faculty/jikerd/papers/ SusAgpeople.html Ikerd, J. (2001b), ‘21st century agriculture: the end of the American farm or the new American farm’, a paper presented at Partnerships for Sustaining California Agriculture, Woodland, A, 27–28 March, http://www.ssu.missouri.edu/faculty/ jikerd/papers/NAF5-EndAmericanFarm.htm Illich, I. (1973), ‘Outwitting the “developed” countries’, in Henry Bernstein (ed.), Underdevelopment and Development, Harmondsworth: Penguin, pp. 357–68. Inbaraj, S. (1997), ‘The geopolitics of East Timor: a media perspective’ a paper presented at the Conference on Alternative Security Systems in the Asia-Pacific, Bangkok, 27–30 March. Itami, H. (1987), Mobilizing Invisible Assets, Cambridge, MA: Harvard University Press. Jackson, W. (1985), New Roots for Agriculture, 2nd edn., Lincoln, NE: University of Nebraska Press. Jackson, W. (1994), Becoming Native To This Place, Lexington, KY: University Press of Kentucky. Jain, A. (1992), ‘Social diversity and technology for sustainable development’, in S. Ito and Y. Yasuda (eds), Nature and Humankind in the Age of Environmental Crisis, Kyoto: Industrial Research Centre for Japanese Studies, pp. 241–52. Kahn, H., G. Peters and L. Ponemon (1999), ‘Reputation assurance: the value of a good name’, Business, February, New York: PricewaterhouseCoopers. Kaplinsky, R. and J. Readman (2001), Integrating SMEs in Global Value Chains: Towards Partnership for Development, Vienna: United Nations Industrial Development Organisation. Kaufman, J. and M. Bailkey (2000), ‘Farming inside cities: entrepreneurial urban agriculture in the United States’, Lincoln Institute of Land Policy Working Paper WP00JK1. Kayanula, D. and P. Quartey (2000), ‘The policy environment for promoting small and medium-sized enterprises in Ghana and Malawi’, IDPM Finance and Development Research Programme Working Paper no. 15, Manchester: Institute for Development Policy and Management. Kelly, K. (1997), ‘New rules for the new economy’, Wired, September, pp. 140ff. Khandker, S. (1998), Fighting Poverty with Microcredit: Experience in Bangladesh, Oxford: Oxford University Press. Klein, N. (1999), No Logo: Taking Aim at the Brand Bullies, London: Harper Collins. Korten, D. (1999), The Post-Corporate World: Life After Capitalism, San Francisco, CA: Berrett-Koehler. Korten, D. (2001), When Corporations Rule the World, 2nd edn, San Francisco, CA: Berrett-Koehler. Kurien, J. (1991), ‘Ruining the commons and responses of the commoners: coastal overfishing and fishermen’s actions in Kerala state, India’, UNRISD Discussion Paper no. 2, Geneva: United Nations Research Institute for Social Development. Kwa, A. (2001), ‘Agriculture in developing countries: which way forward? Small farmers and the need for alternative development-friendly food production systems’, TRADE Occasional Paper no. 4, Geneva: South Centre. Lappe, F., J. Collins and P. Rosset (1998), World Hunger: Twelve Myths, 2nd edn, New York: Grove Press.

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North, D. (1990), Institutions, Institutional Change, and Economic Performance, Cambridge: Cambridge University Press. Oi, J. (1989), State and Peasant in Contemporary China: The Political Economy of Village Government, Berkeley, CA: University of California Press. Owen, W. and O. Darkwa (2000), ‘Role of multipurpose community telecentres in accelerating national development in Ghana’, First Monday, 5(1), http://firstmonday.org/issues/issue5_1/owen/index.html Oxfam International (1998), ‘East Asian “recovery” leaves the poor sinking’, Oxfam International Briefing, October, Oxford: Oxfam International. Oxfam International (2000), ‘Debt relief and poverty reduction: failing to deliver’, Oxfam International Briefing, April, Oxford: Oxfam International. Oxfam International (2001), ‘Patent injustice: how world trade rules threaten the health of poor people’, Briefing Paper, February. Oxfam International (2002), Rigged Rules and Double Standards: Trade, Globalisation, and the Fight Against Poverty, Oxford: Oxfam International. Patry, W. (1997), ‘The failure of the American copyright system: protecting the idle rich’, Benjamin N. Cardozo School of Law, Occasional Papers in Intellectual Property no. 2, Yeshiva University. Pauli, G. (1995), ‘Industrial clusters of the twenty-first century’, in F. Capra and G. Pauli (eds), Steering Business Toward Sustainability, Tokyo: United Nations University Press. Pauli, G., J.H. Faulkner and F. Capra (2000) Upsizing: The Road to Zero Emissions, More Jobs, More Income and No Pollution, Sheffield: Greenleaf Publishing Perry, M. and T.S. Teng (1999), ‘An overview of trends related to environmental reporting in Singapore’, Environment Management and Health, 10(5): pp. 310–20. Pine, B. J. (1999), Mass Customisation: The New Frontier in Business Competition, Boston, MA: Harvard Business School Press. Piore and Sabel (1984), The Second Industrial Divide: Possibilities for Prosperity, New York: Basic Books. Porter, M. (1990), The Competitive Advantage of Nations, London: Macmillan. Porter, M. (1997), ‘Creating Tomorrow’s Advantages’, in Rowan Gibson (ed.), Rethinking the Future, London: Nicholas Brealey. Posner, L. (2001), Unequal Harvest: Farmers: Voices on International Trade and the Right to Food, Montreal, International Centre for Human Rights and Democratic Development. Prahalad, C.K. (1997), ‘Strategies for growth’, in Rowan Gibson (ed.), Rethinking the Future, London: Nicholas Brealey, pp. 62–75. Pretty, J. (2000a), ‘Changing agricultural practices and the impact on biodiversity’, University of Cambridge Committee for Interdisciplinary Environmental Studies, Allied Domecq Public Lecture, 16 March. Pretty, J. (2000b), ‘The promising spread of sustainable agriculture in Asia’, Natural Resources Forum, 24, pp. 107–21. Pretty, J. (2001), ‘The real costs of modern farming’, Resurgence, no. 205, pp. 7–9. Pretty, J. and R. Hine (2001), Reducing Food Poverty with Sustainable Agriculture: A Summary of New Evidence, Colchester: University of Essex. Quibria, M.G. and T. Tschang (2001), ‘Information and communication technology and poverty: an Asia perspective’, ADBI Working Paper 12, Tokyo: Asian Development Bank Institute. Rahim, R.A. and K.J. John (2000), Access, Empowerment and Governance in the Information Age, Kuala Lumpur: National Information Technology Council.

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Rasiah, R. (2002), ‘Electronics MNCs and industrial clustering in Malaysia’, a paper presented at the 3rd Australia-Malaysia Conference, Canberra, Australian National University, 25–27 March. Richardson, D. (1997), ‘The Internet and rural and agricultural development: an integrated approach’, http://www.telecommons.com/uploaddocuments/ Integrated%2Ehtm Richardson, D., R. Ramirez and M. Haq (2000), Grameen Telecom’s Village Phone Programme in Rural Bangladesh: a Multi-Media Case Study, Ontario: Canadian International Development Agency. Riddell, J.C. (2000a), ‘Contemporary thinking on land reform’, SD Dimensions, Sustainable Development Department, Food and Agriculture Organization, http://www.fao.org/WAICENT/FAOINFO/SUSDEV/Ltdirect/Ltan0037.htm Riddell, J.C. (2000b), ‘Emerging trends in land tenure reform: progress towards a unified theory’, SD Dimensions, Sustainable Development Department, Food and Agriculture Organization, http://www.fao.org/WAICENT/FAOINFO/ SUSDEV/Ltdirect/Ltan0038.htm Robinson, J. and J. Tinker (1998), ‘Reconciling ecological, economic and social imperatives: towards an analytical framework’, in J. Schurr and S. Holtz (eds), The Cornerstone of Development: Integrating Environmental, Social and Economic Policies, London: Lewis Publishers. Roddick, A. (2001), Business as Unusual: The Triumph of Anita Roddick, London: Thorsons. Root, H. (2000), ‘Suharto’s tax on Indonesia’s future’, in F. Richter (ed), The East Asian Development Model: Economic Growth, Institutional Failure and the Aftermath of the Crisis, London: Macmillan. Rosset, P. (1999), ‘The multiple functions and benefits of small farm agriculture in the context of global trade negotiations’, Food First Policy Brief no. 4, Oakland, CA: Institute for Food and Development Policy. Rosset, P. (2000a), ‘Genetic engineering of food crops for the Third World: an appropriate response to poverty, hunger and lagging productivity?’ a paper presented to the International Conference, on Sustainable Agriculture in the New Millennium: The Impact of Modern Biotechnology on Developing Countries, Brussels, 28–31 May. Rosset, P. (2000b), ‘Cuba: a successful case of sustainable agriculture’, in F. Magdoff, J. Foster and F. Buttel (eds), Hungry for Profit: The Agribusiness Threat to Farmers, Food and the Environment, New York: Monthly Review Press. Rosset, P. (2000c), ‘The case for small farms’, Multinational Monitor, 21(7–8). Rosset, P. (2001), ‘Genetically engineered crops: can they feed the hungry and reduce poverty?’ Leisa Magazine, 17(4), pp. 6–8. Rosset, P., J. Collins and F. Lappe (2000), ‘Lessons from the Green Revolution: do we need new technology to end hunger?’ Tikkun, 15(2), pp. 52–6. Samuelson, P. (2001), ‘Anticircumvention rules: threat to science’, Science, 14 September, pp. 2028–31. Sari, A. (1999), ‘Environmental policy and crisis in Indonesia’, National Institute for Research Advancement (NIRA) Review, 6(3), pp. 18–21. Schiffer, M. and B. Weder (2001), ‘Firm size and the business environment: worldwide survey results’, International Financial Corporation Discussion paper no. 43, Washington, DC: World Bank. Schmitz, H. (1997), ‘Collective efficiency and increasing returns’, IDS Working Paper no. 50, Brighton: Institute of Development Studies.

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Schumacher, E.F. (1974), Small is Beautiful: A Study of Economics as if People Mattered, London: Abacus. Scott, P. (1985), ‘The United States and the overthrow of Sukarno, 1965–1967’, Pacific Affairs, Summer, 58, pp. 239–64. Sen, A. (1981), Poverty and Famines: An Essay on Entitlement and Deprivation, Oxford: Oxford University Press. Sengenberger, W., G. Loveman and M. Piore (eds) (1990), The Re-emergence of Small Enterprises: Industrial Restructuring in Industrialised Countries, Geneva: International Institute for Labour Studies. Sharma, M. (1999), ‘India: biotechnology research and development’, in G. Persley and M. Lantin (eds), Agricultural Biotechnology and the Poor, Washington, DC: Consultative Group on International Agricultural Research. Shilling, G. (1998), Deflation, Short Hills, NJ: Lakeview Pub. Co. Shiva, V. (2000), ‘Globalisation and Poverty’, Resurgence, no. 202, pp. 15–19. Smit, J., A. Ratta and J. Bernstein (1996), ‘Urban agriculture: an opportunity for environmentally sustainable development in sub-Saharan Africa’, Building Blocks for Africa 2025 Series, Working Paper no. 11, Washington, DC: World Bank. Smit, J., A. Ratta and J. Nasr (1996), Urban Agriculture: Food, Jobs and Sustainable Cities, New York: UNDP. Smith, C. (1998), ‘Human rights in Indonesia’, proceedings of a hearing before the Subcommittee on International Operations and Human Rights of the Committee on International Relations, US House of Representatives, 7 May, http://commdocs.house.gov/committees/intlrel/hfa49594.000/hfa49594_0.HTM Social Investment Forum (2001), Report on Socially Responsible Investing Trends in the United States, Washington, DC: Social Investment Forum Foundation. Stabinsky, D. and N. Sarno (2001), ‘Mexico, centre of diversity for maize, has been contaminated’, Leisa Magazine, 17(4), pp. 25–6. Stiglitz, J. (1998), ‘Must financial crises be this frequent and this painful?’ McKay Lecture, Pittsburgh, PA, 23 September 1998. Streeck, W. (1991), ‘On the institutional conditions of diversified quality production’, in E. Matzner and W. Streeck (eds), Beyond Keynesianism: The Socioeconomics of Production and Full Employment, London: Edward Elgar. Sturgeon, T. (1997), ‘Does manufacturing still matter? The organisational delinking of production from innovation’, Berkeley Roundtable on the International Economy Working Paper no. 92B. Supangkat, H., A. Dean, A. Huston and H. Higuchi (1998), ‘A closer look at SME development in Indonesia’, Sanwa Research Institute & Consulting Corporation (SRIC), Report 3(4), pp. 75–86. Suryahadi, A., S. Sumarto, Y. Suharso and L. Pritchett (2000), ‘The evolution of poverty during the crisis in Indonesia, 1996 to 1999’, Work Bank Working Paper no. 2435, Washington, DC: World Bank. Tewari, M. (1996), ‘When the marginal becomes mainstream: lessons from halfcentury of dynamic small-firm growth in Ludhiana, India’, Department of Urban Studies and Planning Doctoral Thesis, Cambridge, MA: Massachusetts Institute of Technology. Townsend, A., S. DeMarrie and A. Hendrickson (1998), ‘Virtual teams: technology and the workplace of the future’, Academy of Management Executive, 12(3), pp. 17–29. Tschang, T. (2001), ‘The basic characteristics of skills and organizational capabilities

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in the Indian software industry’, ADBI Institute Working Paper 13, Tokyo: Asian Development Bank Institute. Turpin, T. (2000), ‘SMEs and technology diffusion in Asia-Pacific economies: Indonesia a case study’, a paper presented at the conference, Asian Turmoil: Challenges and Opportunities for Local and International Business in the Asia Pacific region, City University of Hong Kong, 23–26 July. UNDP (2000), Human Development Report 2000, New York: United Nations Development Program. UNITE (2000), ‘Sweatshops behind the swoosh’, New York: Union of Needletrades, Industrial and Textile Employees. United Nations (2002), World Economic Situation and Prospects 2002, New York: United Nations. UNRISD (2000), Visible Hands: Taking Responsibility for Social Development, Geneva: United Nations Research Institute for Social Development. Uphoff, N. (2001), ‘The system of rice intensification: agro-ecological opportunities for small farmers?’ Leisa Magazine, 17(4), pp. 15–16. Van Zyl, J. and B. Miller (1996), ‘Agrarian structure in Poland: the myth of largefarm superiority’, World Bank Working Paper no. 1596, Washington, DC: World Bank. Vidal, J. (1998), McLibel: Burger Culture on Trial, New York: New Press. Von der Weid, J.M. and J.M. Tardin (2001), ‘Genetically modified soybeans: blessing or curse for Brazilian agriculture?’ Leisa Magazine, 17(4), pp. 19–29. Von Weizsäcker, E., A. Lovins and L. Lovins (1997), Factor Four: Doubling Wealth, Halving Resource Use, London: Earthscan. Wallerstein, I. (1973), ‘The state and social transformation: will and possibility’, in Henry Bernstein (ed.), Underdevelopment and Development. Harmondsworth: Penguin, pp. 277–83. WBCSD (1996), Environmental Assessment: A Business Perspective, Geneva: World Business Council for Sustainable Development. WBCSD (1999), Eco-efficiency Indicators and Reporting, Geneva: World Business Council for Sustainable Development. Wedel, J. (1998), ‘The Harvard boys do Russia’, Nation, 1 June. Weidenbaum, M. and S. Hughes (1996), The Bamboo Network, New York: Free Press. Weinberger, D. (2002), Small Pieces Loosely Joined: A Unified Theory of the Web, Cambridge, MA: Perseus Books. Wertheim, M. (2000), ‘Can biology end world hunger?’ Los Angeles Weekly, 7–13 July. Wetzler, B. (2000), ‘Boomgalore’, Wired, 8(3), http://www.wired.com/wired/archive/ 8.03/bangalore.html. Wheeler, D. et al. (2000), Greening Industry: New Roles for Communities, Markets and Governments, Washington, DC: World Bank. Wolfensohn, James (1999), ‘A proposal for a comprehensive development framework’, a statement to the Board, Management and staff of the World Bank group, 21 January. http://www.worldbank.org/cdf/cdf-text.htm Womack, J., D. Jones and D. Roos (1990), The Machine that Changed the World, New York: Harper. Wong, M. (2000), ‘Children toil in sweatshop’, South China Morning Post, 27 August. World Commission on Environment and Development (1987), Our Common Future: From One Earth to One World, Oxford: Oxford University Press.

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3.

The contribution of micro-enterprises to regional economic recovery and poverty alleviation in East Asia Charles Harvie

3.1

INTRODUCTION

The economic and social crisis that afflicted East Asia1 from mid-1997 produced the biggest setback to poverty reduction in the region for several decades. Prior to the crisis, East Asian countries had achieved spectacular welfare gains. Consistently high rates of economic growth were translated into quantifiable welfare improvements, primarily because growth was largely inclusive – the poor shared in the benefits of development. Public provisioning of social services was widespread, and the productivity of the poor and their employment opportunities increased enormously. The absolute number of poor people fell and the severity of poverty declined. Between 1975 and 1995 poverty in East Asia2 dropped by two-thirds, and the pace of poverty reduction was faster than in any other developing region. In 1975, six out of ten East Asians lived in absolute poverty according to this standard; by 1995, the ratio had dropped to two out of ten. This meant that the number of poor in the region more than halved, from 720 million to 345 million (World Bank, 1997). Further, the rate of decline accelerated after 1985. The number of people in poverty fell by 27 per cent in 1975–85; in 1985–95 the decline was 34 per cent (World Bank, 1998). Since 1975 the region also achieved substantial gains in life expectancy, infant mortality and literacy rates. These are even more impressive when compared with social developments in other regions, or indeed developed countries during their comparable decades of development. The onset of the economic crisis, however, adversely affected the lives of millions, and aggravated social vulnerabilities. There were many dimensions to this, including falling incomes, rising absolute poverty and malnutrition, declining public services, threats to educational and health status, 72

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increased pressure on women, and increased crime and violence. While the effects of the crisis were particularly acute in Indonesia, where there was a radical breakdown in social order in May 1998, they were also severe in Thailand, Korea and Malaysia. The Philippines was less affected but also suffered a worsening of social conditions. Trade, capital flows and migration linkages amongst countries exacerbated, and hastened, the transmission of economic and social effects across the region. While economic recovery of the region after the crisis of 1997–98 is well under way, there is a general recognition of the important role that small and medium-sized enterprises (SMEs) can play in this process from a number of perspectives (see Harvie and Lee, 2002). The objective of this chapter is to analyse the contribution of one subset of SMEs, microenterprises and of micro-finance more generally, to regional economic recovery and poverty alleviation. In doing so it proceeds as follows. Section 3.2 identifies the contribution of micro-enterprises to regional development and poverty alleviation, and the constraints inhibiting their future development. Section 3.3 provides a picture of the diversity of microlevel enterprises, and highlights two general types of micro-enterprises: livelihood enterprises which provide livelihood to the entrepreneur, and micro-enterprises which have the potential for growth and the generation of employment opportunities. Section 3.4 examines the contribution of microenterprises and the related issue of micro-finance to the attainment of development objectives. Section 3.5 discusses alternative approaches to promoting livelihood and growth-oriented micro-enterprises. Section 3.6 discusses the increased recognition of the role and contribution of microfinance to poverty alleviation, economic participation and regional development. Finally, section 3.7 provides a summary of the major conclusions from this chapter.

3.2

THE CONTRIBUTION OF MICRO-ENTERPRISES AND CONSTRAINTS UPON THEIR GROWTH AND DEVELOPMENT

Most of East Asia’s poor live in rural areas, although urban poverty is also a growing problem in virtually all developing regional economies. Most rural poor are engaged in agricultural or related activities as labourers or small-scale farmers in the informal sector. Although the definitions vary according to the country context, it is generally agreed that the informal sector, whether rural or urban, comprises small scale and micro-enterprises producing and distributing goods and services in unregulated but competitive markets. These enterprises are generally independent, largely family

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owned, employ low levels of skills and technology, and are highly labour intensive. These micro-enterprises are concentrated largely in low-income low-productivity activities, especially in petty trades and services. In many countries, women, who are a significant proportion of the poor and suffer disproportionately from poverty, operate many of these enterprises. Micro-enterprises provide income and employment for significant proportions of workers in rural and urban areas by producing basic goods and services for rapidly growing populations. They account for more than 60 per cent of all regional enterprises and up to 50 per cent of paid employment. With increasing labour force participation among women in developing countries in the region, a greater number of women depend on micro-enterprises in the informal sector for survival. Hence, microenterprise development is increasingly being seen as an essential ingredient in the promotion of broad-based growth, in improving the well-being of the poor and women by providing significant income and employment generating opportunities, and by encouraging indigenous investment. Consequently, there is an increasing policy focus on the need to strengthen entrepreneurship and the contribution of micro-enterprises to attain economic growth with equity, as well as in addressing gender and poverty reduction issues. Pressure to attain such outcomes has been further increased in the wake of the regional economic and social crises. Many constraints to micro-enterprise development exist however, due to a lack of relevant laws and administrative procedures that undermines their legal standing and ability to receive assistance from state agencies; a policy bias toward large firms and capital-intensive import substituting industries; a lack of, or limited access to, institutional credit; exclusion from participatory processes; imperfect market information; and a lack of opportunities for skills development. Of these hurdles, the most formidable is a lack of access to credit. Inadequate collateral, insufficient legal status, high transaction costs and the inability of micro-entrepreneurs to cope with the complexities of dealing with formal financial institutions are among the reasons why such enterprises have difficulty in growing. Most formal financial institutions do not serve the poor because of perceived high risks of default, high costs involved in small transactions, perceived low relative profitability, and inability of the poor to provide the physical collateral usually required by such institutions. The business culture in many economies is also not geared to serve poor and low-income households. Lacking access to institutional sources of finance, most poor and low-income households continue to rely on meagre self-finance or informal sources of micro-finance. These sources limit their ability to actively participate in, contribute to and benefit from the development process. Thus, a segment of the poor population that has viable investment opportunities

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persists in poverty for lack of access to credit at reasonable costs. The poor also lack access to institutional credit for consumption smoothing and to other services such as payments, money transfers and insurance. Most of the poor households also find it difficult to accumulate financial savings without easy access to safe institutions that provide deposit services. In response to this need for finance and credit, innovative and successful approaches have been applied in Asian developing countries in the development of micro-finance and its related institutions. An excellent example of this was the development of group lending schemes for landless people emphasizing long-term sustainability. This scheme led to the development of the Grameen Bank in Bangladesh, which now serves more than 2.4 million clients (94 per cent of them women) and is a model for other countries.3 Micro-finance refers to the provision of financial services to low-income clients, including the self-employed. Improved access to, and efficient provision of, savings, credit and insurance facilities, in particular, can enable the poor to smooth their consumption, manage their risks better, build their assets gradually, develop micro-enterprises, enhance income capacity and enjoy an improved quality of life. Micro-finance services can also contribute to the improvement of resource allocation, the promotion of markets and the adoption of better technology. Without permanent access to institutional micro-finance, most poor households continue to rely on meagre self-finance or internal sources of micro-finance, which limits their ability to actively participate in, and benefit from, the development opportunities. Micro-finance can provide an effective way to assist and empower poor women, who make up a significant proportion of the poor and suffer disproportionately from poverty. Micro-finance can also contribute to the development of the overall financial system through integration of financial markets. Hence, the development of micro-enterprises and micro-finance are intertwined.

3.3

TYPES OF MICRO-ENTERPRISES AND ALTERNATIVE POLICIES FOR THEIR DEVELOPMENT

Micro-enterprises are highly heterogeneous. Some aspects of this diversity relate to size, gender of owner, location and sector of activity. Most microenterprises, however, are single-person, owner-operated enterprises or slightly larger units engaging one or more family members. Enterprises that hire wage employees tend to be the exception. Three approaches to the classification of micro-enterprises in developing economies can be gleaned from the literature. From a policy formulation

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point of view, relating specifically to their contribution to poverty alleviation and development, two useful approaches can be identified: 1. 2.

distinguishing between livelihood (or survival) activities and growthoriented (or viable) enterprises (see ADB, 1997) a fourfold classification, based on past growth performance in terms of numbers of workers (Liedholm and Mead, 1995): new enterprises in the start-up phase (new starts); existing enterprises that had survived the perils of start-up but which have not grown (no-growth firms); existing enterprises that show small growth (small-growth firms); and existing enterprises that have graduated and become ‘small’ enterprises with ten or more workers (graduates).

A third approach, emphasizing the type of micro-enterprise customers and services to be provided from a micro-finance perspective, identifies the following classification of micro-enterprises: 3.

micro-enterprises distinguished on the basis of whether they are already in existence or are start-up enterprises (existing or start-up); their level of business development (stable, unstable or growing); and their type of business activity (agriculture, production or services) (see Ledgerwood, 2000).

3.3.1

The Livelihood–Growth Enterprise Dichotomy (First Approach)

The first approach to micro-enterprise classification emphasizes their needs and the constraints they face. A livelihood (survival or subsistence) activity is one into which an entrepreneur is pushed for want of more profitable alternatives, whereas one is attracted, or pulled, into a growth (viable) activity by considerations of profitability and out of choice by the entrepreneur. In the former case the activity is often just one of many part-time or seasonal activities undertaken to support family income, whereas in the latter case it is usually the main source of family income. In the case of livelihood activities, usually no skills or very rudimentary skills are involved, so there are very low entry barriers to the activities, which are consequently overcrowded. In the case of growth activities, considerable experience and skills are often involved which restrict entry. In the former case, net earnings tend to be used for survival purposes whereas, in the latter, part of the surplus is reinvested in the expansion and growth of the enterprise. Consequently, the former type of micro-enterprise can play an important role in poverty alleviation, while the latter type have the potential to make an important contribution to sustainable

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growth and development. Such a distinction is important for the identification of appropriate policies, and requirements, for these alternative types of micro-enterprise. A number of observations can be made in terms of livelihood enterprises. First, while it is true that many persons are ‘pushed’ into livelihood (survival) activities, once in them, they often stay in them, but for a variety of psychological reasons that are not easy to quantify. Second, livelihood activities are often among several secondary sources of income of the household, while growth activities are more often the primary source. Livelihood activities tend to grow rapidly during times of macroeconomic stress, such as that occurring during the period of the financial and economic crisis in Asia during 1997–98. Third, most livelihood enterprises earn small surpluses. While such surpluses tend not to be reinvested for expansion, this is not an inherent characteristic of livelihood enterprises but, rather, it is a reflection of the poverty of the entrepreneurs who operate them. Fourth, the potential of livelihood enterprises for growth is usually limited by a host of factors relating to both the environment, and to the lack of skills of the entrepreneurs themselves. The absence of skill requirements in livelihood activities contributes to low entry barriers and to overcrowding. Very few livelihood activities have the potential for growth beyond a certain size and level of income yielded, and this is the crucial distinction between them and growth enterprises. These livelihood enterprises can act as an important buffer during periods of economic downturn. A useful summary characterization of the key differences between livelihood and growth enterprises, compiled by the Asian Development Bank (1997), is contained in Table 3.1. 3.3.2

Liedholm and Mead (Second Approach)

Liedholm and Mead (1995) adopt a fourfold classification of microenterprises using past growth performance as measured in terms of numbers of workers added. In doing so, they identify the following classifications: new enterprises in the start-up phase (new starts); existing enterprises that had survived the perils of start-up but had not grown (nogrowth firms); existing enterprises that had shown small growth (smallgrowth firms); and existing enterprises that had graduated and become ‘small’ enterprises with ten or more workers (graduates). While their results pertain to a number of African economies, they are likely to be applicable to the situation in East Asia, where a similar study remains to be conducted. Liedholm and Mead’s work provides valuable insights into designing policy interventions that take into account the different needs of the four types of enterprises identified. For example, they point out that high

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Table 3.1 Major differences between livelihood enterprises and growth-oriented micro-enterprises Livelihood enterprises

Growth-oriented micro-enterprises

1. Capitalization

Relatively low.

Higher, but initial capitalization is often similar.

2. Education (entrepreneur)

Little formal education.

Usually at least secondary schooling.

3. Skills and experience

Relatively low, except for skills acquired traditionally, as in handicrafts; trading often a fertile training ground for later manufacturing of the same product.

Higher, more often acquired through vocational training and/or previous wage employment.

4. Gender

High (often majority) participation of women.

Lower participation of women, but still high in many cultures.

5. Sector

Higher proportion in livestock, backyard poultry, food processing and petty trading.

Higher proportion in manufacturing and services requiring skills.

6. Competition

Usually function in perfectly competitive markets with low barriers to entry and little scope for cutting costs by intensive use of family labour and even by offering credit.

Often occupy ‘niche’ markets with more scope for specialization and product differentiation.

7. Seasonality

Often seasonal and tied to crop cycle, school year, major festivals.

Less affected by seasonality and function throughout the year, even if at varying levels.

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Table 3.1 (continued) Livelihood enterprises

Growth-oriented micro-enterprises

8. Contribution to household income

Usually a secondary source (although vital).

Often primary.

9. Whether only enterprise

Usually one of several ‘multiple’ enterprises (to compensate for seasonality and low returns).

Usually the only enterprise.

10. Use of hired labour

Infrequent, mostly use family labour.

More common, often relatives or children.

11. Surpluses and reinvestment

Surpluses limited and often ploughed back into household expenditure.

Reinvestment of surpluses the norm.

12. Use of credit

Trading activities often started on a consignment basis, livestock required on a profit-sharing basis, boats and rickshaws on lease; however in order to compete, often become net lenders, especially in trading and restaurants.

Credit available from a wider range (informal and semi-formal) and a greater two-way flow of credit so that micro-enterprises are more often net lenders than livelihood enterprises.

13. Potential for growth

Limited in terms of new employment generation, but offer scope for increases in sales, productivity, profitability, and income; growth blocked often by demand constraints, resource constraints and physical constraints (space in home and yard).

Have growth potential; number of workers higher, with more paid employees; employment usually of ‘higher quality’.

Source: Asian Development Bank (1997).

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General and macro aspects

enterprise birth rates (usually over 20 per cent), as well as high attrition rates, suggest caution in engendering new starts. They conclude that it would be more useful, from a policy perspective, to ensure a higher proportion of survivals, to restrict new starts to those with prior experience, and to encourage on-the-job and other skill training programmes for those without the requisite skills. In the case of non-growing enterprises they suggest that focus should be given to increasing incomes through efforts to reduce costs, increase sales or switch product lines. Both financial and non-financial assistance could contribute to each of these objectives. A second goal would be to increase the number of such enterprises that succeed in growing. However, as they point out, the most serious problems non-growing enterprises face, the availability of markets and inputs, are not amenable to credit-based solutions. Effective programmes to address these non-credit needs require operating primarily at a systems level. 3.3.3 Micro-enterprises from a Micro-finance Perspective (Third Approach) The micro-finance literature distinguishes enterprises by whether they are existing or start-up businesses; by their level of business development (unstable, stable or growing); and their area of business activity (production, commercial or service). The level of business development is important when identifying the different types of micro-enterprise to which a micro-finance institution (MFI)4 wishes to provide financial services. This is closely linked with the level of poverty existing in a potential target market. There are typically three levels of business development of microenterprises that benefit from access to financial services: unstable survivors – business operators who have not found other employment and tend to have very unstable enterprises for a limited time; stable survivors – with operators for whom the micro-enterprise provides a modest but decent living while rarely growing; and growth enterprises – or businesses that have the potential to grow and become genuinely dynamic small enterprises. Unstable survivors These comprise the group most difficult to provide financial services to in a sustainable fashion, because loan sizes tend to remain small and the risk of business failure is high. Focusing on unstable survivors as a target market can result in a great deal of time spent by MFIs with clients just to ensure that their businesses survive and that they will continue to be able to make loan repayments. Some technical assistance may also be required, resulting in further time and cost increases. Also, unstable survivors often need credit for consumption smoothing rather than income-generating

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activities. Depending on the objectives of the MFI, these stopgap loans may or may not be appropriate. Generally, the debt capacity of unstable survivors does not increase. Accordingly, the MFI is limited in its attempts to reduce costs or increase revenue, because loan sizes remain small. While not all MFIs have the immediate goal of reaching financial self-sufficiency, over the long term the choice to focus on unstable survivors will likely be a time-bound strategy because access to donor funding may be limited. Stable survivors These comprise the group that many MFIs focus on and for which access to a permanent credit supply is vital. This is the group that benefits from access to financial services to meet both production and consumption needs, while not necessarily requiring other inputs from the MFI. Stable survivors are targeted by micro-finance providers who have as a priority poverty reduction objectives. Stable survivors are often women who simultaneously maintain family-related activities (providing food, water, cooking, medicine and childcare) while engaging in income-generating activities. Generally profits remain low, leading to low reinvestment, low output and a high level of vulnerability. Profits remain low due to the unspecialized nature of the product; the lack of timely and complete market information (beyond the local market); underdeveloped infrastructure facilities; the lack of value added services (such as packaging); and the number of producers with similar products. Growth enterprises These are often the focus of MFIs whose objective is job creation and whose desire is to move micro-entrepreneurs from the informal sector to a progressively more formal environment. These MFIs often establish linkages with the formal sector and provide additional products and services. Growth enterprises represent the upper end of the poverty scale: they usually pose the least risk to the MFI. While generally a heterogeneous collection of enterprises, they tend to share some characteristics and face similar problems. Most have both production and risk-taking experience, keep minimal accounting records, and usually do not pay taxes. In addition, they often have little or no formal management experience. These enterprises tend to produce a single product or line of products serving a narrow range of market outlets and clients, and use labour-intensive production techniques that rely on family and apprentice labour. These firms build their asset base slowly, in an ad hoc manner, and depend largely on family credit for initial investment capital and on informal sector loans for working capital. Cash flow is a perennial problem, and they are very sensitive to output and raw material price changes. They often use second-hand

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equipment. Growth-oriented micro-enterprises are an attractive target group for MFIs, because they offer potential for job creation and vocational training within the community. They can resemble formal sector enterprises in terms of fixed assets, permanence and planning, which offer the potential for physical collateral and more thorough business analysis. All these offset risk for the MFI.

3.4

MICRO-ENTERPRISE, AND MICRO-FINANCE CONTRIBUTION TO DEVELOPMENT OBJECTIVES

Micro-enterprise development, in conjunction with appropriate microfinance support, can contribute to the attainment of four major economic and social development objectives: poverty reduction, empowerment of women, employment generation and private sector enterprise development. In particular, micro-enterprise development contributes to a widening of the pool of entrepreneurship available to society, increases the number of direct participants in the development process and broadens the base of the private sector. Most micro-enterprise development projects have combinations of the first two, or first three, as their explicit objectives. In order to make such projects successful, a supportive role for micro-finance is also crucial. 3.4.1

Poverty Reduction

Reducing poverty and enhancing the role of women in development are the most frequently stated objectives of micro-enterprise development projects. There is an abundance of evidence to suggest that properly designed micro-finance projects have an impact on poverty, and manage to reach the poor (although not always the poorest of the poor) on a scale large enough to cover their costs, meeting the twin tests of outreach and sustainability. Successful poverty-oriented micro-finance projects aimed at micro-enterprise development need to contain two essential design features. First, the poor cannot offer collateral and projects must rely instead on group collateral, or the joint and several liability of group members. Organizing groups and training them in the norms of repayment discipline entails what is sometimes referred to as ‘social intermediation’. Second, poverty-oriented micro-credit projects usually exhibit a set of loan characteristics: small initial loan size, increasing gradually as the borrower builds up an absorptive capacity and creditworthiness; weekly or at least frequent repayment instalments to keep each repayment small and manageable, and to maintain repayment discipline; and a short maturity

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period of usually up to one year. The last feature is not as important as the first two, and is a function of the need to ensure quick turnaround so that the borrower can be extended a larger loan as soon as possible. There are three reasons for these typical loan features. First, they conform to the needs of poor micro-entrepreneurs, who are mostly looking for a working capital loan to expand an existing livelihood enterprise rather than set up a new one. Even when the intention is to start a new enterprise, it is often a simple processing or trading activity or service yielding a regular cash flow from which repayments can be made, and with little fixed capital requiring a larger, longer-term investment loan. The impact of poverty-oriented micro-finance projects usually takes the form of increasing the productivity of a large number of existing enterprises, many of which are operated by women, constitute a supplementary source of household income, and are seasonal and part-time. Although some new enterprises are created, the benefit of poverty-oriented micro-finance is primarily an income-augmenting and not an employment-generating benefit. Second, small initial loan size and repayment in small frequent instalments contribute to ease of repayment and are largely responsible for the impressive repayment record of a large number of micro-enterprise projects. Third, and perhaps most important of all, poverty-oriented micro-finance is the most effective way of targeting the poor and especially women, who self-select themselves in response to loan terms and a lending technology that is not of interest to the non-poor. One effect of this combination of loan features, however, is that each loan typically has only an incremental impact on enterprise and household income, or only a short-term impact, and a series of loans is needed if the household is to raise its income above the poverty line, let alone graduate to bank financing. Limitations of micro-enterprise projects for poverty alleviation Despite the potential benefits for poverty alleviation arising from microenterprise development projects, it should be recognized that there are limitations in the usage of such projects as instruments of poverty reduction. First, available evidence suggests that micro-finance projects often do not reach the poorest of the poor, particularly the old, sick and disabled. Outright transfers for the destitute under social security programmes may be more cost-effective than attempting to reach everyone through microenterprises. Apart from the destitute, there are usually just not enough micro-enterprise opportunities available to cover all the poor, given demand constraints and the lack of skills to produce products for which there is a demand. Second, from a longer-term perspective, micro-enterprise promotion can never be a substitute for a variety of social sector programmes such as primary health care, environmental sanitation, education,

84

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nutrition, and family planning and childcare, or structural changes such as land reform. The many causes of poverty constitute a vast and complex subject and cannot be dealt with by micro-enterprise programmes alone. Hence, there is also a need to focus on anti-poverty approaches and projects that could complement micro-enterprise development. 3.4.2

Empowerment of Women

The empowerment of women is an objective that goes beyond increasing the income of low-income women. Micro-enterprise programmes can lead to empowerment in its social as well as economic dimensions. The mobility of women and their access to information is strengthened by the process of participation in micro-enterprise programme activities, including attendance at weekly meetings and other interactions in the public sphere that come about as a result of economic activities. Empowerment leads in turn to such social benefits as more education and lower fertility rates for girls. Women constitute by far the largest share of borrowers of several major micro-enterprise programmes in South Asia, both rural and urban, as they do in other developing regional economies. Many of these programmes are exclusively for women, and include a strong component of building up self-reliant women’s organizations through which women can develop leadership skills and lobby to remove some of the policy biases, market distortions, and legal and regulatory constraints in the working environment facing them. Interestingly, because women have built up their creditworthiness as reliable borrowers over a number of years, they are now accessing much larger and longer-term loans for their families. This aspect of empowerment contributes to the role of women in decision making in the family, and to their status outside it. It is true, however, that in some societies many loans made to women are either fully or partially controlled by men, while the responsibility for repayment remains with the women. The cases of the Grameen Bank and BRAC in Bangladesh are excellent examples where participation in micro-finance and the development of micro-enterprises is positively associated with a woman’s level of empowerment, defined as a function of relative physical mobility, economic security, ability to make various purchases on her own, freedom from domination and violence within the family, political and legal awareness, and participation in public protests and political campaigning. A positive effect on contraceptive use was also discernible. Characteristics of women’s enterprises Women’s enterprises tend to be home-based because of their family responsibilities, and in South Asia because of traditions of female seclusion as

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85

well. Another characteristic of women’s enterprises is the high degree of concentration in activities with the lowest capital and skill entry barriers, which makes them overcrowded, with low returns, and subject to short-term volatility (high birth and closure rates). Due to the burden of domestic work, such enterprises tend also to be part-time, to constitute a secondary source of household income (the main source being the husband’s wage labour), to be seasonal and to be one of several multiple activities. Because women’s enterprises are concentrated in sectors with particular ease of entry and low returns, new starts and closures tend to be higher for enterprises run by women, and to be particularly sensitive to changes in the overall level of the economy. However, when personal reasons are taken into account, female enterprise closure rates are no higher (Liedholm and Mead, 1995). In addition, women’s enterprises tend to be more concentrated in livelihood enterprises which is why the two objectives of poverty reduction and women’s empowerment largely overlap, and why it is all the more important that development projects serving those objectives reflect a thorough understanding of livelihood activities. 3.4.3

Employment Generation

Available evidence suggests that most micro-enterprises do not grow in terms of the number of people employed. For example, in a study of microenterprises in a number of African countries by Liedholm and Mead (1995) – a similar survey has not been conducted for Asia – over threequarters of all enterprises that started with less than five workers had not added even one worker since start-up (see Table 3.2). Liedholm and Mead (1995), as mentioned previously, adopted a fourfold classification of micro-enterprises, for policy purposes, based on their past growth performance in terms of numbers of additional workers employed: 1. 2. 3. 4.

new enterprises in the start-up phase (new starts); existing enterprises that had survived the perils of start-up but had not grown (no-growth firms); existing enterprises that had shown small growth (small-growth firms); existing enterprises that had graduated and become ‘small’ enterprises with ten or more workers (graduates).

Their study, based upon data from six core countries (Botswana, Kenya, Malawi, Swaziland, Zimbabwe and the Dominican Republic), found that new starts (firms less than one year old) accounted for 28 per cent of all small and micro-enterprises (SMEs) (Table 3.3). They found that new starts were typically higher than 20 per cent a year, but closure rates were

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General and macro aspects

Table 3.2 Growth characteristics of micro-enterprises (% distribution of all enterprises more than one year old that started with 1–4 workers) No growth Small growth Graduates All micro-enterprises Female-owned enterprises Male-owned enterprises Manufacturing enterprises Trade and commerce enterprises Enterprises in urban areas Enterprises in secondary towns Enterprises in rural areas

77.2 84.7 75.1 88.5 76.2 77.3 73.5 77.5

21.7 15.2 23.3 10.7 23.5 21.8 26.2 21.3

1.1 0.2 1.6 0.8 0.4 0.8 0.5 1.2

Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Note: This table refers to all enterprises that had been in existence for more than one year, and that started with less than five workers. Those with missing data, those whose employment declined or grew by intermediate amounts are excluded from these statistics. These exclusions account for less than 5 per cent of those covered by the surveys that started with less than five workers. Source:

Liedholm and Mead (1995), Table 6.2.

also high. Thus, not surprisingly, they found considerable churning and turbulence in the micro-enterprise population. Net new starts (new starts less closures) contributed over 80 per cent of SME employment in the long run, with the remainder coming from net enterprise expansion (enterprise expansion less contraction). Hence, about 80 per cent of people working in small and micro-enterprises were in jobs that were created when the microenterprise was formed. Non-growing firms constituted the largest share of the universe of firms (43 per cent) (Table 3.3) and three-quarters of all micro-enterprises that had been in existence for more than one year (Table 3.2). The bulk of new starts, and by definition all the no-growth firms, corresponded to the livelihood enterprises category. Non-growing enterprises were very small (averaging only about 1.2 workers, smaller even than the average new start with 1.8 workers), and relied almost exclusively on family labour. A significant proportion of the owners of such enterprises are female (60.4 per cent), as is the proportion of the workforce that is female (55.1 per cent). As indicated in Table 3.2, most female-owned enterprises were no-growth enterprises. Small-growth firms constituted only 12 per cent of all small and microenterprise firms (Table 3.3), and a little over one-fifth of all enterprises over one year old (Table 3.2). They accounted for about half of all new jobs created by the expansion of existing enterprises, excluding new starts

87

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Table 3.3 Characteristics of micro-enterprises: contributions to income and welfare (%) New starts

Nongrowing enterprises

Enterprises experiencing small growth

Enterprises that had graduated

Total of all enterprises

28.1

42.8

12.0

0.6

100.0

26.0

27.7

18.4

5.1

100.0

80.0

0.0

10.0

5.0

100.0

10.6

10.9

11.2

10.7

10.9

23.3

24.2

25.4

24.8

24.3

Contribution to employment: Share of all existing enterprises Share of employment among existing enterprises Source of new employment over the long haul

Part-time or full-time activities: Average number of months worked per year Average number of days worked per month

Contribution of SME to household income (% of respondents in category): 100% of household income 50–99% of household income Less than 50% of household income

30.7

35.6

34.0

21.7

33.7

33.3

35.5

41.9

59.5

35.3

36.0

28.9

24.2

18.7

31.0

38.5 35.9 70.4

8.4 8.9 79.5

54.2 42.2 72.7

Contribution of distributional objectives: % of female owners % of female workers % of employment in rural areas

26.9 47.0 71.6

60.4 55.1 74.1

Note: All data are from six core countries (Botswana, Kenya, Malawi, Swaziland, Zimbabwe and the Dominican Republic). Source: Liedholm and Mead (1995), Table 6.1.

88

General and macro aspects

(Table 3.3). The proportion of small-growth firms owned by women as a proportion of the total number of female-owned enterprises was much lower than for men (Table 3.2). While the majority of these firms relied exclusively on family labour, nearly 40 per cent had one paid employee. The share of women as owners of small-growth firms was only 38.5 per cent, and females only contributed 35.9 per cent of the total employment in such enterprises. Less than 1 per cent of all small and micro-enterprises were graduates (Table 3.3), but they accounted for about one-quarter of all new jobs created by the expansion of existing enterprises, excluding new starts (Table 3.3). Jobs arising from the expansion of both small-growth firms and graduates were more likely to reflect profitable business opportunities based on the experience of the entrepreneurs. Their share of employment among existing small and micro-enterprises was only 5 per cent. A very small percentage of them were female owned, a similarly smaller proportion of the workforce being female. The findings from Liedholm and Mead’s study are consistent with the observation that the means through which poverty-reducing microenterprise programmes make an impact is by increasing income rather than generating new jobs. However, given the fact that there is a minority, but still a considerable number in absolute terms, of enterprises that do grow, there is also scope for micro-enterprise programmes that focus more narrowly on growth-oriented micro-enterprises. Such enterprises tend to have a more complex set of requirements for growth other than simply credit, and the need to meet those multiple requirements simultaneously makes it all the more important to provide them with cost-effective delivery of non-financial as well as financial services. 3.4.4

Private Sector Enterprise Development

Liedholm and Mead note that while only 1 per cent of micro-enterprises succeed in graduating to a size of ten or more workers, graduates contributed about one-quarter of all new jobs created from the expansion of existing enterprises in the countries studied because each enterprise added substantial numbers to its work force. Moreover, although only a miniscule proportion of micro-enterprises graduated, the share of existing enterprises with ten or more employees that started as micro-enterprises was much larger, about half. Proponents of private sector development see micro-enterprises as a fertile source of entrepreneurs for the future, a sort of seedbed for the universe of enterprises. In countries where the number of medium and large-scale enterprises is sparse, especially in the private sector, the importance of micro-enterprises as an incubator of new enterprises becomes even more important.

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The contribution of micro-enterprises

3.5

PROMOTING LIVELIHOOD AND GROWTH-ORIENTED MICRO-ENTERPRISES: ALTERNATIVE APPROACHES

The promotion of livelihood and growth-oriented micro-enterprises suggest two quite different sets of development objectives, which themselves correspond to two major types of promotional programmes (see Figure 3.1). As will be suggested in this section, there is a trade-off in micro-enterprise development programmes between making a short-term impact on poverty, mostly through livelihood enterprises and self-employment on the one hand, and longer-term growth-oriented enterprise development and expanded employment on the other, but for a much smaller number of direct beneficiaries. Programmes aimed at livelihood activities have poverty reduction as their main objective, and the vast majority of micro-enterprises are livelihood enterprises (about 71 per cent for the countries analysed in the Liedholm and Mead (1995) study; see Table 3.2). The main benefit of such programmes for existing livelihood enterprises is likely to be higher turnover and an upgrading of productivity, resulting in increased income earned, but not new employment although underemployment of the main operator and the family will decrease. In addition, livelihood programmes can reach previously unemployed persons by helping set up some new livelihood enterprises that will result in both income and employment benefits. Such programmes entail bringing about small improvements for Micro-enterprise classiWcation

Livelihood activities

Growth-oriented activities

Programme objectives

Poverty reduction, women’s empowerment

Employment generation, enterprise development

Programme assistance

Livelihood programmes

Micro-enterprise programmes

Entailing

Enterprise ‘expansion’ but usually only one step up

Enterprise ‘transformation’ (‘escalator’)

Figure 3.1

Two types of micro-enterprise programmes

90

General and macro aspects

many enterprises, often providing only credit, which is why they are sometimes characterized as being ‘minimalist’. Credit alone, unaccompanied by other inputs, tends to be more relevant for the ‘middle’ poor operating livelihood enterprises, especially non-manufacturing livelihood enterprises such as those in agro-processing, transportation services, retail and wholesale trade where working capital requirements are high, skills demand is low, and where backward and forward linkages are not problematic. Credit alone, however, is less relevant for the poorest of the poor starting new livelihood enterprises, for whom skills training and social preparation are as important, or for borderline poor for whom training, technology upgrading, marketing assistance and the availability of inputs may be more important than stand-alone credit. Non-credit inputs such as design, product development, market information and marketing assistance are usually much more important for a large number of manufacturing activities such as handicrafts. Appropriate technology development and the provision of common facility centres also often have an important role to play in assisting manufacturing enterprises. After credit, the importance of training is universally acknowledged, but its effectiveness remains little understood. The most common types of training in small and medium-sized micro-enterprise programmes are: (1) management-oriented or business training (in such skills as cost accounting, bookkeeping, business plan preparation and so on); (2) production-oriented technical skills training; and (3) entrepreneurial development training. Two other categories of training sometimes identified are: (4) credit-oriented training; and (5) general community development or pre-entrepreneurship training, which targets potential entrepreneurs rather than borrowers who have already been selected for programmes, and which focuses on more general skills such as literacy or leadership. Business skills training is relevant to a large number of diverse activities so that micro-entrepreneurs from a variety of subsectors can be brought together conveniently to receive the training. Business training is probably more relevant to growth-oriented micro-enterprises than to livelihood enterprises. Some agencies make business training a condition for credit assistance and integrate it also with post start-up consultancy and counselling. Technical skills training is just as important, especially for manufacturing, food processing, handicrafts, livestock and some service sector activities of both the livelihood and growth-oriented microenterprise type, as well as for micro-enterprises generally, the main barriers to which are the lack of skills and at least secondary education. Skills training is at least as important for ensuring the survival, if not growth, of existing enterprises as it is for generating new starts. Entrepreneurship development training (focusing upon the motivational, attitudinal and

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behavioural aspects of entrepreneurship) is particularly evident in certain countries such as India. Growth-oriented micro-enterprise programmes, on the other hand, have enterprise development as their immediate objective, aiming to lift microenterprises to a qualitatively higher level of sustainability by setting them on the path to long-term growth and seeking to provide a comprehensive range of services, including credit, training, technical assistance and the inculcation of business skills. Being more staff intensive and entailing forms of assistance that, with the exception of credit, take a longer time to deliver, growth-oriented micro-enterprise programmes reach a much smaller number of enterprises. Business skills training and entrepreneur development training are particularly important for growth-oriented micro-enterprises. Generally speaking, non-credit inputs and support services are particularly important for growth-oriented micro-enterprises, and activities with relatively numerous backward and forward linkages such as manufacturing. Business development service delivery mechanisms can be identified as being networks (associations of entrepreneurs which provide mutual support); subcontracting and franchising; technology transfer; counselling (or business advice or mentoring on a range of topics, usually delivered through one-on-one interaction; consultancies (often conducted on-site and related to solving a specific problem); business incubators; and referral centres. Creating business linkages with services provided by the private sector is another aspect of this role. Encouraging linkages of small microenterprises with larger firms has been a long-standing objective in microenterprise development, such as through the encouragement of franchising and subcontracting. One possible way being discussed in Indonesia to encourage micro-enterprise development is tax incentives for procurement from micro-enterprises, and tax write-offs for investment in training microenterprise suppliers.

3.6

THE ROLE AND CONTRIBUTION OF MICRO-FINANCE

It has been estimated that there are 500 million economically active poor people in the world operating small and micro-enterprises (Women’s World Banking, 1995). Most of them do not have access to adequate financial services. Micro-finance, operating through MFIs, refers to the provision of financial services to such low-income clients, including the self-employed. Activities usually involve small loans, typically for working capital; informal appraisal of borrowers and investments; collateral substitutes, such as

92

General and macro aspects

group guarantees or compulsory saving; access to repeat and larger loans, based on repayment performance; streamlined loan disbursement and monitoring; and secure savings products. Although some MFIs provide enterprise development services, such as skills training and marketing, and social services, such as literacy training and health care, these are not generally included in the definition of micro-finance. 3.6.1

Background

Micro-finance arose in the 1980s as a response to concerns about the effectiveness of state-delivered subsidized credit to poor farmers. In the 1970s government agencies were the predominant method of providing productive credit to those with no previous access to credit facilities. Governments and international donors assumed that the poor required cheap credit, and saw this as a way of promoting agricultural production by small landholders. In addition to providing subsidized agricultural credit, donors set up credit unions that focused upon savings mobilization in rural areas in an attempt to ‘teach poor farmers how to save’. This subsidized, targeted credit model supported by many donors was the object of steady criticism in the 1990s, because most programmes accumulated large loan losses and required frequent recapitalization to continue operating. This led to a new approach, emphasizing marketbased solutions that considered micro-finance as an integral part of the overall financial system. Emphasis shifted from the rapid disbursement of subsidized loans to target populations, toward the building of local sustainable institutions to serve the poor. Today the focus is on providing financial services only, whereas the 1970s and much of the 1980s were characterized by integrated packages of credit and training – which required subsidies. In Asia, initiatives by non-governmental organizations, such as that by Dr Mohammed Yunus of Bangladesh, established pilot group lending schemes for landless people, emphasizing long-term sustainability. The Yanus scheme later became the Grameen Bank, serving more than 2.4 million clients (94 per cent of them women) and has become, as mentioned previously, a model for other countries. Changes have also been occurring in the formal financial sector. For example, Bank Rakyat Indonesia, a state-owned rural bank, moved away from providing subsidized credit and took an institutional approach that operated on market principles. In particular, the bank developed a transparent set of incentives for its borrowers (small farmers) and staff, rewarding on-time loan repayment and relying on voluntary savings mobilization as a source of funds.

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3.6.2

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The Goal of Micro-finance and MFIs

In a World Bank study of lending for small and micro-enterprise projects, three objectives of micro-finance were most frequently cited (see Webster et al., 1996): the creation of employment and income opportunities through the creation and expansion of micro-enterprises; increased productivity and incomes of vulnerable groups, especially women and the poor; and reduced rural families’ dependence on drought-prone crops through diversification of their income-generating activities. Micro-finance, in collaboration with micro-enterprise development programmes, is therefore perceived as being a critical element of an effective poverty-reduction strategy. Improved access and efficient provision of savings, credit and insurance facilities, in particular, can enable the poor to smooth their consumption, manage their risks better, build their assets gradually, develop their micro-enterprises, enhance their income capacity and enjoy an improved quality of life. Micro-finance services can also contribute to the improvement of resource allocation, the promotion of markets, and adoption of better technology; thus promoting economic growth and development. Micro-finance can also contribute to the development of the overall financial system through integration of financial markets. Most formal financial institutions do not serve the poor because of perceived high risks, high costs involved in small transactions, perceived low relative profitability, and inability of the poor to provide the physical collateral usually required by such institutions. The business culture in many regional economies is also not geared to serve poor and low-income households. MFIs, as development organizations, aim therefore to service the financial needs of unserved or underserved markets as a means of meeting development objectives. Micro-credit can have a significant impact upon the standard of living of families and social development. Studies have shown that micro-finance services have a positive impact on specific socio-economic variables such as children’s schooling, household nutrition status and women’s empowerment. MFIs have also brought the poor, particularly poor women, into the formal financial system and enabled them to access credit and accumulate small savings and financial assets, reducing household poverty. However, researchers and practitioners generally agree that the poorest of the poor are yet to benefit from micro-finance programmes in most countries, partly because most MFIs do not offer products and services that are attractive to this category. Specific programmes are required to meet their particular needs.

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3.6.3

General and macro aspects

Remaining Challenges

While the achievement of micro-finance in the Asian region, and in particular South Asia, has been impressive relative to that in the 1970s, a number of problems remain. First, despite a general improvement in the policy environment for financial sector programmes, the policy environment for micro-finance in many countries remains unfavourable for the sustainable growth in micro-finance operations. For example, in countries such as China, Thailand and Vietnam the ceilings on interest rates limit the ability of MFIs to provide permanent access to an increasing segment of excluded households. Furthermore, developing country governments extensively intervene in micro-finance to address perceived market failure through channelling micro-credit to target groups that are considered to have been underserved, or not served, by existing financial institutions. With subsidized interest rates and poor loan collection rates, these interventions undermine sustainable development of micro-finance. As a result most developing countries are crowded with poorly performing government micro-finance programmes that distort the market and discourage private sector institutions from entering the industry. Second, inadequate financial infrastructure is another major problem in the region. Financial infrastructure includes legal, information, and regulatory and supervisory systems for financial institutions and markets. Most developing country governments have focused on creating institutions or special programmes to disburse funds to the poor with little attention to building financial infrastructure that supports, strengthens and ensures the sustainability of such institutions or programmes and promotes participation of private sector institutions in micro-finance. Other major financial infrastructure-related problems include a lack of (1) a legal framework conducive for the emergence and sustainable growth of small-scale financial institutions; (2) regulatory and supervisory systems for micro-finance in countries where the micro-finance subsector is approaching a level of maturity; and (3) emphasis on development of accounting and auditing practices and professions. These are important for the development and expansion of market-based micro-finance services since, in order to serve clients who are outside the frontier of formal and semi-formal finance, MFIs must have access to funding far beyond what external agencies and governments can provide. MFIs and micro-credit portfolios cannot be safely funded with commercial sources in the long term, especially public deposits, unless appropriate performance standards and regulation and supervision regimes are developed and enforced and measures are introduced to protect public deposits. In most developing countries, formal and semi-formal micro-finance service providers are not supervised and

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regulated. While this may not be necessary for all types of MFIs, the lack of a system for supervision and regulation, as well as a lack of adequate measures to protect public deposits, can impede the development, and integration, of formal micro-finance within the broader financial system. Third, most retail-level institutions do not have adequate capacity to expand the scope and outreach of services on a sustainable basis to most of their potential clients. Many institutions (1) lack capacity to leverage funds, including public deposits, in commercial markets; (2) are unable to provide a range of products and services compatible with the potential client’s characteristics; (3) do not have adequate network and delivery mechanisms to cost-effectively reach the poorest of the poor, particularly those concentrated in resource-poor areas and areas with low population densities; (4) do not show a vision and a commitment to ensure their financial soundness and sustainability within a reasonable period, and become subsidy-independent; and (5) do not have the capacity to manage growth prudently. Most of the state-sector institutions or programmes that provide microfinance services have been created within, and nurtured by, a distorted policy environment characterized by various degrees of financial repression. They do not have a business culture. Even new institutions created by governments in most developing countries are unable to provide goodquality services, let alone expand their services on a sustainable basis. Most non-government organizations (NGOs) are also characterized by a high level of operational inefficiency, and have a very limited capacity to serve an increasing segment of the market on a continuing and sustainable basis. They suffer from governance problems mainly because they lack ‘owners’ in the traditional sense of the term, and their management assumes a great deal of power. Heavy reliance on the relatively easy access to donor funds has aggravated the governance problems of some NGOs. Inadequate emphasis on financial viability is the most serious problem of MFIs in the region. This prevails among many NGOs, governmentdirected micro-credit programmes, state-owned banks, and cooperatives providing micro-finance services. As a result, only a few MFIs are sustainable. Viability is also important from an equity perspective because only viable institutions can leverage funds in the market to serve a significant number of clients and contribute to broad-based development. Viability is fundamental to reach a larger number of the poor which, in turn, is essential to have a significant impact on poverty reduction. Fourth, agricultural growth, which underpins much of the growth in the rural non-farm subsector, significantly influences rural financial market development. Thus agricultural growth must be accelerated in much of Asia. However, many developing economies are not making adequate

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investment for agricultural growth and rural development. This is a major constraint on the development of sustainable micro-finance services. The insufficient investments in physical infrastructure (especially irrigation, roads, electricity and support services for marketing, business development and extension) continue to increase the risk and cost of micro-finance, and particularly discourage private investment in the provision of microfinance services on a significant scale. Also, in the absence of economic opportunities created by growth-inducing processes, micro-finance cannot be expected to play a significant role in poverty reduction. Fifth, the low level of social development, a distinctive characteristic of the poor in the region, is a major constraint on the expansion of microfinance services on a sustainable basis. This is particularly true with respect to the poorest of the poor, women in poor households, the poor in resourcepoor and remote areas, and ethnic minorities. A vast amount of financial and human resources is required to address this issue. Private sector MFIs are not likely to invest in social intermediation given the externalities associated with such investments. The development of sustainable micro-finance to reach a large segment of the potential market requires supporting social intermediation on a large scale. Finally, the financial crisis of 1997–98 had a number of adverse effects on micro-financing in crisis-affected countries. First, the credit crunch experienced by commercial banks affected MFIs that were formally integrated into the financial system more than those institutions that relied more heavily on donor support. Second, MFIs with a larger share of clients who are small business owners experienced more severe impacts than MFIs that targeted the poor. Third, increased inflation and higher interest rates (from both banks and traditional moneylenders) drove many poor and middle-class people to seek MFI loans to support consumption, school fees and other necessities. Fourth, currency devaluations and price hikes rapidly drove up the average loan size sought by borrowers. While the impact on MFIs varied widely across the region, the financial crisis greatly affected micro-finance institutions, and hence the informal sector and SMEs that rely on such institutions.

3.7

SUMMARY AND CONCLUSIONS

This chapter has analysed the various types of micro-enterprises that are in existence in East Asia. It is important to differentiate between these various types in the formulation of policy. In very broad terms two major types of micro-enterprise can be identified. First, there are those that can be described as livelihood enterprises, which represent an important source of

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income for poor families and entrepreneurs. Such enterprises do not generate much employment and are unlikely to grow. However, their development and growth as a whole can generate more employment as well as alleviate poverty. For many of the economies of East Asia, adversely affected by the regional crisis, focus upon these can assist in the alleviation of poverty. The other major type of micro-enterprise is that of the growthoriented micro-enterprise. These have the potential to grow into small and medium-sized enterprises, and to be sustainable in terms of income and employment generation. They represent a much smaller proportion of micro-enterprises, and consequently their development will affect a much smaller number of the population, but they do represent a better prospect for the longer-term development of the regional economies. It is important that these two types of enterprises are recognized and their own particular requirements identified. For livelihood enterprises, access to finance can be crucial to their development, and in this regard micro-finance institutions can play an important role. In the case of growth-oriented enterprises, access to finance can also be important, as well as the need to gain access to skills upgrading and technology.

NOTES 1. For the purposes of this chapter East Asia is defined to include East and South-East Asian nations (Cambodia, China, Hong Kong, Indonesia, Korea, Laos, Malaysia, Mongolia, Myanmar, the Philippines, Singapore, Taiwan, Thailand and Vietnam) as distinct from those nations in South Asia (Afghanistan, Bangladesh, Bhutan, India, the Maldives, Nepal, Pakistan and Sri Lanka). 2. As measured by the region’s head count index – the proportion (%) of the population with a standard of living below the poverty line – on the basis of US$1 a day (in 1985 purchasing power parity terms). 3. The Grameen Bank is discussed in more detail in section 3.6. 4. A MFI is an institution that aims to provide, in a sustainable way, financial products and services to the poor.

REFERENCES Asian Development Bank (ADB) (1997), ‘Microenterprise development: not by credit alone’, Asian Development Bank, Manila. Harvie, C. and B.C. Lee (2002), Globalisation and SMEs in East Asia, Cheltenham: Edward Elgar. Ledgerwood, J. (2000), Sustainable Banking with the Poor, Microfinance Handbook: An Institutional and Financial Perspective, Washington, DC: World Bank. Liedholm, C. and D. Mead (1995), ‘The dynamic role of micro and small enterprises in the development process’, GEMINI Action Research Program 1, Final Report, Washington, DC.

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Webster, L., R. Riopelle and A.M. Chidzero (1996), ‘World Bank lending for small enterprises, 1989–1993’, World Bank Technical Paper 311, Washington, DC. Women’s World Banking Global Policy Forum (1995), ‘The missing links: financial systems that work for the majority’, Women’s World Banking, April, New York. World Bank (1997), Everyone’s Miracle? Washington, DC: World Bank. World Bank (1998), East Asia: The Road to Recovery, Washington, DC: World Bank.

4.

The new national accounts and international standards in the assessment of enterprises and sectors of the economy Dudley Jackson

4.1

INTRODUCTION

One of the consequences of globalization is likely to be the development of uniform international standards for the assessment of enterprises and of economic sectors, and one of the consequences of the Asian economic and financial crisis is certain to be the application of this sort of assessment. The assessment of a sector of an economy is an important issue because such an assessment promotes ‘transparency’ in the economy and hence provides early warning signs of economic problems, each of which was sadly lacking in the 1997 ‘Asian’ economic crisis which affected the countries of South Korea, Indonesia, Malaysia and Thailand.1 The development of a uniform and internationally standardized set of assessments, or economic indicators, is being made possible by the adoption, now in progress, of the new United Nations System of National Accounts 1993 (abbreviated as the SNA93) and consequential changes to balance-of-payments statistics and to the reporting of government transactions under the Government Finance Statistics (GFS) framework. The countries of the European Community are implementing the SNA93 under the rubric of the European System of Accounts 1995 (the ESA95), but the ESA95 is merely a strict standard for implementing the SNA93, so the ESA95 is not in any sense a competing system of national accounts.2 This chapter introduces the main features of the SNA93, and then discusses, with illustrative data, various measures of assessment which may be applied to the ‘enterprise sector’ of the economy – technically, comprising the sector of non-financial corporations and the sector of financial corporations. In addition to being used for the assessment of a sector of an economy, such economy-wide assessment ratios are likely also to act as benchmark standards by which to assess any individual enterprise. 99

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The assessment of an enterprise is an important issue for small and medium-sized enterprises, because it is these enterprises which, when success is in hand or in prospect, are likely to approach capital markets (themselves increasingly global) for external finance, in the form of either loan finance or new share issues. On any such approach, the enterprise is likely to have a set of benchmark assessment ratios applied to it. The remainder of this chapter proceeds as follows. Section 4.2 conducts a review of the compilation of the new national accounts. Section 4.3 outlines the various means whereby the non-financial corporation sector can be monitored. Section 4.4 identifies the various means for monitoring the monetary and financial institutions sector. Section 4.5 identifies the various means for monitoring the performance of the general government sector. Finally, section 4.6 presents some concluding remarks.

4.2

THE NEW NATIONAL ACCOUNTS

The SNA93 introduces three main innovations: uniform sectorization of the economy; uniform interlinked and comprehensive accounts for each sector and for the economy as a whole; and uniform and standard definitions of items to be recorded in the accounts. First, the SNA93 introduces a uniform system of ‘sectorization’ of the economy into groupings of transactors (technically referred to as ‘institutional units’) by type of institutional unit. The sectors are (in the SNA93 terminology): 1. 2. 3. 4. 5.

financial corporations non-financial corporations general government households non-profit institutions serving households.

Additionally, the sector entitled ‘the rest of the world’ comprises the accounts for transactions between resident institutional units and nonresident institutional units. The names of the sectors are mainly self-explanatory. Financial corporations are the financial intermediaries mainly engaged in financial intermediation, and including insurance corporations (whose primary function is the pooling of risk), mutual funds and superannuation (pension) funds. The central bank is included in the sector of financial corporations, as are any institutional units concerned with supplying auxiliary financial services. The assessment of financial institutions is a specialized matter but,

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because of the importance of this sector in the Asian financial crisis, one section of this chapter illustrates how the SNA93 may improve the monitoring of monetary financial institutions. Non-financial corporations are those institutional units distinguished by the following three characteristics. Their transactions are distinct from the transactions of their owners; they are market producers (covering more than 50 per cent of their production costs by sales – the ESA95 – or whose ‘market output’ is supplied ‘at prices that are economically significant’ – the SNA93); and their principal activity is the production of goods and nonfinancial services. The general government sector comprises all institutional units which are principally providers of non-market goods and services intended for the benefit of the community (for ‘collective consumption’) or for the benefit of individuals where the service is provided to individuals either free of charge or at a price which is not ‘economically significant’, such as free-of-charge education: Government units may be described as unique kinds of legal entities established by political processes which [entities] have legislative, judicial or executive authority over other institutional units within a given area. Viewed as institutional units, the principal functions of government are to assume responsibility for the provision of goods and services to the community or to individual households and to finance their provision out of taxation or other incomes; to redistribute income and wealth by means of transfers; and to engage in non-market production. (United Nations, 1993, para. 4.104)

Although assessment of the sector of general government is a specialized matter, one section of this chapter considers the new Government Finance Statistics (GFS) framework with a focus upon the financial surplus or deficit of the general government.3 The SNA93 and the associated International Monetary Fund Government Finance Statistics will make the performance of government much more transparent. This is a matter of significance because an increasing general government financial deficit – or ‘budget deficit’ – is likely to mean either or both high interest rates and rapid expansion of the money supply (with attendant inflation). The impact of this upon small and medium-sized enterprises is sufficiently obvious not to require further comment. Although it is the intention of the SNA93 to have separate accounts for the household sector and for non-profit institutions serving households, this particular recommendation of the SNA93 may take some years to implement (because of the difficulties of gathering the requisite data for non-profit institutions), and at present most countries’ national accounts

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publish accounts covering the combined sector of households including non-profit institutions serving households. Second, the SNA93 introduces, for each sector, a set of uniform and interlinked accounts for all transactions. The set of accounts is intended to constitute a complete record for each sector of the following distinct sorts of items: 1. 2. 3. 4.

Transactions flows (for example receipts from sales, issuing of new shares). Balancing item flows (for example gross value added, gross operating surplus, gross saving). Non-transactions (flow) changes in assets and liabilities (for example holding gains, catastrophic losses). The value of stocks of economic assets held (comprising non-financial assets and financial assets) and financial liabilities owed, recorded in opening and closing balance sheets.

The set of accounts relating to the sector of non-financial corporations may be schematically illustrated as in Figure 4.1 (with important balancing items, especially relevant to enterprise performance, given in bold). Output (sales receipts) Intermediate consumption

CURRENT ACCOUNTS Production account

Gross value added Distribution and use of income accounts

Compensation of employees

Gross operating surplus

Transfers in Transfers out Gross capital formation

Gross saving ACCUMULATION ACCOUNTS Capital account Net lending (⫹)/ Net borrowing (⫺) Financial account

Change in financial assets

Change in financial liabilities BALANCE SHEETS

Stocks of real assets

Stocks of financial assets

Stocks of financial liabilities

Figure 4.1 Set of accounts relating to the sector of non-financial corporations

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National accounts preceding the SNA93 were deficient in not showing the production of gross value added (at the ‘beginning’ of the economic process) and in not showing the holdings of economic assets and financial liabilities (at the ‘end’ of the economic process). The main innovation of the SNA93 is the comprehensive set of accounts which shows the sequence of economic activity from the initial stage of production with its balancing item of gross value added through to the accounts which show the balance sheets of real and financial assets and financial liabilities. This comprehensive set of accounts is to be published for each sector of the economy and also for the economy as a whole, comprising all the resident institutional units. As can be seen in the schematic illustration, the accounts form an interlinked sequence of accounts, starting with a production account, where the balancing item is gross value added, continuing through various distribution and use of income accounts, each with its respective balancing item. The current accounts conclude with gross saving which is the balancing item on the use of the disposable income account. The accumulation accounts then show how gross saving is used first to acquire real assets with the final balancing item – net lending (⫹) or net borrowing (⫺) – resulting in the acquisition of financial assets or in the incurring of financial liabilities. Finally, the balance sheets and associated accounts show the assets and liabilities held, and the changes in those assets and liabilities. Third, within each of the accounts in the sequence of accounts, there is a list of specified items to be recorded, and each item should, under full implementation of the SNA93, conform to the same internationally standard definition. Taken together, all the innovations of the SNA93 will facilitate the development of uniform international standards for assessment.

4.3

MONITORING THE SECTOR OF NON-FINANCIAL CORPORATIONS

Assessment usually requires the use of a ratio in which some variable, which I shall call the ‘assessment variable’, usually occurs in the numerator of the ratio and in which a related variable, which I shall call the ‘related variable’, usually occurs in the denominator of the ratio. Table 4.1 gives a set of assessment ratios for the sector of non-financial corporations which can be derived from the SNA93, together with illustrative data for the UK and/or Australia. (The implementation of the SNA93 is not yet complete in either country, so the absence of data in

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some cases should merely be taken as indicating that the variable in question is not yet published in the country’s national accounts but is likely to be so within the next few years.) The choice of the UK and Australia for illustrations is dictated by the fact that these are among the first countries to have published national accounts on the SNA93 basis.4 With regard to annual flows, the UK data is given for the 1998 calendar year, but some of the variables are available only for calendar 1997, so for the UK I give either only 1997 data or, where possible, I give 1997 and 1998 data. The Australian data is given for the financial year 1 July 1998 to 30 June 1999. With regard to stocks, the data is for the end of the year: either end-1997 or end-1998 for the UK, or 30 June 1999 for Australia. All data is at current prices (that is, unadjusted for inflation). Conversely this chapter is not concerned with assessments based on volume (that is, price adjusted) measures. Specifically this chapter does not cover assessments using a growth rate, although this is a very common form of ratio assessment. Table 4.1 gives the assessment variable and the related variable in its SNA93 terminology (as nearly as possible). The name of the assessment ratio, given in quotation marks and in bold, is as nearly as possible the Table 4.1 Assessment ratios from the SNA93 for the sector of non-financial corporations £ denotes GBP for 1998 or end-1998 unless otherwise indicated $ denotes AUD for 1998–99 or 30 June 1999 All flows are annual flows; all stocks are end-year stocks Assessment variable

Related variable

Assessment ratio

(1) Net operating surplus

Net capital stock (non-financial assets)

‘Accounting rate of profit’, or ‘return on capital employed’, or ‘return on investment’

$836 200 m

0.076 p.a. ⫽ 7.6% p.a.

Output

‘Rate of return on sales’, or ‘Profit on turnover’,

£1 061 777 m (1997)

0.114 ⫽ 11.4%

Gross value added

‘Gross profit share’

£495 949 m (1997)

0.351 ⫽ 35.1%

$63 772 m (2) Net operating surplus £120 640 m (1997) (3) Gross operating surplus £173 983 m (1997)

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Table 4.1 (continued) Assessment variable

Related variable

Assessment ratio

(4) Distributed earnings (dividends)

Total valuation of shares

‘Dividend yield’

£1 266 800 m (1997) £1 440 900 m $684 600 m

0.065 p.a. ⫽ 6.5% p.a. 0.055 p.a. ⫽ 5.5% p.a. 0.035 p.a. ⫽ 3.5% p.a.

