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Chapter 3. Reasons for variation among SMEs

Section 1. Variation in business performance

1. Variation in profit ratios

An examination of the degree of variation in the ratio of ordinary profit to sales in different sectors of the economy shows that the standard deviation (a measure of dispersion) is especially high in the case of the service industry, and that the retail sector too has a high standard deviation despite a low mean, indicating that there is considerable variation in profit ratios in these sectors (Fig. 1-46).

It is also apparent that the degree of variation in profit ratios varies according to firm size among firms in the same sector. Taking manufacturing as an example, it can be seen that the average profit ratio increases the greater the size of the workforce. There is no major difference in the average profit ratios of the top 10% of firms in each size category, however; indeed, the top firms with fewer than 10 employees have extremely high profit ratios. The average profit ratio of the bottom 10%, on the other hand, is increasingly negative the smaller the size of the company. Looking at the standard deviation, it can be seen that while the variation in the performance of individual firms increases among smaller firms and some small firms are in dire financial straits, some SMEs perform slightly better than the average large firm (Fig. 1-47).

2. Variation in sales growth rates

As in the case of the ratio of ordinary profit to sales, the average sales growth rate increases with the size of a business establishment, but there is greater variation among smaller establishments (Fig. 1-48).

3. Increasing variation in business performance

A study of trends over time reveals that the variation in business performance is changing. The standard deviation of returns on sales among manufacturing business establishments has increased since 1986, and there is growing variation in performance irrespective of size. As the standard deviation grew particularly noticeably between 1990 and 1994, it may be surmised that it was the collapse of the economic bubble that caused the performance of individual firms to become so much more disparate. Although business performances are growing increasingly varied in all size categories, the degree of variation is greater among smaller firms (Fig. 1-49).

Moreover, as has already been noted, variation is relatively greater in the service sector, which suggests that with services playing an increasingly important economic role, variance in the performances of individual firms as economic entities is growing.

Section 2. Causes of variation in business performance

1. Relationship between new activities and business performance

The small business environment is changing tremendously, and it is crucial that SMEs seize the opportunities that such change offers and aggressively engage in new business activities.

An examination of the relationship between new business activities and the ratio of ordinary profit to sales shows that SMEs that upgraded existing products and services and made technological improvements saw their ratio of ordinary profit to sales increase from 2.0% in fiscal 1994 to 2.9% in fiscal 1996, and that profit ratios are higher at SMEs engaged in some form of new business activities than at those not so engaged (Fig. 1-50). Moreover, SMEs that engaged in new activities also had relatively higher sales growth rates(Fig. 1-51).

2. Relationship between networks and business performance

In order for SMEs to respond to the changing business environment and maintain and improve their performance, it is important that they develop their own unique strengths. However, it is difficult for individual SMEs to possess all the necessary managerial resources to enable them to do so, and attempting to acquire all these resources could on the contrary reduce efficiency. Building networks with other firms and relevant organizations to procure the necessary managerial resources externally thus forms an important part of management strategy.

Evidence of the effectiveness of joint R&D with other firms and especially firms in other sectors is the fact that the ratio of ordinary profit to sales of companies involved in joint R&D with firms in other sectors rose significantly between fiscal 1994 and fiscal 1996, and that firms engaged in joint R&D with firms in the same sector, meanwhile, succeeded in maintaining high profitability in both fiscal 1994 and fiscal 1996(Fig. 1-52).

Looking next at the relationship between taking orders and marketing jointly and sales growth rates, it can be seen that SMEs that engage in such joint activities have higher sales growth rates than SMEs as a whole. And as in the case of joint R&D, the effects on profits are even greater if firms take orders and market jointly with firms in other sectors. Moreover, the effectiveness of such activities is significantly greater among SMEs(Fig 1-53).

3. Relationship between outsourcing and business performance

Outsourcing has attracted attention in recent years as an important part of corporate business strategy. The term outsourcing is used here to refer to outsourcing using services, i.e. the external procurement of services traditionally provided within the firm and new services, and it is on the basis of this definition that we will consider the relationship between outsourcing and business performance.

In fiscal 1994, the average ratio of ordinary profit to sales was 1.8% in the case of both SMEs that outsourced and those that did not. By fiscal 1996, however, the gap between the two had grown. Furthermore, outsourcing raised profit ratios more at SMEs than at large firms(Fig. 1-54).

The most commonly cited advantages of outsourcing were related to using outside sources in a firm's weak areas and making up for shortages of managerial resources (enabling firms to utilize specialties outside the firm and concentrate managerial resources on a firm's own strengths), reducing costs (enabling firms to cut the size of their workforces and reduce personnel expenses), and speeding up business activities (such as by speeding up provision of services) (Fig.1-55).

4. Other factors related to business performance

In addition to the above, a variety of other factors impact on business performance. A regression equation was therefore estimated to explain the ratio of ordinary profit to sales in manufacturing and the wholesale sector (Fig. 1-56).

The results show that in manufacturing, workforce size, capital investment, the specialization ratio, overseas sales ratio, overseas purchases ratio, sales growth rate and patents all have a positive effect on the ratio of ordinary profit to sales. The fact that the number of patents owned by a firm has a positive effect shows that firms that put more resources into R&D perform better, while the fact that the overseas sales and overseas purchases ratios also have a positive effect suggests how important it is that SMEs adopt an international approach in their business strategies.

In the wholesale sector, capital investment, the overseas purchases ratio, changes to main products and the sales growth rate were found to have a positive effect. The positive effect of changing main products suggests that it is important that firms change their product lineups flexibly to meet customer and consumer needs.

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