GROWTH, DEVELOPMENT, AND BANKRUPTCY: THE NEED FOR STANDARDIZED MEASUREMENT IN THE SMALL BUSINESS SECTOR Mercy Anselm

Abstract Small business ventures, while providing an engine of growth to capitalistic economies, are simultaneously subjected to the onslaught of market forces, thus making them susceptible to bankruptcy. Hence, mortality rates of small business ventures continue to be very high. It is therefore essential that researchers evolve methods of measuring growth and development so that reliable parameters can be attained, whereby an individual entrepreneur can measure his performance. 1. Introduction The birth of new firms and their subsequent growth or failure has captivated the interest of researchers especially during the past decade and a half The central theme dominating this segment of research focuses on the question of why some firms succeed while others do not. In this context it is important to note that regardless of size and continuity, small firms are indeed the generators of new jobs in any healthy economy (Storey, 1995). However, the mortality rate of these new entrants is abysmally high. No amount of anecdotal evidence can satisfactorily delineate the potential pitfalls that new entrants encounter in the competitive world of small business. It is therefore necessary that any research that probes the survival or demise of new entrants consider both the quantitative and qualitative approach. Contemporary literature is rife with research findings that distinguish between start-up firms with high growth potential from those with no or at best nominal growth potential (Bull, 1991). The purpose of this paper is twofold. The first part focuses on the challenges that academics encounter in trying to measure new venture performance. In the second part an attempt is made to probe the major challenges faced in empiricizing the major causes of bankruptcy. 2. Measuring New Venture Performance In its study "Successful Entrants: Creating the Capacity for Survival and Growth", Statistics Canada has attempted to categorize causal factors of growth into a two dimensional module. In the world of capitalistic competition, a firm's survival is dependent on both its ability to withstand the external shocks of market forces, and also to a very large extent on its degree of adaptability to internal fluctuations in the commercial environment. These fluctuations stem from the wave of persistently changing technologies, as well as erratic consumer demand. Table 1 summarizes Statistics Canada's two-dimensional module, as comprised of internal and external factors, that can either individually or as a group deter-mine the direction to success or failure that a small business venture can take.

Table 1 Growth Depends On Internal Factors

External Factors

*Development of basic markets to survive

*Sound external capital

*Management expertise

*Free market economy

*Sound financial management

*Cooperative banking institutions

*Large market share

*Healthy consumer demand

Statistics Canada's two-dimensional framing of the strategic processes involved in the development of the small firm has, to some authors, instead assumed a multidimensional interaction of factors such as transactions costs, environmental spillovers, vertical and horizontal integration, and technological innovation. Traditional development theory (Penrose, 1959; Chandler, 1962; Richardson, 1972) which focuses on the internal organizational structures, has more recently expanded to include a number of multidimensional factors. Williamson in 1975 developed a new insight into internal organizational structures with a quantitative focus on the phenomenon of transactions costs. In its leap to progress, a firm sometimes finds it more economical to "contract out" some of its production processes. This decision is often the outcome of costs related to the human and environmental elements - that of limited rationality, as well as to the environmental costs of complexity and incomplete information. Such qualitative and quantitative dimensions of analysis have been categorized broadly by Delmar as either dependent or independent. To him growth is the dependent variable which is affected basically by three factors technology, market share and the time period. This last variable is divided into two time frames - the short run and the long-run. The first variable, technology, remains constant in the short run, but varies in the long run. Market share on the other hand can vary both in the long and short run. In his analysis of fifty pieces of research, however, Delmar concludes" these results depict a poor image of the research field. Apparently little effort has been done to truly understand the pros and cons of different growth measures. Most of the research done in this field was difficult to compare because of lack in agreement on or interest in how the dependent growth variable should be measured and calculated. This automatically leads to confusion as to whether or not an independent variable is significant and to the nature of its specific influence on growth." (Delmar, 1997). This lack in valid empirical formulation of quantitative and qualitative factors affecting growth and development has been addressed to some extent by econometricians. In an effort to probe the dynamics of continuance versus survival, these latter have tried to quantify those elements responsible for the success and failure of small business. Reckoning with the fact that continuing in business despite losses or deciding to call it quits, is strictly a personal decision, econometricians have tried to establish stochastic thresholds. While similar studies in labor economics have successfully empiricized these factors, the establishment of such thresholds in entrepreneurial studies are still far from being validly established (Cooper et al, 1992). In today's world where quantitative analysis plays a pivotal role in decision making, a sound understanding of mathematics is inextricably linked with the study of economics. Though it is possible to expound economic theories relying on two or three variables, these arguments flounder when several variables that interact with one another are considered. Entrepreneurial activity is one such endeavour in the economic system whose final outcome is subject to the complex interaction of several variables. It is hoped