Net operating surplus plus property income received1 minus taxes on income

‘Dividend payout ratio’

£144 664 m (1997) £148 271 m $59 614 m

0.568 ⫽ 56.8% 0.533 ⫽ 53.3% 0.404 ⫽ 40.4%

Gross capital formation2

‘Self-financing ratio’

£82 843 m (1997) £83 288 m $48 402 m

£89 945 m (1997)3 £98 030 m3 73 698 m

0.921 ⫽ 92.1% 0.850 ⫽ 85.0% 0.657 ⫽ 65.7%

(7) Current assets minus inventories; that is, current financial assets4

Current liabilities5

‘Acid test ratio’, or ‘liquidity ratio’, or ‘quick ratio’

£404 400 m (end-1997) £422 100 m

0.741 ⫽ 74.1% 0.724 ⫽ 72.4%

Total assets

‘Debt ratio’

$1 129 000 m

0.386 ⫽ 38.6%

Shares and other equity

‘Debt–equity ratio’, or ‘gearing’ or ‘financial leverage’

$684 600 m

0.636 ⫽ 63.6%

£82 215 m (1997) £79 035 m $24 063 m (5) Distributed earnings (dividends)

£82 215 m (1997) £79 035 m $24 063 m (6) Gross saving (or gross retentions flow)

£299 800 m (end-1997) £305 400 m (8) Debt: comprising liabilities of securities other than shares, loans and placements, and accounts payable $435 300 m (9) Debt: comprising liabilities of securities other than shares, loans and placements, and accounts payable $435 300 m

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Table 4.1 (continued) Assessment variable

Related variable

Assessment ratio

(10) Shares and other equity

Total assets

‘Equity ratio’

$1 129 000 m

0.606 ⫽ 60.6%

Market output, sales per annum

‘Average collection period’ (in days)

£1 057 666 (1997)

31.4 days

Interest paid

‘Interest cover’

£27 983 m (1997) £33 853 m $23 069 m

6.2 5.1 3.4

Earnings before interest and tax

‘Price–earnings ratio’

£172 695 m (1997) £174 268 m $78 203 m

7.3 8.3 8.7

$684 600 m (11) Accounts receivable multiplied by 365 £91 000 m (1997) ⫻ 365 (12) Earnings before interest and tax (net operating surplus plus property income received) £172 695 m (1997) £174 268 m $78 203 m (13) Total valuation of shares £1 266 800 m (1997) £1 440 900 m $684 600 m

Notes: 1. Including reinvested earnings on direct foreign investment of £11 366 m (1997), £11 729 m and $2 841 m (respectively); there might be an argument for excluding these amounts from the denominator of the ratio. 2. Does not include acquisitions less disposals of non-produced non-financial assets. 3. Includes acquisitions less disposals of valuables (a relatively minor item of ⫺£55 m (1997) and £40 m respectively); this category is not recorded in the Australian System of National Accounts. 4. Comprising currency and deposits, short-term money market instruments, and other accounts receivable. 5. Comprising short-term money market instruments and short-term loans. Sources: Office for National Statistics, United Kingdom National Accounts: The Blue Book 1999 edition (abbreviated BB) and Australian Bureau of Statistics, Australian System of National Accounts 1998–99, Catalogue No. 5204.0 (abbreviated ASNA), as follows: (1) BB, Tables 3.1.1, 3.1.2, p. 115; (2) BB, Table 3.1.2, p. 115; (3) ASNA, Tables 2.1, 2.4, pp. 31, 34; (4) BB, Tables 3.1.3, 3.1.9, pp. 116, 121, ASNA, Tables 2.1, 2.4, pp. 31, 34; (5) BB, Tables 3.1.4, 3.1.7, pp. 116, 117, ASNA, Tables 2.1, 2.2, pp. 31, 32; (7) BB, Table 3.1.9, pp. 120–21; (8) ASNA, Table 2.4, p. 34; (9) ASNA, Table 2.4, p. 34; (10) ASNA, Table 2.4, p. 34; (11) BB, Tables 3.1.1, 3.1.9, pp. 115, 120; (12) BB, Table 3.1.2, 3.1.3, pp. 115, 116, ASNA, Table 2.1, p. 31; (13) BB, Tables 3.1.2, 3.1.3, 3.1.9, pp. 115–16, 121, ASNA, Tables 2.1, 2.4, pp. 31, 34.

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common name used in financial or management accounting (but there is no standardization in these names).5 Each assessment ratio will now be briefly discussed in turn. Accounting Rate of Profit The accounting rate of profit is the common measure of performance appraisal for enterprises. Although data on gross and net operating surplus has long been published in national accounts, there has so far been little or no data available on the denominator of the ratio, namely the balance sheet valuation of the stock of real assets used. The requirement under the SNA93 to publish sectoral balance sheets means that this balance sheet data will become available and any small or medium-sized enterprise is likely to be assessed against such an economy-wide yardstick. It may also be desirable to take an average of the accounting rate of profit over a number of years rather than to use data for one year only.6 Rate of Return on Sales This is a measure of relative profitability often used in retail and wholesale trade. It basically relates to the net margins set in relation to price over the unit cost of goods bought in for resale, but allowing also for labour cost and depreciation cost. Gross Profit Share The share of gross operating surplus in gross value added differs among enterprises because it is partly determined by the labour intensity of the production process. Enterprises which use a large amount of fixed capital relative to labour (capital-intensive enterprises) tend to have a greater gross profit share and vice versa. Dividend Yield The dividend yield is the return to an investor in shares under the assumption that the investor had purchased the shares at the current market valuation and is benefiting from the net operating surplus. This is a measure that is gross of the shareholder’s income tax. For any prospective issuer of new shares the likely dividend yield will be of interest to subscribers and will be assessed against the prevailing rates of dividend yield.

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Dividend Payout Ratio The payout ratio is a measure of the relative extent to which the enterprise’s total after-tax income is distributed in dividends. Some countries have dividend payout ratios averaging about one-half (as for the UK), but enterprises in other countries have a tradition of trying to retain more of their after-tax income, and so have lower dividend payout ratios (as appears to be the case in Australia). Self-financing Ratio The self-financing ratio is a measure of the extent to which an enterprise finances its capital expenditure out of its own retained gross earnings. The use of depreciation provisions to finance at least part of capital expenditure means that the self-financing ratio has a ‘base line’ of the relative extent of depreciation; but over and above that net income is retained and is also used to help finance capital expenditure. Nevertheless an enterprise is not usually constrained in its capital expenditure to the extent of its own gross retentions, and this means that self-financing ratios tend to be less than one. Acid Test Ratio The acid test ratio is a measure of the ability of an enterprise to meet its short-term liabilities as and when these fall due for payment. A low acid test ratio may indicate ‘liquidity’ problems, and any manager selling on credit is well advised to ascertain the customer’s acid test ratio for obvious reasons. Debt Ratio The debt ratio is a measure of the relative extent to which repayable debt is being used, as opposed to non-repayable permanent finance of equity (whether by way of shares issued or retentions). The lower the debt ratio, the ‘safer’ is the enterprise. Debt–Equity Ratio This is another variant of a debt ratio; enterprises can improve the earnings for their shareholders providing the finance invested from debt earns a net operating surplus greater than the rate of interest on the debt. Hence some ‘gearing’ is financed, but an excess of ‘gearing’ leads to the threat of insolvency.

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Equity Ratio This is the ratio which shows shareholders’ funds in relation to total assets and shows how the enterprise is financed. Conversely this ratio is concerned with the analysis of the extent to which the acquisition of assets has been financed by debt. Average Collection Period (in Days) Generally a normal period is granted before the payment of invoices – usually, as in the UK data, about one month. An increasing average collection period may indicate ‘liquidity problems’, either for an enterprise or for a sector. Interest Cover This ratio measures the number of times annual interest payments are ‘covered’ by the annual net earnings of the enterprise; it is thus a measure of ‘safety’ in regard to the enterprise’s ability to meet the interest commitments on its borrowings. It would also be possible to take this measure net of income tax. Price–Earnings Ratio The price–earnings ratio is normally calculated by dividing the price per share by the earnings per share. However if both the numerator and denominator are multiplied by the number of shares the ratio is unaltered and the measure here presented – the total valuation of shares divided by total earnings ascribed to shares (before interest and tax) – is obtained. This ratio is much used by market analysts in assessing share values, often to determine a ‘best buy’ among shares. The values emerging from the national accounts data are, in effect, a weighted average of all the enterprises’ price–earnings ratios.

4.4

MONITORING THE SECTOR OF MONETARY FINANCIAL INSTITUTIONS

The financial sector played a crucial role in the 1997–98 Asian financial crisis.7 It is therefore crucial that analysts be better able to monitor and assess the performance of this sector and of any individual financial

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institution. The SNA93 subdivides the sector of financial corporations into the following five subsectors: 1. 2. 3. 4. 5.

central bank other depository corporations other financial intermediaries, except insurance corporations and pension funds financial auxiliaries insurance corporations and pension funds.

The requirement in the SNA93 for balance sheets to be published means that through the national accounts better information will become available on this sector, which is particularly concerned with the holding of assets and liabilities. This is a sector where the sufficiency of assets held against liabilities accepted is an important performance indicator. Any such performance ratio is generally known as a liquidity ratio. For an example of a liquidity ratio, consider the balance sheet shown in the United Kingdom national accounts for the subsector called ‘monetary financial institutions’, a grouping together consisting of the central bank and other depository institutions. Table 4.2 gives the some data on stocks of assets and liabilities. Table 4.2 SNA93 balance sheet for the sector of monetary financial institutions in the UK1 Financial balance sheet

Currency Deposits Short-term money market instruments Medium- and long-term bonds Short-term loans Long-term loans Shares and other equity Other accounts receivable/payable Total financial assets/liabilities2

£ billion, end 1998 Assets

Liabilities

7.1 974.6 130.0 318.8 766.7 429.4 60.5 6.0

29.9 2171.1 204.4 111.5 – 8.1 131.7 4.3

2693.2

2661.1

Notes: 1. Comprising the central bank and other monetary financial institutions. 2. Reported totals may differ from sum of components due to rounding discrepancies. Source: Office for National Statistics, United Kingdom National Accounts: The Blue Book 1999 edition, Table 4.2.9, pp. 154–5.

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The table clearly shows the deposit liabilities of the monetary financial institutions, against which the monetary financial institutions hold liquid assets in the form of currency, deposits and short-term money market instruments (such as three-month government bills). (In Table 4.2 the currency liabilities are the liabilities of the central bank.) A liquidity ratio for this sector at end-1998 can be calculated as the total of these liquid assets against all liabilities: Liquidity ratio: monetary ⫽ financial institutions

Liquid assets of currency, deposits and short term instruments Total financial liabilities

⫽ £1 111.7 bn/£2 661.1 bn ⫽ 0.418 The lending of this sector tends to be towards the ‘short’ end of the spectrum, because medium- and long-term bonds and short-term loans make up 40 per cent of total financial assets, and long-term loans comprise only 16 per cent of total financial assets. In the future, ‘prudential guidelines’ for internationally acceptable structures of the balance sheets for monetary financial institutions may emerge from further analysis of the descriptive statistics now about to become available through the SNA93.

4.5

MONITORING THE SECTOR OF GENERAL GOVERNMENT

Although the government sector did not play a major role in causing the 1997 Asian economic crisis, it is nevertheless important to monitor the performance of this sector, partly because governments can run substantial financial deficits which may ‘spillover’ into the current account deficit (the sum of the financial balances of the domestic sectors of the economy being equal, but opposite in sign, to the financial balance of the rest of the world).8 Government financial deficits can also have the consequences of rapid increases in the money supply and attendant accelerating inflation. The advent of the SNA93 will, over the coming years, bring considerable changes in the reporting of government finance statistics. In the first instance, the SNA93 recommends the adoption of accrual accounting.9 The fundamental principle of accrual accounting is that

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flows are recorded for the period in which the economic ‘events’ take place whether there is, or is not, a cash flow corresponding to that ‘event’ during the same period. The International Monetary Fund is currently revising its guideline-publication A Manual on Government Finance Statistics so that reporting of government finance statistics (GFS) will be brought internationally into conformity with the SNA3, and specifically will change from the previous cash-based accounting to an accruals-based accounting. In the second instance, but relatedly, a new conceptual framework is being adopted for government finance statistics. Specifically: The central feature of the new conceptual framework [for GFS] is that it is based on an integrated recording of stocks and flows . . . [with flows being] recorded . . . on an accrual basis. (Australian Bureau of Statistics, Information Paper Accruals-based Government Finance Statistics 2000, Catalogue No. 5517.0, March 2000, paras 3.5 and 3.6)

Furthermore, the classification of GFS flows follows the classification of flows used in the SNA93: namely transactions flows, balancing item flows and non-transactions changes in assets and liabilities with non-transaction changes in assets and liabilities being subdivided into revaluations (changes in assets and liabilities due to price changes) and other (non-transactions) changes in assets and liabilities (such as may occur due to catastrophic losses or ‘events’ such as the discovery of sub-soil assets). The new GFS system will be standardized internationally and will be based on the SNA93 and on the (forthcoming revised) IMF A Manual on Government Finance Statistics. In turn, the new GFS system uses the same concepts and definitions as are used in the SNA93 so that data reported under either system can be linked to data reported under the other system. Dealing with transactions flows only, the new GFS scheme for reporting government finance statistics is considerably simplified and is easy to follow: GFS Operating Statement: less equals less equals

GFS Revenues Transactions flows GFS Expenses Transactions flows GFS Net Operating Balance Balancing item flow Net acquisition of non-financial assets Transactions flows GFS Net Lending (⫹)/Borrowing (⫺) Balancing item flow

GFS Revenues comprises all transaction which increase GFS Net Worth during the accounting period and GFS Expenses comprises all transactions

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which decrease GFS Net Worth during the accounting period (GFS Net Worth is explained shortly). The GFS Net Operating Balance is intended to be the summary measure of the long-term sustainability of government operations and is (approximately) equivalent to the national accounting concept of saving plus net capital transfers. In other words, GFS Net Operating Balance measures the general government’s ability to finance capital formation without incurring debt. GFS Net Lending (⫹)/Borrowing (⫺) is a summary ‘bottom-line’ statistic which: indicates the extent to which government is either putting financial resources at the disposal of other sectors in the economy or utilizing the financial resources generated by other sectors. It may therefore be viewed as an indicator of the financial impact of government activity on the rest of the economy. (Australian Bureau of Statistics, Accruals-based Government Finance Statistics 2000, Catalogue No. 5517.0, March 2000, para. 3.21, emphasis added)

In other words, the GSF Net Lending (⫹)/Borrowing (⫺) measures, if positive, the general government’s ability to repay debt or accumulate financial assets, or, if negative, the general government’s need to incur debt. The important point is that under the SNA93 and the new GFS standards, there will be internationally comparable measures of the government’s financial balance. A simplified scheme for GFS stocks is as follows, and this explains the item of GFS Net Worth: GFS Balance Sheet:

less equals

Assets Non-financial assets Financial assets Liabilities GFS Net Worth Balancing item stock

Assets are entities or instruments over which ownership rights are enforced and from which economic benefits may be derived by using or holding them. In conformity with the SNA93 assets are divided between nonfinancial (‘real’) assets and financial assets. Liabilities represent obligations to provide economic value to other institutional units. The classification of liabilities and financial assets is symmetrical. Table 4.3 gives an example of the new Government Finance Statistics framework as these statistics will be published under the rubric of the

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Table 4.3 Government finance statistics, general government (all levels of government), Australia, 1998–99 $ million

% of GDP

GFS Operating Statement GFS Revenue GFS Expenses GFS Net Operating Balance Net acquisition of non-financial assets1 GFS Net Lending (⫹)/Borrowing (⫺)

222 692 215 012 7 680 4 796 2 884

37.5 36.2 1.3 0.8 0.5

GFS Balance Sheet (30 June 1999) Total assets Total liabilities GFS Net Worth

586 350 300 647 281 523

98.8 50.7 47.4

593 311

100.0

Memorandum item Gross domestic product

Note: 1. Calculated as gross fixed capital formation, $14 253 million, less Depreciation, $9927 million, plus Change in inventories, ⫺$108 million, plus Other transactions in non-financial assets, $578 million. Source: Australian Bureau of Statistics, Government Financial Estimates Australia 1999–2000, Catalogue No. 5501.0, April 2000, Tables 1, 3, pp. 6, 8; note that the statistics reported in this first issue of 5501.0 are to be ‘regarded as experimental estimates’; GDP from Australian Bureau of Statistics, Australian System of National Accounts 1998–99, November 1999, Catalogue No. 5204.0, Table 1.8, p. 18.

SNA93 and the (revised) GFS. As can be seen in Table 4.3, the new GFS framework is straightforward. The new GFS system will have standard international definitions for the items, and so will facilitate international assessment of the transactions of general government. Various assessment ratios may be compiled for the sector of general government, but Table 4.3 simply presents ratios in the form of a ratio of each assessment variable to gross domestic product. We can see that in 1998–99 all sectors of Australian general government had a positive GFS Net Operating Balance (approximately equivalent to gross saving) of 1.3 per cent of gross domestic product, and a GFS Net Lending (⫹)/Borrowing (⫺) of ⫹0.4 per cent of GDP (indicating a small ‘financial surplus’ – or loosely, a budget surplus). Over the period from 30 June 1998 to 30 June 1999, the outstanding ‘borrowing liabilities’ of general government in Australia decreased by 2.4 per cent.

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115

CONCLUSIONS

This chapter has indicated that very large changes are in progress in relation to published macroeconomic data, and that these changes will lead to (1) internationally standardized economic reporting, and (2) the development of internationally standardized assessment ratios for sectors of the economy with concomitant possibilities for ‘benchmarking’ against which individual enterprises can be assessed.

NOTES 1. ‘It is incredible that, just before the meltdown, all these countries’ economic fundamentals were rated as sound by most observers’ Peter Brain (1999), p. 2. 2. This chapter builds on the author’s book, Jackson (2000), which is an introduction to the system of national accounting promulgated in the United Nations, System of National Accounts 1993, and Eurostat, European System of Accounts ESA 1995. Together with the SNA93 (and hence also the ESA95), balance of payments statistics are internationally harmonized under the International Monetary Fund, Balance of Payments Manual Fifth Edition. The SNA93/ESA95 also uses a system of alpha-numeric identification codes for accounting items and for sectors; it is to be hoped that this coding system will come into standard use, but for the sake of keeping this chapter non-technical these codes are not used here. The implementation of the Government Finance Statistics framework is still in its early stages but the International Monetary Fund will at some point issue its Manual on Government Finance Statistics (this revises the 1986 Manual). 3. For an example of the accounts beginning to be issued on the government sector see: Australian Bureau of Statistics: Government Financial Statistics Australia 1999–2000, Catalogue No. 5501.0, Developments in Government Finance Statistics, Catalogue No.5516.0; and Accruals-based Government Finance Statistics 2000, Catalogue No. 5517.0. 4. The first United Kingdom annual national accounts on the ESA95 basis were published in September 1998; the first Australian annual national accounts on the SNA93 basis were published in April 1999. 5. The following references may be consulted on these ratios: Edna Carew (1998), Gaffikin et al. (1990). 6. There are two other measures of profitability that may be obtained from the national accounts. Taking all data at constant prices, the first measure is the net operating surplus divided by the gross (or undepreciated) value of the stock of fixed capital; I argue in Chapter 2 of my book Jackson (1998) that this is the appropriate rate of profit by which to measure efficiency. The second measure is the gross operating surplus divided by the gross (or undepreciated) value of the stock of fixed capital; I demonstrate in Chapter 3 of Jackson (1998) that, under certain assumptions, this ratio approximates to the internal rate of return (that rate of return which discounts the future cash inflows to equality with the present value of the outlays). 7. For example see the discussion of the situation in Korea by Charles Harvie (2000), pp. 58–94. 8. See: Tran Van Hoa (2000), Table 3.1, and Malcolm Dowling (2000): ‘An interesting sidelight on Southeast Asia is that domestic fiscal performance was not an issue in this crisis. They have all been following prudent policies and had generally been operating with fiscal surpluses and low inflation rates. Rather than the government being the cause of the crisis, instability was generated within the private sector’ (p. 208, emphasis added). 9. For an explanation of accrual accounting, see my book Jackson (2000), pp. 72–3 and 76–8.

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REFERENCES Brain, P. (1999), Beyond Meltdown: The Global Battle for Sustained Growth, London: Scribe Publications. Carew, E. (1998), The Language of Money, Melbourne: Allen & Unwin. Dowling, M. (2000), ‘The Asian currency and economic crisis: macroeconomic performance and policy’, in Tran Van Hoa and Charles Harvie (eds), The Causes and Impact of the Asian Financial Crisis, Basingstoke, UK: Macmillan. Eurostat (1999), European System of Accounts (ESA 1995), Statistical Office of the European Communities, Luxembourg, November. Gaffikin, M., P.H. Walgenbach, N.E. Dittrich and E.I. Hanson (1990), Principles of Accounting, Sydney: Harcourt Brace Jovanovich. Harvie, C. (2000), ‘The Korean financial crisis: is bail-out a solution?’, in Tran Van Hoa and Charles Harvie (eds), The Causes and Impact of the Asian Financial Crisis, Basingstoke, UK: Macmillan, pp. 58–94. Jackson, D. (1998), Profitability, Mechanisation and Economies of Scale, Aldershot: Ashgate. Jackson, D. (2000), The New National Accounts: An Introduction to the System of National Accounts 1993 and the European System of Accounts 1995, Cheltenham: Edward Elgar. Tran Van Hoa (2000), ‘Fundamental causes of the Asian financial crisis: an econometric study’, in Tran Van Hoa and Charles Harvie (eds), The Causes and Impact of the Asian Financial Crisis, Basingstoke, UK: Macmillan. United Nations (1993), System of National Accounts, New York: United Nations.

5.

On the evolution of firm organization, SMEs and economic growth in the USA and Japan Elias Sanidas

5.1

INTRODUCTION

The evolution of the organization of firms throughout history has only recently been extensively analysed. This evolution, especially in countries like the USA and Japan, is important to know and understand for many reasons, and in particular for its contribution to economic growth. This contribution is broadly the main theme of this chapter. However, there are generally two types of firms to explore, the large ones and the not so large. Thus, the total number of firms in a national economy includes the large enterprises (LEs), very often vertically integrated and multi-divisional, the medium-sized and the small firms (the latter two are often named SMEs). Researchers such as Chandler (for example 1977, 1986, 1990) and Schumpeter (for example 1950) have extensively analysed the positive role that LEs have historically played in the economic growth of nations like the USA and Germany, and of industries like oil and chemicals. More recently, considerable interest has been shown in the role that SMEs have been playing in shaping national economies.1 This renewed interest is mainly due to the fact that in many countries, from the 1980s onwards, small firms have been playing an increasingly important role in economic growth.2 In this chapter, an attempt will be made to synthesize the importance of all types of firms, under the umbrella of the total number of firms in an economy, in explaining differences in economic growth amongst the most-developed nations today. SMEs represent a high proportion of the overall number of firms in most countries, about 99 per cent;3 consequently any conclusions drawn on the total number of firms will also be applicable to SMEs. At the same time, reference will be made to competition. One of the characteristics of strongly competitive markets is the large number of producers and their inability to influence prevailing prices. This characteristic 117

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will be utilized in this study to provide evidence for the contention that stronger competition entails stronger economic growth at both the macro and micro levels. Similar findings have recently been reached by various researchers.4 In addition, the comparison of the historical evolutions of the Japanese and the American firm will be used as evidence that countries where stronger competition exists will grow faster than in others where oligopolistic and monopolistic elements are more prevalent. In the process of explaining the differences in economic growth amongst the most-developed nations today, elements of organizational innovations will also be included. These elements are necessary to include in this analysis because economic growth is not just about growth in investment and embodied technological change. This will become more apparent in sections 5.2 and 5.3 below. Economic growth will be further examined in section 5.4 and will be tested econometrically in section 5.5. More precisely, sections 5.2 and 5.3 will deal with a historical examination of firm evolution in Japan and the USA respectively. Without such a trip to the past, it is impossible to properly evaluate the present form, structure, quality and quantity of firms in these two countries. In section 5.4, a comparison between the two evolutions will be examined and conclusions drawn. In section 5.5 an econometric model will give evidence to the previous sections and more relevant conclusions will be evaluated. In section 5.6 the implications for the economies of East Asia will be discussed. Finally, in section 5.7, a summary of some of the major conclusions from this study will be separately developed.

5.2

EVOLUTION OF THE JAPANESE FIRM

5.2.1 Japanese Economies of Scope and Decentralization of Decision-making Several scholars have produced a detailed historical evolution of the Japanese economy as well as of the Japanese firm.5 In this study I will synthesize the relevant parts of Fruin’s (1992) Chandlerian historical analysis of Japan’s spectacular economic development. This author distinguishes three types of enterprises which have made their presence felt, namely the zaibatsu, the independent urban firms, and the independent rural firms. Most of the studies have concentrated on the first type, and admittedly the most prominent in shaping Japanese industries in a decisive way. The privatization process that took place in the second stage of the Meiji Restoration, after 1885, was not smooth, leading to the particular set of traits that the zaibatsu acquired during this period. Indeed these groups

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became, from that starting point, a collection of mostly unrelated commercial, industrial and service enterprises which were family owned and for a while family managed. To use a modern term they became conglomerates, and they had to find a way to create interdependence between themselves. Consequently, from this early period, for this type of enterprise, a situation of joint production and distribution occurred, generating economies of scope. As Fruin (1992) remarked: ‘In Japan, zaibatsu grew for the most part by unrelated diversification, which is to say that economies of scale in production and distribution were not the forces behind the development of national or zaibatsu business groupings’ (p. 90). Unrelated diversification was a salient feature of these groupings before the 1930s. The initial clusters were transportation (mainly in shipping), energy production and finance. Manufacturing was crafted onto these initial activities. The extent to which the interrelated constellation of firms was effectively coordinated, contributed to the lowering of costs. For example, this coordination was obvious where raw materials had to be sourced overseas, paid for and insured, shipped to Japan, stored, shipped again, processed and then distributed, thus making the non-manufacturing segment of the value added chain quite extended. Furthermore, when some economies of scale were also realized, they were in intermediate product markets. Economies of scale did not take place until the boom period of the First World War, and in a more extensive way until the late 1950s. ‘In Japan before World War II (WW2), indeed before the late 1950s, the domestic and proximate East Asian markets for volume goods were not large, and it was extremely risky to compete on the basis of economies of scale in most instances’ (Fruin, 1992, p. 113). Some sustainable scale economies were present before the First World War only in some industries, such as textiles, paper, some metals production, food (sugar, beer, milled grains), beverages, some chemicals, and cement. However, only textiles were exported in bulk, thus realizing more economies of scale. A significant corollary of the importance of economies of scope present in this early Japanese industrial development, is the ‘nearly universal separation of production and distribution’ (Fruin, 1992, p. 109). Thus, countless specialized trading companies existed at the same time as some bigger general trading firms, which were part of the largest zaibatsu. The parallel existence of these two phenomena – first, the divorce between distribution and production, and second, the economies of scope – had another consequence: the non-existence of organizational centralization. Consequently, Japanese firms of this period had a non-complex U-form organizational chart. The Japanese holding companies concentrated managerial resources in factories and at the lower level of the firm, and consequently they did not act as a capital market to allocate funds to subsidiary

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enterprises. Even the most managerially advanced companies, the textile ones, retained a relatively simple form. Although zaibatsu firms played a central role in Japanese economic development, the independent enterprises were more numerous, widespread, and diversified in terms of their activities. ‘They were also more important given their estimated two-thirds to three-quarters contribution to the nation’s domestic manufactured product’ (Fruin, 1992, p. 119). Thus, without the natural resources of many Western nations, Japan was going to further reinforce its existing strategy of creating this unique organizational system. One main message is repeated, when analysing Fruin’s detailed study (1992, for example Chapter 5). That is, Japanese firms did not grow very large compared with Western companies. Instead they specialized their production in mainly one or two products at the most, and they concentrated their organizational activities within the factories, thus avoiding centralization and accentuating inter-firm networks. The productfocused inter-firm networks were transformed into large outsourcing groups of enterprises as indicated by a percentage of manufacturing value added. Consequently, vertical integration was low and a large network of product-based firms was already in place in Japan during the inter-war period. Furthermore, horizontal integration, through mergers and acquisitions, especially in textiles, paper, agricultural chemicals, and machinery, frequently led to concentration of resources at production sites and decentralization. This also meant a gradual multifunctional organization of business, starting with a single function such as sales or purchasing or production and then gradually combining these single functions horizontally. Thus, the tendency to specialize in form and function led to interdependence of firms at the same time. 5.2.2

Focal Factories and Sub-contracting

Decentralization of management decisions amounted to the development of what Fruin calls focal factories, which duplicated locally the growing complexity in managerial functions found at the apex of the corporate hierarchy. Within focal factories, a panoply of corporate functions could be found: quality-assurance offices, marketing and sales staff, research facilities, and even personnel departments. Factory managers, like company presidents, were enveloped by a hive of clerical and technical specialists . . . Focal factories were charged not only with labour management but also with technology transfer, product and process innovation, engineering, manufacturing, cost accounting, new personnel policies, regional distribution, and sales coordination . . . (Fruin, 1992 p. 136)

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Why has this focal factories system evolved so strongly in Japan? Several reasons can be detected from Fruin’s analysis. First, there was, from the end of the nineteenth century, a process of trial-and-error adaptation of Western knowledge and technology, which found a fecund area for development in small decentralized local and autonomous firms. The time and economic uncertainty constraints made this process even more necessary in such firms. Second, the economic downturn, following the First World War and defence cuts, caused widespread lay-offs among military arsenals and civilian shipbuilders. This large pool of skilled and semi-skilled underemployed or unemployed workers became the labour pool of many small subcontractors who became suppliers to large firms between the mid-1920s and the beginning of the 1930s. Third, and as corollary of the second reason, larger firms used the smaller subcontractors, also because of their lower wages. Fourth, factories were not producing for the national market but for regional or international markets. Fifth, cost accounting methods were not well developed. Sixth, the well-established regional traders and middlemen prevented companies from centralizing and coordinating relevant functions. This was especially true in textiles, cement, food and beverages, which considered together accounted for 53 per cent of the 200 largest industrial firms in 1930. Seventh, there was no anti-trust legislation to prohibit interlocking business alliances and hence small local firms could exist independently and yet be at the same time part of a bigger group such as the zaibatsu. Eighth, alliances in manufacturing and distribution by small focal firms minimized risks while taking advantage of the production and distribution resources that other firms commanded: ‘a strategy of maximising inter-firm economies of scope through group-driven cooperative transactions made better sense than the pursuit of internal production and allocative efficiencies through vertical integration and product diversification’ (Fruin, 1992, p. 157). Ninth, the performance of focal factories, being strongly correlated with the existence and intensity of inter-firm networks, suggests that there were substantial savings in transaction costs and diseconomies of managerial control. Tenth, the lower price–cost margins of small firms were also due to them pursuing a strategy of producing in distinct niches and thus offering dynamic complementarity (Audretsch et al., 1999). Besides Fruin, Best (1990) tells us a similar story: When the Japanese firms first penetrate foreign markets they often find that they are competing against firms with an array of product lines. But instead of competing with a similar array, the Japanese competitor focuses on the high volume segment and establishes a production facility that minimises complexity. This strategy is based upon the fact that manufacturing overheads in Western companies are usually between 150 per cent and 250 per cent of direct labour costs . . . (p. 142)

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Hence, by focusing on a small number of product lines, Japanese firms greatly reduced costs and consequently they were able to substantially undercut prices (see also Abegglen and Stalk, 1985). There were some alternatives to this system. For instance, an early integration of mass production and distribution was the strategy of the Matsushita electric company, which was founded in 1918. However this was an exception rather than the rule. An extension of the focal factories is found in subcontracting and outsourcing. Parent or generally larger companies have established with suppliers, or generally smaller firms, two types of subcontracting: an informal one according to which written contracts are non-existent, and a formal one. A set of ‘shared network norms’ was established over time in the former one and a trusting relationship developed. In addition, there was a continuous transfer of organizational and technological innovations from the big kaisha firms to the smaller ones, though the latter did not benefit in every respect from this cooperation (for instance not in terms of wages). Within the subcontracting system, special emphasis was given to the component design, which, depending on the relative independence of the smaller firms, maximized technological innovations. Following Best’s analysis (1990, p. 164), three types of component design relationship between automakers and parts makers can be identified: 1. 2. 3.

‘The automaker provides blueprint specifications to a range of potential part makers, each of whom submits a price bid.’ ‘The automaker supplies blueprint specifications but expects the parts maker to suggest alterations in the development process.’ ‘The automaker does not provide blueprint specifications but only component performance requirements. Here the parts maker is expected to have an independent design capacity and be able to solve problems jointly with the automaker . . .’

The second and third types of supplier relations are much more networked than the first, and are more of a Japanese organizational innovation that has been successful in promoting new technologies combined with high quality. This innovation has gradually penetrated other industries as well. As Whittaker (1994) tells us, in 1987, 55.9 per cent of SMEs did some form of subcontracting, though at a decreasing rate from 1981. After the Second World War, the complicated system of Japanese firm networks between zaibatsus, or between the latter and non-zaibatsus, was replaced only in name by the even more intensified network of keiretsus and non-keiretsus. Overall, and by and large, the system has not changed much: a huge number of establishments, especially small ones, still exist and have

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survived despite the recent prolonged recession, all of them intertwined with each other in a cooperative way. Furthermore, after the Second World War the Japanese large firms, such as Toyota, introduced a few unique organizational innovations. These were the just-in-time (JIT) production and inventory process, the automated and flexible manufacturing system (AFMS), adaptable product development (APD), process efficiency, extended quality control and so on (see for instance, Best, 1990; Abegglen and Stalk, 1985; and McMillan, 1984). All these innovations reinforced the dual cooperative system of keiretsus and big firms cum SMEs. Indeed Western researchers on the Japanese economic miracle from 1950 to 1990 have repeatedly observed that there is cooperation in all levels of Japan’s society, for instance between workers and managers, between government agencies and firms and so on: ‘Japan’s physical and geographical characteristics give social reinforcement to its social history of groupism, interdependence, and sense of ON and GIRI – debt and obligation.’ (McMillan, 1984, p. 23).

5.3

EVOLUTION OF THE AMERICAN FIRM

5.3.1 The Start of Big Business, External and Internal Organization: Towards the Second Industrial Revolution The development of the railway system coincided with the USA’s economic industrial take-off period of the mid-nineteenth century. The most important achievement in the railways development was the appearance, for the first time in economic history, of the modern big business based on salaried managers to run multi-million dollar railway firms across the country (Chandler, 1977). These firms influenced, in the decades up to the end of the nineteenth century, many other enterprises in different industries in terms of their organization and management techniques. Famous entrepreneurs who played a marked role in innovating in their own business, were originally trained in the railway firms. Together with the development of a national network of railways, there was a parallel development in telegraph, steamships and cable systems which all allowed for the first time in history a speedy and voluminous dispatch of various products in all parts of the vast country. This in turn paved the way for huge economies of scale and scope in existing and new industries during the second half of the nineteenth century. Besides the railways expansion, another precondition for the second industrial revolution was the superabundance of land, combined with a

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favourable inclination for entrepreneurship (Americans were always fascinated by the success of their business people), and a shortage of labour (McCraw, 1997; Habakkuk, 1962). Big business through mass production began to gather steam in the 1870s and 1880s. Out of the Fortune 500 largest American firms in the mid-1990s, 53 were founded in the 1880s (for example Kodak, Johnson & Johnson, Coca-Cola, Westinghouse Electric), 39 in the 1890s (for example General Electric, Pepsico, Goodyear), and 52 in the 1900s (for example Ford Motor, Gillette, General Motors) (the source of this count is Harris Corporation, 1996). In the 1880s and early 1890s, many small manufacturers in the sugar, leather, salt, distilling, linseed and cotton oil, biscuit, petroleum, fertilizer and rubber boot and glove industries joined by forming large horizontal combinations. The latter resulted mainly as a response to overproduction by numerous small firms in an expanding national market during the 1860s and 1870s, and hence a threatening situation of prices falling below production costs (Chandler, 1986, p. 10). The producer goods industries developed later. Until the depression of the 1890s, most of the combinations and consolidations had been in the consumer goods industries. The American economy was consolidated and strengthened during the period 1890 to 1910 approximately (the core of the Second Industrial Revolution). This consolidation took place through the process of: ●

●

●

● ●

●

●

Full integration of mass production and mass marketing (Chandler’s thesis) for both the consumer goods and producer goods industries. Multifunctional hierarchical business organization (to some extent similar to that of the railway firms). A marked change in the organization of the shop floor (Lazonick’s thesis, 1990). Appearance of big national and international corporations. Salaried managers took over in running big business from the founding entrepreneurs in an increasing way. Middle management and especially top management for the first time replaced market forces in an oligopolistic environment. The learned skills and knowledge within each oligopolistic market were company-specific and industry-specific.

Combinations and integrations in the consumer goods industries before 1897 had almost entirely been engineered and financed by the entrepreneurs themselves. On the contrary, after 1897, when the biggest merger movement in American economic history took place, outside funds played an increasingly significant role in industrial combination and integration.

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Financiers and promoters began to acquire the same type of control over industrial corporations as they did earlier in the 1850s over railway firms. Like the companies making consumer goods, those making producers’ goods also set up nationwide and worldwide marketing and distributing organizations, consolidated production into a few large plants, and established purchasing departments. Also, except in steel, integration usually followed combination in the producers’ goods industries. Such large enterprises often led to diversification of the types of products these manufacturing companies made and sold. The ‘full line’strategy, pioneered by General Electric and Westinghouse, was soon adopted by many other consolidated concerns. By the turn of the nineteenth century, large industrial firms became vertically integrated: forward into distribution and backward into supplies of inputs; also centralized and functionally departmentalized organizations. They became increasingly bureaucratic internally and oligopolistic externally, despite some tendencies for monopolies. Integration and combination by one manufacturer forced others to follow. Following Chandler’s analysis, still further reorganization of firms took place, this time internal in nature. The coordination and control of the flow of materials at a high volume and speed through many departments in which many workers were employed in each of the production processes created most challenging administrative and managerial problems in the second half of the nineteenth century. These problems became acute only in the late 1870s and 1880s but their solutions started taking place in the 1890s and 1900s. During the years of expansion in the 1870s and 1880s, industrialists relied on skilled foremen to recruit, train and manage the workers. That was the ‘inside contracting’ system of labour organization, through which the owners eventually lost control over costs and the coordination of the flow of goods through the many departments. H.C. Metcalfe, in 1885, prescribed a solution to the ‘inside contracting’ system. His solution was an adaptation of the voucher system of accounts developed in railway repair shops to the needs of interchangeable-parts manufacturing. H.A. Towne, F.A. Halsey and other metalworking manufacturers subsequently developed the ‘gain-sharing’ system. However, a further suggestion came from F.W. Taylor who, in 1895, pronounced his ‘scientific management’, according to which standards of premiums and bonuses paid should be determined ‘scientifically’ and not historically. American manufacturers rarely adopted Taylor’s full system. Instead, they gradually, from the mid-1890s to the end of the 1900s, adopted and refined the line-and-staff organization which originally was invented by railway men in the 1850s.

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There is another way of looking into these organizational innovations, which were directly linked to the relation between workers on the shop floor, and the management of the production processes. Skilled workers who played a central role in shop floor operations were transformed into lower managers; thus a valuable cooperation was gained from these transformed salaried employees. As Lazonick said: ‘making skilled workers members of the firm helped management to divide and conquer the labour force’ (1990, p. 229). All these internal organizational reforms further strengthened the power of the larger firms, which in turn accelerated their growth and at the same time the growth of the USA. As Chandler says: ‘Kuznet’s data support the assertion that the industries spearheading American economic growth were those dominated by a small number of large managerial enterprises’ (Chandler, 1990, p. 226). 5.3.2 Diversification of Production and Reinforcement of Big Business: Reversal of the Trend from the 1980s The interwar period was very turbulent with major recessions and booms, which eventually consolidated the structure of the American economy which was shaped before the First World War. The USA was already dominating the world economy before the outbreak of the Second World War. When the latter ended the American economy was even stronger and totally in control of the non-communist globe. It was not though until the late 1960s and especially the 1970s that the European and Japanese nations started threatening this American supremacy. How did managers of the American firms respond to the then developing fierce competition? Chandler and other researchers have suggested that the American firms decided to expand through the process of diversification, either to a minor extent to related industries or to a major extent, for the first time, to unrelated ones. The diversification into unrelated industries led to the emergence of many conglomerates, an innovation of the 1960s for the Americans (Chandler and Tedlow, 1985, p. 739). This trend was reversed later in the 1980s, when consolidation and specialization took place again (Shleifer and Vishny, 1994). In short, the American managers, via the third most important merger movement in their history, chose in the 1960s an easy way of making some extra profits, or at least conserving the existing ones, but they did not lower unit costs of various products via economies of scale, as they so successfully did during the Second Industrial Revolution. In addition, diversification and multi-divisionalization went hand in hand. The continuous process of vertical and horizontal integration, as well

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as product extension into additional industries during more than 100 years of American economic development, ended up in more and more multidivisionalization, hence the proliferation of the M-form6 of American firms. Finally, the propagation of American transnational firms (TNCs) in the world economy, their spreading-out into many nations and sectors through their tool of the ‘visible hand’ (for example transfer prices) certainly makes it possible to make the contention that the supremacy of the American TNCs further solidified the big-business trend of the American firm evolution. However, a reversal towards smaller firms, and an increase in the total number of business concerns, started in the 1980s or even earlier (see for instance Table 1.3b of the 1997 OECD report; or Harrison, 1994). This reversal can be described as follows. The new information technology introduced in the 1950s expanded in the 1960s, but really took off in the 1970s. It allowed the appearance of flexible and programmable machines, which can be used for not just one task but for a whole set of tasks. These machines can extend Tayloristic organization of labour from mass production to the production of small lots and even single products. Consequently: ‘Corporations would be run as networks of establishments often considerably smaller than the classical Fordist factory. Also, many forms of subcontracting, franchising and the like are used to a considerable extent to create formally independent units well integrated in such networks’ (Ernste and Jaeger, 1989, p. 173). Dicken (1992), and others also confirm this conclusion. For instance Chandler (1990, p. 607) says: ‘In the 1960s and 1970s a wide variety of industries shifted from electromechanical to electronically controlled processes of production that began to transform the work place and alter the materials used in production. They realigned the economies of scale and scope, often reducing minimum efficient scale and at the same time expanding the opportunities for exploiting the economies of scope’. The system of flexible specialization can be defined in broad terms as a vertical disintegration of some core industries or as ‘the establishment of a much more independent network of small plants based on a work organization which as a complement to flexibility and specialization explicitly emphasizes professionalization’ (Ernste and Jaeger, 1989, p. 176). Harrison (1994) has argued for similar points in his attempt to explain ‘the changing landscape of corporate power in the age of flexibility’ in the USA. For instance, he mentions vertical disintegration and strategic downsizing of large conglomerates in order to capture the power of core competencies, as being two main factors for the proliferation of smaller firms.

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Finally, the tendencies for disintegration and more specialization were also strongly related to the gradual adoption from the 1980s of the justin-time cum quality control holistic system in an increasing number of American firms, thus further implementing the outsourcing system (Sanidas, 2001). Accordingly, it seems that such an adoption played an even larger role than other factors just mentioned in the paragraphs above, mainly because the lean system or its equivalent of JIT/QC system is holistic in nature and it involves all aspects of the firm such as all employees and managers, engineering designs, strategies, and so on.

5.4

A COMPARISON BETWEEN THE JAPANESE AND THE AMERICAN EVOLUTION OF FIRMS. COMPARISON WITH OTHER COUNTRIES AND RELATION WITH ECONOMIC GROWTH AND COMPETITION

From the very brief historical trip to Japan and the USA, some conclusions can now be readily made regarding the comparison between the American and Japanese evolutions of firms. In Japan, smaller and more numerous firms has been the trend from the beginning of the country’s industrialization process. This was due to the early development of the focal type of company because of limited resources and technology, hence the search for cooperation and consequently economies of scope to the detriment of economies of scale. In the USA we have seen a contrary evolution take place, in which there was a tendency from the beginning of the country’s industrialization process for the creation of big business, diversification of products, and eventually multidivisional organization. This was due to a natural abundance of resources, human and non-human, plus a series of major and minor technological and organizational breakthroughs. This divergent historical evolution of the firm in the two countries demonstrates that there is not a unique way to evaluate competition and the role of SMEs, but this evaluation depends on the historical context of factors such as availability of resources, technology and organization. In other words, what is good for the USA might not be good for Japan, or what is good for Japan might not be good for Canada, and so on. Also, in Japan, many organizational innovations, such as the just-in-time cum quality control (JIT/QC) process7 and the Japanese style of subcontracting, enhanced and sustained the development of SMEs. On the contrary, in the USA, only very recently, from the late 1980s, has there been a reversal in the continuous expansion of big business to the detriment of

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smaller ones. This is explained by the reorganization of the American firms to take into account not only the immense possibilities offered by the huge development of information technology but, more importantly, the imitation of Japanese organizational practices centred around the JIT/QC holistic system. Otherwise, no other major organizational innovations took place in this country after the Second World War except an intensification of product diversification and multi-divisionalism. In Japan, the conglomerate type of business existed from the start of the country’s industrialization process and has continued its development up to the present. On the contrary, in the USA it only appeared in the mid1960s, but its development was reversed in the 1980s. Again this antithesis between the Japanese and the American firm evolutions can be explained by differences in resource and technological endowments as well as historical circumstances. An important conclusion is that in Japan we have a more competitive economic environment than in the USA. Here, stronger competition means that a buyer has a larger choice of suppliers or sellers in the economy. This can be verified mainly by considering the number of firms operating in each industry and in total. Table 5.1 in Appendix 5.1 shows this for 16 OECD countries. In each of the industries examined the Japanese competition is stronger than in any other country (although the data used are not consistent across countries, the comparison is revealing). On the contrary, the American industries are not as competitive, and they often tend to be more oligopolistic. Porter (1990) has also analysed the degree of competitiveness in several countries, such as in Japan and the USA, when he talked about ‘domestic rivalry’. However, he seems to indicate that oligopolistic competition is desirable, at least as an alternative to monopolies and oligopolies with only a few rivals. My argument is, rather, based on the relative importance of SMEs, which offer a more intensive competition than just a larger number of oligopolistic firms. Further evidence indicating that Japan offers a very strong competitive environment, even in the subcontracting sector, is provided by many other researchers such as Miwa (1994), Ito (1994), Watanabe (1997) and Fujimoto and Takeishi (1997). As a consequence of all the analysis so far, the following theoretical model is proposed in order to explain differences in economic growth between the advanced nations. Figure 5.1 summarizes the main points. Briefly, the schema tells the following story. First, the poorer the country the lower its average income and the more unsatisfied the demand for all goods is, which in turn generates more growth ceteris paribus. This is a necessary but not a sufficient condition for high economic growth. This is another way of expressing the controversial convergence theory of growth

130

General and macro aspects Number of firms Value added

Unsatisfied demand Competition

Scarcity of resources and markets

Economic growth

Economies of scope

Economies of scale Cooperation

Interaction between SMEs and LEs, and amongst SMEs

Organizational and technological innovations

Figure 5.1

Summary schema

(for the latter see for example Barro and Sala-i-Martin, 1995, or Jones, 1998 for a comprehensive review). The application of this condition to the two economies under study clearly shows that Japan’s lateness of economic development, when translated into substantial unsatisfied demand, created a solid basis for higher economic growth than in the USA for most periods of the last century. Second, another necessary but not sufficient condition for high economic growth is a continuous flow of minor and major managerial and technological innovations. This took place in both Japan and the USA, though in different ways, in different periods and in different intensities, as sections 5.2 and 5.3 have identified. Third, another necessary, and perhaps sufficient, condition for high economic growth is competition and rivalry amongst domestic firms in all industries. Such competition, especially if accompanied by some cooperation and networking, enhances not so much economies of scale but economies of scope (not necessarily as joint production under the same roof and firm but as joint production in separate establishments, as explained in section 5.2). In turn, strong competition and economies of scope increase value added, which eventually leads to high economic growth. The chance of a larger number of companies creating a larger value added than a smaller number of enterprises is very high, since the various stages of production are increased with a larger number of firms. In other words, horizontal and, especially, vertical integration reduce the value added for a given product, especially in heavy manufacturing industries such as cars. In addition,

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strong competition and a large number of production establishments are also closely related to the system of subcontracting. How is this third condition translated in the two countries? In the USA the tendency for big business, vertical integration, mass production, formation of oligopolies and a limited number of firms has meant a slower economic growth than in Japan (ceteris paribus) over most of the last century. However, I should add that not all the Japanese industries are exposed to domestic and international competition, contrary to the American entire set of industries which have been exposed to international competition at least for a long time. This dual (two-faced) Japanese competition is perhaps the deep reason for the recent prolonged recession in the Asian country. Fourth, economic growth and industrial organization depend on the scarcity or abundance of resources and markets. Thus Japan, with a relatively limited amount of resources, technology and markets at the beginning of its economic development, adopted a different mode of economic organization than in the USA, with its renowned richness in all these factors. This point of the relative abundance of resources will be taken up again at the end of this section. According to the above conclusions, I will now attempt to separate the OECD (as of the year 1990) plus the East Asian countries (these two different groups constitute perhaps the most advanced economies in the world today) into two camps. In the Japanese camp, I will include all the East Asian countries, plus the poorest of the OECD ones, namely Spain, Portugal, Greece, Turkey, plus Italy with its rich North and poor South. In this camp the general characteristic is a dual system of some big companies with a big army of SMEs, which propel their economies in a dynamic way. Also in this camp there is a relative scarcity of natural resources, late development and a reliance on technological imitation. Finally, perhaps as a consequence of all these traits, these countries were the fastest-growing economies in the world (with minor exceptions) between the 1960s and the present (see the quantitative analysis in the next section). In the American camp, I include Canada, Australia, New Zealand, plus all the Northern European countries including France. In this camp the general characteristics are virtually the contrary of the Japanese camp, that is a proliferation of big business, a long history of independent economic and technological development, and a slower economic growth between the 1960s and the present. As a confirmation of my choices, I will briefly give some elements for two countries in terms of their firm evolution, namely Italy (of the Japanese camp) and Germany (of the American camp). Comparison with other countries will be made in the next section in a quantitative way.

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Chandler (1990) has extensively examined some of the main aspects of German capitalism. ‘The greatest difference, however, came in inter-firm and intrafirm relationships. Whereas in the US the new, large, integrated managerial firms competed aggressively for market share and profits, in Germany many of them preferred to cooperate’ (p. 395). Famous German large enterprises are particularly noticeable in the chemical, electrical and mechanical industries, which directly compete with the American giants. Also, a more recent study by Schwalbach (1990) has concluded: ‘technological factors, like scale economies, limit the prosperity of small business. In addition, industries with a high intensity of investments in advertising and R&D, and large domestic and foreign output volumes are dominated by big business’. The quantitative model in the final section will support these remarks. The Italian case is very similar to the Japanese one in terms of firms’ networks and subcontracting. Best (1990) describes it as follows: ‘An industrial district is like a collective entrepreneur. In Brusco’s terms it combines productive decentralization and social integration . . . We can identify a large number of cooperative institutions within the third Italy that serve as functional equivalents to managerial hierarchy . . . They are establishing an alternative to the Japanese institutional complex as a form of the new Competition’ (p. 207). The Italian decentralized and flexible production system has been extensively analysed by others researchers as well.8 The Italian industrial districts are characterized by flexible specialization (which is very different from the Fordist organization), competition and cooperation (Pyke et al., 1990). It should also be added that in Italy, as in Japan, the coexistence between very large firms and a myriad of smaller companies creates a positive and unique lever for economic growth. In the remainder of this section an explanation of the evolution of the Japanese and American firm is conducted by using the tool of linear programming (LP). The following theoretical example of LP will serve to illustrate some of the main issues discussed previously. Suppose that we have two firms, one in the USA and one in Japan, facing the usual simple LP problem of maximizing profits subject to some constraints. Without disclosing, as yet, which LP problem belongs to which country, the two models are formulated first: LP1:

max Z ⫽ a x ⫹ b y ⫹ c z ⫹ d w Subject to: a11 x ⫹ a12 y ⫹a13 z ⫹a14 w ⬍⫽ M1 a21 x ⫹ a22 y ⫹a23 z ⫹a24 w ⬍⫽ M2 a31 x ⫹ a32 y ⫹a33 z ⫹a34 w ⬍⫽ M3

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a41 x ⫹ a42 y ⫹a43 z ⫹a44 w ⬍⫽ M4 a51 x ⫹ a52 y ⫹a53 z ⫹a54 w ⬍⫽ M5 a61 x ⫹ a62 y ⫹a63 z ⫹a64 w ⬍⫽ M6 LP2:

max Z ⫽ a x ⫹ b y ⫹ c z ⫹ d w Subject to:

a11 x ⫹ a12 y ⫹a13 z ⫹a14 w ⬍⫽ M1 a21 x ⫹ a22 y ⫹a23 z ⫹a24 w ⬍⫽ M2

Z is the objective function to be maximized, x, y, z, and w are the four products to be produced, a, b, c, and d are the profit per unit for each product, aij are the substitution coefficients, and M1 to M6 are the technological, human and organizational constraints, such as machines, tools, skilled labour and so on. Furthermore, the firm in LP1 has the intention to produce four products by using six different types of technological, human and organizational inputs or constraints, as all these inputs are readily available. On the other hand, the firm in LP2 also has the intention to produce the same four products, but its resources are limited to only two types of inputs (namely M1 and M2). According to the rules of the LP formulation the firm in LP1 has two possibilities, either to produce the four products considered x, y, z and w, or to increase its production to six products, say, through vertical integration. On the contrary, the firm in LP2 has only one limited possibility, that is to produce only two products amongst the four (the precise combination will be suggested by the solution of the LP2 problem). By now it has become apparent that the firm in LP1 is an American firm with its larger choice of inputs, whereas the firm in LP2 must be somewhere in Japan. It would be possible to extend this LP formulation in order to include differences in demand and networking. Also the programming does not have to be linear in order to demonstrate the relevant issues, but it makes its explanation easier. As an important confirming conclusion drawn from this LP exercise, the Japanese evolution of the firm has been indeed influenced by limited resources (technological, human and organizational) from the beginning of its industrial development a century ago and consequently, it still depends on a myriad of smaller firms for strong economic growth. On the contrary, the American firm has evolved from the beginning of its industrial take-off as a big business and relies much less on the peripheral smaller firms, because resources have always been relatively abundant in the USA.

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5.5

General and macro aspects

QUANTITATIVE EVIDENCE OF THE RELATIONSHIP BETWEEN THE NUMBER OF FIRMS (AS A PROXY FOR COMPETITION) AND ECONOMIC GROWTH

Based upon the previous three sections the following simple but robust cross-country linear regression model is used in order to give some quantitative evidence to the arguments advanced. The 14 European Union countries (Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Netherlands, Portugal, Spain, Sweden, and UK, thus excluding Luxembourg), Norway, plus Japan, the USA, Australia, Canada and Switzerland are included in the sample of the 20 most-developed nations. Smaller countries like New Zealand, and Iceland were excluded. RG ⫽ CONSTANT ⫹ a * Y60 ⫹ b * (TOEST/POP) *EMP99 ⫹ c * PAT ⫹ d * EXDIV ⫹ e * HUCAP ⫹ f * INCTAX (5.1) ⫹ g * AGRSEC ⫹ error RG stands for average annual growth rate of GDP per worker from 1960 to 1990 as a percentage, and is explained by the following factors (see Appendix 5.2 for actual data). Y60 stands for GDP per worker relative to the USA in 1960 (the original data are divided by 1000), and represents the convergence variable mentioned in the previous section. The lower this variable is, the higher the RG becomes. TOEST indicates the total number of establishments (all sectors) in 1990, and represents the competition influence, as well as the organizational structure of industries (for instance, the small focal firms of Japan and the larger more diversified firms of the USA). TOEST is further emphasized by the contribution of the small business sector as represented by the variable EMP99, which indicates the percentage of employment of up to 99 employees in that sector. TOEST is multiplied by EMP99 so that both of them together further stress the contribution of small business to overall competition. POP stands for the population in 1990 and is used to standardize the TOEST as a per capita variable. The regression variable (TOEST/POP) *EMP99 is divided by 1000. The higher this variable is, the higher the RG becomes. PAT is the average annual number of patents granted to residents per 100 000 inhabitants during 1987 to 1990, and it is a proxy for the technological innovations taking place in each country. Thus, we can see from Appendix 5.2 that Japan is the champion in this respect followed further down the ladder by Germany and the USA. The higher this variable is, the higher the RG becomes. EXPDIV is the percentage of export market value

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dominated by the top three destination countries in 1988, and is a proxy for the close integration of each country within a particular region; for example, Canada is trading heavily with the USA. The higher this variable is the higher the RG becomes. HUCAP represents the human capital factor and is approximated by the multiplicative effect of two variables, the HIGEDUC and the SECEDUC. The HIGEDUC is the percentage of the relevant age group receiving fulltime secondary education in 1988 and the SECEDUC is the fraction of the 20–24 year-old population enrolled in higher education also in 1988. These two variables are put together as HIGEDUC * SECEDUC3 (SECEDUC is raised to the power 3 to emphasize the differences in secondary education, though this does not significantly alter the results). Thus we see that the UK is lagging behind most of the other countries in this respect. The higher this variable is, the higher the RG becomes. INCTAX is the personal income tax (on profits, income and capital gains) as a percentage of GDP in 1989, and is a proxy for government intervention in national economies. Thus, as indicated in Appendix 5.2, Denmark is the champion in this respect followed by Sweden and so on. The higher this variable is the lower the RG becomes. Finally, AGRSEC is the percentage of total employment in the primary sector in 1991. Thus, Greece still employs a quarter of its workforce in agriculture, followed by Portugal, Ireland and Spain. The higher this variable is, the lower the RG becomes. The ordinary least squares (OLS) regression on equation 5.1 above gave the following very encouraging results: RG ⫽ 4.3 ⫺ 42.2 * Y60 ⫹ 0.19 * (TOEST/POP) *EMP99 (0%) (0%) (0.3%) ⫹ 0.012 * PAT ⫹ 0.009 *EXDIV ⫹ 0.01 * HUCAP (2.0%) (13.4%) (4.5%) ⫺ 0.03 * INCTAX ⫺ 0.03 *AGRSEC ⫺(1.6%) (9.1%) R2⫽ 0.973;

(5.2)

SEE ⫽ 0.21.

The figures in brackets under the coefficients denote P-values (a P-value of 5 per cent means that the coefficient is significant at the 95 per cent confidence level). Only the variables EXDIV and AGRSEC are not significantly different from zero at the 5 per cent level (13.4 per cent and 9.1 per cent respectively). Furthermore, all coefficients have the expected (right) signs. There is no apparent concern for multi-collinearity. The interpretation of these results can also be seen if we calculate each variable’s contribution to the RG. Thus, regarding the variable Y60, if

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a country such as Japan started in 1960 with a low GDP per worker of 20 per cent as against 100 per cent for the USA, then the average constant RG of 4.3 (the constant of the regression) is only reduced by 0.84 for Japan and by 4.22 for the USA during the period 1960 to 1990. Regarding the contribution of the variable representing competition, that is (TOEST/POP) *EMP99, a country like Japan with a high value of this variable will benefit by an extra 0.81 of one per cent of growth, as against 0.26 of one per cent for the USA. Regarding the variable PAT (patents), the proxy for technological innovations, the extra growth for Japan is 0.52 as against 0.23 for the USA. The human capital variable HUCAP contributes to the growth of Japan by an extra 0.26 and to that of the USA by an extra 0.56 of one per cent growth. Note that all these contributions to annual growth, not only for Japan and the USA but also for every other country in the sample, are comparative contributions, that is they are due to comparing each nation against the others. However, within each country’s economic growth the constant 4.3 per cent indicates the growth generated by each country’s common technological and organizational advancements, investments and so on (common to all nations). Finally, a brief examination of the residuals (see Appendix 5.2) shows that overall the errors are very small and most probably due to errors in the data. What are the main conclusions of this quantitative analysis? First, in relation to the topic of this study, the econometric model shows that competition and SMEs play a clear and decisive role in economic growth. This model shows that even when we take into account some of the fundamental factors in determining economic growth such as unsatisfied demand, technological innovations and human capital, then competition and the number of SMEs still have an important role to play. At the same time, as the number of SMEs is also a proxy for the organizational structure of firms, the regressions confirm the contention that historical differences in company organization (for example small focal firms in Japan as against larger diversified firms in the USA) make significant differences in contributions to economic growth. Second, the convergence factor or unsatisfied demand seems to play a preponderant role in determining economic growth, thus reaffirming similar conclusions from the relevant literature (see for example Barro and Sala-i-Martin, 1995, or Jones, 1998 for a comprehensive review). Third, if the estimated constant of regression (5.2) is further examined, an interesting concept emerges. If all the seven explanatory variables are negligible, then the average growth rate is about 4.3 per cent per annum. If the convergence factor is expressed as 50 per cent of the GDP per capita level of the

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USA in 1960, and all other factors are virtually zero, then the average growth rate is about 2.2 per cent per annum. It is proposed to call these various levels of growth rates thus determined the ‘intrinsic’ or ‘auto-sustained’ rates of growth. For example, if the convergence factor is expressed as about 100 per cent of the GDP per capita level of the USA in 1960, and all other variables of regression (5.2) are virtually zero, then the ‘intrinsic’ rate of growth is about 0 per cent per annum. This also means that unless the other variables such as competitive forces, technological cum organizational innovations and human capital increase, economic growth per capita will tend to go to zero. Consequently as these variables in developed countries tend to be positive and significant, economic growth per capita will not tend to go to zero, thus supporting the endogenous type of economic growth. Fourth, it is worthwhile detecting the reasons for a positive growth rate in the USA in the last 30 to 40 years. Since the initial conditions of economic development were 100 per cent for that country in 1960 (the value of Y60), the average growth rate would have been zero if the other variables of the model were not positive. Thus the American economy grew at an average of 1.4 per cent from 1960 to 1990, because of improvements in human capital (about 0.56 per cent), because of the competitive factor (about 0.26 per cent), and because of technological advancements (0.23 per cent) (the remaining variables cancelling out). In conclusion for this section, it must be emphasized that despite the small sample of data used in this cross-section analysis, the results cannot be ignored. More research is of course needed in order to confirm the empirical findings.

5.6

IMPLICATIONS FOR THE ECONOMIES OF EAST ASIA AND THE USA

The comparison between the two major economies in the world in terms of competitive strength, organizational characteristics and economic growth presented in this study entails some important policy implications for the economies of the USA and East Asia. For the USA and other Western countries evidence suggests that there is a strong tendency for vertical disintegration (Krajewski and Ritzman, 1999, p. 99; or Grant, 1998, p. 196 or 326); this means that the role played by smaller companies for outsourcing purposes becomes more important and that big firms become smaller. For the USA, this disintegration process and the parallel adoption of the JIT/QC system was translated into higher industrial growth rates in the 1990s (Sanidas, 2001). Overall, it seems that American firms are becoming more focused like the Japanese firms have been in the last hundred years or

138

General and macro aspects

so, and hence they have lately been experiencing higher growth rates than before. Thus, it is evident that the recent American experience fully supports the findings of this study, namely that organizational innovation, coupled with stronger competition, leads to higher economic growth rates. For Japan, the situation has been diametrically opposite to that of the USA in the last ten years; Japan has not yet recovered from the recession of 1990–91. Many profound changes are in the process of taking place in this country (see for instance Mroczkowski and Hanaoka, 1998; Ito, 1996; Turner, 1994; Lincoln et al., 1998; Kono and Clegg, 2001). Overall, it seems that both larger firms and SMEs are going through some important transformations; however the direction of the latter is not clear yet: are the keiretsus disintegrating or becoming less lean? Or are the SMEs becoming larger and diminishing in total number? From the above-cited references the conclusions are not as yet clear; certainly the SMEs are still very strong in Japan despite a multitude of problems. Whittaker (1997, p. 214) summarizes his conclusions in this laconic sentence: ‘A transformation is undoubtedly taking place within Japan’s small firm sector.’ According to the findings of this study, it would be a mistake to suggest policies that do not encourage the strengthening of SMEs; Japanese policy makers know that very well (Whittaker, 1997). For the other East Asian economies, the strengthening of competition through the support of SMEs seems to be the best policy at the micro level. For instance, in Korea the eventual weakening of the economic oligarchy (the 30 or so families that control most of the economy), coupled with the encouragement of new small independent firms, would reinforce the Korean economy in the long run. In China, the transition from state-owned firms to private firms would be detrimental to the economy if it took place by encouraging the establishment of larger firms only. Overall, East Asian economies with very large populations would be better off if competition were primarily based on the SMEs of these countries, and there is clear evidence throughout the region of the need to place greater emphasis on their further development.

5.7

SUMMARY AND CONCLUSIONS

This study has examined and contrasted two Chandlerian analyses of firm evolution and subsequent growth, namely one suggested by Chandler’s monumental work, and the other by Fruin’s less voluminous but enlightening work. This study has attempted to add some more light as to why the two largest economies of the world, the USA and Japan, differ in terms of their organizational structures and economic growth. This attempt

Firm organization, SMEs and economic growth

139

consisted of comparing Chandler’s and Fruin’s analyses both qualitatively and quantitatively, and in the context of other scholars’ work. The following partial conclusions can only be part of the more general historical context in which societies and economies evolve. The first two sections provided some qualitative evidence about three fundamental differences between the American and the Japanese firm evolutions (the discussion on these differences took place in the third section). First, from the beginning, Americans opted for the ‘big business’ organization and continued to do so during the twentieth century, contrary to the Japanese entrepreneurs who opted for the smaller or focal firms. Second, American companies have very often been industrially organized as monopolies or oligopolies, and with a tendency for a centralized type of management or one that is multidivisional; whereas the Japanese firms have been a mixture of a handful of conglomerates plus an army of SMEs, and a tendency for a decentralized type of management or one more functional than multidivisional. Third, the Americans have opted for production of diversified related products, whereas the Japanese opted for a small range of products, that is for specialization and subcontracting. Explanations as to why Japanese firms evolved differently from American ones included differences in natural resources and technology, which were examined under the light of (linear) programming models. Other explanations (see section 5.2) were a consequence of historical circumstances. The third section related the two firm evolutions to economic growth and competition. Two main conclusions are worth mentioning here. First, the particular firm evolution in Japan and its consequential organizational features has led to, until recently, very high economic growth, substantially higher than that of the American economy. The econometric cross-country model of the fourth section has carefully shown that countries such as Japan and Italy have experienced higher growth rates than the USA and Germany because of stronger competition elements and more effectively organized firms, as these factors are approximated by the number of SMEs in each country (other reasons for higher economic growth were also included in the analysis). Second, inter-firm economies of scope and nonintegration were a major moving force behind Japan’s higher economic performance, contrary to the intra-firm economies of scale and scope and vertical integration of American firms. In the opinion of the author these inter-firm economies of scope constitute the major Japanese organizational innovation leading to higher economic growth rates. It is worth repeating Fruin’s (1992, p. 157) conclusion again: a strategy of maximizing inter-firm economies of scope through group-driven cooperative transactions made better sense than the pursuit of internal

140

General and macro aspects

production and allocative efficiencies through vertical integration and product diversification . . .

From the fourth section, the econometric analysis shows that a higher economic growth rate for countries such as Japan and Italy comes from the following four main factors. First, from the convergence factor or unsatisfied demand, thus confirming the relevant literature on the matter. Second, it comes from technological innovations. Third, it emanates from the degree of competition and organizational effectiveness as approximated by the number of SMEs. And fourth, it derives from the human capital factor. An interesting corollary of this conclusion is that for the 20 mostdeveloped countries in the sample, if the convergence factor is expressed as 100 per cent of the GDP per capita level of the USA in 1960, and all other factors are virtually zero, then the average growth rate is about 0 per cent per annum. Consequently, as these variables in developed countries tend to be positive and significant, economic growth per capita will not tend to go to zero, thus supporting the endogenous type of economic growth.

141

3810

4.3 0.8 3.7 0.9 0.7 5.3 0.6 0.6 50.7 0.8 1.2 14.7

Australia Austria Canada Denmark Finland Germany*** Greece Ireland Japan Norway Portugal Spain

2.4 0.7 4.3 1.0 0.7 5.5 0.4 0.3 46.5 0.6 1.1 13.7

3820

0.9 0.5 1.3 0.3 0.2 3.3 0.3 0.3 34.0 0.3 0.2 2.2

3830 0.0 0.0 0.6 0.1 0.1 1.2 0.0 0.1 16.0 0.1 0.0 0.4

3832

Establishments* (in ,000)

Data for establishments

ISIC number

Table 5.1

APPENDIX 5.1

1.4 0.1 1.4 0.3 0.3 1.0 0.3 0.1 14.7 0.5 0.2 1.2

3840 0.9 0.1 0.8 0.1 0.2 1.5 0.1 0.1 10.6 0.1 0.1 0.1

3843 15.8 7.6 25.2 5.1 4.9 61.0 9.9 3.5 120.8 4.2 9.9 38.4

POP**

27.2 10.5 14.7 17.6 14.3 8.7 6.1 17.1 42.0 19.0 12.1 38.3

3810 15.2 9.2 17.1 19.6 13.3 9.0 4.0 8.6 38.5 14.3 11.1 35.7

3820 5.7 5.9 5.2 5.9 4.1 5.4 3.0 7.1 28.1 6.2 1.7 5.7

3830 0.2 0.6 2.3 2.4 1.2 2.0 0.4 3.4 13.2 2.3 0.4 0.9

3832

8.5 1.4 5.6 5.9 6.1 1.6 2.5 3.4 12.2 11.2 2.3 3.1

3840

5.6 0.9 3.0 2.2 3.1 2.5 0.7 2.2 8.8 2.1 1.4 0.2

3843

Establishments per 100 000 inhabitants

10.4 4.8 8.0 8.9 7.0 4.9 2.8 7.0 23.8 9.2 4.8 14.0

average

142

1.6 1.1 14.6 35.9

Sweden Switzerland UK USA

1.2 0.0 22.5 53.1

3820

0.4 0.0 9.8 16.6

3830 0.1 0.0 3.7 8.5

3832 0.5 0.1 4.4 11.6

3840 0.3 0.0 2.1 6.6

3843 8.4 6.5 56.7 238.5

POP**

19.0 16.9 25.7 15.1

3810 14.3 0.0 39.7 22.3

3820 4.8 0.0 17.3 7.0

3830

Source:

3810 3820 3830 3832 3840 3843

metal products machinery nec electrical machinery radio, television,telephones,records, etc transportation equipment motor vehicles

Darnay (1995).

ISIC code:

1.1 0.4 6.5 3.6

3832 5.6 1.5 7.8 4.9

3840

3.1 0.5 3.7 2.8

3843

Establishments per 100 000 inhabitants

Notes: These numbers should be treated with caution, as they are not consistent in definitions and accuracy * For the year 1986, or if not available for the year 1987 **POP stands for population in millions ***For Germany, and for 3832, and 3843 the figures were guessed

3810

ISIC number

Establishments* (in ,000)

Table 5.1 (continued)

8.0 3.2 16.8 9.2

average

143

Australia Austria Belgium Canada Denmark Finland France Germany Greece Ireland Italy Japan Netherlands Norway Portugal Spain

Table 5.2

1.5 3 2.7 1.9 1.8 2.9 2.7 2.5 4.1 3.5 3.4 5 2 2.4 4.1 3.9

RG %

0.06 ⫺0 0.01 ⫺0.2 ⫺0.2 0.05 ⫺0.1 ⫺0.2 ⫺0.3 0.26 0.15 0.15 ⫺0 0.07 0.16 0

Error

78 44 58 79 60 47 55 57 21 34 45 20 70 58 20 34

Y60

430 180 490 600 170 110 1980 2290 690 130 3920 7000 420 90 600 2460

TOEST in ,000 17 7.7 10 26.6 5.1 5 56.7 62 10.1 3.5 56.7 123.5 15 4.2 9.8 39

POP millions

Original data used in the regression

APPENDIX 5.2

25.3 23.4 49.0 22.6 33.3 22.0 34.9 36.9 68.3 37.1 69.1 56.7 28.0 21.4 61.2 63.1

TOEST /POP 59 50 55 45 64 61 54 46 81 56 73 75 54 59 65 70

EMP99 % 6.4 17.3 4.9 4.4 5.9 15.9 15.3 28.1 4.8 0.7 0.3 43.2 5.4 6.7 0.2 4.4

PAT

38 53.3 54.4 82.2 38.8 41.5 38.4 31 47.8 55.5 43.3 45.9 49.1 50.1 45.2 40.3

EXPDIV % 0.99 0.8 0.99 1.05 1.07 1.08 0.94 0.94 0.95 0.98 0.76 0.95 1.04 0.94 0.59 1.05

SECEDUC 29 31 33 62 31 40 35 32 28 25 26 30 32 35 18 32

HIGEDUC % 28.1 15.9 32.0 71.8 38.0 50.4 29.1 26.6 24.0 23.5 11.4 25.7 36.0 29.1 3.7 37.0

HUCAP %

14.3 10.2 16.4 16.7 29.4 19.2 7.6 12.3 6.1 13.2 14 15.1 12.8 15 9.2 11.3

INCTAX %

5.5 7.9 2.8 4.5 5.5 8.5 6.1 3.3 25.3 15 8.5 6.7 4.5 5.9 17.8 10.7

AGRSEC %

144

0.03 ⫺0.1 ⫺0.3 0.36

Error

71 82 60 100

Y60

170 150 2630 6000

TOEST in ,000 8.6 6.7 56.6 249.9

POP millions

For the definition of variables see text, section 5.5.

1.6 1.6 2 1.4

RG %

(continued)

19.8 22.4 46.5 24.0

TOEST /POP 63 67 49 56

EMP99 % 22.9 40.4 7.7 19.1

PAT

33.2 38.9 34.9 39.9

EXPDIV % 0.9 1 0.83 0.98

SECEDUC 31 25 23 60

HIGEDUC % 22.6 25.0 13.2 56.5

HUCAP % 23.3 12.7 14.3 13

INCTAX %

3.2 5.5 2.2 2.9

AGRSEC %

Sources: The variables RG and Y60 were extracted from Table B.2 in C.I. Jones (1998). The variables PAT, EXPDIV, SECEDUC, HIGEDUC, INCTAX and AGRSEC are extracted from Tables 7.25, 2.27, 8.11, 8.12, 3.29 and 8.30 respectively in IMD (1992). Note that for Switzerland, SECEDUC was guessed to be 1. HUCAP is a derived variable (see section 5.5). The variable POP was taken from the OECD publication (1995). For the variables TOEST and EMP99, various sources were used and some rather ‘harmless’ estimations were performed because the data in this domain are not very reliable nor consistent. As the authors of the 1997 OECD report on SMEs remarked, ‘The demand for reliable, relevant and internationally comparable data on SMEs is on the rise’ (p. 3). For the 11 EU countries of 1990, the Table 2.8 of the ENSR (1994) report was used without any further calculations. For the three EFTA countries Austria, Finland, and Sweden the corresponding figures were estimated from the information on p. 32–3, same report (ENSR). For the countries Switzerland, Norway, and Canada the figures were estimated by using the sources of the OECD report (1997) on SMEs, Tables 1.1 to 1.6, the manufacturing relevant data from Darnay (1995), and the OECD (1996) report. For Japan, Table 14.2, volume 4, of Statistics Bureau, Management and Coordination Agency, ‘Historical Statistics of Japan’ (1987), was used and the figures were extrapolated for 1990. For the USA, Table 873 of the 1991 National Data Book was utilized, and the figures were extrapolated for 1990. For Australia, various issues of the ‘Yearbook Australia’ were utilized and the appropriate figures were estimated. Note that in the model presented in section 5.5 above, the estimated figures did not alter the significance of the results, mainly because the data for the main countries such as Japan, the USA and Italy are relatively accurate. Also, small changes in these estimated figures do not alter the regression results significantly.

