By Ryan Luikens Cover Story Customs Unraveled Almost everyone has welcomed new government reforms that slash tariff rates, simplify customs procedures and prepare the country for wider integration into the global economy. While on paper the reforms will cost the government LE 3 billion, analysts predict the new rates could actually be a boon to the government by unbinding business. Looming Concerns If the textile sector is any indication, the new government will have to prove its customs reforms look as good in practice as they do on paper CUSTOMS UNRAVELED Almost everyone has welcomed new government reforms that slash tariff rates, simplify customs procedures and prepare the country for wider integration into the global economy. While on paper the reforms will cost the government LE 3 billion, analysts predict the new rates could actually be a boon to the government by unbinding business. By Ryan Luikens Many SMEs struggle to retain their staff as employees prefer to move on to larger companies after they gain the necessary experience. By Courtesy Tarek Makroum Ahmed Abdel Mohsen, SME credit control specialist, believes many SMEs are now more credit-worthy than they were just a few years ago. By Ryan Luikens A lack of funding and qualified employees can lead to operational failure. By Ryan Luikens Gamal El Morshidy, general manager of Proactive Soft, says some of his business was hurt by the global financial downturn.

By Osama Diab

When the economy shifted from being private-capital dominated in the 1950s to almost entirely state-run in the 1960s, government jobs became the ultimate goal for most young people. Despite the low wages, working for the government was synonymous with job security, with access to health insurance and middle-class positions for lower classes that had long suffered from a lack of social mobility.

The economic shift caused an education trend that increased the demand for engineering and science degrees and left a shortage of new graduates with management skills. Few people wanted to ‘waste’ a university degree on studying management or even economics. Faculties of medicine and engineering are still referred to here as “top colleges,” while commerce and business administrations are typically the default option for those who earned poor grades in high school. Even pop culture was endorsing the new trend and economic direction. Abdel Halim Hafez and Laila Morad were singing for the factory and the worker, and traders and business owners were usually portrayed in the media as moronic and brainless. The new economic focus left the small and medium enterprises (SME) sector neglected and struggling.

“SMEs rely on young graduates. There’s some sort of a gap between the supply of the educational system and the requirements of the market, because qualifications and technology are changing rapidly, actually everything is changing rapidly,” says Maged Shawky, chairman of the Egyptian Exchange (EGX).

The health of the SME sector is vital to the overall economy. Along with microenterprises, SMEs in Egypt constitute 99% of businesses in the non-agricultural private sector, about 75% of the private sector’s labor force and 80% of the nation’s GDP, according to figures from the Ministry of Foreign Trade and Industry.

“SMEs are the backbone of the private sector and a vital component of the socio-economic development for emerging economies,” says Ahmed Abdel Mohsen, an SME credit control specialist at a major private sector bank in Cairo. He processes financing applications from SMEs, and while he is not authorized to speak on behalf of his employer, he says smaller enterprises have become more credit worthy than just a few a years ago.

The definition of SMEs varies depending on country. In Egypt, SMEs are organizations and firms with less than LE 5 million in capital and a workforce of fewer than 100 employees. Law number 141 of 2004 defines a small enterprise as any organization with LE 50,000–LE 1 million in capital and less than 50 employees, while those with LE 1 million–LE 5 million and 50–100 employees are considered medium sized. Smaller operations here still struggle to find funds and operate in an environment that is less than encouraging of small and medium scale entrepreneurship, but policies are changing and financiers are starting to look beyond big business. This is a result of the government’s increasing focus on the SME sector to achieve its political and economic goals by creating a more attractive business environment that would help decrease unemployment, control inflation, attract more foreign direct investment and achieve more GDP growth triggered by the National Democratic Party’s “new thought” campaign.

“SMEs finally attracted the attention of local and international banks operating in the Egyptian market aided by the Egyptian government’s new direction to create new regulations and schemes for funding SMEs for their developmental role at various stages of economic development in the local market,” says Abdel Mohsen.

Many analysts have argued that the development of SMEs can also help narrow financial and social gaps as profits have a shorter distance to trickle down. Egypt enjoyed a growth rate above 7% for the past three years, but the poor remained poor. About 40% of Egyptians live at or below the poverty line and government sources put unemployment just over 9% — signs that wealth is still locked in the upper classes.

