18 april 2009 wolfgang lehmacher boao forum for asia annual conference 2009 sme strategies:...

18 April 2009

Wolfgang LEHMACHER

Boao Forum for Asia Annual Conference 2009

SME Strategies:Attracting Talent, Securing Financing & Achieving Growth

Background Information

Executive Summary

Small and Medium Enterprises (SMEs) are a major contributor to the economies of most countries around the world, representing large percentages of both employment and GDP contribution The economic significance of SMEs is further highlighted by their high productivity and role in supporting

innovation and greater income equality

Despite this, SMEs face two key constraints to their capacity to expand: An inability to attract quality staff as a result of low brand recognition, less ability to pay top salaries, low

HR capacity, and a perceived lack of stability Difficulty obtaining external finance and capital due to an unwillingness for banks to lend to SMEs, high

collateral requirements, and poorly articulated business plans

The impact of these constraints can be reduced through the use of a range of innovative solutions SMEs can adopt measures to attract quality staff including:

Clearly articulating their value proposition to employees Offering alternative remuneration packages, or Adopting best practices in HR to improve their competiveness in the job market

Similarly, SMEs can improve their access to finance by: Making themselves more attractive to banks, by opening more transparent communication channels Seeking non-bank sources of finance, or Reducing the need for financing through a variety of means, including the use of asset-light business

models

In order to pursue growth, particularly in the current environment where capital constraints are even more of an issue, SMEs need to adopt innovative growth models that require less capital and fewer additional staff GeoPost’s Collaborative Business Model is an example of the success of this approach

Agenda

Attracting Talent to SMEs

Economic Significance of SMEs

SME Growth Strategies

Access to Financing and Capital

Definition

The term “small and medium enterprises” (SMEs) typically refers to all businesses in an economy excluding large businesses / corporations Within some countries a separate category of “micro” enterprises is considered to exist below “small”, while

in others the definition of “small” enterprises includes “micro” enterprises

In most countries (developed and emerging) SMEs make a significant economic contribution Although only small, micro and small businesses typically make up the vast majority of the number of

businesses, so collectively have a significant impact on the economy E.g. firms with under 20 employees make up 97% of the registered businesses in the USA

Medium businesses are smaller in number, but each individual business will employ more staff and contribute more to the economy

The actual definition of an SME varies widely across (and even within) countries Employee-based definitions are the most common, and are generally within the range of 0 to 500

employees, with an upper limit of 250 employees the most common definition Asset and turnover-based definitions are less common, but used by some countries and institutions

E.g. the World Bank sets an value of US$15m for assets or turnover as the upper limit for consideration as an SME

Accordingly, throughout this pack the definition of SMEs varies as different studies and statistics are quoted (definitions will be noted on relevant slides)

A broad range of definitions exist for the concept of Small and Medium Enterprises

Source: World Bank (1): Where Micro enterprises are defined the term “MSME” is often used to indicate their inclusion. In countries where a Micro business definition exists, the term “SME” would exclude micro-sized businesses

Economic Significance of SMEs (1/3)

SMEs are major employers in both developed and emerging countries, although the extent of their impact varies greatly from country to country

Source: IFC Micro, Small and Medium Enterprises database

MSME Share of Employment % of total Employment, selected countriesMost recent data (1997 – 2005)

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France UK USA Japan Brazil Russia India China SouthAfrica

Across both developed and emerging markets, SMEs account for a significant percentage of total employment

Within each country grouping (i.e. developed vs. emerging) there is considerable variation between countries in terms of SME’s share of employment Amongst developed markets, SMEs in

the UK contribute 40%, while in Japan they contribute 88%

Amongst the BRICS markets most are clustered around 60% although in South Africa only 39% of employment comes from SMEsThe definition of MSMEs is based on the number of employees and is as follows:

France: 0-250 employees UK: 0-250 employeesUSA: 0-500 employees Japan: 0-300 employeesBrazil: 0-100 employees Russia: 0-250 employeesChina: Definitions n/a South Africa: 0-100 employeesIndia:0-10 employees (Micro and Small only, data on Medium businesses not available)

Developed Markets Emerging (BRICS) Markets

Note: Care should be taken in making cross-country comparisons due to differences in definitions of SMEs


