Small and medium enterprises

Abstract:

Chapter 1: Introduction:

Small and medium enterprises have different definitions in different countries. In India, it is known as the Micro, Small and Medium Enterprises (MSMEs) which is defined in terms of investment required. The MSMEs include all the enterprises in which the total investment does not exceed more than Rs. 50 million. The European Commission defines SMEs on the basis of the work force employed, total turnover of the business and the balance sheet total. In the US, the criteria for recognition is based on the work force employed.

Small and medium sized enterprises (SMEs) are one of the principal driving forces in economic development. This sector has been recognised as growth engine around the globe. A healthy and vibrant SME sector contributes in a high and sustainable economic growth. They encourage private ownership and entrepreneurial skills, they are flexible and can adapt quickly to changing market demand and supply situations. They provide employment opportunities to the masses, help diversify economic activity and make a significant contribution to exports thereby increasing foreign trade.

Many economies have acknowledged the need for growth and development of SMEs for industrial restructuring and have formulated national SME policies, programmes and enterprise development policies. Enterprise helps boost productivity, increased competition and innovation, thereby creating employment and prosperity, and revitalizing the communities.

SMEs contribution to the foreign trade has been ever increasing. During the last decade, there has been a considerable increase in the foreign trade arising from the products of these SMEs. The open trade policy has been a great success. The policy makers in developing countries like India, Sri Lanka, Pakistan, and many other South Asian countries have been continuously reviewing their policies to help the functioning of these SME units.

Finance is a subject of major concern to the SMEs. The financial institutions like banks and other money lending firms have come forward with plans of funding these units at very competitive rates. Subsequently, there has been an increase in the lending by such financial institutions to the SMEs. This has increased the efficiency of the SMEs to a great extent.

Chapter 2: SMEs: An Overview

Contribution of SMEs:

SMEs are the backbone or the key drivers of the industrial economy. They can also be described as the engines of growth of the industrial sector. Although they are individually small, collectively they play a multiplayer role in the development of an economy. They have a multiplayer impact in developed as well as developing economies. The main USP of SMEs is low cost production i.e. the ability to manufacture low volumes profitably, meet niche requirements, capitalize on local skills and resources, provide outsourcing opportunities and most importantly create jobs.

The below mentioned table indicates the contribution of SMEs across diverse economies. (Table-1)

Table 1: Contribution of SMEs across diverse economies

The sector has been consolidating over the years. What is new is the articulation and recognition of this process and its pump priming role. Therefore national SME policies, programmes and enterprise development policies have been formulated to support smooth working of SMEs and to overcome major obstacles such as lack of legislation, promotion and infrastructure. This can be done in the form of promotion programmes, positive discrimination hand holding and advocacy. Policy initiatives seek to highlight basic SME skills in low cost production.

SMEs have an impressive presence in service industry ranging from the simple and traditional organisations to the most modern and hi-tech ones. SMEs contribute not only in terms of quantitative factors such as output, employment, income, investment or exports but also in terms of qualitative factors viz the synergies they promote with large industry, their contribution towards balanced regional growth, their contribution in nurturing entrepreneurial spirit, innovation and in providing a nationwide pool of skilled and trained manpower.

While the comparative advantage of SMEs are well acknowledged, SMEs also have their share of pros and cons which prevent them from realising their full potential. They have to face some problems such as lack of proper guidance in the initial stages, lack of funds in the times of crisis, lack of proper marketing strategies, stiff competition from big players, lack of access to latest technology, no proper infrastructure etc.

Therefore, although new SMEs are emerging very rapidly worldwide, the number of SMEs closing down every year is also very high. Also because of the twin forces of globalization and free trade policy of WTO, there is a serious threat to the SMEs sector. It will have to reorient and reinvent itself to overcome these challenges. This can be done by restructuring the small scale organisations, and if nothing works, they have to be closed down. Closures are undesirable but sometimes they are advisable from the resource allocation point of view. Thus the high rate of entries and exits reflect the dynamic nature of this sector and also explains why it is seen as an industrial incubator.

As mentioned earlier, SMEs play a very important role in the development of an economy, especially from the employment point of view. They are very effective for the generation of employment for both skilled as well as unskilled workers. Therefore labour extensive countries should opt for SMEs. Even the underdeveloped or developing countries which are capital intensive and labour extensive, SMEs can be a great help. There has been increasing growth of SMEs worldwide in the recent past. The government of the developed and developing economies have been formulating policies which promote smooth working of the SMEs. SMEs have contributed significantly in the developed as well as developing countries.

In the European Economic Area (EEA) and Switzerland there are more than 16 million enterprises; of which less than 1% comprise large companies while the rest are SMEs. Two thirds of the job opportunities are provided by SMEs in this region and the remaining one third of the job opportunities are by large companies. SMEs are considered the backbone of Asia Pacific region as they account for 90% of enterprises. They provide around 32% – 48% of employment and their contribution to Gross Domestic Product is around 60% – 80% in individual Asia Pacific economies.

Even in the United States, SMEs contribute greatly. It contributed at around 43% of the net employment opportunities from 1990 – 1994.SMEs are considered the engine of economic growth in both developed and developing countries not only because of low cost production but also because of low unit cost of persons employed as compared to large scale enterprises. Thus they provide a significant share of overall employment. Also SMEs assist in local and regional development by regional dispersion of economic activities, thus helps achieving fair and equitable distribution of wealth. SMEs not only contribute towards the GDP but also towards the export revenues.

Although SMEs are at a disadvantage in terms of finance, technology, human resource development and networking; SMEs involved in foreign trade are very dynamic. This may be due to its low-cost labour intensive nature of its products; and since these units generally use indigenous raw-materials; they have a positive effect on the trade balance. For example, SMEs in OECD member states produce about 26% of OECD countries’ exports, and about 35% of Asian exports. Also SMEs increase flexibility in the provision of services and the manufacture of a variety of consumer goods and competitiveness of the market place and thereby curb monopoly of large enterprises. All this leads to fostering of self-help and entrepreneurial culture by bringing together skills and capital through various lending and skill enhancement schemes. Thus SMEs not only enables an economy to maintain a reasonable growth rate but also imparts resilience to withstand economic upheavals.

