Size is in the eye of the beholder

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Size is in the eye of the beholder

A research into the qualitative characteristics of small businesses in

the Netherlands

Petra Dian de Vries

M.Sc. Business Administration Small Business & Entrepreneurship

Final version September 2011

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Picture on the front page (Arbouw, E., 2008. UK 09, Groningen.): An Ames room, invented by Adelbert Ames, Jr. in 1934. An Ames room is a room with distorted dimensions which seems like a normal cubic shaped room to the viewer. But when two similar sized objects are placed in different corners of the room, one object appears to be larger than the other. This optical illusion is created in our minds because our eyes will automatically correct the perspective to what we normally see. This picture is a good example for underlying thesis: depending on how you look at it, firm size can be small or large, depending on which perspective you choose to look at it.

Preface

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Summary

Although small businesses have existed for over 4000 years, there has been surprisingly little research on the concept of small business. Definitions of what a small business is vary and contradict each other greatly, even within the same country. In this research an attempt is made to shed some light on the usability and accuracy of most commonly used existing definitions of small firms, in order to help create a better definition. To do so, we created the main question of our research: Which qualitative and quantitative firm size characteristics could be used in the Netherlands for small businesses and can these characteristics be used to distinguish between micro, small and medium sized businesses? To answer the main question, the following sub questions were formulated:

1) What determines firm size according to existing literature?

2) What qualitative small firm characteristics are used in the literature, in both the Netherlands and other countries?

3) What quantitative small firm characteristics are used in the literature, in both the Netherlands and other countries?

4) Which characteristics should be part of a new definition and can they be used to distinguish between firm size categories?

Sub questions one, two and three have been answered by conducting a literature research. In order to answer sub question four, we have created a questionnaire to empirically test the literature findings from sub questions one, two and three.

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literature, the European Commission guideline seems to be best applicable for this research, because this is the most exhaustive definition which includes FTE’s, temporary workers, the owner/manager(s) and other co-owners who work in the firm. The definition excludes trainees, students who are on a special learning agreement and the time taken for maternity leave. To answer sub question four, we have run statistical tests on the data we gathered from 113 respondents. First, all respondents were sorted into the micro-, small- or medium-sized category based on number of FTE’s and the European Commission guidelines. Then the responses per size group were compared to see if different size groups responded differently to each question. The result from the statistical tests is that ownership/management, decision-making, independence, informality, finance and market share could be useful in a small business definition. The conclusion of the research is that a small business definition should consist of the following variables:

- Ownership and management are in the same hands

- Decision-making is in the hands of one or two person, of which at least one is the owner - The firm has a relatively small market share

- The firm is funded with private capital - The firm is run in an informal manner - The firm is independent

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1.

Introduction

“Small enterprises are easier to describe than to define in precise terms. In other words, you will know one when you see one.”

(McMahon, Holmes, Hutchinson & Forsaith, 1993, in: Holmes & Gibson, 2001)

1.1 Motivation

The history of small businesses can be traced back to at least 4000 years ago, when the first known piece of writing appeared on how bankers loaned money at interest (Barrow, 1998). Small businesses have been the innovative backbone of most economies and they flourished in nearly all ancient cultures. Because of fraud, poor quality and cheating by their owners, small businesses got a bad image. Although small businesses have made up a large part of our history, few people are excited about the subject, until recent years (Barrow, 1998; Bridge, O’Neill & Cromie, 2003).

According to a lot of studies, small businesses account for a large amount of the employment in almost all countries (Van der Wilde, 1987; Barrow, 1998). In most developed economies anything from 6% to 15% of the working population are small-business owners (Barrow, 1998). Over half of all the people in commercial and industrial employment in the United Kingdom work in a small business. In Italy 90% of all industrial firms are small businesses and account for 84% of total employment. In Denmark 92% of all manufacturing firms are small businesses employing 43% of the workforce (Barrow, 1998). In the Netherlands, out of the 360.000 active firms in 2001, 98% employed less than 100 employees (Mosselman, Meijaard & Brand, 2003). So the lion’s share of firms can be considered small. Paradoxically, most literature on businesses is written about large firms, which only make up for 2% to 10% in the average developed economy. Apart from the employment perspective, small businesses have more advantages (Scott, 1991, in: Holmes & Gibson, 2001):

- They can react fast, are flexible, and are close to the customers. - They perform important sub-contract functions.

- They can perform an important import substitution role by producing small scale products. - They are said to be more innovative, which is good for getting new ideas into an economy. - Small firms are usually locally owned, and can counterbalance centralised power distribution

in a society.

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Therefore, the field of small businesses has been an intriguing one for years for researchers, scholars, government bodies, entrepreneurs and everyone else involved in entrepreneurship.

1.2 Relevance

No-one seems to be able to adequately grasp the concept of small businesses. The most common used way to differentiate firms is on the basis of quantitative characteristics, for instance number of employees, turnover or profit per year. Governments that introduce small business programs that are based on such quantitative definitions may not effectively address the right businesses. For instance, large firms who make little profit can be considered small by such a definition and vice versa. Moreover, it appears that every country uses different standard scales when it comes to these quantitative definitions. A good example is the number of employees. In The Netherlands, a small firm has less than ten employees; a medium sized firm has between 10–100 employees and a large firm over 100, according to the CBS (www.cbs.nl, 2008). According to MKB-Nederland (www.mkb.nl, 2008), a small firm has less than 50 employees, a medium sized firm has 50-250 employees and a large firm has over 250 employees. Even within the same country different measures are used.

Another approach would be to use qualitative characteristics. Nooteboom (2003) states that small businesses are characterised by small scale, personality and independence. Informality and lack of business structure is also often mentioned in reference to small businesses. But what is exactly a small scale? Based on what criteria? How would personality be measured? When is a firm independent? With the current mainstream literature it looks like all small businesses have the same characteristics and can thus be perceived as being homogenous. In reality, some large businesses can be characterised as being small, according to these measurements, whereas some small businesses may be characterised as large businesses. In this scenario, government programs do not address the right firms. Also, creating a generally accepted definition is very beneficial for the academic world: (previous) research outcomes in one country can be better compared with research outcomes in other countries. More research into this subject of qualitative firm characteristics is needed, so that academics worldwide can improve the usability, validity and reproducibility of their research, government intervention programs can be better formulated and in the end the prosperity of small businesses can be enhanced.

This research will be based on a research by Holmes & Gibson (2001). The Australian Small Business Coalition wanted to research a base definition of small business. The research paper had to possess the following elements:

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- An analysis of alternative definitions of small business such as defining small business by number of employees, by turnover, by proprietorship or a combination there of.

- A recommendation on a universal definition of small business that is compatible across a diverse range of policy areas.

It is recognised that no one definition of small business will be ‘the best’. Their paper should provide some basic definition, which can be completed with additional requirements for specific needs, such as employee numbers, turnover and etcetera.

After complying with the first two requirements, Holmes & Gibson propose a definition out of nowhere. They state that the elements of the definition capture the key characteristics of a small business and that a small business has fewer than twenty employees. But how did they decide what the key characteristics are? What are their reasons for choosing twenty employees as a cut-off point? Holmes & Gibson seem to make a very large leap from the theory they used, to the definition proposed.

In this research, the Holmes & Gibson approach is loosely followed. First we take a look at what determines firm size and relate that to small firms. Then we will review qualitative characteristics on which small firms distinct from large firms. Third, the existing qualitative small business definitions in use will be reviewed. After that, the quantitative small business characteristics of employees are researched. We only look at employees because numbers of employees are most commonly used in defining small businesses and within the numbers of employees criteria are numerous variations in which numbers of employees can be measured.

The big difference with our research and the Holmes & Gibson research is that in our research the methodology and reasoning is much clearer. Also, we will test our hypotheses empirically to see if the mentioned small firm characteristics actually apply to small firms and whether it is possible to distinguish firm sizes with these characteristics.

1.3 Problem statement

Research objective

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Main question

The main research question is: Which qualitative and quantitative firm size characteristics could be used in the Netherlands for small businesses and can these characteristics be used to distinguish between micro, small and medium sized businesses?

Sub questions

In order to answer the main question, the next sub questions are derived: 1) What determines firm size according to existing literature?

To answer our questions, we will first conduct a literature research on small business theory, commonly used small business definitions and extract the most mentioned variables from those definitions. This will be done for both qualitative as well as quantitative definitions. With the findings from the literature research we are able to answer sub questions one, two and three. The qualitative findings will then be tested in a quantitative empirical test by means of a questionnaire. The items in the questionnaire will be derived from our findings in the literature research. We will test with a few hypotheses whether the most mentioned variables in literature actually return a significant difference in responses between three different firm size groups; micro, small and medium. If so, the variable can be a part of the small firm size definition. If not, the variable will be discarded.

1.4 Structure of the thesis

In this chapter, we have explained the motivation for and relevance of doing this research. Deriving from the motivation and relevance section, the problem statement with the research objective, the main question and the sub questions needed to answer the main question is formulated.

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2.

Theoretical Framework

Introduction

In this chapter we will take a look at the existing literature on small businesses. We will specifically take a closer look at what determines firm size and how these determinants apply to small firms. Next in chapter 2.2, we will research which qualitative variables are commonly used in small business definitions. In the end of this chapter in chapter 2.3, quantitative variables in small business theory are researched.

2.1 Determinants of firm size

In the field of business administration, two main perspectives are the start-off point for many theories about size of firms. These perspectives are the outside-in perspective and the inside-out perspective (De Wit & Meyer, 2004). The outside-in perspective believes that firms should not be self-centered, but should continuously take their environment as the starting point when determining their strategies (De Wit & Meyer, 2004). By picking up on market trends and changes these firms can adapt early to the expected market opportunities. The inside-out perspective believes that strategies should not be build around external opportunities, but around a company’s strengths (De Wit & Meyer, 2004). By building an extended resource-base, a firm can access unfolding market opportunities in the medium and short term. In figure 1 these perspectives are demonstrated.

Figure 1 Outside-in and Inside-out perspective (De Wit & Meyer, 2004)

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The outside-in perspective is a market-driven approach. For a firm that is market-driven, the

competitive position (Besanko, Dranove, Shanley & Schaeffer, 2004) in the market is important. For a

firm that is resource-driven, the resource-based view is important to determine the firm’s strategies (Rangone, 1998; Barney, 1991). In this chapter, these two theories will be related to (small) firm size.

2.1.1 Outside-in perspective

Competitive position

The most common way to establish a firm’s competitive position is to measure its market share (Daft, 2004). Market share expresses in percentages how many customers a firm services out of the total amount of potential customers (or revenues out of the total possible revenues from the entire market). When a firm has a high market share, i.e. the firm serves a high percentage of all potential customers, it can benefit from economies of scale and scope. Firms that are able to benefit from economies of scale and/or scope, normally operate in highly dynamic and unstable environments (Daft, 2001). In a dynamic environment, there are lots of elements influencing the market. An unstable environment is an environment in which there are continuous changes. In order to survive in such competitive conditions, firms have to produce at the lowest possible cost and create economies of scale and/or scope. Therefore, the large firm cannot offer every product a customer wants; they only produce mass goods, with little variation possible in the end product. Small firms can benefit from this fact by producing these small scale or custom made products. That is also the reason why small firms can play an import substitution role. Instead of importing small scale products from a different region (where these products are being made on a large scale,) small businesses can make these products for their home market. Small firms tend to operate in stable, simple environments with few changes and influences (Daft, 2001). A simple and stable environment in itself attracts other firm starters and which leads to a small market share for everyone operating in that market. The need for survival in such markets is also lower, because there are not many influencing or changing market elements. The lack of need for hierarchy is also characteristic for simple and stable environments: there is no use for rendering account in environments in which little changes.

Small firms and competitive position

Most small firms capture only a small part of the potential market. That is because

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- Small firms generally operate in simple and stable environments, which attract more small firm owners and divide the market into even smaller shares.

- In simple and stable environments, there is not as much need for hierarchy as in more complex environments. The firm owner can manage all aspects of the environment by himself, whereas in complex environments it is useful to have other managers whom each control an aspect of the environment and render account to the firm owner.

(Dis) economies of scale and scope

Economies of scale occur when an increase in production volume causes decreasing average costs of production. Economies of scope occur when an increase in the diversity of products produced decreases the average costs of production (Besanko, Dranove, Stanley & Schaeffer, 2004; Bernardt & Muller, 2000; Mugler, 1993). This advantage comes from indivisibilities: indivisibilities are fixed costs which cannot vary with the production output. An example would be a machine, an employee or a building. So, with few products, the average cost would be relatively high (fixed costs + variable costs). When more products are made, the same amount of fixed costs can be spread out over more products, thus lowering the average cost per product. This process can only continue until maximum capacity is reached. Then, the owner has to decide to invest in a new machine, employee or building.

