Promoting SME Development: Some Issues and Suggestions

for Policy Consideration

(Ms) Thitapha Wattanapruttipaisan

Senior Officer, Industrial Services Unit
ASEAN Secretariat
Jakarta, Indonesia
(October 2002)

(The views expressed in this paper are those of the author and do not necessarily
reflect those of the ASEAN Secretariat. Mention of any firm or license process does
not imply endorsement from the ASEAN Secretariat. I am thankful to Mr. Noordin
Azhari, Director, Bureau of Economic Co-operation, ASEAN Secretariat; for his
encouragement in research, and to Dr. N. V. Lam, Senior Economist, ESCAP and
Adviser, Foundation for International Human Resource Development, Bangkok, for
extensive discussions and many useful comments on an earlier draft. The usual
disclaimer applies. The author can be contacted through <[email protected]>)

PROMOTING SME DEVELOPMENT: SOME ISSUES AND SUGGESTIONS

FOR POLICY CONSIDERATION
On several social and economic grounds, small and medium-sized enterprises (SMEs)
are of overwhelming importance in most Asian countries, those in the Association of
Southeast Asia Nations (ASEAN) included. Typically, the SME sector accounts for
upwards of 90 per cent of all firms outside the agricultural sector of East and
South-East Asia, and of Japan as well. It is also the biggest source of employment –
providing livelihood for over three-quarters of the region’s workforce, especially
women and the young. The relative share of SMEs in total output and exports are
generally much smaller, ranging from one-third or less. As such, the SME sector will
remain the backbone of virtually every economy in this region and, for that matter, of
the world in the foreseeable future.

A concerted push in support of SME growth and competitiveness, moreover, is no

longer an option. In fact, the financial and economic crisis of 1997/98 has induced a
return to “the fundamentals” among the “miracle economies” in East and South-East
Asia, including a renewed focus on SMEs. This policy shift has been complemented
with higher budget allocations and external aid for the SME sector, including sizable
resources made available by Japan under the so-called New Mizayawa
Initiative. Such a reorientation is not just to underpin the on-going socio-economic
recovery which was somewhat derailed again due to the 2001/02 global economic
slowdown. It is also necessary to accommodate an expanding pool of millions of job
seekers (especially the young and female workers) and, at the same time, to widen the
available opportunities for the current as well as potential SME entrepreneurs
themselves.

A. A New Development Context

SMEs and, by extension, all business firms have to manage growth and change in an
environment where the pace, patterns and organization of production have evolved
fundamentally since the late 1980s. Trade liberalization at the global and regional
levels, and the new information and communication technologies (ICTs) have
entwined to create rich opportunities as well as formidable challenges to all
interdependent countries and enterprises. The following notes on some of the
opportunities and challenges most pertinent to SME development serve as a backdrop
for a discussion on related of policy issues and suggestions in the promotion of SME
growth and competitiveness in the coming decade.
1. Vast opportunities
A larger proportion of global output is now exported. The ratio of world exports to
production was just under one-fifth in the late 1990s, compared to only 12 per cent in
the early 1980s (ESCAP 2000: 8-9). Even during the global economic slowdown of
2001, the value of world trade (exports) reached $ 12.7 ($ 6.2) trillion. Regionally,
intra-ASEAN trade has also expanded faster than the group’s total trade while the
proportion of goods destined for trade within ASEAN is much higher than before the
progressive and accelerated tariff reduction arrangements, starting in 1993, under the
ASEAN Free Trade Area (AFTA). In addition, most wealth-creating assets such as
finance and technologies can now be packaged, located and relocated with relative
ease within and across economies and regions.

Furthermore, there are now greater scope and more opportunities for inter-firm
linkages for enhanced collective efficiency, technological and innovation capabilities,
and hence competitiveness. In particular, the proliferation of complex networks of
international production and cross-border supply chains has widened and deepened
the potential and avenues for SME involvement. Besides, subcontracting and
outsourcing relationships now cover processing and manufacturing activities and
services of high value-addition and technological sophistication – ranging from
original equipment manufacturing, complete-package production, product design and
engineering, research and development (R&D), to various other high-end support
services.

