Small-Firm Performance: Modeling the Role of ... - Wiley Online Library

Journal of Small Business Management 2006 44(2), pp. 268–284

Small-Firm Performance: Modeling the Role of Product and Process Improvements* by James A. Wolff and Timothy L. Pett

Entrepreneurial and small and medium-sized enterprises (SMEs) firm performance is a complex, multifaceted construct that should be examined with an eye toward its complexity. Our research study seeks to accomplish this examination by proposing a conceptual model of SME performance with two distinct but related outcome dimensions—growth as one dimension and profitability as another. We propose hypotheses for relationships between four antecedent factor conditions— environmental hostility, firm size, innovation capability, and internationalization— and an SME’s likelihood to pursue either product improvement or process improvement as their primary strategic orientation. Furthermore, we propose that an SME product improvement orientation likely has greater influence on growth and profit performance than will a process improvement orientation. The findings of the study suggest that internationalization and innovator position have a positive impact on new product and process improvements, while environmental hostility, internationalization, and product improvement have positive influences on growth as a performance dimension. In addition and as hypothesized, the product improvement orientation is positively associated with growth and in turn profitability, whereas the process improvement orientation showed no statistical relationship to growth and ultimately profitability.

Introduction An important subset of the small- and medium-sized enterprise (SME) and entrepreneurship literature is that which examines venture-related performance

and the various antecedent factors and conditions thought to affect firm performance. Through this examination, researchers hope to provide SME managers and entrepreneurs some guidance

James A. Wolff is associate professor of management, Department of Management, W.F. Barton School of Business, Wichita State University. Timothy L. Pett is director, Center for Entrepreneurship and associate professor, Department of Management, W.F. Barton School of Business, Wichita State University. *An earlier version of this paper was presented at the 50th World Conference of the International Council of Small Business (ICSB), June 2005, Washington, D.C.

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with respect to successful venture performance. Researchers have found solid support for the effects of market attractiveness and resource-based capabilities on performance (Chandler and Hanks 1994). Covin and Covin (1990) found counterintuitive relationships among the level of competitive aggressiveness, environmental context, and the ultimate performance of small firms. Zahra and George (2000) revealed a strong association between commercialization capability, establishment of a reputation for quality, and SME technology firm sales growth. Also, innovation has demonstrated a strong and influential relationship with SME performance (Verhees and Meulenberg 2004; Qian and Li 2003). By their numbers alone, SMEs and entrepreneurial firms are a key segment and driver for most (if not all) national economies. Understanding how SMEs achieve high performance has significant implications for SME owners/managers, SME employees, and the economies in which the SME operates. High levels of performance can facilitate firm growth and subsequent profit performance, which in turn can yield employment gains and contribute to the general economic health of a state, region, or nation. Conversely, low performance may lead to firm stagnation or failure, and the negative economic ramifications commensurate with these outcomes. Given the resource constraints of small firms (Acs 1999) and their susceptibility to distress, hardship, and outright failure with respect to environment change and uncertainty, a better understanding of the contributing factors and mechanisms for high performance is desirable. The goal of this study was to expand our understanding of the factors contributing to firm performance by examining a set of related conditions and actions that we propose are of consequence to high SME performance. Our

empirical research paper examines two characteristics of entrepreneurial SMEs— innovator position and the propensity to internationalize—in conjunction with two contextual variables (environmental hostility and firm size). We propose hypotheses for relationships between the four factors mentioned, and an SME’s likelihood to pursue either product improvement or process improvement as their primary strategic orientation. Furthermore, we propose that SME product and process improvement orientations likely influence growth and profit performance. The hypothesized relationships are developed from much of the significant research conducted in entrepreneurship, small business management, and strategic management over the recent past. Our postulates are explained and illustrated using a structural equation model. The paper is organized as follows. First, we underpin our formal hypotheses and the associated model with a discussion of relevant theory and prior research conclusions. Second, we present a discussion of the methodological issues regarding data, sampling, measures, and analytical tools that were used to test the hypotheses. Third, a discussion of the results of our analysis is included. Finally, we discuss our interpretation and conclusions regarding the findings. The last section also includes discussion about the limitations of our research and implications for research and practice.

