CHAPTER ONE

INTRODUCTION

The purpose of the dissertation is understanding the challenges that effect the development of
new Businesses in a developing economy. This introductory chapter sets the context of the study
by presenting a case of a metalwork business and a literature review and its discussion. The
introductory chapter also gives the purpose of the dissertation, the research questions it poses and
finds answers to, and provides the structure of the study.

1.1 background of the study

Micro and small enterprises (MSEs) are believed to have a vital role in poverty reduction,
employment generation as well as economic development in poor countries like Ethiopia. The
Ethiopian MSEs sector includes a diverse set of operators ranging from petty traders to small
restaurant owners; shoeshine boys to small shoe making enterprises; peddler in the streets to
grocery business operators, etc. Micro enterprises are the smallest, informally organized business
activities while small enterprises are rather formal businesses that fall under purview of the
country’s legal and regulatory system. According to the MWUD (2007), MSEs sector is believed
to be the major source of employment and income generation for a wider group of the society.
The major objective of MSEs development program, which is creating and promoting MSEs in
urban areas, envisages reducing urban unemployment rate.

globally; In recent times the world economy has developed tremendously and this development
can be attributed to activities of Small and Medium Scale Enterprises (SMEs), especially in
developing countries of world (Ariyo, 2005). Basil (2001) reports that the roles played by small
and medium scale enterprises in communal and economic development cannot be overestimated.
The author further documents that SMEs sector is the highest employer of labour and it
contributes immensely to the GDP of any meaningful economy. According to Zonouzi, Hoseyni,
and Khoramshahi (2021), one of the significant challenges in the Iranian labor market is the
closed, unchanged, and liberalized space of the laws and regulations, which is characterized by
an annual decline in its position and rank in the global business arena. However, identifying and
removing the existing barriers, especially political factors, contributes to organizing the business
environment. However, the unfavorable situation of the business environment related to the
unilateral sanctions has led policymakers and planners to resort to interim health policies in the
critical conditions of the Iranian economy. The actual production overtaking is regarded as one
of the implications. SMEs play a key role in the development of European territory: they
represent the main source of occupation (SME annual report 2019; Cerved 2020; ISTAT 2021)
and are considered the first authors of innovation activities in the local contexts (Gilmore et al.,
2013; Labudová & Jánošová, 2019; Mina et al., 2016) contributing to the development of the
entrepreneurial spirit of a region (Staniewski et al., 2015; Del Baldo & Demartini 2016; Del
Baldo & Matacena, 2009; Del Baldo, 2012); it is precisely the ability to be innovative at the
basis of their continuous competitiveness (Juergensen et al., 2020). Against the European
landascape, Italy holds a specific place in the debate on SMEs and Innovation capabilities (Hall,
Lotti, & Mairesse, 2009.) as well as specific criticalities (Carletti, Oliviero, Pagano et Al. 2020;
Confindustria 2020). This key role is guaranteed by some firm-specific characteristics of SMEs:
they have a flexible and simple structure (Tonino Pencarelli, 2021)

In Africa; s. Oluboba (2010) reports that the main problems facing SMEs, which are however
not unsurmountable are: low level of entrepreneurial skills, poor management practices, low
access to money and capital markets, low equity participation from the promoters because of
insufficient personal savings due to their level of poverty and low return on investment,
inadequate equity capital, poor infrastructural facilities, high rate of enterprise mortality,
shortages of skilled manpower, multiplicity of regulatory agencies and overbearing operating
environment, societal and attitudinal problems, integrity and transparency problems, restricted
market access, lack of skills in international trade; bureaucracy, lack of access to information
given that it is costly, time consuming and complicated at times. In the same vein Onugu (2010)
reports that the major challenges facing SMEs include; insufficient capital, lack of focus,
inadequate market research, over concentration on one or two markets for finished products, lack
of succession plan, inexperience, lack of proper book keeping, lack of proper records or lack of
any records at all, inability to separate business and family or personal finances, lack of business
strategy, inability to distinguish between revenue and profit, inability to procure the right plant
and machinery, inability to engage or employ the right caliber of staff, painlessness, cut-throat
competition, lack of official patronage of locally produced goods and services, dumping of
foreign goods and over-concentration of decision making on one (key) person, usually the owner.
Challenges which SMEs face in Nigeria include irregular power supply and other infrastructural
inadequacies. unfavourable fiscal policies, multiple taxes, levies and rates, fuel crises or shortage,
policy inconsistencies, reversals and shocks, uneasy access to funding, poor policy
implementation, restricted market access, raw materials sourcing problems, competition with
cheaper imported products, problems of inter-sectorial linkages given that most large scale firms
source some of their raw material outside instead of sub-contracting to SMEs, insecurity of
people and property, fragile ownership base, lack of requisite skill and experience, thin
management, unfavourable monetary policies, lack of preservation, processing and storage
technology and facilities, lack of entrepreneurial spirit, poor capital structuring as well as poor
management of financial, human and other resources (Dabor, 2017).

In Ethiopia; The Ethiopian MSE (micro and small enterprises) Development Strategy of 1997
had the objectives of facilitating growth and equitable development, creating long-term jobs,
strengthening cooperation amongst MSEs, establishing a basis for growth to medium and large
enterprises, and export promotion. However, there is little evidence of specific, concrete and
practical measures taken by the government to address the barriers faced by women-owned
MSEs and no provisions have been made for facilitating growth-oriented women entrepreneurs
(ILO,2004). According to Aregash (2005), 98% of business firms in Ethiopia are micro and
small enterprises, out of which small enterprises represent 65% of all businesses. the most
critical problems facing small businesses in Ethiopia’s Amhara region are the difficulty of
getting funds, poor infrastructure, corruption, difficulties in securing raw materials, lack of
skilled employees, peace and security issues, challenges in getting licensing, and the absence of
specific small business authority. Even though the political crisis is country wide and affects the
business sector in the whole nation, the study is limited to Amhara region only due to certain
constraints such as financial problems and time (Beshir, 2022) . Small enterprises play a
prominent role in enhancing a nation's economy and can provide income generation opportunity
for low-income groups. These small-scale enterprises offer a work culture and boost the
economy against economic crises, such as low per capita income, poverty, and unemployment.
Based on the Government of Ethiopia, the sector contributes to job opportunities, income
creation, and poverty alleviation. It is the primary source of employment and income for urban
dwellers in most developing countries (Abagissa, 2013)
The above problems are indicators of the existence of skill problems that are posing
challenges to the development of Micro and Small Enterprises in Ethiopia. Therefore, this
study will analyze the entrepreneurial, technical, support scheme of the government,
interpersonal and business skills that lead a success of Micro and Small Enterprises.
1.3 Statement of the problem

MSEs in Ethiopia are expected to play a significant role for national growth and development as
well as minimize unemployment and related social problems. In Dire Dawa, the sector has
stagnated and remains relatively small in terms of its contribution to economy or to gainful
employment. According to Dire Dawa Administration MSEs Development Agency, there are
374 MSEs, which created job only to 5116 people. This indicates that the role of the MSEs in the
city regarding job creation and economic development is very insignificant. There are large
numbers of small scale enterprises in the city. However, the city has not yet exploited their
potential very well to contribute for economic development, job creation and poverty reduction
of the city and the country as a whole.
Research Questions
1. What are the business challenges facing small and micro-enterprises operating within dire
dawa City?
2. .What strategies are employed by small and micro-enterprises in countering the challenges
that they face?
3. What guiding principles can help small and micro enterprises to improve their performance?

1.3.Objective Of The Study1.3 Objectives of the study

The general objective of this study was to examine determinants of growth and diversification of
MSEs in Dire Dawa Administration. The specific objectives of the study were:
• To assess the structure of growth and diversification.
• To identify factors affecting growth of MSEs; and
• To identify factors affecting diversification of MSEs.
3.4.Definitions of some concepts
Though there are different definitions of micro and small enterprises5 , the revised definition of
MSEs by the Ethiopian government will be used in this study (Table 1). Accordingly,
employment and assets have been used to define MSEs (FDRE, 2011).

1.5.1. Newness and smallness of a business

As the liability of newness and smallness co-exists, there is a need to conceptually differentiate
between the two (Bruderl & Schussler, 1990). Stinchcombe (cited in Bruderl & Schussler, 1990,
p. 530) characterized the 'newness' of a business as new roles and tasks to be learned and
invented, social interactions in the organization among strangers lacking a common normative
basis or informal information structure, and stable links not being established with clients,
supporters, or customers when an organization begins operations. In addition, the term 'new' is
used in connection with age related to the extent of accumulated experience (Aldrich & Ruef,
2006). The concept of 'experience' corresponds to the degree of a prior actual engagement with
activities (Heidegger, 1962). As there is more engagement, there is more accumulation of
experience. Thus, newness is the degree of a business’ prior engagement with stakeholders and
internal processes. Therefore, aging and lasting in absolute time are not synonymous (Aldrich &
Ruef, 2006).

