Adaptability and survival during recession

That market economies experience fluctuations from boom to bust over time has long been acknowledged. Within these cycles, recessions are defined by the US National Bureau of Economic Research (NBER) as ‘a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production and wholesale-retail sales’ (NBER, 2010).

Whatever the causes, recessions drive selection both through business exit and entry and through adaptation by existing firms trying to stay alive. So there is a concentrated and accelerated change in both the firm population and individual firm behaviour during recessions. Each recession has its own drivers such that comparison are hard to make and lessons hard to draw, but the 2008/9/10 recession seems most similar to the 1929 crisis, in which a rapid growth in credit combined with an asset price bubble to produce a significant bank crisis (von Mehren, 2009).

Neoclassical theory says that demand and supply, competitive market processes and general equilibrium theory explain the determination of economic outcomes, even in recession. Left alone, recessions in this view are generally self-correcting; prices will eventually adjust and the economy will go back to producing at potential. In the process, the most adaptable and

24See Reydon and Scholz (2009) for a contrary view and Lemos (2009) and Dollimore (2012) for a counter argument that explains how the replicator/interactor distinction, when properly applied, provides the way forward for organisational ecology.

fittest survive and the weakest die, whether the swing in the economy is in growth or recession mode while tending back to a stable position.²⁵

The organisational strategy perspective on recession is that firms that choose and implement the right strategy within the recessionary environment can boost their chances of survival.

This can be achieved by making the right call on how far to cut costs to conserve resources and/or by investing in new products and processes to take advantage of weak competition.

Indeed, the ‘pit-stop’ theory of business behaviour in recession treats firms as more willing to innovate because the opportunity costs of failing to do so are lower than at more normal times (Mensch, 1979). Most likely, firms feel the need to adopt some ambidextrous strategy during recession and adapt through a combination of considered retrenchment and some process improvements and new product or service development (Kazozcu, 2011), although doing so under pressure must be even more risky than attempting it during more normal times.

Organisational ecology, on the other hand, implies that the process of environmental selection at the industry or population level (rather than resulting from the action of individual firms) is speeded up during recessionary periods. Competition causes firms that become unsuited to the environment to be replaced by firms that are even more compatible with the rapidly changing circumstances. In a recession, organisational inertia seriously prevents firms from adapting appropriately to sudden and extreme environmental shocks.

In the evolutionary economics view, recession is an example of particularly intensified creative destruction, in which some firms and industries decline, often terminally, while new ideas, technologies, products and industries emerge and become the driving forces of subsequent economic activity and growth. Recession conditions contribute to this economic restructuring through stimulating business churn (the entry and exit of firms) and by motivating incumbent firms to adapt products and business processes. In this process, even if the scope for adaptation is generally small, it is likely that the more adaptive firms may

25Although the neoclassical view was challenged after the Great Depression by Keynes (1936), suggesting that free-market economies needed some positive and active governance to work effectively, a New York Times article by Krugman (September, 2009) points out: ‘The story of economics over the past half century is, to a large degree, the story of a retreat from Keynesianism and a return to neoclassicism, notably the Friedman view of the world.’ While the fault-lines running through the economics profession are not of concern here, the debate about the extent to which the neoclassical world may need to take on board issues of irrationality and unpredictable behaviour and the idiosyncratic imperfections of markets is certainly apposite.

possess an advantage relative to their rivals. If the more adaptable have some advantage relative to their rivals that confers greater longevity, then a reasonable conjecture is that this advantage should confer even greater benefit during recession as flexibility lets a firm adjust relatively fast to rapidly changing external factors.

Commenting on their survey of business responses in the UK to the recession in 2008/9, a survey by Kitching et al. (2009) found the literature on how businesses respond during recessions was ‘limited and partial’, with few academic studies looking at the causes, processes and consequences of adaptation during recession. The authors point out that recessions do not have a regular impact on industries, countries, regions and firms and that there is no one ‘recession effect’ for businesses, nor any particular best practice to adopt in recession conditions applicable to all businesses. Recessions generate contradictory tendencies; for instance, declining aggregate expenditure and falling input prices. A study of the impact of the latest recession on different sized firms in the UK (Buccellato and Scheffel, 2011) found that, for the services sector, small firms were hardest hit by the downturn, followed by medium-sized firms, which in turn have done worse than large firms.

For the manufacturing sector, however, the opposite results were reported.

What actually happens to any relationships between adaptability, firm size, age and survival in a recession are still wide-open questions. If adaptability contributes to survival in normal circumstances, does it matter even more in a recession for survival, as the attribute should allow firms to respond more rapidly to rapidly changing circumstances? Or is the transforming force of competitive selection on the population amplified in the suddenly shortened business cycle? These are legitimate topics for empirical enquiry.

2. 11 Adaptability and inertia – a perspective issue?

As touched on in section 2.2 above, there is the need to keep a proper perspective on the degree of granularity brought to bear on analysis by the various disciplines. At the macro level of analysis, events over time seem to constitute a flow of repetitive action, with routine and inertia dotted with occasional episodes of revolutionary change. But a closer view at the micro level of analysis suggests on-going – even continuous – adaptation and adjustment (Weick and Quinn, 1999). There is work on what might constitute the boundary conditions

between the two views (Hannan and Freeman, 1984; Kelly and Amburgey, 1991; Amburgey et al., 1993) but there still remains the problem of reconciling large-scale change in goals with changes of routines, or reconciling changes that lead to some minor loss of competency with those that lead to a catastrophic event such as merger or failure.

Helfat and Winter (2011) suggest that firms change all the time so any claim of inertia would require a perspective and time frame that render change practically invisible. So what level of change, from small adaptations to strategically important change, is under consideration, and to what extent is any observed lack of change just a matter of the fineness/coarseness of the view? If routines are an important part of the story, say Helfat and Winter, then the distinction between adaptation and routine responses to change presents significant conceptual difficulties and poses a huge challenge to operational measurement. If inertia is defined as no change of routines, or routines to change routines, then firms with unchanging routines are still capable of changing significantly. This may be through an existing reactive response to environmental change but it can certainly cover a significant range of real change. The question is how well existing routines (including routines for changing routines) manage significant change, as such a routine response would effectively amount to an adaptation?

Helfat and Winter conclude (p.1248) that, because things are always changing to at least some extent, ‘identifying a precise threshold level of change that separates an operational capability from a dynamic one is likely to be fruitless, or to produce answers that vary erratically across cases.’ Instead, they say, it may be more useful to assess the nature and speed of change that a capability enables and to be as open as possible about the level of granularity, the time frame of observation and what this may imply for any conclusions.

Before a summary of the contrasting views of the relative roles of adaptability/inertia and selection in accounting for the survival of SMEs, it is worth discussing, as background to the thrust of the dissertation, the more conceptual, general models that sit above evolutionary economics.