Wake up EA, the battle is about markets… not Migingo

• This blog post is based on LG’s presentation during the 2009 Top 100 Mid-Sized Companies Awards ceremony held in Nairobi on October 1, 2009.

The micro and small-scale sector has expanded rapidly in the last four years. It is an integral part of Kenya’s industry providing over half the total employment. However, the importance of micro and small scale enterprises is far greater than its employment creation. It provides a point-of-entry for many Kenyan entrepreneurs into the manufacturing and services sector. It also serves as a nursery to grow producers of low cost products.

SMEs are major contributors to private sector wealth creation and employment the world over. Studies show that they contribute over 55% of the Gross Domestic Product (GDP) and over 65% of total employment in high income countries; over 60% of GDP and over 70% of total employment in low income countries; and about 70% of GDP and 95% of total employment in middle income countries.

Kenya’s private sector accounts for approximately 80% of the GDP. The SMEs sector alone contributes 18.4% to Kenya’s GDP and cuts across the economy. It provides one of the most prolific sources of employment and income generation. Although the statistical base of the small businesses in Kenya is still poor, there can be little doubt about their relative significance. The Government estimates that SME employment grows at 11% every year, well above the growth of the labour force. There are more than 800,000 small, medium and micro-enterprises in the country, churning out US$3.2 billion and absorbing about a quarter of the 40 million population. It is also difficult to assess the full impact of the global financial crisis on Kenya, but concerns that private equity investors would pull back have not materialised. Certainly not in the SME sector where several new funds are entering the market. But most of the new funds that have entered the market are focussed on small-scale SME and start-up financing, with investment deals ranging from USD50,000 to USD2m.

Tacit knowledge

SMEs represent the biggest share in business establishments in practically all countries and play a key role in their industrialisation. They have extreme flexibility and readily adapt to rapid changes in the environment. SMEs enable better use of existing local capacity, establishing the basis for sustained long-run growth, and the opportunity to expand that capacity in the future.  They provide an increasing measure of national self-reliance and provide a sense of ownership of enterprise and economic growth. SMEs lead in innovation and in adapting new technologies in response to competitive pressure. They play a critical role in the transfer of tacit knowledge through on the job training and have a huge push factor for foreign direct investment. In Kenya in particular, SMEs have become a necessary catalyst for structural change of the economy towards industrialisation and service orientation.

The emergence of growth-oriented SMEs is essential if East Africa is to achieve its economic expansion and poverty reduction objectives. Unfortunately, like many developing countries, entrepreneurs running SMEs in Kenya still face significant barriers. These include a restrictive legal and regulatory business environment that stifles entrepreneurial growth; Persistent difficulties in accessing capital thanks to high collateral requirements, and perceptions of high risk and high transaction costs. Closely linked is the lack of access to market information, skills and knowledge gleaned from practical experience and international best practice. This access is needed to nudge potential entrepreneurs into the open, enable them to effectively interact with capital markets and help them succeed.

The failure of the government to exploit the informal sector as a result of a sectoral bias has led to a delinking of formal and informal sector activities. The most prudent policy would be capitalisation by government on the activities of the informal sector to help upgrade skills and product quality. Every successful venture capital market in the developed economies begun with a government boost. Unsurprisingly, the Kenyan government has yet to rise to the task, and fund managers say there is a lot to do: create tax incentives and tax holidays, fast track business incorporation and trade licenses, and generally make SMEs easier to establish and invest in.

Traditional bottom line

It is gratifying that the growth of SMEs in Kenya has increasingly led to financial institutions structuring their operations to suit this ever growing market. Availability of both short and long term capital to qualified SMEs has allowed many to take advantage of innovative products in the market to start, grow or expand their businesses.

In addition, effective use of technology will be central in attaining competitive advantage, deepening regionalisation and trade pattern changes geared at integration and a greater focus on this sector by governments, pronounces a continued growth forecast for this sector. This has been accentuated by some of the infrastructure developments taking place in the region such as the laying of undersea fibre optic cables that now link Kenya and the region to low-cost and high speed internet. ICT has been identified as one of the fastest growing sectors in Kenya providing opportunities, partnerships and joint ventures in areas of voice and data communication.

SME focus is not entirely driven by private commercial considerations: Donor governments have long structured their interventions around SME promotion, and as a consequence, government money coming through development banks that do not operate on a traditional bottom line represents a huge chunk of private equity funding in Kenya. The Dutch FMO, Norfund, Swedfund, the American Overseas Private Investment Corporation (OPIC), and the World Bank’s International Finance Corporation (IFC) are all prominent players. This focus represents a shift in development aid where donor governments try to supplement traditional programme and budget grants or loans with mechanisms that more closely mimic the private sector.

Migingo

NMG believes that SMEs will continue to play an ever increasing pivotal role in the East African economy, in its diversity and in employment. For this role to grow, SMEs will require further improvements in the enabling environment for business, and continuing and improved access to micro-finance and other financial products. And they’ll need training to improve skills and develop the strategic awareness necessary to survive in the competitive global market.

Finally, let’s remember that no country in the world has ever developed without growing its own indigenous companies that then became the multinationals that we know today. It’s the high time that East Africa started nurturing its future Coca Colas, Microsofts and the like… for the battle is about markets not Migingo Island!