Smallness is about size. There are different measures for the size of a firm. Measures of
smallness of businesses are context specific (Shepherd & Wiklund, 2009). In Ethiopia, two
government agencies use different indicators to categorize firms economically into different
groups. On the one hand, the Federal Small and Micro Enterprises Development Agency
categorizes firms into four groups -- micro, small, medium, and large -- as a base for its micro
and small enterprises development strategy and support frameworks (FDRE, 2011; Ministry of
Trade and Industry, 1997). The agency uses total assets and a headcount of the workers that a
business employs as criteria for dividing firms into these categories. In addition, the type of
sector, that is, industrial or service, that the firm is operating in is also considered. As a result,
enterprises in the industrial sector with up to five workers or/and whose total assets are not more
than 100,000 Ethiopian Birr are categorized as micro-enterprise. For the service sector, the
criteria include five workers or/and total assets not more than 50,000 Ethiopian Birr. Similarly,
the criteria for small enterprises in the industrial sector is those firms employing 6-30 people
or/and total assets of 100,001 Birr up to 1.5 million Birr. A small service enterprise employs 6-
30 people or/and has total assets between 50,001 and 500,000 Birr. Further, the agency indicates
that if there are divergences between the workers’ headcount and total assets, total assets will be
the leading criterion. An enterprise above the indicated size is categorized as either a medium
sized or a large sized enterprise. Since the agency’s mission is supporting micro and small
enterprises, it does not define the exact demarcation between medium and large sized firms.
Further, the definition of the agency excludes higher technology and consultancy service firms.
There are many definitions related to the concept of micro and small enterprises. They differ
between organizations and countries; some look at it from the point of the number of employees.
Another view is in terms of the size of capital. According to International Labor, there is found
to be 75 definitions within 50 industrialized and developing countries. I consider the number of
workers as a criterion for distinguishing between micro, small and medium enterprises. There is
no agreement on a specific number as a basis for determining the size of MSEMs; the number
varies according to the degree of industrial progress, which in turn differs from one country to
another. In Ethiopia, although there is specific legislation in which to distinguish micro and small
enterprises from large enterprises, any of the following sources can be guided: the legislation
which is effective from 2000 defined micro and small enterprises as any income-generating
activity in the field of industry, trade, or services (excluding primary industries) that employs not
more significant than ten workers and with a paid-up capital of not exceeding 20,000 birrs for
micro and 50,000 birrs for small enterprises respectively, who are working in hotel and tourism,
manufacturing and poultry, etc. (Beshir, 2022).
1.5.2. Definition of Micro and Small Enterprises (MSE’s)
There is no generally accepted definition of MSE’s across the globe. Some of the commonly
used criteria include number of employees, asset values, revenue (Sales) and amount of capital
they have and initial investment (Seyoum, 2016). There is no any single definition that can
reflect the differences between MSE’s. Even if organizations give a working definition to MSE’s,
mostly non-definitional policy was adopted by different international organizations across the
globe (UNCTAD, no date). The MSE’s sector is a diversified activity which creates livelihood
opportunity and serve as a remedy to curb the problem of unemployment and poverty (Firasew,
2011). Considering different factors, MSE’s are defined in different ways across the world. Even
though, many countries use common factors for the definition of MSE’s their degree of emphasis
and measures employed quite differ considerably. The factors considered include number of
employees, sales volume, and the capital of MSE’s. Generally, there are operational and
theoretical definition of MSE’s. The first one is largely used for working purposes and the latter
is employed to characterize the sector. Recently, particularly in Europe, there has been some
degree of convergence in the definition of MSE’s. The European Commission used a
combination of employee numbers, annual turnover or balance sheet total and ownership while
defining MSE’s (Zemenu, A., & Mohammed, M., 2014). The official definition of Micro and
Small Enterprises is an enterprise having 10 or less workers (Gebrehiwot, A., & Wolday, A.,
2006). Enterprises having a paid-up capital below 20,000 ETB excluding consultancy or other
firms that use advanced technology are Micro enterprise whereas enterprises having paid up
capital ranges between Birr 20,000 and 500,000 and save other firms using high technology are
small enterprises (Belay, K., Asmera, T., & Tekalign, M., 2015).
1.5.2. ‘Developing’ a business
‘Develop’ is defined in the Oxford Advanced Learner's Dictionary of Current English (p. 995) as
"to start or cause something to start to exist and then become greater." Penrose (1959)
conceptualizes the ‘development' of a firm as an increase in its size or an improvement in its
quality. Likewise, defining a process as progression or the order and sequence of events in an
organizational entity’s existence over time and change as the difference in form, quality, or state
over time in an organizational entity, Van de Ven and Poole (1995, p.512) describe development
as a change process – a progression of change events unfolding during the existence of a
business. Further, Kind and zu Knyphausen-Aufseß (2007, p. 185) define business development
as all activities intended to "creating value and revenue potentials for the company, developing
products and technologies so that they can be commercialized, building relationships with
potential partners, customers and other stakeholders, and maintaining and enhancing those
relations in the interest of the company.” This definition connotes conscious human actions and
decisions. Accordingly, the discussions in this dissertation deal with conscious activities, actions,
and decisions in the process of developing new businesses. Therefore, my definition of
‘developing’ incorporates both the activities and actions of the agents which is in line with Kind
and zu Knyphausen-Aufseß’s (2007) conceptualization and the progress of change in a firm as
conceptualized by Penrose (1959) and Van de Ven and Poole (1995). Thus, the definition of
developing used in this dissertation is developing is increasing a firm’s size and improving its
quality over time as a result of initiating and improving an offer; building, maintaining and
enhancing relationships with potential stakeholders; and acquiring the necessary resources.

1.5.3. Informal enterprises or informal firms

The terms informal business and informal enterprise are used interchangeably. The concept
informal business is used in this dissertation to designate firms operating outside government
regulations (Nelson & De Bruijn, 2005) which do not register their trade, issue invoices, or pay
income tax (Fransen & Van Dijk, 2008; Nelson & De Bruijn, 2005). Informal business activities
are actions performed by both formal and informal enterprises when they do not act in
compliance with government rules and regulations (International Labour Office, 2000). Informal
business activities also connote intra-firm activities performed not in accordance with internal
rules and regulations (Godfrey, 2011; Kok & Berrios, 2019).

1.5.4. A developing economy

Economies/countries in the world are classified into different groups by different international
Organizations like developed economies, economies in transition, and developing economies
(United Nations, 2018). When an economy’s degree of integration into the global financial
system, fuel exports, and per capita gross national income (GNI) are considered Ethiopia, falls
among the developing economies (United Nations, 2018).This dissertation focuses on businesses
operating in the Ethiopian economy. This means that the new businesses operate in the economy
with a low degree of integration with the global financial system, have low fuel exports, and low
per capita GNI. (Gutu, 2020).
1.2.2. Determinant factors of MSE’s
Albeit the degree of the effects is different from one to another, MSE’s can be affected by both
internal and external factors. The factors having strong positive relationship with the growth of
MSEs include factors related with working premise, management and experience, marketing,
infrastructural, financial factors, and also factors related with the external environment
(Mengesha, B. T, 2018). Some of the most critical factors affecting MSE’s include work
premises, access to fifinance, infrastructure, entrepreneurship and business managerial problems
(Cherkos, T., etal, 2018). Furthermore, age of manager’s or owner’s, marital status and education
were also important factors affecting growth of MSE’s in the study area (Tarfasa, S., et.al, 2016).
The development of MSE’s can be affected by internal and external factors the former includes
human resources, finance, production, marketing and development strategy and the external one
includes policies of the government, socio-economic, cultural, the role of related institutions, and
information technology as well. Moreover, there are also other factors that determine the
performance of MSE’s including capital, training, information about the market, marketing
network, product promotional, and institutional capacity (Munizu, M., 2016).

