SMES Have Minimal Impact On Economy Compared To Large Firms
SMES Have Minimal Impact On Economy Compared To Large Firms
Executive Summary
In recent years, most developing countries have embarked on supporting SMEs creation and growth. SMEs help create jobs, support innovation in an economy as well as contribute to economy’s output. The business environment for SMEs is limiting and thus the survival of the SMEs has been facing a number of challenges. In order for business to expand, it requires financing. SMEs face challenges in accessing the necessary financial services as well as advice because they are considered risky. Governmental interference adds on the indirect cost of doing business to SMEs and in the long run, the profits might fail to cover all costs. Though SMEs have a direct impact on economy, such impact is usually small compared to case of large firms. The large impact of large firms on economy might be due to business environment, which highly favor large firms. SMEs face stiff competition from large firms, which have large capital outlay and unlimited access to finance from financial institutions.
Table of Contents
TOC o “1-3” h z u HYPERLINK l “_Toc331672470” Introduction PAGEREF _Toc331672470 h 4
HYPERLINK l “_Toc331672471” The Nature of SMEs Business Environment PAGEREF _Toc331672471 h 4
HYPERLINK l “_Toc331672472” Impact of the Small Business Sector on an Economy PAGEREF _Toc331672472 h 6
HYPERLINK l “_Toc331672473” Problems faced in Small Business Start-Up PAGEREF _Toc331672473 h 8
HYPERLINK l “_Toc331672474” Conclusion PAGEREF _Toc331672474 h 9
HYPERLINK l “_Toc331672475” References PAGEREF _Toc331672475 h 11
IntroductionGross national product (GDP) is used to measure a country’s economy growth. A country economy can also be measured by gross national income. An upward trend in a country’s GDP or gross national income indicates an increase in production by key economic players such which in most cases are firms (Winter-Ember, 2001: 474). Income growth from a country’s economy results to grown demand of products, a scenario which encourages firms to increase their overall output. However, firms and economic regulatory bodies need to match production with demand as an efficient matching in demand and production helps to prevent or reduce inflation. Small and medium sized enterprises (SME’s) as well as large firms have a direct impact on a country’s economy though the level of impact varies just as their sizes differ.
While the determination of a firm’s size can be done in a number of different methods, the number of employees a firm engages at any given time is the most used method in determining whether a firm is an SME or a large firm. Thus, a firm with fewer than 500 employees can be termed as a SME though at times a lower cut-off of 250 can be used (Pleitner & Weber, 2000). SMEs have a positive impact on economy – they create employment opportunities, encourage innovation and they contribute directly to the overall economic value of a country (Mead, 1998). Large firms also contribute to the same though in different proportions.
The number of firms in an economy should match their contributions towards the value added to the economy. According to Amyx (2005), survival of SMEs is largely affected by government regulation and policies. In order to encourage growth of SMEs, these regulations should be removed to encourage more SMEs creation and growth. Considering that SMEs are large in number, their contribution towards economy growth should also be large. However, in many countries the contribution of SMEs is low compared to large firms. This paper, critically appraises the argument that SMEs have minimal impact on economy compared to large firms.
The Nature of SMEs Business EnvironmentSMEs are characterized by low production capacity and high human interaction. However, this high human interaction provides an advantage to SMEs as compared to large firms. The SMEs are also characterized by intensive decisional centralization. Decisions in SMEs are mostly made by managers and employee participation is minimal. SMEs usually have small number of employees and positions, which ease management and control of the organization. The levels that are involved in decision making are less and thus the time taken to make crucial decisions is short. However, the SMEs lack experts’ advice and services due to limited accessibility they have to financial institutions (Amyx, 2005). Many SMEs make inefficient decisions, which mostly lead to poor strategies.
According to Idson (1996), the environment in which SMEs operate is mostly not conducive for business growth and competitiveness. In most countries, SMEs access to capital and finance is limited because financial institutions consider SMEs risky (Longenecker et al. 2006). Moreover, if a SME can access capital, the amount the SME can access is less compared to large firms. Mostly, these SMEs lack the collateral required to access finance or capital to finance their activities. As opposed to SMEs, large firms due to their track record of their performance as well as high investment in the business (Symeonidis, 1996: 35), they can easily access capital for their expansion and for portfolio management. In order to support growth of SME’s, the security required by lender firms for a SME to access loan to finance their growth should be reduced or removed. Therefore, access to capital and finance mostly favors large firms at the expense of SMEs.
