adopting hrm practices and their effectiveness in small firms facing ...

ADOPTING HRM PRACTICES AND THEIR EFFECTIVENESS IN SMALL FIRMS FACING PRODUCTMARKET COMPETITION PA N K A J C . PAT E L A N D M E L I S S A S . C A R D O N Small firms face many challenges in creating a productive workforce given often severe resource constraints and informal organizational structures. This may be particularly problematic in industries with intense product-market competition. In this study, we focus on the relationship between productmarket competition and labor productivity, particularly as influenced by both adopting human resource management (HRM) practices and having a group culture within the organization. We examine our model using a dataset data from 145 UK-based small- and medium-sized enterprises. Our findings suggest that having a group culture is a key factor in the extent to which HRM practices are adopted, as well as how effective adopting these practices is for increasing labor productivity. © 2010 Wiley Periodicals, Inc.

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Keywords: HRM practices, SMEs, entrepreneurship, HRM intensity, group culture, labor productivity

mall firms often face severe threats to their existence (Stinchcombe, 1965) based on their lack of resources and legitimacy in the marketplace (Aldrich & Fiol, 1994). Particular challenges arise in recruiting, retaining, compensating, and motivating employees (Cardon & Stevens, 2004). Often, managers of small firms are not formally trained in implementing human resource (HR) practices, and the firms do not yet have well developed structures, much less formal HR policies or programs (e.g., Heneman & Tansky, 2002). The challenge of developing and maintaining a productive workforce may be particularly problematic when intense competition

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exists in the product markets where the firm operates. Faced by multiple competitors, many with established brands and customer relationships, risk levels and the threat of failure are greater for small firms entering and operating in highly competitive product markets. Thus, small firms need to be particularly focused on maximizing employee productivity. Given their limited resources, small firms have limited options available to them to influence employee productivity. Scholars have suggested that adopting human resource management (HRM) practices can improve small firms’ competitiveness, thus enhancing their legitimacy (e.g., Williamson, Cable, & Aldrich, 2002). Enhanced legitimacy thus en-

Correspondence to: Pankaj C. Patel, Ball State University, Muncie, IN 47304, Phone: 765-285-3194, E-mail: [email protected] Human Resource Management, March–April 2010, Vol. 49, No. 2, Pp. 267– 292 © 2010 Wiley Periodicals, Inc. Published online in Wiley InterScience (www.interscience.wiley.com). DOI: 10.1002/hrm.20346

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ables small firms to attract more qualified employees, which increases labor productivity and allows the firm to better compete in the marketplace. Researchers have also suggested that an organization’s culture plays an important role in creating a productive labor force (cf. Denison & Mishra, 1995). In particular, organizations with a group culture based on cohesion, teamwork, and morale often enjoy greater employee commitment and retention (Cameron & Quinn, 1999). The purpose of this study is to explore the dynamics of firms trying to maximize labor productivity when faced with high levels of product-market competition. In particular, we explore the extent to which adopting more formal HRM practices is helpful to firms striving to Greater competition compete (e.g., Williamson et al., may lead to greater 2002) or whether small firms can effectively enhance labor producalignment between tivity without implementing formal HRM practices. We also exthe organization amine whether alternative mechanisms for increasing proand its employees, ductivity, such as having a certain organizational culture, can also thereby decreasing improve labor productivity. While agency costs, speculation on both sides of this issue has been plentiful in pubbecause agents may lished research, empirical tests have been less common. prefer to enhance This paper makes several contheir own payoffs. tributions to the literature. First, the literature includes mixed findings concerning whether or not HR practices are effective for small firms, which practices are effective, and how effectiveness may vary depending on the size and age of the firm (e.g., Cardon & Stevens, 2004). This study adds to this conversation by exploring how both adopting HRM practices and their effectiveness in small firms may vary based on the degree of competition present in the external product market and by an internal organizational factor of culture. Prior research has not yet explored this realm. Many studies have not adequately controlled for potential industry influences on the ability of small firms to adopt recommended practices or on the effectiveness of those prac-

