Small and Medium-Sized Enterprises in Emerging Markets - Essay Example

SMEs in Emerging Markets This paper examines the trends associated with SMEs in emerging markets and involvesa look at the challenges and support systems for SMEs. Among the challenges examined include constraints such as financial difficulties that hinder small size enterprises from expanding. Other than financial constraints, there are other factors that can impact negatively on the growth of SMEs in emerging markets. This includes limitations like inadequate skills or experience, and competition from large enterprises that enjoy economies of scale. The support systems that this paper explores include how small business in emerging markets can access credit and compete in the same field with large firms. In addition to the challenges and support systems for SMEs in emerging markets, technology is another focus of attention and how it can be used to enhance the growth of SMEs in emerging markets. This is because the global market today is mainly influenced by constant changes in technology. Further, the development SMEs within developing markets also require R&D as a way of enhancing innovation to ensure that products from emerging markets compete at the same level with products from industrialized nations. This paper also discusses how the information from the literature can be used in future to improve the prospect of entrepreneurs and that of SMEs within emerging markets. Introduction SMEs today contribute towards new investments across the globe and thus, the need for various stakeholders to shift their focus in this emerging sector. SMEs normally lack the resources at the disposal of large firms to invest in difficult markets. However, numerous opportunities exist for SMEs in terms of investing in developing markets. For example, South Sudan, a new entrant in the global market presents abundant opportunities for SMEs. In industrialized nations, SMEs have a significant impact on the economy; however, this is not the same in the emerging and underdeveloped countries. This is because SMEs are faced with a number of constraints that include poor infrastructure, collateral requirements that are sometimes considered unrealistic and high administrative costs. In addition, financial constraint is seen as a major hindrance for the development of SMEs in emerging economies1. On another note, where the SME sector is weak, this also impact negatively on job opportunities, innovation and a country’s GDP. In this sense, establishing support structures for SMEs result in various benefits for the emerging markets. This is because supporting SMEs growth results in a positive effect in terms of improving the GDP growth because the output, profits and value-added are bound to increase. Establishing SMEs in emerging markets also improves government revenue through taxation, which should be conducted in an appropriate manner. Establishing a strong SME sector in developing markets provides an avenue to diversify a country’s economy, which helps that country to develop resilience with regard to global recession and the fluctuation of capital flow in certain sectors of the economy. Most importantly, any emerging market need to associate SMEs with three important views that include identifying the sector as the engine for growth and innovation, an avenue to eradicate poverty and improving financial institutions to prevent market failures when establishing SMEs. This paper focuses on the constraints facing SMEs in developing markets and the need to supporting this sector2. The constraints facing SMEs in emerging markets SMEs sector contributes immensely in terms of creating job opportunities and most importantly, in the private sector. This is why SMEs are also termed as “the emerging private sector”. However, SMEs often encounter constraints with regard to their operations and growth compared to large enterprises. Further, accessing financial services is also another headache for SMEs in emerging economies. When establishing SMEs in emerging markets, financial constraint is often viewed as a major impediment. In emerging markets, SMEs often complain about financial obstacles compared to large enterprises. Compared to large enterprises, SMEs often finance their investment using internal resources and are less likely to solicit for bank loans or other external sources. In one study conducted on Indian SMEs, it is evident that additional financial assistance or credit facilities that are subsidized improve the financial standing of SMEs respectively. While this study did not support the use of subsidized lending to improve the financial status of SMEs, but is an indication that SMEs can improve by accessing external financing or support. The connection between SMEs and Foreign Direct Investment in emerging markets is important in terms of establishing a strong SMEs sector3. In essence, SMEs acts as the nucleus of establishing a new business in any emerging market. Establishing a flourishing business environment also means there needs to be output to ensure the business is self-reliant. Today, a major challenge in establishing the SMEs sector in emerging economies is the high cost of conducting business in a globalized market. This high cost of engaging in business often affects negatively on emerging markets as a result of minimizing FDI. A Price increase is another constraint for SMEs thus; preventing SMEs to take advantage of the available opportunities in the emerging markets. Most emerging economies have numerous regulatory policies that prevent SMEs from flourishing in the identified business venture. On another note, most SMEs in emerging markets also face