Small And Medium Enterprises And Their Characteristics Management Essay

In the modern world economy, business transactions can be conducted within the same city, the same country, or even between two countries. The term of internationalization has been adopted by many researchers, for instance Bell (1995):

“A firm’s engagement in a specific foreign market develops according to an establishment chain, i.e. at the start no export activities are performed in the market, then export takes place via independent representatives, later through a sales subsidiary, and, eventually manufacturing may follow.”

Internationalization has become a significant research topic for business academics in the past forty years. A substantial amount of research has focused on multinational enterprises (Dunning, 1973; Markusen, 1995; Kogut and Zander, 2003), with a growing interest in the internationalization of small and medium sized enterprises (SMEs) (Oviatt and McDougall, 1994).

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Meanwhile small- and medium-sized companies (SMEs) have been believed to be significant in supporting economics improvement within a country (Mazzarol, Volery, Doss, and Thein, 1999). For example, in the Netherlands, SMEs account 98.8% of all private-sector companies, contribute 31.6% to Gross Domestic Product (GDP), and employ 55% of the total workforce (EIM Business & Policy Research, 1999). Furthermore, obtaining sales outside their own domestic market is a goal of many small and medium-sized enterprises (SMEs) and their governments (Economic Development Board, 1993).

This thesis will be concentrated on the process of internationalization of SMEs, and especially the barriers of internationalization and motivations for export activities. In fact, SMEs are able to develop abroad since nowadays countries all around the world have become almost indistinguishable in terms of cultures and institutional settings (Johanson and Vahlne, 2003).

1.2 Problem statement

According to problem indication, this there for leads to the following problem statement;

“What are the barriers and motivations of internationalization with regard to small and medium sized enterprises?”

1.3 Research Questions

The following questions will be posed in order to draw conclusions with respect to the problem statement:

What are the characteristics of small and medium enterprises?

How do the enterprises internationalize?

What are the challenges and drivers of internationalization?

1.4 Research Method and Data Collection

1.4.1 Research Method

This thesis will use a literature study as the method of research. To be able to answer the research questions, the research method that shall be used is the literature study. To develop a theoretical framework, exploratory studies are used in this research. It is the most ideal type of research for obtaining a clear understanding of the phenomena of interest (Sekarana, 2003).

1.4.2 Data Colletion

Most of the resources used are secondary data which is data that have already been gathered by other researchers in the past (Sekarana, 2010). So far the author has found several journals and articles discussing internationalization of small and medium enterprises as the main source of this thesis.

Firstly, literature based on drivers and motivations of internationalization of small and medium enterprises were sought using several search engines such as Google Scholar, and also database such as JSTOR. The following keywords were used: Internationalization, SMEs, Drivers and Motivations. These keywords were used separately and in combinations with each other. Secondly, more literature, articles and statistical data were found from the internet. Google is used as the search engine.

Finally, to determine the quality of the literature, it is important to look at the number of citations from other high quality journal included in this literature. Another way to determine if literature is trustworthy is by looking at the references.

1.5 Structure of the Thesis

In the remaining chapters the structure will be as follows:

Chapter 2 shall review and analyze some of the definitions of small and medium enterprises and their characteristics, referring research question Q1.

Chapter 3 will examine the theories and the process of internationalization.

In chapter 4, I will investigate the opportunities and barriers to internationalization.

In the final chapter, conclusions will be drawn and the problem statement will be answered.

2. SMALL AND MEDIUM ENTERPRISES

2.1. Definition of SMEs

There is no single, uniformly acceptable definition of a small firm (Storey, 1994). However, some definitions are very depending on criteria such as number of employees and turn over. In 1971 Bolton Report (Dawes & Haydock in Frank, 1999) attempted to overcome the problem of small firm definition by formulating what it called an ‘economic’ definition and a ‘statistical’ definition. Under the economic definition, a firm is regarded as small if it satisfied the following three criteria: they had a relatively small share of their market place; they were managed by owners or part owners in a personalized way, and not through the medium of a formalized management structure; they were independent, in the sense of not forming part of a large enterprise.

