SMALL AND MEDIUM ENTERPRISES

(SMES)

IN DEVELOPING COUNTRIES

IMPORTANCE & CHALLENGES

A PERSPECTIVE

What are SME's:

SME's are basically small and medium enterprise. For a company or firm to qualify as an SME the factors taken into consideration are number of employees it's turnover or balance sheet total. As per the European Union (EU an SME is defined as '!he cate"ory of micro # small # and medium si$ed enterprises # is made up of enterprises %hich employ fe%er than &'( persons and have an annual turnover not e)ceedin" '( million euros and*or a balance sheet not e)ceedin" +, million euro. !he European -ommission set up , broad parameters in &(.& %hereby companies comprisin" up to .( employees %ere classified as Micro/ entities # up to '( employees %ere classified as Small companies and up to &'( employees %ere classified as medium si$ed enterprises.

!he United States on the other hand takes into account 'Small business criterion' comprisin" type of industry o%nership structure# revenue and number of employees %hich is normally up to '(( . For units consistin" of less than .( employees the small business administration S0A uses the term S121 meanin" Small 1ffice 2ome 1ffice .

3n 3ndia %hich is a developin" country# the 4overnment of 3ndia in &((5 passed an act called the Micro # Small and Medium Enterprise 6evelopment (MSME6 act . As per the act # the main parameter considered is type of enterprise %hich is then further scrutini$ed for various aspects . 7e first talk of enterprises %hich are involved in manufacture * production * processin" of "oods. 7hen investment in plant and machinery is limited to 8s &' lac it is considered a micro enterprise.

3nvestment bet%een 8s &' lacs and 8s ' crore make the enterprise a small enterprise. 7hen investment is more than 8s ' crore but limited to 8s .( crore it comes under a medium enterprise . !he second class en"a"es the 'Service Enterprises' %here investment is limited to 8s .( lacs is labelled as 'Micro Enterprise' . 3nvestment in equipment bet%een 8s .( lac and 8s & crore makes it a 'Small Enterprise' . A 'Medium Enterprise' attracts investment from 8s & crore to 8s ' crore . !he above fact sho%s that different countries * re"ions have different criterion for definin" SME's.
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I !"rta#$e "% SME's &# De'e("!&#) C"*#tr&es SME's are a tremendous contributor to the "ro%th and economy of any developin" country. !hey are considered to be a ma;or "enerator of employment in both rural and urban areas. A number of people depend on SME's for their livelihood. <ot only do they create an en"ine of "ro%th# they also contribute to%ards reduction in poverty. Empirical studies sho% that the SME's make up more than 5( percent of 46= and about >( percent of total employment in countries %hich are less developed. !hey account for around >( percent of 46= and ?( percent of total employment in developin" countries. For instance in =akistan a study conducted by SME6A(Small and Medium Enterprise 6evelopment Authority in &((5 ackno%led"ed the e)istence of ,.& million enterprises .

SME's have a presence across various sectors in developin" countries # be it a"riculture or industry they are e)tremely important for a market %hether domestic

or international to increase efficiency and competitiveness . !his sector is said to be the bi""est provider of ;obs# in most countries # developin" as %ell as developed . 3t is said to be a ma;or source of innovations and ne% start/ups . 4oo"le bein" a classic e)ample . SME's play a key role in maintainin" re"ional and sectoral balance in an economy . !his in turn makes economics especially for developin" countries more fle)ible and adaptable . SME's tend to be more active in rural areas %here they are a source of employment to unskilled %orkers of lo% income "roups # thus contributin" to reduction in poverty as also development of rural economy . SME's "ive rise to ne% entrepreneurs and plays a crucial role in the checkin" of income distribution .
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Cha((e#)es +"r SME's I# De'e("!&#) C"*#tr&es

SME's have al%ays played an important role in the development of a country . !hey are in a %ay the backbone of the country's economy yet there are numerous problems faced by SME's in most countries # more so in developin" countries . Mentioned belo% are some of the issues that pose a challen"e to most SME's 9 ,) La$- "% +&#a#$&a( Res"*r$es: Most SME's are faced %ith the recurrin" problem of shorta"e of finance . !here is a problem of securin" loans from banks or other lenders . Some do not even have access to local banks . A number of enterprises fail to provide bank "uarantees %hich prevent them from "ettin" any or lo% financial aid. !he rate of interest for acquirin" loans is also much hi"her for SME's as is the duration of loan . !hey are considered hi"h risk borro%ers and are vulnerable to market fluctuations . 1n the

other hand # in some developin" countries banks lack sufficient kno%led"e on procedures to lend or financially support SME's . !he current "lobal financial slo%do%n has also contributed to the constraints faced by SME's . !he financial crunch often pushes an SME to function belo% it's normal %orkin" capacity and in some cases may result in shutdo%n . 3nsufficient capital adds to cost of operation and production * services provided . A .??? study by -ollier @ 4unnin" in Aenya linked lack of financial support to e)portin" . Shorta"e of fund proved to be a hu"e barrier for SME's %ho %ant to promote their product * services . !hese conditions block the "ro%th as %ell as functionin" of most SME's in developin" countries.

