This article first appeared in Forum, The Edge Malaysia Weekly on November 14, 2022 - November 20, 2022

Small and medium enterprises (SMEs) play critical roles in most developing countries. According to the World Bank, SMEs contribute the most to job creation and entrepreneurship, but they do not get their fair share of credit or government support. Typically, SMEs account for more than 90% of businesses by number and more than 50% of employment worldwide. 

In Malaysia, the Asian Development Bank SME Monitor showed that there are 1.1 million MSMEs (including micro-enterprises) that account for 97.2% of total enterprises, of which 85.5% are in the retail and wholesale trade. They employ 7.2 million people, or 48% of the total, of which 63.3% are in the retail and wholesale trade, 16.4% in manufacturing, 10.7% in agriculture and 9.3% in construction. They contributed 38.2% to gross domestic product in 2020, broadly similar to other emerging economies. Furthermore, they contribute up to 17% to total exports (13% in 2020 due to Covid-19). This shows that it is the larger firms that contribute to exports, but MSMEs are major employers and contributors to social stability in the country. 

The World Bank estimates that worldwide, 600 million jobs will be needed by 2030 to absorb the growing global workforce, which makes SME development a high priority for many governments. However, access to finance is considered to be a key constraint to SME growth. In Malaysia, the MSMEs only received 16.7% of total bank financing in 2020, it was even lower than the peak of 19.9% in 2007. In terms of non-performing loans, Malaysian MSMEs had a record of 3.2% of total MSME loans in 2020, down from 9.4% in 2007. This is very good, but when you contribute to nearly 40% of GDP, but get less than 20% of bank credit, something is missing.

SMEs are less likely to be able to obtain bank loans than large firms; instead, they rely on internal funds, or cash from friends and family, to launch and initially run their business. The International Finance Corporation (IFC) estimates that 65 million firms, or 40% of formal MSMEs in developing countries, have an unmet financing need of US$5.2 trillion every year, which is equivalent to 1.4 times the current level of the global MSME lending. Their access to non-bank financial institutions (NBFI) is generally very small, especially equity funding, since there are only 135 listed on the Malaysia ACE Market and 34 on the LEAP Market as at the end of 2020.

Although data shows that most MSMEs rely on internal funding (family capital and retained earnings), and official studies show that the key constraints are access to formal funding (bank loans) or access to consultant support, my conjecture is that access to know-how (technical, financial, managerial, marketing and so on) is probably an even bigger barrier to SME development. Without know-how and funding, you cannot buy the talent. With know-how but no funding, you cannot attract the talent. It is a vicious circle facing most MSMEs.

The free market philosophy of most economists since Adam Smith tends to forget that there are differences between big and small businesses. Markets are informational networks across which buyers and sellers exchange information (and knowledge) about each other, products and market conditions, including rules, regulations and general fairness (such as being free from corruption, predatory practices, cheating and market abuse). Large firms operate in large networks, operating in established infrastructure that lower their costs and they often protect their profits through franchises, branding and intellectual property rights. The world is not exactly fair to small players. 

English economist Ronald Coase got his Nobel Prize for his articulation of the importance of transaction costs and social costs to economic development. Firms generally band together to reduce transaction costs, so firms that are efficient in reducing their transaction costs and increasing their income grow relative to smaller firms that do not. He also identified social costs, which are externalities that firms pass to others, such as pollution costs or costs arising from corruption and malpractices. Successful firms and economies are those that lower transaction costs and improve social value. The current system of excessive free-market greed has worsened social value through social inequality and exploitation of natural capital (the environment).

MSMEs typically grow because founder members or partners have special skills (such as cooking or technology) that are better than others. But these talented founders often lack the managerial, marketing, financial and technology skills to move to the next level. In recent years, private equity/venture capital firms have learnt how to “coach” talented start-up entrepreneurs to improve their skills, by bringing in the right talent (know-how), plus the funding, so they can achieve take-off in terms of speed, scale and scope. Once their “market concept” reaches “proof of concept”, additional funding is injected to scale up, so the company eventually becomes a “unicorn”, namely one that when listed will have a value of more than US$1 billion. 

The rule of thumb in the US Silicon Valley is that 90% of start-ups fail, of which half fail within two years. Forbes estimated that 17% of unicorns also do not make it. All this suggests that out of the million-plus MSMEs in Malaysia, many struggle, especially during the Covid lockdown. Many more struggle to make the shift out of old business models into the online area, namely, moving up the knowledge curve in terms of technology, branding and scale, so that they can get more funding from either the banks or equity market.

While there is a lot of effort in Malaysia in trying to boost the SME market — such as the development banks, SME Corporation, Talent Corporation and so on — we are still struggling to find the right infrastructure to help more MSMEs succeed. My view is that we lack the information or knowledge infrastructure that MSMEs need to compete effectively. Just having websites of such knowledge is insufficient, because many MSMEs do not have the time nor knowledge on how to access government funding or improve their technology and management skills to get more funding, relying on the convenience of friends, family or moneylenders. 

In other words, we lack the ecosystem of coaching MSMEs to succeed on how to lower their costs, improve their revenue and manage their operations. Most management consultants do not find MSMEs profitable customers, nor can MSMEs afford such professional advice. Since there is a whole generation of experienced business “baby boomers” retiring, we should have a network of “Entrepreneurial Corps”, like the US Peace Corps, who can volunteer their time and experience to help our MSMEs reach the next level. The good news is that there is a generational shift coming, as many of the MSME founders are retiring and their children are beginning to take over. 

To succeed, everyone has to take risks. The old ways are not working that well. So, having an open mind to help our MSMEs succeed will not only increase diversity, but also improve inclusivity. This is the real challenge in implementing ESG (environment, social, governance) in the coming days. 

Tan Sri Andrew Sheng writes on global issues that affect investors 

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