Theory Review and Hypothesis Development The predominant dependent variable of interest in the strategic management literature is performance (Eisenhardt and Zbaracki 1992; Schendel and Hofer 1979). Michael Porter’s articulation of the “structure–conduct–performance” paradigm (for example, Porter 1985, 1980; Rumelt 1974) analysis of diversification and Jay Barney’s (1991) essay articulat-

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ing the resource-based view of the firm are but a few examples of seminal strategic management research seeking to explain firm performance. Within SME research, the issue of firm performance has also taken a place of prominence as a dependent variable (for example, Lau, Man, and Chow 2004; Sadler-Smith et al. 2003; Swierczek and Ha 2003; Covin and Covin 1990). Researchers attempt to understand the dynamics at work on the performance of firms because to do so may help to improve it. Improved firm efficacy certainly can facilitate a number of desirable outcomes related to economic development, growth, and resilience particularly in light of the dominance (> 97 percent of firms) SMEs represent to the economy. However, researchers acknowledge that performance is a complex and multidimensional construct (Carton and Hofer 2005; Dvir, Segev, and Shenhar

1993). Firm performance may at various times be reflected by, in no particular order, financial outcomes, sales or market growth, customer satisfaction, or establishing a foundation upon which future growth may take place (Dvir, Segev, and Shenhar 1993). Carton and Hofer (2005) argued that financial performance is itself a multidimensional construct, and evidence is provided to support the notion. Growth and profitability have been empirically shown to be distinct and varying elements of performance (Venkatraman and Ramanujam 1987). In the following section, we explain our conceptualization of the relationship between growth and profitability, which leads to our first hypothesis. From the dependent variables, we develop our model in reverse order (right to left in Figure 1), proposing testable hypotheses with respect to product- and processrelated improvements and conditions

Figure 1 Research Model Illustration (All Hypotheses Positive Relationships) H6 Environmental Hostility

H4 H5 Product Improvement

H12 Firm Size

H2 Growth Performance

H13

H10 Innovation Capability

H3 Process Improvement

H11 H7 H8

Internationalization H9

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H1

Profit Performance

(environment, size, innovativeness, and internationalization), which we argue are related to growth and profitability.

Growth and Profitability As previously discussed, firm sales growth and profitability are separable components of the performance construct. Logically, the correlation between growth and profitability measures should be relatively high. However, there are conditions under which the relationship may not be as expected. For example, SME owners/managers may find it useful or necessary and unavoidable to pursue strategies that sacrifice (short-term) profitability for growth. Such risky strategies may be due to environmental conditions (Lau, Man, and Chow 2004; Covin and Slevin 1989) or to a particular time in the firm’s development (Oviatt and McDougall 1994). Without the ability to reach a “critical mass” in revenue at some point in the early development of a firm, the issue of profitability in the traditional sense is moot. In other words, cash flow to cover expenses may favor sales growth over profitability. In a similar fashion, major organizational transformation stages (Miller and Friesen 1984) during the life of established SMEs may necessarily require the (albeit temporary) abdication of profit in favor of sales growth. Such transformations may be the result of new product development and introduction initiatives, competitive dynamics in established markets, or major changes in the market focus or scope for the firm’s products. The industry life cycle stage may have an effect on SME growth emphasis versus its profit emphasis as well (Eisenhardt and Schoonhoven 1990). We present the previous discussion as a way to illustrate the issues surrounding the notion that sales growth and profitability are contemporaneous and substitutable as some research has presented (for example, Qian and Li 2003). Previous research has found evidence for a

positive relationship between growth and profitability due to optimal size or efficient scale (Gupta 1981; Mansfield, 1979), experience curve effects (Stern and Stalk 1998), and firstmover advantages (Lieberman and Montgomery 1988). In many instances, the two are likely positively related, but there are situations where the relationship may be more tenuous. However, particularly with respect to SMEs in the general case, there is likelihood that growth is positively associated with the profitability of an SME. Therefore, H1: Growth is profitability.

positively

related

to

Growth is the outcome of internal organizational processes relative to competitors and the marketplace. We propose that for SMEs, there are two general avenues by which firms can achieve sales growth. The first is by investing organizational resources in the development of new products or in product improvement effort, hence markets may be expanded. The second is by investing in internal organizational processes to improve operational efficiencies, which in turn facilitates growth by enhanced market competitiveness.

