4.2. Definitions of SMMEs 72
4.4.5. Facilitating access to finance for SMMEs 97
countries. Additionally, the degree of competition between banks and the stage of development of the capital markets constitute an underlying force that may explain differences between industrial and developing countries. According to Ayyagari, Dermiguc-Kunt and Maksimovic (2005), in a First World setting such as the United Kingdom, a finance gap occurs when a firm has grown to a size where the use of short term finance is maximised, but the firm is not big enough to access capital funds. He further highlights that by contrast, in developing countries it is probable that a finance gap arises at an earlier stage of the enterprise’s lifecycle. Ayyagari et al. (2005) argued that financial and institutional deficiencies might prevent SMMEs from growing to their optimal size and explain the lack of an empirical causal link between SMMEs and economic development. It is therefore crucial to understand obstacles to SME operation and growth and how they vary.
In terms of SMMEs, the size of the enterprises is certainly a contributor in as far as it impacts on its growth and development. Biggs and Shah (2006) highlighted the fact that small firms consistently report higher growth obstacles than medium size to large firms. Beck (2003) showed that size, age and ownership are the most reliable predictors of firms’ financing obstacles. The authors find that older, larger and foreign-owned firms report lower financial obstacles. This relationship, they further emphasised, is not only statistically significant, but also economically significant. This leads to the fact that in a world with fixed transactions and information asymmetries, small firms with demand for smaller loans face higher transaction costs and face higher risk premiums since they are typically more opaque and have less collateral to offer (Beck, 2003). Not surprisingly, Beck (2003) pointed out that small firms finance a smaller share of their investment with formal sources of external finance.
Do the higher financing obstacles that small firms report actually constrain their growth or do they find ways around these obstacles? Beck (2003) found that higher obstacles faced by smaller firms indeed translate into slower growth. The study found that small firms’ financing obstacles have almost twice the effect on annual growth than large firms’ financing do. The difference, according to Beck (2003), is even stronger in the case of growth constraints related to the legal system and to corruption, where small firms suffer more than three times as much in the form of slower growth than larger firms do. Finally, Beck (2003) pointed out that small firms do not only
report higher growth obstacles, these higher obstacles are also more constraining for their operation than in the case of medium-size and large firms.
Firms in countries with higher levels of institutional development report significantly lower financing obstacles than firms in countries with less developed institutions (Beck, 2003). The positive effect of financial and institutional development, according to Beck (2003), can also be observed in the use of external rights. She adds that better protection of property rights increases external financing of small firms significantly more than it does for large firms, particularly due to the differential impact it has on bank and supplier finance. Combining firm-level data with indicators of national policies and institutions also helps researchers assess the causes for the missing middle phenomenon observed in developing countries (Beck, 2003). For example, Sleuwagen and Goedhuys (2002) showed that smaller firms grow relatively faster in Germany than in Cote d’Ivoire, while the opposite holds for large firms. Beck (2003) questioned what exactly drives these differences in the growth rates of small and large firms in developed and developing countries. They show that the effect of growth obstacles on firm growth is smaller in countries with better developed financial and legal systems and even more, it is the small firms that stand to gain the most from financial and institutional development. The effect, they further add, of financial and legal development on the constraints growth relationship is significantly stronger for small firms than for large firms. Financial and institutional developments thus have the potential to close the gap between small and large firms.
How do financing patterns of SMMEs in today’s developing economies compare with the financing patterns of the past in developing economies? Cull and Xu (2005) indicated that in developing countries finance from friends and family play a much more significant role than industrialised countries. Generally, SMMEs in many developing countries get around market failures and lack of formal institutions by creating private governance systems in the form of long-term business relationships and tight, ethnically-based, business networks. Biggs and Shah (2006) pointed out that there is also variation in access to networks across ethnic groups, for example, Indian entrepreneurs in East Africa, Lebanese firms in West Africa and European enterprises in Southern Africa form business networks, whose members lend to each other, provide personal preferences and ease transactions with an informal contract enforcement system
based on reputation. These networks, they maintain, help entrepreneurs to overcome deficiencies in their economies’ institutional environment.
