Unpacking the draft rules of empowerment

Barrie Terblanche

You could say that the pendulum has swung back in favour of black ownership in the new draft black economic empowerment (BEE) codes released for comment by the department of trade and industry, but that would be oversimplifying things.

A more fitting metaphor is that of a jellyfish being taken for a walk on an elastic leash.

A pull away from black ownership resulted in unpredictable wobbles and lunges, requiring a harder pull in another direction.

South Africa's sprawling empowerment experiment teems with competing interests: broad-based empowerment, narrow enrichment, consultants and verification agencies who like the system as complicated as possible, ease-of-business champions who want to slash red tape, those who want government and corporate spend to prioritise thrift and efficiency, or jobs and skills rather than black ownership, or new business creation rather than bigger black stakes in existing businesses.

A glimpse of how the BEE codes and their permutations affect small businesses shows just how difficult it is to control the experiment and its repercussions. Black economic empowerment started in the late 1990s as a straightforward (some would say crude) favouring of majority black-owned businesses, big and small, in the adjudication of contracts and tenders.

Until very recently, government departments worked on a point system in which the only criteria were price and black ownership. It meant that black-owned businesses could come in at slightly higher prices than white businesses and still win tenders. Many corporates and parastatals set aside contracts for which only black-owned businesses could compete.

For all the good it did, it led to widespread fronting, ranging from downright fraud in which the company cleaner would be made owner of a front company without her knowledge, to less obvious cases, where black middlemen would flog the goods and services of white companies without adding any value.

A lesser-known effect of the previous narrow-based black economic system is the damage caused by more or less well-meaning white business owners who set out to find black partners. Business partnership in a small business is fraught with enough complications under "natural" circumstances.

Friends, colleagues and lovers who start owner-managed businesses together do so at great risk to their relationships, and often small businesses fail for no other reason than personal conflict between the co-owners. Artificial partnerships forged out of nothing more than a need for BEE recognition stand even less of a chance.

Unlike large corporations, minority shares in small businesses almost never earn dividends and can almost never be cashed in, leading to dashed expectations, mutual suspicion and bitter fallouts.

This was one reason why the BEE edifice which emerged in the early 2000s in reaction to narrow enrichment and fronting created a separate category for exempt micro enterprises (businesses with turnovers of less than R5-million).

It was an acknowledgement that BEE shareholder deals simply do not work in small businesses and that the risks that white entrepreneurs in small businesses took meant that they were already pulling their weight in building an empowered economy.

It also acknowledged that the new system, which drastically diminished the importance of black ownership in the calculation of BEE scores in favour of seven criteria (from staff training to charity), required an entire parallel bookkeeping and annual auditing system so expensive that to burden small businesses with it would do more harm than good.

But the problem was that black-owned small businesses were lumped together with white small businesses in the exempt micro enterprise category.

Suddenly they had lost the advantage that black ownership had conferred on them previously, and found themselves competing against better resourced and trained white entrepreneurs with virtually no BEE head start.

This utterly defeats the object of BEE. If there is one category of business that needs a break, it is small black-owned businesses. They are far less resourced and experienced than their white counterparts, and cannot afford to undergo BEE auditing and gain a BEE advantage like their larger black competitors can.

The system does allow for a slight advantage.

Black-owned exempt micro-enterprises are automatically seen as Level 3 BEE contributors, a good enough score, but only slightly better than the Level 4 score automatically given to white-owned exempt micro enterprises. And they stand no chance against white- and black-owned businesses of any size that can afford to undergo BEE scoring and gain a Level 2 or Level 1, the highest BEE score attainable.

In practice, therefore, small businesses feel pressure to disregard their exempt micro enterprise status and undergo BEE auditing at much greater relative cost than large businesses.

There is another reason why many small businesses simply cough up and pay for verification. Nontobeko Jacobs, managing director of Umtha Consultancy, an eight-person Cape Town-based outfit that undertakes social development work for corporates and government, says even though the system may theoretically exempt her from verification, there is no way of telling whether the officials sorting out the competing bids know these intricate details of the BEE system.

"The officials who look at the tender put your tender aside immediately when they don't see a BEE certificate. I'd rather be safe than sorry," she says.

The broad-based BEE system may have been successful to some extent in discouraging the worst excesses of fronting, but an unintended consequence was that attaining the highest BEE scores has become the preserve of those who can afford to spend anything from R6 000 to R60 000 a year for a BEE audit.

Besides, says Keith Levenstein of the Johannesburg-based BEE consultancy Econobee, fronting is still rife. He says he comes across at least three incidents of fronting a day, ranging from fraudulent misrepresentation of data to influence a BEE score, to the use of the BEE certificate of a sister company that has a similar name.

He is sure that fronting will become worse if the new draft BEE codes, recently published for comment, were to become law.

The proposed codes seem to jerk the leash back in the direction of narrow-based black ownership in awarding a BEE advantage, especially for exempt micro enterprises. Black-owned small businesses will automatically get a Level 1 BEE score, 50% black-owned businesses are deemed Level 2, and white-owned businesses are automatically considered Level 4.

