Is HRM a worthwhile investment for an SME ?

by dn246 (student)

University Degree Business and Administrative studies

Is HRM a worthwhile investment for an SME (Small or Medium Sized Enterprise)? Discuss critically.

Human Resources Strategy

Student Number: 12835997

“it is clear from our research that HR has a vital role to play in driving long-term performance in SMEs” (CIPD, 2012)

This paper will examine the concept of Human Resource Management (HRM) within the context of a Small or Medium Sized Enterprise (SME) by presenting its role from various perspectives. It will use a range of academic evidence to discuss both the benefits and limitations of HRM within the SME sector so as to give a rounded critical evaluation of whether it presents a worthwhile investment.

The research upon which the discussion of HRM in the SME sector is based will be evaluated in terms of both findings and methodology. Also considered are whether the results presented in the research support the conclusions reached in promoting the concept of HRM as a worthwhile investment for SMEs seeking to achieve their organisational objectives.

This paper accepts that a commonly agreed definition of HRM is still subject to debate. The search for such a definition is made more complicated by the issue pointed out in Torrington et al (2011), that the term is often used in two distinct ways; one to cover the group of people management activities undertaken by an organisation, such as recruitment, performance management, reward etc… and the other directed at a particular approach to the management of the people within the organisation. Here the focus will be more on the former of the two as to whether investment in HRM activities are worthwhile for SMEs, but some element of the approach to their inaction will also be considered.

Along with the European Commission and the Department for Business Innovation & Skills ( Accessed on 14 Sept 2012) SMEs are here defined as organisations consisting of less than 249 employees. This sector of the UK economy accounts for 99.9 per cent of all enterprises, 58.8 per cent of private sector employment and 48.8 per cent of private sector turnover (ibid). While this definition, based on the number of employees in the organisation, is the most widely accepted it does have limitations. As a SME based on the number of employees may be small within one sector this may not be the case in another. Other measurements have been suggested such as turnover, value of output, capital employed but the level of employment is the most common.

A further issue to be acknowledged is associating a common viewpoint to SMEs so as to allow for discussion as to whether HRM investment is ‘worthwhile’. What could be seen as worthwhile by one SME may not be the same for another at any given point and this will also be subject to change over time. SMEs may be similar in size, although the difference between having one employee and having 249 is probably greater that the difference between having 1,000 and 10,000, but they may differ in a number of other factors such as; business model, sector, life-cycle etc. This acknowledgement that HRM investment may be appropriate and worthwhile in one circumstance but not in another, provides the opportunity to discuss the various strategic approaches to HRM.

The academic literature concerning the link between HRM and organisational performance has mainly been addressed from the perspective of three approaches. The theoretical approach has been based on the resource based view (RBV) of the organisation, which attempts to show how HR is linked to corporate strategy and thereafter organisational performance through the achievement of sustained competitive advantage via the use of human capital. As noted by Becker and Huselid, the theory behind RVB “that organizations can build competitive advantage, and as a result above-average financial performance, based on valuable and inimitable internal resources, offers an appealing rationale for HR’s strategic importance.” (2006, p.900).

The alternative to the RBV approach is the research debate between those who seek to evidence the validity of ‘best practice’ (universalist) verses ‘fit’ (contingency) approaches to supporting the link between HR and improved organisational performance.

As the name suggests the former proposes that it is possible to apply a particular group of HRM practices to any organisation and this will result in an increase in performance. Research has found support for the ‘best practice’ view (Arthur 1994; Pfeffer 1994; Huselid 1995; Delery and Doty 1996; Gill and Meyer 2008; Gooderham et al 2008) but it has also been strongly criticised on a number of fronts including: that a number of its proponents have suggested different bundles of practices and that there is often conflict between the practices within the bundles (Legge 1991); that it presents a unitarist management view of the impact of the HRM practices and neglects the employee view as to the effectiveness of implementation (Kinnie et al 2005); and that it is too simplistic and unlikely to be implementable in reality (Purcell 1999).

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The alternative to best practice in the world of strategic HRM is the ‘fit’ approach, again the name gives a reasonable suggestion as to the methodology. Here the view is that HRM practices need to be suited to the strategic position of each organisation and integration with internal and external factors is required to allow HRM practices to achieve performance improvements.

This is a preview of the whole essay

As with best practice, researchers supporting the fit approach have produced some empirical research to support their view. While it can also be criticised for methodological flaws it has still allowed for strong support within the academic and practitioner communities for the fit approach; (MacDuffie et al 1995; Purcell 1999; Sisson and Storey 2000; Chow 2008; Wang and Shyu 2008). But as with best practice the opponents of the fit approach have responded with criticisms including: that a tight fit between HRM practices and organisational strategy during times of change will have a negative effect on performance as change will be more difficult to implement (Lengnick-Hall and Lengnick-Hall 1988); and that a fit is difficult to achieve in the complex, changing organisational environments in which many companies operate (Boxall and Purcell 2003).

