To the casual observer, small businesses are poor stepsisters of large businesses. But small businesses play a vital role in any economy. They provide employment and competition, and a few innovate and grow to businesses of scale and sophistication. Importantly, in a South African context, a vibrant enterprise sector helps reduce the over-concentration of economic power.
While small businesses may be desirable, engaging with them is difficult. In part, this is because small businesses are extremely diverse. Recognising this lies at the heart of successful attempts by both government and the private sector to promote the sector.
In the second half of 2006, the Gauteng Enterprise Propeller and the FinMark Trust, supported by the department of trade and industry, FNB, Standard Bank, Absa and TransUnion-ITC, commissioned a survey whose aim was to remedy a lack of reliable and accurate information about small businesses, using Gauteng, South Africa’s richest province, as a pilot. In particular, the researchers wanted to find out how many small businesses there were in Gauteng, as well as gain a better understanding of their needs by segmenting the market in a new way.
What emerges in the FinScope Small Business Gauteng survey is that the small business market is so varied that it requires a classification tool that goes beyond formality, size and legal status — it needs to look at the continuum of small business. Hence a new segmentation model, the Business Sophistication Measure (BSM), was created to capture this broad continuum, ranging from street traders to sophisticated and fast-growing enterprises.
The BSM was developed after looking at a set of empirical variables, from the place where business is conducted (such as a footpath or office block), whether a business keeps financial records, issues employment contracts or pays taxes, to issues of access to finance, the penetration of banking services and business insurance. The relative sophistication of the business does not mean that the business owner does not need support, but their needs will be different to businesses in the lower BSMs.
The BSM identifies seven segments, plotting the continuum of business sophistication from informal street vendors to more sustainable business practices. This provides a finer classification and rich lens through which to view the different needs of small businesses with different levels of sophistication, enhancing the ability of policymakers and service providers to home in on areas where the greatest impact can most rapidly be made.
The survey found that more than one million people — or one in six adults — in Gauteng run small businesses. With small businesses accounting for 35% of Gauteng’s employment, the economic and social contribution of this sector is significant. In BSM 1, all small businesses are vendors and hawkers, with no access to water and electricity where they operate, which is mainly on footpaths or no-fixed locations.
The upper BSM tiers represent formally registered businesses. In BSM 7, for example, 94% of businesses are registered and well established, having operated for more than 15 years. Most have a budget, a written business plan, updated financial records, use technology and have access to a variety of financial products. BSM 6 and 7 have the most security in their customer relationships as they are most likely to have service level agreements with customers and long-term contracts of a year or more. Tendering activity emerges only in BSM 6 and 7.
Contrary to the popular view, the FinScope pilot shows that only a small proportion of enterprises are likely to be engines of job creation; most are engaged in business to make ends meet, are not innovative, are not potential growth businesses, nor do they aspire to be. While half of small businesses make between R1Â 300 and R2Â 000 per month, a fifth of all small businesses in Gauteng make between R750 and R900.
Life for these “breadline businesses” is precarious in the extreme. BSM 1 and 2 entities operate below the poverty line, and their owners also have the lowest levels of education. While there may be some viable businesses, most operations in the lower BSMs have little growth potential. Yet, without this kind of economic activity, poverty would be exacerbated — it serves a vital social function in the economy, is rooted in local communities and helps make the poor a little less poor.
While the number of small businesses seems to be growing — perhaps by as many as 200Â 000 in the past year — most of these are trading businesses, including hawkers and spaza shops, with no employees. The survey shows that 70% of all small businesses do not create any jobs. Only registered businesses (about 180Â 000 by number) are likely to be employers, employing an average of five people each. BSM 7 indicates a significant step up from other BSMs by creating an average of nine jobs and having a turnover averaging R463Â 747 annually.
This confirms how critical it is for government and the financial sector to focus on the relatively small number of transitional companies that seem to be successfully moving out of sole trader status and becoming employment-generating entities.
Running a successful enterprise is demanding. Various attributes — gutsi-ness, drive, energy, innovation, ability to take calculated risks, commitment to the business — are vital ingredients for success. What the survey underlines is that not everybody can or has the appetite to be an entrepreneur.
Special focus should be placed on the needs of the 200Â 000 businesses in BSM 5 and 6, called the “zone of transition”, where businesses move from sole trader status into employment-generating entities. This is also where business owners start to say that they would not prefer a full-time job and would rather stay with their business. Enterprises in the lower BSMs tend to see running a small business as a consolation prize for not getting a job in the formal economy, and are likely to remain informal or leave their businesses to become employees.
In South Africa, there is much debate about the “two economies”, in which a formal, well-established, wealthy economy is said to exist side-by-side with an informal, poor and underdeveloped economy. Policy interventions are geared towards “graduating” second economy enterprises and activities into the first, as if the informal sector is a budding formal sector SME. The findings of the FinScope survey show that this assumption is open to question. The extent of graduation would appear to be low, and it is difficult for people to climb the ladder out of the second economy.
Importantly, this zone of transition is a moving target. The zone of transition for personal banking is in BSM 3 to 4, whereas for business banking it is in BSM 4 to 5.
Cellphone use is a significant differentiator of businesses, found as low as BSM 2.
The effectiveness of most official support programmes for small business is limited. The FinScope survey reveals that only 8% of small businesses in Gauteng use government support mechanisms, with Umsobomvu as the market leader. Around seven out of 10 business owners are not aware of any organisations providing support, back-up, advice or training to small businesses in Gauteng. Credit extension to these small businesses is so low that it raises questions about whether banks will achieve their commitments under the Financial Sector Charter.
Segmenting the small business market using the BSM should allow not only government but also the financial sector and other actors interested in promoting a vibrant enterprise sector to target their small business strategies more effectively and enhance the identification of opportunities for innovation in service and product provision to small businesses.
Mark Napier is chief executive of the FinMark Trust. Judi Hudson is a consultant to the FinMark Trust and lectures at Milpark Business School
For more information about the FinScope Small Business survey, visit www.finmark.org.za