This article introduces the concept of small business and the approach to small business development. It answers the questions: Why are small businesses important? How to support small business development? This topic includes micro, small and medium-sized enterprises. The article introduces important nuances in our understanding of the role small businesses play in the economy and how small business development requires a clear analysis of the small business sector in any one location.
What is a small business?
Small businesses are an important and major part of the private sector.
Definitions of small business vary by country and are usually based on the number of employees, the annual turnover or the value of enterprise assets.
The term small business is often used to encompass small and medium-sized enterprises (SMEs). In addition, the terms “very small business” and microenterprise or micro-business are also used. In some countries, other definitions are applied. For example, in Vietnam, the term “household business” is often used, while in South Africa the term SMMEs, or small, micro and medium-sized enterprises, is common.
Official national definitions vary, even within national governments. For example, it is not unusual for the national statistics office to have a definition of a small business that differs from the ministry of commerce or from the ministry of agriculture.
However, the global practice of small business development applies some general definitions. Yet, even here there are significant variations.
Typically, microenterprises are defined as enterprises with up to ten employees, small enterprises as those that have ten to 100 employees, and medium-sized enterprises as those with 100 to 250 employees.
The World Bank Enterprise Surveys consider firm size based on: 5-19 (small), 20-99 (medium) and 100+ employees (large-sized firms). A recent review found the World Bank group used various definitions for SMEs and applied these inconsistently when supporting small business development.
Small businesses or SMEs encompass all types of enterprises, irrespective of their legal form (such as family enterprises, sole proprietorships or cooperatives) or whether they are formal or informal enterprises.
Why are small businesses important?
While small businesses are, by definition, small, the contribution of this sector of the economy is substantial.
- SMEs are many. SMEs account for over 95 per cent of all enterprises in OECD countries. More than 90 per cent of all enterprises can be classed as SMEs (i.e., fewer than 250 employees), and a large share of those can be classed as micro firms, with fewer than ten employees.
- SMEs contribute to economic growth. Global estimates show that SMEs, including both formal and informal enterprises, account for 60–70 per cent of gross domestic product.
- SMEs create jobs. The International Labour Organization states that micro and small enterprises, together with own account workers, account for a 70 per cent of employment worldwide. In most countries, more than 50 per cent of total net employment creation (i.e., new jobs) can be attributed to the smallest size classes of enterprises of between five and 99 employees.
- SMEs are “pro-poor”. SMEs can present viable economic pathways to poor women and men as well as marginalised groups. This is in part because there are not enough economic or employment opportunities directly available in larger firms. However, smaller firms also tend to have lower entry requirements in terms of skills, education and qualifications, as well as financing and equipment requirements.
- Some SMEs grow very fast. A study by the Organization for Economic Cooperation and Development (OECD) shows that while few start-ups (i.e., 2–9 per cent) grow above ten employees, they make a substantial contribution to job creation, ranging from 19 to 54 per cent. While only a few enterprises grow to become larger enterprises and generate most of the new jobs, these high-growth enterprises––often referred to as “transformational entrepreneurs”, “graduate enterprises” or “gazelles”––create vibrant businesses with jobs and income for others, beyond the scope of an individual’s subsistence needs. However, here again, there are locational and cross-country variations found in how SMEs perform.
- Some SMEs are a source of innovation. The OECD finds that a significant proportion of SMEs engage in all forms of innovation, especially in higher-income countries. Even microenterprises with less than ten workers can reach productivity levels above the large-company average.
Despite these benefits, small businesses often face a number of challenges. These challenges may be a direct result of their small size, typically flat organisational structures and lack of specialisation (which varies dramatically across countries). Large businesses have more resources to compete with in the marketplace. However, they may also be due to institutional biases national policies, laws and procedures.
The challenges reflect important nuances in our understanding of the role small businesses play in the economy and how small business development requires a clear analysis of the small business sector in any one location.
- SMEs have high levels of informality. The International Labour Organization estimates there are 420 to 510 million SMEs worldwide, of which nine per cent are formal SMEs (excluding micro-enterprises) and 80–95 per cent are in low- and middle- income countries. In developing and emerging economies, the number of informal SMEs is very high, accounting for a large share of all SMEs. For example, in India in 2007, there were 17 unregistered SMEs for every registered SME.
- SME jobs are not as good. In general, SMEs score lower for most aspects of employment quality when compared to larger enterprises (e.g., earnings and benefits, safety and ethics of employment, quality of working times, security of employment, social dialogue, skills development, workplace relationships). However, studies have also found that differences in the quality of employment are more apparent between countries and economic sectors than between enterprises of different size classes.
- Many SMEs are “survivalists”. Many smaller businesses are survival enterprises, operating out of necessity rather than with intent to grow.
- Churn–SMEs are job creators and job destroyers. Research shows that may young SMEs play a central role in creating jobs, while older SMEs tend to destroy jobs. Young firms are net job creators, while downsizing by old firms accounts for most job losses.
- SMEs don’t drive growth. Current literature suggests that economic growth and transformation in developing economies is unlikely to be driven by micro and small enterprises. Instead, medium and large firms drive these processes, particularly those that are export-oriented and integrated into global supply chains.
How to support small business development?
Small business development is a large topic, with many points of entry. It falls into the broader topic of private sector development and includes issues such a value chain development, market systems development and business environment reform.
Small business development can be supported across four levels of intervention: macro, meso, micro, and meta.
Across all these levels, small business development seeks to catalyse change in public and private institutions, market systems and public and private governance to enable and nurture the promotion of SMEs across all sectors in the economy.