Despite the amount of research conducted into the strategic HRM–organisational performance link its applicability to SMEs should be viewed with a large degree of caution. The overwhelming majority of the evidence produced so far has been from studies within large firms, often in developed western economies particularly the USA. This is problematic for drawing comparisons with respect to SMEs as they should not be viewed as small versions of large organisations, and often use HRM approaches in a different way (Storey 2002).

Bacon and Hoque (2005) have sought to explain something of the variation in the adoption of HRM in the SME sector and their findings give some support to the view that it is better not to adopt a ‘best practice’ approach to HRM in the SME sector as this is clearly what SMEs themselves are doing. Bacon and Hoque state that, “a number of influences both internal and external to the firm are important in explaining variation in the adoption of HRM practices” (2005, 1978). Given this need for SMEs only to adopt HRM practices that are in accordance with the internal and external influences they are under the fit approach seems to be the approach to adopt.

While there has been some research specifically on the link between HRM and performance within the SME sector (Brand et al 2002; Grip and Sieben 2009; Tsai 2010) which does seem to support a link it is still a relatively newly researched area. Bacon and Hoque (2005) point out that while there have been issues of several journals given over to this area of research much more work is required. Most of the current research focuses on very specific localities such as Denmark, Belgium Taiwan and at specific point in time for the groups of SMEs considered. The point in time issue is of relevance as the part in the business cycle at which the SME finds itself has been suggested as a particularly relevant factor as to whether HRM practices are a worthwhile investment (Harney and Dundon, 2006).

A recent study that does consider HRMs effectiveness in an SME context was undertaken by Georgiadis and Pitelis who attempted to identify the key HR features that are associated with improved financial performance within micro-SMEs in the UK Tourism, Hospitality and Leisure sector. Their study uses both the ‘fit’ and ‘RVB’ approach to explore the link between HRM and financial performance for SMEs. This is useful as it is often the case that a combination of different theoretical approaches can be the most practically effective way of approaching an issue for the HR practitioner.

With respect to the ‘fit’ approach Georgiadis and Pitelis have proposed that “SME performance is strongly associated with the deployment of product differentiation strategies, based on quality of service and personal attention to customers combined with a generous compensation package and attention to employees development” (2012, p.820). This is an interesting finding, even if it has to be accepted on a limited scale due to its particular sector focus, as it also shows just how particular the fit has to be to find a positive correlation. Virtually any other combination of differentiation strategy, such as cost leadership or focus (in accordance with Porter 1985) and HR practices actually evidenced a negative performance indicator.

Georgiadis and Pitelis also suggested, citing Way 2002, that the RVB theoretical approach may be of more value in the SME sector as “gaining access to a workforce that produces superior employee output is both valuable and rare” (2012 p.810). This links to the view that in order for an organisation to achieve competitive advantage through its HR practices these need to be; valuable, rare, inimitable and non-substitutable (Wright et al 2005). Georgiadis and Pitelis, again citing Way 2002, propose that as “micro-SMEs are typically more labour intensive compared to their larger counterparts” (2012, p.810) they are likely to rely more heavily on superior human capital than other potential sources of competitive advantage as these are not readily available to them.

The human capital that Georgiadis and Pitelis lay particular emphasis on is that of the owner/entrepreneur of the SME. They point to research (Huselid 1995) proposing that it is the abilities of top management, rather than general employees, that can be an important determinant in organisational success and suggest that due to the high concentration of decision-making power in an SME this is likely to be an even more important factor. Their claim is that the results they produced from their empirical study, which involved a questionnaire being sent to 1,350 (460 respondents) SMEs of varying size, evidence a “direct and strong positive association” (2012, p.817) between entrepreneur’s experience and financial performance. This leads to the conclusion that HR practices designed to support the training and development of owner/entrepreneurs could be a worthwhile investment for SMEs.

Other than investment in their owners capabilities what other areas of HR practice might be seen to lead to improved SME performance? Experian has an index which tracks the likelihood of an SME being successful and has found five indicators – track record of directors’ expertise (which links with the above proposal that the owner/entrepreneurs capacity is crucial); ability to export; willingness to invest back into the business, building of networks with similar companies to get support and internal flexibility. How might investment in HRM be worthwhile for an SME in addressing one or other of these factors?

