Modernization of MSME sector: How to achieve scaling up and technological transformation of MSMEs?

Lack of finance prevents MSMEs from investing in innovative projects, improving their productivity, and seizing opportunities for expanding to enter new markets.

By M H Bala Subrahmanya

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Technology for MSMEs: Technological obsolescence and sub-optimal scale are two critically distinguishing features of Indian MSMEs, which predominantly consist of micro, informal enterprises. Therefore, policymakers in India have two persistent challenges to the modernization of the MSME sector in the country, namely, first how to accelerate technological upgradation and modernization of more and more MSMEs?, and second, how to enable more and more MSMEs to expand their scale of production (for their gradual growth)?

While these two challenges hold good for the entire MSME sector, they are intense in the context of micro-enterprises, both in urban and rural India. In fact, both these challenges are interlinked. If Indian policymakers succeed in inducing a steadily increasing number of MSMEs to go for modernization and technology upgradation, it is likely to result in their expansion of scale. Alternatively, if more and more MSMEs are encouraged to go for scale expansion, it is likely to lead to their modernization and technology upgradation. In other words, it is unlikely to achieve one without the other.

Technology upgradation and modernization is rather a perennial objective of India’s SSI policy up to 2006, and that of MSME policy since 2006. However, we have not achieved much success on this front, either at the national level or at any of the regional levels. Resource deficiency in the MSME sector at large is largely perceived to be the major responsible factor for this. Given their weak internal resources, they are unlikely to appeal to and win over external financiers (private or public). Given this, it is necessary to ponder over what can foster MSME scaling up and how to finetune our MSME policies accordingly. The scaling up of MSMEs is key to enhancing productivity and achieve inclusive growth. In many countries, enabling MSMEs to seize growth opportunities over time is a policy priority to address low productivity growth and widening wage and income gaps.

One way of dealing with resource deficiency is to encourage ‘digitalization’ through the adoption of ICT tools to aid production and marketing. Recent evidence (in the context of OECD countries) shows that the use of digital tools enables even micro enterprises to access international markets. However, even in developed countries, relative to large firms, SMEs’ uptake of ICT is lower, and they face higher barriers to the adoption of several digital technologies in their operational activities. The adoption of ICT tools in Indian MSMEs is limited, to say the least, though precise statistics are not available.

Given the educational background of owners and the locational background of Indian microenterprises, the challenge to acquire ICT tools will remain formidable. To realise the full potential of the digital transformation, including to scale up, firms need to upgrade the skills of workers and management and to invest in complementary knowledge-based capital, such as research and development (R&D), data, and new organisational processes. This calls for investment capital, which the MSMEs lack anyway. This boils down to the access and availability of adequate finance for the sector.

But MSMEs, in general, lack internal financial strength as much as easily accessible external sources of capital (for modernization-cum-scale expansion). Even in developed countries, difficulties in accessing finance are widely recognised as one of the major obstacles to starting and growing a business. Lack of finance prevents MSMEs from investing in innovative projects, improving their productivity, and seizing opportunities for expanding to enter new markets.

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In fact, the growth process of MSMEs can take different paces and forms including organic (i.e., internally generated) and non-organic growth (i.e., through mergers and acquisitions, joint ventures, and alliances). But in all these, the policy can play a role in enabling MSMEs to upgrade technologically and scale up. The policy can support MSME technology upgradation and scale-up, by fostering a dynamic business environment that facilitates entrepreneurship and enables firms of all sizes to reach their full potential, including through better integration in global markets and value chains. Some of the appropriate policy initiatives are as follows:

First and foremost, improved access to finance is needed to boost the widespread technological transformation of MSMEs across the country. In credit markets, adverse selection and moral hazard are exacerbated in the case of micro-enterprises that are without any loan history or collateral to secure a loan. Due to their higher risk profile, micro enterprises also typically suffer from higher loan rejection rates than the rest. The “financing gap” affecting micro enterprises is in fact often a “growth capital gap”.

Empirical evidence shows that SMEs that are more dependent on external finance grow relatively faster in countries with more developed financial markets, i.e. where SMEs can access a range of alternative financing instruments. Appropriate access to finance also improves the post-entry performance of firms, even when controlling for the size of entrants. But in many countries including India, there are few alternatives to traditional debt for MSMEs.

In this context, the case of Austria is noteworthy. Austria’s federal development and financing bank for the promotion and financing of companies offers guarantees of mezzanine investments in SMEs aimed at modernization, expansion, or acquisition of other companies. In fact, in India, we need an exclusive MSME Technology Finance Corporation (MSME-TFC) with branches in all MSME clusters, followed by opening branches in all district headquarters in the country. Such an institution must exclusively focus on the development of new technology through R&D, commercialization of new technologies (from industry or higher education institutions), and upgrading of manufacturing processes of MSMEs. At least 10% of their lending should be devoted to technological – product/process – innovations. They can introduce project-based funding of digitalization of MSMEs as well.

Secondly, acquiring and retaining adequately talented human resources is a challenge for MSMEs. To cater to the exclusive talent needs of MSMEs, departments of management in Universities and exclusive management institutions (in metros and cities, to begin with) should introduce integrated MBA programs for diploma holders who emerge from Industrial Training Institutes. Such MBA programs must have an exclusive focus on “small and medium businesses” in terms of internships, projects, case studies, and application of principles. These institutions must have tie-ups with MSME associations for their internships, project works as well as direct recruitment after their graduation. This can significantly alleviate the human resource constraints of MSMEs. Finally, if technology, finance, and human resource challenges are overcome, MSMEs will be able to conquer regional to national to international markets gradually and steadily.

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