Small and medium-sized enterprises (SMEs) are increasingly being recognised as productive drivers of economic growth and development for African countries. For example, it is estimated that SMEs account for 70% of Ghana’s gross domestic product (GDP) and 92% of its businesses.(2) They also make up 91% of formalised businesses in South Africa (3) and 70% of the manufacturing sector in Nigeria.(4) SMEs not only contribute significantly to the economy but can also serve as an impetus for economic diversification through their development of new and unsaturated sectors of the economy. In addition, innovative and technology-based SMEs can provide an interesting platform for expanding outside of domestic borders, and entering intra-regional and international markets. In view of the increasing emergence of SMEs across sub-Saharan Africa and the significant potential that they hold, it is important to look at what kind of support SMEs receive and their development, success and potential across the African continent.
This CAI paper considers the issue of SME development in Africa over the last few years. It shows that while the number of SMEs in Africa is high, their expectations for growth remain low when compared to other regions in the world. To understand this, it first looks at the amount of support that SMEs receive from their Governments and finds that it varies significantly across the continent. It then highlights the lack of credit access as a major obstacle for many SMEs and argues that if this were to be improved it would significantly increase SME growth and development.
SMEs in Africa
There has been a noticeable increase in the widespread emergence of SMEs in sub-Saharan Africa. The Global Entrepreneurship Monitor (GEM) on South Africa, Uganda, Angola, Ghana and Zambia suggests that the number of small established businesses is high. As Figure 1 illustrates, the percentage of established owned businesses in selected African countries was the highest in Ghana (40%) and Uganda (27%) in 2010, which are both significantly higher than China and Brazil (under 15%). Meanwhile, countries that registered below 10% established business ownership, like South Africa and Angola, are comparable to France, the United Kingdom (UK) and the United States of America (USA). This suggests that while established business ownership is relatively high for some African countries it is relatively average in others.
Figure 1: Established business ownership rate (%) (5)
However, while there are a large number of SMEs in African countries, start-up expectations for growth remain low. In 2010, when asked whether they expected to be employing over five individuals in the next five years, over 80% of respondents from Zambia, Ghana and Uganda said they did not. Meanwhile, respondents from start-ups in France, the UK and the USA showed greater expectations for their business’ growth. This suggests that while start-ups and SMEs are common in selected African countries, entrepreneurs’ expectations of how far their business can go are markedly lower than they are for other countries. To understand this better a closer look at the challenges to SME growth is required.
Figure 2: Expectations for growth in next 5 years (%) (6)
Growing pains: Barriers to SME growth
While there certainly are a growing number of SMEs on the continent, the environment that these are born into and nurtured in, varies greatly. Government’s policy towards SMEs is one important factor to take into consideration when looking at the opportunities SMEs have for growth. Upon investigation, it becomes clear that Government support differs significantly across the continent. In some countries, Government creates numerous barriers to SME development in the form of excessive regulation and red-tape. Chad is one such example. The World Bank Doing Business Report named Chad the most difficult sub-Saharan African country to conduct business in.(7) With a high tax rate of 65% and especially difficult insolvency regulations that demand 60% of the estate value and long processing times, business regulation in Chad makes it difficult for SMEs to operate and make profit. The especially high insolvency costs make it incredibly complicated and costly for entrepreneurs to allow their business to fail without giving them a fatal blow that would prevent them from trying again. Similarly, Eritrea ranks 43rd in Africa due to the absence of building permits issued to the private sector and the difficulty to access credit.(8) Long procedures, delays and waiting times mean that it takes 66 days to set up a business in Chad and 160 in the Republic of Congo. Furthermore, it is extremely costly to operate a business once it has been set up because of poor infrastructure. Problems of corruption, unreliable electricity and poor infrastructure mean that Nigeria ranks only 133rd in the world for ease of doing business, despite Government policy that attempts to encourage entrepreneurship. In 1999, the federal Government implemented a Small and Medium Enterprises Equity Investment Scheme (SMEEIS) which aimed to encourage a more productive SME sector. However, the policy objectives have not been met due to poor implementation.(9) This has restrained SMEs from tapping into the market potential resulting from the country’s young, large and growing middle class and population, thus slowing down economic growth and employment creation.
However, while countries like Chad, the Republic of Congo, Nigeria and Eritrea suffer from high levels of regulatory and institutional barriers with regards to SME growth and development, others like Mauritius, South Africa, Botswana, Ghana, Rwanda and Tanzania have made significant improvements in easing the cost of doing business in their countries.(10) Indeed, the World Bank Doing Business Report 2012 shows that over the last few years, an impressive 78% of African countries undertook meaningful governmental regulatory reform as a means of improving the business climate and encouraging investment.(11) In the World Bank’s Economy Rankings 2012, Botswana ranks first on the continent for resolving insolvency and also features well regarding recovery rate.(12) South Africa, ranks 2nd on the continent thanks to short processing times, high access to credit and the least amount of bureaucracy involved for obtaining construction permits.(13) Likewise, Ghana, Rwanda and Tanzania have all made significantly strides toward easing regulation and creating an enabling environment for business development and growth.(14) The picture is thus clearly a mixed one across the continent.
However, while difficult regulatory environments, poor infrastructure and limited Government support all make entrepreneurship a challenge, some success stories illustrate the potential of SMEs in Africa. Ruff n Tumble, a Nigerian clothing brand, started from the back of a car. The company has since grown significantly into one of the biggest African clothing brands, meeting the demand for a growing African middle class’ desire for quality African sourced clothing.(15) Meanwhile, the lack of Government support given to companies has seen a proliferation of Information and Communication Technology (ICT) hubs spread across the entire continent from Kenya to Cameroon.(16) There are currently over 50 such hubs all over the continent connecting entrepreneurs to investors and providing them with a space in which they can operate and undertake training. Even though some of these enjoy Government support, all were started independently of Government initiatives.