According to Abdel Mohsen, SMEs improve productive capacity while helping decrease poverty and unemployment rates, because they are mostly locally operated organizations. They also help contribute to a more efficient allocation of resources. The major obstacles that SMEs face is the lack of access to funding, the lack of management skills and the know-how of owners and operators of the business.

Lack of funding and business skills are major problems that prevent SMEs from surviving the challenges and turbulence of the market. Due to a high failure rate, it is often difficult for smaller business owners to convince banks and other funding institutions to grant them loans. While larger companies can increase stability by carrying out feasibility studies, developing a business plan and spending aggressively on marketing, advertising, research and development, SMEs usually lack the funds for such measures. Limited resources can also stand in the way of adopting the latest technology and hiring skilled and qualified labor.

SMEs are traditionally owned and run by one person or a family with the entrepreneur often performing the tasks of manager, secretary, sales person and office boy. Because of the lack of funds and experienced staff, decisons are more influenced by the owner’s own experience and instincts. Managers of small and medium businesses are usually experts in their field, such as doctors, engineers or mechanics, but lack the business and management experience to make their enterprises succeed.

“One of the main challenges that face SMEs is financing. The main source of financing is the banking sector, and banks give particular importance to track records, and usually SMEs can’t provide those,” says Shawky. “Another problem is that SMEs are usually owned by a family, which usually lacks that management style that banks require.”

Egypt’s current leadership, which aggressively promotes a liberal, open market economy, realizes the importance of increasing the competitiveness of the SME sector in an increasingly global market.

President Hosni Mubarak emphasized the importance of the SME sector for job creation in his 2005 electoral platform. Through a microfinance program, the government aims to help micro and small businesses create 600,000 new jobs over six years, from 2005 to 2011. Medium-sized enterprises were also to be relied on to create 900,000 job opportunities during the same six years with more than LE 60 billion for startup operations.

Mahmoud Khatab, chairman and CEO of Kenana Brokerage and Securities, relied on his entrepreneurial skills when he started his own business back in 1996, shortly after Egypt reopened its stock exchange in 1992.

“If you sought a bank loan then, no bank would have given it to you, especially since stock brokerage was new to Egypt and was characterized by being high risk,” says Khatab. “Finding qualified employees was also hard because business and economics schools taught nothing about the stock market. No university graduate at this time knew what a stock exchange was. Therefore, we became responsible for training our staff ourselves.”

According to Khatab, many brokerage companies have opened since the late nineties, so after spending a lot of time and effort training someone, a new company would advertise a vacancy in the newspaper and take your entire staff.

Gamal El Morshidy, general manager of Proactive Soft, a company that provides software for stock brokerage companies, automotive companies and call centers, shares Khatab’s concerns. After investing time in training workers, the company, which has been on the market for 13 years, is struggling to retain them.

“University graduates [] usually lack the knowledge needed, and companies have to prepare and train them from scratch,” El Morshidy says. “Usually after you spend a lot of time and effort training them, large multinational corporations recruit them now that they have experience.”

El Morshidy blames the lack of qualified labor on the quality of education. He wonders how, in a highly technical field such as software development, many colleges don’t train students in some basic skills needed in the workplace. “Some students who studied information technology [IT] for five years have never been to a lab before,” he says. “All their knowledge of IT is theoretical. What they learn at college is usually not what we use in real life. The lack of soft skills is also an issue. Even if the graduate’s technical skills are okay, they usually don’t know how to do things like writing a memo or a report.”

Startups in Egypt are usually required to raise their own capital, since banks ask for credit history and collateral. Entrepreneurs who are new to the market usually don’t have any credit history or reputation, leaving the market dominated by those who already have access to funding.

According to Khatab, another roadblock to starting a new business is the scarcity of information and the ambiguity of the business environment in Egypt. “We need the investment authority to make pre-prepared studies to guide investors on how and where to invest their money, so they would have a better idea how to invest instead of taking the easy way and just putting their money in a bank. The problem is that we all work in a very unclear environment with insufficient information,” says Khatab.

With difficulties in accessing funding, finding qualified labor, and the ambiguity of the environment stacking up against them, most SMEs flounder in their starting phases.

Khatab says that often the requirements attached to getting a loan disqualify many worthy enterprises.