Economies of scope occur when an increase in the diversity of different products produced, causes average costs of production to fall (Bernardt & Muller, 2000). A reason for this can be complementaries: there are for instance residual materials of production. One can think of energy that follows from production that can be used for heating the building. Another complementary could be risk spreading, by both importing and exporting. There could be complementaries in time, by producing products which have different demand cycles, like ice cream and hot chocolate. Also, new products can benefit from the already established brand name of the first product, or from the same technology.

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Small firms and (dis)economies of scale and scope

Small firms can benefit from diseconomies of scale and scope when:

- They can provide products or services that are too costly for larger firms to create due to lack of market demand. Large firms usually became large because of economies of scale and/or scope (Holmes & Gibson, 2001).

- Entrepreneurs who own smaller firms may not wish to grow large, because they are satisfied with the lifestyle a small firm can support (Bridge, O’Neill & Cromie, 2003). They are likely to choose a niche market which can sustain their business and lifestyle.

- Small firms may not have the managerial capacity to seize the possibilities for economies of scale and scope

- Small businesses lack the financial capacity to invest in labour, machinery and buildings, which can bring economies of scale and scope.

Transaction Cost Theory

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has access to more relevant information regarding the contract than the other party. Asymmetric information can lead to opportunistic behaviour, where one party tries to take advantage over the other party. The costs of minimalising bounded rationality, difficulties specifying measurements or performance and asymmetric information are transaction costs (Besanko, et al., 2004). If the transaction costs are low, outsourcing can be attractive to firms who have generated economies of scale. If transaction costs are high, it is better to create the products or services in-house.

Small firms and transaction cost theory

Small businesses come into existence or grow larger because of transaction costs:

- A small firm can originate when the addition of the firm to the market lowers transaction costs in comparison to the current market’s transaction costs.

- Small businesses are likely to experience relatively high costs for transactions and therefore are more expected to do everything themselves, which gives them the possibilities of benefiting from economies of scale and scope and grow.

- Another reason for keeping everything in-house might be the need for independency of the entrepreneur. In chapter 2.2, there will be a further elaboration on independency.

The above mentioned theories have an outside-in perspective; the next section is about the inside-out perspective, starting with the resource-based view of the firm.

2.1.2 Inside-out perspective

Resource-Based View of the Firm

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1) Qualified personnel

A quarter of all SMEs have often or from time to time experienced difficulties in filling vacancies (European Commission, 2000). Recruitment problems are perceived equal for low skilled to semi-skilled, as well as to highly skilled workers like technicians and engineers. Nearly a fifth of SMEs have given up trying to fill their vacancies. In order to acquire the right employees for the vacancies, SMEs can offer training to already employed staff. Training is more common in larger companies that employ more people.

2) Finance

Access to finance is an important problem for SMEs (Huang & Brown, 1999). The smallest firms experience most problems in attracting money (Braaksma & Smit, 2010). The financial system and financial habits of the country an SME operates in are mostly accountable for the financial structure of a company (European Commission, 2000). Size, age, profitability and sector have less influence on the financial structure. In almost all European Union countries, access to finance is mentioned in the top three of important constraints on performance. The smaller the enterprise, the more important the finance constraint is. They may have insufficient money or unsatisfactory credit conditions. There are three main reasons for credit suppliers to be hesitant to give credit: the uncertainty of expected returns, the benefits cannot be fully protected and the investment is usually indivisible (European Commission, 2000; Julien, 1998). SMEs can have disproportionate high administrative burdens, compared to larger enterprises (European Commission, 2000). Because of the relatively high administrative burdens, a small firm would need to attract more money in comparison to a larger firm to be able to fulfill these administrative obligations. Most administrative costs are fixed costs, which makes total costs higher when output is lower, as is the case with small firms. SMEs are required to provide fiscal, statistical and social security information (Snoei & Van der Linden, 2010). Also, creating or expanding a business is a lot of bureaucratic work.

3) Managerial capabilities

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4) Time constraints

Time constraints are intertwined with managerial capabilities: if all management has to be done by one person, this person can only spend so much time at each functional area (Bridge, O’Neill & Cromie, 2003). Larger enterprises can hire people to cope fulltime with one specific functional area.

Structure

A firm’s structure can also be a beneficial resource. Structure consists of the following elements (Daft, 2004).

- Formalisation: the amount of written documentation in an organisation. It includes written job

descriptions, policies, manuals, regulations, procedures and so forth. Small firms in general have almost no written documentation, whereas large firms have many written rules.

- Specialisation: this is also known as the division of labour. Specialisation is the degree to

which tasks in the firm are clearly divided into separate jobs. In large firms, personnel usually have a narrow set of tasks. In small firms, personnel usually perform a wide range of tasks, which are not clearly defined.

- Hierarchy: the hierarchy of a firm defines who reports to whom. In small firms the

owner/manager is generally the only person the personnel has to report to. The larger a firm grows, the more likely it is that personnel have to report to managers, who then have to report to the owner.

- Centralisation/decision making: If a firm is decentralised, business units can make large

decisions for themselves. In a centralised firm, the owner(s)/manager(s) make(s) all the decisions.

- Professionalism: is the level of training and formal education of employees. Training and

education is more common in large firms than in small firms, due to the specialisation of the jobs offered.

- Goals: Are the goals of a firm well defined or are they not defined at all? Small firm owners

may have not given much thought to where they want to be in a few years. In contrast, large firms usually have some goals defined on paper.

- Communication: Formal or informal. Larger firms exhibit more formal, longer communication

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- Specified contact moments: Small businesses in general have less, or none at all, specified

contacts moments than larger firms (Wilkinson, Dundon & Grugulis, 2007). In the UK, there are rules about information and consultation in firms, based on the number of employees in a firm (ICE regulations: Information and Consultation of Employees.) The rules state that small firms, (with less than 50 employees) can choose themselves how to inform the employees, whereas larger firms (over 50, 100 or 150 employees) have rules when to inform an employee about what and vice versa (Wilkinson, Dundon & Grugulis, 2007). Due to these rules, larger firms in the UK have more specified contact moments like weekly or monthly meetings. - Teams: In larger organisations with multiple layers of authority, the use of teams is more

essential than in small firms (Pitta, 2008). A lack of leadership in large firms can undermine the business successes, and therefore more teams (with its own leader) are created.

