JPMorgan Chase & Co. : SME Catalyst for Growth in South Africa

The Small and Medium Enterprise (SME) Sector -

Catalyst for Growth in South Africa

J.P. Morgan (JPM), through the JPMorgan Chase Foundation, is launching a new initiative focused on small and medium-sized enterprise (SME) growth in collaboration with three core partners: Dalberg Global Development Advisors, Aurik and Raizcorp. Through this partnership, JPM is supporting the provi- sion of business development support (BDS) services to selected entrepreneurs, with the aim of directly stimulating broader job creation and economic growth while gathering evidence on the value and impact of BDS services.

This report was commissioned by JPM and developed in collaboration with Dalberg. It aims to share lessons gleaned from a combination of publicly available data and in-depth interviews with experts on SMEs. It provides the context and rationale for J.P. Morgan's "SME Catalyst for Growth" pilot programme, which is being formally launched in February 2012.

Stimulating Job Creation and Economic Growth

Amid debate about the role of small business as actual drivers of economic growth, there is strong evidence that small and growing busi- nesses are critical for job creation and em- ployment in developing economies.
South Africa is facing an unemployment crisis; at least 25 percent of the population is job- less, with the number increasing to nearly 40 percent if one includes those that have given up the search for work. At the same time, the level of entrepreneurial activity is low in South

Total early stage entrepreneurial activity (TEA2)

Percentage, 2010

34 33

18 17

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Africa when compared to other emerging mar- kets. According to the Global Entrepreneur- ship Report, the level of early-stage entrepre-

South

Africa

Ghana Zambia Brazil Chile

neurial activity is directly related to per capita income. In 2010, South Africa ranked 35th
out of 54 profiled countries, ranging in income levels and regions, in terms of total entrepre- neurial activity and was below the average for all participating countries. The report shows that the level of early-stage entrepreneurial activity is strongly related to per capita in- come. It was well behind countries such as Ghana, Zambia, Brazil and Chile in its ability
to foster successful new businesses1.

Source: Global Entrepreneurship Monitor (GEM)

Report 2010

In his 2011 State of the Nation address, Presi- dent Zuma stated that "the small business sec- tor is a critical component of the job creation drive". The New Growth Path released in De- cember 2010 by Ebrahim Patel, the Economic Development Minister, set job creation as a priority, with a target of creating five million additional jobs in the next ten years. It aims to

New and established business

Start-up

ownership rate2 25

Percentage, 2010

New

Established

25

17 17

11 13

15

12 11

5 4 2 6 6 6

South Africa Ghana Zambia Brazil Chile

Source: Global Entrepreneurship Monitor (GEM) Report 2010

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reduce unemployment from 25 percent to 15 percent, largely through the development of small businesses.
In the absence of a national census, and for
the purposes of this report, data is drawn from existing studies, including the Finscope Small Business Survey (2010), as well as the SBP SME Growth Index (2011). According to the Finscope 2010 study, the SME sector has an estimated 5.6 million small businesses operat- ing in South Africa, creating 11.6 million total employment opportunities - that is six million
jobs excluding the small business owners them- selves. However, the sector is heavily skewed towards micro-enterprises, with 82 percent of

South African enterprises being micro or very small (as defined by the National Small Busi- ness Act). These businesses are often 'survival- ist' or 'lifestyle' businesses. Two in three busi- ness owners operate their own businesses and do not have any employees. Only 300,000 of the country's businesses employ five or more employees. While medium-sized firms may not produce the bulk of output or production, they generally hire most people in an economy3. Micro and small businesses in South Africa are not achieving the growth required for increased job creation, due to a number of challenges.The focus of this report is the 'small and growing' business sector i.e. small and medium-sized enterprises with the potential for job creation.

Size of small businesses in South Africa

Number of employment opportunities created

67%

Business owners

Additional opportunities

8,0

5,3

22%

3,7

0,3

2,7

3,4

5% 5%

0 1 to 2 3 to 4 5 to 10 11 +

Number of employees

(excluding business owners)

Fewer than 5 employees

5 or more employees

Source: Finscope Small Business Survey 2010

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Challenges to SME Growth

"

To fully realise the potential of SMEs, the sector needs to be approached with a fresh perspective at-

tuned to the challenges it faces. There is a need for the focus to shift from the available collateral in the business to the viability of the business and the ability of the entrepreneur. Each business needs finance tailored to their unique challenges. In addition to this, the business owner needs access to the expertise and market knowledge required to make their business a success."

- Guido Boysen, CEO of GroFin Africa (2010)

