Studies of factors affecting SME decline and recovery

Many firm failures do not happen suddenly, but develop over time as a consequence of decline or crisis. Although small firms are more vulnerable than large ones, few studies have focused on the decline, crises, and turnaround of small firms (Chowdhury et al. 1993). Decline is often seen as a relatively smooth trend, involving a sustained low rate of performance deterioration. In contrast, crisis is usually seen as a sudden performance drop, involving a major downward shift in performance trends. Weitzel and Jonsson (1989) have presented a model of decline consisting of five stages: (1) blindness; (2) inaction; (3) faulty action; (4) crisis; and (5) dissolution.

Slatter (1984) presents ten major symptoms of firm decline: (1) falling profitability; (2) reduced dividends; (3) falling sales; (4) increasing debt; (5) decreasing liquidity; (6) delays in publishing financial results; (7) declining market share; (8) high turnover of managers; (9) top management fears, e.g. ignorance of important tasks or problems; and (10) lack of planning or strategic thinking. Most of these seem to be related to the firm’s finance. However, they are not causes of failure, but indicators of severe problems, and no action should be taken before the underlying primary, or root, causes are identified. For instance, Masuch (1985) analysed vicious circles which cause underperformance, stagnation, and decay in organizations, and found that such vicious circles are usually conceived as spiraling processes.

Thompson (2001: 625-630) grouped the factors associated with decline into three categories (see also Weitzel & Jonsson 1989). First, factors related to inadequate strategic leadership: (1) poor management; (2) acquisitions which fail to match expectations; (3) mismanagement of big projects; and (4) dishonesty. Another category of factors associated with decline relate to poor financial management: (5) poor financial control; and (6) cost disadvantages. Then there are factors which relate to competitive forces: (7) the effect of competitive changes; (8) resource problems;

and (9) inadequate or badly directed marketing. According to Thompson (2001: 632), there is usually more than one factor causing firm failure. Most of these factors associated with decline were also identified in the study conducted by Thain and Goldthorpe (1990); their analysis also revealed lack of information as a factor associated with decline.

Recovery strategies refer to both retrenchment strategies and turnaround strategies (Thompson 2001: 635; cf. Pearce & Robbins 1993). On the one hand, retrenchment can be defined as a set of organizational activities aimed at achieving cost and asset reductions and disinvestment (e.g. Robbins & Pearce 1993). Hence, retrenchment strategies aim to reduce costs by concentrating and consolidating, which typically involves changes in functional strategies. Retrenchment strategies usually have a short time horizon and are designed to yield immediate results. For small firms, retrenchment has been identified as a common but not universal response to economic recession (Michael & Robbins 1998). However, it has also been claimed that retrenching plays a minor role in facilitating recovery (e.g. Barker & Mone 1994).

On the other hand, turnaround strategies relate to changes in competitive strategies and frequently feature repositioning for competitive advantage (Thompson 2001: 647-648). Turnaround strategies are likely to address those areas which must be developed if there is to be a sustained recovery. In addition, they are designed to bring quick results and at the same time contribute towards longer-term growth. However, in the short term small firms typically have no resources required for diversification, for instance. Hence, strategies aiming at increasing organizational efficiency may be more available to small firms.

Retrenchment can be regarded as the first stage of a two -stage turnaround strategy, where the retrenchment phase is overlapped and often obscured by a subsequent recovery stage as the firm implements its strategic redirection (Michael &

Robbins 1998). In fact, as Robbins and Pearce (1992: 304) point out, retrenchment is an integral component of any turnaround strategy for the successful recovery of declining firms. In contrast, Barker and Mone (1994) and Castrogiovanni and Bruton (2000) question this with evidence that retrenchment has no beneficial effects on firm performance in all contexts (cf. DeDee & Vorhies 1998). However, it is important to distinguish between declines which represent a threat to firm survival and those which

do not. To date, in many studies focused on retrenchment and turnaround, the distinction between them has been blurred.

On the basis of case studies, Hofer (1980) identified three successful operating turnaround strategies: (1) cost cutting; (2) asset reduction; and (3) revenue-generation.

In a later large sample study of retrenchment strategies, Hambrick and Schecter (1983) found only the cost cutting and asset reduction strategies. According to Slatter (1984), sustained recovery often requires (1) asset reduction, e.g. by divestment of part of the business; (2) a new leader; and (3) improvement of financial control systems. In a study of twenty firms in the manufacturing and service sectors in the U.K., Slatter (1984) found ten turnaround strategies: (1) change of management; (2) strong central financial control; (3) organizational change and decentralization; (4) product/market reorientation; (5) improved marketing; (6) growth through acquisitions; (7) asset reduction; (8) cost reduction; (9) investment; and (10) debt restructuring and other financial strategies. However, these strategies were often used in combination. Thain and Goldthorpe (1990) present a matrix of recommended turnaround recovery actions depending on the stage of decline, i.e. potential, actual and crisis, and on the key factors determining turnaround success or failure.

It has been found that superior management emphasizing the protection of margins, the efficient use of capital, and a concentration on markets or segments where distinctive competitive advantage is possible are characteristic of firms that have survived most successfully through an economic recession (Clifford 1977; cited by Thompson 2001: 657). Bacot et al. (1993), following Hall’s (1980) study of survival strategies in a hostile environment, studied adaptive strategies and firm survival in an environment dominated by economic decline. Both these studies found that firms employed one or both of strategies which targeted (1) the lowest cost, and (2) a differentiated position. Although Hall (1980) cautioned against diversification, the firms in Bacot et al.’s (1993) study did diversify, primarily through acquisition or by modifying technologies for use in other markets. However, both studies focused on large companies, and diversification may play a different role in such firms than in small ones.

In their study of the characteristics and strategic adjustments of surviving and non-surviving firms, Smallbone et al. (1992) found five broad types of adjustment: (1) product and market adjustments; (2) production process adjustments; (3) employment and labour process adjustments; (4) ownership and organizational adjustments; and (5) locational adjustments. The main findings were that firms which had been most active in making adjustments were the most successful. To achieve real growth, active market development, i.e. identifying new market opportunities and increasing the breadth of customer care, is essential.

It has been found that successful recovery strategies are associated with the primary causes of decline (Pearce & Robbins 1993). For firms whose decline was due primarily to external problems, turnaround was most often achieved through strategies based on an entrepreneurially driven reconfiguration of business assets. On the other hand, for firms that declined primarily as the result of internal problems, turnaround was most frequently achieved through recovery responses with an emphasis on efficiency strategies. Contextual factors such as the nature of the competitive environment play a major role in the firm’s turnaround success (e.g. O’Neill 1986). It is therefore important to take into account the turnaround situation, i.e. the contingencies. According to Finkin (1985), no two turnaround situations are ever exactly alike, so understanding and controlling nuances becomes important in each particular case, and will have much to do with achieving success (see also Thain &

Goldthorpe 1990). Burns (1989: 51) claims that the crisis that triggers the decline to failure is often based on firm-external events.

Most of the studies reviewed above were carried out in the large-firm context.

Therefore, the applicability of the results for the small firm sector can be questioned.