Chapter 3: India’s SME scenario:

The Indian Small and Medium enterprises sector formally known as the Small Scale Industries (SSI) has had a notable importance since the period of Mahatma Gandhi. SSIs were set up in the rural parts of India with a view to inculcate the habit of self reliance amongst the people. Later on, after independence, the SSI units were an important source of income to the people of India. Indian policy makers had noticed the importance of this self reliant industry and had always been striving hard for their progress.

After achieving independence in 1947, India drafted and adopted the Industrial Policy of 1948 which meant that the government would act as both an entrepreneur and also as a governing body. With the beginning of the planning of a free India in 1951, the role of SMEs has been earmarked specially.

In its industrial policy, the government started announcing special schemes for the growth of the SMEs in India. It was in 1956, during the Second Five Year Plan that the government announced the Second Industrial Policy, clearly stating the importance of the SME sector. This gave an impetus to the development of SMEs in a manner that made it possible for them to achieve the objectives of:

Ø High contribution to domestic production.

Ø Significant export earnings.

Ø Low investment requirements.

Ø Operational flexibility.

Ø Low intensive imports.

Ø Capacity to develop appropriate indigenous technology.

Ø Import substitution.

Ø Technology-oriented industries.

Ø Competitiveness in domestic and export markets

Today, small and medium enterprises (SMEs) are the ladder of progress for a nation’s economy, especially in case of developing countries. They contribute handsomely to the exports, the industrial base, the Gross Domestic Product (GDP) and the Gross National Product (GNP) of the nation. Small and medium enterprises help provide employment and various facilities to the society.

In 2006, the Government of India passed an Act known as the Micro, Small and Medium Enterprises Act (MSMEDA), 2006 to define SME sector of India. This Act defines micro, small and medium enterprises in India on the basis type of sector namely manufacturing and the service sector. In case of manufacturing sector, the size of the enterprise is decided on the basis of investment in plant and machinery. In case of service sector enterprise, the size is decided on the basis of investment in equipment required to set up the industry.

Table 2: Definition of SME in India.

Strategic Importance of Indian SMEs:

In Indian economy, the SMEs occupy a place of strategic importance due to its contribution to the overall output, exports and employment. The total number of SMEs has been increasing rapidly. The total number of registered enterprises has been around 3million and has been increasing at an even faster speed. They contribute about 50% of the total industrial output and constitute 42% of total exports. These units produce approximately 8000 units which range from very basic to highly sophisticated products. By providing employment opportunities to nearly 29.4 million people, this sector takes the credit for employment to the largest number of workforce.

Chart 1: Growth rate of SSI sector vis-à-vis Total Industrial Sector.

Chart 2: Growth Rate of Employment in the SSI sector.

Link: http://www.smebank.org/SME%20Sector.htm#2

Role of Indian SMEs:

The role of SMEs in the overall economic growth of the country has been fundamental and has been achieving steady progress over the last couple of years. With a view from the industrial development of India and the overall economic growth, SMEs have to play a vital role since their labour intensiveness helps to generate employment opportunities. In a developing country like India, the SME sector is of utmost importance in order to eradicate poverty and hence to drive sustainable growth. In case of countries where the capital resources are scarce, and an abundant supply of labour, SMEs help in the efficient allocation of resources by implantation of labour intensive production process.

Performance of Indian SMEs:

In the late 1940s, there were around 80,000 units. Today, the total number of units has increased tremendously and the total number of units is approximately 13 million units in 2006-07. Of the total 13million units, around 55% are in the rural India and the rest in cities and urban regions.

Table 3: Number of Small and Medium Enterprises.

The contribution of the SSI sector to the GDP was approximately 13% in 2000-01; this has grown to a 15.5% in 2007-08. The performance of the SSI sector in terms of economic parameters such as number of units, production, employment and export during the last decade is indicated in the table below:

Table 4: Performance of Small Sector in India

The SME has not only been successful in increasing its contribution to the GDP, but it has also outperformed the organized sector to a great extent in terms of production and also in employment creation.

Table 5: Share of SME output to India’s GDP

Employment:

The employment opportunities created by the SMEs is considerable. It is evident from the table below that for every 10 million rupees invested by the SMEs’, more than 4 times of employment opportunities are created; more than any other sector in India. It is clearly seen that in the year 2006, for every 10 million rupees invested in SMEs, generated employment opportunities for around 151.4 persons, whereas, the same amount invested in the other sectors would create employment opportunities for around 37.4 persons only.

Table 6: Investment to employment ratio

Exports:

The SME sector is a major contributor to the total exports of India. Of the total exports by India, approximately 50% exports are contributed by this sector. SMEs are responsible for 35% of the total direct exports and 15% are contributed by its allied activities. The indirect exports may be in the form of export orders of other large units or in the form of production of various parts and components for the making of the finished product. The major trading houses, merchant exporters and the export houses play a vital role in the export development.

The non traditional products account for more than 95% of the exports. The exports from the SME sector have increased tremendously during the last decade. The growth of the garments, leather, gems and jewellery units in the recent past is the reason for the increase in the exports by the SME sector. The SME sector dominates the sports goods, readymade garments, woollen garments and knitwear, plastic products, processed food and leather products industry.

The table below indicates these segments and the corresponding SME contribution. (Table 7)

Table 7: % of SSI in total Export

SME exports growing in tandem with total exports:

SMEs constitute an important segment of India’s industrial production with a contribution to 33% of its exports. During FY03-06, India’s total merchandise exports in US dollar terms witnessed a CAGR growth of 25%, while in the same period SME exports grew at a CAGR of 24%. The remarkable contribution of SMEs in generating employment in the country has been instrumental in addressing issues pertaining to poverty and inequality of income. As per the Third All India Census on Small Scale Industries-2001-02, highly populated states such as Madhya Pradesh, Uttar Pradesh, West Bengal, Maharashtra, Karnataka and Jharkhand together contributed to around 55.4% of the total exporting units in India. In terms of distribution of value of exports from the SME sector, states like Punjab, Haryana, Uttar Pradesh, Tamil Nadu and Maharashtra together contributed 64.75% of total exports.

