AN ANALYSIS OF THE IMPACT OF GLOBAL FORCES ON INVESTMENT

OPPORTUNITIES FOR SMALL AND MEDIUM ENTERPRISES IN

AFRICA: A CASE STUDY OF KENYA.



P.D. MZUNGU


REG.NO. R067545Y





A DISSERTATION SUBMITTED IN PARTIAL FULFILMENT OF THE


REQUIREMENTS FOR THE DEGREE OF MASTER OF BUSINESS


ADMINISTRATION


2008



THE GRADUATE SCHOOL OF MANAGEMENT


UNIVERSITY OF ZIMBABWE







SUPERVISOR: MR D. NIKISI



CHAPTER 1

1.0 INTRODUCTION
This chapter entails the background which will discuss the environmental analysis, the
importance of SMEs, constraints. t will also discuss the research problem, research
objectives, proposition, study justification, scope of research and finally structure of the
study.
Small and Medium sized Enterprise (SMEs) have only just emerged as a field of study in
its own right, as a result of the innovations and the solutions they provide to different
economic problems, particularly in terms of employment there is a sort of consensus on
the importance and key roles these enterprises play in different economies. While it has
been argued that a small firm, because of its size, can only make a minor contribution to
the economy, as there are so many small firms their collective contribution is substantial.

This study will identify if the global forces in Globalization, nvestment Climate, Electronic-
Commerce (e-commerce) and KnowledgeBased Economy (KBE) have made any
contribution to promote the investment opportunities and thereby sustaining the growth of
SMEs, a case study of Kenya.

1.1BACKGROUND

1.1.1 ENVIRONMENTAL ANALYSIS
The term SME covers a wide range of definitions and measures, varying from country to
country and varying between the sources reporting SME statistics. Some of the
commonly used criteria are the number of employees, total net assets, sales and
investment level. However, the most common basis for definition is employment, and
here again, there is variation in defining the upper and lower size limit of an SME.
Despite this variance, a large number of sources define an SME to have a cut-off range
of 0-250 employees. Kenya has adopted the definition of SME as that which has 200
employees or less (Regional Program on Enterprise and Development, n.d).

The importance of the SME sector varies greatly across countries. The importance of
formal small and medium-sized enterprises increases with the economic development.
Previous research has shown that financial and institutional underdevelopment
constrains small and medium size firms significantly more in their operation and growth
than large firms (Beck et al, 2005).

Theory provides ambiguous predictions about the correlations between the business
environment and the size of the SME sector in manufacturing. On the one hand, easy
entry and exit, sound contract enforcement, effective property rights registration and
access to external finance can foster a thriving and vibrant SME sector with high
turnover that sees a lot of entry of new and innovative firms, the growth of successful
firms unconstrained by rigid regulations and exit of unsuccessful ones. On the other
hand, costly entry and exit, rigid labor regulations and restricted access to external
finance can also foster a large SME sector, but one that consists of many small
enterprises that are either not able to grow or do not have incentives to grow beyond a
certain size (Demirguc et al, 2005).

Countries with higher GDP per capita, lower entry and property registration costs,
higher exit costs and more effective credit information sharing systems have larger SME
sectors in manufacturing. Using the official definition of SMEs, we find that countries
with higher GDP per capita, with lower cost of entry costs, more effective systems of
credit information sharing and more rigid employment regulations have larger SME
sectors.

Brownlie (1987) suggests that:
1. The determinants of success are dictated by the business environment;
2. The firm's response to environmental change therefore represents a
fundamental strategic choice;
3. Knowledge of the business environment must precede the acquisition of any
degree of control over it.
cknowledging the validity of these assumptions leads to a realization that effective
management needs to have the best method of collecting information, however there
are problems which come when collecting this information and this is where PEST (
Political, Economic, Social and Technology) analysis comes into use. The following is
PEST analysis for Kenya:

POLITICAL/LEGAL FACTORS
ncreased trade openness has facilitated the rapid growth of a few internationally
competitive firms and a rise in total exports. Some SMEs, however, are less
internationally competitive and are now less likely to export. With economic recovery
and access to new markets through GO, COMES and EC, total exports have
grown in the last few years. Firm data show, however, that since 1999 the average firm
has become less likely to export. This suggests that the average firm is unable to
compete internationally, and that the rise in exports is being driven by a few firms. Only
firms in the textile sector have on average shown export growth, probably because of
GO (World Bank, 2004).

