By Samuel Olufemi Adebiyi (BDS Advisor, EDC, Lagos)
There is no uniform definition of what business failure (BF) is. Bizdic.com defines BF as closure or cessation of activity that results in a loss to its creditors. This means that firms that stop working due to lack of sales or profit, or retirement/death of its principal without leaving any liabilities cannot be classified as a failure. This definition is slightly different from Wikipedia’s, which sees BF as cessation of operations following a firm’s inability to make profit or bring in enough revenue to cover its expenses. In other words, a business can be considered as failed when it has run out of cash. QFinance defines BF simply as an organisation that has gone bankrupt or out of business.
From these definitions, it is obvious that lack of profitability alone is not a necessary and sufficient basis to declare a business as failed. Furthermore, it must be borne in mind that any business, regardless of size can fail. The question then arises: why the strong emphasis on, or interest in small business failures? The answer probably lies in the relative ease of entry and exit as well as the strong potentials of small businesses to simultaneously and significantly contribute to economic growth, employment generation, and poverty alleviation. Before the recent global economic slow (or melt) down, there has been general apprehension about rapid economic growth and simultaneous increase in poverty in many less developed countries, and the general consensus is that a robust small business sector is all that is needed to halt this disturbing trend.
In this paper, the historical importance of small businesses is further underlined. This is followed by a synoptic presentation on various reasons why small businesses fail. The peculiarities as well as the impact of the Nigerian operating environment on the performance of small businesses are also further scrutinised before proposing possible options to redress the incidence of failures. The paper is concluded with possible policy implications for the EDC’s operations and/or activities.
II.The Importance of Small Businesses
Micro, small and medium enterprises (MSMEs), otherwise simply called small (as opposed to large) businesses are generally referred as the engine of growth in many economies. Their importance is usually viewed from the perspective of employment generation, contributions to export earnings and Gross Domestic Product (GDP). In industrialized countries, SMEs are major contributors to private sector employment. Empirical studies have shown that SMEs contribute to over 55% of GDP and over 65% of total employment in high income countries. SMEs and informal enterprises, account for over 60% of GDP and over 70% of total employment in low income countries, while they contribute about 70% of GDP and 95% of total employment in middle income countries (OECD, 2004). Table I presents some more country-specific statistics, which underlined this commonly reported importance of small businesses in many countries.
Table I: Importance of SMEs
Source: International Centre for Entrepreneurship and Career Development, India & NBS – Nigeria
(Apart from employment, Nigerian statistics are clearly out of trend relative to the other countries listed in the table. This will be further elaborated upon later in the fourth part of this paper.)
However, beyond these three parameters, small businesses are also noted, both theoretically and empirically, for overall total factor productivity (or efficiency, as usually defined) in an economy and distributional equality by virtue of its pattern of technology choice. Small businesses tend to use medium-sophistication technology, which is approximately consistent with the factor endowment ratios in most developing countries. For example, the most successful developing country over the last 50 years, Taiwan, is built on a dynamic SME sector. This has produced both (for its time) record breaking growth and a quite low level of inequality, by comparative standards. The experience of Korea, Taiwan’s partner among the Asian Tigers and a more or less equally fast grower, has provided the laboratory to illustrate another point—inequality can fall significantly when the weight of the SME sector rises quickly, as it did for a period after the mid-1970s in Korea (Asian Development Bank; 2004). Furthermore, and according to the United Nations Industrial Development Organization UNIDO, integration of developing countries into the global economy through economic liberalization, deregulation, and democratization is seen as the paramount way to triumph over poverty and inequality. Important to this process, however, is the development of an animated private sector, in which small and medium enterprises play a central role. In countries where attention is paid to developing small businesses along the value chain, SMEs also make significant contribution in the transition of agriculture-led economies to industrialised ones, furnishing plain opportunities for processing activities which can generate sustainable source of revenue and enhance the development process. Small businesses are also known in some cases to help in absorbing productive resources at all levels of the economy and add to the formation of flexible economic systems in which small and large firms are interlinked. Such linkages are very crucial for the attraction of foreign investment since investing transnational corporations normally look for sound domestic suppliers for their supply chains. (Regrettably, this does not currently obtain in Nigeria.)
Qimiao Fan of the World Bank (2003) described SMEs as a major source of technological innovation and new products, adding that those with high turnover and adaptability play a major role in removing regional and sector imbalances in economies. Their large number creates competitive market pressure, while they also play essential role as sub-contractors in the down-sizing, privatisation and restructuring of large enterprises. Because they are at times the only source of employment in poor regions and rural areas, thereby contributing to the generation of income, small businesses play important poverty reduction roles in most developing countries. Finally, the point must also be made that small businesses are like a nursery field since most of the current large enterprises have their origin in SMEs.
Given their importance, it becomes quite plausible to see and appreciate why considerable attention is paid to investigating why small businesses fail and what support policies are required to minimise this fatality.
III.Why Small Businesses Fail
There is a huge and continuously growing literature on this subject. Michael Gerber (Mar.2007) listed ten reasons why most businesses fail. These are lack of management systems; lack of vision, purpose, or principles; lack of financial planning and review; over-dependence on specific individuals in the business and poor market segmentation and/or strategy. Others are failure to establish and/or communicate company goals; competition or lack of market knowledge; inadequate capitalization; absence of a standard-quality programme; and owners concentrating on the technical, rather than the strategic, work at hand. All the ten factors are quite evident among Nigeria’s small businesses.
From a special study on why small businesses fail, Janis Pettit (2004) discovered five major factors why more than half of small businesses fail within the first four years. These factors, which are not remarkably different from those on Michael Gerber’s list are under-capitalization/inadequate sales; lack of a big vision, lack of a clear plan; lack of focus and lack of expertise. Janis particularly stressed the word ‘Big’ in the visioning process and ‘Clear’ in the planning process. Many people get it wrong at this stage, confusing ‘Big Vision’ with ‘Starting Big’; and ‘Clear Business Plan’ with ‘Bogus Business Plan’. Many small businesses fail because of fundamental shortcomings in their business planning, which ought to be realistic and based on accurate and current information as well as educated projections for the future.
In addition to poor management, capital inadequacy and lack of a clear business plan which had already been mentioned, Patricia Schaefer (2006) identified starting a business for wrong reasons, locating the business wrongly, over-expansion and lack of website as killers of small businesses. She said those who start small businesses solely to make a lot of money, to have time for family, or to avoid answering to anyone may find the businesses coming to grief sooner than later. Instead, she said considerations such as passion, physical fitness/mental stamina to withstand challenges, positive attitude, strong drive/determination, using failure as a learning process, honesty/integrity, and consideration for others are far more important factors. In the words of Patricia, “A successful manager is also a good leader when he creates a work climate that encourages productivity. He or she has a skill at hiring competent people, training them and is able to delegate. A good leader is also skilled at strategic thinking, able to make a vision a reality, and able to confront change, make transitions, and envision new possibilities for the future.”
Quoting from the independent works of Michael Ames and Gustav Berle, the United Small Business Administration (SBA) listed factors such as lack of experience, insufficient capital (money), poor location, poor inventory management, over-investment in fixed assets, poor credit arrangements, personal use of business funds, unexpected growth, competition and low sales as the factors making over 50% of small businesses in the USA fail in the first five years.
At the risk of repetition, albeit undue emphasis, extracts from the work of Shaila Rao (2009), who blogs at p2w2(People-to-Work-With)), on why small businesses fail are also worthy of consideration. The absence of a viable market for the product/service, poor capital structure/cash flow crunch, lack of marketing expertise, poor management and being out of touch with customers are, in Shaila’s view, the greatest small business killers. No product/service is worth its while if no one is willing to pay for it or found reasons to buy from a small business as opposed to a corporate giant producing a substitute. Until a business offers something that the customer values (technically called ‘value proposition’), chances of survival are quite slim. On the issue of funding, it is fairly common for small business owners to take up too much debt or underestimate capital required to reach cash flow breakeven, causing many promising ventures to shut down prematurely. Therefore, unless a small business promoter is conservative with his financial projections and be sure to have adequate funds (or personal savings) to cover all the sunk costs, there will be a great chance of early mortality.
