Small firms' choice of business strategies.

• Author: Variyam, Jayachandran N.

According to the standard industrial organization paradigm, firms employ numerous business strategies such as product development, marketing, research, and innovation to gain a competitive advantage over their rivals. Empirical work on firm strategies has focused largely on research and development (R&D) among large publicly-traded manufacturing firms [10]. Two recent developments have increased interest in the choice of business strategies by small firms. First, a growing body of evidence suggests that, after several decades of decline, the employment share of small firms has been increasing through the 1970s and 1980s [16]. With the greater awareness of small firms' contribution to job creation, researchers and policy-makers are increasingly focusing on the sources of small business growth [6]. Second, economic development programs across the U.S. are focusing on small businesses for promoting regional growth [17]. Success of such programs requires a better understanding of factors influencing small firms' choice of business strategies. Business strategies adopted by small firms are likely to be different from business strategies adopted by large firms due to factors such as economies of scale and differences in organizational structure. Studies have shown that small firms engage in small scale R&D work although they may not have a formal R&D department [13]. This informal R&D may include a greater reliance on the acquisition of technical knowledge and die adoption of new production technologies from external sources such as trade publications, scientific journals, and government agencies [14]. Moreover, small firm strategies may be sector-specific. For example, wholesale and retail sector firms may stress quality and attractiveness of their products for higher sales growth while financial sector firms may stress planning.

While small firms adopt diverse business strategies to gain competitiveness, little empirical evidence is available on factors affecting the choice of these strategies. Evidence on the determinants of knowledge acquisition and product innovation is available [141, but determinants of many other strategies such as planning and quality have not been examined. The purpose of this paper is to present empirical evidence on the choice of business strategies by small firms. The paper differs from previous empirical work in several ways. First, whereas most previous studies consider only formal R&D activity, we examine a wider range of business strategies such as planning and product quality. Second, we examine the effect of managerial human capital on strategy choice. While human capital has been shown to have an important effect on firm performance [4], its effect on business strategy has been largely neglected. Third, our data include a large proportion of retail, wholesale, and service firms in addition to manufacturing firms; this is important because a large share of all small businesses are in the non-manufacturing sectors.

2. A Conceptual Model of Strategy Choice

   Much of the empirical work on firm-strategy determinants relates expenditures or other measurements of strategy adoption to firm size, human capital, market structure and other variables that capture revenue and cost differentials across firms [10; 14]. This approach assumes that returns to a particular strategy may differ depending on firms' abilities to use that strategy. The abilities are, in turn, determined by firm characteristics that affect efficiency and access to resources.

   Arora and Gambardella [2, 371] develop a model of business strategy choice among biotechnology firms in which firm returns are linked to firm size, arguing that "larger firms may have better financial resources, they may have higher market power, or they may have some sort of economies of scale which raises the payoffs to all or some strategies in a systematic manner." Feder, Just and Zilberman [8] review the extensive literature on technology adoption in the agricultural sector in which farm size and human capital are the key variables affecting farmers' adoption behavior. These variables influence farmers' capacity to deal with the inherent uncertainty of yield changes associated with new technology.

   While arguments relating the level or intensity of strategy adoption to firm characteristics are most well developed in the case of R&D, these arguments apply to other strategies as well. Pratten [18] concludes from a survey of small businesses that scale-related problems exist especially in marketing. Similar arguments suggest that a planning strategy may yield higher returns to firms with higher endowments of human capital and a technology strategy may bring higher returns to firms belonging to a sector with a favorable technological regime [3].

   A simple portfolio selection model provides a formal framework for analyzing the determinants of business strategies [19]. Suppose the net pay-off ([[pi].sub.1]) per unit of discretionary capital for the representative firm employing a new strategy at level y at unit cost r is given by:

   [[pi].sub.1] = [[pi].sub.1](y,r) + [functions of y,s,h,z]. (1)

   The first component of the pay-off function is the mean return common to all firms and the second component...