Due to increasingly uncertain political climate, business confidence and investment is
declining. That investor perceptions have turned negative is evident in international
surveys such as the World Economic Forum's frica Competitiveness ndex, which
places Kenya near the bottom in terms of economic governance and country risk
ratings. The nstitutional nvestor ndex ratings have fallen nearly 50 per cent since the
end of the 1980s (World Bank, 2004).

Several terror incidents illustrate Kenya's terrorist security risk, including the 1998 US
embassy bombing, the 2002/03 suicide bomb attack in Mombasa, and the simultaneous
(but unsuccessful) missile attack on an sraeli airliner. perceived terrorist threat
against British irways flights resulted in the cancellation of many international flights in
June 2002/03 and was accompanied by a travel warning from +several Western
countries. Such incidents have been extremely damaging to Kenya's large tourism
industry.
Kenya witnessed political instability, political in-fighting especially during competitive
national elections as witnessed in 2002 and 2007. The instability and unpredictability of
macroeconomic and private sector policies, and a history of stalled and half-hearted
reform processes increase business uncertainty and risks in Kenya. n addition to
rampant corruption and unfavourable taxation policies, this has probably contributed to
the low and declining rates of investment by firms in Kenya.

dministrative constraints are also contributing to unfavourable business environment.
Business entry and registration procedures are long and cumbersome. nsolvency
procedures are lengthy and costly. Poor governance has created wide-spread mistrust
of the courts, making enforcement of contracts and security, and resolution of disputes,
very difficult.

Unsuitable financial instruments are being used by financial institutions in regards to
lending. While the cost of finance has come down dramatically in the recent years,
Kenyan banks do not appear to have the tools or capacity to evaluate and monitor loans
to small and medium enterprises (SMEs) with profitable investment opportunities.

ccording to the World Bank (2004) the fragility of institutions is compounded by
weaknesses in financial supervision. Major regulators have suffered from a lack of
independence from government influence and have often been handicapped in
enforcing prudential regulations. The direct government participation in the financial
system was a source of distortions and an indirect source of vulnerabilities. The
Government's role in financial development should be focused on providing a robust
legal and judicial framework, and strong supervision and regulation of financial
institutions and markets, thereby promoting soundness and competition among all
providers of financial services.

Most customers in Kenya below the top tier of corporate and wealthy borrowers face a
non-competitive banking market and are often effectively tied to one bank, with very
high switching costs. Competition is also hampered by deficiencies in the legal
infrastructure and by the presence of many weak banks that are unable to put
competitive pressure on the few strong ones.

ccording to the World Bank (2004) there is a suggestion that there are important
structural problems in bank and non-bank oversight: banking supervision is under-
funded and has not been decisive; the payments system is inefficient; insurance sector
supervision could be more effective; enforcement of capital market rules and
supervision of market participants are still weak; and, finally, the pension system has
very limited coverage and does not provide adequate benefits.

Finally, financial sector specialists emphasize that there is a "financing gap between
the commercial banks and the microfinance institutions. Small and medium-sized firms
are typically too large for a microfinance loan but are challenged in obtaining loans from
commercial banks. There is a sense that monitoring, evaluation and other transaction
costs are too high to make medium-sized loans worthwhile.

The World Bank (2004) points out that the legal system and contract enforcement are
very important in making a good business environment. Secure property and
contractual rights play a vital role in modern economies. When enterprise owners are
unsure about the security of their property rights, they will be unwilling to risk investing
their capital in projects that yield profits only in the medium- to long-term. Several
studies have found that the 'rule of law' is relatively poorly protected in Kenya when
compared to other countries. Looking at the firm survey data, it is seen that perceptions
of the legal system are very poor.

dministrative, legal, and regulatory framework- dministrative, legal, and regulatory
compliance can be a heavy burden on many businesses in Kenya. Direct costs include
taxes, managerial time, lawyer and other professional fees, meetings with and
inspections from local authorities, fees and penalties, and unofficial payments.