Chart 3: Share of SME export to total exports

The composition of export basket of SME’s in India, it has both traditional and non-tradition commodities in nature. There are few commodity groups which are exclusively exported by SMEs such as sports goods, cashew, Lac etc. In the commodity group of engineering goods, SMEs constitute around 40% of the total exports of this commodity group. Similarly, SMEs in basic chemicals & pharmaceuticals finished leather and leather products and marine products account for around 44%, 69% and 50% of the export share in their respective commodity groups. In view of the Government of India’s ambitious target of average GDP growth rate of 9% during the 11th Five Year Plan, SMEs have to play a vital role in achieving this target. It is imperative for the government to address the major issues plaguing the sector and take further inclusive growth oriented policy initiatives to boost the sector. This includes measures addressing concerns of credit, fiscal support, cluster-based development, infrastructure, technology, and marketing among others. As mentioned earlier, SMEs constitute 34% of India’s merchandise exports and in order to increase India’s export share to the global trade, SMEs are expected to enlarge their scope manifold.

Problems Faced by Indian SMEs:

The SMEs in India have been facing lot of issues that hinder the performance and the survival of this sector. The government has been striving hard to provide with policies that would help the smooth functioning of the SMEs. The main problems that have been faced by the SMEs are:

Finance:

Micro, Small and Medium Enterprises, especially the micro enterprises have been facing the problem of inadequate access to finance. This is mainly due to the lack of information on financing activities and also due to the traditional business style. In India, there is also a lack of private equity, venture capitalists and business angels entering the MSME sector which would provide easy financing options to businesses which have unique ideas.

The availability of finance has been a major problem for the SME sector. The SMEs have not been able to have easy access to the loan offered by the various commercial banks and other financial institutions. This is despite the Reserve Bank of India (RBI) and the Ministry of Finance having laid down instructions to the banks and financial institutions to encourage easy financing options to the SMEs. According to Morris et al., 2001:11; “there are strong structural underpinnings to the inadequate flow: the organisational structures of banks, and processes within them, have taken them far from task orientation and have created a specific bias against small loan portfolios.” The government has been constantly seeking new ways to make access to loan funds an easy process for the SMEs.

The small industries sector has been worst hit by the problem of financing. These units have not been able to understand their financial situation and also they haven’t been able to maintain transparency in their financials. The banks and financial institutions have been hesitant with regards to providing financing solutions by means of loans to these small units. This is because in the recent past, the loans that have been offered to some of these units have been transformed in to non-performing assets and hence, the banks have been trying to avoid this high level of risk. The banks and other financial institutions have been in fact extending more of their loans to the medium industries sectors in order to comply with the RBI regulation of financing for the ‘priority sector.’

Infrastructure:

After finance, availing good infrastructural facilities has been a topic of concern for the MSME sector. The infrastructural facilities that are available in the rural parts of India differ substantially with those available in the cities and the urban parts of India. There has been growing concern towards the supply of power at affordable rates to these units. In the rural parts where the rates are comparatively lower than the urban parts, the adequate supply of electricity has been an issue.

The lack of newer technological knowhow has been growing. There has been a huge difference in the technique used in the towns to those used in the villages. Those in the urban areas have now been able to make use of computers and other computer operated machines whereas in the villages, the traditional methods of production are still being used. The transport facilities have not been developed very well. In spite of so many highways being constructed, there has not been ease of transporting facilities for the SMEs at affordable rates. This hinders the rural and semi-urban markets to access new and larger markets in the other parts of India.

Lack of skilled labourer:

Lack of skilled labour hampers the productivity of the SME unit. The skilled labour can make better use of resourced and could also be able to handle computers. Skilled labourers can be of great help with means of management and marketing.

Product Reservation:

For the purpose of good productivity, there has been product reservation which means around 800 products are being reserved to be produced only by the SMEs. The list is being revised on a regular basis but under political influence. The main purpose of product reservation was to create local employment by means of using locally available resources. But due to increased political influence, the main purpose of the reservation has been lost. The SMEs are at times not informed that they produce the reserved product.

Role of Government for SME development in India:

The Government of India has recognised the role of MSMEs in the overall development of the country’s economic situation. The MSMEs are of utmost importance in terms of employment generation, share to the GDP, share to the industrial output, foreign exchange generation, etc. The Government of India has implemented various policies in conjunction with the state government, the RBI and various NGOs for the betterment of the MSMEs in India.

As a stepping stone towards MSME development, the Ministry of Small Scale Industries (SSIs) was combined with the Ministry of Agro and Rural Industries to form the Ministry of Micro, Small and Medium Enterprises (MSMEs). This helped to formulate policies on a national basis bringing all the enterprises whether rural or urban under one cabinet. The main purpose of the Ministry of MSMEs was of drafting policies, programmes, development projects and schemes and also to keep a check on the implementation of these policies.

The Government of India’s has launched a landmark initiative by the introduction of the MSEMD Act, on 2nd October, 2006. It is due to the enactment of this Act that there has been an increase in the SME competitive strength. The issues related to the growth of SMEs had been surfaced and thus, the SME had been able to accept challenges and reap the benefits of large scale economies. The co-ordination of policies at both the state and the national level has helped strengthen the role of SMEs not only at the lower but also at the higher level. A recent policy introduction by the Tamil Nadu government to encourage the agro-based industries by means of providing a wide range of incentives, support for infrastructure development, subsidies for investing in industrially backward areas, capital investment and technology development with an aim to sustain a growth rate of over 10% in the food and agro based sector.

