SMEs: Why do they numerically dominate an economy despite heavy odds for their operations

Small and Medium Enterprises (SMEs) occupy a place of strategic significance in the world economy, because they account for a considerable proportion of total enterprises, employment, national income, and exports in almost every economy, be it developed or developing. They broadly account for more than 95 per cent of the enterprises, more than one-third to half of the employment, more than one-third to half of the national incomes, and one-third to three-fourths of the total exports. Its numerical strength has, obviously, attracted the attention of policymakers not just at the national level, regional level, and local level but at the international level as well.

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International institutions such as The World Bank, International Finance Corporation, Asian Development Bank, etc. have an exclusive focus on SME sector’s promotion and make recommendations for strengthening national policies. Of late, the ability of SMEs to carry out technological innovations leading to new firm creations and existing firm growth has been increasingly coming to the limelight. As a result, policy support for SMEs is getting diversified to include support to encourage SME innovations. Despite these, SMEs tend to fail in a higher proportion in the initial years after their birth, because they face constraints and challenges of various kinds for their operations.

This brings out three critical issues relating to SMEs, which require a deeper understanding: first, SMEs are numerically a strong segment of any economy; second, SMEs bestow on an economy multiple benefits, and third, SMEs face constraints and challenges on multiple fronts. The question is why do SMEs account for a considerable proportion of an economy in terms of various macroeconomic variables such as the number of total enterprises, employment, national income, and exports, despite facing varied challenges and constraints. This is because SMEs emerge rapidly at varying rates, irrespective of times, and nations, primarily owing to locational influences, process influences, and market influences. Of late, due to technological influences as well. It is necessary to elaborate on each of the influences.

Locational Influences

Locational influences provide “protection” for the birth and incubation of micro/small scale enterprises in distant small markets, which are dispersed in countries characterized by underdeveloped infrastructure and transport, low level of income, etc. In such a context, micro/small firms emerge to make use of local resources, employ local skills to meet local needs. They virtually emerge and operate in a protected environment, insulated from external competition. However, when countries develop, infrastructure including transport improves, level of income goes up, small but dispersed markets expand leading to locational influences to “dilute” or “dissipate”.

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This would prompt existing micro/small scale enterprises to gradually grow and alternately, “larger” size enterprises emerge, to take advantage of growing markets. As countries develop further characterized by a steady improvement in infrastructure and level of income, individual markets expand further and some closer ones get merged (resulting in increased urbanization).  The gradual growth of enterprises eventually leads to competition between “newly born smaller enterprises” and “gradually grown/newly born larger enterprises” in the ever-expanding markets. This holds good for almost every developing economy today. [They do remain even in developed countries, maybe, to a much lesser extent.] This explains the competitive existence between small and large. Many non-durable (light manufacturing) consumer goods industries come under this category.

Process Influences

Process influences refer to the scope for the complementary relationships between small-scale and large-scale enterprises. In many industrial operations, large-scale enterprises predominantly engaged in manufacturing technology-intensive products (irrespective of times and stage of development of nations) to assemble them with parts and components manufactured by small-scale enterprises or SMEs, for its subsequent marketing. The former focuses on their core strengths and relies on procuring supplementary products from SMEs. In these industries, SMEs operate as “subcontractors” to large-scale enterprises. This explains the complementary relationship between small and large. Heavy manufacturing industries such as electrical, electronics, automobile, and transport equipment come under this category.

Market Influences

Market influences refer to the scope for the “independent” existence of small-scale enterprises or SMEs in an economy. For certain consumer products, the “total market demand” irrespective of the stage of development of a country, remains small. This is because these products need to be delivered to their consumers in their locality, and therefore, such enterprises need to be located in a small and dispersed manner. Retail trade, restaurants, repairing services, tailoring, branded garments, specialized jewelry, health services, construction services, etc. come under this category. To some extent, SMEs have been challenged in this sphere by large enterprises through a “franchisee system”, in more developed economies. However, their existence is not totally threatened.

More recently, the faster emergence and growth of ICT-based technologies give scope for start-ups, which emerge as small new ventures, but based on the degree of success achieved, they grow and cease to remain as “SMEs”, sometimes in a short period of time. These are technological influences defining a steady emergence of new ventures, rather on a continuous basis.

M H Bala Subrahmanya is a Professor at the Department of Management Studies, Indian Institute of Science – Bangalore. Views expressed are the author’s own.