When the regulatory burden is particularly time consuming or costly, business can be
discouraged. Licensing and registration, for instance, can delay the pursuit of
investment opportunities. Excessive regulation can also drive firms into the informal
sector where they remain unregulated and untaxed, but also short of capital and public
services.

n general, there is evidence to suggest that the regulatory burden in Kenya appears to
be greater than elsewhere in East frica amongst Kenya's trading neighbours.

ECONOMIC FACTORS
Poor infrastructure is also contributing in making the business environment in Kenya to
be challenging. Many firms must sacrifice their profits to purchase generators, dig their
own wells, and repair their own roads as the provision of public goods like roads, water,
and electricity has been extremely poor and unpredictable. Not only may self-provision
of such services be inefficient in an economy-wide sense, but on an individual level they
erode profits, discourage investment, and further reduce international competitiveness.
Poor infrastructure has direct and indirect costs to manufacturing firms (nvestment
Survey, 2004).
Poor infrastructure reliability may also require higher inventories and shape investment
choices and location decisions.

The principal source of discontent with transport infrastructure appears to be the
dramatic deterioration in road quality. fter deteriorating steadily during the 1980s, road
quality collapsed during the 1990s. The reasons were insufficient resources, and
mismanagement of the resources that were allocated. Government allocation of funds
was insufficient, and a decline in donor funding for road infrastructure was not fully
offset by domestic spending on road maintenance. Meanwhile, corruption has resulted
in award of contracts to incompetent contractors and poor quality road works. n T
Kenya's 2001 survey on bribery, the Ministry of Public Works topped the list of public
services in average size of bribe paid, and requests for bribes were encountered in 83.3
per cent of the dealings with that ministry (Transparency nternational, 2003).Poor
quality roads directly and dramatically diminish firm competitiveness and profitability.

The costs, delays, and uncertainties created by a failing road infrastructure affect
businesses poorly; particularly those that handles highly perishable products and face
tight export dead-lines, such as the horticulture industry. Poor road quality increases
vehicle maintenance and trucking costs

Kenya Railways (KR) has fallen from carrying the dominant share of freight traffic
between Mombasa and Nairobi (and almost all freight traffic into Uganda) to now
carrying roughly a fifth of Mombasa port and Ugandan cargo. ts prices for moving
containers can be up to double those charged by road transport. Tanzania Railways
have already won much of the Burundi market and a substantial part of the Rwanda
market, and is actively pursuing the Uganda market (World Bank, 2004).

Kenya has three international airports, Nairobi's Jomo Kenyatta nternational irport,
Mombasa's Moi, and the Eldoret irport, as well as a number of domestic airports. n
addition to passenger services, it has air cargo handling facilities. The 1996 privatization
of Kenya' airline is viewed as broadly successful, and the airline is now an frican
market leader.

ccording to the World Bank (2004) it states that ports are Kenya's single most
important infrastructure constraint. For example, a recent single shipment from
Felixstowe (UK) to Mombasa, the charge for unloading at Mombasa was around six
times the charge for loading at Felixstowe. Costs relating to corruption and delays are
also high. t notes that the port of Mombasa has historically suffered from outdated
equipment, poorly trained personnel and management, overstaffing, corruption, and
political interference.

Electricity outages and surges are extremely costly to Kenyan firms. n 2002, Kenyan
firms reportedly experienced 33 outages less than other countries but still a large
amount and, with the greatest loss of sales, probably more severe and long-lasting than
in competitors. Firms also lose capital and production capacity to surges and outages. t
is common for firms to experience damage to or complete loss of equipment due to
power fluctuations or outages. To cope with frequent outages, 70 per cent of the firms
own one or more generatorsa much higher number than other countries surveyed. n
2002, Kenyan firms met 14.5 per cent of their electricity requirements with these
generators (World Bank, 2004).

