New research identifies factors for upgrading small and medium enterprises

More than 90 percent of all companies in Egypt are micro enterprises, meaning they employ less than five people. At the same time, there is a sizeable gap between these micro and small enterprises and large companies or corporations: a phenomenon, not unique to Egypt, known as the “missing middle.”

Medium-sized companies — defined as those that employ between 50 and 99 people — are the main creators of higher quality products and waged employment, so in a country that suffers from high unemployment rates, the growth of these companies is important, a new study argues.

The study, conducted by the German Development Institute and the Egyptian Center for Economic Studies, looks at what factors determine whether a company can grow from micro and small to medium-sized, in order to help fill the gap.

The report identifies six factors: the quality of education of the company’s owner, including his or her training and work experience; the company’s human resource development; access to finance; market research; international exposure of the company and its owner; and law enforcement, especially in taxation, licensing, regulation, company inspection and competition policy.

While all these factors have been previously identified before as being important, the authors of this German-Egyptian study say that theirs is the first to come to a conclusion about which factors are the most significant for upgrading.

The study focuses on upgrading through innovation — coming up with an idea to give the company an advantage over its competitor — rather than external factors, such as high product demand.

Innovative growth could include an idea for a new product, an improvement in the production process, the introduction of a new marketing method, engagement on new stages of the value chain, or the move to a new sector.

During a three-month mission between February and April in Egypt, the report’s eight authors interviewed 122 experts on small- and medium-sized enterprises, or SMEs.

They also conducted a semi-standardized survey among 102 such enterprises in the textile, food and software industries in Cairo, Giza, Gharbiya and Sharqiya, focusing on their main obstacles and success factors.

The report’s preliminary findings were the subject of a roundtable discussion hosted by the Egyptian Center for Economic Studies in Cairo on 24 April. The final report is due in the autumn. Access to finance, or the availability of financing mechanisms for SMEs, was a key point of discussion among the report’s authors and experts in attendance.

The common assumption is that micro and small companies in Egypt are held back from growing due to a lack of availability of finance. Access to finance did come in second place as a key constraint, though only 25 percent of SME owners said so.

Instead, 44 percent said skilled labor was their biggest obstacle. The discussion’s participants suggested this had less to do with the importance of finance and was more about entrepreneur attitudes and Egypt’s regulatory environment.

Annegret Altpeter, one of the report’s authors, told Egypt Independent: “In fact, we found that the interest amongst SME owners to take out loans was very low. This was due to mistrust in banks and the fear of default. Business owners would tell us that they would hear stories from friends of being put in prison because they couldn’t pay back the loan.”

She added: “There’s also fear of liability extending to all personal belongings and savings, not just the enterprise. Religion was another factor and taking out a loan was seen to be forbidden under Islam. Here, Islamic banking products might play a role.”

Islamic banking practices are in line with Islamic law, which forbids the practice of usury. Islamic banking institutions are well-established in Muslim countries such as Malaysia and Bahrain, and have been growing in areas with large Muslim diaspora communities, such as Europe.

Egypt’s Islamist-dominated Parliament and Muslim Brotherhood businessmen also seem keen on the growth of the country’s Islamic finance industry. As well as being in line with religious practices, it is also a tool for pooling resources from wealthy and liquid Muslim countries, particularly the Gulf States.

Banks in Egypt do lend to SMEs, but in small quantities. Mohamed Ozalp, Blom Bank Egypt’s managing director, said that though banks are willing to lend, it is the lack of a “debt obligation” culture among SME owners that makes it unattractive to do so.

“After the revolution, the percentage of non-performing loans amongst SMEs shot up. There was an attitude of ‘Why should I pay you back now?’ Entrepreneurs need to be taught the acceptance of an obligation when borrowing,” he said.

The report does identify improving the financial literacy of SME entrepreneurs, including how to write a financial statement, as a key policy recommendation. Reforming the regulatory environment is also advised, particularly with regard to the bankruptcy law.

There was some debate about whether banks, driven by corporate demands for profit making, are in fact the suitable mechanism for lending to the SME sector, which contributes 70 to 80 percent to Egypt’s gross domestic product. Some argued for the government to play a larger role.

“If the government can’t handle the risks associated with SMEs, then who will?” Magda Kandil, an economist and the Egyptian Center for Economic Studies’ executive director, asked rhetorically.

A government representative, though, still saw space for private capital.

“Private equity funds and venture capital are the answer,” said Reem El Saady, who is working on SMEs for the General Authority for Investment. But she added that the 1995 law relating to them has to be reviewed.

“The problem is that most of these private equity funds are offshore, and the law relating to them is very vague and restricting,” she said.

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