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SME'S Competitiveness Analysis


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SME'S Competitiveness Analysis

  1. 1. 1 SMEs Competitiveness Analysis in Probolinggo East Java Province Arif Dwi Hartanto Faculty of Economics and Business Brawijaya Univerity Tri Cahyono Faculty of Economics and Business Brawijaya Univerity Narya Ayu Dewani Faculty of Economics and Business Brawijaya Univerity ABSTRACT The development of SMEs in Indonesia, especially in East Java is very prominent in creating jobs and reducing poverty. However, there has been high intensity of competition making the competitiveness is the key for SMEs to guarantee their persistence (sustainability). Therefore, this study aims to identify the main factors affecting the competitiveness of SMEs. Outward Looking Approach is used as the basis for the analysis, where the flexibility and productivity of the business become the main aspect in this approach. Based on interviews of 100 SMEs in food and beverage sector, the results shows that the ability of SMEs in building effective and efficient network is a determinant for SMEs’ level of flexibility and productivity. This network is characterized by three conditions, namely (i) the occurrence of operational efficiency by minimizing transaction costs, (ii) an increase in working capital accessibility, and (iii) the occurrence of an innovative business climate. This study suggests that the expansion of efficient and effective network is critical consideration in the development of SME policy. Field of Research: SMEs, Competitiveness, Business Flexibility, Productivity Business
  2. 2. 2 1. Introduction In recent decades, the role of Small and Medium Enterprise (SME) is increasingly prominent because its contribution to development and economic growth in many countries has become more vital (Tambunan, 2008; Jiang and Ling, 2009; Hafsari, 2011; Indrawati, 2012). One of the important indicators can be seen from its impact to GDP and employment demand. Moreover, recent research also shows that SME can take a role as a key accelerator in creating and disseminating innovations, as well as reducing imbalance among regions because of its flexibility in determining the location of the business that can not be reached by the large-scale industries (Constantin, 2002; Moore and Manring, 2009; Chittithaworn, 2010; Mura & Buleca, 2012; Idar, 2012). SME becomes so important because of its role in creating jobs, maximizing the efficiency of the allocation and distribution by mobilizing and utilizing local resources, and supporting local economic development (Cunningham & Rowley; in Idar, 2012; Hendrawan, 2012). This fact raises a new perspective in seeing the importance of the entrepreneurship role corralated to economic activities of local talent (local genius) in developing economy (Swarcz, 2007; Indrawati, 2012). It also corresponds to what J. Schumpeter stated (Mura& Buleca, 202), that the key factor of economic development lies in the consistency between macro-economic development theory and the micro- economic concept about innovative individual entrepreneurship. Therefore, in recent years, government policy has always been directed towards capacity building of SMEs focused on the production process which is increasingly based on science and technology, this is expected to make a significant contribution in strengthening the domestic economy (Tajuddin,, 2011; Jiang & Ling 2009). As the implication, SME development policy generally is always oriented to the increase of production capacity such as technology and innovation. Even though the development of production is very important, the government can hardly fulfill the improvement of the institutional aspects such as marketing and the development of social capital. Whereas, this factor is more essential, it is a basis of decision-making strategy for SMEs in understanding the characteristics of the market and competitors, responding customer needs, as well as maintaining sustainability of the business for long term (Khairuddin, 2008, in Idar, 2012; Jiang and Ling, 2009; Irjayanti & Azis, 2012). This is consistent with studies of Chittithaworn; (2010) and Irjayanti & Azis (2012) that lack of capability in gaining market information is a determinant factor of underdevelopment of SME capacity that impacts on unsustainability of the business in the intensely competitive market. To overcome such problem, it is necessary to know the success factor of competitive strength of the business through managing institutional aspects in order to succeed in maintaining and developing SMEs for long run. However, most of studies
