Why most small businesses face stunted growth

Poor capital investment among micro small and medium enterprises (MSMEs) and their reluctance to do business with the government are among the reasons that stunt their growth.

The latest Kenya Economic Report (KER) published by a State-backed think tank also revealed that MSMEs do not trade with larger corporations whose scale is larger hence more profits.

Additionally, these businesses operate largely informally without any contractual arrangement which has been noted to cause instability in their operations.

The report by the Kenya Institute for Public Policy Research and Analysis (Kippra) notes that these small businesses are key to the economy, especially in the wholesale and retail sectors, and their role in facilitating operations in larger corporations.

The study underscores the importance of these enterprises in President William Ruto’s Bottom-up Economic Transformational Agenda (BETA).

Kippra executive director Dr Rose Ngugi says the failure of MSEs  trading with the government denies them a ready market.

“If you look at MSEs and who they are trading with, it is individuals or among themselves. Very little goes on with the government and medium and large enterprises,” she said during the report’s launch.

The government, under the Access to Government Procurement Opportunities (AGPO), gives priority to businesses held by persons with disability, youth, and women.

A majority of these businesses are small enterprises. They are entitled to 30 per cent of government tenders.

However, according to the report, which references the Kenya National Bureau of Statistics (KNBS) 2016 MSME Survey, just 0.26 per cent of micro enterprises transact with the government. This figure is 1.82 per cent for small enterprises and 2.78 per cent for medium enterprises.

The report notes that this low uptake suggests that there is a significant opportunity for MSMEs to increase their sales by engaging more with the government process.

“The wholesale and retail trade sector is dominated by MSMEs, most of them operating informally. This tends to limit their access to government support and procurement services such as AGPO, which provides a ready market,” the report says.

The report says 87 per cent of MSMEs sell directly to individual consumers.

“What is the benefit of trading with medium and large enterprises? It is the fact that you can have some even technology transfers. What is the benefit of trading with the government? It is that you have a ready market. You produce and you know that there is a ready market through AGPO,” said Dr Ngugi.

Another advantage as detailed in the report is that MSMEs engaging with government procurement demonstrate higher productivity levels than those selling to individual consumers.

“This reflects the requirements they need to fulfill in making delivery under AGPO. However, challenges such as pending bills, bureaucratic processes, and limited access to financing still limit these engagements,” the report says.

Productivity also increases with an injection of capital investment. According to the report, there is low injection of capital in micro-enterprises. Capital injection, Kippra says in the report, improves labour productivity.

The report shows medium-sized firms have higher capital investment per worker compared to small and micro-sized at Sh295,879, Sh169,563, and Sh56,756 respectively.

“Financial investment in small-sized firms enhances labour productivity by 15.8 per cent, thus these firms experience higher improvements in labour productivity when there is an increase in capital per worker. Small firms are more labour-intensive compared to micro firms, thus more startup capital investment per worker is critical in enhancing labour productivity,” the report says.

In micro firms, the report adds, an increase in financial capital investment increases productivity by 9.1 per cent while increased capital per worker has gains on labour productivity, but to a lesser extent than in small-sized firms.

“This is because micro-enterprises have inadequate intangible capital investments, which include investments in research for development, training, and organisational capital, essential for enhancing labour productivity and competitiveness,” the report explains.

According to the report, MSMEs are integral to the wholesale and retail trade sector, facilitating the distribution and exchange of goods within local communities and across regions.

They also serve as key drivers of economic activity, leveraging their proximity to consumers to meet diverse market demands.

“MSMEs largely engage in trade with each other, with 13 per cent trading with each other and fostering a network of intra-MSME transactions that support local economies and promote entrepreneurship,” the report says.

The study also links contractual arrangements to productivity listing as well cost management, predictability, optimisation of supply chain, resource allocation and enhancement of quality and consistency as the other advantages.

“These benefits collectively contribute to improved productivity within the firm,” the report says.

Contractual arrangements

It is also documented that non-MSMEs, including larger businesses, are also involved in contractual arrangements with MSMEs but this relationship is largely dominated by

“Middlemen play a role in facilitating contractual arrangements for MSMEs. About 4.3 per cent of micro-enterprises, 5.9 per cent of small enterprises, and 12.5 per cent of medium enterprises receive inputs or orders through formal contracts with middlemen,” the report says.

The report says the presence of input contracts has a significant impact on productivity levels, stating that firms with input contracts have higher productivity.

“This suggests that the use of input contracts plays a crucial role in enhancing productivity within firms. Structured agreements are important in enhancing operational efficiency and output levels within businesses,” the report says.

Kippra says that firms with contractual arrangements with government entities have the highest productivity at 74,732.34 while firms with no contractual arrangements have lower productivity levels of 19,083.84.

“These findings highlight the importance of contractual arrangements in enhancing productivity across different types of entities, emphasizing the role of structured agreements in driving efficiency and output levels within various sectors,” the report says.