challenges during the development phase and in some emerging economies, the failure rate is often higher. This results from structural rigidity and lack support for the SMEs sector in most emerging markets. Emerging economies are also facing competition from industrialized nations and this hinders SMEs from accessing the mainstream economy. Further, SMEs have limited capital and this prevents them from accessing the latest technologies to improve their businesses. Technology still poses a major challenge for the establishment of SMEs in emerging markets. The skill level of labor is also not to the standard in terms of improving innovation and thus the need for support from abroad that is sometimes, expensive for newly established SMEs4. While most emerging markets are on the view of internationalizing SMEs, challenges often arise because of their smaller size and limited resources. This in essence, prevents SMEs from accessing the global market. This sector also lack knowledge or experience that is required in the international segment and as such, they are often exposed to a number of threats that include competing with large enterprises. Other threats include numerous barriers to enter a market and power asymmetries associated with value chains. Challenges towards internationalization also arise as a result of poor product and market knowledge, and also cultural differences. Globalization often exposes SMEs to numerous challenges and this impact on business both locally and abroad. This means that, entrepreneurs need to gain knowledge regarding global business in order to compete at the same level with large enterprises that have already established themselves in the international market. The business environment is normally influenced by a number of factors that include the policies implemented by the government, social and economic conditions, and the skills of entrepreneurs, finance and other support systems. The government often participates actively in terms of steering economic growth; in this sense, firms often operate according to government priorities or preferences. Through support by the government, SMEs are able to access a number of inputs, funds and other subsidies5. On the other hand, SMEs are required to reciprocate through ventures aimed at improving the economy, such relationship if often geared towards the process of internationalizing SMEs. In this sense, the government is often interested in improving SMEs exporting capabilities; therefore, in improving exporting capabilities, governments often introduce certain policies or regulations that target international trade. However, the policies often differ between the developed and developing markets. This is often caused by differences such as culture, business context and level of development or industrialization. While the support from governments may exist, SMEs may not realize growth unless the government establishes appropriate institutions and other support structures. This includes providing tax breaks, export training and other incentives. At present, limited research has been conducted to identify most of the impediments to expanding SMEs to a global level. Most SMEs only focus on the local market, but opportunity also exists in the foreign markets. This allows SMEs to remain in business, and can expand probably to international level. Further, most of challenges faced by SMEs emanate from the national economy, infrastructure and institutions with corruption being another challenge that affects the growth of SMEs in emerging markets. In the global arena, SMEs are often underrepresented as a result of numerous challenges encountered in their internationalization. The international arena has become unconducive with regard to start up and firm’s growth compared to the local business environment. At the moment, large SMEs are the ones that have a significant contribution towards exports and FDI. This means that the cost of doing business needs to be reduced in order to allow small enterprises to grow and access the markets beyond6. It is not a big challenge for small enterprises to conduct business internationally with proper structures put in place. Governments are doing much to sort out various impediments affecting the growth of SMEs. In essence, there is need to create a conducive environment to conduct business .Conversely, there are numerous benefits that emerging markets can realize by minimizing trade barriers. The areas that emerging markets needs to focus on include agriculture, airline, the banking and communication sectors. Compared to large enterprises, SMEs tend to experience greater failures because size has an impact on profitability and growth of firms. However, financiers can reduce these losses by focusing on large entrepreneurs; in addition, SMEs are not open, but rather opaque when compared to large firms. There is no transparency in SMEs because of a lack of audited financial statements that can provide relevant financial information and are not obligated to make such information public. In addition, how the business finances are managed is also blurred due to difficulties in separating personal finances and business financing. SMEs in emerging markets tend to have numerous idiosyncrasies in the manner that they conduct business and this has a negative impact on their growth and development. On another note, financers are reluctant to support SMEs because such support is viewed as costly and may not realize reasonable profits. This is because the loans solicited by SMEs are often small compared to loan applied by large firms. As such, lending to SMEs mean that financiers need to minimize risks and share such risks