Graduating to “The Missing Middle”

The role of Micro and Small Scale Enterprises (MSEs) is one of the major issues that grab the attention of politicians and economists. The dominant position often held by these two groups has arguably obscured the understanding of MSEs, even though they deserve credit for putting the issue at the top of public policy agenda. MSEs are, by and large, viewed as a vehicle of job creation, industrialization, and socio – economic transformation. These all are good objectives, however, they do not help us very much to understand the enterprises as they really are – enterprises stand to thrive as private ventures first and foremost. Understanding them, therefore, is very important to track their growth and know the contribution they make to the national economy.

Discussing MSEs in developing economies is equivalent to talking about the broader economy, as they represent the majority of the enterprises. MSEs are often treated the same not only on their key attributes; they also share colorful descriptions in policy documents. MSEs Development strategies everywhere seem to attach the same lofty ideals and promises. Unlike the expectations placed on them, it is not new to hear cautionary tales against the myth of their grand contribution. In fact, there is only scanty empirical data to support what politicians and some economists would have us believe.

Ethiopia’s MSEs development path is no different. It has developed scenarios of transformative impact; it plotted the steps of growth from micro – to – small; from small – to -emerging medium; to achieve basically two overarching objectives: creating jobs and spurring the industrialization process. This is where the concept of graduation came into play: it was devised to facilitate the journey of growth to the aforementioned objectives. The results have been far from satisfactory.

Many of the graduated firms, whenever they have the chance for publicity, echoes problems that they hope will illustrate why they feel stagnated from the pursuit of growth. They stress the business ecosystem, especially the government, has failed to support them.

The government for its part tends to speak of the number of enterprises, and members they have as well as the capital they have amassed and the improvements registered in many of their members’ lives. Both narratives are flawed. While the government statistics are about naked politics, the enterprises’ views are a kind of misplaced lobbying that tend to externalize problems in a bid to create public pressure.

One of the strategy pillars’ of the MSEs strategy is supporting “growth oriented” sectors that have wider externalities. Are they growing? If they are, are they growth oriented the way the policy assumes them to be? Although the answer is not black and white, the overall impression is bleak. The enterprises that make it to medium status are not growing to next level just because supports like the provision of sheds are withdrawn. Newer micro and small firms are operating with the same mentality and resource configuration, wanting to have the same support packages that do not help their predecessor to meet their dreams.

As a society we need to see them growing. And their growth should be viewed from the business economics perspective, which indicates a firm’s growth at the micro level, starting from the resource base, which helps a firm to survive and thrive in its industry or die because of its weaknesses. Nonetheless it is by no means undermining the role a business ecosystem has on a firm’s fate.

Growth from a firm’s perspective could be seen in an increase of employees, market share, profit, and so on, as is the norm in Ethiopia. In our case, asset threshold is used in deciding which firms are graduating to medium status. It also includes a minimum level of permanent and temporary employment opportunity a given medium enterprise should create.

One may argue that in the long term profitability may not be a sufficient condition to thrive as a medium enterprise. However, successful firms are believed to build substantive capability over the years that could keep them in their industry. Firms that grow through competition are also believed to have greater chance of building the dynamic capability that can help them navigate the more chaotic journey of a medium sized enterprise facing challenges many of “the missing middles” suffer: the absence of various resources that help an enterprise to exploit opportunities for robust growth.

The threshold to graduate to a medium enterprise level is having a minimum asset of ETB1.5million, excluding buildings. This does not predict growth or insulate from stagnation. Many firms in this category report the same number of employees, but decreasing margins of profitability. Why? We can view profitability as a function of return on sales and capital turnover, both of which are components of return on investment. If companies repeatedly report poor return on sales they are probably admitting to poor value capture and efficiency, which is not a good sign. On the other hand, capital turnover usually measures value creation, which implies the use of fixed assets and working capital to generate a given amount of sales.

The big question is, therefore, what does this graduation imply? Growing substantive capability or dynamic capability, or both? Substantive capability allows an enterprise to continue to serve. Dynamic capability, on the other hand, helps an enterprise fare well in uncharted waters. Here, a firm’s internal capability, including attributes like managerial skills and technical acumen is critical.

Not having access to finance is critical for many MSEs. Just like many MSEs elsewhere, Ethiopia’s missing middles also suffering from policy implementation neglect.

Globally, firms in this category suffer lack of all sorts of resources. What makes our condition unique is that a good number of the graduated firms are nostalgic for their previous status. Some of them reported “refusing to grow” or hiding facts that would expose them to growth.

Why would businesses refuse to grow? Why do they seem comfortable with being micro or small? Graduating firms not only complain about resource limitations to support their growth, they display a more serious problem that manifests itself with a lack of ambition and drive to grow.

It may mean most of them are not “opportunity entrepreneurs” and operate without entrepreneurial mindset that endlessly seeks growth. Opportunity oriented enterprises have the fighting spirit. Of course, it is true particularly in Sub Saharan Africa where the missing middle curse is more pronounced; but it does not mean a lack of external finance is reason enough to wish to standstill.

In Ethiopia, the MSEs strategy has gone a long time without any serious revision, but the conclusions about its results are unanimous – it has failed to live up to its promise. The medium enterprises strategy is not spurring industrialization. No one is certain whether it is helping enterprises grow competitively. This is why enterprises complain about losing at both ends of the business ecosystem – not benefiting from government support or from the market, reportedly because of the perception of them being government sycophants.

The government has made many promises, including access to land to every growth oriented firm, which is almost impossible. There were also promises of easier loan provision as a policy support, which had limited success. The enterprises do not have the link with banks and experts at commercial banks see MSEs as either undependable or unqualified to do business with, for reasons like a lack of clear accounting reporting and credible business project.

In all these years, the capacity of the government institutions to support the sector has not shown meaningful, sustained incremental changes. They provide the same start up trainings for all, and do not have the professional proficiency to assist graduated firms, or the skill and power to negotiate terms for the enterprises as the policy dictates. The enterprises have developed the habits of externalizing problems to the extent of relegating the responsibility of their personal development to the government.

Officials often complain that enterprises even ask per diems and allowances for trainings organized by the government free of charge. This shows that firms are not willing or capable of joining the more dynamic world of the missing middle, which demands dynamic internal capability that can prepare them to cope with the demands of a competitive market. Changing this needs various interventions, but two things need immediate attention: working on the static capacity of the state follow – up capacity; and working on the MSEs behavior.

7th Year • Dec.16 – Jan.15 2019 • No. 69