Large enterprises can be the SME engine South Africa needs

What you are hearing is a claxon: loud, unmistakable, and sounding a shrill warning to all in our country, from the SME sector to the public at large: South Africa is in real trouble. Petty parlour games and posturing must be suspended. We need a collective response to the existential threat posed by low growth, high unemployment (especially amongst the youth) and morally indefensible levels of income and wealth disparity.

Unemployment drives many of South Africa’s social ills. COVID-19 has turned our national employment nightmare into a supernova, risking incinerating everything in its vicinity, including our democratic constitutional order. History is replete with examples where widespread economic collapse leads to grand societal failures with 1930s Europe being the most obvious. There is no escaping the mutuality of our condition: we are in this together.

We need credible and urgent responses to this challenge. Nature abhors a vacuum, and because both the state and big business are confronted with the impotence of their limited ability to add to employment directly, we are flailing around looking for credible narratives and solutions to the unemployment problem.  As a country, we have been seduced by a three-pronged ‘entrepreneurship’ as salvation trap: 

1. South Africa will be saved by an organic and broad-based wellspring of individual-based entrepreneurship
   • No, given our failed education system and the lack of sufficient formal employment to serve as a nursery for the development of individuals with sufficient intellectual, network and financial capital to genuinely succeed at the rigours of the entrepreneurial journey
   • Additionally, our industrial structure with large and competitively aggressive incumbents in most economic spheres provides very little operating room for new entrants
     
2. A misplaced obsession with start-ups over scaling up existing enterprises
   • Intel’s late chief executive and chairman Andy Grove warned that as important as the mythical moment of creation in the garage is, what happens next where companies scale up is much more important
     
3. A proliferating network of “business incubators”
   • Almost always living off a false economy of subsidised overhead costs paid for by scarce BEE-related funding on an outsourced model and a no return-on-investment from beneficiaries that have graduated from the coop, or alternatively fair user charges applied to erstwhile entrepreneurs for services delivered by these incubators.
   • It is a grand game of subsidies by big business glad to have the problem “off their books”
     

This is simply not coherent policy. I would love to see independent assessments of our more well-known incubators. The three-pronged entrepreneurship as salvation narrative is wasteful both in resources, opportunity costs, and proves personally devastating to erstwhile programme beneficiaries, most of whom will never succeed as entrepreneurs. It represents a form of capture of the policy vacuum by a class of talking heads and quasi-entrepreneurs who have never run or scaled a truly sustainable entrepreneurial business. It is snake oil sales at a national level.

No time to waste to enable Small and Medium Enterprise (SME) opportunities

In November 2017, the Manufacturing Circle, the large manufacturers association founded in 2008, published its Map to a Million New Jobs in a Decade report. The document is an easy-to-consume analysis and recommendation blueprint for creating jobs covering a variety of subjects, including South Africa’s industrial policy. The document offers a primacy for big business in industrial policy as the only legitimate growth driver in South Africa. What it fails to articulate, except very narrowly through supplier relations, is the important opportunities for big business to work with and support the scaling of small businesses.

I half begrudgingly agree with the Manufacturing Circle and acknowledge the primacy of large organisations in a country’s industrial firmament. However, I see big firms as a necessary but not sufficient ingredient for a well-functioning economy. In any event, we cannot simply (by dint of their contribution to taxes, jobs, and their moderating political influence) wish them away. Which is why we should be so careful in our policy considerations around big farmers as well.

My thesis is that big business should see itself as fundamentally intertwined with small. Big needs to behave materially differently to their current and past behaviour in South Africa. The time to dither has been stolen from us. We must act boldly and with new imagination for the possibilities inherent in partnerships between big and small.

The logic of scale and the benefits of large, especially in the modern global economy, are inescapable. I would much rather have a country with a group of large firms committed to the national developmental mission, and if I could get a second present in the Christmas stocking, an empathetic and technocratic state (but that’s a matter for another day). The case for manufacturing to play a more important role as a sector that contributes to national output is incontestable. Compare how manufacturing economies have done relative to service-dominated economies in this crisis, and you see my point. Agriculture should be viewed as similarly important, benefitting from its cohort of large players. But with a new game-plan.

The individual and collective agency of big business in South Africa is critical. Not least because the state must go through a process of fiscal and technical institutional capacity repair after our lost decade, and therefore needs real partners in returning to its developmental strategy. But how can large firms drive the sustainable growth and scaling of SMEs which in turn can help address our challenges around unemployment and indeed poverty and inequality?  Here, I think the Manufacturing Circle report falls short of its promise.

SMEs must form a fundamental part of the developmental equation, and not simply be a rhetorical flourish or gratuitous inclusion for purposes of political correctness.

Derek Thomas, Letsema CEO

Big business should not be allowed favoured status in industrial policy without simultaneously committing to a fully worked out plan for the inclusion of SMEs in the country’s strategic plans. SMEs in a healthy and complementary ecosystem with large organisations perform important functions. Based on my experience over the last 25 years owning and scaling businesses, and indirectly through advisory services, I have found that SMEs have the following real strengths:

1. Nimbleness, with a willingness and ability to take risks freely and move on opportunities without delay
   
   
2. A singular and intense focus on customer requirements that can address very specific servicing requirements, not least because our commercial viability depends on our customer responsiveness
   
   
3. The ability to sustainably exploit a relatively small customer segment profitably and the ability to eke out profitability in market segments without the burden of overhead costs limiting the exploitable viability of otherwise bankable economic opportunities
   