with the SMEs. This allows financiers to minimize the costs that go into processing the loans for SMEs7. It is also important for SMEs to come up with a significant amount as startup prior to soliciting for financial support. Within the emerging markets, other problems exist such as legal, regulatory and institutional flaws that hinder financial institutions to support borrowers. This is because SMEs that operate in emerging markets tend to lack reasonable collateral to allow them to access bank loans. Further, the existence of a weak legal system that is evident in emerging markets tends to prevent financial institutions from lending to SMEs. These SMEs are not also comfortable operating in the formal market and embracing the regulatory framework. They mainly thrive in the informal sector where they do not encounter various restrictions to business. The high rates associated with taxation in emerging markets and other regulations that increases costs in the business environment discourages SMEs from accessing the formal financial markets. Banks are often prevailed upon to acquire certain assets that include government bonds and such policies impact on SMEs in emerging markets. For instance, there are private banks that normal function as industrial-financial groups and controlled by people with political influence and closer ties to the government. As such, these financial groups often give loans depending on certain interests or relationships. Moreover, where there is reluctance by financial institutions to finance SMEs or SMEs view the process to lack transparency, they tend to avoid formal economy. Conversely, bank regulators are seen to play a critical role in either facilitating or deterring commercial banks to finance SMEs. These banks are afraid because SMEs tend to lack reasonable collateral. In other instances, policies with good intentions can also deter banks from lending to SMEs8. Today, most of SMEs may collapse in their formative years in business arena, in a country like Malaysia; the failure rate is estimated at averagely 60%. This is evidence that SMEs in emerging economies encounter serious problems and other obstacles that prevent them to engage in a competitive business venture. As a country, Malaysia in now embracing a knowledge-oriented economy because the impact of globalization means that emerging markets needs to embrace knowledge based economy. An input driven economy will only expose SMEs to further failures because of a rapidly changing global market. In embracing a globalised market, challenges also exist that include recession, barrier created by outsourcing, low input, poor financing and lack of managerial capabilities. Most emerging markets are faced with the challenge of sufficient knowledge associated with market techniques, attracting customers, branding and establishing contacts both locally and internationally. Embracing a knowledge-based economy require intellectual capital to establish a competitive business environment. In such an economy, intellectual capital tends to replace physical assets often used in modern enterprises. The business world is changing constantly and this means that emerging markets have to change their strategies such as shifting to a knowledge-based economy where there is more reliance on intellectual capital9. Establishing support systems for SMEs to thrive in emerging markets SMEs play an important role in the economic progress of emerging nations in terms of improving market’s vitality. For a while now, the number of SMEs in emerging markets has increased and as a result, the large firms no longer dictate the market when it comes to competition. This sector has also been identified for its potential to provide employment opportunities and in most emerging nations, SMEs accounts for averagely 60% of the job market. Wealth of most countries today can be identified with an improved growth of SMEs; therefore, in order for SMEs to flourish in an environment that is competitive, there is need to create a working legal structure or system. At present, most emerging economies are shifting towards creation of proper legal system to support SMEs. This involves enacting laws geared at establishing an efficient legal environment to conduct business. Today, special laws exist that are meant to deal with problems that hinder the progress of SMEs. The establishment of efficient institutions by the government also assists to protect SMEs from unfair competition. This also means that there is need to improve policies targeting the provision of financial services. This would allow SMEs to access credit facilities that are important in terms of expanding to the international market. On the other hand, a social service system that is diversified plays an important role in supporting the progress of SMEs. This involves the emerging markets establishing a number of agencies that provide social services for SMEs; for instance, non-governmental organizations and technical support or consultancy. This would help to provide professional assistance and fast track the growth of SMEs10. The existence of market developing policies play a role in improving a number of variables that relate to the performance of SMEs in emerging markets. This involves policies aimed at leveling the playing ground for both small and large firms. Despite the possibility of such reforms taking time to be realized, they are important in terms of ensuring there is a sustainable equilibrium to also provide SMEs with financial backup. Policies implemented by most emerging markets also need to take into consideration the development of a resilient fiscal solvency and maintaining a stable inflation. Most