CHAPTER 4

SMALL AND MICRO ENTERPRISES

4.1. The Concept of Small Business: Definition and importance

Micro and small enterprises (MSEs) cover a wider spectrum of industries and play an important
role in both developed and developing economies. Ethiopia is no exception and MSEs occupy a
prominent position in the development of the Ethiopian economy. While the small entrepreneurs
can set up a unit even with less capital, enjoy quick returns and have the flexibility to handle the
vagaries(change) of the market, they have to face many problems like lack of finance, poor
operations management, lack of experience, poor financial management, etc,. The process of
setting up a venture begins with searching for an opportunity. Identifying a good opportunity is a
difficult task and involves scanning the environment and the use of creativity and innovation.

4.1.1. Definition of MSEs

Small businesses are playing an important role in the industrial economy of the world. These are
particularly important in the developing economies. Small business is predominant even in
developed countries such as USA, Japan etc.

The definition of a small business varies from country to country and between times in the same
country. There is no generally accepted concept of small business. Small business is an
enterprise that is comparatively small in size, operating in a geographically localized area except
its marketing, employed fewer than 100 employees. It is financed by one individual or a small
group of individuals. Thus, small business may be defined in various ways e.g. in terms of
investment, number of persons employed, volume of output and sales, technique of production
etc.

There are two approaches to define small business. They are: Size Criteria, and
Economic/control criteria.
1. Size Criteria
Even the criteria used to measure the size of businesses vary; size refers to the scale of operation.
Some criteria are applicable to all industrial areas, while others are relevant only to certain types
of business. For instance, some of the criteria used to measure size are: number of employees;

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volume, and value of sales turnover, asset size, and volume of deposits, total capital
investment, volume/value of production, and a combination of the stated factors.
Even though the number of employees-is the most widely used yardstick, the best criterion in
any given case depends upon the user’s purpose. To provide a clearer image of the small firms,
the following general criteria for defining a small business are suggested by Small Business
Administration (SBA).
 Financing of the business is supplied by one individual or a small group. Only in a rare
case would the business have more than 15 or 20 owners.
 Except for its marketing function, the firm’s operations are geographically localized.
 Compared to the biggest firms in the industry, the business is small.
 The number of employees in the business is usually fewer than 100.
This size criteria based definition of MSEs varies from country to country. All over the world,
number of employees or capital investment or both has been used as the basis for defining MSEs.
2. Economic/Control Criteria.
Size does not always reflect the true nature of an enterprise. In addition, qualitative
characteristics may be used to differentiate small business from other business. The
economic/control definition covers:
 Market Share,
 Independence, and
 Personalized Management.
 Geographical Area of Operation.
Therefore, small enterprises have the following characteristics

i. Limited Investment: In a small business enterprise, capital is supplied by an individual

or a small group of individuals.

ii. Personal Character/Owner-Management: A small business is identified with its

owners; who themselves act as managers. Managers as such have maximum motivation

to work; as they themselves happen to be the owners also, at the same time.
iii. Labor-Intensive: Small business enterprises are mostly labour-intensive. The machinery
and equipment used are not very sophisticated and are operated manually. They are
fairly labor intensive with comparatively smaller capital investment than the larger units.

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 That is, for the same investment, a small enterprise provides more jobs to the people
compared to a large enterprise.
iv. Unorganized Labor: Small business enterprises employ less number of workers as
compared with big business enterprises. Workers of these units do not form labour unions
and remain unprotected.
v. A small enterprise has lesser gestation period compared to a large enterprise. i.e., the
period in which the return on investment starts.
vi. Local Area of Operations: The area of operations of small units is generally local as
they have less capital and less marketing facilities at their disposal. Small enterprises
generally carryout their operations so as to cater to the local & regional markets. There is
a local touch between employer and employees; and between employer and customers
though products of some small scale enterprises are exported to many countries of the
world.
vii. Market Share: - The characteristic of a small firm’s share of the market is that it is not
large enough to enable it to influence the prices of national quantities of goods sold to
any significant extent.
viii. Independence: - Independence means that the owner has control of the business
himself/herself. It, therefore, rules out those small subsidiaries which though in many
ways fairly autonomous, nevertheless have to refer to major decisions (e.g., on capital
investment) to a higher level of authority.
ix. Use of local resources: Small enterprises use indigenous resources & therefore can be
located anywhere subject to the availability of these resources like raw materials, labor,
transport Facilities etc. Using local resources, small units are decentralized & dispersed
to rural areas & smaller towns. Thus, the development of small enterprises in rural areas
& smaller towns promotes more Balanced Regional Development & thereby prevents
influx of job seekers from rural areas & smaller towns to bigger cities & urbanizing
centers.
x. More susceptible & highly reactive & receptive to socio–economic conditions. Compared
to larger enterprises, small enterprises are more flexible to adapt changes like
diversification to new products, adapting to new production techniques, substituting new
raw materials, changes in organization structure, new market, etc.