- Independence: If any part of the decision-making lies in the hands of another firm (in the case

of a holding, a concern, hard franchises and etcetera), then the firm is not independent. Small firms are more likely to be independent.

- Owner/manager: In small firms, the owner usually is the manager. This is due to the fact that

there is not enough money for specialised managers, or a need for specialised skills. The larger the firm becomes, the more likely it is the owner will hire a manager to do (some of his) tasks.

Small firms and the resource-based view

Small businesses can both benefit from their resources and experience drawbacks in acquiring enough resources.

- Small firms may have trouble getting loans from banks

- Experience trouble in finding the right personnel: training may be too expensive (professionalism) and tasks may not be clearly defined (specialisation)

- The majority of small business owner/managers lack some skills to be really successful in their business.

On the plus-side, the structure of a small firm can also be an advantage.

- Small firms tend to be less hierarchical; communication lines are short and informal, information is spread around quickly.

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Agency Theory

Agency (costs) theory is about the different motives of ‘principals’ and ‘agents’. It looks at how incentives should be directed in situations where people or firms co-operate in activities with a joint output. Principals can be owners or shareholders, agents can be employees or managers (Bernardt & Muller, 2000). Problems in agency relationships can arise due to moral hazard, imperfect observability and risk aversion (Besanko, et al., 2004). Moral hazard occurs when the agent and the principal have different preferences in actions or outcomes. For instance: an employee can choose to work hard like the boss prefers, or, when the boss is not looking, to hardly work at all. The employee would make himself less tired, while retaining the same salary. Moral hazard cannot be prevented through a contract. Imperfect observability is linked to moral hazard. If the boss would constantly monitor this employee, the employee would probably work hard all the time. But the boss then would not be able to do his or her own job satisfactory, so there are monitoring costs involved. A way to avoid this problem would be to install a piece rate contract: if the employee exceeds a specified level of output, (s)he gets certain level of salary. Costs to keep employees from not doing their job to the boss’ satisfaction are called shirking or slacking costs. Shirking/slacking costs and monitoring costs together are known as agency costs. The last problem is risk aversion. The agent may not be willing to take on as much risk as the principal would like. The agent can prefer a job where his income is assured, instead of taking a job in which his income is not assured, although the jobs have the same expected income. In this case, the principal must pay the agent more money to let the agent bear the risk.

The size of a firm is dependent on the effort of the people working in the firm. If all of the employees are slackers for example, the business will not do well and might even go bankrupt. But if all the employees are monitored carefully and work hard, the business has a higher chance of being a success and grows larger.

Small firms and the agency theory

The larger the firm, the more likely it is that agency costs become higher.

- In a small firm with few employees (if any at all, besides the owner/manager) people are nearer to each other, in both distance and overlapping tasks. Shirking or slacking is harder to do in a small firm because of this nearness.

Conclusion

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2.2 Existing qualitative definitions

Over the years, a lot of scientists have tried to come up with a definition of small businesses. In this chapter some of those definitions will be presented. Other definitions that are not mentioned here have largely the same elements and are therefore left out of this research. To increase comprehensibility, the elements of the definitions will be presented in table 3. The entire overview of the definitions used in this research can be found in appendix 1.

Quantitative characteristics can be formulated by means of numbers. Qualitative characteristics are based on more sources, with an emphasis on ‘understanding’ (Baarda, De Goede & Teunissen, 2005). In this case, understanding small firms. In this chapter an overview will be given on the most common known qualitative characteristics.

Small market share

The vast majority of small firms do not have a large enough market share to be able to influence the market they are operating on. By influencing, one can think of being able to significantly change the prices of products or services, or to significantly influence the total quantities of products or services being sold, on a national level (Bolton, 1978). Small firms face many competitors. Small market share is an ambiguous characteristic, because it depends on how the market is defined and the absolute size of the market. But the lack of any real power to affect the market is an essential small firm characteristic.

Managed in a personalised way

The owners actively participate in all aspects of firm management. Although there may be management layers in the firm, all principal decisions are still made by the owner(s), and not by the senior employees, foremen or supervisors (Bolton, 1978).

Independence

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Legal status

More than half of the small firms are not incorporated, but are sole proprietorships or partnerships (Bangma & De Ridder, 2004; Bolton, 1978). Incorporation of a firm depends largely on the industry it belongs to. For example, 80% of manufacturing firms in the United Kingdom are incorporated as limited companies (Bolton, 1978). As shown in table 1, in The Netherlands the same pattern exists (CBS, 2011). There are in total 844.445 firms in 2009. Almost half of these firms are a sole proprietorship (in Dutch: eenmanszaak). If the partnership and unincorporated company (in Dutch: v.o.f. and maatschap) statuses are included, over 2/3 of all firms in The Netherlands are not incorporated. The incorporated companies, like the limited liability company (in Dutch: besloten vennootschap or B.V.) and the joint stock company (in Dutch: naamloze vennootschap or N.V.), make up for only 1/3 of the total firms in The Netherlands.

Legal status Eenmanszaak V.O.F. Maatschap B.V. N.V.

Sole proprietorship partnership unincorporated limited liability joint stock

nr. of firms 427.830 130.515 41.260 216.345 805

Table 1 Number of firms in The Netherlands, based on legal status in 2009

(Source: CBS Statline, 2011, ‘Bedrijven; grootte, rechtsvorm en activiteit)

The following table shows the number of firms employing a certain amount of employees. Compared to table 2, it can be assumed that the smaller the firm, the less likely the firm is to be incorporated.

nr. of people working in the firm

1 2 3 to 5 5 to 10 10 to 20 20 to 50 50 to 100 100 >

nr. of firms 471.365 148.935 85.410 63.950 36.100 23.365 7.480 7.850 Table 2 Number of firms in The Netherlands, based on number of people working in the firm in 2009

(Source: CBS Statline, 2011, ‘Bedrijven; grootte, rechtsvorm en activiteit)

Ownership and management

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Finance and asset structure

Small firms prefer to supply the cash needed for the firm themselves (Julien, 1998; Bolton, 1978). If the owner’s resources are not sufficient, the next most preferred option is bank credit/debt. Small business owners are hesitant to apply for loan credit, because banks will charge them higher interest rates than they charge large firms (Julien, 1998).

To give an easy overview of the most commonly used characteristics, a table has been created:

R es ea rc h Y ea r M an ag em en t/ o w n er sh ip D ec is io n m ak in g P ri v at e ca p it al In d ep en d en ce In fo rm al it y M ar k et s h ar e P er so n al i n fl u en ce F am il y b u si n es s P er so n al s ec u ri ty L o ca l o p er at io n s F le x ib il it y O n e o u tl et CED 1947 x x x x x SBA (US) 1953 x x Wiltshire Committee 1971 x Bolton Committee 1978 x x x x x Peterson, et al. 1986 x x ABS 1988 & 2000 x x x x x x Oysteryoung & Newman 1992 x x Bell Report 1996 x x x x Holmes & Gibson 2001 x x x x x x x Bridge, et al. 2003 x x x x x Total 6 6 5 5 4 4 2 2 2 1 1 1

Table 3 the number of occurrences of small firm characteristics in definitions

Conclusion

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2.3 Existing quantitative definitions

In this chapter we will take a look at existing quantitative definitions of small firms, in order to be able to make a pre selection for which firms should be included in the empirical part of the research. For instance, firms that have a lot of employees and are therefore likely to be a large firm can be discarded from the research. For simplicity reasons, in this research only number of employees will be taken into consideration and not other quantitative elements such as turnover or balance sheet total.

Problems with the ‘number of employees’ criteria

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Conclusion

In the area of quantitative definitions, the addition of a micro firm category is relatively new to the field and not every definition takes this category into consideration. Most countries employ the same medium sized group as the European Commission (medium sized firms have less than 250 employees), but the boundaries for the small and micro class differ. In the Peterson, Albaum & Kozmetsky research, almost 90% of the respondents agree that a small firm should have less than 50 employees. Therefore, the research in hand will also utilise the European Commission classification. With the literature research from underlying chapter we can answer sub questions one, two and three:

By looking at the literature overview in chapter 2.1, firm size is determined by numerous variables: an example is competitive position. Competitive position can be looked at from both a market-driven (outside-in) and a resource-driven (inside-out) approach. Market-driven determinants are market share, the use of economies of scale and scope and transaction costs. Resource-driven or inside-out determinants are financial structure, qualified personnel (knowledge), managerial capabilities, structure (a combination of the following variables: hierarchy, formalisation, specialisation, decision-making, professionalism, goal setting, (in)formal communication, number of specified contact moments, the usage of teams, independence and ownership-management).

This sub question has been answered based on the literature research, in chapter 2.2. The most mentioned qualitative variables in the definition of small businesses in literature are ownership-management, decision-making, private capital (financial structure), independence and market share. Other less mentioned variables are personal influence, family business, personal security (financial), local operations, flexibility and having only one outlet.

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3.

Methodology

Introduction

In this methodology chapter we will explain how we will collect the data needed in order to answer the main question.

Research type

First, some hypotheses will be formed based on the literature research and a quantitative proxy will be proposed based on existing literature. Then the hypotheses will be tested empirically with a questionnaire. All the elements of the research proposal are placed in a research model for better understanding (figure 2).

Research model

Figure 2 Research model

The conceptual model that we will research in an empirical setting will be shown in figure 3. The linkages between the elements of this model are formed into hypotheses which will be tested in quantitative way in the next chapter. The elements in the conceptual model are derived from the

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literature research. These six elements are the most mentioned variables in small- and medium-sized businesses definitions and will form the six hypotheses.

Conceptual model

Figure 3 Conceptual model

The operationalisation of the variables and the questionnaire itself can be found in appendices 3 and 4. Appendix 3 has been created to give an easy overview of all the variables mentioned and an indication of where to find the questions to measure these variables in the questionnaire (which can be found in appendix 4).

3.1 Hypotheses

The hypotheses are derived from the literature research in chapter two. We have looked at eleven studies on definitions of small businesses and the six most mentioned variables in these definitions have been transformed into the following six hypotheses:

Hypothesis 1: It differs between firm sizes whether management and ownership are in the hands of one person.

We asked the respondents if the owner is the only manager of the business. This item is based on the studies by the CED (1947), Bolton (1978), the ABS (1988 & 2000), the Bell report (1996), Holmes & Gibson (2001) and Bridge, et al. (2003). There are two answer possibilities to this question: ‘yes’ and ‘no’. Firm size Independence Smaller market share Informality Funded with private capital Decision making in hands of

one or two people Ownership/

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Hypothesis 2: Decision-making is done differently between micro, small and medium-sized firms.

This item measures which people are involved in important decision-making. This question is based on literature from the Wiltshire committee (1971), Bolton (1978), the ABS (1988 & 2001), the Bell report (1996), Holmes & Gibson (2001) and Bridge, et al. (2003). Answering possibilities are ‘only the owner(s)’, ‘multiple persons, and among them is/are the owner(s)’ and ‘other people’.

Hypothesis 3: Micro, small and medium-sized businesses are funded in different ways.

The respondent is asked to express in percentages how the business is funded financially. Beck, Demirgüç-Kunt, Laeven & Levine (2008) found out that the smaller the firm (in terms of number of employees), the more likely it is that private capital is the main source of finance for the firm. Respondents were asked to divide 100% over the following options: ‘self-financed’, ‘financed through friends/ family’ and ‘financed through other parties’.

Hypothesis 4: The level of informality is different between micro, small and medium sized businesses.

Informality of a firm is based on the amount of written documentation and on the atmosphere of communication in a firm (Besanko, et al., 2004). This concept was measured with eight items, based on the Bolton committee (1978), ABS (1988 & 2001), Holmes & Gibson (2001) and Bridge, et al., (2003). A five-point Likert scale provided the answering options, ranging from ‘completely disagree’ (1) to ‘completely agree’ (5).

Hypothesis 5: The level of independence varies between micro, small or medium-sized businesses.

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Hypothesis 6: The micro, small and medium sized firm groups each have different market shares.

Most small firm owners do not know their exact market shares, but they generally have an idea if their firm performs better or worse in the market than their competitors’ firms. Therefore, respondents were asked to indicate whether their market share is smaller or larger compared to their direct competitors. A five-point Likert scale was provided ranging from ‘much smaller’ (1) to ‘much larger’ (5).

Other measuring instruments

Next to the aforementioned instruments, other items were added to the questionnaire to test if these items could contribute to the definition of a small firm. These items also come from literature research, but were less mentioned. Most of these items also contained a five-point Likert scale, to improve comparability. All items used in the questionnaire can be found in appendix 3.

Based on the most commonly used variables that have been found in existing literature on small firm definitions, a questionnaire is created (see appendix 4). By trying to think of as few as possible questions to measure each variable, we can measure all variables and not end up with a long, time consuming questionnaire. With this questionnaire we will test whether these variables actually play a role in measuring firm size, based on the answers of micro, small and medium sized firm owners. After the collection of the results, we can conclude which characteristics could be appropriate for a workable small business definition to distinct between micro, small and medium sized firms.. The results of all the answers to each question will be compared to existing literature. If the results support existing literature, the accompanying variable can be considered useful in a new definition. If the result does not support existing literature, we will discard the underlying variable as a possible element of a new definition.

3.2 Sample setting

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www.nationalebedrijvengids.nl (2009). Marktselect provides a random list of firms that comply with the given requested conditions, for example industry code and number of employees. We used www.google.com (2009) to find an email address for each firm. Because of the low success rate, we used www.nationalebedrijvengids.nl (translation: national firms guide) and sought businesses based on type of industry they are active in (e.g. agriculture). The big plus in using this website, is that firms who have entered the most contact information are shown first. This means that firms who have entered an email address are shown on top of the list. Firms selected for this research have less than 200 employees, based on the class-sizes used on the Marktselect DM-CD and used on the www.nationalebedrijvengids.nl website. Furthermore are the firms selected based on BIK-codes (Bedrijfsindeling Kamers van Koophandel): codes 010-750, 804 (other education, like driving schools and study mentoring), 923 (other arts and amusement e.g. dancing schools) and 930 (other services, e.g. hairdressers, manicure, etc.) will be included. The industry codes used in the sample setting are: BIK 0: Agriculture, forestry, hunting, fishery.

BIK 1, 2 & 3: Industry, including publishing companies. BIK 4: Construction

BIK 5, 804, 923 & 930: Wholesale, retail, catering industry, repair and other services, such as hairdressers, fitness instructors, driving schools, Dancing schools, etcetera.

BIK 60-649: Transport

BIK 65-75: Banking, insurance companies and other business services.

3.3 Data collection

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3.4 Measuring instruments

The hypotheses tested in this research will contain the following characteristics, based on their frequency in the reviewed literature (i.e. these are the most mentioned characteristics). If the different size groups in the empirical study show significant differences between each other in answering to the questions regarding these variables, the hypotheses will be accepted.

1) It differs between firm sizes whether management and ownership are in the hands of one person.

2) Decision-making is done differently between micro, small and medium-sized firms. 3) Micro, small and medium-sized businesses are funded in different ways.

4) The level of informality is different between micro, small and medium sized businesses. 5) The level of independence varies between micro, small or medium-sized businesses. 6) The micro, small and medium sized firm groups each have different market shares.

3.5 Data analysis strategy

Data analysis is done with the statistical program SPSS 17.0. First a data file was created: all items in the questionnaire must be defined in SPSS before any calculation is possible. Items were given a name, a description, a code and a measurement level (nominal, ordinal, interval or ratio). Some items were combined into one variable, because they measured one construct. In order to create a new variable which can adequately represent more items, Cronbach’s Alpha was calculated. An alpha score over 0.60 means the items in the measuring scale can be regarded as internally consistent. After that we have to decide which statistical tests we want to perform. We would like to know if a variable actually differs between the different size groups we have created based on EU commission guidelines. Because variables have different measuring scales, we used different statistical methods. Descriptive statistics - To calculate averages, standard deviations and frequency tables.

Cramer’s V - Cramer's V is a statistic measuring the strength of association or dependency between two variables. Cramer’s V can only be calculated for nominal variables.

Chi-square - Chi-square compares two or more samples to see if these samples differ from each other, based on expected or mean numbers. In other words: is there a significant difference in results for one variable between micro-, small- and medium-sized groups? Chi-square can be used for nominal, ordinal and interval/ratio variables.

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Kruskal-Wallis measures as well if there is a significant difference in results for one variable between micro-, small- and medium-sized groups. Kruskal-Wallis can be used for ordinal variables.

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4.

Results

Introduction

In the previous chapters we have presented the literature research and the methodology to test our findings in an empirical setting. In this next chapter we will unveil the results of our empirical data collection. Based on the results we will be able to reject or accept the hypotheses created in chapter three.

4.1 Respondents

We have sent out 723 e-mails and posted a request on LinkedIn (www.linkedin.com) in a group for entrepreneurs to fill out the online questionnaire. Most of the businesses in the dataset are independent, but the people who own a chain-store (the owners have no full control over business decisions) are discarded from the dataset. In a period of three weeks, 89 people returned a valid questionnaire (with the chain-store owners already removed). The partial response rate for the sent out emails is 12 %. An overall response rate cannot be calculated due to the fact that a lot of business-owning friends and family, along with the LinkedIn connections have filled out the questionnaire without a direct e-mail invitation (24 respondents). This brings the total amount of respondents to 113. Almost all businesses are independent, 91,2 % (103 out of 113). Most of the firms have one owner: 58,4 % (N= 66), 41,6 % (N= 47) have two or more owners. Owners are usually also the sole manager of the firm: 70,8 % (N= 80).

Non-response bias

Of the 723 directly approached firm owners, 88% did not fill out the questionnaire. Reasons for this percentage can be (www.greenbook.org, 2009):

- Time constraints

- Potential respondents may have forgotten they were asked to fill out a questionnaire

- While reading the questionnaire deciding not to answer because the questions may be too difficult or time consuming to answer

- Simply not interested in the subject matter

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questionnaire that they found the questions difficult to answer, or felt the questionnaire did not apt to their situation. Due to the subject of the questionnaire, there is no reason to assume that the non-respondents would have answered the questions very differently than the non-respondents have.

Representativeness of the sample

The division of firms based on industry is evenly distributed, with some discrepancy in the construction sector and transport sector.