  3. 3. 3 only discussed about the competitiveness of the institutional aspects, they focused on the mechanisms of coordination and network cooperation that can give mutual benefits. There are still few studies that talked about how institutional mechanisms can produce effective and efficient business networks implicating to the high flexibility and productivity of SMEs. Consequently, the purpose of this paper is to identify and explore characteristics of a SME network in Probolinggo, East Java that can improve competitiveness through flexibility and productivity of the business. Once the identification is found, it can become a reference for policy-making to develop SMEs through business network expansion strategy. The analytical framework used in this study is Micro Outward Looking Approach. Micro Outward Looking Approach is a development concept that emphasizes on the long-term orientation trade sector that leads out (export). 2. SMEs In Indonesia There are various opinions in defining SME in Indonesia. Researchers in Indonesia define SME as business unit that is mostly informal and characterized by labor intensive. It generally requires small capital to build (Marijan, 2005). While Pangabean (2007), describes that SME (i) is firm that does not separate the position of both owner and managerial structure, (ii) uses its own labor, (iii) is unbankable and used its own capital, (iv) has a low level of entrepreneurship, and mostly does not have legal status. So the definition of SME is always referring to some of the main characteristics, namely in the form of assets, sales volume, and number of employees (Pawitan, 2012). In addition, there are several institutions defining SME such as the Ministry of Cooperatives and SMEs, the Ministry of Finance, the Central Bureau of Statistics, as well as some other institutions (Hendrawan, 2012). Despite the variety of definitions of SME, in outline, it still refers to the populist business, which then makes SME as a priority sector in making objectives of economic policy (Tambunan, 2008; Irjayanti & Aziz, 2012; Pawitan, 2012; Wignaraja, 2012). But in recent empirical studies, the government is still paying less attention to some of the constraints faced by SMEs, such as (i) policies that are not supportive for the condition of SME Development, and (ii) inadequate infrastructure (Tambunan, 2008; Siringoringo et al, 2009; Irjayanti & Azis, 2012; Mourougane, 2012). Besides, there are certainly some classic obstacles such as limited capital, the quality of raw materials, technology illiterate and low skill labor (Pawitan, 2012). Other external issues frequently faced by SMEs in Indonesia are the accessibility of information and intense competition due to the opening of the free market like ACFTA (Irjayanti & Aziz, 2012; Pawitan, 2012). This finding is reinforced by Utomo & Dodgson (2001) that the limited access to information for SMEs in Indonesia is caused by the obstacle in adopting information
  4. 4. 4 technology due to slow and uneven infrastructure, while the free trade develops so fast. As impact of this, SMEs: (i) are isolated from market access, (ii) have limited access to capital, (iii) are hard to reach government’s supports or programs, and (iv) still rely on the chain factors that are passed from generation to generation with the very simple product management (Rosid, 2008; Mead and Liedholm, 1998; within Irjayanti & Aziz, 2012). The various issues implicated to degradation of SME internal condition, such as management and production innovation. Whereas, in the context of globalization, one of the key success factors of SME is the application of total quality management (Lewis,, 2006). This condition is also the reason why the target markets of SMEs in Indonesia are relatively small and why they are easily defeated by imported products. 3. Network Management and the Increase of Business Competitiveness One important aspect of building a powerful business is the quality of the network (Jiang & Ling, 2009). This network quality indicates that not all networks implicate to positive things if they do not have the same characteristics of goal orientation. In a theoretical study, this kind of networks is called alliance, a form of agreement between the interested party with another party who has the same orientation. This process stimulates the network members to donate their resources on new things and generate new values (Huseini & Mamahit, 1994; under Main, 2003). It is in accordance with what Porter said (1995), that in this concept there are several activities contributing to the values or services sold to consumers. This process takes place in the relationship among the firm value chain, supplier value chain, and distribution (channel) (Main, 2003). Operationally, the company can take advantage of the relationship (linkage) through appropriate information systems for optimizing and coordinating every business activity. As the implication, it will lead to sustainable competition advantage (Main, 2003; Hutagaol & Feryanto, 2011; Pawitan, 2012). Thus, it can be said that there is a chain that links the various specific aspects of the value chain of members or partners consisting of technologies, capabilities (production, marketing, and management), and product (Main, 2003). This explanation is consistent with Sumarti’s statment (1978), that the optimal economic activity can not be separated from the objective aspect of the relationship networks, so that it becomes the basis of social power. Furthermore, in the context of free trade, network or alliance becomes very important because it plays role in the implementation of networking organization. In some empirical studies, the networking organization implies a significant increase in the internal capacity of the company. As stated by Barney & Wright (1998), the implementation of this networking organization can develop a competitive advantage