1.2.3. Challenging factors of MSE’s

In Addis Ababa Ethiopia, about 55% and 64% of MSE’ affected by the problem of access to
finance. Majority of the MSE’s in Adds Ababa have not accessed loan due to bulky bureaucracy,
limited working premises, and also high collateral requirement (Tarfasa, S., et.al, 2016). Sources
of finance and loan term, low educational level of managers and entrepreneurs, the problem of
working premise provided by government are the problems of MSE’s (Fufa, F. G., 2015). The
problems that MSE’s are facing include: intensive competition, lack of credit facility, starting
business without conducting survey, inappropriate imposition of tax, inappropriate tenure, lack
of business training, lack of working capital, absence of appropriate technology, bad debts and
lack of financial management skill and experience (Zemenu, A., & Mohammed, M., 2014).
Some of the challenges that MSE’s are facing in Ethiopia includes the problem of access to
finance, selling at less price compared with other similar enterprises, lack of access to raw
material, lack of experience in own business, limited market access, lack of working premise,
lack of training access, cultural oppressions, high level of competition, the development strategy
and policy of the country focusing on agriculture than others, unappealing market, lack of
promotion due to the problem of working capital, high tax, unachievable collateral requirement
and high interest rate by credit institutions, lack of technology, weak performance, and lack of
financial management skill (Abdulmelike A, 2018). Some of the foremost regulatory challenges
that MSE’s are facing include high taxes, the problem of tax administration, high collateral
requirement, absence of working premise and lack of supports (Gebrehiwot, A., & Wolday, A.,
2006). While taking credit most MSEs are forced to use the informal institutions in which there
is limited amount of money to meet their credit needs and requirement. This is due to the fact
that there is requirement of collateral, high interest rate and also other governance and related
accountability issues in the formal financial institutions (Abera A, 2012). The most challenging
factors that hinders the growth of MSE’s were problems related with marketing, accounting and
financial related factors, infrastructural factors, technological, business location, educational
status and experience (Samuel B, 2019). Less amount of capital for investment, regulatory
framework, lack of collateral and socio-cultural beliefs and practices are among constraining
factors that influence the MSE’s performance (Osoro, K., & Areba, A., 2013).

1.2.4. Micro and Small Enterprises (MSE’s) in Ethiopia

In Ethiopia, particularly for the low-income earners, the poor and women groups, the micro and
small enterprises (MSE) sector is important. These can be seen from their relatively large
presence in the country, share in employment and small capital requirements. There are
sufficient reasons for governments and other stakeholders in development to be interested in
micro and small enterprises. MSEs are seen as an emerging private sector, forming the basis for
private-sector-led growth in the context of many developing countries, including Ethiopia. In
Ethiopia, at the level of strategy and policy, the roles of MSE’s have received recognition and
seen as means of providing employment, alleviating poverty, ensuring food security, and private
sector development (Gebrehiwot, A., & Wolday, A., 2006). With regard to the promotion in the
community-building and social activities in the rural and small towns, the private small
businesses and micro-enterprises create jobs and new opportunities (Weldeslassie, H. A., Etal,
2019). To improve the performance and role of MSE’s in reducing poverty, transformation of
industries, reducing unemployment and overall development of the economy, lot of efforts has
been made by the government (Cherkos, T., et al, 2018). In Ethiopia MSE’s are recognized as
important vehicles of economic growth, employment creation, income generation, and poverty
reduction, due to these facts, they occupy a prominent position in the development agenda of the
country (Fufa, F. G., 2015). Even though MSMEs make the smallest total proportion of assets,
their contribution to employment creation is much higher than that of medium and large
enterprises (Weldeslassie, H. A., Etal, 2019). In Ethiopia’s industry development plan, MSE’s
given a recognition in and they are considered as vehicles for employment opportunities
(Alemayehu, D. et al., 2016). Within the Industrial Development Strategy of the country, the
Micro and small enterprise (MSE’s) development holds a strategic place. They are the key
instruments of job creation in urban centers, at the same time as job creation is the core of the
country’s development plan. MSE’s development should be one of Ethiopia’s top development
priorities as they play a pivotal role in employment creation (MoUDH, 2016).
 Chapter two
Literature review
2.1. Introduction
The Ethiopian government is implementing a national development plan, the Growth and
Transformation Plan II covering the period 2016/16-2019/20 (National Planning Commission,
2016). The plan has a national vision of becoming a low middle-income country by 2025
(National Planning Commission, 2016). This was preceded by the Growth and Transformation
Plan I covering the period 2010/11-2014/15 (MoFED, 2010). In these national plans, micro- and
small businesses are recognized as important contributors to the gross national product. Hence,
the SMEs, small- and micro-enterprises Development Agency facilitates the preparation and
implementation of national level policies and strategies supporting the development of small-
and micro-businesses in the economy. The Ethiopian economy provides a context for studying
new business development as the government is intervening in new business development
through industrial policies (Mkandawire, 2001) and there are significant economic activities in
the informal sectors (Franken & Van Dijk, 2008). The Ethiopian government provides diverse
support to SMEs like a workspace, skill training, consultations, market development, technology
support, and access to finance (Amha et al., 2015). This support is provided during five
consecutive years or less and it targets formal enterprises and not informal ones (Walther &
Filipiak, 2007). However, many small businesses are informal (about 26 percent of the recorded
economy) which evade tax payments of about 10 percent (Asaminew, 2010). For a long time,
the country had socialist leanings and the private sector was discouraged (Brixiova & Asaminew,
2010; Geda & Degefe, 2002; Taddesse, 1992). Taddesse (1992, p.172) examines the suppressive
laws and regulations of the socialist government for privately-owned small-scale industries in the
economy and says: Investment was restricted to certain areas of activities. Excluding building
and land development costs, allowable private sector investment in small-scale industries was no
more than Birr 500,000. And a one-man-one license principle was in force. A number of
discriminatory mechanisms in project financing, foreign exchange allocation and raw material
rationing were also applied. These restrictions pulled back the rate and scale of development of
new businesses in Ethiopia (Taddesse, 1992). The 1991 revolution overthrew the socialist
government and changed the economic landscape of the country. The new government
introduced market reforms, reduced bureaucratic procedures, and encouraged the private sector
(Geda & Degefe, 2002). At the outset, the government pledged to minimize its role in economic
activities to allow the private sector to take on this role gradually. Since 1991, the Ethiopian
economy has been struggling to overcome the burden of its socialist practices. There are also
very few formal small-scale enterprises in the country (Brixiova & Asaminew, 2010; Wudneh,
2005). From 1991 to 1997 the Ethiopian government supported small businesses under the
investment incentive scheme (IIS), including exemption from income tax and duties on imported
capital goods (Ayele, 2006). The main objectives of the scheme were to induce indigenous
startups, and influence SMEs operated in specific industries and locations (Ayele, 2006; Brixiova,
2009). This has grown into a compressive SMEs development policy and strategy in 1997.

2.2. SMEs development policy and strategy in Ethiopia

The first compressive SMEs development policy and strategy in 1997 was revised in 2011. The
policy documents make explicit the expected socioeconomic roles of new businesses in the
economy. With the primary vision of becoming a competitive economy, businesses are expected
to create job opportunities, increase the society’s income and its fair distribution, and trigger
sustainable economic development (FDRE, 2011; Ministry of Trade and Industry, 1997).
Businesses are also expected to sustain rural development. To these ends, the support package
considers new businesses in selected sectors of the economy (FDRE, 2011; Ministry of Trade
and Industry, 1997) including manufacturing, construction, services, trade, and urban agriculture.
The policy documents pay special attention to the manufacturing sector. In addition, new
businesses with a larger number of owners, females in the ownership, disabled owners, and
members with HIV/AIDS are prioritized for support (FDRE, 2011). Acceptance of a new
business in the support system is related to some pre-conditions like willingness to engage in
priority sectors, willingness to work in a team, and support letters from the local administration
where the entrepreneur resides. However, new businesses engaged in activities such as beauty
salons, stationary, health services, and education services do not qualify for the support package
(FDRE, 2011; Ministry of Trade and Industry, 1997). The implementation of the SMEs
development policy is managed by a mainstream government structure in which the federal
SMEs Development Agency is at the top. The structure includes the SMEs Development
Agency’s offices in regions and city administrations and continues to the lowest administration
unit. The SMEs Development Agency is mainly working at helping unemployed citizens (FDRE,
2011; Ministry of Trade and Industry, 1997). Unemployed citizens with academic qualifications
(diploma and degree certificates) are supported for starting new businesses related to their
professional training. For example, graduates from the department of civil engineering are
supported in establishing new businesses in the construction sector. Likewise, graduates from
computer engineering are supported in starting new businesses in computer maintenance and
sales. Unemployed citizens with no formal education are required to take short-term training in a
priority sector of their preference for starting a company. On completion of the training, they are
required to pass an examination to obtain a certificate of competence (COC). With the certificate,
they can apply for start-up support to the local SMEs Development Agency. Then, they can go
through the required administrative procedures to start a new business. Entrepreneurs have to
register the new businesses as sole proprietorships, partnerships, private limited companies, share
companies, or cooperatives. They are also required to register for trade licenses and taxpayer
codes. An officer in the SMEs Development Agency’s office at a sub-city level said this about
the process: … in general, there is a lot of support given by the micro and small development
office. If we see from the beginning to the end, first the office is working at creating job
opportunities in society. The main criterion for selecting individuals is joblessness! Graduates
and unemployed (persons) are screened through the lowest administration level (at the kebele
and woreda levels). The individuals need to prove that they are jobless. During registration, the
classification is be done as per the sector choice of the individuals which can be construction,
textiles, garments, weaving, tannery, or brick producing. Then the list is given to the TVET
school and they get training as per their registration. Based on the certificates that they get from
TVET, they go to the local micro and small enterprise development office and they go through
the administrative process and start their enterprises.

