Small and Medium Enterprise in International Environment - Research Paper Example

Small and Medium Enterprise in International Environment Contents Executive Summary 2 Introduction 3 Benefits of SMEs 4 Literature Review: SMEs operating in International Environment 6 Risks faced by SMEs 8 Conclusion 11 Recommendations 11 Bibliography 12 Executive Summary Small and medium sized enterprises are independent firms which are smaller in size and employ fewer employees than the standard figure. Small and medium sized enterprises (SMEs) are crucial industrial units for the growth of any economy. They represent a high proportion of all businesses in developing as well as developed economies. Unfortunately there is no single internationally accepted definition of SMEs. Small and medium sized enterprises provide a number of advantages in an economy; some of the most prominent ones are employment, GDP growth, innovation and investment. The key factors identified in this report are the impact of economic integration, dependence on government, low training and human resource management, tariff and non-tariff barriers, high transportation costs, difficulties in obtaining finance, insufficient intellectual property protection, inability to find foreign partners, foreign taxation, lack of management’s international experience, all contribute towards the difficulties that SMEs face in the international environment. Introduction It isn’t easy to take the initiative and risk of running a business in these times of turbulence. An entrepreneur is required to juggle different activities to run an organization. Entrepreneurs and small businesses play an important role in any economy by accelerating economic growth and providing innovative products, employment and ideas. Small and medium sized enterprises (SMEs) are crucial industrial units for the growth of any economy. They represent a high proportion of all businesses in developing as well as developed economies. Unfortunately there is no single internationally accepted definition of SMEs. Countries use different definitions of SMEs according to the size and structure of their economies. Common means of measuring the size of SMEs is number of employees, amount of capital, and annual sales or turnover. The table below shows various SME definitions in the United States, the European Union, Australian and Canada [Uni101]. Benefits of SMEs Small and medium sized enterprises provide a number of advantages in an economy; some of the most prominent ones are employment, GDP growth, innovation and investment. Employment In 2010, over 20.8 million enterprises were active in the non-financial business sector in the European Union, of which 99.8% were SMEs. Approximately 92% of the total business sector comprises of micro enterprises, employ fewer than 10 persons. [Kok11] On January 16th, 2012, The European Commission published a study analyzing the role of small and medium sized enterprises in creating more and better jobs. The study revealed that 85% of the new jobs in the EU between 2002 and 2010 were created by small and medium sized enterprises. Currently SMEs provide 67% of the total employment in EU. [Eur12]. The chart below illustrates the breakup of total embayment provided by the non-financial business economy in European Union. The employment growth of SMEs (1%) is higher than for larger enterprises (0.5%). However an exception is the trade sector, where SMEs employment increased 0.7% annually, compared to 2.2% in large enterprises [Eur12]. Internationally active SMEs are more innovative and report higher employment growth of 7% versus only 1% for SMEs without plans for international activities. [Kok11]. Innovation Along with employment, SMEs are a breeding ground for innovation. They look for access to newer and larger markets and more strategic collaboration to promote their products. Innovation leads to improvements in production process, and reduction of costs. However SMEs lack the financial muscles to take these innovations on an international level, this restricts opportunities for turnover growth. Investment Small and medium sized enterprises are usually set up by locals who bring together the factors of production (the money, raw materials, manufacturing facilities, skilled labor and land or buildings) necessary to produce, offer and sell products and services. SMEs help to remove regional disparities through setting up industries in far flung, less developed and backward areas. They identify opportunities and take initiative of setting up business where large multinationals avoid to setup. The growth of industries and business in these areas lead to a large number of public benefits like better transportation system, health facilities, education, entertainment, etc. Literature Review: SMEs operating in International Environment Global presence provides immense opportunities of growth for all kinds of businesses; it allows them to expand into newer markets. Traditionally exports were the way of making your business international and delivering goods in foreign markets, it is still an important source of expanding into newer markets; however more ways are adopted by firms. Now the process of internationalization usually refers to expanding operations in more than one country, having foreign partnerships, foreign investments, alliances and subsidiaries, branches and joint ventures.[Jus08]. According to Czech researchers Kubickova and Peprny, 2011, who conducted their research via interviewing 450 SME wineries, state in their pare that there are two different theories of internationalization, Upssala model and I-model (Innovation-related internationalization model) The Upssala model, foreign markets are developed in different stages, they are stated as follows: 1. Stage one: no regular export activities. 