  5. 5. 5 by creating value in different way and unique form, or value that can not be imitated by competitors. In addition, the biggest implications of this networking organization is that it may also affect the entrepreneurial orientation of its members (Keh, Nguyen and Ng, 2007; within Pawitan, 2012; Irjayanti & Aziz, 2012). The results of the study of Wilkinson & Brouthers (2006), in Pawitan (2012), shows the orientations exemplified here include export orientation that stimulates every entrepreneur to join training and trade fairs. This resulted in changes of management practice principle, changes of turnover, changes of market demand, better performance compared to competitors, and the growth of orientation it self (Setyaningsih, 2012). Thus, in short it can be said that the quality network has an important role in improving business competitiveness, especially for SMEs. 4. Research Methodology 4.1. Data This study was conducted in Probolinggo, especially in the area where the base SMEs concerning on food and drink commodity as their excellent products are located. The writer classified SMEs into three sections based on the scale of SMEs, namely (i) micro SMEs, (ii) small-scale SMEs, and (iii) medium-scale SMEs. The classification was based on the variable of investment. When it was classified, each scale was identified to know the level of investment return based on SMEs participating in a business network and ones that do not participate in a business network. The data used in this study include primary and secondary data. Primary data were used to get information from the aspects of production and the business environment through questionnaires by in-depth interview method, while the secondary data were obtained from relevant government agencies in the form of data on the number of SMEs and the quantity of output produced by each SME. A total of 100 SMEs in food and beverage sectors were selected by quota sampling. The variables listed in the questionnaire questions covering aspects of age of the business, institutional management, social conditions, facilities and infrastructure, marketing, capital, labor, technology innovation, ease of acquisition of raw materials, as well as profitability. This variable is reciprocal to the main qualifications in seeing the business competitiveness which includes characteristics of SME entrepreneurs, sources and quantity of raw materials, perception about ease of getting raw materials, amount of capital, perception about ease of access to capital, marketing capacity, and perception about ease of access to marketing. 4.2. Method of Analysis The collected data would be analyzed by using descriptive statistical analysis. More specifically, the method of analysis used is as follows:
  6. 6. 6 a. Treatment Effect Analysis Treatment Effect Model is a method used to know the role of the network (associations of food & drink SMEs in Probolinggo) in stimulating business competitiveness. Basically, Treatment Effect model has two equations that are estimated simultaneously, namely: ,i c i c i ucWC   ...................................................................................(1) The equation was used to identify the factors affecting the interests of SMEs to join the network. The C in the equation is the role of SMEs in the network, while W includes profitability, access to raw materials, access to capital, and access to markets. The second equation was used to know the risk level of failure of SMEs, the model specification is as follows, ii cc i c i cCXy   ........................................................................(2) The y is the risk level of SMEs, the C is participation of SMEs in the business network, and the X are the factors affecting the level of business risk. Based on these two equations, it would be known how the role of the business network reinforces the competitiveness of SMEs in Probolinggo. b. Analysis of Micro Outward Looking Approach Looking Outward Micro Approach is a method for detecting operational process of a company started from growing stage of the business until it gains success, the analysis Model conducted by using the results of in-depth interviews which include the two main aspects, namely: (i) aspect of production (including the process of acquiring inputs, production processes, and output), and (ii) aspect of the business environment (including the marketing and business management system). In viewing both aspects, there are at least few aspects that need to be considered including: the availability of raw materials, capital and marketing aspects. 5. Finding and Discussion 5.1. Statistic Result In this study, SMEs in Probolinggo were divided into three (3) characteristics namely: (i) micro-scale SMEs with the number of turnover of less than Rp 10.000.000, (ii) small-scale SMEs with the number of turnover of between Rp 10.000.000, - Rp 100.000.000, and (iii) medium scale SMEs with turnover more than Rp 100.000.000. Based on the questionnaire, it was known that the characteristics of SMEs in Probolinggo based on network membership are like in the following table.