2.3. Support schemes

The Ethiopian government gives different kinds of support to selected new and existing
businesses in Ethiopia including land, working premises, training, market linkages, purchase
facilitation, equipment on lease, and financial loans (Amha et al., 2015). This support is meant to
help the new businesses play a role in the economy and continues during the first five years of
the businesses. After this period, the support stops as the new businesses are expected to be self-
reliant by then (FDRE, 2011; Ministry of Trade and Industry, 1997). The SMEs development
policy and strategy classifies support schemes according to the scale and growth stages of a new
business. Accordingly, the support packages are intended to enhance the economic viability of
small- and micro-businesses and facilitate the transition of new businesses from the micro-
enterprise level to the medium-scale level. Hence, the agency categorizes businesses into four
groups (micro, small, medium, and large) as a base for different support frameworks (FDRE,
2011; Ministry of Trade and Industry, 1997). As shown in the policy documents, the agency uses
total assets and headcount of workers as criteria for dividing the firms into these categories. In
addition, the type of sector, that is, either industrial or service, of the firm is also considered. As
a result, enterprises in the industrial sector with up to five workers or/and whose total assets are
not more than 100,000 Ethiopian Birr are categorized as micro-enterprises. For the service sector,
the criteria for a micro-enterprise include five workers or/and total assets not more than 50,000
Ethiopia Birr. Similarly, the criteria for a small enterprise in the industrial sector is employing 6-
30 people or/and total assets between 100,001 and 1.5 million Birr. A small service enterprise is
one that employs 6-30 people or/and whose total assets are between 50,001 up to 500,000 Birr. A
business in the industrial sector with a capital of 1.5 million Birr and employing more than 30
permanent employees is a medium sized business. Likewise, a service business with a capital of
500,000 Birr and employing more than 30 permanent employees is a medium sized business.
Further, the agency stipulates that if there is a discrepancy between the staff headcount and total
assets, total assets will be the determining criterion. Since the agency’s mission is supporting
micro- and small-enterprises, it does not define the exact differences between medium and large
size. Further, the agency’s definition does not include higher technology and consultancy service
firms (FDRE, 2011; Ministry of Trade and Industry, 1997). Moreover, the policy documents
divide each scale of a new business into three growth stages:
start-up stage, young stage, and established stage. A new business starts as a micro-scale start-up
or small-scale start-up depending on the number of employees and the capital that it has
registered. Then, the transition between growth levels is based on a rigorous evaluation done by
the agency. A new business’ evaluation starts after six months of its formation and requires a
financial audit. The new business is evaluated through nine criteria before being promoted to the
next growth level. A government official of the SMEs growth stage transition case team in a sub-
city said: … The (evaluation) criteria include number of jobs created, capital level, profitability,
market size, productivity, utilization of previous support, use of improved technology,
organizational management and structuring, and discharging responsibilities (paying taxes and
renewing the trade license). Based on the evaluation’s results the businesses are rated out of 100
percent. Then, they get promoted to next higher-level by considering their number of employees
and capital levels.
2.3.1. Stages of growth in a new business, challenges, and related support
To understand how the SMEs development policy and strategy works in practice, the various
stages of growth and the challenges faced by the new businesses are now discussed. The
government agency’s officers include a trade regulatory and inspection officer while officers in
the SMEs Development Agency include a market linkage service officer, a manufacturing case
team officer, and a growth level transition case team officer. It is assumed that the support given
to new businesses will reduce the challenges that they face and accelerate their development
based on their growth stages -- start-up, young small, established small, and early medium
growth. The policy recognizes three stages of small businesses before they progress to the
medium stage. Support starts during the start-up stage. At this stage, the new business needs to
become a legal entity and begin producing and rendering services. The start-up phase faces many
challenges like lack of initial capital, lack of knowledge of legal business forms, lack of
knowhow in bookkeeping and business operations, and lack of entrepreneurial skills. As a result,
the local SMEs Development Agency encourages entrepreneurs to have their own saving
accounts as seed money and/or mobilizing their families for money. The SMEs Development
Agency supports small businesses with seed money to get loans, benefit from state-owned
projects and programs, supports the start-up to set-up stages of their legal business forms,
acquiring taxpayers’ codes, getting legal trade certificates and registration, and providing
training on basic business management, entrepreneurship skills, and basic bookkeeping (FDRE,
2011). After the start-up stage is complete comes the young/early growth stage. At this stage, a
new business strives to become competitive in terms of prices, quality, supply, and profits by
making use of the support that it is given. The young business grows in manpower and total
assets. It relies on bookkeeping systems. At this stage, a business faces challenges like lack of
timely and adequately finance for the nature of its work. The entrepreneur also lacks the
necessary skills and technology for improving productivity and the quality of its products. The
young business does not know about the standards to be maintained and is unable to obtain
proper premises and sales points. Hence, a business may indulge in illegal business practices
(FDRE, 2011; Ministry of Trade and Industry, 1997). The policy document prescribes solutions
like facilitating the supply of regular loans, supporting the development of business plans,
strengthening skill and technology support, providing working and sales places at affordable
rents, and helping the enterprises to operate within the legal framework (FDRE, 2011). The last
stage of a small business as recognized by the policy is the established stage. At this stage, the
business is competitive and profitable thanks to using the support given; the business is also able
to garner new investments. The challenges at this stage include incapability to produce
sustainable and quality products for becoming competent in the market, lack of awareness about
international standards regarding production and productivity, and limited capacity to get
technology and means of production to ensure its competitiveness in the market (FDRE, 2011).
The interventions required at this stage include creating a competitive enterprise (providing
training that capacitates production and productivity and providing market expansion support
help in using modern international standards in the relevant sectors), identifying the means of
production and lease that helps a business to move to the early medium growth stage, and
certifying the enterprises that move to this stage (FDRE, 2011; Ministry of Trade and Industry,
1997). As a small business moves through these established stages, it gets promoted from the
small to the medium stage of growth (FDRE, 2011). With this transition, using production and
selling clusters/centers stops. The business also cannot get loans from micro finance institutions
(MFIs), and government purchase benefits also stop. The manpower that is developed by using
technical and vocational educational institutions also stops and a business is required to have
complete bookkeeping records and submitting financial statements approved by auditors. The
business also has to pass through strict controls pertaining to taxes and VAT (FDRE, 2011;
Ministry of Trade and Industry, 1997). These new challenges discourage some small businesses
from progressing to the medium stage. The following quote taken from interview with an official
of the SMEs growth stage transition case team in a sub-city to substantiates this: After five years
of supporting small businesses, whether they are transformed to medium businesses or not, they
are forced to leave the working premises given by the SMEs Development Agency. If they
succeed in achieving a medium stage, their connections have to be with the investment office in
the area. The SMEs Development Agency is connected to these businesses for sharing
experiences, and they serve as medium sized businesses serve as learning site for small
businesses under the support of the agency. No further support is given to businesses that are
promoted to medium size or to those businesses which are forced to leave their working premises.
The premises are used for other newly established small businesses. An officer of the SMEs
Development Agency talked about the challenges that entrepreneurs face when their businesses
are promoted to medium size: … there are directives prohibiting support from the SMEs
Development Agency which have been promoted to medium size for creating market linkages.
Businesses complain that they do not get access to market linkages. According to them being
promoted is meaningless and they start thinking of dissolving their enterprises and establishing
SMEs to get market opportunities and employment. Enterprises also complain that having a
graduation certificate (certificate of promotion to the medium size) and thus getting an
investment certificate is harmful for them. However, the government facilitates this transition by
providing a readymade industrial zone, buildings for production and sales, and provisions for
reasonably leased land; support through loans from commercial and development banks; and
priority in getting foreign currencies (FDRE, 2011). Thus, different support is given to new
businesses at different stages of their growth considering the challenges that they face. As a base
line, the policy documents recognize that a significant number of small- and micro-businesses
operate as informal businesses and remain small because of the different challenges that they
face including lack of raw materials, capital, and working premises (FDRE, 2011; Ministry of
Trade and Industry, 1997). When it comes to SMEs’ contributions for tackling the challenges of
unemployment, economic growth, and equity in the country, the policy document shows a
systematic approach in alleviating SMEs’ problems and promoting them to medium and large
firms (FDRE, 2011). The policy document specifies the main challenges faced by small
businesses at different stages in their development and the actors responsible for supporting the
businesses. The responsible actors include the SMEs Development Agency, MFIs, the local
government administration, nongovernmental organizations (NGO), capital asset leasing
organizations, the Development Bank of Ethiopian, and vocational and training institutions
(FDRE, 2011; Ministry of Trade and Industry, 1997). All these organizations play different roles
individually and in collaboration with others, at different stages of growth of small businesses.
2.4. Informal economic activities in the Ethiopian economy