Water service is rated extremely poorly in Kenya. Underinvestment in maintenance has
resulted in the collapse of the water and sewerage infrastructure, and yet tariffs are
relatively high.

Extending lines from the main water distribution grid to the development site is currently
the responsibility of the firm. Firms are also being required to pay connection deposits,
which the 2003 CEM reports may run up to $3,850. n addition, they have to make
significant meter rent payments, for water meters are the property of the local authority
(nvestment Climate report, 2003).

TeIecommunications
Kenya's performance in the fixed telecommunication sector is poor, mostly due to the
weak management and financial performance of the public monopoly telecom company,
Telkom Kenya. The arrival of mobile technology has dramatically eased the constraints
of poor landline telecommunications and mobile subscribers dwarf the number of fixed
line subscribers. Yet tariffs are still high, and fixed line nternet access is poor and
expensive.



Donor support
The Government has already begun to normalize relations with donors. For instance, in
2003 the World Bank resumed credits and grants to the country and the nternational
Monetary Fund (MF) concluded arrangements for a poverty reduction and growth
facility (PRGF). n return for donor support the Government of Kenya has committed to
restructure the public sector, reduce the civil service wage bill, attack corruption,
increase development pending, privatize state institutions, and reform the financial
sector.

Donor pressure is most public and acute in the realm of anti-corruption. The US, the EU
and others regularly and vocally criticize the pace and extent of investigations into high
level corruption. Cuts and delays in aid have been promised if the government does not
take more serious action against current and former public officials implicated in
corruption scandals.

SOCIO-CULTURAL FACTORS
n its report, the World Bank (2003) highlighted that firms in Kenya demonstrate an
alarming indifference to and ignorance of the HV/DS problem. While the infection rate
in the workforce is estimated at 15% nationally, more managers believe that none of
their workforce is at risk. Most workers express a willingness to be tested, and even pay
for that test. So far the expansion of the informal sector has saved the Kenyan
economy, providing jobs for the expanding working-age population and a source of
economic growth. Yet the expansion of the informal sector has also limited economic
expansion in many ways.

Rampant petty and grand corruption has hindered business for over a decade and, in
spite of the improvements in 2001 corruption persists at damaging levels. Recent high-
profile corruption scandals have corroded the new government's reputation. Firms in
Kenya report that crime and theft is a major impediment to business. One third of all
Kenyan firms were victims of crime. Crime escalated in Kenya from the mid-1980s, and
by the 1990s violent crime and insecurity were among the hallmarks of Kenya (and
Nairobi in particular). Banditry became common in the rural areas, and housebreaking
and violent car robbery became commonplace in Nairobi. Consequently, the UN has
given Nairobi a security rating below that of Jerusalem and Bogot (Economic
ntelligence Unit, 2003).

While the rise in crime is undoubtedly related to the rise in urban poverty and
unemployment, one study argues that the crime wave can also be traced to flaws in the
policing and political systems. n general the police force is widely recognized as being
underpaid and under-equipped, and a lack of discipline resulted in police violence
becoming a commonplace in the 1990s. t is widely acknowledged that, historically, a
sizable fraction of the police force has participated directly or has been complicit in
criminal activity.

ll-suited training- Kenya's formal training institutions have little orientation toward the
practical needs of the enterprise sector, and firms cannot use the funds they pay into
the training levy to obtain productivity-enhancing training for their manufacturing
workers.

Though the general education level is high, the level and quality of production skills and
technical training in Kenya is low. These training deficiencies can be traced, at least in
part, to structural problems in the technical and vocational training system.

The cost of labor in Kenya appears striking uncompetitivewages of unskilled
production workers are higher in Kenya than all neighbours and strategic competitors.
Higher Kenyan wages are justified if labor and firms are highly productive, but looking at
estimates of the unit cost of labor higher Kenyan wages appear justified only when
compared to Tanzania or Uganda. Compared to sia, however, the cost of labor still
appears high. s a consequence, wages consistent with the regional labor market can't
be reconciled with the global product market (Economic Survey, 2003).