tices, if adopted. Second, while the influence of organizational culture on HRM systems has previously been explored (Lau & Ngo, 2004), such research has typically focused on developmental cultures where employees, technology, and tasks are coordinated. Such coordination and integration often require investing considerable resources that small firms often do not have (Aldrich & Fiol, 1994). Instead, this study specifically focuses on group culture, which emphasizes teamwork and aligning and coordinating human capital within the firm rather than tasks or technology. We consider group culture as a potential moderator of the relationship between product-market competition and labor productivity. Group culture is often easier to achieve with fewer financial investments, making it an appropriate cultural focus for research on small firms. This paper proceeds first by reviewing the literature and building arguments concerning product-market competition and labor productivity as well as HRM intensity (the extent to which firms adopt formalized HR) and group culture. We then describe the methods used to test our hypotheses, present our results, and discuss the findings. Finally, we focus on the implications of our study for scholarship and practice concerning HRM and small firms.

Product-Market Competition Intense product-market competition can play AQ 2 a key role in aligning employees’ and managers’ goals toward more efficient production (Allen & Gale, 2000). Greater levels of competition may enhance incentives and eliminate various inefficiencies, thereby raising productivity. In contrast, lack of competitive pressure may lead to inertia, which results in low worker effort and managerial slack, and hence reduce firms’ productivity growth. Consistent with these arguments, Caves (1992), Green and Mayes (1991), Blundell, Griffiths, and Van Reenen (1999), and Nickell (1996) presented empirical evidence that increased product-market competition is associated with higher firm productivity or higher productivity growth. Human Resource Management DOI: 10.1002/hrm

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Group Culture (H4)

H3 HRM Intensity Product-Market Competition

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FIGURE 1. Proposed Model: HRM Intensity Partially Mediates the Relationship Between Product-Market Competition and Labor Productivity. Group Culture Further Strengthens the Mediating Relationship.

From an agency perspective, Hermalin (1992) identified four mechanisms that may explain the effect of product-market competition on firm productivity. The first is an income effect, where reduced profits in a more competitive environment cause the firm’s agents (owners and employees) to work harder because more income is desired rather than less income (Jensen & Meckling, 1976). Greater competition may lead to greater alignment between the organization and its employees, thereby decreasing agency costs, because agents may prefer to enhance their own payoffs. The second mechanism for how product-market competition may impact firm productivity is a risk-adjustment effect. The greater threat of bankruptcy for inefficient firms in industries with high product-market competition may lead to greater risk aversion by the agent and hence greater effort (Schmidt & Zank, 2005). The third mechanism is the increased effect of change in returns to effort. In markets with lower levels of competition, firms may generate rents and thus may not need to expend extra effort. More importantly, however, greater competition requires greater levels of efficiency to sustain rents, because much of the resource-generated rents withers over time. Thus, agents may become more sensitive to change in the ratio of returns to effort when faced with high levels of competition and will therefore work harder. The fourth mechanism is the effect of improved information in the presence of more rival firms. With greater information about rivals’ competitive capabilities, agents can make more rational decisions for when and how to increase their effort. More importantly, high

correlated costs reduce managerial slack, which in turn results in greater productivity due to increased effort (Hart, 1983). While previous research has focused on a larger cross section of the economy, the effects of product-market competition may be more severe for small firms. Small firms are prone to greater competitive threats due to the liability of smallness (Stinchcombe, 1965), which limits their resources and capabilities and contributes to a lack of legitimacy in the marketplace (Aldrich & Fiol, 1994). Higher levels of product-market competition further diminish small firms’ competitive ability; less resource slack is available under these conditions, making it even more difficult for small firms to respond. Given that small firms are often labor intensive, such firms must rely on workers to develop adequate responses to market conditions. Asiedu and Freeman (2007) found that greater product-market competition enhances small firm productivity due to the pressure to survive. Their limited ability to increase efficiency through cost curves may require small firms to be even more efficient. In addition, employees must be motivated to respond effectively to environmental threats. Productmarket competition could become a disciplinary effect by minimizing monitoring costs, because competition requires employees to be productive to ensure returns from the firm’s human capital investments. In contrast, small firms that face lower levels of product-market competition may have less incentive at the firm or the managerial level to increase productivity. Therefore, as depicted at the bottom of Figure 1, we propose our first hypothesis:

Human Resource Management DOI: 10.1002/hrm

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Hypothesis 1: Higher levels of product-market competition will increase labor productivity.