In general, informal economic activities make a significant contribution to many economies. For
example, Kok and Berrios (2019) indicates that informal economic activities constituted up to 60
percent of the total employment across the 99 countries sampled, ranging from less than 5percent
in several high-income countries to more than 90 percent in several low-income countries.
Moreover, scholars like Fransen and Van Dijk (2008) show the prevalence of informal business
activities in the Ethiopia economy. Most economic activities like bicycle repairs at the corner of
the street, many small traders along the roads, and all kinds of small-scale transportation are
informal in Ethiopia (Fransen & Van Dijk, 2008). The Central Statistical Agency of Ethiopia
characterizes informal business activities as those having no books of accounts and having no
licenses, but making products / services for the market (CSA, 2013). In this context, formality
signifies the practices of starting and operating businesses according to trade laws and
regulations; the other businesses are considered informal businesses. Formalization of a business
involves trade registration and making required payments like paying the income tax. A review
of the SMEs development policy and strategy document and interviews with government officers
show that the Ethiopian economy has a significant number of informal new businesses, along
with the formal ones. From the interviews, I learned that many entrepreneurs prefer to operate
informally, avoiding the costs and controls related to becoming formal entities but they get
money from the production of legal goods and services. These make the businesses competitive
as compared to the formal ones. However, some businesses operate as informal businesses as
they cannot afford the costs of running formal businesses. This condition is recognized by the
Ethiopian government and it provides support to these businesses. An officer of the Trade and
Industry Bureau in a sub-city said: …In the sub-city in general there are different types of very
small business activities. There are many people with ambition and skills for undertaking trade,
but they lack the capacity to penetrate the market. Taking this into consideration, the city
administration made Saturdays and Sundays free for informal traders to supply their goods on the
streets. The city administration understands that these traders cannot rent shops because they do
not have enough capital. So, on weekends the main roads are open to them for selling their
products freely. A special feature of the sub-city is that there are large sales of cultural clothes
which come with weaving patterns. The weavers do not have enough capital to sell their products
in bulk. To solve this problem the sub-city constructed a shade in the open market area and every
Saturday and Sunday these people can sell their products in the shade. They are informal traders
but are facilitated with land and shade to earn their livelihood. This helps them as they have a
fixed place for selling their products rather than wandering here and there on the roads in the city.
This also helps them accumulate resources which they use later to form formal businesses. After
working for some time as informal businesses in the area provided, the businesses get another
shade where they operate formally after securing trade licenses and getting competency
certificates. The work done by the trade and industry bureau before the businesses become
formal is called preparatory work. After some time, most entrepreneurs grow and register as
formal businesses. Then, they get trade licenses, register their capital and addresses, and rent
working premises. However, since there is large number of traders, this preparatory work is not
available to all. That is why many people are still working on the streets and fighting with police
officers because they are not allowed to work there. We believe that these are good citizens who
have skills and a good attitude towards their work. So, the government needs to consider this
aspect as well. The trade and industry bureau is working to bring traders into formal and legal
activities by prohibiting illegal trade practices and having fair trade practices in the area. The
office is undertaking surveillance to identify those businesses that are working without trade
licenses, renewal of trade licenses, and doing other illegal trade. This is for identifying those
businesses which avoid paying taxes. As informal activities form a significant part of national
economies, countries take steps to encourage informal activities to enter the formal economy
through raising tax thresholds, eliminating the need for business licenses for most small
businesses, drafting new laws to make it easy to register a business online and for accessing tax
incentives, and giving tax reductions to small firms (Bosma, Hill, Ionescu-Somers, Kelley, Levie,
& Tarnawa, 2020).

2.5. Reflections on the context

The purpose of this chapter was trying to understand the context of developing a new business in
Ethiopia. The discussion focused on two features of the economy -- the SMEs development
policy and strategy, and informal business activities. These are significant aspects that influence
the development of new businesses in the Ethiopian economy. The policy primarily gives
government support to new businesses to help them evolve from informal and small businesses
into formal medium and large businesses. It is assumed that this support reduces the challenges
that they face while they develop. Instead, being supported by the government has varying
effects as a new business’ development unfolds. Perhaps a new business’ actions and activities
matter more than this support. Thus, there is a need to understand the behavior of a new business
over time in the context of the government’s policy. This involves understanding how new
businesses behave while they are getting the support package, immediately after the support
package stops, and the differences and similarities in the behavior of new businesses with and
without the support. Even though the government supports formal businesses differentially, a
significant number of informal businesses exist in the Ethiopian economy. This contradiction
shows the paradoxical effects of formality. The government’s basic assumption is that the
benefits of formality outweigh its costs. Instead, the benefits of formality may vary as new
business development unfolds. Perhaps businesses’ situations and events affect the outcome.This
is why this dissertation discusses contextual elements because they are important in
understanding new business development in developing economies. Developing a new business
is naturally embedded in its context (Austin, 2002; Hashi & Krasniqi, 2011; Ramírez-Pasillas et
al., 2017; Welter, 2011; Zahra et al., 2014).
 Chapter three
3. Methodology
"...Doing research is not like strolling along an easy, well-marked path to a familiar destination;
it’s more like zigzagging up and down a rocky hill through overgrown woods, sometimes in afog,
searching for something you won’t recognize until you see it. But no matter how indirect your
path, you can make progress if at each step of the way you plan for predictable detours (and
maybe even avoid some of them) ...." (WAYNE C. BOOTH, 2003) ” “…there is no method,
strictly speaking, in social sciences. All there is are other works as sources of inspiration, an
array of various techniques, and a systematic reflection on the work that is being done”
(Czarniawska, 1997, p.vi). “ (Daft, 1983)”
3.1. Research methodology
3.1.2. Data Sources and methods of Data collection
The study used both primary and secondary sources of data. Structured questionnaire was
prepared and used to collect data from all relevant sectors of MSEs in Dire Dawa. Face-to-face
interviews were carried out with the MSEs operators and/or the relevant owner managers in the
selected sectors and important government officers.Observation and informal discussions were
also used as additional information. Variety of books, published and unpublished government
documents, websites, reports and newsletters were reviewed to make the study fruitful. Moreover,
relevant literature and other documentations supporting the objectives of study were reviewed.
3.1.3. Research Area
Ethiopia has nine Regional States and two City Administrations or Governments (Addis Ababa
and Dire Dawa). Each region is divided into zones and each zone into Woredas. Woredas are
further divided into Kebeles, the lowest administrative units. In City Governments, the
administrative division follows slightly a different hierarchy. Each city is divided into sub-cities
and each sub-city into Woredas, the lowest administrative unit in city government structure.
Dire Dawa city is one of the cities organized under the federal democratic republic of Ethiopia.
The city administration area covers nearly 130,000 hectares, of which only 2 percent constitute

3.2. Sampling Method and Sample Size

3.2.1. Sampling method
Stratified random sampling method was used for the study. The strata were the sectors (i.e.
construction, manufacturing and service). The distribution of sample taken from different sectors
is as follows (Table 1)

Source: Own design based on Dire Dawa Administration MSEs Development Agency (2012)
3.2.2. Sample size determination
There are several approaches to determine the sample size. These include using a census for
small populations, imitating a sample size of similar studies, using published tables, and applying
formulas to calculate a sample size. This study applied a simplified formula provided by
(Yamane 1967) to determine the required sample size at 95% confidence level, degree of
variability= 0.5 and level of precision =5%= 1+ ( )2 (1) Where n is the sample size, N is the
population size (equal to 367) and e is the level of precision (equal to 5%). The above formula
required a minimum of 191 respondents and this study was carried out on 190 respondents. A
total of 190 MSEs (142 from construction, 34 from manufacturing and 14 from service sectors)
were randomly selected based on probability proportional to size.