Real wages appear to have been rising rapidly for a decade while firm productivity has
remained stagnant. Several possible explanations for this wage-productivity disconnect
are suggested, including the possibility that regulation is driving low wage jobs into the
informal sector, or non-market driven increases in public sector wages.

TECHNOLOGICAL FACTORS
Kenyan plants and equipment are outdated, overvalued and inefficiently used.
nvestment levels are low and declining. Kenyan investment levels are very low after
decades of decline. Most firms are investing nothing, and few firms that do invest spend
enough to even replace worn out equipment. Surprisingly, given their low rates of
investment, firms' use of capital is relatively high and capital productivity low. Kenya's
capital stock is unusually old, capacity utilization is poor.

The nformation and Communication Technologies, the nternet, and digital
technologies that are based on economic and business principles have been favourable
in Kenya. This being stated, knowledge is now the driver of productivity and economic
growth, leading to a new focus on the role of information, technology and learning in
economic performance. The knowledge content of today's goods and services is vastly
more important than it was in the past decades. The assimilation and synthesizing of
this new information to generate valuable knowledge is now an integral part of business
operations. Understanding the concept of the Knowledge Based Economy and the tools
of the nformation and Communication Technologies in which the producers and
consumers in the nformation Society use as a way to relate to each other are
paramount notions in gaining a keen perspective on the social constructions,
implications, and commercialization impacts on the nformation Economy. The
government of Kenya significantly reduced and in some instances completely removed
tariffs when importing technological tools.




1.1.2 THE IMPORTANCE AND ECONOMIC ROLES OF SMEs
ccording to the UN/ECE Secretariat (1997) the Small and medium sized enterprises
(SMEs) are one of the principal driving forces in economic development. They stimulate
private ownership and entrepreneurial skills, they are flexible and can adapt quickly to
changing market demand and supply situations, they generate employment, help diversify
economic activity and make a significant contribution to exports and trade.
The significance of small and medium sized enterprises (SMEs) in market economies is
global:
n the European Economic rea (EE) and Switzerland there are more than 16 million
enterprises. Less than 1 percent are large enterprises; the rest are SMEs. Two thirds of
all jobs in this region are in SMEs, while one third of all jobs are provided by large
enterprises.

SMEs constitute the backbone of the sia Pacific region, accounting for 90 per cent of
enterprises, between 32 and 48 per cent of employment and between 80 and 60 per cent
of gross domestic product in individual sia Pacific economies.
The strong performance of the United States economy in recent years has been driven
largely by the creation of SMEs, which accounted for 43 per cent of net job creation
between 1990 and1994.

The importance of SMEs can be seen from the fact that they represented 95% of the total
establishments in the member countries of the Organization of Economic Coordination
and Development (OECD). OECD members produce more than two thirds of the words
goods and services (OECD 2002).

n reland SMEs made a substantial contribution to Gross Value dded (GV) in the
economy. n the construction sector, small businesses accounted for over 70% of GV in
2003, while in the services sector contribution was over 40%. ndigenous industry, small
businesses contributed approximately one third of total GV.

Based largely from evidence from sia, Mellor (1976), suggest that on SMEs will
generate rapid, equitable and geographically dispersed growth if there are farm and non-
farm linkages in rural sub-Saharan frica. Using examples from ndia, Pakistan and
Taiwan they point to small farmer demand for fertilizer, construction inputs, and
equipment and repair services provided by SMEs specializing in blacksmith whereas the
farmers additionally purchase consumer goods. They concluded that middle-sized
peasant farmers to a much greater extent than their large scale and urban counterparts
spend incremental income on labour-intensive rurally produced goods, thereby generating
important second round demand multipliers. Rangarajan (1982) found that one percent
addition to the agriculture growth rate stimulated a .5% addition to the growth rate of
industrial output, and a .7% addition to the growth rate of national income.

Rural SMEs provide the primary source of employment for between 3% and 63% of the
labour force in rural Sub-Saharan frica. lthough highly variable, non-farm SMEs share
of rural employment typically fall in the 10-20% range, in contrast to the 20-30% figures
commonly reported for sia, Chuta et al (1979). n Nigeria and Benin, shares in rural
employment attain 63% and 41% respectively because of high female participation rates.
Because the overall level of non-farm activity runs counter-cyclically to the agricultural
calendar, distinct seasonal rhythms characterize non-farm employment, with non-
agriculture activity reaching its peak in the dry season immediately after harvest.

