CHAPTER THREE

SMALL AND MEDIUM-SIZED ENTERPRISES

3.1.Introduction
Small and medium-sized enterprises are seen as means of providing employment, alleviating
poverty, ensuring food security, and private sector development. Small and medium enterprises
(SMEs) cover a wider spectrum of industries and play an important role in both developed and
developing economies. Ethiopia is no exception and SMEs occupy a prominent position in the
development of the Ethiopian economy. In Ethiopia, SMEs sector is the second largest
employment-generating sector following agriculture (CSA, 2014). 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.
3.2.Definition of Small and Medium Business
Small and medium businesses are easier to describe than to define. What is small business? This
question is difficult to answer because size is relative. So that is why defining small businesses
becomes difficult. Typically, we apply the term “small business” to so-called mom-and-pop stores,
such as neighbourhood groceries and restaurants, and the term “big business” to such giants as
Coca-Cola and Shell. But many businesses fall between these two extremes. They are viewed as
big or small depending on the yardstick and cut-off point used. And there are a number of
yardsticks being used for determining a business as small or big.
Specifying size and standard to define small business is necessarily arbitrary, because people adopt
different standards for different purposes. Based on socio- economic conditions, countries define
small business differently. But all may use size and economic criteria as a base to define small
business. Size criteria include number of employees and the startup capital. Size does not always
reflect the true nature of an enterprise; in addition, qualitative characteristics (economic criteria)
are used to differentiate small business from other business. The economic/control definition
covers market share, independence and personalized management.
Some of the important yardsticks used for classifying businesses are the following:

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 • Total assets – the total cash, inventory, land and machinery, and other resources a
business holds
• Owner’s Equity – the total investment made by investors, often referred to as capital
• Annual Sales Revenues
• Number of Employees
Each yardstick has points in its favour, but “number of employees” yardstick has more than any
of the other yardsticks.
Among other things, the yardstick “number of employees” is:
• Inflation-Proof – it is not affected by changes in Birr/Dollar’s purchasing power
• Transparent – it is easy to see and understand
• Comparable – it allows good comparisons of size among businesses in the same industry
• Available – it is easy to get from businesses the information about how many employees
they have
If we accept “number of employees” as the yardstick of size, what should the cut-off point be?
Each definition has its own cut-off point. And the highest “number of employees” allowed in a
definition is 500 persons and below. According to Nicholas Sir polis (SBM 6th ed), for a business
to qualify as small, a business should employ fewer than 500 persons and should not be a part of
another business. In short, it must be independently owned and managed. Let us look at some other
definitions of small business.
While there is no generally accepted definition, research has shown that the average person (USA)
uses the term “small business” to refer to an owner-managed business that employs a handful of
people – usually not more than 20 or 25.
Small business owners tend not to manage particularly aggressively and they expect normal,
moderate sales, profits, and growth.
According to Griffin “small business is defined as one that is privately owned by one individual,
or a small group of individuals; it has sales and assets that are not large enough to influence its
environment.”
Specifying size and standard to define small business is necessary because people adopt different
standards for different purposes. For example, legislators may exclude small firms from certain
regulations and specify ten employees as the cut-off point. Moreover, a business may be described as
“small” when compared to larger firms, but “large” when compared to smaller ones. For example,

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 most people would classify independently owned gasoline stations, neighborhood restaurants, and
locally owned retail stores as small business.

Similarly, most would agree that the major automobile manufacturers are big businesses. And firms
of in-between sizes would be classified as medium on the basis of individual viewpoints. There are
two approaches to define small business. They are:

A. Size criteria
B. Economic/control criteria.
A. 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.
Examples of criteria used to measure size are: number of employees; 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 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.

• 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 SMEs 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 SMEs

Obviously, some small firms fail to meet all the above standards for example a small executives search
firm-the firm that helps corporate client recruit managers from other organization –may operate in many
parts of the country and there by fail to meet the second criteria.