In high and medium income countries, SMEs account for a significant portion of GDP, while in poorer countries their impact is much less

Source: World Bank (1): Data is based on national SME definitions and may therefore vary from country to country in the sample

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High IncomeCountries

Middle IncomeCountries

Low IncomeCountries

SME(1) Share of GDP% of total, World Bank country groups1990-1999 averages

SMEs also make a significant contribution to the Gross Domestic Product (GDP) of national economies

According to Wold Bank studies, this contribution is larger in wealthier countries, in which SMEs tend to be more productive SMEs in high income (mainly western) countries

contribute 46% of GDP on average By contrast, SMEs in the poorest countries contribute

only 5% of GDP

This high productivity is a key aspect of the economic significance of SMEs, with medium-sized enterprises tending to be more productive than other businesses An analysis of business productivity by the

International Centre for Economic Growth showed that business productivity peaks in enterprises with 50-100 staff

This means that countries with a high proportion of medium sized enterprises will have a higher average productivity and higher GDP than countries with fewer businesses of this size

Categories are based on World Bank country classifications, based on gross national income (GNI) per capita:High Income: GNI per capita of US$11,456 or moreMiddle Income: GNI per capita between US$936 and US$11,456Low Income: GNI of US$936 or less


The economic significance of SMEs is further highlighted by their role in supporting innovation and encouraging greater income equality

SMEs are often more innovative and provide better avenues for the introduction of new ideas United Nations research has shown that in developed and more advanced developing countries SMEs

contribute the largest share of innovation that occurs in immature, relatively fragmented industries E.g. in the information technology industry SMEs, especially small start-up companies, are some of the

major developers of new and innovative hardware and software solutions

SMEs are a crucial part of the supply chain – providing materials, sub-assemblies and services to larger businesses in a specialised manner, and distributing goods to customers This increases support for the manufacturing and heavy industry sectors in the economy, which can drive

economic growth and higher output

Furthermore, stimulating the creation of more SMEs enables developing nations to grow a solid middle class A larger SME sector facilitates greater income distribution to a wider population base through the

distribution of profits to business owners This in turn drives consumer spending, which feeds back into the economy promoting further growth

Source: United Nations Industrial Development Organisation; Centre for Economic Grwoth

Impact of the Economic Downturn on SMEs

Declining consumer spending impacts sales Job losses and economic uncertainty are reducing consumer confidence, resulting in lower sales for consumer-exposed SMEs SMEs tend to be hit more heavily by falling sales since they often do not have cash reserves to fall back on

Flow on effects from throughout the value chain The role of small businesses in providing specialised links in the value chain makes them vulnerable to falling sales as demand

drops from other businesses in the value chain (both small and large) E.g. Plummeting sales for automobiles in the USA have hurt small businesses that supply parts to the auto industry almost as

much as the big car manufacturers. The prospect of the major manufacturers going bankrupt, would have devastating knock-on effects for many small businesses down the value chain

Challenges in managing cash flow as customers and suppliers tighten belts Smaller SMEs often run on a low-cash basis and rely heavily on reliable payment of invoices for working capital The economic downturn is resulting in a significant rise in late payments, which can result in cash flow issues for SMEs A survey in Singapore in mid February found that 46% of SMEs had experienced cash flow difficulties as a result of the financial

crisis, while 52% had struggled to obtain payments from customers

Less access to credit and external capital The global financial crisis that sparked the downturn has resulted in less opportunities to source external finance for SMEs

(discussed further in the Access to Finance and Capital section, below)

Growth opportunities for SMEs that are well positioned Although SMEs tend to struggle in recessions, those that have a strong financial position and flexibility in their prices and

business models can achieve opportunistic growth Chances to re-shape the market as rapid changes occur in the competitive landscape due to competitor failures Opportunities for acquisition as competitors struggle

SMEs face a number of challenges arising from the current downturn, primarily due to falling revenues and exposure to cash flow issues. However, SMEs that are well positioned may find growth opportunities

Source: Media articles

Agenda





Obstacles to Attracting Talent

SMEs are at a disadvantage to larger firms when it comes to attracting quality staff, with a number of barriers that must be overcome

