Pain Points Medium-Sized Enterprises

Part
01
of one
Part
01

Pain Points Medium-Sized Enterprises

The pain points medium-sized businesses face differ from region to region, however, difficulties accessing funds needed to finance growth is a common pain point that medium-sized businesses in all regions face. Below two (unranked) pain points for Latin America, Europe, Africa, and North America are mentioned. The COVID-19 pandemic has affected small and medium-sized enterprises (SME) in certain industries (like travel and tourism) more than others and continues to affect them and consequently unemployment rates. Governments have employed policies such as deferring taxes, loan guarantees, subsidies and others to protect this sector. Below is an overview of the findings.

Pain Points in Latin America

  • In Latin America and the Caribbean, the top 3 biggest obstacles for medium-sized enterprises are access to finance (13.3%), an inadequately educated work-force (12.6%), and the informal sector (10.8%) of which the first and the last are expanded on below.
  • Interestingly, growth in this region is said to be lagging in comparison to other emerging countries/regions in part due to the absence of a "solid tier of mid-sized companies able to create productive jobs and a robust middle class of consumers whose spending and saving could propel demand and investment."

Pain Point #1: Access to Finance

  • In Latin America and the Caribbean, 13.3% of medium-sized businesses regard access to finance as the biggest obstacle, while 24.8% regard it as a major constraint.
  • Financial institutions in this region do not have the knowledge entrepreneurs have and are therefore unable to assess the risk associated with the business venture. Consequently, their credit terms are higher than need be. "This problem is exacerbated for SMEs due to the informality and opacity of the financial and accounting information they possess, the narrow division between the personal finances of the entrepreneur and the company, and the lack of collateral that prevents them from delivering part of their assets as a method of compensating creditors in the event of non-payment."
  • World Bank data, for instance, shows that 74% of loans to medium-sized businesses require collateral and the average collateral requested is 187% of the loan amount.
  • Small and medium-sized firms are also impacted "by problems of moral hazard, as creditors cannot observe how entrepreneurs use the funds allocated." As a result, financial institutions might increase interest rates to mitigate these risks.
  • Another factor that increases the cost of a loan is the cost of evaluating, processing and monitoring the loan.
  • SMEs often have limited knowledge of the funding sources available to them, limited capacity to process information, and limited knowledge on how to effectively present a business plan to potential investors.
  • Limited access to finance has a greater impact on SMEs than on larger companies as the latter could finance their investments from internal resources when the finance market is restricted. SMEs need finances to fund their growth.
  • Some statistics on financing in Latin America and the Caribbean:
    • 40.2% of medium-sized firms use banks to finance investments, 49.1% use banks to finance working capital, and 58.4% use supplier/customer credit to finance working capital.
    • For investments, 50.4% of the amount is financed internally and 25.8% is financed by banks.
    • For working capital, 18.6% of the amount is financed by banks.
  • In Argentina, 8.2% of medium-sized firms say access to finance is their greatest obstacle and 34.2% find it to be a major constraint, which is significantly higher than small firms (4.2% vs 19.8%) and large firms (1.7% vs 13.7%). When collateral is needed for a loan in the country, it is often 232.7% of the loan amount. Yet, medium-sized firms in Argentina find labor regulations (13.8%) and tax rates (39.2%) even greater obstacles to their growth.
  • In Ecuador, 7.3% of medium-sized firms say this is their biggest obstacle and 10.6% see it as a major constraint, which is lower than small (10.9%) and large firms (18.4%). When collateral is needed, which is in 75.5% of all loans, the amount of the collateral is 203.8%. Medium-sized firms see political instability (27.4%) and the informal sector (18.8%) as their biggest obstacle.