The Committee also formulated a “statistical” definition which was designed to address three main issues. The first was to quantify the size for the small-firm sector and its contribution to economic aggregates such as gross domestic product (GDP), employment, exports and innovation. The second purpose was to compare the extent to which the small enterprise sector’s economic contribution has changed over time. Thirdly, applying the statistical definition, this allows a comparison to be made among the contributions of small firms in one country with that of other nations.

Furthermore, there is a lack of consensus on how to define SME (Gibb, 1993; Curran and Blackburn, 2001) as each country defines SME differently. For example, in the US and Canada, SMEs are generally defined as firms with fewer than 500 employees. In Japan, different headcount ceilings are used for manufacturing (up to 300 employees), wholesale (up to 150) and retail (up to 50).

In this thesis we use the classification given by the Commission of the European Communities (2003/361/EC 2003). According to the European Union (2003), an SME is an enterprise with fewer than 250 employees and a turnover no more than 50 million Euros or a balance sheet total of no more than 43 million Euros. Small enterprises employ less than 50 and micro enterprises less than 10 employees.

2.2. Characteristics of SMEs

SMEs are always one of the remarkable subjects for the researchers. It may be distinguished from larger firms by a number of key characteristics. Researchers have drawn some characteristic for the SMEs. Characteristics often discussed as typical of SMEs are as followed:

Limited resources (Welsh and White, 1981). A small and medium enterprise generally has limited resources, which means they did not have money to purchase the required machinery and to hire many workers. This is extremely true for new starts-up due to an absence or lack of track record on the firm to entice potential investors and bankers. Hence, it is highly dependent on the capability of the owner to generate resources.

Informal management style (Kotey, 1999 and Slade, 2005). For small and medium enterprises, the management is usually informal. The owner has to do almost everything and employees are normally expected to be able to duty as generalists as there is no clear division of tasks.

Flexibility (Aragon-Sanchez and Sanchez-Marin, 2005). The enterprise has more flexibility to adapt to changes in the environment due to its size and informal structure. It is also vulnerable to grow in the enterprise environment. For example, any changes in government policy or technology might have a strong influence on the firms since instant changes require additional resources or capital. This might become a constraint to the firms to compete and sustain itself in the market.

Dependence on individual decision makers (Feltham and Barnett, 2005). The firms are managed and operated by the owner. The entrepreneurs of the business lead the company and play a role as both employee and employer. The growth of the firms is determined by the owner. Decision making is commonly done by the owner.

3. INTERNATIONALIZATION

Different approaches and perspectives have been contributed to the literature firm’s internationalization (Morgan and Katsikeas, 1997), and these issues have been researched over three decades (Etermad, 2004). For instance, a gradual perspective of SME internationalization is explained in the Uppsala Model, and the Finnish-POM Models (Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977). The other perspective is that SME internationalization is explained by an economic view (Dunning, 1977), and another view is described by a network approach (Kenny and Fahy, 2004; Majkgard and Sharma, 1998; Welch and Welch, 1998). The last view is described as the International New Venture perspective (Oviatt and McDougall, 1994; Zahra, Ireland, and Hitt, 2000). All these models are briefly discussed below.

Of the gradual approaches, the Uppsala Model initiated by Johanson and Wiedersheim-Paul (1975) and further developed by Johanson and Vahlne (1990 and 1977) is widely used to describe pattern of small firms’ internationalization (Andersson, 2004). In Uppsala Model, they make the distinction between state and change aspect of internationalization variables. They argue that the present state of the firm is the important factor in explaining future changes and subsequent stages. The state aspects are represented by the firms “market commitment” to the foreign market and the “market knowledge” about foreign market and operations. The change aspect is seen as “commitment decision” and the performance of “current business activities”.

The concept of market commitment is assumed to be composed of two factors: Firstly, the amount of resources committed, for example, the size of investment in the market (marketing, personnel, organization etc.); Secondly, the degree of commitment, for instance, the difficulty of finding an alternative use for the resources and transforming them to practice.

