Managing a Small Business - Term Paper Example

Managing A Small Business Introduction Great Britain has long been dubbed as a nation of shopkeepers. Perhaps it is more apt to say, a nation of small entrepreneurs. As elsewhere in the world, particularly in those countries, which were once ruled by UK, small businesses here occupy a high position of importance in the national economy in terms of contribution to the gross domestic product and employment generation, the two most important yardsticks for macro-assessment of any sector of the economy. This paper deals with the various aspects of small businesses and their management, and specifically enlarges upon one of the important management issues that bedevils the small businesses viz., business failure. All aspects of business failures and turn around strategies are dealt with. In this context, comparison is made of an erstwhile engineering company, Dust Suppression International Ltd., with another comparable but thriving unit Enviroflo Engineering Ltd., both in UK, with a view to draw appropriate conclusions about the theoretical concepts as they work out in the practical world. Choice of the companies and their background Dust Suppression International Ltd. (DSIL), London, and Enviroflo Engineering Ltd. (EEL), Wolverhampton, belong to the category of small enterprises in environmental control business. DSIL was a pioneer in the field of controlling air borne dust, by spraying a mixture of water and a patented surfactant, called Compound MST. The spray reduces the surface tension of air borne dust particles, helps them to agglomerate, gain weight and settle down instead of (last name) 2 spreading out and polluting the surroundings. While spraying of water for dust control has been a commonly known technique, DSIL improvised upon this by the development of its patented chemical, by brand building (ChemJet), as well as automating the whole process of adding the measured quantity of compound MST, starting and stopping the sprays in line with operations of the concerned industrial plant, strategic location of specially developed nozzles etc. The company claimed minimal addition of moisture to the materials handled, economic operating and maintenance costs and significant savings in capital expenses when compared to the conventional air pollution control systems like cyclones, bag filters and precipitators. It supplied this technology to a number of other companies who capitalised on this economical alternative and built up successful businesses. In spite of these favourable endowments, DSIL did not survive as a business entity and was closed down in the late nineties. EEL has been a late starter compared to DSIL and it is in the conventional dust control systems as well as dust suppression systems, having the best of both worlds. Its entry into dust suppression systems was made possible by luring the top executives of DSIL! High competence in management, particularly marketing, helped EEL to thrive and grow from strength to strength, even while retaining its primary character as a small-scale enterprise. It has spawned a number of subsidiary units, joined hands with compatible companies around the world and has established a name for itself. The success of one company and the failure of the other company as seen above, gives one an opportunity to probe the theoretical and practical aspects of managing small businesses in the background of a comprehensive essay on the subject. (last name) 3 Overview of enterprises According to the 2004 statistics1 published by The Small Service Bureau, Department of Trade and Industry, UK, the privately run small and medium enterprises (SME) numbered 4.3 million at the start of 2004, as compared to 4 million in 2003. Gross turnover of these enterprises was £2,400 billion and the estimated employment was 22 million. Of the 4.3 million units, 99.3% were those that had 49 employees or less, classified as small enterprises. Their share of business employment was 46.8%, and that of turnover 37%. Among these units, enterprises with no employees comprised 72.8% or 3.1 million units, with an estimated turnover of £190 billion. Sole proprietorships, partnerships or companies with an employee-director only, fall in this category. Enterprises having 50 to 249 employees (100 to 499 in Europe) are classified as medium scale units and they total about 26,000 in UK. The following picture gives a vivid idea of this situation. Figure 1: Business Statistics Snap Shot (Source: Dept. of Trade and Industry, News Release, Statistical Press Release, URN 05/92 dt. 25 August 2005) The distribution of employment or turnover value varied widely among different 1. Dept. of Trade and Industry, News Release, Statistical Press Release, URN 05/92 dt. 25 August 2005 (last name) 4 economic activities. While sections relating to agriculture, fishing and forestry (sections AB) of Standard Industrial Classification (SIC) 2003 account for 94 % of the employment in small enterprises, financial intermediation (section J) accounts only 14.9%. Similarly, the turnover ranges from18.3% in manufacturing to 90.4% in sections AB. Suffice it to say that small enterprises are engaged in all areas of economy – primary, secondary and tertiary – with agriculture, fishing, forestry, construction and services dominating the scene. Coming to the legal status situation, sole-proprietor concerns were 2.72 millions, partnership firms were 540 thousand and companies were1.02 million in number. Number of enterprises in millions Figure 2: Employment snapshot (2004) (Source: Dept. of Trade and Industry, News Release, Statistical Press Release, URN 05/92 dt. 25 August 2005) While the number of enterprises