Adopting HRM Practices High levels of product-market competition may prompt small firms to respond by adopting HRM practices. Doing so can have beneficial operational and motivational effects and can improve the firm’s legitimacy as an employer (Williamson et al., 2002). This should ultimately improve labor productivity. While investing in technological capabilities, acquiring valuable resources, or strategic reorientation are some of the possible means to enhance productivity, HRM systems are also of central importance (Bloom & Van Reenen, 2007). Given the efThe increased costs fect of product-market competition on the effort required of (financial and nonmanagers and employees, the degree to which HRM practices are financial) of HRM adopted is of special interest. adoption, especially Scholars have suggested that the degree of product-market compein small firms, tition in an industry affects both the extent to which HRM pracmust be balanced tices are adopted and their effect with the potential on firm performance (Delaney & Huselid, 1996). We expect, therebenefits from such fore, that the effect of productmarket competition on labor proactions. ductivity will be partially mediated by the degree to which firms adopt HRM practices (HRM intensity). A greater degree of product-market competition will lead to adopting more HRM practices (Ichniowski, Shaw, & Prennushi, 1997), which in turn will increase labor productivity. Several previous studies have provided conceptual and empirical evidence for the positive effects regarding the degree of adopting HRM practices and labor productivity (Arthur, 1994; Cutcher-Gershenfeld, 1991; Gerhart & Milkovich, 1990; Huselid, 1995; Ichniowski et al., 1997; MacDuffie, 1995). By adopting HRM practices to enhance labor productivity, firms may be better able to respond effectively to product-market competition. Drawing on HRM adoption in 36 product lines in the steel industry, Ichniowski and

Shaw (1995) suggested that while accounting for costs and benefits, firms adopt HRM practices as a competitive response to increase their productivity. Dynamic environments, coupled with globalization, deregulation, changing customer needs, and increasing product-market competition, require that firms must continually improve their competitive performance by reducing costs, innovating products and processes, and improving quality, productivity, and speed to market. HRM practices play a key role in realizing such efficiencies (Becker & Gerhart, 1996). Whether or not firms adopt HRM practices in response to high levels of productmarket competition, however, is an open question. The increased costs (financial and nonfinancial) of HRM adoption, especially in small firms, must be balanced with the potential benefits from such actions. Given the resource and capability constraints of small firms, adopting HRM practices may not always be possible, because such actions may be costly (Sels et al., 2006; Sels, De Winne, Maes et al., 2006). Osterman (1994) suggested that firms engage in rational cost-benefit calculations before adopting workplace practices in response to their competitive environment. Recent studies by Sels et al. (2006) and by Bloom and Van Reenan (2007) have suggested that firms do not always adopt the most or best HRM practices, especially for small firms where costs to adopt practices may be higher. Adopting HRM practices often requires upgrading firm structure, which is a costly investment, and small firms may find adopting such practices prohibitively costly (Klaas, McClendon, & Gainey, 2000). For example, most small firms often do not have detailed performance management systems. This is because developing and implementing such systems require formal controls (which are not always preferred) (Cardon & Stevens, 2004) and require the entrepreneur to invest time (which is at a premium) (Cardon, 2003; Klaas et al., 2000). Beyond increases in the personnel costs, which may outweigh value added, structural changes needed for HRM practices may also affect employee turnover (Sels, De Winne, Maes et al., 2006); reduce motivation (Brown, Forde, Human Resource Management DOI: 10.1002/hrm