Pain Point #2: The Informal Sector

  • In Latin America and the Caribbean, 10.8% of medium-sized businesses see the informal sector as their biggest obstacle while 29% see it as a major constraint. This is lower in comparison to small firms (13.5% vs 33.1%) and large firms (12.2% vs 28.1%).
  • There is no consensus on what the informal economy (sector) means but regulations are often used "to define the informal sector activities." The International Labor Office has used "informality as the avoidance of government regulations and taxes with the aim to provide a way for families to subsist."
  • 58.9% of medium-sized firms in Latin America and the Caribbean say they are competing against the informal sector. The competition against this sector is "a concern in markets where formal and informal firms effectively compete. In these markets, informal firms gain a competitive advantage over formal firms by not complying with regulations or tax obligations."
  • Because informal firms do not comply with regulations and tax obligations, they are able to reduce their supply costs. Formal firms are unable to offer competitive prices and therefore unable to invest and grow.
  • According to recent economic literature (2018), this type of competition is only possible under certain conditions: there must be a presence of "small and medium-sized companies, low productivity levels, credit constraints and low fixed costs."
  • In Latin America, informal workers are predominantly concentrated in sectors such as retail, construction and agriculture.
  • In Bolivia, 21.5% of mid-sized firms see the informal sector as their biggest obstacle and 57.2% see it as a major constraint. This is slightly lower than small firms (24.5%) but significantly higher than with large firms (5.8%). Here, 73.5% of medium-sized firms say they are competing against the informal sector.
  • In Columbia, 17.3% of medium-sized firms say the informal sector is their biggest obstacle and 41.1% see it as a major constraint. This is higher for small firms (24.3%) and lower for large firms (13.7%). In this country, 59% of medium-sized firms say they are competing against informal firms.

Pain Points in Europe

  • In general, European SMEs believe they are in good shape, experiencing robust revenue growth and favorable financing conditions," are reasonably competitive, have high-quality products, and have a comprehensive customer service. Only 10% of SMEs experience significant difficulties in accessing external finance.
  • Their main concerns lie in the area of taxes and regulations and digitalization to expand their competitiveness.

Pain Point #1: Taxes and Regulations

  • European SMEs say taxes and charges, regulations, and bureaucracy, continue to be major pain points and find it is hampering their ability to be (internationally) competitive. In a European survey, France, Germany, Poland, Spain, and the UK said it strongly affected them. From the World Bank Enterprise Survey, Portugal (63.4%), Greece (40.3%), Hungary (26.9%), Italy (20%), Croatia (47.8%) are among those countries that say tax rates are their biggest obstacle.
  • The European Union (EU) acknowledges that SMEs have difficulties surrounding tax matters such as indirect taxes (VAT), direct taxation (income, capital, double taxation, among others), tax compliance costs, and also the burden that comes with tax administration.
  • The most recent study the EU has conducted on taxation is from 2015 and some of its key findings are that most countries treat large enterprises more beneficially than SMEs when it comes to the burden of tax paid; in comparison to R&D tax incentives, SME tax incentives are not as regularly implemented; the majority of SME tax incentives benefit micro and small enterprises; a great pain point for SMEs is the high compliance burden for taxes.
  • With regard to the last key finding of the 2015 study, a more recent study conducted by the EU showed that the compliance burden is higher for micro-sized enterprises (2.6%) and small-sized enterprises (1.4%). For large-sized enterprises (0.7%) it is lower and for medium-sized enterprises, it is the lowest (0.3%).
  • With regard to regulations, the regulatory complexity is especially challenging for SMEs. Because the number of national technical regulations keeps increasing, it becomes challenging for SMEs to expand across Europe. Because regulations on a European level overlap, SMEs often do not know which rules are applicable to them.
  • The legislation also has not kept up with changes in society such as the blurring line between goods and services. Also, the bureaucratic procedures do not keep the end-user in mind.
  • In Greece, 29.4% of medium-sized firms see tax rates as their biggest obstacle, while 75.4% see it as a major constraint. Interestingly, these numbers are higher for small firms (43% vs 88.7%) and large firms (51% vs 85.1%).
  • In Greece, 2.7% of medium-sized firms see tax administration as their biggest obstacle but 52.9% agree it is a major constraint. Again, these numbers are higher for small firms (6.4% vs 65.7%) and large firms (4.3% vs 75.9%).
  • In Portugal, 56.1% of medium-sized firms see tax rates as their biggest obstacle, while 84.8% see it as a major constraint. As in Greece, these numbers are higher for small firms (65.5% vs 89.9%) and large firms (68.1% vs 82.1%).
  • In Portugal, 11.2% of medium-sized firms see tax administration as their biggest obstacle but 32.8% agree it is a major constraint. For small firms (14.1% vs 53.6%) these numbers are higher and for large firms (4% vs 13.5%) they are lower.

