The Future of Small Scale Enterprises

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By
Shahid Kardar*

Until recently underdeveloped infrastructure like road networks, transportation, etc., had created sheltered local markets for small enterprises. The only competition they encountered was amongst each other from the overcrowding in such a market. Then there were government policies that created the perverse incentives to remain small and operate in an isolated manner. However, even in Pakistan the business environment and the ways of doing business have changed radically. Competition has heightened because of the government’s strategy to create a more competitive environment through deregulation and  liberalization of the investment regime, significant dilution of sector-specific protection from competition and globalization, increasing integration of world economies, the formation of the WTO forcing member countries to scale down trade restrictions and rapid technological developments that have sharply reduced costs of transportation and communications, facilitating the free movement of goods, services, capital and knowledge.

We are therefore seeing large formal sector entities and imported finished products steadily taking over some of the market share held earlier by small and medium sized enterprises, resulting in the reduced growth in their numbers, if not the closure of large numbers of small/ cottage-sized manufacturing, in recent years.

In Pakistan SMEs face economic, technological, marketing and financial constraints. Reliable and efficient infrastructure like power, water, transport and communications are pre-requisites for efficient performance and competitive capability. The problems on account of infrastructural deficiencies are more acute in the case of SMEs since they are located in an unplanned, uncontrolled and dispersed manner. In particular, poor availability of reliable supply of electricity in the last two years has hit small scale industry disproportionately, since a large part of it neither has the financial wherewithal to acquire and operate generators and still remain competitive, despite the high incidence of GST and income tax evasion in this sector. The cumulative impact of these developments has been the drastic transformation of the economic environment in which small and medium sized enterprises function, leaving them with only the option to compete or perish.

In these changed circumstances and improved road and communication networks large manufacturing companies have managed to extend their operations into rural areas, thereby opening up markets that, as argued above, were sheltered because of product and geographical segmentation of the market. These larger enterprises have also managed to enhance their market share with the closing down of a sizeable section of small scale industry as a consequence of crippling load shedding. Given the impact of globalization, better road networks providing access to large scale industry, lack of energy/power and the sharp deceleration in the rate of growth of large manufacturing enterprises to whom small industrial units either sell, or buy from, it is simply bizarre that government growth statistics claim that the small scale manufacturing sector grew by almost 30 percent in nominal rupee terms in 2008/09!

Having discussed how the business environment has altered for the small scale industrial sector the rest of this article will focus on the challenges that they face from globalization. The challenges from globalization have been overwhelming, requiring forced adaptations in management techniques, automation and technology.   Companies are switching from large fixed investments to computer controlled, flexible specialization, and changing their structures to enable quicker responses. In a highly competitive global market experiencing rapid changes in product mix, design and technology, fixed investments have not only become less attractive and more expensive but now also play a reduced role. Along with lower fixed costs of search for markets and customers and of advertising, the factors identified above have reduced the importance of economies of scale, increasing the scope and potential to exploit opportunities for product differentiation. The role of the standardized mass market is diminishing and that of exclusive niche markets for differentiated products growing.

The new communications technology has also brought new areas, like services (computer software, consultancy), into the framework of external trade. Earlier services were not tradable across time and space. Now they can be exported via the internet and even stored electronically and used a long time after they have been produced. Now that services are tradable they can be included as a component in the comparative advantage of developing countries, export of labour-intensive services (programming, data entry, call centers, etc.). Computers can be used to automate low productivity tasks previously performed by office secretaries. The tradability of services across space and the shrinking importance of economies of scale are combining to provide developing countries the opportunity to sell their labour-intensive services and manufactures.

At same time, the increasing internationalization of production, distribution and marketing is enabling the creation of global commodity chains (i.e. business networks of various sized units) from the stage of supply of raw materials to the production, marketing and retail of any product. These commodity chains are either producer-driven or buyer- drive.

There are producer-driven commodity chains for capital and technology-intensive products like automobiles and electronics. The manufacturers of such products are the major driving force. Buyer- driven commodity chains are relevant for products that are design and marketing intensive but relatively labour intensive in their manufacturing stage, e.g., textile garments and leather products. In such cases retailers and brand merchandisers control the chains. The existence of such global commodity chains leaves industrial enterprises no choice but to become part of the chain, simply to access markets. Pakistani manufacturers, even those small sized, know they cannot operate in isolation any more. However, to become a part of these production and trade networks individual enterprises have to meet standards of price, quality and delivery schedules.

All this requires upgrading of technology and development in organizational structures and information systems as increasing presence of multinationals opens up opportunities for subcontracting and outsourcing. The Chinese development experience demonstrates how each enterprise can grow at a faster pace by focusing on its core competency while subcontracting other work, instead of following the Pakistani model of doing everything in-house through vertical integration of production structures within an organization. Poor contract adherence norms in our social system and a weak and tedious judicial system for enforcing contracts are the key obstacles to the development of more productive efficient industrial and commercial structures based on core competencies.

Admittedly, issues like environmental and labour standards under the WTO are adding to the pressure to develop technology, raising the cost of production. Therefore, the need for strategic alliances with others in the global commodity chains to gain access to technologies and markets. This will require a change in attitudes of government functionaries, involving an environment of trust in SMESs, while improving their access to decent quality infrastructure (road networks, railways, ports and utilities – like electricity, gas, water and drainage) and facilitating the development of global associations – the latter being their primary role in accelerating the process of growth of the sectors of industry and services.