The Main Difference between SMEs and Large Businesses - Thesis Example

The Main Difference between SMEs and Large Businesses Student’s Name: Instructor’s Name: Course Code: Date of Submission: Main Difference between SMEs and Large Businesses Introduction SMEs play an integral role in the economy of most countries (Loviscek, 1982, p.36; Beck, Demirguc – Kunt and Levine, 2004, p.1). With this realised importance, it is critical to support these SMEs to grow and develop. However, as compared to established large business organisations, SMEs faces myriad of challenges as result of being vulnerable to external and internal shock (Smit and Watkins, 2012, p.6324 citing Berry, 2002; Laforet and Tann, 2006). One way of conceptualising SMEs is to examine the key differences between them and large firms. The aim of this paper is to examine the principal differences between small and medium business enterprises and the large ones. To attain the later, the paper will explore areas of distinction in factors like risk of failure, market focus and bulk sour of their customer base, strategy implementation, management and ownership structure, source of finance, human resources innovation and knowledge management. Risk of Failure The reality is that all businesses be it a large corporate or a SME, they phase the same macro environment factors with the difference being internal factors. These external macro factors include cut throat competition, globalisation, trade barriers and technology. The risk of failure of SMEs is determined by how they are able to manage risks from wide array of sources. While the macro-environment is the same for all businesses, small and medium businesses have no that opportunity to enjoy in excess benefits like adequate capital and extended human resources as compared to large enterprises. In a nutshell, SMEs/ SMMEs are more vulnerable to major external shocks (Smit and Watkins, 2012, p.6324 citing Berry, 2002; Laforet and Tann, 2006). One area that distinguishes SMEs and larger corporations is the risk of failure. Basing his study in Tokyo in the period 1986 to 1994, Honjo (2000, p557) found out that new firms with low capital formation or a sufficient size has a higher risk of business failure. European Federation of Accountants (2004) notes that the first three years of establishing a business is a critical period since it determines the success or failure of SME. The high risk of failure during this time is tied to the fact that, a new SME has to prove its capability to customers and suppliers, providers of finance, employees and outside investors (p.7). Sheng, Rani and Shaikh (2010, p.229) summarises the risk of failure of SMEs that ‘ from bank’s perspective, financing to SMEs is often regarded to be of higher risk due to the relative opaqueness of these firms as compared to larger firms’. For instance, from a credit risk perspective, SMEs are riskier as compared to large corporate (Altaman and Sabato, 222, p.2 citing Dietsch and Petey, 2004). In conceptualising the likelihood of failure, Altman, Sabato and Wilson (2008) observes that it is critical to distinguish between failure and closure (p.8). Watson and Everett (1996 cited in Altman, Sabato and Wilson, 2008, p.8) developed five points for defining failure. These include ceasing to exist/ discontinuance as a result of various factors, closing to limit loses, closing or a change in ownership, filing for bankruptcy, inability to reach financial goals and closing or a change in ownership. On the other hand, closure occurs when the owner (s) decide to close down for other reasons, but, not for financial reasons. This implies that closure might occur even when the firm is financially successful, as opposed to failure that is associated with financial underperformance. The failure rate of SMEs globally is high since they exhibit short life trends and high death rates (Xiuli and Juan, 2008, p.821). The risk of failure of SMEs in developing countries like Kenya is worrying. For instance, Bowen, Morara and Mureithi, (2009, p.16 citing Kenya National Bureau of Statistics 2007) observes that three out of five business fail within the first few months yet in this economy SMEs accounts for 50% of new jobs created. On the other hand, Smit and Watkins (2012, p.6325) indicates that South Africa SMEs experience 80% failure. On the other hand, the failure rate of SMEs in developed countries is equally alarming. Xiuli and Juan (2008, p.821) notes that ‘United States register 600, 000 SMEs each year, among which only 300, 000 SME live to 1.5 year, and less than 1% can last for 10 years. In china the average life the average life expectancy of SMEs is 3 to 4 years’. European Federation of Accountants (2004) identifies various internal and external reasons why SMEs fail. The internal factors include poor management since most SMEs face competency issues in management (p.7). The danger that poor management poses is the possibility of insolvency (p.8). The next internal factors include deficit in accounting where the owners do not operate according to accounting principles in bookkeeping, general receivable and VAT returns among others (p.10). The third one is poor cash flow management as result of imbalance between the payment terms taken by debtors and those given to creditors. Others include inappropriate source of finance, dependency on customers or suppliers, impending bad debt, overtrading, poor marketing & research and lastly, fraud/ collusion (p.11-16). The external factors include bankruptcy of main supplier or