changes in state variables often require a change in the key institutions, which often take some time to realize their objective. On another note, because of globalization SMEs provides opportunities that emerging markets can exploit. As such, it is important for emerging markets to utilize such avenues as FTAs (free trade agreements) to improve their business. Further, while expanding abroad, emerging markets can also identify regions with low labor costs to establish their manufacturing firms. For instance, Taiwan SMEs are looking at the prospect of establishing their manufacturing firms in Vietnam; therefore, these SMEs can produce their goods and export to other destinations such as the U.S. or Europe11. SMEs in emerging markets should further make efforts to invest in other markets such as the European market; however, barriers that includes linguistic obstacles needs to be solved first. This is possible through collaborating with other European firms as a way of dealing with such obstacles. Further, SMEs in solving linguistic obstacles can also rely on the technology that is supplied by European firms to produce goods that are exported to the European market. The growth of SMEs in emerging markets also requires partnership that is established by creating joint ventures or strategic alliance. Investing in regions where firms can capitalize on cheap labor not only benefits the SMEs, but also the economies of the countries that they have established a strategic alliance or joint venture. Unlike firms that can access capital markets, most SMEs rely on funding from banks. As such, commercial banks are seen as an avenue for SMEs to solicit for external credit. However, the existence of asymmetric information between SMEs and banks tend to affect accessibility to credit by SMEs. As a result, it is necessary to establish SME banks in emerging markets that target the local clients. These banks can establish a long-term relationship with SMEs, which helps obtain valuable information associated with SMEs. This information is important in that it allows the banks to arrive at both pricing and credit decisions. On the same note, relationship lending is important because, it help to solve information problems. Today, the existence of local lenders mainly serves SMEs and this ensures their survival in a competitive market. Since they operate at the local level, they can access information easily from the SMEs that allows them to approve credit for SMEs. This has allowed small businesses to access loans from commercial banks that are closer to their business12. Other than providing finances to SMEs, it is also necessary to improve R&D capabilities for SMEs operating in emerging markets. This is because they face competition from multinationals operating in the same market. Most entrepreneurs in the emerging markets still lack the necessary knowledge to improve their production and services. As such, they are exposed to numerous risks that include collapse of their business ventures in the formative years. A focus on improving R&D capabilities will ensure SMEs in emerging market adopt new strategies to improve their performance as the global market today is marked by constant changes associated with technology and investing in R&D will allow SMEs to remain relevant in the market. The government also needs to play an important role in protecting local SMEs from exploitation by other multinationals and large corporation operating in emerging economies. These corporations may take advantage of the limited knowledge to exploit small business and as a result, there is need for government to implement protectionist’s policies to protect the growth of local SMEs. The labor market in emerging market is still saturated with low skilled workers and this impact negatively on productivity and quality of products from emerging markets. As such, they are not able to compete at the same level with industrialized market. In this regard, the emerging markets need to focus on improving a knowledge-based economy that can compete at the same level with industrialized economies13. Significance of this study Studying the functioning of SMEs in emerging markets has expanded my knowledge on the advantages and the challenges that these enterprises face. Before embarking on this assignment, I did not expect to find many disparities between the challenges involved in establishing SMEs in emerging markets and in developed countries. My expectation was that the government perception of SMEs in emerging markets would be almost similar to that of governments in developed countries towards SMEs in their own countries. Developed countries are characterized by high levels of entrepreneurship that is as a result of availability of funding from both government and private financial institution as well as enjoying a well-developed infrastructure needed for the success of the businesses. Just as in the developed countries, emerging markets in countries such as Japan, China and Brazil operate in a political and economic environment where governments have already identified the need to support these enterprises as important contributors to the economic development of the countries. Consequently, I expected that the level of government support, at least in terms of creating an enabling environment would be same for SMEs operating in the emerging markets and those in developed countries. However, this research has been informative to me, as I have improved my level of awareness in this area. This is because contrary to what I had presumed to be the case, SMEs in emerging market experience additional challenges that might be unique to their environment therefore