New Products, Product Improvement, and SME Growth Growth may be achieved by growing existing product markets or developing new ones. SME new product and product improvement growth is related to research and development, innovation, and the ability to gain advantage over competitors in the product market (Romano 1990). Product improvements and new products provide firms the momentum for market leadership and sales growth (Iansiti 1995). Product innovation opens firms to market share growth and hence sales growth by increasing the customer base in current markets or attracting new customers by

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opening new markets to the firm (Zahra and Nielsen 2002). New products and product improvement effort by SMEs can open the doors to new customers and markets. Thus, H2: Product improvement is positively related to growth.

Process Improvement and SME Growth Covin (1991) examined the contrast between the characteristics of high- and low-performing “entrepreneurial” firms and those of high- and low-performing “conservative” ones. In the study, Covin reported several significant differences that emerged from the data. However, an interesting outcome of Covin’s research that is particularly relevant to our study is the lack of difference in the emphasis on operating efficiency between the entrepreneurial and conservative SMEs. The lack of contrast suggests that operating efficiency may be a universally important aspect of SMEs and small-firm managers. Because SMEs are resource-constrained, firms must get maximum productivity and benefit from the resources they possess. Following basic microeconomic theory, firms grow to achieve optimal size or minimum efficient scale (Mansfield 1979). Additionally, the bynow well-understood principles associated with learning economies within operations and production (Stern and Stalk 1998) provides an impetus to grow. All three of the stated reasons for growth can be facilitated by organizational process improvements. Process improvements can stretch resources, may reduce optimal size, and facilitate learning curve effects. We postulate that operational process improvements and subsequent operational efficiencies positively impact SME growth. H3: Process improvement is positively related to growth.

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Environmental Hostility Environmental hostility is often associated with unpredictability, instability, or general unfavorableness with respect to a firm’s external operating environment. Unfavorable business environments generally lead to difficulties of varying types for many business firms. However, the margin for error can be particularly thin for SMEs. In response to such conditions, SMEs may undertake upstream (supplier intelligence) and downstream (customer market intelligence) environmental scanning (Verhees and Meulenberg 2004). Organizational flexibility and entrepreneurial posture (that is, innovation, proactiveness, and risk taking) can mitigate the effects of hostile environments for SMEs (Lau, Man, and Chow 2004; Covin and Slevin 1989). Small firms may also assume an aggressive posture and be much more proactive in their internal activities when they experience difficult environmental conditions (Covin and Covin 1990). Following this discussion, we propose that SME managers are likely to take a proactive position with respect to product development and improvement activities. Thus, H4: Environmental hostility is positively related to product improvement. Second, innovation and proactiveness as a response to environmental hostility may lead to process improvements to lower costs and thereby preserve financial flexibility. H5: Environmental hostility is positively related to process improvement. In a recent study of market orientation, product innovation and small-firm performance Verhees and Meulenberg (2004) linked market orientation and intelligence to performance. Information gathering, market understanding, environment understanding, and sense-


making are necessary preconditions for high SME performance. Such a market orientation is likely to elicit development of the internal resources and capabilities commensurate with adequately meeting the market’s needs with appropriate products. Chandler and Hanks (1994) found that “[f]irms with higher levels and broader varieties of resource-based capabilities grew faster and had higher levels of business volume” (p. 343). With fewer degrees of freedom for survival, small firms will seek to derive the benefits attributable to size to more effectively fend off the undesirable consequences of environmental conditions. H6: Environmental hostility is positively related to growth.