Experts are required in development of products or processes (Pull, 2003: 85). Such products and processes are difficult to imitate by competitors and thus achieve sustainable business growth. A high investment is required to pay for experts as they offer business services as well as assistance. SMEs lack such human capital to help grow their business to the next level. Therefore, lack of business experts may lead to inefficient production results as well as ineffective marketing strategies. The access to the business assistance and services from experts is first given to large firms and SMEs (Idson & Oi, 1999: 8), which require the assistance for growth, are left on their own.
Despite the step by local governments’ positive moves to protect SMEs, the business environment still favors large firms. The entry into markets by SMEs has been a challenge and thus their growth has been under threat (Edmiston, 2004: 289). SMEs access to support and information structures compared to large firms has also been a challenge. Access to information at the right time helps in decision making (Idson & Oi, 1999). If the access is limited, firms might make decisions based on insufficient information. Large firms’ access to financial information is great compared to SMEs. Thus, large firms’ growth is widely supported by their ability to enter markets and access information as well as support structures.
Amyx (2005) argues that business environment for SMEs is limiting and thus affects their growth and survival compared to large firms. Large firms can access capital as well as finance easily compared to SMEs. Business environment mostly support growth and survival of large firms (Evans & Leighton, 1989:299). The fact that large firms’ initial capital outlay is heavy makes it possible for them to invest in technology and service their loans. Large firms can also access experts’ advice and knowledge. SMEs, which require less capital to start, can be used by government to boost low income earners with entrepreneurial skills to venture into business. Nevertheless, due to government interference in many countries and a biased business environment which mostly favor large firms, SMEs survival and growth, has been a challenge.
Impact of the Small Business Sector on an EconomyAccording to Davis et al. (1996: 297), almost all economies require SMEs, though economies in developing countries with major income and employment distribution challenges require SMEs more than developed countries. Generally, SMEs contribute to job creation and country’s output. Moreover, SMEs are the basis for future large firms. SMEs are also involved in development of technology as they are usually very innovative. Large firms also contribute to economy’ output, job creation as well as to innovation. However, while drawing from expert analysis from King and McGrath (2002), it is arguable that the contribution of large firms has more impact on an economy compared to SMEs.
SMEs play significant roles in national as well as global economy. Local governments’ decision in many countries to support creation of SMEs is due to their ability to create employment opportunities (Davis et al. 1996: 297). This argument draws its impetus from Morisette (1993: 74) postulation that the ability to create job opportunities by a firm reduces with age. A fully grown firm (mostly large firm), may not require extra employees. It is also important to note that growth in production by a firm will attract need for extra human capital and therefore SMEs are the greatest creators of employment opportunities. Decreasing unemployment rate indicate a growing country’s economy, a role SMEs play so well.
However, a firm may be a SME in old age and not all SMEs create jobs. Fully grown SMEs, for example, create jobs almost at the same rate as large firms. The ability by large firms to access finance for expansion or for financing other management activities supports its ability to create jobs (Pavitt et al. 1987: 297). Moreover, large firms’ ability to enter markets supports their growth. Comparing SMEs and large firms job creation ability, though SMEs require small capital for start-up thus create job easily, their ability to grow is limited. In addition, SMEs are risky to decline and thus the probability of job creation as well as job destruction is high (Headd, 2000:13). Due to the fact that an SME can die after a short time as well as it can be created within a short time – the creation and destruction of jobs almost ties.
Symeonidis (1996:35) argues that of all the new jobs created between 2002 and 2010 in the EU, 85% were created by SMEs. The share of SMEs in the overall employment was 67%. EU has been recording a rising new employment since a law on SMEs was implemented. However, increase in employment in the trade sector was higher for large firms compared to SMEs. Employment in SMEs increased by 0.7% compared 2.2% in large firms. Possibly, this was due to a recorded increase in the number of large firms in the trade sector.
According to Idson (1996: 273), about 30-70% of value added is accounted for by SMEs. The value added varies according to industries and countries. The likelihood that an SME’s output is exported is smaller compared to a large firm’s output. SMEs contribute to competitive process that significantly contributes to productivity growth given that most entrants, exits, decline and growth are accounted for by the SMEs. Thus, SMEs contribute to country’s exports, which reduce balance of trade deficit. However, the contribution to exports by SMEs is less compared to their number in given country. For instance, while comparing the number of SMEs in a country and their overall contribution to the value added to the economy with that of large firms, then it is clear that large firms contribute more to economy growth than SMEs (Davis et al, 1996).
SMEs decision to venture into business is mainly due an identified market gap. Normally, markets gaps are precursors to innovation, as SMEs entrepreneurs end up filling such gaps with new products, processes, ideas and technology (Morisette, 1993). This is because the main objective of SMEs is to come up with a product, which is new to the market. According to Pull (2003: 88), most SMEs products are new to the market or even better, when compared to the existing products. The entry of SMEs into markets brings competition and thus the existing firms are forced to improve their products. By being innovative, SMEs contribute to economic growth. However, SMEs face competition from large firms which respond easily to new entrants by flexing their financial muscle. To survive, SMEs should be supported financially to help them invest in their products and thus protect easy imitation of their products.