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4.1.2 Role/Importance of MSEs in Economic development
Micro and Small Enterprises (MSEs) cover a wider spectrum of industries and play an important
role in both developed and developing economies. Ethiopia is no exception and MSEs occupy a
prominent position in the development of the Ethiopian economy. Over the years, the number of
MSEs is growing from time to time and they need a strong support on Scio- economic and
political ground. Some of the contributions are hereunder.
1) Large Employment Opportunities: MSEs are generally labor-intensive. For every fixed
amount of investment, MSE sector provides employment for more persons as against few
persons in the large scale sector. Thus in a country like Ethiopia where capital is scarce and
labor is abundant, MSEs are especially important.
2) Economical Use of Capital: MSEs need relatively small amount of capital. Hence it is
suitable to a country like Ethiopia where capital is deficient.
3) Balanced Regional Development/ Removing Regional Imbalance/: Generally small
enterprises are located in village and small towns. Therefore it is possible to have a
balanced regional growth of industries. Ethiopia is a land of villages. people migrate in
large numbers to big cities. Micro and small-scale units can be located in rural and semi
urban areas to reduce regional disparities.
4) Equitable Distribution of Wealth and Decentralization of Economic Power: It removes
the drawbacks of capitalism, abnormal profiteering, concentration of wealth and economic
power in the hands of few etc. In this way, small & medium scale enterprises bring about
greater equality of income distribution. Micro and small enterprises also encourage
competitive spirit and generate the impetus to self-development.
5) Dispersal over Wide Areas- MSEs has a tendency to disperse over wider areas and they
play a key role in the industrialization of a developing country.
6) Higher Standard of Living: MSEs bring higher national income, higher purchasing power
of people in rural and semi-urban areas.
7) Mobilization of Locals Resources/Symbols of National Identity: The spreading of
industries even in small towns and villages would encourage the habit of thrift and
investment among the people of rural areas. Small scale businesses are locally owned and
controlled, and can strengthen family and other social systems and cultural traditions. They
are perceived as valuable in their own right as well as symbols of national identity.
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 8. Innovative and Productive /Simple Technology: New but simple techniques of
production can be adopted more easily by MSEs without much investment. Small
businesses are highly innovative though they do not maintain their own research and
development.
9. Less Dependence on Foreign Capital/ Export Promotion: MSEs use relatively low
proportion of imported equipment and materials. The machinery needed for these
industries can be manufactured within the country. Micro and small scale enterprises are
opening up fresh avenues in the export market in our world.
10. Promotion of Self Employment: MSEs foster individual skill and initiative and promote
self-employment particularly among the educated and professional class.
11. Protection of Environment: MSEs help to protect the environment by reducing the
problem of pollution.
12. Shorter Gestation Period: In these enterprises the time-lag between the execution of the
investment project and the start of flow of consumable goods is relatively short.
13. Facilitate Development of Large Scale Enterprises: MSEs support the development of
large enterprises by meeting their requirements of inputs of raw materials, intermediate
goods, spare parts etc. and by utilizing their output for further production.
14. Individual Tastes, Fashions, and Personalized Services: Small businesses have the
flexibility to adapt quickly to changes in the business or technological environment.
4.2. Small Business Failure and Success Factors
4.2.1. Small Business Success Factors
When large and small businesses compete directly against one another, it might seem that large
businesses would always have a better chance of winning. In reality, small businesses have
certain inherent factors that work in their favor. You will improve your chances of achieving
success in running a small business if you identify your competitive advantage, remain flexible
and innovative, cultivate a close relationship with your customers, and strive for quality.
Small businesses perform more efficiently than larger ones in several areas. For example,
although large manufacturers tend to enjoy a higher profit margin due to their economies of
scale, small businesses are often better at distribution. Most wholesale and retail businesses are
small, which serves to link large manufacturers more efficiently with millions of consumers
spread all over the world.
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Small business success factors can be seen the same as the efforts exerted in reversing the
factors of failure. There are several positive steps in addition to planning that business owners
can take to improve a firm’s chance for success.
So, by understanding why business fail, entrepreneurs can discover ways to tilt the scales
towards success. These success factors are categorized as:-
1. Conducive Environment;
2. Adequate Credit Assistance;
3. Markets and Marketing Support.
1. Conducive Environment
Successful small enterprises do not emerge, and thereafter survive and grow unless the
environment is conductive. Political, economic, technological and socio-cultural factors in the
environment impinge upon the life of the small enterprises and generate much of the needs
required for their existence.
Political Climate: - The overall political climate in a country is important for the small scale
entrepreneur to consider. Small scale entrepreneur will need positive and encouraging measures
by government and political constituencies to establish private investment. Such measures could
include liberal or nonrestrictive investment policy, creation of promotional agencies, creation of
industrial estates and free trade zones and availability of low-cost loan capital for private
investors.
The Economic Environment: - An analysis of the economic environment is particularly helpful
in investment decision, market measurement and in forecasting. The general state of the
economy dictates what the small enterprise will need especially since it is handicapped in
obtaining capital and credit owning to greater unit costs of small transactions, greater risks
involved, etc. .
Technology: - Technological advances in the environment create new needs for the small
entrepreneur as far as adaptation and adjustment is concerned.
Small scale entrepreneur needs to learn how to adjust to the new technological environment
surrounding him/her, or needs to take a set of advance technologies and bring these to his/her
own level in the small enterprise.
Socio-Cultural Environment: - Finally, the socio-cultural environment also creates a very
important climate for the survival of the enterprises.