Market knowledge is seen as information about markets and operations which is somehow stored reasonable retrieval in the minds of individuals inside the firm, in computer memories or in written reports. International activities require both general knowledge about market operations and market specific knowledge.

Current business activities are the prime source of experimental knowledge for the firm. It could be argued that experience could be gained alternatively through the hiring of the personnel with experience or through advice from persons with experience.

Commitment decisions depend very much on experience since they are a response to perceived uncertainty and opportunities on the market. Decisions to commit further resources to specific foreign operations will more often be taken if experimental knowledge increases. This implies that additional market commitment as a rule will be made in small incremental steps because its takes time to gain experimental knowledge about foreign markets.

The Uppsala model concentrates on the gradual acquisition, integration and use of knowledge about foreign market. According to this model, lack of knowledge is an important obstacle in the development of international operations and such knowledge can be acquired mainly through operations abroad. The gradual acquisition of knowledge increase foreign commitments.

The second gradual model distinguishes three dimensions of internationalization (Luostarinen, 1979). First is Product (P), which describes ‘what’ in terms of the firms’ goods, services, know-how and systems. Second is the Operation mode (O) which relates to ‘how’ firms operate such as through agents, subsidiaries, licensing and management contracts. Third is Market (M), which describes ‘where’ in relation to the selection of markets and takes into account political, cultural and physical differences. The ‘organizational capacity’ dimension was a later addition to describe organizational structure, resources, finance and personnel (Welch and Luostarinen, 1988). Nonetheless, neither gradual model addresses the issues of networking.

The networking view concentrates on non-hierarchical systems where enterprises invest to support and monitor their role in international networks. Referred to as the network perspective, this research draws on the theories of social exchange and resource dependence, and emphases on firm performance in the context of a network of interorganisational and interpersonal relationships (Axelsson and Easton 1992). Such relationships can include customers, competitors, suppliers, private and public support agencies, and friends, family and so on. Organizational boundaries therefore incorporate both business and social relationships.

The theory suggests three methods of internationalization: International extension, explains how a company initially establishes connections with networks in other countries; Penetration, the firms develops the relationships that arise from those networks, which is described as the penetration method; International integration, the time when the company integrates the networks in different countries.

Based to this research, internationalization determined by on an organization’s set of network relationships rather than a firm-specific advantage. Therefore, externalization (rather than internalization) occurs. The network approach offers a complementary perspective to FDI theory given the latter does not account for the role and impact of social relationships in business transactions (Granvetter 1985). Also, internationalization decisions and activities in the network approach appear as patterns of behavior influenced by various network members, while FDI theory assumes coherent strategic decision-making. The network perspective introduces a “more multilateral element” to internationalization (Johanson and Vahlne 1992, p.12). Interestingly, this perspective has evolved from Johanson and Vahlne’s early work, and reflects their ongoing research exploring the management of foreign market entry. For example, their (1992) study of internationalization in the situation of exchange networks found that even if foreign market entry is the gradual process (supporting the Uppsala model), it follow from interaction, and the development and maintenance of relationships over time. These findings support Sharma and Johanson (1987), who found that technical consulting firms operate in a network of connected relationships between organizations, where relationships become “bridges to foreign markets” and offer firms with the prospect and incentive to internationalize.

The International New Venture theory emerged in the mid-nineties in response to the recognition that many firms do not go along with the gradual models in their internationalization process (Etemad, 2004a; Kenny et al., 2004). These firms are called ‘Born Global’ (Knight and Cavusgil, 1996; Rennie, 1993), whilst Oviatt et al., (1994) identify them as ‘Global Start-ups’ or ‘International New Ventures (INV) firms. This model focuses on the age and not on the size of the firms and suggests that the INVs retain unique assets and capabilities that enable firms with limited resources to venture faster into foreign markets.

