Recently I attended presentations by seven experts at the SME (Small & Medium Enterprises) Conclave at Kolkata. It was a highly informative and educated evening session with three experienced bankers and an experienced credit rating expert spoke along with three relatively young speakers. The four experienced speakers dealt with the various problems of the SMEs including the increasing uncertainty arising out of liberalisation and globalisation as also the problems associated with financing SMEs and the various facilities and schemes the banks are introducing to expand their business of lending to SME sector. The realtively younger speakers dealt with more modern aspects on the subject like progress in the use of information technology in the SME sector, the emerging era of SME share trading (the new BSE sponsored stock exchange will be shortly functional with much more stronger and reliable platform than what the currently-defunct OTCEI started providing from the late 1980s) and the potential of value creation through SME brand development.
The speakers highlighted the importance of the SMEs in the Indian economy: they account for 45% of the value of India's industrial production, 40% of India's exports, generate 1.3 million new jobs every year and their number is in the range of 26 million accounting for 98% or so of all non-farm firms. However, most of these are in the organised sector and only 18% of them are in manufacturing (mostly located in 15 clusters and in just nine industrial segments, while the remaining 82% of the 26 million engaged in services sector.
And, they are faced with several problems: low scale of operations and consequent low ability to withstand external shocks, low level of technology and inability to absorb new technology, dependence on few customers where the work as ancillary, inadequate availability and high cost of credit, weak marketing, complete dependence on one or a few key managerial personnel, poor book keeping and record keeping and absolute lack of risk assessment and management. Surveys have revealed that promoters are highly secretive about their operations even with the bankers they wish to depend on for cheap credit (and, of course credit rating agencies) and not very reluctant to upgrade technology and management. The incidence of default to bankers is very high among SMEs and therefore bankers are very cautious about lending to units in this sector because of their inherent high risk, low equity risk capital and little tangible security to offer as collateral.Surprisingly, they face all these problems despite the existence of a plethora of government sponsored supporting agencies at various levels throughout the country.
I recall that 40 years ago, when I began my career with a nationalized banks, the situation of SME sector was by and large the same: they enjoyed the same importance, showed the same potential and suffered from the same problems. And, yet this sector continued to grow over time. Currently, SME sector is growing at the rate of 15%-16% per year according to one speaker. Everyone recognised that many SMEs of the past have become large industrial companies over the years, although many more became sick, closed and dead. Equally interesting, the solutions offered now are also similar: creation of common infrastructure, assistance in marketing and procurement, help in improved designs, special banking facilities tailor-made for small units, support in technology up gradation and use of computers and information technology, help in brand building that creates value and access to stock exchange facility tailored to meet the special requirements of the SMEs. The Truth is 40 years down the line, SMEs will show more or the same situation. The Truth is that a seminar or conference or conclave on SMEs will always be of very little use and waste of time.
To my mind, SMEs always capture the relative importance that they deserve. They will always be the dominant munber of units in all most all economies at any stage of development and engage a significan number of entrepreneurs and workers. They may extract sops and concessions from government but that would never give them any higher importance. This will be true even forty years later or eighty years later in India, the US or Japan and the mortality rate of these units will generally be higher (except in countries like India where their lives will be prolonged at great economic efficiency cost trading off for shortem employment and vote protection).
To be useful the focus has to shift from clubbing all kinds of animals together to properly disaggregated classes of SMEs by their varying sizes, the nature of their activity (specific goods or services), target market (local or regional or all-India and dependence on few, large industrial customers), the promoters' willingness to expand, promoters' ability to do anything other than what they have been doing, and so on. Each class will have problems specific to them and solutions required. Not all wayside cigarette-pan shops will remain in the ownership of the same person or family: but many will do and never change their business or expand. Some wayside confectioneries/ eating houses will grow, even at the cost of encroaching footpaths for their use, but only a few of them would create a chain in a city or operate in various cities. Some of them may create their own brands without spending much, have websites and even arrangements for door-to-door delivery service locally and able to attract funds from banks or NBFCs on the strength of the collateral security they can offer. And, many owners of such SMEs are most reluctant to dilute ownership, except accepting some passive minority shareholders without any intention to give them any say in the business operations.
And, there are many others with excellent ideas and adequate technical background in need of large debt and equity from banks and the formal financial sector, after they have spent some of their own savings in the development of products up to a stage. Their ideas are really big and can succeed provided that get adequate finance and are willing to listen to private equity hand-holding financiers. But most of them want the finance to be extended to them but would demand high prices of shares for the small percentage of equity and look upon private equity investors and banks close monitoring and handholding as unnecessary evil. They will always complain of inadequate bank finance. But it is better that the country does not waste resources on them that have very little chance of being successful.
And, there are many other SMEs, whose promoters employ Chartered Accountant consultants with exposure to bank credit officers to prepare excellent project reports that the banks will find acceptable, though due diligence and rigorous risk assessment would not be feasible. They try with many bankers and sometimes are able to hoodwink one of them. When they fail they complain of shortage of bank credit.
And, there are many SMES who are unfortunate because their inability to see the writing on the wall that they are in the midst of a prolonged downturn in their industry with stocks piling up and receivables bulging or they have become already sick because of the entry of highly competitive, technologically and managerially more savvy SMEs or because of dumping by the Chinese firms. They plead for additional bank working capital but seldom banks are imprudent enough to accede to their request.
The plethora of govt- sponsored supporting agencies is a share waste: these institutions do not keep continuous track of the SMEs of various sizes and location to know in advance if many such units are going to get in trouble due to external market factors and RBI's monetary policy and rush to them to find out who really needs what kind of support and deserves such support.
While many SME owners operate on satisficing levels of profit and market share and may show various degrees of reluctance to grow beyond a point, some of them do graduate at varying pace to become big businesses because of owners' determination coupled with huge latent maket opportunity they happen to exploit. There are still some other owners of SMEs who seek opportunities of luring venture capitalists and other financiers to share the better part of the hogh risk associated with their businesess: most such business firms fail, but a few succeed and suceed to eventually become big corporations. This risk cannot be wished away. All this is an integral part of natural dynamics of emergence, growth and demise of business firms. The Indians, however, have been tuaght since the beginning of Independence to love SMEs and hate large businesses and never try to understand economic dynamics of business organizations. Generally poor people jealous of the rich find mental comfort in this manner, even if such emotions cost them dearly in economic terms. They want to be rich but do not know how and hence defend their poorness in various ways.
We gathered a whole lot of knowledge on the aggregate of the SMEs at the Conclave but were still in search of operationally more useful knowledge at the disaggregated level of different classes, types and sizes of SMEs producing different goods and services. With limited knowledge, it is hardly surprising that SME Conclaves will remain conclaves of exchanging knowledge that is already known or easily accessible to everyone attending the Conclave.
And, I complement the sponsors of the Conclave that they brought home this realization that the Truth about SMEs is all hidden in the aggregation. Small is really too Big to be meaningfully empowered with operationally useful knowledge. Maybe, as a follow-up step, the sponsors may think of organizing conclaves aimed at a few specific class/ type/ size of SMEs with speakers from experts on those specific class of SMEs including some SME owners/ managers. I must admit that I enjoyed listening to all the seven speakers.
PS: Some comments received:
# There have many studies pointing to the importance of SmE for job creation and transformation of industries. In the modern high tech area, the universities have assumed the role of engine of development. Examples are MIT, Stanford, Berkeley, Cambridge, helsiniki Univ of Technology. This idea has not been much appreciated by regular economists and hence not appreciated in India. Finland has done well to develop their SME sector. I brought a group from Finland to work with IiMc, but there was no taker, indian's obsession with brand was a problem.
# I think the importance of SMEs is somewhat over-hyped and romanticized. By now there is enough empirical research that shows SMEs do not have any significant impact on growth, job creation, poverty and inequality. I am all for big corporates replacing the lakhs of low productivity SMEs in India. Bigger companies enjoy economies of scale, provide better quality employment (research shows this) and have the financial muscle to invest in R&D. I am not sure if Indian SMEs are interested in growing beyond a point -- think of a typical Kolkata SME owner and offer him huge financing in return for 50% ownership. I am sure he will ask you to take a hike as he is happy with the modest growth that brings home his daily bread. I vote for big bazaar over nager bazaar any day.
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