Internationalization Following Johansen and Vahlne’s (1977) stage theory propositions, small firms develop their business activity in domestic home country markets. Success in domestic markets provides the capability to move into foreign markets at first primarily through export activity. From this limited exposure to foreign markets through exporting, firms can learn about a customer’s product needs, pricing needs, country distribution systems, and culture, to name a few. Ultimately, in time such learning yields greater commitment to international markets and potentially enhances performance for the firm. Barkema, Bell, and Pennings (1996) suggest that the learning element is key in the internationalization process of SMEs. Likewise, Reuber and Fisher (1997) contend that previous international knowledge or learning is essential to SME internationalization. These convergent themes support the proposition that knowledge and/or know-how are important resources for an internationalization orientation. Most often, SMEs have two general strategic orientations

from which they may pursue international activities—product or process improvements. H7: Internationalization is positively related to product improvement. H8: Internationalization is positively related to process improvement. Internationalization is a major strategic action for an SME. Under the stage theory premise, an SME operates from an established base of business activity. Research has reported internal conditions that impact SME internationalization to include special competitive advantages ( Jaffe, Pasternak, and Nebenzahl 1988), the possession of a unique product, profit advantage, and technological competence (Koh 1989), and underutilized production capacity (Kaynak, Ghauri, and OlofssonBredenlow 1987). H9: Internationalization related to growth.

is

positively

Innovation Typically, SMEs are characterized as resource-constrained when comparison is made to large-sized firms. What SMEs lack in resource endowments may be compensated for by flexibility, agility, and innovation (Qian and Li 2003; Acs and Yeung 1999; Buckley and Mirza 1997). SME innovation is generally manifested in the form of product modifications (Verhees and Meulenberg 2004). Romano (1990) revealed that the internal drivers for SME growth from innovation were technology, R&D, and the ability to generate a competitive edge in the firm’s product market. The ability to innovate and adapt new technology to make product modifications is likely because of the greater creativity and innovativeness of small-firm employees (Acs and Yeung 1999).

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H10: Innovation is positively related to product improvement. Similar to the product improvement arguments presented previously, firms may also pursue innovations in their organizational and manufacturing processes to become more productive and improve quality, reliability, and efficiency. H11: Innovation is positively related to process improvement.

Firm Size In the discussion, we stated that small firms are typically characterized as resource-constrained. Larger firms likely possess a greater array of resources to cope with corporate life cycle changes (Miller and Friesen 1984). Zahra and George (2000) report significant differences in the manufacturing strategies between corporate (CVs) and independent ventures (IVs) in the biotech industry. Many of these differences are directly attributed to the different resource endowments available to the ventures— CVs have the wherewithal to draw upon their corporate parent resources while IVs do not. McDougall, Deane, and D’Souza (1992) reported similar outcomes for computer and telecommunications equipment manufacturing ventures. H12: Firm size is positively related to product improvement. H13: Firm size is positively related to process improvement. The diagram presented in Figure 1 provides a graphic illustration of all hypothesized associative relationships that were tested simultaneously with our statistical methods. Next, we discuss the methodology employed to test the theoretical model.

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Methodology Research Design The research design employed the survey method for data gathering. A representative random sample of 855 smalland medium-sized manufacturing firms was selected from 4,614 firms contained in a biannual directory published by the largest newspaper in a Midwestern state. The random sample represented a broad cross-section of public and private firms from a wide array of standard industry classification (SIC) code industries. A cover letter and survey were addressed to the president or owner from each firm soliciting a response to the questionnaire. Postcard reminders were mailed three weeks after the initial questionnaires. The multiphase approach resulted in a total of 192 key-informant responses, out of which 182 provided complete information. This provided our study an overall usable response rate of 21 percent, which is consistent with similar studies that survey top management or owners (Hambrick, Geletkanycz, and Fredrickson 1993). In our study of SMEs, 68 percent of the respondents reported themselves as being the chief executive officer, president, or vice president. An examination of the sample through a ttest revealed no significant differences for responses between this group and the remainder of the sample, which was classified as “division head” in our analysis. The average tenure for all respondents was about eight years, while the average age of the organization was 30 years.

