Small and Medium Enterprise Development

The small scale manufacturing sector engages, including owners, on average 3 persons per industry and the average employee per industry is 2 persons, while the average annual wage per employee is birr 1914.The average operating surplus per industry is birr 18,934 which shows that income generated by the small manufacturing activities is much better than those engaged in the informal activities.

A distinguishing feature of Small and Medium Enterprise from larger firms is that the latter have direct access to international and local capital markets whereas the former are excluded because of the higher intermediation costs of smaller projects. In addition, Small and Medium Enterprise of the same fixed cost as Large Scale Enterprises in complying with regulations but have limited capacity to market product abroad (Kayanula & Quartey, 2015). Small and Medium Enterprise in Oromia can be categorized into urban and rural enterprises.The former can be sub-divided into ‘organized’ and ‘unorganized’ enterprises.

Organized ones tend to have workers with a registered office and are mostly solely owned by an individual whereas the unorganized ones are mainly made up of artisans who work in open spaces, temporary wooden structures or at home and employ little or in some case no salaried workers. They rely mostly on family members or apprentices. Rural enterprises are largely made up of family groups, individual artisans, women engaged in food production from local crops. The major activities within this sector include: soap and detergents, fabrics, clothing and tailoring, textile and leather, village blacksmiths, timber and mining, bricks and cement, beverages, food processing, wood furniture, electronic assembly, agro processing, chemical based products and mechanics (Liedholm & Mead, 2011; Osei et al., 2010) as cited by (Kayanula & Quartey, 2015)

This sector is characterized by low levels of education and training of the self-employed. They are mostly family owned businesses and there is little separation of the business finances from that of the owners even to the point that the owners or operators personal account is the same as that of the business.

Micro Enterprises are those small business enterprises with a paid-up capital of not exceeding birr 20,000, and excluding high tech. consultancy firms and other high tech. establishments. Small Enterprises are those business enterprises with a paid-up capital of above 20,000 and not exceeding birr 500,000, and excluding high tech. consultancy firms and other high tech. establishments

Small and Medium Enterprise Contribution to Economy

Micro and small enterprise development hold a strategic place within Ethiopia’s Industrial Development Strategy. All the more so as MSEs are the key instruments of job creation in urban centers, whilst job creation is the centerpiece of the country’s development plan. The role of MSEs as the principal job creators is not only promoted in low income countries like Ethiopia, but also in high income countries including the United States of America. Accordingly, because MSEs play a pivotal role in employment creation, stimulating and strengthening MSE development should be one of Ethiopia’s top development priorities.

MSEs are yet to be key players in the manufacturing sector. The potential to fill this gap provides justification for the priority given to MSE development. In Japan - the home of major international companies such as Toyota and Sony - for example, more than half of manufacturing output is generated by MSEs. In Ethiopia, the need to support MSE development goes beyond the current priorities given to employment creation as, in addition, they have a critical role to play in the country’s industrial development, especially when the rapid expansion envisaged for the manufacturing sector under the ongoing renaissance program is taken into account.

Experience shows that, while many MSE start-ups may survive, many others fail in a few years leaving only a small percentage to grow into medium and large enterprises. Nevertheless MSE operators still serve as the most important pool of growth oriented investors engaged in developing entrepreneurial attitudes and skills. For example, if there are half a million MSEs, and 99% are not able to develop into medium or large enterprises or fail completely, this still means that 1% - or 5,000 – become medium sized enterprises, and eventually may become large scale businesses. MSEs should be recognized as incubators of developmental investors. This rational is not limited to low income countries like Ethiopia, but also holds true in high income industrialized countries.

There is also a political justification for providing policy and strategy related support to MSEs. Just as farmers are the basis for a developmental state (developmental administration) in rural areas that will fulfil the interests of rural residents whereby a crucial role is to be played by rich farmers, achieving this would give impetus (for the governing party) to achieve progress in terms of democracy and development and muster the support of the urban population. MSE operators in urban centers, which normally constitute a significant segment of the urban population, also share similar characteristics with rural farmers. The MSE operators in urban centers not only strive to create wealth by providing their labor and mobilizing other resources but are also susceptible to rent seeking behavior. Hence they are expected to benefit from the Micro and Small Enterprise Development Policy and Strategy and become the basis for political support. Among the major benefits from provision of priority support to MSE development is the strategic advantage of mobilizing the remaining sections of the population to support general urban development efforts.