Using number of employees and capital as size criteria, Ministry of Trade and Industry of Ethiopia
adopted official definition of Micro, Small and Medium enterprises as follows:

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 Type of Enterprise Sector No. of Employees Capital (Birr)

Micro Industry ≤5 ≤100, 000

Service ≤5 ≤50, 000

Small Industry 6-30 100,001 -1.5 Million

Service 6-30 50,001- 500,000

Medium Industry 31-100 1,500,001-20 Million

Service 31-100 500,001-7.5 Million

Source: Revised Regulation No. 373/2016 and Proclamation No. 954/2016

B. 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
✓ Personalized management
All three of these characteristics must be satisfied if the business is to rank as a small business. In
addition, geographical area of operation and technology are used as a control criterion.
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.

Independence: Independence means that the owner has control of the business himself. 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,

Personalized Management: It is the most characteristics factor of all. It implies that the owner actively
participates in all aspects of the management of the business, and in all major decision-making process.
There is little delegation of authority. One person is involved when anything material is involved.

Technology: Small business is generally labor intensive. Only few are technology intensive.

Geographical area of operation: The area of operation of a small firm is often local.

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Generally, small business is a business that is privately owned and operated, with a small number of
employees and relatively low volume of sales. Small businesses are normally privately owned
companies, partnerships, sole proprietorships, or cooperatives.

3.3.Economic, social and political aspects of small business

Small and medium enterprises (SMEs) cover a wider spectrum of industries and play an important role
in both developed and developing economies. Ethiopia is no exception and SMEs occupy a prominent
position in the development of the Ethiopian economy. Over the years, the number of SMEs is growing
from time to time. They need a strong support on Socio- economic and political ground. Some of the
contributions are hereunder.
1. Equitable Income Distribution and Improved Standard of Living
According to the FDRE Constitution, the nation is socialistic and so it wants to establish a
socialistic pattern of society. The objective is to ensure non concentration of wealth of economic
power among few hands but to ensure decentralization of economic power and equitable
distribution of wealth. The benefits of economic growth should be shared by as many people as
possible and should also provide better quality life by enhancing the general standard living
standards of people. Increased establishment of small enterprises will do their best in achieving
these objectives.
When compared to other nation states, which have focused on large scale industries, Ethiopia by
focusing on small scale industries has fared better with regard to improving the general standard
of living of people.
2. Creating employment opportunity
The lack of tremendous growth in Ethiopian economy is because the nation is lacking adequate
financial resources but at the same time having much manpower without work.
This lack of finance/capital has led to a state where there is high unemployment and which is
increasing day by day. A better alternative to mitigate this situation is to encourage the
establishment of small and micro enterprises. Small enterprises require less capital to establish and
at the same time they generate more employment according to the capital invested.
3. Rectifying Regional Imbalance
A country would be having some regions, mostly urban regions, which are far very much
developed than other areas, especially rural areas. This leads to disparity among these regions and
in turn these well-developed regions face problems like high migration led problems. This high

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migration puts a severe stress on the existing infrastructure and would lead to poor performance in
supplying civic services adequately to people.
So as to stop migration of people and avoiding stress on civic systems, the establishment of small
enterprises in rural areas, particularly agro industries will reduce people’s migration by providing
employment within their regions. These rural agro industries will also help in increasing the
people’s income in those areas and thereby improving the country’s economy also. On political
grounds, there is a need to encourage small enterprises, and that too in rural areas so as to create
employment opportunities and for income generation for its users.
4. Generation of Foreign (Hard) Currency/Export promotion
The imports of Ethiopia are greater than its exports. With regard to exports, majority of Ethiopian
exports are of either small or micro enterprises origin. From several developed and developing
countries experience, it could be said that small enterprises play a big role in exports than large
exporters. So with strong support measures from Ethiopian government the small enterprises can
also play a very big role in reducing the negative discrepancy between imports and exports. These
strong export measures could take the form of removal of bureaucratic hurdles, easy finance
availability, ensure easy availability of machinery and raw materials, removal or reduction of
taxes, etc.
Small-scale enterprises are opening up fresh avenues in the export market in our world. Realizing
the importance of the small-scale sector in the economy the Ethiopian government has adopted
several measures to speed up the growth of small enterprises.
5. Ancillary Function
Many small-scale enterprises supply parts and accessories to bigger enterprises. This ancillary function
involves specialization in specific areas and results in greater profitability.
3.4. Environment and related problems
The term business environment refers to:
- the aggregate of all the forces, factors and institutions, which are internally affecting
the business through management structure
- as well as which are external to & which are beyond the control of business
enterprises.
Environment refers to forces economic, social, political, technological and other factors that
affects the functioning of the organization.