  7. 7. 7 Table 01. Characteristics of SMEs Business Scale Non-Member of Business Network Member of Business Network Total Number of SME % Number of SME % Total of SME % Micro (Less than 10 million) 16 30% 12 26% 28 28% Small (10 to 100 million) 32 59% 23 50% 55 55% Medium (More than 100 million) 6 11% 11 24% 17 17% Total 54 100% 46 100% 100 100% Source: primary data, 2012 Of the 100 respondents, the numbers of micro-scale SMEs are 28%, small-scale SMEs: 55%, and the rest 17% are medium-scale SMEs. Of the total in this classification, there are 46 respondents who are members of the business network, in which 26% are micro SMEs, 50% are small-scale SMEs, and 17% are medium-scale SMEs, While respondents who did not join the business network totaled 54, in which 30% are micro SMEs, 59% are small-scale SMEs, and 11% are medium-scale SMEs. From the previous respondent identity, based on the questionnaires, the writer can analyze the relationship between the function of the business network and its relation with the accessibility of business integration. The Business integration is seen from the accessibility of raw materials, capital accessibility, and market accessibility. a. Accessibility of Raw Materials Table 02. Business Network Membership and Access to Raw Materials Description Access to Raw Materials Total Low Medium High Number of SME % Number of SME % Number of SME % Number of SME % Non-Member of Business Network 36 67% 12 22% 6 11% 54 100 Member of Business Network 1 2% 18 39% 27 59% 46 100 Total 37 37% 30 30% 33 33% 100 100 Source: primary data, 2012 Based on the findings, table 02 shows that the SMEs that are members of the business network have high access to raw materials. This is proven by the number of SMEs that have high access to raw materials at 59%, medium at 39%, and only 2% that have difficulties in accessing raw materials. This is contrary to the SMEs that are non members of the business network, that the majority having low access to raw materials at 67%, medium access at 22%, and only 11% that have high access to raw materials.
  8. 8. 8 b. Capital Accessibility Table 03. Business Network Membership and Capital Accessibility Description Capital Accessibility Total Low Medium High Number of SME % Number of SME % Number of SME % Number of SME % Non-Member of Business Network 38 70% 16 30% 0 0% 54 100 Member of Business Network 5 11% 27 59% 14 30% 46 100 Total 43 43% 43 43% 14 14% 100 100 Source: primary data, 2012 Based on table 03, SMEs that become members of the business network have high level of accessibility to capital than non-members. In SMEs joining the business network, only 11% that have low access to capital, the remaining 59% have medium access, and 30% have high access. This is very different from SMEs that are non- members of the business network, which 70% have difficulties in accessing capital, only 30% that have medium access to capital, even no SMEs that have certainty of capital accessibility. c. Market Accessibility Table 04. Business Network Membership and Market Accessibility Description Market Accessibility Total Low Medium High Number of SME % Number of SME % Number of SME % Number of SME % Non-Member of Business Network 28 52% 11 20% 15 28% 54 100 Member of Business Network 2 4% 20 43% 24 52% 46 100 Total 30 30% 31 31% 39 39% 100 100 Source: primary data, 2012 Table 04 illustrates that 52% of SMEs that are non-members of the business network have a low market access, 20% of the SMEs have medium access, and 28% of them have high access. It differs from the composition of SMEs that are members of the business network, in which only 4% that have low market access, 43% that have medium access to the market, and 52% that have high market access. In general, when it is viewed from the membership in the business network, it can be seen that the SMEs joining the business network have the ability to access raw materials, capital, and markets better than the non-member SMEs. This indicates that
  9. 9. 9 the participation of SMEs in the business network can support the growth of SMEs, especially in improving business productivity. 5.2. The role of Network toward Income level of SMEs Business network is very important in the development of SMEs in Probolinggo. Corresponding to the estimation results using treatment effect model, it can be seen some of the factors affecting the interests of SMEs to become members of the business network. Equation 1 Description: C = Participation in Business Network BB3 = Index of Access to Raw Materials M3 = Index of Capital Access P2 = Index of Market Access Equation 2 Description: Y = Gross Margin of SMEs X3 = Length of the Business BB2 = Proportion of the Need of Raw Materials Coming from Local Region M4 = Interest Rate Picture 01. Estimation results of the Roles of Business Network on the Productivity level of SMEs Gross margin of SMEs (Y) Interest rate (M4) Role of Business Network(C) Length of the Business (X3) Proportion of the Need of Raw Materials Coming from Local Region (BB2) Index of Market Access (P2) Index of Access to Raw Materials (BB3) Index of Capital Access (M3)