Beck (2003) demonstrated that financial and institutional development has a strong economic effect on easing the financial constraints on SMMEs and increasing their access to formal sources of external finance. However, she asked what policy-makers could do to ease the constraints SMMEs experienced and thus improve their access to finance (Beck, 2003). She pointed out that credit availability to SMMEs depends on the infrastructure that supports financial transactions, including the legal system and the information environment. She further highlighted the fact that commercial laws that effectively assign and protect property rights and their efficient enforcement are crucial for financial transactions. This, according to Beck (2003), included the laws, regulations and institutions to create, register and enforce collateral and an effective bankruptcy system and that firms in countries with more effective and more adaptable legal systems report lower financing obstacles. Literature on SMMEs has shown the positive effect that credit information sharing has had on the credit availability to SMMEs. Pagano and Japelli (1993) indicated that the use of information from these bureaus and of proprietary information from financial institutions for small business credit-scoring has become popular in the United States (US) and other developed economies. Frame and Wolssey (2001) showed that the use of credit-scoring techniques has increased small business lending by banks in the US.
Several techniques provide alternatives to relationship lending for SMMEs. Berger and Udell (2006) indicated that asset-based lending and leasing are both lending techniques focused on the underlying asset as the primary source of repayment. According to Berger and Udell (2006), leasing is mostly for equipment, while asset-based lending is used for accounts receivable and inventory. While asset-based lending relies on a sophisticated and efficient legal system, they maintain that leasing does less so since the ownership of the asset passes on to the financier.
Finally, Berger and Udell (2006) highlighted the banking market structure and regulatory policies influencing this market structure as having an important impact on the availability of SMME financing. They also emphasise the point that while a large share of small banks do not necessarily result in more finance being available to small firms, financial systems dominated by government-owned banks seem less effective in providing credit to SMMEs. The entry of
foreign banks, according to Clarke, Cull, Soledad, Peria and Sanchez (2003), is mostly associated with greater SMME credit availability. For example, they point out that foreign banks can bring the necessary know-how and scale to introduce new transaction lending techniques simply by competing with the domestic banks. This can force domestic banks to then cater for SMMEs which they generally consider to be at a lower level than larger enterprises.
This section summarises the broad range of literature which shows that access to finance is an important growth constraint for SMMEs. It is noted that financial and legal institutions play an important role in relaxing this constraint as well as the fact that innovative financing instruments can help facilitate SMMEs access to finance even in the absence of well developed institutions.
This section highlights some of the research available on access to finance which has a broad range of implications for future research opportunities.
4.4.6. Facilitating access to markets for SMMEs
Not having access to markets has been identified as a major challenge for SMMEs. SMMEs often limit their growth potential by choosing to supply only local markets. Most often SMMEs are not equipped with information on how to access regional, national or even international markets. Finnegan (1999) also identified the problem of SMMEs making little or no effort to investigate new market opportunities, especially at the lower levels where micro-enterprises and even small enterprises do not have the necessary skills for simple market research, and as a result will not be prompted to investigate new markets as they would be of the opinion that they cannot expand their production. Finnegan (1999) cited an example of a Business Development service project in Colombia which worked with approximately 1000 micro-enterprises, with 50% being women and 50% being male-owned micro-enterprises. These enterprises’ main activity entailed producing consumer goods for the local market. Their method of operation involved making use of a mediator for marketing services when producers wished to penetrate new markets or improve their current position. Finnegan (1999) believed that this will make a huge difference to their business from working in specific sectors. He further believes that marketing service providers become experts in issues such as consumer preferences, new trends and designs which translate into expertise on ideas for producers on what to produce and how.
Poor competitiveness, according to Schreyer (1996), of SMMEs and their products and services on national and international markets represents one of the major problems for the economy.
Improving SMMEs competitiveness to facilitate their participation in markets is critical to ensuring the growth of SMMEs. This is also applicable in relation to global competitiveness of SMMEs. It therefore becomes critical to analyse the current practices of SMMEs and identify the areas that are constraining their growth against the backdrop of international trends. Once the areas of weakness have been identified, appropriate response programmes need to be developed.
The SMME Strategy (EM, 2007b) indicated that SMME market potential needs to be ascertained by market testing and research to assess market response to SMME products and services, and to develop monitoring and evaluation systems to ensure that market demands are met and SMME capacities are improved.
The above discussion is simply an overview of some of the challenges that are faced by SMMEs but should never be considered as an all inclusive list. The section that follows is a discussion on some of the strategies that could be put in place to address some of these challenges.