At the same time, the annual turnover threshold under which a business is considered an exempt micro enterprises is set to double from R5-million to R10-million.

This means old-fashioned narrow-based BEE for a greatly expanded group of small businesses, but broad-based BEE for larger businesses (although here, too, black ownership will dramatically increase in importance, but through another mechanism).

The proposed automatic differential between Level 1 and Level 4 exempt micro enterprises is large enough to ensure the rise, once again, of dubious middle-man fronting, if not of the blatantly fraudulent kind.

The BEE system's main counter to fronting is a new law, currently in the form of the BEE Amendment Bill (not to be confused with the new BEE codes), that will criminalise misrepresentation of BEE data,imposing 10-year jail terms and fines of up to 10% of turnover. The Bill also makes it clear that a business owner cannot blame a faulty BEE score on ignorance or bad work by a verification agency, says Levenstein. Any business brandishing a BEE certificate is directly responsible for its veracity.

This may keep the compliance departments of large businesses busy, but it has the unintended consequence of making the BEE system positively dangerous to dabble in for owner-managed businesses.

It rules out the do-it-yourself, trial-and-error way in which small businesses typically integrate into complicated systems such as the labour and tax regimes. The choice will be to hire an expensive consultant or steer clear altogether.

Levenstein believes that the higher threshold for exempt micro enterprises presents a further temptation for companies.

It is easier for large companies to pretend to fall under the R10-million threshold than under a R5-million threshold. The new codes' proposed solution to this particular problem captures the impossibility of the balancing act that South Africa's BEE engineers are trying to achieve.

Exempt micro enterprises, say the new codes, will have to prove that they are exempt by submitting to a BEE verification audit — with no exemption from the fee.

It's web or dead, report finds

Johann Barnard

It would appear that South Africa's small and medium enterprises (SMEs) are living in a material world, and it is costing them. According to a recent study, nearly 80% of local firms with a company website claim profitability, but less than two-thirds of respondents without a website are in the black.

These findings are contained in the SME Survey 2012, which has been produced by World Wide Worx since 2003, and polled 2 000 local SMEs ranging in size from one to 200 employees. The core research question for this edition was: "What impact does a website have on the competitiveness, profitability and sustainability of an SME?"

Apparently quite a bit, based on the profitability measure, but also a whole lot less given the limited use of e-commerce and advanced business-critical online tools.

"The findings leave little room for doubt that any SME should have a website and, where it does have a website but is not using it effectively, should invest more time and effort into a more effective website," World Wide Worx managing director Arthur Goldstuck writes in the report.

"Since the cost of creating and maintaining a website is decreasing — and for basic websites now cost-free — it has become one of the quickest routes to assisting SMEs to become more efficient and competitive."

With small businesses being very cost conscious, it is understandable that the expense to set up and maintain a website can appear dear, particularly in the context of South Africa's small internet audience of around 8.5-million subscribers at the end of last year. User growth is increasing, however, especially since the widespread use of smartphones and improved bandwidth options and costs.

This growing audience is reflected in South Africa's strong online retail sales, which have grown by 30% for the past few years to top R2.5-billion in 2011. "This shows [that] consumers are far more ready to engage with transactional activity online, and entrepreneurs who a find way to make themselves attractive will find an increasingly receptive audience," Goldstuck told the Mail & Guardian.

And, in theory, this is becoming easier as the internet-connected audience grows, but also matures. The potential that exists now and into the future has been captured by World Wide Worx in what it calls the digital participation curve, a model that has been broadly accepted as an accurate predictor of online activity.

This model states that there is a clear correlation between the length of time a person has been an internet user and their willingness to perform transactions (such as banking and shopping online) and to engage in social media. And that length of time has been proven to be roughly five years.

According to a sister World Wide Worx report, 3.2-million South Africans had been online for five years by the end of 2008, a number which grew to 3.75-million by last year.

"All those who began coming on board the internet from 2008 onward, will become fully engaged with it from 2013 onward. And that will mark the beginning of the most sustained acceleration in the digital participation curve that we have yet seen," the May 2012 Internet Matters report says.

This clearly represents an opportunity for entrepreneurs to either beef up their presence and online offerings, or to shrug off their hesitancy and get their feet wet.

Connectivity costs and service are constant bugbears of voice or data subscribers in the country, and Goldstuck says the introduction of high-speed mobile broadband in the form of LTE networks could be the straw that breaks Telkom's back.

"If Telkom doesn't change its modus operandi in terms of its ADSL service, its user base will not only flatten out, but decline."

With the growing number of users and new technologies come great opportunities, and business owners would be doing themselves a disservice to ignore these developments.

The SME Survey therefore concludes with the recommendation that small business support programmes include the creation, maintenance and development of websites as key elements of the support provided to small businesses. Whichever way it is done, SMEs can no longer shy away from the changed reality which dictates that online activities and brand presence form a key part of the business strategy.

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