Source: BusinessWeek; Media articles

Lower Brand Appeal

Lower Brand Appeal

SMEs typically lack the brand recognition of larger firms, meaning that staff are unlikely to seek them out on reputation aloneSMEs typically lack the brand recognition of larger firms, meaning that staff are unlikely to seek them out on reputation alone

Less Capacity to Pay Top

Salaries


Salaries

SMEs are less likely to be in a financial position to pay above-market salaries in order to attract top performing staffSMEs are less likely to be in a financial position to pay above-market salaries in order to attract top performing staff

Lower HR Capacity

Lower HR Capacity

The lean nature of most SMEs generally means that they have smaller Human Resources divisions with less spare capacity to dedicate to more resource-intensive recruitment strategies

The lean nature of most SMEs generally means that they have smaller Human Resources divisions with less spare capacity to dedicate to more resource-intensive recruitment strategies

Perceived Lack of Stability


SMEs are often perceived by potential staff as being a less stable working environment that is more likely to fail at some pointSMEs are often perceived by potential staff as being a less stable working environment that is more likely to fail at some point

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Clear Articulation of Value PropositionClear Articulation of Value Proposition

Potential SolutionsArticulation of Value Proposition

SMEs can overcome a lack of brand strength and awareness by clearly stating the value of working within a smaller environment

Personal interaction with management and exposure to the operations of the business

Greater flexibility in working conditions A smaller and more streamlined structure means it is logistically easier for an SME

to implement flexible working hours and adjustable benefits packages

Opportunities for career development Potential for rapid progression: SMEs are typically more willing to promote

opportunistically, rather than being bound by strict conventions Personalised career path: The smaller size of SMEs makes it possible for staff to be

offered tailored career progression and individual needs-based training

Clear communication channels as a result of more regular inter-personal contact

Less bureaucracy: SMEs are less likely to have complex internal procedures

Vision, values and Culture Although brand recognition may be low, a clear expression of vision and the internal

culture of an SME is a strong selling point

Personal interaction with management and exposure to the operations of the business

Greater flexibility in working conditions A smaller and more streamlined structure means it is logistically easier for an SME

to implement flexible working hours and adjustable benefits packages

Opportunities for career development Potential for rapid progression: SMEs are typically more willing to promote

opportunistically, rather than being bound by strict conventions Personalised career path: The smaller size of SMEs makes it possible for staff to be

offered tailored career progression and individual needs-based training

Clear communication channels as a result of more regular inter-personal contact

Less bureaucracy: SMEs are less likely to have complex internal procedures

Vision, values and Culture Although brand recognition may be low, a clear expression of vision and the internal

culture of an SME is a strong selling point

Lower Brand Appeal

Lower Brand Appeal


Salaries


Salaries

Lower HR Capacity

Lower HR Capacity



Source: BusinessWeek; The Business Times;

SMEs that do not currently offer some of these benefits should make their implementation a priority

Alternative Remuneration StrategiesAlternative Remuneration Strategies

Potential SolutionsAlternative Remuneration Strategies

SMEs can offer profit share opportunities and share option models to staff in addition to salaries Profit sharing models allow for structured bonuses to be paid to staff based on the

performance of the business Employee share option models allow typically function by buying and distributing

share in the company to staff, who can then purchase additional shares if wanted These models differ from executive share options packages in that they are

generally available to all staff in the SME This model has been popular in the US for the past 50 years, amongst both

SMEs and larger businesses

Advantages of such measures are that they allow for more generous remuneration without providing a permanent financial drain on the business Profit-based remuneration schemes are also highly flexible, in that they

automatically adjust in tougher business conditions

These schemes also ensure greater alignment of staff with the business’s strategy and the goals of management

SMEs can offer profit share opportunities and share option models to staff in addition to salaries Profit sharing models allow for structured bonuses to be paid to staff based on the

performance of the business Employee share option models allow typically function by buying and distributing

share in the company to staff, who can then purchase additional shares if wanted These models differ from executive share options packages in that they are

generally available to all staff in the SME This model has been popular in the US for the past 50 years, amongst both