Constraints of Small and Medium Enterprise

Cuevas et al. (2010) indicates that access to bank loan by Small and Medium Enterprise has been an issue repeatedly raised by numerous studies as a major constraint to industrial growth. A common explanation for the alleged lack of access to bank loan by Small and Medium Enterprises their inability to pledge acceptable collateral.

In their view the current system of land ownership and transfer regulations clearly retards and to some extend limits access to formal loan. First, due to lack of clear title to much usable land in Oromia, there is a limited amount of real property that can be put up as collateral. Second, a Government embargo on transfer of stool and family land has further restricted land availability for collateral. Finally, where title or lease is clear and alienable, transfer regulation needlessly delay the finalization of mortgages and consequently access to borrowed capital (p 24). Aryeetey et al. (2010) supported the view of Cuevas et al. (2010) that from the view point of private sector, problems related to finance dominate all other constraint to expansion (p 50). They claimed that the available of collateral plays a significant role in the readiness of banks to meet the demand of the private sector. Collateral provides an incentive to repay and offset losses in case of default. Thus collateral was required of nearly 75 percent of sample firms that need loans under a study, which they conducted on the demand supply of finance for Small enterprises in Oromia (p 19). The study also indicated that 65 percent of the total sample firm had at various times applied for bank loans for their business. Nevertheless a large proportion of the firm had their application rejected by banks. For firms that put in loans applications there was almost 2:1 probability that the application would be rejected. Firms receive loans for much less than they requested for. Among firms that had their applications rejected, lack of adequate collateral (usually in the form of landed property) was the main reason given by banks. Aryeetey et al. (2012) suggest that banks can offer alternative to property as collateral such as guarantors, sales contract and liens on equipment financed.

The generally negative attitude towards MSEs is the core challenge and takes different manifestations of which the most important are.

Lack of knowledge of the potential of MSEs. The attitude that considers engagement in MSEs a sign of poverty and backwardness and discounts their potential role because of this narrow perspective - their size and use of simple technologies, rather than their operations and potential.

Preference for paid employment. Most of the graduates from Ethiopia’s higher education and technical and vocational training (TVET) institutions seek paid secure employment rather than an entrepreneurial path.

Dependency. The dependency syndrome is common and is expressed in an expectation of receiving subsidies and charity rather than working and investing in one’s own future.

These attitudes and the behavior that results undermine the attractions and benefits of hard work and self-reliance as the main routes out of poverty. The practice of selling poor quality products and the desire to make quick profits is more widespread than the practice of making modest profits by producing and selling good quality products and services. The key factor explaining these and other manifestations of attitudinal and behavioral constraints to MSE development is the lack of a development oriented democratic culture.

Inadequate start-up capital is another major constraint most MSEs face during their establishment. It is caused partly by operators that lack the confidence to use their own savings to start a business and persevere through hard work. On the other hand, there is evidence of loans that can serve as start-up capital not being fully utilized and this indicates problems in MSEs’ capacity limits to absorb funds. The prevalence of unused technology and limited willpower to reverse the situation is also not uncommon among MSEs. The market related constraints for MSEs’ products and services are another area of concern. Among the factors that explain marketing-related challenges include examples of MSEs who have made products or provided services without first identifying customers’ needs through a market surveys, use weak marketing strategies (i.e., quality and pricing) and are reluctant to take their own initiative to expand their market access.