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Spencer, & Charlwood, 2008); increase stress (Ramsay, Scholarios, & Harley, 2000); increase transaction costs for employee training (Sels, De Winne, Maes et al., 2006); and lead to increased shirking (Weitzman & Kruse, 1990) due to greater autonomy and coordination costs (W. Cooke, 1993). This suggests that while productivity may increase with adopting some HRM practices, the corresponding increase in profitability may not be commensurate with the increased costs. These costs can be financial and nonfinancial, such as increased time and attention, changes in organizational structure, implementing formal systems, and changes in employee attitudes. Beyond the economic cost-benefit arguments, small firms may lack the learning capability to implement and exploit such practices. Overall, small firms must necessarily have a greater level of consideration of costs and benefits of such practices; thus, adopting HRM practices is not done lightly. In fact, many small firms only implement formal HR programs when forced to do so by legal actions (Gooderham, Nordhaug, & Ringdal, 1999) or rapid growth that demands such practices (Schuler & Jackson, 1999). Based on conceptual and empirical work exploring the link between product-market competition and adopting HRM practices as well as the link between adopting HRM practices and labor productivity, we suggest that the degree of adopting HRM practices will partially and positively mediate the effect of product-market competition on labor productivity. We use HRM intensity to represent the degree of adopting HRM practices. HRM intensity refers to the configuration of best practices that companies adopt across six HR domains: selection, training, career development, rewards, appraisal, compensation, employee participation. These practices are designed to manage the competencies and behaviors of employees to maximize labor productivity (Sels, De Winne, Maes et al., 2006). This leads us to Hypothesis 2: Hypothesis 2: HRM intensity will positively mediate the effect of product-market competition on labor productivity.

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The Role of Group Culture and Productivity In exploring the relationship between product-market competition and labor productivity, and the potential mediating role of HRM intensity, we also propose a moderating role of the group culture present in the organization. Organizational culture can be defined as the set of values, beliefs, and ways of thinking that are commonly accepted by an organization’s members (Schein, 1988). We focus on the underlying value structure that creates meaning in organizational settings. Shared values (“what is important?”) interact with the organizational structure and systems to produce behavioral norms (“the way things are done”) (Uttal & Freeman, 1983). While numerous definitions of organizational culture have been proposed, the framework Quinn and Rohrbaugh (1983) proposed may be of special importance. Quinn and Rohrbaugh’s (1983) Competing Values Model has been used to examine organizational culture in a variety of organizations (e.g., Deshpande, Farley, & Webster, 1993; Quinn & McGrath, 1985; Zammuto & Krakower, 1991). The Competing Values Model incorporates two axes: (1) the control versus flexibility dilemma, which refers to preferences about structure, stability, and change; and (2) the people versus organization dilemma, which refers to differences in an internal or external organizational focus, respectively. Crossing these two dimensions leads to four types of culture (Quinn & Rohrbaugh, 1983): (1) a developmental culture, which relies on adaptability and readiness to attain growth, innovation, and creativity (flexibility, external); (2) a group culture, which sees cohesion, teamwork, and morale as means to foster development, empowerment, and commitment of employees (flexibility, internal); (3) a rational culture, which sees goals as a way to control employee actions through productivity, achievement, and competition (control, external); and (4) a hierarchical culture, which emphasizes efficiency, uniformity, and coordination derived from strict guidelines (control, internal).


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In the context of product- market innovation, focus on the flexibility dimension is of special interest. Flexibility refers to the organization’s spontaneity, change, openness, adaptability, and responsiveness. These values are central to small firms as they maneuver in a competitive landscape (Weaver & Dickson, 1998). The ability to change, being open to new structures, adapting to new demands from the environment, and responding to changes are important to facilitate efficient use of resources. This may be particularly true in small firms, because they typically operate under considerable ambiguity and uncertainty, which require flexibly adapting to market demands (Avlonitis & Salavou, 2007). Moreover, group culture in particular is central to enhancing firm productivity (Cameron & Quinn, 1999; McDermott & Stock, 1999). Gregory Group culture may et al. noted (2008), “While evidence exists to suggest that each significantly reduce culture domain may be related to effectiveness (e.g., Freeman & coordination costs Cameron, 1991; Denison & across members Mishra, 1995; Quinn and Spreitzer, 1991), the group domain and tasks to more appears to be a more consistent effectively increase predictor of effectiveness than the other three domains”1 (p. productivity. 674). Group culture (also known as “clan culture; ” Ouchi, 1981) may play a significant role in enhancing the firm’s operational effectiveness in a highly competitive market environment. Group culture, which emphasizes interpersonal relationships, will have positive effects on employees’ commitment and job satisfaction, which in turn lead to greater labor productivity (Cameron et al., 1991). The positive, employee-focused management espoused by group culture likely motivates employees to contribute more effort to their work (Likert, 1961), due to the elements of a group culture of cohesiveness, attachment, and membership (Naor, 2006). This should increase an organization’s productivity and effectiveness. When employees feel they are part of a tight-knit organizational team, “this creates a sense of mutual