SMEs and larger businesses

Advantages of such measures are that they allow for more generous remuneration without providing a permanent financial drain on the business Profit-based remuneration schemes are also highly flexible, in that they

automatically adjust in tougher business conditions

These schemes also ensure greater alignment of staff with the business’s strategy and the goals of management

Introduction of alternative remuneration strategies such as profit sharing schemes allows SMEs to compete with larger businesses that may offer higher salaries

Lower Brand Appeal

Lower Brand Appeal


Salaries


Salaries

Lower HR Capacity

Lower HR Capacity



Source: Resourcing magazine; Human Resource magazine; Media articles;

Adopt Best Practices in HRAdopt Best Practices in HR

Potential SolutionsAdopt Best Practices

Integrate strategic planning and talent planning Shortages of talent in emerging markets mean that talent has become a key

business input, and should be considered as a key part of SME strategy

Focus on development pipelines In markets such as China and India where many SMEs rely on local university

graduates, it is critical that companies develop close relationships with target universities

Provide internal development schemes Successful SMEs focus on the development of talented internal staff, who will often

be the strongest candidates for line manager roles Clear development paths and tailored internal training programs are key to

developing outstanding internal candidates

Consider outsourcing Key HR functions (including recruitment) can be outsourced to allow SMEs to focus

internal resources on their primarily business activity This approach should also be taken when determining if recruitment is necessary –

outsourcing non-essential business functions eases HR burdens for SMEs

Integrate strategic planning and talent planning Shortages of talent in emerging markets mean that talent has become a key

business input, and should be considered as a key part of SME strategy

Focus on development pipelines In markets such as China and India where many SMEs rely on local university

graduates, it is critical that companies develop close relationships with target universities

Provide internal development schemes Successful SMEs focus on the development of talented internal staff, who will often

be the strongest candidates for line manager roles Clear development paths and tailored internal training programs are key to

developing outstanding internal candidates

Consider outsourcing Key HR functions (including recruitment) can be outsourced to allow SMEs to focus

internal resources on their primarily business activity This approach should also be taken when determining if recruitment is necessary –

outsourcing non-essential business functions eases HR burdens for SMEs

SMEs’ lack of HR capacity makes it more important that core HR functions such as recruitment are carried out in line with best global practices

Lower Brand Appeal

Lower Brand Appeal


Salaries


Salaries

Lower HR Capacity

Lower HR Capacity



Source: MGI; The GMP Group; Media articles

Transparent CommunicationTransparent Communication

Potential SolutionsCommunicate Transparently

Clear communication of business plans and growth strategies Communication of plans and involvement of employees in the strategic process

provides employee buy-in and can reduce the perception that the business is unprepared for threats or changes

Highlighting of aspects of SME structures that provide job security: Due to the smaller size of SMEs relative to other businesses, loss of strongly

performing staff is a more serious threat to the business The absence in most SMEs of formal knowledge management and transfer

mechanisms also ensures that providing job security to staff helps the performance of the business

SMEs also suffer from a lack of external employment resources which makes them more likely to attempt to retain and retrain existing staff if business needs shift

SMEs can also assure job candidates that provision of job security to staff is a key priority for the business

Clear communication of business plans and growth strategies Communication of plans and involvement of employees in the strategic process

provides employee buy-in and can reduce the perception that the business is unprepared for threats or changes

Highlighting of aspects of SME structures that provide job security: Due to the smaller size of SMEs relative to other businesses, loss of strongly

performing staff is a more serious threat to the business The absence in most SMEs of formal knowledge management and transfer

mechanisms also ensures that providing job security to staff helps the performance of the business

SMEs also suffer from a lack of external employment resources which makes them more likely to attempt to retain and retrain existing staff if business needs shift

SMEs can also assure job candidates that provision of job security to staff is a key priority for the business

Employee or candidate perceptions about a lack of stability in SMEs can be addressed through clear communication about the business’s strategy and employee retention priorities

Lower Brand Appeal

Lower Brand Appeal


Salaries


Salaries

Lower HR Capacity

Lower HR Capacity



Source: BusinessWeek; The Business Times;

GIC’s Recruitment and Retention Strategies

Although GIC is by no means an “SME”, it faces similar challenges in terms of recruiting staff, as it competes against strong global brands. As a result, GIC has made its approach to people development a crucial part of its strategy