that econometrics as a tool of research in the field of small and medium business behavior will usher in a more reliable system of analysis. Measures of growth based on subjectivity (Gupta and Govindarajah, 1984), such as an individual entrepreneur's expectation of growth, have been unequivocally rejected by Delmar (1997), and Chandler and Hanks (1993) on the basis that these measures are fraught with anomalies. They do not confine themselves solely to objective measures, but instead also include the entrepreneur's expectations and impressions of growth and development. Questions arise as to what parameters are actually measured since expectatons and impressions of growth can differ widely from one individual to the other. Hence, such invalid subjective measures of growth must not be applied in the analysis of new venture performance. The product life-cycle is another phenomenon which can positively or negatively affect a firm's growth (Anderson and Strigel 1981). Anderson and Strigel agree with Delmar that this impact is felt by the changing market demand for a company's product. When a product is first launched into the market, the initial interest is translated into growth but at a seemingly cautious pace. Later, as the product makes inroads into consumer needs its momentum picks up and the rate of growth rises. At the end of this second phase, the firm stands poised for radical internal changes - changes in technology, changes in personnel, and changes in managerial structure. Once the firm has reached this third stage the firm has crossed the thin line that divides the short-run from the long-run. The dynamic growth experienced during this stage is represented by Figure 1 (omitted). It is important to note the distinction between the movement of a point along a particular curve, and the shift of a point to a new curve. Economic theory states that the former is a short-term measure of growth, while the latter is long-term. Short-run growth (stages 1 and 2) is represented as a movement along each respective curve. However, if the firm is to grow in the long-run (stage 3), it must move from curve I to curve 2 to curve 3 etc. This type of movement signifies dynamic growth. If any firm is to survive the long run, it cannot remain static. In order to continue being viable, the firm has but two choices. One is to increase its size of operations if the future looks positive. If on the other hand, the future looks bleak, then the only option for survival is downsizing. Statistics both in Canada and elsewhere have concluded that less than one in five firms survive to their tenth birthday (Statistics Canada, 1997). While this expansionary phase is taking place on the micro level of an individual firm, the macro aspect of this expansion is that most firms in the economy could also be expanding. This expansion is fraught with problems of increasing costs. It is in this context that the individual entrepreneur encounters serious problems of decision making. Should he further expand, should he downsize or should he maintain the status quo? An overly ambitious desire to expand can very often be the death knell that ultimately leads to bankruptcy. It is therefore of paramount importance that economists evolve quantitative measures of sustainability of the forces of expansion. 3. Empiricizing Major Causes of Bankruptcy In a free market economy, entrepreneurs come and go. While good economic times see a bountiful number of entrepreneurs enter the market, a recession likewise sees the exodus of a large number of entrepreneurs. In Canada, in 1990, 3700 incorporated business firms failed with liabilities totaling 4.1 billion dollars. While it is true that most new entrants play a significant role in job creation, they likewise take center stage when it comes to job losses. This is because the life span of most new entrants is very short. They barely see their fifth birthday, Though much of this high mortality can be attributed to managerial ineptitude (Statistics Canada, 1997), a significant proportion of job losses occurred as a byproduct of two very severe recessions in the early '80's and '90's. Figure 2 (omitted) represents this loss.

What is evident from the chart is that while both recessions were severe, at the height of the second recession in 1992, the number of bankruptcies was one-and-a-half times those in 1982. However, the number of bankruptcies per thousand in both recessions was about the same. Unfortunately, the effects of bankruptcy during the 1992 recession were severely compounded by the growing value of liabilities of these firms, as shown in Figure 3 (omitted). This growth in liabilities is a measure of loss to creditors which often sparks off a domino effect that can trigger further bankruptcies in the next time period. However, despite the fact that the mortality rate of new entrants is dramatically high, research has shown that when it comes to performance, small firms exhibit a wide range of efficiency and success (Baldwin et al, 1994). While a wide body of literature distinguishes between firms with very high growth potentials, and those with relatively low growth potentials, not much research effort has been made to clearly define quantitatively those factors that lead firms to have varying growth potentials, and hence varying susceptibilities to bankruptcy. Hence, a number of researchers have called for a renewed awareness of the conditions that are conducive to the success and failure of new entrants (Sandberg and Hofer). Entrepreneurial environments can be supportive, but they can also be obstructive. Knight et al. (1987) after a detailed study of new venture enterprises primarily in the automobile, airlines and semiconductor industries concluded that, basically there are three forces responsible not just for survival, but also for the growth of small new firms. These are new technology, new markets and government deregulation. And, while it is true that most failures result from unsound evaluations of individual capabilities, others conclude that survival and exit are at no time random. In fact Baldwin and Rafiquzzaman (1995), postulate that those firms who do not survive suffer from low productivity, are smaller, and pay low wages. As well, a Statistics Canada study on the profile of Canadian bankruptcies concludes that "small, young firms are most prone to failure" (Jovanovic, 1982). This same study found that 63.1% of bankrupt firms failed within the first five years of operation. Much of this failure can be attributed to poor management. Another major factor contributing to the failure of small businesses is the high prevalence of weak financial bases. As is evident from the adjoining table many small firms fail due to poor financial management. Small firms are most vulnerable to competitive and recessionary forces to a large extent because of their total dependence on one individual person or family for financial support. As was found by the research, liabilities increase monotonically by employment class (Statistics Canada, 1997). Carrol and Delacroix (1982) have demonstrated that even when firms are launched by individuals who have taken prior stock of the needs of the environment, and made sound financial assessments, in many cases they do in fact fail. Furthermore, within the same country mortality rates differ, as represented by Figure 4 (omitted). In Canada, at present, the province of Quebec has the highest mortality rate, while British Columbia has the lowest. The positions of Quebec, Alberta, and the Atlantic Provinces have worsened in the nineties, as has Ontario's. However, the incidence of bankruptcy in British Columbia has improved significantly. 4. Conclusion The purpose of this paper was to highlight the need for quantitative and qualitative tools for the measurement of growth and development of small and medium business. It is hoped that parameters once established can better enable entrepreneurs to stave off the burdens of bankruptcy. Apparently very little success has been achieved in fully understanding the pros and cons of different measurements of growth and development. Far more relevant theoretical frameworks and quantifiable theory driven empirical research is necessary: The significance and insignificance of independent variables are not yet established. Exploratory research and research methodologies are necessary to better understand the processes not yet explored as of today. Those firms being researched must be analyzed in their own context before generalizations are made. No single study can satisfactorily analyze the various independent parameters that impact on the behavior of a firm so as to provide a paradigm for comparison.

