SMEs in the services sector: New drivers of growth in Africa’s LDCs?

19 May 2016

How can SME service providers in Africa become key drivers of job creation and inclusive growth, and contribute to their countries’ socio-economic transformation?

Today’s rapidly-changing world, fuelled in particular by ongoing advances in technology, is becoming a rich source of new economic opportunities for large and small firms alike. The developed and many developing countries are adapting to the evolving economic climate by producing ever-more innovative and competitive products and services. However, the poorest countries of the world – commonly classified as least developed countries (LDCs) – are finding it difficult to make the necessary transition. Hampered by limited financial, physical and human resources, these countries have not been able to escape the low-development trap and find a path to inclusive economic growth and wellbeing. As a result, there is a noticeable economic divide between the LDCs and the rest of the world.

The role of SMEs in developing Africa’s services sector

Africa has the dubious reputation of being home to 34 of the 48 LDCs, which is a testimony to the continent’s staggering development challenges. The African LDCs have highly variable topography, climatic conditions, resources, and economic circumstances, but they are broadly united in their low levels of industrialisation, vulnerability to external shocks, pervasive poverty, and infrastructural shortcomings – especially in the areas of transport, energy, and telecommunications. Unemployment, particularly among the youth, is at alarming levels. One of the factors exacerbating the unemployment problem is that women are often the victims of discrimination in the workplace, which erodes their economic contribution and influence in society.

The rising prominence of services throughout the world could, though, ring the changes for the African LDCs. Already, services account for roughly 50 percent of GDP in these countries. However, with many being heavily dependent on export earnings derived from a slim range of primary commodities, new sources of investment capital and export revenue are sorely needed. There is mounting evidence that the development of the services sector could deliver these, which would help to rejuvenate languid job markets and freshen up different segments of society.

Recent years have seen strong growth in the ICT (information and communication technology) and tourism sectors in several African LDCs, while the creative economy (responsible for outputs such as musical recordings and cultural events) has been identified as an area with significant growth potential for the continent. Yet many services are delivered on a very limited scale and are not of an advanced commercial type. Although African LDCs do export a number of commercial services, they typically run a services trade deficit. Also, the average contribution of services exports to total exports is only about 28 percent, with as much as half this figure attributed to in-bound travel linked to tourism.

As conversations about the importance of services to countries’ (and especially poor countries’) economies resonate throughout the world, the issue of SMEs (small and medium-sized enterprises) and their contribution to the services sector is often raised. Yet the scope and impact of SME-driven services in LDCs have received scant attention in formal academic literature. Information on SMEs in the services sector in Africa is particularly patchy. However, what is evident from many policy documents, broad economic analyses, business reports, and opinion pieces is that SMEs in the African LDCs face significant hurdles when attempting to develop and market their service offerings, which can be a source of acute frustration and disillusionment, and make the prospect of business success a distant dream.

The term “SME” defies a precise definition, and varies from country to country, and industry to industry. Generally, though, it is used to describe a business entity that operates with limited resources and produces modest financial returns – at least when compared to large corporates. In this article, an SME is taken to mean a business with up to 100 employees, where a “medium-sized” enterprise would have 50-100 employees and a “small” enterprise would have less than 50 employees. Some people make a further distinction between “small” enterprises (10-49 employees) and “micro” enterprises (less than 10 employees).

A defining feature of African LDCs is that the majority of businesses fall into the “micro” enterprise category and are survivalist in nature, i.e. they generate very low returns and have little growth potential. They are also largely unregistered, operating informally and “under the radar” when it comes to tax and other regulatory compliance issues. In contrast, there is a dearth of medium-sized firms that have a reasonable market following, represent attractive investment prospects, and are well placed to deliver an even stronger economic performance if they were to receive external funding or other forms of support. It is these medium-sized firms (sometimes referred to as the “missing middle”) that play a crucial role in creating meaningful jobs and driving long-term, sustainable development in their respective countries.

Performance drivers and constraints

There are many drivers of SME performance in the services sector. First, there needs to be a strong demand for the services that SMEs offer or aspire to offer. African LDCs tend to have small domestic markets due to low buying power among the population and other demand-limiting factors. However, where a country has natural attractions (e.g. scenic beauty or evidence of a colourful history), SMEs might tap into these obvious tourism-related opportunities and offer tailored or niche services that could compete with more traditional tourist offerings.

To flourish, SMEs also need to understand the markets they are serving, whether they are local or international, and be able to readily access those markets. This could be facilitated by, among other things, reliable and affordable transport and telecommunications/ICT, and a regulatory framework that takes SMEs’ specific circumstances into account. The rapid spread of mobile banking services in East and Southern Africa is an example of how advances in mobile phone technology have helped to fan entrepreneurial ideas and create new, high-growth industries that have international reach – even in the face of other, persistent market challenges.

Another key performance driver for SME service providers is being continuously exposed to developments in their particular fields – e.g. through formal or informal networking – and acquiring the skills needed to recognise and act on new business opportunities.

Although SMEs with an entrepreneurial leaning like the freedom to experiment with new technologies and business applications, they also need to adhere to effective financial and operational controls. Sound management underpins all successful businesses, but it can be difficult to practise in small enterprises that are trying to survive on a day-to-day basis. In such circumstances, it is all too common for the niceties of developing and motivating staff, ensuring financial discipline and accountability, and rewarding good performance to fall by the wayside. Nevertheless, developing human capital is one of the essential building blocks in SME development.