Measures Performance. Small and medium-sized private firms are often reluctant to provide specific information regarding performance. The sensitive nature of performance constructs vis-à-vis SMEs makes it somewhat difficult to measure. Following previous research (for example, Zahra and George 2000;


Chandler and Hanks 1994), we employed a categorical approach to assess firm performance. We asked respondents to answer four questions concerning their firm’s performance level when compared to their industry. Each of the items employed a five-point Likert scale format (1 = lowest 20 percent and 5 = highest 20 percent) to determine relative performance levels. Because performance can be viewed from multiple perspectives, respondents were asked to compare their firm to the industry for return on sales (ROS), sales growth, creation of new products or services, and return on assets (ROA). This approach provided multiple assessments of each respondent firm’s performance level. Although we had prior knowledge or expectations that firms utilize different outcomes when it relates to performance, little research has examined this phenomenon with respect to SMEs (Chandler and Hanks 1994). Therefore, an exploratory assessment using a principal component factor analysis with a varimax rotation was employed to determine if different performance outcomes were being utilized by these firms. The result from this analysis suggests the presence of a two-factor solution regarding performance. The findings revealed what we believe are two distinct dimensions of performance–growth and return. Based on our interpretation of the underlying factor structures, we designated the first dimension “growth” because it is composed of sales growth and creation of new products or services. We labeled the second dimension “return” because the components are ROA and ROS. The performance measures are deemed valid because the eigenvalues are above the recommended threshold (1.0) and Cronbach’s alpha for each dimension is strong—0.70 and 0.86, respectively. Product Improvement. Product improvement was measured by asking respondents four questions regarding

new, changed, or improved product or service offerings within their firms. The four items included: (1) leading the industry in new ideas; (2) creating a distinct image for your company; (3) developing new products; and (4) developing brand identity. The scale used was a fiveitem measure with a 1 = not at all important and 5 = very important. A principal component factor analysis with a varimax rotation was used for exploratory analysis and resulted in a single underlying construct. The construct was deemed reliable (a = 0.69) and labeled “product improvement.” Process Improvement. The respondents were asked four questions to tap into what we believe is process improvement within a firm. The four items included: (1) investing in new facilities; (2) incorporating the latest technology; (3) ownership of patents or other proprietary information; and (4) manufacturing process innovation. A five-item Likert-type measure was used with 1 = not at all important and 5 = very important. An exploratory principal component factor analysis with a varimax rotation was utilized to establish the presence of unidimensionality. A single construct emerged with reliability at a = 0.60—the minimum significance threshold (Nunnally 1978). We termed this construct “process improvement.” Environmental Hostility. Similar to Covin and Slevin (1989), environmental hostility was measured using five distinct items. The respondents were asked “How do you perceive the following conditions during the next few years for your business?” The five-response items included: (1) economic conditions; (2) political/ legal/regulatory issues; (3) demographic trends; (4) international/global factors; and (5) societal issues facing the firm. The scale used was again based on a five-point Likert scale with 1 = highly unfavorable and 5 = highly favorable. Principal component factor analysis

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yielded a single, reliable (a = 0.75) construct we labeled “environmental hostility.” Internationalization. The respondents were asked three questions concerning either the firm’s current international activities or intended future international activities. These items were based on Campbell’s (1996) research suggesting that internal constraints may impact managerial decisions concerning exporting even under free trade agreement conditions. We asked respondents to gauge a firm’s intentions with respect to continuance or development of export strategies. The items were scaled on a five-point Likert scale with 1 = strongly disagree and 5 = strongly agree. The three statements were (1) exporting is a desirable task for my firm; (2) my firm is planning to export; and (3) the North American Free Trade Agreement (NAFTA) has influenced my firm’s export decisions. An exploratory assessment of these items through a principal component factor analysis using a varimax rotation provided a one-factor solution with good reliability as measured by Cronbach’s alpha (a = 0.84). This result provides a strong indication that the questions capture the underlying “internationalization” construct. The mean score of the three items was used in data analysis. Firm Size. Firm size was measured categorically by asking the number of employees currently employed by the firm. The scale for this measure was 1 (1–24 employees), 2 (25–49 employees), 3 (50–149 employees), 4 (150–249 employees), and 5 (250–500 employees). Research suggests there are many accepted approaches for measuring firm size (number of employees, sales volume, or total assets). However, SMEs are reluctant to provide financial measures associated with size. Number of employees is an unobtrusive measure that is easily compared across studies