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 2. Adequate Credit Assistance
Small enterprise development cannot be ensured without arrangement for financing. Adequate
and timely supply of credit is critical for new entrepreneurs to emerge especially from a wide
base. A great majority of micro and smalbusiness activities have come about because of special
financing programs offered to them. Thus, requirements are less strict in terms of lower interest
rates than the prevailing commercial rates; less collateral requirements and lower equity ratio;
various assistance schemes such as preparing the project study; etc.
3. Markets and Marketing Support
Market for a small enterprise in a developing country can be quite a problem. The small business
entrepreneur will be in competition not only with locally mass-produced goods but even imports.
Good habits for the success of a business
 Plan thoroughly
 Organize properly
 Find the right people
 Delegate wisely
 Inspect what you expect
 Measure what is done
 Keep people informed-share vision and ice cream-Never walk alone and create channels and
alliances
 Vision: To get where you’re going, you’ve got to have a map
 Market/demand: You can only grow as big as your market
 Strong leadership: nothing ever happens without great people.
 Business models: it’s not just what you do, it’s how you do it.
 Risk management: Those enterprises that anticipate and plan for risk often have an
easier time of adapting to unforeseen complications or problems which may arise.

4.2.2. Small Business Failure Factors

Even though business owners launch their ventures with the best of intentions and work long,
hard hours, some businesses inevitably fail. Dun & Bradstreet defines a business failure as a
business that closes as a result of either (1) actions such as bankruptcy, foreclosure, or voluntary

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withdrawal from the business with a financial loss to a creditor; or (2) a court action such as
receivership (taken over involuntarily) or reorganization (receiving protection from creditors).
Causes of Business Failure
The rates of business failure vary greatly by industry and are affected by factors such as type of
ownership, size of the business, and expertise of the owner. The causes of business failure are
many and complex; however, the most common causes are inadequate management and
financing. Although financial problems are listed as the most common cause of business failure,
consider management’s role in controlling them.
Inadequate Management: - Business management is the efficient and effective use of
resources. For small business owners, management skills are especially desirable—and often
especially difficult to obtain. Lack of experience is one of their most pressing problems. Small
business owners must be generalists; they do not have the luxury of specialized management. On
the one hand, they may not be able to afford to hire the full-time experts who could help avert
costly mistakes. On the other hand, their limited resources will not permit them to make many
mistakes and stay in business.
Lack of proper planning: One of the most common mistakes is to neglect to plan for the future
because planning seems too hard or time-consuming. Planning what you want to do with your
business, where you want it to go, and how you’re going to get there are prerequisites for a sound
business. Your plan should provide a road map for your business, showing you both the
expressways and the scenic routes and the detours.
Lack of commitment and hard work: Another common mistake is failing to understand the
commitment and hard work that are required for turning a business into a success.
Inadequate Financing: Business failure due to inadequate financing can be caused by improper
managerial control as well as shortage of capital. The other type of mistake involves with
finances. Inaccurate estimates of cash flow and capital requirements can swamp a business
quickly. Other common causes of business failure include Neglect, Fraud, and Disaster.
 Neglect occurs whenever an owner does not pay a due attention to the enterprise. The
owner who has someone else managing the business while s/he goes fishing often finds
the business failing because of neglect.
 Fraud involves intentional misrepresentation or deception. If one of the people
responsible for keeping the business’s books begins purchasing materials or goods for
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 himself or herself using the business's money, the business might find itself bankrupt
before too long.
 Disaster refers to some unforeseen happening. If a hurricane hits the area and destroys
the property in the company's yard, the loss may require the firm to declare bankruptcy.
The same is true for fires, burglaries, robberies, or extended strikes.

Specifically, the failure of a business can be caused by the following internal and external
factors:

Internal problems
o Lack of experience/expertise
o Lack of time management/insufficient commitment
o Lack of preparing business plan
o Lack of strategy and strategic leadership
o Poor financial control/failure to manage credit
o Ethical failure/fraud
o Not keeping adequate records
o Poor location for the business
o Poor knowledge of the market
o Faulty product design
External problems
 Lack of finance
 Poor infrastructure
 Economical problem
 Regulatory issues-Government policy framework
 Lack of raw material
 Lack of demand for the product/service

4.3. Problems of Small Scale Business in Ethiopia

Small-scale businesses have not been able to contribute substantially to the economic
development, particularly because of financial, production, and marketing problems. These
problems are still major handicaps to their development. Lack of adequate finance and credit,
and provision of working area are always a major problem of the Ethiopian small business.
Small scale enterprises find it difficult to get raw materials of good quality at reasonable prices in
the field of production. Furthermore, the techniques of production, which the enterprises have
adopted, are usually outdated. Because of their poor financial position they are not able to buy
new equipment, consequently their productivity suffers.