  10. 10. 10 Based on Picture 01, there are three factors affecting the interests of SMEs to become members of the business network, namely: (i) index of access to raw materials, (ii) index of capital access, and (iii) index of market access. Simultaneous equation results explained that the index of raw materials, capital index, and the index of market access have a positive effect on the level of productivity of SMEs amounted to 0.1096, 0.0066, and 0.0206, with an error rate (α) of 5% - 9.99%. This means the bigger the three indexes, the more interested the SMEs to become members of the business network. This indicates that the tendency of SMEs to join the business network is because they expect the network can support them to access raw materials, capital, and the expansion of market segments. The important role of the business network in increasing the revenue of SMEs can be seen from the gross margin (profit), and the gross margin is affected by four (4) factors, namely: (i) interest rate, (ii) length of the business, (iii) the proportion of need of the raw materials coming from local region, and (iv) the role of business network. Of these four factors, the interest rate has no significant effect due to its error rate (α) of 10% - 15%. So there are three factors that significantly affect gross margin; the first is length of the business that has negative impact of -489.070 with an error rate (α) of 5% - 9.99%. This means that the longer the age of SMEs, the more decreased the rate of profit. This phenomenon indicates that the SMEs are not growing, even though the age of the business is long enough. The second is the proportion of the need of raw materials coming from local region, it has negative effect of -176,137 with an error rate (α) of 1% - 5%. That is, the greater the SMEs take raw materials from the local region, the more decreased the gross margin. This indicates lack of the development of micro and small scale SMEs because the need to produce is very low, so they took a supply of raw materials from the local region. The third, the role of business network has a positive effect for 38,400,000 with an error rate (α) of less than 1%. This signifies that when SMEs join a business network, their profit tends to increase. Thus, it can be stated that the impact of the business network is a determinant factor of the profitability level of SMEs in Probolinggo. High level of profitability reflects high productivity. The profitability level is also a determinant of the competitiveness of SMEs, as the high profitability can stimulate companies to invest in research, development and innovation (Chittithaworn,, 2010). Such condition can help SMEs in providing the best value for their customers and differentiate them from their competitors (Pawitan, 2012). The influence of business network to the level of profitability of SMEs in Probolinggo can be indicated by the level of Return on Investment (ROI). When the ROI level is gained rapidly while the level of competition is high, it means the company can overcome the competition problem, and vice versa. It also can be said that the high level of ROI reflects the efficiency of production costs and transaction costs.
  11. 11. 11 Picture 02. The development level of ROI Based on Development of Business Scale on Network-Member SMEs and Non-Network-Member SMEs in Probolinggo. 0 0,5 1 1,5 2 2,5 3 3,5 4 4,5 5 Micro Small Medium Members of Business Network Sources: Processed Data, from Disperindag East Java,2011 Picture 02 shows that the SMEs that are members of business network have increasing levels of ROI. That is, the larger the development of business scale, the higher the ROI level. Thus, the development of SME scale is positively related to the profitability development of SMEs, so that the business can be run efficiently. In contrast, for SMEs that are non-members of the business network, the ROI level tends to be declining and constant. This indicates that the development of SME Scale is not balanced by the level of profitability development, which means the business operation does not run efficiently. 5.3. The Benefits of Network for SME Competitiveness Benefits of the network can be known through their functions for business sustainabilty of the members (Wignaraja, 2012). This sustainability can be seen through the level of accessibility of members in the network that includes business integration which are input, process and output (Jiang & Ling, 2009). Benefit of this continuous accessibility can be indicated from the level of profitability the members can get (Resmi, 2011). If we see the result of the study, it suggests that the role of business network has a significant effect on the profitability of SMEs in Probolinggo, and The profitability indicates the productivity of the business. In addition, from the calculation of ROI, the SMEs in Probolinggo that join the business network also have a high level flexibility in business. This is indicated by the ROI increasing rate that was positively related to the development of business scale. So it can be said when the business scale increases, the SMEs are more flexible in responding to market demand. Therefore, the business
