Why are SMMEs important?

Globally, the Small, Medium and Micro Enterprises (SMMEs) sector has long been
recognised as a key driver of economic growth, and more importantly, as major
source of employment. For example, a recent World Bank study found that "relative
to larger firms, SMMEs enhance competition, entrepreneurship, job growth and spur
economy-wide efficiency, innovation, growth and poverty alleviation. Given the
extraordinarily high unemployment rate in South Africa, and the fact that SMMEs are
generally more labour intensive, it is not surprising that this sector has been the
subject of significant research and support. This has culminated, most recently, in
the establishment of a dedicated Government Ministry and Department to address
small business issues. Based on some of our recent work with the SMME sector, there
is no shortage of concerns that will demand the Ministers attention.

The new Department of Small Business Development will not emerge into a vacuum.
There are already a vast array of national, provincial and municipal policies and
agencies geared towards SMME development. The main forms of this public sector
support include:

Specific tax allowances for SMMES;

A lower regulatory burden (SARS, BBBEE, company reporting etc.);
Various programmes to provide improved access to financing (grants and loans);
Numerous incentives, most of which offer specific and additional benefits to SMMEs;
and
Multiple development agencies and business incubators which provide technical
assistance and in many cases financial support.
These efforts have seen some success. By late 2012, 73% of employed people worked
for firms that employed fewer than 50 people[1], contributing approximately 60% to
the national gross domestic product (GDP).

But despite this support and the apparent strength of the domestic SMME sector,
many challenges remain. There is vast literature on this topic which we will not
attempt to review here. Rather, this article is limited to our real-world
observations, based on our own interactions with a sample of SMMEs as part of an
independent research study. Specifically, over the last few months, we met with
over 90 SMME beneficiaries of government assistance across five provinces to ask
them whether and how their needs are being addressed; and what more could be done
by Government to improve interventions aimed at SMME development.

Without hesitation, most respondents stressed that vast strides have been made in
the development of the sector, and readily acknowledged that they would not have
grown or survived without the assistance received from government and industry.
However, in the same breath, these respondents are quick to point out numerous
challenges. Most of these are not new, but for the sake of the Minister, we think
three sets of issues deserve repeating.

1. Access to finance

As would be expected, the availability of affordable funding remains a primary

concern, despite the vast amounts of money government is pumping into the sector.
When pressed for more information, the respondents identified three specific gaps.

Firstly most entrepreneurs have no track record and, understandably, are not be
able to secure start-up capital from private banks. However, they also and often do
not meet the strict qualifying criteria imposed by public sector funding
programmes. This is largely because these criteria are usually generic and not
sufficiently flexible to respond to unique opportunities in this sector. For
example, most applications for assistance require that the entrepreneur provide
audited annual financial statements and have internal control systems in place. For
an emerging entrepreneur, with low levels of financial skills and resources, this
may be an unrealistic expectation.

Similar problems often emerge further down the business development path, in that
nascent SMMEs are unable to obtain expansion capital without secure collateral or
guaranteed earnings. Rather, many growing SMMEs find themselves in the "missing
middle, where they no longer qualify for grant funding from government but remain
too risky for commercial banks.

Finally, even when an SMME does qualify for grant or expansion finance, these funds
are usually restricted to the financing of capital assets (and paid directly to a
third party). When SMME support programmes do provide the working capital needed to
operate a business (direct funding), it is often limited and ring-fenced for
specific activities; and the resulting lack of cash flow contributes to the demise
of most SMMEs.

These issues are not unique to South Africa and the capacity of Government to fund
new businesses is rightly limited. However, given these limitations, Government
needs to work more smartly, in partnership with the private sector, to ensure that
the right businesses are getting the right form of financial support, at the right
time. Our brief interaction with current SMME programmes and beneficiaries suggests
that this is not the case; there is evidence of substantial wastage in the system.

In addition, Government has a direct role to play as a buyer of goods and services
from SMMEs. Delays in payments from Government can quickly rupture the shallow
pockets of most small businesses. Whereas new systems have been put in place and
our own experience as consultants working for Government suggests that major
improvements have been made, complaints and problems persist. Here too the new
Department could play a valuable role in monitoring the performance of other
Government departments and naming and shaming those that do not comply with agreed
payment standards.

2. The Regulatory Burden

South African entrepreneurs complain that red tape and bureaucracy constrain their
ability to adapt and grow. Small businesses, in particular, battle to keep up with
the raft of regulations imposed on them and are less able to overcome the cost of
compliance.

South Africa is reported to have some of the most inflexible labour laws in the
world. For an SMME, which hires employees as and when the need arises, the ability
to respond positively (and in some case negatively) to fluctuations in the number
of orders received or revenue and profit generated is critical to their survival.
This is compounded for those businesses which produce seasonal goods, most notably
in the agriculture sector. The Minister should consider working with the Department
of Labour to review current labour laws, specifically as they apply to labour-
intensive SMMEs, in order to provide them with increased flexibility when it comes
to the hiring and firing of workers.

Similar challenges are likely to occur across a much wider range of regulations,
including those relating to employment equity, BBBEEE, taxation, company
registration, skills development (i.e. SETA contributions). Whereas concessions
have been made in some of these areas for smaller businesses, the combined cost of
compliance remains high, and this too deserves a serious and comprehensive review.

3. Fragmented support programmes

All the SMMEs we met have been fortunate to have accessed at least one government
funded initiative. However, despite the benefits received, a significant number
indicated that the assistance is not comprehensive. Often they receive finance, but
no accompanying training, or they receive training, but find they are unable to
access other government incentives. For example, a chemical company that we met,
which received funding and training to develop a new product, was denied access to
official export assistance incentives. The resulting funding or training received
is subsequently not used optimally.

In other cases, SMMEs benefiting from one government programme are penalised by a
policy in another area. For example, a craft firm that received finance for capital
assets, was required to pay a high import duty on the purchase of the foreign
inputs used in the machinery. In this instance, trade policies designed to protect
a few, large established firms have the unintended consequence of increasing
barriers to entry for SMMEs.

The Department of Small Business Development would be well-advised to undertake a

rigorous review of existing support measures in this sector, and how they relate to
each other (or not), before rolling out any further assistance.

How do we move forward?

The establishment of the Department of Small Business Development (SBD) has the
potential to shake-up government support to this sector. While some may advocate
for an overhaul of existing SMME development strategies and programmes, we dont
believe such steps are warranted. There are already multiple public, private and
civil society initiatives in place; many of which are having positive results.
Rather, the Department of SBD could play a central role in coordinating all of
these SMME interventions across Government; and dealing with the many barriers to
SMME development that Government itself imposes on the sector. Without adding to
the growing list of demands on this new Department, we would suggest that the
Minister does some homework before she leaps into the fray. Specifically, we would
propose that she considers:

Reviewing the focus, size, effectiveness and potential overlaps between all
government SMME programmes that are already available; and comparing this vast
network of support to the actual needs and general awareness of South Africa SMMEs
on the ground.
Revising the regulatory framework and how it applies to SMMEs, by working across
Government to identify and tackle those regulations that impose a particularly high
compliance and/or reporting cost on small businesses.
Written by Zulaikha Brey and Sifiso Mhlaba, DNA Economics

Notes:
[1] Finweek 4 April 2013