Pain Point #2: Shortage of Skills

  • For Europe, "digitalization is of strategic importance for many European SMEs. More than one in two consider the adoption of new technologies to be necessary in order to secure their own competitiveness." 76% of European SMEs see it as a priority.
  • According to an OECD study, "businesses which are frontier firms in digitalization see higher revenue and productivity compared to less digitally inclined firms in the long run." Access to information decreases the cost of search and distribution, e-commerce makes it possible for firms to reach distant customers.
  • In this area, pain points for European SMEs are that their employees have insufficient digital skills. They also find that it is difficult to recruit IT specialists because they are in short supply on the external labor market.
  • 27% of SMEs regard not having the right skills in place to "implement and benefit from the adoption of new technology" as a severe or major obstacle. The top four digital skills that SMEs say are lacking are software development skills (41%), complex data analysis and mathematical skills (35%), digital strategy and leadership skills (33%), and digital project management skills (31%). The latter two "are crucial for the initiation of the digitalization process and the successful adaptation of new technologies."
  • With regard to recruiting employees with advanced digital skills, SMEs face two obstacles. The first is that there is a shortage of applicants with these skills (46% of SMEs report this). The second is that the high demand for these skills increases salary expectations among applicants (42% of SMEs report this).
  • In France, 28% of SMEs say their employees have insufficient digital skills and 23% say there is a shortage of IT specialists on the external labor market. The top 3 digital skills SMEs lack are digital strategy and leadership skills (31%), software development skills (30%), and complex data analysis and mathematical skills (35%), and digital strategy and leadership skills (29%).
  • In Poland, 27% of SMEs say there is a digital skill gap 25% say there is a shortage of IT specialists on the external labor market. The top 3 digital skills missing are software development skills (49%), complex data analysis and mathematical skills (34%), and website development skills (34%).

Pain Points in Africa

  • In Sub-Saharan Africa, access to capital (22.4%), electricity (13.3%), and the informal sector (10.5%) are the biggest obstacles for businesses. The first and second pain points are expanded on below.

Pain Point #1: Access to Capital

  • In Africa, 40% of small and medium enterprises (SME) say that access to finance is the greatest factor limiting their growth. The funding gap in Africa for SMEs is estimated to be $421 billion. This is a problem because these enterprises need finances to fund their growth.
  • According to the International Finance Corporation, approximately 33% of micro, small and medium-sized enterprises (MSMEs) in North Africa and 50% in Sub-Saharan Africa are unable to realize their credit requirement or can only partially do so.
  • These enterprises have traditionally depended on short-term debt and have, therefore, have been excessively dependent on the banking sector (bank loans and high-yield debt). Often there is a lack of awareness of the financing options (such as micro finance angel investments, venture capital, private equity, and listing on growth segments of local exchanges) available to SMEs to support their growth consequently leaving domestic equity markets underdeveloped.
  • Some problems surrounding access to credit are "high transaction costs, information asymmetries between enterprises and banks, high-risk premiums and stringent collateral requirements. These factors play a particular role for enterprises with a limited credit history or reduced collateral."
  • Another factor is the "onerous credit checks from foreign banks" which prevent SMEs from participating. SMEs often do not have the track record and meaningful data inputs to satisfy the complex scoring models that foreign banks use.
  • According to World Bank data, in Egypt, 9.7% of medium-sized businesses say that access to credit is their biggest obstacle, which is slightly higher than for large businesses (9.6%) and small businesses (8.1%). The factors that score higher for Egyptian medium-sized businesses as obstacles are tax rates (23.9%) and political instability (18.2%).
  • In Mozambique, 20.2% of medium-sized firms say that access to credit is their biggest obstacle. This is significantly higher than for large firms (8.2%) and small firms (13.7%). Only corruption (21.2%) is seen as a bigger obstacle.