expectation and commitment” (Moynihan & Pandey, 2005, p. 426). In addition, group culture may significantly reduce coordination costs across members and tasks to more effectively increase productivity. For example, Bennis (1969) suggested that team orientation and trust are organizational values that play an important role in employee effectiveness. Greater levels of group culture foster social relationships, create an achievement orientation, and facilitate faster decision making, action orientation, and team effectiveness (Denison, Haaland, & Goelzer, 2004; Hatton et al., 1999). Overall, higher levels of group culture lead to better coordination of efforts, resources, routines, and systems. This, in turn, may lead to greater levels of productivity at the firm level, particularly when the firm is faced with high levels of competition in their product markets. Thus, we propose Hypothesis 3: Hypothesis 3: Group culture will positively moderate the relationship between product-market competition and labor productivity.

Group Culture and HRM Practices The presence of a group culture may also moderate the relationship between productmarket competition and adopting HRM practices and the relationship between HRM practices and labor productivity. Beyond the main effect of group culture in enhancing labor productivity, it may also assist in adopting and deploying organizational changes (F. Cooke, 2002; Tushman & O’Reilly, 1997), including the degree to which HRM practices are adopted. In particular, group culture may help reduce the costs of adopting HRM practices, thus encouraging such adoption. It may also significantly enhance the effect of HRM practices, once adopted, on labor productivity. In the next paragraphs, we discuss each potential path. First, group culture may facilitate adopting HRM practices in response to high levels of competition in the product market. As explained, although adopting HRM practices under high levels of product-market competition is advisable, smaller firms may find Human Resource Management DOI: 10.1002/hrm

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such practices have significant costs beyond the value the practices add (Sels, De Winne, Maes et al., 2006). Further, managers of small firms may consider such costs when they determine to what extent they will adopt formal HRM practices. In particular, financial and nonfinancial costs are associated with changing the structure of the firm or implementing new systems and processes (W. Cooke, 1993; Gerhart, Wright, Mahan, & Snell, 2000; Sels, De Winne, Maes et al., 2006). Research has also suggested that implementing new HRM practices significantly impacts employee life and can lead to greater turnover (Sels, De Winne, Delmotte et al., 2006); stress (Ramsay et al., 2000); and reduced motivation (Brown et al., 2008). Such effects have the potential to decrease labor productivity after new HRM practices are adopted and represent real risks that small firm managers must consider. Developing a group culture, with its emphasis on cohesion, communication, and trust, may help reduce most of the problematic indirect costs associated with adopting HRM practices, and thus may encourage greater levels of adoption. Group culture may reduce the costs of increased communication and coordination due to the new systems in place. With greater emphasis on a clan-like culture (Ouchi, 1981), employees may be less inclined to leave (Moynihan & Pandey, 2005), thus mitigating potential turnover. Similarly, employees may share greater levels of loyalty and trust in a group culture (Naor, Goldstein, Linderman, & Schroeder, 2008), thereby reducing moral hazards such as shirking. Overall, group culture may reduce the indirect costs associated with implementing new HRM practices in small firms, and thus might increase the likelihood that firms will adopt new HRM practices if they consider such indirect costs. Group culture can also enhance the effect of HRM practices on labor productivity. In the organizational culture literature, group culture emphasizes flexibility and change and relates to growth, creativity, and external adaptation (Quinn, 1988). A group culture, which stresses tradition, trust, and shared values, is more effective than

