CRIEFF Discussion Paper Number 0105

Flexibility in the Small Firm: the dynamics of market re-positioning and scale adjustment in the early stages of the life cycle

Gavin C Reid

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Abstract
This paper examines flexibility in the small firm in two ways.  First, it looks at the re-positioning of their main product markets that firms undertake in the early life cycle, in an attempt to best exploit their niche advantages.  The market extent variables used are: local, regional, Scottish, national, and international.  A transition probability approach is taken, estimating the probability of moving from one market are to another in a unit period.  In this way, it is possible to compare the long run equilibrium of such a process, with the period by period adjustment.  This examination of short run adjustment to a long period equilibrium provides insights into small firm flexibility as regards market area and niche exploitation.  It is found that the speed of adjustment of small firms is relatively rapid, and they typically get close to the long period equilibrium in just a few periods of adjustment.  This suggests high flexibility in the exploitation of market areas.  Secondly, the paper estimates a model of the dynamics of small firm sales growth.  This is a variant of a Gibrat’s law type of model. It is shown that rapid sales growth is often achieved in the early life cycle.  This process is log-linear in size, dynamically stable, and implies a plausible value for the long run equilibrium size of the small firm.  Over short periods, of just a few years, however, most small firms were yet still below their equilibrium sizes, though a systematic tendency towards equilibrium was observed.  Thus pervasive flexibility was evident in small firm behaviour, both in terms of niche exploitation and growth.  Greater flexibility was observed in niche exploitation, as compared to overall scale.

JEL Classifications
D21, L11, M13, R32

Keywords
Markov chains, Gibrat's Law, flexibility, Scottish small firms

Gavin Reid
Director, CRIEFF

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