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 The success of every business depends on adapting itself to the environment within which it
functions
3.4.1. Environmental analysis
Entrepreneurship does not exist in a vacuum. It is affected by and affects the environment. As the
economies are getting internationally integrated, for an analysis of the environment of entrepreneurship
you would be required to develop an understanding of macroeconomic, and industry/sector specific
factors.

A. Macro environment
The macro environment of an entrepreneur consists of the political, technological, social, legal and
economic environments. All of these are not immediate part of the entrepreneur’s venture yet they have
an impact on his enterprise. Let us now examine the elements of the macro environment of the
entrepreneur one by one.

Political Environment
Entrepreneurship can flourish under a stable and conducive political climate. Government policies
which give priority to growth of trade and industry, infrastructural facilities, and institutional support
gives a stimulus to entrepreneurship. Considering the employment and export potential, the short
gestation period and the fact that small industries act as a seedbed for nurturing and developing
entrepreneurship, the government is supportive of the small-scale sector. It has created an extensive
institutional framework for provision of finance, technology as well as help in marketing is made
available by government institutions.

Technological Environment
The level of technology, the trends and the rate of change in technology all have a direct impact on
enterprise creation. Changes in technology, both innovation and invention change industry structures by
altering costs, quality requirements and volume capabilities. In the advanced countries of the West more
pure inventions have been taking place which created new industries for example Automobile,
Aeronautical, Computer Hardware, Telecommunications, Pharmaceuticals etc. In developing
economies there is usually an imitation of the above through greater process innovation.

It has been observed that many small units use obsolete technologies and do not invest in research and
development (R&D). As a result their goods are of poor quality and lack standardization. A direct
consequence of this is their inability to face competition. In many industries the technological threshold

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is low and as a result the success of an entrepreneur promotes many others to start similar businesses
and he loses the initial competitive advantage. On the other hand if he/she uses certain costly technology
chances of others to quickly becoming his competitors are less.

Socio-Cultural Environment
The customs, norms and traditions of the society also play an important role in either hindering or
promoting enterprise. For example, we sometimes say that the Gurage people are very enterprising. In
many traditional communities of our country working of females out of the home environment is
frowning upon. Many times, the choice of occupation is also dictated by the family traditions.

Socio-cultural factors are also crucial for the operations of multinational companies. It is very important
for a multi-national company to understand the socio-cultural background of its customers in the host
country. Socio-cultural environment is also concerned with attitudes about work or quality concerns,
ethics, values, etc.

Legal Environment
The laws of the country can make the process of setting up business very lengthy and difficult or vice-
versa. The labor laws and legal redressing system also have a bearing on business operations. Patents,
agreements on trade and tariffs and environmental laws also need to be studied. Copyright, trademark
infringement, dumping and unfair competition can create legal problems in the shape of long drawn out
court battles. Simpler legal procedures can facilitate the process of new venture creation and its smooth
functioning including setting up of ancillaries, foreign tie-ups and joint ventures.

