Why small businesses should prepare for the worst

There are at least 450 million small businesses operating in emerging markets, according to the World Bank. The exact number is virtually impossible to pinpoint, because many of these firms fly beneath the official radar.

While we know they make a significant contribution to economic productivity and employment, the lack of hard data makes it difficult to understand the sorts of challenges they face. And how best to support their growth.

Typically, policy-makers and firms themselves focus on the upside: proactive training schemes and programmes that are designed to fast-track skills and help build growth strategies.

But new field research from Amrita Kundu, PhD in Management Science and Operations and Kamalini Ramdas, Professor of Management Science and Operations together with Stephen J. Anderson of Stanford University, suggests we might be overlooking something even more important.

They argue that there’s a downside that must also be addressed if these small businesses are to prosper: that setbacks, interruptions and disruptions to productivity, endemic in emerging markets, must also be anticipated, planned for and resolved both at an individual and policy-making level, in order for these firms to thrive and compete more effectively.

What’s hampering SME growth in emerging markets?

Across emerging markets, small to medium enterprises operate prolifically, collectively employing a significant proportion of the local population. Many of these firms remain small, even though they have the potential and the capacity to grow.

Partly this is due to things like a general lack of infrastructure, technological advancement, modern production and logistical systems and access to financial markets.

One way that government agencies and business owners tackle this is by developing training packages. Often these are controlled trials, where business networks are created within local communities or townships to recruit entrepreneurs and put them through sales or finance training. London Business School is actively involved in initiatives like this. Another way of addressing these issues is to improve access to loans or capital.

Before and after these kinds of intervention, results are measured to assess things like the firm’s ability to borrow, and growth in turnover or employees. Unfortunately, these results have a tendency to be insignificant and at times, completely “unapparent,” says Amrita Kundu.

Together with Ramdas and Anderson, she is interested in looking at the issue from the “flip side.”

Instead of seeing how productivity can be positively spurred by things like training, the researchers wanted to test the hypothesis that productivity was being negatively affected by what they term “disruptions” – unexpected, external interruptions or setbacks affecting management and operations. And that addressing these disruptions could potentially have a far greater impact on productivity than other types of intervention.

“Research has looked at the upside productivity gains of business development interventions like business training and management consulting, but the impact of disruption to business activities on productivity has been largely overlooked,” explains Kundu.

“We wanted to know if things like power outages, employee sickness or supply shortages – issues that are relatively commonplace in emerging markets – were seriously undermining firms’ performance and prosperity. And how these firms could potentially buffer themselves against disruptions and become more resilient to them.”

The problem Kundu and her colleagues faced was lack of data. A dearth of research in this area meant they had no access to existing datasets to put their ideas to the test.

“Economists and business scientists typically look at the big picture in emerging economies to establish the broader economic patterns. That means there’s a real scarcity of publicly available data on the business performance of firms at a granular level, and even less knowledge about the impact of disruptions to business – what they are, how often they happen, how firms react and how effective their responses are. We wanted to take this down to a molecular level, looking at specific businesses and really digging into the detail.”

For Kundu and her colleagues, that meant physically going out to the field and undertaking the painstaking, on-the-ground research themselves.

Between June 2015 and November of 2016, the researchers hand-built their own dataset via four rounds of one-to-one survey interviews and business audits with entrepreneurs from 646 small firms operating in Kampala, Uganda.

Baseline surveys amassed itemised data on the firm and the entrepreneur, with follow ups at six-month intervals over the full 18-month period, to capture detailed information on the kinds of business disruptions that had taken place over that time.

“We pre-identified eight types of disruption,” says Kundu. “These were categorised into managerial disruptions, where the entrepreneur herself can’t manage because of her own sickness, or the illness of even death of a relative. The second category was operational disruptions – things like theft, building damage, employee absence, supply shortages or power outages.”

Each recorded disruption was measured in terms of its unpredictability, abruptness and severity. And its impact.

What the researchers found was striking.

“Astonishing frequency and the sheer magnitude of the impact”

Ugandan entrepreneurs in the study reported an average of one operational, and two managerial business disruptions every six-to-18 months. These disruptions were all exogenous – arising from external circumstances beyond the control of the business owners.

But not only were these setbacks frequent. They were also severe.

“We were surprised by the regularity and the sheer magnitude of these shocks. The surveys revealed that entrepreneurs were dealing with outages, supply shortages, staff disruptions, illnesses and even deaths of staff or relatives that were affecting their businesses at a rate that we simply didn’t expect to see. But perhaps even more surprising is the cost to these firms in terms of sales and salaries,” says Kundu.

In a six-month period, the negative impact of multiple and severe disruptions translated into a drop in sales of a stunning 14 percent. The concomitant drop in sales growth was 18.8 percentage points on average – a “phenomenal loss” that acutely hurts the mid to longer-term prospects for these small businesses.

Significantly, the researchers found that those firms that had set up some kind of resilience strategy to weather unexpected setbacks were able to buffer against these kinds of loss to a much greater extent.

Managerial disruptions are more common and have a high impact on sales, she notes. So losing a key decision-maker for any reason or period of time will be more damaging to sales than a theft or an outage.

“But where small firms have built in high ‘relational resilience,’ with exigency measures in place to help keep things going when the boss is out, they are able to completely overcome any negative effect on their sales. Similarly, firms with high `resource resilience’ are able to overcome losses due to operational disruptions.”, Ramdas notes.

Unfortunately, this wasn’t the case with the majority of the firms surveyed. Most had little or no contingency plans in place to deal with problems when they arose.

“These emerging market firms aren’t building in precautionary resilience, and this is likely because they’re just not conscious of the negative impact on their business,” says Kundu. “They simply don’t see the economic need for contingency measures.”

According to their data, Kundu notes that most small firms need only invest 3.8 percent of monthly sales in building relational resilience.

“Were a firm to set aside 133,000 UGX a month to cover the potential absence of its manager – less than 4 percent of its average monthly sales – to compensate a family member who steps in to cover that absence, it would work out well for both the firm and the individual substituting the boss. It’s a win-win: 133,000 UGX is the equivalent of 66 percent of the average Ugandan salary in exchange for a few days’ cover for the family member involved. For the firms, 3.8 percent of monthly sales also makes this a cost-effective strategy.”

Perhaps even more to the point, though, are the implications for governments. Policy-makers in concrete would do well to devote greater resources into tackling the issue of unexpected disruptions and resilience building among small firms in emerging markets, she says.

“It’s unbelievable to think about the numbers and what these businesses do for the people living in these regions. We know of 450 million in emerging markets, but there are likely to be many, many more beneath the radar. There are relatively few big enterprises, but this interesting long tail of small firms that have the potential to really drive productivity. Our results are robust enough for governments to take note, and address these under-explored dimensions. Just think of the potential impact these businesses could have on economic conditions if they were empowered to go beyond basic subsistence.”