The Government of India has set up various institutions at both national and state level which are both a governing as well as a support body for the SMEs in India. The Ministry of Micro, Small and Medium Enterprises, Small Scale Industries Board, Small Industries Development Organisation (SIDO), National Small Industries Corporation (NSIC) Limited, The Khadi and Village Industries Commission (KVIC) and Coir Board work in co-ordination with the various institutes and assist the SMEs at both national and state level.

Today, the working of the Ministry has lead to the existence of various SME governing bodies which help the smooth functioning of the SMEs. The Industrial Development Bank of India (IDBI), the Small Industries Development Bank of India (SIDBI), National Small Industries Corporation (NSIC), the SME Rating Agency of India (SMERA), etc. all play a convincing part in the development and smooth functioning of the SMEs in India.

Policies implemented by the Government:

The Government of India has been reviewing its policies for the SMEs. The various organisations set up in coordination with the Ministry of Micro, Small and Medium Enterprises look after the formulation and implementation of the various policies for the SMEs.

Finance:

The Government of India in co-ordination with the Reserve Bank of India (RBI), the countries apex bank has been striving hard in order to create policies for making available easy financing options to the SMEs. The RBI has been issuing directives for every bank and financial institution to maintain a quota of funds to be made available to the Micro, Small and Medium enterprises.

The Government of India has set up special financing institutions that provide easy finance options to the SMEs at very nominal interest rates. The Government has taken many initiatives to make finance readily available to the SMEs:

Industrial Development Bank of India:

Industrial Development Bank of India (IDBI) was instituted in 1964 as a wholly owned subsidiary of the RBI as the top institution for providing finance to the SME sector. The Government of India in 1975 passed a law for de-linking IDBI from RBI and making it the principal financial institution for

(i) co-ordination of the working of institutions engaged in financing, promoting or developing industry;

(ii) assisting the development of such institutions; and

(iii) Providing credit and other facilities for development of industry and for matters connected therewith.

IDBI has brought about a revolution in industrial growth by means of providing finance for medium and long term projects in co-ordination with the national policies. The range of products offered by IDBI has been increasing in every field of industrial need be it manufacturing or services sector. IDBI has been empowered to provide financial assistance to all types of small enterprises.

Small Industries Development Bank of India:

The Government, in April 1990, established the Small Industries Development Bank of India (SIDBI) as a fully owned subsidiary of the Industrial Development Bank of India in order to promote financing activities for the Small and Medium Enterprises on a nationwide basis. In March 2000, the government amended the SIDBI Act and de-merged it from IDBI. The amendment led to the change in the capital structure, shareholding pattern, business and borrowing provisions.

The SIBDI has two subsidiaries namely SIDBI Venture Capital Fund and SIDBI Trustee Company Limited. The Credit Guarantee Fund for the Small Industries and Technology Bureau for Small Enterprises are the two associate organizations that work in co-ordination with SIDBI.

Since the foundation of SIDBI, it has been assisting the micro, small and medium sector (MSMEs) providing those with suitable schemes which are tailor made to suit the need of individual organizations. It assists in the setting up of new projects, expansion, diversification, modernization and rehabilitation of existing units. After the de-merger of SIDBI from IDBI, it has introduced several new schemes and products in order to meet the need of both new and existing SME units. It has been maintaining its policies and revising them from time to time keeping them in line with the policy plans of the Government and RBI.

Competitiveness:

The Government has been striving hard in order to provide a competitive edge to the units in the global environment. In order to increase the productivity of the MSME sector so as to overcome the competition that these units can face in the global markets and also to face the competition from the multi-national companies in the local Indian markets, the Government of India has introduced the National Manufacturing Competitiveness Programme (NMCP) in the year 2005-06.

The NMCP programme was implemented to shift the focus of the SMEs from the production to the competitive side of business. There was a need for the SMEs to introduce some structural changes and therefore this programme was introduced. The programme was initiated to increase the competitiveness at the individual firm level and not at industry or sector level.

The need of the hour was to address issues such as technology up gradation, cost reduction, in time delivery, total quality management (TQM) and to enhance the customer service. The NMCP worked in co-ordination with the SMEs and helped attain an environment for the accomplishment of these issues.

National Commission for Enterprises in the Unorganised Sector:

The National Commission for the Enterprise in the Unorganised Sector has been set up to improve the productivity of the unorganised sector. It acts as an advisory board and a supervisory body for the informal sector for generation of large scale employment opportunities on a sustainable basis, particularly in rural areas.

Reservation:

The policy of product reservation had been started in the year 1967 with the government’s objective of attaining socio-economic development by reserving the manufacturing of products solely by the SME sector. The Government introduce this policy with a view to improve the productivity of the SMEs especially in the rural areas which would in turn help to increase employment opportunities and also initiate the people to take up self employing business opportunities.

The Government of India had reserved some products to be manufactured only by the SSI sector. In 1984, the list contained as many as 843 products to be manufactured only by the SME sector. But in the recent years, due to the lack of technological up gradation and competitiveness on the part of SMEs, the has been reduced to as low as 21 products. The de- reserving of the products has been progressive for the re introduction of the SMEs in the main stream.

Simple Process:

The registration of the SMEs was earlier a very painful and lengthy process. This system has now been replaced with the much simpler Entrepreneur’s Memorandum (EM). The introduction of the EM has been the most valuable achievements of the MSMED Act, 2006.

The Need of Credit as a Lifeline of Business:

Finance or credit is of crucial importance for any business to grow and survive. If adequate finance is not available, even the best plans need to be put to halt. In case of MSMEs, credit is needed at every stage be it start up, diversification, technological up gradation, survival and expansion. If finance is not readily available, there is every possibility that the best performing unit can fall sick thus leading to the closing down of the unit.

Thus, the need for a focused credit policy for the MSMEs was recognised by the Government of India. Hence, a credit policy with the following terms was laid down:

Priority Sector Lending:

Providing of credit to the MSME sector has been made compulsory by the government under the Priority Sector Lending Scheme. The priority sector includes agriculture, small enterprises and businesses, retail trade, etc. Under this scheme, the government has instructed banks to ensure that a specified percentage of their lending is made to the priority sector. At present, the limit set by RBI under the priority sector lending for a domestic commercial bank is set at 40% of the net bank credit and for foreign banks at 32% of the net bank credit.