customer, governmental measures & international developments, environmental protection & other regulatory measures and lastly, catastrophic events (p.17). Market and Customers While talking of market and customers the issue of market power arises. Market power in relation to individual organisations is tied to how they are able to have a bearing on the prices they charge (White, 2010, p.4). It is proven that large firms have an upper hand over SMEs in terms of market power. The premise for this uneven ground is attributed to control of resources that large firms have, control of production process and products, economics of scale and legal barriers. This means large firms have competitive advantage over SMEs through market power. On the other hand, SMEs have low fragmented market structure (Tsai, 2002, p.44). For instance, to expound on the later points, we find out that bigger corporations have massive brand advantage than SMEs. Secondly, they have higher investment capability than SMEs and thus, are able to risk by venturing into new markets. The last is ability of larger business institutions to invest in e-business platform which gives them opportunity to develop customer relationship management (Tsai, 2002, p.44-45). In talking about market and customer, the issue of product/ market strategy is important in differentiating SMEs and large corporations. In the product/ market strategy perspective, four options emerge. These are market penetration, new product development, new market development and engaging new market with new products (Burns, 1989, p.47). SMEs have been associated with focused strategies while larger corporations have been associated with differentiated product strategies (O’ Gorman, 2000, p.283). The two approaches illicit mixed reaction with certain works being pro or against the two. Sandberg and Hofer (1987, p.8) posits that product based strategies have proven to be effective than focused based strategies. On the other hand, Cooper (1993, p.242) observes the opposite. ‘It is well documented that SMEs have unique characteristics that differentiate them from conventional marketing in large organisations’ (Gilmore, Carson and Grant, 2001, p.6). This observation summarise the belief that the market and customer focus of SMEs and larger corporation differ significantly. The differences emerge in terms of how the two in the continuum have ability to set or not set prices by being price taker or price maker. The next indication is the bulk source of their customers and international reach. Gilmore, Carson and Grant (2001, p.6) is of the view that these marketing characteristics are tied to characteristics of the manager/ owner and its size. The shortcomings in the SMEs marketing approach is viewed by the later as being informal and haphazard because of low level of informed decision (Scase and Goffee, 1980 cited in Gilmore, Carson and Grant, 2001, p.6). The contributory factors to these shortfalls are as results of inadequate resources and expertise. While in a normative perspective, it is large corporations that dominate in international markets. However, there are SMEs that have superseded various barriers to access the international export market. Merrilees and Tiessen (1999, p.327) have identified difference in international marketing models between SMEs and larger business organisations. From the international marketing perspective they note that SMEs are sale-driven. The basis for this approach is as a result of not having market niche at international level and inability to control clients & agent selection and thus, they are forced to focus on sale. Other factors predetermining this approach include having low level of relationship with foreign customers and inability to adapt marketing mix at international level (p.329, 330 & 331). These challenges inhibit the performance of SME at international level as compared to the larger business organisations which are able to clearly outline their market segment and more focused nice. However, at the local level, the SMEs display higher level of customer relationship through marketing by network (Gilmore, Carson and Grant, 2001, p.6, 8 & 9). Strategy Strategies are critical for a firm survival whether small of big. Strategies provide road maps of attaining organisational goals by outlining how a firm will overcome competition, innovate and meet customers need among other so as to gain market leadership. From a competitive analysis, a firm can be classified either as a market challenger, a market nicher, a market leader or a market follower. According to Loudon, Stevens and Wrenn (2004), the core strategy that a firm adopts depends on its position and is aimed at giving a firm a competitive advantage over rivals in the market (Mathur, 2006, p.56). A market leader is said to command the largest market share with innovative marketing techniques. In order to retain its position as a leader in the market, it undertakes various activities. It can expand the total market share by developing new uses, new users, as well as more usage by existing customers. Moreover, a market leader protects the market share by using relevant market to cushion against challengers. In general, SMEs shows lower level of strategic planning adoption (Gibson and Cassar, 2002, p.172). Guzman, Serna, Torres and Ramirez (2012, p.61) provides an interesting introductory remarks by noting that higher percentage of SMEs employ simple system and procedures so as to improve flexibility, decision making in short times. Secondly, owing to quickness in decision