Note:

Sweden Switzerland UK USA

Table 5.2

Firm organization, SMEs and economic growth

145

NOTES 1. 2. 3. 4. 5. 6.

One of the latest books on this issue is Acs et al. (1999). See for instance Storey (1994). See for example Mulhern (1995). See for example, Caree and Thurik (1998), Nickel (1996) and Pratten (1991). For recent work on small firms in this country see Whittaker (1997). Firm organization according to divisions, and not according to functions as in the U-form. 7. On the importance of this system see Sanidas (2001). 8. For a good review see Pyke et al. (1990).

BIBLIOGRAPHY Abegglen, J.C. and G. Stalk Jr (1985), ‘Kaisha: the Japanese corporation’, New York: Basic Books. Acs, Z.J. and D.B. Audretsch (eds) (1990), ‘The economics of small firms: a European challenge’, Dordrecht: Kluwer Academic Publishers. Acs, Z.J., B. Carlsson and C. Carlsson (eds) (1998), ‘Entrepreneurship, small and medium-sized enterprises and the macroeconomy’, New York: Cambridge University Press. Aoki, M. and R. Dore (eds) (1994), ‘The Japanese firm: the sources of competitive strength’, Oxford: Oxford University Press. Audretsch, D.B., Y.M. Prince and A.R. Thurik (1999), ‘Do small firms compete with large firms?’, Atlantic Economic Journal, June, 27 (2), pp. 201–9. Australian Bureau of Statistics, Yearbook Australia, Commonwealth of Australia, Canberra, various issues. Barro, R.J. and X. Sala-I-Martin (1995), ‘Economic growth’, New York: McGraw-Hill. Best, M.H. (1990), ‘The new competition, institutions of industrial restructuring’, Cambridge: Polity Press. Caree, M.A. and A.R. Thurik (1998), ‘Small firms and economic growth in Europe’, Atlantic Economic Journal, 26 (2), pp. 137–46. Chandler, A.D. Jr (1977), ‘The visible hand: the managerial revolution in American Business’, Cambridge, MA: Belknap Press of Harvard University Press. Chandler, A.D. Jr (1986), ‘The beginnings of “Big Business” in American industry’, in R.S. Tedlow and R.R. John Jr (eds), ‘Managing big business, essays from the business history review’, Boston, MA: Harvard Business School Press. Chandler, A.D. Jr (with the assistance of Takashi Hikino) (1990), ‘Scale and scope: the dynamics of industrial capitalism’, Cambridge, MA: Belknap Press. Chandler, A.D. Jr and R.S. Tedlow (1985), ‘The coming of managerial capitalism: a casebook on the history of American economic institutions’, Homewood. Darnay, A.J. (ed.), (1995), ‘Manufacturing worldwide’, New York: Gale Research, ITP. Dicken, P. (1992), ‘Global shift: the internationalisation of economic activity’, London: Paul Chapman. Ernste and Jaeger, C. (eds) (1989), Information Society and Spatial Structure, London: Belhaven Press.

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European Network for Social and Economic Research (ESNR), (1994), ‘Monitoring, and analysis of the performance of SMEs in their business Environment’, The European Observatory for SMEs, Second Annual Report. Fruin, W.M. (1992), ‘The Japanese enterprise system, competitive strategies and cooperative structures’, Oxford: Clarendon Press. Fujimoto, T. and A. Takeishi (1997), ‘Automobile industry’, in Japan Commission on Industrial Performance (JCIP), Made in Japan, revitalizing manufacturing for Economic Growth, Cambridge: MIT Press. Grant, R.M. (1998), Contemporary Strategy Analysis, Concepts, Techniques, Applications, 3rd edn, Malden: Blackwell Business. Habakkuk, H.J. (1962), ‘American and British technology in the nineteenth century: the search for labour-saving inventions’, Cambridge, UK: Cambridge University Press. Harris Corporation (1996), ‘Founding dates of the 1994 Fortune 500 US companies’, Business History Review, 70 (1) (Spring), pp. 69–90. Harrison, B. (1994), ‘Lean and mean: the changing landscape of corporate power in the age of flexibility’, New York: Basic Books. Imai, K. (1994), ‘Enterprise groups’, in K. Imai and R. Komiya (eds), Business Enterprises in Japan: Views of Leading Japanese Economists, Cambridge, MA: MIT Press. Imai, K. and R. Komiya (eds) (1994), ‘Business enterprises in Japan: views of leading Japanese economists’, Cambridge, MA: MIT Press. Institute for Management Development (IMD), (1992), The World Competitiveness Yearbook, Lausanne, Switzerland. Ito, M. (1994), ‘Interfirm relations and long-term continuous trading’, in K. Imai and R. Komiya (eds), Business Enterprises in Japan: Views of Leading Japanese Economists, Cambridge, MA: MIT Press. Ito, T. (1996), ‘Japan and the Asian economies: a miracle in transition’, Brookings Papers on Economic Activity, 2, pp. 205–72. Jaeger, C. and H. Ernste (1989), ‘Ways Beyond Fordism?’, in C. Jaeger and H. Ernste Information Society and Spatial Structure, London: Belhaven Press. Japan Commission on Industrial Performance (JCIP) (1997), Made in Japan, Revitalizing Manufacturing for Economic Growth, Cambridge, MA: MIT Press. Jones, C.I. (1998), Introduction to Economic Growth, New York: W.W. Norton. Kono, T. and S. Clegg (2001), Trends in Japanese Management, Continuing Strengths, Current Problems and Changing Priorities, Basingstoke: Palgrave. Krajewski, L.J. and L.P. Ritzman (1999), Operations Management, Strategy and Analysis, 5th edn Reading: Addison-Wesley. Lazonick, W. (1990), Competitive Advantage on the Shop Floor, Cambridge, MA: Harvard University Press. Lincoln, J.R., C.L. Ahmadjian and E. Mason (1998), ‘Organisational learning and purchase-supply relations in Japan: Hitachi, Matsushita, and Toyota compared’, California Management Review, 40 (3), Spring, pp. 241–64. McCraw, T.K. (eds) (1997), Creating Modern Capitalism, Boston, MA: Harvard University Press. McMillan, C.J. (1984), The Japanese Industrial System, Berlin, New York: W. de Gruyter. Miwa, Y. (1994), ‘Sub-contracting relationships: the automobile industry’, in K. Imai and R. Komiya (eds), Business Enterprises in Japan: Views of Leading Japanese Economists, Cambridge, MA: MIT Press.

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Mroczkowski, T. and M. Hanaoka (1998), ‘The end of Japanese management: how soon?’, Human Resource Planning, 21 (3), pp. 20–30. Mulhern, A. (1995), ‘The SME sector in Europe: a broad perspective’, Journal of Small Business Management, July, 33 (3), pp. 83–7. Nickel, S.J. (1996), ‘Competition and corporate performance’, Journal of Political Economy, 104 (4), August, pp. 724–46. OECD (1995), ‘Main economic Indicators’, OECD, Paris, January. OECD (1996), ‘SMEs: Employment, Innovation and growth’, OECD, Paris. OECD (1997), Small Businesses, Job Creation and Growth: Facts, Obstacles and Best Practices, Paris: OECD. Porter, M.E. (1990), The Competitive Advantage of Nations, Basingstoke: Macmillan. Pratten, C. (1991), The Competitiveness of Small Firms, Cambridge UK: Cambridge University Press. Pyke, F., G. Becattini and W. Sengenberger (eds) (1990), Industrial Districts and InterFirm Co-operation in Italy, Geneva: International Institute for Labour Studies. Rumelt, R.P., D.E. Schendel and D.J. Teece (eds) (1994), Fundamental Issues in Strategy: A Research Agenda, Boston, MA: Harvard Business School Press. Sanidas, E. (2001), ‘The successful imitation of the Japanese lean production system by American firms: impact on American economic growth’, paper presented in the Academy of International Business for South East Asia Region (AIBSEAR) 2001 Conference in Jakarta, 4–6 July. Shleifer, A. and R.W. Vishny (1994), ‘Takeovers in the 1960s and the 1980s: evidence and implications’, in R.P. Rumelt, D.E. Schendel, and D.J. Teece (eds), Fundamental Issues in Strategy, a Research Agenda, Boston, MA: Harvard Business School Press. Schumpeter, J.A. (1950), Capitalism, Socialism, and Democracy, New York: Harper and Row. Schwalbach, J. (1990), ‘Small business in German manufacturing’, in Z.J. Acs and D.B. Audretsch (eds), The Economics of Small Firms: A European Challenge, Dordrecht: Kluwer Academic Publishers. Statistics Bureau, Management and Coordination Agency (Editorial Supervision) (1987), Historical Statistics of Japan, Japan Statistical Association, Volume 4. Storey, D.J. (1994), Understanding the Small Business Sector, London: Routledge. Turner, L. (1994), ‘Japan suffers in the slump’, International management, 49 (2), March, pp. 30–2. US Department of Commerce, Bureau of the Census (1991), Statistical Abstract of the United States, Washington. Watanabe, Y. (1997), ‘Structural Distinctions within Japanese Manufacturing’, in Japan Commission on Industrial Performance (JCIP), Made in Japan, Revitalizing Manufacturing for Economic Growth, Cambridge: The MIT Press. Whittaker, D.H. (1994), ‘SMEs, entry barriers, and “strategic alliances” ’, in M. Aoki and R. Dore (eds), The Japanese Firm: The sources of Competitive Strength, Oxford: Oxford University Press. Whittaker, D.H. (1997), ‘Small firms in the Japanese economy’, Cambridge, UK: Cambridge University Press.

6.

The East Asian financial crisis in Thailand: distress and resilience of local SMEs Philippe Régnier

6.1

INTRODUCTION

The East Asian crisis has led to various corporate restructuring processes, which create new opportunities for further linkages between OECD large and smaller firms, including transnational corporations (TNCs), and East Asian enterprises interested in global production through business networks (Meyanathan, 1994; Blomstrom and Kokko, 1998; World Bank, 1999). Local enterprises in East Asia do not always refer to heavily indebted conglomerates closely associated to local business and political elites (crony capitalism). They can also be dynamic or promising medium-sized firms, sometimes smaller, which have managed to develop before and survive throughout the East Asian crisis. They represent a significant portion of all existing firms and jobs, of export revenues and of national GDP. They are extremely dynamic in a number of North-East Asian economies (Japan, Taiwan, Coastal China) and are playing an increasingly important role elsewhere (Korea, Indonesia, Malaysia, Singapore and Thailand) (Régnier, 1996, 1998). However, especially in this second category of countries, most SMEs lack technology, know-how and management skills, if not financial capital (Jennings and Beaver, 1997). While their situation has been adversely affected by the 1997–98 crisis (Régnier, 2000), new opportunities are emerging for developing not only profitable but also sustainable linkages with OECD large or smaller business counterparts. Since 1998, UNCTAD (World Investment Reports, 1998, 1999, 2000) has focused on TNCs’ global linkages. In this context, this chapter discusses the issue as to whether East Asian SMEs linked to TNCs tend to be more resilient to market fluctuations than other categories of local SMEs. The East Asian crisis is taken as a starting point. Sudden financial market failure deeply afflicted the local economies, both domestically and regionally. World attention and existing literature has focused on its devastating 148

The East Asian financial crisis in Thailand

149

impact and the restructuring needs of local banks and large corporations. But it has neglected the SME sector, which has suffered even more although this has been less reported in the local media and not at all internationally (ILO, 1999). This chapter starts with an overview of the impact of the East Asian crisis on local SMEs, especially in the most affected emerging economies of the region. The results from two empirical surveys conducted in 1998–99 and 1999–2000 are presented. One interesting outcome is that local SMEs linked to TNCs or other types of foreign affiliates have proven to be more resilient than other types of purely domestic market-oriented SMEs, and this trend is particularly illustrated in the case of Thai SMEs. The rest of the chapter concentrates on the issue of SME business linkages and how they could be promoted in the future, with a public–private partnership approach still lacking or very weak in Thailand and elsewhere in developing East Asia.

6.2

OVERALL IMPACT OF THE CRISIS ON EAST ASIAN SMEs

The overall impact of the crisis can be assessed in four general terms. First, the collapse of domestic demand, combined with a credit crunch, resulted in the demise of a number of local SMEs (at least 10 to 15 per cent of those SMEs in existence before the crisis), as well as in a drastic downsizing of the workforce among the vast majority of purely domestic marketoriented SMEs. Second, various forms of resilience to the crisis have been observed among local SMEs linked to TNCs and foreign affiliates. Third, ongoing moves of post-crisis corporate reform since 1998–99 have been attracting new foreign direct investments, which could produce positive spillover demands on the local SME sector (existing SMEs and the creation of new SMEs). Fourth, financial restructuring has led to timid attempts at reforming SME credit and credit guarantee institutions, including some corporate departments of classical commercial banks facing new challenges from SME venture capital and investment fund competitors. 6.2.1

Empirical Surveys (1998–2000)

There were no data on the SME-related implications of the East Asian financial crisis subject before two small surveys were initiated by the author in close cooperation with UNCTAD between 1998 and 2000. In 1998, the ILO also initiated some research work on the effects of the crisis on

150

General and macro aspects

micro-enterprises, while the World Bank tried to evaluate the impact of the crisis on all categories of manufacturing firms. 6.2.2

First Survey in Korea, Malaysia and Thailand (1998–99)

With a small mandate from UNCTAD, a first survey was conducted in Korea, Malaysia and Thailand. The central objective was to evaluate the overall impact of the crisis on local SMEs, and measure whether SMEs linked to foreign TNCs were more resilent to the crisis than other categories of primarily domestic market-oriented SMEs. Local SMEs were first directly or indirectly affected by the crisis itself, and then by the large corporate restructuring continued in 1999–2000 (especially in Korea and Thailand, although by much less in Malaysia). Direct factors influencing the SME recession were the depreciation of national currencies, the decline of economic activity linked to shrinking consumer demand, and a credit crunch induced by banking and corporate financial turbulence. Indirect factors included the collapse of regional export demand, depression in Japan, severed linkages with local conglomerates, absence of anti-crisis package deals for local SMEs, and weak business regulatory frameworks. In South Korea, for example, 11 589 SME bankruptcies were registered in 1996 (against seven large firms), and the figure rose to 17 168 in 1997 (against 58 large firms) and then to 22 828 in 1998 (against 39 large firms). Manufacturing SMEs suffered much more than those in services. Furthermore, SMEs engaged in light manufacturing were severely affected in comparison to those producing heavy or chemical goods. The decrease in SME exports was much slower than total export contraction, meaning that SMEs reacted more flexibly than large firms on the export front. Although activity has taken off again since the last quarter of 1998, recovery has structurally remained fragile, especially regarding SMEs, until recently. The main conclusions derived from the survey were as follows. First, the export orientation of local SMEs had much more importance in terms of corporate resilience to the crisis than their foreign affiliation. Domestic market-oriented SMEs have been much more vulnerable. Second, SMEs with a high ratio of direct foreign equity participation have, on average, been more resilient to the crisis than other categories of SMEs, due to various forms of assistance from the foreign partner. However, this is not true for all SMEs in this category, even for those wholly or almost wholly foreign-owned. Third, local SMEs with no foreign participation would, in principle, welcome some form of FDI affiliation but want to limit it to a minimum. Those with some foreign participation do not want it any higher despite the intensity of the recent crisis. The fear of losing family

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control is central for financial and intangible reasons, although the situation may be radically different in the case of newly created high-tech or IT SMEs. Fourth, foreign direct investment into local SMEs has primarily originated from East Asia (Japan, Korea, Taiwan and Hong Kong), and not from Europe or Northern America. The majority of wholly foreign-owned SMEs are medium-sized firms, which can be classified as supporting enterprises; most of them are Japanese and concentrated in the automotive, electronic and electrical sectors. In recent years Japanese subcontracting SMEs have tended to follow their large contractors and invest directly abroad. Fifth, SMEs linked to foreign affiliates are still few in number. The bulk of existing SMEs have neither the desire nor the capacity to venture overseas, and even less to go global. Sixth, the pattern of outsourcing by TNCs should be scrutinized in the aftermath of the recent crisis. TNCs could become bridgeheads to enhance SME competitiveness and internationalization. But they could also be attracted by post-crisis liberalized FDI policies to invest in their own outsourcing facilities. It would deepen the local industrial base and increase the local content of final exports, but could be detrimental to pure domestic SMEs confronted by global players. 6.2.3

Second Survey in Thailand (1999–2000)

A second SME survey was conducted in Thailand (Régnier, 2000). Thai SMEs, defined as manufacturing firms up to 200 employees, represent about 98 per cent of total existing firms, 89 per cent of all manufacturing firms with a registered capital below 50 million baht (1999: US$1 = 37 baht) and 76 per cent of total industrial employment. Local SMEs had traditionally been a non-issue in Thai economic policy until the adoption of the first SME Legislation and SME Master Plan in 1999–2000. The intensity of the financial crisis, combined with the first mismanaged intervention by the International Monetary Fund (IMF), caused the death or downsizing of a large number of SMEs, while many large firms had not yet started their own corporate restructuring (Dierman, 1998). SME bankruptcies at least doubled between 1996 and 1998, with 10 to 15 per cent of SMEs disappearing during the first 18 months of the crisis. The three main factors behind the SME business recession have been a sharp decline of domestic demand, a strong rise in input costs derived from the currency depreciation, and a drastic credit crunch due to the size of large corporate non-performing loans (NPLs). Domestic demand fell by 30 to 40 per cent on average (60 per cent in certain sectors) for about 80 per cent of all SMEs, especially the pure domestic market-oriented ones. About 35 per cent of SME non-exporters

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and 55 per cent of SME exporters were able to obtain orders despite the recession, but could not respond because of a lack of cash flow. Over 70 per cent of local SMEs have been severely affected by rising input costs. Capital-intensive and high-tech SMEs have been particularly hurt due to their high import dependency, but also labour-intensive SMEs such as those in textiles, footwear, metalwork and food products relying on specific imported inputs. Consequently, SMEs looked into possible domestic supply alternatives, but these were often not available or of poor quality. Lack of credit access and banking support badly affected a majority of SMEs. The SME sector accounts for about 25 per cent of total NPLs. Credit became scarce not only from bankers (lending to a minority of SMEs anyway), but also from suppliers of raw materials and intermediate products. In late 1997 and early 1998, SME exporters were not even able to identify bankers ready to endorse trading documents. The debate as to whether a credit crunch had been imposed or not on the real economy, and SMEs in particular, is still far from over. It has had many political impacts on the electoral period of late 2000 with the rapid rise of the populist and pro-small business Thai Rak Thai (TRT) party of new Prime Minister Thaksin. The TRT party was founded precisely during the most intense period of the crisis. In 1999, after two years of denial, the World Bank office in Bangkok recognized that a close link could be established between the illiquidity of indebted banks and related large corporations, and the inability of SMEs to access any working capital to help them through the crisis. It is not surprising that many SMEs today have even less trust in banks than before the crisis, and prefer to rely on other formal or informal sources of finance. All SMEs surveyed in various sectors of manufacturing have been resilient to the crisis, thanks to their differentiated links with foreign TNCs operating in Thailand, or based overseas (see details of the survey in Régnier, 2000). This is even true for some SMEs which, in 1997–98, had to face a total collapse of orders from major foreign clients, but were able to overcome the business downturn in 1998–99, thanks to their strong TNC networks (especially those involving Japanese TNCs). The survey identified strong resilience capacities among two categories of foreign-affiliated SMEs. The first category consists of SME subcontractors linked to TNCs operating in Thailand, and concrete examples have been documented in the automotive, electric and plastic sectors. The second category of foreign-affiliated SMEs is composed of SMEs producing final goods and related services for TNCs operating overseas in sectors like agro-food, jewellery, textiles apparel and the electricity sector.

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The two surveys, combined with additional work conducted by the author, together with the Investment Division of UNCTAD (publishing the Annual World Investment Report), has enabled the identification of a number of key business and inter-firm linkages which have been effective during the East Asian crisis.

6.3

SME–TNC LINKAGES AND RESILIENT NETWORKS IN THAILAND

The second survey, in particular, has permitted the drawing together of a number of observations which prove that some SME–TNC linkages have been quite effective in explaining the resilience of some local SMEs during the crisis. First, existing pre-crisis linkages have played a significant role. In various ways, a number of local SME entrepreneurs became inspired by the production and management best practices of TNCs along the production and value added chain. In some cases they were able to obtain direct access to TNCs, while in others they obtained, through TNCs, access to business schoools or vocational training centres sponsored or co-sponsored by those TNCs. Furthermore, some SME entrepreneurs were formerly trained on TNC sites or learnt their qualified job through specialized supplying or subcontracting linkages vis-à-vis TNCs. In a not insignificant number of cases, SME entrepreneurs happened to be former TNC employees who decided one day to establish their own business (sometimes with direct assistance and initial orders from the former TNC employer). All the above observations are particularly relevant to numerous local SMEs contracting or subcontracting to Japanese affiliates in the automotive, electrical and electronic sectors. In such cases the Thai middleaged entrepreneurs concerned can speak fluent Japanese, and have been exposed to training and professional experiences in Japanese subsidiaries and even at headquarters. During both the creation and development of their SME business, they have been able to rely on dense interpersonal networks with Japanese senior expatriates living in Bangkok and their counterparts in metropolitan Japan. Second, some local SMEs have been resilient during the crisis through various forms of financial support provided by TNCs and their local affiliates. Despite the collapse of local demand, some TNCs have maintained a sustainable level of orders to prevent the bankruptcy of their most reliable SME contractors: a case in point is Toyota. They have also delayed terms of payment for various deliveries, components and inputs required by local SMEs to supply them with intermediate goods and parts. They have

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facilitated SME access to credit by introducing and guaranteeing some SMEs vis-à-vis local or foreign bankers; Japanese and overseas Chinese financial networks have definitely been more supportive than Thai commercial bankers. In a few cases, foreign affiliates have even provided fresh money such as temporary cash flow or have become minority shareholders.

6.4

LINKING LOCAL SMEs AND FOREIGN FIRMS IN THAILAND: FUTURE PERSPECTIVES

The commodity and production chain of OECD and East Asian TNCs has been deeply affected by the ongoing globalization process. Outsourcing and multilevel subcontracting practices vis-à-vis local SMEs will continue to expand, at least in a few core sectors, according to old but also new patterns (Grunsven, 1998). Classical subcontracting at the subsector level may be more and more replaced by various subcontracting layers among mediumsized firms, SMEs and even micro-enterprises. In other cases, subcontracting networks are emerging across borders and corporate clusters including various types and sizes of SMEs. 6.4.1

Limits of Public Intervention

Most East Asian emerging economies have promoted SME development policies since the 1970s or 1980s. However, priorities have been neither well defined nor focused upon according to different categories of SMEs in the formal and informal sectors. SME policy implementation has seldom gone beyond political rhetoric and outside heavily centralized sectoral ministries. In most cases, it has also been biased in favour of big business. Yet SMEs have flourished in Japan, Taiwan, Hong Kong and Coastal China (Régnier, 1996, 1998) based on local entrepreneurial dynamics and local pro-business enabling conditions. Taiwan has become the most impressive SME export-oriented newly industrialized econonomy of East Asia (Ministry of Economic Affairs, 1999). SME internationalization policies, however, have been initiated with mixed results elsewhere (Malaysia, Singapore and South Korea). Thailand’s industrialization has primarily relied on foreign direct investment combined with local oligarchic business families heavily involved in commercial and financial activities. Specific policies in favour of SMEs have been scarce compared to other East Asian emerging economies, and have seldom gone beyond pure political rhetoric and highly centralized bureaucracies in Bangkok. During the crisis the new democratic regime seemed more concerned for the SME sector, but focused in practice on

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large corporate restructuring. Despite strong development and financial aid pressure from Japan, the Thai administration took about two years to produce the first-ever adopted SME Bill and an integrated SME Master Plan. Implementation of these measures was difficult in the preelectoral year of 2000. Furthermore, the Ministry of Finance and the Asian Development Bank agreed to reform rather drastically local public financial institutions supposed to be in charge of SME promotion but which were rather inefficient (such as the Small Industry Finance Corporation and the Small Industry Credit Guarantee Corporation). 6.4.2

The Role of Private Inter-Firm Linkages

The building up of sustainable regional and global market linkages with local SMEs depends on their capacity to conform production to TNC global standards (Kokko, 1996). So far, only a small minority of Thai SMEs have already reached that qualitative stage, but this does not necessarily mean continued support from contracting TNCs during sharp market fluctuations such as the East Asian financial crisis. Very few TNCs, with some Japanese exceptions, have adopted a comprehensive and sustainable strategy supporting outsourcing and subcontracting SMEs (Whittaker, 1997). More TNCs could be inspired by this type of medium- or long-term cost-effective win–win strategy, and could assume that due to the recent crisis more local SMEs are less hostile to foreign partnerships. However, local surveys show that most family-based SMEs are not prepared to open up their paid-up capital and therefore their own books to foreign ‘intrusion’. For example, the initiative of the Thai Stock Exchange Authority to launch a secondary market of SME stocks failed in the spring of 1999. Not a single one of the SMEs accepted to be listed among the first 60 preselected SMEs. 6.4.3

TNCs and Local Conglomerates as Global SME Bridgeheads?

Since the late 1980s, some TNCs in the automotive and electronic sectors have invited their best suppliers to invest in East Asia. This strategy could possibly be explored in other sectors or subsectors where Thailand could have a relative competitive edge. Until now, few non-Japanese TNCs have decided to act as outsourcing bridgeheads in favour of the best-performing SMEs locally. East Asian and Thai conglomerates could also play a similar SME internationalization bridgehead role. However, there are two obvious limits. First, most SMEs are hostile to local conglomerates due to their crony capitalist and oligopolistic privileges obtained from military and political elites. Second, even the largest

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conglomerates are poorly internationalized outside East Asia and do not have marketing and production sites in North America and Western Europe. Outside Thai Airways, and possibly the agro-food sector, not a single Thai brand is known internationally. There are only a few exceptions among Japanese, Korean and Taiwanese leading TNCs, already fairly globalized beyond the East Asian region. 6.4.4

Internationalization of SMEs by Themselves?

North American, Western European and East Asian SMEs are primarily active in their respective domestic and regional markets. At the interregional level, SMEs are present in transatlantic transactions (especially between the USA and the European Union) and in transpacific ones (East Asia and the USA). A minority, but significant number of dynamic and specialized SMEs, are fairly internationalized – if not globalized – but within the OECD zone. Due to rather well-established and dense transatlantic flows of SME products and technology (including new technologies), some are even present in Japan, Hong Kong and Singapore. However, their business success stories are not yet documented and publicized in order to encourage other SMEs to venture outside Europe and the USA. The small elite of the best Thai SMEs are primarily internationalized through direct or indirect exports in East Asia and beyond. Most others face various family business-related and human resource constraints, which tend to limit their capacity to explore external markets if personal networks are not at their disposal (like overseas Chinese networks for example). Due to different ownership and manpower profiles of IT SMEs (for example through e-commerce) new perspectives may arise on this front. But Thailand has been affected, like all other East Asian emerging economies, by the collapse of the NASDAQ and US high-tech stocks in 2000–2001. It is also assumed that due to globalization pressures and new liberalization commitments, several East Asian industrial sectors are opening up to foreign competition (Salazar, 1996). For example, since January 2000, Thai car-parts SMEs have had to look for external partnerships if they want to survive new inflows of imports. Malaysia and, especially, China could become strong competitors. Corporate sector reforms and restructuring have also been attracting new FDI inflows, which could at least indirectly lead to various pulling effects on Thai SMEs. 6.4.5

The Role of SME Clusters and Industrial Districts

The local development and internationalization dynamics of SME clusters and industrial districts has been well documented within and outside

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Europe after the so-called ‘Italian model’ (Schmitz, 1998; Sengenberger and Porter, 1998). The division of labour and flexible specialization within clusters and districts enable various forms of SME pooling to penetrate OECD markets. Today, best-performing SME networks are even capable of strategic business intelligence self-organization to match international demand and competition standards. More and more SME business alliances should be able to link up with East Asian markets, especially in North-East Asia where similar dynamics have been on the rise since the 1980s (Rutten and Upadhya, 1997). In SouthEast Asia, several governments (including the Thai Ministry of Industry in 1998–99) have been studying how to foster SME clusters after the Japanese/Taiwanese and European models (Whittaker, 1997). In addition, a limited number of transfrontier growth triangles have been selected, at least on paper, where local and foreign firms can enjoy a package of performing infrastructure, communication channels and business incentives. 6.4.6

SME Transnational Corporations on the Rise

Among best-performing SMEs, some have expanded on both the domestic and international fronts. Today, small-sized TNCs, or so-called transnational SMEs, are active in highly specialized niches and medium- to high-tech sectors (Fujita, 1998; UNCTAD, 1998a). Due to their high SME density and tradition, Western Europe and Japan are probably taking the lead worldwide in this respect. A similar phenomenon is gradually emerging in developing East Asia. During his 1999–2000 survey, the author was able to identify a few Thai SMEs which are already highly specialized in niche markets (for example in the agro-food and jewellery sectors) and are able to match various business intersections between large Asian and non-Asian corporations and SMEs.

6.5

CONCLUSIONS

The East Asian financial crisis has revealed the limits of purely foreign investment-based and export-driven industrialization as a ‘development model’, vulnerable to structural weaknesses and sudden external shocks as proved to be in the case in Thailand. The desirable emergence of competitive local firms and resilient SMEs may have to follow different but not necessarily contradictory avenues. Some options may consist of promoting private sector linkages and networks, including those among domestic and foreign SMEs (UNCTAD, 2001). The Thai authorities can play a role as facilitator to enable the implementation of entrepreneurially driven

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initiatives, and directly or indirectly support various types of demanddriven business development services (BDS). Thai BDS providers should include financial instruments tailored to the real needs of SMEs, with governmental institutions paying more attention to the real economy (than in 1998–2000) and eventually combine forces with bilateral or multilateral donors to support BDS local development. A definite option is to make better use of existing supply and export lines between Thai SMEs and large firms, partly but not exclusively through foreign affiliates operating in Thailand and in the rest of the region. However, this strategy shows that local procurement and outsourcing policies, whether proposed by host government agencies and/or by TNCs themselves, do not automatically boost the development, diversification and upgrading of existing SMEs in terms of market access, technology and management. Looking at the liberal FDI and foreign ownership legislation adopted in Thailand in 1999–2000, the former democratic government seems to have used the crisis as a leverage to attract foreign acquisitions and to bring along their supporting suppliers. This strategy has paid off. Thailand was, in 1998, one of the first destinations of FDI together with Brazil, China, Mexico and Venezuela. Net inflows in 1998–99 represented one-third of the total cumulative FDI received by Thailand since 1980. Then it dropped in 1999–2000 due to the massive recapitalization of the banking sector. Inflows decreased in 2000–2001 due to the US recession and the neo-populist profile of the new administration in Thailand restricting foreign access in some areas (such as retail business and supermarkets for instance). Global pressures and rising East Asian competition for FDI could increase business risks for non-internationalized Thai firms, and particularly for vast segments of poorly productive SMEs. This new trend could affect the local conditions of entrepreneurship and the modalities of creating new enterprises. This is one reason why the Thaksin government has been trying, since early 2001, to boost both production and consumption of locally made goods. The debate remains open as to whether SME creation and development will be predominantly spurred from above or from below. In the first scenario, large domestic corporations, foreign TNCs and local joint ventures may provide the driving engine with various spillover effects on different layers of SMEs. In the second scenario, which seems to be the option envisaged by the Thai Rak Thai party in power, stimulation of domestic demand, especially among the non-privileged segments of the Thai population, should provide the main boost to local SMEs, and possibly also to micro-enterprises (with poverty alleviation and employment

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creation objectives). Considering the size of the domestic debt, it remains to be seen how budgetary and other public means can be mobilized for the purpose of stimulating local demand. At the end of the day, both strategies may be valid and operational if they are combined with exploring new public–private partnerships for SME promotion.

REFERENCES Abdullah, M.A. (1998), SMEs in Malaysia, Policy Issues and Challenges, Aldershot, London: Ashgate Publishers. Blomstrom, M. and A. Kokko (1998), ‘Multinationals and Spillovers’, Journal of Economic Surveys, Vol. 12, pp. 247–78. Dierman, P. van (1998), The IMF Reform Agreement: Evaluating the Likely Impact on SMEs, Jakarta: Asia Foundation. Finnegan, G. (1999), ‘Micro and Small Enterprise Development and Poverty Alleviation in Thailand’, A Series of Working Papers, ILO and UNDP, Bangkok. Fujita, M. (1998), The Transnational Activities of SMEs, Dordrecht, New York: Kluwer Academic Publishers. Grunsven, Leo Van (1998), Regional Change in Industrializing Asia: Regional and Local Responses to Changing Competitiveness, Aldershot: Ashgate. Howard, R. (1995), ‘Can small business help countries compete?’, Harvard Business Review, November–December, pp. 88–103. ILO (1999), ‘Towards full employment’, technical report prepared for the Asian Regional Consultation on the Follow-up to the World Summit for Social Development, Regional Office for Asia and the Pacific, ILO, Bangkok. Jennings, P. and G. Beaver (1997), ‘The performance and competitive advantage of small firms: A management perspective’, International Small Business Journal, 15 (2), 58, pp. 63–75. Karagozulu, N. and M. Lindell (1998), ‘Internationalisation of small and mediumsized technology-based firms: An exploratory study’, Journal of Business Management, 36 (1), pp. 44–58. Kokko, A. (1996), ‘Productivity spillovers from competititon between local firms and foreign affiliates’, Journal of International Development, Vol. 8, pp. 517–30. Meyanathan (1994), ‘Industrial structures and the development of small and medium enterprise linkages’, Washington, DC: World Bank Institute, World Bank. Ministry of Economic Affairs (1999), The Experience and Achievement in Providing Guidance and Assistance to SMEs, Taipei, Taiwan: Small and Medium Enterprise Administration. Régnier, P. (1996), ‘The dynamic Asian economies, local systems of SMEs and internationalisation’, in OECD (ed.), Networks of Enterprises and Local Development, Paris, pp. 225–32. Régnier, P. (1998), ‘Dynamics of small enterprise development, state versus market in the Asian NIEs’, in P. Cook, C. Kirkpatrick and F. Nixon (eds), Privatisation, Enterprise Development, and Economic Reform, Cheltenham and Northampton: Edward Elgar, pp. 206–28.

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Régnier, P. (2000), SMEs in Distress: Thailand, the East Asian Crisis and Beyond, Aldershot, London: Gower/Ashgate Publishers. Rutten, M. and C. Upadhya (eds) (1997), Entrepreneurs in Asia and Europe: Towards a Comparative Perspective, New Delhi: Sage. Salazar, M. (1996), ‘Problems and prospects of micro and small industries in the process of economic liberalisation in Southeast Asia’, in R. Islam (ed.), SMEs in a Period of Economic Liberalisation: Opportunities and Challenges, New Delhi: ILO, pp. 52–116, 226–35. Schmitz, H. (1998), ‘Fostering collective efficiency’, Small Enterprise Development, 9 (1), pp. 1–10. Sengenberger, W. and M.E. Porter (1998), Clusters and Competition, Boston, MA: Harvard Business School Press. Tambunan, T. (2000), The Development of SMEs in Indonesia during the Suharto Era, Aldershot, London: Ashgate Publishers. UNCTAD (1998a), A Handbook on FDI by SMEs: Lessons from Asia, Geneva. UNCTAD (1998b, 1999, 2000, 2001), World Investment Report, Geneva. Whittaker, D.H. (1997), Small Firms in the Japanese Economy, Cambridge: Cambridge University Press. World Bank (1999), Asian Corporate Recovery: Corporate Governance, Government Policy, Two Industrial Surveys and Regional Conference Papers, Bangkok: World Bank Office.

PART II

Internal (micro) aspects

7.

Managing knowledge development in SMEs: no longer the poor cousins, as training changes to learning?1 Llandis Barratt-Pugh

7.1

INTRODUCTION: A KNOWLEDGE-DRIVEN WORLD

One of the advantages in being disorderly is that one is constantly making exciting discoveries. A.A. Milne (1882–1956)

We live in a world where our four-year-old computers often look most inadequate, and where students find concepts they learned in their first year at university have been revised and superseded by the time they move into the workplace. The speed at which our knowledge base is changing has a critical impact on the way organizations form, compete and regenerate. As knowledge creation and learning become core business capabilities, how does this reposition small and medium-sized enterprises (SMEs)? So long the poor cousins of larger organizations in terms of formal training activity, are they just as poorly placed when developing organizational learning capability? Let me paint for you a workplace scenario. Whether in large or smaller organizations we find ourselves thrust into an ‘enterprizing world’ where, as knowledge workers, we are required to be enterprizing beings. The world of work for many has increasingly become the American 24/7, 24 hours a day, seven days a week. In the past, our more mechanistic workplaces were controlled by ordering us in time and space. Managers wanted to know where we were, and what we were doing. Now our jobs are less tangible, less bound by place and time, and all too often dominate our own social space. Management control in such a situation now relies on filtering the texts that we read, and mediating the texts that we enterprizingly produce. Thus 163

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language, and the control of meaning, have now become the primary instruments of organizational management. In this environment of knowledge work, even our organizational production has become less about physical commodities, and more about producing new identity and access to networks. For example, the Pokémon trading cards I bought for my friend’s children last Christmas were really about increasing their access to, and interaction with, groups of their peers through these new possessions. Of course, as Du Gay (1996) and Gee et al. (1996) would insist, if your business is actually about the production of identity, then controlling or mediating the development of your employee’s identity becomes a particularly critical concern. The role of these knowledge workers is to develop new knowledge, new identity, new methods of access and belonging between customers in increasingly disparate societies. But what we are asked to produce is not the traditional knowledge passed down from on high, and from generation to generation. This is knowledge as a more transient substance, changing rapidly, to the point where it is more part of each process than an actual substance. We are asked to customize products and processes locally, adapting to each customer interaction. In this scenario people development is inseparable from enterprise development. Knowledge making is increasingly continuous and spread throughout the organization. Training us for the routine is just replicating past experience and knowledge, when what is required of us is constant adaptation. In this scenario of workplace learning, producing new knowledge, and therefore extending our own identity, becomes the key to organizational growth. As Hendry et al. (1995) state, ‘People are the actors through whom strategy unfolds’. I will suggest in this chapter that in such a world, smaller organizations, with less cultural dissonance, have a greater opportunity to thrive when compared with their larger cousins. Less concerned with symbolic and linguistic managerial control, less encumbered by the growing quantity of controlling texts and competing internal cultures within their organizations, they are perhaps better positioned to take a more pragmatic and adaptive approach. While formal training may be more easily resourced by larger organizations, SMEs can be far more culturally attuned to informal organizational learning processes. Indeed the report later in this chapter on the research that explores this issue will also support the view that these fleas may move, while the elephants remain shackled to their histories. This chapter explores the relationship between our changing conceptualization of knowledge and the resulting implications for organizational growth, with specific attention to SMEs. Section 7.2 emphasizes the transient nature of knowledge and the potential advantage that SMEs may possess in assimilating and developing new learning and new knowledge in a changing world. Section 7.3 identifies the importance of SMEs in the context of

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Australia, and the importance of innovation and knowledge creation for their competitiveness in global and domestic markets. Section 7.4 highlights existing studies relating to why SMEs should, and need to, invest in training and learning. Section 7.5 identifies some of the barriers facing SMEs when it comes to formal learning and training. Section 7.6 discusses the movement towards organizational learning, and discusses the potential competitive advantage that SMEs may possess over their larger rivals. Section 7.7 constructs the key issues that form the focus of attention in this study. The research study method is outlined in section 7.8. Section 7.9 discusses the data analysis process. Section 7.10 discusses the broad research findings, and section 7.11 maps emerging themes from the study while section 7.12 maps emerging relationships found from the study. Finally, section 7.13 provides a summary of the major conclusions from this study, emphasizing that SMEs may well be more effectively positioned, through their use of informal learning processes, to facilitate more rapid and more inclusive construction and reconstruction of their organizational knowledge and thus be advantaged in adapting to changed markets and environments.

7.2

KNOWLEDGE AS SHIFTING DESERT SAND

There can be little doubt that the development of new knowledge is now at the heart of organizational competition, and that organizations which seek to disperse and adapt existing knowledge bases must be more effectively positioned. To achieve this, managers in those organizations need a tacit understanding of knowledge as a local and social construction within their organizations. It is these beliefs that may change training into learning, process replication into adaptability, and organizational control into organizational learning. This chapter explores these issues and examines the gap that exists between current theory and current management practices. Do managers still see knowledge as tablets of stone, or do they encourage their people to be knowledge creators? It is difficult for many to move away from previous conceptualizations of knowledge as some form of codified expertise, towards the emerging beliefs that knowledge is just a series of assumptions about how the world may work, which are sometimes shared with others but are always in a state of transition. Our changing perceptions and values in relation to knowledge are the critical focus of this discussion and research. It may help this exploration to pursue a relevant allegory. In the film Instinct (Turelaub, 1999), Anthony Hopkins plays an academic who studies and lives with apes in the wild, and is subsequently viewed by his peers as having himself turned savage. Psychiatrist Donald Sutherland sends his junior psychiatric colleague, Cuba Gooding, to examine Hopkins.

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Perhaps inevitably there is a reversal of roles in this search for learning, as Hopkins passes his primitive learning experiences on to the young academic, his supposed inquisitor. At one critical phase in the examination Hopkins overpowers Gooding and turns inquisitor, forcing Gooding to confront the effects of his new constrained imprisonment. Hopkins asks Gooding to express what he has lost at that moment in time. Gooding begins by saying he has lost his power or his freedom, but then realizes that what he has really lost is his illusions. ‘You have taken away my illusions,’ he shouts at Hopkins. In contrast to the stark reality of the primitive world of cause and effect that has been experienced by Hopkins while with the apes, Gooding recognizes that much of our own world is about the assembly and dis-assembly of our own, and sometimes shared, perceptions and illusions. They may be imperfect but our identity is constructed and reconstructed around each experience and each new perception of how the world works. The story presents us with an allegory of our managerialized world and the increasing reality for many of the transience of our assumptions about how the world works, and therefore the transient nature of knowledge. How we should present our products, service our customers, or interview our employee is a changing and evolving database. Even though much of our society endeavours to present knowledge as something far more solid, lasting and universal, Nuthall (1999, p. 143), perhaps, points us in the right direction for greater understanding by indicating that we should view knowledge to be ‘as much a process as a substance’. That is, we should recognize the impermanence of knowledge, as our views of how the world works are constantly adapting. In SMEs, where customer interaction is usually far more dominant than internal interactions, there is less time for illusions to become entrenched, and more opportunities for sharing customer assumptions of how the world works. SMEs perhaps are better placed to accept and develop new learning and new knowledge in a changing world. The research upon which this chapter is based is focused on the same issues. Organizations are open systems, and driven by environmental change. What is right one year may well not be right the next year. As one participant in this research project succinctly suggested, ‘No one calls it the firm any more – there’s nothing firm about it now!’ For smaller organizations this creates a paradox. On the one hand, they are just as, if not more, vulnerable to extreme environmental change. On the other, they have the capacity both to sense change systemically within their organization and rapidly to activate internal change. They are less bound by the politics of factional interests which disempower strategic intent in larger organizations, and more able to communicate new vision through more direct communication networks. They are fleas, not elephants, and they may therefore

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be in a position to secure an advantage as the environment changes. They can in fact dispense with their previous illusions with more ease.

7.3

THE IMPORTANCE OF SMEs, AND THE MANAGEMENT OF KNOWLEDGE DEVELOPMENT

The Australian Bureau of Statistics updated survey of 1997 (ABS, 1998, p. 8) indicates that there are over 948 000 SMEs that provide about 3.3 million jobs, or over half the total documented employment in Australia. In the context of the aftermath of the Asian financial and economic crisis, the continued economic prosperity of Australia has to be partially dependent on SMEs developing a sustainable competitive advantage, and enhancing the role of small businesses in the globalization of the Australian economy (Hine and Kelly, 1999). There is an unusual agreement that it is the human resources of organizations that can provide the opportunity for enterprise adaptation and in the development of competitive advantage (Handy, 1994). In 1995 the Karpin report (Karpin, 1995) highlighted the critical link between future prosperity in Australia, business success and organizational development based on more organically managed cultures, which would promote greater employee inclusion and produce opportunities for knowledge generation. Karpin indicated that the key to business revival was the release of human energy inside organizations (Ingalls, 1976), and the utilization of their intellectual and social capital reserves. Given the increasingly competitive situation following Asian business tremors, and the role of SMEs as potential major players in the Australian economy, I would argue that their ability to innovate and create knowledge will be critical. The focus of this chapter is therefore on a research study that explores what values are held by managers in organizations concerning training, learning and knowledge development, and examines the potential for managing knowledge development within SMEs. This field of research is framed by three central issues. The first issue concerns the relationship between training and learning investment, and business benefit. What research exists that supports investment in this area? The second issue concerns the relationship between SMEs and their take-up of formal training. What does research tell us about SME investment in this area? The third and final issue concerns the relationship between organizational learning processes and SME cultures. What facilitates patterns of organizational learning? Each of these issues will be reviewed to show how previous research and literature has shaped the key questions of the research study.

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7.4

Internal aspects

WHY SHOULD SMEs INVEST IN TRAINING AND LEARNING?

This research focuses on learning and training as a catalyst for organizational change. What evidence is there that investment in training and learning actually provides positive results? The tenuous link between training and subsequent business benefits has been a regular subject for investigation. However, as Maglen et al. (2001, p. 12) indicate in their recent study, ‘the human resource function of enterprises cannot be disengaged from the business setting in which it operates’. As Trist et al. (1990, p. 35) emphasize, the main problem with studying organizations is that their environments change. They describe this dilemma as the causal texture of the environment. It is difficult to link directly any changes in an organization’s performance to single training and learning initiatives. However, international studies suggest that there is a positive link between strategic HR value adding activities, such as targeted training, and organizational performance (Becker and Gerhart, 1996; Huselid et al. 1997). Although Rogers and Wright (1998) indicate that a positive relationship seems to exist between training investment and subsequent organizational performance, their review of a range of studies found that such a linkage is neither consistent nor universal. Boocock and Loan-Clarke (1999) found similar evidence in a study of SMEs. In Australia there is further evidence of a positive relationship between training and learning investment and organizational performance. While Smith and Hayton (1997) outline what drives business to invest in training activity and what factors appear to moderate the type and style of training adopted, a number of recent studies have provided empirical evidence that return on investment for training is nearly always positive and can be very high (Blandy et al., 2000; Doucouliages and Sgro, 2001; Dochery, 2001). These studies again note the difficulty of measurement in this area, but emphasize that training appears to act as a mechanism for change and is enhanced when supported by, or bundled with, other strategic human resource initiatives (Dyer and Reeves, 1995). With positive evidence to encourage investment in training and learning as a catalyst of change and performance improvement, what prevents wider SME investment in this area?

7.5

SMEs AND BARRIERS TO FORMAL LEARNING AND TRAINING

The second issue, or perhaps myth, concerns the relationship between SMEs and training, or as characterized by Marlow (1997, p. 58), ‘[s]o much

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opportunity . . . so little take up’. I will suggest that this much-quoted relationship in fact misrepresents the polarization that exists in SME training investment, and also fails to account for the valuable situated and informal learning practices that exist within SMEs. Kilpatrick and Crowley (1999) reiterate the claim that SMEs are underrepresented in training activity and this view is also supported by the recent National Centre for Vocational Education Research (1998) statistics. However, the Coopers & Lybrand (1994) study, prepared for the Karpin report (1995), presents a dichotomous picture. It reports the usual barriers to training for SMEs of relevance, theoretical content, immediate benefits and specific needs. However, in some SME cases it appears that cost was not a barrier to training, with leading SMEs outspending their larger partners on a dollar-per-head basis. On the other hand, 20 per cent of SMEs allocated nothing to training. Hine and Kelly (1999) suggest from their research that SMEs value training and learning. Those SMEs that participate do so wholeheartedly. For many SMEs collaborative learning experiences are, logistically, the only formal option available (Boocock and Loan-Clarke, 1999; Maniukiewicz and Williams, 1998). Those who resist such investment often do so through fear of giving away competitive advantage in learning discussions with others (Mulcahy and James, 1999, p. 17; Deakins and Graham, 1997). Another issue that may be in question here is, what counts as training? Field (1997) has indicated the move in organizations from training to learning. The increasing informality of what counts as training may be an issue in both collecting data and in the interpretation of such data. Learning within organizations is less visible and less recorded than formal training. There is every indication that SMEs operate with more informal practices, but that does not mean that they are less valuable practices. Coopers & Lybrand (1994, p. 32) in fact indicate that SMEs value the informal more. Kilpatrick and Crowley (1999, p. 212) emphasize that SMEs prefer ‘hands-on’ learning and actually believe it is more effective, ‘because workplace learning is more contextualised’. This evidence suggests that the traditional lower uptake of formal training by SMEs may in fact be enhanced by more informal and contextually relevant learning patterns within the organization. What is in question here is not the extent of learning done by SMEs, but how it is enacted and with what intentions and outcomes. Perhaps the emerging pattern reflects the move from a systematic process of training to more appropriate systemic organizational learning.

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Internal aspects

MOVING TO ORGANIZATIONAL LEARNING: A COMPETITIVE ADVANTAGE FOR SMEs?

While there is a more nebulous research link between training or learning and organizational performance, especially with SMEs, the link between organizational learning, knowledge development and success or survival is more firmly represented in the literature (Senge, 1990; Nonaka and Takeuchi, 1995). This reflects the changing role of knowledge as a competitive resource for organizational growth, and changing managerial perceptions toward the exclusivity of knowledge creation. There has been a shift in thinking from just developing individuals, towards developing the organization and organizational learning. Sanchez (1996) indicates that current market competition is only a superficial expression of what is actually the real contest, the battle for skills acquisition and knowledge creation. Creating what is needed for today is insufficient, since the need is to prepare for markets that do not yet exist for unserved customers with unarticulated needs (Hamel and Prahalad, 1994, pp. 103, 227). This is unlikely to happen using the patterns of the past. The development of such new knowledge will be sourced from new patterns of learning within organizations. The achievement of such capability is dependent on recognizing the need to involve all employees in knowledge creation and recognizing that knowledge construction will be a transitory and continuous process. Knowledge can no longer be viewed as owned and created by the privileged few for dispensing within training programmes to the many. As Sanchez (1996, p. 13) indicates: ‘Knowledge is the set of beliefs held by an individual about causal relationships. Shared beliefs are organizational knowledge.’ Mayher (1990, p. 79) states that, ‘there is no knowledge without a knower’. He makes the point that knowledge does not exist without us. It is a human and social construction, a process we engage in to make sense of a complex world. As such a social process, knowledge is inextricably linked to those who form and discuss and perhaps write down their perceptions. It is situated, that is attached, to places and to people. This view of knowledge represents a significant shift from positions that view knowledge as a commodity of the privileged, towards recognizing knowledge as a social construction (Searle, 1995). It is the social construction of knowledge that lies at the heart of organizational learning practices. Organizational learning requires a culture that enables employees to take knowledge and to modify it from one situation to another (Stevenson, 1991; Engestrom, 1993). The much-quoted work of Lave and Wenger (1991) has promoted this more socio-cultural view of learning inside organizations, where learning is an integral and inseparable

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aspect of social practice. However, it is important to note at this point that the training environment in Australia has been dominated by the competency-based approach to training since the early 1990s (Anderson, 1996). This competency-based training approach can be used to construct cultures of training compliance (Legge, 1995). However, there are also opportunities, with the arrival of second-generation competence approaches, to maximize the flexibility of competence-based learning processes to support organizational learning practices. Mulcahy and James (1999, p. 17) indicate that a developmental approach to competency-based learning that accentuates learner control can facilitate greater social learning contexts, organizational learning and knowledge creation. To what extent are training managers and owners using developmental approaches which focus more on organizational context and learning, rather than just programming competencies into their employees? It would however be wrong to portray informal organizational learning as the strategic panacea for organizations and especially SMEs. Such informal learning is strongly shaped by organizational cultures and, having dispensed with the facilitators of formal training, employee learning within the organization may well be directed and controlled by powerful managers curtailing the opportunities for diverse perceptions, different visions and ultimately new knowledge (Cooper and Law, 1998; Bojie, 1994). Mitev and Marsh (1997) indicate that in many cases owner-managers may have needs to remain in control, which could be dysfunctional to the development of more organic learning processes. However, organizational learning is a very different approach to training and learning that is based on facilitating knowledge development, and not the simple replication of skills. As Tangri and Scaone (1998) indicate, for SMEs the production of new information is a vital commodity in any knowledgebased economy. Such a perspective rejects traditional exclusive and acquisition models of training and learning, and replaces them with learning that is situated within the organizations, is collaborative and inclusive. To what extent do the more fluid processes of small and medium-sized businesses enable them to retain a more organic approach to learning in comparison with their large competitors, and provide the previously described organizational competencies for competitive advantage? Merrilees et al. (1998) suggest that some SMEs appear to take advantage of serendipity through their ability to be flexible and adaptable when exploiting opportunities. Their suggestion is that managers and owner-managers should perhaps be changing human resource development (HRD) strategies from organizing training to learning and growing knowledge. Are the informal contexts of SMEs therefore the basis of potential competitive advantage? When Nonaka and Takeuchi (1995, p. 166) discussed

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the hypertext organizational structure, it was portrayed as the goal of larger organizations to build knowledge capability. Perhaps the informal structures and relationships of SMEs inherently reflect similar characteristics. In his review of his own work New Alchemists, Handy (1999b) currently suggests that some of the economic patterns of smaller business are now replicated by thriving larger business where growth patterns based on achieving a customer base and equity growth outstrip traditional attainments of profit and income. The connection between ideas and business success usually attributed to smaller business, is emerging as stronger than the traditional larger business characteristic between capital and success. His suggestion is that because of this the fleas are more nimble than the elephants. Perhaps this is so because their more informal ways of learning and growing enable them to adapt more quickly in a turbulent environment which does not allow the time for more formal and measured training approaches.

7.7

CONSTRUCTING THE FOCUS FOR THE RESEARCH STUDY

The current debates within the literature indicate two principal issues for exploration. The first is that there appears to be a consensus emerging that organizations can only build the appropriate competitive competencies through generating cultures of continual learning, where ‘training’ is focused on building situational knowledge development and broad participation in learning processes. The second issue concerns the relationship between training and SMEs. There are indications in the literature that the climates of SMEs are closer to the more organic, team-based, focused practice of the emerging situational and socio-cultural theories of learning within organization support. To what extent, therefore, would the practices of managers and owners responsible for training activity in SMEs differ in their perceptions of training and training goals from their larger competitors? It is now over 20 years since Drucker (1980) predicted, so accurately, that knowledge would be the critical organizational resource of the future and be the key to competitive advantage. Drucker (1980, pp. 2–3) forecast that in this more turbulent, irregular, non-linear and erratic world there would also be a time ‘of great opportunity for those who can understand, accept, and exploit the new realities’. Drucker understood and indicated to us that the stable world of Taylorism was past: ‘He assumed there would be one right way . . . His assumption has proved wrong’ (Drucker, 1980, p. 23). Coupled with this irregularity of experience, Drucker forecast the change towards knowledge work and knowledge workers and the subsequent

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implications for organizational control and learning: ‘Knowledge work unlike manual work cannot be replaced by capital investment. . . . The employees are the capitalists . . . Employees have the knowledge’ (Drucker, 1980, p. 190). The implications are clear: where knowledge is a changing currency its inclusion and generation becomes a critical business function and traditional patterns of training aimed at simple control and replication fall short of stimulating generative learning cultures. To what extent has this almost distant message of 20 years ago permeated the thinking of training managers and owner-managers with training responsibility and power in SMEs? To what extent do these managers and owners responsible for training activity, and specifically those within SMEs, share these perceptions and seek to attain such goals? Are they locked into traditional formal patterns of learning acquisition, or do they recognize the need to create cultures of knowledge generation and adaptation from within their organizations? Research by Kotey and Meridith (1997) and Carrier (1999), supports the assumption that there is a strong relationship between the values of ownermanagers and their subsequent enterprise strategy and performance. It is therefore reasonable to assume that in relation to training activity, and the associated outcomes, there is liable to be a strong relationship between owner-manager assumptions about learning and knowledge, their values concerning learning and knowledge, and their behaviour and actions towards learning and knowledge in the organization. Schein (1995) suggests that organizational cultures and behaviour observed are the products of the values held by the organization. These values are formed by the assumptions the organization holds about how the world works. But which of these areas of approach would be most applicable for this study? In terms of constructing a field study, would it be more appropriate to examine organizational practices by examining assumptions held about learning and knowledge, by trying to determine the values held by managers, or by looking at organizational practices and behaviour? Pilot interviews indicated that asking training managers and managers responsible for purchasing training to define their epistemological stance and their views and assumptions about knowledge, would result in rather a short data collection process. Any research approach aimed at this level of the assumptions held by managers therefore seemed inappropriate when designing the study. While it would have been possible to use observations within organizations, and to make inferences from the patterns and outcomes of current training and learning behaviour, a more direct approach offered a richer, more efficient data collection process. The decision was made to focus on training managers and managers responsible for purchasing training, and to examine what they valued in the training and

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learning they organized and what they valued as outcomes from that training and learning process. Did managers and owners conceive training in terms of traditional input acquisition models, or was their conceptualization of training framed by learning, situational and organizational learning, and the development of organizational knowledge? As Whipp (1992) indicates: Learning goes way beyond training, embracing structural adjustment, the use of experimentation, the development of new language and the reshaping of values . . . Knowledge then has to be codified and diffused within the organisation and entrenched knowledge and beliefs broken down . . . the relation between such learning and strategy formation and implementation is reciprocal. (p. 51)

While governments and educators philosophize about the appropriate landscapes for training, training managers may be influenced by such discussions, new concepts and language, but it is they who play a critical role in constructing those landscapes through their purchasing power. Having reviewed the literature and constructed the previous argument, the following questions appeared to be those most worthy of investigation: ●

●

●

What do managers and owners of businesses with responsibility for training want their employees to gain from training activity? What do they conceptualize the aim of training to be? What do managers and owners of businesses with responsibility for training want their organizations to gain from training activity? What do they conceptualize the outcomes of training to be? What are the differences between the expectations of owner-managers of SMEs and larger organizations concerning training and organizational learning processes? Do the cultures of SMEs predispose them to more organic forms of learning?

In returning to the original allegory from the film Instinct that illustrated the central focus of this study: which do managers and owners with power and responsibility for training value the most, their current illusions, or those that are yet to be generated?

7.8

THE RESEARCH STUDY METHOD

The study focused upon managers who had the power to determine the focus of training and learning. The study investigated what they valued in the training they planned, and what strategic outcomes they valued in

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terms of continued learning and development. A series of 30 in-depth interviews and observations formed the basis for the study. There is no attempt here to study a representative or typical case; the selection of cases is justified by focused sampling as suggested by Leman (1994). Indeed Merriam (1994) indicated that such a non-probability sample is effective when, as in this study, the research is exploring what is occurring. Patton (1996) further suggested that such a purposive sample has a logic and power and provides rich information. In fact, such a collection of cases will provide a structural representation for the purpose of the study (Stake, 1994), and the multiple cases suggested in this research design offer a robust framework for data collection (Remenyi et al., 1998). The research context was restricted logistically to companies within Western Australia, and for data sites focused upon 30 training managers and their critical role in purchasing training and framing employee and organizational development strategies. To enable training managers to talk with freedom and discuss both their activity and their values, individual interviews with guide point questions were chosen as the basis for the research. These interviews formed the basis of a multiple-site case study approach. As the interview depth was considered the critical component of the study, the decision was made to focus available resources of the project on these key managers, rather than reduce the number of cases through additional interviews. As Snowden (1999) indicates, a story provides a simple agent through which we can communicate complex meaning. What did training managers want from training and what did they value in training and learning? What were the organizational outcomes of their intentions and strategy in terms of the learning community? How did their underlying values concerning the nature of knowledge frame the resulting learning outcomes? Finally, what, if any, are the relationships that exist between the way managers use training and the building of organizational knowledge? The sites were chosen to provide a stratified sample of cases from Industry Training Council data and a matrix of geographical location, company size and industry context focused on a wide and disparate sample. Following initial telephone interviews 23 sites were chosen for subsequent data collection. The selection was based upon three criteria: achieving an effective representation of large and SME organizations, an acceptable industrial sector sample and open access for interviewing. The data collection carried out was based on recorded interviews. Telephone interviews were used where distance precluded face-to-face contact. A process of review was used for participants to ensure that the transcribed data represented the conversation and their reality appropriately. The questions were piloted and developed to form a sequence of

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conversational cues that could be used to guide the interviews from practical workplace issues towards the attitudes, values and underlying assumptions that were held about training and learning in the organization. The questions were given to the managers before the interviews together with briefing notes containing explanations of specific terms. The interview conversations established the general focus and characteristics of the training that the organizations employed. Managers were asked to specify what they valued in their training experiences and to illustrate the inputs made by learners. The focus then moved to the organizational context and the importance of adaptability within the workplace and the contribution of training processes to this goal. Finally, managers were asked about continued workplace learning at individual and team levels, and then given an open opportunity to discuss changes they would like to make to link the realities they had specified to some of the personal attitudes and values that had emerged in the conversations. To this point the research had gathered considerable diversity of perspectives. The study now focused upon examining the patterns of this diversity rather than reducing the diversity to a single ‘truth’, as Manen (1997) suggests, is not to claim that, above others, there is one correct or superior mode of inquiry to ascertain the truth, or other meaning of something. There is no true meaning just as there is no uncontested truth. (p. 42)

7.9

THE DATA ANALYSIS PROCESS

The organizations were coded and both SMEs (using ABS measures) and larger organizations mixed together through the coding process. The analysis was planned using two researchers working independently on the data to cross-check the links made with the data, and then to use the practitioners as a final reflective mirror for the cases. A distinction had to be made between what the managers were achieving and what they would like to achieve; and what interpretations could be placed upon both what the managers said, and did not say, about what they valued in the training and workplace situation. A complex picture emerged of the training architecture that was being constructed. This outcome is far more effectively represented in the national study that previous telephone interviews had contributed towards, and was subsequently published and edited by Mulcahy and James (1999). The analysis of the qualitative data was based upon the first phases of Strauss and Corbin’s (1998) grounded theory approach to data analysis. Strauss and Corbin (1998) indicate that the techniques and procedures they provide are not meant to be used rigidly in a step-by-step fashion, but

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provide researchers with a set of tools that can be applied in unique configurations within each methodology and for each set of data. The aim is to bridge the path from simple description of situations, through to conceptual ordering of themes, and then finally to theorizing about the relationships that exist. This analysis began with a review of the data, using open coding. That is, plotting the emerging themes from the interviews and observations. Similar themes were then gathered together and examined so that the dimensions of these themes, their properties and attributes, could be grouped and reviewed for patterns of divergence, similarity or polarization. The third stage of the analysis comprised of an axial coding approach to specific areas of the coded data. That is, building up a framework of relationships between the themes and dimensions. At this stage there were three emerging themes that showed considerable variety in subject responses. The first concerned what the managers wanted from training inputs. The second concerned what outcomes they wanted from training inputs. The third concerned how valued the employees were as instigators of change. In addition it appeared that each of these themes had gathered responses that reflected very different management values. At one extreme of each theme there were responses indicating that the acquisition of work skills, the replication of work skills and conformity were valued. At the other extreme of each theme there were responses indicating that the development of learning skills, generative competence and the adaptation of existing processes were valued. The decision was taken to focus further analysis on these three themes. This involved judging where organizational response to these three themes lay in relationship to the two extreme positions. A double-blind ranking process was employed, using two researchers working independently, and making the judgement that was used to plot the responses of each Table 7.1

The emerging themes and dimensions

Traditional extreme

Emerging themes

Developmental extreme

What training outcomes are valued? Fixed job related inputs >

< Learning abilities. What workplace outcomes are valued?

Replication of competence

< Adaptation of competencies.

> What organizational outcomes are valued?

Employee conformity

>

< Employee creativity.

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organization as in Table 7.1. This tabulation provides a graphic representation of the values expressed by managers in the organizations. Finally, the relationships between these emerging themes and dimensions were explored to search for patterns in terms of context, strategies and consequences. The analysis focused first on the patterns emerging across all the data sets and then focused on how the small and medium organizations (SMOs/SMEs) and larger organizations rated in comparative data sets.

7.10

THE BROAD RESEARCH FINDINGS

Companies were comprehensive in their approach to training with a bias towards skill-based training with nationally derived competencies. Training was seen as increasing skills and competencies to fulfil job-based needs. While learners had some input to training experiences, the skills developed through the learning process were generally not recognized. Learning was centred upon training and was segregated, rather than being ongoing learning in the workplace. While all organizations recognized the essential need for employees to adapt to change both individually and as an organization, there was limited attention to workplace team learning. Training managers recognized the benefits of continued learning for coping with change, but in many cases cited a managerial short-term production focus as a critical barrier where the employee responsibility for personal learning was seen as external to the workplace. There were specific issues associated with smaller and remote organizations who indicated that they suffered from the inability to create what they wanted due to the ‘tyranny of distance’, ‘the inability to hold onto their investment’ and ‘the lack of a critical mass’. The twin disadvantages of a distant and dispersed workforce made training and learning interaction difficult.

7.11

MAPPING THE EMERGING THEMES

During the process of analysing the data three themes emerged, where there was considerable variation in the dimensions that the data displayed. The first theme concerned what the managers wanted and valued in training. While in some cases training was seen as fixed inputs of job-related knowledge and skills, other managers wanted the process of learning to contribute to creating future learning abilities. The second theme concerned their view of employee competency in the workplace. In some cases, the focus was on the job and the replication of competence, while in others

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there was a focus on the person and the adaptation of competence to the changing situation. Third, and finally, there was a difference in how the workplace culture valued the employee. In some cases, passive conformity was valued, while in others active creativity was valued and encouraged. The evidence gathered from each case study was used to determine the position of each organization between the dimensions of each of the three continua that have just been outlined, as the following extracts illustrate. If we review the first theme and dimensions, concerned with what the managers wanted from training, it is evident that the social capital of learning skills is defined by the purchaser. The view was expressed by some that ‘those skills develop somewhere else’. There appeared to be a segregation of knowledge creation, learning direction, and the associated skills to the owner-manager elites. Others wanted training to provide the opportunity to increase learning skills and the ability to question. The second theme and dimension concerned their view of employee learning in the workplace: competence for replication or adaptation? Some managers recognized the ‘balance between competence and flexibility’ and the need to ‘be adaptive to what is happening . . . there are so many variables’. These managers appeared to recognize both the need to acquire more ‘concrete skills’ and the need to adapt those skills constantly to the changing workplace demands. However, many focused on employee roles ‘the systematic’ and compliance, excluding the benefits of flexible responses, expecting them to ‘go back to the workplace and utilize the skills’. Finally, the third theme and dimension indicated differences in how the workplace culture valued the employee. Language such as the ‘leading hand’ or ‘chargehand’ almost presupposes a manual contribution to the workplace culture, rather than a cognitive contribution. Training that had constructed employees to be custodians of knowledge and skills did not empower them to be constructors of knowledge: ‘I wouldn’t say we had identified our employees as a major asset’. Workplace learning in this case may occur by necessity but not by design because employees ‘can’t get their messages through to management’. Adaptation to change is a passive quality in employees who ‘aren’t senior enough to make change’. Management perhaps views organizational culture and training as additive rather than adaptive: ‘not supportive of learning unless it can be done in a way that does not interfere with the business . . . Would be nice if it was safe, OK, to do some learning’. Where employees were seen as valued intellectual capital the language was very different. ‘Every single transaction was seen as a learning curve, teams were encouraged to work through problems, because if you don’t continue to learn in teams you’re dead’. Even the work structure contributed to learning where ‘we rotate so that we are in a learning situation

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Small and medium-sized enterprises 12

Series 1 Series 2 Series 3

10

Ranking

8 6 4 2 0 1

2

3

4

5

6

7

8

9

10

11

Organizations Series 1: What training outcomes are valued – Scale : 1 - Fixed job related inputs or 12 - Learning abilities. Series 2: What workplace outcomes are valued – Scale : 1 - Replication of Competence or 12 - Adaptation of Competency. Series 3: What organizational outcomes are valued – Scale : 1 - Employee Conformity or 12 - Employee Creativity.

Figure 7.1 The individual SME organizational responses to the three emerging themes all the time and pick staff who feel the same way’. Figure 7.1 graphically displays how each SME organization response was rated against the dimensions of the three emerging themes. Figure 7.1 shows how the responses from each SME organization were plotted against the dimensions of each of the three emerging themes (Series 1/2/3). A lower ranking represents more traditional values towards training and knowledge creation, a higher ranking represents more developmental values towards learning and knowledge creation. While the graph shows a polarization between the SMEs, these results were more positive than those from the larger organizations.

7.12

MAPPING THE EMERGING RELATIONSHIPS

There were patterns that emerged both in the data as a whole and between what was valued in training and learning, and what was valued in employee subsequent behaviour and organizational contribution. There were marked differences between cultures where compliance was valued, and those cul-

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tures where contribution was valued. The following relationships emerged when the patterns between the three continua were examined: ●

●

●

●

●

There was a strong relationship between organizational learning activity in the workplace and organizations where managers recognized the role of the training process in developing individual learning abilities. There was a strong relationship between organizational learning activity in a workplace and organizations where managers recognized that competence needed active individual adaptation in the workplace situation. There was a stronger relationship between organizational learning activity in a workplace where managers both recognized that competence needed active individual adaptation in the workplace situation, and managers recognized the role of the training process in developing individual learning abilities. The relationships above were far stronger within the SMOs studied than the larger organizations. The relationships above were stronger within the SMEs studied, when SMOs with strong external influences and current retrenchment activity were excluded.

It would be inappropriate to suggest that a theory emerged from the data, but the data suggests that organizations are unlikely to achieve knowledge production and organizational learning unless investment in training is seen as the development of learning practices and the organizational culture then continues to enable learning and the adaptation of work practices. If we accept that in the organizational context training is turning to learning, it would appear that SMEs are no longer such poor cousins. There is evidence to suggest that the barriers that exist when accessing formal training do not have such an effect in the development of more informal organizationalbased learning practices. There appears to be more of a symmetry between the natural working processes of SMEs and organizational learning practices. It also appears that the owners and managers of the SMEs in this study placed more value on their employees’ contribution to this process, and recognized the impermanence of their current organizational processes.

7.13

CONCLUSION

This initial analysis of the data would appear to indicate that recognizing the social nature of knowledge construction, and valuing the knowledge of the process of learning, has positive implications for organizational health and cultural renewal. It would appear that SMEs are in a strong position

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to develop their inherent informal learning practices, arising from the results of this study, and may benefit from more fluid and inclusive forms of learning leadership. Equipping learners to continue learning and be active partners in workplace learning are prerequisites for an organizational learning community. Organizations may value the ability of employees to change and adapt, but often employees have not been equipped effectively to respond to that challenge. Where managers legitimize the development of learning abilities and the contribution of learners in the workplace environment, there is the possibility of developing a more adaptive culture. Employees in an organization need to be viewed as instigators of cultural change, rather than products of that change. The evidence concerning what managers value about training suggests that in the case of SME managers and owners they are more likely to hold fluid epistemological beliefs, in most cases as the tacit knowledge gained from their dynamic experiences. This may be a critical prerequisite to the development of organizational learning patterns. Organizations that wish to restrict learning to the 2 per cent of time that is spent in training may miss the potential 98 per cent dividend. It seems a reasonable assumption that such a strategy will not equip them for global competitiveness. It may be that, as Coopers & Lybrand (1994) found, successful SMEs have a strategic view of training because they were used to dealing with change rather than reacting to it. Mulcahy and James (1999) indicate that ‘there is evidence to suggest that SMEs run on informal training where the competence based approach does not fit the bill . . . it’s done almost intrinsically . . . our staff are our partners.’ Perhaps SME exclusion from formal training increases self-reliance and a more organizational approach to learning. Gibb (1997) indicates that with small business such contextualized learning is related to success, a predictor of business benefit. It may be that there are unique opportunities for SMEs to leverage organizational change through more flexible approaches to building knowledge, training and learning, which are, in some cases, being grasped. Perhaps the managers who run smaller organizations are only too aware of the transient and fragile environment within which they exist. They may be less reliant on external expertise and place more value on the contribution of their own staff and the necessity of continual learning for survival. Ironically it is these assumptions about the environment, which may include the perhaps unconscious recognition of the transient and distributed nature of knowledge, which forms a more appropriate value set for the extension of individual identity and subsequent organizational development. They may see more clearly the inseparable links between individual and organizational learning (Hendry et al., 1995). To return to the allegory at the start of this chapter, such managers may be less likely to cling to past illusions, be more

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prepared to create informally new knowledge with their employees, and therefore may no longer be the poor cousins of larger businesses. The fleas may jump where the elephants fear to tread.

NOTE 1. For Clifford David Barratt-Pugh, a great teacher: 1917–1999.