The regulatory environment in which SME service providers in Africa operate can greatly improve their chances of success, but it can also be an instrument in their demise. Understandably, many small businesses are resistant to various types of regulation because compliance can be costly, time-consuming, and energy-sapping. However, well-crafted regulations can help to bring order and certainty to a business sector by prescribing clear entry criteria and performance standards, and by averting market failure induced by excessive competition. Unfortunately, in many of the African LDCs, regulations are opaque, used for protectionist purposes, mired in red tape or motivated by corruption. What is needed is a shift in emphasis from government control/meddling, to government support aimed at building companies’ competitiveness.

Another leading constraint to SME service providers’ effectiveness in Africa is a general lack of access to finance, both for start-up purposes and for local or international expansion. In most African countries, traditional banking has largely failed, leaving about 80 percent of the continent’s population “unbanked” in a formal sense. Personal savings have traditionally been the main funding source for SMEs, although microfinance institutions have made quite strong inroads into a number of markets. More recently, mobile banking services, such as the M-Pesa money transfer system, have gained traction. However, what is really needed is a stronger entrepreneurial culture to take root across the continent, and more venture capitalists and other investors to take risks on new and promising business ideas.

SME service providers, perhaps more than their larger counterparts, are very sensitive to the quality of their countries’ national infrastructure as this has a clear impact on efficiency levels and effectiveness. For example, congested and unmaintained roads, and unreliable and expensive electricity and telecommunications services can add significantly to the cost of doing business and dash SMEs’ hopes of delivering competitively-priced services at a regional or international level.

The need for a sound policy environment

It is of concern that although the SME services sector is playing an increasingly important role in poor countries’ economies, it receives little attention at the official policy level. SMEs often appear on the policy agenda, but this rarely translates into concrete and viable initiatives. As a largely neglected group, SME service providers often end up, by default, having to adhere to the same rules and regulations as those applying to larger firms, or they simply opt to remain in the shadows as informal, non-tax-paying entities. In East Africa, countries like Tanzania and Rwanda have been making a concerted effort to streamline regulatory processes so as to fast-track business registration and licensing and facilitate easier access to finance. However, SMEs in these countries still struggle to become competitive in the face of high taxation rates, a plethora of financial reporting requirements and much unnecessary bureaucracy.

In cases where governments do focus on the small business community, financial and other interventions are typically designed for business start-ups. Often overlooked are the more established SMEs, which may be enjoying the economic benefits of operating in “clusters” with other businesses (in, for example, the transport, construction, hospitality/tourism and education sectors), making inroads into regional or international markets, and creating jobs. Such SMEs are ideal candidates for government grants, subsidised training and business facilitation initiatives because these support measures will build on an existing foundation. The importance of strengthening the micro enterprise sector in Africa should not be downplayed, but the real drivers of growth are the larger SMEs (or at least those with more technological, as opposed to labour-intensive, capacity), since they have greater potential to get involved in exporting and/or act as service links in regional or international value chains.

A policy environment that provides the necessary stimulus for SME development should be the result of an honest and ongoing appraisal of the economic climate in the country, the needs of specific sectors and sub-sectors, and extensive consultation between the government, its social partners and private business concerns.

Looking towards a more sustainable future

If African countries are serious about creating a vibrant SME services sector, one of their anchor strategies should be to adopt a holistic, long-term vision. Sometimes in their eagerness to tackle unemployment, LDC governments focus on boosting economic growth, forgetting that more growth in the absence of supportive and responsible development programmes can erode a country’s productive resources and do little to mend the divisions that society and economic circumstances have created between people.

In September 2015, 193 countries adopted the UN Sustainable Development Goals (SDGs), which set out what countries should be doing to reverse the vicious cycle of poverty, inequality, under-development, and environmental degradation that is evident in many parts of the world. Resting on three interlocking pillars – economic development, social development, and environmental protection – the SDGs envisage a future that has been rescued from the current “short-termism” that characterises much political and economic thinking, particularly in Africa. The relationship between SMEs and the SDGs has not been explored in any depth. Nevertheless, the latter have particular relevance for SME service providers in Africa’s LDCs as many of the goals have themes that SMEs on the continent can easily relate to, e.g. the need for quality education and healthcare, reliable energy sources, resilient infrastructure, decent employment opportunities, and safe places to live and work.

SMEs in the services sector in Africa have the potential to become the new rising stars across the continent (particularly in the area of tourism, which is brimming with opportunity). However, politicians, businesses and employer groups, sustainable development experts, and many other stakeholders need to find a common language and path if they are to lead the continent into a brighter future.

Authors: Sonja Grater, Senior Lecturer, School of Economics, North-West University, Potchefstroom, South Africa. Ali Parry, Extraordinary Research Scientist, TRADE Research Focus Area, North-West University, Potchefstroom, South Africa. Wilma Viviers, Director, TRADE Research Focus Area & WTO Chair, North-West University, Potchefstroom, South Africa

This article is an adaptation of a forthcoming conceptual paper to be published by ICTSD.

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