Another development trend pushed and pulled by the ICT revolution is the significant
uplift in productivity, resilience, and flexibility of economic activities and services in
consequence of the widespread diffusion of ICTs. In particular, these new
technologies are behind the tremendous upsurge in e-commerce. Currently, this
market is largely confined to the developed region which, for example, accounted for
85 per cent of business-to-business transactions (estimated at some $ 450 billion) in
2000). E-trade is expected to grow at an exponential rate to reach the trillion-dollar
mark well within this decade. Trade via the internet has now become an intrinsic part
of an increasingly large number of SMEs in the developed countries. Respectively
about one-half and one-third of the medium- and small-sized enterprises in Europe
maintain an e-mail contact address or a presence on the world wide web; there are no
comparable data in the case of SMEs in ASEAN or Asia.

2. Daunting challenges
But the almost unlimited opportunities for gainful growth through trade on the
demand side are countered balanced by highly formidable challenges on the supply
side. Firstly, competition has become increasingly fiercer among the global and
regional economies and enterprises, SMEs included. There are also many more
producers competing for both existing and new markets and market segments for
goods, services, finance, and other wealth-creating technologies and knowledge. The
competitive strength of China is notable in the above regard, even before the country
became a WTO member in December 2001. Indeed, market penetration and
displacing pressures from China have been keenly felt by producers across Asia,
particularly those suppliers (especially SMEs) at lower stages of technology
sophistication and relying on a high import content.

Secondly, consumer preferences and market standards have become more

sophisticated and exacting. Competitive advantage is now determined by several
non-price parameters such as quality, health and safety, social equity in employment
and production, and ecological compatibility of products and processes. Furthermore,
market demand is also constantly changing -- a trend facilitated not least by the rapid
advances in ICTs, bio-engineering, and new materials sciences. In consequence,
there are more frequent introduction of new products and processes, faster and more
innovative design changes, shorter product cycles and smaller output batches, higher
quality and greater mass customization, just-in-time sourcing and more punctuality in
delivery.

B. Policy Implications and Options

The new development context is likely to require a change in both perception and
practices -- in other words, a new or different mindset -- in the promotion of SME
development. As is apparent from the preceding discussion, competitiveness is
increasingly human-made; furthermore, it can be leveraged by factors other than
location and natural resource endowments. One lever is through the maintenance of
an on-going access to the available store of global information and knowledge --
including market standards, marketing opportunities and technologies. Another is
embodied in the large gains in collective efficiency and flexibility through
participation (whether or not at arm’s length) in clusters of firms, or in networks of
inter-linkages backward with suppliers, laterally with other producers and providers,
and forward with users and consumers. Yet another leverage relates to the capability
for on-going learning and improvement in efficiency and flexibility; indeed, business
enterprises (both large and small) must become and remain a learning organization in
the new development context.
A note of cautious optimism is warranted at this juncture. There is much evidence on
the emergence of competitive industries and on the revitalization of domestic regions
pushed and driven largely by networks and clusters of SMEs. The process has taken
place in both developed regions, notably Western Europe in the late 1980s, and
developing economies. Within Asia itself, many large domestic firms as well as
transnational business conglomerates, commanding widespread “brand” or “name”
recognition, are born and bred locally. However, the very large majority of them had
a more humble origin mostly as small-scale enterprises, often operating in smaller
township, at the initial stages of their start-up around half a decade or so ago.