BIBLIOGRAPHY Anderson, D. (1996), Training Market Reforms and their Impact on the VET System, Centre for Employment Education and Training, Monash University, Australian Council for Educational Research, Australian Government Publication Service, Canberra. Australian Bureau of Statistics (ABS) (1998), ‘Small Business in Australia Update’, Canberra, Commonwealth of Australia, Australian Government Publication Service. Becker, B. and B. Gerhart (1996), ‘The impact of human resource management on organisational performance’, Academy of Management Journal, 39 (4), pp. 779–801. Blandy, R., M. Dochery, A. Hawke and E. Webster (2000), Does Training Pay? Adelaide: National Centre for Vocational Education Research. Bojie, D.M. (1994), ‘Organisational storytelling: the struggles of pre-modern, modern and postmodern organisational learning discourses’, Management Learning, 25 (3), pp. 433–62. Boocock, G. and J. Loan-Clarke (1999), ‘Management training and development in small and medium sized enterprises’, Journal of Small Business and Enterprise Development, 6 (2), pp. 178–90. Bourdieu, P. (1990), The Logic of Practice, Cambridge: Polity Press. Carrier, C. (1999), ‘The training and development needs of owner managers of small business with export potential’, Journal of Small Business Management, 37 (4), pp. 30–41. Coopers & Lybrand (1994), Training Practices and Preferences of Small Business in Australia: A Report for Training Providers, New South Wales, Technical and Further Education New South Wales Press, report June 814R/je. Cooper, R. and J. Law (1998), ‘Organisation: Distal and Proximal views’, in A. Baracharach (ed.), Research in the Sociology of Organisations, Greenwich, CT: JAI Press. Cope, B. and M. Kalantzis (1997), Productive Diversity, Sydney: Pluto Press. Deakins, D. and L. Graham (1997), ‘New venture support: an analysis of mentoring support for new and early stage entrepreneurs’, Small Business and Enterprise Development, 5 (2), pp. 74–89. Dochery, M. (2001), Training Investment and Business Performance, Adelaide: National Centre for Vocational Education Research. Doucouliages, C. and P. Sgro (2001), Enterprise Return on Training Investment, Adelaide: National Centre for Vocational Education Research. Drucker, P.J. (1980), Managing in Turbulent Times, New York: Harper & Row. Du Gay, P. (1996), Consumption and Identity at Work, London: Sage.

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Dyer, L. and T. Reeves (1995), ‘Human resource strategies and firm performance’, International Journal of Human Resource Management, 6 (3), pp. 656–70. Engestrom, Y. (1993), ‘Developmental studies on work as a testbench for activity theory’, in S. Chaiklin and J. Lave (eds), Understanding Practice: Perspectives on Activity and Context, Cambridge: Cambridge University Press. Field, L. (1997), ‘Shifting the focus from training to learning’, Australian and New Zealand Journal of Vocational Educational Research, 3 (2), pp. 24–39. Gee, J.P., G. Hull and C. Lankshear (1996), The New Work Order: Behind the Language of New Capitalism, Sydney: Allen & Unwin. Gibb, A. (1997), ‘Small firms training and competitiveness’, International Small Business Journal, 15 (3), pp. 13–28. Hamel, G. and C. Prahalad (1994), Competing for the Future, Boston, MA: Harvard Business School Press. Handy, C. (1994), An Empty Raincoat, London: Hutchinson. Handy, C. (1999a), The New Alchemists, London: Random House. Handy, C. (1999b), ‘The New Alchemists’, public lecture, Australian Institute of Management, Observation City, Perth, 15 November. Hendry, C., M.B. Arthur and A.M. Jones (1995), Strategy Through People, London: Routledge. Hine, D. and S. Kelly (1999), ‘Standing alone small business and the global market’, Small Enterprise Research, 7 (2), pp. 67–83. Huselid, M.A., S.E. Jackson and R.S. Schuler (1997), ‘Technical and strategic human resource management as determinates of firm performance’, Academy of Management Journal, 40 (1), pp. 171–88. Ingalls, J. (1976), Human Energy, Boston, MA: Longman. Karpin, D. (1995), Enterprising Nation, Canberra: Australian Government Publishing Service. Kilpatrick, S. and S. Crowley (1999), Learning in Small Business, Quality and Diversity in Vocational Education and Training Research, Melbourne, Royal Melbourne Institute of Technology, Australian Vocational Educational and Training Research Association. Kotey, B. and G. Meridith (1997), ‘Relationships among owner-managers, personal values, business strategies and enterprise performance’, Journal of Small Business Management, 5 (2), pp. 56–72. Lave, J. and E. Wenger (1991), Situated Learning: Legitimate Peripheral Participation, New York: Cambridge University Press. Legge, K. (1995), Human Resource Management: Rhetorics and Realities, Basingstoke, Hampshire: Macmillan. Leman (1994), Competence Based Management Development, Department of Employment, Sheffield. Maglen, L., S. Hopkins and G. Burke (2001), Training for Productivity, Adelaide: National Centre for Vocational Education Research. Manen, M.V. (1997), ‘From meaning to method’, Qualitative Heath Research, 7 (3), pp. 345–69. Maniukiewicz, C. and S. Williams (1998), ‘Partnerships and networks’, Small Business and Enterprise Development, 6 (1), pp. 68–79. Marlow, S. (1997), ‘So much opportunity: so little take-up: the use of training in smaller firms’, Small Business and Enterprise Development, 5 (1), pp. 34–48. Mayher, J.H. (1990), Uncommon Sense: Theoretical practice in Language Education, Portsmouth, NH: Heinemann.

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Merriam, S.B. (1994), Qualitative Research and Case Study Applications in Education, San Francisco, CA: Jossey-Bass. Merrilees, B., D. Miller and J. Tiessen (1998), ‘Serendipity, leverage and the process of entrepreneurial internationalisation’, Small Enterprise Research, 6 (2), pp. 3–11. Mitev, N. and E. Marsh (1997), ‘Small business and information technology: risk planning and change’, Small Business and Enterprise Development, 5 (3), pp. 228–45. Mulcahy, D. and P. James (1999), Evaluating the Contribution of Competency Based Training, Adelaide: National Centre for Vocational Education Research. National Centre for Vocational Education Research (1998), ‘Research at a glance: small business and vocational educational training’, Australian Training Review, 38, p. 22. Nonaka, I. and H. Takeuchi (1995), The Knowledge Creating Company, Oxford: Oxford University Press. Nuthall, G. (1999), ‘Learning how to learn’, International Journal of Educational Research, 31, pp. 141–256. Patton, M.Q. (1996), Utilisation Focussed Evaluation, 2nd edn, Newbury Park, CA: Sage. Remenyi, D., B. Williams, A. Money and E. Swartz (1998), Research in Business and Management, London: Sage. Rogers, E.W. and P.M. Wright (1998), ‘Measuring organisational performance in strategic human resource management’, Human Resource Management Review, 8 (3), pp. 311–31. Sanchez, R. (1996), Dynamics of Competence Based Competition, Oxford: Pergamon. Schein, E.H. (1995), Organisational Culture and Leadership, San Francisco, CA: Jossey-Bass. Searle, J.R. (1995), The Social Construction of Reality, New York: Free Press. Senge, P.M. (1990), ‘The leaders work: building organisational learning’, Sloan Management Review, Fall Issue, pp. 7–23. Smith, A. and G. Hayton (1997), ‘Enterprise training in Australia’, 2nd International Conference of the Journal of Vocational Education and Training, Policy and Practice in Vocational Education and Training, Huddersfield. Snowden, D.J. (1999), ‘The paradox of story’, Journal of Straggly and Scenario Planning, November, pp. 8–18. Stake, R. (1994), ‘Case studies’, in N.K. Denizin and Y.S. Lincoln (eds), Handbook of Qualitative Research, Thousand Oaks, CA: Sage, pp. 236–47. Stevenson, J. (1991), ‘Cognitive structures for the teaching of adaptability in vocational education’, in G. Evans (ed.), Learning and Teaching Cognitive Skills, Melbourne: Australian Council for Educational Research, pp. 144–63. Strauss, A. and J. Corbin (1998), Basics of Qualitative Research, Thousand Oaks, CA: Sage. Tangri, D. and D. Scaone (1998), ‘SMEs in the information economy’, Small Enterprise Research, 6 (2), pp. 89–93. Trist, E., F. Emery and H. Murray (1990), The Social Engagement of Social Science, Philadelphia, PA: University of Pennsylvania. Turelaub, J. (1999), Instinct, screenplay, Los Angeles: Warner Brothers. Whipp, R. (1992), ‘Human resource management and competition strategy’, in P. Blighton and P. Turnbull, Reassessing Human Resource Management, London: Sage.

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APPENDIX: INTERVIEW PROTOCOL Date: Interviewer: Interviewee:

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Interview / Organizational Code / Location – Size – Industry

In your organization which groups of people are trained? Who does the training? Who decides the content and standards of the training? What do you want the employees to learn from the training experience? Do you want their training to be focused on the content provided by the trainer or on the learning needs expressed by the employees themselves? How important is it for the employees to be adaptive to changes and also to make changes at their workplace? Can the employees bring about change or are they simply responding to change? Does the training they have help them cope with change? Can you give any examples where their learning has helped them tackle new situations? Do they display improved learning skills such as change of attitude, motivation, or skills like that? Do they express some anxiety then about the changes? If you had to decide how much of the training was about learning work skills and how much was about developing the skills of learning, what percentage split would you like? We are not just looking at training – can you give examples of where learning takes place at work? Can you give any examples of how you encourage individual or team learning to take place at work? Do reviews or appraisals come into it? Is there any team or group work, meetings at the workplace? Is there any mentoring within the organization? How important to you is the ability of your employees to learn? How important to your organization is the ability of your employees to learn? What changes would you most like to make to the training you run if you were able to?

8.

Ethical values in business: a study of Malaysian small and medium-sized enterprises Za’faran Hassan and Arawati Agus

8.1

INTRODUCTION

An important contemporary issue in the management of business organization is business ethics. With the increasing complexity in the business environment, the issue of business ethics has gained much attention among researchers in recent years. Contemporary business literature abounds with topics on, or related to, business ethics. Ethical behaviour has also been extensively discussed and accepted as an important component of managerial decision-making (Etheredge, 1999; Velasquez, 1996). In order to understand better the role of ethics in the business environment, we need to become familiar with the part ethics plays in the decision-making process. Business decisions are made by individuals or by committees. Therefore, the ethics of business is actually the ethics of the individuals making up the business and who make business decisions. Ethics are revealed through a decision maker’s behaviour when solving business problems that emerge from the environment. Such behaviour evolves from attitudes toward the condition within the environment that created the problems. Despite the proliferation of research on business ethics, there are as yet few studies examining the perceived importance of ethics on business operations and especially amongst Asian small and medium-sized enterprises and, particularly, those in Malaysia. SMEs account for more than 80 per cent of total manufacturing establishments in Malaysia; of these, 88 per cent are small-scale enterprises and 12 per cent are medium-scale enterprises (Singapore Productivity and Standards Board, 1997). The majority of Malaysian SMEs are concentrated in the traditional sectors of food and beverages (20 per cent), fabricated metal products (18 per cent) wood and wood products (17 per cent) and basic metal (4 per cent). The SMEs assume a critical role in the country’s industrialization programme through strengthening of both 187

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forward and backward industrial linkages. The SMEs in Malaysia will transcend from their present state to undertake a more important role in order to support the requirements of Malaysia’s industrialization process and conforming to the guidelines set by the Second Industrial Master Plan (IMP2) and the Third Outline Perspective Plan (OPP3). The importance of Malaysian SMEs will become more apparent as the country expands its industrial base in meeting the challenges of the new millennium and developments in the international economy and global markets. These firms are becoming more important in terms of employment and output in the economy. Therefore, it is important to focus attention on their experiences with regards to their skills and business practices and their potential to overcome their shortcomings. Given the universal management reaction to turbulence in the external economic environment, an interesting issue that arises is whether SMEs in Malaysia are any different from their counterparts in the West. While the recent economic crisis accentuates the importance of quality to an organization’s survival, the significance of the human side of quality management has also become apparent. Throughout the input-process-output model of products and services, the human aspect in the quality equation is often taken for granted in lieu of the emphasis put on technical aspects, including quality tools, processes and outcomes. Maintaining quality and appropriate ethical values in business becomes very difficult and mechanistic especially when the concerns are centred on improving profits and reducing costs. Understanding ethical values in business amongst Malaysian SMEs may provide insights in managing and maximizing quality in these organizations. The objective of this study is to explore the ethical ideologies of ownermanagers of Malaysian SMEs regarding the perceived importance of ethics in their business operations. In doing so it proceeds as follows. Section 8.2 conducts a review of the relevant literature, and generates a number of hypotheses to be tested in the empirical section. Section 8.3 details the research methodology and the sample, and section 8.4 reports on the results before a discussion of their implications in section 8.5. Some conclusions are offered in section 8.6.

8.2 8.2.1

REVIEW OF THE LITERATURE The Perceived Role of Business Institutions and Business Ethics

Globalization of the business environment creates an increasingly complex set of relationships for today’s managers. Although motivated essentially by profit, business as an activity provides numerous important services to

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society. It is business activity that brings all goods and services within society’s reach. Business also generates a major proportion of the nation’s employment, contributes substantially to the country’s income and wealth, and to a large extent provides a major impetus to the growth and expansion of a country’s economy. In the process of rendering such services, society has demanded that businesses be responsible for the needs of their employees, their workplace safety, as well as contributing towards community development. Thus, business involves economic relationships among different groups of stakeholders. These stakeholders may include customers, employees and stockholders, suppliers, competitors, governments and communities. This complexity increases when stakeholders have conflicting claims that need to be addressed. Employees want to keep their jobs; the government is concerned with the welfare of its citizens; whilst stockholders are looking for the best return on their investment. Business ethics as a field is defined by the interaction of ethics and business. Business ethics refers to the measurement of business behaviour based on standards of right and wrong, rather than relying entirely on principles of accounting and management (Hartman, 1998). According to De George (1995), business is a social activity and, like all social activity, could not function unless certain moral prerequisites are fulfilled. He also emphasized that there are several levels of moral analysis. The major focus of business ethics at the macro level is the moral evaluation of the economic system of free enterprise, and of possible alternatives to and modifications of it. A second level of moral analysis is the study of business within the free-enterprise system. Thirdly, within the economic system and businesses themselves are individuals who invest in, run, work for, buy from, and in many ways are affected by them. The field of business ethics thus embraces these three levels in their interconnectedness, as well as treating them as discrete areas of investigation. A business can only be as ethical as the people who own, manage and work for it; but its organization and practices can be more or less conducive to ethical activity, which in turn can be reinforced or impeded by the larger system of which it is a part. Finally, because business is becoming more and more international and global, a fourth level of analysis considers international businesses, conditions of international trade, the distribution of goods and jobs, the role of business in environmental preservation and protection, and activities that affect mankind as a whole. The field of business ethics is rapidly becoming big business and, among other developments, recent years have seen the proliferation of a great number of articles and books on ethical problems in business. One main focus of business ethics is the question of whether a business believes it is ultimately responsible to its stockholders (the ‘stockholder’ approach) or to its various stakeholders (the ‘stakeholders’ approach) (Argandona, 1998; Velasquez, 1996).

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The ‘stockholder’ perspective Milton Friedman (1970) and organizational theorists like Herbert Simon (1965) assert that the business of a business is to make profits, and that social reform, welfare and the like are the proper concern of government and not of business. The basic idea of managerial capitalism is that in return for controlling the firm, management vigorously pursues the interest of the stockholders. Scholars and managers alike continue to hold sacred the view that managers bear a special relationship to the stockholders of the firm. Since stockholders own shares in the firm they have certain rights and privileges, which must be granted to them by management as well as by others. Sanctions, in the form of the Law of Corporations and other protective mechanisms in the form of social custom and accepted management practices, as well as myth and ritual, are thought to reinforce the assumption of the primacy of the stockholders. Thus, the ‘stockholder’ view argues that managers should conduct business in the interest of the stockholders by supplying goods and services to consumers, whereas applying the organization’s resources to providing social goods undermines the market mechanism and may threaten the survival of an organization (Blair et al., 1999; Carson, 1993; Etheredge, 1999). Central to the stockholder view of the firm is the idea that management can pursue market transactions with suppliers and customers in an unconstrained manner, as long as they maximize profit or return on investment for the stockholders of the firm. The ‘stakeholder’ perspective The ‘stakeholder’ view, on the other hand, argues that business has a responsibility toward different stakeholders. All those to whom the firm has any moral obligations are collectively referred to as stakeholders in the firm. Businesses therefore bear a fiduciary relationship to stakeholders such as suppliers, customers, employees, stockholders and the local community, as well as management, in its role as agent for these groups. Each of these stakeholder groups has a right not to be treated as a means to some end, and therefore to participate in determining the future direction of the firm in which they have a stake. The stakeholder theory asks a decision maker to consider, in reaching a business decision, the interest of each individual or entity that holds a stake in that decision, or who will be affected by the decision. In order to consider the stakeholders of a business decision it is critical to be able to understand the interest of each party, to be able to empathetically evaluate what the potential impact on the stakeholder will be and what the stakeholder perspective on the decision is likely to be. This is not as easy as it may first appear. For instance, one might not necessarily be able to

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identify all of the parties who might be impacted upon, or to completely understand the nature of each party’s interests, or even the effect the decisions will have in the end. According to the stakeholder view, businesses play an important role. Businesses help solve problems of public concern and that this role can be profitable too to do so (Argandona, 1998; Donaldson and Dunfee, 1994). Since the firm has a responsibility to many constituencies, it is not accurate to claim that a firm owes allegiance only to the owners or shareholders of the firm. Nor is it clear from a moral point of view that the interests of the shareholders always take precedence over other interests (De George, 1995). The stakeholder perspective asserts that managers should weigh and balance all of the competing demands on a firm by each of those who have a claim upon it, in order to arrive at the firm’s obligation in any particular case (Goodpaster, 1991). Therefore managers should consider carefully all the obligations involved, instead of just looking from the point of view of profitability and from the point of view of the shareholders. This view is compatible with the utilitarian approach and does not preclude the interests of the shareholders overriding the interests of the other stakeholders affected, but it ensures that all affected will be considered. Business should be conducted in a way that achieves profit, but not at the expense of, or against the interest of, the different stakeholders of the firm, other than the stockholders. It simply means that all those whose interests are involved in a particular business decision get fair consideration. 8.2.2

Personal Moral Philosophies

Research has identified several factors that influence managers’ reactions to the unethical behaviour of their subordinates (Bellizzi, 1995; Bellizzi and Norvell, 1991) and how managers’ ethical orientations affect their decisions about ethical issues faced by themselves and their subordinates (Barnett et al., 1994). One measure of ethical orientation, personal moral philosophy, is a potentially key influence on managers’ ethical decision making (Ferrel et al., 1989; Hunt and Vitell, 1986). Personal moral philosophy has been found to influence decisions about a wide variety of both non-business and business-related ethical issues (Barnett et al., 1994; Forsyth et al., 1988; Vitell et al., 1993). Managers’ moral philosophies may be particularly important due to the influence these managers can have on the ethical climate of their organizations (Schwepker et al., 1997; Wotruba, 1990). Past empirical studies have examined moral philosophy and its impact on the ethical decision making of marketers (Barnett et al., 1994; Tansey et al., 1994; Vitell and Singhapakdi, 1993). The moral philosophy construct is based primarily

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upon the ethical theories proposed by Forsyth (1980) and, within this framework, individuals’ moral philosophies can be parsimoniously represented by the extent to which they are relativistic and idealistic (Forsyth, 1992). Forsyth (1980) developed a taxonomy of moral philosophies based on the relativism and idealism dimensions. Table 8.1 presents this taxonomy, with a summary of the characteristics of ‘absolutists’, ‘situationists’, ‘subjectivists’, and ‘exceptionists’. Relativism Relativism is the degree to which an individual ‘rejects universal moral rules’ as appropriate guidelines for ethical decisions (Forsyth, 1980, p. 175). According to Forsyth, individuals high on ‘relativism’ (highly relativistic individuals) generally feel that moral actions will depend upon the nature of the situation and the individuals involved (that ethics is relative). Relativists believe that morally correct actions will often produce negative consequences as well as positive ones. What is right in one situation may be wrong in another. Relativists will also tend to emphasize circumstances over violation of ethical principles when judging others. Highly relativistic individuals should be less likely to make harsh judgements about questionable actions, since they believe that it is impossible to apply universal principles or rules to every situation. They may be hesitant to judge others’ behaviour without being intimately familiar with the situational factors that contributed to the questionable behaviour. Table 8.1

Taxonomy of personal moral philosophies High relativism

Low relativism

High idealism

Situationists ● Rejects moral codes ● Personal analysis of actions in each situation ● Relativistic ● Idealistic skeptic

Absolutist ● Accepts moral codes ● Ethical decisions ● Must not harm others ● Deontologist

Low idealism

Subjectivists ● Rejects moral codes ● Personal values determine judgments, not universal codes ● Ethical egoist

Exceptionists ● Accepts moral codes, but open to exceptions ● Optimal outcomes not possible for all ● Teleologists: utilitarian

Source: Adapted from Forsyth (1992) and Tansey et al. (1994).

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Idealism Idealism involves the extent of an individual’s concern with the welfare of others (Forsyth et al., 1988). Idealism refers to the degree to which individuals assume that desirable consequences can always be obtainable with the right action (Forsyth, 1980, p. 176). Individuals high on ‘idealism’ assume that harming others is always avoidable and these individuals tend to exhibit higher honesty and integrity. Idealistic individuals accept universal principles when making ethical judgments. An idealist, however, accepts the idea that good outcomes for all can be achieved by morally correct actions. Individuals who are idealistic and non-relativistic (absolutists) seem consistently more likely to condemn morally ambiguous actions. Since idealistic individuals believe that it is possible to avoid harm to all stakeholders if the morally correct action is chosen, they are likely to judge questionable actions with mixed outcomes more harshly than non-idealistic individuals. 8.2.3

Personal Values as Predictors of Ethical Values in Business

According to Connor and Becker (1979), an individual’s attitudes are based on the personal value system of the individual. Dessler (1991) defines values as a basic belief about what is important and unimportant, what one should do or should not do. Values are prescriptive beliefs and are the underlying antecedents of behaviour as well as the linchpin of ethical decision making (Rokeach, 1979). Thus ethical values are prescriptive beliefs about what is right and what is wrong (Fritzsche, 1997). Values may be based on rules and are referred to as deontological or rule-based beliefs. Alternatively, values may be based on the perceived outcomes or ends and are referred to as teleological beliefs (see Table 8.1). Previous studies have found that adherence to deontological and/or teleological norms affect individuals’ judgments about ethical issues (Fritzsche and Becker, 1984; Hunt and Vasquez-Parraga, 1993; Mayo and Marks, 1990). Singhapakdi et al. (1995) examined the importance of ‘relativism’ and ‘idealism’, two moral philosophy components as predictors of the importance of ethical values. Their study suggests that idealistic and non-relativistic marketers (absolutists) are more likely to rate ethical issues as important and to judge ethically ambiguous actions more harshly than others. Singhapakdi et al. (1995) found support for the hypothesized positive influence of idealism on a marketer’s perceptions of the importance of ethics and social responsibility in achieving organizational effectiveness. Blair et al. (1999) found that, for American managers, idealism is a significant and positive predictor of the perceived importance of ethics and social responsibility in achieving organizational effectiveness. Relativism, however, is not significantly correlated with the perceived importance of

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ethics and social responsibility in achieving organizational effectiveness. In the case of Malaysian MBA students, their study found that on the stakeholder factor, relativism is not significant, while idealism is a significant and positive predictor of the importance of ethics. With regard to the stockholder factor, Malaysian MBA students’ relativism was found to be significant and negatively correlated, while idealism was found to be significant and positively correlated with the perceived importance of ethics. 8.2.4

Research Hypotheses

In many respects, the study presented here replicates that by Blair et al. (1999), with the exception that the sample of respondents for this study comprises actual owner-managers of Malaysian SMEs instead of Malaysian MBA students. This study is aimed at testing whether the personal values of the owner-managers of Malaysian SMEs (relativism or idealism) can also predict their ethical values in business. The findings enhance our knowledge and understanding of whether cultural factors influence the ownermanagers’ personal ethical values and whether these personal moral values impact on the managers’ perception of the importance of ethics and social responsibility. Specifically, this study tests the following hypotheses. SME owner-managers who are high on idealism are more likely to rate ethical issues as important and are more likely to judge ethically ambiguous actions more harshly than others. Hypothesis 1: Idealism positively influences perceptions of the importance of ethics and social responsibility in achieving organizational effectiveness for Malaysian SMEs’ owner-managers. SME owner-managers who are more relativistic are less likely to make harsh judgments about questionable actions. They tend to believe that it is impossible to apply universal principles or rules to every situation. Thus they may not perceive that ethics and social responsibility is important in their decision making. Hypothesis 2: Relativism negatively influences perceptions of the importance of ethics and social responsibility in achieving organizational effectiveness for Malaysian SMEs’ owner-managers. The findings of the hypothesis testing may indicate whether the SME owner-managers perceive ethics and social responsibility as important in achieving organizational decision making, and whether this perception is influenced by their personal moral values.

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195

RESEARCH METHODOLOGY

8.3.1 Operationalization of Variables and Reliability of Measurement Instrument The reliability of a measure indicates the extent to which the measure is without bias (error free) and hence offers consistent measurement across time and across the various items in the instrument (Sekaran, 2000). It indicates the stability and consistency with which the instrument measures the concept and helps to assess the ‘goodness’ of a measure. The internal consistency of measures is indicative of the homogeneity of the items in the measure. In other words, the items should ‘hang together as a set’, and be capable of independently measuring the same concept such that the respondents attach the same overall meaning to each of the items. This is indicated when the items and the subsets of items in the measuring instrument are highly correlated. Consistency can be examined through inter-item consistency reliability tests. This is a test of the consistency of respondents’ answers to all items in a measure. To the degree that the items are independent measures of the same concept, they will be correlated with one another. The most popular test of inter-item consistency reliability is the Cronbach’s coefficient alpha or Cronbach’s alpha (Cronbach, 1946; Cronbach, 1990), which is used for multipoint-scaled items. The higher the coefficients, the better the measuring instrument. This study utilizes the PRESOR instrument developed by Singhapakdi et al. (1995) to measure the perceived relative importance of ethics and social responsibility on business effectiveness. This scale measures attitudes similar to the ‘stockholder’ and ‘stakeholder’ perspectives along separate dimensions of the perceived importance of business ethics. The PRESOR instrument, originally containing 16 items, was developed to measure the perceived relative importance of ethics and social responsibility as a refinement on the Organizational Effectiveness Menu previously developed by Kraft and Jaunch (1992) to assess business effectiveness. Blair et al. (1999) also utilized this instrument and interpreted the items in the ‘Good Ethics Is Good Business’ factor of the PRESOR instrument in terms of the stakeholder view, and the items in ‘Profits Are Paramount’ factor according to the stockholder perspective. A similar interpretation of these factors will be adopted in this study. The Blair et al. (1999) study indicated that the reliability of the PRESOR was supported by a Cronbach alpha of 0.70. The importance of the two personal moral philosophies of idealism and relativism is measured by the Ethics Position Questionnaire (EPQ) developed by Forsyth (1980). The original Ethics Position Questionnaire consists of 20 items and these items were measured on nine-point Likert

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Scales; ten of the items are designed to assess relativism and the other ten items assess idealism. Scores on the two scales can range from 10 to 90, with higher scores indicating higher levels of idealism or relativism. The EPQ has consistently exhibited high levels of reliability with a Cronbach Alpha of 0.81 for the relativism scale and 0.86 for the idealism scale (Barnett et al., 1994). Similarly, past research has also supported a twofactor solution consistent with the idealism and relativism dimensions (Barnett et al., 1994; Singhapakdi et al., 1995; Tansey et al., 1994; Vitell and Singhapakdi, 1993). 8.3.2

Sample

The sampling frame of this study constitutes the companies listed in the 1999 Directory of the Small and Medium Industries Development Corporation (SMIDEC) of Malaysia. The actual study sample comprises 115 SMEs located in the state of Selangor. The respondent companies were chosen based on a stratified random sample. Using a well-stratified process, the element of diversities that may exist among industries would be captured. The sample size represents about 25.6 per cent of the sampling frame of 450 companies in clerical and electronic products, transportation equipment, machinery and engineering, as well as resource-based businesses. A small-scale company is defined as a company with full-time employees of not exceeding 50 and annual sales turnover not exceeding 10 million Malaysian ringgit. A medium-scale company, by contrast, is a company with full-time employees of 51 to 150 and with an annual sales turnover of 10 to 25 million Malaysian ringgit. 8.3.3

Data Collection

Data was collected via mailed questionnaires. Out of a total of 200 mailed questionnaires to SMEs within Selangor, 115 usable questionnaires were collected for analysis. This represents a 57.5 per cent response rate. The respondents comprised owner-managers of these SMEs.

8.4 8.4.1

RESULTS Factor Analysis

Because the PRESOR scale has been shown to have a different factor structure in previous studies (Singhapakdi et al., 1995; Etheredge, 1999),

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the multivariate statistical technique of factor analysis was carried out on both the PRESOR and EPQ instruments. Factor analysis is a technique that is particularly suitable for analysing the pattern of complex, multidimensional relationships for a large number of variables and to determine whether or not the information can be condensed or summarized in a smaller set of factors or components. It addresses the problem of analysing the structure of interrelationships (correlations) among a large number of variables (for example scores or questionnaire responses) by defining a set of common underlying dimensions, known as factors. This type of analysis can first identify the separate dimensions of the structure and then determine the extent to which each variable is explained by each dimension. This analysis is an additional means of determining whether items are tapping into the same construct. The analysis is carried out to test the reliability of the scales again and to ensure that these instruments are applicable in the Malaysian cultural context. 8.4.2

Measure of Sampling Adequacy (MSA) and Test of Sphericity

Preferably, for factor analysis, the sample size should be 100 or larger and, as a general rule, the minimum is to have at least five times as many observations as there are variables to be analysed (Hair et al., 1995). Therefore, there is a need to ensure that the data matrix in this study has sufficient correlations to justify the application of factor analysis. To ensure that critical assumptions underlying the utilization of, and appropriateness of, factor analysis for the data set that were collected in the study, the Kaiser–Meyer–Olkin statistical test for measuring sampling adequacy (MSA) and the Bartlett test of sphericity were carried out prior to factor analysis. Inspection of the anti-image correlation matrix reveals that all the measures of sampling adequacy (MSA) are well above the acceptable level of 0.5. The anti-image correlation matrix is the matrix of partial correlations among variables after factor analysis. This matrix indicates the degree to which the factors ‘explain’ each other in the results. The diagonal values on the anti-image correlation matrix contains the measures of sampling adequacy for each variable, and the off-diagonal values are partial correlations among variables. The Bartlett test of sphericity provides the statistical probability that the correlation matrix has significant correlation amongst at least some of the variables. The results of the Bartlett test of sphericity is significant and the Kaiser– Meyer–Olkin measure of sampling adequacy is greater than 0.60 (see Table 8.2), thus offering further evidence of the factorability of these items. Therefore, we conclude that it is appropriate to proceed with factor analysis.

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Table 8.2

Factor analysis results

Items Factor 1: Idealism 1. Deciding whether or not to perform an act by balancing the positive consequences of the act against the negative consequences is immoral. 2. The dignity and welfare of people should be the most important concern in any society. 3. Moral actions are those which closely match the ideals of the most perfect action. Factor 2: Relativism 1. There are no ethical principles that are so important that they should be a part of any code of ethics. 2. Moral standards are simply personal rules which indicate how a person should behave, and are not to be applied in making judgments of others. 3. No rule concerning lying can be formulated, whether a lie is permissible or not permissible totally depends on the situation. Kaiser–Meyer–Olkin measure of sampling adequacy Bartlett’s Test of Sphericity Approx. chi square df Sig.

8.4.2

Factor loading

Means

0.65

2.57

0.84

4.97

0.73

5.57

0.78

3.75

0.88

3.00

0.72

3.92

0.720 749.273 190 0.000

Factor Structure

Factor extraction, using the maximum likelihood extraction method, was carried out to determine the number of factors necessary to represent the data, and varimax rotation was utilized to make the factor structure more interpretable. Using the maximum likelihood extraction and varimax rotation method in factor analysis for the EPQ scale, two factors emerged with eigenvalues higher than one. Both of these factors accounted for 53.97 per cent of the variance, with the first factor accounting for 36.15 per cent of the variance and the second factor accounting for 17.83 per cent of the variance. Results of factor analysis on the PRESOR scale for the 115 subjects yielded three factors as similarly reported in previous studies (Etheredge, 1999; Blair et al., 1999; Singhapakdi et al., 1996). The first factor, corresponding to the ‘stakeholder’ view, accounts for 26.06 per cent

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of the variance. The second factor, corresponding to the ‘stockholder’ view, accounts for 23.30 per cent of the variance. The third, however, only accounts for 15.9 per cent. Together all three factors account for a total of 65.3 per cent of the variance. 8.4.3

Reliability of Measures

Reliability analysis was carried out on both the PRESOR and the EPQ instruments utilized in this study. Generally, the Cronbach alpha (measuring the reliability of the research variables) ranges from 0.6 to 0.7, with the exception of ‘idealism’ with a lower Cronbach alpha reliability value of 0.54. The results obtained, including means and standard deviations of the research measures, are depicted in Table 8.3. 8.4.4

Hypothesis Testing: Regression Analysis

To test Hypotheses 1 and 2, multiple regression analysis was conducted on the stakeholder and stockholder factors as dependent variables with relativism and idealism as the independent variables. Adjusted Coefficient of Determination (R2), Beta Coefficients or standardized regression coefficients, F and t values were examined. The results of the regression analysis, as shown in Table 8.4, indicate that relativism is significant and negatively correlated (t ⫽ ⫺3.20, p ⬍ 0.002) with the stockholder factor (Adj. R2 ⫽ 0.076, F ⫽ 5.662, p ⬍ 0.005), while idealism is positively but not significantly correlated (t ⫽ 0.37, p ⬍ 0.71) with the stockholder view. However, both relativism (t ⫽ ⫺0.96, p ⬍ 0.34) and idealism (t ⫽ ⫺1.07, p ⬍ 0.29) were found to be negatively, but not significantly, correlated with the stakeholder factor (Adj. R2 ⫽ 0.013, F ⫽ 1.766, p ⬍ 0.18). Therefore Hypothesis 2 is supported by the results of the regression technique, but no support was indicated for Hypothesis 1. Table 8.3

Reliability of measure

Measures

No. of items

Mean

Std. deviation

Cronbach alpha

PRESOR Scale Factor 1: Stakeholder view Factor 2: Stockholder view

5 6

27.7 28.3

7.4 6.0

0.63 0.67

EPQ Scale Factor 1: Idealism Factor 2: Relativism

3 3

13.1 10.7

2.8 3.4

0.54 0.64

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Table 8.4

Regression analysis

Dependent variable Independent variable

Beta

t-value

Sig. t

Stakeholder Factor Relativism Idealism (Adj. R2 ⫽ 0.013, F ⫽ 1.766, Sig. F ⫽ 0.176)

⫺0.098 ⫺0.110

⫺0.962 ⫺1.073

0.338 0.286

Stockholder Factor Relativism Idealism (Adj. R2 ⫽ 0.076, F ⫽ 5.662, Sig. F ⫽ 0.005)

⫺0.316 0.037

⫺3.199 0.371

0.002 0.712

Examination of collinearity diagnostics indicate high Tolerance Values (⬎0.40) as well as low VIF or Variance Inflation Factor values (⬍10.0) for ‘idealism’ and ‘relativism’. This implies that the problem of collinearity (correlation between the two independent variables, relativism and idealism) is not significant and does not reduce the predictive power of relativism and idealism as the independent variables, nor will it impact upon the study’s findings. The results of the data analysis indicate that the majority of these SME owner-managers hold on to the moral personal values of idealism (refer to Table 8.3: ␮ ⫽ 13.1). However, what is interesting is that those ownermanagers who are idealist may not necessarily perceive ethical and social responsibility as important; whilst those who are relativists, according to this study, will perceive ethical and social responsibility as unimportant in their decision making related to achieving organizational effectiveness (refer to Table 8.4: Adj. R2 ⫽ 0.076, F ⫽ 5.662, Sig. F ⫽ 0.005 and t-value for relativism is ⫺3.199, Sig. t ⫽ 0.002).

8.5

DISCUSSION AND IMPLICATIONS

This study has reported the results of a national study of the moral philosophies of owner-managers of Malaysian SMEs, and the perceived importance of ethics for their business operations. A key finding of this study is that these SME owner-managers tend to score higher on the stockholder view (␮ ⫽ 28.3) as compared to the stakeholder view (␮ ⫽ 27.7) and idealism (␮ ⫽ 13.1) as compared to relativism (␮ ⫽ 10.7). Another interesting finding is that relativism is not a significant predictor of the stakeholder view (t ⫽ ⫺0.96, p ⬍ 0.34) amongst these SME owner-managers.

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201

Instead relativism was found to be negatively correlated with, and a significant predictor of, the stockholder view (t ⫽ ⫺3.20, p ⬍ 0.00). This supports the results of Blair et al. (1999), who found that for the Malaysian MBA students, relativism was significant and negatively correlated with the stockholder factor. Although the present study also found that idealism is positively correlated with the stockholder view, the correlation is not significant. Perhaps this implies that, generally, the SME owner-managers tend to hold to the perspective that ‘profits are paramount’. This may be one possible reason why the Malaysian SMEs managed to survive in comparison to their larger conglomerate counterparts during the 1997 financial crisis. Furthermore, the finding that they are high on idealism indicates that they may tend to exhibit high honesty and integrity but hold on to the perspective of ‘subordination of ethics and social responsibility’ in the achievement of organizational effectiveness. Thus they are more likely to say that one’s ethical obligations do not extend beyond the minimum actions required to operate within the law as long as it does not hinder profitability. One possible explanation for these findings could be from the perspective of cultural and value influence on organizational behaviour and task implementation in Malaysian companies. According to Asma Abdullah (1994), Malaysians tend to be more ‘collectivists’ rather than individualistic in terms of attitudes at work. Malaysians generally emphasize working together, relationships with work colleagues and group harmony. The finding of high idealism amongst owner-managers of Malaysian SMEs seems to concur with the finding of Blair et al. (1999) that suggested a possible linkage between high idealism and the importance in Malaysian culture of not harming others or hurting other’s feelings and the important value of preserving one’s face. ‘Preserving face’ implies maintaining an individual’s dignity by not humiliating or embarrassing a person in front of others. Just as we all choose our own natures, so must we choose our own ethical precepts. The findings of this study indicate that moral responsibility belongs to each of us individually, and in our own unique ways. The findings on the stockholder view also indicate that the majority of these Malaysian SMEs seemed to take a neutral approach of stressing that good ethics may not necessarily mean good business; moral business practices will have an economic advantage only in the long run. Thus this provides little incentive for businesses that are designed to exclusively seek short-term profit. As more and more businesses compete for the same market, short-term profits will dictate the decisions of many companies simply as a matter of survival. It may be that in difficult times, businesses are more concerned with economic survival and different results may emerge in more prosperous times. Furthermore, some moral business practices may

202

Internal aspects

not be economically viable even in the long run. This might be the case with retaining older workers who are inefficient, as opposed to replacing them with younger and more efficient workers. Finding and following the moral course is not easy and this may be particularly acute for the business person. The pressure to produce is intense and the temptation to cheat may be great. Although the law provides useful points as for minimum behaviour, no clear moral guidelines have emerged. Therefore, when the business person is faced with a difficult decision, a common strategy is simply to do what tends to be correct to the individual at any given moment. Our results highlight the unique influence of cultural values on perceived importance of ethics and social responsibility in business operations in achieving organizational effectiveness. Most concepts and courses on business ethics were developed in Western Christian-dominated countries. This leads to ethnocentric perspectives about ethical standards. There is a need to examine in what ways and to what extent the normative ideas about business behaviour in Asian cultures are similar to, or different from, those of the West. Business ethics are culture specific and what is considered normative in one culture may be considered unethical in another. In many South-East Asian nations, for instance, favouritism, nepotism and personal connections have a significant impact on owner-managers’ decisions. However, this is usually explained in terms of cultural factors such as strong kinship ties and obligations that expect individuals to give preference to family. In undertaking this study, no evidence of business ethics initiatives were found amongst the SMEs studied in the Malaysian private sector. Most local SMEs do not have written or documented ethical codes, although there were some beginnings among firms involved in export businesses. There appear to be no business initiatives against corruption even though, with the growth in business, white-collar crime is on the increase. Furthermore, with a few exceptions, there are also no business initiatives in the training of employees or managers on business ethics amongst most SMEs. Business people in SMEs generally have a very narrow and limited conception of who the stakeholders are in their organizations. It is usually limited to the stockholder. The need to establish a wider view of stakeholders as including workers, suppliers, consumers and the public at large is a necessary condition for the development of business ethics amongst SMEs. SMEs provide jobs for a large proportion of the labour force, especially in rural areas where the population is too small to justify large industries. These SMEs could play a meaningful role in underdeveloped parts of many Asian countries. The provision and creation of jobs by the SME sector therefore ensures a healthy balance in economic growth in both the urban

Ethical values in business

203

and rural areas and thereby promotes economic stability. The contribution of SMEs to the community in the form of social services, training and job provision is therefore of crucial importance. It is extremely important that guidelines be set for SMEs to involve themselves more effectively in the social responsibility and ethical conduct of businesses in the country. Presently, many underdeveloped and developing countries are experiencing socio-political and economic changes. In order to promote the image of an enterprise, it is essential that social involvement and ethical conduct of the enterprise be emphasized. SMEs generally should strive for greater transparency, communication and linkage with communities in which they operate. Perhaps they could address, amongst other things, employee welfare, in terms of housing, medical and other social services, sponsoring essential community services, aid against pollution, occupational safety as well as support for community development programmes.

8.6

CONCLUSIONS AND LOOKING TO THE FUTURE

In conclusion, SMEs should consider some of the trends that will impact on development in business ethics in the coming decade over the period 2003–2013 and some of the developments that are needed in a global economy. There is the beginning of interest in ethical issues with the advent of globalization and its impact on many Asian and South-East Asian countries. Thus, an awareness of, and a commitment to, business ethics is especially important for SMEs embarking on international business where institutionalized safeguards are less established and transactions are between people from different cultures. The success of globalization is dependent on the establishment of a universe of meanings and of discourse on normative patterns of behaviour. Ethical behaviour is essential for longterm business survival and success, both from a macro perspective and a micro perspective. From a macroeconomic perspective, unethical behaviour like bribery, unfair discrimination, deceptive information, coercive acts and theft usually distorts the market system, leading to an inefficient allocation of resources. At the micro and individual firm level, unethical behaviour, such as failure in meeting fiduciary responsibility and actions resulting in mistrust in supplier, customer and employee relationships, leads to decreased long-run performance. To implement business ethics amongst SMEs, one has to pay more attention to the discipline of business codes of conduct. These operating rules and guidelines should be set up and enforced by established institutions and associations. This situation represents a great challenge for business ethics.

204

Internal aspects

To sensitize and educate business people is a very difficult task, because many people in underdeveloped and developing countries believe that the first and most important thing is to develop the economy, while they lose sight of the essential things. The economy, during the recent economic and financial crisis, overrides everything and this prejudice strongly influences many people, including the government, entrepreneurs and workers. Business ethics as a conscious endeavour, however, is needed to advocate, promote, apply and cultivate a balanced relationship between business and society. Committed entrepreneurs with their foresight, sagacity and unique mission play a critical role in this process that aims beyond the narrow benefits of business. It is also important to develop rules and guidelines on the basis of appropriate standards and established personal characteristics of business people. The major issues that need to be addressed in the field of business ethics amongst SMEs include: ●

●

●

●

● ● ●

●

The approval and support of entrepreneurs and enterprises of the academic discipline of business ethics. Organizational policy development on a comprehensive code of ethics that should be implemented as part of standard operating procedures of SMEs. Attention on issues that invite unethical behaviour amongst SMEs in policy development. Guidance and tools for entrepreneurs and SMEs to evaluate the ethical dimensions of a decision alternative. Benefits and social obligations of the business enterprise. Equal treatment of technical and human aspects in business. The relationship between justice and efficiency in business organizations. Understanding the personal values and organizational mediating factors relationship amongst decision makers in SMEs.

There are a number of limitations regarding this study. Its focus has been limited to owner-managers of Malaysian SMEs. The study conducted, like any other correctional analysis, is susceptible to the caveat regarding causation prevalent in all cross-sectional research. Another caveat to this study is the variance research design approach, which is limited in terms of its static perspective. Another limitation also applies in terms of common method variance based on the utilization of a single research data collection method and data based solely on individual cognition and perception. Behaviour in actual situations might differ. Furthermore, future research may possibly study whether personal moral philosophies of the SME

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205

owner-managers influence their ethical behavioural intentions and ethical judgments. Future research should also look at the possible link between personal characteristics of owner-managers of SMEs and their personal moral philosophy.

REFERENCES Argandona, A. (1998), ‘The stakeholder theory and the common good’, Journal of Business Ethics, 17, pp. 1093–1102. Asma, Abdullah (1994), ‘Leading and motivating the Malaysian workforce’, Malaysian Institute of Management (MIM), 29 (3), pp. 24–40. Barnett, T., K. Bass and G. Brown (1994), ‘Ethical ideologies and ethical judgments regarding ethical issues in business’, Journal of Business Ethics, 13, pp. 469–80. Bellizzi, J.A. (1995), ‘Committing and supervising unethical sales force behavior: the effects of victim gender, victim status, and salesforce motivational techniques’, Journal of Personal Selling and Sales Management, 15 (Spring), pp. 1–15. Bellizzi, J.A. and D.W. Norvell (1991), ‘Personal characteristics and salesperson’s justifications as moderators of supervisory discipline in cases involving unethical sales force behavior’, Journal of the Academy of Marketing Science, 19 (Winter), pp. 11–16. Blair, M.E., C.M. Axinn and S.V. Thach (1999), ‘The ethical ideologies of American and Malaysian MBA students as predictors of ethical values in business’, Proceedings (Part II), 7th Tun Abdul Razak International Conference, 2–4 December, Penang, Malaysia: School of Management, University Sains Malaysia, Kuala Lumpur, pp. 611–20. Carson, T. (1993), ‘Friedman’s theory of corporate responsibility’, Business and Professional Ethics Journal, 12, pp. 3–32. Connor, P.E. and B. Becker (1979), ‘Values and the organization: suggestions for research’, in M. Rokeach (ed.), Understanding Human Values: Individuals and Societal, New York: Free Press. Cronbach, L.J. (1946), ‘Response sets and test validating’, Educational and Psychological Measurement, 6, pp. 475–94. Cronbach, L.J. (1990), Essentials of Psychological Testing, New York: Harper &Row. De George, R.T. (1995), Business Ethics, Englewood Cliffs, NJ: Prentice Hall. Dessler, G. (1991), Management, New York: Prentice-Hall. Donaldson, T. and T.W. Dunfee (1994), ‘Toward a unified conception of business ethics: integrative social contracts theory’, Academy of Management Review, 19, 2 (April), pp. 253–84. Etheredge, J.M. (1999), ‘The perceived role of ethics and social responsibility: an alternative scale structure’, Journal of Business Ethics, 18, pp. 51–64. Ferrel, O.C., L.G. Gresham and J. Fraedrich (1989), ‘A synthesis of ethical decision models for marketing’, Journal of Macromarketing, 9, pp. 55–64. Forsyth, D.R. (1980), ‘A taxonomy of ethical ideologies’, Journal of Personality and Social Psychology, 39, pp. 175–84. Forsyth, D.R. (1992), ‘Judging the morality of business practices: the influence of personal moral philosophies’, Journal of Business Ethics, 11, pp. 461–70. Forsyth, D.R., J.L. Nye and K. Kelly (1988), ‘Idealism, relativism, and the ethic of caring’, Journal of Psychology, 122, pp. 243–8.

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Friedman, M. (1970), ‘The social responsibility of business is to increase its profits’, New York Times Magazine, 13 September. Fritzsche, D.J. (1997), Business Ethics: A Global and Managerial Perspective, New York: McGraw Hill. Fritzsche, D.J. and H. Becker (1984), ‘Linking management behavior to ethical philosophy: an empirical investigation’, Academy of Management Journal, 27 (March), pp. 166–75. Goodpaster, K. (1991), ‘Business ethics and stakeholder analysis’, Business Ethics Quarterly, 1 January, pp. 53–72. Hair, J.E. Jr., R.E. Anderson, R.L. Tatham and W.C. Black (1995), Multivariate Data Analysis With Readings, Englewood Cliffs, NJ: Prentice Hall. Hartman, L.P. (1998), Perspectives in Business Ethics, Chicago, Il: McGraw Hill. Hunt, S.D. and S. Vitell (1986), ‘A general theory of marketing ethics’, Journal of Macromarketing, 6 (Spring), pp. 5–16. Hunt, S.D. and A.Z. Vasquez-Parraga (1993), ‘Organizational consequences, marketing ethics, and sales force supervision’, Journal of Marketing Research, 30 (February), pp. 78–90. Kraft, K.L. and L.R. Jaunch (1992), ‘The organizational effectiveness menu: a device for stakeholder assessment’, Mid-American Journal of Business, 7 (1) (Spring), pp. 18–23. Mayo, M.A. and L.J. Marks (1990), ‘An empirical investigation of a general theory of marketing ethics’, Journal of Academy of Marketing Science, 18 (Spring), pp. 163–71. Rokeach, M. (1979), The Nature of Human Values, New York: Free Press. Schwepker, C.H., O.C. Ferrel and T.N. Ingram (1997), ‘The influence of ethical climate and ethical conflict on role stress in the sales force’, Journal of the Academy of Marketing Science, 25 (Spring), pp. 99–108. Sekaran, U. (2000), Research Methods for Business: A Skill-Building Approach, New York: John Wiley. Simon, H.A. (1965), Administrative Behavior, 2nd edn, New York: Free Press. Singapore Productivity and Standards Board (1997), ‘ASEAN small and medium enterprises: small and medium industries in Malaysia’, at http://aeup.brel.com/ sme.html Singhapakdi, A., S.J. Vitell, K.C. Rallapalli and K.L. Kraft (1995), ‘The perceived role of ethics and social responsibility on organizational effectiveness: a survey of marketeers’, Journal of the Academy of Marketing Science, 21 (Winter), pp. 49–56. Tansey, R., G. Brown, M.R. Hyman and L.E. Dawson, Jr. (1994), ‘Personal moral philosophies and the moral judgments of salespeople’, Journal of Personal Selling and Sales Management, 14 (Winter), pp. 59–75. Velasquez, M. (1996), ‘Why ethics matters: a defense of ethics in business organization’, Business Ethics Quarterly, 6, pp. 201–22. Vitell, S.J., K.C. Rallapalli and A. Singhapakdi (1993), ‘Marketing norms: the influence of personal moral philosophies and organizational culture’, Journal of the Academy of Marketing Science, 21 (Fall), pp. 331–7. Vitell, S.J. and A. Singhapakdi (1993), ‘Ethical ideology and its influence on the norms and judgments of marketing practitioners’, Journal of Marketing Management, 3 (Spring/Summer), pp. 1–11. Wotruba, T.R. (1990), ‘A comprehensive framework for analysis of ethical behavior, with a focus on sales organizations’, Journal of Personal Selling and Sales Management, 10, pp. 29–42.

PART III

Strategic aspects

9.

Key issues in understanding the internationalization process of the small firm: an Australian perspective Susan Freeman

9.1

INTRODUCTION

The global nature of many industries and the changes in working practices, which have emerged over recent years, are forcing many small and mediumsized enterprises (SMEs) to consider internationalizing their activities at a very early stage (Oviatt and McDougall, 1997; Keogh et al., 1998; Coviello and McAuley, 1999; Styles, 1998; Atkins and Lowe, 1994). Many studies and conceptual papers in the field of internationalization (Johanson and Vahlne, 1977; Welch and Luostarinen, 1988; Sullivan, 1994) and globalization (Porter, 1990; Ohmae, 1990; Yip, 1992, 1998) have discussed and addressed how rapidly internationalization has become a more desirable option for firms than in the past. This is primarily due to improvements in international communications and transportation and increased homogeneity of international markets (Welch, 1978; Siu and Kirby, 1998; Cafferata and Mensi, 1995; Leonidas et al., 1999). This increasing incidence of firm internationalization is not restricted to large firms. There is evidence that both small and medium-sized firms are also rapidly internationalizing, and often early in their development (Jack and Bower, 1997; Atkins and Lowe, 1994). In an empirical Scottish study by Jack and Bower (1997), where there were many small firms based in this small home market, early internationalization, assisted by networking, was seen as an important part of their development strategy to ensure growth and indeed survival. Greater understanding of the particular problems facing small businesses is of practical importance for those who are involved in small business (Huang and Brown, 1999) and for researchers, knowing that the problems can aid in directing their research effort (Banks and Taylor, 1991; Siu and Kirby, 1998; Cafferata and Mensi, 1995; Leonidas et al., 1999). For example, Day (2000) discusses the failure rate of many UK-based small firms, from numerous studies, possibly being as high 209

210

Strategic aspects

as 60 per cent. However, he suggests that this figure is overexaggerated and that it is more likely that ‘almost two out of every three small businesses do not leave a trail of wreckage, dissatisfied customers and bad debts in their wake’ (p. 1034). Day (2000) suggests that far more should be done in regard to research about the small firm, and the appropriate fit of government policies to assist their survival, than is currently the case: So the small firm is too important, too dominant and too much about creating the future business generation for marketing practitioners and educators not to consider how we can help it survive and prosper. (p. 1034)

Increasing globalization requires a response from the small firm, and small firms are responding through increasing participation in this world economy (Graham, 1999). This implies that greater understanding of small firm potential and contribution to the economy is required. For example, for small business owners and managers, the perception of the problems they face may influence their behaviour, such as information seeking (Pineda et al., 1998), knowledge acquisition, attention directing and business performance (Walsh, 1988). Policy makers also need to be aware of the specific problems facing small businesses (ABS, 1997a) as this will assist them in formulating policies and developing small business assistance programmes (SBAPs). For example, Asia is a growing region and Australian firms need to be equipped and skilled as well as supported by government economic, political and financial policy to compete effectively in the global economy. Globalization, for Australia, was seen in many respects as a return to levels of integration that characterized Australia’s earlier development. Yet modern twists to globalization are recognized, including fast growth in the Asian region, the nature of the modern technological change, the increasing involvement of the new service industries and increasing international competition. These factors will place a much greater premium on initiatives by both small firms and governments to improve the competitiveness of national economies (Graham, 1999; EPAC, 1995). Day (2000) suggests, given the pressure and obstacles facing the small firm: One might argue that marketing is different for the small firm compared to the larger organization, that is more intuitive, more creative, more about networking and more about operating under extreme time pressure and all without the comfort of being able to make decisions in an ordered and linear fashion. (p. 1035)

In summary, this chapter will address a number of issues related to small firm internationalization. In section 2, alternative viewpoints on the

An Australian perspective

211

concept of the small to medium-sized enterprise (SME) are discussed. Section 3 outlines the structure and contribution of SMEs to the Australian economy and section 4 analyses approaches to internationalization and Australian SMEs in the context of East Asia. In section 5, a discussion of some major research issues in the internationalization of SMEs is addressed, including recent trends and areas of current and future research focus. Finally, in section 6, a summary of the major conclusions and implications for the internationalization processes for SMEs is presented.

9.2

THE CONCEPT OF THE SMALL TO MEDIUM-SIZED BUSINESS: ALTERNATIVE VIEWPOINTS

The concept of the small to medium-sized firm needs to be clarified for the purpose of this chapter. What is a small firm? Internationally, the SME has been variously defined in terms of employee numbers, sales and profit levels (Banks and Taylor, 1991; Siu and Kirby, 1998; Cafferata and Mensi, 1995; Leonidas et al., 1999; ABS, 1997a, 1997b). In 1995, the Australian Federal Department of Employment, Workplace Relations and Small Business, for the purpose of their own programme of commissioned research on small firms, identified the most commonly used definition of small business which is also the one defined by the Australian Bureau of Statistics (ABS) (ABS, 1997a, 1997b). The ABS defined a small business as all manufacturing firms with less than 100 employees (5 to 99) and all other non-agricultural firms with less than 20 employees (5 to 19). A large firm in Australia is one employing 100 or more employees. Thus the definition of a small and medium-sized firm is one that has 5 to 99 employees in the manufacturing sector and 5 to 19 in all other nonagricultural sectors. The ABS also identified very small businesses (VSBs), which they refer to as micro-businesses, employing less than five people. However, there is no universally adopted definition of the term ‘small firm’. Other empirical studies, for example, an Australian study by Huang and Brown (1999), classified small businesses in terms of industry. The Huang and Brown (1999) study of small businesses was taken from a database funded by the Federal and State Governments of Western Australia for a study of 7544 businesses in 1997. This study was called the Business Growth Program (BGP). Businesses were classified according to the average employees in each industry category, comprising small manufacturing firms (employing 1 to 5), wholesale (employing 6 to 12 employees),

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retail (20 to 99 employees), and property and business services (employing 100 or more). Using the Australian Bureau of Statistics (ABS) standard definition, the last industry group mentioned in this study, property and business services with 100 or more employees, is defined as a large firm in the Australian economy. Therefore, it cannot be considered a small or even medium-sized business if standard Australian measures are used. So there is confusion over the use of definitions even in the Australian business environment. The range of definitions that focus on two factors, the number of employees and the level of sales of the firm, is considerable. For example, Calof and Viviers (1995), in an empirical study of 172 South African exporting manufacturing SMEs, defined an SME as having fewer than 1000 employees (1995, p. 74). The same study had ‘on average between 51 and 500 employees and had average sales of between 10 000 000 and 25 000 000 South African Rands’ (1995, p. 74). At the time of the study 3.17 rand was equivalent to one US dollar. However, the stage of economic development of South Africa is significant. It has a large rural economy, a large population, and a very large unskilled employee segment, which would indicate some distinct differences between the Australian and South African markets. It is suggested that two factors, employee numbers and firm sales, are two comprehensive factors for defining SMEs. However, the measures used in the South African study are too high for use in an Australian context. The Australian definition of an SME using the ABS framework would define ‘fewer than 1000 employees’ (Calof and Viviers, 1995) as indefinite. The average figure of employees in the Calof and Viviers study was 51 to 500. This would mean that the range of firms could be anywhere from one employee to 999 employees. This is an unworkable definition and incapable of being applied to the Australian or all Asia-Pacific markets, which are characterized by many small to medium-sized firms (Styles, 1998). The measures used in Calof and Viviers (1995) are too broad and lack accuracy and practicability. By contrast, Keogh et al. (1998), an empirical study using a case study method of data collection of six UK-based SMEs in the oil and gas industry, defined SMEs as those with less than 150 employees: ‘All companies had less than 150 employees’ (1998, p. 60). This market would seem culturally more similar to the Australian context than the prior study. However, sales were not included in this study as an additional measure of SMEs. This figure is certainly much closer to the ABS definition of between 20 to 99 employees. However as the UK market is larger in terms of population and firm number it would seem appropriate that a smaller unit of measurement is required for the Australian market.

An Australian perspective

9.3 9.3.1

213

SMALL AND MEDIUM-SIZED BUSINESSES IN AUSTRALIA Structure of Australian Small Business

As mentioned above, the Australian Industry Commission and Department of Industry, Science and Tourism in 1997 released a report, A Portrait of Australian Business, that was the second of a series of statistical reports presenting the results of a five-year Business Longitudinal Survey (BLS). The report presented survey results classified by firm size, industry and age. It was the first comprehensive and statistically reliable picture of Australian firms classified by size. The report provided general agreement on a number of factors about small business. It also suggested that while these firms are small in size, their economic contribution to the Australian economy is significant and that they are the major business category in the Australian market. However, their international involvement remains low, but other evidence suggests that more firms are now internationalizing to take advantage of international markets (ABS, 1997a, 1997b). The report tracked the growth and performance of these firms. Figure 9.1 summarizes the structure of Australian business in terms of numbers of businesses and people employed, by sector and business size for the 1996–97 report. The employment figures include both the government (public) and the private sector. The report provided a general view that Australian SMEs were active within the market and also entering international markets more readily. In the 1994–95 report there were 812 400 non-agricultural private sector businesses of which approximately 785 800 were small (Australian Industry Commission and Department of Industry, Science and Tourism 1997 report, A Portrait of Australian Business). The total employment in small business in this particular sector was 2.68 million. Small firms were responsible for 31 per cent of the total wages and salaries and 32 per cent of sales of goods and services in the Australian economy for 1994–95. This is not insignificant. The definition used for small business was that recommended by the ABS, namely 5 to 99 employees in manufacturing industry and 5 to 19 employees in all other nonagricultural industries. This definition included medium-sized enterprises, as firms employing 100 or more employees were classified as large firms. In Australia in 1994–95: ● ●

approximately 97 per cent of all businesses were small business; and approximately 2.7 million people were employed in small business, which represented nearly half of Australia’s private sector employment.

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Strategic aspects ALL BUSINESSES Total Public and Private sector • Businesses – 1 051 900 • Employed – 8302 900

PRIVATE SECTOR

Agriculture, Forestry & Fishing • Businesses – 117 400 • Employed – 345400

Non-Agriculture Sector • Businesses – 929 500 • Employed – 6470 600

PUBLIC SECTOR

Public Trading & General Government Organizations • Organizations – 5000 • Employed – 1486 900

PRIVATE SECTOR SMALL BUSINESS Agriculture, Forestry & Fishing • Businesses – 104 500 • Employed – 254600

Non-Agriculture Sector Small Business • Businesses – 899 700 • Employed – 3247 300

Non-Employing Businesses • Businesses – 409 100 • Own Account Workers – 640 800

Employers • Employed in their own business – 291 600

Employing Businesses • Businesses – 490 600 • Employed – 2 606500

Employees (Wage & Salary Earners) • Employees – 2314 900

Source: ABS 1997a.

Figure 9.1

The structure of Australian business 1996–97

Small firms were seen as dynamic and driving Australia’s level of economic growth (ABS, 1997a, 1997b). In the decade to 1994–95, small business provided nearly half of the 1.2 million new jobs that were created. These are significant facts and point to the importance of the small to medium-sized firm in the Australian market. It also indicates why it is important to know more about this unit of analysis, the small business. Small firms in Australia were also an important source of exports. Firms

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employing less than 20 persons in the 1995–96 report above accounted for approximately 15 per cent of total exports in 1995. These firms tended to be involved increasingly in R&D. Small businesses were responsible for more than 15 per cent of all private sector R&D activity in Australia. They were also important to innovation implementation. The same report confirmed that SMEs were responsible for introducing more fundamentally new innovations per employee than larger firms in Australia. Moreover, these innovations were a major contributor to economic growth and long-term prosperity as they could provide research for new product development or even entirely new industries (ABS, 1997a, 1997b). For the 1994–95 report the following characteristics of Australian business were identified. The majority of firms are more than five years old, holding true even for very small enterprises (VSEs: employing one to four people). However, the process of firm growth and higher exit rates by smaller firms ensures that the larger firms (100 or more employees) tend to be older. Nearly 96 per cent of all firms in the report (SMEs and large firms) had no foreign ownership. Foreign ownership was found to be relative to enterprise size. Less than 1 per cent of businesses employing less than five people had any form of foreign ownership. Yet approximately 50 per cent of the largest firms had at least some foreign ownership. In addition, approximately 4 per cent of all businesses in Australia export. Nearly 1.9 per cent of firms employed between one to four people and are therefore classified as ‘very small enterprises’ (VSEs). In summary, on average 45.7 per cent of firms employ over 100 people, which is classified as ‘large firms’ in the manufacturing and non-service sector in the Australian context. Finally, the study found that the ratio of 1 VSE to 25 large firms actually exported. This indicated that size is a considerable influence on the level of internationalization in the Australian market. Yet these small firms have had to adapt to changing internal (government policy) and external (globalization and international financial instability) conditions in order to compete with international firms both domestically and overseas. The globalization of many industries as well as the lack of supportive and integrated government policy at the national and international level has made this task very difficult for the small firm. Graham (1999) discusses the full impact of globalization that has been facilitated by Australian Federal government policy changes and, in particular, the noticeable shift to the political right, incorporating the embracement of economic ideology adopted in key economies such as the USA and the UK. For example, the conservative governments of Thatcher and Reagan pursued policies of liberalization, deregulation and privatization, which focused on and emphasized the private sector. In Australia the Labor government (1983–96) embarked on privatization, deregulation and tariff

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liberalization as key reforms during its period in government. In the area of government policy initiatives, market policies have been designed to allow private firms the freedom to make decisions about the allocation of resources which, combined with a reduction in transaction costs, results in increased globalization (Bora, 1995; Graham, 1999). Graham (1999) refers to three factors as specific twists to the modern globalization era for Australian SMEs, such as rapid growth in Asia, the involvement of new service industries, and the increased level of international competition, which have placed greater pressure on both firms and governments to generate new initiatives to improve the competitiveness of national economies. Graham summarizes the three ways that small firms have responded: 1.

2. 3.

By giving consideration to a range of factors when making investment and location decisions; for example tax, rents, availability of skilled workforce, transport and travel costs, efficient infrastructure and government incentives. By improving their human resource management, as ease of international movement of capital has enabled companies to seek competitive advantage through skilled and productive labour. By adopting a more global outlook in response to periods of slow growth in domestic markets and the emergence of growing regional markets (Graham, 1999; EPAC, 1995).

Despite these considerable obstacles small firms have made a sizeable contribution to national economies and international markets, and are active even as very small enterprises in the Australian market. 9.3.2

Micro-businesses

The contribution to the Australian economy by VSEs, or mico-businesses, comprising non-employing firms as well as those employing between one and four persons, is also very significant. In the 1996–97 report there were 751 500 micro-businesses representing 81 per cent of all private sector nonagricultural businesses. Micro-businesses accounted for 25 per cent of all employment. Moreover, non-employing businesses tended to be concentrated in the construction, property and business services, retail trade and manufacturing industries. In the 1996–97 report these four industries accounted for 63 per cent of the 409 100 non-employing businesses. The construction industry with 95 500 businesses (23.3 per cent of non-employing businesses) predominated, followed by property and real estate businesses

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(16.2 per cent), retail trade (15.8 per cent) and manufacturing (7.4 per cent). Other industries accounted for 37.3 per cent of non-employing businesses. Businesses employing one to four people accounted for about 10 per cent of all non-agricultural employing business income in Australia in the 1996–97 report. The figures for businesses with 5 to 19 employees and 20 to 99 employees were 21 per cent and 23 per cent respectively. Businesses with 100 or more employees accounted for 46 per cent of the income of nonagricultural employing businesses (ABS, 1997a, 1997b). In the 1995–96 report, the proportion of businesses with foreign ownership increased markedly as business size increased. Merely 1.5 per cent of businesses with one to four (VSEs) employees had any degree of foreign ownership. The proportion with foreign ownership increased slightly for firms with five to 19 employees (small businesses) and 20 to 99 employees (SMEs) (1.7 per cent and 7.1 per cent respectively), with a significant increase to 25.8 per cent for businesses with 100 to 499 employees, where approximately 49.1 per cent had some level of foreign ownership. The report provided support for the view that firm size does correlate with levels of foreign ownership (ABS, 1997a, 1997b). In the 1995–96 report, larger firms (100-plus employees) had a higher propensity to export goods and services than smaller firms. Of businesses with more than 200 employees 38 per cent were exporters. By comparison, less than 2 per cent of the smallest firms (employing 1–4 persons) exported goods and services. In the 1995–96 report, small firms (employing one to 19 employees) accounted for 11 per cent of the value of exports. The report provided support for the view that while internationalization offers firms opportunities for new markets, sales and market share, it is still very difficult for small business to begin this process. 9.3.3

The Business Environment

Australia is a successful and growing market that experienced solid economic growth in 1997–98, while most of its neighbouring countries in the Asia-Pacific region suffered a severe slump and weaker than anticipated international conditions (Industry Science Resources, 1997–98). Why has the Australian economy succeeded so well despite the Asia-Pacific financial downturn since late 1997? During 1997–98, the key drivers of growth were in two sectors, services and mining (Industry Science Resources, 1997–98). For example, the service sector accounted for 80 per cent of total employment and nearly 70 per cent of production. The two sectors grew at 5.2 per cent during 1997–98. Increases in employment only occurred in two sectors, agriculture by 2.2 per cent and services by 1.6 per cent (Industry Science Resources, 1997–98).

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The Asia-Pacific Rim countries and Australia are comprised of many SMEs (Industry Commission and Department of Industry, Science and Tourism, 1997). Many of these SMEs are international, some at a very early stage in their existence (Coviello and McAuley, 1999; Styles, 1998; Cavusgil, 1984). Internationalization is considered to be a major contributory factor to Australia’s global success (ABS, 1997a; Industry Commission and Department of Industry, Science and Tourism, 1997). Yet the level of internationalization of Australian small businesses remains under-researched, although some studies have suggested that the figure is very low (ABS, 1997a; Industry Commission and Department of Industry, Science and Tourism, 1997; Styles, 1998; Atkins and Lowe, 1994). Yet Ries (2001) highlights the significant contribution to the level of growth in the Australian economy that is being made by SMEs, and that they are increasingly involved in the East Asian economies (Industry Science Resources, 1997–98). But this region is challenging for these small firms. The recent Asian financial crisis has led to two particular problems for small firms in the Australian market: The plunge in the share values of mid-sized companies over the past year [2000] has two broad effects on business. One is that it makes the cost of raising new capital for acquisitions and expansions very expensive. The second is that it makes Australian companies vulnerable to takeover. Any Australian company trading at a 50 percent discount to its US or UK competitor is easy pickings. (Ries, 2001, p. 25)

This has led to much change in what can only be described as turbulent times in the business environment of Australia and its region of East Asia. But despite these problems, trade remains active. For example, 60 per cent of Australian merchandise exports have been to East Asian countries in recent years and total exports grew by more than 8 per cent during 1997–98 despite the financial crisis in Asia. However, this figure does reflect the fact that exporters have been diverting sales to alternate markets together with increased export competitiveness as a result of the depreciation of the Australian dollar. For these reasons, and the added burden of the addition of a Goods and Services Tax (GST) in mid-2000, many Australian smaller firms have had to list on the Australian Stock Exchange to raise the necessary capital. The reasons behind this type of approach are tactical – spread the risk. For example, Technology One Ltd, a small Australian accounting and administrative software firm, listed in 2000 and has decided to concentrate on international expansion to enhance growth following falling domestic market share and to recoup some returns on its considerable investment in R&D:

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[Technology One Ltd’s] solution has been to open offices in New Zealand and Malaysia and, once those countries have become positive contributors, [their] plan is to expand into markets such as Hong Kong and Singapore . . . [but they] won’t go to the US for the foreseeable future because of the difficulties of managing a far-flung empire . . . countries close to Australia with a Commonwealth background are more receptive to Australian products and ideas. (Ries, 2001, p. 25)

Similarly MYOB, another small Australian software administrator producer for the home market, listed in 2000 and feels it is crucial that they develop their electronic interchange business model offshore: Thus, over the next two or three years, MYOB will be making a determined effort to lift user numbers in several major offshore markets. While achieving critical mass offshore is essential to prosperity – and perhaps survival – in the short term, reported earnings will suffer. (Ries, 2001, p. 25)

MYOB has had to focus on long-term growth, through international expansion, and to sacrifice sales in the short run to achieve sustainability. Overall, small business in Australia has been active offshore. In Australia in 1994–95, approximately 97 per cent of all businesses were small business and nearly 2.7 million people were employed in small business, which represented nearly half of Australia’s private sector employment. In addition, nearly half of all firms in Australia had some form of international involvement (Industry Commission and Department of Industry, Science and Tourism, 1997). The suggestion has been made that firms in Australia are actively internationalizing (Australian Industry Commission and Department of Industry, Science and Tourism, A Portrait of Australian Business; Industry Science Resources, 1997–98). However, there is little empirical evidence, apart from this extensive national study, to support this, or even what the general level of internationalization of Australian SMEs might be (Styles, 1998; ABS, 1997a, 1997b). The literature has a great deal to say about the performance criteria for SMEs (Barney, 1991; Oviatt and McDougall, 1997; Coviello and McAuley, 1999; Robinson, 1999), but not about the nature of internationalization (Welch and Luostarinen, 1988; Sullivan, 1994; Renforth, 1998) and the level across industry sectors (Oviatt and McDougall, 1997; Keeble et al., 1998; Keogh et al., 1998). Firms that internationalize at inception are defined as start-ups or international new ventures (INVs) (Oviatt and McDougall, 1997). There is some suggestion that Australia has a number of successful INVs but no recent empirical evidence of the percentage of Australian SMEs in this category is available (Styles, 1998; ABS, 1997a and 1997b). The size of SMEs

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is significant. Nearly half of businesses in the Australian economy in 1996–97 had some level of international activity, but notably they were firms that were mostly large firms, defined as firms that are employing 100 or more. For example, approximately 49.1 per cent had some level of foreign ownership (ABS, 1997a, 1997b). Similarly, in the 1995–96 report, larger firms (100-plus employees) had a higher propensity to export goods and services than smaller firms. Larger firms, or businesses with more than 200 employees, were likely to be exporters 38 per cent of the time. How long SMEs take to internationalize their various value added activities, the extent and level of internationalization and how it occurs (entry mode) is also of interest to researchers (Keeble et al., 1998; Keogh et al., 1998; Sullivan, 1994). Older firms are more international (ABS, 1997a, 1997b). Yet that may have more to do with them having survived, and therefore going on to further levels of international activity, than to do with SMEs not internationalizing. It is easier to internationalize if you are an older and bigger firm as the learning curve is not so steep. However, the extent of SME internationalization, and when that takes place, is not sufficiently understood in the Australian context. This chapter has considered the impact on firm performance at different levels of internationalization in the literature. Evidence was not conclusive that there are differences in firm performance between SMEs that internationalize and those that do not (Keeble et al., 1998). The literature review considered the age of the SMEs as they internationalize, especially that percentage of SMEs that internationalize at inception (INVs) (Keeble et al., 1998; Keogh et al., 1998). However, there is a considerable difference between INVs and SMEs, as INVs focus on age not size (Oviatt and McDougall, 1997). In this study both aspects will be discussed, but the major focus in the literature, of the two aspects, is on size. This was defined in terms of number of employees (ABS, 1997a, 1997b). However, the number of employees needs to be related to industry sectors. The distinction was between manufacturing and non-agricultural sectors (ABS, 1997a, 1997b). The number of employees per sector is a more accurate measure as small numbers of personnel can utilize technological communication and transportation in a manner that used to be the exclusive prerogative of multinational enterprises (MNEs) (Cafferata and Mensi, 1995). Given the small size of the Australian economy, sales by international standards is not likely to provide a good measure of firm size. This chapter will define SMEs in terms of industry sector and numbers of employees. Use of a single measure alone, such as personnel, as a measure of the size of the firm is not viewed as accurate without including the sector, given the changing technological environment (Jack and Bower, 1997; ABS, 1997a, 1997b).

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Australian SME behaviour in the Asia-Pacific Rim has seen performance levels that do not reflect the general level of recovery in other Asian markets (Industry Commission and Department of Industry, Science and Tourism, 1997). Australian SMEs have been involved in the growth of a range of highly competitive, global industries. Australia recorded a 4.2 per cent GDP annual growth figure in December 1999 (Far Eastern Economic Review, 1999). This was well ahead of the annual growth rates of 1–2 per cent in many Asia-Pacific markets since 1997 (Far Eastern Economic Review, 1999). For example, annual economic growth rates for a range of East Asian markets in 1999 were China (8.2 per cent), Hong Kong (⫺1.0 per cent), Taiwan (4.5 per cent), Indonesia (⫺1.7 per cent), Malaysia (3.0 per cent), the Philippines (2.4 per cent), Singapore (4.0 per cent), Thailand (1.5 per cent), Japan (0.9 per cent), South Korea (7.0 per cent), India (5.8 per cent) and New Zealand (2.3 per cent) (Far Eastern Economic Review, 1999).