Approaching the issue of business failure from what looks like a maverick approach, James M Hussey (Ezine Articles, 2010) says small businesses do not fail for lack of money, fierce economic competition or because of the nature of the operating economy. They fail because the owners think they're good at what they do, forgetting that there are others doing exactly the same thing. Hussey says he “understands that there's more to work than simply closing deals and building your client list...but not much more! Sure, you need to invest your time and money into fulfilling your customers' orders, you need to actually do the work you set out to do per the contract language, you need to make sure you're delivering the best customer service you can, you need to make sure your price and the value of the service and goods you're offering makes sense...but besides that: if you are in business, you're in sales. You're in marketing.”In other words,and as far as Hussey is concerned,the failure of most small businesses can be attributed mainly to weak sales and marketing techniques.
In a very recent work, Susan Ward (2010) said small businesses fail because those who start them fail to:
·do the market research to find out if there's any genuine market for their product and/or services,
·bother to get the money sorted out before they start the business
·choose a feasible business model
·plan for growth or what happens if the new business is a success; and
·plan an exit strategy
Susan’s last point is clearly additional to what has been thrown up earlier. Indeed, so many small business promoters work hard creating small businesses and building them into successful enterprises, but many of these same people have no plan for what will happen to their successful small business when they're done. Since many small businesses are dependent on one person's talents and personality, then the need for an explicit plan, which goes beyond wishful thinking, is necessary to avoid failure at the exit of the pioneer promoter.
Alyice Edrich (2003) came up with twenty five basic reasons why small businesses fail. Some of these, which had not gotten any mention in this presentation include fear, procrastination, choosing quantity over quality (or cutting corners), poor follow-ups, wrong spending pattern (too little or too much), cockiness (pride and arrogance) and blame shifting/incessant excuses.
Finally, it can be deduced from the work of Qimiao Fan (2003) that small businesses have some inherent disadvantageous characteristics that will require that they be provided with public supports. Such characteristics, apart from limited managerial capabilities, include lack of economies of scale, lack of collective voice and influence on policy, frequent cases of market failures and their biases against small businesses, weak financial capacity to undertake R&D or procure other costly support services such as Business Development Services (BDS), and huge knowledge gaps (most small business promoters don’t know what they need to know but which they don’t know). When these public supports are not available, chances of failure can be very strong.
IV.Some Peculiar Small Business Challenges and Failure in Nigeria
The findings of Qimiao in the last paragraph quite aptly describe the circumstances surrounding the failures as well as dismal performance of small businesses in Nigeria. However, as we found in Table I, small businesses in Nigeria lag behind their counterparts in other countries in terms of productivity and in terms of contributions to aggregate economic growth. As a matter of fact, their contribution to export earnings is negligible, relative to other countries, which implies that there must be additional, albeit country-specific reasons or factors militating against the survival of small businesses in Nigeria.
First is the predominance of ‘necessity’ entrepreneurs over ‘opportunity’ entrepreneurs. A necessity entrepreneur is that promoter who starts a business because he needs to ‘do something’ rather than stay idle, whereas an opportunity entrepreneur embarks on a business to take advantage of identified market opportunities. Whereas a necessity entrepreneur will buckle and fall (albeit fail) at the slightest threat, an opportunity entrepreneur will always be concerned about how to maintain or expand market share. The absence of a well thought-out programme of converting necessity to opportunity entrepreneurs in Nigeria is one of the reasons for poorer small business performance (and therefore possible higher failure rate) in Nigeria.
Closely related to this first point is the distorted and corrupted value system in Nigeria. In a normal business cycle, there will be an initial gestation period, when no income accrues. This will be followed by the commencement of inflow, which may fall below outflow (or expenses) until the break-even point is reached. Then profit will start to grow on an incremental basis until the growing business matures. Where the entrepreneur is constantly innovating, the point of maturity may be delayed or prolonged. Along the way, the entrepreneur is called to bear some pains or face some challenges. While the serious ones will, with determination and perseverance, weather the storm, the ‘flight-by-the-night’ ones will exit into ‘quick-fix’ options, leading to the death of the original business. This is one major reason for small business failure in Nigeria – the tendency to run businesses half-heartedly because there are other fast, alternative, means of ‘making money’. A corrupt value system, coupled with weak operating capacity in terms of skills, knowledge and right attitude, constitute major killers of small businesses in Nigeria.