1. Monitoring and benchmarking competitiveness

In general, SMEs will have to be assisted and facilitated to grow, multiply and
replicate into a sufficient (critical) mass across industries and sectors. In the process,
the level of competitiveness and dynamism of domestic enterprises and, by
implication, of the economy as a whole will be greatly enhanced. However, focus and
targeting are unavoidable in the context of SME support activities and services. On
the one hand, government has become “leaner and meaner” with functional
divestment through policy liberalization, asset privatization and administrative
deregulation. In fact, no countries will likely have the necessary resources for the
concurrent and open-ended support of the massive number of their SMEs; these range
from several hundred thousands to a few millions in the larger, more populous and/or
SME-intensive economies (e.g., China, Indonesia, Republic of Korea, Taiwan
Province of China etc.)

On the other hand, there are huge differences in the capabilities and competitiveness
of SMEs. As is the case of sectors and industries regarded by government as of
priority importance, business enterprises deserve closer attention and concerted
support if they are more efficient, innovative, growth-oriented, outward looking,
learning capable and linkage ready. Firstly, such firms are likely to be very much
fewer in number. Policy intervention would have a better chance of success as it
would be more focused and manageable, both administratively and
financially. Secondly, they will be more receptive to an efficiency-oriented and
time-bound approach in policy support and facilitation. This approach is similar to
the provision of fishing rods and related fishing skills to SMEs; it is thus different
from the distribution of the fish itself to the target beneficiaries as often has been the
case. Thirdly, they are also better placed for self-diagnosis and self-improvement after
the initial provision of assistance and facilitation measures. Meanwhile, partial cost
recovery in cash and in kind, plus resource pooling are comparatively more feasible
among these target firms.

Competitiveness has a foundation at the micro-level, whether or not it is measured

and benchmarked at the industry, sectoral or national level (Porter, Sachs and
Mcarthur 2001: 21; and Meyer-Stamer 1995: 143-146). Regrettably, however, there
is currently little, if any at all, data and information needed to monitor and compare
the evolving capabilities and potential of the top layers of SMEs in priority sectors
and industries over time. Such an exercise is indispensable for a more accurate
identification of core competencies of the SMEs under consideration as well as of
their shared areas of weakness for follow-up capacity building. Indeed, learning
what a country and its enterprises are, or can be, good at producing is a key challenge
of economic development (Rodrick 2002: 7a). But the same exercise is also essential
for better SME performance management and policy impact assessment. In
particular, useful benchmarks can be obtained as regards the on-going changes
(whether progressive or regressive) in the capabilities and competitiveness of direct
SME exporters and first-rank SME suppliers to large domestic enterprises or
cross-border production networks. These benchmarks constitute a solid input for the
consideration of policy framers as well as for emulation by those SMEs presently in
the lower ranks or tiers of suppliers.

To be credible, the data and information for monitoring and benchmarking purposes
have to be obtained in an objective, systematic, periodic and (statistically) robust
manner. The persisting shortage of such sample survey results in this regard is
another structural statistical weakness in most developing countries, despite the
intrinsic socio-economic importance of SMEs and the renewed policy focus on
them. In this connection, a framework for such a remedial exercise is discussed at
length, and a pilot project for testing purposes is proposed, in Wattanapruttipaisan
(2002a: 70-78 and 84-85).

2. Subcontracting compact
As noted previously, the promotion of inter-firm networking as a ready bridgehead to
domestic and external competitiveness has been given high policy priority in the
developing world, including ASEAN. The sustainability of such inter-firm
arrangements naturally is conditional on a durable compliance to exacting
requirements for outsourcing and subcontracting (Altenburg 1999, Gereffi 1999, and
Humphrey 1998). However, a major drawback in business matching events and trade
fairs is the lack of solid information as regards the evolving capabilities of the
producers concerned. A product or service may appear competitive on display but
there is no guarantee that the needed volume or variety of supplies can be increased
by the pertinent enterprises cost effectively, and with their quality and reliability
remaining uniform or assured. In addition, sustained competitiveness depends on
learning-based and innovation-driven improvements in product design, quality and
delivery. For a variety of reasons, however, the improvement process may not be
realized in an efficient, continuous and flexible manner by the suppliers concerned.

