2. Literature review
In this chapter the researcher will critically examine the literature related to small to medium enterprises issues. This chapter is meant to provide the in depth insight to small business success factors and failures through critical analysis and evaluation of work done in this field by other authors.
2.1.1 Context of small to medium business
In recent years there has been a large discussion about how SME’s find it difficult to survive in different economies. In Zimbabwe the failures of small to medium enterprises is caused by main factors which include the shortage of funds, poor management skills, lack of planning and lack of training of the employees. However the discussion might be focusing on finance constraints to start up a business.
The term small business or small to medium enterprise (SME) has no universally agreed definition. The type of definition differs depending on countries, jurisdictions, industries, different international bodies etc. In different countries the first criterion that has been used to define small businesses is that of the number of personnel involved in the daily operations of the business or simply the number of employees as the case may be. It is therefore idle for one business to get sufficient funds to sustain the current economic situations. According to Darlberg (2011) in Egypt small business firms are defined as those having more than 5 and few than 50 employees. Vietnam on the other hand defines them as those having between 10 and 300 employees and the World Bank has defines SMEs as those businesses with an absolute number of 300 employees. Vietnam on the other hand defines them as those having between 10 and 300 employees and the World Bank has defines SMEs as those businesses with an absolute number of 300 employees. The Inter-American Development Bank has established its own definition of SMEs as those firms or business establishments having a maximum of 100 employees. In Zimbabwe, ZIMRA uses a loose definition that says a small company is one with six to 40 employees, annual turn-over of $50 000 to $500 000 and assets valued at between $50 000 to $1 million. Meanwhile in Zimbabwe the Small and Medium Enterprise Development Corporation (SMEDCO) defines a small business as an enterprise with 50 or less employees. The Zimbabwean definition provided by SMEDCO gives a much clearer picture as compared to the other definitions and is more applicable in the context of a developing country as Zimbabwe. Thus businesses that are regarded as small within the other countries noted above where it in the Zimbabwean context then these will not be regarded as such. This in itself implies that the definition adopted of what a small business is will also depend on the This means that employees are considered a crucial factor in the establishment of the size of a business organisation as employees are viewed as a cost in terms of the wages that require to be paid to them. In other words employees are used to establish whether a business is large or small based on the general notion that manpower or labour is not a cheap resource. Thus due to the size of small firms those that have made an effort to define what small businesses are based on the number of employees all hold the notion that the higher the number of employees the larger the business hence the greater its financial muscle to cope with the labour cost. It is this notion that leads us to the second criterion which is used to define what SMEs are i.e. based on revenue. However the assumption that the more the number of employees the larger the business tends to be rather misleading at times as there are businesses that are capital intensive and require a small number of employees. Thus it is clear to note that defining small firms therefore on the basis of the number of individuals employed does not result in an overall conclusive definition.
Some proponents have defined small firms on the basis of the revenue which the firm makes. According to the World Bank a firm to be regarded as small is one that makes a maximum of US$ 15 million in annual revenue and according to The Inter-American Development Bank less than US$ 3 million. These figures are applicable to European nations and developed countries but when applied as a yardstick to measure firm size in developing countries such as Zimbabwe then this can give a rather misleading picture. SMEDCO however defines small businesses as those having an annual revenue base of less than US$ 1000 000 in annual revenue, with the maximum being pegged at US$800 000 per annum .This definition is more reflective of a characteristic of small firms in the context of developing countries where demand patterns are lower as compared to those in developed countries. The use of revenue as an overall definition of what small businesses are, provides a much better definition as compared to the number of employees as the sore gist of conducting a business is to generate cash inflows also known as revenues. Thus the more revenue an entity earns the larger it is because revenues serve as a useful form of capital when ploughed back to finance purchase of assets, finance improvements in product and service provision and to expand business scale of operations. However this measure also has a drawback as also several arguments exists in establishing what precisely consists revenue. This is so because various definitions of revenue also exist in the same manner as various definitions of what small firms are.