Furthermore, Coviello and McAuley (1999) argue the internationalization happens gradually. With his extensive study of internationalization, Gripsurd (1990) points out that there is a three-stage model describing how an organization develops its international business study. First, the organization starts as a “potential exporter”, where they do not yet have the opportunity to export any of their goods or services. During this stage, the organization is still producing and distributing its products in the domestic market. Moreover, in the second stage, the firm is known as a “passive exporter”, where it has the opportunity to export its goods or services. However, they only represent upon request; therefore, there is no self-initiative. To continue, in the third stage, the firm is known as an “active exporter”, when it is increasing export activities abroad. With respect to the explanations, it is clear that Bell (1995) and Gripsrud (1990) mainly focus on the idea that internationalization develops in a number of stages. It happens gradually, not just with a single movement.

3.1 Process of Internationalization

There are six steps that have been used for understanding about the internationalization of the small and medium enterprises. This process is not mattered only for the small and medium firms but applied in larger firms as well (Moberg and Palm, 1995 in Jennie and Zetterwall). These steps involved respectively, why internationalization (motives), company situation (SWOT), what (product and service), where (market selection), how (entry modes), and when (point of entrance).

3.1.1. Find out motives for internationalization.

When a company goes internationalization it is often driven by certain stimuli or stimulus. Sometimes external and internal pressure such as competition, excess capacity of resources and a small and decline home markets put pressure on the company for becoming international. Other time firms go international because they want to. They have a unique product that is not widely available from international competitors or a technological advance in a special field (Czincota & Ronkainen, 1995).

3.1.2. Clearly define the current situation of the enterprise (through conducting a SWOT analysis).

To enter a foreign market does not mean new opportunities, but also a totally new situation with new environment and cultures. To find out whether a firm is ready to meet and handle this new situation or not, a complete analysis of the company situation has to be done by using SWOT analysis (Thompson & Strickland, 1995, in Jennie & Zetterwall). Company’s economy, production, personnel, marketing, international experience and language capabilities are some factors those must be analyzed into SWOT analysis (Moberg & Palm, 1995 in Jennie & Zetterwall). Potential markets and marketing environment have to be analyzed to find attractive opportunities and avoid environmental threats.

3.1.3. Decide on the product or service enterprise wish to integrate in this process.

The success of the firm depends on its products offered and on how well the firm is able to differentiate the product or service from what the competitors offer. When a company enters in a new market it should start with a small share of the assortment, mainly quality products or already established products.

3.1.4. Select the right market to penetrate.

When firm decides to enter foreign markets, the customers and market conditions are quite different from their home market. That stage firms need to enhance international marketing strategies considering different aspect of the marketing such as product, price, promotion, place, logistics, competition, and so on. The firm’s strategies decided, whether use to the existing product or develop a new product to serve the foreign market. A firm operating the international marketing should not only identify the product for different markets but should also develop suitable strategies for growth such products. Whether a single standardized can be offered worldwide or a customize product need to be develop for each market is the most significant product decision that firms has to do while operating in international markets. In the international market, decision related to quality, packaging and labeling of product require specific attention and consideration. Product strategy of the firm in international markets is often influenced by cultural context (Joshi, 2005). Therefore, it is a responsibility of the manager/owner to know the taste and preferences of the customer in a target market, and formulate the product strategy according to the marketing conditions. Sometime color, size, and packaging of the product play vital role in the success of the firm (Joshi, 2005).

3.1.5. Decide on mode of entry.

After the selection of the market has been done, the company has to decide how to approach the foreign market. A firm can, for example choose to sell directly to the final consumer, to sell indirectly through distributors and/ or agents, or to produce locally in foreign countries. The choice depend on factors such as, resource of the exporting company, the characteristics of the product, the goal of the internationalization, the distribution culture in foreign markets, and the number and demand of the customer (Czinkota & Ronkainen, 1995).

3.1.6. Find the right moment to do it.

Furthermore, a company has to determine when to enter the foreign market. The company must be sure that market is ready, that the company has enough resources and the right market channel and product for specific market (Moberg & Palm, 1995 in Jennie & Zetterwall).