Institutional Arrangement:

Small Industries Development Bank of India (SIDBI) is the principal financial institution for promotion, financing and development of the MSE sector. Apart from extending financial assistance to the sector, it coordinates the functions of institutions engaged in similar activities. SIDBI’s major operations are in the areas of (i) refinance assistance (ii) direct lending and (iii) development and support services. The commercial banks are important channels of credit dispensation to the sector and play a pivotal role in financing the working capital requirements, besides providing term loans (in the form of composite loans). State Financial Corporation’s (SFCs) and twin-function State Industrial Development Corporations (SIDCs) at the State level are the main sources of long-term finance for the MSE sector.

With the liberalization of the Indian economy, greater emphasis was placed on meeting the credit needs of MSMEs. This was manifest through the following initiatives:

Ø Earmarking of credit for micro enterprises within overall lending to micro and small enterprises.

Ø Opening of specialized SME branches.

Ø Enhancement in the limit for computation of the aggregate working capital requirements on the basis of minimum 20% of the projected annual turnover.

Ø Enhancement of composite loan to Rs.1 crore (Rs.10 million).

Ø No collateral security for loans up to Rs.5 lakh (Rs.0.5 million) [Banks may on the basis of good track record and financial position of the units, increase the limit of dispensation of collateral requirement for loans up to Rs.25 lakhs (2.5 million)]

Credit to MSE sector from Public Sector Banks

The table below gives the status of credit flow to the micro and small enterprises (MSE) sector from the public sector banks since 2000:

As at the end of March

2000

2001

2002

2003

2004

2005

2006

2007 (P)

Net Bank Credit (NBC)

3,16,427

3,41,291

3,96,954

4,77,899

5,58,849

7,18,722

10,17,614

13,17,705

Credit to MSEs

46,045

48,400

49,743

52,988

58,278

67,634

82,492

1,04,703

% to NBC

14.6

14.2

12.5

11.1

10.4

9.4

8.1

8.0

Table 8: Credit to SME sector by Public Banks

The UK SME Sector:

Napoleon once rightly said that the British are a nation of shopkeepers. Small and Medium sized enterprises have been the backbone of British economy since the ancient times.

The SME sector in the UK is defined differently for various institutions. For instance, for the Department of Trade and Industry (DTI), it is defined on the basis of the number of employees in the unit.

Table 9: Definition according to the Department of Trade and Industry

Since the UK is a part of the European Union (EU), it also has to follow the EU definition of the SMEs. According to the definition of the European Commission, there are approximately 23 million SMEs that fall within the European Union. The European Commission defines the SMEs on the basis of turnover, balance sheet s and the number of employees employed. In order to qualify, the enterprises must fulfil the limit for the maximum employs that can be employed and either the turnover limit or the balance sheet limit.

Table 10: Definition according to the European Commission

The EU definition is also followed by the Companies Act.

Table 11: Definition according to the Companies Act

The Small and Medium Enterprise sector is widely spread in the United Kingdom. The off license shop, the corner shop, the restaurant, the accountant, the web designer, the engineering business or the hairdresser, are the different types of SMEs in existence in the United Kingdom forming the backbone of the UK businesses.

Significance of UK SMEs:

The UK SMEs contribute around 33% of the total GDP. They provide employment opportunities to more than 50% of the total employment in the UK. They contribute to 37% of private sector turnover. The SMEs in the UK as in the other developed and the developing nations are a strong support for the overall growth of the economy, creating more and more employment opportunities year after year.

Table 12: Showing no. of enterprises, employment and turnover for the year 2007

In the year 2007, there were approximately 4.7 million enterprises in the UK which saw an increase of 4.8% over the previous year. This increase has been the highest increase in a year since 1994, the first time since the time series began. An estimated 22.7 million people were employed by the SMEs. The SMEs contributed to nearly 99.9% of all UK enterprises which contributed to approximately £ 2800 billion of the total production. The SMEs contributed to 59.5% of total private sector employment and 51.5% to the total private sector turnover. According to the data, around 175,000 businesses register for VAT every year.

The most important feature of the UK SMEs is that a large number of the businesses are dominated by enterprises which have no or very few employees. Around 73% of all UK businesses consist of self employed businesses accounting for only 7.4% of the GDP around 24% employees which have less than 10 employees. There is a huge concentration of the SMEs in the service sector. Approximately 72% enterprises with employees are into the service sector whereas 17% are engaged in the production activities and around 8% in construction. . The UK SMEs contribute approximately £ 1.48 trillion towards the total UK turnover and GDP.

Chart 4: Number of enterprises

Only 22% of SMEs are involved in exporting activities. Exports don’t form a major part of the SME business. Most of these perform their export activities in countries close to the UK. In the UK, women entrepreneurs are actively involved in business owning 17% of the total businesses. The minority ethnic group (MEG) makes up for around half of the owners. Despite having such huge contributions, the UK SME sector has always been overshadowed to the large UK corporate houses and has been considered to be fragmented and often ignored.

Employment:

The UK SMEs employing one or more person in all employ approximately 14.23 million people out of the total working population of 30 million. Around 1.1 million enterprises operate in the Business Services sector recognised in Section K by the Standard Industrial Classification 2003 (SIC 2003). This sector represents approximately 24% of the total UK private sector enterprises. This sector employs around 4.3 million people approximately 19% of the total private sector employment. The turnover of this sector amounts to £421 billion of the total UK private sector turnover.

With regards to employment, the wholesale, retail and repairs sector (SIC2003 Section G) has been the biggest employer. With 562,000 enterprises, this sector provides employment to 4.8 million people which amount to 21% of the total UK private sector employment.

Chart 5: Section wise distribution of employment

At the beginning of 2007, small enterprises (0-49 employees) contributed 47.5% of the total private sector employment having varied between various sectors according to the Standard Industrial Classification 2003 (SIC2003).