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.) A$$ess t" Mar-ets:

0ud"ets of numerous SME's are limited @ thus their reach to a la"er market is much smaller . !he consumer base is restricted because they are not able to promote or advertise their services on a much %ider scale . 0esides this in certain developin" countries SME's are out of sync %ith the current business practices and are una%are of the latest business trends . Access to "lobal markets in times of tou"h competition also proves to be a hindrance to the "ro%th and e)pansion of SME's ( 1f course one must mention here that %ith the advent of the 3<!E8<E! this issue has some%hat been resolved . 0ut in many developin" countries # the inland and remote areas are still not easily accessible . Accordin" to 1E-6 (1r"ani$ation for Economic -o/operation and 6evelopment report# SME's

account for almost ?( percent of "lobal businesses . !hey makeup '( percent of 46= and 5( percent employment . 3n spite of the above fi"ure representation of SME's of developin" countries is considerably lo% %hen it comes to international trade . 3n 3ndonesia for instance # only &/, percent of SME's are into e)portin" . !aken in totality # a minuscule ./' percent of SME's in developin" countries are actively en"a"ed in "lobal markets .
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/) Pr"$ess "% D&str&0*t&"#:

Failure to establish proper marketin" net%orks is another challen"e faced by SME's of developin" countries . !heir kno%led"e of distribution channels is limited and they fail to identify proper routes of profitable options available to them . SME's that utili$e correct information at the ri"ht time # only are capable of tacklin" this problem . An avera"e %ould perhaps find it difficult to "et into minute details as they lack the internal resources to even develop a concrete supply chain . 4ereffi (.??& in his study spoke of !ai%an %here the SME's lacked concrete distribution net%orks thereby hinderin" there operational and marketin" capabilities .

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1) Pr&$&#) Strate)2 :
SME's in developin" countries find it difficult to set the ri"ht price for their product . !he main reason bein" i"norance or not havin" a proper idea of the prevailin" market prices . !his problem not only curtails e)ports # in fact it prevents SME's from securin" competitive prices in the domestic*international markets . Settin" the achievable tar"ets as %ell as prices %hich are at par %ith the prevalent prices to ma)imi$e the enterprise profit is most of the time a difficult task for SME's in developin" countries . !here is also the burden of maintainin" a stron" position financially . !his in turn directly impacts securin" any kind of price advanta"e . A study in .?B> of >' e)port manufacturers ( SME's of Cene$uela by Frances %as proof of this fact .

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3) 4*a(&t2 C"#tr"(:
=roduct desi"n # brand ima"e # suitable packa"in" and a hi"h standard of the product * service manufactured * provided are all features that describe quality . !hou"h the standards of quality control are different in various developin" countries # the problem remains the same across the board . Most of the time quality is considered the main criterion for doin" business in the market and also sustainin" it 3nsufficient kno%led"e %ith re"ards to characteristics of the product # manufacturin" technolo"y # etc are the main problems afflictin" SME's in

developin" countries. !his impedes their quest in maintainin" quality. !his is ma"nified by the fact that SME's are very often una%are of the demands*requirements of the market. For them it is much simpler to

produce*e)port a standardi$ed product . 3t is also true that a product mi"ht sell %ell in the domestic market but fail to make an impact internationally . Studies conducted by Fi"ueirdo and Almeida in .?BB talk of sub/standard products bein" manufactured by 0ra$ilian SME's %hich resulted in products bein" re;ected . Carious SME's do not have the means to conduct the research for methods to improve or maintain product*service quality . !his leads to competition from similar firms %hich are providin" the same standard*quality of product at competitive prices.
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5) La$- "% S-&((e6 H* a# Res"*r$es :

!his is another challen"e SME's have to face. !his is a factor %hich may have an impact # "ood*bad on the performance of the enterprise . =resence of educated and skilled labour is a bi" asset to any business or"ani$ation . Unfortunately SME's in developin" countries often lack this asset . SME's have a tedious task of attractin" talented*skilled manpo%er as most of them may not offer pay packa"es %hich are e)pected by the employees . Another problem further rises in retainin" the talented lot and providin" them a conducive business climate for "ro%th . Employees in most SME's are habituated to conventional methods of functionin" %hich are not sufficient to take on professional level of conductin" business . Absence of such skilled personnel tends to hamper creativity or uniqueness of the SME . Solvin" of

comple) business issues for initiatin" "ro%th oriented business policies becomes cumbersome . SME's tend to avoid providin" trainin" to employees to cut do%n on e)penses . !his further makes it difficult to retain employees %ho are not only skilled but can also 'multitask' .