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and is less likely to be biased significantly from true levels. The measure is also in keeping with the U.S. government’s classification of business size as reported by the Bureau of Census and is widely accepted in the literature (Milliken, Martins, and Morgan 1998). Innovation. To measure innovation capability, we used an approach similar to that employed by Qian and Li (2003) but adapted for privately held companies. R&D expenditures are a general indicator of a firm’s effort to improve its operating processes, create new products, or improve/modify existing ones. Therefore, we asked the respondents to indicate their firm’s level of prior years R&D expenditures relative to the average level of those in their industry. The response items were based on a fivepoint scale ranging from 1 = lowest 20 percent of firms in the industry to 5 = highest 20 percent of firms in the industry.

Analysis and Results Construct Validation In this study, we used a two-step process of analysis following Anderson and Gerbing (1988). The first step involved a multistage process to validate the overall construct validity of the measures used in this study. The second step employed structural equation modeling to test our hypotheses simultaneously. A confirmatory factor analysis (CFA) was undertaken using AMOS 4.0 to test for the multidimensionality and convergent validity of the constructs (Arbuckle and Wothke 1999). The underlying purpose of the CFA was to provide evidence for the viability of the constructs and the measurement model. With this evidence, we can have more confidence in the findings resulting from the test of the hypothesized model. The results of the CFA loadings and reliability are reported in Table 1. All composite


Table 1 Confirmatory Factor Analysis Loadings and Measurement using AMOSa Scales

Standardized Loadings

Returns Return on total assets (ROA) compared to competitors Return on totals sales (ROS) compared to competitors Growth Total sales growth compared to competitors Creation of new products or services compared to competitors Product Improvement Creating a distinct image for your company Leading the industry in new ideas Develop brand identity products Develop new products Process Improvement Incorporating the latest technology Investing in new facilities Ownership of patents or other proprietary information Innovation in manufacturing processes Environmental Hostility Political/legal/regulatory International/global Economic Demographic Societal Internationalization Exporting is a desirable task for my firm My firm is planning to export NAFTA has influenced my firm’s export decisions

a = 0.860 0.907 0.841 a = 0.70 0.809 0.659 a = 0.69 0.582 0.710 0.640 0.570 a = 0.60 0.570 0.503 0.679 0.550 a = 0.75 0.621 0.606 0.664 0.646 0.549 a = 0.84 0.926 0.949 0.674

Model fit statistics: c2/df = 1.79 ( p = 0.00), RMSEA = 0.05, NFI = 0.97, NNFI = 0.98, and CFI = 0.99. All items were scored from 1 to 5 (n = 182).

a

constructs using multiple items were included in the analysis. Multiple criteria were used to assess the goodness of fit for the constructs. The results suggest that the standardized loadings are highly significant for all these items, which indicates that the underlying constructs are valid. Following Kline (1998), the descriptive fit was assessed by the ratio found from c 2 to

degrees of freedom (df ) as well as root mean square error of approximation (RMSEA). In addition, the normed fit index (NFI), nonnormal fit index (NNFI), and comparative fit index (CFI) fit indices for the model were examined. The criteria mentioned were used to indicate that the data fit the CFA satisfactorily (c 2/df = 1.79, RMSEA = 0.05, NFI = 0.97, NNFI = 0.98, and CFI = 0.99). This

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Table 2 Correlations, Means, and Standard Deviations of Study Variables Variable 1. 2. 3. 4. 5. 6. 7. 8.