1.1.3 CONSTRAINTS
The development of small and medium enterprises (SMEs) in Kenya is generally believed
to be a desirable end in view of their perceived contribution to the economy. However
SMEs are subjected to a number of constraints that affect their ability to compete with
larger firms. The constraints facing the SMEs in most cases are similar in most countries.
The actual performance of SMEs, however, varies depending on the relative economic
efficiency, the macro-economic policy environment and the specific promotion policies
pursued for their benefit.
The following are some of the constraints faced by SMEs:

1.1.3.1 Access to Finance
SMEs encounter great difficulties while raising fixed and working capital because of the
reluctance of banks to provide loans to SMEs. Banks are reluctant to lend to SMEs
because of high processing and monitoring costs of loans to SMEs. The loan application
forms for investment financing from banks are long, tedious, and redundant.

The other problem entrepreneurs face in seeking institutional finance is with regard to
preparation of the project proposal. n most cases the entrepreneur often lacks the ability
to formulate a proper project proposal. Even when he/she prepares the proposal drawing
on outside expert services, there is no guarantee that the proposal will be evaluated
properly as the financial institutions themselves lack adequate capability for proper project
evaluation.

One of the main factors that have hampered flow of institutional finance into SMEs is
banks' pre-occupation with collateral based lending. Traditionally banks have used fixed
asset ownership, particularly land ownership as the basis for judging credit-worthiness.

Because of lack of proper autonomy and accountability the public sector financial
institutions are beset with inflexibility, inefficiency, political interventions and corruption.
Since the performance of the bank officials is not properly evaluated they lack the
incentive to bring a large number of suitable borrowers, particularly those in the SME
sector in line with institutional financing. This has increased bureaucracy and corruption in
most financial institutions.

1.1.3.2 LegaI, ReguIatory, and Administrative
Government and regulatory authorities often impose certain conditions on registration and
maintenance of a business in form of license renewal, annual return, clearance from
environmental department etc. nvestors are required to procure trade license from local
government bodies by paying statutory fees. The process involves unnecessary delays,
harassment and side payments. The procedure is complex and the issuance of the
license is not automatic even though the investor has made payment of requisite fees and
declaration by the investor that the proposed investment is in conformity with the rules
and regulations and zoning restrictions of the local government authority.

Manufacturing units employing a certain minimum number of employees are required to
be registered with the specific office for example office of the Chief nspector of Factories
and Establishments. The job of the Factory nspector is to oversee the working condition
and safety measures in the factory. n practice, the regulation has proved to be a major
source of delay and harassment.

ll industries are also required to obtain a certificate from the Department of Environment
in respect of proper arrangement for anti-pollution and safety measures. Here again, the
requirements are not clearly stated for the type and size categories of industry and the
investor is not allowed to go ahead with investment on the basis of the undertaking that
the requirements will be complied with. n most cases this has been a dragging matter to
most investors.

1.1.3.3 Human CapitaI
SMEs are characterized by poor skill level of workers. They have difficulty attracting
talented workers since these talented workers often shun away from working for these
SMEs. Professional workers perceive SMEs as risky due to lack of enough job security.
Larger companies are able to provide attractive remuneration packages, job
advancement, training, job design, job security, etc. lack of enough personnel has
deprived employees from specializing in particular jobs and in most cases the owner of
the business is forced to get involved in daily operations of the company. This has
contributed to managers or owners of the company losing strategic focus of the business
and thereby affecting the survival of the company.
1.1.3.4 TechnoIogy
Croft (1996) points out that technology has had a major impact on companies in the last
two decades. Organizations wishing to remain competitive must invest large sums of
money in research, design and development.
Technology has played a part in altering job design, taking over routing activities and
increasing the demand for specialist staff. t reduces the need for multiple levels of
management and can increase the range of services on offer, and productivity, thereby
reducing the numbers of staff needed.