Small firms have also been defined in the context of the assets which they hold or simply their total assets. According to the European Union firms with less that € 10 million in total assets are considered to fall within the small to medium enterprise category. Conversely the World Bank on the other hand defines small firms as a business with a maximum of 15 million in total assets (Darlberg 2011). This notion is based upon t1he belief that assets represent an investment which is reflective of the size of an entity. Thus it is often believed that there is a positive relationship between the size of an entity and the total assets held i.e. the larger the entity then the more its total assets and vis-à-vis.
According to Uganda Bureau of Statistics (2008:5), an SME is a business that employs 5 to 50
People (small scale) and 51 to 500 people (medium scale). This means that, in Uganda, SMEs are classified into categories of small scale and medium scale businesses. However, in Botswana,
SMEs are categorized into three groups. Nkwe (2012:30) states that more variables are used to
determine SMEs, such as employment level, annual turnover and annual balance sheet total. He
states that, currently, Botswana’s accepted definition of SMEs is based on three categories of
enterprises using the annual turnover and the number of employees. Similarly to Botswana,
Namibia uses these categories to classify SMEs. According to the Namibia Institute of Public
Policy Research (IPPR; 2010:5), the ministry of Trade and Industry in Namibia define SMEs as a
sector of business organisations composed of small business enterprises with full time employees ranging from 6 to 100 employees
2.2 Imperical literature
A large number of researchers have highlighted a number of reasons why small to medium firms fail as mentioned above.
Failure of SME’s is due to lack of capital. King (2007:15) states “lack of capital is often the most
critical challenge that a successful SME faces as its very success creates this and it quickly
becomes a vicious circle.” Without the management looking for money to fund the business operations this may lead to corporate failure. The profit in the business activities may not be sufficient enough to fund the extra working capital required for the operating cycle. This is more often when a business has more inventory or debtors hence the money to fund the day to day operations of the business is not readily available as money will be tiered up in stock. The security system of small business to defend themselves against bad debts is insignificant. According to Vallely (2008) management must be able to analyse the financial statements using ratios to determine the position of the business. By knowing the position of the business management can now make plans and decisions that will solve or attack the problem at hand. By calculating ratios the business can assess the businesses risk and implement such measures to correct or prevent those measures. . Moreover according to Gonzalez, Reyes ; Ruth (2011) SME’s fail because they do not have access to loans from financial institutions hence they find it difficult to raise enough capital to fund their operations or invest.
The Technological Capabilities Theory popularised by Lall (2001) argues that smallness is dangerous just like in the animal kingdom where younger and smaller animals are easy prey for predators. This theory easily states that small to medium enterprises find it hard to acquire loans form financial institutions because they lack collateral security to pledge and the financial institutions find it risky to lend money. This implies that the only way for small businesses to raise capital is self-financing or to borrow money from friends and family. However these small businesses face high operating costs and this may result in their collapse. Ogbokor (2012:15) states that access to finance is a severe problem and banks require high security or collateral, financial statements and a business plan, which SMEs are unable to draft on their own (in most cases) unless they have to pay for the service of a consultant. However, According to Nuyoma (2010:7-10), more than 40% of Micro, Small and Medium Enterprises (MSMEs) in Namibia identify access to finance as the most serious obstacle to growth and failure of SME’s.
Small to medium businesses should learn how to manage their working capital. According to Tom (2005) for a small firm to be effective and efficient there is no need to undertake basic credit- controls checks and ask for trade reference from firms. It will be expensive for the business to fund qualified accountants to do proper book keeping. Therefore these businesses should try by all means to keep their receipts and payments statements. This does not need a professional accountant to take care of the accounting records therefore this is cost effective to the business. Padachi (2006) using the regression analysis stated that the small firms should ensure a good synchronization of its assets and liabilities. Small firms should extend their credit payments period so as to manage their liquidity well and also reduce the debtor payment periods for the company to receive efficient money to finance their day to day operations. However it may be a good idea for such businesses not to offer credit sales to customers because much cash might be tied up in debts and some debtors may default payments thereby causing losses to the business at large.