2. Stage two: export through independent agents 3. Stage three: sales subsidiary set up abroad 4. Stage four: establishment of production unit. According to I-model, firms try to enter those markets first about which they have enough information and where the likelihood of failure is least, later the company gradually enters the foreign and culturally distant markets. Some of the important factors and issues that influence internationalization of SMEs are: Impact of Economic Integration Economic integration occurs when governments of different states decide to unify and create economic policies that benefit the trade and economic relations between member states, for instance the Eurozone. Economic integration can have a substantial influence on the international trade of SMEs by lowering the barriers to export. For instance a study found that due to NAFTA’s formation, there was a large-scale increase in the share of total exports of American SMEs to Canada and Mexico, from 24% in 1992 to 33% in 2001 [Les07]. Dependence on Clients SMEs are also going global to be in touch with their larger clients and to ensure that they receive the future contracts from their valued consumers. SMEs try to relocate themselves depending on a major customer’s decision to relocate to another country. For instance Ford Motor Co. used to take its suppliers overseas to ensure quality, reduce costs and comply with local restrictions. When they decided to start a new plant in Europe, they gave a multi-year contract to Loranger Manufacturing Corp., a medium-sized automobile parts manufacturer on the condition that it will relocate near the new plant. This firm was originally based in Pennsylvania. The supplier accepted this offer because Ford was its primary customer [Les07] Dependence on Government SMEs outnumber larger firms the world over, and they tend to outnumber larger firms in international trade in almost all industry sectors. Even then, larger firms have quite obvious benefits over their smaller counterparts. SMEs are still more dependent on governments to facilitate them access to foreign markets, than larger firms. Around 90% of U.S. SMEs involved in exports have only one location. Governments often have strict export-related support policies, for instance in Czech Republic the company pays for all the export costs except when exports are outside European Union, in such a case it may obtain an export subsidy. Lack of Exposure SMEs face difficulties in creating foreign affiliations and finding foreign investment in their businesses because of low-recognition. 40% of larger firms export to direct affiliates whereas only 17% of SMEs exports go to foreign affiliates. Thus limited options are available for SMEs to access foreign markets. Moreover only 63% of SMEs had sales in only one foreign market, whereas 54% of large firms export to five or more foreign markets. [Les07] According to a study conducted on 450 wineries in Czech Republic, one of the major problems was that Czech wines were not recognized in the global markets. They should recognize the importance of promotion, and utilize a series of programs of the Wine Fund which support the promotion of Czech wines [Lea11]. Risks faced by SMEs Currently SMEs face tough competition in the global arena as large firms spend millions to make strong presence in all the major markets of the world through advertising, corporate social responsibility (CSR) and foreign investment. This is why SMEs need to be proactive in thinking of strategies to face challenges from larger firms in the international market. Training With ever changing technology and customer demands, employees need to up-date their skills on continuous basis. Compared to large enterprises, SMEs tend to focus less on training of employees. SMEs usually practice less formal training activities such as on-the-job training and self-directed learning; they tend to lack in enterprise-provided training courses, mentoring programs, job rotation, study visits and exchanges. Cost of Going International SMEs serve foreign customers in a significantly different way than large firms. An important reason includes cost of going international such as differences in labor cost and investment in technology. These costs influence the budgets of SMEs more compared to larger organizations. The cost of going international also includes tariff and non-tariff barriers to trade. SMEs lack the negotiation power and lobbying capacity that larger firms have. They find it difficult to cut across red tape and bureaucracy. Tariffs Tariffs are taxes on import or export of certain good, into and out of a country depending upon the government’s policies. Most of the small and medium sized firms are located in industries such as textiles and apparels, meat products, food related items, chemicals, agricultural produce etc. These products usually have high tariff on import in most of the developed countries. This reduces the profit margin of exporters, proving them less incentive to trade. High transportation costs Trade requires a lot of transportation of goods from one location to another. SMEs unfortunately lack the financial muscles to bear high transportation costs, and thus try to make profit from local economy instead of sending goods for international trade. SMEs export directly as well as indirectly through wholesales and other intermediaries. SMEs are a good source of providing intermediary goods to other small and large firms. Difficulty in obtaining financing According to World Trade Organization, 80% to 90% of the world trade relies upon trade finance [Wor12]. Thus the potential loss to the economy of shrinking trade finance can be tremendous. Having access to trade credit financing options, especially for small and medium sized businesses is crucial to trade. Banks are usually reluctant to provide credit facilities to small sized enterprises because they are unable to provide guarantees and collateral that large firms can provide. They also lack the asset-base and financial results that banks require to offer favorable terms of credit and trade credit facilities. Thus SMEs are unable to deal with costs to develop in foreign