making, they are able to respond to changing customer needs. Moreover, the operations strategies are demarcated by dynamic innovative approaches and relationship management. The later observation is affirmed by O’ Gorman (2000, p.283) who states that managers/ owners of SMEs have to choose on how to compete. However, the overriding themes in most SMEs are focused strategies, flexibility, fast response time and closeness to customer. Despite of the above strengths, SMEs are also associated with strategy weaknesses such as insufficient business-related knowledge that managers in larger firms poses. Second is the application in irregular basis factors like formal plans and cost control. Moreover, in if they are applied, they use them intuitively rather than objectively (Brinkmann, 2002). The question is how SMEs and Large firms apply various business strategies. One common characteristic that is associated with SMEs flexibility and adaptability while responding to business challenges. For instance, SMEs are able to respond quickly with a single decision on issues relating market opportunities (Olsson, 2011, p.18).flexibility is also evident in human resource management and work load allocation. The reason behind this proposition is that most SMEs have limited resources, financial obstacles and few employees. This forces them to engage in high level of multi-tasking and informal management structures (Olsson, 2011, p.17). While SMEs are flexible in their strategy implementation, they have not been good in change management as compared to large firms. The success of large corporations is tied to research and development. Take a case example of Apple Inc and Samsung. The key features of Apple’s business model are its ability to marry art with technology and the use of Word-of-Mouth (WOM), as well as a Buzz for its products. In marrying art with technology, the company not only makes its iPhones perform better in comparison to products of rivals but also are appealing to consumers. Essentially, customers feel nice when having good looking products. “Apple iPhones do not just perform better than competing products; they look better, as they marry art with technology, which makes people feel good in carrying one around, and even showing to their friends” (Mourdoukoutas, 2011). Management Organisational structures are like the backbone and hence critical for survival of an organisation (Xiuli and Juan, 2008, p.821). The commonly adopted management and ownership structures of SMEs and large corporations also offer an insight on the possible differences between the two. Windrum and Berranger (2002, p.9) postulates that ‘organisational structures of small firms tend to be flatter than in large firms, with management performing multiple organisational task’. This is because most owners lack specialisation and is faced with resource constraint. The advantage associated with this flatness is flexibility and dynamism in decision making which allows the owner/ manager to exploit new business opportunities that might emerge without following rigid formal business structures associated with large business organisations (Senol and Akturk, 2008, 480). Xiuli and Juan (2008, p.821) opines that, since in early stages SMEs are exploratory, they tend to adopt line functional structure depending on their size. Line functional structure in SMEs can be exhibited as line authority commanding system based on centralised command or as functional authority management system that embraces division of function. However, in most scenarios, they note that most SMEs at start up adopt centralised command. The beauty of centralised approach is ability to make decision in faster and flexible manner and thus guaranteeing coherence between operations and strategy. Secondly, it allows for direct control and distribution of resources. The problem associated with the same, is that it kills input from other employees and makes it hard to create responsibilities between departments. The agency theory explains the concept on separating management from ownership in large organisations. The underpinning premise is that efficiency is created when a contract of engagement is created between management, owners and employees (Eisenhardt, 1989, p.58). In most cases, large corporations are managed by professionals who are not necessarily owners. However, at a time it is common to find managers who are equally shareholders in large corporations (Dalton at al., 2003, p.14). The structure of larger organisations is complex and full of hierarchies & power relations. The design exhibited here is formal and has a chain of command along functional departments. Decision making and communication is structured with evidence of vertical and horizontal flow (Malone, 1986, p.3). This is the contrast that emerges with the reason being that, large organisations are able to employ and remunerate professionals according to their value while SMEs are faced with numerous constraints of trying to survive. The ownership of SMEs can be conceptualised from two models. The first is the wholly family owned business where the owner has a direct control over the operations and strategy development. In this perspective their focus is continuity. The second is the one where a professionally managed company has a share in it. This allows them to easily access credit facilities (Fernandez and Nieto, 2002, p.1 and 2). However, various literatures points that most SMEs are family owned. Yuan and Vinig (2007, p.4 citing Smith and Miner, 1983) observes that, in smaller companies, the owner is the one who ensures integral competencies. They further note that, ‘as long as the owner’s mental and physical resources can contain management challange, the governance structure isn’t an issue (Yuan and Vinig, 2007, p.4 citing Ward, 1997).Family business is seen as where majority of stock is owned by one family. Others see it as where one family is control taking into consideration stock ownership (Madueno, Jorge and Gardey, 2011, p.6). To the contrary, most large corporations are listed in stock exchange. However if not listed, they are professionally managed since there is separation of management and ownership. Source of Finance Financing is critical for the growth of any business as it empowers a firm to venture into new territories, develop new products, attract employees and creates ability to buy capital equipments. In a nutshell it is source of cash flow and survival prospects (OECD, 2006, P.2). How SMEs and established bigger business organisation fund their business operations are different. This is tied to the fact that larger corporations are known, they have wide market base, wide asset base that can act as collateral, streamlined management and business plans which can be used to solicit funds. On the other hand, SMEs have fewer assets; some might not be credit trust worthy and have insufficient expertise to manage them. Apart from this the bigger organisations can engage in initial public offers at national and international level (Matic, Gorajek and Stewart, 2012, p.15). The more an organisation is well funded the more it can wield higher market power (Tsai, 2002, p.44 & 45). Bergel and Udell (2004, p.3) notes that, ‘large institutions have comparative advantage in transactions lending to more transparent SMEs based on hard information, while small institutions have comparative advantages in relationship lending to informationally opaque SMEs based on soft information’. Access to finance has been identified as one of the thorny issues in the growth and development of SMEs. For instance, in euro zone, access to finance is the second most pressing issue (Kraemer- Eis and Lang, 2012, p.5). Owing to various constraints like imperfect information about SMEs by various financial institutions, most SMEs resort to internal funding. Matic, Gorajek and Stewart (2012, p.16) observes that, ‘Australian smaller businesses are less likely than larger business to seek external finance (debt and external equity funding)’. In their finding, they observed that small business have the tendency of raising more of their debt from financial intermediaries and use less trade credit than larger business. In applying pecking order theory to SME financing, Rocca, Rocca and Cariola (2012, p.6) indicates that retained earnings is the most preferred source of finance. The other sources preferred in the hierarchical order are debt and equity finance. The same observation is evident in Slovakia where SMEs prefer to use retained earnings as the principal source of financing followed by bank debt, trade credit and external equity. Moreover, small firms are likely to use more of retained earnings and less bank debt as compared to medium and large firms (Jana, 2010, p.67 & 69). Jana (2010, p.69) postulate that, as a result of information asymmetry between SMEs and formal financial institutions, SMEs find difficult to access their credit facilities. This consequently drives them to seek funding informal funding from trade credit, financial support from family and friends. In developing economies like Mauritania, SMEs rely on bootstrap financing where the owner relies on informal sources instead of financial institutions (Padachi, Howorth and Narasimhan, 2011, p.4). The emerging observation is that all businesses rely on internal finance. However, the degree of reliance is what differs. For instance, in Slovakia, Large firms rely on 64% of the internal finance, medium ones rely on 66% and smaller ones rely on 75% of internal finance (Jana, 2010, p.70). Human Resources Employees are the epicentre of idea creation and implementation of strategic management plan (Denning, 2000, p. 2). However, numerous SMEs have resource constraints facing them. This means they can’t compete with large businesses in the human resource perspective. With resource constrains, SMEs are not able to attract and retain high calibre and experienced staff. This is because; such employees would go to large organisations where their remuneration is commensurate with their effort. Moreover, SMEs do not offer opportunities for career progression and sponsored training opportunities as compared large ones. Lastly, the threat of poaching is eminent in most SMEs as employees consider them as entry points and not places for self actualisation in terms of career (Rashid, p.12). Innovation Businesses can’t survive without innovation. Tung (2001, p.41) postulates that it is not the strongest business that survive, but those that are able to anticipate and adapt to change. Innovation relates to improvement in product and ways of doing business/ operations among others so as to be competitive and create for the target customers. As a result of myriad of factors facing SMEs, empirical data points to the fact that SMEs are much innovative in their way of to doing business (Acs, 199, p.3). Olawale and Garwe (2010, p.729 citing Herrington, 2006) attributes their innovation capacity to ability create and introduce new technologies and products and push the existing large firms by creating effective ways of survival. One way is how the SMEs are able to develop a close knit customer relationship (Hall, Lotti and Mairesse, 2009, p.13). Indeed if the trend in registration of patents also confirms the level of innovation among SMEs. Boud et al. (1984 cited in OECD, 2000b, p.7) indicate that companies in U.S which had sales less than $ 10 million accounted for 4.3% of the sale from the sample list, while accounting for 5.7% of the registered patents. Gellman (1976, 1982 cited in OECD, 2000, P.7) notes that SMEs contribute 2.45% more to innovation per employee as compared to large enterprises. The essence of being innovative is to be able to fight it out with bigger organizations which have huge resources at their disposal. Indeed, SMEs have higher opportunity for innovation based on the fact that they tend to develop close working relationship with customers. This allows them to constantly gain feedback from consumers which are integral in product development and operations structuring. The only difference that hinders the innovative endeavor of SMEs is tied to four factors. The first is the financial bottlenecks because of reduced access to external finance, higher cost incurred in developing innovation and high risks. Moreover, SMEs have inability to hire highly qualified personnel. The third is the inability to manage innovation process. Lastly, is the inability to do effective market research (Tiwari and Buse, 2007, p.8). The innovations of SMEs are also evident in seizing opportunities at local level. In seizing opportunities, an organisation achieves more than just creating markets for its products. The management is able to study and understand the industry dynamics and the key success factors responsible for driving the performance of an organisation. An analysis here involves looking at the implications of the economy, socio-cultural trends, global market and demographics on the performance of the organisation. This enables an organisation to see the strategy being implemented by its competitors. By so doing, the organisation can identify potential loopholes in this strategy in order to move in and seize these opportunities. On the other hand, large organisations embrace long term research and development in objective manner and large scale perspective. They believe that innovation is core to their survival. To contrast the difference in innovation, we can examine how some major global corporations conduct innovation. In marrying art with technology, Apple has been able to come up with better products compared to its competitors. These include the Mac (Pro, Mini, iMac, MacBook, Air, Pro, and Xserve), iPhone, and the iPod (Shuffle, Nano, Classic, and Touch) (Modi et al, 2010). All these unique products are a result of marrying technology with art. As such, Apple has branding machine able to product numerous products rather than coming up with a single one. Mourdoukoutas (2011) “This marriage of art and technology transforms the company from a computer and iPhone maker into a branding machine that churns families of blockbuster products rather than single products”. The other case example that can be used to show how large organisations are objective oriented in innovation is Samsung. In the first stage of Samsung Electronics Company’s science and technology policy adoption and implementation, the company focused on purchasing technologies from overseas. Some of the technologies that Samsung Electronics Company imported were design and after-fabrication technologies which were more complicated and difficult. However, with time Samsung Electronics Company accumulated the necessary technologies for the manufacture of the DRAM, home appliances, as well as other consumer electronic products. In the second stage, Samsung Electronics Company imported the design technology for the 256 K DRAMS from Micron technology. The electronics company also adopted wafer fabrication and assembly technologies. It is during this stage that Samsung Electronics Company started receiving technology training and advice from experts (OECD, 2009, p.88). In the last stage of the adoption and implementation of Samsung Electronics Company science and technology policy, acquisition of design technology was based on technical information from advanced companies, reverse engineering, as well as other relevant DRAM designs. Other developments during this stage included the use of internally accumulated knowledge to develop wafer fabrications assembling technologies, minimizing time for commercialization of new electronic products, mass production lines and joint ventures in product development (OECD, 2009, p.88). Knowledge Management There are various theories that seek to examine the application of information and knowledge by business organisations in order to implement their business strategies and edge out competitors. Knowledge-based theory of an organisation or firm is one of the significant information system theories that seek to explain how data, information and knowledge are applicable and useful in the operations of a business organisation. According to the knowledge-based theory of an organisation, knowledge is a significant and strategic resource that determines an organisation’s ability to gain competitive advantage and register superior business performance. This is because an organisation’s knowledge resources are usually embedded in the business culture, policies, operations, identity, systems and human resources of an organisation. This complexity makes extremely difficult to imitate an organization’s knowledge