Indeed, the compliance process itself requires mindset changes because a large
number of subcontracting prerequisites are traditionally not practiced or expected by
most SMEs, among other firms. To begin with, there is little room for compromise
on quality, and compliance to quality management systems recognized worldwide is
through certification under the International Organization for Standardization (ISO)
9000 series of standards, ISO 9001 and 9002 especially. Such certification is no
longer an option. But changes are also required in several other business practices
which include certain conditions as regards employment and workers’ amenities in the
workplace, regular audits of factory layouts and work flows, the offer of
unconditional product warranties and after sales service, and the extension of credit
on delivered products. There is, moreover, the imposition of penalties for
under-performance, for example, in terms of quality consistency, defect and rework
ratios and liabilities, timeliness in delivery etc. (Momoya 2000: 160-161, and
Altenburg 1999: 32-34).

All these require, in turn, a compilation of the typical preconditions for inter-firm
networking, including through subcontracting. The listed specifications can be
regarded as general guidelines or “best practices” for emulation expected of SMEs
from the demand side. Likewise, from a supply-side perspective, they can form the
basis of a SME subcontracting compact or “code of conduct”. A demonstrated
adherence to such a compact or code would qualify the SMEs concerned as possible
subcontractors or supply partners, just like an ISO certification does for quality
control, assurance and management.

3. ICTs and e-commerce

The issue in this context is not whether to assist SMEs to invest in ICT-based facilities
and services. Rather, it is how best to encourage SMEs to make the most
cost-effective use of the new technologies in production, marketing and
networking. A word of caution is necessary, however. Firstly, the tremendous
expansion of digital connectivity and e-commerce has been highly concentrated in
North America and Western Europe, as pointed out earlier. Secondly, many regional
SMEs, those on the top layers in priority industries and sectors especially, will surely
have “to go with the flow” of electronic interactivity (or be crushed by it). As surely,
however, there is an extensive agenda to be accomplished before large segments of
the regional SMEs can be transformed into the so-call “virtual” enterprises and
entrepreneurs.

Within the middle- and low-income countries in Asia, for example, the constraints on
e-commerce among SMEs are simply wide ranging. Significant efforts have to be
made by both the public- and private sectors to create, regulate, stabilize and
legitimize the domestic markets for e-business. The process has to take place in
conjunction with measures to build up the ICT and e-commerce capabilities and
potential of the targeted SMEs. An over-arching issue in these connections is the
quality, relevance and accessibility of domestic institutions for education, training and
extension services to underpin a more effective diffusion and adaptation of ICTs
economy-wide.

4. Policy consistency
An enabling policy and institutional environment matters even more in another
context. Because of their limited scale of operations, the costs of participation and
capacity building are relatively more disproportionate on SMEs, compared to those
shouldered by the large firms. At the same time, by default or accident, changes and
adjustments in the policy, regulatory and institutional framework have not always
empowered SMEs. The sector and its entrepreneurs are often constrained by opaque
discretion, over-bearing regulations and expensive delays. A compounding factor
operates at the same time -- namely the well-known “perverse incentive syndrome”
facing most SMEs.

A one-stop agency for the promotion of SME development would prove helpful, just
like its counterpart in the promotion of foreign direct investment. There has been
some centralization of responsibilities in a number of countries, including Malaysia
and Thailand, where the main concern is to ensure better coordination and greater
coherence and consistency of policies and regulation impinging on SMEs. However,
other important functions include advocacy, outreach (especially in capacity building
and information dissemination), and policy performance and impact
evaluation. Again, an effective discharge of these functions would depend
significantly on the systematic and sustained collection of data and information for the
monitoring and benchmarking of SME capabilities, competitiveness and adherence to
certain subcontracting benchmarks or code of conduct, as discussed earlier.

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Source: http://www.aseansec.org/ 10/2002