3.3. Methods of Data Analysis

3.3.1. Descriptive and inferential statistics
Both qualitative and quantitative techniques were used to analyze the data. The qualitative data
obtained from key informant interviews and personal observations were analyzed through
description and narratives using words. The quantitative data on the other hand were analyzed by
using descriptive and inferential statistics such as percentages, frequencies, mean, variance,
standard deviation, chi-square tests, F-test, and T-test. 2.3.2. Method of analyzing growth The
CAGR is preferred than average growth rates or number of changes in employment since start up
in several studies of employment growth. The use of compound annual growth rates permits a
much more precise assessment of the timing of employment growth effects Liedholm & Mead
(1999). In the same way the analysis of employment growth of MSEs in this study was done
using CAGR.
3.3.1.1. Econometric models
In the studies of firm growth, researchers often use three kinds of econometric models to
estimate significant factors for growth, such as multinomial Logit models, Logistic or probit
regression models and multiple linear regression models. In multiple linear regression models,
the dependent variable is explained by means of a set of independent variables. In this analysis, a
multiple linear regression analysis was used to test whether or not the key independent variables
were related to the dependent variable. The multiple linear regression analysis was chosen
because growth measure, annual compound growth of MSEs, used as the dependent variable
takes a continuous measure. For the analysis of the growth of MSEs in Dire Dawa, the multiple
linear regression models that were used to estimate are formulated as follows: Growth in
employment = f (Manager/owner age, Manager/owner gender, Manager/owner education,
Previous work experience, Right advice, Sector type, Access to market, Own premises, Access to
finance, Amount of initial capital, Access to infrastructures, Social networks, Vertical linkages,
Horizontal linkages, and Supporting markets).
The general multiple linear regression models is specified as:
ln(((CE/IE)1/)−1)= 0+ 1ln(AGE)+ 2lnEDU+ 3ln(I−CAP)+lnΣ +ln =1
Where
ln(((CE/IE)1/)−1)= the logarithm of compound annual growth rate
0= the intercept term
i= the coefficient of logarithm of manager age, initial capital and education
i = the coefficient of
ln(AGE)= ln(EDU)=ln(I−CAP)= ln( )= the logarithm of explanatory variables
ln ( )=logarithm of the error term
= number of explanatory variables
3.3.1.2. Multicollinearity test
As we are producing multiple regression models, we need to be aware of certain features of the
multicollinearity. That means, when two or more independent variables are highly correlated
with each other this is known as multicollinearity. The existence of multicolinearity might cause
the estimated regression coefficients to have the wrong signs and smaller t-ratios that might lead
to wrong conclusions. There are two measures that are often suggested to test the presence of
multicolinearity. These are: Variance Inflation Factor (VIF) for association among the
continuous explanatory variables and contingency coefficients for independent variables. The
technique of variance inflation factor (VIF) was employed to detect the problem of
multicolinearity among the continuous variables. According to Gujarati (2003), VIF can be
defined as:

Where, R2 is the square of multiple correlation coefficients that results when one explanatory
variable (xi) is regressed against all other explanatory variables. The larger the value of VIFi the
more “troublesome” or collinear the variable Xi is. As a rule of thumb, if the VIF of a variable
exceeds 10, there is a multicolinearity problem. Similarly, contingency coefficients were
computed to check the existence of multicolinearity problem among the independent variables.
The contingency coefficient is computed