Development ActivitiesDevelopment ActivitiesKey Attributes of GIC’s People Development planKey Attributes of GIC’s

People Development plan

Consistent and structured approach

Objective assessment criteria

Engages top-level management

Transparent review process

Employee engagement (through a structured development process)

Actively monitored

Adaptive and open to review/change

Utilises innovative approaches

Carefully designed job assignments (the most critical development activity), potentially involving rotation and alternative assignments

Requirement-based training program: “On-the-Job” training, including:

Current Role Alternative assignment / project work Job rotation

Structured training program, implemented at the central and business unit levels, including modules focusing on: International competency Operational competency Work techniques People management

Targeted individual development plans Mentoring / Coaching

SMEs should look to adopting the core principles of a transparent, structured approach as a means of significantly improving their value proposition to current and propsective staff

GIC’s Compensation Framework

Compensation benchmarking is conducted for similar positions in the relevant geographical market both: Internally (GIC and GeoPost Group) Externally (similar firms)

Benchmarking is conducted for a position’s: Total compensation level, and Compensation mix (i.e. base salary and

discretionary bonus proportion levels)

Packages consist of: Base salary Discretionary bonus – at-risk payments

which are tied to the performance of individuals and to the whole firm

Additional benefits – including private healthcare, pension plans, etc.

Adjustments are made: Annually on a firm-wide basis Individually if the scope of the role changes

Total Compensation Package

Total Compensation Package

Base Salary

Discretionary Bonus

Additional Benefits

Benchmarking

Annual Adjustment

Individual Adjustment

GIC Approach to Setting CompensationGIC Approach to Setting Compensation

This is supported by a compensation scheme that emphasises benchmarking against the market and creating a balanced overall package

By adopting a similar approach, with a larger emphasis placed on the role of discretionary bonuses in the form of profit sharing, SMEs can compete with larger firms for top performers

Impacts of the Downturn on Talent Attraction & Retention

The economic downturn in many countries has resulted in layoffs and rising unemployment, which has shifted the supply / demand balance of potential candidates In January 2009 the CEO of headhunters Morgan McKinley declared the “war for talent” over as a result of massive declines in

job vacancies in the UK Private sector job vacancies in Hong Kong fell 24% from October to November 2008, and concerns have been raised about an

influx of university graduates in 2009 who may be unable to find work This will reduce the impact of obstacles such as SMEs’ lower brand recognition and less competitive salaries, and make

potential solutions more effective as job seekers are presented with fewer alternative opportunities in larger firms Well-positioned SMEs may take this opportunity of a greater availability of job seekers to recruit talented staff that have been

shed from competitors

Despite this general trend of job losses, talent shortages remain at upper levels in many industries Despite layoffs at a factory level, many Chinese firms are still experiencing a shortage of talented, experienced line managers

and managers A recent survey by the Economist revealed similar issues in Russia, with 38% of Russian firms indicating that they struggled to

find staff with business development skills despite the economic downturn This ongoing shortage in key areas highlights the need for SMEs to implement low-cost best practice solutions such as focusing

on development pipelines for key staff

Tough economic times also create a greater need for retention of talented staff to maintain and improve business productivity and resilience to the downturn Like all businesses, SMEs will need to tightly manage costs in difficult times, which may mean reducing staff. In this

environment, ensuring that the most valuable staff are retained becomes critical for the survival of the business Richard Hoon, CEO of Asian executive search firm I Search International, recently summarised the situation: “In good times,

SMEs need good people. In bad times, they need even better people.”

