Liability of Smallness What it Means and Essay

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  • Subject: Business
  • Type: Essay
  • Paper: #35239364

Excerpt from Essay :

Liability of Smallness: What it Means and What Can Be Done in Response

The historical record contains few examples of the smaller underdog winning out over larger opponents, with examples such as David and Goliath being the exceptions rather than the rule. This paucity of examples is due in large part to the so-called liability of smallness which suggests smaller firms are more vulnerable to competition, a constraint that is especially salient for entrepreneurial firms that begin as smaller entities with less experience and resources compared to their larger competitors. The liability of smallness is further aggravated by the liability of newness where start-ups are viewed less favorably compared to longer-established firms. To gain some fresh insights into these issues, this paper provides a review of the relevant literature concerning the liability of smallness, the liability of newness, and how some real-world firms have responded to these constraints. A discussion concerning how smallness exacerbates the decline and demise a firms is followed by an analysis of firms that especially vulnerable to these forces. Finally, an examination of how smaller firms can be assisted is followed by a summary of the research and important findings in the conclusion.

Review and Discussion

Background and Overview

Small firms are the lifeblood of the American economy. In fact, just around 2% of the companies in the United States have more than 100 employees and small firms represent the fastest growing segment of the national economy, accounting for 75% of all new jobs that are created each year (Heneman & Berkley, 2002). In some ways, smaller firms would appear to have some competitive advantage over their larger, well established counterparts. After all, smaller companies can be leaner, nimbler, more cost-effective and can take advantage of niche opportunities more efficiently than larger, more cumbersome and bureaucratic enterprises. In this regard, Poole and Van der Ven (2004) report that, "While large generalist organizations occupy the center of the market, small specialist organizations exploit peripheral niches. Further, the rate of resource exploitation is believed to be much stronger for specialist organizations, allowing specialists to reach a better fit with their environment" (p. 138). Furthermore, Knoke (2002) reports that well established, larger firms can also suffer from two types of liabilities:

1. A liability of obsolescence, in which inertial forces lock organizations into outmoded strategies and structures adopted in their early years, thus rendering these older firms less able to adapt to rapidly changing environments; or,

2. A liability of senescence, in which rigid devotion to accumulated rules and routines reduces their efficiency compared to younger, more flexible organizations even in stable environments (2001, p. 48).

Nevertheless, a growing body of research concerning new firm failure rates indicates that two liabilities are salient for understanding the effect of being smaller and newer and their respective effects on start-ups. The first, the "liability of newness" is important because this perspective suggests that new firms do not succeed because of a combination of internal and external factors (Zacharakis, Meyer & DeCastro, 2002). The second liability, the so-called "liability of smallness," concerns the difficulties that small firms experience following their initial launch (Zacharakis et al., 2002). According to Zacharakis and his associates, "The 'liability of newness/smallness' framework identifies problem factors (internal and external) which inhibit new venture success" (p. 1). The two halves of the "newness/smallness" liability framework are discussed further below.

Liability of Smallness. As the term implies, "bigger is better" when it comes to the size of companies and their ability to survive in an increasingly competitive and globalized marketplace. For example, Heneman and Berkley (2002) emphasize that, "Small businesses face different concerns than those of larger organizations. The concept of 'liability of smallness' suggests that small organizations, relative to larger ones, face problems of access to financial and material resources that make it difficult to compete and survive" (p. 53). Likewise, Frese (2000) reports that, "Large-scale research has shown that there is a liability of smallness. This means that those who start out with a high amount of capital are more likely to succeed than those who start out with little capital, because they have a headstart right at the beginning. Good equipment makes it possible to grow more quickly than when one has poor tools" (p. 107).

Indeed, larger firms appear to be like larger planets or even stars in that their stronger gravity attracts more interstellar material to them while smaller heavenly bodies attract very little in comparison. In this regard, Chengalur-Smith, Sidorova and Daniel (2010) suggest that the same effects can be discerned in the business world where larger enterprises enjoy the lion's share of resources and support while smaller firms go begging. For example, Chengalur-Smith and her colleagues emphasize that, "Organizational size is the first among the key demographic factors that have been shown to influence organizational legitimacy and, consequently, the ability to attract resources and support from others" (2010, p. 657). These assertions may seem exaggerated, but the research to date and the experiences of tens of thousands of failed small businesses lend support to these claims. For instance, Chengalur-Smith et al. note that, "Smaller organizations have several disadvantages compared with large organizations, primarily due to difficulties in raising capital and creating organizational routines when their resources are stretched thin" (p. 657).

While there are alternatives available for raising capital that smaller enterprises can use, the harsh reality is that talented human capital remains elusive for many smaller companies simply because they are unable to compete with their larger counterparts in terms of pay and benefits as well as better working accommodations. In this regard, Chengalur-Smith et al. add that, "In competing with large organizations for labor input, small organizations are at a major disadvantage, since they cannot offer the long-term stability and internal labor markets that large organizations are thought to have" (p. 658).

For many consumers faced with products or services provided by a known mega-corporation such as Johnson & Johnson or Proctor and Gamble or those provided by a recent start-up, the choice is clear and they will opt for the known quantity and quality more often than not. This point is made by Chengalur-Smith and her associates when they advise, "Large organizations seem more legitimate because their size is taken as an indicator of prior success and future dependability. Together these disadvantages underlie a liability of smallness as originally described by Aldrich and Auster (1986)" (p. 658). Unfortunately for start-ups, their liabilities do not end with their size alone but also include the amount of time they have been in operation and these issues are discussed further below.

Liability of Newness. Unfortunately, the only cure for the liability of newness is to survive in the jungle that is the world of business sufficiently long to no longer be regarded as "new," a feat that eludes a hefty percentage of start-ups. According to Changalur-Smith et al. (2011), "The liability of newness proposition suggests that a young or new organization is likely to have lower legitimacy and a higher chance of failure" (p. 659). While their larger competitors are busy innovating and following their established processes and procedures in efficient ways, smaller firms are forced to devote significant amounts of time and energy in creating these systems for their own firms. In this regard, Changalur-Smith and her associates also note that, "The explanation for this phenomenon is that young organizations expend significant amounts of time and effort on coordinating new roles for the individual actors and on their mutual socialization. Therefore, they may be less efficient than more established organizations with which they are forced to compete" (p. 659).

Clearly, the longer a company is able to stay in business, the more credibility they will accrue as a result of the accumulation of a track record of customer service and reliable products and services and there is no substitute for this attribute. This places start-ups at a distinct disadvantage because they are forced to formulate from scratch what their larger competitors simply take for granted. For instance, Changalur-Smith and her colleagues (2011) also emphasize that, "Emerging organizations may face intense selection pressures as they could lack formal goals and clear boundaries. In addition, they are more vulnerable because they lack bases of influence and stable relationships with external constituencies, and hence lack legitimacy" (p. 659). This point is also made by Brinckmann, Salomo and Gemuenden (2011) who report, "New ventures face a liability of newness and a liability of smallness. The fledging new firm's competitiveness and growth depend on the founding team's capacity to acquire resources and to configure them in a value creating fashion" (p. 218).

Finally, the liability of newness can operate in favor of larger, more established companies because of the relationships they build over time, relationships that can make or break a company, particularly in the short-term. In this regard, Changular-Smith et al. conclude that, "Older organizations are likely to have established social networks, including supplier and client groups, which makes them more resilient to minor variations in…

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