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other cultures on human relation issues (Cameron et al., 1991). In particular, group cultures emphasize interpersonal relationships that will have positive effects on employees’ commitment and job satisfaction (Cameron & Quinn, 1999), which are central to effective HRM practices (Becker & Huselid, 2006). The presence of group culture should thus enhance the effectiveness of HRM practices Developing a once adopted because the natural tensions and stresses of adoptgroup culture, ing new practices are reduced by the greater levels of trust and with its emphasis communication inherent to on cohesion, group culture. Thus, organizations with more of a group culcommunication, ture are likely to adopt HRM practices more effectively, lead- and trust, may help ing to a stronger relationship reduce most of the between product-market competition and adopting HRM pracproblematic indirect tices (as explained above) and a stronger relationship between costs associated HRM intensity and labor productivity (as explained here). Thus, with adopting HRM we propose Hypothesis 4: practices, Hypothesis 4: Group culture will moderate the mediating effect of HR intensity such that group culture will lead to an increase in adopting HRM practices and positively increase the effect of HR intensity on labor productivity.

Data and Measures Sample The data we used to test these hypotheses was taken from a survey conducted in 2005 by Michie (2006). The initial sampling frame was derived from a stratified sample of firms in the UK from the Dun & Bradstreet database. Stratification was based on (1) firm size and (2) the primary industry sector of business activity. To reflect our focus on small firms, the survey focused only on firms employing between 10 and 100 employees. In addition, using the 1992 Standard Industrial Classification (SIC) codes, nine industries were identified: four in manufacturing and


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five in the service sector. The selected industries represented the breadth of small- and medium-sized enterprises in the sampling frame. Specifically, these industries represent variance in the following characteristics: value added, regulatory environment, growth or decline, and extent of customer base. By focusing on specific industries and firms with less than 100 employees, the survey reduced the problem of firm heterogeneity that has been an increasing problem in analyzing HRM in small firms (Cardon & Stevens, 2004). A total of 4,252 firms from Dun & Bradstreet met the specified sampling frame criteria based on firm size and SIC codes. Initially, 3,508 firms were contacted and asked to participate in the survey. Of the contacted firms, 3,212 declined and 194 agreed but eventually failed to complete the interview. Ulitmately, 172 interviews were completed successfully for a response rate of approximately 5%. Low response rates (around 10%) are typical from SMEs (Dennis, 2003), possibly due to lack of time for small firm owners and limited ability to delegate responding to a survey to managers because they may not have the full knowledge of the firm’s strategic activities and goals (Bartholomew & Smith, 2006). Telephone surveys of the selected companies were thus conducted. The following protocol was used, following guidelines by Michie (2006): (1) The main contact person identified from the Dun & Bradstreet databases was sent a one-page briefing on the survey objectives and the expected length of the interview (around 40 minutes); (2) the person was then contacted to inquire if he or she would agree to the telephone interview. To ensure that the respondent understood HR terminology and definitions of financial variables in the survey, a glossary of terms was sent in advance. Of the 172 firms contacted, 27 firms were excluded from the final sample due to insufficient data or falling outside the target size band of 10–100 employees. The final sample included 145 firms, representing six industry sectors: nursing homes, pharmaceutical/medical manufacturing, grocery stores, cleaning, textiles, and leisure.

Variables Labor Productivity We use two indicators for labor productivity, measured using a Likert scale with 1 = a lot better than average to 5 = a lot below average: (1) change in labor productivity over the last twelve months and (2) change in labor productivity over the last three years. The reliability of the measure was 0.83. Although we could have used numerical measures to assess productivity, almost twothirds of the sample did not provide quantitative responses to these items. Moreover, we did not find differences among firms that provided sales data and those that did not provide such information. More importantly, a qualitative assessment of labor productivity over a period of time provides an alternative to measures focusing on sales per employee (Guthrie, 2001), which may be subject to fluctuations and may be affected by cost of goods sold. In addition, the employee may not control all sales outcomes (Guthrie, 2001). Obtaining actual financial data from small firms is difficult (Bartholomew & Smith, 2006). Not only do many small firms lack official financial records, they also face fluctuating demands for their products (Dennis, 2003). Lack of available information and limited willingness to share such information require reliance on subjective assessments. Other scholars that have used subjective productivity measures include Bartel (2000; 1item scale; 0–100% productivity), Baron, Black, and Lowenstein (1989; 1-item scale; 0–100% productivity), and Krueger and Rouse (1998; employee self-reported productivity). Kersley, Alpin, Forth, Bryson, Bewley, Dix, and Oxenbridge (2006) carefully compared subjective and accounting based productivity measures and found modest differences. In a detailed survey, Forth and McNabb (2008) found the correlation between subjective and objective measures in HR contexts fell between 0.38 and 0.65, with most correlation coefficients larger than 0.5 and all of them statistically significant. Thus, we used a subjective measure of labor productivity as other scholars have in previous studies. Human Resource Management DOI: 10.1002/hrm