Economic Environment
Liberalization, globalization and opening of the economy of Ethiopia, has increased the space for
business operations. It has also opened channels for foreign investors to start operations. The resultant
competition, rapid and complex changes have generated uncertainties, which have to be handled by the
entrepreneurs.

B. Sectoral Analysis
After having understood the general environment in which the business has to take birth, it is important
to study the sector or industry conditions in which the entrepreneur proposes to launch a venture. This
will help to put the proposed venture in the proper context. The purpose of industry analysis is to
determine what makes an industry attractive- this is usually indicated either by above normal profits or

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high growth rates. For such analysis one should study the history of the industry, the future trends, new
products developed in the industry, forecasts made by the government or the industry. It is also advisable
to study the existing or potential competition, threat of substitutes and entry barriers. Sometimes there
might be bilateral agreements between countries regarding some sectors or government policy that is
sector specific or some event that throw up challenges.

There might be certain constraints regarding availability of technology, manpower or raw materials,
which are industry specific. Similarly, there might be certain strengths of a particular sector, which
might outweigh some negative general trends. Currently the cement and steel sector are on an upward
swing with a favorable climate in the housing sector as well as government’s thrust on the construction
sector.

C. SWOT analysis
At this stage, conducting a SWOT analysis will help the entrepreneur to clearly identify his/her own
strengths and weaknesses as well as the opportunities and threats in the environment. Threats in the
environment can arise from competition, technological breakthroughs, change in government policies
etc. He / she might possess certain unique skills or abilities, which along with his/ her knowledge and
experience can provide him/ her cutting edge.

Strengths are positive internal factors that contribute to an individual’s ability to accomplish his/her
mission, goals and objectives. Weaknesses are negative internal factors that inhibit an individual’s
ability to accomplish his/her mission, goals and objectives. An entrepreneur should try to magnify his
strengths and overcome or compensate for his/her weaknesses.

Opportunities are positive external options that an individual could exploit to accomplish his/her
mission, goals and objectives. Threats are negative external forces that hinder an individual from
accomplishing his/her mission, goals and objectives. These could arise due to competition, change in
government policy, economic recession, technological advances etc. An analysis of the above can give
the entrepreneur a more realistic perspective of the business, pointing out foundations on which he can
build future strengths and remove obstacles. The hierarchical approach to the development of business
idea is given below.

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 Figure 3.1: Hierarchical environmental analysis
The entrepreneur has to use the opportunities provided by the environment, combine these with his/her
unique strengths in terms of knowledge, skills, experience etc. and then take a decision to launch a
particular product or service. The proposed product / service should be compatible with the capability
of the entrepreneur, resources available in the environment and the need of the society.

3.4.2. Opportunities in Contemporary Business Environment

We have observed above that the business environment is constantly evolving as a result of
demographic, technological, legal and other changes. These constantly throw up new challenges for
entrepreneurs. Some opportunities, which can be explored by the potential entrepreneur, are given
below.

E-Commerce
Comprehensive system of trading that uses networks of computers for buying and selling of goods,
information and services.
E-commerce includes buying & selling of-
o Goods- eg. Digital cameras, music systems, clothes, accessories.
o Information- eg. Subscription to a site and get access to information.
o Services- eg Ethiojobs, shaadi.com, naukri.com
M-Commerce
M-Commerce or mobile commerce refer to buying and selling products through wireless handheld
devices such as mobile phones and personal digital assistants (PDAs). The phrase mobile
commerce was originally coined in 1997 by Kevin Duffey at the launch of the Global Mobile
Commerce Forum. Mobile Commerce is often called as "a retail outlet in your customer’s pocket.”
M-commerce opened the door for new application and

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 services. Critical news which people need while traveling is made available- traffic news, weather
news, stock market reports
Niche Marketing
Niche marketing is a marketing strategy, which can be intelligently used by a small entrepreneur. The
entrepreneur can try and identify a very specific market segment called a niche. By providing personal
service, convenience and value to the customers the small entrepreneur can successfully compete with
the bigger market players. The standardized goods produced on large scale cannot cater to the special
requirements of a small segment of the market. For example, there is an emerging niche in the world
food market for health-conscious people who want to consume only organically grown foods.