Off the total employment provided by small enterprises, 94.3% were engaged in agriculture, fishing and forestry (SIC2003 section AB). In mining, quarrying, electricity, gas and water supply (SIC2003 section CE), 12% of employment was provided by the small industries.

Obstacles to achieving business success in UK:

The businesses in the UK have been facing a number of obstacles that hinder their growth and performance of the businesses. The Department of Trade and Industry (DTI) and the British Chamber of Commerce have assessed the business members with regards to the common problems faced by SMEs in the UK.

Chart 6: Barriers to Growth of Business.

Access to finance:

Financing of the business for the purpose of start up and also for expansion has been a major obstacle for the SMEs in the UK. There is a huge financing gap in the UK with regards to financing SMEs. The business units prefer informal sources of finance over debt and equity finance.

One of the most attractive options for the businesses is the debt finance. But businesses are reluctant to introduce any kind of debt finance in the business. They rather are dependent on savings from family and personal sources. The businesses are unwilling to introduce any kind of external sources of finance whether large or small which hinders the growth options for the businesses.

The small businesses do not have access to the equity markets and cannot easily access equity capital like the large business houses. Since the small businesses cannot easily access equity they have to turn to debt financing made available by the commercial banks and financial institutions.

The small firms have been facing problems in raising finance even after decades of policy reforms by the government. The small businesses cannot avail financing at affordable rates and also need to provide collateral for the loans which makes it difficult for these businesses to acquire finance through other sources that is through personal savings, savings from friends and relatives, etc.

According to the Natwest SERTeam survey of Quarter Two 2005, there are just 1% of businesses which have had problems for accessing finance. But there is lack of evidence for the fact that there exists problem within the UK economic structure. There are problems faced by the women entrepreneurs, entrepreneurs from the Minority Ethnic Group (MEG) and high technology business due to the various social and economic reasons, risk being one of them.

Chart 7: Sources of SME finance in the UK Bridging the Finance Gap, HMT, p.18

Competition:

Competition has always been another important barrier for business growth. In the UK, the small businesses have to face huge competition from large retail outlets. The large units have high level of influence and financing options as compared to the small and medium enterprises. This unfair competition from the large companies is a great threat to the Fast Moving Consumer Goods (FMCG) sector.

Government Regulation:

Regulation has been a barrier to growth for both start ups and also for growing concerns. The UK regulations cost approximately £100 billion per year. The government has recently been paying increased attention to the regulatory burden. There is increased regulation as the UK has to keep up with the European Union’s Six Presidency Agreement.

The Association of Chartered Certified Accountants (ACCA) has been constantly opposing the regulations and demanding simplified government regulations. The ACCA has recognized the fact that some regulations are of importance for the growth of businesses and also to protect the rights of the employees. The understanding of the various regulations needs a sophisticated approach in order to avoid the complex impact. The small businesses are laden with excessive regulatory requirements. Even the individual employment regulations affect the businesses with regards to the size, sector and the composition of the personnel.

Tax:

The government needs to review the tax system in the UK. A low tax burden which is simpler and easy to understand should be introduced. There is a constant change in the tax structure which makes it difficult for the businesses to cope with it. UK is the second country after India which is increasing the amount of tax legislation.

According to a poll conducted by the British Chambers of Commerce in 2007, it showed that approximately 69% of the people surveyed felt that the tax system for business needs to be rationalised.

Labour:

There are strict labour laws followed in the UK. Also, the employers’ contribution to the National Insurance of the employees is also an additional tax burden to the employers. The level of skilled labour is relatively lower in the UK as compared to other nations like France and Germany. A lot of time and money needs to be spent on the training of the staff even for skills that the employees should have grasped during their education.

An overview of SMEs Finances in the UK:

The small and medium enterprises have been playing a key role in the motivation, facilitation, and industrial restructuring in the developed nations (Birch, 1979 and Birch et al., 1993). They played a key role in the creation of employment, wealth and economic growth not only in the developing nations but also in developed nations (Story, 1994).

The UK SMEs played a crucial role in the economic development and industrialisation in the UK. The strategic importance of the SME sector has impacted the UK in the various aspects such as government, financial institutions, academics and practitioners’ practices and thinking. The stakeholders agree to the fact that the SMEs play a vital role in the economic development of an economy (Deakins, Logan and Steel, 2000). It is the lack of government intervention for the problem of market failure that has bad effects on the performance of the country’s economy.

In the UK, the entrepreneurs, like in the developing country tend to rely on the informal sources of finance and savings. The main cause of the failure in the UK markets to supply finance to SMEs was the liberalization and globalization of trade and economy. The emergence of global free trade policy had many advantages over and above the traditional small industries.

The economic restructuring in the UK, increasing poverty and unemployment are the issues that helped government intervene into the SMEs and hence minimize the impact of the failure of capital markets. The government has been implementing various strategic policies in order to support the entrepreneurs in the country in order to eradicate poverty and increase employment opportunities. The SMEs in the country have been facing problems to access finance and support for capital investment. According to Deakins and Hussain (1994), the banks readily provide financing options for short term period but are hesitant for providing long term financing thus hindering the SMEs growth on long term basis. Hence, the UK SMEs are inclined with an increased level of debt than the large firms and have to rely on the short term financing means (Holmes and Kent, 1991). This in indicative from the imperfections of the capital markets which thwart the small businesses from accessing the equity and debt finance.

The ethnic minorities SMEs in the UK prefer informal sources of finance and hence fill the financing gap. The evidence suggests that in case of startups, there is lack of informal sources of finance and hence the startups are on a large scale supported by the banks (Mason and Harrison, 1993).

According to the earlier research, it is evident that the SME financing decisions are consistent with the pecking order theory (Holmes and Kent, 1991; Scherr et al., 1990 and Mayers, 1984). Under this situation, the entrepreneur at the first instance chooses a personal source. The second and third would be short and long term borrowing respectively from the various banking institutions. Finally, if the entrepreneur is in need of more finance, he will turn up to equity finance which affects the ownership powers of the entrepreneur (Cosh and Hughes, 1994). According to researchers, in the Pecking Order Theory, the businesses do obtain an optimal capital structure of debt and equity ratio. The entrepreneurs ensure total control of the business by obtaining finance from informal sources and not opting for equity finance.