Meanwhile, Masurel and Montfort (2006) explored the changes between stages in the life cycle of small and medium-sized enterprises in the professional services sector. They distinguish four different, subsequent stages in the life cycle. 1. Starting; 2. Growth; 3. Maturity; 4. Decline. They found that the first three stages represent an increase in diversification in sales, increase in differentiation of labor force, and increase in labor productivity. In the last stage, the diversification in sales, differentiations in labor force, and labor productivity all drop. As growth as one crucial key in this life cycle, SMEs starts internationalization which has become more and more relevant to the competitiveness of enterprises of all sizes. Recently, SMEs that start with a global strategy can change swiftly to take advantage of cross-border activities, which offers chances not only for revenue growth but also the exchange of knowledge and the development of capabilities, thereby strengthening the long-term competitiveness of the firm.

3.2. The Models of Internationalization

Tookey (1969) developed an early example of modeling progression through various steps, pre-dating the Uppssalla model; this involved the advancement of the firm from exporting, to international marketing and finally international business The behavioural approach of the Uppsala views internationalization as having four stages (Johanson and Wiedersheim-Paul 1975, Johanson and Vahlne 1977) while Bilkey and Tesar (1977) identify six steps, Aijo (1977), Cavusgil (1980) and Reid (1981) identify five, while Czinkota (1982) identifies six.

Johanson and Wiedersheim-Paul (1975), Johanson and Vahlne (1977)

Stage 1: No regular export activities; Stage 2: Export via agents; Stage 3: Establishment of a sales subsidiary; Stage 4: Production or manufacturing in a foreign market.

Bilkey and Tesar (1977)

Stage 1: Management not interested in exporting; Stage 2: Management willing to fill unsolicited orders but not effort made to explore feasibility of actively exporting; Stage 3: Management actively explores feasibility of active exporting; Stage 4: Firm exports experimentally to psychologically close county; Stage 5: Firm is now an experienced exporter; Stage 6: Management explore feasibility of exporting to psychologically distant countries.

Cavusgil (1980)

Stage 1: Firm sells only in domestic market; Stage 2: Pre-export phase, the firm searches for information and evaluates feasibility of starting to export; Stage: Experimental involvement, firm begins exporting to psychologically close country; Stage 4: Active involvement, exporting to more new countries, direct exporting and increase in sales volume.

Czinkota (1982)

Stage 1: The completely uninterested firm; Stage 2: The partially interested firm; Stage 3: The exploring firm; Stage 4: The experimental firm; Stage 5: The experienced small exporter; Stage 6: The experienced large exporter.

Reid (1981)

Stage 1: Export awareness, problem of opportunity recognition and arousal of need; Stage 2: Export intention, motivation, attitude, beliefs and exporting about exporting; Stage 3: Export trial, personal experience from limited exporting; Stage 4: Export evaluation, results from engaging in exporting; Stage 5: Export acceptance, adoption of exporting or rejection of exporting.

4. DRIVERS AND BARRIERS TO INTERNATIONALIZATION

Drivers of Internationalization

There must be some motivations behind the decision to go international. Leonidou, Katsikeas and Percy (1998) determine that organizations are typically willing to market themselves for four reasons. First, it may be due to slow growth in the domestic economy as evidenced by a reduction in the number of the home market opportunities. Consequently, an organization will look for other opportunities by entering new international markets (Chandra, Styles and Wilkinson, 2009). Second, there may be a trade deficit followed by currency devaluation and a number of export restrictions. Third, the world trading system may become more liberalized leading to a minimization of international market entry barriers. Forth, it might be more intensive global competition in the global business environment.

All these trends have developed the dynamic of exports. The creation of exports is not only due to the self-initiative of a company, but also by the government. This is also confirmed by Gripsrud (1990) who suggests that the government of a country may believe their firms to think globally by expanding their service areas to foreign markets, due to the expectation of an increasing volume of exports from the country. Thus, it will help the economy of that country.

Furthermore, OECD (2009) also analyzed motivations for small and medium-sized internationalization including growth motives, knowledge-related motives, network or stoical ties and domestic or regional market factors.

4.1.1 Growth Motives

Growth opportunities associated with international markets were identified as a key driver of firm internationalization in several recent studies (Orser et al., 2008), (Rundh, 2007), (Barnes et al., 2006), (Reynolds, 2007). The possibility of growth in other markets and increased profit opportunities from international expansion were highlighted as key stimuli for exporting. Firms’ overseas venturing decision also seems to be motivated by a need for business growth, profits, an increased market size, a stronger market position, and to reduce dependence on a single or small number of markets. The growth motives is very closely linked to maximizing returns and minimizing costs in purchasing, production and sales.