9.4 9.4.1

INTERNATIONALIZATION OF SMALL BUSINESS Approaches to Internationalization

Internationalization of the firm as an option is one thing, but implementing the actual process of internationalization activities is another. According to the literature there are a number of ways in theory by which the smaller firm can internationalize. Briefly, many researchers have presented internationalization of small to medium-sized businesses and new ventures as an orderly, well-planned step-by-step process, known as the Stage Model approach (Johanson and Vahlne, 1977; Keogh et al., 1998; Coviello and McAuley, 1999). However, there is now wide disagreement about this approach with more interest being placed on the Network Relationship approach (Keeble et al., 1998; Coviello and McAuley, 1999; Oviatt and McDougall, 1997; Keogh et al., 1998; Styles, 1998), which addresses the complexity of relationships in international business to provide an understanding of internationalization as a concept. SMEs are becoming increasingly active in international markets and contribute considerably to economic growth and prosperity of a market (Reynolds, 1997). However, the understanding of marketing principles as they apply to large and small businesses is not clear. While it is possible to argue that ‘basic principles of marketing [may be] universally and equally valuable to both large and small businesses’ (Siu and Kirby, 1998), the phenomenon of SMEs has only recently been addressed (Davis et al., 1985). The suggestion is made that SMEs do plan, but the question is whether this

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needs to be carried out formally with a marketing plan, and what specifics should be included (Carson, 1985; Hills, 1987; Hisrich, 1989). While there are a large number of research studies into marketing in the context of an SME or small business (Carson et al., 1995; Hills, 1987; Hisrich, 1989), the empirical evidence has tended to be ad hoc in manner. The general result has been a lack of any systematic approach to the subject (Carson et al., 1995). Marketing in small business in a systematic manner still remains underresearched (Carson, 1985; Carson et al., 1995). Thus an appropriate small business marketing theory, specifically related to the understanding and knowledge of issues such as strategic marketing (Hills, 1987; Hisrich, 1989) and the internationalization of SMEs (Cafferata and Mensi, 1995; Coviello and McAuley, 1999; Atkins and Lowe, 1994; Styles, 1998), is not available. The research tends to be plentiful in some areas but not in others. For example, the literature dealing with SME exporting is well developed and includes general research on a range of issues including the behaviour and strategies associated with exporting (Kaynak et al., 1987; Bonaccorsi, 1992; Baird et al., 1994; Dalli, 1995; Douglas, 1996). There are also a number of research streams that have developed an understanding of the relationship between firm size and export behaviour (Culpan, 1989; Samiee and Walters, 1990; Bonaccorsi, 1992) and the performance characteristics of SME exporters (Beamish et al., 1993; Bijmott and Zwart, 1994; Naidu and Prasad, 1994; Moini, 1995; Katsikeas et al., 1996). However research is developing in other related areas. 9.4.2

Australian SMEs in the Asian Context

Asia’s long-term position looks very positive (Yip, 1998; FitzRoy et al., 1998; Freeman, 1999; Goad, 1999; Far Eastern Economic Review, 1999), and global economic growth has remained strong in the first decade of the twenty-first century and is likely to continue. Yet the biggest risk facing all markets is the global financial market (Goad, 1999). This is largely the reason for the Asian crisis. Some Asian markets have survived better than others for various reasons. Consumer spending has not been consistent in Asia and the region was not anticipated to make a full regional recovery until 2001 (Goad, 1999). However, Australian firms have continued to perform well with exports for the period of 1997–98 in mining and manufacturing achieving an 8 per cent increase in merchandise exports, with 60 per cent of Australian merchandise exports to the East Asia region (Industry Science Resources, 1997–98). However, the level and extent of internationalization of Australian SMEs in this region and in others remains unclear without further research. Research indicates that Australian SMEs are active in international markets, especially

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223

in the Asia-Pacific Rim, and are contributing to the region’s economic growth and prosperity (Reynolds, 1997), but evidence is sparse with regard to volume and type of international involvement, including its depth, scope and dispersion. The increasing participation of SMEs in international markets has been captured in the substantial literature on SME export activity, and includes general research on behaviour and strategies associated with exporting (Kaynak et al., 1987; Baird et al., 1994; Dalli, 1995; Douglas, 1996). For example, studies have included the relationship between firm size and export behaviour (Culpan, 1989; Samiee and Walters, 1990; Bonaccorsi, 1992), and the performance characteristics of SME exporters (Beamish et al., 1993; Bijmott and Zwart, 1994; Naidu and Prasad, 1994; Moini, 1995; Katsikeas et al., 1996, 1997). More recent literature is now focusing not on SMEs and exporting behaviour and economic performance, but on the nature and the process of the internationalization of SMEs (Coviello and McAuley, 1999; Renforth, 1998; Freeman, 1999; Atkins and Lowe, 1994; Jack and Bower, 1997). Studies are explaining the process of international involvement of SMEs over time, as well as SMEs that leap straight into international markets and are known as ‘start-up’ firms (Robinson, 1999; McDougall and Oviatt, 1996; McDougall et al., 1994; McDougall et al., 1992; Oviatt and McDougall, 1997), and ‘international new ventures’ (INVs) (Robinson, 1999; Oviatt and McDougall, 1997; Katsikeas et al., 1996).

9.5 9.5.1

RESEARCH ISSUES IN THE INTERNATIONALIZATION OF SMEs Trends

Currently, research has tended to shift from a focus on SMEs and exporting to an understanding of the processes and patterns that explain how smaller firms increase their international involvement over time, and how relationship networks may be involved in this process (Hills, 1987; Hisrich, 1989; Cafferata and Mensi, 1995; Coviello and McAuley, 1999; Styles, 1998). Broadly, three specific schools of research, or theories, are presented in the literature. These three specific schools of research cover the literature on the process of firm internationalization. They do not apply specifically to SMEs and small business but broadly describe theories as they apply to firms in general, irrespective of size. They are, firstly, the Foreign Direct Investment (FDI) theory; secondly, the Establishment Chain (Stage) Models of Internationalization theory; and,

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thirdly, the Network Perspective theory. For example, studies such as Cavusgil (1984) concluded that studies of British, Swedish, French and American firms supported a gradual pattern in the internationalization of firms. Other studies refute the phenomenon of the incremental internationalization of firms (Coviello and McAuley, 1999; Sullivan, 1994; Oviatt and McDougall, 1997). An alternative view of internationalization, Foreign Direct Investment (FDI), is described as a pattern of investment in foreign markets, which is explained by rational economic analysis of international, ownership and location advantages (Williamson, 1975; Dunning, 1981, 1988). An alternative view, also process-based, argues that internationalization does not always result in a smooth, evolutionary path of development and may include both outward (exports) and inward (imports) patterns of international expansion (Welch and Luostarinen, 1988, 1993). Typically, small businesses may rely on a number of networks and alliances as part of their drive for internationalization (Coviello and McCauley, 1999; Beamish, 1990; Oviatt and McDougall, 1997). For example, strategic alliances may be organized for the use of foreign resources for any of the value added activities but most commonly for the manufacturing, distribution and marketing strategy (Leonidas et al., 1999; Cafferata and Mensi, 1995). This suggests that the process of internationalization may involve relationships and networks. A clear understanding of the process of internationalization for SMEs and Australian SMEs in particular is not available. Further research is needed. SMEs exist in a range of industries and often studies confine themselves to one or two industries, which does not provide a general understanding of internationalization as a process (Huang and Brown, 1999). In particular, the literature review established why it might be necessary and important to look at service industries and software, information technology as well as the usual manufacturing industries (Cafferata and Mensi, 1995). For example, SMEs seem to be very active in some of the most volatile and technology-laden industries, which on first impression would seem unusual given that many SMEs lack experience and resources (Welch, 1978; Siu and Kirby, 1998; Cafferata and Mensi, 1995; Leonidas et al., 1999). There are a number of recent empirical studies on the process of SME internationalization (Coviello and McAuley, 1999; Leonidas et al., 1999; Styles, 1998) and SMEs that internationalize at inception such as start-ups or INVs (Oviatt and McDougall, 1997). The very detailed conceptual paper by Oviatt and McDougall (1997) on INVs, suggested that the majority of INVs are SMEs and warrant particular attention. This attention is also required across industries to give an idea of the overall process of internationalization of SMEs rather than industry-specific situations (Coviello and McAuley, 1999; Styles, 1998; Huang and Brown, 1999).

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In addition, an understanding of the economic environment, and in particular the level and type of government support for the small firm, is required for better appreciation of the pressures and obstacles facing the small firm internationalization process. Skills and experience are important for the small firm entering foreign markets, but so too is government support. Day (2000) contends that access to necessary government support varies considerably from country to country, and yet it is important to understand the need for small firm support as they make such a valuable contribution to many economies, not just in Australia: the ‘95/5’ split between large and small firms is relatively universal, what does vary, though, is the support given to small business through their national economic infrastructure in terms of available funding, business angel networks, venture capital access, commercial, educational and government support . . . we argue that we need to also be able to develop entrepreneurship within the context of marketing, and marketing within the context of entrepreneurship in order that we are able to understand fully the most common business forms – the small firm. (Day, 2000, 1036)

In addition, empirical research covering a range of industries, which focuses directly on the level and extent of internationalization of SMEs, remains under-researched (Welch, 1978; Siu and Kirby, 1998; Cafferata and Mensi, 1995; Leonidas et al., 1999; Oviatt and McDougall, 1997; Coviello and McAuley, 1999; Styles, 1998; Huang and Brown, 1999). A review of the literature on the process of internationalization of SMEs suggests a lack of cohesion – conceptually, empirically and methodologically. 9.5.2

Areas of Current and Future Research Focus

Other research into SME internationalization suggests that SMEs are not disadvantaged with regard to internationalization where the advantage is located in the use of technology for communication and transportation (Welch, 1978; Siu and Kirby, 1998; Cafferata and Mensi, 1995; Leonidas et al., 1999; Atkins and Lowe, 1994). This suggests that SMEs in high-tech industries or in environments that are reliant on greater levels of technology in communication and transportation should not be disadvantaged in achieving internationalization. However, research is insufficient in this area. Also research is not able to provide conclusively that SMEs involved in high-tech industries are achieving higher levels of internationalization than SMEs in low-tech industries. Of relevance to this chapter is whether Australian SMEs are active in more than one region or whether they remain reasonably local in their value-added activities. Current research (ABS, 1997a, 1997b; Styles, 1998; Atkins and Lowe, 1994) does not provide

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evidence to support claims as to what regions Australian SMEs are most active. Nor how many regions Australian SMEs participate in. Further research is needed here. There is also considerable debate about how the process of internationalization occurs in SMEs (Keogh et al., 1998; Coviello and McAuley, 1999; Styles, 1998). For example, what is the extent and degree of internationalization of Australian SMEs and when should SMEs internationalize? Also, the age of the firm as it internationalizes, as an influence on firm performance, is not clearly understood in the literature (McDougall and Oviatt, 1996; McDougall et al., 1994; McDougall et al., 1992; Oviatt and McDougall, 1997). For example, most INVs are SMEs that internationalize within two years (McDougall and Oviatt, 1996; McDougall et al., 1994; McDougall et al., 1992; Oviatt and McDougall, 1997). A growing number of SMEs are known as international start-up SMEs because like the INVs, they internationalize at inception or within two years of their start-up date (Oviatt and McDougall, 1997). Of interest to this field of research is the question of when SMEs internationalize. It may be important to identify at what stage of their development most SMEs internationalize, so that policy can be developed to support SMEs at the most critical time of their planning for market expansion. Of interest to this chapter is the level and degree of internationalization. However, the mode of entry is also important (Dalli, 1994). The choice of entry into markets as SMEs internationalize is important for two main reasons. Firstly, the type of entry mode will provide some support or otherwise for the relevance of the foreign direct investment (FDI) theory of internationalization as it applies to SMEs. This suggests that further levels of FDI will enhance performance (Williamson, 1975; Dunning, 1981, 1988; Buckley and Casson, 1976; Coviello and McAuley, 1999). It would also be of interest to see if SMEs that internationalize at inception use different entry modes. While this may have no effect on profits and may even have negative effects (and consequently negative effects on firm performance) it may provide SMEs with a long-term competitive advantage. The effect of different entry modes on performance of SMEs may be difficult to gauge. But it is of relevance to know if SMEs are internationalizing for strategic reasons (long-term growth) or for market share (short-term growth). There is also the problem of internationalization being measured and defined as an observable resource commitment (Sullivan, 1994; Coviello and McCauley, 1999). Studies suggest that for an activity to be incorporated and seen as ‘international’ by the firm or SME it must be demonstrated (Coviello and McCauley, 1999) and measurable (Sullivan, 1994). This is a particular problem for new SMEs. SMEs are often just embarking on international expansion (Coviello and McCauley, 1999), and in particular this

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will be the case for INVs (McDougall and Oviatt, 1996; McDougall et al., 1994; McDougall et al., 1992; Oviatt and McDougall, 1997). Both SMEs and INVs may have little or no sales because their product or service is under development. However, for that type of activity and other activities to be considered international there must be a demonstrated commitment to sell output in multiple countries upon completion of development (Oviatt and McDougall, 1997). The number of countries is important. A demonstrated commitment to one foreign market may still be considered sufficient for the purpose of classifying a firm as international if the sales or profit are measurable (Coviello and McCauley, 1999) or a strategic purpose lies behind the need to enter a market and maintain a presence, for example for competitive reasons (Yip, 1992, 1998). The number of countries will also determine if the activity is local, regional or global in its dispersion (Yip, 1992). Certainly different types of entry modes offer SMEs greater control over their international activities. The relevance of control and SME performance is of general interest (Dalli, 1994). Further research is needed to provide evidence as to what entry modes SMEs use when they internationalize. Are there different entry modes preferred by SMEs that internationalize at inception? Do different entry modes affect the level of SMEs’ profit? And sales? Do entry modes that provide more control for SMEs affect performance? All of these questions are of importance to the general area of international marketing and particularly to an understanding of the particular process of SMEs and internationalization. Presently, this area has been insufficiently researched. Finally, the need for supportive and consistent government policy to aid small firm internationalization, in Australia and indeed elsewhere, is not new. Graham (1999) has suggested that many Australian small firms have a negative perception towards general government policy and their handling of the business environment. He suggests that government policy needs not only to focus simply on the barriers facing the small export firm but also to work much more closely with entrepreneurs and assist in small firm networking and relationship building: As the vast majority of Australian small business proprietors currently have a negative attitude towards federal government policies as they affect small business, the need for new policy initiatives is urgent . . . High on the list are lower taxes and . . . reduced red tape and more advice or support for small business . . . perhaps it is time to consider a more radical approach . . . for small and medium-sized entrepreneurial enterprises. (p. 99)

Similarly, Carson et al. (1995) and Coviello and Munro (1997) support a governmental approach that supports the development of networking and

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relationship building to assist the small firm entrepreneur to select foreign markets and entry initiative through opportunities that emanate through existing contacts and network links, rather than focusing solely on the strategic decision-making process of managers within the small firm.

9.6

SUMMARY AND CONCLUSIONS

Research is shifting focus to SMEs and exporting, to the processes and patterns that best explain how smaller firms increase their international involvement over time (Coviello and McAuley, 1999). The general literature on the internationalization process of firms tends to be inappropriate as an explanation of SME internationalization (Siu and Kirby, 1998; Brooksbank, 1990; Sashittal and Wilemon, 1996). Firstly, the internationalization literature tends to rely on the large multinational firm as the traditional unit of analysis. This is despite the fact that (1) SMEs are very active in international markets, and (2) the literature suggests that there are differences between larger and smaller firms in their management style, independence, ownership, and scale and scope of operations (Atkins and Lowe, 1994; Siu and Kirby, 1998). The recent pace of technological change, together with the increasing numbers of people with international business experience, have provided new opportunities for MNEs and SMEs (Jack and Bower, 1997; Oviatt and McDougall, 1997). These two technological facilities, low-cost ease of communication and travel, provide the means to engage in business activities in multiple markets not just for MNEs but also for SMEs. This implies that new venture INVs, most often SMEs, with limited resources are also able to compete successfully in the international arena (Oviatt and McDougall, 1997). However, empirical research is lacking in this area to justify these assertions. The literature on the internationalization concept does not conclude that size of the firm (small versus large) is a barrier to internationalization (Bonaccorsi, 1992; Calof and Viviers, 1995). However, it can be argued that SMEs face internal constraints, or moderators, such as limited capital, management, time, experience and information resources (Buckley and Casson, 1976; Siu and Kirby, 1998; Styles, 1998). It is suggested that the internationalization of SMEs is expected to be different from the larger firms because of (1) firm characteristics, and (2) behaviour used to overcome size related issues. Size and resource base will be firm characteristics that are likely to be different for small business and large enterprises. Strategies used to deal with lack of resources, financial and non-financial, as well as a lack of experience may imply that small businesses and large enterprises may have different approaches to internationalization. While a

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body of research on the internationalization of SMEs has begun to emerge, it has not consolidated into a distinct body of literature, nor is it supported by empirical research. The concern here is, what is the current level of knowledge on the internationalization of SMEs? Both the foreign direct investment (FDI) approach and the Stage Model approach to understanding internationalization in the research literature can be easily identified, and are well developed in the body of literature. But research on the third school, the Network Perspective approach, is fast emerging. However, the literature is not consolidated across the three theories and each of these three schools has tended to develop independently. The implication is that each of these three schools approaches an understanding of internationalization differently, from a different theoretical basis (Johanson and Vahlne, 1977; Dunning, 1988; Buckley and Casson, 1976; Coviello and McAuley, 1999; Oviatt and McDougall, 1997). There is the possibility that the research is becoming overly specialized, which is a major concern for international business researchers as indicated by Dunning (1988), Buckley and Casson (1976), McDougall and Oviatt (1996) and Coviello and McAuley (1999). The concern that is raised in this study is that the specialization of each of these schools has prevented integration in the literature on the process of SME internationalization. Finally, while research is continuing to find a clear picture on small firm international involvement and the inherent problems, and policies, to support these important contributors to national growth, it is often perceived by small firms as lacking direction, consistency and real understanding of what, for example, the high-technology firm faces in its efforts to internationalize products and activities. Further research that not only provides new insights on networking approaches for market selection, and entry approaches, but also the role of government policy to facilitate this process, would be very welcome.

BIBLIOGRAPHY Asundi, R. (1996), ‘Globalisation and its effects on strategies of small and medium enterprises’, in S. Sachdeva, Proceedings on the International Conference on Globalisation and the Market Economy: The Challenges of Change, New Delhi: Management Science Association and Global Business and marketing Association, pp. 339–58. Atkins, M.H. and J.F. Lowe (1994), ‘Stakeholders and strategy formation process in small and medium enterprises’, International Small Business Journal, 12 (3), April–June, pp. 12–24. Australian Bureau of Statistics (ABS) (1997a), ‘Small business in Australia’, Cat. No. 1321.0.

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Jack, S.L. and D.J. Bower (1997), ‘Success and peripheral entrepreneurs: a scottish perspective’, paper presented at the Babson-Kauffman Entrepreneurship Research Conference, Babson College, April. Johanson, J. and J. Vahlne (1977), ‘The internationalisation process of the firm: a model of knowledge development and increasing foreign market commitment’, Journal of International Business Studies, 8, pp. 23–32. Katsikeas, C.S., S.L. Deng and L.H. Wortzel (1997), ‘Perceived export success factors of small and medium-sized Canadian firms’, Journal of International Marketing, 5 (4), pp. 53–72. Katsikeas, C.S., N.F. Piercy and C. Ioannides (1996), ‘Determinants of export performance in a European context’, European Journal Of Marketing, 30 (6), pp. 6–35. Kaynak, E., P.N. Ghauri and T. Olofsson-Bredenlow (1987), ‘Export behaviour of small Swedish firms’, Journal of Small Business Management, 25 (2), pp. 26–32. Keeble, D., C. Lawson, H. Lawton Smith, B. Moore and F. Wilkinson (1998), ‘Internationalisation process, networking and local embeddedness in technologyintensive small firms’, Small Business Economics, 11, pp. 327–42. Keogh, W., S. Jack, J. Bower and E. Crabtree (1998), ‘Small technology-based firms in the UK oil and gas industry: innovation and international strategies’, International Small Business Journal, 17 (1), pp. 57–72. Leonidas, C., A. Leonidou and S. Adams-Florou (1999), ‘Types and sources of export information: insights from small business’, International Small Business Journal, 17 (3), pp. 30–48. McDougall, P.P. and B.M. Oviatt (1996), ‘New venture internationalisation, strategic change, and performance: a follow-up study’, Journal of Business Venturing, 11, pp. 23–40. McDougall, P.P., R.B. Robinson and A.O. DeNisi (1992), ‘Modeling new venture performance: an analysis of new venture strategy, industry structure, and venture origin’, Journal of Business Venturing, 7, pp. 267–89. McDougall, P.P., S. Shane and B.M. Oviatt (1994), ‘Explaining the formation of international new ventures: the limits of theories from international business research’, Journal of Business Venturing, 9, pp. 469–87. McMillan, C. (1994), ‘Globalisation: multicultural versus regional approaches to trade policy’, Business and Contemporary World, 6 (3), pp. 137–51. Moini, A.H. (1995), ‘An inquiry into successful exporting: an empirical investigation using a three stage model’, Journal of Small Business Management, 33 (3), pp. 9–25. Naidu, M. and V.K. Prasad (1994), ‘Predictors of export strategy and performance of small and medium-sized firms’, Journal of Business Research, 31, pp. 107–15. Ohmae, K. (1990), The Borderless World: Power and Strategy in the Interlinked Economy, London: Collins. Oviatt, B. and P. McDougall (1997), ‘Challenges for internationalization process theory: the case of international new ventures’, Management International Review, 37 (2), pp. 85–99. Pineda, R.C., I.D. Lerner, M.C. Miller and S.J. Phillips (1998), ‘An investigation of factors affecting the information-search activities of small business managers’, Journal of Small Business Management, 36 (1), pp. 60–71. Porter, M.E. (1990), ‘The competitive advantage of nations’, Harvard Business Review, March–April, pp. 73–93. Renforth, W. (1998), ‘Assessing internationalisation: an alternative measurement technique’ edited by S.J. Gray and S. Nicholas, proceedings for the Inaugural

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Conference of the Australia-New Zealand International Business Academy, ‘The Challenges of Globalization’, ANZIBA, Australian Centre of International Business, Department of Management, University of Melbourne, Victoria, 13–14 November, pp. 345–52. Reynolds, P.D. (1997), ‘New and small firms in expanding markets’, Small Business Economics, 9 (1), pp. 79–84. Ries, I. (2001), ‘Suffer the little companies’, Australian Financial Review Weekend, 24–25 March, p. 25. Robinson, K.C. (1999), ‘An examination of the influence of eight alternative measures of new venture performance for high potential new ventures’, Journal of Business Venturing, 14, pp. 165–87. Samiee, S. and P.G.P. Walters (1990), ‘Influence of firm size on export planning and performance’, Journal of Business Research, 20, pp. 235–48. Sashittal, H.C. and D. Wilemon (1996), ‘Marketing implementation in small and midsized industrial firms: an exploratory study’, Industrial Marketing Management, 25, pp. 67–78. Siu, W.S. and D.A. Kirby (1998), ‘Approaches to small firm marketing: a critique’, European Journal of Marketing, 32 (1), 2, pp. 40–60. Styles, C. (1998), ‘Export performance in Australia and the UK’, Journal of International Marketing, 6 (3), pp. 12–36. Sullivan, D. (1994), ‘Measuring the degree of internationalisation of a firm’, Journal of International Business Studies, 25 (2), pp. 325–42. Sullivan, D. and A. Bauerschmidt (1990), ‘Incremental internationalisation: a test of Johanson and Vahlne’s thesis’, Management International Review, 30 (1), pp. 19–30. Thorelli, H. (1987), ‘Entrepreneurship in international marketing: some research opportunities’, in G.E. Hills, Research at the Marketing/Entrepreneurship Interface, US Association for Small Business and Entrepreneurship, GA, pp. 183–204. Walsh, J.P. (1988), ‘Selectivity and selective perception: an investigation of managers’ belief structures and information processing’, Academy of Management Journal, 31 (4), pp. 873–96. Welch, L.S. (1978), ‘Pre-export activity: the first step in internationalisation’, Journal of International Business Studies, Spring/Summer, pp. 47–58. Welch, L.S. and R. Luostarinen (1988), ‘Internationalisation: evolution of a concept’, in P.J. Buckley and P.N. Ghauri (eds) The Internationalisation of the Firm: A Reader, London: Dryden, pp. 155–71. Welch, L.S. and R. Luostarinen (1993), ‘Inward-outward connections in internationalization’, Journal on International Marketing, 1 (1), pp. 46–58. Williamson, O.E. (1975), Markets and Hierarchies, New York: Free Press. Yip, G.S. (1992), Total Global Strategy: Managing for Worldwide Competitive Advantage, Englewood Cliffs, NJ: Prentice Hall. Yip, G.S. (1998), Asian Advantage: Key Strategies for Winning in the Asia-Pacific Region, Reading, MA: Addison Wesley Longman.

10.

Entry mode decisions of Indonesian small and medium-sized manufacturers in the export market Heru Satyanugraha

10.1

INTRODUCTION

In exporting its products, a firm has to make two strategic decisions: first, to choose the target country market, and second, identify the most suitable type of export entry mode to use. The structural mode decision is considered as the key factor in any international marketing strategy, as it affects all marketing mix variables and will have a major impact on the firm’s export business performance (Wind and Perlmutter, 1977; Anderson and Gatignon, 1986; Terpstra, 1987; Hill et al., 1990; Klein, 1993; Root, 1994). The relative importance of the export entry mode decision may even be greater for industrial products, because brand names, advertising and pricing are usually less critical for industrial products than for consumer products (Davidson, 1982; Haas, 1986; Kim and Daniels, 1991). The export entry modes, or types of organizational systems employed to bring products into the market, can be viewed as the varying degrees of channel integration. At one extreme, the firm can integrate forward and perform all the marketing and distribution functions itself by establishing a sales subsidiary in a foreign market. At the other extreme, a firm can choose not to perform any of these functions and instead leave the tasks to independent firms. A firm may also use intermediate options such as commission agents and forming distribution-related alliances with foreign firms (Anderson and Coughlan, 1987; Klein et al., 1990). Several theoretical frameworks have been offered to explain the export entry mode decision. The degree of forward integration in the channel structure has traditionally been explained by a production cost argument (Stern and El-Ansary, 1992). Production costs in this sense refers to the costs of actually performing distribution functions. The most efficient structure is the one that provides utilities of time, place and assortment by 234

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choosing functions to minimize average total cost. The assumption that all firms desire more control leads to a preference for integration in the exporting process, but such an arrangement may be feasible only if the associated costs can be spread over a large volume of business. The internationalization theory, which is also referred to as the ‘Stages Theory of Internationalization’, proposes that the firm’s export behaviour is a developmental process involving a sequential stepwise progression, in which the firm follows a sequential orderly process of increased international involvement and the associated changes in organizational forms (Johanson and Wiedersheim-Paul, 1975; Turnbull, 1987). Johanson and Vahlne (1977) further extended the export stages theory and suggested that companies have a natural tendency to integrate vertically over time. The more experience the firm has in international markets, the higher the tendency to integrate forward and move further in the stages of export development. This experience-curve effect means that as the firm accumulates experience it is able to lower its cost of distributing the product in the international market, which enables it to further integrate forward. These cost-efficiency arguments may only offer a partial explanation of channel integration. Researchers have stressed the need to complement efficiency considerations with strategic issues concerning governance modes. It is argued that firms may be willing to sacrifice the cost advantages of different levels of integration in order to meet their strategic needs (Hennart, 1988; Contractor, 1990; Kim and Hwang, 1992; Cavusgil and Kirpalani, 1993; Kwon and Konopa, 1993; Cavusgil and Zou, 1994). The purpose of this study is to empirically examine the explanatory power of a model of export entry mode decision, made by small and medium-sized firms. The model evaluated incorporates relevant strategic and production cost factors, in order to capture better the objectives and constraints of firms in making export entry mode or channel integration decisions. This study is part of a broader effort to understand the dynamics involved in the strategic decision concerning export entry mode. Current studies in the entry mode decision are mostly focused on firms in developed countries, and cover the entry modes from exporting to direct investment. Very little research has been done on the decision-making processes of firms from developing countries, where issues and problems facing such firms are likely to differ from those facing firms in the developed countries (Anderson and Tansuhaj, 1990; Da Rocha and Christensen, 1994). Kinsey (1988) identified governmental policies and incentives and market-related products as distinct types of problems faced by firms in developing countries that export their products. There are differences as well in managerial and organizational factors of decision making (Das, 1994). The export entry mode decision is even more important for

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SMEs, as different entry modes give a firm varied degrees of control as well as require different resource commitments, responsibility, and attendant risks (Ahmed, 1977; Czinkota and Ronkainen, 1998). This study is the first to analyse the export market entry mode decision for Indonesian small- and medium-scale firms, and indeed represents a major step toward the generalization of a model for small- and medium-scale exporting firms based in developing countries. Studies of entry mode choice into export markets have focused on that where a dichotomous choice exists, whether the channel is direct versus indirect or whether the channel is integrated versus non-integrated (Anderson and Coughlan, 1987; John and Weitz, 1988; Seifert and Ford, 1989; Ramaseshan and Patton, 1994), or have examined the various modes in direct exporting only (Klein et al., 1990; Aulakh and Kotabe, 1997). This study examines three channel integration choices that cover the whole spectrum of integration, including the non-integrated or indirect, the intermediate mode, and the fully integrated mode. This chapter proceeds as follows. Section 10.2 conducts a brief review of the literature relating to export entry mode. Section 10.3 identifies the hypotheses to be explored and tested in this study, and section 10.4 outlines the study methodology. The major analysis of the study and the presentation of findings is conducted in section 10.5. Section 10.6 presents a summary of the major conclusions from this chapter.

10.2

REVIEW OF THE LITERATURE

10.2.1

Export Entry Mode

The export entry mode, or the degree of forward integration decision, is addressed differently by different researchers, who generally classify it into the indirect exporting versus direct exporting mode; or into integrated versus non-integrated mode. Recent research has focused attention upon a further classification of the modes. Indirect exports occur when manufacturers sell to independent organizations (middleman, agent or distributor company) operating in the firm’s home country, which then exports the products to the foreign market. Direct exporting occurs when manufacturers sell their products to foreign customers or foreign middlemen (agents or distributors) directly or through the manufacturer’s owned sales subsidiary (Seifert and Ford, 1989; Stern and El-Ansary, 1992; Bowerox and Cooper, 1992; Cateora, 1993; Root, 1994; Albaum et al., 1994; Keegan, 1995). Anderson and Coughlan (1987) offer a model of export entry mode

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choice distinguishing between integrated and non-integrated modes. The differences are based on the functions performed. The integrated mode is when the firm performs all the marketing and distribution functions itself, which is primarily conducted through captive agents (company sales forces or company distribution division). The non-integrated mode is when the firm does not perform any of these functions, but instead lets other firms perform the functions that are primarily conducted through independent intermediaries (outside sales agents or distributors). Other researchers argue that the degree of forward integration in the foreign market can be looked at as a position along a continuum, based on the functions performed (Klein et al., 1990). Klein et al. investigated four types of direct exporting: the use of distributors, the use of commissioned agents, the use of home office salespersons, and the use of sales subsidiaries in the target market. A distributor is an independent firm that takes title to the products and performs most of the necessary functions within the foreign country. A commissioned agent is an independent firm that performs only the selling functions, while other necessary functions are performed largely by the focal firm. The use of home office salespersons is a mode whereby the focal firm serves the foreign market directly from the home country of the firm, and its salespersons travel and products are shipped from the firm’s home country directly to foreign customers. The sales subsidiary is the mode whereby the firm establishes a physical presence in the foreign country, where its salespersons are located and significant inventory is stored. Osborne (1996) and Aulakh and Kotabe (1997) investigated three types of direct exporting, which are the use of foreign distributors, the use of commissioned agents and joint ventures, and the use of wholly owned subsidiaries. The intermediate mode here includes the use of commissioned agents or when the firm forms distribution-related alliances with other foreign firms. 10.2.2

Production Cost Perspective

In determining the most cost-effective entry mode into the export market researchers have adopted a domestic marketing perspective, and relied on an analysis of the costs of producing the export function (Clasen, 1991; Cateora, 1993). The major criterion is a mode’s ability to exploit economies of scale and perform export tasks at the lowest possible cost (Terpstra, 1984). Based on this argument, when sales volume and sales potential for the product are high, firms tend to use a higher degree of forward integration in the export market. The more a firm is able to achieve benefits from economies of scale, the greater will be the degree of forward integration. Small markets necessitate indirect distribution due to limited sales potential,

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and volumes may not be substantial enough to cover the cost of more expensive direct distribution alternatives. An empirical study by Lilien (1979) supports the economies of scale interpretation. However, Anderson (1985) found no significant production cost effects, and John and Weitz (1988) found mixed results from the two constructs they used to represent the production cost construct. In their study to empirically test the distribution choice in foreign markets by small business exporters, Ramaseshan and Patton (1994) found that sales volume is one of the factors that significantly distinguish small business exporters using direct modes from those using indirect modes. However, sales volume was found to be negatively correlated with integration. This is contrary to results from previous research on the influence of sales volume on the channel integration decision (Klein et al., 1990). In his study of New Zealand small to medium-sized manufacturing exporters, Osborne (1996) found that sales value was the single most important factor in the decision to channel integration, overriding the importance of other factors. 10.2.3

Internationalization Process Theory

The basic proposition of the internationalization process theory is that the firm’s export behaviour is a development process involving a sequential stepwise progression, in which the firm goes through a number of stages in its international involvement: (1) no regular exports, (2) exports via independent representatives or agents, (3) sales subsidiaries, and (4) establishment of production plants abroad (Johanson and Wiedersheim-Paul, 1975). In their paper, Johanson and Vahlne (1977) state that the internationalization process is a form of knowledge development. Thus, the more international experience the company has, the lower the perceived risk and cost of running a foreign business, and the more resources the management tend to commit to foreign countries. Reid (1982) argues that there are limitations to the stages model. He found that many companies do not move through each and every stage, and many companies use a combination of channels in different, or in the same, market. Turnbull (1987) empirically questioned the validity and premises of the internationalization process theory, and he cast considerable doubt on the usefulness of such approaches for understanding the process. Millington and Bayliss (1990) incorporated strategic planning into international experience to explain the internationalization stages chain, and concluded that a stepwise internationalization process was the exception rather than the rule. In their empirical study, Sullivan and Bauerschmidt (1990) found that the internationalization pattern of firms was not influenced by their knowledge due to psychological or geographical proximity

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as claimed by the internationalization process theory. Their study failed to support the internationalization theory, and they argued that this view of internationalization has only been respected owing to its intuitive logic and theoretical parsimony. Bell (1995) explored the initial export decision of small software firms and the internationalization process of such firms. He concluded that there is very little support for the notion that small software firms progress systematically from exporting to other market serving modes. Young et al. (1996) investigated further the internationalization process of Chinese multinational enterprises, and concluded that there is evidence of leapfrogging of stages in the internationalization process. 10.2.4

Strategic Rationale Perspective

Arguing that firms in any industry seek to gain a competitive advantage that will allow them to outperform rivals and achieve above-average profitability, Porter (1980, 1985, 1990) suggests that the path to competitive advantage means the successful implementation of internally consistent competitive advantage, and identified three generic competitive strategies: cost leadership, differentiation and focus. It is argued that successful implementation of the generic strategy requires different resources, organizational arrangements, control procedures and incentive systems (Porter 1980, 1985). Porter’s model of generic strategies has been well received and frequently tested (see Chrisman et al., 1988). Dess and Davis (1984) developed instruments to measure Porter’s cost, differentiation and focus strategies, and in their study found that control of distribution channels is one of the most important aspects of differentiation strategies. Partridge and Perren (1994) argued that unless demonstrated by a lowest-price strategy, cost leadership is relatively invisible and therefore cannot be used to win customers and gain competitive advantage. The cost leadership strategy can instead be a precarious strategy that may accelerate the move towards a commodity market in which ultimately no one benefits. Namiki (1988) found that four different patterns of competitive strategy can be employed by firms in export markets: (1) marketing differentiation, (2) differentiation focus strategy, (3) innovation differentiation, and (4) product-oriented differentiation strategy, such as customer service and high-quality products. It is also argued that, while cost leadership and a differentiation strategy are about how to compete, the focus strategy is about where to compete (Porter, 1980). Therefore, of the three generic strategies, it is the differentiation strategy that is most relevant in explaining the ‘how to compete’ strategy and the degree of integration. The conceptual relationship between the differentiation strategy and integration is based on the rationale that a differentiation strategy is intended to create a more unique image for firms, products and services. This

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requirement necessitates that marketing activities be performed in-house rather than contracted to other firms, since integrated channels provide the firm with more control over necessary channel functions (Keegan, 1995). Lilien (1979) and Anderson and Coughlan (1987) found that the level of product differentiation is positively related to the degree of channel integration. Ramaseshan and Patton (1994) found that the product service level is associated positively with channel integration, indicating that firms which are giving importance to service – as in back-up support, repair or installation – tend to use integrated channels. Osborne (1996) found little support for the general relationship between product service level and channel integration, but argued that the findings still show a positive association between service level for certain product types generally considered in need of field service and channel integration decision. 10.2.5

Section Summary

This study explores the integration decisions of firms engaged in exporting by classifying the entry modes into: (1) market exchange mode (defined as indirect exporting, or the non-integrated mode), (2) intermediate exchange mode (defined as the use of a contracted channel, either merchant or agent type of intermediary), and (3) hierarchical exchange mode (defined as the use of sales subsidiary in the target market). Studies in the export entry mode choice have mostly focused on a dichotomous choice, either direct versus indirect modes or integrated versus nonintegrated modes, which are far from reality. Recent studies have examined more choices, but only in the direct exporting categories (Klein et al., 1990; Aulakh and Kotabe, 1997). Meanwhile, indirect exporting is still used extensively by firms in developing countries (Anderson and Tansuhaj, 1990). Therefore, the classification used in this study, by examining three different modes including the indirect exporting mode or non-integrated mode and two types of direct exporting or integrated modes, is believed to be more appropriate for the study of exporting firms from developing countries. Our review of the literature has shown that there are different theoretical perspectives for explaining the export entry mode or channel integration decision in the foreign market. The production cost perspective maintains that scale economies are the basis for deciding the degree of channel integration. The international process theory implies that international experience influences the willingness to commit more resources into the forward integration decision. The strategic rationale approach enumerates the strategic benefits of forward channel integration when following the differentiation strategy. The models and theories discussed above have largely been treated separately. This is convenient in the development of theories, but in empirical

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testing it is important to develop a model that includes all the constructs of firm-specific and market characteristics appropriate as determinants of export channel integration. By examining a model that includes constructs developed from all of the relevant theories, we hope to contribute to a better understanding of both the theories and the influences on channel integration.

10.3

RESEARCH HYPOTHESES

Based on the conceptual model of decision making offered, a set of hypotheses corresponding to the objectives of this study is proposed. There are three hypotheses to test the contribution of the three variables to the choice of the channel structure. Firms are better able to realize economies of scale as the size of the market becomes larger, which suggests the tendency of increasing the integration of the distribution channel mode (Anderson, 1985; Anderson and Coughlan, 1987; Klein et al., 1990). This leads to the following hypothesis: Hypothesis 1: The size of the market is positively related to the degree of forward channel integration. The international experience of the firm is defined as its understanding and realistic perceptions of foreign operations, risks and returns in foreign markets (Stopford and Wells, 1972). In accordance with the internationalization theory (Johanson and Vahlne, 1977), it is expected that as a firm picks up experience in international markets it can better perceive risks and returns, and therefore becomes more confident. This is manifested in a willingness to commit more resources. Therefore, internationally experienced firms are more willing to undertake forward integration in their channels of distribution than the less experienced ones. This leads to the following hypothesis: Hypothesis 2: The level of experience in international marketing of a firm is positively related to the degree of forward channel integration. A differentiation strategy to create more value than competitors can be implemented along various dimensions: brand image, technology, customer service, product positioning and so on (Porter, 1980, 1986). A differentiation strategy requires higher consumer awareness along with high levels of service and therefore requires that such activities be performed internally, since a high degree of forward integration provides the firm with more control over channel functions (Keegan, 1995). A differentiated product

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usually commands higher profit margins, therefore firms are willing to invest in fixed costs of channel integration (Harrigan, 1985; Porter, 1986). This leads to the following hypothesis: Hypothesis 3: The greater the differentiation strategy followed by a firm, the greater the degree of forward channel integration in foreign markets.

10.4

METHODOLOGY

10.4.1

Variable Measurement and Operationalization

In this study, the market exchange mode is reflected by the use of an indirect channel structure, whereby the firm sells to independent middlemen, agents or distributors in the home country who perform most of the necessary exporting functions to the foreign target market. Intermediate exchange is reflected by the use of foreign middlemen, agents or distributors under contract to market and sell the product to the foreign market. The hierarchical exchange mode refers to the use of a sales subsidiary in the foreign target market. It is argued that channel volume can be measured using a psychometric method. Various measures used by different researchers (Anderson and Coughlan, 1987; Klein et al., 1990; Ramaseshan and Patton, 1994) are to be combined into scales used in this study as perceptual measures, which are: the potential market value of the product in that country, potential firm’s sales in that country and percentage of total firm’s existing exports to total sales. Most researchers use a single-item scale to measure experience directly as the number of years the firm has been involved in exporting (Ramaseshan and Patton, 1994; Klein et al., 1990; Anderson and Coughlan, 1987). To measure international experience, a three-item scale is proposed: the number of years the firm has been in business, the number of years the firm has been exporting and the perception of the manager relating to his knowledge of international business practices and procedures. To measure the strategy of differentiation, the three-item scale developed by Aulakh and Kotabe (1997) that incorporates the various dimensions of creating a unique image is adapted and expanded in this study to include after-sales service to the customers. The items included in the scale used in this study are technological edge over competitors, higher-quality standards for the products, unique image for the products and after-sales service to the customers.

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243

Sampling Frame

Small and medium-sized businesses are defined differently in different countries and by different researchers depending on their own needs. Some researchers in more developed countries define small and medium-sized businesses as those with less than 500 employees (US Bureau of the Census, 1993; Moini, 1995; Seringhaus, 1993; US Small Business Administration, 1989). Others define firms with sales less than US$5 million as small firms, and sales between US$5 million and US$50 million as medium-sized firms (Czinkota, 1988; Czinkota and Johnston, 1983; Ali and Swiercz, 1991). Indonesian manufacturers tend to use more workers than those in more-developed countries, therefore classifications based on number of employees may not represent the same category. In order to be able to compare the results with other studies, the sales criterion was used in this study. Only firms with sales less than US$50 million are considered as the study population. All manufacturers with export operations listed in the Indonesian Exporter: Directory Facts and Figures 1994 published by PT Capricorn Indonesia Consult Inc., Indonesia, together with the Directory of Indonesian Exporters 1999 published by the National Agency for Export Development, Ministry of Industry and Trade, Republic of Indonesia and from the Standard Trade and Industry Directory of Indonesia 1999 published by PT Kompassindo were identified. Firms which export industrial products comprise the study population, and were selected based on the classification of the industry in the directory. 10.4.3

Data Collection

Primary data was collected based on direct contact with 980 small and medium-sized Indonesian manufacturers in industrial products. A personalized cover letter and questionnaire was mailed to the key informant of the firms. Key informants were identified by name from the directory and were usually either the owner, general manager or export marketing manager of the firm. The participants were asked to concentrate on the one foreign country which was the most important market to them, and answer questions relating to the channel decisions in that country. A total of 219 questionnaires were received for a response rate of 22.4 per cent, which was considered typical for this type of research even in developed countries (Aulakh and Kotabe, 1997).

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10.4.4

Strategic aspects

Reliability and Validity Assessment

The theoretical framework includes ten indicators to measure the three underlying constructs. A reliability analysis indicates strong support for the use of the instrument in its reliability. All the constructs show strong reliability, with Cronbach’s alpha value of 0.7953 for channel volume, 0.7595 for international experience and 0.9091 for differentiation strategy. In order to ascertain the construct validity, factor analysis with varimax rotation was performed to verify that the items used in a scale were tapping the same construct. The results indicate that the latent variables, or factors, really represent the construct they were conceptualized to represent. 10.4.5

Method of Analysis

The individual hypotheses were tested through a multinomial logit model. Multinomial logit models have been used in previous entry mode research, for example, Agarwal and Ramaswami (1992), Gatignon and Anderson (1988), Kim and Hwang (1992), Klein et al. (1990), and Aulakh and Kotabe (1997). This analytical model is appropriate given that the purpose of this study is to examine the relationship between a categorical dependent variable with three possible values, and a number of metric independent variables. A multinomial logit model estimates sets of coefficients to reflect different levels of the dependent variable. The size of the various coefficients indicates the extent to which individual predictor variables contribute to the utility of choosing the level of channel integration beyond the contribution to the utility of the market exchange mode which is used as a base mode (Malhotra, 1984).

10.5

ANALYSIS AND PRESENTATION OF FINDINGS

10.5.1

Validity of the Overall Framework

The research model was first assessed to confirm the overall model fit before examining the effects of individual independent variables in predicting the choice among the channel modes. The result of the multinomial logit analysis, with the market exchange mode as the base mode, shows that the chi-square value of 125.633 is significant at p ⫽ 0.000, thus indicating that the independent variables are significantly associated with the outcome. To ascertain whether the model fits the data well, it was used to classify

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the observations. The results show that the model has a high predictive ability both overall and for each mode. 10.5.2

Results of Hypothesis Tests

Estimation of the parameters in the model entailed the use of SPSS Grad Pack 9.0 and the Newton–Raphson method of maximizing the log-likelihood function in its multinomial logit program, and are presented in Table 10.1. Hypothesis 1 relates market size to the degree of channel integration. The decision rule for this hypothesis is to support the hypothesis if the p-value is ⬍0.05, and the estimated coefficients for market size are positive. The signs and significance level of the coefficients for market size support Hypothesis 1 (B ⫽ 1.401, p ⫽ 0.000 for hierarchical exchange mode, and B ⫽ 0.528, p ⫽ 0.002 for intermediate exchange mode). This means that the probability of using the hierarchical exchange mode is higher than the probability of using the market exchange mode, and the probability of using the intermediate exchange mode is higher than the probability of using the market exchange mode when the market size increases. The value of coefficient B for the hierarchical mode is 1.401, which is greater than the value of the coefficient B for the intermediate mode (0.528). This means that when the market size increases, the probability of using a hierarchical exchange mode is greater than the probability of using an intermediate exchange mode. This finding suggests that as market size increases, firms are more likely to use a higher integrated channel mode than a market exchange mode. Thus market size is positively related to the degree of forward channel integration. Hypothesis 2 examines the relationship of firms’ international marketing experience to forward integration in the export market. The decision rule for this hypothesis is to support the hypothesis if the p-value is ⬍0.05 and the estimated coefficients are positive. The test results reveal that the p-values are ⬎0.05 and the estimated coefficients are negative for both the hierarchical exchange mode and the intermediate exchange mode (B ⫽ ⫺0.270, p ⫽ 0.364 for hierarchical exchange mode, and B ⫽ ⫺0.003, p ⫽ 0.867 for the intermediate exchange mode). Therefore Hypothesis 2 is not supported. The findings indicate that experience in international marketing is not related to the degree of forward channel integration. Hypothesis 3 considers how a differentiation strategy relates to channel integration. The decision rule for this hypothesis is to support the hypothesis if the p-value is ⬍0.05 and the estimated coefficients are positive. The estimated coefficients are both positive and significant (B ⫽ 2.402, p ⫽ 0.000 for the hierarchical exchange mode and B ⫽ 1.462, p ⫽ 0.000

246

Parameter estimates

Variable

Experience Market size Differentiation strategy

Experience Market size Differentiation strategy

Table 10.1

Degree of integration

Hierarchical

Intermediate

0.297 0.265 0.340 0.225 0.174 0.255

⫺3.756E-02 0.528 1.462

Std Error

⫺0.270 1.401 2.402

B

0.028 9.248 33.005

0.825 27.844 49.897

Wald

1 1 1

1 1 1

df

0.867 0.002 0.000

0.364 0.000 0.000

Sig.

0.963 1.696 4.316

0.764 4.059 11.043

Exp(B)

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for the intermediate exchange mode). This means that the probability of using the hierarchical exchange mode and the probability of using the intermediate exchange mode is greater than the probability of using the market exchange mode when the differentiation strategy increases. The value of coefficient B for the hierarchical mode is 2.402, which is greater than the value of coefficient B for the intermediate exchange mode (1.462). This also means that when the differentiation strategy increases, the probability of using the hierarchical exchange mode is greater than the probability of using the intermediate exchange mode. Therefore, Hypothesis 3 is supported. The findings suggest that as firms follow a more differentiation strategy, firms tend to use a more highly integrated channel than for the market exchange mode. The firm’s differentiation strategy is positively related to the degree of forward channel integration.

10.6

SUMMARY AND CONCLUSIONS

Three hypotheses were tested in this study: that the size of the market is positively related to the degree of forward integration; that the level of international marketing experience of a firm is not related to the degree of forward integration; and that the differentiation strategy of a firm is positively related to the degree of forward integration. The results derived from the study indicate, first, that market size is positively related to the degree of forward integration. High product volume is likely to afford economies of scale, thereby lowering production costs. This study supports the notion by Klein et al. (1990) that the ideal entry mode arrangement should reflect both the costs of actually performing distribution functions and the costs involved in governing the mode. Second, that the level of international marketing experience is not related to the degree of forward integration. This lack of impact of experience on international channel choice is contrary to the findings of earlier research (see Gatignon and Anderson, 1988; Klein et al., 1990), but is in accord with the findings of Ramaseshan and Patton (1994). The results in this study seem to indicate that Indonesian exporters do not believe that experience influences economies of scale nor lower production costs. Third, the study finds a positive relationship between the differentiation strategy of a firm to the degree of forward integration, which agrees with the findings of Aulakh and Kotabe (1997). As the differentiation strategy is measured along various dimensions, including product differentiation, it is also in accord with the study of Anderson and Coughlan (1987) and Lilien (1979), who found that the level of product differentiation is positively related to the degree of forward integration. It shows that when

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Indonesian small and medium-sized firms pursue a more competitive strategy to create a more unique image for their firms, products and services, they are inclined to perform more of the marketing activities themselves (a more integrated forward integration). In summary, these findings indicate that the decision of Indonesian small and medium-sized firms to choose either to set up a sales office in the foreign market, or to use foreign distributors, or to be passive exporters by letting other firms in Indonesia do all the marketing activities for them in the foreign market, depends on the size of the foreign market, and the efforts the firms used to create a unique image for their products and services. The implications of these findings are that an integrated view of economic efficiency and strategic forces are needed to decide on export entry mode. The findings imply that firms’ strategic objectives go beyond the efficiency considerations of cost minimization. The factors influencing the export entry mode choice by Indonesian manufacturers in their export market are not particularly different to the factors found in studies of other countries. In general, firms exhibit a strong tendency to take control in foreign operations when they are pursuing a differentiation strategy in the export market. The findings of the study show that the export entry mode decision by Indonesian small and medium-sized firms is a rational decision. It suggests to executives the importance of expanding their decision framework beyond the narrow confines of entry mode decision in isolation of their firm’s overall strategy. These results also point to the role that a differentiation strategy plays in exporting decisions. The findings provide managers with a better understanding of the importance of each variable influencing the export entry mode decision. Hence they can better prioritize the relevant variables in evaluating the degree of forward integration alternatives. This further implies the importance of having capable and knowledgeable export marketing staff for Indonesian firms, and that experience might not be needed to export actively. Finally, all the findings can be useful in the formulation of policies and export promotion programmes by the government of Indonesia and any export promotion agencies. There are a number of extensions to this study that could be conducted. First, in this study a positive framework was tested which means that the primary purpose was explanation. It describes and explains how firms choose degree of forward integration in their export market, rather than what they should do. To gain a more normative meaning, an appropriate extension of this study would be to incorporate some performance measures as criteria. Second, the framework studied here is static and did not address the possibility of transition from one mode to another. A longitudinal study would be required in future research to understand the

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effects of such a transition. Third, while an integrated approach was taken in this study, it was still basically only incorporating strategic perspectives into the economic rationale. Forward integration is a managerial decision, therefore future research should consider behavioural perspectives explicitly in the framework. Fourth, the study used a multiindustry approach, which assumed homogeneous behaviour among the industries. Industry-specific studies could be conducted to determine the differences in the nature, if any, between these different industries. Finally, this study has only empirically tested the decision-making process of Indonesian small and medium-sized firms in exporting their products. A similar study in other developing countries would enable the generalization of the results for small and medium-sized firms in other developing countries.

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11.

Technological sourcing in small and medium-sized Australian manufacturing firms Paul L. Robertson, Thomas Keil and Erkko Autio

11.1

INTRODUCTION

Access to external sources of information and knowledge can improve the ability of firms to learn and to increase their efficiency and competitiveness. This is especially true for smaller firms and for firms in industries in which information and knowledge are expanding rapidly. Gaining access to new knowledge is not always easy however, not only because some knowledge may be proprietary or tacit, but also because it is not always clear where to look for high-quality knowledge. Moreover, large geographical distances between potential sources and recipients of knowledge can significantly raise the transaction costs of searching. Firms need therefore to find inexpensive formal and informal channels for extracting information and knowledge from diverse sources including competitors, suppliers and customers, some of whom may be located far away. In this chapter we present a sectoral analysis of how small and mediumsized enterprises (SMEs) in Australia, a geographically remote country with relatively low levels of domestic R&D activity, cope with their need for external information and knowledge. The effects of environmental embeddedness and firm learning on technological sourcing are discussed in section 11.2, and the implications of literal and metaphorical clustering of firms are explored in section 11.3. The roles of suppliers and customers as sources of technological knowledge are analysed in section 11.4, while the importance of sectoral variations is outlined in section 11.5. In section 11.6 we examine the specifically Australian context of our study and test several hypotheses concerning the R&D behaviour of SMEs in a small and relatively isolated economy. Finally, we discuss our results in section 11.7 and draw a number of policy conclusions.

253

254

11.2

Strategic aspects

LEARNING, EMBEDDEDNESS AND TECHNOLOGICAL SOURCING

The ability of a firm1 to learn is, in part, a function of the extent of its access to other firms or to individuals that hold different items of information and knowledge.2 While some learning is based exclusively on the use of facts and concepts that a firm already possesses, when possible it is generally cheaper and quicker to purchase or borrow from others. This is especially true for small firms that rely primarily on established products or processes, with occasional incremental improvements, rather than on a conscious strategy of acting as agents of innovation by concentrating on the development or employment of novel products or processes. Such firms often lack the financial and intellectual resources to generate substantial technological discontinuities from within, even though they may bring about important cumulative changes through learning-by-doing. Even learning-by-doing may be made more efficient however if the knowledge of other firms can be tapped. Thus the efficiency of virtually any firm may be improved by contact with others that can supply information and knowledge (Leonard-Barton, 1995).3 Although the benefits that may result from gaining access to relevant information and knowledge are obvious, the process can be difficult. In some cases, other firms may be in a good position to keep proprietary control over their knowledge, either by maintaining secrecy or because of a high degree of tacitness. But even when barriers to access are small, it may be hard for firms to locate and recognize information and knowledge that are especially relevant to them. In a complicated environment, ‘problem-holders’ do not always know where to find solutions, nor are ‘solution-holders’ necessarily aware of the full range of problems to which their knowledge is applicable (Robertson, 1998). In particular cases, where innovation arises from different sources than in the past, connections between the problem-holders and solution-holders may be indirect, or even non-existent, since heuristics for learning usually involve searching first in locations that have previously been fruitful. Over time, knowledge networks may expand as indirect contacts between firms are converted into direct connections and further indirect contacts are established (Callon, 1993), but it is also possible that lock-in resulting from previous decisions by firms may create future barriers to exploring for new knowledge and information.4 As Granovetter points out, however, firms do not act in isolation, nor are they restricted to arm’s-length market relationships. The individuals who comprise firms are embedded in wider social networks that lead them to favour contacts with persons whom they already know (Granovetter, 1973, 1985). Furthermore, firms as a whole belong to wider ‘business groups’ that

Technological sourcing

255

are organized along various familiar ‘axes of stability’ such as ethnicity and kinship relationships, and geographical and social propinquity (Granovetter, 1995). But although Granovetter correctly decries the relative paucity of analyses of institutions of intermediate degrees of formal organization that lie between the extremes of markets and hierarchies,5 the operations of some of these have been discussed for nearly a century. In particular, Marshall (1919, 1961) described the activities of firms in ‘industrial districts’ in which the geographical clustering of companies in the same industry, as well as their suppliers and customers, promotes informal but powerful exchanges of knowledge through the interactions of employees of firms with similar interests.6 Autio (1996) has refined Granovetter’s concept by distinguishing between manufacturing and technological embeddedness.7 When there is manufacturing embeddedness, a firm is closely linked with traditional manufacturing chains in which its relationship to suppliers of physical inputs and customers for physical outputs, together with the firm’s own resources, help to determine the scope and efficiency of its productive activities. The field of action when there is technological embeddedness, on the other hand, is a function partly of the technological paradigm in which the firm currently operates and partly of its access to external technological knowledge held by other firms and individuals with whom it interacts. In this study, we combine the approaches of Granovetter and Autio and of Marshall to investigate the operations of firms that are embedded in particular technological contexts but also face geographical constraints on their embeddedness. We consider the extent to which the ability of firms to gather technological knowledge is a consequence of their relationships with external sources. While industrial districts can function in a strongly positive sense when most of the knowledge that they need for learning is available locally in a dense network of competitors, suppliers and customers – as Marshall argued – such embeddedness can also result in firms becoming locked into established relationships in mature industries in which new ideas no longer flow strongly and there is resistance to change in general (Grabher, 1993). As a result, the firms may be locked out of relationships with other firms that are located at some distance, but are nevertheless more innovative and possess knowledge and information that are more relevant to their competitive needs.

11.3

COMPETITORS AND GEOGRAPHICAL CLUSTERING

Firms that operate within an established technological paradigm tend to look for information and knowledge ‘locally’ in both metaphorical and

256

Strategic aspects

literal senses. As a technology matures, leaders generally appear who are recognized as arbiters of technological practices in product and process design and implementation. These are firms within an industry that have good sales and profitability records as well as firms from other industries that have good reputations for supplying equipment and other inputs with important technological characteristics. In addition, where there are substantial customers, their needs may set patterns that affect the behaviour of their suppliers. Although there may be no geographical clustering, firms connected in these ways occupy similar ‘social locations’ that are close in an informational sense. Generally speaking, the strength of communication channels reflects the relative importance of these various loci of information and knowledge, with some channels operating directly while others, such as the trade press, may offer less direct but also more wide-ranging communication of information and concepts. Different firms in an industry often attach different degrees of importance (Callon, 1993) to various potential sources according to the strength of their existing contacts and how many resources they put into developing new contacts. Granovetter (1973) and Rogers (1995) agree that, while firms often go to familiar sources for routine information, data about innovation may often come from groups (or ‘cliques’) with which a firm has ties that are relatively infrequent and weak. For example, a firm with equipment supplied by one of several possible sources will frequently tend to look first to that firm for information on evolving process technologies, but if it becomes dissatisfied with the service that it has received, it may look elsewhere for new information. Whether this will take the form of a full-scale exploration for new sources however, or be limited to a more narrow search, depends on the resources that the firm wishes to commit, and also perhaps on more random factors including information found in the media or through casual personal contacts. As time passes and information and knowledge spread, the recruitment of new contacts can also occur (Callon, 1993), although the relative importance of the new recruits for existing members of the network will vary depending on factors such the industries of the respective firms, and whether there are other direct or indirect points of contact. The geographical positioning of firms is also of importance in determining information flows. Not only may the costs of acquiring knowledge be less when firms are closer together, but clustering can also change the quality of communication among firms and their members. As Marshall wrote, in industrial districts ideas can be ‘in the air’, available to all those sharing the same atmosphere. When those ideas positively reinforce each other – as in the shipbuilding industry in Glasgow and the textile and engineering industries in Lancashire before 1914, the automotive industry in Detroit between

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257

1900 and 1970, steel and various metalworking industries in the Ruhr until the 1970s, and Silicon Valley at present – the consequences can be highly favourable for technological progress. Moreover, as the examples illustrate, industrial districts can function well for innovative and mature industries alike. When new technologies are developed outside an industrial district however, it can be less beneficial to be located in that district. Many firms will be most closely connected with, and most accustomed to seeking information and knowledge from, their neighbours. But as outsiders are less likely to be consulted, the mutual reinforcement of an industrial district can lead to a vicious circle, rather than to a virtuous circle as in a successful environment. As a consequence, firms can lock themselves and others into outmoded technological regimes (Grabher, 1993) by rejecting things ‘Not Invented Here’. When there are positive outcomes available, both metaphorical and geographical clustering can encourage fruitful exchanges of information among competitors. Geographical concentration clearly increases the possibility of both formal and informal exchanges. Nevertheless, the wider the range of sources of technological information and knowledge that firms can consult, the more likely they are to anticipate, or at least keep up with, trends. A heavy reliance on local sources is dangerous except in circumstances in which local knowledge is at world-frontier levels. Even though transaction costs may be reduced by embeddedness in local networks, these savings can be offset by losses in efficiency that result from an inability to draw on knowledge that is not locally available. Firms should aim therefore to take advantage of local embeddedness while establishing and maintaining contacts with the wider technological community.

11.4

SUPPLIERS AND CUSTOMERS AS SOURCES OF TECHNOLOGICAL KNOWLEDGE

Customers and suppliers are also possible sources of valuable technological information and knowledge for a firm. Suppliers can provide knowledge in several important ways. Firstly, knowledge can be embodied in new equipment that performs tasks more efficiently than earlier models. Secondly, firms can help their customers to learn to make more efficient use of the equipment or other products that they have supplied. While this is often true for capital goods, it can also apply to other types of inputs. At its most basic, this knowhow can be transmitted as instructions printed on a package, but it can take a more personal form as, for example, when a photocopier repairer provides instructions on how to prevent paper from jamming. Thirdly, suppliers can take an active role in product or process development. The use of ‘strategic

258

Strategic aspects

sourcing’ by Japanese firms that take advantage of the design skills of their suppliers is well known (Nishiguchi, 1994). Suppliers are also commonly used in developing complex products and systems (CoPS), such as weapons systems, in which the bulk of the design is undertaken at the component level by contracting suppliers under the direction of a ‘systems integrator’ (Hobday, 1998). Finally, suppliers can provide equipment or knowledge for complementary goods in order to increase sales of their own products. Von Hippel (1988) reports several cases in which suppliers generated innovations that increased the demand for their own products. Similarly, when Columbia decided to commercialize the long-playing 331/3 rpm phonograph record, it contracted for the development of suitable record players that could be purchased inexpensively (Langlois and Robertson, 1992). Even within established industries, close access to suppliers can be aligned with technological progressiveness. Jones (1996) has found, for example, that boat builders in the expanding and progressive sector of the industry in Queensland are more likely to engage in design relationships with their suppliers than are conservative builders in the Sydney region. Customers can provide another potentially important source of information and knowledge. While it is possible for a firm to ‘choose its customers’ by designing its products to emphasize the firm’s own strengths (Reinertsen, 1997), it is often desirable to consult customers directly to determine what characteristics are in demand (Bureau of Industry Economics, 1995). In the case of CoPS, which are custom-built, the needs of customers must be carefully studied by both customers and suppliers (Hobday, 1998). Joint development projects may then ensue, with the original inspiration coming from either the supplier (Laage-Hellman, 1997) or the user. Furthermore, Von Hippel (1976, 1988) found that users frequently develop important improvements in existing products that they use, which they may then pass on at little or no cost to the original suppliers. He indicates that firms should maintain close contacts with ‘lead users’ for marketing purposes. These are users who encounter needs well in advance of the marketplace in general and who would benefit substantially from improvements to solve their specific problems (Von Hippel, 1988). Lundvall (1988) offers some additional reasons for producers to monitor their customers. For one thing, product innovations by users may call for new demands for process equipment. Secondly, bottlenecks and technological interdependencies encountered by users can represent potential markets for an innovating producer. Finally, monitoring the competence and learning potential of users can help producers to judge the respective capabilities of various users to adopt new products. A firm must find some way of communicating with its suppliers and customers, as well as with its competitors, if it is going to benefit from embeddedness. Geographical proximity may again be of value by allowing

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259

good contacts to be established relatively cheaply, but this can also be a constraining factor if the firm becomes so committed to local connections that it neglects to establish contacts with more distant firms with better access to innovative knowledge.

11.5

SECTORAL VARIATIONS

The extent to which the innovative activities of a given firm may be helped or hindered by being part of a regional network depends heavily on the scope for innovation provided by the broader environment and on where innovations emanate from in particular cases. While access to new knowledge and information might sometimes be best achieved by location in a particular district, such as Silicon Valley, not all innovative industries are geographically concentrated, and not all firms can be located close to the centres of innovation in their industries. In general, therefore, firms must find ways to tap into more distant sources of information and knowledge, even though this may entail losses in time and increased transaction costs. This is especially necessary for firms located in peripheral regions if they are to have any chance of maintaining competitiveness. Exclusive concentration on local sources can be an actual danger in the case of mature industries because of the threat of lock-in. While firms in established relationships, as in an industrial district, are recycling information and resisting change, strategically valuable innovations could arise elsewhere, in different industries as well as in different locales. The dominant logic of the business (Prahalad and Bettis, 1986) might, however, restrict the search to local networks. In this case, access to wider communities of knowledge could pay off handsomely, especially when a firm’s competitors remain locked into local networks.

11.6

THE AUSTRALIAN CONTEXT

In this study, we address the implications of these observations concerning innovation, access to information and knowledge, sectoral maturity, and the regional structure of industries by examining the behaviour of small and medium-sized manufacturing firms in four sectors of the Australian economy: electrical engineering and electronics; mechanical engineering and machinery; plastics; and clothing. As is shown in greater detail below, the sampled firms vary significantly on a sectoral basis in terms of their technological characteristics and their relationships with competitors, suppliers and customers. Protection levels are high for clothing firms but moderate in other sectors.

260

Strategic aspects

Table 11.1

Indicators of R&D performance

GERD/GDP, %, Australia GERD/GDP, %, OECD Average BERD/GDP, %, Australia BERD/GDP, %, OECD Average

1994

1998

1.57 2.10 0.74 1.41

1.49 2.18 0.67 1.51

Source: OECD (2001), Tables 5 and 25.

Australia is a geographically remote nation that is rich in natural resources but has a low population density. The land area is almost exactly equal to that of the Continental US (the 48 contiguous states) but the total population is less than 20 million persons. Moreover the population is highly concentrated, with over half of the people living in the five mainland state capital cities of Sydney, Melbourne, Brisbane, Adelaide and Perth. Sydney and Melbourne alone account for around one-third of the total national population. Education and literacy levels are high and per capita incomes in purchasing power parity terms are approximately at the mean of those of Western European nations. With a few exceptions, Australian manufacturing firms adopt technologies developed overseas, rather than generating them locally. While this relates in part to the small size of the economy, it is also true that, relative to gross domestic product, both gross domestic expenditure on R&D (GERD) and business enterprise expenditure on R&D (BERD) in Australia are low by OECD standards (Table 11.1). Between 1984–85 and 1990–91, most of the increase in BERD was generated by firms with fewer than 500 employees, while the share of BERD accounted for by ‘very large’ firms with 1000 or more employees declined from 54 per cent to 37 per cent. In the early 1990s this trend was reversed, with the share of very large firms increasing again. Although the share of BERD contributed by medium-sized firms with between 100 and 499 employees also increased between 1990–91 and 1992–93, that of firms with 99 or fewer employees remained stagnant or decreased, particularly in manufacturing (Industry Commission 1995: vol. 2, pp. 513–14). 11.6.1

Hypotheses

As a consequence of their low investments in R&D, Australian firms need to be in close contact with other firms on a wide geographical basis in order to attain and maintain high levels of international competitiveness. On the

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basis of the concepts presented so far, we have developed four hypotheses that we test in later sections. Hypothesis 1: Firms in relatively high-technology industries are engaged more frequently in development alliances with competitors than firms in lower-technology industries. Hypothesis 2: Firms in relatively high-technology industries are engaged more frequently in development alliances with suppliers than firms in lower-technology industries. Hypothesis 3: Firms in relatively high-technology industries are engaged more frequently in development alliances with their customers than firms in lower-technology industries. Hypothesis 4: Firms in relatively high-technology industries have a wider geographical range of contacts than firms in lower-technology industries have. 11.6.2

Methodology

The sample for this study has been drawn from small and medium-sized firms in Australia.8 Sources such as phone directories and other company databases were used to select the firms. Three selection criteria were used: ●

●

●

Each of the chosen firms has 250 or fewer employees. An upper limit was set because firm size repeatedly occurs as one of the factors that most influences firm behaviour. For instance, the ability to manage a large number of external relationships is different for a firm with 20 employees than for one with 2000 employees. A common cut-off point in studies of small and medium-sized firms is 250 employees. The main activity of the chosen firms is in the electrical engineering and electronics (Electro), mechanical engineering and machinery (Mechanics), clothing or plastics industries. The firms are all located in the Sydney and Melbourne metropolitan areas, which host the largest populations of small and medium-sized firms.

The study uses a cross-sectional design. Data were obtained through a questionnaire posted to 2000 firms. The questionnaire was accompanied by a letter that briefly explained the purpose of the study and promised that confidentiality of the information provided would be maintained. From the

262

Strategic aspects

initial sample, 80 firms had to be excluded because of incorrect addresses. An additional seven firms were excluded because their characteristics did not meet the sampling criteria. Therefore, the effective sample size is 1913 firms. The managing director or owner of the firm was chosen as the respondent. These persons presumably have the best first-hand knowledge of the overall behaviour of their firms. However, this choice also has a drawback in that many of the firms refused to answer due to either lack of time or lack of motivation. The growing number of questionnaires sent to small and medium-sized firms has apparently reduced their willingness to participate in scientific studies. The mailing resulted in 276 useable responses, which translates into a response rate of 14.4 per cent. This percentage is not untypical for studies of small and medium-sized firms.9 11.6.3

The Data

The industry distribution of the respondents is depicted in Figure 11.1. In the sample, the plastics industry dominates with 44.9 per cent of all respondents. The second-largest group is electrical engineering and electronics with 23.6 per cent. About 15.2 per cent of the firms are in the mechanical

Clothing 12.7%

Not known yet 3.6% Elec. engineering 23.6%

Mech. engineering 15.2%

Plastics 44.9%

Figure 11.1

Distribution of the firms in the sample

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Technological sourcing

Table 11.2

Demographics of the sample

Characteristic

Mean

Median

Standard deviation

Age at the time of data collection (in years) Total annual sales in 1996 (in million ECU) Number of employees in 1996 Profit before taxes in 1996 (in thousand ECU) Average yearly sales growth from 1990 to 1996 in %

17.40 1.77 17.72 152.70 13.02

14.00 0.66 7.00 27.65 5.76

14.14 4.09 32.01 496.55 29.90

engineering sector and 12.7 per cent in the clothing sector. A small proportion of the firms that could not be allocated precisely to any of the four sectors has been excluded from the analysis. Table 11.2 presents the general demographics of the firms in the sample. The average age of the firms was 17.4 years. The median age of 14 years is very close. This indicates that the sample was not dominated by very young firms or by very old firms. The relatively small median number of employees and the small value of sales suggest that the majority of firms in the sample are rather small. In the sample, the average profit and sales figures are influenced by some extreme cases, as can be seen from the large differences between the respective means and medians. The large standard deviations support this interpretation. 11.6.4

Sectoral Analysis

Table 11.3 summarizes sectoral differences in the demographic characteristics of the firms. The ANOVA test shows significant differences in firm age and in the number of employees in 1996. For the total annual sales in 1996 and the average yearly sales growth significant differences also emerge, although at or slightly above the 0.05 level. As is shown in Table 11.4, there are significant sectoral differences in the technology characteristics of the firms. The data for the R&D to sales ratio can be interpreted to mean that the firms in the electrical engineering and electronics sector may be characterized as high-technology firms in comparison to the firms in the other three sectors, a finding that is reinforced by the other two sets of answers. ‘imitability’, a measure of the potential of other firms to learn or replicate a firm’s technology, is based on the answers to three Likert-type questions on a scale from 1 (low imitability) to 7 (high imitability). ‘Knowledge intensity’ is also the average

264

Table 11.3

Strategic aspects

Sectoral comparison of firm demographics

Variable

Electro

Mecha

Plastics

Clothing

ANOVA

Age at the time of data collection (in years)

11.89 (9.29)

22.71 (18.95)

18.01 (13.30)

19.26 (15.15)

0.001 (5.789)

Total annual sales in 1996 (in million ECU)

0.64 (1.75)

2.70 (7.08)

2.23 (4.10)

1.20 (1.08)

0.053 (2.600)

8.65 (20.91)

20.23 (27.16)

24.16 (40.10)

9.12 (8.62)

0.005 (4.359)

150.69 (734.71)

170.08 (300.77)

196.57 (429.49)

96.43 (197.35)

0.872 (0.236)

24.74 (51.90)

10.08 (16.81)

11.50 (20.98)

2.24 (12.85)

0.050 (2.668)

Number of employees in 1996 Profit before taxes in 1996 (in thousand ECU) Average yearly sales growth from 1990 to 1996 in per cent

Notes: In the sector columns, the upper value in each row is the mean value. The value in brackets is the standard deviation. In the ANOVA column, the upper value is the significance level. The value in brackets is the F-value of the ANOVA test.

Table 11.4

Sectoral comparison of firm technology characteristics

Variable

Electro

Mechanics

Plastics

Clothing

ANOVA

Imitability1

3.83 (1.38)

4.70 (1.56)

4.54 (1.39)

4.92 (1.21)

0.001 (6.015)

Knowledge intensity2

5.92 (1.05)

5.67 (1.13)

5.43 (1.07)

4.98 (1.33)

0.001 (6.006)

17.73 (19.60)

5.93 (9.86)

4.94 (5.63)

6.76 (7.76)

0.000 (17.665)

R&D/Sales (%)

Notes: 1. The imitability measure was formed by aggregating the answers of three Likert type questions. This measure draws on previous research by Zander and Kogut (1995). A high score on this construct reflects an easy imitability of the core resource or technology. The measure received a Cronbach Alpha score of 0.71. 2. The knowledge intensity of the business was measured using the average of the replies to three Likert type questions. The Cronbach Alpha score for this construct was 0.70. In the sector columns, the upper value in each row is the mean value. The value in brackets is the standard deviation. In the ANOVA column, the upper value is the significance level. The value in brackets is the F-value of the ANOVA test.