remained at about 3.7 millions between 1995 and 2001, there has been a gradual increase since then, with 7.5% increase at the beginning of 2004 compared to the beginning of 2003. This increase is the nett addition, since the attrition rate among small businesses is proverbial and dealt with elsewhere in this essay. The significance of these statistics is hard to overlook. Small businesses are only small in name but big in terms of importance to our national economy. The one significant aspect of small businesses is employment generation coupled with individual enterprise. (last name) 5 Management issues for small business Choice of legal structure, financing, marketing, succession and survival are the important management issues for small businesses and they also have a bearing on success or failure. These issues are briefly dealt below, with a view to draw the broad picture of business promotion. Legal status of businesses An enterprise is formed in any one of the following legal categories: Sole proprietorship Partnership firm Private limited company Public limited company Co-operative sector unit Sole proprietary concerns are easy to set up. They have no separate legal status other than the individual setting them up. Profits are fully owned and taxed together with other personal income. They have a high degree of flexibility and freedom of decision-making. Statutory audit of accounts, or divulging records to public is not necessary. As against these benefits, they suffer from the significant disadvantage of unlimited liability including risk to personal assets, not deployed in business. Funds constraints often affect these units, since there is no equity participation by others and all the funds are either owned or borrowed. Ownership cannot be transferred but the business itself can be sold off as a going concern. The burning desire of a large number of entrepreneurs to venture into business and the obvious ease with which sole proprietary concerns can be set up explains the predominance of this class of enterprises, as seen in the statistics noted above. Unfortunately, it is also one of the reasons for the unusually large number of business failures as well. (last name) 6 Partnership firms also enjoy many of the advantages of sole proprietary concerns and are relatively easy to set up. Collective experience of the partners gives edge to decision making. Statutory audit of accounts, or divulging records to public is not necessary. However, unless otherwise provided for in the partnership agreement, death, bankruptcy or retirement of one partner dissolves the firm. Partners are liable for debts both individually and jointly and this liability does not cease with the death of a partner. Business profits are clubbed with other personal income and taxed, whether retained in business or drawn. Finally, while partnership firms can be converted to limited liability companies, it is more difficult to transfer ownership to others. Limited companies (private or public) are distinct legal entities and separate from the promoters. To this extent, they are governed by the statutory laws in terms of conduct of business, audit and disclosure of accounting records, etc. They have the advantage of insulating the promoters from the liability of the company to an extent though not fully. Company’s continuance is ensured irrespective of death or bankruptcy of a promoter. It is possible for them to raise equity more easily, access venture capital and expand ownership. Business profits and capital gains when assets are transferred, are subject to tax on the company, while salaries drawn as well as dividends received are taxed in the hands of the promoters. It is more difficult and expensive to set up limited companies. The two companies selected for this essay are limited companies. Co-operatives are formed by voluntary agreement between members for promotion of their economic activity. As institutions, they are subject to government regulations and supported by concessional financing and marketing assistance. (last name) 7 Finance for small business Having noted the predominance of small enterprises, it is appropriate to discuss their ability to access finance, which is crucial for not only setting up a business but also for gaining in other resources. As already noted, in proprietary concerns the owners bring their own capital or raise limited loans (against security of personal assets) from close friends and relatives and this is a limiting factor. Retained profits and trade credit add to the finances in due course. In spite of this, proprietary concerns have limitations on access to capital. To an extent, even partnership firms suffer from this infirmity but funds come from more than one person and the liabilities are shared. New partners can be inducted if necessary for additional finance. In the case of limited companies, funds can be organised as equity capital including venture capital and external credits in the form of bank loans against capital and current accounts, trade credit, and retained profits. Public limited companies organise funds through sale of shares and debentures, through accepting deposits, through venture capital funds and most importantly by leveraging the equity funds to raise loans from financial institutions. This feature is termed as ‘gearing’, which is in essence, the ratio of debt to equity of a company. The higher the gearing, the greater is that company’s financial resource. Of course, debt funds are to be serviced by payment of interest and repayment of principal. Hence, margins on the business are important and must exceed the cost of borrowing substantially or else, highly geared companies can go