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The"r&es That I#%(*e#$e SME's

!%o theories %hich are most relevant to the financial policies of the SME's are the =eckin" 1rder !heory and the !rade 1ff !heory . 0oth strive to e)plain the capital structure of the SME's . . =eckin" 1rder !heory9 3n .?B+ # Myers propounded a capital theory called a =eckin" 1rder !heory . !his theory states # DA firm's capital structure is driven by the firm's preference to finance %ith internally "enerated funds instead of %ith e)ternal financin".D Emperical evidence sho%s the main source of financin" of SME's are their '3nternal 8esources' . !hey tend to refrain from utili$in" 'E)ternal 8esources' basically because of t%o factors / Asymmetric information and transaction costs . 7hen SME's choose not to utilise e)ternal financial aid and in the process "ive up a lucrative business investment there is a rise in asymmetric information cost . !ransaction cost come into play %hen an SME chooses to accept e)ternal finance . 1n identifyin" a source # the SME %ill after usin" internal resources opt for e)ternal 'debt financin"' and only later settle later for 'equity financin"' . Accordin" to this theory 'SME's %ith a positive cash flo% use it to lo%er debt ratio' and

'SME's %ith a ne"ative cash flo% increase their debt ratio in response to lack of internal resources' . & !rade 1ff !heory 9 Accordin" to this theory of capital structure Dfirm's %ith a debt ratio belo% the tar"et ratio ad;ust their debt up%ards to%ards the tar"et debt ratioD and Dfirm's %ith a debt ratio above the tar"et ratio ad;ust their debt do%n%ards to%ards the tar"et debt ratioD . SME's utili$e the principles of this theory by usin" the 'ta"et/ad;ustment model'(!a""art #.?>> and Ealilband @ 2arris# .?B+ . SME's have a set debt ratio %hich they tar"et and accordin"ly ad;ust to%ards it . !his model helps SME's ad;ust 'tar"et debt ratios' by comparin" the previous and future (!ar"et period's ratios . !he above theory helps ma)imise the value of the enterprise . Si$e # a"e # "ro%th opportunities # internal resources all tend to influence decision makin" process of SME's . !he de"ree of effect above theories have on individual SME's depends lar"ely on these factors .

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S"(*t&"#s t" Pr"0(e s +a$e6 72 SME's:

SME's are the very fabric of economic "ro%th in developin" countries . 3t is for this very reason that it is important to discuss the viable solutions to the problems encountered by them . 0riefly mentioned belo% are the same . a Ease in the process of settin" up of SME's .

b Availability of finance on lon" term basis %ith lo% rate of interest .

c 0anks and 3nsurance companies reali$e the challen"es faced by SME's and introduce rules @ re"ulations accordin"ly .

d Simplified system of re"istration and licensin" .

e !ransparent ta) system and ease in %ritin" of contracts .

f Fle)ible labour re"ulations for protection of ri"hts of both labour and enterprise .

" =rovision of 0usiness 6evelopment Services (06S by public institutions .

h Assistance by public institutions in obtainin" information about market and distribution process .

i =rovision of macro/economic frame%ork allo%in" SME's to operate in a fair manner .

; Fo"istics and Supply -hain Mana"ement pro"ramme like U<361's Sub/ contractin" and =artnership E)chan"es (S=G pro"ramme for SME's in developin" countries .

k 4overnment assistance at local and re"ional level to identify demand supply clusters as %ell as conductin" of %orkshops for trainin" labour .

l A separate stock e)chan"e for SME's or the permission to trade at e)istin" ones .

m Settin" up a -redit 8atin" A"ency for SME's .

Special 6evelopment -enters for SME's %ithin 0usiness =arks*Special

Economic Hones (SEH .

o Market assistance from E)port =romotion -ouncil to identify international markets and assist in procedures of international trade .

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C"#$(*s&"#
Stron" SME sector can propel a developin" country for%ard by diversifyin" and e)pandin" it's domestic economy . 3ncrease in SME "ro%th has a direct impact on the 46= "ro%th of a nation due to it's increase in profits # value added services and output . !hey are a "reat "enerator of employment and contribute tremendously to income "eneration and e)port revenues . !hey are therefore a sector that should be actively promoted and encoura"ed in all developin" countries .

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