Service Sector
Unlike products, services are not tangible, they cannot be stocked, and they cannot be marketed through
wholesalers and retailers - if you want a haircut you will have to go the barber or a beauty saloon.
Production and consumption are simultaneous. Advantage of setting up a service enterprise is that they
require lower investments compared to the manufacturing sector.

Tourism
Tourism is amongst the fastest growing industries the world over; it is the highest foreign exchange
earning sector for many countries and offers tremendous opportunity for entrepreneurship and
employment. It includes any business connected with the activities of tourists such as travel arrangement
(rail, road, air or sea), accommodation (hotels, motels, guest houses), food and entertainment

Apart from the potential in providing these direct services, tourists use many indirect services. For
example, they hire taxis for local site visit, they need guides and interpreters. There is a shortage of
service providers in all these areas. The gap between the demand and supply is likely to increase in the
foreseeable future opportunity. The growing segments of tourism include Cultural Tourism, Heritage
Tourism, Adventure Tourism, Eco-Tourism, Rural-Tourism, and Religious Tourism. Some people have
even capitalized on the high cost of Medical Services abroad and have promoted Medical Tourism. It is
clear from the above that this sector has untapped potential which can be exploited by potential
entrepreneurs.

Entertainment

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The entertainment industry is another sector, which boasts of very high rates of growth. There are
innumerable entertainments ranging from news, sports, cartoons, family dramas, music, religious etc.
Music industry is also flooded with music videos, remixes, music and film nights.

Enterprises can be set up to provide services for pre and post production including script writing, music,
dubbing, animation, editing to name a few. Like the tourism sector the entertainment sector too has a
host of feeder activities attached to it - supply of jewelry, food, banners, posters which provide endless
entrepreneurial opportunities.

Green Entrepreneurship
Conservation and Environment protection are presently getting a lot of attraction. Green
Entrepreneurship signifies concern for the environment. Such business activity should be chosen which
has the least adverse impact on the environment. This concept also stresses upon the prevention of waste
at the source rather than at the end of the process. It concentrates on new and creative ways to recycle
usable materials, use of substitutes or processes that are less polluting as well as adoption of waste
minimization strategies.

3.5.Small Business Failure factors

The following are some of the major factors, which cause most small business failures.
• Lack of finance
• Poor operations management –lacks the ability to operate a small business.
• Lack of experience – Many owners start businesses in industries in which they have no experience
• Poor financial management
• Lack of information about customer
• Lack of marketing research, technical competence,
• One person management, nepotism and favoritism to family members
• Over-investing in fixed assets – Owners who over-invest in fixed assets may find themselves with
no access to funds for working capital.
• Poor credit practices – Owners often sell on credit to meet (or beat) the competition and find that
they lack the additional working capital required or the ability to collect receivables.
• Failure to plan – The lack of a strategic plan to guide the business in the long run

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• Unplanned and uncontrolled growth (Expansion beyond resource) – Growth is natural and
healthy, but unplanned growth can be fatal to a business.
• Inappropriate location – Owners who choose a business location without proper analysis,
investigation, and planning often fail. Too often, owners seek “cheap” sites and locate themselves
straight into failure.
Other common causes of business failure include neglect, fraud, and disaster.

• Neglect occurs whenever an owner does not pay sufficient attention to the enterprise. The owner who
has someone else manage the business while he or she 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 himself or herself with the
company'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 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.
Problems in the Ethiopian Small Business
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. SMEs face challenges from lack of finance, poor managerial skill,
political instability, insufficient use of technology, lack of machinery and spare parts and shortage of
skilled manpower, which are some of the reasons behind the slow growth of SMEs in Ethiopia.

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