bankrupt easily. Venture capital has come into major reckoning in the wake of Information Technology boom and its main aim has been to fund high risk but high potential (unlisted) companies with a view to either cash in and exit at an appropriate time or acquire a share by conversion of venture capital into equity. (last name) 8 By their very scale of operations, legal status and ability to garner capital, small businesses have to fall back upon their other attributes to be able to find feet, survive, grow and earn profits. Limited finances may mean limited ability to attract right talent, acquire right guidance and technology, capitalise on opportunities as and when they come etc. Growth with profitability and marketing are interdependent and one is not possible without the other. Inadequate finance has killed many an otherwise decent business ventures. Networking as a marketing tool for small businesses One often hears terms such as networking and relationship marketing, which are almost synonymous. By whatever name one may refer to this function, it is the most important issue for survival and growth of any enterprise, small or not. Small businesses need to fall back upon and exploit networking concept more vigorously since they do not have the resources of a larger company to indulge in expensive advertising, brand building, pricing power, large sales force and distribution arrangements etc. Let us first consider a couple of definitions from experts in the field: “It is essential to distinguish between the network itself, which is a social construct; and networking, the activity which develops, maintains or uses the network. Broad definitions might say something like, a network is an ‘association of people with shared interest(s), background, aim or almost any bond imaginable - which is prepared to make use of individual members” (Heald, 1985)2. Peter Drucker’s ‘network society’3 emphasises the importance of independent contractors and outsourcing 2. Heald, T. (1985) “Networks: Who We Know And How We Use Them” 3. Drucker, P. F. (1997) “Managing in a Time of Great Change” (last name) 9 (Drucker 1997:63). Kelly describes the modern business environment as a ‘network economy’ (Kelly 1998)4.” Relationship marketing is about “the importance of the whole relationship between the parties. Relationship marketing can therefore be regarded as all of the activities an organisation uses to build, maintain and develop customer relations.” (Dibb et al. 1997:148)5. Networking is the process of deliberately creating and sustaining relationships at individual and organisational levels for mutual benefit. Since all transactions involve human intervention, maintaining relationships helps in creating the necessary background for achieving the overall objectives of an organisation. A few examples illustrate the success of networking as an effective but inexpensive marketing method. The neighbourhood stores, typically a sole proprietary concern, is a prime example of excellent relationship marketing. The customers and their day-to-day needs are well known to the business owner; pleasantries are exchanged routinely; personal attention to service on the one hand and, loyalty to buy that service on the other, complement very well; business volumes and customer base remain steady. Marketing expenses are minimal. Coming to a typical small enterprise in engineering business, networking is seen in all most all occasions. For example, many process industries represent a fragmented market with small, medium and large units co-existing. These plants are large in number, have their own associations and executives of these companies exchange information of mutual interest routinely. Supplier-engineering companies develop satisfied customers as a base, with emphasis on cordial relations with decision-makers and then expand it into a network by a process of referral letters, telephonic verification and informal word-of-mouth publicity. Industry 4. Kelly, K. (1998) “New Rules for the New Economy: 10 Ways the ..” 5. Dibb, et al (1997) “Marketing Concepts and Strategies” (last name) 10 associations help in this process. Similarly, many engineering units in industrial estates specialise in certain areas of processing. To the upstream industries, they are a source of business for sale of raw materials or semi-finished goods; to the down stream units, they are suppliers of semi-finished or finished goods for further processing / assembly work. The interdependency is very clear and the importance / efficacy of networking among them cannot be over emphasised. This has been one aspect of marketing that DSIL failed to exploit, in the face of rising costs of production and intense competition for business, in UK. Although, it pioneered dust suppression systems, it failed in marketing efforts. EEL on the other hand, reached out to international customers and exploited its network of collaborators to outsource hardware items and serviced third country customers, at competitive prices. It has a record of supplying systems to Russia for which the designs were developed in UK and components outsourced from India. Thus networking as a marketing tool encompasses family business in ethnic and social networks, organised networks in industrial estates, subcontracting and outsourcing methods. Succession issues in management of small businesses Succession is a major issue for not only family owned small businesses but also even for giant industrial corporations identified with the promoter families. In the case of large corporations, division of assets / liabilities, management control, valuation and share holding are the major issues which are to be resolved to the satisfaction