Pain Point #2: Lack of Electricity

  • Another major obstacle for enterprises in both Sub-Saharan Africa (13.3% choose this as the biggest obstacle) and North Africa (11.8% choose this as the biggest obstacle) is electricity. In Sub-Saharan Africa, 45.1% of medium-sized businesses regard electricity as a major constraint, while this is 37.7% for the Middle East and North Africa.
  • According to the World Bank, in 2018, 47.66% of the population had access to electricity in Sub-Saharan Africa of which 78% of the urban population had access and just 31.5% of the rural population had access.
  • In Sub-Saharan Africa, power outages are a frequent occurrence and 75.6% of firms say they experience electrical outages. Typically, per month, there are on average 8.5 power outages with an average duration of 6.5 hours per outage. Medium-sized firms lose on average 7.6% of their annual sales due to these outages.
  • In the Middle East and North Africa, the impact of electrical outages is lower. Here, 39.4% of firms experience electrical outages. Per month there are on average 9.1 outages which last for an average of 9.9 hours and lead to an average loss of 4.1% in annual sales.
  • To cope, 64.9% of medium-sized businesses in Sub-Saharan Africa own or share a generator but the average proportion of electricity received from a generator is 26.7%. For the Middle East and North Africa, 45.6% of medium-sized businesses own or share a generator and receive 29% of their electricity from it.
  • Besides electrical outages, upon application, it takes on average 36.1 days to obtain an electrical connection in Sub-Saharan Africa and 101 days in the Middle East and North Africa.
  • For the Gambia, these numbers are higher. Here 93.2% of firms experience electrical outages. Per month, there are on average 21.1 power outages with an average duration of 5.8 hours per outage. The average loss in sales for medium-sized firms is 14.7% of their annual sales, which is slightly higher than for small (14%) and large firms (14.2%).
  • For Egypt, the numbers are lower. Here 25.3% of firms experience electrical outages. Per month, there are on average 0.7 power outages with an average duration of 1.2 hours per outage. The average loss in sales for medium-sized firms is 0.2% of their annual sales, which is the same for small firms but slightly higher for large firms (0.4%).

Pain Points North America

Pain Point #1: Cyber Attacks and Data Breaches

  • US SMEs are focused on "profit margin growth (62%), revenue growth (57%), and building a company’s reputation (41%)." To achieve this, SMEs plan to increase productivity and operational efficiency, among others, by adopting technologies such as machine learning, smart algorithms, and artificial intelligence technologies.
  • Canadian SMEs also want to utilize technology to increase their bottom line as "40% of SMEs agree using technologies to redesign products and services is important for revenue growth. Likewise, just under two-thirds (62 percent) say digital technology provides them with new business opportunities."
  • One of the major concerns of SMEs surrounding the use of digital tools to increase productivity and efficiency is privacy and security. Approximately 31% of US SMEs say this is one of their biggest barriers to using digital tools. According to another survey globally (which includes the US and Canada), concern about cyber and data security among SMEs has increased from 7% in 2017 to 29% in 2018 (this figure coincides with the figure presented in the Deloitte report).
  • Security concerns include: "security breaches or attacks at service providers of digital tools, lack of data privacy policy or privacy service agreement, fraudsters using apps, exposure of personal identifiable information, weak authentication protocols, lack of control of where the sensitive, information is located, and data quality and privacy violations."
  • According to the Ponemon Institute, 61% of SMEs have experienced cyberattacks and 54% have experienced data breaches. Cyber attacks can cost from "an average of $2,157 for a ransomware to more than $1,000,000 for more damaging, sophisticated cyber-attacks."
  • In Canada, 18% of businesses have been the victim of a cyberattack or data breach between 2017 and 2019 of which 37% say the attack cost more than $100,000. 50% of small business owners "believe that their business may be vulnerable to a cybersecurity attack, and 56% stated that they’re concerned about how a breach could affect their business."