leading to them achieving different results from similar undertakings in developed countries. This assignment has indicated that small enterprises are not able to expand because they are denied accessibility to credit by financial institutions and other lenders. Instead, the large enterprises often benefit from the financial institutions and other lenders. This has allowed large enterprises to expand further and internationalize SMEs. However, what I think is the most important among the challenges is in the support structures offered to the SMEs operating in emerging markets. Although governments have shown great interests in supporting them, there is evidence to suggest a lot is still to be done to improve the chances of SMEs succeeding. I think offering financial help in terms of providing loan to SMEs operating in emerging might not be the most important input to facilitate their success these might only result in further debts due to the weakness in other areas of the economy. This raises question on what additional measures are necessary to enable small enterprises not only access more funds but to also develop better strategies will allow them to expand and compete at the same level with large enterprises. Based on the research undertaken for this assignment I have indicated various solutions that are being identified through research, and among them is the establishment of medium sized or small banks to provide credit to small enterprises. According to my own assessment of the environment under which SMEs in emerging markets operate, providing an enabling environment by introducing measures such as protection from competition from cheaper alternatives from more developed countries. Moreover, improvement of the infrastructure and technology to ensure faster access to latest global trends are some of the most important areas that need improvement for the SMEs to perform better. Further, skills and experience in fast tracking the development of SMEs is important; however, in the emerging market, these qualities still lacks among entrepreneurs and is the main reason for the collapse of SMEs in the emerging market. Today, marketing is digitized and thus further research needs to focus on how SMEs can use various media platforms provided by improvement in ICT to enhance the growth of SMEs in emerging markets. Consequently, this assignment provides ground for me to delve further into investigation on how the business environment can be improved to ensure SMEs in emerging markets compete favorably with larger businesses as well as multinationals in the global arena. This understanding is also important for future studies related to how to improve the growth of SMEs in emerging markets and other developing markets to reach or surpass the levels achieved by similar undertakings in developed countries. Because SMEs mainly focusing on the local market, they are important components of economic development attained within the areas they operate. Therefore, government should consider them as important contributors to the national economy through taxation and creation of self-employment opportunities for entrepreneurs and the employment of others in these localities. The experiences I have gained during the course of this assignment will therefore act as an important groundwork for me to move further into research on the implementation of more suitable strategies and policies to improve the level of performance recorded by SMEs in the emerging markets. Conclusion The existence of SMEs in emerging economies provides an avenue for prospective entrepreneurs with limited capital to also take advantage of the available opportunities in the business environment. Previously, the business environment was not conducive for small investors because it required large capital to set up a business. However, the emergence of SMEs has provided small entrepreneurs with an opportunity to also invest and compete for market share in a field saturated by large enterprises. This is because channels exist to enable SMEs remaining in business; this includes the opportunity to solicit for credit necessary to improve the business. In addition, the protectionist policies are also important in ensuring that large firms do not exploit SMEs. As a result of the many SMEs that now exist in the emerging markets, job opportunities have been created and this help in improving the GDP of the emerging economies. In addition, these SMEs have managed to collaborate with foreign investors that have helped to improve skills and experience. This is evident from the quality of products coming from emerging market that are able to compete at the same level with products from industrialized countries. The growth of SMEs in emerging markets also contributed to the establishment of medium and small sized financial institutions that can offer credit to SMEs in the informal economy to move to the formal market. Other than the emergence of medium and small sized banks, R&D capabilities in the emerging markets has also improved as a result of the need to compete at the same level with the industrialized economies. To this end, investment in SMEs seems to be an ideal way of improving economic growth of the emerging economies since they provide numerous opportunities for prospective entrepreneurs and job seekers. Bibliography Arslan, Ozgurand Karan, Mehmet. Credit risks and internationalisation of SMEs. Journal of Business Economics & Management 10, no. 4 (2009): 361-368. Ayyagari, Meghana; Demirguç-Kunt, Asli and Maksimovic, Vojislav. Firm Innovation in Emerging Markets: The Role of Finance, Governance, and Competition. 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