Government Support for Small Business in the UK:

Overview:

The World Bank’s International Ease of Doing Business Index ranks UK at the 6th position. There are certain flaws in the government support policies for the small business. The Thatcher reforms of the 1980s had brought about a boom in the small business industry making UK a good place to do business. The time consumed for completing the required formalities is high which hinders the small business both for start up and also for growth.

The government has been providing with many support grants for the small business. In the UK, obtaining of finance through banks may, at times, be very uneasy. The government with the help of various public funding agencies provides various grants which depend on the location, size and sector of business. The government offers maximum grants to the new business start ups. The government support available differs in England, Scotland and the Wales.

The Community Development Finance Initiatives (CDFI):

The Government has developed the Community Development Finance Initiative under which independent organizations are set up throughout the country in underdeveloped areas to provide loans and support to businesses. At the moment, there are approximately 68 CDFI’s throughout the country which help develop the financing activity for the small businesses and individuals.

The Community Development Finance Association has been recognized by the government for its role of providing innovative financing options to the small business. The loans and financing options differ from place to place and from sector to sector. The rate charged by the CDFI’s is very low. The main feature of the CDFI’s is that no credit check is conducted for loan approval. The members at CDFI consider each application and grant them loan according to the firm specific requirement.

http://www.smallbusiness.co.uk/channels/small-business-finance/government-grants/guides-and-tips/1072252/small-business-grants-and-loans.thtml

Grants for Research & Development:

Research and Development activities are the lifeline of a business. There is an immense need for new ideas and adapt to the changing technology. In order to promote research and development in the UK, the government offers grants to the small businesses and individual depending on various factors. Grants range from £5,000 to £ 500,000 depending upon the type of research conducted.

The amount of grant available differs from the size of the firm and also the type of projects undertaken. There are five types of projects for which the grants are provided. The projects include proof of market, micro projects, research projects, development projects and exceptional development projects. The grant for research and development is administered by regional development agencies (RDA’s).

http://www.smallbusiness.co.uk/channels/small-business-finance/government-grants/guides-and-tips/1072252/small-business-grants-and-loans.thtml

The Prince’s Trust:

The Prince’s Trust has been active since the 1976. The Trust actively works with the people from the 14-30 years of age group. They help provide various practical and financial help to the youths of the country which are having problems to access education and also have been unemployed for a long period of time.

The trust offers start up loans of up to £4,000 for new sole trader start ups and of £5,000 for partnership businesses. The interest rate charged by the Trust is as low as 3% p.a. with the loan to be repaid within a period of 1-3 years.

http://www.princes-trust.org.uk/about_the_trust/what_we_do/programmes/business_programme.aspx

Grants for Business Investment (GBI):

The Grants for Business Investment is granted for investment in projects which intend to bring about an increase in the productivity, skills and employment levels in the deprived areas of England. The government provides investment options from a minimum of £10,000.

The Industrial Development Act, 1982 provides the power to GBI to provide financial assistance to businesses in the deprived areas under section 7(1) in order to maintain the financial stability. Section 8 provides powers to GBI to support to provide grants to SMEs outside the deprived areas. The grants of up to £ 2 million are been granted by the Regional Development Agencies (RDA’s) whereas grants of more than £2 million are administered by the Department for Business, Enterprise and Regulatory Reform (BERR).

http://www.berr.gov.uk/files/file40543.pdf

Regional Selective Assistance (RSA):

The Regional Selective Assistance is the main grant offered by the Government in the Scotland. This grant is offered to businesses of all sizes. The eligibility of the grants depends on various factors such as:

Ø The project must take place in an assisted area within Scotland.

Ø The project must help create new job opportunities or should help protect the present jobs in the business.

Ø There should be the need for capital investment in the project.

Ø The project should have a reasonable chance of success.

Ø The funds for the project should be mainly contributed by the private sector.

Ø The project must be appealing to the RSA to invest in it.

Each application is individually assessed. The amount of grants made available varies from application to application depending on the size of the business, the type of projects and the employment level involved.

Cluster development in SMEs:

A cluster as defined by the Oxford dictionary means: ‘A group of similar people or things growing or occurring together.’ A cluster means a group of similar activities taking place at the same place at the same time.

In the words of Professor Michael Porter, a business cluster is defined as

“geographic concentration of inter-connected companies, specialised suppliers, service providers, firms in related industries, and associated institutions (for example universities, standards agencies, and trade associations) in particular fields that compete but also co-operate.”

A cluster, as defined by the laghu udyog in India, is as a sectoral and geographical concentration of enterprises, in particular small and medium enterprises faced with common opportunities and threats.

http://web5.laghu-udyog.com/clusters/clus/ovrclus.htm

Indian Scenario:

Cluster development has emerged as an effective way of SME development in India. The development of clusters makes it easy for the industry to blossom in the area of the cluster. The common problems of the industry like competition, acquiring finance, skilled workforce, availability of raw materials, etc can be solved easily in clusters. The Small Industries Development Organisation (SIDO) introduced the Small Industry Cluster Development Programme with a view to bring together the small industries especially in the rural areas under one eye. The National Resource Centre for Cluster Development (NRCD) was started in January 2004 with a view to promotes the idea and need of cluster development in India. At present there are in all 388 clusters in India both and urban and rural level.

http://www.nisiet-cluster.org/aboutus.html

The United Nations Industrial Development Organisation (UNIDO) has played a convincing role in the cluster development in India. The UNIDO has launched the Cluster Development Programme in India in association with the Ministry of Small and Medium Enterprises. The main aim of UNIDO’s Cluster Development Programme is to contribute to the overall development of the small business sector to bring about sustainable development.