The third major point is the dismal state of infrastructure, with particular reference to power supply, transportation and workspace. The available power supply is too low, and its transmission and distribution dismal. Table II brings Nigeria in sharp contrast with other countries.
Table II: Comparative Analysis of Consumption of Electricity in Selected Countries
Source: E..E. Okafor (2008)
Since most small businesses are too weak to provide alternative power source, the epileptic electricity supply situation in Nigeria has drastically reduced capacity utilisation, causing (in addition) damage/loss of equipments and ultimately total demise of many small businesses. For the few that have continued to weather the power storm, their high cost of production has resulted in loss of product price competitiveness. Generally speaking, Nigeria is known as a high cost origin and this explains why the country is not doing well in the export market – be it of goods or services. According to a 2005 MAN (Manufacturers Association of Nigeria) Survey report, the generation of power by its members was responsible for 36 per cent of production cost. As a result of this, 10 per cent of its members was operating at 48.8 per cent, 60 per cent at varying stages of coma while 30 per cent had completely closed down. If this was the case for MAN members, most of which are medium to large enterprises, then the case of micro/small businesses in the face of epileptic power supply can only be imagined.
Apart from the poor road conditions, alternative means of transportation are either literarily non-existent (e.g. rail) or beyond the reach of small businesses (e.g. air transportation). Closely related to power and transportation bottleneck is lack of dedicated workspace for small businesses. There are literarily non-existent cluster parks in Nigeria. Virtually every small business promoter has to secure its location at usurious costs from shylock landlords who, through sudden and frequent rent alterations can bring flourishing small businesses to sudden grief. In the absence of any compensatory effort for these inadequacies, it becomes quite easy to see why the mortality rate of small businesses in Nigeria is quite high.
In many countries, especially those of Asia, the matter of supportive infrastructure for small businesses are literarily taken for granted, and where inadequacies exist, strong public support is provided – either to compensate for the inadequacies or to research into alternative ways of overcoming the effects of lapses in infrastructure. India is a good example of countries where researches into the application of alternative energy sources as well as non-electricity dependent technologies for rural applications are given topmost consideration. This takes us to the fourth peculiar point as to why small businesses fail in Nigeria – absence of clear public support for small businesses to thrive. Research and Development (R&D) efforts are not just dismal; the small business community is literarily cut off from the little R&D efforts/results. Therefore the global acclaim that small businesses are innovative and are constantly adopting modern technology has not materialised to any reasonable extent in Nigeria. This is another reason why Nigerian small businesses are not internationally competitive. In an era of globalisation, the poor or lack of ability to compete internationally represents another source of business failure.
Apart from the dearth of public support for R&D, other dimensions of weaknesses in public support relate to limited access of entrepreneurs to critical Business Development Services (BDS), lack of special government patronage of small business products (as a deliberate market support, as it is currently being practised in many Asian countries), and weak/uncoordinated institutional arrangement in support of small business development – leading to duplications, gaps and unhealthy rivalries). In Canada, 43 per cent of government purchases and 66 per cent of government contracts are made to the small business sector (Public Works and Government Services, Canada 2008).
Another major killer of small businesses in Nigeria is the issue of multiple-taxation. The three-tier governmental structure as enshrined in the country’s constitution gives each tier of government some rights and privileges, some of which are exploited to bring small businesses under a heavy and life-threatening yoke of taxation. In Doing Business in Nigeria (2010), the World Bank Group says an entrepreneur in Nigeria makes 35 tax payments, spending an average of 938 hours per year to prepare them. Similar statistics for OECD and Sub-Saharan Africa are 12.8 payments, 194.1 hours; and 37.7 payments, 306 hours respectively.
The current trade policy regime, which sees no need to protect Nigerian small businesses from unfair dumping of sub-standard imported products, is another contributory factor to the failure of small businesses in Nigeria. Though the World Trade Organisation (WTO) advocates liberalised trade globally, the need to protect small businesses from unfair competition in a country such as Nigeria cannot be ignored. Even in the most liberalised economy of the world (that is the USA), the government, through the Small Business Administration (SBA) and the Department of Agriculture, still offers some supports to small businesses and the agricultural sector respectively.