  12. 12. 12 network in Probolinggo has benefits for business sustainability of its members. It can be traced from several key factors including: 1. Business efficiency by minimizing the transaction costs In general, transaction costs that often arise in SMEs are (Yustika, 2008): (i) cost of searching information, (ii) cost of producing, contract enforcement, and monitoring contract (iii) cost of waiting during the production time, (iv) management fees, and (v) cost of distribution. In fact, before the business network was built, the members were very difficult to find information, especially Information about raw material (input) and how to market the products with suitable prices. Without such information, most of the SMEs can be the victim of asymmetric information that tends to harm the development of their business for long-term. when the network was built, there was cohesive information in the partnership contract between the SMEs and the input provider or the output user. This is done in order to make the business run well and sustain. the partnership contract can guarantee or support SMEs to sustain for long term. This is evidenced by the reduction in transaction costs of each network member. The transaction costs are mostly used for improving business management, distributing input and output, and transportation costs. 2. Increasing the accessibility of working capital Before joining the business network, the accessibility to capital for SMEs is very low, in terms of initial capital mobilization (start-up capital) and access to long-term working capital for investment. For the initial capital mobilization, the functions of business network involves three aspects, namely financial assistance, technical assistance, and assurance program. Meanwhile, to improve access to capital it needs the role of other members in providing loans to members in need. This is done in order to help members that have limited access to bank credit. This is kind of social insurance provided among the fellow members of the network. 3. Creating an innovative business environment Before joining the network, Most of the SMEs managed their product traditionally or manually. However, after participating in the network, SMEs gets easier in marketing, technology, information access, entrepreneurship preparation, gaining capital, and other benefits. This will encourage the development of marketing, better product management (production), and more attractive product packaging. 6. Conclusion and Recommendation Based on the analysis by using Micro Outward Looking Approach, some of the functions of the business network are to cover the internal and external problems. This
  13. 13. 13 internal problems happen due to poor business management. Some of the main internal problems of SMEs before joining the business network can be classified into five aspects, namely: (i) financial management issue, (ii) difficulty in accessing labor, (iii) difficulty in managing raw materials, (iv) difficulty in managing quality & quantity control, and (v) cultural issues of the entrepreneurs relating to entrepreneurial spirit. While for external problems, there are several factors that affect the problem, including: (i) institutional aspects, (ii) the socio-politics, (iii) infrastructure, and (iv) marketing. In the analysis of growth and development, the business network has benefits in some product innovation and marketing expansion, strategies in business are aimed to improve product quality in order to compete in the broader market, and expansion functionates in strengthening and improving product quality and innovation. Resmi (2011) explained, a good quality product is the product that can meet the needs and exceed the expectations of consumers, and it can fulfill the dimensions of quality in terms of performance, features, reliability, conformation, durability, service ability, aesthetics, and perceived quality. The dimensions of quality for service can be measured from: direct evidence (tangibles), empathy, reliability, responsiveness, and assurance. When the aspects in micro outward looking aspect model can be catered, then the implications for the flexibility and productivity of SMEs can be run well and can be perpetuated in the long run. From the previous conclusions, the important role of the network is its function in improving the accessibility of the network members in the supply of raw materials, capital and market expansion. Because this function is very important, the network needs to be managed by professionals who have the entrepreneurial spirit, so as the network can develop its link to get suppliers of raw materials, the owner of capital, as well as business participants widely. It is expected that the business network is not the forum for the opportunists who is just seeking rent, especially, the government's aid hunters that are covertly using development programs as their modus. Moreover, because there are some differences of fundamental problems faced by SMEs either micro, small, and medium business, the development of the business network should be tailored to the specific needs of SMEs, such as the expansion of market for micro and small SMEs. Through this action, it is expected that the interest of SMEs to participate in the business network increases. Coaching and the network empowerment should not be conducted based on the principle of equality but the principle of the needs of its members. So that the activities of the network are diverse.
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