The factor in the Experian index that could have some link to HRM practices is the relationship between SME success and flexibility. Georgiadis and Pitelis, citing Forth et al 2006, state that “the nature of HRM [in SMEs] hinges heavily on the personal relationship between the management and the employees” (2012, p.811). They go on to state that the “HR practice closer to the informal and relational model identified as relevant for services SMEs, is the organisation’s commitment to its employees (OCE)” (ibid). This suggests that in SMEs OCE is particularly valuable in creating a relationship between the employee and the organisation, which can lead to a higher degree of discretionary effort (what some might term ‘engagement’) and improved performance.

While much of this does need to be approached with some care, for example the issues of direction of causality along this rather long chain of events is problematic, it does raise some interest in the idea that SMEs that invest in HRM practices that lead to a strong OCE could produce worthwhile improvements in performance. That being said the empirical data in the Georgiadis and Pitelis study failed to find any direct correlation between evidence of OCE and profitability (2012).

A potential consequence of this belief in the importance of OCE as a HRM practice capable of producing worthwhile improvements in SME performance is that it could actually make showing the benefit to SMEs of HRM more difficult. Georgiadis and Pitelis, citing Barney and Hansen 1994, state that OCE “can create a climate of trust that allows firms to dispense with costly and demotivating bureaucratic controls” (2012, p.811). So by investing in a form of HRM that relies more on the emotional bonds between organisation and employee the common evidence of HRM in an organisation may become less required and therefore less visible.

This is perhaps were the idea of the SME sector being full of organisations with informal or rather non-existent HRM practices may come from. Perhaps the search for evidence of formal HRM practices has led some researchers to conclude that the lack of them means a poor state of HRM in SMEs. Bacon and Hoque state that the “research undertaken to date depicts a generally poor state of HRM in SMEs…with SMEs being less likely than larger organizations to have adopted sophisticated practices” (2005 p.1976). When rather it is more a contingency approach by SMEs, as formal HRM policies are out of line with the OCE approach to HRM in an SME and thought to have the potential to restrict the employment relationship and employee creativity and innovation.

Baron and Hannan on the other hand have raised an interesting point by drawing attention to their findings of an increasing number of SMEs adopting new practices in HRM. They suggest this is due to the increase in the number of small ‘knowledge intensive firms that are profoundly dependent upon human resource expertise in order to recruit, select and retain talented staff”, (2002, 23). This point again draws attention to the difficult of making generalisations about HRM in the SME sector. Small firms in knowledge intensive industry such as IT may consider investment in HRM more worthwhile than a similar sized firm in a sector where labour is not required to be so highly-skilled and therefore is easier to come by.

A specific issue to address with the current research into HRM practices in SMEs and one that makes it difficult to give a judgement on how worthwhile it is for an SME to invest in such practices is that the research presented lacks a longitudinal perspective. This is particularly important in relation to SMEs as the organisation can change to such a large degree over what might be quite a short period of time. So within the life-cycle of the SME it might go through various periods when HRM practices are more or less worthwhile in achieving its organisational goals e.g. what is happening during the early stages of a business and how does this relate to HRM compared to what is required as the SME grows.

Another matter that can be seen to be problematic is continuing the informality and flexibility that was an initial driver of the start-up. As an SME grows flexibility in its people management practices can lead to problems caused by the potential for inconsistency of practice. As a result HRM investment may become more worthwhile to deal with such an issue.

A criticism that can be levelled at much of the research concerning HRM practices in SMEs and which makes the practical decision on the whether to invest in HRM more problematic is that nearly all the research takes it for granted that the strategic aim of the SMEs under review is growth. So what HRM practices in place are judged against this belief that they need to be able to support financial growth, but this may not always be the case, perhaps the economy is such that consolidation is required, if this was the case a different type of HRM practice may be expected.

In conclusion Bacon and Hoque seem to suggest that SMEs are waking up to the fact that investment in HRM is a worthwhile investment for their organisations and state that the “message concerning the importance of HRM would seem to be getting through to some SME’s as fragments of HRM practices can and do filter down” (2005, 1978). But perhaps the reluctance of a large amount of SMEs to take on more formal HRM policies is a statement from them that they are not convinced that the investment is worthwhile.

Bacon and Hoque have admitted that that the adoption of HRM faces a degree of “scepticism that the link between HRM and the economic performance of SMEs” (2005, 1977) is supportable and by continuing with their ‘informal’ brand of people management perhaps they have found what works for them. As Ram et al (2001) maintained the market forces that impact on SMEs will predict the extent to which they take on board an enhanced level of HRM. The factors that affect businesses are felt particularly keenly by SMEs and it is the economic conditions in which they find themselves that will be the major indicator as to whether they consider HRM investment worthwhile.

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Word Count excluding References – 2,950

Word Count including References – 3,767