Growth Profitability Product Improvement Process Improvement Environment Hostility Internationalization Firm Size Innovation

Mean

SD

1

2

3

4

3.44 3.42 3.82 3.35 3.32 3.33 2.74 2.92

0.99 0.93 0.75 0.76 0.56 1.01 1.48 1.18

0.531** 0.373** 0.250* 0.431** 0.392** 0.419** 0.499**

0.142 0.111 0.283* 0.290* 0.288* 0.271*

0.399** 0.149 0.346** 0.212* 0.403**

0.070 0.239* 0.207* 0.354**

5

6

0.380** 0.336* 0.352** 0.314** 0.250*

7

8

0.334**

*p < .01 **p < .001

confirmed the dimensionality and convergent validity of the constructs in the model (Anderson and Gerbing 1988; Fornell and Larcker 1981). Convergent validity is observed when the item coefficients to the latent construct are significant. Anderson and Gerbing (1988) suggest that when the corresponding t-values are greater than 2.0, there is evidence for convergent validity. Within the AMOS software package, critical ratios are given instead of t-values being reported; the critical ratio measure is a similar measure to the t-value. In all cases, the critical ratios loaded significantly on the corresponding latent construct. These findings suggest evidence for convergent validity. Table 2 reports the means, standard deviations, and correlations of the constructs. We followed Anderson and Gerbing’s (1988) suggestion to employ a multistage process to verify construct validity. Both discriminant and convergent validities were determined satisfactorily through a process of principal components and confirmatory factor analysis. We used structural equation modeling to test all hypothesized relationships simultaneously. Again, following the method of Anderson and Gerbing (1988)

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outcomes from the analysis show an adequate model based on fit indices provided (Table 3). The results from the statistical analysis support most (but not all) of the major premises of the hypotheses developed (Table 3). Briefly, we find support for the hypothesized positive relationships between innovator position and product improvement ( p < .001); innovator position and process improvement ( p < .001); internationalization and product improvement ( p < .001); internationalization and process improvement ( p < .01); internationalization and growth ( p < .001); environmental hostility and growth ( p < .001); product improvement and growth ( p < .001); and growth and profitability ( p < .001). There was no significant positive relationship between environmental hostility and either product improvement or process improvement and between process improvement and growth. The last result indicates that a process improvement orientation may not yield growth and, in turn, profitability. Conversely a product improvement orientation does yield higher growth, and in turn, higher profitability. Finally, the findings demonstrated no support for the hypotheses


Table 3 Structural Model Parameter Estimates and Goodness-of-Fit Statistics Estimates and Fit Statistics

Standardized Critical

Model Parametersa Environment Hostility → Product Improvement Firm Size → Product Improvement* Innovation → Product Improvement Internationalization → Product Improvement Environment Hostility → Process Improvement Firm Size → Process Improvement Innovation → Process Improvement Internationalization → Process Improvement Environment Hostility → Growth Internationalization → Growth Product Improvement → Growth Process Improvement → Growth Growth → Returns Goodness-of-Fit Statistics c2/df = 2.62 RMSEA = 0.07 NFI = 0.95 NNFI = 0.96 CFI = 0.97

Estimate

Ratios

−0.098c 0.016c 0.226 0.205 −0.170c 0.044c 0.209 0.131 0.592 0.161 0.313 0.127c 0.509

−1.10 0.47 5.34 4.16 −1.86 1.25 4.76 2.57 5.30 2.50 3.57 1.50 7.83

R2b

0.21

0.16

0.24 0.26

a

All parameters are significant except for the impact of firm size on product and process improvement, environmental hostility on product and process improvement, and process improvement on growth. b Indicates the proportion of variance accounted for product improvement, process improvement, growth, and returns. c Not significant.

examining firm size on either product or process improvements. Figure 2 shows a graphic illustration of the supported relationships.