Where, C= Coefficient of contingency

χ2 = Chi-square random variable and
N = total sample size.
The decision rule for contingency coefficients is that when its value approaches 1, there is a
problem of
association between the independent variables (Perry et al. 2004).
3.3.1.3. Explanatory variables of multiple regression models
Review of literature on factors influencing growth of MSEs, past research findings and the
researcher’s knowledge of the MSEs of the study area were used to establish analysis of this
study. In other words, among a number of factors, which have been related to growth of MSEs,
in this study, the following individual entrepreneur characteristics, firm characteristics, social
networks, inter-firm cooperation, and supporting market were factors hypothesized to explain the
dependent variable (growth in employment). Individual Entrepreneur Characteristics We now
discuss individual entrepreneur characteristics for which there is significant empirical evidence
from developing countries: manager or owner age, education, previous work experience, gender,
and right advice. Numerous growth factors examined in the developed country literature are
understudied in developing countries. Entrepreneurs or managers with higher formal education,
work experience and training would therefore be expected to grow faster. The firm grows if
successful, closes if unsuccessful (Goedhuys & Hardi 2002).
Manager/Owner age (AGE): The results of past studies all indicate a significantly negative
relation between age and growth ambition, the reason might be the entrepreneur’s initial goal of
growth, or a higher energy level and willingness of younger entrepreneurs to test their abilities as
compared to older entrepreneurs Welter (2001).
Gender of the manager (GEN): Welter (2001) found a significant difference between the
ambition to grow among male and female entrepreneurs.
Manager/Owner education (EDU): It is observed that high education level has a positive
impact on firm performance in terms of growth (Sapienza & Grimm 1997).
Previous work experience (W-EXP): Delmar & Shane (2006) found that founders’
entrepreneurial experience and experience with related industry does matter to firm’s success.
Previous entrepreneurial experience provides tacit knowledge of organizational routines and
skills by which they know how to find required resources and how these resources can be
appropriately utilized for current business (Delmar & Shane, 2006; Shepherd et al. 2000).
Right advice (ADVICE): It shows training, advisory and other technical assistance for
managers/ owners of MSEs since start up to the time of study. According to Admasu (2012), to
make MSEs competitive and profitable, increasing the capacity and skill of the operators through
continuous trainings, experience sharing from successful enterprises and provision of advice and
consultancy are crucial.
Firm characteristics
Certain firm characteristics are associated with MSE growth. The relationship between MSE
growth and six widely studied firm-level factors in the developing-country literature: sector type,
access to market, working premises, access to finance, amount of initial capital and, access to
infrastructure are assessed.
Sector type: Division of MSE s by sector type was believed to be helpful to study each sector
critical factors that affect the performance of MSEs. This is because firms in different sectors of
the economy face different types of problems. That means the degree of those critical factors in
food processing sector may differ from the factors that are critical to textile and garment and
wood and metal work sectors (Admasu 2012).
Access to market (AC-MKT): It refers to availability of market or demand to the
products/services of MSEs. Esther (2008), showed that access to market plays a significant role
in promoting MSEs as result, in this study, access to adequate market is expected to positively
correlate with enterprises growth.
Own premises (PREM): It shows availability of own working place or industrial land.
According to Fred (2003), access to industrial land has been major factors in firm growth and has
a positive impact to MSEs growth.
Access to finance (AC-FIN): For various reasons ranging from a lack of collateral to bias
against small firms, MSEs tend to face greater financial constraints than do larger firms. MSEs in
developing countries apply for and receive formal bank loans relatively infrequently; they thus
typically rely on other types of credit such as trade credit, overdrafts, and informal loans.
Microfinance institutions also provide important sources of financing for MSEs, but their
outreach is typically more limited than that of traders who frequently provide working capital in
cash or kind, especially in rural areas (Swinnen 2005).
Amount of initial capital (I-CAP): Access to financial service and the amount of paid up
capital in Birr during start-up have positive relationship to growth of MSEs. Larger or more
profitable firms are likely to have access to a larger pool of earnings that can easily be reinvested
in the firm. On the other hand, small firms that are profitable can reinvest retained earnings but
are less likely to get access to a broader set of credit instruments, especially from the formal
financial market. Explanation for this goes to inadequate collateral, lack of a significant credit
history and inadequate equity capital on their balance sheet, which is a serious barrier to
accessing credit by smallmanufacturing firms that might have been indispensable for their
growth and expansion (Okoh & Song 2000).
Infrastructure (INFR): The availability of suitable infrastructure to the function of MSEs is
important. Infrastructures like electric power supply, water supply, road, telephone, utilities and
transports have positive impact on the growth of MSEs and MSEs which have good and enough
infrastructures grow fast (Solomon 2004).
Social Networks (S-NET): The term ‘‘social networks” is used here to refer to relationships
between individuals. Having an extensive social network is a valuable asset that can help an
entrepreneur obtain access to information (e.g., leads about profitable business opportunities) as
well as resources (e.g., credit). While social networks can enhance MSE growth in any context,
they can be critical to firms’ growth prospects in environments with pervasive market failures.
The literature points to the role social networks can play in helping entrepreneurs overcome
obstacles related to transaction costs, contract enforcement, and regulation. Social networks also
have numerous potential downsides for MSE growth. In some cases, it may be too expensive for
or inaccessible to the poorest entrepreneurs, may provide unequal access to resources, lack of
stability, may be deeply rooted in societal traditions.
Inter-firm cooperation
Virtually firms interact with other firms. The relationship between inter-firm cooperation and
MSE growth can be analyzed considering vertical linkages, horizontal linkages and supporting
markets. Vertical linkages (V-LNK): Individual firms form vertical linkages with their buyers
and suppliers. Vertical linkages can facilitate MSE growth by expanding a firm’s set of viable
business opportunities and by improving firm capabilities such as when corporate buyers assist
with quality, maintenance, and technical issues (Berry et al. 2002) or when input suppliers offer
training or information related to the use of improved technologies.
Horizontal linkages (H-LNK): Similar firms may group themselves or be organized by an
outside party to work together-these are referred to as horizontal linkages. Horizontal linkages
can help MSEs overcome many of the disadvantages of being small, providing a way to
consolidate production, improve their negotiating position with buyers or suppliers, access
market information or services, or lobby for political or regulatory changes (Goldmark & Barber
2005; Steen et al. 2005).
Supporting markets (S-MKT): Services provided through supporting markets-such as finance;
consulting, legal, and tax advice; market information; and skills training-are often directly related
to improvements in capacity. For example, skills training may allow firms to offer new products,
while finance may allow them to produce greater volumes. Access to market information or new
technologies, on the other hand, may help firms seek or respond to new opportunities.
Relationship with supporting organization including trade association, universities and
vocational schools, financial institutions, local and national level government agencies, and
private business service provider. Supporting services may be offered directly to MSEs on a fee-
for-service basis, or they may be embedded in firm relationship, that is, delivered through
vertical or horizontal linkages. While the absence or weakness of supporting markets is often
identified as a constraint on MSE growth (Field et al. 2000; Gibson et al. 2001; Lusby &
Panlibuton 2002)
3.4. Specification of Logit model for analysis of related diversification of Micro and Small
Scale Enterprises
There are several methods to analyze the data involving binary outcomes. However, for this
particular study, Logit model was selected over other methods such as discriminant and linear
probability models. Hosmer & Lemeshow (1989) pointed out that the logistic distribution (Logit)
has got advantage over the others in the analysis of dichotomous outcome variable in that it is
extremely flexible and easily used model from mathematical point of view and results in a
meaningful interpretation. Related diversification is the dependent variable which occurs when
the company adds to or expands its existing line of production or markets. In this case, the
company starts manufacturing a new product or penetrates a new market related to its business
activity.
Manager/owner education (EDU): It is observed that high education level has a positive
impact on firm performance in terms of growth and diversification (Storey 1994; Sapienza &
Grimm 1997).
Ownership concentration (OWN-CON): It refers to the direct involvement of the entrepreneur
or entrepreneurial team in the effective control of the firm. These features eliminate one of the
main causes to pursue a diversification policy, i.e., the agency costs associated to the separation
of ownership and control. Amihud & Lev (1999) also found that ownership concentration
negatively associated with diversification.
Entrepreneur’s wealth (ENTR-WLTH): Because the firm may be mainly concentrated in the
activities it controls that could induce it to diversify to reduce specific risk, entrepreneur wealth
is expected to be positively related to the probability of diversification.
Firm Size (FRM-SIZE): This variable is related to the size of the firm resources (e.g human,
material, information, financial). It was measured in terms of the change in number of
employment. Bigger firms may have more resources to diversify, but their company structure
(e.g. bureaucracy) might not allow it. See the research of Fukuda et al. (2006) argue that small
and medium size companies were more vulnerable during the economic crisis.
Opportunities (OPP): This is defined as a case where firms had encountered a chance or
favorable environment that facilitate diversification such as local market contingencies,
development projects, infrastructure development (e.g. a new road), and personal contacts. This
might play an important role in pulling business owner towards diversification.
Information and communication technology (ICT): According to Shin (2001), diversification
can increase the demand for information and communication technology (ICT) because of the
need for coordination of business resources across multiple markets. It is expected to be
positively related to the probability of diversification.
Risk management (RISK-MGT): Risk management is a further factor often invoked to explain
diversification behavior (Ellis 2000). The basic logic of this argument is that previous experience
of market failure can provoke diversification as a means of spreading perceived risk and
reducing the impact of total or partial failure on businesses. Hence, it is hypothesized that risk
management and diversification are positively related.
Strengthening the household asset basis (STR-ASSET): Strengthening the household asset
basis can be an additional important factor in diversification choices. In particular, members of
better-off household can undertake innovative activities or engage in highly remunerative wage
labor (i.e. migrate abroad) with the specific aim of accumulating savings needed to expand the
business, offer education opportunities to the young generation, or insure themselves against
illness and aging. In addition to that, diversification may also occur as a means to consolidate
household natural capital (i.e. to enhance the environmental sustainability of a particular
livelihood strategy). Therefore, it is hypothesized that strengthening the household asset basis
and diversification are positively related.
Availability of Key-Assets (KEY-ASSET): Availability of key-assets (such as savings,
working premises, labor, education and/or access to market or employment opportunities, access
to common property natural resources and other public goods) is a an evident requisite in making
households and individuals more or less capable to diversify (e.g. Abdulai & Crole 2001).
Investment of a proper mix of the above endowments can be important driver towards
diversification. Availability of key asset and diversifications are positively related.
 Chapter 4
4. RESULTS AND DISCUSSION
4.1. General characteristics of Micro and Small Scale Enterprises

4.1.1. Characteristics of business owners or managers

Among the sample respondents included in the analysis, 71.6% of business owners or managers
were males and 28.4% were females and the average age of the respondent were approximately
31years. At the time of study, about 46.8% of the owners or managers of the enterprises
completed secondary school and only 6.8% and 15.8% of the respondents completed technical
and vocational education and training (TVET) and higher education, respectively. The rest
(30.5%) of the owners or managers of the enterprise completed primary school education. The
compound annual mean growth rate for enterprises owned and managed by those who completed
elementary education was 0.39. Whereas the compound annual mean growth rate for enterprise
owned and managed by those who completed secondary school was0.68. The growth rate
registered by enterprises owned and managed by graduates of TVET was 0.50. MSEs managers
who had diploma and degree from higher college and university have registered growth rate of
0.96which was the highest compound annual mean growth rate among others (Table2).

Table 2. Educational level of owners or managers and growth rate of enterprises

Source: Field survey (2013)

4.1.2. Characteristics of the enterprises

As stated earlier, the sample firms were operating in three sectors of the economy that are
construction 142 (74.7%), manufacturing 34 (17.9%), and service 14 (7.4%). Thus, most of them
were engaged in construction followed by manufacturing and service. This division of MSEs by
sector type was believed to be helpful to study each sector determinants that affect the growth
and diversification of MSEs. This is because firms in different sectors of the economy face
different types of problems. That means the degree of those determinants in construction sector
may differ from the determinants that are critical to manufacturing and service sectors. The
evidence in Table 3 shows that the sample enterprises that were studied had a mean of 4.68years’
experience in the business, and Birr 6909.47 paid up capital at start-up. The result showed that
small and micro enterprises started their businesses with a capital less than 20000.00 Birr. The
study also showed that there were approximately 6 and 7 employees at start-up and at the time of
the study, respectively. The mean annual compound growth measure and annual average growth
rates were 0.57 and 0.31 respectively. The annual change in job per enterprise was 0.10 which
means, on average, each enterprise increased 0.10 individuals in terms of employment annually.
The annual compound growth rate and average annual growth rate since start-up indicated that
overall growth performance was low compared to other developing countries by using the same
measurement. For instance, the CAGR of small and micro enterprises in Botswana, Swaziland
and Zimbabwe were 6.3, 4.1 and 5.6%, respectively. The AAGR of Botswana, Swaziland and
Zimbabwe were 8.4, 6.6 and 7.4% respectively (Minilek & Chinnan 2012).

Table 3. Descriptive statistics of enterprise characteristics Variables in the study

Source: Field survey (2013)

Access to suitable working place is the most important factor to MSEs growth and expansions
(or diversifications). Large numbers of MSEs which account for 42.6% had working place given
by government but most of the working places were not suitable for displaying and marketing
their products. About28.9% of MSEs had working places rented both from government and
private owners, 4.7% had inherited their working places where as 23.7% obtained their working
places from other sources of production site such as given by NGO (Table 4).