The difficulties in finding appropriate technologies have limited SMEs innovation and
competitiveness. The unwillingness to invest in technology can also be explained by the
cost factor. t is costly to acquire or develop technology.

1.1.3.5 Access to Markets
n most countries the import procedure is greatly controlled and regulated. mport tariffs
are usually high and there are quantitative restrictions. ll these have facilitated lesser
access of domestic producers to imported raw materials. This has particularly affected
SMEs as they are affected more adversely by the regulated trade regime.

However, import liberalization can also expose domestic producers to competition from
foreign goods. To ensure a level playing field and to enable domestic SMEs to compete
effectively with imports, the right policy concerns need to be addressed. SMEs should
ensure that to successfully secure a new market, besides having a good marketing
strategy, access to market information and the ability to have a wide distribution network
are two main keys in determining the effectiveness of the marketing strategy. Free trade
means more competition from all over the world. When SMEs venture oversees with
limited marketing experience and little access to international partners add to the existing
constraints. These have reduced their ability to compete effectively in foreign markets.


1.2 RESEARCH PROBLEM
Kenya has one of frica's worst performing economies, notwithstanding pick-up of
economic growth starting in 2004. The economy is market-based, with some state-owned
infrastructure enterprises, and maintains a liberalized external trade system. The
economy's heavy dependence on rain-fed agriculture and the tourism sector leaves it
vulnerable to cycles of boom and bust. The agricultural sector employs nearly 75 percent
of the country's 37 million people. Half of the sector's output remains subsistence
production (Kenya country profile).

Despite the apparent significance associated with SMEs and the numerous policy
initiatives introduced by Kenya government during the past decade to accelerate their
growth and survival, their performance in Kenya has been disappointing. There is an
alarming rate of business failure which is of great concern; there is therefore urgent need
for research on the factors which may be responsible for influencing SME growth in
Kenya. The presumed importance attached to the SME sector rests on the belief that if
factors which influence growth are identified, then certain beneficial characteristics which
contribute to the growth process can also be identified; businesses possessing these
characteristics could then be selected for special assistance.

lthough some research has been carried out on the SMEs in Kenya to find out more
about their activities, factors that contribute to their development and its effect on the
economy of the country has not been assessed enough. However, since the global forces
of globalization, e-commerce, investment climate and knowledge-based economy had a
lot of influence on the good performance of multinational corporations and transnational
companies, it was necessary to find out if these same factors would have any effect on
the SMEs in Kenya and in the process having an impact on the economy as a whole.



1.3 RESEARCH OBJECTIVES
SMEs are traditionally characterized by high failure rates. They are six times more likely
than their large counterparts in being driven out of business (Storey, 1994). Such a high
failure rate attracts an investigation that will find out the constraints faced by SMEs.
t is paramount that SMEs should be active and vibrant if a country's economy is to be
competitive. This research will try to find the existing gaps and ways in which this can
be improved in order to maintain and attract new SMEs.
The objectives that will be covered in this research will be as follows:
1.3.1. To determine the importance of SMEs and the current position in Kenya's
economy.
1.3.2. To evaluate the impact of globalization, investment climate, e-commerce and
knowledge- based economy (KBE) on the performance of SMEs.
1.3.3. To identify ways in which the government of Kenya is assisting the SMEs.
1.3.4. To assess the performance of SMEs in Kenya.
1.3.5. To identify ways in which the SMEs can meet the challenges encountered.

1.4 PROPOSITION
The literature review has demonstrated the importance of globalization, investment
climate, e-commerce and KBE. When these factors are available in a country then firms
have the opportunity to compete. t can be argued that high levels of productivity is
critical to the success of the manufacturer, therefore, due to lack of economies of scale
enjoyed by larger companies SMEs become incompetent. Based on these
observations, the following propositions were developed: The government policies play
an important role in determining the firm's decision to expand locally and internationally;
implementing an e-commerce strategy needs to meet the challenges of KBE and
investment climate. regionalization strategy is a current strategy opted by SMEs
rather than globalization due to economies of scale.
The political interests surpass the need to pursue good investment climate. n this way
SMEs are slow to adopt e-commerce thereby larger business have a competitive
advantage.

