There is a broad consensus in Egypt nowadays that empowerment of small and medium enterprises (SMEs) holds the key to the country’s economic problems. This is evident in the numerous discussions, workshops and debates that are regularly held about the subject.
It is also a main pillar in all of the presidential candidates’ electoral programs and was even part of the previous regime’s economic plans. The reinvention of Banque Du Caire as the SME bank was a decision taken during Mubarak reign.
Yet with all this conviction, medium size enterprises still constitute only a fraction of Egypt’s economic platform with the majority comprised of micro and small enterprises that have failed to upgrade to the medium level.
According to the CAPMAS Census of Population, Buildings and Enterprises, over 90% of enterprises in Egypt fall within the microscale with the number of employees ranging between one and four, which constitutes 58% of total employment. The report also shows that medium-sized enterprises constitute only 0.13% of businesses in Egypt and employ only 3% of the workforce.
The German Development Institute (GDI) in coordination with the Egyptian Center for Economic Studies (ECES) conducted research to identify why micro and small enterprises fail to upgrade to medium-sized businesses and presented their finding at a roundtable discussion held at the ECES.
The study focuses on Egypt, but is also part of a larger research initiative by GDI on SME upgrading that includes two similar studies being carried out in the Philippines and India.
Senior ECES economist Iman Al Ayouty explained that most developing countries are characterized by the “missing middle phenomenon” whereby the majority of economic activity and employment is generated by micro or large enterprises.
This constitutes a problem, she explains, since medium-sized enterprises are the main creators of employment opportunities, income and export generation, and they have the ability to innovate and absorb imported technology.
The study aims to identify main factors that determine the upgrading of micro and small enterprises in Egypt to medium enterprises, defining upgrading as enterprise growth through innovation.
GDI’s Annegret Altpeter explained in her presentation that innovation can occur in the enterprise’s process, product, marketing, functionality and sectors. These types of innovation lead to growth in the enterprise’s returns, assets and employment.
The German researchers developed a research methodology which helped them determine the main factors that hinder the ability to innovate and hence grow. Interviewing over 100 business owners, 122 experts from the government, private sector, civil society and academia, the businesses were classified into two groups: those who — over the course of the previous five years — have managed to upgrade by achieving at least 50% growth, and those that have failed to do so.
The results show that there are six main determinants of SME upgrading in Egypt: quality of education of the business owner, human resource development, access to finance, market research, international exposure and law enforcement.
For quality of education — which includes training and work experience — the owners of 76% of SMEs that were able to upgrade had previous work experience with leading multinational firms, while owners of 97% of non-upgraders did not have a higher level of education such as a master’s degree.
The level of education of a business owner is of vital importance for the development of the SMEs, since it affects a multitude of other factors. For example, the ability to conduct market research or produce high quality products is to a great extent determined by the level of education of the business owner.
Furthermore, the ability to attract and retain skilled labor is subject to the owner and management’s adoption of proper HR procedures. Although 67% of the companies interviewed mentioned the skills and behavior of labor as a main obstacle to growth, it cannot be ignored that management’s incompetence sometimes plays a role in the high turnover of labor.
Tarik Tawfik, Managing Director of Cairo Poultry Group and Vice Chairman of Farm Frites Egypt, stressed this point during the discussion. “I tend to agree that it is mostly a management and ownership issue rather than a labor issue. […] It is just an issue of proper compensation and HR development and the retention level and competency level is very high,” he explains.
“I [speak] from my own personal experience. We are commanding a division with 12,000 employees with a turnover of almost 1–1.5%, from the lowest level of labor to the highest level of management,” he continued.
This translates into proper HR development which is one of the six factors highlighted by the research team. They quote one of their respondents — a software developer — saying: “Most of my employees stay for a long time because I [train them]. I have a good personal relationship with them, and I sometimes pay them extra money as an incentive.”
Perhaps one of the most commonly mentioned obstacles hindering the growth of SMEs is access to finance. Although there is a noticeable effort by financial institutions to introduce SME finance to their product lines, such efforts have had a limited impact.
“Financial institutions have introduced SME financing units because it was expected of them,” said Maximilian Kern of GDI. “But the fact is that most of the credit directed at the private sector is not for SMEs — they receive only a tiny share of 7–8% of the loans although they constitute the majority of companies in Egypt.”
Surprisingly, however, only 33% of the interviewed SMEs mentioned access to finance as an obstacle to growth. In their research, the German team further divided the companies that were able to upgrade to medium enterprises within the last five years into two groups: those who achieved 100% growth (which were termed gazelles) as opposed to those who couldn’t go this extra mile.
They found that only 20% of the gazelles considered finance to be a success factor and only 15% had obtained a bank loan. Although these findings might strengthen the notion that access to finance is not a main determinant of success, Kern stresses that when companies were asked what they would choose to help them in their business, 50% mentioned access to finance.
It must be noted, however, that entrepreneurs with a high level of education and international exposure and who are able to conduct market research and invest in HR development usually come from a wealthier background. Therefore, access to seed capital from friends or family might have played a role in the research team’s findings.
It is also likely that their ability to develop business plans and growth strategies based on a market understanding would go a long way in convincing financial institutions to lend to them if such seed capital is not available.
GDI concluded their presentation with a set of policy recommendations that aim to strengthen and promote each of the six factors. Examples include promoting entrepreneurial skills in primary and secondary schools, promoting exchange programs in universities to increase international exposure, increasing awareness among SME owners of the importance of HR development and improving the regulatory environment by introducing a bankruptcy law.
Although all six factors mentioned by GDI are somewhat interrelated, what seems to be the most important factor in SME growth is the level of education. Highly educated entrepreneurs are more likely to innovate and develop new ideas, products and process rather than imitate existing ones. bt