Modelling Small Business Growth and Profitability

Abstract

This paper develops a simple structural model relating small business performance to firms' market position and the characteristics of their owner-managers. Attention focuses on two questions: What determines firms' choice of business strategy? And, how does strategy choice change subsequent business performance? Taking into account both relationships, the paper examines the links between the performance of a large group of Irish small businesses over the 1993--94 period and their market and owner-managers' characteristics in 1991. The analysis suggests three main empirical results. First, firms' turnover growth and return on assets are only weakly related in the short-term; above average growth rates are therefore no guarantor of high profitability. Moreover, a number of characteristics of firms' market position and their owner-managers are found to have the opposite effects on profitability and growth rates. Secondly, our data provides no evidence of the persistence of turnover growth rates above or below the average. Above average profit rates were also found to persist only in the very short term. Thirdly, small firm performance is shown to depend strongly on strategy choice, with turnover growth being particularly strategy dependent. This highlights the importance for small firms of making the correct strategy choices, a point emphasised by the negative profitability and growth effects of some strategy choices. One strategy choice that had positive effects on both profitability and growth was the development of new export markets.