The economic downturn has resulted in rising unemployment which has expanded the pool of available workers, however talent shortages still exist in some areas and staff retention has become more critical


During the downturn SMEs should focus more heavily on the solutions discussed as a means of retaining essential staff and gaining an advantage in attracting high performers

Agenda





Challenges in Accessing Finance & Capital

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Share of SMEs(1) Reporting a Problem as Major/Very Severe% of total2002-2003 survey of SMEs across 71 (mostly developing/emerging) economies

(1): SMEs defined as businesses with employees < 250Source: World Bank Enterprise Surveys

Financing issues considered a major obstacle by a large

percentage of SMEs

Access to affordable finance is regularly reported as a major issue for SMEs across many countries

Typical Financing Problems Encountered

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Philippines Indonesia Malaysia India China Thailand Singapore Australia Taiwan Japan HongKong

SouthKorea

Bureaucracy and Red Tape

Banks Not Willing to Lend toSMEs

Insufficient Collateral

Project Proposal notAccepted

Problems Encountered in Financing Asian SMEs% of Respondents encountering the problem2008

This is particularly the case in emerging markets, where a combination of less sophisticated SMEs and a less developed banking sector results in significant problems for SMEs in obtaining finance from banks…

Source: UPS SME Survey 2008

SMEs in emerging markets are perceived by lenders as higher risk, reflected by:

• Lower willingness of banks to lend to them

• High collateral requirements

• Tight requirements on project planning

More developed economies have more sophisticated banking sectors that have the capacity to cater to SMEs through specific offers and pricing systems

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Internal Funds /RetainedEarnings

Banks Equity Leasing Trade Credit DevelopmentFinancing

Informal Sources(e.g. friends,family, etc.)

Small Businesses (<20 employees)

Medium Businesses (20-99 employees)

Larger Businesses (100+ employees)

SME Sources of Finance

Financing Patterns by Firm Size(1)

% of investment financed from internal and external sources2002-2003 survey of SMEs across 71 (mostly developing/emerging) economies

… with the result that SMEs are more likely to be forced to rely on internal funds as a source of finance

Source: World Bank Enterprise Surveys

Larger businesses are more than twice as likely to finance

investment from bank lending…

(1): Note that “Large businesses” in this survey includes all businesses with more than 100 staff, which will include some businesses classified as SMEs elsewhere

A lack of external finance provides a major barrier to investment for many SMEs, as internal funds may not be sufficient to allow expansion

(1)

SMEs

… while SMEs are more likely to resort to informal

funding sources

Solutions to the Financing ChallengeBecoming More Attractive to Banks

SMEs to establish an informal collective among SMEs, Business Associations, Local Governments

The collective provides an open forum and knowledge sharing group efficiently learn and help each other

Bank representatives may be invited

One potential solution to the difficulties SMEs face in securing finance is to become more attractive to banks. This can be done by forming collective groups to improve communication and shared understanding with banks

Source: Asian Development Bank

Step 1: Form a Collective

Step 1: Form a Collective

Step 2: Start Bank RelationStep 2: Start Bank Relation

Step 3: SMEs Gain Skills

Step 3: SMEs Gain Skills

Step 4: SME PresentationStep 4: SME Presentation

Step 5: Business Plan

Step 5: Business Plan

The collective studies bank products and discusses bank’s view on SMEs

At this stage SMEs may open a banking relationship, but not commence borrowing

Banks have an opportunity to informally examine SMEs as future candidates for lending and other services

SME understands bank’s view and expectations

SMEs realise and undertake their own capacity building on technical skills

Banks may help SMEs gain skills

SME makes a comprehensive company presentation Demonstrates

upgraded technical skills

Discloses information in a professional manner

Bank has already gained significant knowledge about SME through informal dialogue

Finally, SME can present a Business Plan for a specific project

SME provides a loan application

SME submits its collateral arrangement proposal

By this stage Bank can expect a wide range of services from the relationship

Asian Development Bank Framework for SME-Bank Dialogue (1)Asian Development Bank Framework for SME-Bank Dialogue (1)

(1): The ADB framework is primarily targeted at the smaller end of the SME sector

Solutions to Financing ChallengePursue Alternative Sources of Finance

SMEs can seek sources of external finance outside of banks to improve access to finance Private equity and venture capital investors generally have different appetites for risk than banks, which

may suit the needs of SMEs There has been rapid growth in venture capital and private equity in Asia in recent years, primarily

concentrated in Japan and Korea. Hong Kong and Singapore are also centres of regional venture capital activities

Venture capital can be a source of capital for growth to SMEs, particularly those that are in the early stages of development E.g. Venture capital in Taiwan focuses on helping to develop small high-tech companies and is primarily

driven by fund managers with experience in the U.S. venture capital industry However, venture capital availability varies by market, and is dependant on SMEs growing rapidly to

provide return on investment

Private equity investment tends to occur at later stages in an SMEs growth cycle, and is used to finance the restructuring and growth of established firms Private equity is a common source of non-bank funding for SMEs in developed Asian economies such as

Korea and Japan Private equity investment in SMEs is also increasing in emerging markets such as India, where it is being

facilitated through local banks E.g. ICICI bank, India’s largest private lender, has set up a US$200 million private equity fund

exclusively for the SME sector

An additional benefit to SMEs from private equity or venture capital financing can be the introduction of expertise as the investors become actively involved in advising the business owners However, the downside of this can be a partial loss of control for the owners of the business

Another option for SMEs is to seek finance from non-bank sources, such as private equity firms, who may be more willing to invest in sectors that banks believe are too risky

Source: Pacific Economic Cooperation Council; Media articles

Impact of the Economic Downturn on Availability of Finance (1/2)

The credit crunch that hit the global financial sector and sparked the economic downturn continues to affect banks in many countries around the world It is more expensive for banks to funds loans to businesses and consumers Banks are facing rising loan defaults, as economic conditions impact their retail and business customers

This has led to three major impacts on the ability for SMEs to obtain finance from the banking sector:

The financial crisis has weakened banks in many countries, increasing the difficulties SMEs face in obtaining finance from banks…

Banks are even less willing to extend loans to SMEs As banks “de-risk” their loan, they are reducing exposures to higher risk segments (including SMEs) For many banks this involves treating SMEs collectively rather than targeting individual businesses,

meaning that even strong-performing SMEs may be effected E.g. The Korean government has been forced to introduce loan guarantees in order for banks to

lend to small businesses

1

Interest rates on business loans have gone up significantly, and have not fallen as swiftly as housing loans as central banks reduce official interest rates While some Indian banks lowered interest rates by as much as 1.5% in December 2008, the new

rates were generally only available on loans for secured products (homes, automobiles, etc.) Despite official Korean interest rates falling 2% in the last year, banks in Korea have only passed this

reduction on for housing loans, with other loans still facing high rates As a result of this, the cost of borrowing for SMEs remains high

Banks are less accommodating in their treatment of SMEs in an effort to reduce losses Requirements for collateral have increased (personal assets from business owners is increasingly

being demanded) Non-performing loans are being managed more aggressively, placing pressure on struggling SMEs

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Impact of the Economic Downturn on Availability of Finance (2/2)

Non-bank lenders have also seen a significant increase in their cost of funding as a result of the credit crunch, resulting in significantly higher interest rates and fewer loans for SMEs E.g. Reliance Capital, a Non-Bank Finance Company (NBFC) in India, reported a rise in its cost of funds

from 9.5% to 13% in the last 6 months of 2008 As a result loan disbursements have fallen significant, especially to the SME sector

There have been reports that other Indian NBFCs are sitting on any cash reserves they may have rather than lending to SMEs, out of a fear that loans will not be repaid

Availability of private equity and venture capital has decreased as business failures and plummeting stock markets have hit the existing investments of these businesses

E.g. investments by private equity firms in China fell drastically in the third quarter of 2008 to US$2 billion, a drop of 42% from the corresponding period one year before

The fall was mainly attributed to smaller private equity firms, which are more likely to invest in SMEs, but are also having significant problems raising capital in the current market

…while also reducing the availability of SME finance from non-bank providers

In this environment it becomes even more important for SMEs to consider approaches that reduce the need for external finance


Agenda





Barriers to SME Growth

The previous sections of this briefing have highlighted two key challenges that SMEs across the world face: An inability to compete with larger firms in attracting high performing staff A lack of access to finance and capital

Both of these factors act as a constraint on SMEs wishing to grow their businesses, as they limit the availability of resources (either capital or skilled employees) needed to implement expansion plans

As a result, SMEs must adopt innovative growth models that are explicitly designed to anticipate and overcome these constraints if they are to successfully expand

Source: World Bank; Asian Development Bank

The previous sections have highlighted the key constraints that SMEs face. These can be significant constraints on their and require innovative growth models to overcome them

Traditional Expansion ModelsD

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Capital Requirement

Organic GrowthJoint VentureLicensing / Franchising

Partnership / Service

Agreements

An agreement with an external provider to allow geographic or product expansion

Leasing intellectual property (i.e. branding)

to a company in a foreign market

A company jointly formed a new entity

with one or more local players

Expansion into new markets / products by

adding to internal capabilities

Acquisition

Minimises capital requirementProvides quick access to the marketUtilises existing assetsLower regulationMost flexible

Minimises capital requirementProvides quick access to the marketUtilises existing assetsLower regulationMost flexible

Minimises capital requirementQuick access to marketLower regulationFlexibility to change arrangements after contract expiry

Minimises capital requirementQuick access to marketLower regulationFlexibility to change arrangements after contract expiry

Provides more controlCan leverage joint knowledgeShare riskCan provide a degree of flexibilityAccess to partner’s staff / capabilities

Provides more controlCan leverage joint knowledgeShare riskCan provide a degree of flexibilityAccess to partner’s staff / capabilities

Full control of growth plansProvides the flexibility to design operations upfrontProtects intellectual property

Full control of growth plansProvides the flexibility to design operations upfrontProtects intellectual property

Limited controlLimited returns

Limited controlLimited returns

Limited control over assetsCan be difficult to find appropriate franchisees / licensees

Limited control over assetsCan be difficult to find appropriate franchisees / licensees

Can be difficult to manageSubstantial capital requirementIntellectual property loss riskRegulatory complexity

Can be difficult to manageSubstantial capital requirementIntellectual property loss riskRegulatory complexity

High capital requirementRequires internal development of competencies

High capital requirementRequires internal development of competencies

Highest capital requirementRegulatory complexity

Highest capital requirementRegulatory complexity

The acquisition of an existing foreign entity

Full control of growth plansProvides existing operations, staff and capabilitiesProtects intellectual property

Full control of growth plansProvides existing operations, staff and capabilitiesProtects intellectual property

Traditionally SMEs have adopted any one of five broad models to pursue growth

These models can struggle to address SME growth barriers They are both highly capital intensive The organic model requires the development of internal

competencies, which can be a challenge for SMEs which struggle to recruit talented staff

Growth using these models will be even more difficult in the current economic environment

These models can struggle to address SME growth barriers They are both highly capital intensive The organic model requires the development of internal

competencies, which can be a challenge for SMEs which struggle to recruit talented staff

Growth using these models will be even more difficult in the current economic environment

Challenges of Capital-Intensive Expansion

Capital Requirement



AgreementsAcquisition

These models are capital-intensive, and often rely heavily on the recruitment of talented new staff to expand operations or effectively manage new acquisitions

However, several of these models fail to address the common constraints that SMEs face, particularly in the current economic climate

Suitability to Current Economic Conditions

Strengths:

More effective use of the joint assets of stakeholders – lowering capital requirements, pooling talented staff and increasing efficiency

Develops collaborative relationships with partners and stakeholders that reduce the negative effects of lower control / permanency of arrangements

This is because stakeholders work together rather than compete in their arrangements, as relationships are viewed on a longer term basis, rather than as opportunistic

Value in the current environment:

Can allow SMEs to continue to expand, despite:

Capital limitations – by utilising joint assets and capital of stakeholders

Increased risk aversion – by spreading risk across stakeholders

Lower investment attractiveness – by utilising the joint capabilities and reducing the capital required for a project, an investments can become more attractive

Uncertainty – by injecting more flexibility into expansion models

Models that require less capital and are more partnership-focused, allowing SMEs to expand without the need for significant financial or staffing inputs

Capital Requirement



AgreementsAcquisition

These models offer less capital intensive and more flexible modes of expansion, and allow SMEs to leverage the staff and capabilities of a partner

These models offer less capital intensive and more flexible modes of expansion, and allow SMEs to leverage the staff and capabilities of a partner

18 april 2009 wolfgang lehmacher boao forum for asia annual conference 2009 sme strategies:...

Documents

medium enterprises smes

emerging smes

small businesses

capital slide

number of businesses

term small

capital constraints

registered businesses