Case Study:

Ludhiana Knitwear Cluster:

Overview:

The Ludhiana Knitwear Industry has been a flourishing industry. This industry had a good domestic market but failed when it had to compete with the international goods. The lack of skilled labour, lack of innovative skills for production, limited range of products, conventional methods of production, lack of knowledge of foreign markets and poor institutional support were the reasons of the low productivity of the knitwear industry. The Ludhiana cluster included around 12,000 units and employed approximately 400,000 workers.

UNIDO Cluster Development Programme Outcome:

The UNIDO cluster development programme brought together all the SME units. The cluster helped the entrepreneurs to solve the problems faced by them mutually. The main challenge being to conquer new markets, the UNIDO brought together six local exporters and formed the Apparel Exporters’ Association of Ludhiana (APPEAL). The total number of members in this group has now increased from six to 54 contributing 80% of the total exports by the Ludhiana cluster.

New variety of yarn was introduced to the cluster enabling them to produce new variety products. Many new techniques of production had been introduced enabling them to grow at a faster pace. The new products enabled them to attain growth of 30% against the industry growth rate of 15%. The increased productivity led to savings of approximately USD 1.2 millions. The introduction of new training programmes helped in providing training to around 400 new people and 75 firms. Out of the 400 people approximately 300 were women which led to female employment in the knitwear industry. Specific measures were introduced to address the problems of energy saving, store management and better finish for the products.

The UNIDO helped to create a new umbrella association between the local government and the cluster known as Federation of Knitwear and Allied Industries Associations (FEKTA). This helped the local government body to understand the issues of the knitwear industry and draft policies which would boost the growth of the cluster.

The main achievements of the UNIDO Cluster Development Programme in the Ludhiana Cluster Development are:

Ø The Cluster Development Programme benefited more than 150 firms directly and many more indirectly through the implementation of various activities by APPEAL and the Knitwear club.

Ø The introduction of new energy saving and store management techniques led to cost cutting and increased productivity thereby creating savings of more than USD 1 million.

Ø The participation in trade fairs and buyer-seller meetings led to the acquisition of new domestic and international markets resulted in increased turnover of USD 4 million.

Ø The introduction of 45 new yarns induced additional investments to the level of USD 8 million.

Ø The need of poverty eradication and women empowerment was understood and necessary steps led to the introduction of women employment in the clusters.

Ø The introduction of the public-private partnership by means of FEKTA led to increased investments of nearly USD 10 million.

http://www.unido.org/fileadmin/import/24330_successsmeindialudhiana.2.pdf

http://www.laghu-udyog.com/publications/books/clusdev/ch3.pdf

UK Scenario:

The cluster development policy adopted by the UK is based on the international best practice based in the five stages of cluster development of mobilisation, diagnosis, collaborative strategy, implementation and assessment.

The Regional Development Agencies (RDAs) work in close association with the local government authorities, trade associations and educational institutions to assist the development of clusters. The RDA’s have been working with the Government in mapping the clusters which helps highlighting the important areas of existing clusters as also indicating the need for the development of new clusters in areas biotech and nanotechnology.

The policy for the regional cluster development is drafted by the Regional Economic Strategies (RSEs) by recognising the sectors of vital importance in the region. The RDAs help in networking of the cluster members and by helping the enterprises in the cluster to create a link between them.

UK Cluster Mark:

The Department for Business Innovation and Skills (BIS) adopted Cluster Mark in November 2008 in order to recognise the excellence in cluster development. The need for the Cluster Mark was to increase the level of investment in the UK on the basis of internationally accepted criteria. The best performing clusters are selected by the RDAs on the basis current excellence and the work done for developing the cluster.

http://www.berr.gov.uk/whatwedo/regional/clusters/page39357.html

Case Study:

Scotland Food & Drink Cluster:

Overview:

The Scottish Food and Drink cluster is a major cluster in the Scotland with a turnover of £7.3 billion providing employment 48,000 approximately 17% of Scotland’s workforce. This cluster includes the food processing industry as the core unit and also includes the drinks, agriculture, fishing and aquaculture. The cluster also contributes nearly £2.47 billion to the economy by being an important part of the supply chain for the Scottish Tourism Industry.

The Food and Drink Cluster was formed in 1999 in order to improve its competitiveness in the global market which it had been suffering competition from 1990. The main aim of this cluster is for a Smart Successful Scotland by means of creating, learning and better networking to bring about a sustainable growth and prosperity along with competitiveness.

The Outcome of the Cluster:

The Scottish Food and Drink Cluster is one of the most successful clusters in the UK. The whole industry has joined hands in order to have a sustained growth with increased productivity. The industries in the cluster have common interests of developing themselves by innovation and sharing their experiences. The contribution received from the Scottish Enterprises and Highlands and Islands Enterprise Scottish Food and Drink has helped the Scottish Food and Drink cluster to attain the following:

Ø Ease in accessing important market information by means of collaborations.

Ø Gain new listings with UK retailers by gaining reputation.

Ø Provide better training to the workforce thereby building their skills.

Ø Development of new products by using innovative means of production.

The functioning of the cluster has helped the Scottish Food and Drink attain the status of a familiar brand due to the support received by the regional agencies and public agencies. The Government of Scotland’s first ever National Food and Drink Policy has been laid on the guidelines of the cluster. The cluster now aims to attain the sales target of £10 billion by the year 2017 and thus giving Scotland the name of ‘Land of Food & Drink.’

http://www.scotlandfoodanddrink.org/56908

http://www.scotlandfoodanddrink.org/7180

http://www.scotland.gov.uk/Topics/Health/health/19133/17475

Developing SMEs in India:

The Government of India has acknowledged the importance of SMEs for the overall development of the economy and hence has chalked out development strategies to promote SMEs in India. The following initiatives have been taken by the Government:-

Ø [explain]Protective discrimination in the form of Reservation, Priority Sector Lending, etc.

Ø Integration between large and small e.g. subcontracting ancillarisation and vendor development.[elaborate]

Ø Institutional support through a net