Pain Point #2: Access to Finance

  • According to the TMF Group, small businesses in Canada have problems accessing finance and "inadequate infrastructure to expedite their growth and cash on future opportunities. Government initiatives are not very prominent, although there are initiatives in place. Some companies are unable to find the initial $500K or $1m of investment needed, whereas some struggle with securing investment to accelerate market growth."
  • Mentor Works points out that 21% of Canadian SMEs experience challenges when trying to secure funding.
  • In the US, 18% of medium-sized firms experience challenges when accessing credit.
  • When applying for a loan with a bank in the US, SMEs have to wait long for a credit decision or funding and they face a difficult application process. When applying for a loan with an online lender, they face high interest rates (53%) and unfavorable payment terms (32%).
  • When applying for credit in the US, 22% of SMEs are fully rejected, 19% receive some of the funding (1-50%), and 13% receive most of the funding (51-99%). The rejection rate is higher for smaller firms and decreases with medium-sized firms. Rejections occur because "lenders have [difficulties] in judging smaller businesses’ credit risk, due to a combination of the lack of publicly available information, insufficient credit histories for younger firms, and their lack, of assets to offer as collateral."
  • Finances in the US are sought to expand the business, pursue new opportunities, acquire business assets (56%), meet operating expenses (44%), refinance (27%), replace capital assets or make repairs (20%), or other reasons (5%).

COVID-19 Effect on SMEs

  • The COVID-19 pandemic has impacted SMEs on both the supply and demand side. Though empirical evidence in this stage is limited, below the impact of the pandemic on SMEs is provided.

Supply Side

  • As a result of the pandemic, SMEs do not have full access to labor or cannot fully utilize them because workers are sick, need to look after their children or other people dependent on them, or due to lockdown or quarantine measures.
  • Companies have responded by introducing or increasing teleworking. In the US, over April-May, there has been an increase (from 12% to 20%) of small businesses transitioning their employees to teleworking. In Germany, at the beginning of the pandemic "88% of German SMEs operated with mandatory in-person work, 81% expect that the pandemic will make their companies more flexible and one-third of SMEs esteems digitalization has grown in importance due to the pandemic."
  • Not all SMEs are able to act correspondingly. In Europe, only 56% of companies "with 50 or fewer employees provided remote access to email, applications, and documents for their employees." The Organization for Economic Cooperation and Development (OECD) mentions that the cost of teleworking may be higher for SMEs and there may be low levels of digitalization and problems accessing and adopting technologies. In Japan, only 10-20% of SMEs are able to resort to teleworking as there is a lack of infrastructure and a lack of knowledge in using digital tools among workers.
  • Supply chains have been interrupted and consequently, there is a shortage of parts and intermediate goods. When SMEs rely on suppliers from COVID-19 affected countries or regions they are more vulnerable. This is also the case when "business networks and supply chains, with connections with larger operators (e.g. MNEs) and the outsourcing of many business services critical to their performance" are disrupted. Obstacles in transportation by sea, road, or air also affect these enterprises.

Demand Side

  • The sudden reduction or loss of demand and revenue affects SMEs ability to function and cause liquidity shortages. On top of that the reduction in consumer spending due to a loss of income (as a result of being laid off or an inability of firms to pay salaries), "fear of contagion, and heightened uncertainty" add to the impact on SMEs.
  • The effect of these developments is more pronounced on SMEs because they are more vulnerable and have lower resilience due to their size. A study of SMEs in the US "suggests that 50% of small businesses are operating with fewer than 15 days in buffer cash."

