SMEs: What Really Is the Problem?
To properly define the problem, three research questions are unavoidable: (1) What are the basic, unique characteristics of an SME that differentiate it from a large organization in our business environment? (2) What are the respective weights of those differentiating elements in terms of their contribution to business risks? (3) Are those elements amenable to transformation? In answering these questions, we relied on evidence from our portfolio.
The key differentiators we found were: legal structure, governance and compliance, strategy and operations, and financial literacy. Issues like commercial viability were important, but not critical. We found evidence of two companies in our portfolio, same sector, with similar target markets, similar business models, similar revenue and cash flow performance, yet different risk categories. There is evidence that, almost always, sole ownership structures tend to avoid accountability mechanisms – for instance, having an advisory board, checks and balances, authorizations, multiple mandate account control, and succession arrangements. We also found that the extent of the problem is mediated by the rigor of sector regulation. So, for instance, Tier 4 operators in the finance sector may have advisory boards and some semblance of governance structures, but in actuality, the mechanisms are cosmetic in effect. Again, we compared our finance sector portfolio businesses to others in the food and hospitality sector and found similarities in the beta profile. Having said that, it’s important to mention that dozens of limited liability concerns we have interacted with over the years have a 100% single ownership shareholding structure. In such internal environments, we have found evidence of weak governance and compliance mechanisms, zero strategy, and porous accounting systems, in spite of their commercial viability. We make this point to emphasize the fact that ownership structure, in and of itself, does not constitute organizational risk. It’s the organizational design that flows from it, which determines robustness and protection from the downside.
The Lean Startup Methodology: Could this Be the Solution?
Lean Startup Methodology (LSM) is a systematic approach for testing business hypotheses in the marketplace and using agile engineering to improve the business model (pivot) through multiple iterations. Knowledge on the conceptual foundations of Lean Startup Methodology is still being refined through empirical investigations as researchers continue to explore the space and its claims to reducing startup mortality rates. Four key names deserve mention for building the theoretical pillars that support the current state of literature (Blank, 2006; Ries, 2011; Furr & Ahlstrom, 2011).
Blank (2006) was the first to popularize the concept of Customer Development as an iterative process for testing and validating hypotheses upon which a business model is designed. Notwithstanding methodological breakthroughs on how to eliminate market risk for early-stage ventures, some researchers agree that the underlying philosophical thinking of lean practices derives from earlier work pioneered by other researchers (See Popper, 1999; Sarasvathy, 2001; Harper, 1999). Sarasvathy (2001) emphasizes the process of entrepreneurial learning using scientific investigation methods, which incidentally guides the Lean Startup methodology. Other researchers, such as Harper (1999), have cited the work of Popper (1999) to describe a problem-solving framework that uses hypotheses and experimentation to arrive at validated knowledge.
So, what does this all mean, and what does it have to do with reducing SME risk in Ghana?
LSM was originally developed to incubate startups that are pre-revenue by validating their business model through experimentation and agile engineering. Over the years, its application has been extended to reach post-revenue early-stage ventures that are looking to scale, thereby necessitating an iterative process to validate the business model. The latter mode of application is quite suitable for addressing the high-risk SME issue within the Ghanaian context. The second reason why it matters is this: most financial institutions approach the SME problem with a causal thinking paradigm, instead of the effectual model of decision-making as discussed by Sarasvathy (2001). There are a lot of pre-judgments about what every SME needs and how to approach the problem of de-risking its value chain. The result is a swathe of how-to seminars on subjects that are, at best, treated academically: bookkeeping, sales, marketing, etc. Important as these are, they are not central contributors to the SME mortality problem. The issues are far more complex, wrapped in a cultural fabric that emphasizes privacy and opacity over disclosure and accountability. There is a reason why 92% of registered businesses in Ghana prefer sole ownership structures over other models. Cultural predilection, we believe, is a key driver. Deploying Lean Startup practices using a well-designed accelerator program, over time, will help to de-risk early-stage businesses by emphasizing accountable and transparent governance.
What are the Implications?
Clearly, the current model is not for working banks, the revenue authorities, and various actors in the SME ecosystem. Banks deploy straight-jacket credit products for a limited number of SME customers who can meet a bank’s often stringent conditions, which almost invariably include 3-year financials (audited). Not only is it exclusionary, but it creates inefficiencies by saddling SME relationship managers with portfolios that generate sub-optimum value. Tax officers are unsure how to estimate the taxable income of sole ownership SME operators because the financial performance and position are by word-of-mouth. This has to change, and the change must be by careful design, supported by the entire ecosystem. In more concrete terms, here is what change could mean from a systems perspective:
NOTE: The evidence-based approach that underlines the Lean Startup Methodology requires technology tools and proprietary techniques to help SMEs continually validate their business model. Every organization must find what works within its context and deploy such tools for the benefit of its SME customers.
Government: Use GoG agencies like NBSSI, NEIP, MASLOC, and others to create Public-Private-Partnerships with private sector-run Business Incubators and Accelerators, and designate their SME training programs as essential must-haves in order to access credit facilities from public sources.
Banks: (1) Credit products have to be developmental and not transactional. This is where important organizational milestones are included in facility covenants to justify future drawdowns. (2) A shift from the “Relationship Manager” model to the sector-based Incubator/Accelerator model is critical. Every bank must have an Incubator program to nurture SME clients and track their progress over time using key metrics. The basic “Relationship Manager” model will no longer to sufficient to provide a competitive edge. Instead, a needs-based classification that marries customized organizational development milestones at the enterprise level, with business facilitation at the industry level, is necessary for growth.