Problems faced in Small Business Start-UpDespite the significant roles played by SMEs on economies, they face a number of challenges which result too their closure. Pleitner and Weber (2000) argue that as many as 30 percent of start-up SMEs fall or decline during their third year of operation. The fall of SMEs has been associated to a number of challenges, which they face during their start-up and in their business continuity. The challenges range from technology unavailability, marketing strategies that are ineffective, low production capacities, the inability to identify diverse markets, limited access to finance/capital as well as inability to afford skilled labor (Pleitner & Weber: 2000).
Experts or skilled labor is crucial to business growth. Skilled labor support and enable an organization achieve its strategic goal (Evans & Leighton, 1989: 299). The time taken to carry out a duty by skilled personnel is mostly less compared to unskilled personnel. SMEs ability to access skilled personnel is challenged by the limited finance they have. It is difficult for the SMEs to employ skilled personnel, who are more costly compared to unskilled ones. In order to effectively identify new markets as well as develop products that match customers’ demand, a firm requires skilled personnel. On contrary, large firms with large capital outlays as well as unlimited access to finance, easily afford skilled personnel and experts. Using the skilled personnel, a large firm efficiently identifies markets, strategize on marketing its products and finally it continuously works on improving the quality of its products.
Lower capital outlay is required for setting up SMEs. Thus, it is extremely simpler to set up a SME compared to large firms, which require high capital investment. This makes financial institutions to assess SME as risky and thus reducing their ability to access finance. Finance or capital is highly required for growing firms. With enough capital, a firm can expand its operation and thus enter new markets (Winter-Ember, 2001: 86). To create a new product as well as market the product, it requires finance. Unless a firm can access finance by financial institutions, it may be difficult or take time for a firm to grow. Therefore, the low capital requirement for start-up by SME limits their accessibility to financial institutions to finance their growth.
SMEs cite government policies and regulations as one of the obstacles in their growth. Government policies like social security contributions, corporate taxes, fiscal policies, labor laws as well as personal income taxes are some of obstacles to SMEs growth. Thus, the SMEs blame governmental interference as a major source of negative impact. The indirect labor costs arising from governmental regulation brings along increased costs of operation. To this end, Pleitner and Weber (2000) argue that low investment mostly attract low profits. Therefore, SMEs having low capital investment, their profits are low to cover all the costs incurred due to government interference.
Multinational companies benefit from both domestic and international markets. According to King and McGrath (2002), most large firms access international markets yet only a few SMEs can achieve this. SMEs face a number of challenges in their attempt to access foreign markets. The challenges include discriminatory contract awarding, identifying the markets, differing technical standards as well as fluctuating exchange rates. The limited access to international markets by SMEs affects their growth. The procedures involved in winning an international contract may also require experienced firms while most SMEs may lack the required experience.
Sustainable growth by a firm requires experts and heavy investment in technologies, which help in development of quality products (Symeonidis, 1996: 35). Development of high quality products enables firms to achieve customer loyalty by satisfying the customers. Due to low capital outlay as well as limited access to finance, SMEs face challenges in financing development of new products and paying for experts. In order to retain customers as well as attract new ones in today’s world of competitive business, the quality of products should be of high quality than the competitors’ products. This is a milestone some SMEs may fail to fulfill.
ConclusionSMEs play significant roles in the economy of a country. They are easy to start-up as they require low capital outlay and thus low income earners can afford to start-up small businesses (Evans & Leighton, 1989: 299). SMEs create jobs and employment, contribute to value added as well as contribute to country’s innovation. However, compared to large firms the contribution of SMEs may be shortly lived. SMEs accessibility to capital, information and support structures is limited as they are considered risky. Governmental interference in terms of personal taxes, corporate taxes and labor laws add to their indirect costs. Due to the low production capability, the profit achieved by the SMEs cannot cover all indirect costs as well as operation costs (Idson, 1996: 273).
However, the contribution of SMEs to economy is not proportionate to their numbers. Despite the large number of SMEs, their contribution to value added is low. Considering SMEs account to approximately 85 percent of all firms and over all jobs created in an economy, SMEs should cover approximately 85 percent of the economic output (Pull, 2003: 88). The challenges faced by SMEs mostly cause them to contribute less compared to large firms. Therefore, the impact of large firms on economy is larger compared to small and medium enterprises.
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