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Product-Market Competition Product-market competition has been widely studied in the context of small firms (e.g., Asiedu & Freeman, 2007; Berger & Udell, 2006). To measure competition, we followed Nickell (1996), Aghion, Bloom, Blundell, Griffith, and Howitt (2005), and Bloom and Van Reenen (2007) using five broad measures. Of the five measures, two measures were derived from secondary sources and three measures were self-reported. A combination of such measures controls for any self-reported bias and ensures that the firm respondent is well aware of the firm’s external environment. There are two secondary measures for product-market competition. The first, degree of import penetration, based on three-digit industry, is measured as the ratio of total imports over domestic production. This is constructed for 2000–2005 to eliminate any potential contemporaneous feedback. The second measure is a three-digit industry index, the Lerner Index of Competition, which is calculated as (1 – profits/sales). The Lerner Index explains the extent of profit margin (profits/sales) in an industry. By subtracting the profit margin from 1, we get the extent of lower profit margin. A higher Lerner Index means a lower profit margin, which indicates greater industry competitiveness. The Lerner Index is typically used as a measure of product-market competition (Aghion et al., 2005; Bloom & Van Reenen, 2007; Nickell, 1996). Drawing on Bloom and Van Reenen (2007), we calculate averages of annual sales and annual profits during 2000–2005 across the entire firm-level database in each relevant industry sector (excluding each firm). The remaining three measures are selfreported. These include (1) the number of competitors a firm faces (0 for “no competitors,” 1 for “fewer than 5 competitors,” and 2 for “5 or more competitors”); (2) the degree of competition in the market (1 for “very high,” 2 for “high,” 3 for “neither high nor low,” 4 for “low,” and 5 for “very low”); and (3) the life-cycle stage of the firm’s product market (1 for “growing,” 2 for “maturing,” 3 for “declining,” and 4 for “turbulent”). The items were reverse coded to reflect that

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higher values indicate a greater degree of competition. To ensure combinability of the first two measures derived from secondary sources and the latter three self-reported measures, we first tested reliabilities of the two groups of indicators and then conducted a discriminant validity test. Finally, we ran a modification indices test. The reliability for the first two measures was 0.87, while the latter three was 0.88. We conducted a discriminant validity test to see if the two set of measures were different by comparing two models: (1) the proposed measurement model and (2) the measurement model while constraining the two sets of indicators to 1. We find no significant differences (x22 = 0.13, df = 1; p Based on three= 0.72). This indicates that the two sets of measures are not different. digit industry, is We therefore combined the measures by joint loading of the five measured. items on the product-market competition construct after standardizing the values. The resulting reliability was 0.85. Overall, product-market competition is a robust measure that combines internal assessment and external measures of competition. It is a good measure because it indirectly indicates that the firms in our sample are well aware of the competitive environment, given that their self-assessments were consistent with secondary data regarding such productmarket competition. HRM Intensity A conservative measure of the extent of key HRM practices adopted uses an HRM index (e.g., Sels, De Winne, Delmotte et al., 2006; Sels, De Winne, Maes et al., 2006). Prior work by Delery and Shaw (2001), Huselid (1995), and Wright and Snell (1991) has shown how managing competencies (KSA; cf. HR flows), behaviors (cf. rewards), and empowerment practices (cf. employee influence) are central to enhancing labor productivity. Drawing on Sels, De Winne, Maes et al. (2006), we identify practices (binary coded: 1 if the practice is followed, 0 if the practice is not followed) in six functional HR domains, each representing one of the central Harvard policy areas (Beer,