SMEs face numerous challenges in terms of access to finance, market access, skills and networks, and the enabling environment. Many businesses face financial constraints and cash flow uncertainty. Businesses often lack the collateral and financial records (e.g. audited financial statements) required for loans from commercial banks. Application processes tend to be bureaucratic. There are high transaction costs and a lack of aware- ness about the procedures involved in gaining financing. These challenges are evident in the fact that 75 percent of applications for credit by new businesses are rejected and only two
percent of new SMEs are able to access loans4, whilst only only 2% of businesses seeking private equity are successful5.
Among actors seeking to promote SME growth, there has been much attention fo- cused on providing debt and equity financing for businesses to succeed and achieve scale. The banking system remains the main source of capital to start and grow businesses. Fin- scope estimates that 47 percent of business owners are formally banked through commer- cial banks. There are also a number of publicly funded entrepreneurial support instruments that provide grants and debt and equity solu- tions to SMEs. In 2011, Finance Minister Pravin Gordhan stated that government sup- port to businesses would include R600 mil- lion for enterprise investment incentives. Sup- port for small businesses would be provided through the South African Micro-finance Apex Fund (R282 million over three years) and Khula Enterprise (R55 million). Patient capi- tal is available through development finance
institutions (DFIs), micro-finance institu- tions, Corporate Social Investment Grants and foundations. The venture capital (VC) space is growing with an estimated R2.6 billion in- vested in the VC asset class between 2000 and
2010, 50 percent of which went to businesses in the start-up phase6. EEnterprise Develop- ment (ED) is one of the elements contained within the Black Economic Empowerment (BEE) scorecard, and has a target contribution of 3% net profit after tax per annum. Corpora- tions contribute a large amount to the sector through enterprise development. For exam- ple, Standard Bank South Africa contributed R35 million in 2010.
While it is true that capital is essential and plays a key role in the ability of a business to progress, it is not the only necessary ingredi- ent for success. There are non-financial barri- ers for SMMEs in South Africa which hinder growth.
The enabling environment is a key bar- rier to growth. Crime and theft ranked as the third highest obstacle to growth for business owners in the Finscope survey. Labour regula- tions are inflexible, impose a high minimum wage for staff and often result in difficulties with unions and strikes. Poor infrastructure
is often a constraint, with issues such as high energy costs and lack of consistent electricity supply, high cost and/or limited availability of transport. In Finscope, competition is ranked as the third greatest obstacle to growth for businesses7. This shows that businesses are unable to deal with natural market competi-
tion by finding defensible niche markets and

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products. The economic slowdown has had a negative impact on business growth, with 40 percent of businesses surveyed for the SBP "SME growth Index 2011" highlighting this as the primary barrier to growth.
This shows that businesses are unable to deal
with natural market competition by find- ing defensible niche markets and products. The economic slowdown has had a negative impact on business growth, with 40 percent of businesses surveyed for the SBP "SME growth Index 2011" highlighting this as the primary barrier to growth.
Also, businesses often lack the necessary knowledge and networks required to be successful in a particular market or industry. They are unsure of what product or service should be sold in the market, and do not know how to attract and retain a sufficient customer base. Financial constraints hinder enterprises'

"

ability to grow management capacity and staff base. The Finscope study highlights this, par- ticularly in start-up businesses. When starting up, 44% of business owners cite money-related matters and 50% cite business strategy as their main obstacles8. Even the "money-related" challenges are less a problem of availability of capital, and more to do with entrepreneurs' lack of awareness of financing instruments
and limited skills and knowledge on who to approach. Without support, the likelihood of these entrepreneurs creating competitive and sustainable businesses is slim.
SME experts identify business support as a priority focus area for the South African SME sector, and a range of individuals and organ- isations have responded by providing a range of services broadly referred to as business development support (BDS). These organisa- tions have the potential to address the barriers to SME growth.

In reality, it is the ability of the entrepreneur to identify the factors that dictate the conditions and

circumstances under which a business should thrive and take appropriate courses of action that

ultimately leads to the success of the business. In short, it is a matter of skill and aptitude."

- The Entrepreneurial Dialogues: State of Entrepreneurship in South Africa. 2010. GIBS, Endeavor, FNB.

Business Development Support as a Catalyst for Small Business Growth

In South Africa, BDS providers have the potential to provide small businesses with much needed skills to address these chal- lenges. They can help address management and strategic challenges through provision of training and ongoing advice to business
owners. However the market itself faces some constraints.
On the demand side, the high cost of BDS services can discourage business owners from using them. There is also a strong perception of limited value for money for all these servic- es, which affects uptake for even high quality providers. This is likely linked to experiences
with the poor quality interventions available in the market. Businesses face diverse chal- lenges and have differing needs, and as such require tailored services. Some businesses may require short-term technical support on a specific system, while others need broader strategic support. On the supply side, the market is fragmented, with multiple players
varying in size, scope and quality. No nation- al quality controls or standards exist in the current market. There is limited data avail- ability on the outcomes of BDS provision, due largely to weak monitoring and evaluation systems to track BDS relative strengths and weaknesses. There is a lack of transparency in

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the sector, with providers and financiers hesi- tant to share results. Businesses have limited knowledge of these services, often resulting in low uptake. The asymmetry of information is clear in the Finscope survey, wherein 75 per- cent of small business owners stated that they
were not aware of business support organisa- tions, and 94 percent have not made use of these services. Small business owners who
did make use of support organisations were most likely to get support and advice relating
to starting up a small business9.

New Initiative to Help Address These Issues

Based on these findings, the SME Catalyst
for Growth programme was designed to help drive employment generation and economic growth in South Africa by improving access to effective BDS. It seeks to increase the amount of funding available for high-quality providers of BDS that will be used to provide support for growing South African enterprises. Simultane- ously, it aims to introduce greater transpar- ency and awareness of the potential benefits
as well as the relative merits of different types of BDS offerings available in the market.
The programme design began with the iden- tification of 35 leading organizations that provide support to small businesses through a total of 62 individual interventions. This
subset of the broader market of providers was selected to be representative of the market in terms of type of services, scale, quality and stage of business growth served. The organi- zations were segmented into four categories
of support: (1) access to finance, (2) market access, (3) BDS and (4) enabling environment. Across all categories, 53 percent of interven- tions were focused on the start-up phase, and
68 percent on micro to small enterprises10.
Given the importance of capacity for business growth, the analysis focused primarily on BDS. Within BDS, services ranged from shorter- term management and business training courses to mentoring and coaching to tech- nical skills training, with almost 50 percent
of the interventions focused on start-ups11. Through desk research and expert input, seven
high-potential partners were short-listed,
based largely on their strong reputations and track records within the space. These provid- ers were then evaluated according to four criteria: