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Pathways to profits for micro and small enterprises

Bilal Zia's picture

Numerous research studies on micro and small firms from around the world have shown that (a) microenterprises are ubiquitous; and (b) only a very small percentage of such firms scale up to become SMEs.

The obvious question is why?

It is not for want of help. Each year billions of dollars in aid is given to developing economies to help entrepreneurs establish and grow their ventures.  Yet evidence suggests that this money is having little impact in some of the key areas it is directed towards improving.

Take microcredit for example. A recent review of six randomized evaluations from four continents suggests that, while microcredit has some benefits, it has not led to the transformative improvements in business performance and poverty reduction widely expected.

Business training programs have been one response to the question, “What else can we do?” Over the past few years, it has become a popular approach among policymakers, public, private, for-profit, and charitable institutions around the developing world. However, among the field studies conducted to date, few have found significant and lasting improvements in firm sales or profits.

One tact is to simply conclude that business skills don’t matter. However, the issue instead could lie with whom the training targeted, how it was delivered, and what it covered. First, it is important to recognize that not all emerging market entrepreneurs want to be entrepreneurs. Indeed, the majority of micro and small business owners are subsistence entrepreneurs running businesses out of necessity. If given the chance, they would prefer to be employed. Providing training to such individuals may be somewhat of a lost cause, resulting in little or no improvements in business performance over time.

Second, the intensity of the training program, and how it is delivered, could influence results. For example, the studies reviewed by McKenzie and Woodruff used training programs ranging from two days to several months, the majority being quite short in duration, while the longer programs involved less contact time overall.

Finally, and this is related to how these programs are delivered, is what content they cover. Most teach general business skills, with a primary focus on record keeping and managing finances, and relatively little on building skills in marketing (e.g. pricing, customer relations) and operations (e.g. inventory management).

In a new study conducted in South Africa in collaboration with researchers from the London Business School and Stanford University, we seek to address these challenges in the existing literature.

We started by implementing an initial screening to identify entrepreneurs who had the potential and motivation to grow their businesses (as determined by a scoring rubric from their initial application form). This was followed by two intensive 10-week long courses in either finance or marketing skills, with businesses randomly assigned to either group as well as to a control group. Separately identifying the impact of marketing skills versus finance skills allows us to better understand how these different sets of skills lead to improvements in firm performance, and for whom.

The analysis finds that while both marketing training and finance training led to roughly the same increase in monthly profits (~$157US), the paths through which these profit changes occurred are remarkably different.

Marketing training tended to shift a firm owner’s focus onto business ‘growth’ by encouraging the implementation of marketing/sales activities that increase scale (e.g. sales, employees) and, in turn, lead to greater profits. For instance, firm owners in the marketing group demonstrated higher performance on growth related policies (e.g. the within firm percentage change in sales or employees) and were more likely to implement practices connected to top-line business growth (e.g. market research, marketing tactics, sales tactics).

By contrast, finance training tended to shift a firm owner’s focus towards greater ‘efficiency’ in the business through more finance/accounting activities that decrease costs and subsequently increase profits. Specifically, firm owners in the finance group tended to perform better on efficiency related policies (e.g. the within firm percentage change in costs or outputs-to-inputs). They were also more inclined to conduct practices focused on enhancing business efficiency (e.g. financial tracking, financial analyzing, financial planning).

These patterns suggest that the mechanism of change may differ for marketing training (growth focus) versus finance training (efficiency focus), but both can increase profits for small business owners.

Finally, we wanted to gain a better understanding of the variation in impacts that each training program had on different entrepreneurs; that is, who might benefit more from marketing training and who might benefit more from finance training. Consistent with a ‘growth focus’ explanation, we find that small business owners who had a lack of exposure to different market and business contexts before training tended to do better when they received the marketing/sales training program. For example, participants who had never lived or travelled outside of Cape Town who lacked exposure to how businesses are run in different places.

We believe that marketing training was most beneficial to such individuals with ‘narrow exposure’ because marketing encourages entrepreneurs to look outside their existing business context to develop new perspectives on managing products, customers, competitors, distributors and suppliers.

By contrast, finance training was more beneficial for businesses that were more established; that is, firms that were operating in a more permanent manner. This suggests – and is consistent with an ‘efficiency focus’ explanation – that once a firms reaches a minimum threshold in terms of size or scale, improved finance/accounting skills can be put into practice to reduce costs and increase efficiencies in the business.

The implications of our findings are two-fold: First, stimulating firm growth is not just about improving access to money. Business skills can play a central role in helping business grow and scale up. Moreover, building entrepreneurs’ business skills is a sustainable investment. Second, different business skills benefit different types of enterprises, hence, investments in training should be targeted. Our research offers evidence on how such targeting can be effective depending on the stage of the business life cycle.

A version of this blogpost also appears in the International Growth Center website: http://www.theigc.org/blog/when-entrepreneurship-training-matters-most/

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