The Production Theory as in Laidler (1972) indicates that small businesses are inefficient because they do not operate at the minimum efficient scale where economies of scale are enjoyed. This is because their average costs are always falling. The theory further asserts that if firms do not find a way of increasing their scale so as to be able to enjoy economies of scale, they remain uncompetitive and hence have a high likelihood of failing. Since SMEs generally do not enjoy economies of scale, the current study also examines the extent to which failing to attain economies of scale can be a cause of failure. Under production theory once more, according to Mudavanhu (2011) the government should offer securities to the small firms so that they get credit or have access to loans. It is the duty of the government to protect infant industries and give them some funds to fund their projects.
Sheppard (1995) came up with the resource-dependence theory. The theory’s basic assumption is that firms survive by acquiring and effectively managing resources obtained from their environments. Thus adopting Sheppard’s notion a small firm is deemed to be successful if it is able to effectively manage its resources. Fernandez (2008) highlighted resource-dependence theory by stating that the majority of organisations dissolved due to resource insufficiency. This therefore implicates that the survival of small firms is dependent upon maintaining a quality and sufficient resource base that they can make use of to ensure continued survival an ensure expansion objectives are realised. According to Townsend, Busenitz ; Arthurs (2010) lack of resources is among the factors that shape small business fatality rates as this impact on a firm’s ability to capitalise on opportunities.
Studies in Ghana, namely Inkoun (2003) however postulated that the ability of a small firm to survive will depend on the entrepreneurial skills of the proprietor. Thus he outlined that there was a linkage between small firm survival and entrepreneurship in existence. He found out that proprietors with business related qualifications tended to survive by 30% more than non-qualified proprietors. Thus educational background is also being considered as a valuable factor in ensuring continued firm survival. According to Ramis (2002) although training on management issues is of importance to small firm owners, it can only achieve the desired effect only if the business in itself has a high growth potential. Thus a characteristic of a small firm being successful is having the potential to increase in its scale of operations as stagnancy will lead to vulnerability to failure. Jaafer and Abdul- Aziz,(2005) believed that entrepreneurial characteristics of small business proprietors in the form of creativity and the need for achievement are crucial success factors in driving a small firm towards success. However according to Tian (2005) competition which small firms faced from both domestic and foreign firms was more predatory than entrepreneurial skills. In his study small to medium firms that were faced with fierce competition from larger and more established firms were three times running the risk of collapsing than those without competition.
In addition Koush (2008) studies SME failure in South Korea and found out that foreign competition was an attributable factor to the failure of small businesses. He also concluded that the importation of foreign goods and services done in developing countries was a factor to consider in examining the causes of curtailment in operations of some small firms. His study divided competition into domestic and foreign as he tried to highlight the differences in the intensity of competition. Koush established that foreign competition was more intense and stronger that domestic competition various factors such as superiority of foreign goods in terms of the quality and also that they were cheaper due to being made at lower costs of production. Thus an inability to cope with competition can be outlined as a possible cause of small enterprise failure as noted by Koush. Moreover Baggs (2005) studies indicated that the failure of SME’s was caused by trade barriers. Imports duties became expensive for businesses which imported their raw materials leading to the failure of some businesses. In Zimbabwe the government implemented the Zim-Asset blueprint chapter 7.4.1 and indicated that the ministry responsible for Small to Medium Scale industries should strategies in providing building capacity and technical training to traders so as to increase export revenue
Dinwiddy (1974) believed that African small enterprises failed because apart from management inexperience small business owners did not have external close relationships with suppliers, commercial banks and financial establishments as well as having a close relationship between themselves. This could be of problematic consequence and consequences varied according to the nature and scale of the small business concerned, and according to location of its market. However Kambwale, Chisoro ; Karidia concluded that owners of SME’s should get adequate training. The government should try y all means to implement SME training schools and also provide enough financial support.