of not only the successors but also other stakeholders like the lending institutions and governmental regulatory agencies. Sooner or later these issues are settled. Day-to-day management and operations of the units are not generally affected by succession struggles. However, in the case of family run small businesses, it is a different story altogether since there is no external pressure to implement some sensible (last name) 11 succession plan. This leads to lot of indecision that impinges upon day-to-day running of the business, demoralisation and conflict among family members. Such developments can lead to failure of the business since these businesses do not have a second rung of management staff. Another typical reason for failure of small businesses is that owners have no long-term stake in the venture, their capital being treated only as an investment for short-term gains. DSIL suffered from this malady and when the original senior executives left the organisation for newer pastures and the promoter company (The Ward Group) that owned DSIL had practically no succession plan. Their objective was to also make short-term gains from investment in different businesses with no clear focus. With no clear focus on continuity and no clear succession plan for management, the group diversified at random into unrelated businesses like environmental control (DSIL), bottled mineral water (Chiltern Hills brand) and ‘Fox Hunting’ expeditions! Failure was written largely into some of their business plans from the very beginning. While one member of the family looked after one business, there was no one else to guide or succeed that member. Management and business failure An astonishing 10 % of all businesses disappear every year in the USA and the situation is no different in UK. Writing in Harvard Business Review, Ram Charan6 avers that, “The inability to take decisive action is rooted in a company's culture.” Any business venture is faced with issues, which are to be decided on a regular basis. Some are routine and require no great effort or debate while some issues are so important as to have a direct bearing on the health of 6. Charan R. (2006) “Conquering a Culture of Indecision” (last name) 12 the business. The inability or indecisiveness stems from the attitude of the leader, according to Ram Charan. He goes on to add that in order to break this cultural habit, organisations should encourage frequent and open discourse among members through meetings, reviews and seminars; encourage intellectual honesty i.e., expressing one’s honest professional opinion irrespective of the views held by the leader, and, instituting a system of rewarding high achievers. Sadly, these things that did not happen in DSIL, if one were to go by the migration of experienced staff to competitors on the one hand and the diffusion of management’s attention to too many unconnected businesses, with short-term perspective. By contrast, their charismatic leader, Mr. Harold Wylie7, has been leading EEL from the forefront. He had recognised the potential of the technology developed by DSIL and hence decided to diversify into that line as an addition to an existing line of products to serve the same customer base. EEL methodically wooed the top executives of DSIL and with their help and leadership, successfully started to market the new product. It did not stop there. It took note of the changing market conditions within UK and hence did not hesitate to reach out to international customers in an innovative way of outsourcing from hardware from cheaper sources. This happened at a time when ‘outsourcing’ in engineering industry was not a fashionable word as at present. The role of decisive organisational culture, as postulated by Ram Charan can thus be seen in action. Lack of a well thought out succession plan, as already pointed out earlier is another frequent cause for business failures and this issue affected DSIL too. In an interesting case study entitled: The Ghost in the Family Business8, which appeared in the Harvard Business Review, 7. Harold Wylie, www.hwenvirofloltd.com/index.html 8. Miller et al. “The Ghost in the Family Business (HBR Case Study and Commentary)” (last name) 13 Miller et al narrate the fictional story of a family business and its travails, precisely due to its failure to have a decent succession plan. A succession plan does not consist of one answer to one contingency. It should logically provide for at least a second line of action should the unexpected happen to the first line of defence. The moral of the story is ‘expect the unexpected’, or, ‘hope for the best but, plan for the worst case scenario.’ This is where professionalism comes into play and large organisations, with their depth of professional management, score over smaller businesses. Family run small and medium size businesses are averse to letting outsiders getting too close to business secrets or taking a look into the financial aspects. Writing in the International Small Business Journal, Watson9 et al bring out a curious fact about the very fact of failure of business. Different studies point out to conflicting statistics of failure – one concluding that the greatest number of failures occur in the manufacturing sector while the other maintaining an exact opposite view i.e., that the greatest survival rate is in fact among the manufacturing sector itself! The essay goes on to point out that the choice of definition of the term ‘failure’ itself is the root cause of such conflicting statistics. It may be noted that ‘Discontinuance for whatever reason, sale of business to others, inability to keep the show going on’ etc. are some of the formal descriptions of a failed