based resources (fsc.yorku.ca, 2010). An organisation’s data generate information and knowledge which are essential knowledge assets in an organization (Muzzucato, 2006, p.305). It is through technology or rather information systems that organisation generates information from data that are from an organisation’s knowledge-based and intellectual assets. The management component arises when organisations are in the potion of generating value from the knowledge assets. It focuses on codifying data from employees, business partners, clients and sharing the information within and without an organisation with the main aim of devising best practices in an organisation. However, not all information is valuable to an organisation and thus organisations should determine what information qualifies their organizational and business strategy needs. Knowledge is the fundamental understanding, insight and practical know-how that enable human beings to intelligently function. This knowledge transforms into manifestations such as a business practice, strategy formulation and technology within organisations and firms. These transformations generate expertise when appropriately used and results into employee and business organization effectiveness hence competitive advantage and superior business performance as compared to those of their competitors. The difference in knowledge management between SMEs and large firms is tied to ownership and organisational structure. As already noted in SMEs the owner is likely to be the manager thus, few layers of management and centralised decision making. The advantage of this is shorter time span in decision making. The beauty of this is that, if the manager appreciates the role of knowledge management, they become the central figure in knowledge management implementation. However, being a one man show, the owner cum manager can lack time to focus on strategic issues touching on knowledge management. This is the exact opposite with large corporations where responsibilities can be delegated (Wong and Aspinwall, 2004, p.50). Apart from the above, the structures of SMEs are simple flat structure. This gives them a head start over large organisations as they are able to conduct with ease vertical and horizontal integration while initiating change (Ghobadian and Gallear, 1997). Lastly, the culture of SMEs is organic and fluid. This is because they have few numbers of employees and thus controlling them and creating a vision is easier as compared to large organisations. Thus, implementing knowledge management in SMEs is easier as compared to large firms (Wong and Aspinwall, 2004, p.50). While SMEs can be able to easily apply knowledge management, this has not been the case in development of the same. It is observed that SMEs lag in developing knowledge management practices and utilisation of the same (Evangelista et al., 2010, p.33). This is because of the limited resources they own. On the other had large firms have taken a lead in the utilisation of the same concept (Evangelista et al., 2010, p.35). The inability to utilise Knowledge management is evident since SMEs lack knowledge repositories. Secondly, SMEs are not good at utilising foreign sources of knowledge because their resource capacity is constrained and limited. Lastly, most SMEs do not make technology part of knowledge manage as they tend to lean towards humanistic approaches (Evangelista et al., 2010, p.36). Conclusion The chief focus of the discourse was to explore the major difference between SMEs and large business organisations. The emerging theme is that while, all of them are key to growth and development of economy, the two display distinct characters. In all the distinguishing properties examined, large corporation had a comparative advantage over SMEs. The only head start that SMEs had over large firms is in flexibility and innovation. In the discussion it was found out that SMEs have higher risk of failure as a result of being susceptible to macro-economic shock and globalisation ripple effects. In terms of management and ownership structure the finding was that most SME are family owned with the owner having direct control. In a nutshell such organisations exhibit flat hierarchies as opposed to large firms that are complex and hierarchical in nature. In relation to strategy formulation and implementation, it was found that large organisations are well conversant with the same. However, they are rigid as compared to SMEs in terms of flexibility and response to market changes. The other discovery was that large corporation have access to wide array of sources as compared to SMEs which relies on the owners input and restricted loans from financial institutions. In terms of human resources, the smaller firms have a lower capacity of remuneration and application of human resource best practices. However, it has been found that employers in SMEs have the ability to build the required trust and close working rapport. On the other hand, large organisations are able to employ above three employees, employ best industrial relations practices and ensure specialisation. In a nutshell, the work conditions in large organisations are favourable as compared to SMEs who are generalist with less pay. For innovation, the realisation was that SMEs and large corporate are innovative in their own way with the difference being focus, magnitude and application of the same. However, the critical is that SMEs are innovative, but do not apply them effectively. 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