Industry codes Bik 0 Bik 1,2,3 Bik 4 Bik 5, 804, 923, 930 Bik 60-649 Bik 65-75 agriculture forestry fishing

industry construction Wholesale, retail, services Transport Banks, insurances, business services CBS statistics 10% 5% 13% 29% 3% 29% Sample 14% 5% 6% 25% 12% 37%

Table 4 Comparison of actual distribution of firms based on industry versus the sample

4.2 Procedure

To collect the data, we have sent out a questionnaire with both open and closed questions. The questionnaire has 36-41 questions, depending on the type of firm or if the questionnaire is filled out by an independent without personnel (ZZP-er). The answers to the closed questions are given on a five-point Likert scale. These scales have been specifically developed for this research. Filling out the questionnaire takes about ten to fifteen minutes.

The questionnaire is divided into four parts. Part one comprises some general questions about the firm and its owners/management. In part two the respondent is asked to answer questions about the key product or service and its market. Part three enclosed questions about the firm’s internal characteristics based on finance and several informality dimensions. The last part, part four, is about the numbers of employees that are active in the firm.

4.3 Descriptive statistics

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firms have 1-10 FTE’s, small firms 11-49 FTE’s, medium firms employ 50-249 FTE’s and large firms have over 250 FTE’s).

Industry code BIK 0 BIK 1, 2, 3

BIK 4 BIK 5,

804, 923 & 930

BIK 6-649 BIK 65-75 Total

Industry Size (FTE’s) Agriculture forestry hunting fishing

industry construction Wholesale retail catering repair and other services Transport Banking, insurance, Business services Micro (1-10) 4 0 2 24 2 34 66 Small (11-49) 12 0 3 0 4 8 27 Medium (50-249) 0 6 2 4 8 0 20 (Large) Total 16 6 7 28 14 42 113

Table 5 Distribution of the firms

Table 6 is an overview of employment distribution in the firms from the questionnaire. As in table 6, the results are categorised based on the European Union classification.

(N ) M ea n to ta l n r. F T E ’s M ea n fix ed fu llt im e M ea n fix ed p ar t-tim e M ea n te m p . fu llt im e M ea n te m p . p ar t-tim e O w n h o u rs Co -o w n er h o u rs Z Z P in u se Z Z P F T E ’s EU-classification Micro 66 2,22 3,69 2,75 0,5 0,88 43 8 1,84 1,25 Small 27 31,85 20,37 10,78 2,96 3,63 52 22 1,52 3,36 Medium 20 96,80 74,70 23,70 2,6 4,1 72,2 35,5 1,60 1,36

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4.4 Hypotheses

Hypothesis 1: It differs between firm sizes whether management and ownership are in the hands of one person

To establish if management/ownership appears more in micro, small or medium sized firms, the following question was asked:

-The owner(s) is/are the only manager(s) in your firm. Yes/no.

The frequencies and percentages of the answers to this question are shown in table 7. Size (FTE’s) Owner/manager

yes Owner/manager no Micro (n=66) 82% (n=54) 18% (n=12) Small (n=27) 52% (n=14) 48% (n=13) Medium (n=20) 60% (n=12) 40% (n=8) Table 7 Management and ownership per firm size

Based on the frequencies in table 7 and the results of the Chi-square test for owner-management (X² = 12,954, p ≤ 0,01), we can assume that the smaller the firm, the more likely it is that ownership and management are in the same hands. The trend is not linear: the smaller the firm, the more likely it is that management and ownership are in the hands of one person but this does results only applies between micro and small firms. Between small and medium sized firms, the trend is not linear . We conclude based on this empirical study that in a small firm ownership and management are in the same in hands. The first hypothesis is accepted.

Hypothesis 2: Decision-making is done differently between micro, small and medium-sized firms.

The accompanying question to research this variable is: In the case of important business decisions, like hiring/firing personnel or other expensive investments, the decisive vote is in the hands of:

1) Only the owner(s)

2) More people, including the owner 3) Other people

The descriptive statistics for decision making can be found in table 8.

Micro Small Medium

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owner

Others 6% (n=4) 15% (n=4) 10% (n=2)

Table 8 Descriptive statistics for decision making

Based on the Cramer’s V result for decision-making (V = 0,422, p = 0,000), we can conclude that decision-making is a good distinctive characteristic for firm size. This makes sense, because in a firm where there is just one person employed, decision making almost automatically comes down to this sole person. In a firm where more employees are active, it is likely there are also more specialised managers who take decisions within their specialty. These decisions are mostly budget bound by upper management/the owner(s), but within the budget these managers can make their own decisions. The third answering option could apply to franchisors that decide whether a franchisee must invest in a specific product assortment or a special marketing campaign. The last option could also include silent partners who have no ownership rights whatsoever, but do make the decisions. The trend is linear: in smaller firms the decision is more often made by only the owner. This hypothesis is accepted.

Hypothesis 3: Micro, small and medium-sized businesses are funded in different ways.

In table 9 the frequencies are shown how many firms per size group are completely self financed, without any other form of financing. 37 firms are partially self financed and/or financed by friends/family and/or financed through third parties.

Completely self financed

Micro 46% (n=52)

Small 12% (n=14)

Medium 9% (n=10)

Table 9 Self financing per firm size

Table 9 shows a gradual downwards motion for self financing per size group and the chi-square result is (X² = 8,701, ≤ 0,05). Therefore this hypothesis will be accepted.

Hypothesis 4: The level of informality is different between micro, small and medium sized

businesses.

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all eight scores has been produced. The descriptive statistics for informality (the scores on informality are rounded off to whole numbers for simplicity) can be found in table 10.

Informality 1 2 3 4 5

Micro 9% (n=6) 52% (n=34) 27% (n=18) 12% (n=8) -

Small - 22% (n=6) 48% (n=13) 30% (n=8) -

Medium - 20% (n=4) 30% (n=6) 40% (n=8) 10% (n=2)

Table 10 Descriptive statistics for the informality variable

Kruskal-Wallis returned a significant result for informality/hierarchy (X² = 27,209, p ≤ 0,001). Hierarchy is a good criterion to define firm size, the hypothesis is accepted.

Hypothesis 5: The level of independence varies between micro, small or medium-sized

businesses.

Independent Franchise Co-operation Non-market active holding

Micro 88% (n=58) 12% (n=8) - -

Small 100% (n=27) - - -

Medium 90% (n=18) - 10% (n=2) -

Table 11 Independence per firm size

To examine independence, we asked if the firm is a non-market active holding (This is a firm formed purely for legal reasons without any actual employees), a franchise (and the sub question: how much of the decision-making is taken out of your hands?), does cooperative purchasing, marketing, etc., or if it is independent. As mentioned before, 91,2% of the respondents indicated they run an independent business. The results are shown in table 11. Cramer’s V actually does return a significant result, but a weak association (V = 0,260, p ≤ 0,05). This hypothesis is accepted.