Discussion and Conclusion The primary contribution of this paper to the literature on small-firm performance, namely SME growth is the dis-

tinction between product improvement and process improvement as an orientation for growth. Acs (1999, pp. 12–13) stated that “the importance of the relationship between innovation and firm growth is also clear. The successful entrants that grow the most are those that develop some type of innovative activity either with new products, new technology or human resources.” The

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Figure 2 Research Model Outcomesa Environmental Hostility

Product Improvement Firm Size Growth Performance

Innovation Capability

Profit Performance

Process Improvement

Internationalization

a

Solid lines: statistically significant; broken lines: nonsignificant.

results of our research support this premise in part. Innovation (and internationalization) that works through new product and product improvement efforts appears to be related to growth. However, if new technology is interpreted to mean new processes and process improvements, our data do not support this element of the premise. These findings reveal that among small businesses, environmental hostility only has a direct relationship to growth (H6), while the hypothesized relationship to either product (H4) or process improvements (H5) never materialized. In fact, contrary to the theory developed earlier, the negative relationships (even though not significant) between environmental hostility and both product and process improvements were not at all what we expected. It could be that small business managers become very defensive to conserve organizational resources

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in times of significant environmental hostility. The results from this study when compared to Covin and Slevin (1989) raise issues that future studies need to examine. The results with respect to internationalization reveal both a direct relationship to growth (H9) and a relationship to product improvement (H7). Although internationalization had a significant influence on process improvement (H8), the relationship between process improvement and growth was not supported (H3). The results suggest that the SME internationalization construct seems to be a significant factor in explaining product and process improvements and growth as it relates to product improvement. Indeed, internationalization may be reflective of a form of learning or capability development that enables leaping of the stages of internationalization by small firms


(Verhees and Meulenberg 2004; Johansen and Vahlne 1977). The results of the study also suggest that innovation plays a significant role in both product (H10) and process improvements (H11) for small businesses. These findings are not surprising because product and process improvements are likely due to the greater creativity and innovativeness of small businesses (Acs and Yeung 1999). According to Romano’s (1990) research, a central theme related to the growth of firms is the innovativeness of small businesses. However, based on our findings, we are inclined to suggest that innovation’s impact on growth is evident when product improvement mediates such relationships (H2). Certainly, more research is needed in this area to understand all the complexities involved. Unexpectedly, firm size had no apparent effect on either product (H12) or process improvement (H13) for this sample of small businesses. Although other researchers (for example, Zahra and George 1999) found significant relationships between the size of a firm and manufacturing approaches, our study found no support for such relationships. Finally, the data suggest that product improvement (H2) is associated with greater growth of the firm, while process improvement (H3) did not demonstrate such a relationship. Analysis of the data also suggests that growth is significantly related to profitability (H1). These findings support Acs and Yeung’s (1999) work, which suggested that the ability to innovate and adapt to make product improvements is likely due to the greater innovativeness of small businesses. In addition, we suggest that profitability will also improve as a result of growth achieved by new product development. Intuitively, the relationship between innovation and growth may seem to be clear. The results from our research indi-

cate that the effects of innovation are more complex than such a general statement might indicate. This study provides an examination of the relationships of product and process innovation activities and SME performance; however, this study has its limitations. First, the sample was limited to a single respondent, and geographically to one region. The design can be defended from the perspective that SMEs in a limited geographical region face similar external environment uncertainly as well as internationalization pressures. The design also limits the generalizability of the results; however, we believe that the results are reflective of issues facing SMEs today. Research in the future should attempt to extend the sample to multiple regions and include multiple respondents from each SME. A second issue deals with the measurement of product and process improvements. Although we are convinced that we captured these dimensions of these firm activities, scale development in this area would be useful for researchers examining these important issues facing SMEs. Research should also examine SME product and process improvements using multiple sources, for example, relevant archival sources. These findings present a number of interesting opportunities for research in this area. For example, researchers should examine when managers are likely to implement product or process improvements. The current findings are based on cross-section data; certainly a longitudinal study investigating this area may find that the timing of relationships is also an important consideration. Additionally, researchers should explore why or how SMEs with limited resources choose between product and process improvements investment decisions. This would be of interest to researchers in the area. Although, we rationalized that both (product and process) are important for growth and eventually profitability, in

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fact it may be that some form of sequencing by SMEs may be undertaken in response to the environment.

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