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Table 11.5

Sectoral comparison of alliances with competitors

Variable

Electro Mechanics Plastics Clothing ANOVA

Total number of alliances with potential competitors

1.36 (1.67)

0.86 (1.15)

0.91 (1.84)

1.11 (3.08)

0.469 (0.848)

Information exchange with potential competitors

2.32 (1.56)

2.17 (1.55)

1.83 (1.22)

2.35 (1.57)

0.070 (2.378)

Joint consortia with potential competitors

2.16 (1.43)

2.23 (1.78)

1.67 (1.14)

1.47 (0.83)

0.008 (3.999)

Alliance contracts with potential competitors

1.90 (1.32)

2.08 (1.76)

1.56 (1.17)

1.59 (1.08)

0.101 (2.099)

Shared equipment or facilities with potential competitors

2.24 (1.45)

1.98 (1.54)

1.71 (1.38)

1.68 (1.04)

0.087 (2.212)

Joint ventures with potential competitors

2.19 (1.45)

2.27 (1.80)

1.58 (1.22)

1.50 (1.16)

0.003 (4.769)

Notes: In the sector columns, the upper value in each row is the mean value. The value in brackets is the standard deviation. In the ANOVA column, the upper value is the significance level. The value in brackets is the F-value of the ANOVA test.

of three Likert-type questions, this time ranging from 1 (low intensity) to 7 (high intensity). It measures the extent to which a firm’s product or service contains a knowledge component. To further test this interpretation of sectoral variations, a series of two-sample T-tests was computed in which the firms in the electrical engineering and electronics sector were compared with the firms from the other three sectors. This test reveals differences between the electrical engineering and electronics sector compared with the other three sectors at significance levels of 0.001 or less. While the firms in the various sectors seem not to differ significantly in the number of partnerships they have with potential competitors (Table 11.5), differences exist between the sectors as to the form of alliances in which firms engage. Firms from the electrical engineering and electronics and the mechanical engineering and machinery sectors seem to be more involved in joint consortia and joint ventures with potential competitors, and also in sharing equipment and facilities, than is true of firms in the plastics and clothing sectors. The results from the two-sample T-test (Table 11.6) are, on the whole, supportive of our first hypothesis that firms in high-technology industries are engaged more frequently in development alliances with competitors than are firms in lower-technology industries. Even though the differences

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Strategic aspects

Table 11.6 Two-sample T-test for differences in competitor relationships between high-technology and low-technology sectors Variable

High Low technology technology

T

df

Sig.

Total number of alliances with potential competitors

1.36 (1.67)

0.93 (1.97)

⫺1.501

226 0.135

Information exchange with potential competitors

2.32 (1.56)

1.99 (1.37)

⫺1.593

255 0.112

Joint consortia with potential competitors

1.90 (1.32)

1.67 (1.31)

⫺2.137

254 0.034

Alliance contracts with potential competitors

2.24 (1.53)

1.76 (1.36)

⫺1.216

254 0.225

Shared equipment or facilities with potential competitors

2.19 (1.45)

1.71 (1.38)

⫺2.202 95 963 0.030

Joint ventures with potential competitors

2.19 (1.45)

1.71 (1.38)

⫺2.365

255 0.019

Notes: In the sector columns, the upper value in each row is the mean value. The value in brackets is the standard deviation. Significance levels are based on two tailed t-statistics.

regarding the overall number of alliances with potential competitors and information exchanged with potential competitors are not quite significant at the 0.10 level, there are statistically-significant differences in the types of alliances pursued. The high-technology firms seem to be more involved in closer forms of collaboration such as joint consortia, joint ventures, or shared equipment and facilities. What is revealed most clearly, however, is the overall reluctance of firms in all sectors to engage in this type of alliance. With the exception of the first line, all of the results in Table 11.5 are based on Likert-type questions on a scale ranging from 1 (never) to 7 (very often). Even in the most extreme groups, alliances with competitors never approach the mid-point of the scale, thus implying a low degree of embeddedness. The observation accords well with earlier studies of the behaviour of Australian firms. In its survey, the Bureau of Industry Economics (1995, p. xvii) found that less than one-third of the respondents participated in ‘core’ forms of cooperation including ‘preferred customer and supplier agreements, joint ventures, partnerships and business networks’. Of the firms that did cooperate, the Bureau found that slightly more than one-half (perhaps 18 per cent of the total number of respondents) involved firms other than suppliers and customers, such as competitors (1995, p. 67).

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Table 11.7

Sectoral comparison of supplier structure

Variable

Electro Mechanics

Plastics

Clothing

ANOVA

Share of largest supplier

33.29 (25.64)

29.67 (22.44)

37.14 (25.21)

43.39 (23.50)

0.139 (1.854)

Closeness of relationship with largest supplier1

2.85 (1.74)

2.82 (1.59)

3.23 (1.65)

3.20 (1.57)

0.379 (1.031)

Share of three largest suppliers

51.71 (32.57)

46.86 (23.92)

58.44 (30.71)

64.96 (25.47)

0.087 (2.224)

Share of five largest suppliers

59.11 (32.62)

61.68 (27.29)

68.23 (30.07)

75.00 (21.90)

0.131 (1.898)

Notes: 1. The overall closeness of the relationship with the most important supplier was measured using the average of the replies to three Likert-type questions. The Cronbach Alpha score for this construct was 0.75. In the sector columns, the upper value in each row is the mean value. The value in brackets is the standard deviation. In the ANOVA column, the upper value is the significance level. The value in brackets is the F-value of the ANOVA test.

Tables 11.7 to 11.9 present information on the second hypothesis, that firms in relatively high-technology industries are engaged more frequently in development alliances with suppliers than are firms in lower-technology industries. The data, in which lower numbers indicate relatively weak relationships, are not consistent with the hypothesis. Both knowledge sharing and joint product development with a firm’s single largest supplier are more likely to occur in relatively low-technology sectors (Tables 11.8 to 11.9). Furthermore, the share of a firm’s most important supplier and the overall closeness of the relationship with that supplier are larger and stronger in low-technology sectors (Table 11.7). Although further investigation is needed, these findings may be attributed, at least in part, to the nature of the particular industries studied. The Bureau of Industry Economics argues for example that ‘firms in [the clothing and footwear industry] often need preferred suppliers and tend also to work with retail stores’. Tables 11.10 to 11.12 provide partial support for Hypothesis 3, that firms in relatively high-technology industries are engaged more frequently in development alliances with their customers than are firms in lower-technology industries. The share of the largest customer and the closeness of the relationship with that customer are greater for firms in the electronics sector than for those in lower-technology sectors (Table 11.10). This is consistent with the finding of the Bureau of Industry Economics (1995) that firms in the information technology and telecommunications industry, which partly overlaps with

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Strategic aspects

Table 11.8 Sectoral comparison of knowledge-sharing and product development activities with suppliers Variable

Electro

Mechanics Plastics Clothing

ANOVA

Knowledge sharing with largest supplier1

3.85 (2.18)

3.76 (2.14)

4.45 (2.06)

4.12 (1.82)

0.164 (1.719)

Joint product development with largest supplier2

3.42 (2.12)

3.53 (1.97)

4.34 (2.03)

4.26 (2.11)

0.017 (3.444)

Notes: 1. For this variable, firms evaluated a Likert-type question stating that the firm is often exchanging confidential information with its most important supplier. 2. For this variable, firms evaluated a Likert-type question stating that the firm is often cooperating in product development with its most important supplier. In the sector columns, the upper value in each row is the mean value. The value in brackets is the standard deviation. In the ANOVA column, the upper value is the significance level. The value in brackets is the F-value of the ANOVA test.

Table 11.9

Two-sample T-test for differences in supplier relationships between high-technology and low-technology sectors

Variable

High technology

Low technology

T

df

Sig.

Knowledge sharing with largest supplier

3.85 (2.18)

4.26 (2.04)

1.323

248

0.187

Joint product development with largest supplier

3.42 (2.12)

4.16 (2.05)

2.389

245

0.018

Notes: In the sector columns, the upper value in each row is the mean value. The value in brackets is the standard deviation. Significance levels are based on two tailed t-statistics.

electronics, had a higher level of customer relationships than was true for other industries. In addition, the t-test relating joint product development with the largest customer to relative technology levels is significant at the 0.10 level (Table 11.12). On the other hand, knowledge sharing with the customer does not vary significantly by sector or by level of technology (Tables 11.11 and 11.12). In general, for all sectors, the Likert-type scores for closeness of relationships, knowledge sharing and joint product development tend to be about one point higher for relationships with customers than for those with suppliers, indicating there is a higher degree of technological embeddedness in customer-based networks.

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Table 11.10

Sectoral comparison of customer structure

Variable

Electro

Share of largest customer (%)

52.45 (27.67)

32.42 (19.73)

28.63 (21.09)

24.96 (21.74)

0.000 (15.390)

4.65 (1.86)

4.19 (1.62)

4.31 (1.63)

3.71 (1.48)

0.077 (2.309)

Share of three largest customers (%)

75.02 (25.09)

59.78 (24.13)

47.82 (24.70)

44.61 (28.24)

0.000 (15.620)

Share of five largest customers (%)

78.80 (27.70)

71.77 (24.10)

58.49 (25.30)

52.22 (28.11)

0.000 (9.493)

Closeness of relationship with largest customer1

Mechanics Plastics Clothing

ANOVA

Notes: 1. The overall closeness of the relationship with the largest customer was measured using the average of the replies to four Likert-type questions. The Cronbach Alpha score for this construct was 0.80. In the sector columns, the upper value in each row is the mean value. The value in brackets is the standard deviation. In the ANOVA column, the upper value is the significance level. The value in brackets is the F-value of the ANOVA test.

Table 11.11 Sectoral comparison of knowledge-sharing and product development activities with customers Variable

Electro Mechanics

Plastics Clothing

ANOVA

Knowledge sharing with largest customer1

5.26 (2.02)

5.11 (1.64)

5.15 (1.88)

4.65 (1.74)

0.470 (0.847)

Joint product development with largest customer2

5.31 (1.94)

5.56 (1.85)

5.83 (1.62)

5.56 (1.40)

0.271 (1.312)

Notes: 1. For this variable, firms evaluated a Likert-type question stating that the firm often exchanges confidential information with its most important customer. 2. For this variable, firms evaluated a Likert-type question stating that the firm often cooperates in product development with its most important customer. In the sector columns, the upper value in each row is the mean value. The value in brackets is the standard deviation. In the ANOVA column, the upper value is the significance level. The value in brackets is the F-value of the ANOVA test.

270

Strategic aspects

Table 11.12 Two-sample T-test for differences in customer relationships between high-technology sectors and low-technology sectors Variable

High technology

Low technology

T

df

Sig.

Knowledge sharing with largest customer

5.26 (2.02)

5.05 (1.81)

⫺0.757

252

0.450

Joint product development with largest customer

5.31 (1.94)

5.73 (1.63)

1.684

251

0.093

Notes: In the sector columns, the upper value in each row is the mean value. The value in brackets is the standard deviation. Significance levels are based on two tailed t-statistics.

Table 11.13 Sectoral comparison of supplier firm’s geographical distribution Variable

Electro

Mechanics

Plastics

Clothing

ANOVA

% of suppliers in metropolitan area

58.87 (32.54)

69.47 (30.13)

66.79 (33.03)

60.33 (36.38)

0.323 (1.167)

% of suppliers in rest of state

14.50 (23.38)

16.14 (24.83)

11.09 (21.98)

13.06 (21.00)

0.616 (0.599)

% of suppliers in rest of Australia

19.13 (19.10)

8.01 (13.30)

10.82 (14.94)

13.00 (24.71)

0.010 (3.857)

% of suppliers in USA and Canada

4.41 (8.37)

1.29 (3.72)

4.38 (12.65)

8.71 (3.48)

0.136 (1.866)

% of suppliers in Asia

1.47 (3.20)

2.55 (1.02)

3.20 (7.85)

10.04 (20.74)

0.000 (7.456)

% of suppliers in Europe

1.60 (5.36)

4.84 (17.96)

3.69 (11.69)

2.70 (7.60)

0.553 (0.700)

Notes: In the sector columns, the upper value in each row is the mean value. The value in brackets is the standard deviation. In the ANOVA column, the upper value is the significance level. The value in brackets is the F-value of the ANOVA test.

Tables 11.13 to 11.15 summarize our comparison of the respective geographical scope of activities of relatively high-technology and lowertechnology firms. The results provide partial support for our fourth hypothesis that firms in relatively high-technology industries have a wider geographical range of contacts than is true for firms in lower-technology

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Technological sourcing

Table 11.14 Sectoral comparison of customer firm’s geographical distribution Variable

Electro

Mechanics

Plastics

Clothing

ANOVA

% of customers in metropolitan area

53.79 (35.68)

61.31 (29.53)

63.94 (29.98)

35.51 (32.29)

0.000 (7.207)

% of customers in rest of state

14.76 (21.29)

16.82 (21.86)

13.73 (16.85)

27.16 (28.45)

0.012 (3.711)

% of customers in rest of Australia

20.10 (22.27)

19.55 (19.98)

18.61 (19.86)

36.56 (27.11)

0.000 (6.117)

% of customers in USA and Canada

2.84 (6.26)

5.26 (2.04)

4.06 (1.94)

3.67 (1.57)

0.000 (7.957)

% of customers in Asia

3.65 (9.86)

1.15 (3.18)

1.38 (4.73)

5.79 (1.52)

0.045 (2.726)

4.86 (15.81)

2.11 (6.72)

1.92 (8.75)

1.58 (6.04)

0.045 (2.530)

% of customers in Europe

Notes: In the sector columns, the upper value in each row is the mean value. The value in brackets is the standard deviation. In the ANOVA column, the upper value is the significance level. The value in brackets is the F-value of the ANOVA test.

industries. High-technology firms seem to have a larger percentage of customers abroad. The results for Asia and Europe are significant at the 0.10 level, and the results for the USA and Canada are highly significant (Table 11.15). This finding is in line with the argument that the global nature of high-technology industries might force firms to internationalise early. In contrast to our hypothesis, firms from the lower-technology sectors seem to use a larger percentage of suppliers from Asia and Europe. This is not a total surprise since it results in part from the relatively high degree of dependence of clothing firms on Asian textile suppliers (Singleton, 1997). Interestingly, the high-technology firms use a larger percentage of Australian suppliers from outside their metropolitan area or state, which is consistent with Hypothesis 4. Our findings differ somewhat from those of the Bureau of Industry Economics (1995) survey. The BIE found that around one-third of Australian firms that networked (or one-ninth of the respondents) had arrangements with overseas firms. While the extent of cooperation was greatest for firms in higher-technology sectors such as information technology and telecommunications, and scientific and medical equipment, it was lowest for the clothing and footwear sector. As the published BIE study does not distinguish between

272

Strategic aspects

Table 11.15 Two-sample T-test for differences in the geographical scope between high-technology sectors and low-technology sectors Variable

High technology

Low technology

% of suppliers in metropolitan area

58.87 (32.54)

66.24 (33.00)

% of suppliers in rest of state

14.50 (23.38)

% of suppliers in rest of Australia

T

df

Sig.

1.439

237

0.152

12.49 (22.41)

⫺0.571

237

0.569

19.13 (19.10)

10.60 (16.69)

⫺2.944

% of suppliers in USA and Canada

4.41 (8.36)

3.13 (10.30)

⫺0.827

% of suppliers in Asia

1.47 (3.20)

3.76 (19.95)

% of suppliers in Europe

1.60 (5.36)

% of customers in metropolitan area

76.07

0.004

237

0.409

2.502

236.83

0.013

3.76 (12.67)

1.832

207.85

0.068

53.79 (35.86)

58.56 (31.91)

0.996

249

0.320

% of customers in rest of state

14.76 (21.29)

16.66 (20.78)

0.624

250

0.533

% of customers in rest of Australia

20.10 (22.27)

21.86 (22.19)

0.545

249

0.586

% of customers in USA and Canada

2.84 (6.26)

0.37 (1.79)

⫺3.088

65.43

0.003

% of customers in Asia

3.65 (9.86)

1.20 (4.05)

⫺1.922

69.13

0.059

4.86 (15.81)

1.26 (6.94)

⫺1.753

70.13

0.084

% of customers in Europe

Notes: In the sector columns, the upper value in each row is the mean value. The value in brackets is the standard deviation. Significance levels are based on two tailed t-statistics.

connections with overseas suppliers and customers however, the difference between the two sets of findings may be influenced by the use of different levels of aggregation. Irrespective of differences in the scope of their overseas relationships, however, firms in all sectors remain overwhelmingly committed to dealing with Australian suppliers and customers. With the exception of suppliers to the clothing sector, at least 88 per cent of all sectoral supplier and customer relationships are with Australian firms. Moreover, they tend to be

Technological sourcing

273

concentrated even within Australia, with the bulk of both suppliers and customers being located in the same state as the responding firms and usually within their own metropolitan areas.

11.7

CONCLUSIONS: DISCUSSION AND POLICY RECOMMENDATIONS

Our results are broadly consistent with similar studies (Bureau of Industry Economics, 1995; Dean et al., 1997). If, as we believe, firms need access to substantial pools of external information in order to establish and retain their technological competitiveness, then our findings raise concerns over the ability of small and medium-sized Australian firms to continue to operate at world-class levels. In addition to their limited willingness to establish close relationships with other firms, the firms that we surveyed maintain only limited contacts outside their own states. Contacts with foreign firms are very limited indeed. As the level of indigenous R&D in Australia is very low, the ability of local SMEs to keep up with important innovations seems to be below optimal levels. This lack of technological embeddedness is perhaps not of much importance in industries in which the rate of technical progress is low, but poor access to innovative knowledge is bound to impede the development of firms in highly innovative industries since their ability even to imitate international best practices must be low if firms cannot learn quickly about developments elsewhere. A major policy implication of our findings is that the Australian government should not only encourage networking behaviour and greater levels of technological embeddedness by SMEs, as it does at present (Dean et al., 1997), but should consider carefully what sorts of relationships between firms lead to the largest increases in innovative learning. Given the considerable fear that Australian firms have of losing competitive knowledge through networks and their very limited belief that they are themselves likely to gain knowledge that is useful, the encouragement of formal networks is only one of several policies that the government should consider if it wants to increase the access of Australian firms to innovative information and knowledge. Other looser forms of embeddedness should also be fostered. One possibility would be for the government to increase its own activities as a collector and disseminator of knowledge on an international basis (Robertson, 1998). Another would be to develop ways of bringing innovative knowledge directly to Australia. For example, in recent years the Singapore government has deliberately encouraged the establishment of operations by high-technology multinational firms in the hope that this would generate spillovers to

274

Strategic aspects

locally-owned firms (Loh, 1998; Chiu et al., 1997; Virmani and Rao, 1997). Although Australia already has substantial investments by foreign firms and its population is more highly educated than was true in Singapore, the success of the Singaporean economy in updating its technology since the 1980s suggests that some modification of Singapore’s initiative might be worthy of consideration.

NOTES 1. Although participants in both early and contemporary markets have not necessarily been firms but other types of organizations or individuals, much of the analysis that follows applies equally well to other types of actors whenever they can learn more efficiently through participation in a wider external environment. 2. ‘Knowledge’ is often defined as processed information, while ‘information’ is regarded as a raw material used in the process of creating knowledge (Fransman 1994). ‘Learning’ involves (1) collecting additional information; (2) processing both additional and existing information into some form of knowledge that the organization can use operationally; and (3) determining new ways of acquiring information and processing it into knowledge – that is, learning how to learn. Here, we use ‘learning’ to refer to all three activities. 3. Of course, the reverse is not always true. Firms that can keep information and knowledge to themselves may benefit as a result. Attempts to establish asymmetries of information are a natural outcome of competition. 4. For example, on the basis of his concept of ‘design hierarchies’, Clark (1985) argues that search patterns for solutions are determined by earlier decisions concerning which technologies to adopt. Thus the early adoption of the internal combustion engine by automobile producers meant that many subsequent design decisions were made within that context, and information on alternative technologies came to be regarded as irrelevant. 5. Although, as Hamilton and Feenstra (1995) have argued, markets and hierarchies might best be thought of as complementary rather than as alternatives. 6. Leonard-Barton (1995, p. 152) lists seven categories of external sources of technological knowledge: other companies – non-competing, other companies – competitors, universities, vendors, national labs, customers, and consultants. While Afuah (1998, p. 69) lists four external categories: a firm’s external value-added chain of suppliers, customers, and complementary innovators; university, government and private laboratories; competitors and related industries; and other nations or regions. Here we concentrate on competitors, suppliers (vendors) and customers. 7. Although firms will in most cases be embedded in both technological and manufacturing networks, the distinction helps to isolate the mechanisms and results from two different types of interaction. 8. A comparable sample was collected for small and medium-sized Finnish firms. However only the Australian firms are analysed in this chapter. 9. By comparison, a similar survey of 5000 SMEs sponsored by a government agency and conducted by the Australian Bureau of Statistics resulted in approximately 1300 responses (Bureau of Industry Economics, 1995) and a telephone survey of 5500 small and mediumsized service and manufacturing firms generated 912 responses (Dean et al., 1997). The somewhat lower response rate that we received can probably be accounted for by the fact that our survey was of considerable length (five smallprint pages), required detailed answers, was privately sponsored and was conducted by post.

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REFERENCES Afuah, Allan (1998), Innovation Management: Strategies, Implementation, and Profits, New York and Oxford: Oxford University Press. Autio, E. (1996), ‘Embeddedness, growth constraints, and innovative strategies among SMEs: the resource-based perspective’, paper presented to the RISE 1996 Conference on Innovative Strategies and Entrepreneurship, Jyväskylar. Bureau of Industry Economics (1995), Beyond the Firm: An Assessment of Business Linkages and Networks in Australia, Research Report 67, Canberra: Australian Government Publishing Service. Callon, M. (1993), ‘Variety and irreversibility in networks of technique conception and adoption’, in D. Foray and C. Freeman (eds), Technology and the Wealth of Nations: The Dynamics of Constructed Advantage, London: Pinter, pp. 232–68. Chiu, S.W.K., K.C. Ho and T.-L. Lui (1997), City-States in the Global Economy: Industrial Restructuring in Hong Kong and Singapore, Boulder, CO: Westview. Clark, K.B. (1985), ‘The interaction of design hierarchies and market concepts in technological evolution’, Research Policy, 14, pp. 235–51. Dean, J., S. Holmes and S. Smith (1997), ‘Understanding business networks: evidence from the manufacturing and service sectors in Australia’, Journal of Small Business Management, 35, pp. 78–84. Fransman, M. (1994), ‘Information, knowledge, vision, and theories of the firm’, Industrial and Corporate Change, 3 (3), pp. 713–57. Grabher, G. (1993), ‘The weakness of strong ties: the lock-in of regional development in the Ruhr area’, in G. Grabher (ed.), The Embedded Firm: On the Socioeconomics of Industrial Networks, London: Routledge, pp. 255–77. Granovetter, M. (1973), ‘The strength of weak ties’, American Journal of Sociology, 78, pp. 1360–80. Granovetter, M. (1985), ‘Economic action and social structure: the problem of embeddedness’, American Journal of Sociology, 91, pp. 481–510. Grannovetter, M. (1995), ‘Coase revisited: business groups in the modern economy’, Industrial and Corporate Change, 4 (1), pp. 93–130. Hamilton, G.G. and R.C. Feenstra (1995), ‘Varieties of hierarchies and markets: an introduction’, Industrial and Corporate Change, 4 (1), pp. 51–91. Hobday, M. (1998), ‘Product complexity, innovation and industrial organisation’, Research Policy, 26 (6), pp. 689–710. Industry Commission (1995), Research and Development, Report No. 44, 3 vols, Canberra: Australian Government Publishing Service. Jones, R. (1996), ‘Small firm success and supplier relations in the Australian boatbuilding industry: a contrast of two regions’, Journal of Small Business, 34 (2), pp. 71–78. Laage-Hellman, J. (1997), Business Networks in Japan: Supplier-Customer Interaction in Product Development, London: Routledge. Langlois, R.N. and P.L. Robertson (1992), ‘Networks and innovation in a modular system: lessons from the microcomputer and stereo components industries’, Research Policy, 21 (4), pp. 297–313. Leonard-Barton, D. (1995), Wellsprings of Knowledge: Building and Sustaining the Sources of Innovation, Boston, MA: Harvard Business School Press. Loh, L. (1998), ‘Technological policy and national competitiveness’, in T.M. Heng and T.K. Yam (eds), Competitiveness of the Singapore Economy: A Strategic Perspective, Singapore: Singapore University Press, pp. 40–73.

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Lundvall, B.-Å. (1988), ‘Innovation as an interactive process: from user–producer interaction to the national system of innovation’, in G. Dosi, C. Freeman, R. Nelson, G. Silverberg and L. Soete (eds), Technical Change and Economic Theory, London: Pinter, pp. 349–69. Marshall, A. (1919), Industry and Trade, London: Macmillan. Marshall, A. (1961), Principles of Economics, 9th (variorum) edn, London: Macmillan. Nishiguchi, T. (1994), Strategic Industrial Sourcing: The Japanese Advantage, New York and Oxford: Oxford University Press. OECD (2001), Main Science and Technology Indicators, Volume 2001/1. Prahalad, C.K. and R.A. Bettis (1986), ‘The dominant logic: a new linkage between diversity and performance’, Strategic Management Journal, 7 (6), pp. 885–501. Reinertsen, D.G. (1997), The Design Factory: A Product Developer’s Toolkit, New York: Free Press. Robertson, P.L. (1998), ‘Information, similar and complementary assets, and innovation policy’, in N.J. Foss and B.J. Loasby (eds), Economic Organization, Capabilities and Co-ordination, London: Routledge, pp. 261–88. Rogers, E.M. (1995), Diffusion of Innovations, 4th edn, New York: Free Press. Singleton, J. (1997), The World Textile Industry, London: Routledge. Virmani, B.R. and K. Rao (1997), Economic Restructuring, Technology Transfer and Human Resource Development, Singapore: Toppan. Von Hippel, E. (1976), ‘The dominant role of users in the scientific instrument innovation process’, Research Policy, 5 (3), pp. 212–39. Von Hippel, E. (1988), The Sources of Innovation, New York: Oxford University Press. Zander, U. and B. Kogut (1995), ‘Knowledge and the speed of the transfer and imitation of organisational capabilities: an empirical test’, Organisation Science, 6 (1), pp. 76–92.

12.

SMEs and the Internet: a comparative study – China and the UK Bob Ritchie and Clare Brindley1

12.1

INTRODUCTION

The potential impact on local, national and international markets from the widespread adoption of the Internet and e-business by smaller organizations is likely to be very significant. The Internet has been heralded as having a major impact on business in the 1990s and in the early part of the 21st century. Estimates (for example, by Durlacher, 1998) suggest that although the penetration of the Internet and e-business within the small business sector in the UK was initially low (in 1998 approximately one-third of SMEs utilized the Internet), forecasts (for example by Durlacher, 1998) have suggested a dramatic growth to around three-quarters of smaller businesses implementing e-business applications by 2003. In the case of the UK alone, there are estimated to be 2.4 million businesses employing fewer than 500 people (OECD, 1998a) with 1.5 million (almost 30 per cent of all businesses; OECD, 1998b) employing fewer than 11 people. What is interesting is not just this growth but the application of the Internet within their business strategy. Berthon et al. (1998, p. 691) commented that ‘more systematic research is required to reveal the true nature of commerce on the Web’. The research that has been done to date has often concentrated on e-business applications, involving large organizations operating in consumer markets. Though some authors, for example, Dutta and Evrard (1999), have begun to explore the use of the Internet by SMEs, the literature in this area is not vast and remains highly anecdotal. This study draws together the evidence from other studies in the field to develop a framework for the competitive environment for SMEs incorporating the Internet into their strategic development. The framework is evaluated through a comparative study of SMEs within the UK and China that draws on the different economic developmental contexts of the two countries and assesses the international competitive dimensions of the Internet to SME strategic thinking and development. 277

278

Strategic aspects

Difficulties are often experienced in differentiating the terms ‘e-business’ and ‘e-commerce’. The term ‘e-business’ represents the application of Internet technologies to all the business activities, operations, processes and communications both internally and externally with other supply chain members and agencies. E-business includes, for example, ‘research and development, marketing, manufacturing and inbound and outbound logistics. The buy-side e-commerce transactions with suppliers and the sell-side e-commerce transactions with customers can also be considered to be key business processes’ (Chaffey, 2002, p. 7). E-commerce, on the other hand, is defined as the subset of e-business processes which involve the communication of transactional or economic information (for example purchase orders and invoices) and financial payments (for example credit card authorization) between the organization and members of its supply chain and its customers. The definition of business used throughout this study is based on the number of employees, with 0–9 employees representing the ‘micro’business, 0–49 representing the small business and 50–249 representing the medium-sized business. A comprehensive survey of 1042 small and medium-sized (SMEs) UK enterprises by the Durlacher Quarterly Internet Report (1998) found that Internet access penetration is currently at 54 per cent for medium-sized companies and 33 per cent for small companies, led by the professional and business services sector at 60 per cent penetration. The 43 per cent of intranet-using SMEs stated that they intend to install an extranet within the next 24 months. E-mail has now become of critical importance to many SMEs with 66 per cent of Internet-using SMEs placing it into the top two categories of importance to their business; of these Internet users, 38 per cent described it as very important (the top category) to their work. Only 4 per cent of SMEs thought the Internet would remain unimportant to them during that period. An earlier report in 1997 by Durlacher found that 81 per cent of SMEs recognize that the Internet will be an intrinsic part of their businesses’ future and see themselves as being on-line within five years (http://www.durlacher.com). The view (Durlacher, 1998) that the Internet would become an integral and crucial part of the SMEs’ working environment has been fully justified to date and suggests that this will remain the dominant strategic driver within the next five years. If the Internet and Web technologies were to enable these smaller businesses to engage in the wider competitive arena, either through choice or necessity (that is proactively or reactively taking actions to protect their existing markets and customer base), then the effects on the nature of the competitive processes are likely to be profound. If the SMEs in other countries, for example China, were to behave in a similar fashion, the impact on the competitive environment and processes are difficult to predict,

SMEs and the Internet

279

especially in the global context. Evidence suggests that China is seeking to promote the opportunities by encouraging entrepreneurs through lower initial investments and providing easier access to Internet services (Buck, 1996), and through the establishment of the Business Online Facilitation Association in January 2000 to promote Internet utilization amongst all businesses. Another project is the Business Online Project, established in July 2000, which seeks to link 1 million small businesses and 10 000 medium businesses on-line within a one- to two-year horizon (Tang, 2000). Although detailed data on business utilization of the Internet is not available for China at present, the indications are that a significant expansion is taking place in Internet usage, one that is directly comparable to the usage in developed countries. The number of Internet users has grown from 0.6 million in 1997 to 2.1 million in 1999 and to 8.9 million in January 2000 (China Internet Network Information Service, 2000). This escalating rate of growth, if sustained, would make China the largest market of Internet users. Most of this expansion is credited to young individuals, academic organizations, IT businesses and foreign-owned companies. The usage by smaller Chinese organizations in the manufacturing sector is not known with precision but is considered to be low in comparison to other countries such as the UK. The expectation is that growth in this sector is imminent and likely to be rapid. Although the number of users has grown, the rate of growth of Internet hosts has failed to keep pace and China currently has a very low ratio of hosts to users (48 955 Internet hosts in January 2000; China Internet Network Information Service, 2000). In comparison to the more-developed economies this would be seen as very low, although less so in comparison to other developing economies. There are two primary aims of the overall study: firstly, to assess the rate and nature of Internet adoption by smaller organizations; and secondly, to draw comparisons between the patterns observed in the UK and in China. The present study reports on the preliminary stages of this research and is designed to: ●

●

●

Develop a framework of primary variables viewed as likely to influence the nature and level of adoption of Internet usage by SMEs for both e-business and e-commerce applications. Undertake empirical studies with a small number of SMEs in both the UK and China and draw comparisons concerning their rate of adoption of e-business and e-commerce. Evaluate the framework through this empirical evidence for two countries at different stages in their economic evolution and free market economic positions.

280 ●

●

Strategic aspects

Draw tentative conclusions concerning the relative importance of the contextual variables in the framework. Provide a basis for further research in the use of the Internet by SMEs for competitive advantage.

The main expectation of the study was to gain a snapshot of the familiarity and use of the Internet by commercial enterprises. It was recognized that this was indeed only a snapshot and that the rate of technological change and the developments in global competitive pressures may invalidate this data within a short time period. However, as Cheng (1999, p. 3) states, ‘it can be a very confusing marketplace for small and medium sized businesses’, and unless we can begin to identify usage patterns and perceptions of the Internet within SMEs it is difficult for academics, trainers or government agencies to provide appropriate solutions. The key question remains the willingness and the capability of the owner-manager of the SME to adopt the new Internet technologies and to engage in the opportunities for competitive development that these will afford. This question is being addressed by the authors in a multidimensional perspective through the Manchester Metropolitan University’s Centre for Creativity, Enterprise and Innovation, which is undertaking a programme of research into various dimensions of e-business developments in the smaller organization. An important dimension of the research is to undertake comparative studies across different countries to assess the generic factors and possible specialist local factors which either encourage or restrict the rate of adoption. The studies within the UK and China reported in this study reflect this approach. The research focused not only on the level of usage of the Internet but equally on the nature of this use and perceptions of the impact on the competitive approach operated by the business. The interest is not primarily on whether SMEs use the Internet but on how they currently or prospectively see its application within their business strategies in terms of market competition and supply chain management. The remainder of the chapter proceeds as follows. In section 12.2 the set of factors influencing the Internet competitive environment within which SMEs are increasingly operating, is constructed and explained. Section 12.3 elaborates upon the overall methodology and data collection approaches employed in the UK and China, including modifications necessary to accommodate differences in context. In section 12.4 the results from the UK and China are then presented individually, incorporating an analysis and explanation of the findings and appropriate comparisons between the two countries. The concluding section, section 12.5, relates the findings to those of other studies and to the Internet Competitive Environment Framework

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developed within the chapter, to evaluate the robustness of the framework and to suggest directions for further study.

12.2

SMEs AND THE INTERNET

The developments in information and communication technologies (ICTs) are predicted (for example Kalakota and Robinson, 2000; De Kare-Silver, 2000) to pose significant opportunities and threats to all businesses including the SME sector. Ritchie and Brindley (2000a) developed this theme of the radical changes in the international competitive environment and the implications for SMEs. The conclusion that many SMEs may compete on level terms with larger businesses in the international arena depends on a number of interacting elements in the competitive environment. Figure 12.1, adapted from the authors’ work (Ritchie and Brindley, 2000a, 2000b), indicates the range of elements influencing the impact of the Internet’s competitive environment on the SME. ICTs are recognized as providing the key driver of strategic change in most economies in the twenty-first century. An issue of interest to researchers and policy makers is the extent to which different economies will share this feature, and the potential differences between the more-developed economies such as the UK and less-developed economies such as China. This framework seeks to provide the basis for undertaking this comparative analysis.

Niche markets

e-business technologies Entry/exit barriers

Knowledge and skills SME

Cross-sector collaboration

Government regulation Supply chain relationships

Transaction economics

Note: In the interest of clarity not all of the interactions have been represented by arrows in the diagram.

Figure 12.1

SME Internet competitive environment framework

282

Strategic aspects

In addressing the key dimensions of the Internet competitive environment framework at this stage, we are not seeking to establish any relative ranking of the elements themselves. It is also evident that there exists a significant degree of interaction between the elements within the framework. The elements may simultaneously generate threats as well as opportunities to the smaller business, which may currently be operating in a relatively protected niche or local market. Such threats may be counterbalanced by opportunities to enter new markets on a wider geographical area. The e-business development element within the framework, together with the associated communication technologies, provides the technological platform on which SMEs may develop their businesses. In some respects, the business may be totally orientated around the e-business technologies. In other cases the technology is simply the vehicle for communicating with suppliers, customers and delivering the product/service. Changes in legislation and government regulation covering transactions within the Internet and e-business consumer protection (Deloitte Consulting, 1999) are amongst the developments seen as necessary at the national and international levels to facilitate the development of e-business. For example, the issues of commercial security of transactions and the fears of fraud represent major barriers to the confidence of users, both individual and organizational, of the Internet as an e-commerce channel (Buck, 1996). One might anticipate differences in the degree of such regulation of Internet financial transactions between the developing economy of China and the developed market economy of the UK, on the basis of the banking and financial infrastructures. The supply chain relationships are also likely to fundamentally alter with disintermediation (that is, skipping members in the previous supply chain and substituting the services they provided) and new supply chain partnering arrangements taking place in a more amorphous supply chain model (Ritchie and Brindley, 2000b). E-business technologies facilitate such opportunities but equally place strains on the existing supply chain relationships by virtue of the fact that these may be subject to change at short notice. Many of the previous fundamental parameters associated with transaction economics2 are no longer inviolable. Costs, prices, volumes and profit margins at each stage in the supply chain are now subject to negotiation and change, especially as the supplier has the capacity to link directly with the customer or consumer of the product or service. The changes in transaction economics when combined with the changing supply chain relationships, both contractual and noncontractual, have generated a competitive environment in which both entry and exit barriers have fallen. For example, the previous scale

SMEs and the Internet

283

economies and investments required to establish and to maintain an international marketing and sales presence are no longer necessary. The Internet provides the opportunity and means for the smallest organization to communicate directly with its potential customers on a global basis at relatively low costs. It is evident that e-business technologies are eliminating many of the barriers previously associated with the scale or reputation of the larger organization. Another feature of the emerging global competitive marketplace supported by the Internet is cross-sector collaboration. In some respects this is the continuation of the previous evolution of combining compatible or complementary products and services, though the Internet enhances the capacity to achieve this more effectively. In other respects, this means the generation of new collaborations and product or service combinations based around identifiable customer or consumer groupings. Governments in developing economies such as China have the capacity to encourage such developments by implementing policies to enhance foreign direct investment (FDI) and providing a regulatory framework that supports international investment in partnership with domestic businesses (Ritchie et al., 1998). To date this has been primarily targeted at the larger multinational organizations, though evidence (for example Liu et al., 2001) suggests that smaller organizations are now developing such partnerships with Chinese businesses. Previous studies (for example Andersen Consulting, 1999; Deloitte Consulting, 1999) have indicated the importance of knowledge and skills as a determinant of the rate of progress in the adoption of the e-business technologies by SMEs. This is viewed as more than just technical knowledge and competence, and concerns the potential application of e-business to the existing markets, business relationships and organizational processes. The personal background of the owner-managers or those responsible for the development of the Internet technology within the business and their previous computing experience were also viewed as potentially important factors. The application of e-business knowledge and skills provides opportunities for the SME to identify and develop niche markets possessing equivalent competitive advantages to those of the larger organization. Many smaller organizations can now compete on very specialized products and services designed specifically for small groups of customers. The combination of these developments, driven by changes in ICTs, is resulting in new configurations of supply chains and the associated relationships. Ritchie and Brindley (2000a) conceived of such changes resulting in a highly dynamic and less predictable set of supply chain and competitive relationships which they termed the amorphous supply chain.

284

12.3

Strategic aspects

METHODOLOGY

The methodology used to research the SME sectors in both the UK and China is developed initially in this section, indicating some of the problems experienced and the limitations of the data. UK Study A telephone survey was administered to a random sample of UK SMEs drawn from an SMEs database, compiled by the local Training and Enterprise Council. The database contained the names of 300 SMEs located in Cheshire within the North-West region. Of the companies contacted,3 35 agreed to participate in the survey, a 19 per cent response rate. The database did not cover only one particular sector and thus responses were obtained from SMEs in the manufacturing (43 per cent respondents), retail and distribution (20 per cent respondents), services (31 per cent respondents) and professional sectors (3 per cent respondents). This sectoral response is congruent with the nature of the Cheshire SME economy, and would broadly represent the distribution within the UK in terms of sectors and size. China Study There were difficulties in replicating the UK study approach in China. For example it was not possible to generate a database of SMEs and contact addresses, e-mail addresses or telephone numbers. The initial pilot study, comprising six businesses, adopted an approach that engaged a research representative in Beijing who made contact with the businesses in person and asked them to complete the answers in the form of a questionnaire. The original questions used in the UK telephone survey had been translated into Chinese to enhance the quality of the responses. It was found necessary to conduct the questionnaire completion on a face-to-face basis to ensure consistency in the interpretation and recording of responses. The subsequent study involved the researcher engaging directly with the SME managers in China through a structured interview process that paralleled the initial questions raised in the UK. Again, it was not possible to draw the sample companies from any central database and most of the contacts were generated through existing business networks, and all were located within the Beijing area. The nature of the sample selection did mean that it was not random, nor was it necessarily representative of businesses in terms of size and sector. Whilst the methodology required some changes to fit the context of the

SMEs and the Internet

285

SME sector in China, the methods employed and the evaluation of the findings sought to ensure that this would not prove detrimental to the validity of the conclusions. The final responses to the survey, including the pilot study, numbered 22 companies. The sectoral distribution of respondents was represented by manufacturing (29 per cent of respondents), retail and distribution (7 per cent of respondents), services (50 per cent of respondents) and professional sectors (14 per cent of respondents). All the businesses employed fewer than 50 employees and most (86 per cent) employed fewer than 10 people. The strong nature of the family association with, and involvement in, the business made the determination of the number of ‘employees’ somewhat problematic.

12.4

RESULTS FROM THE STUDY

The study sought to address issues associated with the use of the Internet, including the benefits perceived and problems encountered and how the facilities may be utilized to improve both individual and organizational performance in the marketplace. The evidence from China is compared with the findings from the UK and conclusions are drawn in terms of the Internet Competitive Environment Framework outlined in Figure 12.1. 12.4.1

UK Study

The characteristics of the companies and the respondents within each company are summarized in Table 12.1. The number of employees was used as the indicator of the size of the business, given that many companies would be reluctant to give measures of financial performance over the telephone. In the majority of cases the size of the company restricted the respondents to the single owner-manager, though in the larger companies more than one respondent was involved. The second part of the survey concentrated on the respondents’ use, experience and views of the Internet. A significant proportion, 48 per cent, of the respondents did not have any access to the Internet either at work or at home. Forty-three per cent had access at work and a further 14 per cent had access at home as well as at work. The proportion of SME businesses providing no access to Internet facilities at the workplace proved surprising, though the present trends of Internet adoption might suggest that this will be a short-lived phenomena. Equally surprising was the response indicating that 94 per cent of respondents using the Internet accessed this from work premises rather than their home. This response was also unexpected

286

Table 12.1

Strategic aspects

UK study

Respondent characteristics

%

Age of company ● Less than 10 years ● 10 years or more

40 60

Size of company ● 1 to 9 employees ● 10 to 49 employees ● 50 to 249 employees

49 34 17

Respondent’s gender ● Female ● Male

37 63

Respondent’s age ● 24 years and below ● 25 to 44 years ● 45 and over years

12 64 24

Educational qualification ● degree qualification ● sub-degree qualification ● no post-school qualification

14 29 57

given the increased penetration of personal computers in the home in the UK, and the expectation that many SME owner-managers may utilize computer facilities at home to undertake both personal and business activities. The following analysis pertains only to those who have some type of access to the Internet (that is 52 per cent of the total sample), while those without access have been excluded. The primary reason for using the Internet was for work purposes (83 per cent of respondents), whilst the remaining 17 per cent used it primarily for pleasure. Of these, 10 per cent claimed to use the Internet for both purposes. It is perhaps not surprising that a significant proportion indicated the usage for work given that the survey was conducted at the workplace. Seventy-eight per cent claimed to use the Internet every day, whilst a further 11 per cent logged on only once a week. Some 11 per cent of respondents did not use the Internet facility, even though they had access. The time spent surfing the Internet at work varied for those that used the Internet regularly, with 28 per cent of the sample spending one hour per day, 39 per cent spending between one and three hours per day and a further 11 per cent of respondents spending between one and three hours per month. Respondents were not asked at this stage if the time spent logged onto the Internet was exclusively for work

SMEs and the Internet

287

purposes, hence it is not possible to attribute this access time to work or recreational purposes. The survey then explored the Internet abilities of the respondents. Seventeen per cent classified themselves as Internet beginners, 55 per cent felt they were competent and 28 per cent indicated they were very competent. Those in the competent and very competent categories indicated that they already had Internet experience before using it at work. The beginners were asked why they were not competent with Internet usage. The response from every member of this group cited lack of time to learn, rather than the system being too complex or new as the reason for their lack of expertise. The focus of the study was on identifying the use of the Internet for commercial purposes. A significant proportion of the respondents (61 per cent) had a company Web page.4 The reason provided for those organizations not possessing a Web page included: ●

●

●

their customers were non-IT literate and it was therefore pointless to have a site; currently, the technology was only being used for internal staff communications; quotes from consultants to create a Web page were too costly.

However, a number of those currently without a Web site stated that they were considering creating one in order to increase their company profile. This result corresponds with other larger, though less detailed, surveys (for example SECTEC, 1999) which found that the majority of businesses in the UK were focusing on the marketing communications and sales aspects of the technology as opposed to the e-business opportunities available. Some 42 per cent of the companies used the Internet for direct mail purposes, many citing the benefits of a cheap, direct link to their clients. One respondent said that using the Internet for direct mail purposes allowed them to retain a presence in their clients’ minds, whilst another stated that he had proven it generated a better response ratio than the more traditional letter and telephone approach. The majority of the companies in the survey possessing a Web site did not keep a record of the number of hits their Web site received, suggesting that they were not using the more sophisticated tools available to evaluate the effectiveness of their strategy. Summarizing the main reasons for adopting and using the Internet for commercial purposes, advertising was seen as the primary objective in using the Web (55 per cent of respondents). The Web page and direct mail were seen as being a cheap and targeted form of advertising. The next key objective was to obtain general business information (33 per cent) but only

288

Strategic aspects

5 per cent used it to gain competitor information. None used it for staff training purposes and only a small percentage used the Internet as a way of ordering from suppliers (only 5 per cent indicated this type of usage). The survey explored whether these objectives were the same as the initial reasons for adopting the Internet in the first place. Around 22 per cent stated that an increased company profile was their primary reason for adopting the Internet, the majority stated improved links with customers (39 per cent) and a further 29 per cent suggested that efficiency improvements was the primary reason for its adoption. Only 5 per cent of those using the Internet cited competitive pressures as the primary reason for adopting the technology. However, this latter reason may be implicit in the other objectives. The proportion of respondents (28 per cent) using the Internet for e-commerce purposes reflects a generally low level of usage, given the potential of the technological facilities available. Of the 72 per cent that did not presently use e-commerce, 33 per cent were considering implementing this service and the remaining 39 per cent had no plans to do so. The small proportion already using the Internet for e-commerce transactions, claimed that 79 per cent of their customers are able to purchase products or services from the company via the Internet. The majority of these businesses (that is 82 per cent employing e-commerce) suggested that their customers were satisfied with the Internet in terms of the security and cost of commercial transactions. This appears to contradict the findings of Bussgang and Spar (1996, p. 129), who argued that often the cost of processing payments over the Internet may deter small on-line entrepreneurs from the start. However, those businesses responding positively were generally the medium-sized (that is those employing 50 to 249 employees in Table 12.1) entrepreneurial businesses. Of those companies that had introduced the Internet, nearly 70 per cent were satisfied with it. This level of satisfaction needs to be viewed in the context of the somewhat limited objectives that the businesses were seeking to achieve through their utilization of the Internet and Web-based developments. The introduction of the Internet to the workplace had not been easier or harder than expected. Those that were not satisfied were mainly concerned with time issues, or more specifically lack of time, to exploit the potential of the Internet and to refresh and update their Web sites to maintain customer interest. Updating is indeed a significant concern: ‘If a set of pages languish for months unchanged, the stream of visits will diminish to a trickle’ (Bond, 1995, p. 27). The time factor appears to be exacerbated by the SMEs’ reluctance to use external assistance because of the perceived costs involved. For 67 per cent of the respondents, queries or problems concerning the Internet and its usage were directed to internal staff, drawing

SMEs and the Internet

289

on valuable time for an SME. Mitev and Marsh (1998, p. 228) found that a significant number of small businesses ‘did not consider maintenance and training costs when purchasing technology’. Finally, the respondents were asked what was the best and worst thing about the Internet for their business. Responses were collected via an open-ended question and the results were then classified into categories. The best thing was seen, by the overwhelming majority (94 per cent), to be the Internet’s excellence as an information and communication tool for both staff and customers. Responses in terms of the worst thing were more diverse though there were three significant ones. The most significant response (43 per cent) was that it was perceived to prevent personal contact with customers. The proliferation of ‘junk’ sites was also a concern (15 per cent). The lack of resources to invest in appropriate technology (18 per cent), for example fast modems, prevented the SMEs being able to fully exploit the Internet for commercial purposes. Typically the research results showed resource poverty within SMEs that restrained their development. 12.4.2

China Study

The nature and construction of the sample in this preliminary study of Chinese entrepreneurs suggests the need to exercise some caution in drawing other than tentative conclusions at this stage from the data. We might expect, for example, that small businesses outside of the major cities, and in the less-developed regions of China, would demonstrate significantly different experiences to those resident in Beijing. In presenting the findings we develop some initial comparisons with the responses from the UK SMEs. There was only one respondent interviewed in each of the Chinese companies, reflecting the high proportion of micro-businesses with less than ten employees. In the case of the Chinese SMEs they were extremely reluctant to provide details of financial performance measures such as turnover and profits. The number of employees was again used to give an indicator of the size of the company. There was a further problem in estimating the size of the business on this basis, as in many cases family members were often involved in the business though were not formally recognized as employees. The characteristics of the Chinese companies and the respondents within each company are summarized in Table 12.2. A comparison of the characteristics of the two sample populations is provided in Table 12.3, giving an opportunity to explore possible differences in their composition. The higher proportion of small businesses in China probably reflects the more recent liberalization of the Chinese economy, the decline of the previous industrial structures and organizations, the

290

Table 12.2

Strategic aspects

China study

Respondent characteristics

%

Age of company ● Less than 10 years ● 10 years or more

74 26

Size of company ● 1 to 9 employees ● 10 to 49 employees ● 50 to 249 employees

64 36 –

Respondent’s gender ● Female ● Male

– 100

Respondent’s age ● 24 years and below ● 25 to 44 years ● 45 and over years

42 47 11

Educational qualification ● degree qualification ● sub-degree qualification ● no post-school qualification

6 28 66

development of new domestic and international markets, and the encouragement of a culture of entrepreneurship. These structural factors are also likely to be responsible for the higher proportion of young businesses in China than in the UK. The significant differences in the proportion of female respondents might suggest differences in the Chinese entrepreneurial culture in this sector, though the sample size prevents any further development of this issue. There is a further difference in the age distribution of the respondents between the two countries. This may reflect the greater preparedness of the younger person to engage in the risk taking and change associated with the new entrepreneurial culture being fostered in the Chinese economy (Ritchie et al., 1998). Comparisons on the basis of educational backgrounds suggests a much greater degree of similarity between the two samples, with the majority possessing lower-level and often skillbased qualifications. These findings may support the view (for example Koh, 1996) that entrepreneurship is dependent more on individual psychological characteristics (for example propensity to take risks, tolerance of ambiguity) than on specific educational achievements. Further exploration of the Chinese data indicated that a high proportion (86 per cent) of Chinese respondents conducted their Internet access from

291

SMEs and the Internet

Table 12.3

Comparison of UK and China sample: demographics

Respondent characteristics

UK %

China %

Age of company ● Less than 10 years ● 10 years or more

40 60

74 26

Size of company ● 0 to 9 employees ● 10 to 49 employees ● 50 to 249 employees

49 34 17

64 36 –

Respondent’s gender ● Female ● Male

37 63

– 100

Respondent’s age ● 24 years and below ● 25 to 44 years ● 45 and over years

12 64 24

42 47 11

Educational qualification ● degree qualification ● sub-degree qualification ● no post-school qualification

14 29 57

6 28 66

their work premises rather than their home, although a number of them operated the business from their homes. This response reflected that found in the UK businesses, suggesting that although there may be a high level of penetration of personal computers in the home, these tend not to be utilized for business purposes. All of the Chinese respondents displayed very similar patterns at the individual level to their colleagues in the UK in relation to the use of the technology, both in terms of the frequency and time spent on a regular basis on the Internet. In relation to the intended business applications the ownermanager in China identified these as primarily relating to the promotion of the business and its products through the Web. The main impetus for the emphasis on the marketing communications applications was the fear that other competitors may use the medium to gain competitive advantage. The majority of users tended not to use the Internet to gain information concerning competitors or general business information but tended to ‘surf the net’ in terms of more general interest, a similar pattern to that revealed by many of the UK respondents. The Chinese managers displayed little recognition of the potential to alter the fundamental relationships with

292

Strategic aspects

customers, suppliers and other intermediaries (for example e-business application), focusing primarily on the Internet as a marketing tool, or more precisely a marketing communications and sales tool. The respondents in China expressed a lower level of satisfaction with the technology and Internet services than those in the UK, probably reflecting the more recent development of Internet facilities in China and the lower number of service providers. The role of the Chinese authorities at the national and regional level in facilitating the Internet technologies may offer some further explanation. Despite the apparent differences in the level of the Internet service offered in China as against the UK, there are very similar patterns emerging in relation to the recognition and adoption of the e-business technologies in relation to the strategies and operations of the business. The SMEs in both countries appear to view the potential essentially in terms of a marketing communications vehicle and not in terms of a development that provides opportunities to alter every other element of their business in the future. The element of the survey concentrating on the respondents’ use, experience and views of the Internet in a business context produced results different from those in the UK sample. A smaller proportion of Chinese SMEs (22 per cent) than in the UK sample (48 per cent) did not have any access to the Internet either at work or at home. Sixty-two per cent had access at work and a further 19 per cent had access at home as well as at work. Caution needs to be exercised against drawing too many inferences from this response, given the nature and composition of the sample. The analysis of those businesses that have some type of access to the Internet (that is 68 per cent of the total sample) demonstrated some similarities with the UK SMEs. The primary use of the Internet was work-related (89 per cent) with a smaller proportion (11 per cent) using it for pleasure. As reported in the UK study, it is perhaps not surprising that a significant proportion indicated the usage for work given that the survey was conducted at the workplace. A large proportion (83 per cent) claimed to use the Internet on a daily basis with the remainder logging in on average once per week. A small proportion (8 per cent) chose not to use the Internet facility on their PC. Analysis of the time spent surfing the Internet or using its services at work provided a similar pattern of responses to those in the UK. As with the UK study, respondents were not asked if the time spent logged onto the Internet was exclusively for work purposes, hence it is not possible to attribute this access time to work or recreational purposes. Exploration of the competence of the respondents in using the Internet technologies produced broadly similar responses to those of the UK managers, reflecting a reasonably high level of self-declared competence in the basic skills.

SMEs and the Internet

293

On the primary issue of the utilization of the Internet for commercial purposes, a broadly similar proportion of the Chinese respondents (72 per cent) had a company Web page. The reasons provided for those organizations not possessing a Web page included the lack of IT access and literacy of customers, focus on internal use of ICT facilities (for example financial accounting) and the perception that the development of the Web site might require expensive external specialist advice. All of those not currently possessing Web sites indicated that they were planning to create one in order to increase their company profile and image within the market place. This finding corresponds to that in the study of the UK respondents and other larger studies indicated earlier. It was evident that the majority of the Chinese SMEs viewed the Internet as more of a business-to-consumer facility, which sought to communicate marketing information in terms of the business, products and services, though the Web sites tended to focus more on the business perspective. On the use of the Internet for business-to-business purposes, there was a generally low level of application, with less than 20 per cent engaging or developing a capability within this area. There was also a lower level of interest than in the UK, with only 27 per cent of those currently not using the business-to-business applications considering this as a future development. Although most of those businesses (85 per cent) offering the service to customers to purchase products or services from the company via the Internet suggested that their customers were satisfied with the service and the security offered for commercial transactions, the more general view pertaining in China was one of less confidence in the commercial security of such services. The key application indicated by the majority of those using the Internet was that of external communications, including the direct mailing of existing and new customers. There are as yet fewer legal constraints in China on the use of mailing lists and the distribution of information to existing and potential customers via the Internet. In summary, the main reasons for adopting and using the Internet for commercial purposes was one of marketing communications, advertising and promotion (67 per cent of respondents). Although they displayed similarities to the SME owner-managers in the UK in relation to their focus on marketing communications, the degree of development was less, probably reflecting lower levels of utilization of the Internet by their customers. The businesses in China tended to use the Internet resource more frequently than their UK counterparts to obtain general business information (56 per cent) though only 15 per cent used it to gain competitor information. A small proportion, around 5 per cent, used the Internet as a way of ordering from suppliers, though many indicated that this was an intended future application. The majority of those surveyed indicated that their

294

Strategic aspects

original objectives in using the Internet had been achieved. These objectives related mainly to an increased company profile, improved links with customers and, to a lesser degree, efficiency improvements. Competitive pressures were viewed more extensively by the Chinese respondents as the primary reason for adopting the technology. Most of the Chinese businesses indicated that the introduction of the Internet to the workplace had been more problematic than expected. This was primarily due to the delays and technical problems experienced, though many reflected on the time required to overcome such problems, often due to the lack of professional expertise available within the organization or the local business environment. The lack of personal time to fully exploit the potential of the Internet and their Web sites to maintain customer interest was viewed as a further contributor to the problems experienced. As with the UK SMEs, the time factor appears to be exacerbated by the shortage of internal resources and the reluctance to use external assistance because of the perceived costs involved. The majority of the businesses sought to resolve the queries and problems encountered internally rather than seeking external advice which tended to delay the solution of such problems. Responses to what was perceived as the best and worst thing about the Internet for their business were generally similar to the UK situation. The best thing (nominated by 82 per cent) was seen to be the Internet’s capacity as an information resource and communication tool for existing and, more significantly, new customers. The worst thing (nominated by 100 per cent) related to the quality of the Internet service available, which was not only slow but very unreliable in terms of the communications quality. This probably reflects the phenomenal growth in the demand for Internet and other ICT services (for example mobile telephones) in China combined with the low level of investment in the ICT infrastructure. The businesses themselves complained of the lack of resources to invest in appropriate technology, as did their UK counterparts, suggesting that this constrained their ability to utilize the Internet services effectively.

12.5

CONCLUSIONS

The level of access to Internet technologies was lower than anticipated amongst the smaller as opposed to the medium-sized businesses, though this is likely to change rapidly in the UK as well as in China. Those SMEs employing the Internet within the business tended to view it primarily as a marketing communications tool and had yet to explore the potential for other dimensions of their business. The sample of Chinese businesses

SMEs and the Internet

295

surveyed indicated a similar approach to the use of the Internet. Berthon et al. (1998, p. 703) believe that Internet technology ‘is characterised by ease of entry, relatively low set-up costs, globality’, yet for the SME owner this may not be the perception they have. Equally, the experience of engaging in the Internet has not led SMEs to consider this as a low-cost exercise, quite the reverse as they struggle to maintain the currency of their hardware and software investments. Moreover the level of usage by those claiming to work with the Internet was generally low, reflecting issues concerning the lack of time available to engage with the technology more fully. The comparative analysis of the responses between the UK and Chinese experiences of Internet adoption and development suggests a number of differences. These differences in contextual variables are captured well by the Internet Competitive Environment Framework (Figure 12.1). Differences in the development and application of the Internet within SMEs, and their supply chains, may be explained less by the extent of technology diffusion. The evidence suggests that differences in infrastructure may provide a more substantive explanation of both the capability and willingness to develop and implement e-business strategies and associated applications. For example, government regulation and economic policies in China at the national, regional and local levels contribute to the preparedness of SMEs and other businesses to undertake commercial developments utilizing the Internet. Trappey and Trappey (2001, p. 206) concluded that ‘China’s Internet development and control is hindered by a lack of basic technology such as PCs, a poor business and government communications network, unclear government regulations, a stagnant state sector, and a banking system in need of reform and privatization.’ The development of e-business strategies, especially in the micro- and smaller businesses, will be dependent on such factors providing support, encouragement and facilitation. The evidence gleaned from the UK and Chinese studies to date, whilst not refuting the Internet Competitive Environment Framework presented, does suggest that the rate at which the SMEs are engaging in the technology is much slower than anticipated. Moreover, the recognition of the potential for radical changes to their business is not particularly well developed and the adaptation of strategies and tactical plans to accommodate the opportunities and threats is not yet evident, a view reflected by Ritchie et al. (1998). Almost all of those surveyed had some recognition that the advent of the Internet would alter the commercial environment, but few were able to articulate this in other than general terms for their particular sector or market niche. There is a degree of homogeneity between the experiences of SMEs in the UK and China. The literature and the evidence available for the larger

296

Strategic aspects

organizations (for example Liu et al., 2001) suggest that competitive pressures, combined with variations in the contextual situation, formulate the primary drivers for strategic change. An important parameter in strategic change in the global competitive environment is the adoption and application of e-business. If e-business adoption is viewed as a staged process (Peet et al., 2002) then the position of the SMEs in both countries may be engaged at the first level, that is marketing communications. There are some differences in the degree of adoption between the two countries within this stage. Such differences are determined by the infrastructure variables which are exogenous, hence outside of the control of the individual organization. These may be represented by the Internet service providers’ provision or legal controls on business development. As China moves more towards a global and fully liberalized economy, it is less likely to be represented as a laggard. The implications for policy within China, and to a lesser extent in the UK, to provide the necessary support to the small and especially the micro-business sectors include reducing legislative constraints, encouraging and facilitating training, the provision of expert advice and enhancing financial aids to SMEs to fund the necessary investment in hardware, software and systems development. The Internet Competitive Environment Framework was constructed as a conceptual framework to identify the main influencing factors on the rate of e-business adoption by the SME sector. The evidence supports the relevance of each of the factors, though provides less evidence on the relative importance of each factor. Both UK and Chinese SMEs viewed the Internet primarily as a marketing communications tool to promote products and services more widely, supporting the general conclusions of Trappey and Trappey (2001) and Ritchie and Brindley (2000a). Such evidence also suggests that in terms of the evolution of e-business strategies, the development of business-to-business strategies, the use of the Internet as a strategic information resource, and changing supply chain relationships, are not the immediate concerns of SMEs in either China or the UK. It appears that managers in both China and UK SMEs are typically time-poor, reactive and focused on exploring niches which alters their perception of the varied uses and strategic opportunities associated with Internet technologies. Although the SMEs in China are generally of a smaller scale, more family oriented, and have had a shorter period of existence, there are similarities between the profile of the entrepreneurs in terms of their basic knowledge and skills. The ‘entrepreneurial spirit’ appears to flourish in both countries despite the lack of specific training and development programmes. The inclusion of this dimension in the framework may assist in reflecting the nature of entrepreneurship and the behavioural characteristics (for example Koh, 1996).

SMEs and the Internet

297

Future research should develop an understanding of the business and commercial implications for the SMEs and seek to address the issues that may presently deter the entrepreneur from developing strategic responses to the opportunities and threats posed by the ICT developments. The development of more in-depth studies within particular SMEs to investigate these issues, and the monitoring of changing attitudes and perceptions in longitudinal studies, are likely to prove essential in interpreting and understanding the responses of SMEs to the emerging technologies and new models of competition. Chinese SMEs appear to have significant issues concerning the basic technology, access and associated support services which have largely been overcome by their UK counterparts. SME ownermanagers in both countries still need to engage fully with the potential impact this technology may have on their markets and supply chain relationships and other competitive pressures.

NOTES 1. The authors acknowledge the contribution of Tom Tang, a research student with the Manchester Metropolitan University, towards the collection of the empirical data in China. 2. ‘Transaction economics’ relates to the exchange of goods and services between members of the supply chain. Financial considerations of costs, profit margins, volume of activity, value added and risk are the essential ingredients of the economic exchange decisions taking place between members. 3. Although all of the companies on the database were approached, only 63 per cent were contactable (due to discrepancies in the database, company failures and companies that did not wish to engage in any telephone discussion) and of these 19 per cent agreed to participate. 4. Although the presence of Web pages for the total population surveyed was not directly investigated it is highly unlikely that this proportion (that is 61 per cent) would be representative of the total population, given that many of the companies declined to participate on the grounds that they either did not possess computers or had no Internet access.

REFERENCES Andersen Consulting (1999), ‘e-Europe Takes Off’. Berthon, P., N. Lane, L. Pitt and R.T. Watson (1998), ‘The world wide Web as an industrial marketing communication tool; models for the identification and assessment of opportunities’, Journal of Marketing Management, 14 (7), pp. 691–704. Bond, O. (1995), ‘Setting up a world wide Web site’, Managing Information, 7 (4), pp. 26–7. Buck, S.P. (1996), ‘Electronic commerce: would, could and should you use current Internet payment mechanisms?’, Internet Research: Electronic Networking Applications and Policy, 6 (2–3), pp. 5–18.

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Bussgang, J. and D. Spar (1996), ‘Ruling the Net’, Harvard Business Review, May–June, pp. 125–33. Chaffey, D. (2002), E-Business and E-Commerce Management, Harlow: Pearson Education. Cheng, E. (1999), ‘Making size matter less’, Revolution, July, p. 3 supplement on the Internet for small business. China Internet Network Information Service (2000), http://www.cnnic.cn/ De Kare-Silver, M. (2000), e-Shock 2000, Basingstoke: Macmillan. Deloitte Consulting (1999), ‘The new economics of transactions: evolution of unique e-business Internet market spaces’, https://www.dc.com/obx/pages.php? Name⫽e-BusResearch Durlacher (1998), ‘Quarterly Internet report: the SME market’, Q2/98 July, www.durlacher.com Dutta, S. and P. Evrard (1999), ‘Information technology and organisation within European small enterprises’, European Management Journal, 17 (3), pp. 239–51. Kalakota, R. and M. Robinson (2000), e-Business, Reading, MA: Addison-Wesley. Koh, H.C. (1996), ‘Testing hypotheses of entrepreneurial characterisitics: a study of Hong Kong MBA students’, Journal of Managerial Psychology, 11 (3), pp. 12–15. Liu, J., R. Ritchie and J. Wang (2001), ‘FDI and Western Development in China; Strategic Considerations for Multinational Companies’, 28th Annual Conference of the UK Chapter Academy of International Business, Manchester Metropolitan University, April 2001, Proceedings Vol. II, pp. 512–40. Mitev, N.N. and A.E. Marsh (1998), ‘Small business and information technology: risk, planning and change’, Journal of Small Business and Enterprise Development, 5 (3), pp. 228–45. OECD (1998a), Globalisation and SME’s: Synthesis Report, Volume 1, Paris: OECD. OECD (1998b), Globalisation and SME’s: Country Studies, Volume 2, Paris: OECD. Peet, S., C.S. Brindley and R.L. Ritchie (2002), ‘The European Commission and SME support mechanisms for E-business’, European Business Review, 15 (5), pp. 335–41. Ritchie, R.L. and C.S. Brindley (2000a), ‘Will ICT’s change the balance of global competitive advantage? Ascendancy of the SME in international business’, 27th Annual Conference of the UK Chapter Academy of International Business, University of Strathclyde, April. Ritchie, R.L. and C.S. Brindley (2000b), ‘Disintermediation, disintegration and risk in the SME global supply chain’, Management Decision, 38 (8), pp. 575–83. Ritchie, R.L., L. Zhuang and Q. Zhang (1998), ‘Managing business risks in China’, Long Range Planning, 31 (4), pp. 606–14. SECTEC (1999), ‘1998–1999 business survey’, South and East Cheshire Training and Enterprise Council. Tang, J. (2000), ‘Recent Internet developments in the People’s Republic of China: an overview’, Online Information Review, 24 (4), pp. 316–21. Trappey, C.V. and A.J.C. Trappey (2001), ‘Electronic commerce in Greater China’, Industrial Management and Data Systems, 101 (5), p. 201–9.

PART IV

Policy aspects

13.

Public policy and SME development Charles Harvie and Boon-Chye Lee

13.1

INTRODUCTION

Policies to promote the development of SMEs are common in both developed and developing countries (Storey, 1994; Levitsky, 1996; Hallberg, 2000). In the case of developed countries, it has become commonplace for governments since the 1970s to implement policies or programmes designed to promote aspects of small and medium-sized enterprises (SMEs). This has coincided with an increase in the importance, in terms of contribution to employment and GDP growth, of SMEs in most of the developed economies (Storey, 1994). In the OECD countries, SMEs currently account for more than 95 per cent of firms and 60–70 per cent of employment (OECD, 2000). This is in part the result of an ongoing process of industrial restructuring that began in the late 1970s which saw large firms substantially reduce their output and labour, creating large pools of unemployed workers, a proportion of whom were motivated to start their own businesses (Storey, 1982). That process was given added impetus with the move towards privatization and market deregulation in the late 1980s and 1990s, resulting in broad organizational trends that have included outsourcing and downsizing (Parker, 2000). Developments in information and communications technology, rising affluence and the development of niche markets, as well as the declining importance of economies of scale as the key source of competitiveness, have also contributed to the growth of the SME sector in developed economies. In the case of developing economies, policies designed to assist SMEs have been an important aspect of industrial policy and multilateral aid programmes such as those of the United Nations since the 1950s (Levitsky, 1996). As discussed in Chapter 3 of this volume, micro- and small businesses are playing an important role in the alleviation of poverty and empowering certain groups including that of women. Moreover, the movement by some formerly centrally planned developing economies (such as Vietnam and China) and highly regulated economies such as India towards 301

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Policy aspects

deregulated and market-oriented economies, with the emphasis on developing a vibrant private sector oriented economy, have given further impetus to the development of small businesses in many developing economies. However, while there are wide variations across countries the traditional picture is one where the relative importance of SMEs tends to decline as a country moves up the developmental ladder (see for example Hallberg, 2000 and Liedholm and Mead, 1999). The process of globalization, characterized by increasing trade and capital flows, market opening and liberalization and knowledge flows, has resulted in global sourcing and marketing for large enterprises. Outsourcing and the increasing involvement of small businesses in the supply chains of large transnational corporations has presented them with many business opportunities. Hence the traditional decline in the role and importance of SMEs in developing countries may likely change in the future. As the available data for the Asia-Pacific Economic Cooperation (APEC) economies indicate, SMEs account for a significant proportion of the labour force in both developed and developing economies (see Table 13.1). In addition, they also comprise a significant proportion of the business enterprises (see Table 13.2). It may therefore be argued that, purely from the viewpoint of their significance in their economies, SMEs warrant attention from governments. Storey (1994) has argued, in the UK context, that Table 13.1 Contribution of micro-, small and medium-sized enterprises to private non-agricultural employment, selected APEC countries (%)

Australia Hong Kong, China Japan Korea Mexico New Zealand Peru Philippines Singapore USA

Micro (⬍5 employees)

Small (5–19 employees)

Medium (20–99 employees)

All SMEs

25.9 31.1 13.1 31.2 36.2 23.0 62.5 36.7 7.1 5.2

20.9 13.0 29.9 11.3 13.9 18.0 16.6 25.8 16.8 13.6

19.2 24.8 26.9 36.2 15.2 19.0 8.8 7.1 19.2 17.9

66.0 59.4 69.9 78.7 65.2 60.0 87.9 69.5 43.1 36.7

Source: Hall (2002). Hall (2002) reports the ‘latest available data’ as at the time of his study.

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Table 13.2 Number of private non-agricultural SMEs as a percentage of firms, selected APEC countries (%)

Australia Chile Hong Kong, China Japan Korea Mexico New Zealand Peru Philippines Singapore Thailand USA

Micro (⬍5 employees)

Small (5–19 employees)

Medium (20–99 employees)

All SMEs

69.9 82.1 86.8 56.5 72.7 91.7 84.2 96.5 91.1 67.4 79.0 60.5

24.3 15.0 7.6 34.7 17.8 6.3 7.1 3.1 8.2 24.3 18.4 28.9

4.9 2.1 4.9 7.4 8.6 1.6 8.0 0.3 0.4 6.1 2.0 8.9

99.0 99.1 99.3 98.7 99.1 99.6 99.4 99.9 99.6 97.8 99.4 98.3

Source: Hall (2002). Hall (2002) reports the ‘latest available data’ as at the time of his study.

the increased importance of SMEs means that public policies towards them cannot be considered in isolation from other influences in the economy and cannot be left to those with a particular interest in SMEs. The significance of SMEs in their economies makes it important for policy makers to ensure that these enterprises do not face impediments that hamper their ability to operate efficiently and do not face onerous administrative compliance costs. We should be careful, however, not to conclude from this that it necessarily follows that policies specifically favouring SMEs over larger firms should be implemented. As Lattimore et al. (1998) note, ‘while economic importance provides a strong basis for public policy consultation with small business, in itself it provides little justification for specific interventions’. Many policies relating to SMEs are based on the perceived weaknesses or disadvantages that they suffer relative to large firms. Studies of the problems faced by SMEs have concluded that they suffer from similar weaknesses in developing countries as they do in developed countries (Levitsky, 1996). However, a problem with government policies with respect to SMEs is that they have tended to be characterized by a lack of coherence, as Storey (1994) observed in the context of European countries, where ‘public policies have been developed, jettisoned, and often reintroduced on

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Policy aspects

a piecemeal basis’. Second, as Hallberg (2000, p. 1) noted of developing country SMEs, they are: a very heterogeneous group. They include a wide variety of firms – village handicraft makers, small machine shops, restaurants, and computer software firms – that possess a wide range of sophistication and skills, and operate in very different markets and social environments. Their owners may or may not be poor. Some are dynamic, innovative and growth oriented; others are traditional ‘lifestyle’ enterprises that are satisfied to remain small.

These observations are largely pertinent also to SMEs in developed countries and point to a key difficulty in policies designed to cater to such a diverse grouping of enterprises. However, recent trends, in both developed and developing countries, suggest that public policy is increasingly being focused more upon market-oriented strategies and the establishment of a level playing field for all enterprises, rather than, as in the past, direct measures aimed at, for example, reducing the cost of credit. The microenterprise literature is particularly pertinent in explaining this change of emphasis.1 In section 13.2 we offer a categorization and critical appraisal of the various policies. As Storey (1994) has argued, ‘The prime objective of macroeconomic policy is not solely to assist smaller firms, but rather to provide a framework for all sizes of enterprise in the economy to flourish.’ Thus, the test that a policy or programme favouring SMEs must pass is that not only must it have a sound economic rationale but also, given the costs of design and implementation of such programmes and the possibility of distortions to business incentives, it must demonstrate that it is capable of delivering net welfare benefits to society as a whole. We examine each policy argument from this viewpoint. In section 13.3, we examine the possibilities offered by networks in helping SMEs deal with the disadvantages they experience because of their relatively small size. Finally, we summarize our main conclusions in section 13.4.

