Exploration or Exploitation- A dilemma for SMEs

Many  SMEs in the post startup stage face a dilemma of exploring new areas or exploiting the existing one to sustain their entrepreneurial journey.

Recently I met my college friend after a long time who has been successfully running his herbal extraction business for the last four years. The business has been fairly stable in terms of control on operating metrics, market reach and supply chain. Over a period of four years, he set up a good team to run the business. The business has beenfinanciallyrewarding with a stable cash flow. 

Having attained stability in the business, he proposed to me a plan to diversify into other areas. The reason for exploring new areas is to beat the threat of risks to business from any sources.

The question came to my mind was- Is timing for exploring newer areas is appropriate?, Is it not too early? Whether the firm has reached a level of perfection resulting in full exploitation of the opportunity exists in the present one?

He is not alone…

Many MSMEs show a sense of urgency to diversify the business in order to mitigate the risk to themselves and expand the horizon.  The reasons are many and varied and also very personal for entrepreneurs. They feel diversification is the best bet to fend off the challenges from technology shifts, competition, changing customer reference, or may be a temptation for higher profit per unit of investment etc. It may be very personal like higher social status associated with certain businesses or it could be even for satisfying their desire to establish themselves in the area of their passion. 

Exploitation or Exploration – A dilemma:

The SMEs especially those who crossed the startup stage tend to review their strategy and always confronted with the challenges- To maximise the benefits (exploitation) or hunt for the is generally(exploration).

As exploration and exploitation require different sets of capabilities, engaging in both sets of activities is generally challenging for firms, especially for resource-constrained small and  medium-sized enterprises (SMEs). Both require different types of preparedness.

Exploration/Diversification is a must to remain in the business:

Established businesses often excel in harvesting existing opportunities (exploitation). For instance, they improve the reliability of production processes, reduce material cost, or optimize the firm’s internal routines.

Focusing on a single business or set of capabilities—does not seem much better when viewed from a long-term perspective. Single-business companies do indeed perform very well in the short run, but when we observe these over decades, a different picture emerges: Many of the single-business firms simply cease to exist.

Many incumbent SMEs, over time, tend to remain to focus their attention on exploiting existing products and processes, thereby reducing their entrepreneurial activities, and, ultimately,becoming stagnant.

Evidence has consistently shown that such exploitation is a required yet insufficient condition for long-term business success. In order to prevail across time, firms also need to be entrepreneurial and search for new business opportunities.

It’s not hard to imagine why single-business firms might struggle to stay longer. Once their primary offering reaches the end of its lifespan, the only possible next steps are decline,merger, or sale.

However, there is a caveat with regard to diversification, especially for SMEs. It’s a well-known rule the long that diversification works only if the diversifying company can exploit economies of scope by extending to areas related to existing businesses.

It is a major challenge for all established companies that they need to continually explore novel business activities and thereby remain entrepreneurial throughout the organizational life cycle.

Pursuing both at a time- A difficult proposition for SMEs

A critical determinant of long-term success is the firm’s ability to pursue opportunities oriented toward the long-term (i.e., engage in exploratory activities) while at the same time harvesting short-term efficiency gains arising from the refinement of existing products and processes (i.e., engaging in exploitative activities).

Though looks sound, pursuing both sets of activities—exploitation and exploration—has been found to be challenging for firms, in particular for small- and medium-sized businesses(SMEs).

We need both but prioritisation is important

We have discussed above that for long-term success, every enterprise needs to explore newer areas. However what is important for SMEs especially beyond the start-up stage is to focus on exploiting the opportunity in the existing business before embarking on exploration.

When your company is doing well, revenue is pouring in, profit is rising, how do you know if you could be doing better? How can you tell which of your management practices are making the difference and which are merely doing no visible harm?

The companies need to work on areas like stretching the sales, driving down the costs, improving the bench strength, upgrading the technology, enhancing the quality etc. These steps can be effective if they undertake such exercise by benchmarking to better ones. The measures will lead to exploiting the opportunities to the fullest extent.

We believe this is an important step for SMEs before undertaking the exploration of newer opportunities.  

Conclusion:

Many MSMEs are looking for diversification into newer areas in order to mitigate the risks emanating from the  existing business. Though it is good for long-term sustainability, it is  highly desirable to undertake only after exploiting the opportunities existing  in the present business.