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...
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