Macro level development refer to changes in the investment climate and business environment.
Meso level development refers to work with public, private and civil society organisations, including business representatives organisations. Interventions at this level also encompass value chain and supply chain activities.
Micro level interventions focus on firms. This may include the provision of training, information or finance to business.
The final level is the meta-level. This refers to programme interventions designed to encourage changes in attitudes, social norms and values, such as encouraging entrepreneurial attitudes and improving the way business success is recognised and rewarded.
In the remainder of this article, I will focus on the role of SME development agencies and business environment reform.
Governments have a long tradition of creating public or semi-public SME promotion agencies that coordinate and provide small business development support services. Some agencies have succeeded in delivering demand-driven and appropriate services; others have developed a relatively poor reputation of being bureaucratic or supply-oriented entities that do not offer quality services based on the needs of SMEs.
There are a number of key features to consider in the design and management of SME development agencies:
- Creating a business-like, market oriented organisation that responds to the specific needs, constraints and opportunities facing the SME sector
- Defining clear target groups within the broader SME sector and develop tailored programmes and services
- Defining a sustainable method of programme and service delivery that recognises and monitors changes in the market systems SMEs and other support agencies and actors operate within
- Establishing a robust monitoring, evaluation and results measurement system, which measures the agency’s performance and broader impact.
Around the world, small business development agencies exhibit a range of institutional structures. Because one of the main advantages of creating an SME development agency is to provide a business-like, focused service that understands and effectively responds to business needs, it is often more beneficial to establish some independence from government. This includes:
- Staff who have business experience and an understanding of how to work with the business community
- An ability to respond to changing business and market demands (i.e., less bureaucratic than many government ministries)
- An organisational culture that reflects good business practice
- A governing board or council with a strong understanding of good cooperate governance and private sector engagement.
There is a wide range of services an SME development agency can provide. These include:
- Financial services (e.g., SME credit, equity, insurance, leasing)
- Non-financial services, also known as business development services (e.g., training, information, mentorship)
- Diagnostic tools to assess the enterprise (this includes self-administered assessment tools)
- Business incubator management
- Government policy and strategy development related to SME development (i.e., advising on or supporting government policy making and strategy development)
- Coordination of government programmes and services in the SME sector
- Regulatory compliance (i.e., helping SMEs comply with legal and regulatory requirements)
- Legal and regulatory reform (i.e., advising on or supporting governments in its efforts to create a more enabling business environment)
- Monitoring and research o the SME sector
- Secretariat to an SME council or small business advisory body
- Member services (in the case of an agency run by a chamber of commerce, business association or employers’ organisation)
- Advocacy on SME development issues.
There are many issues to consider when defining the programmes and services of an agency.
The first step in this process should be to assess the current state of SME development services, identifying gaps or weaknesses in the range of services offered to SMEs and the defined target groups. This involves an investigation into the problems and opportunities experienced by SMEs and the ways they can be supported. It also involves a mapping and assessment of other service providers.
It is critically important for development agencies to understand and assess their effect on other service providers. Often, public-funded agencies can, unintentionally, undermine or crowd-out the services provided by other actors. Identify gaps in the SME development service market.
Successful SME development is based on a clear understanding of these systems and developing responses that improve the functioning of market systems. This requires a good understanding of how these market systems operate and good coordination of services.
It is important to regularly monitor and evaluate the performance of SME development programmes and services. This should move beyond basic output measures, such as the number of clients, number of people trained, etc. It is better to focus on the broader outcomes of the programmes and services, such as the changes in SME employment, participation in export markets and contribution to economic growth.
It is essential that a robust and credible monitoring, evaluation and results measurement system be established. The Donor Committee for Enterprise Development Standard for Results Measurement is a very helpful tool for this purpose.
Business Environment Reform for SMEs
In a report I wrote in 2018 on Creating Better Business Environments for Micro and Small Enterprises, I surveyed the literature and interviewed donor and development agencies on this topic. The following practices were recommended for business environment reforms that benefit the micro and small enterprise sector:
- Give priority to levelling the playing field. Ensure firms are not disadvantaged in the business environment based on their size.
- Simplify, reduce costs and improve transparency. This will improve conditions for all firms, especially the small and most vulnerable.
- Invest in an objective assessment of the business environment. Place more effort on proper diagnostics, improving the quality of data to guide policy making, including an assessment of how the business environment affects micro and small enterprises.
- Identify the causes and not just the symptoms. Carefully analyse national circumstances and contexts and identify the root causes to poor micro and small enterprise performance.
- Think small, aim for growth. Understand how government policies, laws and regulations affect the micro and small enterprise sector and its potential for growth.
- Avoid single, isolated reform measures. Understand how change in one part of the system may affect other parts.
- Improve representation and voice. Promote dialogue between the private and the public sector and ensure the micro and small enterprise sector is able to participate in these processes.
- Improve policy coordination and coherence. Ensure the specific needs and opportunities of the micro and small enterprise sector are addressed by government, whether through specialised MSE development agencies or inter-ministerial mechanisms.
- Apply a gender lens to reform. Ensure the sex of a business owner is not a determinant of success.
- Apply the SME Test. Ensure new public policies, laws and regulations consider the impact on the SME sector in advance.
Small business development is a strategically important focus of many private sector development programmes. While there is great variation among the enterprises that comprise this sector, paying attention to the contributions and challenges of SMEs in local and national economies provides an important and useful lens for those who wish to promote economic growth and create more decent and productive employment for women and men, and those in marginalised social groups.