Hypothesis 6: The micro, small and medium sized firm groups each have different market shares.

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presented in table 12. It appears from table 12 that micro firm owners actually do consider their market share smaller than their direct competitors. The small and medium sized firm owners do not offer very different responses. The Chi-square test showed a significant result between the size groups (X² = 30,560, p = 0,000), as well as ANOVA (F (1, 111) = 9,177, p = .003). Market share can be considered a good criterion for firm size evaluation, based on the Chi-square and ANOVA result. The hypothesis is accepted.

Market share Mean S.D. Smaller Equal Larger

Micro 1,46 0,614 58% (n= 38) 36% (n= 24) 6% (n= 4)

Small 2,37 0,629 7% (n= 2) 48% (n= 13) 44% (n=12)

Medium 3,30 0,801 20% (n= 4) 30% (n= 6) 50% (n= 10)

Table 12 Mean, standard deviations and frequencies for market share in different firm size groups

Conclusion

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5.

Conclusion

In order to draw conclusions in underlying research, it is useful to take a look again at the research questions stated at the beginning of the thesis. The main question is: Which qualitative and quantitative firm size characteristics could be used in the Netherlands for small businesses and can these characteristics be used to distinguish between micro, small and medium sized businesses?

The sub questions deriving from the main question are:

What determines firm size according to existing literature?

By looking at the literature overview in chapter 2.1, firm size is determined by numerous variables: an example is competitive position. Competitive position can be looked at from both a market-driven (outside-in) and a resource-driven (inside-out) approach. Market-driven determinants are market share, the use of economies of scale and scope and transaction costs. Resource-driven or inside-out determinants are financial structure, qualified personnel (knowledge), managerial capabilities, structure (a combination of the following variables: hierarchy, formalisation, specialisation, decision-making, professionalism, goal setting, (in)formal communication, number of specified contact moments, the usage of teams, independence and ownership-management).

What qualitative small firm characteristics are used in the literature, in both the Netherlands and other countries?

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Other less mentioned variables are personal influence, family business, personal security (financial), local operations, flexibility and having only one outlet.

What quantitative small firm characteristics are used in the literature, in both the Netherlands and other countries?

According to chapter 2.3, by far the most mentioned and used quantitative variable is number of employees. Other encountered quantitative variables are turnover and balance sheet total.

Which characteristics should be part of a new definition and can they be used to distinguish between firm size categories?

The following characteristics showed a significant difference in responses between size groups and that is why they should be part of a new small business definition: ownership-management, decision-making, market share, finance, informality and independence. Because of the significant differences between size groups, we can also conclude that these characteristics can be used to distinguish between firm size categories. At this point our main question can be answered:

Which qualitative and quantitative firm size characteristics could be used in the Netherlands for small businesses and can these characteristics be used to distinguish between micro, small and medium sized businesses?

Based on this research, an improved small business definition should possess the following qualitative characteristics:

- Ownership and management are in the same hands

- Decision-making is in the hands of one or two person, of which at least one is the owner - The firm has a relatively small market share

- The firm is funded with private capital - The firm is run in an informal manner - The firm is independent

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6.

Discussion and research implications

In this chapter we will look at the implications of the results. What we have found based on the results from the empirical test is that all variables need more fine-tuning. It is unimaginable that other researchers on the subject matter have not better specified these variables in the past thirty-odd years. The ambiguity in the exact definitions of the variables is astonishing. There are so many ways a variable can be interpreted and somehow no one seems to be bothered to better define these variables. What is meant with market share? What is independence exactly? We have shed some more light on the right path to better define small businesses, but it seems that we have shed even more light on how much work is to be done in this field of research.

This research could have been performed more thoroughly: there are a lot of items covered with just one question. In future research it would be better to restrict the research to the variables which have generated a significant result in this research and compose more questions to measure one item. Also, this research did not come with a lot of explanation per question. This has been done on purpose so that respondents would not have been prejudiced towards an answer in any way. There were quite a few remarks at the end of the questionnaire about this: especially micro firm owners felt the questionnaire did not apply to their situation and found it hard at some times to answer the questions. We have provided answer suggestions in case a firm has no personnel and we tried to keep formulation of the questions as simple and understandable as possible. It could be that micro firm owners are not familiar with some business theories that larger firms automatically encounter due to growth (by hiring educated professionals that have studied business theories).

Management and ownership are in the same hands

As expected, the larger the firm, the more managers are recruited or the owner does not manage his/her firm but hires someone else to do that. There is not much difference in these results for small and medium-sized firms on this item.

Finance

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medium-sized category, only 50% is completely self financed and around 50% of the firms make use of other party funding.

Market share

The variable market share returned a significant result in difference between size groups. The problem with this variable is that it cannot be easily measured. Market share could apply for instance to the number of consumers served out of the total number of potential clients available in a given area. It could also be measured as the percentage of sales revenue or sales volume gained out of the total available sales revenue or sales volume in the market. In future research it would be useful to clarify what type of market share is meant. On the negative side, this will make a questionnaire more difficult for respondents to fill out. In this research, answering options are subjective: “How would you compare your market share as to that of your direct competitors?” The scale varies from much smaller to much larger which are arbitrary answering options. It depends on the respondent whether (s)he feels market share is smaller or larger. In future research different definitions of market share could be examined to see if one type of market share (e.g. number of clients served) creates different results in the same firm category from another type of market share (e.g. revenues captured).

Independence

Based on Cramer’s V it could make sense to differentiate firm sizes on independence, but Cramer’s V being a weak association and the fact that almost all the firms in the sample are independent makes independence not a good criterion according to this study. In further research it would be sensible to use more non-independent firms in the sample, like franchisees or co-operations. With a more equal distribution of firms with different forms of independence, a more accurate result can be calculated. Also, some franchise firm-owners may feel they have a lot of control over their own firm, whereas another firm-owner with the same franchise formula may feel he has no control whatsoever about business decisions. The same goes for cooperative purchasing or marketing formulas. Even owners who are actually independent (not part of e.g. a franchise, cooperative purchasing or marketing formulas) can experience a feeling of not having much choice in suppliers, marketing options, etc. and may feel they are not really independent.

Research implications

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Size is in the eye of the beholder