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Spector, Lawrence, Mills, & Walton, 1984) to operationalize HRM intensity. These measures are as follows:

stitutes for one another or interacted synergistically (Delery, 1998). Group Culture

1. HR flows a. selection (5 items), e.g., “The recruitment/selection process for these employees emphasizes their ability to collaborate and work in teams.” b. training (6 items), e.g., “Is the opportunity for training available?” c. careers (3 items), e.g., “Employees have few opportunities for upward mobility.” (reverse coded). 2. Rewards a. appraisal (2 items), “Performance appraisals are based on objective quantifiable results”. b. compensation (6 items), e.g., “The organization uses individually based performance related pay.” 3. Employee influence a. participation (4 items), e.g., “Employees are consulted about new hires.” In total, 26 items reflected practices in one of the six identified domains of HRM practices. As explained by Chadwick and Cappelli (2000), an additive index is most likely to accurately reflect the influence of HR systems on firm performance; therefore, we combined the 26 practices into one index: the HRM intensity index. This index reflects a configuration of best practices, assuming that each of the different HR domains has an independent effect on performance (Pfeffer, 1994). Overall, an SME’s score may range from an index score of 0, representing organizations that use none of the HR practices, to an index score of 26, representing those firms that use all of the practices. The additive index assumes that a low score on any one domain can be compensated for by a high score on any other. A multiplicative index may not be appropriate because an extreme score on any one variable would exert a disproportionate influence on the index as a whole (MacDuffie, 1995). Furthermore, a priori, we had no basis to predict whether the items within the index were sub-

Organizational culture with an emphasis on AQ 4 group culture facilitates teamwork, cohesion, and more affective outcomes due to the group orientation. The four-item scale (a 5-point Likert scale ranging from 1 = strongly disagree to 5 = strongly agree) was adapted from the “group culture” scale of the Michigan competing values framework (Quinn, 1988). The items were reverse coded so that higher scale values indicate greater levels of group culture. This four-item scale covers the firm’s human relations within the internal organizational structure. Specifically, the scale reflects how cohesion, teamwork, and morale lead to employee development, empowerment, and commitment (Henri, 2006). The four items were (1) employees feel like an important part of this company; (2) there is a strong workplace culture in this company; (3) employee participation is central to company performance; and (4) there is a strong sense of loyalty to the company among employees. A previous scale validation study by Quinn and Spreitzer (1991) showed that the scale had a reliability of 0.77. Prior work by Dosoglu-Guner (2001) also indicated a high reliability of 0.75. The scale has been internationally validated by Lau and Ngo (1996) in Hong Kong ( = 0.81) and in China ( = 0.91). The reliability for our study was 0.78, which is satisfactory given the reliabilities found in previous studies. Control Variables. Seven control variables were included in the analyses, including industry sector, capital intensity, firm age, firm size, firm financial performance, degree of unionization, and low-cost strategy. We discuss each briefly. Potential industry differences may significantly affect labor productivity. We therefore control for industry sector using dummy codes representing the six broad industry categories represented in the sample: nursing homes, pharmaceutical/medical manufacturing, grocery stores, cleaning, textiles, and leiHuman Resource Management DOI: 10.1002/hrm

HRM_20346.indd 276

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HRM_20346.indd 277

I

Correlations 0.48 0.43 22.54 21.72 3.54 0.19 2.10 9.83 0.59 3.17

Mean 0.14 0.12 13.21 19.01 1.46 0.08 0.82 4.86 0.12 1.26

SD 1 –.10 .12* .08* .07* .02 .07* .13* .04 .05*

1 1 .03 .05 .02 .04 .02 –.04 .03 .02

2

1 .10* .04 .03 .02 .11* .04 .02

3

1 .06 .02 .02 .01 .03 .01

4

1 .01 .04 .12** –.04 .07

5

1 .02 .01 .01 .02

6

1 –.05* .03 .04

7

1 –.08** .06

8

1 .06**

9

AND THEIR

EFFECTIVENESS IN

* p