According to the article by The Small Business Advisor (1999: 58), most small businesses fail because they lack good customer relations. Small businesses lack direct contact with the customers, they do not provide promotions, prices are inconsistent, and lack of new product packaging. Customers are one of most important group of stakeholders that a firm must satisfy. However it is difficult to build customer loyalty. According to Scarborough and Zimmerer (2003: 374-6), the following factors influence customer relations: right to safety, right to know, right to be heard, right to education, and right to choice. In terms of right to safety, there will be no trust in small business owners if they do not provide customers with safe, quality products and services. Therefore for a small business to be successful it has to build good customer relations for it t be successful.
Pickle and Abrahamson (1990:167) argue that it is not unusual for a small business
owner to select a location based primarily on convenience or cost. A location may be
chosen because of the availability of a vacant building, proximity to the owner’s residence or low rent. One of the reasons why small businesses fail is because they select a site for their business without first making a thorough analysis of the overall location’s potential for the business’s survival and growth. According to Siropolis (1990: 228), the importance of location is determined by the type of the business, proximity of the business to its customers, i.e. must customers travel to the business or must the business owner travel to the customers. Other factors to be considered are whether the business offers a special product or service with little direct competition, and whether convenience is the key selling point in what the business
offers to customers. Siropolis (1990: 229) notes that poor location may be caused by a supermarket or any other competing small business enterprise being located close to the new small business.
According to Longenecker (2003: 271), the importance of the location decision is underscored by the costs and impracticality of pulling up stakes and moving an established business if the decision on the location proves to be wrong. Based on this, if the choice of location is particularly poor, the business may never be able to get off the ground, even with adequate financing and superior managerial ability. In the article by All Business: Champions of Small Business (2004), the above view is corroborated and mention is made of the fact that even the best restaurant or retail store will fail if it is in the wrong place. It is important to consider factors such as traffic how many potential customers pass the business (during the course of an afternoon or evening) and convenience, (how hard is it for the regular customers to get to the location on a regular basis), when scouting for a location for a business.
As mentioned by Keasey and Watson (1993: 229), small businesses that are contemplating purchasing new technology have great difficulties since they don’t have enough knowledge and the high opportunity cost of scarce management time, in isolating the cash flows pertaining to the project. Jones and Tilley (2003:8) explain that many small firms lack time, resources, technology or expertise to research and develop new business ideas and innovations. This weakness can become a critical factor limiting growth and expansion in small businesses.
This chapter began by highlighting some of the factors that contribute to the failure of small to medium businesses, namely lack of capital, lack of loans from financial institutions, poor working capital management, poor economies of scale, foreign competition, management inexperience, poor customer relations, lack of employee satisfaction, lack of technology and poor location. The purpose of this literature review was to identify key factors that play a role in the failure of small businesses. An important point that should be kept in mind throughout this discussion is that information about the running of businesses should be made more readily available and that the existing structures of business information need to be revisited. The purpose of this literature review was to identify key factors that play a role in the failure of small businesses. The researcher will focus on failure to raise funds to start up the business.
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Keasey, K. & Watson, R. 1993. Small Firm Management. England: Oxford Publishing.
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Tian, D (2005). Determinants of SME failure in Malaysia. A quantitative approach. Canadian journal of economics vol 66 pp 19-35
Townsend, D. M., Busenitz, L. W., & Arthurs, J. D. (2010). To start or not to start: Outcome and ability expectations in the decision to start a new venture. Journal of Business Venturing, 25(2), 192-202.
UNIVERSITY OF ZIMBABWE
TITLE: A STUDY TO EXPLORE THE POSSIBLE FACTORS LEADING TO FAILURE OF SMALL TO MEDIUM BUSINESSES
TAPIWANASHE B MHERE
PROJECT PROPOSAL SUBMITTED PARTIAL FULFILLMENT OF THE REQUIREMENTS OF ACCOUNTANTS DEPARTMENT.
FACULTY OF COMMERCE