13.2

CATEGORIES OF GOVERNMENT SUPPORT POLICIES FOR SMEs

Policies in support of SMEs may generally be categorized according to their objectives (see Table 13.3): broad macroeconomic objectives, such as the creation of jobs or the reduction of unemployment; social or equity objectives such as the redistribution of income; market failure or efficiency arguments, which relate essentially to considerations of static efficiency;

Public policy and SME development

Table 13.3

305

Categories of SME support policies

Macro objectives

● ● ●

Social objectives

● ●

Correction of market failure/inefficiency (static efficiency objectives)

● ● ● ● ●

●

Dynamic efficiency objectives

●

Creation of employment Economic development Export growth Income redistribution Poverty alleviation in developing countries Presence of externalities Market access barriers Asymmetric information Small number of competitors Information imperfection (lack of access to information about potential markets) Levelling the playing field Promotion of innovation

and dynamic efficiency arguments, in particular the promotion of innovative activities. It is apparent that there are broad areas where these policies overlap with those in other areas of concern, in particular with competition policy. Each of these categories of SME support policies is now discussed in turn. 13.2.1

Macroeconomic Objectives

The broadest objectives of SME policy are macroeconomic in nature. These include the creation of employment (or the reduction of unemployment although the first may not achieve the second if participation rates rise) and, in the case of developing countries, developmental objectives. As Levitsky (1996) noted in the case of donor aid programmes targeting SMEs in developing countries, ‘all programmes were justified by arguing that small enterprises generated more employment for a given investment of scarce capital . . . Donors also looked to small enterprises as a way of dispersing economic development and of raising the standard of living of the rural sectors of the population.’ Employment creation is also a major objective of many SME policies in developed countries (De Koning et al., 1992; Revesz and Lattimore, 1997). Creation of employment Because SMEs account for a significant proportion of employment in their economies, it is argued that selective policies aimed at creating

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Policy aspects

employment in small business should be pursued. More recent analyses have pointed out flaws in the rationale for such an objective. Revesz and Lattimore (1997), for example, argue against adopting such an approach on several grounds. Although their arguments relate to the Australian case, they are largely applicable to other countries as well. Revesz and Lattimore (1997) note that the argument that small firms are a major source of new jobs is based on inconclusive cross-sectional data, pointing out that no long-term longitudinal study of job creation has yet been undertaken. Further, even if it is true that small business has been responsible for more than a proportionate amount of net new jobs, it does not follow that policies to promote the SME sector are justified. First, they note that although the SME sector may be where many of the new jobs have been created, this does not mean that they are responsible for their creation, and indeed they argue that many of the new jobs were created in this sector not because SMEs are better able to generate new jobs but because the products for which demand has increased are largely supplied by SMEs. That is, the recent trends in employment shares reflect changes in demand patterns in the economy (Lattimore et al., 1998); and there is what Revesz and Lattimore (1997) term a ‘confusion of medium and cause’. By implication, policies promoting SMEs will be misconceived if the pattern of demand shifts in the future. Second, Revesz and Lattimore (1997) argue that, given that the optimal size of the business unit is determined by technology and transaction costs,2 government intervention may serve to distort the optimal distribution of firm sizes. Third, they argue that small firm survival rates are far lower than those for large firms, so that selective policies favouring small firm start-ups may increase turbulence, with attendant social and economic costs. Fourth, subsidies imply higher taxes, which may reduce incentives to work in addition to creating distortions in other sectors of the economy. Further, any subsidies to one sector of the economy at the expense of other sectors, or financed by additional taxes, should be justified on the basis that the net welfare benefits to society of such subsidies are positive (Storey, 1994; Belli, 1997). Fifth, Revesz and Lattimore (1997) point out the arbitrariness of the focus on job creation rather than job destruction, arguing that an equally arbitrary (and unsatisfactory) approach would be for an advocate of big business to argue for policies to stop job destruction on the basis that saving a job from being lost in a large firm is as valuable as creating one in a small firm; or for an advocate of a large public sector to argue against public sector rationalization on the same grounds. Sixth, most small firms do not grow much or contribute significantly to net job creation. Job creation policies are therefore better targeted at those

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307

firms that do grow rapidly, but this would require unusual facility on the part of policy makers in picking winners. A programme to create jobs in SMEs is therefore not likely to be very successful in achieving its objective (Lattimore et al., 1998). Seventh, even if it is true that SMEs have been responsible for most of the new jobs created in their economies in the recent past, a policy of assisting SMEs would not necessarily be the most effective way of creating new jobs. For example, a subsidy to SMEs to employ a previously unemployed person would not necessarily be more effective at eliciting a positive response from SMEs than it would from large firms along a range of dimensions such as the initial recruitment response, the duration of employment of any subsidized worker, the quality of the job and any associated training, and the extent to which participating firms would get a subsidy for a worker they would have hired anyway. Finally, Revesz and Lattimore (1997) argue that government assistance programmes for ‘small’ firms can be counterproductive if they reduce the incentive for growth of businesses that are about to exceed the threshold definition of a small firm. Levitsky (1996) reports evidence from India in the 1980s indicating that the government’s policies of concessional assistance to SMEs was ‘constraining the growth of many enterprises that preferred to stay small rather than lose their privileged status’, and indeed may have reduced the competitiveness of industry as a whole. 13.2.2

Social Objectives

Income redistribution Assistance to SMEs is sometimes justified by governments on the basis that the existing distribution of income is less than socially equitable. Aid agencies operating in developing countries have been drawn to provide assistance to small enterprises as a means of poverty alleviation and of improving the distribution of income (Levitsky, 1996). This is often tied in with other objectives such as creating employment, training, dispersing the benefits of development to rural areas and catering for rural markets through rural small enterprise programmes, and promoting indigenous entrepreneurship. However, as Hallberg (2000) points out, ‘SME owners and workers are unlikely to be the poorest of the poor, so that SME promotion may not be the most effective poverty alleviation instrument.’ For developed countries, the income redistribution justification may be even less compelling. Storey (1982) has argued, in the UK context, that financial assistance to small firms would most benefit the relatively wealthy who are more able to start new businesses – citing evidence

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Policy aspects

that although there were more ‘working-class’ entrepreneurs than ‘middle-class’ ones, small firms were much more likely to be started up by people from middle-class backgrounds than by those with working-class backgrounds. In addition, there are more direct methods – such as income transfers – to achieve income redistribution objectives which are likely to be more effective than SME support policies (Hallberg, 2000). 13.2.3

Market Failure or Inefficiency

The conventional economic rationale for government intervention in markets based on market failure derives from the insight that competitive markets deliver optimal outcomes. According to the neoclassical economic paradigm, consumer welfare is maximized under conditions of perfect competition, and this outcome is Pareto-optimal, or ideal, in that no other outcome can achieve the same level of welfare for society as a whole (Van Cayseele and Van den Bergh, 2000). The conditions for markets to deliver Pareto-optimal outcomes are well known: many buyers and sellers in the market; a homogeneous product; perfect information regarding the availability of goods and services and the state of the technology; freedom of entry and exit by producers; and the absence of ‘spillover’ or external effects. Under these stringent conditions, unencumbered markets represent the best way of organizing the allocation of scarce resources. Failure of the market to deliver competitive outcomes results when any of these conditions is not met to a significant degree, and may therefore warrant government intervention. From this perspective, perfectly competitive markets may be regarded as an ideal that, while unattainable by and large, can be approximated by a judicious mix of market-oriented policies and government intervention. However, the presence of market failure does not in itself justify government intervention. A market failure argument for government policy in favour of SMEs must demonstrate not only that there is a failure of the market in some sense but also – since, in general, subsidies to one sector of the economy have to be provided at the expense of other sectors or by way of additional taxes raised for the purpose – that such a policy is capable of delivering net welfare benefits to society as a whole.3 A related set of arguments pertains to competitive conditions that, for various reasons, may be a source of disadvantage to smaller firms relative to larger ones. We call attempts to remove these sources of disadvantage ‘levelling the playing field’ so that SMEs can compete on a more equal footing with their larger counterparts. These are discussed below.

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309

Presence of externalities The presence of positive externalities or spillover effects from a particular activity is often taken as a justification for government involvement in that activity. R&D activities, because they generate positive effects for external parties that are not fully appropriable by those undertaking the activities, fall into this category and government subsidies or direct grants are commonly employed to encourage them. From the viewpoint of SME policy however, there is no particular reason why R&D that is undertaken by SMEs should be treated more favourably than if it is undertaken by large firms. The available research on the relative innovativeness of small versus large firms has been inconclusive despite extensive research into this issue since the 1950s.4 Other instances of externalities are discussed below. Subsidies for small firm start-ups are sometimes justified on the basis that they create more employment than comparable assistance to large firms (Storey, 1982). We examine this argument and discuss the issue of employment creation below. Number of competitors Competition is an area where SME policy overlaps with other policy concerns. Firm start-ups are sometimes encouraged on the basis that they result in net additions to the existing stock of firms in an industry, and this is therefore a good thing if the number of the existing firms is too ‘small’ (market concentration is ‘high’) so that there is an insufficient degree of competition in that industry. However, a policy aiming to achieve a particular size distribution of firms in any industry would be misconceived. As Hallberg (2000) points out, there is in fact no optimal or ideal size distribution of firms, but rather an ‘equilibrium’ size distribution determined by ‘resource endowments, technology, markets, laws, and institutions.5 Indeed, some of the factors that determine the equilibrium size distribution of firms – technology-determined economies of scale, resource endowments, and consumption patterns – are in a sense ‘natural’ determinants of firm size (Hallberg, 2000) that are arguably best left to the determination of market forces. Further, although a high market concentration has traditionally been regarded as conducive to the abuse of market power by firms, this is not necessarily the case: the opposite may be true, with more intense competition reducing profit margins and the number of firms that can survive in an industry (Symeonidis, 2000). Symeonidis (p. 22) argues that ‘[t]his means that concerns with the level of concentration need not take precedence over the need to ensure that competition remains effective, i.e., firms do not engage in collusive practices and no barriers to entry are created.’

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Policy aspects

Information imperfection A commonly cited disadvantage that SMEs are said to suffer is lack of information about potential or current markets, which hampers their ability to compete effectively and/or exploit potential market opportunities. Lattimore et al. (1998) cite evidence indicating that small firms experience greater difficulties than large ones establishing a distribution network in export markets and that they suffer more from lack of information. However, they argue that: greater difficulty is not, by itself, a good basis for policy intervention. An economic rationale for assistance to small firms to commence exporting would require that there was some failure which led to firms not exporting when the benefits of exporting – either private benefits or the sum of private benefits and other benefits to the rest of the economy – were greater than its costs. (Lattimore et al., 1998, p. 76)

Lattimore et al. (1998) list three types of externalities which may justify government intervention in the form of export assistance to SMEs. First, reputational externalities may exist in the form of a firm’s marketing building up product reputations and market presence for other competitors from the same country as well as for itself – for example, Australian wines. Second, firms may learn a lot from leading-edge customers overseas and from the mere challenges of exporting, and there may be knowledge spillovers to other firms in the same country as the exporting firms. Third, firms entering new markets learn about how to sell in those markets and there may again be knowledge spillovers. The presence of spillovers or externalities, Lattimore et al. (1998) argue, would provide the most durable theoretical case for export subsidies. However, it is likely that the size of the spillovers is relatively small, which would imply that any assistance should be correspondingly small. Levelling the playing field SMEs operate at a disadvantage relative to larger firms in a number of areas. Lack of access to finance and to technology are commonly cited as key areas of disadvantage suffered by smaller firms and constitute significant hurdles faced by SMEs. Disadvantage resulting from government policies In some cases the disadvantage may be the result of government policies that generate fixed costs that create a competitive disadvantage for smaller firms, or otherwise tilt the playing field against them. In particular, the cost of regulatory compliance may be more onerous for small firms than for larger ones. Smaller businesses may experience greater difficulties for a number of reasons

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(Lattimore et al., 1998). First, if there are fixed costs in compliance, such as learning about the regulations and putting in place systems to ensure compliance, these costs are likely to represent a higher proportion of turnover for SMEs than for large firms. Second, smaller firms are less likely to have the resources to employ staff to deal with regulatory matters, forcing a larger proportion of managers’ time to be devoted to these issues and diverting attention away from the job of running the business. Lattimore et al. (1998) cite Australian evidence indicating that, in 1994–95, although SMEs’ share of economic activity was around one-third, they bore around 85 per cent of the total paperwork compliance burden. Recognition of the relatively higher burden on SMEs with regard to compliance costs has turned much recent policy attention to the question of regulatory reform. Many aspects of this – including the elimination of unnecessary regulations, more simple compliance, easier access to information about regulatory requirements and the elimination of inconsistencies in regulations between different jurisdictions and/or agencies – are relevant to firms of all sizes (Lattimore et al., 1998). These reforms are desirable from the viewpoint of removing regulatory hurdles to the efficient operation of all businesses regardless of their size. Other government policies may have the effect, albeit unintended, of discriminating against smaller firms. These include the following (see Hallberg, 2000): ●

●

●

●

●

Official and unofficial levies that discourage small firms from growing and becoming formal. Tax structures that distort incentives and discriminate against small firms. Government procurement procedures that discourage successful bidding by small firms. Zoning regulations that restrict SME operations and entry into high-income markets. Labour market rigidities that make hiring and firing workers difficult and expensive, and limit the flexibility and mobility of the labour force.

However, it is not always clear that policies – for example labour market regulations such as redundancy payments or provisions against unfair dismissals – which are claimed to disadvantage smaller firms proportionately more than larger ones should be removed for the former in what is sometimes known as ‘regulatory tiering’. This is the term used to describe the practice of applying more lenient regulations to small businesses or exempting them altogether from regulations judged to be overly

312

Policy aspects

burdensome to them (Lattimore et al., 1998). While governments are aware of the impact that regulatory tiering can have on the small business vote, they also need to take into account the interests of the wider community, the employment conditions of employees generally and the impact on overall economic efficiency. As Storey (1994, p. 267) has expressed it, ‘the entrepreneur’s “red tape” is often the same as a worker’s “right” or a neighbour’s “environment”.’ Bickerdyke and Lattimore (1997, pp. 55–6) make the same point: What [regulatory tiering] does is lower standards in order to lower the costs of compliance for owner-managers. And it is other people (workers and consumers in the broader community) who bear the costs of such lower standards. So any attempts to alleviate the apparently unfair burden on small business owner-managers occasions other re-distributions, which may also be regarded as unfair.

Achieving an appropriate balance between the overall interests and welfare of the community and those of the SME sector is likely to remain a difficult task. Lack of access to finance Lack of access to finance has been one of the more pervasive problems faced by SMEs in both developed and developing countries. It represents a major constraint which can significantly affect the ability of a firm to grow, upgrade its technology, expand its markets, improve its management capabilities, raise productivity, or simply to survive (Levitsky, 1996). Lack of access to finance by SMEs is generally attributed to capital market imperfections which have resulted in financial institutions being less skilled at servicing the financial needs of SMEs, and the lack of non-bank capital markets that SMEs can tap into (Hawtrey, 1997). With respect to the difficulties that SMEs encounter in gaining access to debt financing, a recent conference of the Pacific Economic Cooperation Council (PECC) concluded that the reasons typically relate to: firm size, risk, knowledge, and flexibility. SME borrowing requirements are small and frequently do not appeal to financial institutions. More collateral may be required than SMEs can pledge. Financial institutions may lack expertise in understanding small and medium knowledge-based business. The flexibility in terms and conditions of financing that SMEs require may not be available. (PECC, 2003)

In addition, banks generally have difficulty assessing loans to SMEs because of the lack of accurate and reliable information on their financial condition and performance, unconvincing and weak business plans, all of

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313

which imply higher transaction costs in the processing of such loans. As a result, SMEs generally find themselves faced with higher interest rates for any loans they are able to secure, as well as more stringent requirements for collateral (Lattimore et al., 1998). The alternatives to debt financing involve equity capital but here the problems are even more pronounced, particularly for SMEs in developing countries which tend to be undercapitalized. Equity capital would allow firms to spread and share the risk of high-growth strategies by sharing equity ownership, but attempts to develop capital markets geared to small firms have not proved successful (PECC, 2003). The high fixed costs involved in stock exchange listing and the ongoing requirements for continuing disclosure act as a disincentive to SMEs. In turn, the higher risk profiles of these firms and the limited information they can provide means that they do not represent very attractive propositions to the broking community (PECC, 2003). Hall (2002) reports evidence for some APEC economies suggesting that the proportion of bank loans to SMEs has declined since 1984: from 39 per cent in 1994 to 19 per cent in 2000 in Australia; from 40 per cent in 1992 to 27 per cent in 1999 in Chinese Taipei; and a less pronounced but similar downward trend in Canada, Indonesia, Japan and Korea. The only exception to this pattern for APEC countries, for which comparable data were available, is the US. While the reasons for the decline (in both relative and absolute terms) in funds available to SMEs are unclear, Hall (2002) postulates three possible explanations: (1) some statistical anomaly such as bracket creep as borrowers seek larger loans to offset the effects of inflation; (2) other more attractive sources of finance, such as venture capital, becoming available to SMEs; and (3) banks tightening their lending to SMEs, either as a result of regulatory changes (for example, BIS requirements) or because of the banks’ perception of SME loans as less attractive. Hall concludes that the third explanation is the most likely. If correct, this may have long-term consequences for the number of new firm start-ups and for SME growth. Hall’s (2002) study also reports an apparent trend in the APEC economies towards policies that positively discriminate in favour of smaller firms gaining better access to finance (see Table 13.4). Between the periods 1994–96 and 2000–2001, for example, the proportion of APEC economies that provided discriminatory tax rates favouring SMEs increased from 18 per cent to 60 per cent, while the proportion of countries with programmes to provide financial support for start-ups increased from 6 per cent to 60 per cent. In contrast to the observed trends in recent years that appear to favour policies actively favouring SMEs through policies such as subsidized loans

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Table 13.4 Finance policies in support of SMEs in APEC countries (% of APEC countries) Policy Government underwriting of credit guarantee for SMEs in domestic operations Government support for SMEs engaged in exports Venture capital support General finance support (e.g. subsidized or regulated interest rates) Support programme to provide micro-finance for start-ups Concessionary tax rates or favourable tax treatments for SMEs

1994/95

2000/01

47

45

53 41 65

70 70 50

6 18

60 60

Source: Adapted from Hall (2002), Table 7.3.1.

and exports assistance, subsidies for start-ups and concessionary tax rates, Hawtrey (1997) argues for more market-oriented policies that aim for greater diversity and depth in the capital markets for the small business sector. He notes a number of developments arising from increased competition which indicate that the problems faced by SMEs in Australia are being alleviated. The developments include an increase in the availability of finance for SMEs, a decrease in interest margins, an increase in willingness to lend on the basis of cash flow, and innovations in loan schemes tailored to the requirements of SMEs. He suggests that policies should have three main objectives: (1) genuine competition between the various strata of the financial sector, from banks to non-bank financial intermediaries to foreign banks; (2) the removal of artificial disadvantages to SME financing such as the lack of advocacy (that is, expanding the powers of the Banking Ombudsman to allow representation for not just individuals but also small businesses) and the absence of national codes of behaviour for the extension of credit; and (3) actively nurturing the growth of open (particularly equity) capital markets for SME financial products. Likewise, PECC (2003) recommends the promotion of a flexible environment for a venture capital market specific to SMEs. And, drawing on the very successful experience of Bank Rakyat Indonesia in developing its own approach to the provision of uniquely tailored lending programs to SMEs, it also recommends that financial institutions be encouraged to tailor credit to SMEs and greater emphasis be placed on training programmes to help bank staff better understand the special requirements of SMEs.

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Lack of access to technology It is generally accepted that smaller firms are disadvantaged relative to large firms in terms of access to technology. Access to technology and making improvements to current technology are not ends in themselves, but a means to achieving dynamic efficiency and innovativeness. This issue is discussed in the following subsection. 13.2.4

Dynamic Efficiency and the Promotion of Innovation

The market failure rationale for government intervention in markets discussed above is based on the notion of departures from static efficiency. In the kind of world envisaged by static efficiency arguments, the implicit assumption is that the technology of production is stable and that companies will compete on the basis of price and quality. However, a relatively recent occurrence has been the increasing focus on the importance of dynamic efficiency as an objective of policy (American Bar Association, 2002; Clarke and Evenett, 2003). A survey of competition policy regimes by Industry Canada (1995) found that ‘around the world, competition policy is increasingly recognised as a vital element of the framework for a dynamic market economy’. Dynamic efficiency is concerned with technological innovations enhancing welfare, and refers to ‘the use of resources so as to make timely changes to technology and products in response to changes in consumer tastes and productive opportunities’ (Bureau of Industry Economics, 1996). As Audretsch et al. (2001) argue, ‘In a dynamic economy competition in product and process innovations may have a more significant effect on welfare, at least in the long run, than does any likely variation in price.’ UNCTAD (1998) is less equivocal, asserting that ‘[d]ynamic efficiency is probably the most important beneficial effect of competition’. The conceptual underpinnings linking competition to dynamic efficiency or innovation are provided by Porter (1990), who argues that ‘healthy competition’ is essential to delivering ongoing innovations in products, processes and methods, which in turn are critical to a country’s prosperity. The available research on the relative innovativeness of small versus large firms has been inconclusive despite extensive research into this issue since the 1950s. Policies intended to encourage R&D activities in all firms regardless of their size, through grants and subsidies, therefore seem appropriate in this context. Indeed, the evidence would seem to suggest that it is technological opportunities, rather than firm size, that explain firm innovativeness (see, for example, Scherer, 1970; Shrieves, 1978; Cohen and Levinthal, 1989; Geroski, 1990). However, it is generally accepted that smaller firms, because of their relatively low levels of employment of technical specialists, are disadvantaged relative to large firms in a number of

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areas, including establishing communication with external sources of scientific and technological expertise and knowledge. From the viewpoint of their management, there are opportunity costs in seeking out appropriate external sources of technical and other advice (Rothwell, 1991). In section 13.3 we explore firm networks and their potential in assisting smaller firms to overcome the disadvantages associated with small size. 13.2.5

Summary

The review in this section suggests that many of the arguments put forward for subsidizing SME activities (as distinct from some activities of firms regardless of size) are not economically justified. As Hallberg (2000) argued, SME assistance programmes are often motivated more by social or political considerations than by economic ones. Nonetheless, SMEs are widely acknowledged to suffer from disadvantage relative to large firms, principally in the areas of access to information and technology. In the following section we examine the possibilities offered by networks in meeting the needs of SMEs in these areas.

13.3

FIRM NETWORKS

There is increasing recognition that collaborative and other kinds of networks of firms offer a way in which small firms can circumvent some of the disadvantages associated with their lack of size. In addition, such networks can promote knowledge sharing and specialization, and exploit joint production economies (Lattimore et al., 1998). Humphrey and Schmitz (1996) cite mounting evidence in both developed and developing countries that networking helps SMEs to become more competitive. As a result, governments have increasingly promoted firm networks, particularly amongst smaller firms. Government intervention to promote such cooperative networks would appear to be economically justified because of (1) the benefits, in terms of static and dynamic efficiency and enhanced competitiveness, that derive from such cooperation; and (2) the apparent difficulties in coordination experienced by firms in initiating the formation of networks. In this section, we review some of the recent literature on firm networks and explore the implications for policy. 13.3.1

Types of Networks

A number of taxonomies of firm networks have been identified in the literature. The typical examples are geographically based, but these are by

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no means the only forms of network possible. Humphrey and Schmitz (1995, pp. 8–9) identify three kinds of firm networks. A cluster is a sectoral and geographical concentration of enterprises. Some of the benefits arising from such a concentration, known as ‘external economies’ (which we discuss in the next subsection), include the emergence of suppliers catering to the firms in the cluster, the emergence of a pool of workers with skills required by the sector, and the possible emergence of marketing or distributional agents who provide service links to more distant markets. The second kind of firm network identified by Humphrey and Schmitz (1995) is the industrial district. According to Rabellotti (1995), an industrial district emerges when a cluster develops beyond mere specialization and divisions of labour between firms, and develops ‘implicit and explicit forms of collaboration among local economic agents within the districts, enhancing local production and sometimes innovation capability’ (Rabellotti, 1995). Rabellotti defines industrial districts in terms of four key factors: ●

●

●

●

a cluster of geographically proximate and sectorally specialized firms (mainly SMEs); both forward and backward linkages among firms, based on both market and non-market exchanges of goods, information and people; a common cultural and social background linking firms and creating a behavioural code, sometimes explicit but often implicit; and supportive regional and municipal governments.

Finally, Humphrey and Schmitz (1995) use the term network to refer to a cooperative enterprise of firms exhibiting collective efficiency, which is not necessarily tied to being in the same locality, although most networks that have been studied are geographically concentrated. While the external economies of networks that are not geographically concentrated tend to be small, the gains from joint action can be substantial (Humphrey and Schmitz, 1995) and presumably provide the motivation for the network. We use the general term ‘network’ to refer to all three. Another more commonly used taxonomy takes a supply chain perspective in distinguishing between horizontal (or lateral) and vertical networks (for example, Berry, 1997; Nooteboom, 1999; Fritsch, 2001). Indeed, Berry (1997) argues that the distinction between small–large firm cooperation (comprising mainly vertical subcontracting relationships) and small–small firm cooperation is the basic analytical one. Horizontal network relationships are those between firms at the same level of the supply chain, while vertical ones are those between firms at different levels of the supply chain, typically with suppliers or customers. The exact form that is manifested in

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practice varies by industry and is determined by, among other things, differences in technology and market structure (Berry, 1997). However, while the distinction serves as a convenient starting point for analysis, Berry argues that the key to understanding networks is not so much the static structural differences but ‘to understand the dynamic processes by which firms and sectors are transformed to create the system that finally emerges’. This echoes a theme sounded earlier in Humphrey (1995) emphasizing the need for further study of the processes of change that result in the failure or success of networks. 13.3.2

Network Concepts

Networking by small firms allows them to derive efficiency gains. Central to understanding how this occurs is the concept of external economies, which may be traced to Alfred Marshall’s nineteenth-century analysis of industrial districts in Britain (Humphrey and Schmitz, 1995, 1996). Marshall noted the economies which ‘can often be secured by the concentration of many small businesses of a similar character in particular localities’.6 Examples of such external economies include the accumulation of a pool of specialized workers, easy access to suppliers of specialized inputs and services, and the ready dissemination of knowledge among firms in the cluster (Schmitz and Nadvi, 1999). External economies are incidental effects produced as unintended consequences of other activities which are consciously (or deliberately) pursued as joint actions. There are two types of joint action: individual firms cooperating together, for example, in sharing equipment or in product development; and groups of firms cooperating in business associations, consortia, and so on (Humphrey and Schmitz, 1995, 1996). The incidental and the deliberate effects are combined into the concept of ‘collective efficiency’, which may be defined as ‘the competitive advantage derived from external economies and joint action’ (Schmitz and Nadvi, 1999, p. 1504). This definition emphasizes the notion that competitiveness in this context cannot be understood by focusing on individual firms. Examples of collective efficiency gains arising from a cluster of producers of similar products include the gains from specialization, the attraction by the cluster of suppliers and buyers, the creation of a pool of specialized workers, and the ready diffusion of knowledge among firms in the cluster. Efficiency gains can be static, such as the easy availability of inputs, or dynamic, such as the speedier dissemination of new ideas (Humphrey and Schmitz, 1995). However, while it is generally accepted that the conceptual framework described above is useful, it remains incomplete. Schmitz and Nadvi (1999) identified two main areas of deficiency in the theory. First, the

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collective efficiency framework fails to adequately capture the importance and role of external linkages, which can be critical to the development and success of the cluster. Second, if a strategic response is required to external challenges, joint action by local enterprises may not be adequate. This implies a role for public agencies as catalysts or mediators. The role of government agencies is discussed in section 13.3.4 below. The Marshallian framework outlined above yields insights about the kinds of benefits in the form of specialization of labour, economies of scale and access to markets that firms derive from cooperative networking, and tends to apply mainly to geographically concentrated, horizontal firm clusters. More recent authors have investigated both the sources of networks’ advantages to their members, and the underlying structural requirements for the benefits to occur. On the former, Fritsch (2001) distinguishes between the benefits accruing to horizontal links and those accruing to vertical ones. In addition some benefits accrue to both horizontal and vertical networks. Fritsch argues, however, that the principal benefit of networks as typically described in the literature is that they allow firms to realize a relatively high degree of division of labour, and that moreover it is in vertical relationships that these benefits tend to occur. He suggests that such networks are characterized by redundant vertical relationships, where redundancy in a business relationship means that ‘there is a tendency for customers to have more than one supplier of certain goods and that suppliers are not dependent on only one customer’. Fritsch’s (2001) conclusion that vertical relationships offer cooperating firms greater potential benefits is at odds with much of the literature where the traditional focus has been on horizontal relationships, and suggests that this aspect of cooperative linkages may warrant closer study. Nooteboom (1999), employing what he calls a ‘constructivist’ approach, has proposed another dimension to the conceptual framework. He argues that firms, like people, have different knowledge based on their experiences. He suggests that as a result, the primary function of the firm may be cognitive in nature, and that the firm acts as a focusing device which achieves its objectives by directing and aligning the perception and understanding of the people connected with it. This implies that by focusing on a particular perception of its environment the firm ‘runs the risk of missing out on perception of opportunities and threats from other directions’, and that there are benefits to having access to wider or alternative perceptions other than its own. Networks therefore serve an important function by providing complementary, external sources of cognition. However, as Nooteboom (1999, p. 795) argues: Such outside sources of complementary cognition require a certain ‘cognitive distance’ which is sufficiently small to allow for understanding but sufficiently

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large to yield non-redundant, novel knowledge. For the external source to maintain novelty it is crucial to maintain distance. Acquisition or merger may eliminate distance and thereby novelty.

Nooteboom’s (1999) analysis thus at least partly addresses the first of the deficiencies of the Marshallian framework identified by Schmitz and Nadvi (1999), that is, the role and importance of external linkages. Indeed, its principal implications would appear to be in conflict with those of the Marshallian framework. Where the transactions-cost approach of the latter would prescribe greater integration of activities within larger firms in the face of greater uncertainty (for example, from increased complexity and variability of both technology and markets), Nooteboom’s analysis suggests that under these conditions there is a greater need for external partners to provide complementary cognition (Nooteboom, 1999). 13.3.3

Networks and Innovation

Networks also have a role to play in helping firms participate more effectively in innovation-related activities. As DeBresson and Amesse (1991, p. 364) argue: If innovation consists of new technical combinations, networks provide the flexibility with which to exploit opportunities for the recombination of various components . . . If the firm is considered as a (temporary) combination of resources the innovative enterprise is a new combination but not the only possible form which it can take. Inter-firm networks can also provide a means of recombination, one that has distinct advantage over individual firms . . . These possible combinations are explored through the process of ‘hyper-interaction’ within the network, while finding the complementary assets outside the firm necessary to make the innovation viable.

From a different perspective, Lundvall (1988) argues that small firms lacking an in-house R&D capability can develop information networks to enhance their knowledge absorption capacity. This occurs by learning from both customers and suppliers, interacting with other firms and taking advantage of knowledge spillovers from other firms and industries. Connection with the ultimate users of innovation is also of importance. As Freeman (1991) notes, successful innovations tend to be characterized by ‘determined attempts to develop an understanding of the special needs and circumstances of potential future users of the new process or product. Failures were characterised by neglect or ignorance of these needs.’ Not surprisingly, firms with highly qualified management personnel are better

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able to assess their own deficiencies as regards knowledge and technical skills, and to link up with other firms or organizations that are able to help them overcome those deficiencies. While firms of all sizes participate in networks, it is arguable that the benefits from such participation are potentially greater, relatively speaking, for smaller firms, which tend to experience to a greater degree than large firms problems of access to information and to potential markets. Vernon (1979) argued that small firm networks tend to be less global and more locally based in nature, with more limited sources of information – for example, in the form of personal exchanges, collective learning, cooperation, and perhaps information from locally-based large firms or multinationals in the same industry. The literature would appear to support the view that being part of a network lowers the cost of information to firms and allows them to avoid subsequent problems of exclusion and entry barriers (DeBresson and Amesse, 1991). For firms with formal R&D departments, networks can encourage cooperation with other firms and universities and other public research institutions. Even for firms that do not formally engage in R&D, participating in information networks and the development of skills are critical in fostering and maintaining the ability to engage in innovative activities, and not necessarily of an exclusively technological nature. In addition, the relationships involved are not necessarily directly oriented towards innovation. UK data indicate that, in general, innovative SMEs have dense external networks involving other firms (mainly SMEs) in a range of technical, marketing and manufacturing relationships and involving infrastructural institutions such as universities and private sector research institutes (Rothwell, 1991).7 The flexibility of such relationships goes some way towards explaining why some firms opt for a network structure rather than internalization. 13.3.4

Policy and the Role of Government Agencies

The foregoing discussion suggests that much remains to be done in furthering our understanding of the properties of networks, the ways in which they add value to their members, and how their formation can be stimulated and encouraged. The European experience has been that where firms cluster they find it easier, because of the external economies that arise, to overcome obstacles in access to inputs and to product markets. However, as Schmitz and Nadvi (1999, p. 1509) warn, ‘successful clusters cannot be created from scratch. There needs to be a critical mass of enterprises and skills (however rudimentary) that outside assistance can “hook into”.’ A prior step to formulating any policy measure in this regard would

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therefore be to identify whether any such critical mass, or potential for such, exists. Schmitz and Nadvi (1999) point, for example, to the importance of trade networks for incipient clusters. Humphrey and Schmitz (1996) argue that effective interventions need to follow what they call the ‘Triple C approach’. First, they need to be customer oriented, to allow firms to learn about, and from, the needs of their customers. This supports research indicating that many effective networks have a strong buyer orientation. Further, by implication the focus will likely be on external linkages as well, since many buyers will not be local. As Berry (1997) argued, ‘[g]ains from inter-firm cooperation tend to be greater and that cooperation easier to achieve when the cooperating firms sell their product(s) outside the region and/or outside the country’. Second, support is more effectively directed collectively, that is at groups of firms rather than at the level of individual firms. This not only has lower transaction costs but also encourages cooperation and mutual learning (Schmitz and Nadvi, 1999). Third, they need to be cumulative in the sense that they are able to generate the capacity of firms in the network to continuously upgrade and improve, thus obviating the need for further public support. This highlights the intention of many policies of the catalytic function of government support programmes. A number of writers (for example, Schmitz and Nadvi, 1999; Nooteboom, 1999) have pointed to the possible role of government agencies as catalysts or facilitators of networks, or as mediators within networks. Berry (1997) argues that, although private intermediaries tend to be more effective than public ones, government agencies can nonetheless contribute by organizing trade fairs. Buyers, both private and public sector ones, can also: jump-start dormant clusters as some producers receive new orders, others try harder, a sense of rivalry among producers can come from the transparency of the process, innovations get copied and so on. (Berry, 1997)

In this context, Berry (1997) points to Korea’s policy of mandating and nurturing increased vertical linkages, which had spectacular results in vastly expanding the role of SMEs in the Korean economy in the period since the mid-1970s. The extent to which the Korean example serves as an appropriate model for other countries is an interesting question. Finally, the fundamental importance of the creation of a stable macroeconomic environment and legal regime, and the provision of a trained and educated labour force through appropriate educational and training facilities and policies, should be understood as a given (Berry, 1997; Mani, 2002).

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323

Summary

From a policy perspective, a number of conclusions may be drawn. First, policies should seek to encourage the establishment of these links and networks. While it is not clear what role policy plays in the process of encouraging the formation of firm networks, some decentralization of policy to regional and local government seems warranted in the case of geographical clusters and industrial districts (Humphrey and Schmitz, 1995). Levitsky (1996) suggests that planned forms of location and relocation of SMEs may be more successful if they are based on existing clusters or industrial districts. Also, Humphrey and Schmitz (1995) report that successful interventions in both developed and developing countries have tended to be joint public–private sector initiatives often focused on specific sectors. Second, if public assistance to SMEs is deemed justified, delivery of this assistance to a network is more cost-effective than assistance to individual enterprises, as transaction costs are lower. Third, given the disadvantages that smaller firms tend to suffer in terms of access to better-qualified personnel, policy emphasis can usefully be placed on upgrading the skills of small firms. This has the additional benefit that better-trained and better-qualified persons are better able to assess the technical and knowledge gaps of their own firms and hence better able to appreciate the advantages of establishing links with other firms and institutions that complement and augment the capabilities of their own firms. In addition, community training and education programmes should fit the needs of SMEs, with technical schools, appropriate technical institutes and other training centres located, as far as possible, in the vicinity of clusters and industrial districts (Levitsky, 1996). As Berry (1997) observes, the key questions for policy makers are: what is the optimal role of the public sector, and how does the role vary according to the setting? Much work remains to be done in arriving at the answers, but this fact should not be taken as a prescription for inaction given that the weight of the evidence strongly indicates the benefits that accrue from cooperative firm networks.

13.4

CONCLUSIONS

In this chapter, we reviewed the policy arguments in favour of assisting SMEs in various areas of their operations. Our review suggests that many of the arguments put forward for subsidizing SME activities (as distinct from some activities of firms regardless of size) are not economically justified. Nonetheless, it is widely acknowledged that SMEs suffer from

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disadvantage relative to large firms, principally in the areas of access to information and technology. Our examination of the possibilities offered by networks in helping SMEs deal with the disadvantages they experience indicates that there are benefits that firms can derive from participating in networks. Further, because networks can assist firms overcome some of their inherent disadvantages, they can become less reliant on public assistance and more able to compete on an equal footing with larger firms, once the initial impetus is provided for the formation of cooperative networks that can enable firms to compete more effectively.

NOTES 1. 2. 3. 4.

See Chapter 3 of this volume. See the discussion under ‘number of competitors’ below. See Belli (1997) for a good discussion of the role of government in relation to the market. See Rothwell (1991, Table 4) for a summary of the advantages and disadvantages of small versus large firms in innovation. 5. See also Gans and Quiggin (2003). 6. Alfred Marshall, Principles of Economics (8th edn, 1920), quoted in Humphrey and Schmitz (1995). 7. These results tend to be supported by other studies as well: see for example Basri (2000).

REFERENCES American Bar Association (2002), ‘The economics of innovation: a survey’, Section of Antitrust Law, American Bar Association, July. Audretsch, D.B., W.J. Baumol and A.E. Burke (2001), ‘Competition policy in dynamic markets’, International Journal of Industrial Organization, 19, pp. 613–34. Basri, E. (2000), ‘Inter-firm technological collaboration in Australia in an international context: implications for innovation performance and public policy’, Working Paper 2000–01, AEGIS, University of Western Sydney. Belli, Pedro (1997), ‘The comparative advantage of government: a review’, Working Paper No. 1834, World Bank. Berry, Albert (1997), ‘SME competitiveness: the power of networking and subcontracting’, Inter-American Development Bank, Washington, DC, January. Bickerdyke, Ian and Ralph Lattimore (1997), ‘Reducing the regulatory burden: does firm size matter?’, Industry Commission Staff Research Paper, Canberra, December. Bureau of Industry Economics (1996), International Cooperation on Competition Policy: An Australian Perspective, Canberra: AGPS. Clarke, Julian L. and Simon Evenett (2003), ‘A multilateral framework for competition policy?’, Chapter II in State Secretariat of Economic Affairs Switzerland and Simon J. Evenett (eds), The Singapore Issues and the World Trading System: The Road to Cancun and Beyond, World Trade Institute.

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Cohen, Wesley M. and Daniel A. Levinthal (1989), ‘Innovation and learning: the two faces of R&D’, Economic Journal, 99, September, pp. 569–96. DeBresson, C. and F. Amesse (1991), ‘Networks of innovators: a review and introduction to this issue’, Research Policy, 20, pp. 363–79. De Koning, A.C.P., J.A.H. Snijders and J.G. Vianen (1992), ‘SME policy in the European community’, paper presented at Gateways to Growth: Opportunities for Smaller Firms in the EC, cited in Storey (1994). Freeman, C. (1991), ‘Networks of innovators: a synthesis of research issues’, Research Policy, 20, pp. 499–514. Fritsch, Michael (2001), ‘Innovation by networking: an economic perspective’, in K. Koschatsky, M. Kulicke and A. Zenker (eds), Innovation Networks: Concepts and Challenges in the European Perspective, Physica-Verlag Heidelberg, pp. 25–33. Gans, Joshua S. and John Quiggin (2003), ‘A technological and organisational explanation for the size distribution of firms’, Small Business Economics, 21, pp. 243–56. Geroski, P.A. (1990), ‘Innovation, technological opportunity and market structure’, Oxford Economic Papers, 52, pp. 586–602. Hall, Chris (2002), Profile of SMEs and SME Issues in APEC 1990–2000, APEC Small and Medium Enterprises Working Group, Singapore: World Scientific Publishing. Hallberg, Kristin (2000), ‘A market-oriented strategy for small and mediumscale enterprises’, Discussion Paper No. 40, International Finance Corporation, World Bank. Hawtrey, K.M. (1997), ‘Finance for Australian SMEs: policy issues’, Economic Papers, 16 (2), June, pp. 39–50. Humphrey, John (1995), ‘Industrial reorganization in developing countries: from models to trajectories’, World Development, 23 (1), pp. 149–62. Humphrey, John and Hubert Schmitz (1995), ‘Principles for promoting clusters and networks of SMEs’, paper commissioned by the Small and Medium Industries Branch, United Nations Industrial Development Organization, October. Humphrey, John and Hubert Schmitz (1996), ‘The triple C approach to local industrial policy’, World Development, 24 (12), pp. 1859–77. Industry Canada (1995), ‘Competition policy as a dimension of economic policy: a comparative perspective’, Occasional Paper No. 7, May. Lattimore, R., A. Madge, B. Martin and J. Mills (1998), ‘Design principles for small business programs and regulations’, Staff Research Paper, Productivity Commission, Australia, August. Levitsky, Jacob (1996), ‘Support systems for SMEs in developing countries: a review’, paper commissioned by the Small and Medium Industries Branch, United Nations Industrial Development Organization, March. Liedholm, Carl and Donald C. Mead (1999), Small Enterprises and Economic Development, London and New York: Routledge. Lundvall, B.A. (1988), ‘Innovation as an interactive process: from user–producer interaction to the national system of innovation’, in G. Dosi, C. Freeman, R. Nelson, G. Silverberg and L. Soete (eds), Technical Change and Economic Theory, London: Pinter, pp. 349–69. Mani, S. (2002), Government, Innovation and Technology Policy: An International Comparative Analysis, Cheltenham: Edward Elgar Publishing. Nooteboom, Bart (1999), ‘Innovation and inter-firm linkages: new implications for policy’, Research Policy, 28, pp. 793–805.

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OECD (2000), ‘Small and medium-sized enterprises: local strength, global reach’, OECD Observer, June, pp. 1–7. Parker, Rachel (2000), ‘Small is not necessarily beautiful: an evaluation of policies in support of SMEs’, Australian Journal of Political Science, 35 (2), pp. 239–53. Pacific Economic Cooperation Council (PECC) (2003), ‘Financing small and medium enterprises: challenges and options’, Summary Report of the discussion at the Second Annual Conference of the PECC Finance Forum, Hua Tin, Thailand, July. Porter, Michael E. (1990), The Competitive Advantage of Nations, London: Macmillan. Rabellotti, Roberta (1995), ‘Is there an “Industrial District Model”? Footwear districts in Italy and Mexico compared’, World Development, 23 (1), pp. 29–41. Revesz, John and Ralph Lattimore (1997), ‘Small business employment’, Industry Commission Staff Research Paper, Industry Commission, Canberra, August. Rothwell, R. (1991), ‘External networking and innovation in small and mediumsized manufacturing firms in europe’, Technovation, 11 (2), pp. 93–112. Scherer, Frederic M. (1970), Industrial Market Structure and Economic Performance, Chicago, IL: Rand McNally. Schmitz, Hubert and Khalid Nadvi (1999), ‘Clustering and industrialization: introduction’, World Development, 27 (9), pp. 1503–14. Shrieves, R.E. (1978), ‘Market structure and innovation: a new perspective’, Journal of Industrial Economics, 26, pp. 329–47. Storey, D.J. (1982), Entrepreneurship and the New Firm, London and Canberra: Croom Helm. Storey, D.J. (1994), Understanding the Small Business Sector, London: Routledge. Symeonidis, George (2000), ‘Price competition and market structure: the impact of cartel policy on concentration in the UK’, Journal of Industrial Economics, 48 (1), March, pp. 1–26. UNCTAD (1998), ‘Empirical Evidence of the Benefits from Applying Competition Law and Policy to Economic Development in order to Attain Greater Efficiency in International Trade and Development’, Intergovermental Group of Experts on Competition Law and Policy, May. At http://www.unctad.org/en/docs// c2emd10rl.en.pdf. Van Cayseele, Patrick and Roger Van den Bergh (2000), ‘Antitrust Law’, in Boudewijn Bouckaert and Gerrit De Geest (eds), Encyclopedia of Law and Economics, Volume III. The Regulation of Contracts, Cheltenham: Edward Elgar, pp. 467–97. Vernon, R. (1979), ‘The product cycle hypothesis in a new international environment’, Oxford Bulletin of Economics and Statistics, 41 (4), pp. 255–67.

14.

The changing role of local government in promoting China’s collective township and village enterprises Russell Smyth1

14.1

INTRODUCTION

Collective township and village enterprises (CTVEs) have been the driving force behind China’s high rate of economic growth over a sustained period. In most East Asian countries central governments have implemented industrial policies designed to foster small and medium-sized enterprise development. An unusual feature of China’s industrial development is that local governments have performed this role. Various authors have described the close relationship between local governments – or township-village governments (TVGs) – and CTVEs as a form of ‘corporatism’ or have likened TVGs to economic corporations (see for example Oi, 1988, 1992; Che and Qian, 1998; Walder, 1998). However, in recent times the economic relationship between TVGs and CTVEs has undergone significant change. An important feature of the changing relationship concerns the role of TVGs in arranging financing for CTVEs under their control. The aim of this chapter is to review these recent developments. The main argument will be that as monitoring costs have increased, local governments have adopted indirect forms of governance over CTVEs, such as leasing and shareholding cooperative reform as vehicles to raise capital, while retaining direct control over the most profitable firms. The chapter is set out as follows. The next section provides a brief overview of the historical evolution of CTVEs in China and outlines their distinguishing characteristics. Section 14.3 describes the traditional role of TVGs in financing CTVEs under their control. The advantages and disadvantages of this approach are discussed in section 14.4. Section 14.5 evaluates recent reforms, which are designed to address existing problems and highlights some outstanding issues. Finally, section 14.6 contains the summary and conclusions.

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14.2

Policy aspects

HISTORICAL EVOLUTION AND DISTINGUISHING FEATURES OF CTVEs

CTVEs first emerged in the late 1950s in Jiangsu Province in eastern China as commune- and brigade-run enterprises. Their main role was to mobilize surplus labour and other local resources in rural areas in order to achieve local self-reliance and rural industrialization. These enterprises were under the jurisdiction of the Ministry of Agriculture, and there were strict regulations governing the industrial activities that they could carry out. However, since economic reforms were introduced in the late 1970s, these regulations have been relaxed and now CTVEs are involved in most light industries. The fastest-growing industries have been building materials, food processing, garments and textiles as well as those providing inputs for state-owned enterprises (SOEs). In 1984, the Central Committee of the Chinese Communist Party and the state Council approved a ‘Report on Creating a New Situation in Commune- and Brigade-Run Enterprise’. In this report, rural enterprises were officially renamed township (xiang) and village (cun) enterprises – CTVEs. The objective of the policy was to abolish regulations detrimental to the development of CTVEs so as to provide equal footing for CTVEs and SOEs. Responding to the new policy, the Agricultural Bank reformed its organizational structure, and provided a larger number of loans to CTVEs. As a result, the CTVE sector expanded rapidly, in terms of both size and number. CTVEs actively entered into new areas. With the introduction of new government policies to promote rural areas, CTVEs cooperated with urban enterprises and research institutes under central government initiatives such as the ‘Spark Plan’ and, in doing so, developed new production methods, technological knowledge, management knowhow and marketing channels. Traditional CTVEs, which originated in Jiangsu Province, have distinctive ownership arrangements (known as the ‘Sunan model’). The residents of the township or village which established the CTVE own the firm, but do not have the usual privileges of ownership, such as the right to appropriate, use or transfer the assets. The TVG exercises the control rights as the communal representative of the residents, giving it de facto ownership. The TVG exercises both direct and indirect control. In the initial stages of development the local government has a direct managerial role – it chooses or approves projects, raises funds and mobilizes manpower and other resources within its jurisdiction. Once the CTVE is established, in most cases the local government delegates some decision-making power to professional managers and does not exercise control over the day-to-day operations of the CTVE. However, the TVG still retains the power to

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appoint and dismiss managers. According to Oi (1992): ‘Those who run the enterprises are dependent on the local government officials who appoint them. There is competitive bidding to win contracts, but local officials ultimately decide who will be given the contract.’ Hence it is in the best interests of CTVE managers to make all major investment decisions in close consultation with the local government.

14.3

THE TRADITIONAL ROLE OF LOCAL GOVERNMENTS

In the past TVGs have had a pivotal role in securing loans from either the Agricultural Bank of China (ABC) or Rural Credit Cooperatives (RCCs) – two of the main sources of external funds for CTVEs. TVGs performed three specific functions. First, in most cases, while the manager put in the formal application and signed the loan papers, TVGs prearranged or negotiated loans on behalf of CTVEs under their control. In some instances, the TVG secured funds from the ABC as a block and distributed the funds among CTVEs, as the TVG considered appropriate. In other cases, TVGs negotiated loans with local branch managers on behalf of a specific enterprise. This is confirmed in several field studies in the 1980s. For example Oi (1998) reports that in the late 1980s the township government in Zouping, in Shandong Province, secured agreement from the ABC to provide 1 million RMB in low-interest loans for one of its enterprises. Second, the TVG provided an informal or formal guarantee to the ABC and RCCs that the loan would be repaid. Lin et al. (1992) conducted field research in Yuanping, Shanxi Province, in 1984 and 1985. Their conclusion (at p. 265) was that ‘a government guarantee is required in most cases’ and that the banks consider this more important than the enterprise’s individual creditworthiness. Writing about the practice in Zouping, Oi (1998, p. 43) states: ‘Regardless of whether the factory manager or the collective signs for the loan, the owner of the firm – the TVG – bears the financial responsibility for the debts of its enterprises.’ The most common guarantor was either the township economic commission (jinglianwei) or the village economic cooperative (jingji hezuoshe). The TVG itself was often not well placed to absorb the risk. This is because its funds were limited under fiscal sharing arrangements with the central government. However, it spread the risk across all the CTVEs under its control. Whiting (1996) conducted interviews with local branch managers and government officials in Wuxi (Jiangsu Province), Wenzhou (Zhejiang Province) and Shanghai in 1991 and 1992. She points out that the TVG was often an ‘empty guarantor’ (kong danbao), meaning that when a

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CTVE defaulted on its loans the debt was paid off by the other enterprises irrespective of the specifics of the contract. Whiting states (at p. 92), that the TVG ‘frequently places levies on the retained profits of the successful enterprises under its jurisdiction in order to repay the delinquent loans of enterprises that are performing poorly (tongshou huandai)’. Third, TVGs exercised pressure on local branches of the ABC and RCCs to direct credit to certain enterprises. Throughout the 1980s, and in some locations into the 1990s, the ABC used a series of credit ratings when allocating loans. The criteria used to devise the weightings included economic results ( jingji xiaoyi), development trends ( fazhan qushi), and potential sales performance (chanpin xiaolu) (Shen, 1990). However, political interference from TVGs in the credit allocation process was still common. Ho (1994, p. 125) states that in Jiangsu: ‘Before making major lending decisions, credit cooperatives generally consult with township governments to seek their views and priorities.’ Shen (1990) puts the role of the TVG in influencing lending decisions in stronger terms. He suggests that when rating enterprises, banks ‘are unable to avoid local administrative interference. Some local governments and bureaus, in order to ensure that the enterprises under their jurisdiction receive a high rating, have no qualms about personal intervention.’ Whiting’s (1996) interviews suggested that local government interference in credit allocation was facilitated through institutionalized relationships. The ABC appointed local managers of their branches, but local township and village officials had to approve their appointments. In some cases, officials performed the dual role of manager of the township economic commission and manager of the local RCC.

14.4

ADVANTAGES AND DISADVANTAGES OF THE TRADITIONAL ROLE OF LOCAL GOVERNMENT

14.4.1

Advantages

A number of econometric studies have found that CTVEs with strong levels of TVG involvement are as efficient as private firms with well-defined ownership rights. For example, Svejnar (1990) runs a series of regressions using pooled panel data from 400 CTVEs and private enterprises in Wuxi in Jiangsu, Jieshou in Anhui, Shangrao in Jiangxi and Nanhai in Guangdong over a 16-year period. He used dummies to distinguish between different ownership forms. All of the coefficients on the ownership dummies were statistically insignificant, which suggests that ‘private ownership and

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community ownership appear to have similar effects on productivity’ (Svejnar, 1990, p. 253). Pitt and Putterman (1996) reached similar conclusions to Svejnar (1990) using pooled data on 200 enterprises distributed across ten provinces between 1984 and 1989. Dong and Putterman (1997) use a subset of Pitt and Putterman’s data. However, unlike Svejnar and Pitt and Putterman who estimated deterministic functions, Dong and Putterman (1997) used a stochastic production frontier model and checked the robustness of their results under alternative assumptions regarding the random error component and the component measuring technical inefficiency. Their finding was also that there was no evidence that private enterprises had a productivity advantage over traditional CTVEs. One explanation for these perhaps surprising results is that there could be significant benefits flowing from informal institutions in the initial stages of market development. In Chinese capital markets the legal rights of creditors are not well protected and collaterals are uncertain because of well-known problems related to adverse selection and moral hazard. Zhang (1993, p. 53) states that under these circumstances, ‘local governments have proved indispensable to the local banking institutions for operations at the local level’. Several studies have pointed to the positive role TVGs have had in the initial provision of capital to CTVEs (see for example Lin et al., 1992; Naughton, 1994; Oi, 1998). The sponsorship of TVGs made it easier for CTVEs to get access to capital, which was an important reason for their growth in the 1980s and first half of the 1990s. Without the support of the TVG most CTVEs would not have the resources to provide formal guarantees. The experience of post-socialist economies in Central and Eastern Europe has been that new start-up businesses proliferate, but have trouble getting access to capital and as a result remain small, undercapitalized and dependent on formal capital markets. 14.4.2

Disadvantages

Soft budget constraint The budget constraint illustrates the relationship between expenditure and earnings. An enterprise is said to have a soft budget constraint if it expects to be bailed out in times of financial trouble. One view is that CTVEs face hard budget constraints because local governments face hard budget constraints. Unlike the central government, local governments cannot run budget deficits and have limited funds because of fiscal sharing arrangements with the central government (see for example Perotti et al., 1999). However, this view overlooks the fact that TVGs cross-subsidize poor-performing firms. Several commentators have argued that local budget constraints on CTVEs are soft because local governments make

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transfers between CTVEs to meet loan obligations to lending institutions (see for example Koo and Yeh, 1997). Others argue that the influence of local governments over lending institutions softens budget constraints. Naughton (1995, p. 153) suggests that in the 1980s and early 1990s, to the extent that they were guaranteed formal and informal credit, ‘CTVEs did not have completely hard budget constraints’. Up until the mid-1990s, CTVEs had fairly easy access to bank credit. A common perception is that from late 1988 to mid-1990 CTVEs became the main target of a government-induced credit squeeze designed to curtail inflation. In this period about 2 million CTVEs ceased production. However, the statistics suggest that access to credit was not the real problem. The zhili zhengdun (readjustment and rectification) programme was launched in the fourth quarter of 1988 and put into effect in the second half of 1989. This resulted in a significant drop in the industrial growth rate due to a slump in domestic demand. The industrial growth rate in the first half of 1989 was 10.8 per cent, but it fell to 0.9 per cent in September and ⫺2.1 per cent in October. The government responded by increasing bank credits. Thus, contrary to popular belief, total loans by state banks increased by 22.33 per cent in 1989 and 48.39 per cent in 1990. A substantial proportion of this was directed towards CTVEs. In the first half of 1990 CTVEs received 64 billion RMB in loans on top of a 25 per cent growth in 1989 (Lo, 1997, pp. 60–61). Encourages lending to marginal enterprises As indicated above, TVGs have played an important role in encouraging the ABC and RCCs to make loans to small-scale rural enterprises that otherwise would find it difficult to get credit. However, the downside is that the TVG often contributes to the availability of ‘easy credit’ for marginal enterprises, rather than putting pressure on these enterprises to perform. This issue is exacerbated because of asymmetrical information between the banks and the TVG. The local branches of the ABC and RCCs do not have well-trained staff, hence they usually rely on the opinion of the TVG when making lending decisions. This contributes to the soft budget constraint. Dewatripont and Maskin (1995) argue that soft budget constraints occur because creditors lack information and commitment not to refinance bad projects – that is creditors have less information than enterprise managers and thus are prone to approve projects that are unprofitable. There is some empirical evidence to support this suggestion in field studies. For instance, one bank manager Whiting (1996, p. 96) interviewed in Shanghai complained that ‘it was impossible for his staff to conduct a feasibility study to assess the market potential of a proposed project. Instead, the staff relied on the opinions of the town’s political leaders and enterprise managers.

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As a result, the bank has repeatedly granted loans for products that ultimately were unsalable. In many of these cases firms in the same geographical area producing the same products had saturated markets.’ This problem has compounded as markets have matured. The product standard and mix of CTVEs is not well suited to more sophisticated consumer markets. The main performance criteria which has been used to evaluate CTVEs is output maximization. This is because indirect taxes, which are based on output, form a large share of tax receipts from CTVEs. Hence, at least in the past, township officials have focused on output maximization in evaluating the performance of managers (Whiting, 1996, p. 73). Because township officials placed most of their emphasis on output maximization most CTVEs produce bulk runs of low-standard products, which are copied from urban enterprises or foreign firms. In the past CTVEs have been flexible in terms of being able to adjust their product mix, but as per capita income has increased consumers are demanding better standards which entails higher levels of product innovation. As a result, CTVEs have high levels of debt. In 1997 total losses of TVEs were 80.6 billion RMB, which was 70 per cent higher than 1995 (Ge, 1998). News reports suggest that in some locations as many as 90 per cent of CTVEs are making losses and that the debt to asset ratio is 85 per cent (Cheng and Sheng, 1998). In Hunan Province alone, at the end of 1998, the accumulated deficit of TVGs was 3.8 billion RMB, with 85 per cent of all CTVEs making losses.2 It is difficult for the ABC and RCCs to collect loans backed with collateral from TVGs once they are in default because the formal legal framework in China is underdeveloped. For example, Whiting (1996, p. 93) reports that in Wenzhou, as of mid-1992, the ABC had attempted and failed to collect several outstanding loans guaranteed by collateral (usually buildings or equipment). The property had not been auctioned because the courts were unwilling to enforce the judgment. Capital shortages One implication of mounting bad debts is that by the mid- to late 1990s TVGs did not have the same influence in procuring loans. Zhang (1999) conducted interviews with local bank officers and enterprise managers in Hangzhou, Zhejiang Province. In contrast to Whiting’s (1996) and Oi’s (1998) studies for earlier periods, he found that the power of local governments to influence the allocation of bank loans was limited. As a result total loans to CTVEs fell by around two-thirds in 1998, in spite of an increase in M2 (cash and deposits). Several studies suggest CTVEs were facing capital constraints from the beginning of the 1990s, when informal methods of raising capital started to prove restrictive (see for example Hong, 1995; Liu et al., 1998). The fact that banks are less willing to lend to

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CTVEs has worsened this constraint, to the extent that there is now a severe capital shortage. One solution is to raise funds through the Rural Credit Institute or Rural Cooperative Fund, but neither lend to CTVEs under normal circumstances and both charge a higher interest rate than the state-owned commercial banks. Capital shortages are exacerbated because of ad hoc local government intervention. One problem with having significant levels of TVG involvement is that it is often hard to know who is the true owner. This has made banks reluctant to lend because they are uncertain about who will be responsible if the firm makes a loss. There is a lot of anecdotal evidence of government abuse based on field research. For example, Cai (1990) states that in southern Jiangsu managers often complain that local governments take funds from CTVEs as they please, and treat enterprises under their control like ‘money trees’. Ho (1994) makes a similar observation based on extensive interviews in Jiangsu. He found that: ‘Personal abuse of power was [a] problem. At the township and village levels, because power was concentrated in the hands of the local party secretary and his/her deputies, an often-heard complaint was that those in authority acted like “little emperors”, contracting out township-village enterprises to their friends and supporters (or appointing them to senior positions) as rewards’ (Ho, 1994, p. 388).

14.5

MEASURES TO ADDRESS THESE PROBLEMS

14.5.1

Shareholding Cooperative Reform

In order to address these problems, TVGs have experimented with alternative governance structures, while retaining direct control and financing over the most important and profitable CTVEs. This represents one solution to the costs of monitoring large numbers of CTVEs. One of the benefits of the governance structure of traditional CTVEs is that it helped to facilitate financial contracting because the TVG is well placed to monitor managers. However, there are significant monitoring costs associated with the separation of beneficiaries and control. These have become more pronounced as CTVEs have matured. In most cases, the value of CTVE assets is well in excess of that borrowed with the assistance of the TVG, which raises issues about who should own and control the assets. One of the main approaches to ownership reform is to convert CTVEs into shareholding cooperatives. At the end of 1997 over 20 per cent of CTVEs had been transformed into shareholding cooperatives (Oi, 1999, p. 624). In some localities the figure is much higher. For instance, of the 14 000 CTVEs

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in Changzhou almost 60 per cent have been transformed into shareholding cooperatives (Wan and Ding, 1999). Two of the main objectives of shareholding cooperative reform have been (1) to reduce government interference in small CTVEs, and (2) provide a mechanism for CTVEs to raise funds for modernization and technical renovation. However, much casual evidence suggests that shareholding reform has not reduced government interference in management. The main problem is that the official figures on shareholding numbers are inflated through ‘disguised switch-overs’. There is considerable anecdotal evidence to suggest that local officials often do not understand what shareholding cooperatives are, so have included firms in the official statistics that are not in fact shareholding cooperatives. According to one report in the official People’s Daily: ‘Some enterprises only change their names when carrying out stock ownership reforms . . . The enterprise’s Board of Directors, Board of Supervisors and Shareholder Meeting all perform no practical functions, and the bulk of power within the enterprise remains concentrated in one person’s hands’.3 There are a number of field studies that have found that local governments still retain considerable power in enterprises classified as shareholding cooperatives. Clegg’s (1998) field research interviewing enterprise managers and local officials in Shandong Province is representative. She states (at p. 76): Decision-making processes in [shareholding cooperatives] are poor and the various share-systems are not well understood – they often diverge from government regulations. Local governments tend to remain very influential in major decisions regarding asset management, profit distribution and the appointment of managers and still lay claim to a large share of the profits. At the village level, the roles of directors, managers and cadres are often difficult to distinguish. Power remains concentrated in the hands of the village Party Secretariat.

A second objective of shareholding cooperative reform is to raise capital for cash-strapped CTVEs. Issuing shares to management and workers provides an alternative source of capital to bank lending. When shareholding cooperatives need funds for a new investment, the common practice is to issue new shares. However, in practice, shareholding cooperative reform has not worked as a method of raising capital in the manner in which it was intended. One of the main disadvantages of worker ownership is that it promotes poor risk-sharing. Hansmann (1990, p. 1772) states: ‘If the workers supply the required capital themselves – for example by investing their pension plan assets or other forms of personal wealth in the firm – they will be badly underdiversified. If the firm goes bankrupt, they will not only lose their jobs but savings as well.’ In profitable enterprises, this has not been a factor for workers in China. In firms that are performing well,

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workers receive large dividends and are content to invest their savings. In fact, in field research conducted in Liaoning and Shandong, Helman (1996) found that in some better-performing firms workers would have invested more of their savings if given the chance. In small loss-making firms though, which are often selected for experimentation with shareholding cooperatives, risk diversification is an important consideration that workers have to take into account. In these cases, often workers do not have sufficient information to make informed decisions about risk and return considerations. This issue has been magnified because of the practice of forced shareholding. According to China’s Labour Law, managers and workers in shareholding cooperatives should be free to decide whether or not to purchase shares. The Labour Law stipulates that there should not be repercussions if specific staff members choose not to participate in share issues, but in practice this is what has happened. In some cases where workers have decided not to invest savings there is evidence that firms have withheld their wages. In other cases workers who were unable or unwilling to purchase shares have been forced to resign or retire. This has occurred in Gaijiang, Jiangning and Tanxing counties in Jiangsu (Hong, 1995, p. 366). On 30 October 1997 the State Council issued a document condemning local governments in Henan, Jilin, Shaanxi, Shandong and Shanxi for using administrative means to force managers and workers to purchase shares. However anecdotal evidence suggests that government directives have had little effect. 14.5.2

Outright Privatization

Over the past ten years, limited outright privatization has become more popular as an alternative to shareholding cooperative reform. Oi (1998, 1999) emphasizes that private firms are starting to grow in number and scale. The ABC is a strong advocate of privatizing CTVEs, on the basis that TVGs made a number of improper guarantees in the 1980s. Private ownership was incorporated into the Chinese Constitution in March 1999. An amendment to Article 11 of the Constitution places private business on the same level as the public sector. It changes the original clause ‘the private sector is a supplement to public ownership’ to ‘the non-state sector, including individual and private businesses, is an important part of the socialist market economy’.4 As a result, local governments have implemented various incentives and policies to promote private firms. These include altering one’s household status, for individuals who start businesses over a certain size. At the provincial level, private firms are now treated on the same footing as collective and state-owned firms. For example, the Jiangsu

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Provincial Government has adopted a new set of policies to give private enterprises the same access to credit as collective and state-owned firms.5 One reason for this development is that compared with traditional CTVEs and shareholding cooperatives, private firms have simpler governance structures. In the advanced coastal areas, where the trend towards privatization is the strongest, the monitoring costs associated with running large numbers of CTVEs became such that it was not practical for TVGs to continue their hands-on involvement with all the firms. As Oi (1999, p. 625) puts it, ‘for some villages it is easier to sell some of the enterprises or at least sell part of the shares in them and get income without the headaches’. However, this does not mean that China’s small and mediumsized enterprise non-state sector is ‘going private’. Oi (1999) makes the point that local governments still control most of the more successful CTVEs, as well as numerous resources on which private firms depend. Others such as Wank (1999) stress that the close relationship between local governments and the private sector lessens the threat to the local state from an emerging business class. Where outright privatization of small loss-making firms is not viable, TVGs have experimented with alternative governance structures. One method is to combine leasing and selling. In these cases, the current assets of the CTVE are sold and the fixed assets, such as the building and the land, are leased. For example, the Dachijia Sofa Factory in Penglai sold its current assets for 1.76 billion RMB and leased its building and land for 181 300 RMB per annum (Cheng and Sheng, 1998). A second method suitable for restructuring loss-making CTVEs that cannot be sold is a ‘peeled lease’. With the permission of the bank, the assets are leased to an individual who can reregister as a different enterprise, while the original legal body still exists and is responsible for the debt. A third option is to use rent to offset debt. Under this approach the bank takes over the debts of the enterprise and leases its assets to an enterprise or individual.

14.6

SUMMARY AND CONCLUSIONS

In the past, TVGs have had an important role in procuring finance for CTVEs under their control. Throughout the 1980s, the ABC, RCCs and TVGs worked together as an ingenious surrogate for well-defined formal capital markets in rural areas. Over this period, and into the 1990s, traditional CTVEs with significant levels of TVG involvement were the engine room driving China’s high rate of economic growth. However, from the mid-1990s TVGs have started to regard CTVEs, with high levels of debt, as a burden rather than an asset. In terms of financing, the traditional benefits

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of TVGs in terms of being well placed to monitor managers, started to be subsumed under the growing costs of monitoring activities with maturing markets. In response, TVGs have moved to more indirect forms of governance over a sizeable share of CTVEs under their control, while retaining direct control, and responsibilities for financing, of the most important and successful CTVEs. These alternative governance structures include shareholding cooperative reform, leasing and outright sales. Some of these, such as shareholding cooperative reform, have experienced teething problems. Nevertheless, it is likely that we will continue to see more shareholding cooperatives, private firms and other organizational forms as TVGs and CTVEs adjust to changing market circumstances.

NOTES 1. Parts of this chapter draw on arguments developed in Smyth (1999a, 1999b, 2001). This chapter was prepared with financial assistance from a Research Block Infrastructure Grant awarded to the Asian Economies Research Unit in the Department of Economics, Monash University. Xin Deng provided valuable research assistance. 2. China Economic Times, Internet Edition, 30 June 1999 (in Chinese). 3. People’s Daily, 14 January 1998, p. 10 (in Chinese). 4. China Daily, 16 March 1999. 5. People’s Daily, 9 April 1999 (in Chinese).

REFERENCES Cai, X. (1990), ‘Why the township and village enterprise “debt chain” is hard to break’, Shanghai Finance, 12, pp. 35–7 (in Chinese). Che, J. and Y. Qian (1998), ‘Institutional environment, community government, and corporate governance: understanding China’s township-village enterprises’, Journal of Law, Economics and Organisation, 14, pp. 1–23. Cheng, P. and Z. Sheng (1998), ‘Report on TVE property rights system reform in Penglai’, People’s Daily, 4 December, p. 4 (in Chinese). Clegg, J. (1998), ‘Multi-stakeholder cooperation in China: changing ownership and management of rural enterprises’, in F. Christiansen and J. Zhang (eds), Village Inc. Chinese Rural Society in the 1990s, London: Curzon, pp. 66–82. Dewatripont, M. and E. Maskin (1995), ‘Credit and efficiency in centralised and decentralised economies’, Review of Economics Studies, 62, pp. 541–55. Dong, X.Y. and L. Putterman (1997), ‘Productivity and organisation in China’s rural industries: a stochastic frontier analysis’, Journal of Comparative Economics, 24, pp. 181–201. Ge, X. (1998), ‘Where do TVE’s losses come from?’ Economic Daily, 26 June, p. 7 (in Chinese). Hansmann, H. (1990), ‘When does worker ownership work? ESOPs, law firms, codetermination and democracy’, Yale Law Journal, 99 (8), pp. 1749–1816.

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Helman, A. (1996), ‘The shareholding cooperative system in China’, paper presented at the 8th Chinese Economic Association (UK) Conference, LSE, 17–18 December. Ho, S. (1994), Rural China in Transition: Non-Agricultural Development in Rural Jiangsu, 1978–1990, Oxford: Clarendon Press. Hong, Z. (1995), ‘The shareholding cooperative system and property rights reform of China’s collective township-village enterprises’, Asian Profile, 23 (5), pp. 359–69. Koo, A. and K.C. Yeh (1997), ‘The impact of township, village and private enterprises’ growth on state enterprises reform: three regional case studies’, in Joint Economic Committee, Congress of the United States, China’s Economic Future: Challenges to US Policy, New York: M.E. Sharpe, pp. 381–402. Lin, Q., J. He and H. Du (1992), ‘Rural industrial enterprises and the role of local governments: a Chinese case study’, in D. Jones and J. Svejnar (eds), Advances in the Economic Analysis of Participatory and Labour-managed Firms:A Research Annual, vol. 4, Greenwich, CT: JAI Press, pp. 243–71. Liu, Y., S. Chew and W. Li (1998), ‘Education, experience and productivity of labor in China’s township and village enterprises: the case of Jiangsu province’, China Economic Review, 9 (1), pp. 47–58. Lo, D. (1997), Market and Institutional Regulation in Chinese Industrialisation, 1978–1994, London: Macmillan. Naughton, B. (1994), ‘China’s institutional innovation and privatization from below’, American Economic Review, Papers and Proceedings, 84 (2), pp. 266–70. Naughton, B. (1995), Growing Out of the Plan: Chinese Economic Reform, 1978–1993, Cambridge: Cambridge University Press. Oi, J. (1988), ‘The Chinese village inc.,’ in B. Reynolds (ed.), China in a New Era: Continuity and Change, New York: Paragon, pp. 55–75. Oi, J. (1992), ‘Fiscal reform and the economic foundations of local state corporatism in China’, World Politics, 45, pp. 99–126. Oi, J. (1998), ‘The evolution of local state corporatism’, in A. Walder (ed.), Zouping in Transition: The Process of Reform in Rural North China, Cambridge, MA: Harvard University Press, pp. 35–61. Oi, J. (1999), ‘Two decades of rural reform in China: an overview and assessment’, China Quarterly, 159, pp. 616–28. Perotti, E., L. Sun and L. Zou (1999), ‘State-Owned enterprises versus township and village enterprises in China’, Comparative Economic Studies, 41, pp. 151–79. Pitt, M. and L. Putterman (1996), ‘Employment and wages in township, village and other rural enterprises’, in G. Jefferson and I. Singh (eds), Reform, Ownership and Performance in Chinese Industry, Washington, DC: World Bank. Shen, S. (1990), ‘Several thoughts on credit rating work’, Shanghai Finance, No. 2, p. 40 (in Chinese). Smyth, R. (1999a), ‘Rural enterprises in Jiangsu Province, China: recent institutional changes and future prospects’, Development Policy Review, 17, pp. 191–213. Smyth, R. (1999b), ‘Shareholding cooperative reform and ownership of China’s collective township-village and small-scale state-owned enterprises’, New Zealand Journal of Asian Studies, 1 (1), pp. 60–76. Smyth, R. (2001), ‘Historical evolution, financing and the changing nature of corporate governance in China’s collective township and village enterprises’, Asian Academy of Management Journal, 6 (1), pp. 81–97.

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Svejnar, J. (1990), ‘Productivity, efficiency and employment’, in W. Byrd and Q. Lin (eds), China’s Rural Industry: Structure, Development and Reform, New York: Oxford University Press. Walder, A. (1998), ‘The county government as an industrial corporation’, in A. Walder (ed.), Zouping in Transition: The Process of Reform in Rural North China, Cambridge, MA: Harvard University Press, pp. 62–85. Wan, S. and S. Ding (1999), ‘Operation on property rights’, Shenzhen Economic Daily, 14 March, p. 2 (in Chinese). Wank, D. (1999), Commodifying Communism: Business, Trust and Politics in a Chinese City, Cambridge: Cambridge University Press. Whiting, S. (1996), ‘Contract incentives and market discipline in China’s rural industrial sector’, in J. McMillan and B. Naughton (eds), Reforming Asian Socialism, Ann Arbor MI: University of Michigan Press. Zhang, G. (1993), ‘Government intervention versus marketisation in China’s rural industries: the role of local governments’, China Information, 8, pp. 45–73. Zhang, J. (1999), ‘Managerial incentives and agency problems in rural collective enterprises in China’, paper presented at the 11th Conference of the Chinese Economic Studies Association (Australia), Melbourne, 15–16 July.

15.