business10. Failure rates among technocrat-promoted businesses are mainly caused due to a) over enthusiasm to get going before thinking through or, in other words, poor business planning and b) inability to bring in necessary funds, especially the working capital. Financial institutions, with their over cautious approach to secure their credit, keep a tight leash on funds flow and 9. Watson et al. “Small Business Failure Rates: Choice of Definition and Industry Effects” 10. Course Material, “Failure & Turnarounds” (last name) 14 many a time this results in choking of working capital and the resultant loss of business. In this respect, traditional businesses families with years of experience behind them fare much better. They start small, plan more diligently and provide for contingencies. Cash flow management is much superior as is their ability to negotiate input prices and market credit. Benjamin Mark Cole11 quotes Jim Siegfried, partner in charge of the Coopers & Lybrand LLP entrepreneurial advisory services group in Los Angeles: "Many (entrepreneurs) do not fully understand the capital requirements, the startup money and the working capital (needed) for growth…When you read the press, everything is success stories. People have a misconception about how easy it is to get financing." “Don't procrastinate, never ignore the competition, avoid sloppy or ineffective marketing, never ignore customers' needs, look for competence, and watch your cash flow,” advises All Business.Com12 Conclusion Small businesses are an important part of any national economy. They represent the animal spirit of human enterprise. They contribute very substantially to the GDP, employment and most importantly, to the development of new ideas in all human endeavours. Statistical evidence confirms the importance of this sector of economy. Management of small businesses is now growing subject for teaching, research scholars and academics. The important management issues for small enterprises, indeed for any enterprise, are its legal constitution, financial resources, networking / marketing and survival coupled with growth. Each one of these issues is of considerable importance if business failure is to be avoided. 11. Cole, B.M. (1997) “Amid Success Stories,…Companies” 12. Townes, G. (2002) “Beating the odds: Remembering the Basics…Businesses” (last name) 15 Inadequate capitalisation and defective succession planning are the bane of many businesses that fail. Networking and outsourcing are crucial for survival in the highly competitive international business scenario. Information technology has shown the way in this regard and it is this very technology that permits all businesses, big or small, to look beyond traditional solutions and to adopt strategies that would keep them in business. Reference List Beale, S. “10 Top Tips for Successful Networking”, Available: http://www.soleproprietormagazine.com/articles/networking/tips-beale.asp (Accessed 7th August, 2006) Charan R. (2006) “Conquering a Culture of Indecision”, Harvard Business Online, Available: http://harvardbusinessonline.hbsp.harvard.edu/hbrsa/en/hbrsaLogin.jhtml (Accessed on 7th August, 2006) Cole, B.M. (1997) “Amid Success Stories, Cautionary Tales about Failure - Small Businesses in Los Angeles County, CA - The Fastest Growing Private Companies” Los Angeles Business Journal, Nov 17, 1997. Available: http://www.findarticles.com/p/articles/ mi_m5072/is_n46_v19/ai_20134700 (Accessed on 7th August, 2006) Course Material (2006) “Failure & Turnarounds”, The Business School, University of Hertfordshire. Dept. of Trade and Industry, (2005) “Statistical Press Release, URN 05/92, News Release, dt. 25 August 2005, Available: http://www.statistics.gov.uk (Accessed on 7th August, 2006) Dibb, S., Simkin, L., Pride, W. and Ferrell, O. C. (1997) “Marketing Concepts and Strategies”, Houghton Mifflin, London Drucker, P. F. (1997) “Managing in a Time of Great Change”, Butterworth Heinemann, London Gavin C., Reid G.C, Lowell R., Jacobsen L.R., Margo E. and Anderson M.E, (2002) “Profiles in Small Business - A Competitive Strategy Approach.” Routledge, London Heald, T. (1985) “Networks: Who We Know And How We Use Them”, London: Coronet, London Harold Wylie, http://www.hwenvirofloltd.com/index.html (Accessed 15th August, 2006) Kelly, K. (1998) “New Rules for the New Economy: 10 Ways the Network Economy is Changing Everything”, Fourth Estate, London Miller, W.D., Boschwitz, G., Rudy Boschwitz R., Whiteside, M.F., Mattos, J and Ward, J.L, (2000) “The Ghost in the Family Business (HBR Case Study and Commentary)” Available: http://harvardbusinessonline.hbsp.harvard.edu/hbrsa/en/hbrsaLogin.jhtml; $urlparam$kNRXE2ULYRiR52NiwJYH5SF?ID=R00308&path=arc&pubDate=May2000&_requestid=623 (Accessed 7th August, 2006) Townes, G. (2002) “Beating the odds: Remembering the Basics of Business can help - Management Advice - Managing Small Businesses”, Black Enterprise, Earl G. Graves Publishing Co. Available: http://www.findarticles.com/p/articles/mi_m1365/is_6_32/ ai_80900325 (Accessed 7th August, 2006) Unknown, (1998) “Small Business Economics”, Springer Netherlands, Volume 11, No. 4, p 371 – 390. Available: http://www.springerlink.com/(vouaupjxztxrurvspfx5c2fq)/app/home/ contribution.asp?referrer=parent&backto=issue,6,8;journal,63,114;linkingpublicationresults,1:100338,1 (Accessed on 7th August, 2006) Watson, J. and Everett, J. (1998) “Small Business Failure Rates: Choice of Definition and Industry Effects”, International Small Business Journal, Vol. 17, No. 2, 31-47 (1999), Available: http://isb.sagepub.com/cgi/content/abstract/17/2/31 (Accessed 7th August, 2006) http://www.herts.ac.uk/lis/subjects/business/biz_subj.html Read More