PROBLEMS EXPERIENCED BY SMEs

SME owner-managers are most conversant with their enterprises, but are frequently not able to identify all the factors impacting on their enterprise

Conference: Entrepreneurship in Africa Sustainable Globalisation. Pretoria: Tshwane

University of Technology]. 87

McGrath, S. 2005a. Skills Development in Very Small and Micro Enterprises. Cape Town: HSRC Press.

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activities and/or overrate the significance of external factors, while underrating internal weaknesses (Manning, 199688 cited by Kesper, 2000:12; and Bloch & Kesper, 2000a89, b90 cited by Kesper, 2000:12). This view is also reiterated by Kaplinsky and Morris (1999:717-737) and Kesper (1999b:137-164), who state that SME owner-managers believe that the primary obstacles to their survival is external to the enterprise. In contrast to these beliefs, research on technology upgrading of SMEs in South Africa (Dunne, 1999:24; Kaplinsky & Morris, 1999:717-737; Kesper 1999a:14-15; 1999b:137-159; and Kesper 2000:14-15), suggest that SMEs should devote more attention to internal weaknesses by improving their internal operations.

Entrepreneurs usually experience difficulty in identifying factors, which impede on enterprise growth (Berry et al., 2002:50). According to Dockel and Ligthelm (2002:291) cited by Naicker (2006:17), problems experienced by SMEs can be categorised as follows:

 Economic problems: Problems relating to the state of the economy, e.g. employment opportunities.

 Industry-related problems: Problems relating to the type of industry in which the enterprise operates, which may include demand and supply factors, obstacles to entry and level of competitiveness in the industry.

 Enterprise-based problems: Problems relating to internal difficulties experienced by the enterprise such as resource availability, i.e. finance, entrepreneurship and the effective use of these resources.

The importance of the above three categories of problems, call for closer scrutiny thereof:

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Manning, C. 1996. Market access for small and medium-sized producers in South

Africa: the case of the furniture industry. Unpublished PhD. Thesis. University of Sussex,

Brighton. 89 Refer to footnote 72. 90 Refer to footnote 73. 91

Dockel, J.A. & Ligthelm, A.A. 2002. Factors that contribute to small business survival. Pretoria: University of South Africa.

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Economy-based problems

The performance of the South African SME sector depends largely on macroeconomic conditions and industrial or market structures (Kesper, 2000:7-8). A survey on business success factors of SMEs in Gauteng (Ligthelm & Cant, 2002:19-25; and Naicker, 2006:16), returned that in the macroeconomic environment, crime was perceived as the largest problem, followed by inflation, unemployment, interest and exchange rates. SME success is tied in with the local economic conditions as the SME sector’s market growth usually takes place at the same rate as the macroeconomy as a whole, therefore should there be an economic downturn, SMEs will usually also experience difficulty (Berry et al., 2002:85). All categories of SMEs identify declining demand levels and a lack of customers’ purchasing power as one of their core constraints (Berry et al., 2002:86; and Leopoulos, 2006:226).

Enterprise-based problems

In surveys on Latin America and South African micro- and small enterprises, it was found that less than 50% of business closures were attributed to business failures, i.e. financial or economical infeasibility due to insufficient demand and inadequate working capital. The remainder of closures are attributed to personal reasons or the availability of better options or Government interference (Liedholm, 2002:232-234).

Internal factors such as human resource problems encompassing poor staff planning, multifunctional management, high employee turnover rate, inadequately trained employees, low productivity and difficulties in recruiting quality staff (Beaver, 2002:102; Berry et al., 2002:51; Williamson, 2000:27; Ligthelm & Cant, 2002:34; and Watt, 2007:34-35), are considered to be impediments to SME success. SMEs face several challenges involving the need to increase the level of human capital and assuring the effective use of such resources. It is argued that the roles of labour, labour markets and skill levels are the most important factors contributing to small enterprise growth (Berry et al., 2002:51). South Africa in particular is prone to underinvestment in human capital with low

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levels of foremen, mid-management, staff motivation skills and team- building skills. This need is reflected in SME owner-managers’ response identifying human capital investment as the second most important aspect where assistance is required after market development (Berry et al., 2002:61-62,65).

Training and education further influence the owner-managers’ perception of business success (Ligthelm & Cant, 2002:34; King & McGrath, 2002:3192 cited by Naicker, 2006:16-17,28; and Devey, Skinner & Valodia, 2002:2293 cited by Naicker, 2006:16-17,28), as owners with management qualifications regard their business as very successful compared to owners without management qualifications. Managerial skills not only influence owners’ perceptions about their business, but various literature sources (Viviers, Van Eden & Venter, 2001:1194 cited by Watson, 2004:1- 2), acknowledge that a lack of managerial skills and training is an important cause of enterprise failure (Naicker, 2006:18), complemented by a lack of experience and a lack of organisational culture acting as an impediment to the establishment of SMEs.