The diversity among entrepreneurs and the varied characteristics of a new venture warrant research methodologies that are all encompassing in approach. Finally the influence of market uncertainty makes it almost impossible to predict firm performance. However, both the positive and negative influence of the environment on firms can be researched thus providing an explicit understanding of the vagaries of the capitalistic market. Research can thus provide the firm with an insulating mechanism that can help temper the many vicissitudes of the market. References Anderson, O., and Strigel, W. H., (1981), "Business surveys and economic research - A review of significant developments", in International Research on Business Cycle Surveys (ed. by H. Laumer and M. Ziegler), Munich, Springer-Verlag. Baldwin, J.R., (1995), The Dynamics of Industrial Competition: A North American Perspective, Cambridge, Cambridge University Press. Baldwin, J.R. and Rafiquzzaman, (1995), "Selection vs. evolutionary adaptation: learning and post-entry performance", International Journal of Industrial Organization, 13, 501-22. Bull, I. and Winter, R., (1991), "Community differences in business births and business growth", Journal of Business Venturing, Vol., 6., 29-43. Chandler, A. D. jr., (1962), Strategy and Structure: Chapter in the History of the American Industrial Enterprise, Cambridge, The MIT Press. Chandler, G. N., and Hanks, S. H., (1993), "Measuring the performance of emerging business: A validation study", Journal of Business Venturing, Vol., 8., 391-408. Delmar, F., (1997), "Measuring growth: Methodological considerations and empirical results", in Entrepreneurship and SME Research: On its Way to the Next Millennium (ed. by Rik Donckels and Asko Miettinem), USA, Ashgate Publishing Ltd. Gupta, A. K. and Govindarajan, V., (1984), "Business unit strategy, managerial characteristics, and business unit effectiveness at strategy implementation", Academy of Management Journal, Vol., 27., 25-41. Jovanovic, B., (1982), "Selection and the evaluation of industry", Econometria, 50, 649-70. Knight, K. E., Dowling, M. J., and Brown, J. B., (1987), "Venture survivability: An analysis of the automobile, semiconductor, vacuum tube, and airline industries", Frontiers of Entrepreneurship Research, 138-153. Penrose, E. T., (1959), The Theory of the Growth of the Firm, Oxford, Blackwell and Mott. Richardson, G.B., (1972), "The Organization of Industry", The Economic Journal, Sept. Sandberg, W. R. and Hofer, C. W., (1987), "Improving new venture performance: The role of strategy, industry structure, and the entrepreneur", Journal of Business Venturing, Vol. 2-1, 5-28. Statistics Canada., (1997), Failing Concerns: Business Bankruptcy in Canada.

Statistics Canada., (1997), Successful Entrants: Creating the Capacity for Survival and Growth. Storey, D. J., (1995), "Symposium on Harrison's 'Lean and Mean': A job generation perspective", Small Business Economics. Vol., 7., 337-340. Williamson, O. E., (1975), Markets and Hierarchies. Analysis and Anti-Trust Implications: The Economics of Internal Organizations, New York, Free Press. About the Author Mercy Anselm, Instructor, Department of Economics, Atkinson College, York University, Toronto, Canada Dr. Mercy Anselm York University 4700 Keele Street North York, Ontario M3J 1P3 Canada Tel: +1 (905) 856-1221

Fax: +1 (905) 669-1102

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