Table4. Production site at start-up

Source: Field survey (2013)

As indicated in Table 5, the survey result showed that the majority of enterprises were registered
as partnership (91.6%) and few were as sole proprietorship (8.4%). In Ethiopia, cooperatives are
tax-exempted and are assisted in organizing and legalizing their entity as cooperatives by
Cooperative Promotion Agencies.
Table 5. Form of ownership of the
enterprise

Source: Field survey (2013)

4.1.3. The main source of start-up capital

As shown in Table 6, about 71.6% of start-up capital of sample enterprises came from internal
source of finance, especially, personal savings of entrepreneurs, followed by loans from micro
finance institutions (16.3%), other sources (9.5%) and family assistance (2.6%). The majority of
initial sources of financing for small businesses in Dire Dawa come from personal savings.
Credit for start-up both from formal and non-formal financial markets is relatively rare. Banks do
not normally practice risk lending to new investors of small enterprises, which do not have a
record of accomplishment. Thus, many small enterprises begun with very small amount of
capital from personal savings and household assistance, from family, and steadily build up their
enterprise by reinvesting profits. Consistent findings were obtained in (USAID 2002; Kawai &
Urata 2001).

Table 6. Sources of finance at start-

up

Source: Field survey (2013)

Besides, the result of key informants’ interview showed that majority of MSEs in the study area
use informal sources. The formal financial institutions have not been able to meet the credit
needs of the MSEs. The reason for emphasizing on informal sector is that the requirement of
collateral/guarantor is relatively rare in this sector. On the other hand, the loans provided by
micro financial institutions are inadequate, with a short repayment period, need 20% of the loan
amount pre-saving in the micro financial institutions’ account and high interest rates. This
resulted in limited growth, survival and diversification of MSEs. The significant numbers of
MSEs (81.1%) had shortage of credit and no adequate access to capital through credit. Only
18.9% of MSEs did not have shortage of capital and had access to credit (Table 7). Lack of
access to credit or shortage of credit is one of the most significant factors that affect the growth
of MSEs which has negative impact on MSEs growth (Mulu 2007).

Table 7.Access to credit facilities by MSEs from formal financial institutions

Source: Field survey (2013)

In order to investigate factors responsible for inaccessibility of credit, survey respondents were
asked to indicate the reasons. As presented in Table 8, some MSEs were discouraged by the
bureaucratic processes involved (27.9%), inadequate loan amount (17.9%), lack of collateral
(14.2%), no need of credit (10%), high interest rate (7.4%), and other reasons (3.7%).

Table8. Reasons for not obtaining credit from formal financial

institutions

With regards to market competition, almost 80.5% of MSEs faced some degree of market
competition, 8.4% faced strong market competition while 11.1% had no market competition in
their sector (Table 9).
Source: Field survey (2013)

According to the data presented in Table 10, about 85.8% of the respondents sold their
products/services in the local market in Dire Dawa and 14.2% sold their products/services in the
external markets inside the country. However, no firms were participating in external market
outside the country (export trade) to sell their products/services. But from the interview of the
officials, there are opportunities for those who are participating in export trade like pre-saving
amount in macro finance account is 15% of their loan amount which is 5% less from pre saving
normal amount.

Table 10. Location of product/service

selling

Source: Field survey (2013)

4.1.4. Business owners/managers previous experience before start-up

It is expected that owners’ or manager’s previous experience has a positive impact on enterprise
growth. A related business oriented experience gives a person the required technical skill
necessary to start and run the business efficiently. The descriptive result of this study supports
previous study findings (Liedholm & Mead 1999; USAID 2002). As indicated in Table 11, start-
up skills of owners or managers before starting the business were obtained from self-experience
(46.8%), on job training (40%), training from business development service (10%) and family
(3.2%).
Table 11.Sources of business owners/managers start-up skills

Source: Field survey (2013)

As shown below in Table 12, there existed a strong relationship between the availability of
previous experience and the type of business. Manufacturing enterprises were started by people
with the related experience than construction and related services enterprises. The percentage
value of related experience for manufacturing was 88.24%, and that of service and construction
were 71.43% and 61.97%, respectively.

Table12.Business experience of MSE owners/managers

Source: Field survey (2013)

Nowadays, in the contemporary business environments internal and external relationship of the
enterprises is the most important thing for any type of organization irrespective of their size
(large, medium, and small) to work with co-worker, find input, access market information,
distribute output, get training and professional advices, compete and cooperate with other
enterprises, etc. Relationships, including social network, horizontal and vertical linkages, and
connections to supporting markets, offer many tangible, crucial advantages to MSEs. These
advantages include increased production capacity and ways to consolidate production, increased
efficiencies, mechanisms to spread both costs and risks, increased bargaining power for inputs or
raw materials, and channels to obtain information about and improve techniques used for
production, marketing, transportation, and technology. These relationships, then, play a critical
role in facilitating MSE growth and diversification. Linkages can expand business opportunities
and enhance firm capabilities at the same time. The survey result showed that the percentage of
accessing social network (45.8%), vertical linkage (37.9%), horizontal linkage (32.6%) and
support market (36.3%) were low which might lead to failure and closure of the enterprises
(Table 13).

Table13. Internal and external relationship of the enterprises

Source: Field survey (2013)

4.1.5. Sources of growth of different enterprises

The major factors that affect growth and diversifications of MSEs are listed below. Respondents
were asked to indicate the degree to which these factors are affecting the growth and
diversifications in their business enterprise. Respondents’ answers were based on the five likert
scale type choice where, 1 = strongly agree, 2= agree, 3 = undecided, 4= disagree and 5=
strongly disagree. The result is tabulated below (Table 14). According to the respondents, major
problems which led to failures of business enterprises engaged in construction, manufacturing
and service in the study areas were finance (interest rates, collateral requirements, bureaucracies
to access finance etc.), marketing (relationship with suppliers and customers, access of market
information and others) and premises (absence of their own premises, the rent of house is too
high and the current working place is not convenient for their business) which had total mean
values of 1.45, 1.73 and 1.89 respectively. The mean value of finance, marketing and premises
for each sector were almost the same. The mean scores of 1.52, 1.33 and 1.73 with standard
deviation of 0.90, 0.76, and 1.27 of the respondents in Table 17 shows that those operators
engaged in construction, manufacturing and service have faced strong problem related to finance
respectively. The result also show, majority of respondents strongly agreed with marketing
problem. This agreement is justified by the mean scores of 1.75, 1.67 and 1.82 with standard
deviation of 1.03, 1.13 and 1.17 for an operators engaged in construction, manufacturing and
service respectively. Similarly, respondents of the three sectors strongly agreed with problem
related to the premises. This is also justified by the mean scores 1.98, 1.79 and 1.91 with a
standard deviation of 1.11, 1.02 and 1.14 for operators engaged in construction, manufacturing
and service respectively. The next major problems which affected the growth and
diversifications of business enterprises engaged in construction, manufacturing and service in the
study areas were right advices (from financial institutions, legal advices), opportunities (related
to market access, infrastructure etc.), technology (lack of appropriate machinery and equipment,
skills to handle new technology, money to acquire new technology, etc.), and legalization
(government policy, bureaucracies in relation to company registration and licensing), taxation
and like which had total mean values of 2.09, 2.09, 2.39 and 2.59 respectively Table 14. The
mean scores and standard deviations in Table17 below shows problems related to right advice for
enterprises engaged in construction, manufacturing and service. Respondents agreed with
absence of right advice from different institutions, NGOs etc. This is justified by the mean scores
1.85, 1.96 and 2.18 with a deviation of 0.73, 1.12 and 1.47 for operators engaged in construction,
manufacturing and service respectively. Majority of the respondents of construction and
manufacturing agree with opportunities problems related to market access, infrastructure etc.
Their mean scores are 2.05 and 1.54 and standard deviations are 1.14 and 0.72 respectively. But,
the mean scores and standard deviations for enterprises engaged in service are 2.45 and 1.04.
Similarly, the respondents of construction and manufacturing agree with technological problems.
Their mean scores are 2.21 and 2.15 and standard deviations are 1.53 and 1.30 respectively. But,
the mean scores and standard deviations for enterprises engaged in service are 2.91 and 1.58
respectively. By the same token, respondents of the three sectors agreed with the legalization
related problems. This is justified by the mean scores 2.51, 2.96 and 2.51 with a standard
deviation of 1.11, 1.46 and 1.11 for operators engaged in construction, manufacturing and
service respectively. But other problems like access of qualified workers, industrial experience,
manager skill, entrepreneurial experience, managers’ work load, competitiveness and
organizational structure had small effect on the growth and diversification of business enterprises
engaged in construction, manufacturing and service in the study area (Table 14).
Table14.Description of common factors that affect the growth and diversifications of MSEs

Source: Field survey (2013)