“Most people who can satisfy the requirements and collaterals of taking a loan are not the ones who really need it. If I need to have LE 10 million to borrow LE 100,000, I wouldn’t need the LE 100,000 anyway. They must encourage banks to take risks so people who don’t have money would still have a role to play in the economy. If they only depended on people who have money, they don’t really need loans anyway, so we will keep running in the same circle without getting anywhere,” Khatab says.

According to Mohamed Omran, vice chairman of the EGX, 75% of SMEs apply for bank loans and 92% of those are rejected. Loans to SMEs make up only 6% of bank loans.

Even though the government has been working on facilitating funding for SMEs, banks are still reluctant and cautious to finance them.

Funding institutions consider SMEs high risk for several reasons, including the lack of solid financial grounds, vulnerability to inflation and market turbulences, and their inability to afford higher collaterals offering loan guarantees, in addition to their lack of dependable audited data to keep track of returns. They are also mostly self-owned or family-run and operate with few employees to minimize cost, as opposed to having a formalized management structure like larger corporations.

“Banks’ policies tend to be conservative when it comes to SMEs funding by imposing higher interest rates and collaterals than the ones offered to larger corporations,” explains Abdel Mohsen.

For a startup business to acquire funding from banks, it should present a feasibility study for the proposed business, according to Abdel Mohsen. Also, the owners should prove that they have been operating in the same line of business, which might be hard for some potential borrowers. However, most startup customers prefer to start the business depending on their own resources, delaying the bank funding to a later phase where they can prove their worthiness, and also when they can supply dependable data to meet the bank’s criteria.

Abdel Mohsen argues that the new trend in facilitating SME funding should start helping small and medium businesses learn how to acquire funding in order to expand their business. This would, in turn, narrow the gap between the borrowers’ qualifications and the banks requirements.

When it comes to funding, some industries are luckier than the others. According to Abdel Mohsen, banks favor businesses operating in the productive sector. Currently, the sectors most attractive to banks are food, chemicals, plastic and textile manufacturing due to their low risk and highly profitable nature. Also, the fact that they mostly operate locally somehow minimizes the risk. Because of high demand here, the construction industry is one that is considered highly profitable despite having a high risk margin and a capital turnover cycle that is longer than other industries, Abdel Mohsen says.

The Nile Stock Exchange (Nilex), a new stock exchange for small and medium enterprises, was launched last October to improve SMEs’ access to finance. The exchange offers more flexible listing rules than the EGX including a minimum capital requirement of LE 500,000 to get listed rather than the LE 5 million required on the larger market.

“Recognizing the important role played by the SMEs in the Egyptian economy, the Egyptian exchange launched Nilex by the end of 2007 to create a new platform for growing small- and medium- sized enterprises in order to facilitate their access to finance and provide them with the benefits of being traded, under an appropriate, secure, yet flexible regulatory framework,” says Shawky.

Nilex is not competing with banks or any other parties, according to Shawky, but rather complementing other finance sources for the SMEs.

“We are basically targeting mid- and small-cap fast growing companies and the finance provided through the stock exchange is usually long-term finance to help companies pursue their expansionary plans,” he says. “This is most of the time complemented with a credit line from banks to finance the company’s working capital and operations cycle.”

But only three companies — Masria Card, El-Badr Plastic, and TN Holding — have been listed and there is skepticism about the viability of the project. “Theoretically, the stock exchange is an alternative source of funding, because instead of going to a bank, a company can raise capital by selling shares in a public offering,” says Khatab. “But in Egypt, investment basically depends on the reputation of individuals. Even though an SME could be very successful and profitable, it’s likely to be unknown to people. Therefore, I don’t think Nilex is the right way to provide SMEs with the funding they need. Funding SMEs won’t be successful except with banks.”

Shawky says the EGX is not oblivious to the confidence problem, and has thoroughly studied the issues surrounding SME finance.

“It took us almost two years to study international SMEs’ markets experiences and how they addressed the issue of the confidence. Therefore, we maintained the majority of the main market disclosure rules to ensure market efficiency and investor protection,” he says.

“From another perspective, we are very selective in listing potential SMEs, in order to introduce a success story to the market.”

The listing of only three companies cannot be blamed on the performance of Nilex, but rather the general market condition and the investment environment. Some companies’ shares lost up to 80% of their stock market value in the credit crunch, which might hold back companies (whether large, medium or small) from going onto the market, since its offering is more likely going to be undervalued.

