Theories of Growth of Small Scale Enterprises

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Theories of Growth of Small Enterprises

Various theoretical models have been developed which describe the growth of small businesses. One class of theoretical models focus on the learning process, either active or passive, and the other models refer to the stochastic and deterministic approaches.

In the passive learning model (Jovanic 1982 cited in Liedholm 2001), a firm enters a market without knowing its own potential growth. Only after entry does the firm start to learn about the distribution of its own profitability based on information from realized profits. By continually updating such learning, the firm decides to expand, contract, or to exit. This learning model states that firms and managers of firms learn about their efficiency once they are established in the industry. Firms expand their activities when managers observe that their estimation of managerial efficiency has understated actual levels of efficiency. As firm ages, the owner’s estimation of efficiency becomes more accurate, decreasing the probability that the output will widely differ from one year to another. The implication of this theoretical model is that smaller and younger firms should have higher and more viable growth rates (Stranova 2001, Cunningham and Maloney 2001 and Goedhuys 2002).

In the active learning model (Erickson and Pakes 1990 cited in Goedhuys 2002), a firm explores its economic environment actively and invests to enhance its growth under competitive pressure from both within and outside the firm. The potential and actual growth changes overtime in response to the outcomes of the firm’s own investment, and those of other actors in the same market. According to this model of learning, owners or managers could raise their efficiency through formal education and training that increases their endowments. Entrepreneurs or managers with higher formal education, work experience, and training would therefore be expected to grow faster. The firm grows if successful, closes if unsuccessful (Goedhuys 2002, Harding 2002, Aboulzeedan, and Busler undated).

The other set of growth theories of firms include the Stochastic and Deterministic Approaches. The stochastic model, which is also known as the Gibrat's Law, argues that all changes in size are due to chance. Thus, the size and age of firms has no effect on the growth of small enterprises. According to Becchetti and Trovato (undated) empirical tests of the law has indicated that it only considers size and age as potential variables which may significantly affect firm growth by neglecting other explanatory variables which may significantly affect firm growth. The deterministic approach assumes, on the contrary, that differences in the rates of growth across firms depend on a set of observable industry and firm specific characteristics (Becchetti and Trovato, undated and Pier Giovanni et al 2002)

Empirical Finding on Growth Pattern of Enterprises

Start-up Experiences

According to Liedholm (2001), the evidence on new start-ups in developing countries has been virtually non-existent. Not much is known about the central determinants driving small-scale manufacturing new start-ups in developing countries.

Ozcan (1995) argued that indigenous entrepreneurship appears to be the single most important force behind the small firm development. Limited job opportunities in local markets and the search for wealth divert many youngsters to early employment in such enterprises. Potential entrants carry a hope of being their own bosses. Kawai and Urata (2001) indicate that the most popular motive, which was attributed for new start-ups by respondents, was to become independent. Other motives that received high response rates include trying out their potential and work independently. Behind these non-economic and somewhat spiritual motive comes the profit-seeking motive.

Small firms or firms that do not require huge initial capital and any high technology are more apt...
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