Impact Based on Surveys

  • In Canada, in March, SMEs experienced a 50% drop in sales, and 25% - 33% of SMEs did not expect to survive longer than 1 month. In April, 90% of businesses in Canada and the US were affected and 33% did not have sufficient reserves to last more than a few weeks. In May, in the US, 20% of businesses temporarily shutdown and 33% expected to close down permanently within 2 months while in Canada 81% of SMEs were negatively affected, and 32% worried about their viability over the next year.
  • In Korea, in March, 61% of businesses were impacted and 42% feared they would be out of business in 3 months and 70% in six months. In Japan, in March, 39% of SMEs reported supply chain disruptions while 26% experienced a decrease in orders and sales. At the beginning of April in several Asian countries, 30% of SMEs expected to fire 50% of their employees and 50% had up to a month cash reserve.
  • In Belgium, in March, 75% of SMEs reported declines in turnover and 50% feared not to be able to pay costs in the short term. In April, in the UK, 37% of SMEs expected to furlough 75-100% of their staff within a week, 6% were out of cash, and 57% had three months reserves or less. In May, in the UK, 37% of firms were considering or had already made redundancies, 41% of firms had temporarily closed, 35% feared they would not reopen again.

Forecasts on Impact

  • In the US, McKinsey estimates that "between 1.4 million and 2.1 million US small businesses could close permanently as a result of the first four months of the pandemic." The image below shows which industries will be more affected.

Government Response

  • Globally, governments have responded through policies on labor; by deferring tax, debt moratorium, and social security and pension moratorium; through financial instruments such as loans, loan guarantees, grants and subsidies; and structural policies.
  • Policies on labor were directed at (partial) redundancies, wage subsidies, and the self-employed. Governments "put measures in place to contribute to wage payments for employees temporarily out of work or on sick leave."
  • Countries have deferred taxes, debt moratorium, and social security and pension moratorium to "enable SMEs to postpone payments, in order to avoid further eroding their liquidity."
  • Structural policies were aimed at finding new markets, speeding up teleworking and digitalization, innovation and training and redeployment. These policies are meant to "address urgent short-term challenges but also contribute to strengthening the resilience of SMEs in a more structural way and support their further growth."

Government Response Columbia

  • Columbia has employed 2 financial instruments (among other measures): loan guarantees and direct lending to SMEs.
  • On April 6, "the government announced the creation of a new COP12 trillion special guarantees program to mitigate the impact of COVID-19 on the business sector. Through this program, the government will guarantee small business loans serving liquidity requirements to pay for personnel and fixed costs." The government also provided financial relief to SMEs that were struggling with their credit in the next 2 months and a line of guarantees so enabling SMEs to pay for salaries.
  • On 9 April, "the government announced a line of loan guarantees" to pay for 3 months of salaries of MSMEs to a max of 5 minimum wages, under the condition that no worker was laid off.
  • On 16 April, the government announced the National Guarantees Fund (FNG) would provide loan guarantees for MSMEs to pay for working capital and payroll costs.

Government Response Malaysia

  • In Malaysia, "new financing facilities for SMEs have been set up by banks, in addition to a decrease in the policy rate."
  • On March 24, Malaysia’s Central bank announced "it requested a 6-month moratorium of all bank loans affected by the outbreak, except credit card balances."
  • On March 27, there was a second round of support measures of which 40% of the total stimulus of USD 57 billion, was meant for (small) business. "Bank Negara Malaysia (BNM) has issued a directive to all banks to grant an automatic six-months moratorium of all loan/financing repayments effective from April 1, to September 30, 2020. During this period, borrowers/customers with loan/financing that meet the conditions do not need to make any repayment, and no late payment charges or penalties will be imposed."
  • As part of the country's digital strategy, it had set up the Malaysia Digital Economy Corporation. This corporation "offers an extensive list of digital solutions for SMEs by Malaysian tech companies."

Sources
Sources