Many small businesses have also failed in Nigeria on the account of weak access to finance. This is usually the case when a business, started with owners’ equity, fails to get additional funds that are critical for expansion and/or modernisation of production process. That Nigeria ranked 87 out of 183 countries in terms of business credit access (see Doing Business 2010 Report) is in itself a pointer to credit constraints, and the situation is clearly below this average for small businesses, which are naturally discriminated against. The challenge of weak access is further aggravated for small businesses by untimely disbursements and usurious interest rates which, working together, have turned into poison what should naturally have been life-lines. Furthermore, the impact of specialised development finance institutions such as the Bank of Industry (BOI), which are expected to deliver credit at lower than market rates, is yet to be felt.
V.Redressing Small Business Failures in Nigeria: the Minimum Imperative
It can be said that the solution to arresting the failure of small businesses in Nigeria is by dealing with all the causative factors highlighted in the earlier section, but that will amount to over-simplifying a seemingly complex problem. A combination of actions is needed, focusing on both the internal and the external operating environment of the Nigerian small business. On the internal side, the first priority is for the small business promoter to acquire the right skills and knowledge needed to start, operate and expand the business or adapt it to changing environmental dictates. He needs to advance beyond what can be described as a mere practice of technical skills towards a true running of business. To do this, a strong awareness creation is the number one step: to let the promoter know what he needs to know but which he does not know or is not aware of. Until he is convinced about this, a knowledge/skills impartation programme will not fully achieve the intended effects. This is major gap in the current entrepreneurship promotion programme in Nigeria. The experience of Lagos EDC so far has helped to confirm this. The Centre was set up on the assumption that its products and services will be demand-driven. Because this has not materialised, the Centre has had to divert some of its energy into creating awareness about the relevance of its offers within the entrepreneurial community. Clearly, this responsibility (for awareness creation) lies in the public domain and can be quite expensive (even if the actual BDS delivery will be undertaken by the private sector).
It is the responsibility of the small business promoter to respond positively to the awareness campaign by taking steps to learn about entrepreneurship. It is in this process that he will get to appreciate the fact that there is great danger in underestimating the difficulty of starting a business. More than a decade ago, Dun & Bradstreet came up with an often quoted research report that 88.7% of businesses fail due to management mistakes. There are no reasons to believe that things have changed remarkably thereafter. Therefore, an enhancement of entrepreneurship training and the BDS market in Nigeria is a major step to arresting business failures. This will require actions on both supply and demand sides. On the supply side, there must be Train-the-Trainers programme to swell the pool of BDS Providers, while on the demand side, there should be a public programme of financial assistance to enable small businesses pay for training/BDS services in the short to medium term.
Three major components of the skills acquired in the process of entrepreneurship training or exposure to BDS are management, business plan preparation and marketing. The management skills will, among other things, enable the promoter to set priorities, select appropriate business model and plan exit strategy. The business plan he is now able to prepare will serve as his success guide. Just as an army that goes to war without a plan or a football team without a match plan runs a high risk of failure, so also is a small business without a plan. As is commonly said, to fail to plan is to plan to fail. Most small businesses that have come to grief would have survived if they were premised on sound business plans with realistic assumptions. Furthermore, a strong grounding in marketing precepts is necessary to help transform necessity entrepreneurs to opportunity entrepreneurs. ‘Necessity enterprises’ have very little chance of long-term survival.
The issue of financial discipline/prudence and sufficient knowledge/literacy to distinguish between cash flows and profit on one hand, and personal/business finance on the other hand will help to minimise the risk of failure. Many cash spinning small businesses have been abused by their owners as they spend not just the profit, but also part (or all of) the capital.