markets. Moreover currencies fluctuations tend to hit small firms harder because of their inability allocate resources towards measuring and managing foreign exchange risk. They are not able to get involved in complex risk management strategies such as dealing with foreign exchange derivatives. Difficulty receiving and processing payments is another major issue for small and medium enterprises because they are weaker in exercising legal action. It is easier to delay or cancel the payment of small firms than large firms because SMEs cannot perform the same actions as a large firm can, when it comes to debt collection. Insufficient Intellectual Property Protection Intellectual property rights are privileges given to the creator or inventor to have the exclusive rights over the use of their creation for a certain period of time [Wor121]. It can be on someone’s artistic work, computer programing, gadget, medicine, sounds, writing etc. Small firms are great innovators but often do not patent their products or lack the financial capacity to fight against intellectual property rights infringement. Therefore their products are easily copied by others. Foreign taxation SMEs do not have expert financial advice to tackle foreign taxation laws, nor are they big enough for governments to be provided favorable tax holidays or other monetary or non-monetary benefits. Therefore they are a victim of double taxation (taxation on returns in home country and on sales and returns in foreign country) Inability to find foreign partners Large companies are well-established and have good presence in foreign lands. Foreign investors and businesses are usually enthusiastic to introduce and become partners with a well-known name into their country. SMEs suffer because they are not very well-known and lack the kind of public façade that large companies possess. The have difficulty in identifying reliable foreign representatives. Lack of government support Governments usually have a bias in favor of large organizations and multinationals operating in their countries, as governments are willing to provide favorable terms of trade to them. This is not the case with SMEs, in fact in most of the developing countries, governments do not provide the benefits and facilities to SMEs that they need in order to survive and grow. The same is the case with foreign governments if a small firm tries to trade or operate there. Management’s International Experience Managers with prior international experience can drive their firms more smoothly towards internationalization. Generally SMEs find it difficult to attract managers who speed up the entry into foreign markets. SMEs trying to go into newer markets should try to attract experienced managers instead of those doing it for the first time. However they face difficulty in finding appropriate foreign representatives. Language difficulties and cultural differences also hamper the growth of SMEs which try to enter foreign markets. Whereas Multinationals and large forms spend millions and billions on research to find ways to integrate the other country’s culture with theirs. Conclusion As a result of the research conducted above, we have defined the major benefits small and medium sized enterprises provide to an economy and what kind of barriers they face as they go international. It is a general tendency of governments to favor large multinationals instead of their local small businesses, which don’t have as strong financial muscles. There are immense cultural and language barriers that hamper the growth and establishment of inexperienced managers of SMEs, on foreign grounds. It is also very difficult for them to find foreign affiliates and investors. This report is an effort to gather valuable information related to the key issues and risks faced by small and medium enterprises in international environment. Following are my recommendations as solutions to the immense constraints SMEs face in the global arena. Recommendations Below written are my recommendations for how SMEs can tackle issues in the global arena much better: Standardization of SMEs: There should also be standard classifications of SME size. This will enable comparison of data and research across different countries and different periods of time to find out similarities, differences and trends over time and across boundaries. This information will assist in creating effective policies and tools by governments and non-governmental local and international organizations to prescribe policies that are helpful to SMEs to internationalize. Reduce cultural barriers: Government and Non-government organizations can provide services to managers of SMEs who lack international experience, train them about different cultures, languages and publish research reports about the industries in foreign markets. Information Technology: There can be an online portal for SMEs to help them identify foreign business partners, affiliates and investors who might be interested. Financial Sector: Banks and other financial institutions should recognize the SME sector for its high exports and growth prospects, and provide trade credit facilities to assist them carryout trade smoothly. Government: Governments have a huge role to play here. They need to become proactive in organizing export promotion activities and providing export subsidies to SMEs more, compared to larger forms which already have the financial strength to bear trade costs. It should inform SMEs and encourage participation in international trade fairs and exhibitions. Bibliography Uni101: , (United-States-International-Trade-Commission, Small and MediumSized Enterprises: U.S. and EU Export Activities, and Barriers and Opportunities Experienced by U.S. Firms, 2010), Kok11: , (Kok, et al., 2011), Eur12: , (European-Commission, 2012), Jus08: , (Dabrowska, 2008), Les07: , (Lloyd, 2007), Lea11: , (Lea KUBÍČKOVÁ, 2011), Wor12: , (World-Trade-Organization, 2012), Wor121: , (World Trade Organization, 2012), Read More