“I said before that we would consider getting five companies listed in the first year quite an achievement. This kind of stock exchange never grows fast in the starting phase. Something else is that we are witnessing an economic downturn, which in turn puts more pressure on SMEs,” says Shawky.

“Most investors had their money in big companies and they’ve been hurt badly. Investors are now busy with studying and watching the main market instead of a new market they don’t have any experience with.”

According to Shawky, starting a stock exchange is not a process that lasts for just a year or two, but rather a long process that aims to change how SMEs manage their operations and finances. “We appointed nominated advisors to help SMEs restructure their financial and managerial systems to meet the criteria of Nilex,” he says.

Shawky keeps his expectations low and realistic, he says, and expects only one or two more companies to be listed in Nilex in 2009.

SMEs exist across almost all sectors and industries, making it difficult to measure the effect of the global financial crisis on them. However, it is clear now that banks are willing to pay more attention to the underserved SME sector.

The recent global liquidity problem and the upcoming recession proved that large corporations are not as immune as they were thought to be. As a result, the Central Bank of Egypt (CBE) is encouraging SME funding by announcing a decrease of interests imposed on SMEs.

Egyptian banks will start financing local SMEs, according to a December article in independent daily newspaper Al-Masry Al-Youm.

“Given the repercussions of the financial crisis, SMEs are the winning horse of the coming period due to lack of risk amid fears of granting credit,” Ahmed Selim of the Arab African International Bank told the newspaper.

“The financial crisis affected us because of our stockbroker clients,” says El Morshidy. “Stockbrokers can’t make new investments now because they’re trying to cut down on their expenses. But we all hope this won’t last for long. As for automotive companies’ clients, they still invest in software and don’t seem to have been affected by the crisis.”

Abdel Mohsen adds, “the government incentives will encourage local banks and international banks operating in Egypt to give more of their attention, time and money to SMEs, especially [since the sector] has proved in the last four years its efficiency and credit worthiness.”

The model Egypt can follow to give a hand to SMEs and allow them to solve many of the nation’s problems might lie northwards. Italy has succeeded in teaching the world how large economic growth and prosperity can come from the small and the medium. Although Italy is the seventh largest economy in the world by GDP, according to the International Monetary Fund, 98% of its industrial firms have less than 100 employees, and 90% have less than 20 workers. The Italian economy is known for its heavy reliance on small firms, yet it manages to be one of the largest economies in the world.

Italy’s recipe for success is the adoption of a concept called “SME clusters,” which is a group or network of SMEs in one activity sector that unite together to produce a certain outcome, taking into account the cultural and geographical grouping of firms.

As a small firm, growing from the local community is advantageous and promotes cooperation and trust between the company and other local firms, which are likely to share the same culture. Being attached to a certain area allows businesses to build a good reputation and gain a clientele base.

SME clusters also allow small firms to focus more narrowly on a small part of the overall job, which helps make better use of their limited resources. Division of labor among the firms also leads to a better quality end product since every small firm is more likely to excel at its assigned task. Also, since staff are highly specialized in one specific area, their skills aren’t necessarily as attractive to other firms, which helps the SME retain its employees.

Local training institutions usually specialize in the cluster’s activity, making it more likely for them to succeed and helping the people of the region gain solid skills. Workers in a cluster are also more likely to be well-trained and more skilled, since it’s a local industry of a certain geographical area and everyone in that area is likely to know how the industry operates and have a good general knowledge of it.

Another advantage is that the concentration of players from the same industry in one area would cause competition to soar. This kind of fierce competition will lead to more efficient allocation of resources, higher quality and lower prices. When a country has such an organized and efficient industry, the SME cluster or industrial district is more likely to become world-renowned and attract international attention and global demand.

In Egypt, many industries including textiles, leather, furniture and software have the potential to benefit from this concept as there are already SME cluster-like areas, such as the furniture industry in Damietta and the Smart Village in Cairo.

Developing the SME sector is a real challenge that is beginning to receive more attention from both the government and private sector.

Khatab says, “having a clear national vision that everyone is aware of and [can] work towards is necessary for developing the SME sector, the overall economy and to improve the well-being of Egyptian society.”

The company you work for, the shop where you buy your groceries, the deli where you grab your breakfast on the way to work, your lawyer, dentist, and favorite shoe store: all are evidence of how SMEs can directly and indirectly affect the quality of everyday life. bt