Types of financing available to Small and Medium Enterprise

Ethiopia’s financial sector is dominated by the banking sector (commercial banks) which currently represents more than 92.6 percent of total assets of the financial sector, excluding the assets of the Development Bank of Ethiopia (DBE) and National Bank of Ethiopia (NBE). MFIs constitute 5.2 percent and insurance companies 2.2 percent of the total financial sector assets. There is a considerable increase in assets of MFIs from 4.4 percent of the total financial sector assets in 2005/06 to 5.2 percent in 2011/12 demonstrating the increasing role of microfinance institutions in poverty alleviation, asset building and employment creation particularly in rural communities. Financial intermediation is a driving force for economic development: an expansion in credit to the private sector in fact enables firms to invest in productive capacity thereby laying the foundation for a sustainable growth path. However, Ethiopia is falling behind its peers in this area (Figure 5). In 2011, credit to the private sector in Ethiopia was equivalent to about 14 percent of GDP compared to the regional average of 23 percent of GDP. Moreover, while the worldwide trend has been an

The banking sector. Government-owned banks dominate the Ethiopian banking system and this makes of Ethiopia an exception within Sub-Saharan Africa and across the developing world, where banking systems have much higher shares of private and foreign participation. Public banks, which mainly focus on financing large enterprises, are dominating the credit market share of lending in the banking sector. The share of private banks in outstanding credit lending has dropped from 39 percent of the market share in 2009/10 to 32 percent in 2011/12 while that of the public banks rose from 61 to 68 percent during the same period, 2009/10 to 2011/12. Table 2 indicates that the total disbursement of public banks has almost tripled in the last three years during 2009-2012 as public banks (particularly the Commercial Bank of Ethiopia) focused on financing large scale public infrastructure projects. At the same time, the lending capacity of Development Bank of Ethiopia was enhanced through the introduction of NBE bills while the annual new credit disbursement of private banks has increased by only 28 percent in the same period.

Despite the overall disintermediation trend, the Ethiopian financial sector continues to have the potential to be a driver of growth. The banking sector remains stable, well-capitalized and continues to be highly profitable. Figure 6 shows how the Ethiopian banking sector ranks higher than the SSA average in terms of profitability measured on the basis of Return on Equity (ROE). High profitability is also explained by limited competition. Although the total number of banks operating in Ethiopia has increased from 11 in 2006 to 18 in 2012, the bank assets concentration index (focusing on the 3 biggest banks) shows that Ethiopia’s banking sector is much more concentrated than the SSA and Low Income Group averages.

The microfinance sector. Microfinance is a dynamically developing sector in the financial industry in Ethiopia. At the end of 2012, there were 30 licensed microfinance institutions (MFIs) operating in Ethiopia. Their deposits amounted to Birr 5.5 billion and represented the savings of 2.6 million clients. Some MFIs are sizeable financial institutions in their own rights and bigger than some of the commercial banks. The sector is highly concentrated, with the 5 largest MFIs (owned by regional governments and operating in different regions without competing with each other) corresponding to 89% of total sector assets and 83% of total borrowers. The predominant loan methodology is group loans, but some MFIs have started to offer individual loans. This development needs to be expanded to support the development of MSMEs. MFIs are not yet exchanging information through the credit bureau at the National Bank of Ethiopia, although the credit bureau’s technology would allow for it. Access to financial services. Access to financial services remains highly limited all over Ethiopia with only 1.97 commercial bank branches and 0.33 ATM per 100,000 adults (compared for instance to Kenya where there are 5.17 commercial branches and 9.46 ATMs per 100,000 adults). Access to finance remains a top obstacle for enterprises. The recently published data of the 2011 Ethiopia Enterprise Survey (WB, 2012) confirm that access to finance remains a top obstacle for enterprises: this is perceived as the main business environment constraint by micro (41%), small (36%), and medium (29%) enterprises in Ethiopia, compared to an SSA average of 24%, 20%, and 16% respectively (Figure 7). The same survey indicates that almost 93% of small enterprises and over 95% of medium enterprises have either a checking or a savings account (a percentage higher than the respective SSA averages) but only 3% of small enterprises and 23% of medium have a loan or a line of credit. These low percentages can be explained by (among other factors) the extremely high value of collateral needed for a loan, corresponding to 249.3% (253.5%) of the loan amount for small (medium) enterprises, against a SSA average of 160%. This also means that there is a very high potential for profitable cross-selling to be exploited by banks if they target these existing account holders and offer them credit/