In a study conducted on enterprise success factors in SMEs in Gauteng, South Africa, it was concluded that a lack of technical and managerial skills (Brink, Cant & Ligthelm, 2003:Online; and Rogerson, 2008:70-71) impedes on business development. Research conducted on SME failures in South Africa returned that failure is primarily caused by a lack of management skill and training. This finding is confirmed (Radipere & Van Scheers, 2005:40995 cited by Rogerson, 2008:70-71), by 90% of a sample

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King, K. & McGrath, S. 2002. Globalization, Enterprise and Knowledge Symposium. Oxford: s.n.

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Devey, R., Skinner, C. & Valodia, I. 2002. The informal economy in South Africa. Johannesburg: The Development Policy Research Unit.

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Viviers, S., Van Eeden, S. & Venter, D. 2001. Identifying small business problems in

the South African context for proactive entrepreneurial education. Global International

Enterprise. S.l.:s.n. 95

Radipere, S. & Van Scheers, L. 2005. Investigating whether a lack of marketing and managerial skills is the main cause of business failure in South Africa. South African

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of 1 000 entrepreneurs who believe that SME failure is due to a lack of managerial skills.

The owner-manager’s characteristics (O’Gorman, 2001:60-75), may also act as a barrier to growth in that the personality, managerial skills and style including the entrepreneur’s and/or management’s negative attitude towards change, may negatively influence an enterprise (Leopoulos, 2006:226; and Naicker, 2006:39). Other operational problems encountered according to Leopoulos (2006:226), are:

 The use of uncoordinated changes in management practices without accompanied strategic planning and continued observation (Smart, Maull, Childe & Radnor, 2004:2-12).

 Limited resources to effect improvements.

 Lower productivity compared to larger enterprises (European Commission, 2003:Online).

 Lack of organisational dynamics to grow beyond a one-person operation (Rogerson, 2004:770-771).

According to Berger and Udell (2001:Online), and Reynolds and Lancaster (2006:396-397), a high percentage of small organisations fail in the first five years of trading, often as a result of overtrading and financial strain. Access to finance as a constraint on SME development has therefore featured prominently in a number of studies. With regard to funding secured from banks, SMEs encounter various obstacles, with lenders perceiving SMEs as non-transparent in the utilisation of the funding, while SMEs complain that their business risk is overrated, resulting in harsh financing conditions impeding on their competitiveness (St-Pierre & Bahri, 2006:547). Internationally, this view is mapped in the following countries (St-Pierre & Bahri, 2006:547):

 Malaysian bankers regard SMEs as non-performers and thus exercise a cautionary attitude towards them (Rahman et al., 2003:Online).

 Belgium bankers regard SMEs as extremely high risk entities, given the difference between management objectives and banker

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objectives (Janssen & Wtterwulghe, 199896 cited by St-Pierre & Bahri, 2006:547).

South African bankers are no different in their perspective of SME’s as their international counterparts. South African bankers are less inclined to finance SMEs (Pretorius & Shaw, 2004:Online), due to their perceived high level of risk and a weak expected return (St-Pierre & Bahri, 2006:547). The difficulty experienced in access to finance is most prominent in micro- and informal enterprises and considered to be the main obstacle to their development (Kubheka 2006:Online97 cited by Rogerson, 2008:62-67). This is emphasised by South African microenterprise surveys, with the inaccessibility to finance listed as one of the primary external constraints faced by SMEs. Some of the factors that contribute to the complex financing problem are insufficient knowledge of the SME entrepreneurs e.g. their inability to draw up a business plan; the lender’s inability to determine the SME’s credit risk attributed to a lack of enterprise information; and general communication issues (Berry et al., 2002:65,68,77), leading to low levels of entrepreneurship and a high failure rate (Kotze & Smit, 2008:35; and Rajaram, 2008:62) among South African SMEs. According to Rogerson (2001b:127) and Skinner (2005:35- 40), emerging African SME entrepreneurs, also experience a lack of credit as a major constraint. These entrepreneurs are dependent on personal savings or loans from relatives and friends as the source of their start-up capital. High interest rates, lack of credit history and collateral, and a complex finance application process, are some of the factors contributing to the low usage of formal bank loans.

Access to finance encompasses different kinds of finance to fulfil the varying needs ranging from long-term capital to short-term capital, to equity finance and debt finance, with longer-term finance more difficult to obtain. The inaccessibility to different kinds of finance has a negative

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Janssen, F. & Wtterwulghe, R. 1998. L’influence de l’interprénétration du dirigeant et

de son enterprise sur l’endettement bancaire des PME: état de la question. Paper

presented at 4ième Congrès International Francophone de la PME, Metz, France, October.

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Kubheka, B. 2006. Small business survey highlights.[Online]. http://www.finmarktrust.org.za.

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effect on SMEs, as most enterprises need long-term and short-term finance to succeed. SME finance demand is also multifaceted due to enterprises’ different needs for capital to run their operations, the different resources they can invest and the varying accessibility to external finance. A further aspect that influences finance is that financial institutions provide grants more easily to older and/or larger firms, than younger and/or smaller firms, supporting the underlying assumption that micro- and young enterprises are less creditworthy than the larger enterprises. Further research however needs to be conducted to determine if the higher failure rate is a cause or a consequence of the higher credit rejections (Berry et al., 2002:70,96).

Interest rates furthermore form an integral part of SME finance. Interest rates have a dualistic purpose by regulating the supply of finance as well as the demand for finance. Equalisation is effected through a risk premium that is levied on riskier loans in proportion to the perceived risk, in addition to the prime rate. This results in higher interest rates charged to the SME sector and particularly on longer-term loans (Berry et al., 2002:71). Accessibility and availability of finance due to inadequate credit information in the credit assessment process, SMEs’ inexperience in the loan application process, and high loan transactions costs are the typical reasons for failures in SME financing world-wide (Berry et al., 2002:70,96).

It is therefore important to develop an effective and efficient process whereby all SME dimensions are evaluated when measuring the borrower’s risk. According to Allegret in Chanel-Reynaud and Bloy (200198) cited by St-Pierre and Bahri (2006:547), “… the approach adopted by the banks within the framework of their financial diagnosis is unsuitable to the context in which enterprises, in particular the SME’s, currently evolve. In this way, the new financial diagnosis of an enterprise must be capable of taking into account the turbulence and recurring bumps that have affected enterprises since the early 80’s”. The

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Chanel-Reynaud, G. & Bloy, E. 2001. La banque et le reisque PME, Lyon: Presses universitaires de Lyon.

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development of a more inclusive SME risk measurement framework will enable lenders to make rapid and objective decisions based on the actual business environment, while SME management cannot criticise the banking environment of over-valuating the risk. At present, few risk evaluation models exist which allow for an overall evaluation of SME risk. The lack of suitable risk models is emphasised by the banking sector’s continued reliance on financial models where information is derived by way of financial statements, since this information is considered more objective than information obtained from other sources, as stated by the following sources:

 Lévy and Sauvage, 200399 as cited by St-Pierre and Bahri, (2006:548), for the quotation system of the Banque de France.

 Müller, 2003100 cited by St-Pierre and Bahri (2006:548) for Switzerland.

 St-Pierre, 2004101 cited by St-Pierre and Bahri (2006:548) for Canada.

These lenders, along with others, do not take into account the shortcomings of financial information. Factors that have an impact on the financial performance of an organisation include the structure of the enterprise and the quality of business practices, along with numerous other risk factors (St-Pierre & Bahri, 2006:548).

However, some studies refute the access to finance obstacle argument. Levy (1996102) cited by Berry et al. (2002:77), in a survey of 134 small South African enterprises, found that access to finance was an important but not primary obstacle, even in younger enterprises. It was identified that debt-free enterprises’ debtless structure was due to either a reluctance to borrow, or high interest rates.

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Lévy, J. & Sauvage, F. 2003. La cotation de la Banque de France et le ratio

McDonough. Bulletin de la Banque de France,112. [Online]. www.banque-

France.fr/fr/telechar/bulletin/etu112_1 . 100

Müller, H.-U. 2003. Notation interne: exemple Crédit Suisse. [Online].

www.cvci.ch/upload/Public/Discours/Zuberbuhler03.ppt . 101

Refer to footnote 7. 102

Levy, B. 1996. The Business Environment for Industrial Small and Medium

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Industry-related problems

According to Viviers et al. (2001:11103) cited by Naicker (2006:18,28), Huang and Brown (1999:73-85) and Watt (2007:34-35), market-related factors that exert the most negative influence on enterprise success are increased competition, limited market size, low demand, inefficient marketing, poor competitor understanding, poor location and market understanding and the inability to identify the target market. South African SMEs are hampered by a structural problem in that they, contrary to SMEs in other developing countries, do not complement larger organisations with spesialised products or services. Instead, they compete with larger enterprises in the same product markets (Qualmann, 2000:41104 cited by Rogerson, 2004:770-771), albeit for different consumer segments.

In conclusion, the following SME problems (Berry et al., 2002:73; and Laforet & Tann, 2006:374) need to be addressed:

 Insufficient entrepreneurship, i.e. lack of knowledge, training, networking and skills.

 Lack of good business opportunities.

 Inadequate entrepreneurial business acumen.  Low capital availability due to, e.g. low savings rate.  Information availability difficulties.

 Market fragmentation and customer dependency.  Difficulty in securing finance.

 Pressures exerted on interest rates due to default rate and the need to cover transactions costs.

For SME owner-managers, it is important to identify the most problematic areas in managing their small enterprise. By identifying the problem areas, owner-managers can address problems through education, training and information-gathering activities (Huang & Brown, 1999:73-85).

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Refer to footnote 94. 104

Qualmann, R. 2000. Economic development and employment promotion in South

Africa: analysis with special reference to SMME promotion and strategy options for the German Development Cooperation. Unpublished report. Bonn: GTZ

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