1.5 STUDY JUSTIFICATION
Kenya has one of frica's worst performing economies, notwithstanding a pick-up of
economic growth starting in 2004. The economy is market-based, with some state-
owned infrastructure enterprises, and maintains a liberalized external trade system. The
economy's heavy dependence on rain-fed agriculture and the tourism sector leaves it
ups and downs since these two sectors are not stable.
Kenya like any other country needs to evaluate the performance of the SMEs in order to
determine if it is achieving the goals it has set for itself. This is important as it has
proved that SMEs play a significant role in the domestic economies of most countries
around the world. They are an important vehicle for development and growth in any
economy as they constitute the majority of enterprises found even in all industrialized
countries. This can be seen from their population of the establishments, employment
creation, and contribution to their country's economy, and their role in innovation is
widely recognized. There is now free and rapid flow of massive amounts of capital
around the world (Micklethwait et al 2000).The impact of globalization, investment
climate, e-commerce and knowledge-based economy on the performance of SMEs can
not also be understated. Therefore, the research will look at how these have had an
effect on SMEs in Kenya.
dditionally SMEs are an important job creator. They are involved in more labour
intensive businesses that require lesser capital spending when compared to larger
organizations (Storey 1994). Much as it is appreciated that SMEs are subject to a
number of constraints that affect their ability to compete with larger firms, the role which
they play in the economy of most countries can not be overlooked.
The importance of SMEs can be seen from the fact that they represent 95% of the total
establishments in the member countries of the Organization of Economic Coordination
and Development (OECD). OECD members produce more than two thirds of the world's
goods and services (OECD 2002). The same is also the case in the sia and Pacific
regions where SMEs accounted for over 90% of the private business sector (UNESCP
2001).
The research will find out the economic roles of SMEs in Kenya and the highlights in
their success will be of benefit to most SMEs in Kenya to emulate from. The findings
could also involve creation of awareness of market forces that the government and
other players were ignorant of.

1.6 SCOPE OF RESEARCH
n Kenya, the baseline survey of medium and small enterprises revealed that there are
approximately 910000 SMEs which are registered and unregistered employing up to 2
million people. ccording to a 2004 Kenya SME Country Study commissioned by the
FC, there are estimated 22,000 SMEs in Kenya, representing 66% of all formally
registered private enterprises. n 2003 SMEs in Kenya employed 3.2 million people and
accounted for 18 percent of the national GDP. Therefore, for the purpose of this
research, the scope of the research has been limited to the registered private SMEs and
those based in Nairobi only.

1.7 STRUCTURE OF THE STUDY
This paper is organized into five chapters. Chapter one covered an overview of the
environment in which SMEs operate in Kenya. Their importance, economic roles and
constraints are presented. This is followed by a discussion on the research problem,
objectives, hypotheses and study justification. Chapter two will review the literature on
globalization, investment climate, electronic commerce, KBE and implications on SMEs.
Chapter three will discuss the research methodology of the postal survey and website
study. The findings and discussions are done in chapter four. The final chapter five
provides areas of future research, conclusions and recommendations.




CHAPTER TWO

2.0 LITERATURE REVIEW

2.1 INTRODUCTION
The chapter looks at globalization, investment climate, e-commerce and knowledge-
based economy (KBE) and how these have affected small and medium enterprises
(SMEs) in the various industrial sectors in Kenya. n individual evaluation of these
concepts has been attempted due to the wide coverage of the concepts.
There is overwhelming evidence that globalization is good for economic growth and in
most instances for poverty reduction. Globalization is a dynamic process referring to the
speed and extent to which conditions (economic, social, business) become interlinked
and global. Julien et al (1993) observes that since 1980, there had been dramatic
changes in globalization which included: more trade liberalization especially the
Uruguay Round of 1995, privatization and de-regulation, the liberalization of capital
flaws and integration of global money and stock markets and lastly the dynamic growth
of foreign direct investment (FD).