Supporting SMEs through venture capital policy Barbara Cornelius and Sandra Van der Laan

15.1

INTRODUCTION

Small and medium-sized enterprises (SMEs) are the ‘seeds’ from which an economy is grown, accounting ‘for 60–70 per cent of jobs in most OECD countries’ (O’Shea and Stevens, 1998, p. 26). The primary stumbling block for most SMEs, however, is the lack of capital and managerial expertise to support growth. To this end, developing a venture capital market is a priority in many parts of the world because venture capitalists provide both financial and strategic assistance to new and innovative SMEs. Therefore government policies directed toward aiding and/or enhancing venture capital can result in benefits for the economy as a whole. Contrasting the success of government policy initiatives in relation to venture capital is not, however, a new activity (Harper, 1991; Isaksson and Cornelius, 1998; O’Shea and Stevens, 1998; Pfirrmann et al., 1997; Wright et al., 1998). Contrasting business cultures in various environments has also been extensively conducted (see for example Crainer, 1999; Hofstede, 1984; Shane, 1993; McGrath et al., 1992). In this study we seek to combine the two activities by examining the relationship between venture capital, culture and successful policy making. Indeed, drawing from the vast literature available on these topics, it is apparent that a strong nexus exists between venture capital and culture (Black and Gilson, 1998; Bygrave and Timmons, 1992). Drawing conclusions about the correlation between a particular policy and the growth of venture capital cannot be justified, as neither policies nor venture capital growth are economically isolated. Clearly, a number of additional factors influence the development of this industry. However, since such an assessment appears to be called for, given the number of governments attempting to formulate appropriate policies, we have decided to use available statistics on the absolute size and proportion of gross domestic product (GDP) consisting of venture capital investments as a measure of policy success (OECD, 1998; Wright et al., 1998). 341

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This chapter is structured as follows. Section 15.2 presents background material used to determine our choices of countries to be included in the study. In section 15.3 we define our use of the venture capital vernacular. Section 15.4, containing the body of this study, describes various venture capital policies in the context of the culture in which they are applied. Section 15.5 draws some conclusions about the lessons that can be learned from this examination of three regions and six different countries, which have made some attempt to promote the development of a venture capital industry. Finally, section 15.6 contains a summary of the major conclusions from this chapter.

15.2

BACKGROUND

A number of countries around the world have encouraged SME development through policies that support venture capital. To illustrate, the US government, inspired by the example of private funds, licensed and regulated pools of venture capital funds (the Small Business Investment Company Act of 1958). Sweden has experimented with a number of programmes beginning with direct government investment through Foretagskapital in the early 1970s through to the more indirect initiatives now predominant (Isaksson and Cornelius, 1998). German policy makers have generally adopted a ‘laissez-faire’ attitude toward venture capital. Germany appears currently to be relying on EU policies and a revision of capital market access schemes (for example EASDAQ). By contrast, Dutch policy makers have indirectly supported venture capital development through such initiatives as the development of a substantial guarantee scheme. These activities have provided the foundations for a vibrant growing industry. Singapore was an early point of diffusion for venture capital, receiving much of its venture capital structure from American venture capitalists. India, by contrast, began with efforts to support micro-businesses and only gradually shifted to supporting venture capital. Indian policy makers have, however, fully embraced the venture capital ethos, creating initiatives in the 2000–2001 budget which are intended to increase the scale of venture capital activity. It is yet to be seen how successful these initiatives will be. Australian policy makers also entered the fray late, but have adopted venture capital as a potential solution to economic woes (Australian Academy of Technological Sciences and Engineering, 1983, pp. 10–11).

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15.3

343

VENTURE CAPITAL

‘Venture capital’ is a term that does not have unilateral agreement on its definition (Black and Gilson, 1998; Cornelius, 1999). General Doriot, the founder of American R&D, which was the first venture capital firm with public investors, is considered the ‘father’ of traditional venture capital. He had a set of rules for investing which, according to Bartlett (1995, p. 2), defined the ‘venture capital process’ as ‘an investment process entailing [those] . . . rules’. Consideration of investments by Doriot involved: 1. 2. 3. 4. 5. 6.

New technology, new marketing concepts and new product application possibilities. A significant, although not necessarily controlling, participation by the investors in the company’s management. Investment in ventures staffed by people of outstanding competence and integrity. Products or processes which have passed at least through the early prototype stage and are adequately protected by patents, copyrights or trade secret agreements. Enterprises that showed promise of maturing within a few years to the point of an initial public offering or a sale of the entire company. Opportunities in which the venture capitalist can make a contribution beyond the capital dollars invested. (Adapted from Bartlett, 1995, p. 2.)

Doriot’s rules form the basis of most definitions of venture capital today. Definitions such as ‘long term financing (equity or potential equity) leveraged with management support and provided to unlisted, potentially high growth businesses’ (Cornelius, 1992, p. 1), or ‘the provision of equity, or equity related, finance to potentially high growth, privately owned companies [over] relatively long term horizons (five to ten years) and ongoing active involvement with [their] portfolio companies’ (UK Venture Capital Journal in the Department of Industry, Technology and Commerce, 1989, p. 5) are testament to this. Venture capital is characterized by several distinguishable stages of investment. It is important to comprehend the distinction between these stages, as an investment at a particular stage will have a significant impact on the level of risk undertaken and the level of return possible: 1.

Seed – this is the stage when the initial concept of a business is formed. This is a relatively short stage when research and prototype development takes place.

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Start-up – this stage is concerned with the early commercialization and marketing of the product. Expansion – financing is provided for the growth and expansion of the firm that has, at this stage, some track record. Mezzanine – this is often the last stage of financing before an initial public offering (IPO). Buyout (buy-in) – finance to provide for the purchase of a firm or the operating division of a firm from its owners. This type of finance is not considered ‘traditional’ venture capital. (OECD, 1996.)

3. 4. 5.

15.3.1

Policy Development

According to Patricof (1989), five conditions must be satisfied for venture capital to succeed. Industries must be deregulated and, consequently, competitive. A positive image of entrepreneurship will encourage innovation. There must be a market for small shares combined with a liberal tax structure that will influence investor and entrepreneurial participation in the market. Finally, there ought to be flexible labour rules allowing for varied levels of participation and mixed methods of reward. There are many varying types of policies and programmes that can be developed and instituted to provide the necessary financial, fiscal and regulatory framework to encourage venture capital investments. ‘Governments determine the types of financial instruments that will be designed and used, and also which type of investor (e.g. banks, pension funds, individuals) will provide the funding’ (OECD, 1996, p. 34). These policies and programmes can be direct or indirect in nature and can be manipulated to focus assistance on particular industries or types of investments. Direct intervention in the venture capital market has taken several forms. For example: ●

●

Creating a government-owned and operated fund (Victoria, Australia). Fund matching – proportionately matching private capital raised with public investment (for example Australia’s Innovation Investment Funds scheme).

Indirect intervention by governments has been more common than direct methods (O’Shea and Stevens, 1998). These measures vary greatly globally, but the commonest forms are: ●

Tax system – ‘the level of the capital gains tax rate (CGT) and in particular its differential from the rate on ordinary income is a

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●

●

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key determinant of investment flows to venture capital’ (OECD, 1996, p. 34). Guarantee schemes – these types of schemes encourage investment by lowering the levels of risk borne by investors. Governments attenuate losses of investors by guaranteeing say 50 per cent of capital invested if the investment fails (for example, the Netherlands). Provision of access to divestment options – establishment or provision of access to ‘over-the-counter’ or second boards (similar to NASDAQ) by legislative acceptance of companies with listing requirements at different levels (for example, Sweden). Legislative or regulatory assistance – changing or improving legislation and regulations that affect investment and SMEs generally (for example, the changes to the ‘Prudent Man rule’ in the US allowing higher-risk investments by pension funds).

15.4

GOVERNMENT POLICY IN ACTION

Government policy directed towards the enhancement of venture capital markets has generally had mixed success. This result however is not due to the type of policy chosen, but more to the individual government’s ability to institute the appropriate policy or programme for the prevailing environment. This environment encompasses more than just the economic environment. Policy makers need to have regard for issues such as the cultural and social appropriateness of their policies. This assertion can best be illustrated by examining the history of venture capital development in various environments. 15.4.1

US Experience

Venture capital has been successful in the US despite occasional trials and tribulations. This success can be attributed in part to the fact that the US has over time provided the legislative framework and regulatory support to allow venture capital to flourish. Several main pieces of US legislation have impacted markedly on venture capital investment. Many of the ebbs and flows in US venture capital parallel these, with investment rising during periods of low capital gains tax rates and falling in periods where capital gains tax rates have risen. This story is somewhat complicated by the Employee Retirement Income Security Act (ERISA), but it is commonly accepted that this legislation, too, enhanced capital availability for small firm growth. Whether it be by luck or design policy makers managed to

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recognize the nexus between economic recovery and investment and addressed the problem through legislative channels. An additional reason, however, for the US success in venture capital can be attributed to the cultural milieu in which it developed. Entrepreneurship is and has been an acceptable career avenue. Americans have been trained over time to look up to ‘self-made’ individuals and aspire to emulate them (Bygrave and Timmons, 1992; McGrath et al., 1992). Capitalism has a positive image; creating wealth and living well is seen as an ideal state (Hofstede, 1984). These attitudes, while not quantifiable or tested in terms of their contribution to venture capital development, influence the acceptance of and participation in programmes designed by the government to promote the industry. 15.4.2

Swedish Experience

Policy in Sweden in relation to venture capital has been more direct in nature. ‘The Swedish government established a state run venture capital fund as early as the beginning of the 1970s’ (OECD, 1986, p. 33). This initiative was less than successful as the entire framework needed was not in place. This initiative was inhibited by ‘inexperienced management, unfavourable tax regulations and a lack of exits’ (Isaksson and Cornelius, 1998, p. 6). Undeterred, the Swedish government created two investment corporations in 1992, Atle and Bure, to supply traditional venture capital. The mandate this time was clear with the prevailing policy objective stated as: The overall purpose of trade and industry policies is to improve the business climate. More specifically, it concerns deregulation, strengthening of competition, privatization of state enterprises, promotions of industrial R&D and the spread of new technology, stimulation of private enterprise and securing short and long term international competitive strength. (NUTEK, 1994, p. 13)

This time the Swedish government, with their clearly articulated objectives, created a more complete environment for their venture capital investment corporations. Proposals for tax incentives were discussed and the government provided financial support for the promotion of small business (OTC) markets. Over time, the government decreased its holdings in Atle and Bure by creating a more differentiated stock market and publicly listing subsidiaries of Atle and Bure (Isaksson and Cornelius, 1998). Sweden’s interventionist policies were commensurate with their homogeneous society that is both collective and individualistic at the same time (Holmberg and Åkerblom, 2001, p. 71). This paradox that underlies their business life allows Swedes to believe that individual independence is important, but that it can be fulfilled and expressed through society

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(Crainer, 1999). Thus by stating clear objectives and appropriate policies, combined with an educational period in which the benefits of venture capital became visible to the populace, Sweden has produced an active and sustainable venture capital market. 15.4.3

Dutch Experience

The venture capital market in the Netherlands also owes its current state of health to active interventionist policies from its government. Dutch government intervention has been indirect. In 1981 the Dutch government set up a major initiative in the form of a guarantee scheme, the Garantieregeling Particuliere Participatie-maatshappijen (GPP) (Brouwer and Hendrix, 1998). The GPP scheme guarantees investments until 2005. When the scheme was first begun, many of the well-established regional and captive funds increased their lending to more risky SMEs, in line with government objectives (Brouwer and Hendrix, 1988). The Dutch government, in 1982, also created an ‘over-the-counter’ (OTC) market with the objective of facilitating the public offering of venture capital-backed firms (Brouwer and Hendrix, 1988). This initiative ended in failure as the share market crash in 1987 had an extremely deleterious effect. The Dutch government has since introduced a set of schemes further enhancing venture capital. These schemes have improved the legislative and regulatory framework within which SMEs operate, and assist with networking and advice. The GPP scheme however, provided the impetus for the vibrant state of venture capital that the Netherlands currently enjoys. The Netherlands could not have achieved this success without attention to the cultural and existing regulatory context in which the schemes were meant to operate. The GPP scheme was built upon existing investment funds, simply redirecting their focus and providing support during the period in which they learned to manage the increased risks associated with venture capital. The government also recognized the need for a second board, or over-the-counter, market to serve the needs of investors and entrepreneurs. While this was not re-created after its collapse in 1993, those who made use of it have turned to the European, North American and British equivalents. The Dutch government continues to support the industry, although little support is required with a populace that is entrepreneurial and flexible (Shane, 1993). 15.4.4

German Experience

A German venture capital market has ostensibly existed since the 1960s. It came about as a result of private capital deficits and sinking private capital

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quotas for medium-sized companies and savings banks. In the 1970s, the German Ministry of Economic Affairs became involved in the market by offering incentives, such as refinancing at favourable interest rates and return guarantees, to non-profit guarantee societies, Mittelstandische Beteiligungsgellschaften (MBGs), and encouraging them to provide equity capital to SMEs (Pfirrmann et al., 1997). This programme failed due to over-riding liquidity requirements that prevented the MBGs from actually providing any venture capital. There was a continued demand for risk capital geared toward long-term growth, so the Deutsche Wagnisfinanzierungsgellschraft (WFG) was established in 1975 with the participation of 29 German banks under federal government contract. The aim of the WFG was to provide venture capital, including management assistance and network support, to SMEs. Due to the fund’s placement in financial institutions and management’s conception of their fiduciary responsibility (risk averse), the WFG could not fulfill its function (Pfirrmann et al., 1997). The role of an active venture capital investment partner is anathema for inherently risk-averse banks more suited to passive monitoring. In the early 1980s the successful American venture capital model triggered venture capital euphoria. German investment companies, operating under the auspices of the banks, were vigorously participating in the early phase of high-technology firms, following the US model (Pfirrmann et al., 1997). As in other countries the euphoria faded, and after 1987 investment policies were quickly reoriented. German investment companies thereafter concentrated on established firms, and financed expansions and management buyouts (MBOs) (Pfirrmann et al., 1997). Any venture capital that exists in Germany does so as a private initiative and largely without state support. 15.4.5

Singaporean Experience

Policy makers in Singapore were determined, upon independence, to create a stable and competitive environment that would attract foreign capital. To do so, a ‘paternal[istic] capitalism’ was developed wherein the government was to be ‘the planner and the mobilizer of the economic effort . . . nurturing . . . the free enterprise system’ (Turnbull, 1977, p. 326). In 1968 the Employment Act and Industrial Relations (Amendment) Act 1968 were introduced, which provided for strict control of trade unions, limiting their ability to disrupt business operations and thus ensuring overseas capitalists of the security of their investments in Singapore (Turnbull, 1977, p. 325). The result of these policies was, as is well known, a stable and growing economy. The stability encouraged a natural conservatism in the

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predominantly Chinese populace. In 1986 the Minister for Industry and Trade began a reassessment of the government’s policies toward economic development. The researchers found that ‘contemporary Singapore has a low tolerance for failure . . . that failure at the job or in business will mean “castigation and ruin” ’ (Ray, 1994, p. 161). It was also noted that, in more entrepreneurial economies, failure was taken as an opportunity to learn. The government decided to redress the attitudes of the populace toward risk, believing that the ‘right mixture of public policies’ could create more entrepreneurial behaviour (Ray, 1994, p. 160). By 1985, there were venture funds totalling S$100 million available. The government had established the Singapore Economic Development Board (SEBD) and an SEDB venture capital fund as well as tax incentives for such investment. Teaming up with a private fund manager already established in Singapore, two early-stage venture capital funds of S$50 million each were launched by the government in 1991 (Hock, 1991). Growth in the industry was impressive. By this time there was an equity pool of S$1.2 billion (Scheela, 1994, p. 74), by 1995 it had reached S$5.3 billion (Toh, 1996, p. 1). With the launch of the government’s Technopreneurship Fund (another S$1 billion) in 1999, the capital available for such investments had reached S$10 billion (Ellyn, 2000). Additionally, the government altered bankruptcy laws allowing those forced into this procedure another chance at business (Euromoney, 2000). Singapore now has a well-established venture capital market with more depth than any other in this study apart from the US. The key feature of the successful Singaporean experience has been the government’s continuing commitment to fund entrepreneurial development. Policy makers have done this through a combination of regulatory and tax reforms, direct investment, co-investment and education all aimed at changing the attitudes of a once conservative populace. As stated by Singapore’s Minister Tan, Minister of State for Communications and IT and Trade and Industry, ‘By the government having gone into this field . . . we have made entrepreneurship socially acceptable’ (Ellyn, 2000, p. 11). 15.4.6

Indian Experience

Venture capital in India is at an earlier stage of development than that of any other country in this study. The government officially recognized the importance of venture capital in 1988 with the launch of the Technical Development and Information Corporation of India and Gujarart Venture Finance Ltd (Leibowitz, 2000). It was not until 1991 that deregulation minimized some of the financial restrictions that had inhibited the growth of new ventures and venture investment companies. However, there continued

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to be a number of impediments to the growth of the venture capital industry given limited liquidity for investors. These included high tax rates on capital gains and dividends, high import duties on machinery needed for development (reduced from 40 per cent to 30 per cent in 1991) as well as little supportive infrastructure for development. Additionally, political realities left most investors unwilling to take the risks associated with public sector projects. By 1996, somewhat counter-intuitively, the introduction of a more formal venture capital structure encouraged greater participation in equity investing both by foreigners and by Indians. The regulation of venture funding through the Securities and Exchange Board of India (SEBI) ‘mitigat[ed] the bureaucracy [previously] associated with venture investing in the country’ (Leibowitz, 2000, p. 37) thus reducing some of the risk previously associated with the possibility of corruption in decision making. Additionally, changes in the tax structure, cutting top rates from 40 per cent to 30 per cent and eliminating long-term capital gains or dividend tax from equity investments made by venture capital funds, encouraged the growth of private venture capital (Mitra, 2000). Currently, returns on venture capital investments are tax free when capital is distributed to investors with a one-time 20 per cent tax paid by the venture capital fund upon distribution (Government of India, 2000). This is again expected to stimulate further investments in venture capital. There are still only limited funds available for seed or start-up ventures in India. Two central government organizations, IDBI (Industrial Development Bank of India) and SIDBI (Small Industries Development Bank of India) have venture capital arms and are involved in some earlystage ventures, but these are largely structured as debt, not as equity investments. Private funds, because of government tax exemptions that apply to equity investments, structure their investments as shareholdings but also concentrate their investments at the mezzanine level (Mitra, 2000). There is a need for better infrastructure to support new enterprise. There is a need for a well-regulated, formal, over-the-counter or second board market. There are regulatory changes that could assist the development of venture capital in India even further. For example, companies are still prohibited from buying back their own stock (Mitra, 2000), a fairly standard way for investors to exit from ‘living dead’ portfolio companies. The regulatory shift allowing investors to place up to 20 per cent (Mitra, 1997) of their assets in a single investment is only an improvement over the previous restriction of 5 per cent if it is coupled with an ability to take majority control. When entrepreneurs retain majority ownership, the ability of the investor to exercise any control over an early-stage investment is limited. This dissipates any desire to become involved with companies that could use not only financial aid but managerial assistance. The result then of the

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larger-size investment continues to be later-stage and generally more expensive investments. 15.4.7

Australian Experience

When venture capital was virtually non-existent in Australia the Management and Investment Companies (MIC) programme was established ‘to encourage the development of a venture capital market’ (Harper, 1991, p. 3) and address a perceived market imperfection (BIE, 1987, p. 119). The MIC programme provided tax concessions for licensed MICs and a regulatory framework in which they must operate (BIE, 1987, pp. 24–7). This programme was adapted from the American Small Business Investment Company (SBIC) programme with very little alteration. Those few alterations however contributed to its collapse. Because the Australian regulatory environment in 1983 had no ambit for limited liability partnerships, the MICs were formed as publicly listed companies. Investors were not tied to their investment throughout the early stages of company development, as they would have been in limited liability partnerships. Hence when the ‘lemons’ appeared, funds were withdrawn; with funds withdrawn there was limited capital to develop the ‘plums’ as they ripened. The MIC programme was discontinued in 1991, only seven years after it was inaugurated. Adopting legislation designed in, and for, another environment did not lead to the successful introduction of venture capital. The MIC programme was followed by Pooled Development Funds (PDF) in 1992. This programme too was designed to ‘encourage the provision of patient equity to small or medium-sized Australian companies’ (PDF Act, 1992, 2044). Managers in the failed MIC programme were able to extend their learning curve through the auspices of the PDF programme. Both schemes met with only limited success due, in part, to the absence of institutional investors and the absence of sufficient appropriate exit mechanisms. There were also problems given the timing of these ventures (pre-1987 crash). Both Australian schemes failed to take into consideration any cultural differences between Australia and the US. In a country where entrepreneurship has been suspect, where egalitarianism is the norm, and where wealth tends to be associated with dubious behaviour (Sykes, 1994) or heredity (dependent on the dubious behaviour of one’s ancestors), schemes that were reliant on the individual supporting entrepreneurship and on individual wealth generation were unlikely to succeed. Policy makers abandoned the indirect, tax-driven models for a more direct effort to educate the investing public about venture capital. They embarked on a new scheme to educate the populace about the role venture

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capital can play both individually and for the country. The Innovation Investment Funds (IIF) are two-thirds financed with government money, one-third of funding coming from private individuals. The Innovation Investment Funds were designed to make use of government contributions to leverage the investments of private individuals. Invested capital is to be returned to all subscribers, including the Commonwealth, with interest at a rate commensurate with the risk-free rate at the time of investment. Thereafter any profits are to be divided between the Commonwealth (10 per cent) and private sector investors (90 per cent); after disbursements to fund management (IIF Program, 1997). Australian policy makers hope that this will encourage venture capital by increasing the profit opportunities for investors, and by ‘develop[ing] fund managers with experience in the early stage venture capital industry . . . [thereby creating] a self-sustaining Australian early stage, technology-based venture capital market’ (IIF Program, 1997). The scheme has not been in operation long enough to make a judgement on its success. 15.4.8

Significance of Venture Capital: A Country Comparison

Table 15.1 is taken from Baygan and Freudenberg (2000, p. 19) with the addition of Singapore and India. It provides a snapshot of the venture capital markets in various countries. A cursory glance at these figures and Table 15.1

US Total Europe Germany Netherlands Sweden Singapore India* Australia**

Total venture capital investments, 1998–99 Investments made in million US$

Investments made as a % of GDP

59 531 26 764 3 366 1 823 1 361 422 324 321

0.643 0.182 0.159 0.463 0.570 0.581 0.001 0.088

Notes: *Indian figures include debt. **Australian investments include buyouts, mining and agriculture. Source: Most countries: Baygan and Freudenberg (2000) (Australian figures to 1998). Singapore: Asian Venture Capital Journal (2001) and World Bank (2001). India: Indian Venture Capital Association (1998).

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it is not difficult to see the enormous influence venture capital has in many economies. The US with the highest level of venture capital investments is closely followed by Singapore and Sweden when one examines the investments made in 1999 against GDP for the same year. Table 15.1 also emphasizes the level of investment in Australia, Germany and India, which by comparison with the other economies discussed is low. As a percentage of GDP the Australian and Indian investments are not significant.

15.5

THE MAJOR LESSONS

Policy makers in the US followed the lead of their entrepreneurial investors and, through a variety of legislative reforms, encouraged the further development of a venture capital market over the long term. Singapore, Sweden and the Netherlands, responding to the success of the American model, created their own versions of the venture capital industry through direct (Sweden, Singapore) and indirect (the Netherlands) initiatives. The Swedish model took into account the paradoxical collectivist–individualistic cultural paradigm by directly funding venture capital during a learning period and then, once the populace seemed to be accepting the role of venture capitalists, creating a market that would allow public participation in the industry. The Netherlands, already having an entrepreneurial culture and investment companies, encouraged a change in direction through legislative initiatives. In Singapore, policy makers basically began from scratch, first building an economy then developing the attitudes that would keep it growing. India, starting late, has used both direct and indirect methods to kickstart venture capital. The focus, given the timing of the initiatives, has not surprisingly been on ‘dot coms’. The success of India’s initiatives cannot be determined given the short time period they have been in existence. However, the initiatives appear to address most of the primary areas of concern highlighted by Patricof (1989), and should assist an already entrepreneurial people to invest. Given India’s expertise (as a net exporter of IT professionals) the government has correctly targeted investments. All these countries adopted programmes designed with their own regulatory system and cultural milieu in mind. The only attempt to adopt and adapt a policy wholesale from another country took place in Sweden, where policy makers introduced a tax deduction scheme copied from the UK Business Expansion scheme (NUTEK, 1994). The proposal failed in its entirety and was dropped fairly quickly (Isaksson and Cornelius, 1998).

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Contrasting the relatively successful policy initiatives that were undertaken in the US, Singapore, Sweden, India and the Netherlands, we have observed major failures in the attempt by the Australian government and by German policy makers in their efforts to kick-start venture capital in their respective countries. The Australian government began with indirect initiatives and failed to catch the public imagination. The current effort is too early to judge, but from our perspective appears to be more appropriate for educating both evolving venture capitalists and their investors. In yet another attempt to adopt and adapt a programme to the Australian environment, the British Enterprise Network (BEN), which linked entrepreneurs and investors through various media, was imitated through the auspices of the Enterprise Market. The additional attempt to provide more information about investment opportunities and investors through the Enterprise Market, while laudable, failed due to inadequate understanding of the target market. The lack of targeting, given the limited size of the country, would appear to be another problem yet to be addressed. The German position is still embryonic. There is recognition by policy makers that venture capital would be beneficial. Beyond a pilot programme, no direct or indirect initiatives have been undertaken. Investors, largely institutional, still subscribe to traditional fiduciary roles advocating low-risk investment strategies. Germany has a bank-centred capital market. German banks are few in number but large in size relative to German firms and play a central governance role in monitoring management. Additionally German SMEs have traditionally been financed through bank loans (Feyerabend and Mertes, 1999, p. 42), not equity. As a result of the dominant role of banks in the market, particularly as shareholders, Germany has failed to develop an ‘equity culture’ (Wright et al., 1998). [T]he banks’ conservative approach to lending and investing, and social and financial incentives that less richly reward entrepreneurial zeal and more severely penalize failure are less [than] conducive to entrepreneurial activity. (Black and Gilson, 1998, p. 272)

The prevailing tax system in Germany is another major impediment to the development of an equity culture. The level of tax, which may account for over 50 per cent of the original gain, means that such investments are almost prohibitively costly for German investors (Feyerabend and Mertes, 1999, p. 47). There are no special tax advantages for firms specializing in venture capital investments as there are in many of Germany’s neighbours. In fact, taxation at the point of disposal represents a handicap for private equity investors (Feyerabend and Mertes, 1999).

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Culturally, then, Germany does not appear to be in a position to readily support entrepreneurial development through indirect venture capital initiatives, such as the establishment of a share market or the introduction of tax incentives or other policies promoting particular types of investment. This will be difficult for Germany to achieve given that: the forces of economic selection cause culture and economic institutions to become mutually supportive . . . [and] . . . cultural institutions support existing economic patterns. (Black and Gilson, 1998, p. 271)

The existing patterns, whether cultural or structural in terms of the prevalent economic institutions, must be broken. India and Australia appear to be reaching out to both entrepreneurs and potential investors more successfully than Germany, yet only time will tell which of these countries have found appropriate approaches to bolster entrepreneurial economic activity. For the emerging markets of East Asia, there are clear lessons that can be taken from the outcomes of the various initiatives inaugurated from around the world. Without entrepreneurs creating new economic opportunities no venture capital will evolve, as there will be nothing in which to invest. Entrepreneurship must be encouraged through education, through example and limiting the repercussions (legal and cultural) that are often attached to failure. However, entrepreneurs cannot succeed without funds to back their ventures. Government policy makers must be careful that the initiatives they propose are culturally acceptable. They cannot simply adopt programmes that have worked elsewhere and assume that they will work equally well in a new environment. An assessment of the sophistication of potential market participants must be undertaken with both direct and indirect initiatives developed targeting specific players. These initiatives must be monitored in order to ensure that they are achieving their potential, but they should not be cut off early for lack of short-term results. Venture capital investing is for the long term.

15.6

CONCLUSIONS

A venture capital market can only be successful if the framework is in place across the entire process. That is, from investment to divestment. In environments where the industry is mature, such as the US, there are favourable regulations and incentives at the investment stage; experienced, risk-taking agents to manage and oversee investments; the appropriate avenues to divest their investment; and an entrepreneurial culture from which to

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harvest the investment opportunities. Government policy can have a substantial impact on all the phases in the process. The structural impediments faced by the German, Indian and Australian venture capital markets all fall in the province of public policy. Indian officials have attempted to structure policies that limit the opportunities for favouritism, that encourage investment in areas where India appears to have a technological advantage and that will reward investors willing to take risks. German venture capital will not be transmogrified; it needs culturally appropriate policies and programmes to facilitate the growth and expansion of the market. Australia appears to be learning from early mistakes and is now adopting a more interventionist, educational and direct approach which should stimulate further venture capital development. However, unless the lessons of Singapore are learned, that is unless the government adopts a continuing and consistent approach, venture capital in Australia too will face further struggles for survival. To be able to enjoy the economic and social benefits that a vibrant venture capital market can bring, it becomes imperative that policy makers are clear in their objectives and active in their work. The process should be addressed as a whole, not piecemeal. Creating a favourable environment for SMEs to grow and develop will have a larger impact on the economy as a whole, as they broaden the base from which an economy can grow.

REFERENCES Asian Venture Capital Journal (2001), 31 January, http://www.asiaventure.com/ sample2.htm Australian Academy of Technological Sciences and Engineering (1983), ‘Developing High Technology Enterprises for Australia’ (Espie Report), Melbourne. Baygan, G. and M. Freudenberg (2000), ‘The internationalisation of venture capital activity in OECD countries: implications for measurement and policy’, Directorate for Science, Technology and Industry Working Papers, OECD, DISTI/DOC(2000)7. Bartlett, J.W. (1995), Equity Finance: Venture Capital, Buyouts, Restructurings and Reorganizations, 2nd edn, Volume 1, John Wiley & Sons, Canada. Black, B. and R. Gilson (1998), ‘Venture capital and the structure of capital markets: banks versus stock markets’, Journal of Financial Economics, 47, pp. 243–77. Brouwer, M. and B. Hendrix (1998), ‘Two worlds of venture capital: what happened to US and Dutch early stage investment?’, Small Business Economics, 10, pp. 333–48. Bureau of Industry Economics (BIE) (1987), ‘Review of venture capital in Australia and the MIC program’, Commonwealth of Australia. Bygrave, W.D. and J.A. Timmons (1992), Venture Capital at the Crossroads, Boston, MA: Harvard Business School Press.

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Cornelius, B. (1992), Securities, Covenants and Case Studies in Venture Capital: Risk and the Investment Agreement, University of New England. Cornelius, B. (1999), ‘Venture capital nomenclature: an analysis’, unpublished seminar paper, 13 August 1999, University of Wollongong Department of Accounting and Finance Seminar Series, pp. 1–10. Crainer, S. (1999), ‘The Swedes are coming’, Across The Board, New York, June, pp. 31–5. Department of Industry, Technology and Commerce (1989), Working Party Report, ‘Strategy for the Australian venture capital industry: facilitating the innovation process’, Commonwealth of Australia. Ellyn, G. (2000), ‘A bright venture capital industry’, Presidents and Prime Ministers, 9 (3), pp. 11–12. Euromoney (2000), ‘Can Singapore learn to take more risks?’, Euromoney, July, p. 146. Feyerabend, H.A. and H. Mertes (1999), ‘Germany: private equity and venture capital funds’, International Financial Law Review, London. Government of India (2000), ‘New regime for venture capital funds announced’, Press Information Bureau, 22 January 2000, http://pib.nic.in/archive/budget2000/ budget2000r14.htm Harper, I.R. (1991), ‘The impact of financial deregulation on the availability of venture capital in Australia, Issues in Business Finance’, Background Paper No. 15, Commonwealth of Australia, pp. 3–14. High Technology Financing Committee of the Australian Academy of Technological Sciences (Sir Frank Espie, Chairman), (1983), ‘Developing high technology enterprises in Australia’, Australian Academy of Technological Science, Parkville, Victoria, April. Hock, T.L. (1991), ‘OCBC group backs direct investments’, Asian Finance, 17 (8), p. 73. Hofstede, G. (1984), Culture’s Consequences: International Differences in WorkRelated Values, Thousand Oaks, California: Sage Publications. Holmberg, I. and S. Åkerblom (2001), ‘The production of outstanding leadership: an analysis of leadership images in the Swedish media’, Scandinavian Journal of Management, 17 (1), March, pp. 67–85. IIF Program (1997), ‘Policies and Practices Direction 1 1997’, Research and Development Act 1986, Commonwealth of Australia. Indian Venture Capital Association (1998), www.vcline.com/invest.htm Isaksson, A. and B. Cornelius (1998), ‘Venture capital incentives: a two country comparison’, presented at the 10th Nordic Conference on Small Business Research, Vaxjo Sweden, 14–16 June, pp. 1–23. Leibowitz, A. (2000), ‘International-VC dollars double for India’s tech deals: recent government deregulation of financial sector fuels venture activity’, Venture Capital Journal, May, pp. 36–7. McGrath, R.G., I.C. Macmillan, E.A. Yang and W. Tsai (1992), ‘Does culture endure, or is it malleable? Issues for entrepreneurial economic development’, Journal of Business Venturing, 7, pp. 441–58. Mitra, D. (2000), ‘The venture capital industry in India’, Journal of Small Business Management, 38 (2), pp. 67–79. Mitra, S. (1997), ‘India: the next 10 years’, Global Finance, 11 (4), pp. 69–74. NUTEK (1994), ‘Small Business in Sweden’, National Board for Industrial and Technical Development, B 1994:7, Stockholm.

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OECD (1986), Venture Capital: Context, Development and Policies, Paris: OECD publications. OECD (1996), ‘Venture capital in OECD countries’, Financial Market Trends, 63, February, pp. 15–38. OECD (1998), OECD Economic Surveys 1998 – Netherlands, OECD Publications, Paris, France. O’Shea, M. and C. Stevens (1998), ‘Governments as venture capitalists’, OECD Observer, August/September, pp. 26–9. Patricof, A. (1989), ‘The internationalisation of venture capital’, Journal of Business Venturing, 4, pp. 227–30. Pfirrman, O., U. Wupperfeld and J. Lerner (1997), Venture Capital and New Technology Based Firms, An US–German Comparison, Physica-Verlag, Heidelberg. PDF Act (Pooled Development Funds Act) (1992), No. 100 of 1992, Parliament of the Commonwealth of Australia. Ray, D.M. (1994), ‘The role of risk taking in Singapore’, Journal of Business Venturing, 9, pp. 157–77. Scheela, W.J. (1994), ‘The increasing importance of venture capital in Singapore’, Journal of Asian Business, 10 (3), pp. 73–86. Shane, S. (1993), ‘Cultural influences on national rates of innovation’, Journal of Business Venturing, 8, pp. 59–73. Sykes, T. (1994), The Bold Riders: Behind Australia’s Corporate Collapses, Sydney: Allen & Unwin. Toh, H.S. (1996), Challenge for Venture Capitalists, Investing Funds 1996, AsiaOne website (http://asiaone.com), The Business Times section, Singapore Press Holdings Ltd. Turnbull, C.M. (1977), A History of Singapore, 1819–1975, Oxford: Oxford University Press. World Bank (2001), World Bank Country Data, 31 January, http://worldbank.org/ data/countrydata/aag/sgp-aag.pdf Wright, M., K. Robbie, M. Albrighton, C. Mason and R. Harrison (1998), The European Venture Capital Market, London, UK: Stationery Office.

Index Abegglen, J.C. 122, 123 accounting rate of profit 104, 107 accrual accounting 111–12 acid test ratio 105, 108 Acs, Z.J. 14 Adamu, A. 40 adaptable product development 123 Aditjondro, G. 32, 33 adverse selection 331 Agarwal, S. 244 Agricultural Bank of China 328–30, 332, 333, 336, 337 agriculture 39–43, 95–6 Ahmed, A.A. 236 aid programmes 301, 305, 307 Akerblom, S. 346 Albaum, G. 236 Ali, A. 243 Altieri, M. 40 Amesse, F. 320, 321 Anderson, B. 53 Anderson, C. 37 Anderson, C.P. 235, 240 Anderson, D. 171 Anderson, E. 234, 236, 238, 240–42, 244, 247 ANOVA test 263–5, 267–71 anti-image correlation matrix 197 Aoki, K. 53 Argandona, A. 189, 191 ASEAN 3, 6, 203 Asia-Pacific Economic Cooperation 4, 6, 7–9, 10, 19–20, 302–3, 313–14 Asian Development Bank 76, 77, 79, 155 Asma, A. 201 assessment ratios 103–9, 114–15 assessment variable 103–6, 114 assets 105, 110–11, 113 Atkins, M.H. 209, 218, 222, 223, 225 Atle 346 Audretsch, D.B. 14, 121, 315

Aulakh, P.S. 236–7, 240, 242–3, 247 Australia 112–14 internationalization 24, 209–29 non-financial corporations 103–9 technological sourcing 25, 253–74 venture capital 351–3, 354, 355, 356 Australian Bureau of Statistics 112, 114, 167, 210–15, 217–20, 225 Australian Industry Commission 213, 218, 219, 221 Australian Stock Exchange 218 Autio, E. 255 automated and flexible manufacturing system (AFMS) 123 axial coding approach 177 Baark, E. 53 Baird, I.S. 222, 223 balance of payments 99 balancing item flows 102, 103, 112–13 banks 13, 96, 348, 354 central 100, 110–11 China 328–31, 332–4, 336–7 Indonesia 92, 314 Thailand 149, 152, 154, 158 Banks, G. 31 Banks, M.C. 209, 211 Barber, C. 33–4 Barnett, T. 191, 196 Barney, J.B. 219 Barraclough, S. 31 Barro, R.J. 130, 136 Bartlett, J.W. 343 Bartlett test of sphericity 197, 198 Bauerschmidt, A. 238 Baygan, G. 352 Bayliss, B.T. 238 Beamish, P.W. 222, 223, 224 Becker, B. 168, 193 Bell, J. 239 Belli, P. 306 Bellizzi, J.A. 191 359

360 Berry, A. 44, 317–18, 322, 323 Berthon, P. 277, 295 Berton, V. 42 Best, M.H. 121, 122, 123, 132 Bettis, R.A. 259 Bickerdyke, I. 312 Bijmott, T.H.A. 222, 223 BIS requirements 313 Black, B. 341, 343, 354, 355 Blair, M.E. 190, 193–5, 198, 201 Blandy, R. 168 Blomstrom, M. 14 Bojie, D.M. 171 Bollier, D. 53 Bonaccorsi, A. 222, 223, 228 Bond, O. 288 Boocock, G. 168, 169 Bora, B. 216 Borrus, M. 44, 45 Borton, J. 53 Bower, D.J. 209, 220, 223, 228 Bowerox, D.J. 236 BRAC (in Bangladesh) 84 Bramall, C. 41 Brindley, C.S. 281, 282, 283, 296 British Enterprise Network (BEN) 354 Brookfield, H. 31 Brooksbank, R. 228 Brouwer, M. 347 Brown, A. 209, 211, 224, 225 Brusco, S. 132 Buck, S.P. 279, 282 Buckley, P.J. 226, 228, 229 budget constraint 331–2 budget deficit 101, 331 Bure 346 business development services 158 business enterprise expenditure on research and development (BERD) 260 Business Expansion scheme 353 Business Growth Program (BGP) 211 Business Longitudinal Survey 213 Business Online Project 279 Bussgang, J. 288 buyout (buy-in) stage 344 Bygrave, W.D. 341, 346 Byron, Y. 31

Index Cafferata, R. 209, 211, 220, 222–5 Cai, X. 334 Callon, M. 254, 256 Calof, J.C. 212, 228 Camp, L.J. 53 capacity building 4, 6, 9–15, 20 capital 46, 108, 333–4 capital gains tax 344–5, 350 capitalism 35, 148, 155, 190, 346, 348 Carrier, C. 173 Carson, D.J. 222, 227 Carson, R. 36 Carson, T. 190 Casson, M. 226, 228, 229 Cateora, P.R. 236, 237 Cavusgil, S.T. 218, 224, 235 Ceglie, G. 44 Celarier, M. 32 central banks 100, 110–11 Chaffey, D. 278 Chandler, A.D.Jr. 117, 123–7, 132, 138 channel integration 234–6, 238–42, 245 Che, J. 327 Cheah, H.B. 31, 37, 44, 51 Cheah, M. 37, 51 Cheng, E. 280 Cheng, P. 333, 337 China 3, 5, 6, 19, 41, 44, 138 CTVEs 26, 327–38 Internet (impact) 25, 277–97 Chio, S.W.K. 274 Chrisman, J.J. 239 Christensen, C.H. 235 Christerson, B. 44 Clad, J. 35 Clarke, J.L. 315 Clasen, T.F. 237 Clegg, J. 335 Clegg, S. 138 cluster strategy 18 Cobb, C. 35, 38 cognition/cognitive distance 319–20 Cohen, S. 44 Cohen, W.M. 315 Cole, J. 53 collective efficiency 317, 318–19 collective township and village enterprises (China) 26, 327–38 commercial banks 13, 96, 149, 154 Community Supported Agriculture 42

Index comparative advantage 14, 46, 56 competency-based learning 171, 182 competition 45, 117–18, 129–31, 134–7 competitive advantage 18, 56, 167, 169–72, 226, 239, 280 competitiveness 17–18, 37, 38 competitors 255–7, 265–6, 305, 309 complex products and systems 258 component design relationship 122 Connor, P.E. 193 consumer goods 124–5 consumption smoothing 75, 80, 93 Contractor, F.J. 235 convergence theory of growth 129–30 Cook, P. 44 Cooper, M.B. 236 Cooper, R. 171 Cope, B. 45 Corbin, J. 176 core competencies 16, 127 Cornelius, B. 341–2, 343, 346, 353 corruption 30, 33, 34, 350 cost leadership 239 costs fixed 310–11, 313 monitoring (of CTVEs) 327, 334, 337 overhead 48, 121–2 transport 10 see also production costs; transaction costs Coughland, A.T. 234, 236, 240–42, 247 Council of Mutual Economic Assistance (COMECON) 40 Coviello, N.E. 209, 218–19, 221–9 craft production system 45 Crainer, S. 341, 347 credit 105, 108, 329–30, 332 micro-enterprise 74–5, 79–84, 90 Thailand 149, 150, 151–2, 154 Cronbach’s alpha 195–6, 199, 244, 264, 267, 269 crony capitalism 35, 148, 155 cross-sector collaboration 281, 283 Crowley, S. 169 Culpan, R. 222, 223 culture 202, 341, 346, 354–5 customers 257–9, 267–73 Czinkota, M.R. 236, 243

361

Dalli, D. 222, 223, 226, 227 Daniels, J.D. 234 Darnay, A.J. 142, 144 Da Rocha, A. 235 Das, M. 235 Dasgupta, S. 31 Davidse, J. 48 Davidson, W.H. 234 Davis, C.H. 221 Davis, P.S. 239 Davis, S. 46, 47–8 Day, D. 209–10, 225 Deakins, D. 169 Dean, J. 273 de Bono, E. 39 DeBresson, C. 320, 321 debt 33, 81, 312–13, 333, 337 debt-equity ratio 105, 108 decision-making 118–20, 187, 190, 235–6, 249 De George, R.T. 189, 191 De Kare-Silver, M. 281 De Koning, A.C.P. 305 de la Kruz, R. 40 deontological beliefs 192, 193 deregulation 215, 301, 344, 349 Dess, G.G. 239 Dessler, G. 193 Dewatripont, M. 332 Dicken, P. 177 Dierman, P. van 151 Dieter, H. 31 differentiation strategies 239–42, 244, 245–7, 248 Dillion, H. 33 Ding, S. 335 Dini, M. 44 direct mail 287, 293 disintermediation 282 distributed earnings 105 distribution channels 234–6, 238–42, 245 diversification 21, 28–60, 126–8 dividend payout ratio 105, 108 dividend yield 105, 107 division of labour 18, 43, 49, 157, 319 Dochery, M. 168 Donaldson, T. 191 Dong, X.Y. 331 Doucouliages, C. 168

362

Index

Douglas, M. 222, 223 Douthwaite, R. 37 Drucker, P.J. 172–3 D’Souza, G. 39, 42 Du Gay, P. 164 Dunfee, T.W. 191 Dunning, J.H. 224, 226, 229 Durlacher 277, 278 Dutta, S. 277 Dyer, L. 168 dynamic efficiency 305, 315–16 e-business/e-commerce 5, 9, 11–12, 20, 156, 277–83, 287–8, 292, 295–6 EASDAQ 342 ecological imperative 36, 37, 38 ecological sustainability 31, 33–6, 38 Economic Planning Advisory Commission (EPAC) 210, 216 economic growth firm organization and 23, 117–45 number of firms and 134–7 role of SMEs 3–26 economic recovery, regional 22, 72–97 economic sector (assessment) 22, 99–115 economies of scale 10–11, 15, 18, 49, 50, 301 Indonesia 237–8, 241, 247 Japan 119, 128, 130, 139 USA 123, 126, 127, 130 economies of scope 18, 49 Japan 118–21, 128, 130, 139 USA 123, 127, 130 efficiency 305, 315–19 El-Ansary, A.I. 234, 236 Ellyn, G. 349 embeddedness 25, 254–5, 266, 273 employment 5, 7–8, 19, 85–8, 305–7 Employment Act (Singapore) 348 Engestrom, Y. 170 Enriquez, L. 40, 41 enterprise sector (assessment) 22–3, 99–115 ‘entrepreneurial engine’ 5–6, 9, 19 entrepreneurship 12, 14, 44, 74, 225, 290, 296, 355 entry barriers 281–3, 309 entry modes 24–5, 226–7, 234–49 equity capital 313

equity objectives 304, 305, 307–8 equity ratio 106, 109 Ernste, H. 127 Estes, R. 38, 49 Etheredge, J.M. 187, 190, 196, 198 ethics 24, 37–9, 187–205 Ethics Position Questionnaire 195–9 Evans, P. 44 Evenett, S. 315 Evrard, P. 277 exit barriers 281, 282–3 exports 4, 8, 10–11, 16–18, 150, 310 Australia 218, 220, 222–3, 224 entry mode (Indonesia) 24–5, 234–49 Thailand 156, 158 external economies 317, 318, 321 external organization 123–6 externalities 56, 305, 309, 310 factor analysis 196–7, 198, 244 Ferrel, O.C. 191 Feyerabend, H.A. 354 Field, L. 169 finance 75 access to 12–13, 15, 312–14 of CTVEs 329–30, 332, 334–8 see also credit; micro-finance; venture capital financial intermediaries 100, 110, 314 financial corporations 99–101, 109–11 financial leverage 105, 108 Finger-Stich, A. 31 firm networks 316–23 firms organization (Japan) 23, 117–45 size 306, 309, 315–16 FitzRoy, P. 222 fixed costs 310–11, 313 flexibility 18, 21, 30, 49 flexible specialization 45, 127, 132, 157 focal factories (in Japan) 120–23 focus/focus strategy 49–51, 239 Fombrun, C. 38 Ford, J. 236 Fordism 127, 132 foreign direct investment 8, 18 Thailand 149–51, 154, 156, 158 theory of internationalization 223, 224, 226, 229

Index Forsyth, D.R. 191–2, 193, 195 forward integration 234, 236, 237, 240–42, 245, 247–9 franchising 91, 127 Freeman, C. 320 Freeman, S. 222, 223 Freudenberg, M. 352 Friedman, M. 190 Fritsch, M. 317, 319 Fritzsche, D.J. 193 Fruin, W.M. 118–19, 120–21, 139 Fujimoto, T. 129 Fujita, M. 157 Fukuoka, M. 42 fund matching 344 gain-sharing system 125 gains from trade 9 Galbraith, J.K. 54 Gatignon, H. 234, 244, 247 Ge, X. 333 gearing 105, 108 Gee, J.P. 164 general government 100, 101, 111–14 genetic modification 39, 40 geographical clusters 26, 255–7, 317, 323 Gerhart, B. 168 Germany 131–2, 342, 347–8, 352–6 Geroski, P.A. 315 Gershuny, J. 49 Gibb, A. 182 Gill, S. 37 Gilson, R. 341, 343, 354, 355 Ginzberg, E. 49 Global Reporting Initiative 37, 38 globalization 4, 6, 20, 99, 203, 302 export success and 16–18 see also internationalization Glover, D. 31, 33 GNU General Public License 53 Goad, G.P. 222 Godley, W. 28 Goland, C. 52 Goletti, F. 52 Goodpaster, K. 191 Goods and Services Tax (GST) 218 government 12, 14–15, 20, 281–2 local (China) 26, 327–38 policies (venture capital) 344–53

363

policies (SME development) 25–6, 215, 301–24 support policies 304–16 Government Finance Statistics 22, 99, 101, 112–14 GPP scheme 347 Grabher, G. 255, 257 graduates 76, 77, 80, 85–8 Graham, L. 169 Graham, P. 210, 215–16, 227 Grameen Bank 75, 84, 92 Granovetter, M. 254–5, 256 Grant, R.M. 137 Gray, J. 41 Gross, N. 48 gross capital formation 102, 105 gross domestic product 114, 341 gross national product 38 gross operating surplus 102, 104 gross profit share 104, 107 gross saving 102, 103, 105 gross value added 102, 103, 104 grounded theory approach 176 growth -oriented micro-enterprises 22, 73, 76–9, 81–2, 88–91, 97 see also economic growth Grunsven, L. van 154 guarantee schemes 345, 347 Haas, R.W. 234 Habakkuk, H.J. 124 Hair, J.E.Jr. 197 Hall, C. 3, 4, 5, 6, 9–12, 302, 313–14 Hallberg, K. 15, 30, 301–2, 304, 307–9, 311, 316 Halsey, F.A. 125 Hamel, G. 170 Hamelink, C. 45 Hanaoka, M. 138 Handy, C. 167, 172 Hansmann, H. 335 Haq, K. 37 hard budget constraint 331, 332 Harman, W. 39 Harper, A. 31 Harper, I.R. 341, 351 Harrigan, K. 242 Harrison, B. 127 Hartman, L.P. 189

364

Index

Harvie, C. 3, 4, 73 Hawken, P. 55 Hawley, S. 37 Hawtrey, K.M. 312, 314 Hayton, G. 168 Head, M. 32 Heeks, R. 53 Helman, a. 336 Hendrix, B. 347 Hendry, C. 164, 182 Hennart, J-F. 235 hierarchical exchange mode 242, 245–7 Hill, C.W.L. 234 Hills, G.E. 222, 223 Hine, D. 167, 169 Hine, R. 39, 42 Hirschhorn, J. 38 Hisrich, R.D. 222, 223 Ho, S. 334 Hobday, M. 44, 258 Hock, T.L. 349 Hofstede, G. 341, 346 Holderness, M. 45 Holmberg, I. 346 Hong, Z. 333, 336 horizontal integration 120, 126, 130 horizontal networks 317–18, 319 ‘hot money’ 31 household sector 100, 101–2 Howard, M. 31 Huang, X. 209, 211, 224, 225 Hughes, S. 44 human resources 12, 171, 216 Humphrey, J. 44, 52, 316–18, 323 Hunt, S.D. 191, 193 Huselid, M.A. 168 Hwang, P. 235, 244 idealism 192–6, 198–201 Ikerd, J. 39, 41–2 Illich, I. 55 imports 152, 224 Inbaraj, S. 33 income redistribution 307–8 India 43–4, 307, 349–56 Indonesia 5, 6, 30–35 export entry mode 24–5, 234–49 industrial clusters 43–51, 156–7 industrial districts 26, 43–5, 132, 255–7, 317, 318, 323

Industry Canada 315 Industry Commission (Australia) 260 Industry Science Resources 217–19, 222 Industry Training Council 175 inflation 96, 101, 111, 313, 332 information 305, 310, 320–21 access to 13, 25, 253 information communication technologies (ICT) 5, 11, 267 Internet see Internet sustainable development 43–5, 52–5 information technology 10–12, 18, 127, 129, 156 infrastructure 10, 11–12, 15, 94, 321 Ingalls, J. 167 initial public offering (IPO) 344 innovation 4, 13, 18, 45, 122 networks and 25, 320–21 product 14, 258, 259, 315 promotion of 305, 315–16 Innovation Investment Funds 344, 352 ‘inside contracting’ system 125 insurance corporations 110 integration 4, 20 channel 234–6, 238–42, 245–7 horizontal 120, 126, 130 see also forward integration; vertical integration intellectual property rights 10, 53 interest cover 106, 109 interest rates 94, 96, 101, 313, 334 intermediate exchange 242, 245–7 internal organization 123–6 International Development Research Centre (IDRC) 53 International Financial Corporation 29 International Labour Organization 149 International Monetary Fund 22, 32–3, 35, 99, 101, 112–14, 151 international new ventures 219–20, 223, 224, 226–7, 228 internationalization process 24, 209–29 process theory 238–9 of SMEs 6, 156, 221–8 stages theory 221, 223, 229, 235 Internet 5, 10, 11, 16, 44, 47, 48 impact (China/UK) 25, 277–97

Index intranet 278 Isaksson, A. 341, 342, 346, 353 Israel, M. 31 Italy 43, 131, 132, 157 Izurieta, A. 28 Jack, S.L. 209, 220, 223, 228 Jackson, W. 42 Jaeger, C. 127 Jain, A. 46 James, P. 169, 171, 176, 182 Japan 6, 23, 117–45 Jaunch, L.R. 195 Jessup, T. 31, 33, 235 job creation 5, 19, 85–8, 305–7 job destruction 306 Johanson, J. 209, 221, 229, 238, 241 John, G. 236, 238 John, K.J. 53 Johnston, W.J. 243 joint actions 318, 319 joint ventures 5, 10, 13, 158, 237, 265 Jones, C.I. 130, 136, 144 Jones, R. 258 just-in-time system 123, 128, 129, 137 Kahn, H. 38 Kaiser-Meyer-Olkin test 197–8 kaisha firms 122 Kalakota, R. 281 Kalantzis, M. 45 Kaplinsky, R. 44 Karpin, D. 167, 169 Katsikeas, C.S. 222, 223 Kaynak, E. 222, 223 Keeble, D. 219, 220, 221 Keegan, W.J. 236, 240, 241 keiretsu 122–3, 138 Kelly, K. 48 Kelly, S. 167, 169 Keogh, W. 209, 212, 219–21, 226 Khan, Z. 42 Kilpatrick, S. 169 Kim, J. 234 Kim, W.C. 235, 244 Kinsey, J. 235 Kirby, D.A. 209, 211, 221, 224–5, 228 Kirpalani, V.H. 235 Klein, N. 53 Klein, S. 234, 236–8, 240–42, 247

365

knowledge 11, 281, 283 development 24, 163–83 sharing 267–70, 316 spillovers 18, 310, 320 Kogut, B. 264 Koh, H.C. 290, 296 Kokko, A. 148, 155 Kono, T. 138 Konopa, L.J. 235 Koo, A. 332 Korea 3, 6, 43, 138, 150–51, 322 Korten, D. 49 Kotabe, M. 236–7, 240, 242–4, 247 Kotey, B. 173 Kraft, K.L. 195 Krajewski, L.J. 137 Kurien, J. 31 Kwa, A. 39 Kwon, Y-C. 235 Laage-Hellman, J. 258 labour market 311 Langlois, R.N. 258 Lappe, F. 40 Lattimore, R. 305–7, 310–13, 316 Lave, J. 170 Law, J. 171 Lawler, E. 49 Lazonick, W. 124, 126 ‘lead users’ 258 lean production system 45, 128 learning 13, 16–17 knowledge development 24, 163–83 technological sourcing 254–5 leasing 337, 338 Ledgerwood, J. 76 Lee, B.C. 3, 4, 73 Legge, K. 171 Leibowitz, A. 349 Leman, S. 175 lending 102 loans 151–2, 329–30, 332–3 see also credit; micro-finance Leonard-Barton, D. 254 Leonidas, C. 209, 211, 224, 225 Lever-Tracy, C. 44 Levinthal, D.A. 315 Levitsky, J. 301, 303, 305, 307, 312, 323 liabilities 105, 110–11, 113 liberalization 10, 14, 215–16

366 Liedholm, C. 76–7, 80, 85–8, 302 Likert scales 195–6, 263–5, 266–9 Lilien, G.L. 238, 240, 247 Lilliston, B. 52 Lin, Q. 329, 331 Lincoln, J.R. 138 linear programming 132–3, 139 Lipton, M. 52 liquidity ratio 105, 108, 110–11 Liu, J. 283, 296 Liu, Y. 333 livelihood enterprises 22, 73, 76–9, 89–91, 96–7 living standards 34, 50, 93, 305 Lo, D. 332 Loan-Clarke, J. 168, 169 local government (China) 26, 327–38 local SMEs (Thailand) 23, 154–7 location (in MPS/SPS) 46, 51 Loh, L. 274 Lovelock, J. 36 Lowe, F.J. 209, 218, 222, 223, 225 Lundvall, B.A. 258, 320 Luostarinen, R. 209, 219, 224 M-form organization 127 McAuley, A. 209, 218–19, 221–9 McCraw, T.K. 124 McDougall, P. 209, 219–21, 223–9 McGrath, R.G. 341, 346 McMillan, C.J. 123 macroeconomic objectives 304, 305–7 Maglen, L. 168 Makridakis, S. 48 Malaysia 150–51 ethical values 24, 187–205 Malhotra, N.K. 244 management buyouts (MBOs) 348 Management and Investment Companies 351 Manen, M.V. 176 Mani, S. 322 Maniukiewicz, C. 169 market exchange mode 242, 244–7 market failure 94, 304–5, 308–15 market size 245, 246 marketing 46, 221–2, 225 markets 14, 281–3, 309 access to 10–11, 15 Marks, L.J. 193

Index Marlow, S. 168–9 Marsh, A.E. 171, 289 Marshall, A. 43, 255, 256, 318 Maskin, E. 332 mass customisation 45, 47 mass production system 21, 29, 43, 45–53, 124, 127, 131 material (in MPS/SPS) 47–8, 51 Mayher, J.H. 170 Mayo, M.A. 193 Mazhar, F. 42 MBGs 348 Mead, D.C. 76–7, 80, 85–9, 302 Meadows, D.H. 36 Meiji Restoration 118 Mensi, R. 209, 211, 220, 222–5 Meridith, G. 173 Merriam, S.B. 175 Merrilees, B. 171 Mertes, H. 354 Metcalfe, H.C. 125 Meyanathan, S. 148 mezzanine stage (venture capital) 344, 350 micro-business Australia 211, 215, 216–17 China 289, 295 micro-enterprises 13 contribution to economic recovery and poverty alleviation 22, 72–97 micro-finance 15, 74–5 institutions 22, 80–82, 91–6 role/contribution 82–8, 91–7 Miles, R. 49 Miller, B. 39 Millington, A.I. 238 Mirsky, J. 37 Mitev, N. 171, 289 Mitra, D. 350 Mittal, A. 40 Miwa, Y. 129 Moini, A.H. 222, 223, 243 Mollison, B. 42 Monbiot, G. 52 Monden, Y. 49–50 monetary financial institutions 109–11 monopolies 118, 129 moral hazard 331 moral philosophies 191–6, 204–5 Mroczkowski, T. 138

Index Mulcahy, D. 169, 171, 176, 182 multinational enterprises 228 multinomial logit model 244, 245 Munro, H. 227 MYOB 219 Nadvi, K. 43, 318, 320, 321–2 Naidu, M. 222, 223 Namiki, N. 239 NASDAQ 156, 345 national accounts 22, 99–115 ‘natural farming’ 42 natural resources 46, 120, 131 Naughton, B. 331, 332 net borrowing/lending 102 net capital stock 104 net operating surplus 104–5, 107, 108 Netherlands 342, 347, 352–4 Network Economy 48–9 network perspective theory 224, 229 network relationship approach 221 networks 25, 91, 132, 209–10, 227, 229 global production (in SPS) 43–51 inter-firm 13–14, 18, 120–21, 316–23 technological sourcing 254, 259, 273 in Thailand 153–4 new starts 76, 77, 80, 85–8 Newfarmer, R. 28 Newton-Raphson method 245 niche markets 18, 46–7, 157, 281–3, 301 Nielsen, F. 42 Nishiguchi, T. 258 no-growth firms 76, 77, 80, 85–8 No Logo counter-movement 53 non-financial corporations 99–109 non-governmental organisations (NGOs) 18, 37, 95 non-performing loans 151, 152 non-profit institutions 100, 101–2 non-tariff barriers 8, 9, 10–11, 20 non-transactions changes 102, 112 Nonaka, I. 170, 171 Nooteboom, B. 317, 319–20, 322 North, D. 46 Norvell, D.W. 191 NUTEK 346, 353 Nuthall, G. 166

367

OECD 4, 10, 11, 14, 17–18, 127, 129, 131, 148, 154, 156, 260, 277, 301, 341, 344–6 Ohmae, K. 209 Oi, J. 41, 327, 329, 331, 333–4, 336 oligopolies 118, 124, 129, 131, 155 open coding 177 opportunity costs 316 Organizational Effectiveness Menu 195 organizational learning 163–5, 167–72, 180–81 Osborne, K. 237, 238, 240 O’Shea, M. 341, 344 output 8, 104 outsourcing 120, 122, 128, 151, 154, 155, 158, 301, 302 over-the-counter markets 345–7, 350 overhead costs 48, 121–2 Oviatt, B. 209, 219–21, 223–9 owner-managers 16, 171, 173, 174 ethical values (Malaysia) 24, 187–205 ownership of CTVEs 330–31, 334–5, 336–7 see also privatization Oxfam International 32, 33, 53, 54 Pacific Economic Cooperation Council (PECC) 312, 313 Parker, R. 301 Partridge, M. 239 Patricof, A. 344, 353 Patry, W. 53 Patton, M.A. 236, 238, 240, 242, 247 Patton, M.Q. 175 Pauli, G. 50 ‘peeled lease’ 337 peer-based learning 13 Peet, S. 296 pension funds 110, 345 perfect competition 308 performance 38, 110 role of SMEs 3–26 Perlmutter, H. 234 ‘permaculture’ 42 Perotti, E. 331 Perren, L. 239 Perry, M. 31 personal moral philosophies 191–6, 204

368

Index

personal values 193–4 Pfirrmann, O. 341, 348 Pine, B.J. 45, 47 Pineda, R.C. 210 Piore, M.J. 43, 45 Pitt, M. 331 Pomerleano, M. 5 Pooled Development Funds 351 Porter, M.E. 39, 46, 129, 157, 209, 239, 241–2, 315 Posner, L. 39 poverty 32, 33, 34 alleviation 5, 22, 30, 72–97, 305, 307–8 Prahalad, C.K. 39, 170, 259 Prasad, V.K. 222, 223 PRESOR 195, 196–7, 198 Pretty, J. 39, 42, 54 price (in MPS/SPS) 48, 51 price-earnings ratio 106, 109 ‘prime systems’ 36–7 private sector enterprise development 88 privatization 215, 301 in China 336–7 in Japan 118–20 problem-holders 254 process efficiency 123 process innovation 315 producer goods 124–5 product diversification 121, 125–9, 139, 140 innovation 14, 258, 259, 315 product development adaptable (APD) 123 joint 267, 268–70 production costs 48–50, 234–5, 237–8, 240, 247–8 production systems mass 21, 29, 43, 45–53, 124, 127, 131 sustainable 4, 21, 28–60 productive diversity 45 profit 81, 104, 107 provider (in MPS/SPS) 48–9, 51 Prudent Man rule 345 public expenditure 15 public goods 48 public intervention (Thailand) 154–5 ‘push pull system’ 42

Putterman, L. 331 Pyke, F. 132 quadruple bottom line 35–9 quality control 10, 123, 128–9, 137 Qian, Y. 327 Quibria, M.G. 45 quick ratio 105, 108 Rabellotti, R. 317 Rahim, R.A. 53 railway system (USA) 123, 125 Ramaseshan, B. 236, 238, 240, 242, 247 Ramaswami, S.N. 244 Rao, K. 274 Rasiah, R. 52 rate of return on sales 104, 107 Ray, D.M. 349 Readman, J. 44 Reeves, T. 168 regional difference (policies) 7–9 regional economic recovery 22, 72–97 regionalism 4–5 Régnier, P. 148, 151, 152, 154 regulatory tiering 311–12 Reid, S.D. 238 Reinertsen, D.G. 258 relationship building 227–8 relativism 192–6, 198, 199–201 Remenyi, D. 175 Renforth, W. 219, 223 reputational externalities 310 research 223–8, 241–2 research and development 14, 18, 309, 315, 320–21 Australia 25, 215, 218–19, 253, 260–74 resource allocation 75, 93, 131, 216, 308 return on capital employed 104, 107 return on investment 104 Revesz, J. 305–6, 307 Reynolds, P.D. 221, 223 Richardson, D. 53 Riddell, J.C. 53 Ries, I. 218–19 risk 81, 312–13, 335–6, 343, 348, 350 Ritchie, N. 52 Ritchie, R.L. 281–3, 290, 295, 296 Ritzman, L.P. 137

Index Robertson, P.L. 254, 258, 273 Robinson, J. 36–7 Robinson, K.C. 219, 223 Robinson, M. 281 Rogers, E.M. 256 Rogers, E.W. 168 Rokeach, M. 193 Ronkainen, I.A. 236 Root, F.R. 234, 236 Root, H. 32, 33, 34 Rosset, P. 39, 40, 52 Rothwell, R. 316, 321 rule-based beliefs 193 Rural Cooperative Fund 334 Rural Credit Cooperatives 329–30, 332, 333, 337 Rutten, M. 157 Sabel, C.F. 43, 45 Sala-i-Martin, X. 130, 136 Salazar, M. 156 Samiee, S. 222, 223 Samuelson, P. 53 Sanchez, R. 170 Sari, A. 35, 128, 137 Sarno, N. 39 Sashittal, H.C. 228 savings 92, 102, 103, 105, 335–6 scale (in MPS/SPS) 49, 51 Scaone, D. 171 Scheela, W.J. 349 Schein, E.H. 173 Scherer, F.M. 14, 315 Schiffer, M. 30 Schleifer, A. 126 Schmitz, H. 44, 52, 157, 316–18, 320, 321–2, 323 Schumacher, E.F. 49, 55 Schwalbach, J. 132 Schweithelm, J. 33–4 Schwepker, C.H. 191 scientific management 125, 127, 172 Scott, P. 34 Searle, J.R. 170 seed stage 343, 350 Seifert, B. 236 Sekaran, U. 195 self-employment 75, 89, 91 self-financing ratio 105, 108 Sen, A. 40

369

Senge, P.M. 170 Sengenberger, W. 43, 157 Seringhaus, E.H.R. 243 Sgro, P. 168 Shane, S. 341, 347 shareholding cooperative reform (in China) 334–6, 338 shares 105, 106, 109 Sharma, M. 40 Shen, S. 330 Sheng, Z. 333, 337 Shilling, G. 48 Shiva, V. 39 Shrieves, R.E. 315 Simon, H.A. 190 Singapore 187 venture capital 342, 348–9, 352–6 Singhapakdi, A. 191, 193, 195–6, 198 Singleton, J. 271 Siu, W.S. 209, 211, 221, 224–5, 228 skills 12, 16, 90–91, 178–9, 281, 283, 323 see also training small-growth firms 76, 77, 80, 85–8 small business assistance programmes (SBAPs) 210 Small Business Investment Company (SBIC) programme 342, 351 Small Industries Development Bank of India (SIDBI) 350 Small Industry Credit Guarantee Corporation 155 Small Industry Finance Corporation 155 small and medium-sized enterprises in China 26, 327–38 concept (alternative views) 211–12 development (key issues) 4–6 development, policy and 25, 301–24 ethical values 24, 187–205 export entry mode 24–5, 234–49 firm organization 23, 117–45 internationalization process 24, 209–29 Internet and 25, 277–97 knowledge development 24, 163–83 local (Thailand) 23, 148–59 role (growth/performance) 3–26 supporting 26, 341–56 sustainable production 21, 28–60 technological sourcing 25, 253–74

370

Index

Smith, A. 168 Snowden, D.J. 175 social imperative 36, 37, 38 social intermediation 82, 96 Social Investment Forum 38 social mobility 21, 29 social objectives 304, 305, 307–8 social responsibility 193–5, 200–202 social sustainability 31–2, 34, 38–9 societal wealth indicator 38 soft budget constraint 331–2 solution-holders 254 South and East Cheshire TEC 287 Spar, D. 288 Spark Plan 328 specialization 18, 316, 318 flexible 45, 127, 132, 157 sphericity test 197, 198 Stabinsky, D. 39 stable survivors 81 Stage Model approach 221, 223, 229, 235 Stake, R. 175 stakeholders 24, 189–91, 195, 198–202 Stalk, G.Jr. 122, 123 standards, international 22–3, 99–115 start-ups 5–6, 14, 19, 76, 306, 309 Australia 219–20, 223–4, 226–8 venture capital 313–14, 344, 350 state-owned enterprises 138, 328 Stern, L.W. 234, 236 Stevens, C. 341, 344 Stevenson, J. 170 Stiglitz, J. 31, 54–5 stockholders 24, 189–90, 194–5, 199–202 Stopford, J.M. 241 Storey, D.J. 301–4, 306–7, 309, 312 strategic alliances 10, 13, 224 strategic rationale perspective 239–40 strategic sourcing 257–8 Strauss, A. 176 Streeck, W. 45 Sturgeon, T. 49 Styles, C. 209, 212, 218–19, 221–5, 228 subcontracting 91, 132 Japan 120–23, 128–9, 131, 151 Thailand 152–5 USA 127, 131 subsidies 306, 307, 308, 314

Suharto administration 32–5 Sullivan, D. 209, 219–20, 224, 226, 38 Sunan model 328 Supangkat, H. 33 suppliers 257–9, 267–8, 270–73 supply chain 4, 278, 280–83, 295–7, 302, 317–18 Suryahadi, A. 34 sustainable abundance 49, 50 sustainable advantage 56 sustainable development 4, 21, 28–60 sustainable management 37–8, 39, 51 sustainable production system (SPS) 29–30, 43–53, 56 Svejnar, J. 330–31 Sweden 342, 346–7, 352–4 Swiercz, P. 243 Sykes, T. 351 Symeonidis, G. 309 systems integrator 258 tacit knowledge 253 Taiwan 5, 6 Takeishi, A. 129 Takeuchi, H. 170, 171 Tang, J. 279 Tangri, D. 171 Tansey, R. 192, 196 Tansuhaj, P.S. 235, 240 Tardin, J.M. 39 tariffs 8, 10, 215–16 taxation 306, 311, 313–14, 333, 354–5 capital gains 344–5, 350 Taylor, F.W. 125 Taylor, S. 209, 211 Taylorism 125, 127, 172 technological sourcing 25, 253–74 technology access to 11–12, 315 transfer 91, 120, 122 see also information communication technologies (ICT); information technology; Internet Technology One Ltd 218–19 Technopreneurship Fund 349 Tedlow, R.S. 126 teleological beliefs 192, 193 Teng, T.S. 31 Terpstra, V. 234, 237 Tewari, M. 44

Index Thai Rak Thai party 152, 158 Thai Stock Exchange Authority 155 Thailand 5, 6 financial crisis 23, 148–59 Thaksin government 152, 158 Thatcher government 215 time (in MPS/SPS) 46–7, 51 Timmons, J.A. 341, 346 Tinker, J. 36–7 Toh, H.S. 349 Towne, H.A.125 Townsend, A. 49 township-village governments (TVGs) 327–34, 336–8 Toyota 49, 123, 153 trade barriers 15, 19 non-tariff 8, 9, 10–11, 20 tariffs 8, 10, 215–16 training 90–91, 153, 178–9, 323 knowledge development 24, 163–83 TECs 284, 287 Tran, V.H. 3 transaction costs 9, 10, 52, 74, 121, 216, 253, 257, 259, 306, 313, 320, 322–3 transaction flows 102, 112–13 transnational corporations 4, 302 Thailand 23, 148–59 USA 127 transparency 99, 101 transport costs 10 Trappey, A.J.C. 295, 296 Trappey, C.V. 295, 296 triple bottom line 36 Triple C approach 322 Trist, E. 168 Tschang, T. 45 Turelaub, J. 165 Turnbull, C.M. 348 Turnbull, P.W. 235, 238 Turner, L. 138 two-sample T-test 265–6, 268, 270, 272 U-form organization 119 UK Internet impact 25, 277–97 monetary financial institutions 110 non-financial corporations 103–9 unemployment 301, 305

371

Union of Needletrades, Industrial and Textile Employees (UNITE) 32 United Nations 301 System of National Accounts 22, 99–104, 107, 110–14 UNCTAD 148–9, 150, 153, 157, 315 UNDP 37, 38 UNRISD 37 unstable survivors 80–81 Upadhya, C. 157 Uphoff, N. 42 USA 41, 243 big business 123–8 firm organization 23, 117–45 venture capital 345–6, 352–4, 355 Vahlne, J. 209, 221, 229, 235, 238, 241 value added 48, 81, 119–20, 130, 220, 224, 225 gross 102, 103, 104 value chain 45, 119, 153 value system 37, 39 values ethical 24, 187–205 personal 192, 193–4 Van Cayseele, P. 308 Van den Bergh, R. 308 Van Zyl, J. 39 Variance Inflation Factor (VIF) 200 variety (in MPS/SPS) 47, 51 varimax rotation 198, 244 Vasquez-Parraga, A.Z. 193 Velasquez, M. 187, 189 venture capital 14, 149, 313, 314 supporting SMEs 26, 341–56 Vernon, R. 321 vertical integration 50, 117, 120–21, 126, 130–31, 139, 235 vertical networks 317, 319, 322 very small enterprises 211, 215–17 Vidal, J. 32 Vietnam 3, 5, 6, 19 Virmani, B.R. 274 Vishny, R.W. 126 ‘visible hand’ 127 Vitell, S. 191, 196 Viviers, W. 212, 228 Vojta, G. 49 Von der Weid, J.M. 39

372 Von Hippel, E. 258 voucher system (of accounts) 125 Walder, A. 327 Walsh, J.P. 210 Walters, P.G.P. 222, 223 Wan, S. 335 Wank, D. 337 Watanabe, Y. 129 Web pages/sites 287, 289, 293, 294 Webster, L. 93 Weder, B. 30 Weidenbaum, M. 44 Weinberger, D. 49 Weitz, B.A. 236, 238 Welch, L.S. 209, 219, 224–5 Wells, L.T. 241 Wenger, E. 170 Wertheim, M. 40 Wetzler, B. 53 WFG 348 Wheeler, D. 37 Whipp, R. 174 Whiting, S. 329–30, 332–3 Whittaker, D.H. 122, 138, 155, 157 Wiedersheim-Paul, F. 235, 238 Wilemon, D. 228 Williams, S. 169 Williamson, O.E. 224, 226 Wind, Y. 234 ‘Wintelism’ 45 Wolfensohn, J. 28

Index Womack, J. 45, 49 women 74, 84–5, 91 Women’s World Banking 91 Wong, M. 32 World Bank 3, 28, 32, 35, 72, 93, 148, 150, 152, 352 World Commission on Environment and Development 36 World Business Council for Sustainable Development (WBCSD) 38, 39 World Trade Organization 6, 19, 35, 53 Wotruba, T.R. 191 Wright, M. 341, 354 Wright, P.M. 168 Wurster, T. 44 Yeh, K.C. 332 Yip, G.S. 209, 222, 227 Young, S. 239 Yunus, M. 39, 92 zaibatsu 118–20, 121, 122 Zander, U. 264 zero cost 49 zero defects/inventory 49–50 Zhang, A. 40 Zhang, G. 331 Zhang, J. 333 Zou, S. 235 Zwart, P.S. 222, 223 Zysman, J. 44, 45