This suggests that while Government support may be limited in most countries, it does not always hold SMEs back. Indeed, entrepreneurs create new opportunities in spite of difficult regulatory environments and are not entirely constrained by them. For this reason, this paper argues that while Governments can certainly do more to facilitate and encourage local business development in African countries, access to credit for entrepreneurs remains the key problem for SME development.
Illustrating this point, the African Development Bank (AfDB) recently reported that only 20% of African SMEs had access to credit and that only 9% of the investments SMEs make are funded by a bank.(17) This stands in stark contrast to South America and the Caribbean where 44% of SMEs reported access to credit, and to Europe were 23% of SMEs’ investments are financed through bank loans.
Lack of credit access places a heavy burden on entrepreneurs to raise large amounts of capital for business development themselves and makes it hard for ideas to growth into enterprise. Improving access to credit is thus crucial if SMEs are to reach their potential and allow businesses to move from start-ups to established businesses with growth potential. Credit is also essential for creating an entrepreneurship spirit as it allows businesses to fail and rebound rather than just fail. Indeed, it is common for a number of start-ups and small businesses to fail, and a climate that allows failure allows an entrepreneur to learn from that failure and start afresh. It is in such an environment that innovation and success can most thrive.(18) Supporting this statement, Ernst & Young’s recent survey on entrepreneurship found that most respondents were ‘serial entrepreneurs’ in that they have launched one or two other companies before achieving success.(19)
Notwithstanding this difficultly, there are a number of indicators that suggest that the situation is improving. With regards to access to credit, the AfDB report found that a number of banks in East Africa had a significant amount of clients in the SME sector and that all banks in Kenya and Zambia have created departments aimed at SMEs, while 75% of Tanzania’s banks offer the same service. Meanwhile, over half of bank loans go out to SMEs. However, when lending to SMEs, banks favour long standing clients and insist on a ‘deposit first’ policy.(20) This makes it difficult for SME owners without a credit history and without significant capital to access credit. Despite increasingly recognising the importance of the sector, banks should thus further support SME development by creating better lending facilities aimed at lower income clients.
While African SMEs face significant obstacles that can affect their development and growth, these vary from country to country. Some Governments make it increasingly difficult for local businesses to flourish through burdensome regulation that lengthens important procedures and raises the stakes of failure. However, this is not the case across the continent and a number of countries have since made significant improvements to their business regulation. Furthermore, while regulatory barriers to growth can be damaging to start-ups and small businesses, they do not discourage innovation or business development on a wide scale. Indeed, impressive innovation continues to emerge from countries were regulation is cumbersome. What does make SME growth and development especially difficult, however, is lack of access to credit. If this can be improved, African designed innovations could provide local economies with substantial opportunities for growth and job creation.
Written by Leah Gatt (1)
(1) Contact Leah Gatt through Consultancy Africa Intelligence's Industry and Business Unit (firstname.lastname@example.org).
(2) Abor, J. and Quartey, P., 2010. Issues in SME development in Ghana and South Africa. International Research Journal of Finance and Economics (39), pp. 218-228.
(4) Mamman A., Elridge, D. and Branine, M., 2007. Skills need of SMEs and the informal sector in Africa: Problems prospects of employment creation in Nigeria. Scientific Journal of Administrative Development (5), pp. 145-177.
(5) ‘Global Entrepreneurship Monitor Survey Data’, May 2012, http://www.globalentrepreneurshipmonitor.
(7) ‘Doing business 2012: Doing business in a more transparent world’, World Bank, 20 October 2011, http://www.doingbusiness.org.
(8) Carstens, M., ‘Best and worst sub-Saharan countries for start-ups’, July 2012, http://ventureburn.com.
(9) Mamman, A., et al., 2007. Skills need of SMEs and the informal sector in Africa: Problems prospects of employment creation in Nigeria. Scientific Journal of Administrative Development (5), pp. 145-177.
(10) Carstens, M., ‘Best and worst sub-Saharan countries for start-ups’, July 2012, http://ventureburn.com.
(11) ‘Doing business 2012: Doing business in a more transparent world’, World Bank, 20 October 2011, http://ictsd.org.
(12) Carstens, M., ‘Best and worst sub-Saharan countries for start-ups’, July 2012, http://ventureburn.com.
(14) Doing business 2012: Doing business in a more transparent world, World Bank, 20 October 2011, http://ictsd.org.
(15) Nel, L., ‘The lady who turned her out of trunk fashion idea in a national range’, BusinessTrade.org, August 2012, http://www.businesstrade.org.
(16) Hersman, E., ‘From Kenya to Madagascar: The African tech-hub boom’, BBC News, 19 July 2012, http://www.bbc.co.uk.
(17) Calice, P., Chando, V. and Sekioua, S., 2012, ‘Bank financing to small and medium enterprises in East Africa: Findings of a survey in Kenya, Uganda, Tanzania and Zambia’, African Development Bank.
(18) ‘Les Miserables’, The Economist, 28 July 2012, http://www.economist.com.
(19) ‘Nature or nurture? Decoding the DNA of an entrepreneur’, Ernst & Young, 2011
(20) Calice, P., Chando, V. and Sekioua, S., 2012, ‘Bank financing to small and medium enterprises in East Africa: Findings of a survey in Kenya, Uganda, Tanzania and Zambia’, African Development Bank.