   
4. Most importantly though, through a variety of mechanisms like the use of “appropriate technology” and the discipline imposed by our limited pool of capital drive, a more aggressive labour intensity-per-unit of invested capital than larger firms; this last point is rendered even more important in a post-Covid world where capital for real economy investment will be in short supply

At the same time, we as SMEs are subject to important weaknesses. Ultimately, the nature of the activities we can undertake are limited in the following manner by our small capital base:

• We cannot sustain risky or too ambitious an investment for too long
• We cannot often access bank loans or other sources of capital with anywhere near the same efficiency as big business
• We cannot enter meaningful partnerships with truly large global firms. We would be overwhelmed
• We cannot do the kind of deep research and development that produces ground-breaking inventions or drives the creation of new industries
• We cannot afford to access the requisite complementary and service inputs in a country where these service clusters are underdeveloped, often in-house at large businesses, or far away from global markets, and thus prohibitively expensive
  

And yet, we can count our contribution to South African jobs in aggregate in the millions. The possibilities of expanding the scale of SME operations or replicating their scope in related activities carries enormous positive employment and fiscal opportunities for South Africa.  As a private investor I would sooner invest to expand a business than try to start a new one for a variety of reasons. The same applies to the national scale.

Nine themes: Solving unemployment through partnership

Here is my list of themes we should consider, as we drive towards solving our unemployment crisis through the creation of healthy industrial ecosystems characterised by large domestic firms and SMEs:

1. A general openness and acknowledgement that while we may occupy different cabin classes, we are aboard HMS South Africa together and that our fates and fortunes are intertwined; this will help drive more generosity of spirit and imagination about the ecosystem and our joint survival prospects
   
   
2. Supply chain partnerships that are not expedient or transactional but long-term in nature and which enable SME development; this allows for the building of long-term game plans with a common vision. The best national industrial policy provisions include conditionalities or quid pro quos. In this model the SME gets the supply contract provided it creates a certain amount of jobs, treats workers fairly, trains, ensures BEE targets are met, invests in some R&D, introduces exciting new products and perhaps even exports. This does not mean that the relationship does not have contestability events but that these are informed by the meeting of pre-determined targets. Remember, small in general is beholden to big
   
   
3. Big business should propose that the state use big corporates as partners and implementing agents (where appropriate) for its industrial policy goals on an extended value chain or ecosystem basis. In other words, just as the state hands out favours and opportunities to big business, so too could big business in relation to its SME ecosystem, provided the necessary qualifying criteria and performance frameworks are in place
   
   
4. Supplier and enterprise development funding represent such an important tool, and yet it has proliferated across a multitude of wasteful institutions each with its own bureaucracy, overheads, and leakage. These are deadweight losses that when aggregated across the system represent a meaningful waste to the country. Perhaps larger pools aggregated in a smaller number of institutions or a single centralised fund can drive expertise and specialist funding models This would allow SA to establish an appropriate private sector-driven governance forum over scarce resources with high-level industry and government specialists. Leveraging public sector finance would be easier and more meaningful. Sectoral councils could be established to determine the most appropriate investment and funding priorities 
   
   
5. A re-imagination of the possible role of SME as beneficiation agents in the value chain of large businesses. SME can add specialised value to smaller volumes of product into specialised niches. SME can partner with corporates regarding the results of R&D efforts, which address markets too small for the corporate to justify in their strategic planning but could be additive in exports and economic activity for the country. This may involve some inconvenience in additional complexity to the big business, but mainly it is about a burden on the imagination and a more generous disposition towards other smaller players in the ecosystem
   
   
6. Production ecosystem partnerships between big and small. SME can produce certain products at lower overheads and with higher employment intensity than larger firms. This means looking into the production universe with trust and imagination for opportunities for local production by SME, and not being selfish about economic activity needing to be under the direct factory roof of the big business 
   
   
7. Buying local, but with teeth. With a little commitment, we could create symbiotic supply relationships to reduce avoidable imports. I have seen some crazy perversions where BEE considerations lead to imports in preference to equivalent quality local manufacturing. This is while there is no preceding contemplation or offer of an improved BEE score as a qualifying condition for the local manufacturer. When were local manufacturing jobs so devoid of value to the national game-plan?
   
   
8. Industrial SME financing is a specific kind of product required for the healthy operation and scaling of SMEs. We have some way to go in this regard. Thankfully, best-case examples in countries like Germany (kfW) and Brazil (BNDES) exist which we can draw upon. The state should partner with commercial banks to offer appropriate loans and products to SMEs. The risk of trying to scale SME funding through DFIs will lead to two inescapable problems: loan book concentration risk, and an increase in defaults 
   
   
9. Lobbying for an ecosystem model with the state and demanding capable public institutions with appropriate products and services is necessary. Large companies have ‘voice’. They are more easily heard by the state than are SMEs. I am ok with that; just use your voice productively

South Africa is faced with a clear and present danger. Time is of the essence and our resource toolbox is near empty. COVID-19 has thrown the existential threat to the country into great relief. We must act now, and our strategic planning must be scrupulous. Our use of scarce resources must be well contemplated. It starts with the recognition that we are blessed to have large firms with deep capital structures, both public and private.

These large industrial firms must carry the South African flag in their philosophical contemplation, strategic planning and in their actions. An important part of their role in sustaining their own profitability and institutional longevity should involve a re-imagination of their relationship with SME. The relationship should be multi-dimensional. Big business must relate with SME in a more productive and mutually beneficial manner and by using their voice with the state to help drive all of us out of our developmental quagmire.

Derek Thomas is CEO of Letsema, a management consultancy at the heart of a diversified investment group.