On the external or macroeconomic side are several other issues requiring urgent holistic actions to checkmate high mortality rate. First is on the status of infrastructure with particular emphasis on energy supply and workspace. From this paper, it is evident that a steady power supply will not only increase capacity utilisation, but will also reduce production costs, enhance product price competitiveness and project viability through enhanced profit margins. Small businesses should also be assisted to overcome the challenge of access to workspace, perhaps through the facilitation of cluster establishments by the government. A cluster is a geographically proximate group of interconnected enterprises and associated institutions in a particular field, linked by commonalities and complementarities (Porter,2000). Many small businesses, particularly those in the category of cottage and household enterprises located in rural/backward areas experience difficulties achieving economies of scale in both the production process as well as the purchase of raw materials, equipment and other necessary inputs. They also face significant obstacles of internalising functions such as training, market intelligence, logistics and technology innovation. Experiences in many countries, mostly in developed countries, show that enterprise clusters can be a powerful means for overcoming the above mentioned constraints and succeeding in an ever more competitive market environment, thereby overcoming early failures. Through clustering and networking, individual enterprises can address problems relating to their size, production process, marketing and distribution, procurement of inputs, risks associated with demand fluctuations, market information, and improve their competitive position. There are two types of inter-firm cooperation that can be developed by small businesses operating in clusters: horizontal cooperation (i.e. among businesses occupying the same position in the value chain) and vertical integration (i.e. among businesses as well as with larger enterprises along the value chain). The time for concrete action by Federal and State Governments that have repeatedly talked about cluster promotion, but have taken no concrete step towards implementation is now.
The matter of capital inadequacy has gotten repeated mention in this paper and should therefore be tackled to reduce the likelihood of failure. There should be efficient access (in terms of size, time and cost/price) to finance by small businesses. The microfinance banks, in their present forms, have not met the needs of small businesses. Therefore, the ongoing review by the Central Bank should emphasise the issue of efficiency in credit delivery to small businesses. Instead of doing direct disbursements, the existing Development Finance Institutions (e.g. Bank of Industry, National Agricultural and Cooperative Development Bank and NERFUND) should be made to do wholesale funding to reformed MFBs, which will in turn retail to small businesses.
The need for better public support systems for the small businesses in Nigeria cannot be over-emphasised. Precise policy and regulatory reforms with particular priority towards R&D, regulatory red tape (e.g. in product registration with NAFDAC), multiple taxation and lack of coordination/information exchange mechanism among public institutions have become matters requiring urgent attention. The tariff regime must also be tinkered with, not to protect inefficiency among the Nigerian small businesses, but to shield them from unfair dumping of imports that substitute for their products. Deliberate policy of government to procure a certain percentage of its goods and services from small businesses will also enhance their survival possibilities. Market failures, especially in credit delivery and infrastructural services, should be compensated for, while regulations governing leasing, venture capital and equity market should be reviewed with the small business in mind.
VI.Concluding Remark: Policy Implications for the EDC’s Operations and/or Activities
By design, the activities of the EDC may appear to focus primarily on the emergence of new small businesses, but equally well embedded in the Centre’s Entrepreneurship Development Programmes (EDP) is the antidote to high mortality rate among small businesses – promotion of skills, knowledge and attitude amongst would-be business promoters or those already in business as necessity entrepreneurs. Therefore, the EDC should give the following two-pronged actions further emphasis:
a)Enhancement of traffic/promotion of more subscribers to the Centre’s products and services. The Centre must be commended for its promotional actions so far. Other approaches that may be added include introduction of popular vocational trainings (embedded with entrepreneurship training), public speaking at strategic events by the Centre’s professionals, writings in strategic media to boost the Centre’s visibility, participation in specialised entrepreneurship Fairs as BDS providers and small business counsellors, etc. The one-day free monthly business seminar can be complemented with a regular and well advertised mentoring programme. The ALF and CBN brands should also be further played up and utilised to attract traffic to the Centre. Outreach activities should equally be increased. The more people we have passing through the Centre’s tutelage, the more we will be contributing to the reduction of small business failures in Nigeria.
b)Intensified Advocacy Programme. This should cover areas such as the need for the CBN to sustain its intervention in the EDCs beyond five years as a deliberate step to consolidate the emergence and growth of new and viable small businesses, which are unarguably the nursery for large enterprises. There should also be advocacy on targeted subsidies/incentives to adjust for market failures – especially in the supply of, and demand for BDS); improved business environment and financial services to small businesses; public supports on matters such as legal/regulatory requirements, and compensatory support for infrastructural failures/inadequacies.
While (a) remains a matter for in-house consumption/necessary action, we may actually utilise the opportunity of the on-going evaluation exercise by the CBN to commence action on (b).
Alyice Edrich (2003): Work at Home or Stay at Home: You can do Both