4.1.2 Knowledge-related Motives

Garvey and Brennan (2006) suggest that knowledge assets both push and pull SMEs into international markets. The ‘push’ dimension pertains to the importance of managers’ previous international experience and related management capacity factors. There are also related findings on the internationalization triggering effects of knowledge aspects, including R&D investment, innovation capabilities, unique product or technology, and language skills; and firm resource base, as indicated by such proxies as size, age, and experience.

4.1.3 Network or Social Ties and Supply Chain Links

Camara and Simoes (2008) have highlighted the importance of network/social ties and supply chain links in triggering SME’s first internationalization step and extending internationalization processes. The research studies particularly reported the stimulating effect on export activity of firms’ soft assets, including social and network capital, some of which may have accrued through managers’ immigrant background and associated links.

4.1.4 Domestic or Regional Market Drivers

There is also support from recent relevant research (Lopez, 2007), (Staoian, 2006) on the push effects of firms’ limited or stagnating domestic market on internationalization behavior. The enterprise differed significantly in their export tendency, with export propensity increasing in regions with less favorable domestic conditions, local incentives to export and good export infrastructure. Recent evidence from Chile and Indonesia further suggest a greater tendency to export among firms from sectors characterized by high levels of export intensity and presence of foreign buyers. The Indonesian finding on the importance of foreign buyers’ presence is significant as it reinforces the earlier observed need to boost SME’s role in global value chains through facilitating their integration into production or supply systems of foreign affiliates of larger firms (OECD, 2008).

4.2. Barriers to Internationalization

In order to identify the term ‘internationalization’ with the main focus of the thesis, Coviello and McAuley (1999) stated that not only large organizations, but also small and medium sized organizations, can become global. In addition, they also state that the international expansion of an SME is certainly useful when it comes to contributing to the economic growth and prosperity of a country. However, one thing that should be remembered is that not every SME is ready to expand into international markets. Despite the fact that they have small or medium sized organizations, there must be some factors and limitations in terms of finding global market opportunities.

There have been a number of studies which have focused on the barriers to internationalization (Leonidou, 1995; Campbell 1994; Katsikeas and Morgan, 1994, Morgan 1997). The barriers to internationalization can be categorized into five broad areas: financial, managerial, market based (including both the domestic and international markets), industry specific and firm specific. It is widely acknowledged that barriers to internationalization can exist at any stage in the internationalization process (Morgan, 1997). Furthermore, the perception of the barriers can vary in intensity depending on the degree of internationalization of the individual firm (Burton and Schlegeliclch, 1987; Cavusgil, 1984; Kedia and Chhokar, 1986; Katsikeas and Morgan, 1994).

4.2.1 Financial Barriers

Limitations in finance and related physical resources have continued to be highlighted as a leading barrier to the internationalization of SMEs. It including financial barriers in general (Campbell, 1994; Burpitt & Rondinelli, 2000), resource availability ( Karagozoglu & Lindell, 1998), cost of operating overseas (Bilkey, 1978), and limited access to capital and credit ( Buckley, 1989; Coviello & McAuley, 1999). The pertinent evidence include the observed disadvantages faced by enterprises international new ventures or early-stage SME exporters, relative to their more established counterparts, in regard to accessing operating and term loans and the terms thereof. Lack of capital requirements and other firm resources and limited access to key infrastructure were also reported by SMEs.

4.2.2. Managerial Barriers

Difficulties arising from limited managerial knowledge base emerge as a top barrier to SME internationalization in several recent surveys. Managerial barriers are including managerial attitudes (Andersson, 2000; Burpitt & Rondinelli, 2000), lack of international experience and skills (Karagozoglu & Lindell), limited management time (Coviello & McAuley, 1999; Buckley, 1989), commitment, and partnership difficulties. Managerial risk perceptions and lac